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By Stuart Grudgings
KUALA LUMPUR, Jan 21 (Reuters) - Malaysian stocks suffered their biggest drop in 16 months on Monday as investors woke up to the risks of what is expected to be the Southeast Asian country's closest national election.
Speculation that Prime Minister Najib Razak would call the election has been swirling as far back as 2011, but his window for going to the polls is narrowing fast ahead of an April 28 deadline for dissolving parliament.
Investors have been luke-warm on Malaysian stocks for the past few months compared to most of its regional peers. On Monday, they rushed for the exits after rumours circulated online over the weekend that Najib was poised to hold the election as early as March.
"People are worried about the elections. That's the trigger," said an analyst at a local investment bank who declined to be identified.
The benchmark FBI KLCI stock index fell 2.43 percent to 1,635.63, its worst single-day drop since September 2011 as election nerves sparked selling across the board. Most other regional stock markets were steady on Monday.
The ringgit currency also fell, losing 0.5 percent against the dollar on stop-loss selling related to the slide in stocks.
Among the biggest stock losers were government-linked firms whose close political connections would be at risk in the unlikely - but far from impossible - event of an opposition victory ending the Barisan Nasional coalition's 56-year rule.
Autos-to-property conglomerate DRB-HICOM, controlled by tycoon Syed Mokhtar Al-Bukhary, fell 3.36 percent, while government-controlled Malaysian Airline slid 3.47 percent.
Telecoms firm Axiata Group Bhd, majority owned by the government, plunged 5.12 percent, while government-linked bank CIMB Group Bhd lost 4.49 percent.
Malaysia's financial markets were caught napping in 2008 when shock gains by the opposition redrew the country's political map and sparked a 10 percent one-day plunge in the main index.
The scope for a surprise is very much alive five years later due to a lack of reliable opinion polls and signs that the three-party opposition led by former deputy prime minister Anwar Ibrahim is mounting a well-organised campaign.
Najib is widely expected to win, but a failure to secure the two-thirds parliamentary majority the coalition lost in 2008 could trigger ruling party infighting and a leadership battle within months. A thin victory for the ruling coalition could lead to intense horsetrading as Anwar tries to form his own governing majority.
"The biggest worry is a hung parliament. That would be terrible," said Kaladher Govindan, head of research at TA Securities, a local brokerage.
"If it's a clear majority there can be a decisive growth agenda."
He said the hefty losses by government-linked and telecoms firms on Monday could be a sign that investors were starting to shun defensive stocks and preparing to buy cyclical plays that should gain once election uncertainties ease.
So far this year, the Kuala Lumpur index has fallen 3.2 percent percent, underperforming its Southeast Asian peers. Its 14-day relative strength index is at 31.87, the lowest in the region. A level of 30 or lower indicates a market is oversold.
Retail investors led the selling on Monday with a net 21.9 million ringgit ($7.2 million).
One Kuala Lumpur-based equities trader said that foreigners were trimming positions ahead of the polls, adding that the election was likely to overshadow the market for the first half of this year.
"Telecoms were among best performers last year, so they are selling targets," she added.
Foreigners withdrew a net $42 million from Malaysian offshore equity funds in the last six months of 2012, while adding a net $129 million and $230 million to Philippine and Thai funds respectively. (Additional reporting by Siva Sithraputhran and Anuradha Raghu in Kuala Lumpur, Viparat Jantraprap in Bangkok; editing by Simon Cameron-Moore)