Fixing the economy: Troubling signals on Putrajaya’s economic focus

This article first appeared in The Edge Malaysia Weekly, on May 6, 2019 - May 12, 2019.

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Much water has flowed under the bridge in Malaysia since the regime change on May 9, 2018. Ironically, it turned out to be a double whammy for the new government, now that it is not only saddled with huge inherited problems, but also daunted by the explosive expectations of the voters who demand quick delivery of election promises. The new government has spent much time cleaning up the mess left behind by its predecessor and renegotiating several lopsided big-ticket contracts which ran into billions of ringgit, saving costs or minimising losses in the billions again, not to mention the ongoing high-profile legal proceedings, involving, yet again, billions. What’s more, much progress has been made in the realm of governance with greater transparency and accountability.

The magnitude and the array of political, social, economic and institutional issues that the new government has to wrestle with are simply out of the ordinary. Institutional reforms, in particular, are the hardest to bring about in the absence of a two-thirds majority in parliament as these entail — more often than not — constitutional amendments. Obviously, there is a crying need for prioritisation in terms of urgency. Fixing the economy clearly merits immediate attention.

The Malaysian economy is visibly underperforming way below its potential, mainly due to the strong headwinds in the external sector, like many other emerging economies in the region. The trade wars that the US has unleashed on its major trading partners, notably China and the European Union, have contributed much to the malaise of the world economy. In this regard, Malaysia, with a relatively small domestic market, has fewer policy options than big economies with a large domestic sector.

The sedated external sector is obviously a serious problem. However, nothing much can be done about it, as export demand is beyond Malaysia’s control, and it would be foolish to try to fix it by penalising imports. There are some troubling signals from Putrajaya that the government may shift its focus from exports to imports, based on a weird logic that diverting domestic demand from imports to import-substitutes would create jobs and increase gross domestic product, which is a recipe for disaster. Capital goods and intermediate inputs account for the lion’s share of total imports, where consumption goods take a relatively low profile, which means that the space for import substitution is rather limited. Taxing imports of capital goods and intermediate inputs would hurt the manufacturing sector badly, as it would raise production costs and render Malaysian exports uncompetitive internationally. As a result, exports will decline more than imports, turning Malaysia’s current account surplus into deficit, which also means that any likely expansion in the domestic sector will be more than offset by a more severe contraction in the external sector of the economy with net negative impacts on economic growth.

To be sure, the above line of reasoning is not meant to downplay the importance of the role of the domestic sector, especially in times of economic slowdown, for a more vibrant domestic sector can take up the slack in exports and stabilise the economy. This, however, is best done through monetary and fiscal incentives, and not through trade barriers.

Besides, Malaysia must honour its tariff commitments in its regional and bilateral trade agreements with its major trading partners and more importantly, its multilateral World Trade Organisation obligations. Any attempt to raise tariffs at this juncture would lead to troublesome trade disputes and risk Malaysia being isolated.

It is pertinent to bear in mind that Malaysia owes its prosperity to its fairly liberal trade policies. For one thing, trade-investment linkages have made Malaysia an important link in the global production chain with the presence of numerous transnational companies in the country. For another, Malaysia has been a low-inflation economy, thanks in no small measure to its liberal trade policies which made imports cheaper.

There has been much talk on social media about the rising cost of living in the country in the wake of the recent by-elections outcomes, which, however, is not borne out by recent disinflationary statistics. The Consumer Price Index did shrink in the first two months of this year, stoking deflationary fears. That many households find it difficult to make ends meet is not due to rising prices but stagnant household incomes. This calls for measures to raise household incomes through job creation and skill upgrading.

Policy constraints have made the task of fixing the economy doubly difficult. On the fiscal side, fatigue has set in, with Malaysia continuously running deficit budgets since 1998 and the national debt rising to RM741 billion (excluding contingent liabilities) in 2018. It does not make sense to raise taxes or cut public expenditure to balance the books, at a time when the economy is decelerating. It would also be difficult to increase public expenditure to stimulate the economy without an increase in the budget deficit and national debt.

On the monetary side, too, there is a policy dilemma. Rising interest rates in advanced economies exert upward pressure on interest rates in emerging economies. On the one hand, an increase in policy rates would prevent capital outflows and strengthen the national currency but only at the cost of even slower growth at home. On the other, a decrease in policy rates would stimulate the domestic economy, but this would trigger more capital outflows which would further weaken the ringgit.

There is only so much that any responsible government can do under such Catch-22 situations. Under the current circumstances, GDP growth of around 4.5% is considered respectable. The pall on the global economy is expected to ease by 2020. Meanwhile, it would be wise for policymakers to concentrate on improving the investment climate in the country, making it increasingly business-friendly and lowering the cost of doing business through administrative reforms that would expedite bureaucratic processes with best practices, impeccable integrity and good governance, paving the way for better times.


Emeritus Professor Datuk Dr Mohamed Ariff is Professor of Economics and Governance at INCEIF, the university for postgraduate studies in Islamic finance