Cover Story: Malaysia adjusting to the ‘new normal’

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SINGLED OUT as Asia’s only net casualty of lower oil prices, it is easy to forget Malaysia was the world’s envied hotbed for billion-dollar home-grown IPOs just two years back. That is just one example of how quickly fortunes can turn in the current post-global financial crisis and post-US Federal Reserve quantitative easing (QE) era — so much so that experts deem volatility as a constant feature in the new normal.

Back home in Malaysia, the higher priced RON97 petrol that was eschewed at the pumps not too long ago is now reportedly facing a supply shortage as its price differential with the regular RON95 dwindled to a mere 20 sen a litre effective Dec 1, with prices fixed at RM2.46 and RM2.26, respectively.

There is no early Christmas cheer, though. Consumers are already paying new prices for goods that have been priced upwards in anticipation of higher costs next year as the Goods and Services Tax (GST) kicks in from April.

Year-end holidays abroad will also likely be dearer with the ringgit skidding 2.73% in five days to 3.4757 against the greenback midday last Friday — a level last seen over five years ago in September 2009. The loss is 10.5% if measured from its recent high of 3.1463 on Aug 27. Currency experts are keeping close watch on movements as economists still see reason for concern.

The ringgit’s slide happened as oil prices tumbled to hover at their lowest in five years after the Organization of the Petroleum Exporting Countries (Opec) resolved to maintain output at its late-November meeting, a move that experts say both defends its market share and forces US shale gas producers to cut supply.

At the time of writing, Brent and West Texas Intermediate (WTI) were hovering at US$69.15 and US$66.20 per barrel — down close to 40% from their year-high of US$115.06 and US$107.26 since late-June. The premium Bloomberg Asia-Pacific Tapis crude price stood at US$72.58 last Friday — 31% below the US$100 to US$105 that economists calculate Malaysia had based its revenue projection and planned its Budget 2015 on. Petronas’ official selling price for Tapis was US$82.09 in November, down from US$90.55 in October and US$117.17 in November 2013, Bloomberg data showed.

Chua Hak Bin, head of Emerging Asia Economics at Bank of America Merrill Lynch, told clients Malaysia’s fiscal deficit could widen to 3.8% of GDP next year from 3.5% this year — missing the country’s 3% target for 2015, despite scrapping fuel subsidies. This was after Petroliam Nasional Bhd (Petronas) president Tan Sri Shamsul Azhar Abbas reportedly said the national oil company’s payments to the government could be 37% lower at RM43 billion next year (2.3% of GDP) if oil prices continue to hover around US$75 a barrel.

Assuming a worst-case scenario of a sustained drop in Brent to US$60 in 2015, the ringgit will see persistent weakness and Malaysia’s GDP could only grow 3% to 4% next year — sharply below the official projection of between 5% and 6% — AllianceDBS Research’s economist Manokaran Mottain wrote in a Dec 3 note. “Risk of a trade deficit scenario is highly likely in the first half of 2015,” he said, adding that a small current account deficit situation could happen as early as 1Q2015, should exports remain weak.

Renewed fears of foreigners unwinding their high positions in Malaysian Government Securities (MGS) on the possibility of a sovereign rating cut should Malaysia fall into the so-called twin deficit situation — current account deficit as well as fiscal deficit — next year also sent the local benchmark FBM KLCI 4.1% lower in just four days to 1,745.69 points last Thursday before recovering to end the week at 1,749.37 points. This is still the lowest since September 2013 when there was similar fear of Malaysia’s current account balance falling into a deficit from weak exports.

In short, the fear of Malaysia not meeting its fiscal targets is compounded by fears of falling oil prices dragging CPO prices lower, which combined could cause exports to fall sharply and push the current account and balance of payments into a deficit next year. If this materialises, Malaysia could see a sovereign rating downgrade. Widespread fears of that happening will cause foreigners to trim holdings in financial assets more aggressively, resulting in sharper-than-expected depreciation of the ringgit, observers say.

A more bearish market outlook will also hamper fundraising exercises, and curb any second round “wealth effect” from stock market gains, they add.

Between July and October this year, foreigners had already withdrawn about RM7.3 billion or more than US$2.2 billion worth of investments in Malaysia’s sovereign debt, as seen by the fall in foreign holdings of MGS to 45.91% in October from 48.35% in July. Foreign holdings of MGS stood at RM147 billion in October, Bank Negara Malaysia data show. This is just over one-third of Bank Negara’s reserves of RM411.7 billion (US$125.7 billion) as at end-November 2014, which was enough to fund 8.4 months of retained imports and 1.1 times short-term external debt. In just one month, Bank Negara’s reserves had fallen by US$2.4 billion from RM419.7 billion as at end-October.

Yet, Minister in the Prime Minister’s Department Datuk Seri Abdul Wahid Omar, the former group CEO of Malayan Banking Bhd whom Prime Minister Datuk Seri Najib Razak tapped to head the country’s Economic Planning Unit, insists Malaysia is still a beneficiary of lower oil prices and can meet its 3% fiscal deficit target for 2015 if oil prices stay at the current US$70 levels.

“I think it is very important to note the fact that in Malaysia, we always work on medium-term planning and we’re mindful that in the global markets, be it equities, oil prices or currencies, these are all subjected to market fluctuations. It is our belief that if we focus on fundamentals, then, in the medium term, things will be ok,” Abdul Wahid tells The Edge.

Pointing out that Malaysia has over the years reduced its dependency on resource-based exports and now has the services and manufacturing sectors making up over 80% of the country’s economy, he insists the country has strong enough fundamentals to withstand any near-term shocks.

Malaysia is also not in danger of falling into a twin-deficit situation should oil prices remain above US$70 per barrel, Abdul Wahid says, pointing out that the situation continues to be carefully managed. Already, fiscal savings from the scrapping of fuel subsidies  are RM11 billion to RM13 billion of the total RM37.7 billion budgeted for subsidies in 2015, he adds. He declines, however, to say at what level of oil price Malaysia would no longer see net benefits.

RHB Research Institute executive chairman and chief economist Lim Chee Sing also reckons investors have over-reacted to the plunge in crude oil prices. He reckons that a RM3 billion to RM5 billion revenue gap resulting from lower oil prices “is still manageable and can be bridged” by a combination of measures, such as having Petronas maintain a high level of dividend to the government as well as the government cutting its planned RM6 billion increase in development spending budgeted for 2015 and utilising the RM2 billion contingency expenditure.

“[A combination of these measures] would mean the government could still achieve its fiscal deficit target of 3% of GDP next year if measures are taken to cut expenditure and/or raise revenue,” Lim says.

But what if oil falls below US$65?

Should Brent crude fall another US$10 to average US$65 per barrel, however,  Lim calculates that Malaysia’s fiscal deficit could widen by another one percentage GDP point and potentially derail the government’s momentum.

“I would say it would be difficult for the government to achieve its fiscal deficit target if Brent crude were to fall below US$70 on a sustained basis unless GST revenue turns up to be much stronger than anticipated,” he says, adding that oil prices could temporarily slip below US$60 a barrel, given the current oversupply situation is estimated at 1.8 million barrels a day more than the estimated demand of about 92.4 million barrels a day.

“When most news on oil and gas is negative, markets tend to over-react by suppressing oil prices. I do expect oil prices to find a bottom somewhere in 1Q2015 and start to rebound from there, but I’m no expert in oil prices,” Lim says, adding that he is “slightly more optimistic” than the Petronas president’s forecast of US$70 to US$75 per barrel.

Nonetheless, Lim concurs that concerns over the prices for another two sizeable Malaysian exports — liquefied natural gas (LNG) and crude palm oil — falling in tandem with oil prices are not unfounded. For one, the plunge in crude oil prices has wiped out biodiesel margins, reducing the likelihood of any increase in demand from non-mandatory usage of biodiesel. While Malaysia is now a small net oil importer, the inclusion of LNG makes it a net exporter of oil and gas — RM60.7 billion or 6.1% of GDP last year and RM42.6 billion or 5.4% of GDP in the first nine months of this year.

According to Lim, the potential net impact on CPO exports is relatively smaller given that CPO accounts for about 6% of total exports versus 8% for LNG.

Pointing out that LNG prices fell about 23% in 2009 when crude oil prices fell an average 37%, he reckons that a 20% fall in LNG prices could translate into an RM11 billion decline in export value or about 1% of GDP. That’s just a very rough estimate, however, as “there are no global benchmarks on LNG because each LNG exporter has a different cost structure due to differences such as transport costs”. Moreover, Malaysia’s LNG exports are based on long-term contracts, which means that “sliding prices will probably take a longer time to show”, BaML’s Chua says.

“Ceteris paribus (all else being equal), a rough calculation would suggest that it would take LNG prices to fall more than 40% and CPO prices more than 20% before the current account would risk falling into a deficit,” Lim says. As at end-September, Malaysia’s current account surplus stood at RM43.4 billion or 5.5% of GDP, that’s better than a surplus of RM37.3 billion or 3.8% of GDP last year.

Still, latest export numbers could spark more jitters.

That Malaysia’s exports plunged 3.1% year on year in October and saw its trade surplus narrow to just RM1.19 billion from RM9.3 billion in September as the value of imports rose flags “warning signs for the fourth quarter current account balance”, Chua writes in a Dec 5 report.

With soft commodity prices, weaker oil, and patchy global economic growth, Malaysia’s export performance will likely remain lacklustre in the months ahead, Chua says, pointing out that Malaysia’s current account surplus had already narrowed to RM7.6 billion or 2.8% of GDP in 3Q, from RM16 billion or 6.1% in 2Q.

“There is a risk that the current account could slip into a small deficit in 4Q, especially if imports stay strong. Malaysia last registered a current account deficit during the 1997 Asian financial crisis,” Chua adds.

Whether or not a weaker ringgit will help shore up exports in the months ahead, Chua would not be surprised Malaysia continues to tap Petronas to cover its cash needs.

“Petronas has been Malaysia’s cash cow and sovereign oil fund. Some might even regard Petronas as the government’s banker of last resort, providing ready funds in the event of a crisis,” Chua says, pointing out that Petronas “has probably paid out more than RM500 billion to the government over the past decade. If not for these funds, the fiscal deficit would have been twice as wide”.

“And that’s exactly the point, Malaysia is too reliant on Petronas and vulnerable to Petronas’ fortunes… If we accept lower oil prices as ‘the new normal’ Petronas’ profits and cash flow could easily fall by more than half in the coming years.”

Petronas is already warning of lower capex due to lower oil prices, something Chua reckons will come home to roost. “Oil and gas investments and projects was a centrepiece of the whole Economic Transformation Programme. With oil and gas investments likely to subside, weaker investments will slow GDP growth next year. There is no other clear substitute which can replace Petronas’ leadership,” Chua says.

For those looking for a silver lining from the oil price slide, economists like Chua reckon that the recent weakness “has increased the likelihood of Bank Negara staying on hold and accommodative in 2015” at least for the first half of 2015.

RHB’s Lim shares this view, given that the downside risks to economic growth are far greater than the concern of a spike in inflation upon the implementation of GST. “The best course of action [for Bank Negara] would probably be to maintain its overnight policy rate at the current level and continue to intervene, from time to time, in the foreign exchange markets to prevent spikes in the currency that could be damaging to business investment decisions,” he says.

This respite, however, is only temporary. As volatility is seen as a new constant in the new normal, it is likely that every policy decision could have a critical bearing on the sustainability of Malaysia’s competitiveness.

This article first appeared in The Edge Malaysia Weekly, on December 8 - 14, 2014.