Weight of economic reforms

IT’S great that a new Economic Action Council (EAC) was formed recently to rejuvenate the country’s economy. As economic reforms were previously put on the back burner, Malaysia is now rapidly becoming less relevant to investors.

On October 2010, I attended a talk in Kuala Lumpur by Joe Studwell, the famed author of a number of popular books including How Asia Works: Success and Failure in the World’s Most Dynamic Region and Asian Godfathers: Money and Power in Hong Kong and Southeast Asia.

The talk took place just a few months after the then National Economic Advisory Council’s (NEAC) National Economic Model (NEM) was announced amid great fanfare. However, the NEM was later put on the back burner.

During the question and answer session, I asked Studwell for his take on the Malaysian economy. His frank reply, if I recall correctly, was that investors would just ignore Malaysia as it is becoming less and less relevant! Could he be right?

Recently, I looked up a few financial and economic indicators to gauge where Malaysia stands economically. Alas, it appears that Studwell may be right.

First, I examined the important and influential MSCI Emerging Market Index, which tracks the stock performance of emerging markets and is generally used as a benchmark for mutual funds.

After the 1982 debt crisis in Latin America, the World Bank was confronted by the problem of how lesser developed countries could finance their rapid growth. The answer was to re-brand these countries as “emerging markets” to make investing in them look respectable.

In 1988, Morgan Stanley Capital International launched its Emerging Market Index. This made fund managers feel safer in investing in these countries as many disparate markets were included in the Index. This is portfolio diversification, so to speak.

When the Index made its debut, Malaysia had the highest weighting of the total at more than 30%. But by March 2018, Malaysia only constituted less than 3% weighting of the Index. Comparatively, Taiwan, which has a population of 24 million, holds about 12% of the total in the Index.

When China was included in 1996, its weighting was only 0.5% of the total. As of March 2018, it had the highest weighting at about 30%.

Finance should be used judiciously to serve the real economy. Hence, if possible, efforts should be made to make our stock market more dynamic and enhance the possibility of increased weighting in this Index.

Here is the key: even a small increase in the weighting will help to bring in billions of dollars to a country’s stock market.

For example, it was reported that MSCI will increase weighting of China A- shares in the MSCI Emerging Market Index from 0.7% currently to 3.3% (Reuters, “MSCI to quadruple weighting of China Ashares in its global benchmarks”, March 1, 2019).

It was further reported in a Bloomberg article that “This weight increases will lead to inflows of over US$10bil in 2019 due to passive funds benchmarking the MSCI EM Index. The total could reach US$73bil including all funds benchmarked to related indexes” (“What analysts say about MSCI’s move to boost China stocks”, The Star, March 2).

Changes in the index weighting will have an impact on asset allocation. Endowment funds, pension funds and exchange-traded funds globally which deploy asset allocation strategy will have to buy a country’s stocks based on the increase in weighting to track the benchmark index.

By the way, asset allocation essentially involves deciding how much and when to allocate one’s money to different assets such as stocks (developed and/or emerging markets), bonds, commodities, cash, real estate and other assets in one’s investment portfolio.

It is envisaged that diversification among different assets can help to mitigate severe losses and enhance returns. A typical portfolio involves 60% stocks and 40% bonds. EPF’s investment portfolio comes quite close to that.

Secondly, I looked at the foreign direct investment by country based on the United Nation’s World Investment Report 2018. Foreign investment is often considered beneficial to receiving countries as it helps to bring in new capital, technology and jobs.

By the way, Visual Capitalist has created a remarkable visual map of foreign direct investment by country. The brief results are as follows: China (US$136bil), Singapore (US$62bil), Indonesia (US$23bil), Vietnam (US$14bil), Philippines (US$9.5bil), Malaysia (US$9.5bil) and Thailand (US$7.6bil). In short, our neighbouring countries have increasingly out-competed us for foreign direct investments.

Thirdly, I reviewed the per capita income in China and Malaysia. It was estimated that China’s GDP per capita income, based on current prices, was US$10,099 in 2018. Malaysia’s was US$10,703. About 20 years ago, per capita income in Malaysia was about four to five times that of China. From 1998 to 2018, China’s income rose almost 12-fold. What’s behind this phenomenal rise? The short answer is structural economic reforms. China started out as the world’s factory. As its per capita income increases, China is now a huge and attractive consumer market to CEOs and investors alike.

In sum, it looks like economic reforms are long overdue. The key here, I think, is to encourage and attract more private and foreign investments. The debt-fuelled economic growth has probably run its course. An equity-driven model instead of a debt-driven one should be encouraged and promoted for companies. Consumption should be largely supported by higher incomes instead of increased household debts.

Going forward, will the reforms be substantive or just cosmetic? Will it still be a case of the more things change, the more they continue to be the same? Time will tell and history will judge.