Zeti turns vocal on IMF

Asiamoney, October 2011

It is a queasy sort of a day when Asiamoney meets Zeti Akhtar Aziz, Governor of Bank Negara Malaysia, at Washington DC’s Four Seasons Hotel in September, and not just because of the jetlag and the changeable weather. We meet during a period of miserable uncertainty in world markets: the eurozone in crisis, the US staring at a double-dip recession, and markets looking hopefully to the IMF/World Bank annual meeting to provide some direction, which they utterly fail to do.

For Zeti, the mood is not as bad as it is for some others: Malaysia is basically doing fine, and while it will clearly slow as a result of global problems, it would be a surprise if its growth rates dipped below 4% at any point in the next 12 months. But what’s striking about this meeting is that the normally reticent and softly-spoken Zeti has some unusually strong opinions about problems in the west – and how to fix them.

That’s because, having worked through the Asian financial crisis – she was rising through the Bank Negara ranks at the time and became governor in its aftermath, in May 2000 – she believes there are clear lessons about the process of recovery that the west has not yet shown much sign of taking on board.

“While we need to deal with the financial sector and bring about regulatory reform, it has to be accompanied by pro-growth policies,” Zeti says. “That is what we did in the Asian crisis. We had to do the financial and debt restructuring, but for a chance for those policies to be successful we needed to have growth.” She’s quite specific about what she means – which also stands out, in a week dominated by broad and grand statements and an absolute minimum of practical detail: she  highlights policies to support SMEs, households, access to finance, credit enhancements, infrastructure development and private sector incentives. “We had a V shaped recovery,” she says. “Many parts of the developed world, and the IMF, said we would have a lost decade. We didn’t.”

The west, she says, just hasn’t been doing what it needs to. “Only now are we seeing some of these measures being implemented in the US,” she says. “They needed to have been implemented three years ago.” She also calls for policy that is “more anticipatory rather than reactive. When we were managing the crisis in Asia we looked at what was the worst yet to come and what did we need to do to deal with it, rather than just implementing policies to prevent a collapse and thinking that was it.”

Malaysia is not a member of the innumerable groupings and federations in world finance – the G7, the G20, the G24 – instead making its presence felt more in Asean and in Islamic finance initiatives around the world. Lacking a voice on the world stage, it is perhaps not surprising that she is not a fan of the IMF, nor of representation of emerging economies within it. “The IMF has to become neutral,” she says. “This neutrality and credibility would be enhanced if there was greater representation of emerging markets in the role of the IMF and in its governance process. Crises don’t just happen in emerging markets; this is something the IMF didn’t highlight to the world until quite late.” She says while the IMF has sought to increase that representation, it has done so “in a very incremental manner.”

She goes further and doubts the leadership the IMF has shown; Asiamoney’s interview takes place directly before the formal start of the meetings, but it’s unlikely her opinion was changed by any of the statements of the following days. “The IMF doesn’t seem to have a significant role in this,” she says. “We have looked for the IMF to have a greater role in recognizing what the issues are in their surveillance, and we look for it to provide solutions to many of these problems. Their solutions have not been forthcoming.”

So how does all this affect Malaysia and Asean? “In emerging markets we are doing better [than in the west] but we are going to see moderation in our growth as well, because we are very much part of the global economy and most of us are highly open. But we are still going to see growth, and are still on a growth path.”

Across Asia, central bank governors are having to deal with shifting priorities. For much of the last year, most of them have had to fight off inflation, and have correspondingly been rising interest rates through the year. There are markets where inflation remains a challenge – Vietnam, India, China – but across most of Southeast Asia it’s all but stopped being an issue.

Take the Bank of Thailand, which has raised rates on seven separate occasions since December, reaching 3.5%. “I think we were on the right direction so far, but if you ask the question from now on, we do think the slowdown in the world economy will mollify somewhat the inflation pressure,” says Prasarn Traitvorakul, Governor. “The job is to take a proper balance, but the balance lately has tilted towards the risk of growth becoming more apparent than inflation pressure.” When the bank next meets to discuss rates, on October 19, it would now be a major surprise to see another hike.

In places like Thailand, where domestic consumption is strong and the outlook good, the global problems have arguably been helpful. “We hope that some slowdown in the world economy will lower the pressure from the supply side,” says Prasarn. (A wild card, though, is a new government policy offering to buy local rice at heavily subsidized rates; HSBC has warned that, with Thailand being the world’s biggest rice producer, this could put inflation back on the agenda in rice-importing countries.) Like many Asian nations, Thailand has sought to boost intra-regional trade’s proportion of the overall national trade balance sheet, reducing reliance on the west, and this should prove helpful. “The feeling is not too pessimistic or optimistic,” he says. “There are threats from what’s happening in the euro zone and the US, but there are also encouraging factors like regional integration in trade and financial flows.”

Zeti, in Malaysia, has been viewing the world with similar interest. From late 2010 Bank Negara raised rates four times in seven months, from 2% to 3%, and then stopped in July, “given the increased uncertainties and the significantly heightened risks to growth,” says Zeti. From her perspective, in a country with palm oil and rubber at the heart of the national economy, commodities were the most important thing to watch. “As commodity prices stabilized, which was a major factor from the supply side producing higher inflation, demand has slowed globally,” she says. “This will limit inflation, so most central banks have paused their increases in interest rates.” Official estimates of full-year growth in Malaysia are 5-6%, but it dropped to just 4% year on year in the second quarter of 2011.

Zeti says that for central bank governors in Asia, “the biggest challenge is to have price stability in an environment of sustainable growth. You have rising prices, and at the same time you also have risks to growth, and those risks have become higher because of what is happening around the world.”

One area Asia cannot escape is capital flows. In recent years foreign money has flooded into Asia, particularly Asian bonds, in search of yield backed by strong fiscal stories. But as always, when markets get really bad, capital instead is withdrawn from these supposedly riskier asset classes, despite the fact that the risks appear far bigger in the developed world. In some cases, this isn’t a judgment on risk at all, but a need to liquidate capital in order to pay down other exposures.

Indonesia is the market that has most to lose in this respect; by the end of August foreign ownership of rupiah-denominated government bonds stood at over 35%. That money has been chasing the Indonesia story: a transformed fiscal position over the course of the last decade, a growth model predicated on commodities and domestic consumption, and an apparently successful and stable democracy. But for some time, investors both local and foreign have worried: what if it all leaves again?

Rahmat Waluyanto, in the debt management office of the Ministry of Finance, says that a modest reversal has started to happen. In the space of a week in September, foreign ownership dropped from 35.4% to 33.6%. But he is at pains to point out that foreign ownership in the government bond market is still heavily net positive, at around US$5.5 billion year to date. The withdrawal, he says, “has nothing to do with domestic economic fundamentals but FX movements due to jitters caused by the worsening euro debt crisis.” Not all fixed income is fully hedged in terms of FX exposure, hence the withdrawal, he says, although in fact non-deliverable forwards on the rupiah have been moving up, not down. “There’s no reversal yet; the real money accounts still stay,” Waluyanto says. “Indonesia has the capacity to withstand,” he adds, citing relatively large foreign exchange reserves (which crossed US$100 billion for the first time earlier this year), a widening domestic investor base (including retail investors, pension funds and insurers), and a bond stabilization framework.

Indonesia has mentioned this framework before, but it’s not always been clear what’s involved. Waluyanto says there are four strategies to negate a negative impact of a sudden reversal: the debt management office will use funds from the annual budget to buy back government securities; state-owned companies will buy in; so will be Treasury Unit and Government Investment Unit of the finance ministry; and if necessary, parliament can approve the use of accumulated cash surpluses to buy government securities.

Zeti, too, notes a change in the threat of capital flows. “We are seeing very significant surges in capital outflows and reversals,” she says. “Previously it destabilized us quite significantly. But in the current environment we are seeing these flows are better intermediated by emerging economies.” In 2009, she says, Malaysia’s reserves declined by $25 to $30 billion, with a major depreciation in the currency. “But we could take it in our stride.” She says that, in contrast to the Asian financial crisis, Malaysia has more resilient financial institutions, more developed financial markets, higher reserve levels, a more flexible exchange rate, and more instruments to sterilize inflows than before. Today, around 20% of Malaysian government bonds are foreign-held.

Whatever else happens, southeast Asia is surely the only part of the world where you can still find people barracking for sovereign upgrades at a time when the rest of the world is falling apart. In the Philippines and Indonesia, expectations are high of improved ratings from international rating agencies. Both countries can provide long lists of improvements, from budget deficits to domestic market depth and government responsibility. With Turkey having been upgraded in early September, its Asean peers are not about to stop waving the flag now. Indonesia, Waluyanto points out, has credit default swaps trading considerably tighter than Turkey’s; proof, he says, that if the story is bright there, then it’s brighter still in Indonesia. “So Indonesia should now be in the investment grade category,” he says. It’s good that somewhere in an uncertain world, there are people looking up and not down.