This article first appeared in Corporate, The Edge Malaysia Weekly, on June 6 - 12, 2016.
IF the 10-year economic cycle theory holds true, the global economy could be heading for another recession in the not too distant future after having collapsed in 2008/09 during the US subprime mortgage crisis.
While it could be a stretch to say Malaysia is nearing a possible recession, there is, however, a visible slowdown in the domestic economy as conversations among Malaysians these days revolve around job cuts, slower sales, difficulties in payment collection and unsold properties. Realistically, considering that the gross domestic product is chalking up growth of more than 4%, how bad could the economy get?
The last time Malaysia took a heavy beating was during the 1997/98 Asian financial crisis sparked by an attack on the currencies of Southeast Asian countries, beginning with the Thai baht. Leading up to that fateful year, Malaysia’s economy was booming with GDP growth of 9.5% in 1995. Private consumption grew at 9.4% and private investment at a double-digit 25.3%, driven by foreign direct investment (FDI).
The government’s fiscal position was decent then as well. Public debt was at RM91.36 billion, or 41% of GDP. And spending was prudent, running a surplus of RM1.9 billion.
However, the country’s current account balance was in a deficit in the mid-1990s. Companies were highly leveraged, and worse still, loaded with foreign currency-denominated loans, thanks to the strong ringgit. In 1997, the private debt-to-GDP ratio soared to 170%, contributing to the downfall of many corporations during the crisis.
When the crisis struck in mid-1997, the ringgit plunged against the US dollar, losing 53.4% by the end of the year to 3.87 from 2.54 on Jan 1. The Kuala Lumpur Composite Index, meanwhile, lost half its market capitalisation within a year after the bloodbath. By end-1997, the benchmark index had declined by 594.4 points from 1,230.53 points at the start of the year. Heavyweight Malayan Banking Bhd’s share price hit a low of RM2.30 at the time.
Nevertheless, the recovery was quick. GDP, which contracted 7.4% in 1998, was back on the growth path the following year, expanding 5.8%.
Fast forward to 2016, and economic indicators paint a gloomy picture of the outlook for the country. GDP growth has slowed for four consecutive quarters, hitting 4.2% in the first quarter of the year compared with 5.6% in 1Q2015.
Private investment, one of the four growth engines of the Malaysian economy, has not been robust, increasing only 2.2% in 1Q2016 compared with 11.6% in 1Q2015.
Economists attribute the weakness to poor commodity prices and a cautious business sentiment with entrepreneurs unwilling to invest amid global uncertainties.
“The bright spot is the recent awarding of several mega projects that would provide some support for growth. However, in the current economic environment, it remains uncertain if we will see the same multiplier effects from these projects as those from other areas of investment during the initial phase of the implementation of Economic Transformation Programme (ETP) projects. Oil and gas projects are fewer, real estate investments are based on Malaysian Investment Development Authority’s approval and FDI is slower,” says UOB economist Julia Goh.
Another economist sees a pullback in the private investment space, half of which involves properties, thus posing a risk to the economy.
“It’s really about a potential bubble in commercial and retail property. Bank Negara doesn’t think this is macro risk and I agree, but the situation bears watching,” he says.
At the same time, it does not help that households are grappling with whopping debt. Malaysia’s household debt is among the highest in Asia. It has been creeping up since 2008 and amounted to 89.1% of GDP by end-2015.
Some quarters say it is crucial for the country’s employment rate to remain high as households need to service their debts.
“Households are already beginning to deleverage but this will be a slow, drawn-out, multi-year process. In the interim, consumption growth may be depressed unless there is some rebalancing between labour income and capital income, which is currently happening,” says an economist.
Meanwhile, the government’s fiscal position is not as strong as it was at the onset of the Asian financial crisis. For one, the government is fighting to narrow its fiscal deficit — which started to yawn in the early 2000s — from 3.2% last year. Public debt, which is flirting with a self-imposed ceiling of 55%, is also a concern.
The government was shaken further when tumbling commodity prices, a trend that began in 2014, slashed the handsome sum of oil revenue it had been receiving as petroleum income tax and royalties from oil majors operating off the local shores, and as dividend from Petroliam Nasional Bhd (Petronas).
To fill the hole that the shrinking oil revenue left in the government’s coffers, the Goods and Services Tax was implemented last year, which has proved timely.
Crude oil prices fell from a peak of US$115 per barrel in June 2014 to as low as US$27 per barrel in February this year. Crude has since recovered to the US$50 per barrel range but low prices continue to pose a risk to the domestic economy, says an economist.
The ringgit was battered last year as commodity prices fell, plunging 22.8% from 3.4 to 4.29 against the greenback. This year, it has shown some strength but is still hovering between 3.8 and 4.2. The FBM KLCI, meanwhile, ended on a flat note in 2015, touching 1,682.59 points.
“The government’s revenue has been affected by the lower oil prices, causing it to cut back on expenditure,” says RHB Research economist Peck Boon Soon. In other words, a tighter budget now means the government has less means to stimulate the economy, given its already strained financial condition.
All this does not augur well for the country, especially now when many would expect the government to play a more prominent role in boosting the economy — like it did in 1997 — as the private sector wanes. The current private investment figure pales in comparison to what was seen in the 1990s while private consumption has slowed significantly as consumers, already dealing with a highly leveraged situation, look less capable of propping up the economy like before.
Unfortunately, the external environment also poses a risk to the country’s economic growth. Currently, economists opine that China is one of the biggest risks, more because of its debt-restructuring efforts and potential for policy mistakes than its expected slower growth. This became clear last August when the deliberate devaluation of the renminbi roiled global currency markets, says an economist.
Peck, however, is optimistic. “If China can manage its debt well, that risk will be contained,” he says.
There is also concern about how the US Federal Reserve will raise its interest rates — gradually or sharply. The expectation of higher rates has already driven large amounts of funds out of emerging markets, putting significant pressure on their currencies, including the ringgit.
Are we in the same situation this time around?
What is similar between the situations now and during the Asian financial crisis is the excessive investment in commercial properties, observes an economist. He opines that the hike in residential property prices over the past few years is justifiable, given the supply-demand mismatch.
“Over-investment in property hasn’t been overly credit-driven, so we don’t expect any bust to have the same sort of effect as the Asian financial crisis, especially since our banks are much better prepared now,” he adds.
During the 1997/98 crisis, the property sector accounted for a chunk of the loans in the banking system — 33.2% of the total — while non-performing loans (NPLs) amounted to RM8.7 billion or 6.2% of total loans outstanding to the sector.
According to Bank Negara Malaysia’s 2015 Financial Stability and Payment System Report, the total exposure of Malaysian financial institutions to the local property market was RM733.4 billion. “This represents 25.7% of total financial system assets as at end-2015. Banks continue to account for the bulk of the exposure with about 90% of it related to end-financing for the purchase of residential and non-residential properties,” the report states.
Corporate debt in 1997/98 soared to 170%, stemming from over-lending by financial institutions. It led to a high level of defaults in the private sector, forcing the government to step in via government-linked entities to bail out the troubled companies.
Non-financial corporate debt had climbed to 104.8% of GDP as at end-2015, according to Bank Negara. However, the leverage this time around is different as it is due to company-related and domestic macroeconomic factors rather than an increase in risk appetite associated with low global interest rates and ample liquidity.
The Bank Negara report says that despite the increase in corporate leverage, it is at a reasonably prudent level. It adds that generally healthy balance sheets enabled most businesses to absorb and adjust to the volatile exchange rates and commodity prices last year.
“The median interest coverage ratio (ICR) remained high at 5.3 times, comfortably above the prudent standard of two times. More importantly, corporate debt-at-risk, measured as the share of debt borne by firms with an ICR of less than 1.5 times, remained low and stable at 8.9% of total corporate debt,” the report states.
Does Malaysia have more tricks up its sleeve?
When asked about the possible worst-case scenario for Malaysia, given the current weak spots in the economy, economists polled by The Edge agree that this would only happen if there was a major external shock.
“In such a scenario, the region, including Malaysia, will not be spared. This time, it could be more severe because the recovery process could take much longer, given that the advanced economies will need to delve deeper into negative interest rates,” says UOB’s Goh.
A local economist says a slowdown, coupled with debt deflation causing a decline in consumption and investment, could be the worst position the country could be in. He is, nevertheless, optimistic, saying the country can survive even that situation, though it could possibly lead to a recession.
Peck believes it would take the country a longer time to come out of a recession if it happens because the domestic components are weakening while the government’s fiscal position is not strong.
“There is high household debt, a limit to pushing consumers to spend, and businesses are weakening. The only component that looks decent is exports but even that seems to be driven by a cheap ringgit rather than an increase in demand,” he says.
However, a local economist believes there are many options available to Bank Negara and the government to weather any storm. He reasons that the government’s fiscal constraints are largely self-imposed.
“Despite all the noise, the government’s debt is actually a little below the global average and contingent liabilities, both explicit and implicit, are manageable. One thing I think both fiscal and monetary authorities are doing is keeping an eye on the long term rather than over-reacting to short-term economic fluctuations,” he says.
The question now is, when push comes to shove, would the government forgo fiscal discipline on the budget deficit in order to stimulate the economy? This would probably come at the expense of a sovereign downgrade by international rating agencies, given that the deficit is a key component under watch.