TO SAY THAT 2015 will be a crossroads for a trade-dependent economy such as Malaysia is probably no overstatement. In fact, many export-oriented countries are now bracing for tougher headwinds in view of the recent weaknesses in advanced economies such as Europe and Japan.
Magnifying the uncertainty is China’s cloudy economic outlook following a downturn in the property sector due to the stringent monetary measures implemented by the government to contain rising asset prices.
But with Malaysia’s GDP growth managing to surprise on the upside in the first half of 2014 and consumers continuing to splurge like there is no tomorrow, is this fear of another period of economic turbulence justified?
For better perspective, comparisons with previous pre-crisis cycles may help us see where the economy stands and what to expect in the near term. Indeed, economic conditions have generally improved since the recovery from the global financial crisis in 2009. Real GDP growth has picked up, averaging 5.8% per annum after experiencing its first contraction since the Asian financial crisis in 1998.
International reserves have surged on the back of improved trade performance, while the equity market has climbed to a new high following sustained capital inflows. Similarly, private investment and consumption have rebounded strongly, with the latter induced primarily by a stable labour market and easy credit.
The banking system has continued to be sound, with capital ratios standing higher than the levels required under Basel III. Bank Negara Malaysia has also beefed up the country’s defences against significant downward pressure on the ringgit by establishing swap agreements with various Asian countries.
That’s the good news. The Malaysian economy is in fundamentally better shape than it was during the period preceding the Asian financial crisis and is almost comparable with what it was before the global financial crisis (GFC). But worries linger on several counts, especially in the financial market.
The first concern is Malaysia’s deep linkages with global trade. While exports have finally revived after remaining lacklustre in the first three-quarters of 2013, Europe’s economic malaise and China's wobbly economic growth can easily turn the trend around in the near term.
Bear in mind that China is now one of Malaysia’s single largest trading partners. Should the country sneeze, Malaysia will likely catch a cold. And Europe’s economic malaise is a risk to China and hence to Asian countries in general. If the European economies continue to be dragged down by disinflation, which could risk a deflationary spell in the near term, they will not have enough purchasing muscle to absorb China’s exports.
Luckily, the world’s largest economy, the US, is finally firing up its engines to help support global trade. The uptrend in the ISM Manufacturing Index, which monitors employment, production inventories, new orders and supplier deliveries, suggests that Malaysian exports will be somewhat supported, given their strong past correlation.
But again, the fate of the US economy will likely continue to depend on its policy actions, especially on the future course of interest rates, as determined by Janet Yellen’s Federal Reserve. As long as the Fed continues to believe that labour market conditions remain fragile (despite the overall improvement in payroll numbers), rates will not be raised soon.
However, the bad news is that there is an increasingly upbeat sentiment about the labour market for which the financial market is already pricing in an increase in 2015. This means that while global trade continues to support Malaysia’s trade and current account (balance of payments) performance, capital outflows will likely exert pressure on the financial account, causing strain on the ringgit.
Indeed, the aforementioned swap agreements will come in handy should the above scenario unfold. They will act as new ammunition against a possible decline in the ringgit, thanks to Bank Negara’s initiative. However, financial market jitters may linger, especially when foreign holdings of Malaysian Government Securities (MGS) remain close to 50% of total outstanding MGS. The fear is that a sudden and massive exit by foreign investors can knock down the value of the ringgit should they feel jittery about aspects of the economy. But why should they?
Admittedly, the macro picture has not taken a turn for the worse since the GFC, but market sentiment, often fanned by greed and fear, may prove to be a crucial factor that changes investor sentiment. And in the case of Malaysia, market confidence may also be rattled by factors such as accelerating inflation, a weakening domestic economy and a narrowing interest gap following the anticipation of higher rates in the US.
With inflation likely running above 4% in 2015 on the back of subsidy rationalisation measures and the implementation of the Goods and Services Tax in April next year, international investors may have an excuse to divert their funds away from Malaysian shores.
The lack of fiscal space may also be an excuse to temporarily relook other markets. While the budget deficit is almost at the same level as what it was a year before the GFC erupted, the debt level looks less favourable than in 2008.
While it remains true that Malaysia’s debt is way below what it used to be in the mid-1980s (at roughly 100% of GDP) and comprises mainly of domestic debt, the financial market may continue to feel uneasy. On top of that, when the level of household debt is incorporated into the assessment, its desire to exit the market temporarily and remain on the sidelines becomes greater.
Notwithstanding this, while the financial market may not be too kind to the Malaysian economy in 2015, it is worth noting that economic fundamentals have not deviated significantly from the previous cycle, especially when one disregards the side effects of pump-priming measures that were meant to uplift the economy in 2009.
Those measures, while causing some strain to government and household debt, were aimed at protecting the welfare of the population and preventing the business sector from collapsing and causing the entire economy to break apart. In fact, measures to alleviate these imbalances are now being pursued despite their unpopularity.
Therefore, from a long-term perspective, one should not be overly pessimistic about the economy.
Nor Zahidi Aliasis chief economist at the Malaysian Rating Corp Bhd
This article first appeared in The Edge Malaysia Weekly, on November 03 - 09, 2014.