Cover Story: From QE to QT: Risk of a global recession dims Malaysia’s trade outlook

This article first appeared in The Edge Malaysia Weekly, on June 27, 2022 - July 03, 2022.
Cover Story: From QE to QT: Risk of a global recession dims Malaysia’s trade outlook
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THE prospect of a global recession on the horizon is in focus again following the US Federal Reserve’s sharp and unexpected 75-basis-point increase in the Fed funds rate, as it steps up efforts to tame skyrocketing inflation in the country.

Since early June, the Fed has also embarked on quantitative tightening, as opposed to easing, when it started scaling back its balance sheet and stopped reinvesting maturing debt in its securities portfolio, effectively reducing the money supply in the system.

Economists say rising inflation has already cast a pall over consumer confidence in both developed and emerging markets. The Fed’s resolve to stabilise prices alongside softening consumer demand has many believing that the likelihood of a recession in the US is now higher than before.

Elsewhere, other developed-market economies are also suffering from high levels of inflation. Last week, inflation hit a 40-year high of 9.1% in the UK — the highest among G7 nations. Central banks in developed economies have embarked on monetary tightening to fight inflation, save for the Bank of Japan, which continues to maintain a dovish stance.

The fight to keep inflation from spinning out of control in the West comes at a time when the growth of Asia’s economic engine — China — comes into question. While the country appears to be coming out of recent lockdowns and economic activity is bouncing back, the damage to performance has already been done, says Citi Research in a recent report.

“We’re now projecting Chinese growth this year at 3.9%, compared with 5.1% just two months ago,” says Citi Research in its June 22 global economic outlook and strategy report.

There is also the ongoing war between Russia and Ukraine to contend with. After more than 100 days since the former invaded its neighbour, there is still no resolution in sight. Commodity prices have come off their highs but remain elevated, and this has hit Europe harder than the rest of the world because of the region’s dependence on Russia’s commodity exports.

Amid all the noise, it is easy to believe that a global recession is imminent.

Standard Chartered chief economist for Asean and South Asia, Edward Lee, says his core scenario remains that of slower global growth rather than a recession, even though the risk of a recession has increased. He also says a distinction has to be made with the term “recession”, where depth, diffusion and duration matter.

“People tend to conjure up images of Covid or the global financial crisis when hearing the term ‘recession’. We do not rule out a technical recession, but we are projecting slower growth rather than an outright recession in 2023,” he explains.

Notably, the word “recession” can be defined in several ways. The most popular and simplistic way of describing one is when GDP growth contracts for two consecutive quarters. This is what the market calls a technical recession.

Meanwhile, the US National Bureau of Economic Research defines a recession as a “significant decline in economic activity that is spread across the economy and that lasts more than a few months”. The bureau looks at several indicators, from GDP to unemployment, real income, decline in consumer spending and a stagnation in industrial production and retail sales.

A blow for external trade

With global financial conditions tightening amid the more hawkish monetary policy stance, external demand could start to taper off. This may already be affected by high inflation, says Edward.

He highlights that trade is starting to slow, partly due to a base effect. “This can be seen more clearly from a volume versus value perspective. For example, as of March, global export value was up 14% year on year, but only up 2% y-o-y in volume,” he explains.

If the world does fall into a recession, it will not bode well for Malaysia’s external trade. According to the Ministry of Finance, the export of goods is expected to contribute 37% to the total economy of RM2.4 trillion in 2022.

“Exports to the US and China account for a quarter of Malaysia’s total exports, and about 20% of nominal GDP. Hence, a slowdown in these economies will be felt at home,” says CGS-CIMB Securities head of economics Nazmi Idrus.

Malaysia’s top three export destinations are China (RM192 billion in 2021), Singapore (RM173.4 billion) and the US (RM142.2 billion).

Lee Heng Guie, executive director at the Associated Chinese Chambers of Commerce and Industry of Malaysia’s Socio-Economic Research Centre (SERC), points out that between 2015 and 2021, the US commanded a share of 10.1% of Malaysia’s exports on average per annum. He recalls that during the 2008 global financial crisis, the recession in the US lasted 18 months, causing a steep decline of 26.5% in Malaysia’s exports to the country before recovering marginally by +0.2% in 2010.

However, the Covid-19 shock to the economy in 2020 had the opposite effect on the growth of Malaysia’s exports to the US, which grew a robust 13% in 2020 and 30.4% in 2021, boosted by the roaring demand for personal protective equipment (PPE) and rubber gloves, electrical and electronic products as well as chemical products, he says.

As we know it, the demand for rubber gloves and PPE was not sustainable, and exceptional, as total exports to the US moderated to 10.6% in 1Q2022. “Assuming that the US economy goes into a recession, it is expected to shave off Malaysia’s exports to the country to a lower growth trajectory or even a contraction, depending on the duration and magnitude of the recession,” he adds.

OCBC Bank economist Wellian Wiranto says Malaysia’s economic prospects in 2H2022 look less rosy than in 1H2022, especially on the export front, due to the slowdown in major markets. Nevertheless, he thinks the product mix offered by Malaysia’s exports, namely semiconductor chips and commodities, should continue to offer support.

“If the end-demand falters in these key markets [China, the US and the eurozone], it would ultimately deal Malaysia’s export receipts a blow,” he adds.

In 2021, the top three exported manufactured goods from Malaysia were electrical and electronic products (valued at RM455.7 billion), followed by petroleum products (RM95.7 billion) and chemicals and chemical products (RM70.7 billion). The top three primary industry products exported were palm oil (RM75.8 billion), liquified natural gas (RM36.6 billion) and crude petroleum (RM20 billion).

Where will that leave investments and the ringgit?

Malaysia is deemed one of the few attractive destinations for foreign direct investment (FDI) in the region. However, investors may consider stalling their investment decisions in the event of an economic downturn.

This, coupled with the high cost of borrowing on rising interest rates, could dampen the inflow of FDI into the country. The bulk of Malaysia’s FDIs is invested in the manufacturing sector, followed by the services sector.

During the global financial crisis, FDI net inflow fell to RM5.12 billion in 2009 from RM23.93 billion in 2008. Nevertheless, the rebound was swift as FDI net inflow increased to RM29.18 billion in 2010.

A similar trend was also observed during the Covid-19 pandemic, when FDI net inflow declined to RM13.28 billion in 2020 from RM32.36 billion in 2019. It rebounded a year later, with net inflow of RM48.14 billion in 2021.

Standard Chartered’s Edward, however, believes that FDIs may be slightly stickier as companies have longer-term considerations for such decisions. “We have seen this region, including Malaysia, benefiting from higher FDIs, driven by considerations such as improving supply chain resilience and growth markets,” he says.

Meanwhile, the ringgit had already depreciated to 4.40 against the US dollar at the time of writing. At the start of the year, the local currency was 4.19 against the greenback.

Economists say the hawkish Fed’s monetary policy is disrupting the performance of the ringgit.

“Higher interest rates in the US and the narrowing yield gap with Malaysia could mean capital will flow towards US Treasury securities in search of higher investment returns. And the ringgit will be under pressure against the strong dollar as US dollar-denominated assets turn more attractive to yield-seeking investors,” says SERC’s Heng Guie.

CGS-CIMB’s Nazmi highlights that the US dollar does have a special position as a safe-haven currency and at a time of weakness, we can see an appreciation in the greenback and a weakening of the ringgit.

Heng Guie believes that if there is an economic deterioration in the US economy and inflation subsides, the Fed will pause its monetary policy tightening. In that event, the ringgit will see a reprieve and that should ease the volatility of capital flows. “Having said that, we caution that there is a monetary lag and the strong inflationary pressures could stay stubbornly high initially,” he warns.

“The concern is stagflation — low economic growth, high inflation and high unemployment. Stagflation or recession-inflation situations present a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.”

Is there any upside?

The hope now is that the US will be able to engineer a soft landing for its economy, thereby softening the impact that other economies could face as well. However, many think the probability of such a landing is small. That is because apart from the issue of aggressive monetary policy tightening in developed nations, there are other moving parts.

OCBC’s Wiranto opines that an upside scenario could involve many things. “A sudden and quick resolution to the Russia-Ukraine war would weigh on commodity prices such that inflation fears would recede. This could allow the Fed and other major central banks to tighten less than foreseen, for instance.

“Or perhaps if China could find a way to really stamp out the Omicron spread without the cycle of lockdowns it has gone through? A lot of stars have to be aligned for such a positive scenario, unfortunately.”

Standard Chartered’s Edward, who anticipates a slowdown rather than a recession, believes that Southeast Asia is still playing catch-up in terms of recovery from Covid-19. He thinks there are still some tailwinds to the region’s growth, particularly in domestic activity, but is also aware of the fact that being export-oriented, the region will not be insulated from external demand weakness.

“China is moving to a more targeted approach and its likely strong push to boost growth and lower unemployment in 2H2022 may provide some support versus a growth slowdown in other regions,” he says.

The bottom line is that the degree of impact on Malaysia, should a recession materialise, would depend on the extent of the recession — whether it is mild or severe and synchronised across multiple countries.

UOB Malaysia senior economist Julia Goh says central banks in Asia will raise interest rates following the Fed’s move to accelerate its rate hike cycle as the inflation pressure globally has put policymakers in a bind. “It will be increasingly challenging for central banks in the region to hold on to their accommodative stance as the Fed accelerates its pace of tightening, thus widening the rate differentials to the point of detrimental financial effects,” she notes, adding that there will be more rate hikes to come in the region, although the pace is unlikely to match that of the Fed.

In the end, says Goh, only time will tell whether this ends up as a policy misstep by central banks that tips the world into a recession.


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