Nicholas Spiro
Nikkei Asian Review
March 29, 2016

Commentary

Emerging Asia’s central banks are sitting pretty, especially when compared with their Latin American counterparts.

Many of South America’s monetary guardians have been forced to raise interest rates aggressively over the past several months to combat a sharp rise in inflation, but emerging Asia’s central banks have been able to loosen monetary policy, with rate cuts in India, Indonesia, Taiwan and, most conspicuously, China.

Yet for Bank Negara Malaysia, the country’s central bank, these are challenging times.

Incumbent governor Zeti Akhtar Aziz is stepping down on April 30 after 16 years, at a time when investor sentiment towards south-east Asia’s third-largest economy remains volatile. The region’s sole net oil exporter, its ringgit currency has lost 25.5% against the dollar since September 2014, although it is up 10.5% since mid-January amid a stabilization in oil prices.

The stakes for Malaysia are high.

Zeti has proved to be one of the most credible and respected emerging market central bank governors. Since the ringgit’s peg to the dollar was jettisoned in 2005, interest rates have remained remarkably stable (with the exception of emergency cuts imposed during the global financial crisis) and the central bank’s autonomy has increased significantly. She has also been extremely candid about the reputational damage wrought by the scandal surrounding 1MDB, Malaysia’s state investment fund.

The changing of the guard at the central bank is taking place at a sensitive time for Malaysian assets. While the country’s main equity index has risen 7.5% since late January, Malaysia’s local government bond market suffered outflows of foreign capital – which accounts for nearly half of the market, one of the highest shares in developing economies – in February for the first time in five months, according to data from JP Morgan. This reveals the fragility of the recent improvement in sentiment.

While oil prices have risen 33% since mid-February, they have been more or less stable since early March, with Brent crude, the international benchmark, struggling to surpass the $40 a barrel level. This explains why the ringgit’s rally is fading, despite dovish comments from U.S. Federal Reserve chair Janet Yellen on March 29 which buoyed emerging market assets.

While sentiment towards Malaysia has been shaped mainly by external factors, the 1MDB scandal has shaken investor confidence. The country’s attorney-general has cleared premier Najib Razak, who chairs the fund’s advisory board, of any wrongdoing over a $680m payment linked to 1MDB that ended up in his bank account but Najib remains mired in the scandal amid signs he may be losing his grip on his party, the ruling United Malays National Organisation (UMNO).

The central bank under Zeti has been the only domestic institution to take a hard line on the scandal at a time when there are mounting concerns, notably among credit rating agencies, about the political and economic governance of Malaysia. On March 23, Zeti announced that the central bank had launched enforcement proceedings against 1MDB for failing to provide documentation to substantiate its decision not to repatriate $1.8bn in foreign investments.

Not surprisingly, there are growing concerns that Zeti’s successor – who will be appointed by Najib, who doubles as the country’s finance minister, once all the candidates have been vetted by the central bank – will lack the independence and credibility that have underpinned confidence in Malaysian monetary policy.

JP Morgan notes that “the current preference of decision-makers seems to be for the appointment of an outsider”, with Zeti’s successor “faced with a difficult task, as economic growth remains under pressure and fiscal policy remains constrained [by the drop in revenues stemming from low oil prices].”

An indication of whether the new governor will be willing to stand up to the government could be the extent to which monetary policy becomes more dovish after six years in which the central bank’s benchmark rate has remained in a narrow range of 2.75% to 3.25%. A sudden cut in rates could be treated by investors as a sign that the central bank has succumbed to political pressure.

Yet with headline inflation having risen to 4.2% last month – above the central bank’s 2-3% target and up from 2.7% at the end of last year – and persistent concerns about the ringgit given the scope for a renewed decline in oil prices, a cut in rates would be difficult to justify, notwithstanding the increased pressure on monetary policy to help shore up growth at a time when there is little scope for fiscal stimulus.

Indeed, Malaysia’s new central bank chief will be under even more scrutiny given the severe governance problems which the 1MDB scandal has exposed and the standards set by Zeti during her 16-year term as governor.

Zeti has set a high bar for her successor. Even if Malaysia’s new central bank chief is a respected and market-friendly policymaker, her governorship will prove a hard act to follow.

Nicholas Spiro is a partner at Lauressa Advisory, a specialist property and macroeconomic consultancy in London.