Jonathan Rogers_ifraweb
Jonathan Rogers
For Indonesia and Malaysia, the recent collapse in oil prices must feel like a re-run of the late 1990s financial crisis. The rupiah and ringgit are plunging against major crosses, and domestic bond markets in the two countries have been hammered as full-blown capital flight takes hold.
Last week’s price swings looked dreadful, and the Malaysian and Indonesian authorities must feel rather worried when they contemplate the impact of collapsing oil prices on Venezuela, another major energy exporter.
Venezuela’s foreign exchange reserves are at an all-time low and inflation is around 65% as the country faces trouble servicing its debt and paying for imports with severely reduced oil revenues.
Its long-term debt recently traded just shy of fifty cents on the dollar and, with the global economic recovery looking shaky and capital markets volatility on the rise, the last thing anyone would want is a Venezuelan default. But while fundamentals in Indonesia and Malaysia are more sound than those of Venezuela, the latter serves as a warning that things can get very nasty very quickly when the backbone of your economy is ripped out.
Asia is set to enjoy the wealth transfer effect of cheaper oil, given that most countries in the region are major oil importers. Malaysia and Indonesia are telling exceptions, and are going through some abysmal times.
LAST TUESDAY THE Indonesian rupiah fell to its lowest level since 1998 – the height of the Asian crisis – and foreign investors have been busy selling stocks and bonds. Some US$600m-equivalent of Indonesian stocks were liquidated last month by offshore investors, the highest in a couple of years, while US$550m-equivalent was pulled from domestic debt.
Meanwhile the ringgit touched a five-year low against the US dollar a few weeks ago and is at a 33-year low versus the Singapore dollar, a closely watched cross rate here in the city state where the Malaysian shops are just 45 minutes away over the causeway.
Domestic bond yields in Malaysia have been soaring in tandem with the rout on the foreign exchange markets and Maybank analysts reckon as much as US$7bn-equivalent has been pulled from Malaysia’s domestic bond markets by foreign investors over the past month in a classic example of capital flight.
This phenomenon is something I have warned about in this column over the years and, although foreign participation is often seen as a crucial component of the development of local bond markets – around 40% of the Malaysian onshore bond market is held by foreign investors – the sudden withdrawal of those funds can cause havoc in a relatively short period.
As a result, short-end yields have spiked and the ample pipeline of domestic Malaysian deals has frozen up as issuers are unwilling to pay the new higher premium required to clear the primary market. Time will tell whether all this has been overblown and whether it represents a massive buying opportunity for the rupiah and ringgit and local stocks and bonds in those countries.
Former Prime Minister Mahathir Mohammad warned in March this year of the possibility of Malaysia facing another financial crisis, and perhaps he called it right. He of all people is certainly qualified to talk about financial crises, having steered Malaysia through the Asian financial crisis and famously blamed the rout on financier George Soros, whom the good doctor branded a “moron” for shorting Asian currencies.
Whether or not Mr Soros is a moron or not I couldn’t possibly comment on here. I do know that he parlayed one of the most successful leveraged bets of all time when he took the view that Britain would be forced out of the European Rate Mechanism (ERM) in the early 1990s but it’s never been clear whether his bets caused the Asian currency collapses later in that decade.
THE QUESTION FOR Malaysia and Indonesia in the short run is whether they will find themselves in the nightmare situation of having to push up short-term rates in order to steady their currencies, thus putting stress on the financial system when it needs to find growth to plug the hole left by lower oil revenues.
India successfully managed its way out of last year’s attack on the rupee and it’s likely that Indonesia and Malaysia will do the same. But there will be some bumpy moments, particularly if any pressure to raise rates due to currency routs and capital flight comes in the context of a Federal Reserve rates normalisation.
Leveraged households and corporations in both countries will feel considerable pain and the authorities will need to have some contingency plans up their sleeves.
Looking back to the stagflation of the 1970s, it’s best to be mindful of the extraordinary power the oil price to mess up the global economy.
This time around, it’s the potential that low oil prices have to cause defaults at the sovereign level and among oil producers. Around 16% of US junk bond issuance is from oil and oil-linked companies, and the systemic risk posed by a persistently low oil price must not be underestimated.
For now though, I’m going to attempt to enter the spirit of the season of goodwill and look forward to taking a hop over the causeway to catch some rather unseasonable bargains. It would be rude not to.
