http://www.nst.com.my/news/2015/09/riding-out-volatile-global-trends-strong-fundamentals
Riding out volatile global trends with strong fundamentals
By Mustapha Kamil and Rupa Damodaran - 18 September 2015 @ 11:01 AM
Question: We are going through a rough patch, what with latest developments in China and other countries. Are we really facing stormy days ahead of us in terms of the domestic economic picture?
Answer: This is going to be a challenging period, and much of it as a result of global and regional developments.
First, the world hasn’t recovered as it should have from the global financial crisis. The recovery has been very slow, particularly in Europe. Even in the US, seven years have gone by and it hasn’t exited from the policies that were implemented at the height of the crisis. Extreme measures in terms of quantitative easing have been tapered but they have not raised interest rates yet.
Many of the emerging markets, including China, undertook policies to rebalance their economies and to restructure. As a result, this has led to some slowing of their economies.
So around the world, global demand has slowed and this, of course, has an impact on our economy.
Then, uncertainties have increased in almost every area at the same time — uncertainty as to when the policy adjustment might happen, the uncertainty of the direction of commodity prices, oil prices, in particular, and the uncertainty relating to the financial reforms that are taking place in the world economy — all these are generating volatility in the financial markets. Cumulatively, these developments generate conditions that are likely to persist for a long period of time.
Question:
Technically, if the US is on a strong footing, it will raise the interest rate.
If China is weak, it will push down the rate. How good is US and how weak is
China?
Answer: Firstly, the US is already on the road to recovery. All the numbers show that the growth is improving, the unemployment level is reducing and consumption spending is improving. Even investments are taking place, so they are now looking at a window of opportunity to start raising rates.
I don’t think moving the rates from zero level to higher rates is going to derail their growth process because it looks like they have improved their underlying fundamentals. That would be positive for us because they are our second largest trading partner.
However, this has been made difficult by the unstable conditions currently prevailing in the international financial markets. In China, they had excessive investment activity. They were like us during the 1990s where the economy was overheating arising from significant over-investment that reached 42 per cent of GDP.
It generated excess capacity and they don’t have enough consumption demand. They are now rebalancing their economy by reining in these excesses and strengthening their consumption activity. They have also undertaken other financial reforms and developed their financial infrastructure. To us, all these moves by China are very positive and will secure a growth that will be more sustainable. If they did not take these measures, China would be more vulnerable to destabilising conditions and this will have a negative impact on our region.
The fact that they have undertaken these kinds of measures is positive for us because it increases the prospects over the medium and longer term, their economy is going to be more sustainable and will be a positive factor for the Asian region. This is important for us because they have a significant influence the whole of Asia. I would like to see their future as more sustainable and I believe the kind of policies that they are taking now will ensure they increase their prospects for achieving such an outcome.
Question: Is this what they call “new normal” for China, no more robust growth but more stable and sustainable growth?
Answer: Growing by more than 10 per cent is just like us in the 1990s when we were bringing in the eight to 10 per cent growth and as we saw it was not sustainable. At the time, we also had a deficit in our current account in the balance of payments and high inflation. For years afterwards, our investment didn’t recover because we had excess capacity.
Question: We did quite well from the global financial crisis because of the restructuring that we did in 1997/1998. Are you saying that we are better prepared now if there is eventually a problem?
Answer: Yes. Even if we were to experience setbacks, we can bounce back. Why we can do so is because we have the fundamentals — we have a financial system that has remained solid throughout the global financial crisis and throughout this period of financial volatility. And the world is experiencing these volatilities for more than one year now. Actually, the reversal in capital flows began in September 2014, and now is September again. So, it is about one year. Despite that, we have had a growth of five per cent. Our banks are still lending. There is no disruption on the lending activities by the banking system.
Question: Have we diversified our economy from 1998 to now?
Answer: The economy is now driven by domestic demand. It is the main driver of growth. In the 1990s, we were an export-led economy. Now, we are driven by domestic demand. We are growing between four and five per cent which is a favourable growth in this kind of environment in which world trade has slowed. Secondly, we have diversified within economic sectors. We have a services sector which used to contribute 40 per cent to our economy, now it has risen to 55 per cent. The manufacturing sector is now 25 per cent. So if we add up, more than 80 per cent of our economy comes from the manufacturing and services sector. We are now less dependent on oil and commodities.
Question: Why is the ringgit the worst performer among Asian countries?
Answer: This is a strong dollar story. Let me tell you that. More than 120 currencies have depreciated against the US dollar. So we are not alone in experiencing the depreciation. Then, those oil producers and commodity producers have depreciated much more than the others that depreciated against the US dollar. It reflects the strong US dollar. In Malaysia’s case, we also have domestic issues that have affected sentiments and confidence. These things need to be resolved because at least that would contribute to the recovery in our currency.
Question: How big a part do domestic factors play in the depreciation of the ringgit?
Answer: There are many countries apart from us which have domestic factors such as political uncertainty affecting their currencies too…. in Latin America and other parts of Asia.
For us, it is a new phenomenon… we didn’t have it before. It so happens that it has now coincided with the two factors — the strengthening US dollar and weak oil and commodity prices. We didn’t have those issues as far as I can remember but I don’t think these (domestic) issues are insurmountable, I think they can be resolved.
We would, however, have depreciated anyway as we have financial markets which are open and so we have previously experienced significant inflows and outflows and we have lived through it.
At one time, the oil price came down to as low as US$36 per barrel in 2008 but we survived it.
I would describe the current depreciation as a cumulative effect of these factors.
The point is, given these issues, they have to be urgently addressed. Then we would definitely see a recovery, improving the sentiment and confidence in our country and a recovery in our currency.
Question: The RM weakening should help exports but this is not happening, Are we in sectors which are non-competitive?
Answer: When the ringgit depreciated, had the world economy been strong, there would indeed be demand for our exports. But there is a slowing of global demand. Those in the resource-based industries may, however, benefit from this.
Question: How did the global demand situation change so fast when it was only a year ago that the oil price was more than US$100 per barrel?
Answer: It is because of the supply and the potential supply that may come on stream, in particular from the US, Iraq and Iran which was to increase. Markets usually run ahead of that outlook, and then the world economy is now facing a slowdown in demand. The increase in supply and the slower demand results in that outcome.
Commodities have also become an asset class, so they have made price
adjustments more pronounced, from that which reflects the
underlying demand and supply. It
exaggerates the price movements and it is what we have now.
Because the impact
of this uncertainties on oil revenue, the government has taken fiscal reforms
and restructuring, the oil revenue which used to contribute 40 per cent of
revenue in 2009 is now somewhere in the region of 22 per cent. They have reduced
the dependence on oil.
If the contribution to total revenue was still 40 per
cent, then it would have had a devastating effect. I know that GST is not
popular but it is something that the government has to do because the
government needs to improve its revenue position.
Question: The latest monetary
statement last Friday is supportive of our current activities. What will it
take to relook this stance — is it the US, China, commodity prices or domestic
issues?
Answer: There has been steady growth of loan demand and in the overall
growth of our economy. The interest rates continue to be supportive of the
economy. Although we may experience some moderation in growth following these
external developments, we don't see on the horizon the risk of our economy
going into a major economic slowdown.
If we see that happening on the horizon,
then we would reassess our policy. But right now we see our fundamentals
remaining strong and inflation numbers in the range we projected with our
growth also remaining in the range we have projected.
Our inflation may go
above three per cent in the first few months going into next year but for the
year generally it will be between two and three per cent. We projected that in
the few months after the GST, prices would go up. Our projection is that it
will peak in the first quarter of 2016 and then it will taper down.
We don’t
see inflation spiralling because private consumption demand is moderating to
6.4 per cent from around 8.0 per cent. In other words, it is not a factor that
drives our prices.
Externally, prices are also low so we don’t have imported
inflation. Based on these two factors, we don’t expect prices to increase
further after the first quarter of 2016.
Question: On the international
reserves which have fallen below US$100 billion. Is it alarming?
Answer: No,
we’re not alarmed as that is why we built our reserves. During the early part
of the global financial crisis, it had dropped to US$80 billion but we rebuilt
our reserves from the surplus on our current account of the balance of payments
and from the subsequent inflows.
We expect as a growth economy and with
developed financial markets, we will continue to receive inflows. We will
therefore rebuild our reserves levels again.
Just like your savings, you can
use them when you need to and after that you can rebuild them again. We will
intervene to ensure orderly conditions in the foreign exchange market and avoid
abrupt and sudden changes in the foreign exchange rate.
We are not concerned
about the level of reserves as we have seen this before when our reserves drop
quite significantly and each time we rebuild the levels.
A country of our size
does not actually need such a high level of reserves but we do it because we
want to have this buffer.
Question: Will the capital outflows continue?
Answer:
Well, that depends on our growth outlook and on the levels at which oil prices
and commodity prices will stabilise. Clarity on the direction of monetary
policy in the US and when the conditions in China will stabilise and when our
domestic issues get resolved are important.
Once that happens there will be a
great chance that our currency will begin to appreciate and inflows will
return. Why? For two reasons, we are an economy that is experiencing growth and
because we have a highly developed financial market. Our bond market is well
developed and the largest in Southeast Asia.
These are factors which will draw
inflows into the economy.
Prior to these reversal in capital flows we were
among the economies that experienced the higher inflows and our currency
appreciated much more than others during that period. The only other country in
the region which appreciated much more than us is Korea.
Question: Will we see
a free fall of the ringgit if there is a reversal of all the inflows?
Answer:
No, as not all capital flows are short-term.
Many are also long-term
investments. These include pension funds and certain insurance companies and
they are looking at the performance of the entities and corporations that they
have invested in which would generate positive and favourable rates of return
for their investments.
They make the assessment and they recognise this is a
challenging period but because of our fundamentals and the track record, they
stay with us just like FDIs (foreign direct investments) which have been
invested in our country here for more than 100 years
They look at our
fundamentals and do not exit because of certain specific developments that are
happening. But for new investments, they may wait and see but those who have been
here continue to remain in our markets.
Question: Don’t you consider the hold
on MGS (Malaysian Government Securities) by a large number of foreign investors
as alarming?
Answer: No, it is not alarming. Despite 40 per cent being held by
non-residents, we also have significant number of strong domestic institutional
investors like EPF, Tabung Haji and the insurance industry which has reached
greater degree of maturity. The insurance industry is an important segment of
the financial system which demand longer term investments because of the nature
of the business. They are an important player in our bond market, fixed income
market and then you also have the asset management and wealth management funds.
So if foreigners sell the papers our own institutional investors will step in
to buy them.
The papers that have been sold are mostly the Bank Negara bills.
They sell them as they are the most liquid and they don't experience any
significant loss.
While there is a good secondary market for MGS, but they start
selling the most liquid instruments first and then the less liquid ones. So far
there is no major significant adjustment in the market. Certainly there is no
collapse in the bond market as a result of sell off.
Question: It took 1-1.5
years to recover from the crisis, this time round would you be able to give a
time frame for Malaysia’s recovery?
Answer: The first question is whether there
is similarity to the previous crisis. Even though in both periods we saw the
currency depreciated. It depreciated 40 per cent during the Asian financial
crisis and by 27 per cent during the current period between September 2014 and
September 2015 but everything else is different.
Let me contrast— the economic
and financial conditions now and then which are very different.
Growth is now
five per cent. Previously it was a minus seven per cent contraction. Our
current account now is in surplus while at that time it was deficit of around
five per cent.
Our financial system now is strong, then we had many small
financial institutions which were vulnerable. We had 74 financial institutions
including finance companies and banks, which were very small. Now we have solid
banks that are even going out to expand their operations in the region.
In
terms of market correction, at that time stock market dropped by 70 per cent
compared to now, which is significantly less.
What has helped us now — we have
a more developed bond market, which is now 110 per cent of our GDP. Before, it
was only 35 per cent. This has helped to diversify and spread out the effects
of the volatility on our financial system.
Finally, our reserves level now
stands at 7.4 months of retained imports compared with only three months then.
We also have the potential now to sustain our growth given our more diversified
sources of growth. We are from a position of strength as we have diversified
the economy in three ways. One is between export and domestic demand as sources
of growth. Two is to have diversified across economic sectors and three is to
have private and public sectors as drivers of our growth.
Before, the
government had a bigger role in the economy but now it has a lesser role and
the private sector is driving investment activities and the numbers show it.
So
we have a more balanced economy and we also have the policy space and tools.
The financial system is also supporting the economy by the continued credit
growth.
For those reasons even if we are set back, we have the potential to
bounce back to generate growth. In addition, we have the policy space to support
the economy.
My assessment is: We are not talking about the same conditions
prevailing during the Asian financial crisis.
If we took 1.5 years to recover
then, we are going to do in a shorter period of time now, given the
strengthened position prevailing now.
But we need to be vigilant and address
any areas of weaknesses that we have and resolve the problems that we have.
Question: What are the inherent weaknesses we still have?
Answer: In our
aspirations to achieve high value-added activities, we need to move faster
through improving our education, innovation and improving our productivity and
efficiency levels.
Question: Is our external debt level too large and
unnerving?
Answer: No, the government relies on domestic market and we have a
developed domestic bond market. For the corporate sector, the external debt is
also at manageable level.
Those with external debt also have foreign income and
so they are able to sustain the repayment of those debt serviced.
We need to
look at the components of our external debt. Some include the operations of the
commercial banks and their liabilities are matched by assets.
Some are
inter-company loans, those too are not of a concern.
Look at the real corporate
sector and see how much funds they have borrowed from foreign banks abroad and
how much they have accessed the international capital market.
I believe that
amount is about 30 per cent of total external debt.
Much of such businesses
also have foreign income to service their debts. They have investments abroad.
Their foreign investments abroad generated income for them so it becomes a
natural hedge.
Those who don’t have such natural hedge have actually hedged the
foreign borrowing, so they don't have the risk if the currency depreciates.
Only a part of the external debt is vulnerable to the currency movements.
Question: The Government called for GLCs (government-linked companies) to bring
back money to support the ringgit. Is it a supportive move?
Answer: Bringing
back your foreign currency investments now will be worth more in ringgit terms.
Those who have opportunity to do so will be taking profit on their investments.
Their investments would have appreciated by 27 per cent which is huge.
This is
an opportunity and it will be an inflow that will support the value of the
ringgit. Many of them have massive investments abroad and can take advantage of
the circumstance.
Question: Are our investments abroad more than the external
debt level?
Answer: We have an inflow of FDIs and also an outflow of FDIs by
our people. That now exceeds the inflow. These are by our pension funds,
sovereign wealth fund and other investment corporations.
Yes, we are an
exporter of capital now and, yes, it would support our currency if there was a
reversal in their investment activities. But it has to be at their discretion
and judgment call.
But such domestic investment activity would support our
overall economy and the currency and would signal confidence in our own economy
that there are opportunities for investments here as well.
Read More : http://www.nst.com.my/news/2015/09/riding-out-volatile-global-trends-strong-fundamentals
Read More : http://www.nst.com.my/news/2015/09/riding-out-volatile-global-trends-strong-fundamentals
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