Malaysia’s big ambitions

Emerging Markets, September 2011

Malaysia has big ambitions. In 2010 Prime Minister Najib Razak announced the Economic Transformation Programme: a vast, enterprising plan with the overall goal of turning Malaysia into a high-income fully developed nation by 2020.

Perhaps spurred by the arrival of credible opposition in Malaysia for the first time in its modern history, Najib’s reforms go further than broad macroeconomic goals. They include political and social change as well as capital market development and a revamp of corporate governance among Malaysia’s companies. The prize, in economic terms, is a targeted growth rate of 7% annually over the next 30 years, and Malaysian citizens who are four times wealthier in real terms in 2020 than they were in 1990.

[Subhead] Malaysia and world turmoil

In the short term, though, Malaysians are looking at yet another sequence of ructions in the developed world and wondering how it will affect them. The good news: Asean nations are, in the main, in far stronger fiscal positions than most other parts of the world and therefore better equipped to deal with the problems; while Malaysia doesn’t have quite the almost debt-free fiscal position of some peers, it looks dramatically healthier than any western nation you could name. The bad news: Malaysia’s still a major exporter, and can’t be completely immune from problems elsewhere.

“Malaysia is a relatively low-volatility country,” says Dato’ Lee Kok Kwan, Deputy CEO of CIMB. “During downturns it tends to perform much better [than peers] because of that lower volatility. The GDP growth rate for 2011 may be below 5%, but it’s still decent growth.” And to look on the bright side, the flagging world economy has dampened concerns that had been rising about inflation in Malaysia, fuelled by commodity price rises.

Analysts are broadly positive about Malaysia’s outlook. “We rule out a double-dip in the Malaysian economy,” says Manokaran Mottain at AmInvestment Bank. “Robust levels of domestic demand, along with ample liquidity and the government’s ETP, will provide support at the tail end of this year.” He acknowledges, though, that the unstable global economy is certainly a negative for Malaysia, hitting both overall trade and external demand. He expects a 5% growth rate to be achieved, provided there is not a very large drop in crude oil prices or major delays to ETP projects. “As a net exporter of oil, Malaysia still relies heavily on crude oil in terms of generating income for the country,” he says.

Much like Indonesia, there has certainly been no shortage of foreign capital wanting to engage with Malaysia. “We are awash with liquidity,” says Lee. “We’re at the highest level of excess liquidity ever: the central bank needs to sterilize the system.” FDI has increased, after a period of stagnation around 2009. And portfolio flows, which were negative for about three years up to the end of 2009, have become consistently positive, attracted to Malaysia’s commodities and defensive characteristics. Foreign ownership of bonds, too, continues to rise. “The fundamentals are almost zero foreign currency debt, high FX reserves, and significant surpluses in the current account and trade account. The country, structurally, is in very good shape to absorb shocks.”

Internationally, there is a similar view. “Whenever regional markets take a dip, Malaysia outperforms every time,” says Chris Oh, analyst at UBS. “Our view remains that Malaysia will still outperform, although the reality is it will go down.” The Malaysian market, he says, has long been a story underpinned by two themes. “One, it is a relatively under-owned market: foreigners who had not been in Malaysia will come to put money here. Two, on a relative basis, Malaysia has a more stable source of funding from domestic investors.”

[Subhead] Power in banking

Malaysia’s relative strength is probably most clearly illustrated in its banking sector. 14 years on from the financial crisis, it is a powerful industry, with RM1.6 trillion in assets, healthy coverage ratios and low problems with loan impairment. “If you compare the banking sector today versus 1998, the system is significantly different, and stronger,” says Lee. “Delinquencies are low, profitability is decent, structurally it is in good shape, and the reliance on foreign currency is low. 2008 was a severe, multi-standard deviation downturn, but Malaysian banks went through that crisis completely unscathed. Nearly all remained profitable.”

With this has come the development of a relatively deep and liquid capital market. The development of Malaysia’s local currency bond market in particular has been a vital prop to the growth of the financial system and broader economy. Where once Malaysian enterprises would have to seek dollar funding, and incur foreign exchange risk, now a wide range of issuers can tap ringgit funds at durations out as far as 25 or 30 years in some cases. That is a crucial support for long-term project financing, among other things, and as major institutional investors like the Employee Provident Fund continue to gain scale and sophistication, there is more and more reason to be positive about bond market strength.

This is one of the main sources of discussion today. Malaysia’s institutions are in the process of introducing their second Capital Market Masterplan, a document designed to govern the development of the markets over the next 10 years, alongside a corporate governance blueprint being launched simultaneously.

These programs are discussed in more detail in the roundtables within this report, but in essence they aspire to promote capital formation, expand the efficiency and scope of intermediation, deepen liquidity, build capacity, improve governance and help Malaysia become a more international centre. “There’s going to be a lot of work ahead of us for everyone involved,” says Tan Sri Zarinah Anwar, chair of the Securities Commission, Malaysia’s market regulator. “In the first capital market masterplan [which governed 2001-10), it was relatively easy to do because it was a very nascent market. In today’s very uncertain conditions, with so many diverse inputs coming from so many sources, we need flexible terms on how we implement the new plan.” Zarinah says that Malaysia has a “very robust infrastructure”, but notes it “needs to build a corporate governance culture: internalising the spirit and substance of corporate governance.”

[Subhead] Islamic leader

One of the mainstays of the development of Malaysia’s financial services industry and capital markets has been the evolution of Islamic finance in the country, creating what is unarguably the most sophisticated and mature market for Islamic banking anywhere in the world. While most countries are still trying to build a domestic industry, that job is clearly done in Malaysia; for the last few years, the priority has instead been to make Kuala Lumpur a hub to attract foreign capital into Islamic finance. The Malaysia International Islamic Finance Centre is the centrepiece of this initiative, and has already succeeded in attracting some of the world’s biggest name in funds management, such as Aberdeen to Nomura.

“The government has supported the market greatly, and the infrastructure and regulatory environment are already there,” says Encik Mohd Effendi Abdullah, Head of Islamic Markets at AmInvestment Bank. “It’s easy to operate in that system. The next step is, with the government having liberalized the industry, we need to attract foreign investment here into Islamic banking. The government has given several international licences.” For some time, an Islamic megabank licence has been under discussion, although meeting its onerous terms – such as US$1 billion of paid-up capital – has apparently been problematic for bidders. A licence is apparently going to be awarded in the third quarter.

The sense of going international is pervasive at Bank Negara Malaysia, the central bank, on both the conventional and the Islamic side. “The world is highly dynamic,” says Dr Zeti Akhtar Aziz, Governor. “The environment, both domestic and international, is rapidly changing. There is therefore further work to be done.” Partly, this is about product development. “As Malaysia moves up in the value chain and transitions to new areas of economic activity, new kinds of financing will be required.” She refers to urbanization, and an ageing population, as other spurs. But Zeti’s main enthusiasm these days, beyond the domestic duties she has fulfilled for more than a decade, is the sense of Malaysia’s role in a regional and world community. “Going forward, we will become even more interdependent,” she says. “Emerging economies will become more interlinked. Malaysia will be very much part of this process. In fact, our financial institutions are having great presence in other parts of the world while our own financial system will be more liberalized. We will become increasingly connected, especially with other emerging economies.” One of Bank Negara’s priorities today is positioning Malaysia’s financial system to be ready for that, and to be in front of it, in keeping with the national ambition to be a more developed economy.

Again, Islamic finance tends to underline these themes. Dr Zeti has, for example, been at the forefront of the development of the International Islamic Liquidity Management Corp (IILM), a collaborative effort between 12 central banks and two Islamic multilaterals. IILM will issue short-term multi-currency Shariah-compliant liquidity instruments in order to boost cross-border flows between financial centres, and to preserve liquidity among Islamic markets and financial institutions. Zeti personally was a spearhead in this initiative; not coincidentally, IILM’s global headquarters is in Kuala Lumpur.

Going international is not straightforward, though; while Kuala Lumpur has attracted some world-class names to set up in Islamic fund management, for example, it’s less clear that they’ve brought any money with them. With every passing year more people in the country talk about wanting internationals to commit to bringing capital in, rather than just creating an avenue for it to leave Malaysia.

Malaysia’s stock market has been in a period of innovation for several years, trying new initiatives such as launching derivatives, facilitating listed sukuk, launching real estate investment trusts and fostering an Islamic commodities exchange. It’s a significant presence: Dato’ Tajuddin Atan, CEO of Bursa Malaysia, points out that as well as the achievements in the bond market, the stock market is home to more companies than any other in the Asean region. The market needs more secondary liquidity – Atan discusses this in the roundtable elsewhere in this report – and would like a greater chunk of more government-linked companies to be listed (which is a stated ambition of Khazanah, the state entity tasked with improving the performance of those GLCs). But generally, it stands comparison with Asean peers very well.

The stock market also plays into the Islamic theme, with the vast majority of stocks (by number more than by market capitalisation, since most banks are not Islamic) being Shariah-compliant.

[Subhead] New politics

Malaysia is due a general election next year, and it will represent an interesting and potentially divisive time for the country. For most of its history Malaysia has had no credible opposition; the strong showing of Anwar Ibrahim’s coalition in the last election was a major shake-up for the country, and it is widely felt that Prime Minister Najib’s reformist efforts have in large part been prompted by the messages of that election. Najib has recognised the need to end affirmative action policies which have supported Bumiputras, or ethnic Malays, but which have arguably reduced competitiveness and ultimately caused the country to suffer. Ending these policies, while keeping the multi-racial country in some unity, is a major challenge, and the election will be something of a referendum on how he is doing. “There’s very little doubt that the Prime Minister is extremely committed to changing things, but with Malaysia it is a question of delivery and implementation. History suggests we should be cautious in that regard,” says Robert Prior-Wandesforde, head of India and South-east Asia economics at Credit Suisse.

If that test is passed, though, Malaysia otherwise exhibits long-term thinking, and not just because of Najib’s 2020 vision. A great deal of long term infrastructure is approaching the development phase in Malaysia, providing a spur to the economy if the external situation deteriorates. Between October 2010 and June 2011, six rounds of projects – 87 initiatives within 65 projects (out of 131 identified in an initial roadmap document) – were announced, expected to bring in RM170 billion in investment and 362,000 jobs, according to UBS. They are wide ranging: the first round included an Asia e-University, a six-star St Regis hotel in Kuala Lumpur, a foundry plant in the Kulim High-Tech Park, a new low-cost carrier terminal at the airport in Sepang, and a bio-oil fuel plant in Sabah, for example. Numerous others have been announced since from petroleum and gas to education, healthcare, data, technology and mass transit.

Malaysia has a long track-record of wildly ambitious plans and has not always delivered on them. For this series, a group called the Performance Management and Delivery Unit (PEMANDU) is tasked with enabling the projects. “Investors have been sceptical about the pace of ETP implementation as BN [the ruling party]’s other government initiatives in the past are perceived to have disappointed,” says Oh. “The roll-out pace suggests a greater urgency on the part of PEMANDU and the government to roll out the private sector initiatives that will help recharge the domestic economy.” Oh says, though, that investors are really waiting for the roll out of the biggest infrastructure spending projects, such as the MRT (mass rail transit), high speed rail and Klang river revitalisation. One knock-on effect of the initiatives may be warmer relationships between Singapore and Malaysia: one of the biggest projects underway in Malaysia is in Iskander, just across the strait from Singapore. As part of this project, a one-stop customs immigration and quarantine terminal should be built at each of the two land crossings between Singapore and Malaysia, which should halve the time it takes to cross the border.

Not everyone is convinced that Malaysia can do quite what Najib asks in the next 10 years. “That would be a challenging task,” says Taimur Baig, a chief economist at Deutsche Bank. “The country is endowed with rich natural resources and is unburdened by its relatively small population, but in terms of graduating to that next level where you can unambiguously call it an economic powerhouse, the jury is very much still out.” But even if it doesn’t achieve as highly as it aims, there are positive developments underway in Malaysia; at a policy and a regulatory level, many of the ambitions look like international best practice. The big question for the country will be whether those big ideas can trickle down into thorough, effective implementation.