Could Mahathir’s clean-up spark a financial crisis?
Revelations that Malaysia's public debt is closer to 80% of GDP than previously disclosed 50% is pushing down shares and driving capital outflows
Though few expected the opposition Pakatan Harapan coalition to win Malaysia’s May 9 polls, markets were mainly calm following Mahathir Mohamad’s spectacular return to the premiership.
His appointment of well-respected ministers to economic and finance related portfolios, as well as creation of a council of experienced advisors including a former central bank chief, meanwhile, aimed to reassure investors that his government would remain business-friendly.
But three weeks into Mahathir’s course-shifting term, market skepticism is already starting to creep in. The coalition campaigned on promises to scrap an unpopular goods and services tax (GST), reintroduce petrol subsidies and review toll road concessions. Mahathir has also called for the review of large-scale investment projects awarded during the predecessor Najib Razak’s administration.
Moody’s Investors Service and Fitch Ratings have weighed in with a shared view that GST abolishment could raise government deficits if not offset by other revenue-raising measures. Fitch has forecasted short-term “headwinds”, while noting that current economic growth momentum is still strong.
Foreign investors have apparently received similar memos and are retreating from Malaysian stocks, with outflows greater than US$224.4 million (892.4 million ringgit) being dumped since the election, according to reports published on May 28.
Malaysia’s Kuala Lumpur Composite Index (KLCI) plunged 3.7% on May 30, the biggest single-day slump since October 2008, coinciding with the height of the global financial crisis. Shares rebounded 1.24% today (May 31) in line with a regional rebound, Reuters reported.
Rising foreign capital outflows follow on recent revelations of higher than previously acknowledged national debt levels and the recent cancellation of high-speed rail (HSR) project connecting Kuala Lumpur to Singapore, developments that, among others, now appear to be impacting international confidence in the country’s finances.
Public debt as a percentage of gross domestic product (GDP) was officially recorded at 50.8% at year-end 2017, a figure endorsed at the time by international ratings agencies and promoted by then-premier Najib as evidence of his government’s sound fiscal management.
Lim Guan Eng, Malaysia’s newly appointed finance minister, now claims federal debt and liabilities currently stand at 1 trillion ringgit (US$251.70 billion), equal to 80.3% of GDP.
Lim accused Najib’s government of misrepresenting Malaysia’s financial situation and has vowed to establish a true baseline for the country’s finances. Doing so, he acknowledged would “unsettle the financial markets, alarm the credit rating agencies and investors’ confidence in our institutions.”
Mahathir’s government has reopened graft investigations into 1Malaysia Development Berhad (1MDB), a state development fund created and overseen by Najib believed to be linked to billions of dollars in pilfered losses. The indebted fund faces ongoing international graft probes in Singapore, the US, Switzerland and elsewhere.
Armed police seized and carted off luxury items and US$29m in cash during recent raids on properties linked to Najib, who became a key suspect in the 1MDB scandal after a suspicious transfer of US$681 million allegedly linked to 1MDB was discovered in his personal bank account.
Najib has consistently denied any wrongdoing and explained the millions of dollars discovered in his account were a gift from a Saudi royal.
Lim has said the finance ministry and Auditor-General’s office were under Najib denied access to certain accounts and reports and cited so-called “red files” that were accessible only to certain parties as impeding officials and auditors from carrying out their due diligence duties. He also said the finance ministry, as many suspected, had propped up 1MDB by paying its debts though no exact figures have been disclosed.
Analysts believe the recent selloff of Malaysian assets was mainly sparked by looming concerns over the nation’s debt level, causing some in the financial press to take issue with Lim’s cards-on-the-table and Mahathir’s take-no-prisoners approach to the previous government.
Bloomberg columnist Andy Mukherjee, for one, described Lim as “taking a sledgehammer to 1MDB” while investors were “uneasy about things getting out of hand.”
Financial analysts earlier this month predicted that foreign capital would likely continue to flee the country. Still, foreign inflows into Malaysian stocks in 2018, estimated at US$635 million, are the highest as a percentage of market capitalization in the Asia Pacific according to Credit Suisse Group analysts.
Despite funds flowing out as rapidly as they previously flooded due to uncertainty around the new government’s policies, Lim maintains that Malaysia’s economic fundamentals remain strong, citing a stable financial sector and well-capitalized banks. Harapan has also framed radical cost-cutting measures as a buoy for investor confidence.
This week’s cancellation of the multibillion-dollar Kuala Lumpur-Singapore HSR project was taken as a measure to curb spending and future debt. The 350-kilometer rail system would have cut travel time between the two cities from about four hours by car to 90 minutes by train. Singapore and Malaysia signed a binding agreement to construct the HSR in 2016.
Aborting the project will force the Malaysian government to pay compensation to Singapore. Mahathir has said Malaysia would study to what extent compensation could be reduced. Singapore has already acquired private land intended for the line’s terminus and would be expected to defend the deal’s compensation clauses.
HSR would have been one of Southeast Asia’s costliest ever bilateral infrastructure projects if completed. Analysts have estimated that final costs would range from US$12.5 to US$17.5 billion (50 to 70 billion ringgit).
Mahathir recently told the Financial Times that government cost estimates for the project were US$28 billion (110 billion ringgit), further stirring market confusion about the project. He has said his government could revisit the project once Malaysia restores its finances.
Another project now being assessed is the East Coast Rail Link (ECRL), financed by a US$14 billion (55 billion ringgit) loan from the Export–Import Bank of China. At least US$3.2 billion (13 billion ringgit) has been paid to China Communications Construction Company, which was appointed the contractor without an open tender.
ECRL aims to link the South China Sea in Malaysia’s rural east with the western seaport of Klang and the strategic shipping routes along the Strait of Malacca, shortening sea-bound shipping by way of freight transport over land, while touting to provide Malaysians with economic benefits and skilled employment opportunities.
Prior to his election, Mahathir cautioned against some foreign and Chinese investments in large-scale infrastructure projects over fears that Malaysia could be forced into sovereignty-undermining deals if unable to service its debts to Beijing. It has not been made public how much of Malaysia’s national debt is held by Chinese entities.
Mahathir has not yet directly addressed the issue of Chinese development projects and it remains to be seen whether the terms of ongoing projects can be renegotiated or cancelled. Analysts have mixed views on the potential effects of ECRL’s cancellation, though some believe planned infrastructure projects could overheat the economy and stoke inflation.
A recent economic forecast by Singapore’s DBS Bank predicted GDP growth in Malaysia would slow to 5.0% in 2018-19, down from 5.4% in the first quarter of 2018. The report indicated that private consumption would still drive growth following the removal of GST and potentialy spur new private investment.
To maintain the current fiscal deficit of 2.8% of GDP, Malaysian authorities will need to cut back on public investment and spending, potentially slowing GDP growth in the process. DBS believes the reintroduction of a Sales and Services Tax (SST) will not be enough to offset the revenue shortfall expected from the rescinded GST, though higher oil global prices promise to give national coffers a new boost.
Lim told the South China Morning Post in a recent interview that expenditure cuts, higher oil prices and increased dividend contributions from government-linked firms would enable Malaysia to maintain its fiscal deficit at near 3%.
While the political earthquake and financial revelations in Malaysia may have spooked some foreign investors, many Malaysians regard Lim’s candor and forthrightness as a breath of fresh air. Despite ballooning debts and flagging confidence, at least Malaysia’s new authorities seem to have a transparent plan.