The Economic Transformation Program

My verdict: Good to Pretty Good. Liked the fact that PEMANDU is there, supposedly to ensure proper execution of the projects.

Hwang DBS: The Government held an Open Day to present ideas for the Economic Transformation Program (ETP) on various key economic sectors for the country – including oil, gas & energy, financial services, palm oil and wholesale & trade. In our view, the program, approach and selected ideas/initiatives highlighted inspire optimism. If implemented successfully, we believe the projects will be able to generate greater economic activity.

Among the key projects, we understand that the RM36bn KL MRT, which features in the Greater Kuala Lumpur plan, has received high level of commitment – increasing the likelihood of the project’s approval. Potential beneficiaries: Gamuda (High Conviction Pick; TP: RM4.35), MMC (Buy; TP: RM3.20).

The Rubber Research Institute (RRI) project was also included. Potential beneficiaries: MRCB (High Conviction Pick; TP: RM2.25), WCT (Buy; TP: RM3.60).

Other mega projects include the previously shelved RM8bn high speed train to Singapore (potential beneficiary: YTL Corp; Not Rated) and the Klang river project (potential beneficiaries: SP Setia (Buy; TP RM4.80), YTL Power (Hold; TP: RM2.50), MRCB).

The drive to improve Kuala Lumpur’s attractiveness would also benefit large landowners in the greater KL area such as SP Setia, Bolton (Buy; TP: RM1.50) and DNP (Buy; TP: RM2.25).

Implementation is key. There will definitely be major challenges to some of the initiatives. Implementation is a key test for the ETP. In our opinion, Senator Dato Sri Idris Jala and PEMANDU’s (Performance Management and Delivery Unit) role in facilitating implementation would help enhance the likelihood of success. Successful execution of the ETP would help transform the country and attract investments.

Highlights of Economic Transformation Program
Sector Initiative Potential beneficiaries
Greater KL KL MRT - received high level of commitment Gamuda, MMC
Rubber Research Institute project MRCB, WCT
High speed train to Singapore YTL Corp
Klang river project SP Setia, YTL Power, MRCB
Initiatives to make KL more attractive SP Setia, Bolton, DNP
Oil, gas & energy LNG regasification plant KNM, Dialog, Kencana
Financial services Create regional champion Maybank
Improve capital markets Bursa Msia
Promote bond market Maybank
Business Services Increase level of skilled workforce Jobstreet
Health services Promote generic drug manufacturing and export Pharmaniaga
Education Push for health services education Masterskill
Source: PEMANDU, HwangDBS Vickers Research

ETP: Macro takeaways
NKEA projects will achieve economic growth of 6%
A high income nation with GNI per capita of USD15,000 by 2020
The NKEAs will contribute over 73% of Malaysia’s GNI (USD523 billion in 2020)
92% of funding for the projects will come from private investment and only 8% from public funding
Will generate an additional 3.3 m jobs, over 60% will be in medium-income or high-income salary brackets
NKEA Labs feature 131 EPPs and 60 Business Opportunities
Source: PEMANDU, HwangDBS Vickers Research



Construction sector

From the EPPs (Entry Point Projects) for Greater KL, there were several projects that will provide opportunities for contractors.

MRT – Gamuda and MMC are potential beneficiaries of the project. Gamuda’s orderbook could double and MMC’s triple, but we believe the sector will benefit given the sheer size of the RM36bn project. Among the key projects, we understand that this project has received high level of commitment – increasing likelihood of the project’s approval.

High Speed Rail (HSR) – This RM8bn project was initially proposed in 2008 but put on hold. The lab recommended a study by Land Public Transport Commission (SPAD) and Economic Planning Unit (EPU) to determine the feasibility of the project with results to be tabled to the Cabinet by
January 2011. Potential beneficiary: YTL Corp (Not rated).

Klang river project – In March 2010, the Selangor government appointed three companies to carry out the project that was expected to attract RM50bn worth of investments. Potential beneficiary: YTL Power (Hold; TP: RM2.50), MRCB.

In addition, the Rubber Research Institute (RRI) project was among projects included in the Greater KL National Key Economic Area (NKEA). Potential beneficiaries: MRCB (High
Conviction Pick; TP: RM2.25), WCT (Buy; TP: RM3.60).

Property sector

The “Greater KL” NKEA aims to improve KL’s ranking to one of the Top 20 most liveable cities and economic cities in the world by 2020 (currently ranked 79/130 in recent quality of life survey). Initiatives proposed include:
a) Foreign magnet: Attracting 100 of the world’s top MNCs & high-skilled immigration;
b) Improved connectivity: High-speed rail to Singapore, MRT (integrated urban rail system);
c) New attractions: Rejuvenation of rivers, greener KL, iconic places; and
d) Enhanced services: Pedestrian network, solid waste management.

PEMANDU expects KL population to balloon to 10m by 2010 from 6.5m currently, creating demand for 1m new homes. Areas identified to benefit the most from transformation of KL:
a) High-impact: RMAF base @ Sungai Besi, Dataran Perdana, MATRADE @ Hartamas, RRIM @ Sungai Buloh, Kampung Baru
b) Ripe for redevelopment: Bukit Bintang, Pusat Bandar Damansara, Dataran Sunway, 1 Utama, Subang Bestari, Balakong, Serdang

Aside from GLC/Bumi developers tipped to benefit from government land redevelopment (eg MRCB, Boustead, Bolton, SP Setia, Mah Sing), owners of large landbank and investment assets in KL should also stand to benefit.



Oil and gas

PEMANDU has identified 12 EPPs and 7 BOs (Business Opportunities) for the oil, gas and energy sector under the NKEA. A 3 pronged area of focus – sustain, grow and diversify. The EPPs and BOs are expected to bring about RM76.8bn in GNI (Gross National Income) and create 52,000 jobs by 2020.

Several of the broader initiatives presented included PETRONAS strategies such as enhancing oil recovery in existing fields, developing smaller fields, and the construction of a LNG regasification terminal to meet the nation’s gas demand. However, what we understand that is making the difference is the role that PEMANDU will be playing to ensure smooth and effective implementation of the said EPPs. This, we believe, would be the critical factor leading to the success of the program.

Based on the roadmap shown by PEMANDU, we understand that the government is looking to receive its first LNG imports into the country by 2013. This would mean that the tender for the LNG regasification plant could be out as early as the beginning of 2011, assuming 2 years of construction.

We see KNM Group (Hold; TP: RM0.55), Kencana Petroleum (Not Rated), and Dialog (Not Rated), as potential beneficiaries to the project. The initiatives highlighted include the 10m cubic metres oil storage terminal in the works spearheaded by Dialog and Vopak in Pengarang, Johor. The development of small fields and enhancement of oil recovery should benefit a handful of local oil & gas players.

Tanjung Offshore (Hold; TP: RM1.60) could stand to gain under its engineering and marine divisions while both Alam Maritim (Buy; TP: RM1.40) and Petra Perdana (Fully Valued; TP: RM1.00) could benefit under their OSV operations.

Malaysian Property Bubble?

If you say Malaysian property bubble, it does not look so plausible ... but if you replace it with KL or Penang property bubble, you have more nodding heads - with possibly the property sales and developers disagreeing.

Malaysian Insider: Prices of residential property have surged by as much as 35 per cent in the past year despite a growing overhang in supply, far outpacing income growth and giving rise to concerns that the market is becoming unsustainable.

Figures provided by the National Property Information Centre (Napic) show that average prices for homes in Malaysia rose a whopping 19 per cent to RM273,000 in the first half of this year, from RM220,000 in the same period last year. For Kuala Lumpur, the increase has been even more dramatic, rising an eye-watering 35 per cent to more than RM700,000 in the first half of the year, up from RM523,000 last year.

The market, however, may be starting to lose its appetite for properties due to the high prices.

Napic’s Property Overhang reports show that unsold properties in Malaysia rose to 22.6 per cent of new launches in the second quarter of this year, from 19.5 per cent in the fourth quarter of last year. For Kuala Lumpur, unsold properties rose to 16.1 per cent from 15.8 per cent, while for Selangor it rose to 14.6 per cent from 12.4 per cent.

Checks on developments completed this year also show that vacancy rates remain at 50 per cent or higher.

The Edge business weekly reported recently that the government is mulling capping mortgages to 80 per cent of value in a bid to keep the market from overheating although MCA has come out strongly against the move. This comes as Singapore introduced a series of measures to reign in investors and speculators, such as a 70 per cent mortgage cap for buyers with more than one property and launching 36,000 public housing units this year and next.

While Napic does not have a housing affordability index, a rough calculation shows that the average price of RM273,00 is about 5.6 times that of an average annual household income of RM48,000. The average price of a KL home is now a steep 13 times that of the average urban household income of RM54,000 and a possible sign that the market is headed for a bubble.

The sharp increase in prices is said to be at least partly due to speculative demand as investors snap up multiple properties in the hope that prices will keep on spiralling upward — despite low occupancy rates that could affect rental yields.

Some real estate agents and developers have privately expressed worries that the market is already too speculative and the price escalation is not sustainable.

“I am all for sustainable price growth but the current market is too speculative,” one developer told The Malaysian Insider. “Most of the units are taken up by employees of the developer hoping to sell for a profit when the development is completed.”

Many developments completed in the past year such as Ameera in SS2 Petaling Jaya, Cova Suites in Kota Damansara and Challis Damansara in Sunway Damansara are experiencing only about 30-50 per cent occupancy rates, according to real estate agents. A check on new high-end condo Zehn in Pantai where sellers are asking for RM2.2 million per unit revealed the building to be almost completely dark at night.

Rental yields are starting to slide given that supply far outstrips demand.

A typical unit at Ameera is on the market for RM750,000. Given a 90 per cent margin of financing (MOF) over a 20 year tenure, the monthly loan repayment for a unit there works out to be about RM4,855. Rental rates at Ameera, however, are only about RM3,000 for a partly furnished unit.

A stand-off could be developing where buyers are now balking even as sellers are trying to hold out for higher prices.

Housing and local government minister Datuk Chor Chee Heung said that the high savings rate in Malaysia meant that there appears to be no shortage of takers despite the prices. He added that there will be a limit although he was unclear as to how far prices will continue to rise.

“We have to continuously tell developers not to push the boundaries,” he said when contacted by The Malaysian Insider. “There is bound to be a maximum.”

Chor said that the government is building some 76,000 low cost units that cost about RM42,000 each in the next three years, but it is unable to tell private developers how much to build to boost supply of middle class housing in the market.

Real Estate and Housing Developers Association (Rehda) president Datuk Michael Yam said that the issue of rising property prices was partly due to an imbalance of supply and demand as more migrants move to land scarce Kuala Lumpur as well as higher cost of raw materials.

“Even if 50,000 new housing units are needed in KL, that is still a huge number to build,” he said at a recent Rehda media briefing.

One developer, however, privately expressed concern that the market had become too speculative and the dramatic increase in housing prices may become unsustainable.

Property speculation remains rife despite a supply overhang

“I am all for sustainable price growth but the current market is too speculative,” one developer told The Malaysian Insider. “Most of the units are taken up by employees of the developer hoping to sell for a profit when the development is completed.”

There are signs that the government is concerned that a real estate bubble is forming as investors pour money into property in the hope that prices will keep spiralling upwards.

The Edge business weekly had reported over the weekend that the government is exploring the possibility of increasing mortgage caps to 80 per cent of loan-to-value ratio in a bid to keep the market from overheating. This comes as Singapore introduced a series of measures yesterday to reign in investors and speculators, such as a 70 per cent mortgage cap for investors with more than one property and launching 36,000 public housing units this year and next.

Such a move, however, may only serve to hurt first-time homebuyers who will have to struggle to come up with the down payment whereas richer investors are unlikely to face such difficulties.

My Views: Yes, the property prices in KL and Penang are frothy, well, not just frothy but very frothy. The ones still bullish are usually those who still have one or two properties in their hands, looking to offload.

Almost every single valuation matrix would put property prices in KL and Penang in the overvalued category. The basis for housing - live in ownership or rental. For live in ownership, its affordability ratio. For rental, its effective yield relative to prevailing interest rates. On both accounts, affordability is out of reach and rental yields are falling rapidly.

Usually those still bullish will cite factors out of these two basis ~ most popular being foreign buying, followed by relative valuations compared to similar properties in other Asian cities. Bullshit and more bullshit.

Foreign buying, is basically speculation when they cannot even rent it out for a 2% rental yield. Foreign buying for capital appreciation is hocus pocus because locals will not take the foreign investors out ~ you bought at RM1,500psf, it will not be a local to buy from you at RM2,000psf. What you need is another more deluded foreign investor to pay you RM2,000psf.

Foreign buyers are mostly leaving finished units and houses empty. Don't believe me, go check out houses and apartments costing more than RM2m and RM1m respectively. If you can get 50% occupancy, call me and tell me where!!!

Relative valuations argument is even stupider, if you are a qualified accountant in Malaysia, after working 5 years you may get RM8,000 a month ... does that mean you will get RM8,000 a month in HK, Singapore?? Of course not, you may get HK$35,000 and S$7,500 a month. So, how does the relative property valuations argument stand up??? Properties, like any asset is just a reflection of the earning capacity of their residents .... unless you tell me that the bulk of Malaysian properties are taken up and lived in by foreigners!!??





But property bubbles do not get pricked so easily. When low interest rates is prevailing and other sectors of the economy are so weak, central banks cannot just raise rates to dampen property speculation as the broader economy will get hurt.

As unpopular as it may sounds, the measures will have to be property sector specific. I will support the following: anyone buying their second, third , etc properties ... should only be allowed a maximum of 70% loan from any financial institutions.

Multi Sports, Xinquan - Post mortem

Red chips in Bursa. The first couple were hard to swallow, who will dare bring more in. Investment bankers were patting themselves before the listings, now they wondered if they are doing the right thing.

Why these shares almost immediately trade below IPO price:

a) the usual question, why choose to list in Malaysia, that in itself is a difficult question to answer, how to dispel the rumours that they are too small to list back home

b) the pricing will have to be fair relative to what other red chips are being priced in SGX, Xinquan was priced too high at IPO

Does that mean we should forget about bringing red chips over to list on Bursa? No, but we need to rethink our strategy.

1) Investors will be concerned that they have never seen the operations and that they may never get "good research coverage" or even corporate news analysis on the counter. The investment banker should be coming out with decent research reports for at least 2 years (updates on each quarterly results). Any red chip listing on the Bursa should have to pay RM100,000 a year to two other brokers research house to cover their stock for two years.

2) Bring in respected investors or institutions when applying for IPO - e.g. get EPF, LTAT or influential investors such as Quek or Kuok or other interesting outfits such as "private equity firms" or "respected long term asset management firms" to take substantial stakes pre-IPO. These shareholders should have a minimum holding period of not less than 12 months before they can sell.

If you don't implement these two measures, I can safely bet you that all upcoming red chips to be listed on the Bursa will drift below IPO price almost immediately upon listing, unless you manage to bring in those red chips that are sufficiently big enough (e.g. market cap more than RM1bn).

The final question mark is that there is still the sneaky suspicion that these smallish red chips may be packaged to list on Bursa or other overseas exchanges by "amalgamating a few smaller companies as one" - this lack of long term cohesion is a worry.

The other way confidence could return to these red chips is if these companies continue to show good results quarter after quarter for a substantial period, and/or these companies were to be "bought aggressively" by institutional investors or private equity firms with the intention of taking them private (because they traded so cheaply). Once these things happen, you will find investors regarding these smallish red chips with a different and improved mindset. You cannot blame investors for being cautious with so many unknowns.

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Shoe sole maker Multi Sports Holdings Ltd was the second China-based company to debut on Bursa Malaysia’s Main Market on Aug 19. The group, known in the industry as the provider of the Huoxing brand of shoe soles, prides itself on being the “one-stop shoe sole specialist” for China’s sports footwear industry as it is “vertically integrated” and is able to process raw materials to produce components needed as well as design and develop shoe soles.

The company operates in Jinjiang city in Fujian province, China’s sports shoe manufacturing capital and one of the world’s largest sports shoe manufacturing centres. In 2007, Jinjiang accounted for 20% of the world’s total sports shoe production. There are an estimated 3,000 shoe manufacturers in Jinjiang producing an estimated 700 million pairs of shoes per year, according to Multi Sports’ initial public offering (IPO) prospectus, citing the China Leather Industry Association. In 2008, Multi Sports Group had a 1% market share of China’s 2.1 billion pairs of rubber/plastic shoe soles production and 0.2% market share of the 10 billion pairs in the footwear soles sector in China, based on its output of 22 million pairs of sports shoe soles.

The group, one of the five largest shoe sole-makers in Jinjiang, currently has a 1,929-strong workforce, of whom 64% or 1,241 are skilled workers. The group has 300 customers, including Guohui, 361 degrees and Xdlong, manufacturers of well-known local sports shoe brands. Between 2005 and 2008, its annual production grew from about 4.9 million to 22.1 million pairs of shoe soles, with some 300 designs across four main product lines. Multi Sports’ production capacity is set to triple over the next two years as some RM30 million of the RM48.96 million gross proceeds from the IPO has been earmarked for the expansion of its production capacity within 24 months.

OSK Research, in a note dated Aug 7, says Jinjiang’s existing order book is three times its production capacity and reckons that the group’s earnings would see a compound annual growth rate (CAGR) of 18.3% over the next two years. In the past two years, the group registered a CAGR of 33.9%. OSK expects margins to improve on the back of higher production volume. “Compared to the first Chinese IPO, we are slightly more positive on Multi Sports premised on its current order book which is three times its current capacity; high cash conversion cycle; less competition (about 100 shoe sole producers versus over 3,000 shoe manufacturers in Jinjiang). Previously, we pegged Xingquan International Sports Holdings Ltd’s FY2010 PER at 5.4 times based on S-share companies listed in Singapore rather than Hong Kong or China-listed companies. We believe it is more realistic given its lower earnings base and market capitalisation. Using the same FY2010 PER valuation of 5.4 times FY2010 EPS, we derive a fair value of RM1.03, with an upside potential of 21.5%,” OSK says.

The Quek family, who is a major shareholder of Multi Sports Holdings Ltd, has sold off a chunk of its equity stake in the Chinese shoe sole-maker. According to filings to Bursa Malaysia last Friday, the Quek family, via its Cayman Islands incorporated vehicle GuoLine Group Management Co Ltd, had disposed of a 3.6% stake comprising 12.97 million shares in Multi Sports on Aug 24. The Quek family had held about 15% of the company before selling down the shares. It now owns about 11.4% stake or 41.03 million shares in Multi Sports. Multi Sports IPO: 85 sen Now: 52 sen

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Xinquan International Sports

307.33m shares
IPO: 1.71
High: July 15 2009 (1.81)
Now: 1.39

The current Executive Chairman, Mr. Wu Qingquan established Jinjiang Xingquan in 1995, jointly with his wife, Mdm Zhuang Hongji, and his brother, Mr. Wu Lianfa, to engage in the manufacture of shoes and shoe soles for local and international shoe manufacturers. In 2009, they acquired the entire share capital of Addnice Holdings for a purchase consideration of USD21.503mn which was satisfied entirely by the issuance of the Consideration Shares at an issue price of USD1 per Consideration Share. The products under the 'Addnice' brand are distributed across 20 provinces, municipalities and autonomous regions within the PRC. Products which the Company manufactures as OEM are also distributed outside the PRC by its OEM customers. As at the Latest Practicable Date, the Company has appointed 29 authorized-regional distributors and 43 direct retailers to distribute its 'Addnice' products. The Company's 'Addnice' products are sold via 954 'Addnice' specialty stores and 464 retail stores totaling 1,418 point of sales. An aggregate production capacity for sports and leisure shoe products and shoe sole products in Quanzhou amount to approximately 5.9 million and 14 millions pairs per annum, respectively.

For its financial year ended December 31 2008, Xingquan posted RM323.56mn revenue and RM65.76mn profit after tax.This company is established in Bermuda.

RM2.10, OMG, it went downhill amidst a good bull run for most equity markets. Underwriter CIMB Investment Bank Bhd recently activated and completed the price stabilisation mechanism, a first in the local market since it was introduced in early 2008, in relation to Xingquan’s listing. But even CIMB said enough is enough, we should only take so much losses. The price stabilisation mechanism, which is not uncommon in other markets, was aimed at assuring investors that a party was backing the stock in the initial stages of its listing.

The IPO price was RM1.71. In terms of the attractiveness of the stock at the fundamental level, its IPO price of RM1.71, the valuation of roughly five times forward price-to-earnings ratio (PE) did not compare well with similar stocks listed in Singapore. China-based athletic footwear stocks in Singapore include China Hongxing Sports Ltd at 7.3 times 2009 PE, China Sports International at 3.1 times PE and Hongguo International Holdings at 5.7 times PE. Plus Xingquan was much smaller, hence CIMB was suckered into pricing it at RM1.71 - not the company's fault.

p/s photos: Hanako Takigawa

Outlook For Ringgit For The Rest Of 2009

• Malaysia Ringgit (MYR) has appreciated 6% after hitting a low in early March taking the ytd losses to 1% as of May-end 2009
• March 3, 2009: MYR fell to the lowest level (3.725-3.735/USD) in 3 years due to weakening exports and foreign investment
• February 2009: To promote bilateral trade and investment for economic development, Malaysia's central bank and Chinese central bank established RMB40billion currency swap arrangement for 3 years
  
  Risks for ringgit in 2009:
• External balances: electronic and commodity exports are contracting at a sharp pace and the trend is likely to continue through 2010 with a sluggish recovery in 2010. Presently greater contraction in imports relative to exports is sustaining the trade and current account surpluses and forex reserves
• Easing capital flows: keeping interest rate on hold in April and May 2009 has helped reverse some of the past capital outflows. Rising bond issues at higher yields and sharia bond issues are a plus. But ratings downgrade due to increasing fiscal deficit can weigh on debt inflows. Impact on lower corporate earnings ad revival of risk aversion can weigh on stock market. A recession in 2009 and rising bond issues in U.S. (safer-haven) can be a negative. FDI is expected to fall over 50% y/y in 2009 due to decline in export manufacturing related capex
  
• Central Bank policy: In 2008, central bank was intervening in the FX market selling USD reserves to contain currency depreciation but in 2009 the central bank has been defending the exchange rate to support exports especially as reserves have also been declining. foreign exchange reserve stood at US$88bn as on 15 May, 2009 which is sufficient to finance 8.3 months and 3.8 times the short-term debt. Large forex reserves and external surpluses are a plus to deal with export contraction and any revival of capital outflows. Trend in USD and SGD will also be improtant determinants of movement in ringgit
  
• Since the central bank decided to keep key rate at 2%, USD/MYR is expected to be higher by the end of Q2 2009. But USD/MYR will be lower in H2 2009 as the economic situation is improving. But further stabilization in domestic and global economy is still necessary to guide USD/MYR around 3.45 by the end of 2009
• MYR continues to track the SGD and is expected to weaken against USD in mid-2009 due to anticipated resurgence in USD strength
  
• Declining forex reserves and depreciating SGD would put further pressure on ringgit
  
• Confidence of ringgit would be dampened due to increasing deficit on overall balance of payments, declining exports, outflow foreign capital, and expectation of further rate cut by central bank
• In 2009, ringgit would be weak against USD as the process of de-leveraging by international investors will continue to boost demand for USD
  

p/s photos: Hanako Takigawa

Dissecting The Economics Of Malaysia

The size of Malaysia’s export sector is huge at more than 100% of GDP. Hence its importance in driving domestic demand should not be exaggerated. The manufacturing industry is under severe assault due to the collapse in exports. Consequently, manufacturing employment has plunged by 10% from year ago and wages are also falling. In contrast, private consumption fell only 0.7% year over-year in the first quarter, and imports of consumer goods have been relatively resilient.

One reason could be that, even though exports are a significant part of the economy, manufacturing employment is relatively small – about 18% of total employment. By contrast, service sector accounts for close to 60% of total employment. Meanwhile, agriculture and plantation make up 9% of employment, and the construction sector 13%.

Resources/plantation exports such as palm oil, petroleum, natural gas and minerals account for about 30% of total Malaysian exports and the share is rising. China, being the past decade’s fastest growing economy with an seemingly insatiable appetite for resources, has naturally increased in bilateral trade with Malaysia. Trade between the two countries has increased four-fold since 2002.

Malaysia’s exposure to manufactured-goods exports to the G7 is still large, commodities and China are playing a more prominent role in terms of overall exports. The better outlook of these segments – compared with that of manufactured goods exports – will help pull the economy out of the slump.

Malaysia’s banking system is healthy and in a position to support a recovery in household spending. Remarkably, the lending rate of Malaysian banks has fallen to new lows in response to the central bank’s rate cuts and the authorities’ efforts to facilitate borrowers’ access to credit. There are already signs of stabilization in indicators of domestic demand. Housing approvals and loan disbursements for car purchases are bottoming.

Resources-related industries contribute over 50% of government revenues. Since late 2008, both palm oil and crude oil prices have rebounded strongly. Unless they collapse anew, exports of crude oil and palm oil, which accounts for 15% of total Malaysian exports, will boost both domestic income and government coffers and help plug the fiscal deficit.

The odds of recovery in domestic demand are notable, despite continued contraction in the export sector. The 1997-1998 Asian financial crisis was a watershed event for Malaysia’s banking industry. Although some post-crisis policy measures adopted by the Malaysian authorities – mostly notably capital controls – have long been a source of controversy and outright criticism, banking industry consolidation and much stricter supervision from the central bank have fortified the position of banks and largely insulated them from the current global
credit crisis.

Industry consolidation and continued enhancement in risk management have borne fruit in the form of enhanced returns on capital. Currently, the Malaysian banking sector is well capitalized, with a risk-weighted capital ratio of 14.2% as of March 2009. The private credit-to-GDP ratio has fallen since the Asian crisis, implying there has been no froth in bank lending over the past several years. Within the structure of banks’ loan portfolios, household loans account for 54% of all loans, while lending to the manufacturing sector is only 11%.

Malaysian banks are awash with liquidity as the country runs a large current account surplus (17.5% of GDP in 2008). The loan-to-deposit ratio in the banking system is 74%. Bank credit accounts for about 90% of gross financing to the private sector.

Still, Malaysia’s banking system is not without problems. Bankruptcies are rising sharply, access to credit has deteriorated markedly since the onset of the global credit crisis and banks remain somewhat wary of extending credit. The problems in Malaysia’s banking sector pale when compared with the difficulties in many other countries around the world. A relatively healthy banking system puts Malaysia in a better position to cope with economic challenges stemming from the synchronized global growth slump.

The government’s recent move to scrap the long-standing Bumiputera ownership requirement for 27 service sectors and to increase foreign ownership of its commercial banks (from 49% to 70%) could help unlock growth potential by encouraging investment and boosting productivity within domestically-oriented segments. This, along with other reforms within the public sector aimed at reducing red tape, corruption, government intervention and overall inefficiency, could unleash positive forces that will produce stronger growth in domestic segments of the economy.

Malaysia small caps offer a better outlook profile than many other emerging markets. They will benefit most from potential political and economic reforms. Besides, small-cap valuations are decent on both an absolute basis and relative to the emerging market small-cap universe. The currency’s outlook is bullish versus the U.S. dollar. The country has huge external surpluses and the ringgit will benefit from the U.S. dollar’s decline. Relative to other Asian currencies, the rating the outlook for the ringgit as neutral as the central bank is unlikely to allow for much appreciation due to export sector concerns. As for currency valuation, the currency is cheap versus the greenback but is fairly valued versus the Singapore dollar.


p/s photos: Hanako Takigawa

Roubini's 10 Risks To Global Economy Growth Prospects (Part 1)

Nouriel Roubini: This week, I will discuss why the recovery will be sub-par and below trends for a few years once it does occur, and why there is even the risk of a double-dip W-shaped recession.

The crucial issue facing us is not whether the global economy will bottom out in the third or fourth quarter of this year, or in the first quarter of next year. It's whether the global growth recovery, once the bottom is reached, will be robust or weak over the medium term--say 2010-11. As I argued last week, one cannot rule out a sharp snapback of GDP for a couple of quarters, as the inventory cycle and the massive policy boost lead to a short-term growth revival. My analysis, however, suggests that there are many yellow weeds that may lead to a weak global growth recovery over 2010-11.

The current consensus among "green shoot" optimists sees U.S. economic growth going back in 2010 to a rate that is close to the 2.75% potential growth rate, and returning to potential by 2011. Many optimists go even further, arguing that the snapback of demand and production after the depressed levels of the current recession will lead growth to be well above trend (3.5% to 4%) for a couple of years, as most previous U.S. recessions have been followed by a period of above-trend growth once the recovery gets going. Yet a detailed analysis suggests that growth will remain well below potential for at least two years--if not longer--as the severe vulnerabilities and excesses of the last decade will take years to resolve. Let us examine 10 factors that will cause below-potential economic growth over the medium term even after this recession is over.

First, an incorrect interpretation of the causes of this crisis has led to a policy response that doesn't resolve the fundamental causes. The right way to think of this crisis is of its being caused by: excessive over-borrowing and overspending by households; excessive and risky borrowing and lending by financial institutions; and excessive leverage of the corporate sector in a global economy where housing, asset and credit bubbles got out of hand and eventually went bust. So this is a crisis of debt, credit and solvency, not just illiquidity. The alternative interpretation is that this is a crisis of confidence--an animal-spirit-driven, self-fulfilling recession--that has led to a collapse of liquidity (as counterparties don't trust one another) and of aggregate demand (as concerned households and firms cut consumption and investment in ways that can turn a regular business-cycle recession into a near-depression).

Note that even those who believe that this is a crisis of over-leverage and overspending agree that aggressive monetary and fiscal easing is necessary to prevent a severe recession triggered by such excesses from turning into a near-depression. But while such easing is necessary to prevent the global economy from falling off a cliff into the depression abyss, the ability of these over-leveraged economies to resume lending, borrowing, spending, investment and growth depends on the resolution of the excesses that caused the crisis in the first place.

Yet true de-leveraging by households, corporate firms and financial institutions has not even started, as private losses and debts are being socialized and put on the balance sheet of governments. The lack of true de-leveraging--or appropriate debt restructuring--will lead to a corrosive debt deflation and limit the ability of households to spend, of firms to invest, and of banks and other financial institutions to lend. In other words, if this is a crisis of credit and solvency rather than just illiquidity and confidence, much more is needed than easy money and massive fiscal stimulus to resume high economic growth. Worse, the socialization of private losses creates--down the line--another dangerous debt and solvency problem, this time for the sovereign, with risks of a more severe financial crisis once a refinancing crisis occurs and/or the ability of the sovereign to borrow more is curtailed.

The right way to resolve a problem of excessive debt relative to equity capital is to reduce such debt and convert it into equity. Corporate debt and the financial sector's unsecured liabilities should be converted into equity. Even household debt can be converted into equity by reducing the principal value of mortgages and providing an equity upside to the mortgage creditor in the form of a warrant.

Second, in current-account deficit countries (i.e., where the country spent more than its income), consumers need to cut spending and save more: shopped-out, savings-less and debt-burdened consumers have been hit by a wealth shock (falling home prices and stock markets), rising debt-servicing ratios and falling incomes and employment. These deficit countries include not only the U.S., but also the U.K., Ireland, Iceland, Spain, many emerging European economies, Australia and New Zealand.

In these economies, the retrenchment of consumption and buildup in savings to reduce debt, restore net worth and resume robust spending will take several years. In the U.S., consumption averaged 65% of GDP (and household savings averaged 11% of disposable income) for a long time before the latest decade-long housing bubble and consumption binge.

At the peak of the bubble, consumption had risen from 65% to 72% of GDP, and the savings rate plunged to zero and even negative for a few quarters. Currently, consumption has fallen from 72% to 70% of GDP and saving has increased from near zero to about 5% of disposable income. Even if one were--heroically--to assume that consumption will not revert to the long-term average, a fall from 70% to, say, 67% is likely and necessary, while the savings rate goes toward double digits.

But how can households reduce debt ratios that have increased from 65% of disposable income in the early 1990s to 100% in 2000 and 135% today? And the debt ratio risks rising even further as price deflation leads to debt deflation (a rise in the real value of nominal debts). One solution might be to save a lot to reduce debt and rebuild net worth, but the "paradox of thrift" scuttles this. If households sharply cut spending and save more, the recession becomes a near-depression and the ensuing fall in income further increases the debt-to-income ratio. The only remaining solution is debt default and debt reduction.

Third, the financial system (specifically, traditional commercial banks) is severely damaged, and the credit crunch will thus not ease very fast. Most of the shadow banking system is either gone or in severe difficulty. The equivalent of a bank run has hit most of the highly leveraged institutions of this system: 300 non-bank mortgage lenders are bust; the system of conduits and structured investment vehicles is gone; two major broker-dealers are gone, one merged with another bank and the last two converted into bank holding companies; money-market funds cannot even cover their costs, as interest rates are zero and now under the umbrella of a government guarantee; half of all hedge funds may close shop in the next couple of years; even private equity will experience a serious refinancing crisis once "covenant lite" clauses and payment-in-kind toggles run their course; finance companies and insurance companies are also in trouble and need government support and recapitalization. Securitization is a shadow of its recent peaks and the attempt to revive it--TALF--has been a mixed bag.

After $12 trillion of liquidity support, guarantees, insurance and recapitalization, most of the U.S. financial system is under effective government control. And the financial sector damage is not limited to the U.S.: Most major U.K. banks--with the exceptions of HSBC and Barclays -are under effective government control. The IMF estimates massive losses on loans and securities of other European banks, given their exposure to both domestic borrowers and emerging Europe, a region on the verge of a broader financial crisis. According to the IMF, even Japanese and other Asian banks are not immune to significant losses on loans and securities.

Over time, financial institutions in the U.S. and around the world will clean up their balance sheet. But systemic banking crises are not resolved in a few months: They usually last several years and are associated with a persistent credit crunch. Given that a lot of economic activity is financed with debt/credit, this crunch will inflict persistent damage and restrict the ability of households and corporate firms to borrow, consume, spend and invest.

Fourth, a large part of the corporate sector is also under severe financial stress, and its ability to increase production, employment and capital spending will be restricted by poor profitability driven by slow revenue growth, deflationary pressures and rising corporate defaults. While most U.S. corporations are less leveraged than they were in 2000-01, the corporate sector has a large fat tail--similar to that of the household sector--that is severely indebted.

Firms that in the past would have been able to roll over their loans, bonds and debts coming to maturity now face a liquidity crisis that may lead them into costly debt restructuring. Some firms that would have gone into Chapter 11 debt restructuring will end up in socially costly liquidation (Chapter 7) because of the lack of financing. This process of corporate debt restructuring or outright liquidation may take years.

But the main constraint to a recovery in the corporate sector will be a weak recovery of corporate profitability. If the global economy grows at sub-par rates in 2010-11, corporate revenues will grow slower than otherwise; and if deflationary pressures remain across the world--given the glut of supply relative to aggregate demand--pricing power of firms will be limited and profit margins will be further squeezed. The ability to control costs and restore earnings by slashing employment will reach a limit, and excessive employment contraction has negative macro effects: Fewer jobs means less income, less consumption, less corporate revenue and lower profits and earnings.

p/s photos: Hanako Takigawa