Tan Sri Dr Zeti Akhtar Aziz on Malaysia Financial status~ NST interview Part 2/2

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.

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