Oil Price Slump Adds to Malaysia’s Economic Headwinds

By Nigel Cory

Kuala Lumpur city center. Source: Trey Racliff's flickr photostream, used under a creative commons license.

Kuala Lumpur city center. Source: Trey Racliff’s flickr photostream, used under a creative commons license.

The headwinds facing Malaysia’s economy are growing. As Asia’s only remaining net oil and gas exporter, Malaysia has been hit the hardest by a rapid drop in oil prices, while a slowing global economy has dragged down its critical export sector. In addition to lower oil prices, efforts to recover from recent floods and a scandal-hit government investment fund have made the task of managing the economy much more difficult for Prime Minister Najib Razak.

Malaysia’s ability to counter changing economic conditions is constrained as oil and gas revenue accounts for around a third of the government’s budget. Four months after the 2015 budget was initially tabled, Najib delivered a speech on the government’s financial position on January 20. As part of the revised 2015 budget, which assumed an oil price of $55 per barrel, Najib announced $1.5 billion in spending cuts and a revised 2015 growth forecast (of 4.5-5.5 percent from 6 percent previously), and proposed ways to boost Malaysia’s economic resilience.

Najib’s initiatives to boost growth focus on export promotion programs, trade facilitation and infrastructure programs, and measures to boost tourism, including cutting visa fees for Chinese tourists.

Malaysia’s government-linked companies (GLCs) were another key part of Najib’s economic response plan. GLCs make up half of Malaysia’s stock market capitalization and dominate key sectors such as utilities, transport, and agriculture. Najib’s speech outlined plans for these companies to simultaneously invest more domestically while requiring them to pay higher dividends to the government.

But the most prominent GLC and Malaysia’s only Forbes 500 company, state-owned oil and gas company Petronas, warned in November 2014 after reporting third-quarter results that its dividends would be lowered to $4.78 billion in 2015 (compared to $8.16 billion in 2014), a prediction based on an oil price of $75 per barrel. The state-owned company has also flagged a 15-20 percent cut in investments. Petronas’s fourth-quarter report at the end of February will give a better idea of the true size of the impact to Malaysia’s budget. Malaysia will likely get a second budget reality check once the impact of dividend cuts from GLCs become clearer.

Compounding this economic pressure is the impact of the floods that hit Malaysia in late 2014 and early 2015, the worst in decades. The recovery effort to help 400,000 affected people and many towns and cities recover, which was reflected in Malaysia’s revised budget, adds more spending to a budget that is already under pressure. The floods also impacted another of Malaysia’s key commodity export, palm oil, which struggled to make up for the 20 percent fall in palm oil prices in 2014.

These conditions have buffeted Malaysia’s currency, the ringgit, which has fallen around 12 percent against the U.S. dollar in the last 6 months. This makes it among the worst performing currencies in Asia. While this may make Malaysia’s exports more competitive, it raises other financing issues. In an effort to prop up the currency, Malaysia’s central bank has spent an estimated $12 billion — 10 percent of its foreign exchange reserves — since August. This move raises concerns given the effect it has on Malaysia’s ability to service its large foreign borrowings, which become more expensive with a lower currency.

Najib’s woes have also sprung from a growing financial and political scandal around the billions invested in state-owned investment fund 1 Malaysian Development Bhd (1MDB), whose advisory council Najib chairs. According to its figures from February 2014, 1MDB has assets of $14.1 billion, outweighing its liabilities of $11.5 billion. However, sovereign risk ratings firms such as Fitch have said that the uncertainty about 1MDB’s ability to service $7.4 billion in U.S. dollar-denominated debt raises concerns about Malaysia’s overall risk rating.

Economic and fiscal pressures have added to the political pressure Najib already faces from former prime minister Mahathir Mohamad and former finance minister Daim Zainuddin. The task to manage these economic, financial, and political challenges is not going to be easy, especially if oil prices remain at current levels and the economic slowdown continues.

Mr. Nigel Cory is a researcher with the Sumitro Chair for Southeast Asia Studies at CSIS. He previously served as an Australian diplomat in Malaysia and the Philippines.

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