IT would seem that Malaysia’s luck hasn’t run out just yet. Barely a fortnight after the world began talking about the possibility of crude oil prices dropping to US$30 a barrel, Brent prices jumped by the most in 6½ years last Thursday and went on to reach US$48.45 before settling at the US$47 level for the week.

The 14.7% surge to that intra-week high, from its lowest in almost seven years of US$42.23 intraday on Aug 24, helped Malaysia’s bellwether FBM KLCI stock index gain 5.3% over four days to end the week at 1,612.74 points.

While Wall Street’s rally on renewed optimism of a US economic recovery also lifted spirits across global stock markets last week, those gains on Bursa Malaysia took some by surprise, as it came ahead of the Aug 29 and 30 Bersih 4 street rally calling for transparency and electoral reforms. The gains also came even as ratings agency Moody’s Investors Service says “clouds are gathering on Malaysia’s positive [sovereign ratings] outlook”.

Depending on whom one asks, there are people who reckon Prime Minister Datuk Seri Najib Razak last week won some brownie points by bringing critics and old guard alongside academics and corporate chieftains on board his 10-man special economic committee to minimise the impact of “any arising economic issues”.

The members include former second finance minister Tan Sri Nor Mohamed Yakcop — who in 1998 helped former prime minister Tun Dr Mahathir Mohamad put in place the since rescinded ringgit peg and capital controls — and CIMB Group chairman Datuk Seri Nazir Razak, who has been openly critical of the current administration. “Will speak [the] truth to [those in] power & hope it will help [the] government to steer economy through this turmoil and lessen the pain,” Nazir said on his Instagram account last Thursday, after the surprise appointment.

“I hope the new economic committee will take the bull by the horns and introduce radical reforms rather than adopt superficial measures. We are coming from a position of weakness because of the current policy framework, and politics is a sign of that weakness. Too much politics is bad for economics and progress,” says Tan Sri Ramon Navaratnam, chairman of ASLI’s Centre for Public Policy Studies.

Others, however, point out that Malaysia already has res-

pected policymakers like Bank Negara Malaysia Governor Tan Sri Zeti Akhtar Aziz, who was not selected to join the committee, whose chairman, Datuk Seri Abdul Wahid Omar, is minister in the Prime Minister’s Department in charge of the Economic Planning Unit. They also reckon the ringgit’s precipitous fall in recent weeks was more than a mere reflection of wavering confidence.

INCEIF emeritus professor Datuk Mohamed Ariff, for one, says the country needs to act fast to regain confidence and credibility, and that there are “clear writings on the wall” that Malaysia’s economic fundamentals “have weakened considerably in recent times”.

“It appears that the country is in denial mode … The sharp fall in commodity prices, rapidly shrinking ringgit, ballooning external debt, ailing stock market and falling central bank reserves are all taking a heavy toll on the Malaysian economy. And yet, we keep hearing that the fundamentals are still strong. Such talk only serves to dampen investor sentiment further, as these give rise to the impression that the government cannot even recognise or understand that there is a problem in the first place, let alone fix it,” he says, adding that Malaysia cannot blame all its woes on external factors.

“The crisis the country currently faces is largely home-grown. It smacks of poor governance and mismanagement. The ongoing financial scandals speak volumes. The poor handling of the issues with no straight answers and the absence of checks and balances have affected the country’s image in the global arena … The economy is bogged down in a crisis of confidence and credibility. To put the economy back on track, we must restore confidence and credibility, which can only come with increased transparency, disclosures and accountability.”

That Malaysia’s public debt has ballooned considerably on the back of 18 straight years of budget deficits limits policy manoeuvres when the country needs to weather global economic headwinds. While the headline debt-to-gross domestic product ratio is below the 55% self-imposed ceiling, public debt is north of 66% if quasi-government guarantees were to be included, experts say.

“Stock market volatility, commodity market selldown and economic slowdown in China, not to mention the eurozone malaise, are all symptomatic of an impending global deflation,” says Ariff, without providing a timeframe.

As he sees it, Malaysia is “most vulnerable” to happenings in the Chinese economy, as China is currently the number one destination for Malaysia’s exports and number one source of Malaysia’s imports.

“Obviously, we are less prepared now than we were in the mid-Nineties for such eventualities. In the mid-Nineties, we had five consecutive years of budget surplus (1993-1997), our short-term external debts accounted for less than a third of the total. Now, we are inflicted with budget deficits year after year since 1998, while foreigners hold roughly half of government bonds,” says Ariff.

With at least 25% of government revenue still coming from oil and gas (although down from 39.6% in 2008), experts like him doubt higher tax receipts, including those from the newly implemented Goods and Services Tax, can fully make up for smaller oil-related receipts, thus there is limited room for fiscal stimulus.

A new normal for oil prices, at US$30 to US$40, should it happen, “will likely imply a significantly higher fiscal deficit (exceeding 4% of GDP) and a structurally lower current account surplus,” says Chua Hak Bin, head of emerging Asia economics at Bank of America Merrill Lynch (BaML).

“It will also mean that the government can no longer rely on Petronas (Petroliam Nasional Bhd) as a lender and banker of last resort in times of crisis,” he says. Already, the national oil company, when announcing a 47% drop in its second-quarter net profit on Aug 14, said it needed to draw on its reserves and “persevere with more austerity measures” as its operating cash was not enough to cover both its capital expenditure and the RM26 billion dividend committed to the government this year.

“Policy options are becoming more limited. Governor Zeti and Prime Minister Najib have ruled out capital controls. Forex intervention will have to be conducted more sparingly, given the rapid depletion of Bank Negara’s foreign exchange reserves,” Chua says, adding that US$8.8 billion was spent defending the ringgit in July and another US$2.2 billion in the first two weeks of August.

Bank Negara will release its end-August reserves figures on Sept 4. As at mid-August, the central bank’s reserves stood at US$94.5 billion (RM356.4 billion), down 33.2% from the recent peak of US$141.43 billion in May 2013.

While the reserves are still adequate to finance 7.5 times retained imports and are one times short-term external debt, RHB Research Institute executive chairman and chief economist Lim Chee Sing says the latter “is a weakness and a concern should there be a more significant erosion in foreign investor confidence, causing them to sell down their holdings of financial assets in the country and/or withdraw whatever deposits they have placed with the Malaysian banking system”.

While local institutions, such as the Employees Provident Fund — whose total investment assets stood at RM667.21 billion as at end-June 2015 — insurance companies and sovereign wealth funds, have sufficient liquidity to absorb foreign selling, Lim says “price will have to give if there is continuous foreign selling”.

That foreign investors still hold 47.84% of the RM345.84 billion outstanding Malaysian Government Securities means there will be pressure on the ringgit and Bank Negara reserves if redemptions accelerate the way they did on the local equity market where foreign holdings are estimated at around 23% in August. Foreigners have pulled RM11.8 billion out of the local bourse year to date, surpassing the RM6.9 billion net outflow for the whole of 2014.

Between March 2013 and June 2015, the balance of payments saw RM29.1 billion net outflow, largely because the RM129.2 billion net outflow from the financial account exceeded the RM100.4 billion net inflow in the current account, where a surplus position has dropped to RM7.58 billion in June 2015 from nearly RM40 billion in September 2008 as Malaysia’s exports to the world fell faster than its imports. A negative balance of payments erodes Bank Negara’s reserves position.

“The impending US Federal Reserve interest rate hike, under current market conditions, will only worsen the sell-off in the ringgit,” BaML’s Chua says, pointing out that the market currently expects 50% chance of a rate hike happening by year-end and only 16% in September.

“Our [ringgit-US dollar] forecast of 4.28 is for end-2016 and is now close to being breached. We will review the forecast, pending our assessment on the Fed rate decision, given current market developments,” he adds.

The US Federal Market Open Committee is scheduled to meet in mid-September, late-October and mid-December this year. Bank Negara’s monetary policy committee will meet three days earlier, on Sept 11, when it is expected to keep the key interest rate unchanged, at 3.25%.

Citi Research economist Kit Wei Zheng, in a recent note, says the 100 to 150 basis point rate hike that “most thought” is needed to defend the ringgit “is unpalatable, given softening growth and limited evidence of imported inflation”.

“Drastic rate hikes will also be counter-productive as softer domestic demand and knock-on impact from non-oil fiscal revenues could give speculators another reason to short the ringgit,” he adds.

Malaysia’s high household debt, at 87.8% of GDP — among the highest in the region — also raises the odds of savers being taxed with negative real (inflation-adjusted) returns.

Deutsche Bank economist Diana Del-Rosario is more sanguine about Bank Negara’s reserves building up again, pointing out that Malaysia recorded a surplus in the balance of payments in the second quarter, driven by a turnaround of other investments like loans and forex deposits to net inflows.

“We do not know the reason behind these inflows, but we suspect they could be due to the weaker ringgit or a result of a government/Bank Negara initiative to contain the decline in reserves. If so, then it is likely these inflows could continue for the rest of the year,” she says, adding that the current account surplus “could also widen as exports slightly improve and imports soften because of weak demand prospects”.

She also reckons the government could “make modest adjustments to its foreign exchange administration policies” such as cutting the time limit for the repatriation of export proceeds to less than six months.

According to Citi’s economists, a sizeable difference between trade data reported by Malaysia and its trading partners “suggested that a chunk of export earnings were kept offshore, notwithstanding Bank Negara regulations that export proceeds have to be repatriated within six months”.

Still, they also told clients that the government’s appeal to repatriate liquid foreign assets had hitherto had only limited effects as some government-linked investment companies claimed that such decisions “would have to be made primarily on commercial grounds, given the need to hit target returns”. “An easier option would be the conversion of about US$30 billion of foreign currency deposits with onshore banks,” the Aug 24 note reads.

Yet the impact of such moves would be fleeting, should there be high selling pressure, experts admit.

“Whether the market has been overly bearish and if there is more weakness to come will depend largely on whether the major world economies can do more to hold up growth, if need be, or whether more policy missteps — such as China’s heavy intervention in the equity markets and renminbi devaluation that derailed confidence — are being taken to cause the global growth cycle to turn down earlier than expected.

“Whether Malaysia has enough policy options to weather the storm also depends on the extent of the storm, and whether it is global in nature, although there is room for the country to take appropriate measures to mitigate it,” RHB’s Lim says.

Over the longer term, he says Malaysia — which is stuck in the middle-income trap — needs a stronger ringgit to encourage industries to gradually advance up the value chain to restore competitiveness. “Emphasis on the quality of products and services with good branding is what we need as the country evolves into a developed country by 2020.”

That means Malaysia needs to get its act together quickly for the ringgit to strengthen again.

This article first appeared in digitaledge Weekly, on August 31 - September 6, 2015.