by Gillian Terzis
Australian Business Review
5 OCT, 2015

Markets around the world have endured a wild ride in recent times, as global events conspire to spook investors into rash decision-making. Nowhere is this phenomenon more pronounced than in emerging economies.

Take, for instance, Malaysia’s economic struggles. The Malaysian ringgit has been one of the poorest performing currencies in the world, shedding 26 per cent against the US dollar this year and plumbing to a 17-year low of 3.9 ringgit against the greenback. An analyst note from Merrill Lynch illustrates that in some respects, Malaysia appears in weaker shape than it was in 1997 at the time of the Asian financial crisis. For instance, household debt as a share of GDP is now at 86 per cent, compared with 46 per cent in 1997; public debt as a percentage of GDP has climbed from 31 per cent in 1997 to 54 per cent today.

The steep correction in commodity markets hasn’t helped the country either. The commodities upon which Malaysia is heavily reliant (palm oil, petroleum, and rubber) have endured precipitous declines, with little reprieve in sight. The probable downward trajectory of crude oil prices in the short to medium term is certain to inflict even more pressure on the beleaguered currency.

Moreover, the rhetoric and actions undertaken by Malaysia’s federal government are likely to disabuse one of any optimism, no matter how cautious, for the country’s economic outlook. It has been alleged by the Wall Street Journal that RM2.6 billion ($840 million) had been transferred into the personal accounts of Prime Minister Najib Razak from companies connected to 1Malaysia Development Berhad, a heavily indebted state-owned strategic development company. Razak has since shut down an investigation into his administration’s alleged graft and mismanagement of state funds.

Unsurprisingly, these revelations have weighed on investor sentiment, with foreign investors withdrawing some RM11.7bn out of equities markets to date. The country’s bond markets are also a source of vulnerability, with big moves recorded in the lead up to the maturation of RM8.2bn of government debt on October 15. (Commentators have expressed concerns about the country’s rapidly waning currency reserves.)

RHB Banking Group credit strategist Fakrizzaki Ghazali told Malaysian newspaper The Star that “the funds that were redeemed but not repatriated look likely to be reinvested, although current volatility means timing will be a major issue”.

Swings of nearly 1 per cent on Malaysian government bond yields in the past fortnight highlight the unpleasant reality that volatility is now the ‘new normal’ for all sorts of asset classes — commodities, equities, bonds — around the world.

But these struggles are not unique to Malaysia. Its neighbour (and South-east Asia’s largest economy) Indonesia has seen the value of its stockmarket decline by 21 per cent and the rupiah’s rout has been similarly relentless. It’s a similar story in other emerging-market economies like Thailand, Sri Lanka and Vietnam, which are highly exposed to global capital outflows and are burdened by a large share of US dollar-denominated debt. With the greenback poised to strengthen and the Fed on track to hike rates, these emerging market economies will be confronted with an increase in the value of these debts and their associated servicing costs.

As the Federal Reserve marches towards policy normalisation, many observers fear a redux of the events that followed the Fed’s ‘taper tantrum’ of 2013, which saw investors pull $US53.8bn out of emerging market equity and bond funds between May and September 2013 — a move that completely destabilised emerging markets. Today, investors are already scrambling for the exits and slashing their exposure to emerging market debt as the prospect of a Fed rate hike draws nearer. Meanwhile, within countries like Malaysia, there are those who view the confluence of these developments as portents of an event of worse magnitude: regional contagion on the scale of the Asian financial crisis.

These fears, however, may be overblown. Economist Nouriel Roubini wrote in an article published on the Project Syndicate website that “significant turbulence” as a result of the Fed’s actions in emerging markets will be inevitable, “but the risk of outright crises and distress is more limited” — primarily because the outbreak of the Asian financial crisis forced many countries to implement drastic fiscal and market reforms. He does note, however, that a Fed rate rise will be calamitous for countries with “macroeconomic and policy fragilities” and that are heavily dependent on external borrowing.

Still, even if Roubini’s assertion proves correct — that the Fed’s action will cause a temporary period of market volatility, rather than prolonged pain — there’s another elephant in the room. A slowdown in the Chinese economy could trouble the region, particularly for those countries that depend on commodity exports. Diversification of exports is, of course, one way to hedge against such a downturn and build economic resilience, but for countries like Malaysia and its peers, it may be a case of ‘too little, too late’.

The combination of an anaemic global trade environment and the impotence of monetary policy will heighten emerging-market vulnerability amid stiffening headwinds. With their weapons to boost growth somewhat depleted, emerging economies will find themselves in a bind — one that could present a setback for advanced economies.