Country Report / Malaysia
With the South Johor development region opening up and the banking market on the verge of full liberalization, Malaysia presents growing opportunities for investment.
Malaysia's capital, Kuala Lumpur
After decades of being wary of foreign investors, Malaysia is gradually ramping up its efforts to attract inward investment. However, continued controls by the central bank and involvement of government-linked companies in most areas and sectors mean that investors must look carefully at what they are getting into.
Ai Ling, director with the sovereigns team at Fitch Ratings, says that the main constraint to foreign investment is the country’s so-called bumiputra rights, the regulations outlining the stake that must be held by domestic entities in any business involving foreign investors. “The problem is that it affects the whole investment environment because there has been a leaning toward preferential treatment for some companies,” she says. “However, they are trying to move away from that—for example, by increasing the efficiency and transparency of the government’s procurement exercise.”
“In terms of foreign direct investment,” Ling adds, “there are some interesting opportunities, but there needs to be greater macroeconomic diversification. They need to take an overall view on foreign investment and work on that, not just in particular regions. They need to create a more equal playing field for foreign investors.”
The Malaysian government still maintains strong restrictions on foreign investment in some sectors. Foreign investment in the insurance sector, for example, is restricted to 49% ownership in companies for new entrants and 51% for those with existing stakeholdings. For some industries, though, the bumiputra requirement is relaxing. Foreign investors can hold up to 70% of shipping companies and some service industries, and in South Johor—a region where the government is hoping to promote investment—the bumiputra requirements are zero for some sectors.
Warming to Foreign Investment
Didi Yahya, executive director of investment banking, Malaysia, at JPMorgan, says the Malaysian government is keen to develop the South Johor region, also known as the Iskandar Development Region, because of its proximity to Singapore. “They are hoping that this area can bring in foreign investors to Malaysia,” he says. South Johor has more-liberal property ownership rules for foreigners, and the government has abolished the capital gains tax for property. Says one analyst: “It is an area where the services sector will come into play. They really want to build up sectors to diversify away from manufacturing, and they are trying to tap Singaporean investors for that.”
But the niches they are trying to create in this region are not unique and would definitely require foreign participation in order to be a success, notes the analyst: “There is a potential labor hindrance, and whether they can develop these niches will require a drive from foreign investors and also for reform measures to continue on the fiscal front. Malaysia’s fiscal policy is still quite heavy-handed.”
It does signal, however, that Malaysia is opening up to foreign investment. In addition, although full-privatization of state-owned companies will not happen any time soon, the government-linked investment companies (GLICs) are selling off stakes in a number of government-linked companies (GLCs). “Privatization is a continuing process,” says Yahya, “and Khazanah, the holding company for state-owned entities, has stated it will continue to divest shareholdings in a number of government-linked companies in an orderly manner while continuing to hold strategic stakes in these companies.”
Khazanah last year issued an exchangeable bond for TM, the Malaysian telecom company, which, according to Yahya, could increase liquidity in the stock market—to the benefit of portfolio investors. The $750 million deal was the first-ever Shariah-compliant exchangeable bond.
In addition, a number of LBOs have been launched by domestic and foreign investors. Energy and transportation company MMC recently completed a $2.71 billion acquisition of energy firm Malakoff. The deal’s financing package was significant in that it included a junior sukuk bond, the first corporate hybrid debt security in Malaysia and the first Islamic corporate hybrid instrument with a 100% equity weighting.
Markets Become More Open
The financial markets and financial services industries are also moving toward greater liberalization. Abhishek Kumar, market analyst at Financial Insights, says: “The Malaysian central bank has issued a financial sector master plan—first launched in 2001—and the local banking market is in the process of implementing the changes. Phase one involved developing a stronger domestic banking market through mergers and acquisitions.” Phase two continued the infrastructure development and freed some restrictions on foreign investment. “The final phase—complete liberalization—was expected to begin in 2007 but has been pushed back now,” he says.
The master plan has provided a relatively smooth path to liberalization of the banking industry, and Malaysia should soon see complete opening of its banking market to competition. “The central bank is working hard to get the regulations in place as quickly as possible, but it has to look at the market to see how it is working,” Kumar says. “So the process has simply slowed down as the local banking market adjusts to changes already in place.”
Nonetheless, there has already been significant internal investment into the banking sector in Malaysia. ANZ Bank, for example has picked up a 13% stake in AmBank, which it is looking to increase to 25%. In addition, the Dubai Investment Group bought a 40% stake of Bank Islam Malaysia Berhad, and the Kuwait Finance House is looking to make a purchase in the country.
The Malaysian banking sector has also been quite pioneering in the development of Islamic banking and Shariah-compliant structures (sukuk). “Islamic banking now accounts for 12% of assets in Malaysia, and they are looking to grow it to 20%,” says Kumar. “Malaysian banks have been very innovative and were the first to issue a sukuk globally,” he notes. “And they are pushing the field in terms of establishing a secondary market as well.”
There has been a great deal of M&A activity specific to Islamic banking as well, with Middle Eastern firms realizing the potential of Malaysia as a central hub to get into Asia proper. Aside from the Dubai Investment Group and the Kuwait Finance House, Rahji Bank has established itself in Malaysia and is looking to grow organically, and Qatar Islamic Bank established the Asian Finance Bank there in early 2007.
The country is also helped by the fact that it is considered one of the most politically stable countries in the region. “It has been ruled by the [Barisan Nasional] coalition for a long time,” one analyst explains. The next election must be called by the middle of next year, but the coalition is once again expected to face little competition.
In terms of the economic picture, one positive development is how the currency has performed since moving to a float. The central bank stopped pegging the ringgit to the dollar in 2005, moving to a managed float against a trade-weighted basket of currencies. Although the ringgit has appreciated 6.8% to the dollar since unpegging, a number of analysts still see it as undervalued. “This has created a positive environment for investors coming to Malaysia, especially portfolio investors,” says one analyst. “They are less worried about having currency controls in place, and people are being more optimistic as far as Malaysia is concerned.”
For international investors, another positive development was the scrapping of the capital gains tax. But Ling notes: “It is still the case that when international investors want to take part in this market, there will likely be some involvement of the government-linked companies. The preferential rights mindset and ethnic-based affirmative action policies must change in order for more international investors to look at the market. Gradually this is happening, but it is a very slow process.”