Saturday, July 5, 2008

Political power wrestling - who is the biggest loser?

The Star Online: Business - BizWeek

INFLATION is roaring, consumer confidence cratering, world economies cooling, commodities skyrocketing, currencies weakening, equities on the bleeding edge and businesses turning cautious. Meanwhile, sodomy/sexual allegations are being hurled all over the place.

That pretty much wraps up the perfect storm over the past week, correct?

Nope. It actually describes what happened in 1998.

For Malaysians, it’s the potent combination of political and economic crisis deja vu. It’s time we decoupled economic crisis from snarky politics. No, really.

As Malaysians grapple with the rising temperature in the political climate and their sentiments swing like ping pong on the mud-sling machine politics, pocketbook issues may hop on to the back seat. But if that’s true, then it’s a dangerous distraction. For all’s not that rosy on the economic front.


Some parallels may be striking (between 1998 and now) but truth is, the political and economic dimensions are starkly different today. For one, the Malaysian economy is a lot more resilient today to withstand external shocks.

Still, record high commodity prices and the unprecedented rise of world oil prices are pounding the pressure on inflation and creating some hardship among the general populace. A tottering US economy has also heightened the vulnerability of economies all over the world.

Also today, Malaysia has arrived at political crossroads. The political scenario has been fluid since the outcome of the general election. Key projects announced earlier have been delayed while some others under the Ninth Malaysia Plan and development corridors have been scrapped.

Businesses are finding it difficult to lure foreigners in and investors remain wary against the backdrop of such uncertainty.

Amidst all the scurrilous and demonising political posturings, Malaysians can be forgiven if they are finding it a tad hard to grasp the scale of the economic anxieties they potentially face.

The bigger worry really is this – can our leaders/policy makers transcend these distractions and formulate policies to help us ride the economic uncertainty or will they be afflicted by a bad case of “policy paralysis” as an analyst aptly puts it?

Triple whammy

Clearly, there are doubts and with that, it turned out to be a week of perfect storm in Malaysia on so many levels. For the stock market, it suffered a dramatic eye popping sell off on a triple whammy of factors –political mud slinging, rising oil prices and weaker external environment and lastly, and most – unexpectedly this – Bursa Malaysia had to halt trading on Thursday due to some major technical glitch.

(Key world indices had also performed dismally over worries of rising oil prices and weak US data that dogged the market throughout the week).

The trading halt on the Malaysian stock market due to a technical glitch was an extraordinary coincidence as share prices have been plunging dramatically since the start of the week. And while it is understandably a major beef for market participants and the exchange deserves flak thrown at it for the system error, major exchanges such as New York, London, Australia, India and key Asian exchanges have also faced similar software glitches in the past although halting trading for the whole day appears unprecedented. A repeat of such performances would be far too testing for investors.

Foreigners have been gradually slashing their exposure to Malaysian equities since March. A local research house points out that many foreign favourites have suffered severe beating; Gamuda Bhd, SP Setia Bhd and Air Asia Bhd have seen their value halved year to date. Stalwart stocks like Genting Bhd and Resorts World Bhd have plunged by almost half from their 2007 peaks and valuations are even below the SARS level.

Even so, the analyst points out that foreign shareholding in the local bourse and their persistent selling is an “overhang against any big rebound”.

The flipside – the analyst says – “the depressed share prices of stocks with high foreign shareholding is an opportunity to accumulate positions gradually”.

Oil shock

At the epicentre of the world’s economic dilemma is the persistent rise of oil prices. World oil price hit a record high of US$145/barrel late in the week. It has more than doubled over the past year over a multitude of reasons – weak US dollar, overzealous speculation, surging demand and lower oil inventories and concerns on conflict in the Middle East.

The oil shock continues to reverberate throughout world economies and even as “bourgeois” analysts churn out mind bogglingly bold predictions that oil may reach US$200/barrel, there are not many who dare scoff at such predictions, cognisant of the fact that oil prices over a year ago stood at US$65/barrel.

The US “credit crunch” which begun in the summer of 2007 continues to be a threat to global economies. The housing crisis and financial losses suffered by the US system has yet to show any signs of abating.

Just over the week, Malaysia cut its forecast for export growth from 7% to 6% citing slowdown in US, its largest trading partner.

Malaysia’s GDP growth has also been cut twice in a span of 12 months. The official 2008 real GDP growth forecast stands at 5%-6% and the authorities have recently admitted that it may come in at the lower end of this range.

Tide shift

More significantly, the tide of fiscal policy appears to be shifting as global inflation gathers steam.

Up until recent weeks, central bankers were eager to stave off cooling economies by adopting a loose monetary policy at the expense of a possible inflation breakout.

And for as long as the world’s largest economy US under the stewardship of the Federal Reserve was ‘slash happy’ (the Fed has cut rates by 325 basis points from 5.25% to 2% in seven consecutive meetings between September 2007 and April 2006), it seemed like an acceptable strategy.

The turning point arrived not too long ago. At the June 25th Federal Open Market Commitee (FOMC) session, the Fed left the federal funds target rate unchanged at 2%. It sent a clear signal that the Fed was getting ready to do battle with inflation.

The neutral stance by the Fed that it may reverse its pro-growth policy, sent echoes all over. Central bankers in Vietnam, India, Indonesia and the Philippines recently raised interest rates while China’s central bank did not ruled out raising rates to fend off inflation.

On Thursday, the European Central Bank raised interest rates by a quarter of a point.

Inflation creeping up

In Malaysia, like in many other parts of the world, creeping inflation is a major fret factor on the back of rising fuel and food prices .

Bank Negara governor Tan Sri Zeti Akhtar Aziz recently said Malaysia’s inflation is likely to hit 6% to 7% in June (it rose 3.8%, a 22-month high in May). Most expect July’s inflation to spike up by 8% as the higher electricity tariffs kicks in this month.

Malaysia’s June headline inflation is worrying, but some of its South East Asian peers are worse off even if the gap is somewhat narrowing. In June, Indonesia’s inflation rose 11.3%; Vietnam by 26.8% and Thailand by 8.9%S.

With that, analysts who only two weeks ago seemed noncommittal on the direction of interest rates, have suddenly seen the light – there is wider consensus now that Bank Negara may tighten the screw a little on its accommodative monetary policy by raising the Overnight Policy Rate (OPR) by some 50 basis points this year. (note: a rise in OPR will likely cause banks to increase the rates for deposits and loans.)

“It is a question of when, not if. Rates will be heading higher” says TA Research.

Will higher rates hurt or help?

Central banks tinker with interest rates to prop up a sagging economy by slashing rates or root out inflation by raising rates.

Higher interest rates strengthens the currency and curbs inflation by raising the cost of borrowing, thus restricting rapid credit growth that has increased the money supply.

The downside of higher rates is that it slows economic growth as cost of borrowing for businesses and individuals goes up. Central banks have to constantly juggle these priorities depending on which is a bigger threat but eventually, something has to give.

With that, concerns over a possible stagflation – inflation and stagnation – has resurfaced. Stagflation, a central bank’s worst nightmare, is a combination of sliding demand and rising prices.

Even if Bank Negara has historically not raised interest rates in a reactionary manner, Malaysians would do well to prepare themselves for such an eventuality. “Higher rates mean more hardship as it increases the cost of servicing our debt.

We have to be prepared for that, over and above the painful rise in food, electricity and fuel prices,” says an analyst.

Higher borrowing cost will crimp loans growth and lead to a weakening in asset quality in the banking sector, which in itself poses another major headache.

But there are mixed views on whether rate hikes is the way to go. Recently, Second Finance Minister Tan Sri Nor Mohamed Yakcop pointed out that if inflation is driven by consumption, reducing rates would have the desired effect. On the other hand, raising rates to root out cost-driven inflation - which is what we are facing currently - would be ineffective.

Given the “commodity cost-push” nature of the present inflationary episode, Aseambankers says it is more likely that “non-interest rate” measures will be used to deal with inflation.

The question is ...

Is it time to work the worry beads?

Can we dodge the bullets thrown at us by the global economic dilemma?

Or will politicking and internal strife leave Malaysians staring down at the barrel of economic woes a little too late to cushion its staggering blows?

Bottom line - we need someone to connect the dots for us, not throw them out of whack.

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