Lim Mah Hui - Global Financial Crisis and Impact on Malaysia_2008 at SERI

7/27/2019 Lim Mah Hui - Global Financial Crisis and Impact on Malaysia_2008 at SERI

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Global Financial Crisis and Impacton Malaysia

Dr Michael Lim Mah HuiAugust 5, 2008

Seminar on Global EconomicTrends


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Triple Witches Brew

Trouble in the :U.S. and U.K. Housing Markets

Financial MarketsCommodities Markets


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Figure 1

Property Prices

Source: Richard Duncan, Finance Asia, Sept. 2007


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1976 1980 1984 1988 1992 1996 2000 2004

Price-to

-RentRatio

Source: D. Papadimitrius et. al. Strategic Analysis, Jan. 2006. Levy Economics, Institute of Bard College

Figure 2

Housing Price-to-Rent Ratio


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1

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1965 1970 1975 1980 1985 1990 1995 2000 2005

Figure 3

Ratio of Median House Price to MedianHousehold Income

Source: International Herald Tribune, Sept. 20, 1997

Median house price is 5 times

median household income


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U.S.Housing Bubble Bursts

House prices started declining in early 2006. Have fallen

20%. Expect another 10% fall before reaching bottom. Every 10% fall shaves off $2 tr. from household wealth.

U.S. growth 70% powered by consumption. Consumershave negative savings rate.

Home equity - a rich source of cash & credit for U.S.consumers.

If no mortgage equity withdrawal in 2005, real GDP

growth would be 0.2% instead of 3.5% (Calculated RiskResearch).


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U.K. Housing Bubble Bursting

Equally, if not more, overheated as U.S. market. 1996-2007 prices tripled.

2008 average median house price $370,000 - 6xaverage salary vs. 3x in 2003.

U.K. consumer debt -166% of gross disposable incomevs. 127% in U.S.

40% of house sale agreements collapsed due to inabilityto get mortgage or back-out from sale.

Prices fallen 10% and could fall another 20% - 30%


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9Source: Halifax at MarketOracle.co.uk


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Financial Innovations &Financial Crisis Securitization of loans introduced in 1980s (ABS-

asset back securities)- package loans into securitiesfor sale.

Originate and Distribute (O&D) model allowed banks

to transfer risks to other investors; increased volumeof loans to the system.

Subprime - housing loans to weak credit borrowersusing teasers like introductory ARMs, low down/zerodown payment, loose documentation.

$1.5 trillion subprimes booked in 2004, 2005, 2006when housing sector peaked and declined


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CDO Market

Collateralized Debt Obligations - higher level of

complication and leverage. CDO consists of package of ABS (asset backed

securities) arranged in different tranches with

different credit ratings, returns, and paymentpriority.

Investors choose which tranche to investaccording to risk appetite.

Often funding mismatch; cross-selling CDOs

CDO of CDS; CDO squared; CDO cube.


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Typical CDOSUBPRIME MORTGAGESSUBPRIME MORTGAGESSUBPRIME MORTGAGESSUBPRIME MORTGAGES

5% Subordinated Tranche

15% Mezzanine Tranche

80% AAA Tranche


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100

200

300

400

$BIL

LIONS

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Figure 5

Growth in CDO Issuance/Milestones

Source: Presentation on Subprime to ADB by Credit Mortgage Group of TCW Inc., Sept. 2007


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Crisis Spreads to CDO, SIV, LBOs,Monolines, Credit Cards, Auto loansetc. When lower tranche gets hit, holders of upper tranches

panic and head for exit, causing prices to fall.

Investors no longer want to fund CDOs.

SIVs (structured investment vehicles). SPVs to short

fund high yielding assets like CDOs, MBS. Investors panic, no longer want to fund CDOs, SIVs. Led

to freeze in commercial paper market.

Credit default swaps market ($60 trillion). 7 top

monolines guarantee $4 trillion CDS. Monolinesdowngraded.

Fannie Mae and Ginnie Mae - guarantee $5 trillion ofmortgages - also downgraded.


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Model of Financial Instability

Minsky - 3 types of financing.

Hedging - cashflow exceeds principal.

Principal and interest (P+I) paid.

Speculative - cashflow meets I, not P.

Ponzi - cashflow does not meet even I. Payment fromfurther borrowing and price increase

Mixture determines level of financial instability.

Financial innovation push to Ponzi financing.

Reduced margin of safety.


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Consequences of financialcrisis

Weak financial sector and depleted capital Generalized credit crunch and higher interest

rates affecting consumers, house owners,corporations

Economic slowdown in U.S. - delayed by exportsrising and fiscal pump priming, but unlikely to beaverted

Continuing uncertainty of financial marketsreflected in extreme volatility

Inflation + stagnation => stagflation


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Inflation - Number 1 concernnow

Some inflation numbers : Rate in May/June 08vs. (2007) U.S. - 5.2% (2.7%) worst in 17 years China - 7.7% (4.8%) India - 7.8% (4.4%) Europe - 3.7% (2.0%) Malaysia - 7.7% as of June 08, (2.0%)

Vietnam - 25.2% (8.3%) Singapore - 7.5% worst in 26 years


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Commodities Market -Inflation Inflation - demand led and supply constraints

Era of disinflation over as Chinas role assupplier of cheap labor and goods decline andbegins to be major consumer.

In China,1988-2005, share of GDP going tolabor fell from 53% to 41%.

Pressure for wage increase will increase cost of

exports and fuel inflation Chinas GDP growth over 10% yearly. Between

2000-2007, GDP tripled from $1.2 tr to $3.3 tr


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Inflation

Geo-political instability in Middle East adds to

concerns over supply of commodities particularlyof oil. Oil price doubled in less than 12 months,rose 5x from 2003.

Prices of agricultural commodities also shot upas demand for bio-fuel competes for use ofagricultural products. Rice prices tripled btw Janand May 2008.

Role of financial speculation in commodities alsocontributory factor


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Stagflation

Policymakers caught between rock andhard place - struggling to raise interestrates and to tighten credit to control

inflation. Same measures suppress investment and

consumption contributing to slow growth

GDP growth in Asia (ex Japan) projectedto be about 5% in 2008.


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Impact on Asia and Malaysia

Two theoriesU.S. slowdown will pull down rest of the world;

Decoupling of rest of world from U.S.

Impact on financial markets

Impact on trade

Impact on capital flows


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Impact on financial markets

Global equities market more tightly linked.Fall in Asian equities markets even moresevere than in the U.S. Equity markets

decline: U.S. - 20% Japan - 34%

China - 50% Singapore - 30% India - 45% Malaysia - 27%


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Financial Markets Reasons : withdrawal of foreign equity funds

from Asia to cover losses in U.S. China and India markets over-heated

Bond markets - emerging market bond yield

risen. Banking system still relatively strong and stable.

Except for some Japanese and Chinese banks,few banks exposed to subprime assets.

Corporate leverage ratio improved dramaticallysince 1997 crisis. Average debt:equity


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National Balance Sheet

Asian economies strong national balancesheet :

large current account surplus

huge foreign reserves

many governments budget surplus or slightdeficit (except for Japan)

Manageable external debt


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A Note on Malaysian BankingSystem - some concerns Total loans > GDP RM 675b vs. RM 505b

2007 loan growth > GDP growth - 8.6% vs 6.3%

Loans to household sector (consumption) 56%vs to non-HH sector 45%. Residential property - 27% (RM 180b)

Non-residential property - 9% (RM 60b)

Passenger cars - 16% (RM 106b)

Personal use + credit cards- 7% (RM 53b) Securities (shares) - 4% (RM 30b)

Working Capital - 29% (RM 195 b)


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Impact on Asian Trade U.S. absorbs 25% of total world exports

Percent trade with U.S. in 2006 China 21%,

Hong Kong 15%

India 17%

Malaysia 19%

Recent data cast doubt on decoupling thesis Japans exports shrank 1.7% in June for first time in 55

month.

Signs of falling demand in other Asian countries.


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Impact on Malaysia - Trade

Malaysia - open economy - exports (RM 605 bil.+ imports RM 505 bil.)= 2 x GDP

20% of exports to the U.S. (not including indirect

exports through third countries) Manufactured goods = 78% of total exports

Electronics and electrical exports

= 60% of manufactured goods exports or47% total exports


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Impact on Malaysia - Trade Slowdown in E&E was - 4.2% in 2007 and

- 9.4% in Q1 2008. Impact will be more severe in H2 2008. Booking

to billing ratio dropped from >1 in mid 2007 to

0.8 in mid 2008 Compensated by increase in other

manufacturing sectors like petroleum products,optical and scientific equipment, pulp and paper

Total manufacturing exports = + 0.3% increase2007 and +1.0% in Q1 2008


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Impact on Malaysia - CapitalFlows Malaysia - strong balance of payment

Current account surplus (2004-2007) from RM57 bil to RM 100 bil Comfortable foreign reserves (2004-07) from

US$ 66 bil to $101 bil = 8 months import and

6.2x short term external debt Since 2005, net outflow of capital investments

yearly of about RM 40 bil

In 2007, net outflow of direct investments of RM9 bil (outflow RM 38 bil vs. inflow RM 29 bil) 2007 portfolio investments still positive net inflow

of of RM 18 bil. Could be negative for 2008


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MIDA Approved Investments2005-2008

Malaysia

Rgt Millions Domestic Foreign TotalInvestment Investment Investment

2005 13,173.7 17,882.9 31,056.6

2006 25,765.1 20,227.9 45,993.0

2007 26,506.3 33,425.9 59,932.0

H1 2008 8,421.4 17,747.8 26,169.2

Penang

Rgt Millions

Domestic Foreign Total Employment

Investment Investment Investment

2005 717.4 3,907.5 4,624.8 21,642.0

2006 1,432.5 3,918.2 5,350.6 13,539.02007 1,625.2 3,143.4 4,768.7 8,833.0

H1 2008 4,518.5 781.2 5,299.7 N.A.


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Malaysia - MIDA ApprovedInvestments 2005-2007 (RM Bil)

Amount of approved FDI vs. DomesticInvestment2005 = RM17.8 vs. RM 13.2

2006 = RM 20.2 vs. RM 25.82007 = RM 33.4 vs. RM 26.5

H1 2008 =RM 17.7 vs. RM 8.4

Some comparisons 2007 - China $75b;India $20b; Vietnam $18b.


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Conclusions

Financial crisis far from over. Will spill over intoreal economy;

U.S. economy going into stagflation;

Asian economy slowdown but still positivegrowth. Bigger threat is inflation;

Financial markets highly volatile and hasdropped more drastically in Asia;

Macro economic fundamentals in Asia relativelystrong and robust;


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Conclusions

Trade will be affected - especially in E&Eindustry in Malaysia with impact on employment;

Outflow of portfolio investments 2008 likely;

Less impact seen on capital flows. In fact,Malaysia has net capital outflows;

Malaysian banking system - loans too reliant on

household consumption; not enough forbusinesses. Consumption bubble.


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Thank You!By

Dr Michael Lim Mah Hui

Lim Mah Hui - Global Financial Crisis and Impact on Malaysia_2008 at SERI

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