Is 2018 a Good Year?

There are several predictions for 2018. Some are more ominous than others – the world will end,  nuclear war, earthquakes, tsunamis and many more depressing thoughts.

How about the economy? Quite frankly, if the world is going to end then there is no need for any forecast. Just prepare for the worst! And here I could end this week’s entry.

But we live on hope and it is still the season of joy, peace and hope. In that spirit, I will try to gather the future for 2018. Global GDP is forecast to grow between 3.7% - 4.0%. For Malaysia, the consensus seems to suggest a range of 5.0% - 5.5%. Will that happen? Yes, if the following things hold:

·       domestic demand is strong;

·       inflation is below 3.5%;

·       oil prices remain in the current range;

·       fiscal deficit as a percentage of GDP improves further;

·       household debt will not implode; and

·       external position remains favourable

The bigger risk for Malaysia is political. The GE 14, trade impact with Trump’s “US First” policy, escalation of tensions between U.S. and North Korea and instability in the Middle East. Geopolitical risks far outweigh other considerations. And there is a chance of a recession every 10 years.

But let’s hope for better things and “hope is like the sun – if you only believe in it when you see it, you will never make it through the night” (Holdo, quoting Leia, from “Star Wars: The Last Jedi”).

May God bless Malaysia! And a very Happy New Year!

                                             Picture source: https://www.vecteezy.com/

Household Debt and Financial Stability

Global household debts (consumer and mortgage) have been consistently on the rise with around USD152 trillion in 2015. The top five countries with high household debts to GDP include:

	%
(i)         Switzerland	127.7
(ii)        Denmark	123.6
(iii)       Australia	123.0
(iv)       Netherlands	111.3
(v)        Canada	99.8

Malaysia’s household debt (% of GDP) from 2002 to 2016 was as follows:

According to the IMF, although finance is generally believed to contribute to long-term economic growth, “recent studies have shown that the growth benefits start declining when aggregate leverage is high”. From experience and past crises, increases in private sector credit, including household debt, may raise the likelihood of a financial crisis and could lead to lower growth. In 2016, on average the household debt to GDP ratio reached 63% in advanced economies and 21% in emerging market economies.

Globally, household debt has continued to grow in the past decade. The IMF had a sample of 80 advanced and emerging market economies to study the relationship between debt, growth and stability.

Findings show there is a trade-off between the short-term benefits of rising household debt to growth and its medium-term costs to macroeconomic and financial stability. In the short term, an increase in the household debt-to-GDP ratio is typically associated with higher economic growth and lower unemployment, but the effects are reversed in three to five years. Moreover, higher growth in household debt is associated with a greater probability of banking crisis. These adverse effects are stronger when household debt is higher and become more pronounced for advanced than for emerging market economies.

The impact of household debt on financial stability from a balance sheet and cash flow point of view was examined by IMF staff. The result of which is shown below:

Figure 1 – First and second round effects of the build-up of household debts on financial stability

Note

The above figure depicts the interactions between household debt, the financial sector, and the real economy. The balance sheet view (panel 1) shows assets and liabilities (debt) at the household level, whereas the cash flow view (panel 2) shows household income and expenses in the form of consumption and debt service. The two main channels through which household debt and consumption interact are deleveraging and debt overhang. Debt overhang may adversely affect aggregate demand through deleveraging or a crowding out of consumption by the debt service burden. Deleveraging can occur through forced or accelerated repayment of debt, reduction in new credit, and increased defaults or personal bankruptcies. From a legal standpoint, default follows from a situation in which assets and income are insufficient to cover debt-servicing costs, and bankruptcy from lack of sufficient assets and income to repay the debt. There may be second-round effects, such as Fisher-type debt-deflation dynamics, that may be caused by downward asset price spirals.

However, country characteristics and institutions can mitigate the risks associated with rising household debt. Even in countries where household debt is high, the growth-stability trade-off can be significantly mitigated through a combination of sound institutions, regulations, and policies. With better financial regulation and supervision, less dependence on external financing, flexible exchange rates and lower income inequality may reduce the impact of rising household debt on risks to growth.

The IMF concludes that overall, policymakers should carefully balance the benefits and risks of household debt over various time horizons while harnessing the benefits of financial inclusion and development.

Sources: Trading Economics, CEIC and IMF (Oct 2017)

Leveraged Buy-Outs – How are Financial Instruments Designed?

The outline structure of a leveraged buy-out may be depicted as follows:

  

Figure 1:  Outline structure of a leveraged buy-out

To make an offer for a target company, a new company is established (Newco) to raise necessary funds for the acquisition from investors and banks.

In a large buy-out it is usual to see several buyers of debt, mezzanine and equity that carry different risks and rewards (Figure 2).

Figure 2: Types of financial instruments risk and reward

  

In principle creating financial instruments is similar to painting – there are a fixed number of primary colours and a fixed variety of financial characteristics. However, there are two basic sources of financial returns – yield (or income) and capital gains (or wealth creation).

Table 1: Creating a hierarchy of financial instruments by varying risk and reward

Financial engineering blends together a series of rights and obligations to create a mix of risk, reward and control. The “best” instrument is one that ticks all the boxes in Table 1 above – secured, interest, dividend and share of capital gain. But some are mutually exclusive. In the end, negotiation skills determine instruments that are best subscribed for a buy-out. 

Source: Private Equity Demystified – An Explanatory Guide by John Gilligan and Mike Wright

P2P Lending in Malaysia

Digital Finance is growing fast across the world, and Malaysia is no exception.  During the SCxSC Digital Finance Conference held in November 2017, Securities Commission Malaysia (SC) outlined the progress made in digital markets. The SC strategy aims to enhance access to financing, increase investor participation, augment the institutional market, and develop synergistic ecosystems.  According to SC, the equity crowdfunding (ECF) and Peer-to-Peer (P2P) financing platforms have funded 450 campaigns, raising a total of RM50 million to meet the financing needs of the Micro, Small and Medium Enterprises (MSMEs) (Read more here).

Source: https://i2.wp.com/blog.seedly.sg/wp-content/uploads/2017/10/Peer-to-peer-how-it-works-01.png?ssl=1

Currently there are six P2P operators approved by SC.  P2P financing is a web-based innovation that broadens the ability of entrepreneurs and small business owners to unlock capital from a pool of individual investors in small amounts and provides a quick turnaround time to obtain financing for their businesses, through an online digital platform.  The P2P framework is part of SC’s on-going effort to provide greater access to market-based financing through the application of innovative technology solutions (Read more here).

Below is the fact sheet for P2P lending by Funding Societies Malaysia, a SC’s approved P2P operator.

Source: Funding Societies Malaysia.  This table has been prepared by Modalku Ventures Sdn Bhd (“Funding Societies”) for information purpose only. It is not intended to be an offer for financing or invitation to subscribe or purchase of securities. Financing application and approval are subject to policies and guidelines (including due diligence and credit assessment) maintained by Funding Societies from time to time. Funding Societies reserves the right to change the information of this table without prior notice and to request for additional documentation or impose additional conditions for financing, if deems fit. 

How to Gain Exposure to Cryptocurrency in Malaysia

Warning: This article is not intended to provide any buy or sell recommendation on any kind of cryptocurrency, it is not an investment advice.  Security Commission (SC) has warned the public that investment in cryptocurrency poses significant risks to investors (Read more here)! 

On 22 November 2017, Bank Negara Malaysia (BNM) Governor Tan Sri Muhammad Ibrahim said in his keynote address, “Readying the Financial Sector Amid the Evolving War on Terrorism Financing”, that the regulators must prepare themselves as digital currencies will become the new norm.  As such, BNM is developing the regulatory structure for digital currencies and from 2018, persons converting crypto currencies into fiat money currencies will come under anti-money laundering law  (Read more here).

There are many tutorials available on the internet about cryptocurrency, but they might be too complicated for the general public to comprehend.  The easiest way to gain exposure to cryptocurrency is to own some of it.  The most popular cryptocurrency now is Bitcoin, which is currently trading at around RM 35,000 per coin.  But not to worry, you can own a fraction of a Bitcoin, in a Satoshi (unit).  One Satoshi is equivalent to 0.00000001 Bitcoin, the smallest unit of Bitcoin currency.  As such, owning 100,000 Satoshi, or 0.001 Bitcoin cost only about RM 35 (as at 23 November 2017).   

Currently in Malaysia, according to the info in the press link (Read more here), there are 11 platforms providing cryptocurrency buy/ sell services in Ringgit Malaysia.  They are not regulated, yet.  Thus, the risk of theft and fraud may be high.  It was reported that a popular Bitcoin exchange was hacked and USD 30 million worth of Bitcoins were stolen by attackers on 21 November 2017 (Read more here).  If you plan to buy cryptocurrency in large quantities, it is advisable to store them in “Cold wallet” rather than “Hot wallet”.  The topic on cold and hot wallet will be covered in another article, soon!

To test one of the platform stated in the press link above is to buy RM50 worth of Bitcoin.  The entire process may take less than 30 minutes.  The tools you need are:

·        Smart phone (either Android or iOS)

·        Hot or Cold wallet.  (Hot wallet normally is attached to the exchange)

·        Online Banking Giro Account

You may follow the steps below:

1.      Open Google Play or App Store on your phone, download and install your desired Bitcoin exchange app.

2.      Follow the instruction to signup an account.  Remember, STRONG password is important!

3.      Verify your identity.

4.      Enable Two-factor Authentication.

5.      Tap the “Deposit” icon in the apps, then follow the instruction to transfer money from your bank account to the exchange’s account.

6.      Wait about 10 minutes to receive the successful confirmation notice of the transfer from the app.

7.      You can now buy Bitcoin by tapping the “Buy” icon.  Viola!  You now own your first Bitcoin currency!

8.      If you already have a “Cold wallet”, now it is time to transfer your Bitcoin to your cold wallet.  (Bitcoin could be transferred to another third-party wallet and thus the original purchase is legit).

The exchange charged about 3 ~ 4% for the buy transaction.  As such, the Bitcoin you may own is not the full RM 50 but about RM48+.  Also, transferring Bitcoin from the wallet provided by exchange to third-parties’ hot or cold wallet is also chargeable.