The Malaysian people have unmasked corrupt bankers and politicians with the conviction of the former Prime Minister on corruption charges, and the settlement with Goldman Sachs for $3.9 billion over the 1MDB scandal.
These bold actions set the stage for Malaysia's next upswing in growth, and a narrowing of the income gap with Singapore.
How can these unmaskings be positive? Let's talk about that.
Politics is one of the factor buckets that financial markets discount.
The politics of a country can have a profound effect on investment values, both positive and negative. Less corruption, an honest legal system and pro-growth capital friendly policies are good for investment values, and more corruption, no legal system and anti-growth policies destroy investment value.
However, the important part of the process is not the current level of corruption, but the direction of politics either in favor of less corruption, better governance and pro-growth policies, or the opposite.
Politics tends to go in cycles, and the political cycles can be long, so they are investable. One of my strategies is to identify a positive political cycle that has not yet been fully appreciated or discounted in markets; one pushing toward less corruption, better governance and pro-growth policies; and invest before other investors come in.
This was the case in the late 1960's and 1970's in Japan, then in China in the 1990's and 2000's, and now in South East Asia and Malaysia in particular.
The ASEAN countries include Singapore, Malaysia, Thailand, Philippines, Indonesia, Brunei, Vietnam, Cambodia, Laos and Myanmar. Around 600 million people.
There is a direct correlation between the level of corruption in a country and the level of income. Less corruption equals higher average income. Singapore anchors the ASEAN region and is one of the least corrupt countries in the world according to World Corruption Perception Index. Singapore is a high income country precisely because they treat corruption as a serious problem. Singapore acts as a model for other countries in Asia on what to do to become a high income country, such as reducing corruption.
Singapore used to be part of Malaysia, and then it split off to become an independent city-state. Malaysia is Muslim majority and primarily ethnic Malay, or Bumiputera. Singapore is primarily ethnic Chinese. There has been a healthy competition between Singapore and Malaysia since the 1960's. From an economic point of view, Singapore is winning with per capita income similar to the US, and more than four times higher than Malaysia.
The Malaysian people were well aware that they were losing the economic battle to Singapore as their politicians were enriching themselves at the expense of economic development.
This is the situation I identified around ten years ago, that the Malaysian people were getting fed up with corrupt politicians. The political cycle was in play.
Then former Prime Minister Najib launched a venture called 1 Malaysia Development Bank, or 1MDB for short. It was to be a sovereign style wealth fund used to spur economic growth. Goldman Sachs raised billions of dollars for 1MDB, some of which was diverted into Najib's personal account and other unauthorized uses.
As the misappropriation by the PM and his cronies became more egregious, the people of Malaysia became more fed up, and a whole political movement erupted as people took to the streets in protests.
I went to several demonstrations to observe first hand what the true situation was on the ground. All of the protests were peaceful. Everyone was respectful, orderly and kind. On both sides. The protestors wore yellow shirts. Riot police and military were located within blocks of the protests, but they never engaged each other. There was no violence. Even trash was picked up by protestors. Ultimately, this movement swept Najib and his ruling party out of office, bringing back former Prime Minister Mahathir.
This was all accomplished without any violence or bloodshed. It was a fair, peaceful democratic outcome. Najib left office. Power was transferred in an orderly fashion.
The next test for Malaysia was whether the courts would convict the former Prime Minister, or as many suspected, he would be freed, which would be a negative outcome for Malaysia.
The Malaysian courts found former Prime Minister Najib guilty of corruption. He was fined $49 million and sentenced to 12 years in prison. Pretty serious sentence and fine. Plus Malaysia reached a settlement with Goldman Sachs for $3.9 billion.
No matter what happens from here, the Malaysian people have conducted themselves with honor and decorum and are to be commended. They have told the world that Malaysia is a country of laws, and you can invest there with confidence.
This is a win for Malaysia because it shows that Malaysia is moving in the right direction away from cronyism and corruption, and to a more open, transparent and fair economy. This "soft infrastructure" of a fair legal system is critical for any country if they want to increase their per capita income. Why?
Because local investors will have more confidence to keep their money in Malaysia and invest, and more international investors will now come to Malaysia as they know their hard earned money will be treated fairly and that the courts are fair.
Due to the courage of the Malaysian people to unmask corruption and hold their leaders accountable, economic growth will be higher, and Malaysia's economy will start to catch up with Singapore. Remember, Singapore, while having excellent governance, is a small and high cost location to operate when compared to its neighbor, Malaysia. With improved governance more companies will choose Malaysia over Singapore as both move forward.
A similar dynamic is in operation with China. Malaysia was already benefiting from China's One Belt One Road initiative. As the perception of better governance in Malaysia strengthens, more money will flow directly from China into Malaysia. Also, companies looking for alternative locations to Hong Kong or China for factories and service operations will increasingly choose Malaysia to locate.
Think about the evolution and maturation of the political process in Malaysia, especially compared to other countries in ASEAN. Thailand is under military rule. Indonesia has numerous governance issues, as does Philippines. Most other ASEAN countries are sub-investment grade. Good investment opportunities to be sure, but poor governance makes the job more difficult. By holding its leaders accountable, Malaysia becomes that much more attractive as an investment destination.
The good news for investors is that the political events in Malaysia are not yet fully understood and appreciated by many, and therefore are not fully priced into financial markets. Local press presents the corruption trial as a negative, but in reality, the whole episode is actually one of the more important positive political events in Malaysia's history, and bodes well for the future.
Now that the people of Malaysia have demanded and are getting better governance and accountability from their leaders, per capita income will grow faster than Singapore, and Malaysia will close the economic gap with its erstwhile partner. Malaysia can move forward on its goal to become a high income country. More to do, yes, but the direction and momentum are positive. Investors coming in now can benefit disproportionately as markets have yet to fully discount the good news afoot in Malaysia.