Expect Continued Asian Currency Weakness,
Malaysia However Faces Real Structural Problems.
Posted 31st August, 2015 by IPM Group
The title of this piece is a little of a misnomer as it is not just Asian weakness we face, but the whole emerging markets from South America to Europe onwards to the Middle East and then Asia. But we are focused on Asia at the moment so let us continue.
I wrote and forewarned what we face in the article I posted on March 15th entitled “9 Trillion US$ Carry Trade That May Take The World Economy Down, What is it exactly?”
We also warned about stock market corrections are on the horizon dated the 25th May see here
As a reminder: The Asian crisis of 1997 to 1998 was due to the deleveraging event of the carry-trade of that time, which simply engulfed Asia as the interest payments of it’s foreign denominated debt doubles and even triples relative to their investment income stream in their own domestic currencies due to their currencies collapsing.
This particular event in history was down to a carry-trade estimated at approximately 1 to 2 trillion US$.
Today this world carry-trade is estimated at between 9 to 10 Trillion US$ - Do you see the problem here ?
So let us compare numbers behind Malaysia of 1997 to 2015 - We are pointing out Malaysia in particular not due to any political leanings whatsoever, this is purely a macro economic fundamental view point, which stands out due to the country's exposure to foreign denominated debt (US$).
From Bank of America
Concerns that Bank Negara Malaysia may re-introduce capital controls is resurfacing after the ringgit plunged past RM4 against the US dollar, with FX reserves dropping below the $100bn psychological threshold. The MYR has depreciated by 12% against the US dollar since the start of the year and by about 26% from its peak in August last year. BNM’s FX reserves fell to $96.7bn at end-July, falling below the $100bn threshold and down by about $9bn in July alone. At the peak, FX reserves were $141bn in May 2013.
During [the crisis ‘97 to ‘98], the ringgit collapsed by about 89% from peak-to-trough at its worst (to 4.71 from 2.49 against the USD). The ringgit has depreciated some 26% in the current crisis. During that episode, the KLCI fell by about 79% from peak-to-trough (from 1,271 to 263) at its worst. The KLCI today has fallen by only about 12% from its recent peak. Nevertheless, downside risks remain given looming Fed rate hikes, China’s RMB devaluation and the political crisis.
But depletion of FX reserves is more severe this time, down $44.7bn so far from the recent peak in May 2013, versus $8.2bn during the Asian crisis episode. Capital controls enacted in 1998 allowed BNM to rebuild FX reserves quickly, rising +$13bn to $32.6bn in a year (Chart 2).
This political crisis is probably the worst in Malaysia’s history, with no resolution in sight over the 1MDB scandal.
Malaysia’s vulnerability is also heightened by higher debt leverage – household, quasipublic and external – than during the Asian crisis.
Household debt is 86% of GDP (2015) , almost double that pre-Asian crisis (46%) (1997). External debt is 69% of GDP(2015), much higher than the 44% in 1997.
Even if half of external debt is MYR-denominated, foreign withdrawals will still pressure the ringgit and FX reserves.
Public debt is 54% (actually closer to 70% and above) of GDP today (2015) versus 31% in 1997. Inclusive of government guarantees, quasi-public debt rises to 70% of GDP. This moreover do not include the potential liabilities from 1MDB, including “letters of support” to circumvent the use of guarantees. Only corporate debt is lower today, at 86% vs. 105% of GDP in 1997. Government-linked companies, pension and pilgrimage funds are also facing pressures to bail-out 1MDB by taking over its assets, including power plants and property projects.
As this carry-trade unwind elevates itself with a vengeance (in the months ahead ?) just matching the falls in the MYR in 1998 will push US$ ag MYR today towards 6 from todays level of 4.17 (as of 31st August, 2015).
Now as BoA mentioned above, there has been some talk about the fear of Bank Negara (Malaysian Central Bank) instigating currency controls. This will harm Malaysia significantly in the short, medium and long term. Foreign investment will go elsewhere, plus this will also discourage any immediate investment or relocation plans from foreign companies and / or expatriates. Considering the huge property developments in Malaysia these last few years (especially the Southern State of Malaysia - Johor, on the border to Singapore) - without expatriates or foreign investment who is going to support this market exactly ?
A weaker MYR would actually benefit the country in the longer term, if the correct government policies are put in place to attract businesses and foreign capital, a weaker currency would make investment a lot more attractive proposition. Standing in the way of a weaker currency is only ever going to enormously aggravate structural problems that are already in place.
So in our opinion we do not see imminent capital controls considering this is a world event with a stronger US$ against all of Asia (including China) and not just Malaysia, however as the crisis intensifies and if the political situation deteriorates further - who knows ?
Domestically how do you hedge against continued currency weakness? Well holding gold is yet again proving to be an extremely important part of your asset portfolio going forward.
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