Recent events could give one a sense of déjà vu that Malaysia is setting itself on a similar path to Brazil.
Najib Razak, the Malaysian Prime Minister, has seen his popularity plummet with a recent mass demonstration in Kuala Lumpur calling for his resignation. Just as Dilma Rousseff has been tainted by the Petrobras scandal, so Najib has found himself tainted by the scandal embroiling 1MDB (the sovereign wealth fund that has been his ‘brainchild’) where he is chairman of the advisory board. 1MDB got into difficulties by becoming overly leveraged with USD11bn in debt but it is also facing accusations of the misappropriation of its funds; close to USD700m is alleged to have found its way into a bank account associated with Najib Razak from an un-named Middle Eastern donor. To make matters worse, Najib has dismissed various officials, including the attorney general who was coordinating an investigation into 1MDB, prompting Dr Mahathir to comment in an interview “I think at some stage he has to go because today he has undermined the legal system.”
This scandal is now extending beyond Malaysian boundaries as reports suggest the US Justice Department is investigating transactions related to misappropriation at 1MDB as part of international corruption investigation. There are also reports of US investigations into real estate deals involving Najib Razak’s stepson and Jho Low, a businessman caught up in the 1MDB scandal. Hong Kong and Switzerland are also reported to be investigating bank accounts alleged to be linked to Najib. Inevitably, this scandal seems to have further to run; Najib’s announcement to improve transparency and that state funds will invest USD4.6bn in the stock market is unlikely to restore investor confidence.
The Malaysian ringgit, although not yet as bad as the Brazilian real, has been amongst the worst performing currencies against the US dollar this year taking the exchange rate through 4.4 intraday and beyond the Asian Crisis low. Tan Sri Dr Zeti Akhtar Aziz, the governor of Bank Negara Malaysia, earlier this week cited the following factors as pressuring the ringgit: a stronger dollar in anticipation of the Fed starting to normalise rates; the impact of slower growth in China (Malaysia’s largest trading partner) and the domestic situation. On the latter she said “we don’t need any more scandals. We don’t need political uncertainty. When they resolve all the issues relating to 1MDB, then we will see a recovery in our local currency.”
A clear negative is the decline in Malaysia’s foreign exchange reserves which have shrunk by USD20.7bn since the start of the year and, as at the 15 September, amounted to USD95.3bn; this is sufficient to finance 7.3 months of retained imports and is 1.1x the short-term external debt. Malaysia, like Brazil has some exposure to commodities (oil and gas amounts to ~15% of GDP), so its fiscal deficit and external accounts are coming under some negative pressure, although it still expected to retain a current account surplus of ~2-3.5% of GDP in 2015. Government debt to GDP was ~53% in 2014 but Moody’s note that only 3% of total government debt is foreign currency. In terms of 1MDB the government has a MYR5.8bn explicit guarantee that could potentially be triggered.
However, unlike Brazil, Malaysia has the luxury of starting from a firmer footing on its economic metrics and sovereign rating; the Malaysian sovereign is rated A3/A-/A- by Moody’s, S&P and Fitch respectively with positive/stable/stable outlooks. Fitch commented in response to the demonstration in Kuala Lumpur calling for Najib’s removal that “weak governance is already factored into the sovereign rating.” At this stage, “economic factors - including progress in fiscal consolidation, the resilience of growth, and renewed pressures on the external finances - remain more important for now in the agency's assessment of the credit trajectory.”
Even if Malaysia is put on negative watch and downgraded, it has 3 notches of cushioning before being threatened by relegation to the realms of ‘junk’. But while the ringgit has been punished, our models suggest our Malaysian USD Eurobond universe in general, excluding 1MDB bonds, is still only trading around 1-2 notches cheap.