06.04.2018 (Capital Economics) -

• Against the backdrop of a strong economy and with gerrymandering stacking the odds firmly in his favour, Prime Minister Najib Razak is highly likely to win an election which will now take place by May. While this should provide certainty for investors, it means the institutional problems hampering Malaysia’s economy are unlikely to be solved.

• Today’s decision to dissolve parliament means that an election must take place in Malaysia within the next 60 days, with an exact date set to be announced by the Electoral Commission soon. The Prime Minister has been dogged by allegations of corruption relating to the 1MDB state investment fund and faces a charismatic opponent in 92 year old former Prime Minister Mahathir Mohamad. Despite that, victory for the Malay’s National Organisation party (UMNO), which has been in power for almost 60 years, does not really look in doubt.

• First, Najib enters the election against a strong economic backdrop. Growth in 2017 was a strong 5.9%. (See Chart 1.) Second, the opposition’s efforts will be hampered by yesterday’s decision to temporarily dissolve the main opposition party because it did not post the correct documentation. Mahathir now cannot not use the party’s name or logo, impacting his ability to campaign. Third, widespread gerrymandering means that it would take a huge shift in votes for the opposition to clinch victory.

• On the plus side, continuity of governance would provide certainty for investors and consumers. This offers a welcome contrast to other countries in the region, namely Thailand and the Philippines, where the uncertain political environment represents a major downside risk to growth. (See Chart 2.)

• In particular, a number of key large-scale Chinese investment projects, including the upgrading of some sea ports, as well as the East Coast Rail Link, are expected to be a key driver of the economy over the next couple of years. The future of these projects would be at risk in the unlikely event that Mahathir wins the election.

• However, a victory for UMNO would reduce the chances of Malaysia tackling its institutional problems. Faced with a resurgent opposition, Najib has increased hand-outs to his mainly ethnic Malay supporter base. His victory would likely further entrench the system of affirmative action which grants privileges to ethnic Malays in areas such as housing, education and finance, and damages the economy by preventing the most able from rising to the top.

• What’s more, given that UMNO are still likely to win the election, even while embroiled in accusations of embezzling an estimated $3.5bn from 1MDB, there seems little hope that widespread corruption throughout the economy will be tackled.

• The upshot is that trend growth is likely to languish at around 4.5% y/y. To put that into context, when Hong Kong reached the same GDP per capita as Malaysia today it grew by an average of over 9% y/y over the following five years. The equivalent figure for Singapore was 8% and for Korea it was 6%.