Recently I've been doing a bit of reading around the financial situation in Malaysia. It's an interesting country for many reasons. Geographically you could say that it sits in the heart of Asia Pacific, on the South China Sea close to Singapore and just south of the rapidly growing economy of Vietnam. Its population is growing and is has a Muslim majority, which has some interesting implications for the development of Islamic finance.

In the short-term, however, there are certainly challenges to address in Malaysia. These were highlighted in the Malaysian Department of Statistics report from June 2013. This report showed that in the country's external trade statistics there had been an RM4.2bn (6.9%) year-on-year drop in exports to RM56.7bn. Imports over the same time period saw a slight bump, up RM0.7bn (1.3%) to RM52.4bn.

The same set of statistic also show that Malaysia saw a RM3.6bn (3.2%) fall in total trade year-on-year, while the country's trade surplus plummeted 53.1% year-on-year, down to RM4.3bn.

To add to the current sense of unease, the Malaysian ringgit has dropped in value. The Malaysian currency was down 8.8% against the US dollar between May and August 2013, while closer to home, at the end of July 2013 it hit a 15-year low against the Singapore dollar, for example.

Ratings agency Fitch Ratings has also revised Malaysia's outlook to 'negative' from 'stable'. In its report, Fitch says that the change reflects its assessment that prospects for budgetary reform and fiscal consolidation to address weaknesses in the public finances have worsened since the government's weak showing in the May 2013 general elections.

This year's election results were incredibly close, so much so that the coalition with the greater popular vote is not the coalition that today forms Malaysia's government. The ruling Barisan Nasional (BN) coalition, which includes prime minister Najib Razak's United Malays National Organisation (UMNO) party, won a majority 133 parliamentary seats but only 47.38% of the popular vote. On the other hand, the Pakatan Rakyat (PR) coalition won 50.87% of the popular vote, but just 89 parliamentary seats, some 23 seats short of a simple majority. The Fitch outlook report specifically points to the government's minimal mandate as a concern that it will not be able to sufficiently address the country's public finance issues.

Malaysian federal government debt increased to 53.3% of GDP at the end of 2012. At the end of 2011 this figure was 51.6%, while in the four years since 2008 it has gone up from 39.8%. Fitch also state that the general government budget deficit had risen to 4.7% of GDP in 2012, partially due to a 19% increase in public wages that had occurred in the year running up to the election.

While the government has a target of a 3% deficit in 2015, the change in outlook for Malaysia reflect the doubts that the ratings agency has in this being achieved without additional consolidation measures.

Trade Profile

Despite that negativity, there are positives to be found in Malaysia, and fortunately these are largely on the trade side of things. Malaysia is rich in oil and other natural resource commodities. As emerging markets in Asia and further afield continue to grow rapidly, demand for commodities will increase, which in turn should have a positive knock-on effect for the Malaysian export market.

A report from HSBC Global Connections published in February 2013 predicts that exports from Malaysia to the rest of Asia (excluding Japan) will grow by approximately 10% per annum in 2013-15, before increasing even further to 11% per annum for the period 2016-2020.

The HSBC report also predicts that Malaysia's trade with other regions around the world can expect to increase. Exports to sub-Saharan Africa will grow by about 9% per annum during 2016-2020, while Middle East and North Africa exports are also predicted to expand by approximately 9% per annum over the period to 2020. Despite the troubles currently being experienced in the eurozone, Malaysian exports to Europe (excluding Russia) are also expected to rise at around 4% per annum in 2013-2015, reaching over 6% per annum in the following 2016-2020. Export growth to both Latin America and Australasia is also predicted.

Malaysia’s imports are also predicted to grow in the report. India and Vietnam are predicted to be the two fastest-growing sources of imports between 2016 and 2030, followed by those from Bangladesh and China.

Malaysia has previously succeeded in driving export growth by moving up the supply chain. Another HSBC report earlier in 2013 noted that Malaysia had gradually shifted from animal products to industrial machinery. This report also predicted that industrial machinery to remain the world’s top export sector, accounting for around 25% of goods exported among the top 25 trading nations by 2030.

A similar report published by Ernst & Young and Oxford Economics in 2012 highlights just how much Malaysia stands to benefit from this upscaling of its supply chain profile. Machinery and transport were the top export sector in Malaysia in 2010, with a value of US$ 86bn, but this is forecast to increase by 10.6% per year, reaching US$ 235bn by 2020. A similar pace of growth is predicted for other manufactured goods (US$ 31bn in 2010, up to US$ 79bn in 2020) and the services sector (US$ 33bn in 2010, up to US$ 72bn in 2020). The report states that the top nine export sectors for Malaysia were worth US$ 233bn in 2010, less than the prediction for machinery and transport alone in 2020. Overall, these nine key sectors are predicted in the report to be worth US$ 548bn in 2020.

As well as Malaysia's role in global trade, its position as one of the pre-eminent nations in Islamic trade finance should not be overlooked. For example, in the Islamic Centre for Development of Trade's annual report on the trade of Organisation of Islamic Cooperation (OIC) countries for 2013, Malaysia rated as the third biggest OIC nation in terms of global trade, with a trade figure of US$ 424.5bn. Only Saudi Arabia and the UAE had a higher global trade figure in the report. Malaysia is also the second biggest OIC player in terms of global trade in services (US$ 80.2bn), only behind Saudi Arabia.

New Developments

Some recent developments serve to give a flavour of the positive predictions that are being made for Malaysian trade. For example, 2013 is the first year that the Malaysia-Australia Free Trade Agreement (MAFTA) has been in operation. The agreement seeks to let both countries advance their trade interests in a mutually beneficial manner in addition to the ASEAN agreement. Malaysian trade with Australia was worth A$ 17.7bn in 2012, and MAFTA is designed to enhance that corridor.

This year, Standard Chartered has lent RM134mn (about US$42mn) to two Malaysian solar projects. The lender is Sun Energy Ventures, a company sponsored by SunEdinson. This is a first for Malaysia, as Standard Chartered had previously never lent to the Malaysian renewables sector.

Another first for Malaysia in 2013 has seen SWIFT open a corporate services centre in Kuala Lumpur. The centre offers services such as IT development, qualification testing, support, business operations, accounting and finance analysis and transactional functions. Speaking earlier in the year to GTR magazine, Francis Vanbever, chief financial officer at SWIFT explained why Malaysia had been selected as the venue for the society's Asian expansion: "We are pleased to select Kuala Lumpur as our new corporate services centre, based on its excellent balance between the quality of doing business and the cost of doing business. To come to this conclusion, we have considered many parameters such as the maturity of business establishment processes, support by the government, the availability of talent and the quality of office location."

There are certainly financial challenges facing Malaysia. How the political situation in the country hinders attempts to tackle the public debt crisis remains to be seen. One this that is clear is that, in the long-term, Malaysia's trade sector offers real potential for growth.