Cover Story:The State Of The Nation:Prudence Versus Growth

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This article first appeared in Corporate, The Edge Malaysia Weekly, on June 6 - 12, 2016.


WHAT Prime Minister Datuk Seri Najib Razak said is quite true — Malaysia is not to blame. The US$1 fall in crude oil prices that led to the government losing RM450 million in revenue and the 1% drop in China’s economic growth that caused the Malaysian economy to shrink 0.4% were not within the government’s control. The sooner everyone comes to grips with Malaysia’s vulnerability to large global forces, the better it can focus on strengthening the economic fundamentals.

Going by the numbers above, the government has a lot to sweat over. Brent crude has fallen 19.3% over the last year. That is a US$11.84 fall that cost the government RM5.33 billion in revenue. China’s economy has been wobbling and registered gross domestic product (GDP) growth of 6.7%, its slowest since the last financial crisis.

Malaysia’s first quarter headline numbers are a sign of hard times. GDP growth slowed to 4.2%. Growth in all key economic sectors moderated year on year but the agriculture sector was the worst hit with a contraction of 3.8%.

Still, economists say Malaysia remains on track to achieve the government’s goal of GDP growth of 4% to 5% in 2016 and reach its fiscal deficit target of 3.1%. The confidence has something to do with how Malaysia is getting a grip on the oil price dive.

Thanks to the well-diversified economy, state finances did not collapse with the drop in crude oil prices. In fact, the government now relies less on oil money and operates on a leaner budget — with an oil price assumption of US$30 to US$35 a barrel for 2016.

Najib removed broad-based subsidies on fuel and essential items and cut scholarships to save billions of ringgit. Then, billions more were raised through a series of tax hikes and the implementation of the unpopular Goods and Services Tax (GST) to prevent a meltdown in state finances. The government collected RM27 billion in GST last year and is expected to collect RM39 billion this year.

No two economies are directly comparable. But, relative to other oil-producing nations, the health of Malaysia’s public finance seems enviable. Next to Malaysia’s projected 3.1% fiscal deficit as a share of GDP, Saudi Arabia’s is expected to be 13%. Venezuela’s was estimated at 20% at the end of 2015.

Many also expect better times to come for Malaysia’s state finances. Even as it struggles with slumping profits and its operational cash flow, national oil firm Petroliam Nasional Bhd has promised to give the government RM16 billion in dividends in 2016, taking funds from its reserves. In 2015, Petronas gave out RM26 billion in dividends.

IHS Global Insight Asia-Pacific chief economist Rajiv Biswas says crude oil is now trading above the government’s price assumption and is expected to continue improving. This puts Malaysia in a “comfort zone” for continued state spending on infrastructure, he adds.

Plus, Beijing has promised to roll out major stimulus to counter the country’s slowing growth, making the suggestion that a hard landing for the republic will destabilise the Malaysian economy seem an exaggeration.

Yet, slower-than-expected growth is not entirely out of the question. In the first quarter of 2016, Malaysia’s public and private investments slumped in the face of economic uncertainties. Net exports shrivelled worryingly by 12.4%. The poor numbers from trades and businesses may be a prologue of lower corporate earnings and, in turn, lower revenue for the government. Corporate tax, accounting for about 12.6% of government revenue in 2015, was the government’s second-biggest income source.

United Overseas Bank (M) Bhd economist Julia Goh says, “After four quarters of GDP growth deceleration, it appears there are still more downside risks to the outlook for this year and next.”

If the dismal numbers from the private sector deteriorate further, the prime minister will have to rethink the government’s strategy. As in the past, cutting expenditure will not be sufficient and the government will be expected to step in to stimulate the economy. This is tricky for the current administration, which has gone to great lengths to paint itself as most prudent, both to persuade voters of its financial ambitions and to convince credit rating agencies of the country’s fiscal discipline.

Pump-priming is expensive and spending more to support a flagging economy when the state finances are already stretched will put Najib’s fiscal deficit goal of 3.1% to GDP at risk. Malaysia’s fiscal position swung from a surplus of 2.4% of gross national product (GNP) in 1997 to a deficit of 5.6% in 2002 when the government stimulated a recovery after the Asian financial crisis.

The same was seen during the government’s response to the US subprime mortgage crisis in 2008 and 2009. The government introduced a RM7 billion stimulus package in 2008 and the fiscal deficit rose from 3.2% to GDP to 4.8%. When that was not enough, Parliament passed a bigger package of RM60 billion and pushed the fiscal deficit to 6.7% of GDP in 2009.

Borrowing for growth is an option. But, unlike in the past, the government-debt-to-GDP level is now a serious concern. After the 2009 spending spree, a swift recovery followed but government debt raced to 53.3% to GDP, from 41.5% in 2008. It has been growing since. As at Dec 31, 2015, Malaysia’s sovereign debt was a staggering RM630.5 billion or 54.5% of GDP, flirting close to the government’s self-imposed ceiling of 55%. This excludes billions in expenditure classified as off-balance currently being borne by the government.

A decline in Malaysia’s nominal GDP in the event of an economic slowdown can push government debt into the danger zone. The debt ceiling is voluntary and can be adjusted based on needs. But, economists warn that increasing government borrowing to put life back into the economy should only be reserved for dire circumstances such as a recession.

There are other monetary and fiscal levers Najib or Bank Negara Malaysia can pull should the economic conditions worsen. But most of them will affect the economic fundamentals Najib is so desperate to strengthen.