This article first appeared in The Edge Malaysia Weekly on September 4, 2017 - September 10, 2017

THE ringgit may be about 12% weaker than the 3.80 at which it was first pegged to the US dollar 19 years ago on Sept 2, 1998, but experts say Malaysia’s economy and its institutions are fundamentally a lot stronger today than two decades ago when the Asian financial crisis struck. Growth prospects are also looking better than at the beginning of the year.

Yet, at the rate technology has spurred change and disrupted traditionally strong businesses in recent years, can Malaysia or any nation say for certain that it can withstand a potential crisis ahead?

“Malaysia is definitely a lot better prepared in the sense that I don’t think it is going to have a similar type of crisis. [The problem is that] the [type of] crisis keeps changing,” says Asean+3 Macroeconomic Research Office (AMRO) chief economist Dr Khor Hoe Ee.

According to him, many of the vulnerabilities exposed during the 1997/98 Asian financial crisis, such as currency mismatch and balance sheet weaknesses, had been addressed. “Despite the huge swing in exchange rates, you don’t see any distress in corporate balance sheets. So [that’s] credit for the regulators and central bank for addressing that particular type of vulnerability.”

Yet the next financial crisis could well come in the form of a cyberattack “or something in the shadow banking system” that the world does not fully know, let alone prepare for.

“That is something I think a lot of regulators are still worried about — when and where [a new crisis] is going to come from and how it is going to affect the system. But, certainly, on the traditional type of weaknesses — vulnerability in the balance sheet, currency mismatch, maturity mismatch — [a crisis stemming from that] is much less likely,” says Khor, who is also closely monitoring the household debt level and the supply and demand situation in the property market.

“Everybody is worried about [the build-up/bubble]. People think that the equity market, for instance, is too rich and it’s time for a correction. People also think the bond market is another bubble waiting to burst and we need to [be mindful] but so far [a crash] has not happened. It is hard to tell what is going to happen but what’s important is that central banks and regulators have been doing a lot of stress-testing and some of the stress tests are quite severe. They shock the system by three percentage points and most of the time, the risk is not systemic. Definitely, it would lead to some distress in the corporate and household sector but it will not cripple the banking system. So there could be a downturn, a recession even, but at the moment, the risk is diminished, in our view,” he adds.

There is only a 15% chance of a recession happening in Malaysia, according to Bloomberg data, a figure that Khor sees as “not too bad”. The low risk is perhaps no surprise, given that Malaysia’s economy defied expectations by growing 5.6% in 1Q2017 and surprised further by expanding 5.8% in 2Q2017.

UOB Malaysia economist Julia Goh too reckons that Malaysia and Asia are today “fundamentally stronger” but can ill afford to rest on their laurels.

“Learning from past crises, Asia has also set up contingent life lines should another crisis emerge. But Asia also needs to look at the weak spots and repair the roof while the sun is out. This will help lower the odds and mitigate the impact of the next crisis,” she says, adding that rising debt levels had been flagged as a potential risk by sovereign rating agencies even as the US Federal Reserve and central banks around the world contemplate normalising monetary policy.

“Concerns lie in the fact that the sharp debt build-up has started to drag down sovereign debt profiles, including in China,” she explains, pointing to how China’s fourth largest developer by property sales, Greenland Holdings Corp, had just disclosed RMB457.5 million (RM296 million) of overdue debt.

“How Asia weathers it depends on the firepower of China and effectiveness of the central banks and governments to manage the contagion, ring-fence the spillovers, stabilise markets and support the economy.

“So far, it appears manageable as we assume China has the firepower to manage the spillovers and the currency swap lines extended will help boost confidence and ensure sufficient liquidity support,” adds Goh, who expects major central banks to normalise their monetary policy gradually to avoid excessive market volatility and disruptions.

Apart from an emerging market debt crisis, the possibility of a trade war or trade action is also on economists’ watch with tensions emerging as the US investigates China under section 301 of the US Trade Act of 1974.

“It is possible that in the coming year, the US could find evidence of practices that warrants enforcement actions and it remains to be seen how both sides react. How China responds is important in determining if there is any prospect of a negotiated solution to avoid the escalation of tensions … What’s important is for the rest of the world to uphold openness to trade and strengthen domestic policies to address common issues such as loss of jobs due to technology and rising inequality,” Goh says.

AMRO’s Khor emphasises the importance of Malaysia weaning itself off cheap and unskilled labour and moving up the industrial value chain.

“That is not easy because every country in the region wants to do the same, even Singapore. Although Singapore is already a high-income country, it is feeling the need to reskill labour with a lot of change and new innovation taking place, be it fintech or automation. Pretty soon, automation will create a lot of redundant labour and you will need to retrain workers for other industries. The problem is that, typically, other industries are services that are lower paying, which could be a big problem. In the US, they are creating jobs but wages are not going up, so it is a big challenge globally,” he says.

“I think Malaysia’s advantage is that the infrastructure here is much more developed than in many of the other Asean countries. It is already at a relatively high end in terms of infrastructure but it needs to upgrade the skills of the labour force and that’s a big challenge,” he adds.

“Having good policy is one way to mitigate risks in the region,” Khor says, noting AMRO’s approach to engaging government and central bank officials in dialogue towards better policy implementation in the respective countries.

“Prevention is the first line of defence against financial crisis,” he says, explaining how AMRO tries to identify risk and vulnerabilities for an economy and come up with policy recommendations to address those risks.

AMRO is referred to as an Asian alternative to the International Monetary Fund (IMF), whose heavy-handed ways and rigid prescriptions during the 1997/98 crisis gained it more critics than fans, especially in Malaysia and neighbouring Indonesia.

According to Khor, AMRO is different from the IMF, which is a global institution and rule-setting body. The latter means the IMF may be inflexible on certain types of policy, including discouraging capital controls or foreign exchange intervention, whereas AMRO is “more flexible in its assessment and prescription”.

“To the IMF, macro-prudential policies should only be applied if there is a systemic risk whereas my own view is that macro-prudential policy is a very pragmatic response to emerging imbalances in the region, especially in the housing market. This is not to say that one is right and one is wrong but there can be a difference [in approach],” Khor explains.

Specifically, AMRO is the macroeconomic surveillance unit and custodian of the Chiang Mai Initiative Multilateralisation (CMIM) multilateral currency swap arrangement between the Asean+3 members.

“We [AMRO] like to see ourselves not as the lender of last resort but as the lender of second resort. Central banks will always use their own reserves first and when they feel that their reserves are a bit on the low side, they can go to the market to borrow or they come to us. We have the facility ready so that when they need the liquidity, they can come to us. The last resort is when nobody wants to lend to you; it is then that the IMF comes in,” Khor says.

So far, the good news is that none of the member countries has found the need to draw on the CMIM facility. Bank Negara Malaysia can borrow up to US$7 billion or 30% of its total access from the CMIM without IMF links. But with central bank reserves above the US$100 billion psychological level and at their highest since June 2015, Malaysia is not expected to need the facility, especially if global trade continues to expand.

“There will be dips, every now and then, like China’s weaker-than-expected July trade data [growth slowed to 7.2% year on year in July after a strong 11.3% rise in June] but the rest of the region seems to be okay,” says Khor, who reckons that Bank Negara should “hold interest rates and support the economy as long as [it] can”, although the risk is on the upside for interest rates. “It is prudent to hold, perhaps with a tightening bias,” he adds.

Goh says in a recent note, “As the external environment poses increasing challenges in the form of global policy uncertainty, protectionist sentiment and geopolitical threats, Malaysia’s ability to face up to unpredictability lies in pursuing forward-looking adjustments that ensure sound macroeconomic management, market openness and liberalisation, drive new opportunities for growth, focus on innovation and technology, greater transparency and governance, fiscal and debt sustainability, human capital development, economic inclusion and social cohesion.”

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