This article first appeared in The Edge Financial Daily on November 28, 2017

KUALA LUMPUR: The year 2018 is likely be a tale of two halves for Malaysia given the election cycle, said Morgan Stanley Research.

It noted that historically, domestic demand and private consumption momentum tend to accelerate in the run-up to elections, likely because pre-election measures before tapering off thereafter.

“We believe recent policy measures are likely to boost sentiment and support consumer spending, leading to a repeat of such growth patterns around the election cycle once more. This is so since we think policymakers are likely to refocus on fiscal consolidation efforts post elections to achieve near-balanced budget by 2020,” the foreign research firm said in a report on “2018 Asean Economic Outlook: Three Transitions” released yesterday.

Morgan Stanley Research is expecting “significant policy support” in Malaysia where pre-election spending tends to spur domestic demand significantly.

“Indeed, we note that pre-election feel-good initiatives have featured prominently among the measures in Budget 2018 announced in October, such as personal income tax rate cuts, special payouts for civil servants and government retirees, cash handouts for Felda settlers, enhancing benefits for employees of government-linked companies and removing specific toll collections.

“In particular, policymakers expect the reduction in personal income tax rates to raise disposable income by RM1.5 billion. This month, the ministry of finance also announced that the government is considering measures to ease the burden of middle- and lower-income households, should the retail price of RON95 gasoline and diesel exceed RM2.50 for three consecutive months,” it noted.

The parliament is due to be dissolved by June 2018, with elections held no more than 60 days later.

Morgan Stanley Research is also of the view that Malaysia’s interest rate normalisation path is unlikely to be aggressive, expecting Bank Negara Malaysia (BNM) to hike rates by 25 basis points in the first quarter of 2018.

“This is because of a few factors. [One is that] the current policy rate at 3% is not far off compared with the historical peak policy rate level of 3.5%. In particular, we note that the last time the overnight policy rate was at the 3.5% level between April 2006 and October 2008, gross domestic product (GDP) growth and headline inflation averaged 6.1% year-on-year (y-o-y) and 3.6% y-o-y respectively over the period, with the headline consumer price index rising to a peak of 8.5% in July and August 2008.

“We expect 2018 growth and inflation to average lower than the levels seen back then,” it added.

The research firm also pointed out that unlike other central banks, BNM has already normalised the policy rate to a greater degree. “Since 2010, BNM had already been ratcheting up the policy rate to the current level of 3%.”

Looking to the medium term and notwithstanding the cyclical pickup, Morgan Stanley Research believes that, however, the structural story in Malaysia remains one of the weakest in Asean.

“The commodity super cycle coincided with the erosion of non-commodity competitiveness. Malaysia’s declining global manufactured export share and the rising share of unemployed being graduates [suggesting skills mismatch] mean that structural reforms are required to improve productivity, particularly in human capital,” it said.

“In this context, we note that policymakers have adopted a multipronged approach via focusing on physical connectivity (upcoming/ongoing infrastructure projects), including the East Coast Rail Link, the MRT Lines 2 and 3, the LRT Line 3 and the Kuala Lumpur-Singapore High-Speed Rail, social connectivity and reducing reliance on low-skilled foreign labour.

“Given that Malaysia no longer has the low cost arbitrage to depend on, we believe more would need to be done — particularly on education system reforms — to raise productivity,” added Morgan Stanley Research.

Meanwhile, the research firm estimates that every 10% rise in oil prices will improve Malaysia’s current account surplus by about 0.1% of GDP, all else being equal.

“In addition, to the extent that policymakers have built in a Brent price assumption of US$52 per barrel in the 2018 national budget, any upside surprise in oil prices will lead to higher oil-related revenue and likely greater fiscal room for the government,” it said.