The pinnacles of the Petronas Twin Towers protrude through low clouds in Kuala Lumpur. 
The pinnacles of the Petronas Twin Towers protrude through low clouds in Kuala Lumpur. 

From missing airplanes to jail-bound opposition leaders, Malaysia has recently made international headlines for all the wrong reasons. Will the nation's economy be next?

That's the thrust of new report from Sarah Fowler of U.K.-based Oxford Economics, which ranks Malaysia the "riskiest country in Asia of those we consider," more so than India, Indonesia and even coup-happy Thailand. On the surface, she points out, all's well: Growth is zooming along at 6.2 percent, the external balance is reasonably sound and political stability reigns. But all's not what it seems. "Prompted by its high levels of public debt, rising external debt and shrinking current account surplus, there has been a shift in the perception of risks towards Malaysia and away from Indonesia," Fowler explains.

Malaysia wasn't included in Morgan Stanley's "fragile five" list of shaky emerging economies last year, as were India and Indonesia. But Fowler scratches at a number of Malaysian vulnerabilities that deserve more attention: external debt levels that in recent years have risen to close to 40 percent of gross domestic product; a higher public debt ratio than India; the biggest short-term capital flows among the 13 major emerging markets Oxford tracks, including Indonesia; and a shrinking current-account surplus.

This last point is still somewhat of a positive. As the mini-crises in developing nations last year demonstrated, a balance-of-payments surplus is a very good thing to have. Also, Malaysia's use of so-called macroprudential policies has succeeded in preventing huge property bubbles of the kind afflicting Singapore and Hong Kong. But Malaysia's current-account surplus is dwindling, from 16 percent of GDP in 2008 to 3.7 percent last year. And household debt is, to use Fowler's words, "worryingly high" at more than 80 percent of GDP compared to less than 60 percent in 2008.

What really concerns Oxford, and myself, is the complacency factor in Putrajaya. Malaysia is effectively a one-party state, having effectively been ruled by the same party for six decades. Its 40-year-old, pro-Malay affirmative-action program chips away at the country's competitiveness more and more each passing year. The scheme, which disenfranchises Malaysia's Chinese and Indian minorities, is a productivity and innovation killer. It also has a corrupting influence on the political and business culture.

"A climate of entitlement amongst the Malay community limits entrepreneurialism and vested interests within the United Malays National Organization still resist change," Fowler argues.

The need for change is becoming acute, though, as China's dominance grows and neighbors like the Philippines get their acts together. Indians just elected the party of reform-minded Narendra Modi and Indonesians will soon choose a successor for Susilo Bambang Yudhoyono in a contest that's all about reducing corruption and improving governmental efficiency. And Malaysia? Well, Prime Minister Najib Razak's lackluster party is clinging to power. Meanwhile, opposition leader Anwar Ibrahim may soon be in jail again on sodomy charges many see as politically motivated.

The government's handling of Malaysian Air Flight 370 said it all. Its deer-in-the-headlights response to the plane's disappearance was the product of an insular political culture. The trouble is, that insularity is holding back a resource-rich economy that should be among Asia's superstars, not its weakest links.

To contact the writer of this article: William Pesek at wpesek@bloomberg.net

To contact the editor responsible for this article: Nisid Hajari at nhajari@bloomberg.net