Malaysia heads to the polls

Emerging Markets ADB editions, May 4 2013

Malaysia goes to the polls today for what is expected to be the closest general election in its history.  Last time around, in 2008, when the outcome turned out to be a surprise – with the ruling Barisan Nasional party losing its two thirds parliamentary majority for the first time – the stock market fell 9.5% the following day. What will happen this time?

Different election results will have divergent effects on the markets, and the mood around the outcome will have to express itself very quickly: the results will probably not become clear until a short time before Bursa Malaysia opens on Monday morning.

UBS analyst Chris Oh outlines three possible outcomes. The first, and UBS’s base case, is an incumbent government victory with a similar or slightly smaller majority than in the 2008 election, with the current leadership retained “with minimal political fallout.” In this instance, Oh said, “the market should enjoy a relief rally given that the event risk has passed and we have political stability and policy status quo.” The stronger the win, the stronger the likely post-election rally. Post-election, he would expect reform to continue to be implemented in this scenario.

The second outcome is a narrow BN win with an internal leadership struggle post-election within UMNO, the party that leads the BN coalition. If that happened, “policy changes may be necessary to pander to the narrowing support base for the leadership,” making reform tougher to enact, Oh said. “We anticipate that the market would drift sideways or down as investors remain on the sideline in anticipation of delays in policy implementation.”

The third possibility is a change in government to the Anwar Ibrahim-led Pakatan Rakyat coalition. This would be a considerable event in Malaysia’s history: it has had no change of government since independence in 1957. If this were to happen, Oh argued, “the fear of the unknown becomes the greatest risk factor”; he raised the possibility of civil disorder, policy shifts, and a standstill in the public delivery system. “Due to the high level of uncertainty, equity investors would likely reduce weightings in the equity market at least until the new government establishes itself and provides political stability and a clear policy direction.”

While that sounds negative in the short term, “the likelihood is that the market would re-rate strongly as the emergence of a strong two-party political system can only be positive for the structural long-term development of the country,” Oh said.

Analysts noted some other variables in play. Sanjay Mathur at RBS said that all parties appeared to be promising higher subsidies and other income support. “Even if these promises are partially realised, the country’s fiscal position is likely to be compromised,” Mathur said, adding that public debt in Malaysia, at 52% of GDP, is already close to a national self-imposed limit of 55%.

Deutsche Bank advised clients on Friday to be positioned long USD/MYR going into the weekend, arguing that political risk premium was already priced in.

Malaysia is vulnerable to changes in international sentiment towards it, as foreign investors hold more than 40% of the country’s government bonds and over half of its central bank bills. “What happens if this money cuts and runs?” asked an analyst. “Our guess: a local money management bid will emerge, relatively quickly, to check the disorderliness.” The Employee Provident Fund, the country’s powerful pension fund, has the heft to step in to cover the supply of government issuance, he suggested.