Time for reforms

The government needs to come up with a four-year comprehensive plan as to how it wants to reform. — Bloomberg

LAST week, an analysis of the global economy for the second half of 2023 (2H23) was presented with the view that rate hikes are still prevalent among major central banks, thanks largely to the persistently high and sticky core inflation rate.

While the US economy may enter into a recession in 2H23, the likelihood of it being short and shallow is rather certain, mainly driven by strong consumer sentiment and a robust labour market.

Nevertheless, despite the economic headwinds, certain equity markets have done exceptionally well, driven by strong liquidity as well as expectations that central banks will cut rates as soon as late this year or early 2024.

Given the above scenario, what are Malaysia’s prospects in 2H23?

Perhaps to answer that question, we need to dissect the outlook into three parts – the economy, politics (which we cannot seem to ignore) and markets.

Economic data points

James Carville, the adviser to Bill Clinton in the 1992 presidential campaign, coined the term “it’s the economy, stupid!” as the US economy was then experiencing economic recession and the sitting president, George H.W. Bush was seen to be out of touch with the voters and ordinary Americans.

Similarly, economic issues are always the heart of any government and a government cannot ignore the good, the bad or the ugly economic data points that affect the lives of the people.

Yes, we had a strong 5.6% year-on-year (y-o-y) growth in the first quarter of 2023 but the consensus or even the government expects the rest of the year to be softer, mainly driven by persistently high core inflation prints, which led Bank Negara to raise the overnight policy rate (OPR) by 25 basis point (bps) in May to 3%.

The cost of living issue is tough to handle, especially for the low-income group. At a time when the government’s finances are tight, it is difficult to implement economic reforms that will fix the finances of the mass majority.

While the government is seen doing much to help the lower-income group in the form of continuous subsidy allocation as well as cash handouts, the narrative out there seems to suggest not enough assistance is being provided to the extent this will turn into an election issue in the upcoming six state polls.

Nevertheless, the Malaysian economy is still poised to grow respectably well with a consensus estimate that the economic growth this year will be approximately 4.3%.

As far as the OPR is concerned, the likelihood that Bank Negara will keep the rate unchanged for the rest of the year is gaining momentum, especially now that headline inflationary pressure has eased, despite the sticky core readings.

The weakening Chinese economy too is a concern for Malaysia as, together with other Asean economies, external demand has been impacted.

Malaysian exports for the first five months dropped by 2.3% y-o-y and imports down by just 1% y-o-y, the resultant 8.7% shrinkage in trade balance will be a key factor in economic growth this year.

Ringgit weakness

The weak ringgit is not helping either and while most analysis recognises the fact that the fall of the currency could be attributed to the yield spread between ringgit assets (in the form of deposits or ringgit bonds) vis-a-vis the US treasuries or even other benchmark yields, efforts must be made to address leakages and illicit fund transfers that have weakened the currency considerably.

Malaysia, for the longest time, has been enjoying trade and current account surplus (albeit a lower percentage of gross domestic product or GDP) and there is no reason for the ringgit to be weak if efforts are not made to curtail outflows.

These outflows are also seen in the form of repatriation of profits via dividends, repayment of loans by foreign companies operating here to their headquarters, and net errors and omissions, which averaged approximately RM21.3bil per annum between 2010 and 2022.

Net portfolio outflows too have been significant, especially last year when RM50.6bil left the country.

There is also a possibility that the availability of facilities like foreign currency deposits in the banking system that has also caused a decline in the local currency as well as hoarding activities as corporates take advantage of the yield spread between the ringgit against other currencies.

These are some of the other reasons that are plaguing the ringgit and policymakers need to address them quickly before someone yells “See you at Five”.

The recent statement by the Financial Markets Committee, which suggested that Bank Negara may intervene to curtail the ringgit’s weakness and excessive currency movement, may not be the best approach for Malaysia to tackle the slide in the local currency.

As at the end of April 2023, Bank Negara’s foreign currency loans amounted to US$16.15bil (RM75.5bil) and the central bank also had some US$23bil (RM107.5bil) in net short position in forward and futures in foreign currencies against the ringgit.

This suggests while Malaysia had total reserves of US$114.42bil (RM534.6bil) as at the end of April, the net reserves, after taking into consideration of these two items, are only US$75.28bil (RM351.7bil).

After all, the daily foreign exchange (forex) average turnover volume this year has already surpassed US$15.1bil (RM70.6bil), which suggests our net foreign reserves are only five times the daily average volume, and intervening in the forex market to support the ringgit may not be the best option.

Haven’t we learned from the past episode how much the nation lost due to the 1991-1993 forex scandal?

Politics and reforms

Despite having secured a two-thirds majority in Parliament under the unity government, the current government does not seem to be able to implement the much-needed reforms of not only the structural issues related to our tax revenue but also others.

These include institutional reforms, law reforms, a competitive and transparent budgetary process for large scale infrastructure projects, addressing Malaysia’s low wages structure (Malaysia has one of the lowest compensation of employees-to-GDP ratio) and education reforms to stop the brain-drain.

Instead, we have been bombarded with racial and religious issues as the opposition continues to harp on what they know best to gain voters’ confidence.

With the six states going to the polls as early as August this year, all eyes will be on the potential outcome with the given scenario that the status quo will remain in terms of the current administration running each state.

Nevertheless, the unity government will see some dent in the near-absolute power that it has in the three states.

In Penang, the unity government held 35 out of 40 state seats while in Selangor, the unity government held at least 48 out of 56 seats before the dissolution of the state assembly.

The Negri Sembilan state assembly, in which the unity government holds all 36 seats, is another state where the opposition may take some seats too.

The outcome of the state polls has no direct bearing on the unity government at the federal level.

However, should one or two states fall to the opposition, the political temperature is expected to rise, which may lead to a party or parties switching alliances to the other side and forming the next federal government.

Hence, although Datuk Seri Anwar Ibrahim has a super majority to run the unity government, the rug can be easily pulled under his feet if a new alliance is formed and Malaysia may go back again to being politically unstable, which will again cause anxiety among investors.

It is the market

This column highlighted how unloved the local bourse has become over the last 10 years with foreign portfolio holdings, minus those held for strategic purposes, now at just 6.2%-6.3%.

Although the market trades at very attractive multiples based on the 12-month forward price-to-earnings ratio, attractive dividend yield as well as low price-to-book ratio, the excitement in the market is missing mainly due to how minute the market has become relative to regional markets.

The recent reduction of stamp duty by five basis points is hardly moving the needle in attracting investors back to the market while expediting the time to market may be sending the wrong message as to Bursa Malaysia’s main objective of listing quality companies rather than quantity.

This is not a numbers game where the more listed companies we have the better but the government should instead look for opportunities to loosen up listing criteria for large startups that are eligible for listing.

Losing homegrown startups to other exchanges is the last thing Malaysia needs right now to revive interest in the local bourse.

It is everything

In summary, since the 15th general election, the sitting government led by Prime Minister Datuk Seri Anwar Ibrahim has made a lot of concessions to ensure his support remains strong and hence we have seen in the past seven months a lot of compromises made to satisfy certain political parties of the unity government as the parties with smaller number of seats seems to have more bargaining power.

With the upcoming six state elections, the reform agenda has taken a back seat with populism measures taking centre stage.

While the headwinds have been there, economic growth has been decent but with the passing of time, the window is getting narrower for the government to introduce reforms, not only economic reforms but also financial, educational, social, and political.

Low-lying fruits are aplenty but it will always hurt the masses as the country is not ready for it, mainly due to the low wage structure that we have.

What the government ought to do is to come up with a four-year comprehensive plan as to how it wants to reform with the end in mind and broken down into annual targets in each of the areas mentioned above.

Only then Malaysia will be on course and the ringgit as well as the economy and stock market will have a ray of hope.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.