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OH NO! INFLATION, POLITICAL UNCERTAINTY & SLOW DOWN IN THE ECONOMY

By John Ching, 24 -7-2008

Just last week a journalist for a magazine contacted me for comments on the effect the latest developments in the country have on potential MM2H participants.

More specifically he was asking if the effects of the increased food and fuel prices, political uncertainty – issue of leadership for the country and slow down in the economy have spooked MM2H participants. I told him my comments in brief but have decided to expand them into an onsite article here as the issues he has raised are indeed interesting.

Looking at my clients I don’t think the potential MM2H participants are  as worried about the micro developments in Malaysia right now as they are about the global outlook. The MM2H participants like most look firstly for security and secondly for growth in this place they call 2^nd home.

I think MM2H participants are more afraid of the effects of the housing slump, sub-prime loan crisis and credit crunch in the US economy spilling over to the real economy worldwide and of course worldwide inflation.

Sure the recent fuel and food price increase of 40% and the corresponding increase in almost every item is a problematic but it is not a unique Malaysian phenomenon but is a global one. It doesn’t mean that if a foreigner chooses not to move to Malaysia he can avoid the inflation.

Furthermore the effects of the increase in the local Consumer Price Index are felt directly by Malaysians who are under the purview of the local income per capita and earning the RM. Any increase in the local CPI is softer on a foreigner that does not make a living in Malaysia and usually has his work and other income generating instruments overseas or in a regional or global spread.

The political order of the country has for the first time since independence changed at the last election and the opposition now forms 37 % of the parliament and some say this is instability. But by and large, MM2H participants that hail from advanced countries, have 2 or 3-party political systems at home anyway and therefore the lively debates of democracy is not a novelty. Those that hail from autocratic countries, I suspect look at it as an enlightening glimpse of government in action rather than worry.

Any slowdown in the economy such as lower growth of GDP, slower manufacturing export and construction figures do not directly affect people who are not making a living in that particular place.

Although inflation, interest rates, currency exchange rates would.

INFLATION

In this case inflation is a problem affecting all countries in the world at the current moment. Inflation is at a 15 year highs in Saudi Arabia, a 14 year high in Switzerland, 11 year high in the U.K., 10 year high in Japan and the list goes on.

Rising prices: Year-over-year global inflation rates as of July 2008. (Sources: Reuters, Associated Press, International Monetary Fund, Bespoke Investment Group)

The map above shows the July 2007 to July 2008 increase of inflation figures of the major countries of the world (www.cbc.ca). The figure for Malaysia for the roughly same period (June 2007- June 2008) has just been released at the time of writing and is 7.7%. This more than doubled the May 2007 - May 2008 figure of 3.8% although the main reason for the rise was the fuel hike of 40% in June 2008.

According Kuala Lumpur based fund managers, the estimated figure for say July 2007 – July 2008 should be above 7% but the rates for other countries would also rise in by then.

The International Monetary Fund said that the rate of inflation for the top 70 economies is likely to breach the 5% mark by the 3rd quarter 2008 and that it is on the advance in both emerging and developed nations.

An important point is a lot of essential items such as fuel, food and construction materials are controlled items in Malaysia as the government regulates their prices and this will to a great extent control the upward movement of the CPI.  

Fuel for example is still subsidised by the government although there was a 40% hike back in June. The pump price for a litre of petrol is RM 2.70 when many economists put the unsubsidised price at RM 4.50.

INTEREST RATES

The interest rate is a consideration for MM2H participants as in most cases they will have to deposit an amount of money in the fixed deposit in a local bank. The chart below shows the interest rates of fixed deposit/time deposits in various currencies as quoted by the website of HSBC in that respective country. Criteria is an amount of approximately RM 300,000

Although the fixed deposit rate in Malaysia is not the most attractive in the world, it can be considered to be in the medium range.

CURRENCY EXCHANGE

This is a plus point for a MM2H participant that has transferred or is going to transfer money to Malaysia. Below is the movement of the RM in relation to other major currencies for the last 5 years (source www.finance.yahoo.com)

British Pound to Malaysian Ringgit Exchange Rate

Euro to Malaysian Ringgit Exchange Rate

Japanese Yen to Malaysian Ringgit Exchange Rate

U.S. Dollar to Malaysian Ringgit Exchange Rate

With the exception of the Euro, the RM has been generally strengthening against the GBP, YEN and USD in the last 5 years and it is set to appreciate some more.

The following report by Bernama early this month (July 2008) captures the position of the RM nicely.

“The Malaysian Institute of Economic Research (MIER) has suggested that the government relaxes existing controls on the ringgit, especially on offshore trading.

Such a move will strengthen the local currency and ease the pain of inflation, according to MIER executive director Professor Emeritus Datuk Dr Mohamed Ariff Abdul Kareem.

“Imports would be cheaper while contributing to lower prices of goods. A strong ringgit is also good as it is a plus factor for the stock market,” he said.

Bank Negara Malaysia’s governor Tan Sri Dr Zeti Akhtar Aziz was quoted recently as saying that Malaysia’s inflation last month probably exceeded six per cent following the adjustment in fuel prices.

Zeti said domestic inflation was expected to remain elevated for the rest of this year and in early 2009 but should moderate in the second half of 2009.

According to Mohamed Ariff, Malaysia has limited policy options due to budget deficits over the last 10 years.

“There is a sort of fiscal fatigue setting in. So, with the economic slowdown, we have to consider another expansionary budget. This will again make our budget deficits bigger, not smaller,” he said.

“As for interest rates, we cannot raise it too much as this would hurt the economy. I think the only option left for the central bank is the exchange rate,” Mohamed Ariff said.

“Thus, relaxation of controls would be helpful. The ringgit should be allowed to appreciate on its own. We do not want it to appreciate artificially, as this would be disastrous,” he said.

“We should give the market a little more leeway. Let the ringgit rise a bit. I think it is still undervalued,” he added.

Mohamed Ariff pointed out that other currencies in the region were appreciating more than the ringgit, vis-a-vis the US dollar.

Asked how much the ringgit should appreciate, he said: “I don’t think we should decide on that. Leave it to the market forces. In times like this, when deciding on the position of the ringgit, the risks are very limited.”

Mohamed Ariff said the ringgit is now facing a different situation from that experienced during the Asian financial crisis.

“In 1997, the ringgit was over valued by more than 20 per cent. Today, it is undervalued by about five per cent,” he said.

“The risks we face today are therefore very different. We don’t have to worry about speculative attacks on the ringgit,” he added. — Bernama”

Kuala Lumpur based economists I have spoken to today, estimate the RM to rise to RM 3.1 to 1 USD at the end of this year and RM 2.9 to 1 USD early next year.

A rise from the current RM 3.24/USD1 to say RM 2.9/USD1 would be an increase of 10%. This roughly means MM2H participants that transfer money from a USD account to Malaysia would stand to make 10% just from the currency exchange alone. This plus say 3.7% of interest rate from 12 months local fixed-deposit placement would add up to about 15% gain.

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