Is the 1997/98 spectre on hand?

By Stephanie Jacob

A decline in the stock market accompanied by a falling ringgit have raised the spectre of another Asian financial crisis ala 1997/98. However more than a decade and half later, is Malaysia as vulnerable as it was then or are its fundamentals strong enough to weather this recent bout of volatility?

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Words like sell-off and contagion are worrying to say the least and when they are used in the context of a nation’s economy, can have a serious impact on investor confidence and economic stability.

The year 2014 started off with these words being thrown around as a massive sell-off that began in some emerging markets, spread quickly to all the other so called emerging markets around the world, including Malaysia.

Following the sell-off, numerous (and often contradictory) reports were published as the views of policy makers, economists and fund managers were sought to make sense of why foreign funds were exiting the emerging markets, at what appeared to be a very significant pace and what it all meant for the affected economies.

In the wake of some very bleak reports in the media, the question on the minds of most Malaysians appeared to be if the country is heading towards a crisis akin to that of the Asian Financial Crisis of 1997/1998.

The short answer to that appears to be, no.

To understand why that is, it is necessary to both look back at the situation the country was in at the point of the 1997/98 financial crisis and to compare Malaysia’s fundamentals to the emerging markets at the forefront of this sell-off known as the ‘fragile five’ – whose fundamentals are not as strong.

What happened in the Asian Financial Crisis

It is generally agreed that many of the countries that fell into the financial crisis of 1997/98, did so because of their weak macroeconomic fundamentals.

Key among these was that most of the countries had been, and were recording current account deficits leading up to the crisis. In Malaysia, the current account deficit stood at about 3.7% just before the crisis hit.

Recently a researcher at Morgan Stanley coined the term ‘fragile five’ to collectively describe the emerging markets of Brazil, India, Indonesia, South Africa and Turkey which are seen as the most vulnerable to the fallout from the US Federal Bank’s decision to begin tapering its bond buying programme. The causes for concern in these economies were identified as their high dependence on foreign investment and current account deficits.

In contrast, the latest numbers released just earlier this evening show that for the year of 2013, the current account recorded a RM37.3 billion surplus.

Despite fears earlier in 2013 that the country’s surplus was rapidly declining, the final figures for the year 2013 seem to be allaying concerns somewhat.

Group chief economist for RAM Holdings, Yeah Kim Leng noted that “the earlier concern of the current account balance turning deficit now has been proven wrong, we are seeing a widening of our current account surplus and that is expected to continue this year, with expected improvement in our export growth momentum.”

Furthermore said Yeah, unlike in the past and in contrast with the fragile five economies Malaysia’s exposure to foreign currency debt is “very low and importantly, our reserves (country’s foreign currency reserves) level is more than sufficient to withstand any sharp outflow in foreign portfolio capital.”

In latest figures released earlier this week, Bank Negara Malaysia reported that its international reserves amounted to RM436 billion (equivalent to US$133.1 billion) as at Jan 30, 2014, which is sufficient to finance 9.4 months of retained imports and is 3.6 times the short-term external debt.

At the point of the 97/98 crisis, reserves were only sufficient to cover three plus months of retained imports.

The other big concern with the fragile five economies is the depreciation of their individual currencies against the US dollar since quantitative easing was announced.

While Malaysia was not immune, and the ringgit too depreciated against the greenback hitting a 52-week low on Jan 27, 2014, nonetheless there are signs that the tide is already beginning to turn, with news reports suggesting that ringgit volatility will decline to an 11 month low on the back of a widening current account surplus.

Quantitative easing tapering and its impact on Malaysia

The impact of quantitative easing tapering which is expected to drive some foreign funds to reverse capital flows out of the emerging markets and back to the United States, remains the biggest concern to these markets including Malaysia. That being said, the large sell-off in January is seen by economists as being indiscriminate.

Yeah said that this fear of contagion in the emerging markets meant that Malaysia was lumped together with all other emerging markets and put into a common asset class, irrespective of each individual market’s strengths or weaknesses.

He added that while there had undoubtedly been some rebalancing among the foreign funds since the US Fed’s announcement, the outflow has been “more than adequately been offset…and has been well absorbed by our domestic institutions.”

So while the capital outflow has resulted in some gyrations in the market, Yeah anticipates that Malaysia is not likely to be faced with the same magnitude of a crisis that might be felt by some of the other emerging markets.

His points are echoed by Royal Bank of Scotland plc’s (RBS) managing director and head of economic research Sanjay Mathur who said while the “taper of the QE is never pleasant”, the recent spate of capital outflows should be attributed more to indifferent selling and is unlikely to be a recurring incident.

Using countries like Argentina and Turkey as examples, Mathur emphasised that their local conditions there were simply not the same as that of Malaysia, and that the latter’s health should not be viewed through the same lens. “We do think that some degree of distinction and discrimination will come in 2014,” he said.

Mathur added that he believed that the taper “will by itself have a small impact on exchange rates and the ringgit, as bond yields in Malaysia have already adjusted by around 100 basis points over the course of 2013, and the trade surplus is no longer narrowing.”

Furthermore concerns over currency depreciation leading to a full blown crisis, are also overdone and unfounded and Mathur said that he believes that “Malaysia’s currency remains as competitive…and we are not sitting on major imbalances.”

Another often identified concern in Malaysia’s scenario is the high amount of foreign ownership of local currency bonds and the fear of what will happen should these investors start heavily selling these bonds.

However Mathur says that it is not that clear cut, explaining that when investors participate in a particular bond market they base it on the fundamentals (which are relatively strong) and that furthermore in the Malaysian context there appears to be a growing number of long term players (possibly foreign central banks or sovereign wealth funds) who have a lot of holding power, and this somewhat insulates the market.

In addition, a recently released Credit Suisse report noted that foreign bond holding had fallen from 49.5% to 45.1% since May 2013.

Can the QE bring benefits?

While the tapering of the QE in itself is a disruptive process to many emerging market economies, including Malaysia and does not offer any direct benefits to the economies – there are some positives that can be drawn from the strengthening of the US economy (which allows for QE tapering to be undertaken).

Being a net exporter, an improvement in the US market presents an opening that can be capitalised upon by Malaysia.

RAM Holdings’ Yeah explains that Malaysia “can benefit in the trade and investment channel of growth even if the financial channel is feeling the effects of the withdrawal of foreign capital – which will likely be short-term, and mitigated when the real economy shows improvements through the trade and investment channel.”

With Malaysia’s fundamentals being substantially stronger than it was in the buildup to the Asian Financial Crisis, and with a measure of discrimination beginning to be applied to the conditions of the individual emerging markets by the foreign funds – a crisis akin to that seen in 1997/98 appears highly unlikely.

“There may be another sell-off this year but there is not going to be a sell-off from January to December, month after month. Volatility is here to stay, but momentum is strong, fundamentals are good and inflows are expected to be stable,” concluded Mathur.

Yesterday: Is the sell-off relevant to Malaysia

Tomorrow: The Market Impact