Although Malaysia’s currency has tumbled back to where it was in the late 1990s, the reasons this time around are rather different.

Headlines in the country have been dominated for weeks by allegations surrounding 1MDB, the state investment fund. At one point earlier this year it looked set to default on its dollar debts, and is now under investigation over claims of large-scale misappropriation.

Prime Minister Najib Razak himself has been drawn into the saga, following allegations that he received $700m in payments made by 1MDB, something he has vigorously denied.

Last week Mr Najib reshuffled his cabinet— removing the deputy prime minister in a move analysts saw as an effort to strengthen his position by removing his most powerful critic. The attorney-general, who has been overseeing the 1MDB probe, also stepped down citing health reasons.

The scandal over 1MDB is no longer simply a matter of personal politics, with some linking it directly to the recent weakness in Malaysian assets as fund managers reassess the country’s investment risks.

The Kuala Lumpur stock index is Asia’s worst performer over the past year, falling by a quarter in US dollar terms, while the ringgit has dropped sharply to its lowest level since the Asian financial crisis of the late 1990s.

“There is a sense that market sentiment has been weighed down by [the] 1MDB imbroglio, with the currency market seemingly bearing the brunt of adjustment thus far,” wrote Wellian Wiranto, economist at OCBC Bank.

Ringgit weakness has continued despite aggressive action from the central bank to defend it. The country’s foreign exchange reserves dropped $5bn in two weeks alone during July, an indication its currency intervention has been accelerating. Having peaked at around $140bn in 2013, Malaysia’s reserves are now close to $100bn and still falling.

Jason Daw, FX strategist at Société Générale, warns that the central bank could quickly run out of ammunition, and may soon have to let the ringgit depreciate “well below” the current level of around 3.80 against the US dollar.

Malaysia has also been hit hard by the fall in global commodity prices, notably oil. The country is one of Asia’s top crude exporters, and unlike Indonesia, does not get the benefit of cheaper fuel imports when global energy prices drop.

Though it does not run consistent current account deficits like Indonesia and India, its terms of trade have been deteriorating for months. Last year, the country ran a surplus of 1.7 per cent of gross domestic product, which is forecast to drop to 1.1 per cent next year. The most recent trade data, for April and May combined, showed Malaysia’s exports fell almost 8 per cent year on year.

“We think the bigger threats to Malaysia’s economy lie . . . in the form of the slump in the currency, which has highlighted the country’s rapid build-up of US dollar debt, and the decline in commodity prices, which has caused a collapse in export revenues,” said Capital Economics in a report.

The long-awaited interest rate rise from the US Federal Reserve, when it comes, could also spell trouble for Malaysia. The country has the second highest portion of government debt owned by foreigners in Asia, at around a third, making it susceptible to rising funding costs in the event of large scale capital outflows.

Though yields on Malaysian government debts have barely budged this year, still hovering around 3.5 per cent, the cost of protection against default has risen more than a third.

And having reported strong growth in the first quarter, many expect the economy to slow significantly through the rest of the year, as lower exports hit earnings and as the temporary effects on spending ahead of a new sales tax wane. HSBC reckons at least one rate cut is likely as activity slows.

Despite these mounting headwinds, some have adopted a more sanguine attitude. Fitch recently reaffirmed the country’s “A-” rating, and revised its outlook from negative to stable.

Emerging markets globally have been suffering this year as investors adjust the balance of their exposure to the US and the rest of the world. Many currencies and stock markets in developing nations have fallen sharply this year, with Brazil, Ukraine and Turkey in particular performing far worse than Malaysia or any other Asian economy.

Sacha Tihanyi, FX strategist at Scotia Bank, believes further ringgit weakness in the short term is inevitable, but that much of the bad news around the economy is already priced in.

“It’s all political risk that is hurting the currency,” he said. “The market will overshoot and present an opportunity. It’s going to be a matter of time and timing.”

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