Scrabbling on the precipice

Although few observers are prepared to make unconditional predictions of collapse in Malaysia, prognoses are far less optimistic than six months ago, and deteriorating by the week. "Given the pace of the economic slowdown that we are seeing from the most recent numbers, the risk is all on the downside," says Gan Chin Lee, Singapore-based senior economist at Nikko Research. "I'm just in the middle of revising down my GDP forecasts for 1998 from plus 2% to minus 1%." Growth in 1997 was around 7% and just weeks ago the government was forecasting 4.5% growth this year.

With Indonesia suffering riots and near collapse of the government, Korea facing the restructuring of much of its industrial base and Thailand feeling the strain of the IMF austerity package, a pessimistic view of Malaysia is understandable. Yet in the middle of last year, when events in Thailand prompted the financial rout that spread across Asia, Malaysia was reckoned to be very different from its neighbours.

Its property sector was much less speculative than that in Thailand, the arguments ran, and its banking system was better capitalized. If the ringgit weakened, exports would boom, rapidly improving the current account and stabilizing the exchange rate. Most important, unlike Thailand and Indonesia where the private sector had borrowed heavily offshore in foreign currencies, Malaysian debt was largely domestic. As exports picked up, interest rates would therefore be able to fall back fairly quickly to more normal levels, giving the economy the power it needed to pull out of a crash path.

In one respect these arguments have been proved correct: Malaysia has had more room for manoeuvre than other countries in the region and prime minister Mahathir Mohamad has not had to go to the IMF for a bail-out. The economy, which had reached the top of its cycle in 1996, still turned in "healthy" 7.8% growth last year. Property prices held up. The banks' average non-performing loans were reported to be a very manageable 5%.

But now the pressures that led to a 33% devaluation of the ringgit and a 40% fall in share prices on the Kuala Lumpur Stock Exchange are starting to have a widespread effect. "The economy is contracting sharply," says Samir Mehta, investment analyst at Lloyd George Asset Management in Hong Kong. "Manufacturing has held out so far because of electronic components. But heavy industry, construction, banking and finance are all grinding to a halt." And exports have failed to boom. The high import content of most manufactured exports means companies are struggling to afford inputs, let alone invest in more capacity. "We are looking for minus 2% or minus 3% growth this year," says Mehta. "By the third or fourth quarter of this year, people on the street will really be able to feel it."

The real-estate market, so far spared the corrections suffered elsewhere, is about to crash. "There have been very few transactions recently, so economic reality is not reflected in the published prices," says an analyst. "But with no-one expecting to make gains from capital appreciation any more, investors have to look at yield. This in turn is compared with the returns on deposits or fixed income. With three-month interbank rates now around 11%, there will be few takers unless capital values fall substantially, thereby raising rental yields from the 6% they achieved in 1996."

Asset wipe-out

Most observers are forecasting a fall in capital values of between 30% and 40%. Even this may not be enough to cope with supply. Just under 640,000 square metres of new office and retail space came on stream in the Klang valley area around Kuala Lumpur alone last year. A further 1.3 million square metres will be completed this year, and there will be little if any demand for it.

A sharply deteriorating economy and an imminent fall in property prices will put further strain on a banking system already hurt by excessive short-term foreign-currency borrowing. "The banks are clearly in bad shape because they overextended loans during the boom of the past three or four years," Mehta says. Loan growth in Malaysia, which had virtually tracked economic growth after the crash in 1985, suddenly took off in the second half of 1993. Between 1993 and 1996, total loan growth expanded by about 21% a year, more than twice GDP growth. That this abundant liquidity largely found its way into speculative ventures rather than productive assets is now becoming clear. Real estate and also stocks were bid to ridiculous levels. Lending for share purchases during this heady period rose at an annual rate of 46%.

Some estimates suggest that half of new bank lending over the past four years went into equity and property speculation. Much of the collateral that backed it has been wiped out already: the prices of high-flying stocks such as second-liner Quality Concrete have fallen by over 90%, even in local currency terms. More collateral will evaporate when the property slump begins in earnest. Ironically, that looks likely to be exacerbated by banks' attempts to clean up their balance sheets. Late last year, for example, many began to refuse to accept property as collateral, a move that will have the opposite effect to that intended.

"The rush by bankers to shun property collateral will itself produce the collapse in value that will devour bank capital," says number-one-ranked Asia strategist Russell Napier, an analyst at CLSA Global Emerging Markets.

At the moment, the Malaysian banking and finance system still looks quite healthy compared with Thailand's or Korea's, with non-performing loans (NPLs) officially at 8.7% as of February, even under the tighter definition of three-months overdue introduced late last year. "So far, the bulk of the problem has been in the finance companies, as the main defaults have come on vehicle loans and stock financing," says Mehdee Reza, banking analyst at Credit Suisse First Boston in Hong Kong. "NPLs in this sector range from the low single digits to the high 30s. But we have yet to see the big correction in property prices. When this happens, later this year, the impact on the banks will be substantial."