This article first appeared in Forum, The Edge Malaysia Weekly on January 8, 2018 - January 14, 2018

I remember some years back, a popular TV advertisement used the phrase “What if…?” to denote the possibility of a potential scenario unfolding, and showed how we should be prepared for it. In the context of the global and Malaysian economic landscape, the same “what if” question may have to be asked when looking at the scenarios that could unfold this year.

Specifically, the global economy last year performed in such a way that surprised many observers. It was not the US economy that raised eyebrows, as the world’s largest economy was already expected to cruise smoothly into 2018. Indeed, high-frequency data such as capacity utilisation was already revealing increasing strength in late 2016, which led to stronger capital spending last year. Add the tight labour market to the equation, and the 2.5% projected growth for this year is not a remote possibility.

But the euro and China economies were flashing upbeat statistics as well. After enduring a turbulent period characterised by the European Central Bank’s quantitative easing as well as debt restructuring in countries such as Greece and Ireland, hopes of a meaningful turnaround are finally becoming a reality. The recent growth statistics of Germany and other core euro countries testify to this recovery in momentum.

And China, an economy that many investors are losing sleep over, is finally showing some resolve in rebounding from its weakest growth pace since 2000. A growth momentum turnaround in 2017 may not end there, although some are still worried about a possible reversal this year. Of course, the rebalancing act will continue as the country seeks to avoid a catastrophe arising from the implosion of its debt problem. But China is not going to neglect its “growth” agenda, for sure. Though President Xi Jinping will continue to drive the economy by aiming for “quality” instead of “quantity”, he will certainly not want to be remembered as the leader who had a negative impact on growth and the financial markets during his term. This bolsters the view that his growth agenda will continue to support the global economy in the near to medium term.

So the question is, if 2018 turns out to be a roaring year, would it be akin to the early part of the 1990s or more closely resemble the period just before the 1997 Asian financial crisis? And what if it turns out to be the complete opposite of everyone’s expectations today? Nobody has an absolute answer, although many tend to have a more optimistic scenario in mind. It is worth remembering that business, investment and economic strategies this year will largely be tailored to the scenario that one has most firmly in mind.

Investors and businesses likening 2018 to one of the adrenaline-charged years of the early 1990s would undoubtedly be more aggressive in their decisions. One thing is for sure — asset allocations would favour equity investments to capture further upsides in the market. Investors will take advantage of market retracements as the cycle is still in an early stage. A synchronised global recovery that has just begun would mean that it will likely last more than a year before the bull in the equity market gets exhausted.

In this scenario, interest rate hike cycles are just beginning. As the global economy strengthens, demand pull will eventually bring back the inflation genie. This will be cause for cheer for many advanced economies, such as the US and Europe, which long to see further recovery in price levels. For emerging market economies, capital inflows will once again inundate their shores as the greenback retreats as it did during past synchronised global recoveries.

Hence, emerging market currencies will appreciate against the US dollar, while their domestic economies will strengthen on the back of stronger external demand. For a small, open economy like Malaysia, this is the much-awaited window of opportunity to widen its policy space in preparation for rainy days in the coming years. Indeed, this will be the time to build up our external reserves to provide sufficient buffers against vulnerabilities on the external front.

It will also be the time to sustain efforts to rebalance the economy. On the household side, continuing measures to reduce indebtedness should be undertaken. This is not to say that lending should be restricted across the board. Instead, lending to those who are already highly leveraged should be curtailed to avoid compounding their financial distress.

On the government side, efforts to trim its debt should be prioritised as well. This is because as interest rates climb, debt service charges would also increase. According to the latest Economic Report 2017/2018, the federal government’s debt service charges are expected to climb to around RM31 billion this year from RM26 billion in 2016. Between 2010 and 2016, debt service charges had risen 9% per annum, outpacing nominal gross domestic product growth of 7% per annum on a compound annual growth rate basis. Hence, reducing the amount of debt would greatly save future debt service charges.

However, should 2018 resemble the exuberant years of 1995 and 1996 (that is, the period just before the Asian financial crisis), some precautionary measures would not go amiss. In particular, investors should tread cautiously and look for clues of “over-exuberance” that could cause the bear to rear its head in the financial markets. Holding cash would be a wise strategy. Indeed, Malaysians who were cash-rich and took advantage of the collapse in the housing market during recessionary times made extraordinary gains in the subsequent years.

But of course, the difficult part is to guess whether the market is already at the tail end of the cycle. One of the effective ways to do this, in my opinion, is to see the level of overconfidence among investors. The less concerned investors are about risks, the more likely the downfall will come. Similarly, cautious statements by central bankers would normally mean that the market has more room to manoeuvre.

A case in point is the famous “irrational exuberance” statement by former US Federal Reserve chairman Alan Greenspan in December 1996, which was accompanied by another three-year boom in the stock market before the dotcom bubble erupted. But in our case now, Janet Yellen is feeling more confident about the equity market. Though “highly valued”, the market is not necessarily “overvalued”, according to her mid-December 2017 statement.

So, stay cautious. After all, the bond market has had a good run since the 2008 global financial crisis. And history shows that the debt market takes a beating following interest rate hikes (the 1980s illustrate this point well). We are hopeful that there will not be a repeat of this in 2018.

Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd. The views expressed here are his own.

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