Malaysia politics are fractured and do not support acceleration in economic growth. The circumstances around Prime Minister Mahathir’s resignation on 24 February confirm this and reinforce our caution on Malaysian equities. A much larger discount to historic valuation or the establishment of a more coherent ruling coalition is needed for us to turn more positive.
But there is a potential silver lining. Mahathir’s divorce from Anwar Ibrahim’s PKR party and the embrace of the opposition UMNO party may remove the distraction of the implied promise of a May 2020 handover to Anwar. It is also unlikely that Anwar could muster the scale of mass protests seen in the Reformasi movement in 1998 after Mahathir sacked him as deputy PM (those protests also followed the economic trauma of the Asian crisis of 1997 and in an era when Mahathir was tainted by crony capitalism).
Yet, even in this optimistic scenario, the issue of uncertain succession to 94-year old Mahathir remains.
Ruling coalition: strains turn to fractures but this may prompt a better rebuild
Prime Minister Mahathir has resigned rather than retired. The King (Sultan Abdullah Ri'ayatuddin) has asked him to stay on as an interim PM. The resignation may be a precursor to Mahathir assembling a more coherent ruling majority.
The context for Mahathir’s resignation is threefold:
- Succession – since the 2018 election, there has been uncertainty over the date of Mahathir’s handover to Anwar Ibrahim (the leader of the largest single party in the ruling coalition, the People’s Justice Party, PKR, with 21% of total parliamentary seats and 39% of ruling coalition seats immediately after the 2018 election), concern by Mahathir loyalists that if he announced a handover date the remainder of his term as PM would turn him into a lame duck, and recent speculation that Mahathir was considering re-crafting the coalition by jettisoning Anwar loyalists and embracing the opposition United Malays National Organisation (UMNO, 18% of parliamentary seats);
- Divided ruling coalition – the ruling coalition (Pakatan Harapan, or Alliance of Hope) was assembled in 2015 prior to the 2018 election and made up of formerly feuding rivals (particularly Mahathir and Anwar), who were united almost solely by their opposition to the pre-2018 PM Najib Razak, under the banner of anti-corruption;
- Division in Anwar’s party – within Anwar’s own PKR party there is division between those in his camp and those in the camp of Azmin Ali (who also happens to be a Mahathir loyalist); indeed, on 24 February Azmin led a bloc of defectors from the PKR (amounting to 5% of parliamentary seats and reducing the PKR’s share of total seats to 18%, or the same as the UMNO).
Relatively low FX rate risk but equities are unattractive relative to Asia peers
Equities (MSCI Malaysia index) are down 6.0% ytd (worse than MSCI EM which is down 1%) and down 12% over the last year (much worse than up 8% for EM). Malaysia trailing price/book is on a c10% discount to the 5-year median (whereas EM is on c5% premium).
Malaysia should have low FX rate risk:
- A 2% current account surplus is forecast by the IMF over 2020-21,
- The real effective exchange rate implies c10% under-valuation,
- Import cover is over 5 months, and
- Merely 2% inflation is forecast by the IMF over 2020-21.
However, we remain cautious on Malaysia; its government is divided at exactly the moment it needs to coherently address four main economic challenges:
- Negative shocks from US-China trade friction and the coronavirus (technology hardware products make up over 50% of exports).
- Highly sensitive relations with China over overlapping territorial claims in the South China Sea (Malaysia naval defence is totally reliant on the US) and over contracts related to Belt and Road infrastructure projects (China is already consistently the largest source of FDI in Malaysia).
- Fiscal deficit spiked after the 2018 election (3% in 2019).
- Middle-income trap (although Malaysia’s cUS$11k per capita GDP is one of the highest in our small emerging and frontier coverage, real GDP growth is not forecast by the IMF to reach 5% at any point over the next five years).
The combination of valuation, growth, reform and politics is more attractive elsewhere in small Asia (eg Bangladesh, Indonesia, Pakistan, Philippines, Vietnam).
There is considerable uncertainty as to whether Mahathir can fashion a more united ruling coalition, but doing so would certainly temper our caution on the investment case. Nevertheless, the succession risk to 94-year old Mahathir would persist.