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Malaysia: corruption scandal is haunting the prime minister

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Growth in Malaysia slowed down as a result of lower commodity prices. The involvement of PM Najib in a large corruption scandal is hurting his position and international investors’ confidence. This has resulted in increased external pressure on the economy and the balance of payments.

Strengths (+) and weaknesses (-)

(+) Strong business environment

The 18th position on the World Bank’s Ease of Doing business ranking indicates one of Malaysia’s key strengths: a relatively strong business environment.

(+) Strong external position                 

Malaysia’s current account balance has been in surplus since the end of the Asian crisis. Combined with an import cover of about 6 months and sizable sovereign wealth funds, Malaysia has a strong external position.

(-) Fiscal balance shows a structural deficit

Despite the large oil revenues, the government budget shows a deficit of between 3-5% of GDP. Subsidies and (infrastructure) investment are the main drivers of the deficit.

(-) Tensions between ethnic groups

Even though the Malays are the majority in the country, the Chinese and Indians dominate the economy. Affirmative action policies have created tensions between the different groups. However, the risk of full blown escalation is small.  

Key developments

1. Lower commodity prices resulted in slower economic growth

Economic growth is expected to have slowed down to 4.8% in 2015 (from 6.0% in 2014), largely due to lower commodity prices (in particular: oil). Growth is forecasted to decelerate further to 4.3% in 2016 and to recover afterwards (figure 1). As usual, domestic demand, in particular private consumption, was the main growth driver and is expected to remain so. Consumption growth will, however, likely slow down, given a stagnant labour market and a moderation of real disposable income growth. Unemployment increased during 2015 by 0.5%-point to 3.5%, while inflation is expected to peak in the first quarter of 2016, due to the introduction of the goods & services tax (GST) in 15Q1 and higher import prices due to the depreciation of the ringgit. Moreover, consumer sentiment is down sharply; the MIER consumer sentiment index fell to 70.2 in 15Q3 from a previous high of 122.9 in 13Q1. A structural drag on private consumption is the high level of household debt in Malaysia (88% of GDP). Private fixed investment is expected to remain robust (with the exception of the oil industry) and public investment will likely increase in 2016 (especially infrastructure investments). Net exports are expected to contribute positively again in 2016, since the price competitiveness of Malaysian producers (mainly the electric & electronics sector) improved on the back of the sharp depreciation of the currency. Easing of monetary or fiscal policy is not expected. Monetary policy is restricted by external pressures on the currency (see development 2), while government revenues are deteriorating due to lower oil-related revenues. The GST-introduction in 2015 reduced the fiscal dependence on oil to just 15% in 2016 from almost 40% of total government revenues in 2009.

2. External pressures increased during 2015

During 2015, emerging markets were under increased pressure on financial markets, because of weaker than expected global economic growth and the upcoming US FED rate increase. The fall in commodity prices worsened the situation for Malaysia, resulting in a lower than usual current account surplus in 2015 (expected: 2.4% of GDP). Also the 1MDB corruption scandal (see development 3) aggravated the loss of confidence of international investors and unveiled that governance was weaker than generally thought. The exchange rate against the USD depreciated by 22.8% during 2015 (figure 2). During the same period, FX reserves dropped by USD 20.7bn (17.8%), which is a signal that the central bank tried to intervene in the FX market to stabilize the currency. The import cover, however, remains sufficient at about 6 months. There are also signs that foreign investors sharply reduced their holdings of Malaysian equity and bonds. Between 2010 and 2013, large amounts of foreign funds flowed into the Malaysian economy, resulting in large foreign holdings in the stock market (end-2014: 23.5%) and government bonds (32.4% in 15Q3) which makes the country vulnerable to capital outflows.

Figure 1: Growth is slowing down
Figure 1: Growth is slowing downSource: EIU
Figure 2: Sharp depreciation of the ringgit
Figure 2: Sharp depreciation of the ringgitSource: EIU

3. PM Najib under pressure after his involvement in the 1MDB corruption scandal

The scandal around Prime Minister Najib and 1MDB (a Malaysian Sovereign Wealth Fund) and the consecutive handling of the crisis by the prime minister, have severely dented his image. The scandal involves an alleged USD 681m transfer from the state fund into the personal accounts of the prime minister. Najib’s policy response was to consolidate power and to actively silence all critics. In July, he sacked five ministers, including the Deputy Prime Minister (Muhiyiddin Yassin), which is highly unusual in Malaysian politics. PM Najib also replaced the Attorney-General Abdul Gani Patail by Apandi Ali, a conservative judge that is known to be a close ally of PM Najib. In January 2016, the new attorney general cleared Malaysian Prime Minister Najib of corruption charges, since the money was transferred by the Saudi royal family and was largely repaid. The 1 MDB scandal is now also being investigated in several other jurisdictions for illegal practices (e.g. money laundering). Former ruling United Malays National Organisation (UMNO) official Khairuddin and his lawyer Chang lodged reports against 1MDB in several jurisdictions, and were subsequently accused of economic sabotage and detained under Malaysia’s Security Act, an anti-terrorism law. Also the Conference of Rulers (the nine rulers of the individual states) and the Central Bank openly asked for an investigation of the scandal. In the past weeks, the government is further reducing press freedom after rumors that Najib is looking for a deal, in which he will not be prosecuted and will also keep his personal wealth. The latest amendments to the media law allow the government to block all websites that defame Malaysia’s leadership. Moreover, the government is now blocking all, even international, websites that allows the citizens to access the Sarawak Report, the whistleblower’s website. Even if Najib resigns, it is unlikely that the UMNO, who has been in power since independence in 1957, loses power. The former opposition alliance, Pakatan Rakyat (PR), has ceased to exist as a result of a series of policy disputes. The new opposition alliance, Pakatan Harapan, so far, failed to get public attention, due to limited coverage in the press. Moreover, their leader, Anwar Ibrahim, is in jail till 2020 on sodomy charges.

Factsheet of Malaysia
Factsheet of MalaysiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Malaysia is a middle-income country in Southeast Asia. It has a diversified and competitive economy with a major industrial sector (mainly electronics), substantial natural resource wealth (oil and gas) and a growing agricultural sector (largely palm oil and rubber). Malaysia positions itself as an Islamic Finance centre and has a rather substantial financial sector. It is one of the most open countries in Asia with the export value of goods and services mounting to 69% of GDP in 2015. Singapore and China are its largest export partners, closely followed by Japan and the US. A share of the electronic parts exported to Singapore and China are inputs for final consumer goods shipped to the US and Europe.

Malaysia scores above the global average and relatively good compared to other South-east Asian economies on the world governance indicators. However, the scandal around Prime Minister Najib and 1MDB (a Malaysian Sovereign Wealth Fund) unveiled that governance was weaker than generally thought. During the last decade, press freedom has deteriorated significantly.

Since independence from the UK in 1957, Malaysia’s politics have been dominated by Barisan Nasional (BN) coalition and its predecessor. The Malay-supported United Malays National Organization (UMNO) is the main party in the multi-ethnic coalition. Two other important parties in the coalition are the Chinese-oriented Malaysia Chinese Association (MCA) and the Indian-supported Malaysian Indian Congress (MIC). The elections in 2008 were the first were the BN coalition lost its two thirds majority in parliament due to the strengthening of the opposition Pakatan Rakyat (PR) alliance. PR dissolved in 2015 due to a series of policy disputes. The successor, Pakatan Harapan, so far failed to get public attention. The opposition leader, Anwar Ibrahim, is in jail till 2020 on sodomy charges. 

Economic indicators of Malaysia
Economic indicators of MalaysiaSource: EIU
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