This article first appeared in Forum, The Edge Malaysia Weekly, on March 14 - 20, 2016.

The good thing about the current global economic turmoil is that not many are panicking about it, and hopefully, it remains so for the near term. Sure, there are jitters here and there, but there is generally no palpable sense of panic. Even with China’s equities going into a tailspin recently, and emerging markets dragged down by slumping commodity prices and sagging currencies, the overall mood has been rather “serene”. In fact, a similar atmosphere pervaded the G20 summit that took place in China late last month.

But not panicking does not mean that global policymakers, asset managers and people in the street in general are seeing the light at the end of the tunnel. No, not at this juncture, I believe.

In fact, save for the US, consumers and businesses are still sceptical about spending, and policymakers are biting their nails, trying to avoid what is commonly described as the “Wile E Coyote moment” — a metaphor used by economists to label a sudden economic shock that leads to crashes in equities, currencies, financial markets or economies — as exemplified by the Looney Tunes cartoon character of the coyote that chases a roadrunner around, plunges off a cliff and injures itself badly.

Economic issues are just part of the worries of financial market investors. Politics is another factor that keeps pounding equity and bond markets worldwide. Rising populist movements, as evidenced by the popularity of presidential candidates Donald Trump in the US and Marine Le Pen in France, raise the prospects of an abrupt change in foreign policies, which, of course, does not augur well for sentiment on global growth at this point.

But confusion over what should be done to bring back growth stability remains the hot topic of the day. After all, memories of the 2008/09 global financial crisis are still fresh in people’s minds, what with the world’s biggest economy being on the verge of experiencing a 1930s-style depression, conventional policies being ditched in favour of unorthodox means to get the economy back on track, and China firing up all its economic cylinders through a huge fiscal injection that ultimately created a property bubble.

While central banks’ efforts to push down interest rates to the extreme end certainly play a role in avoiding a more severe collapse of the world economy, there is now a widespread consensus that the rescue baton has to be passed on to the fiscal team. In fact, this was the main takeaway from the recent G20 summit, where a broad agreement was reached about the limitations of central bank-led stimulus and that “monetary policy alone cannot lead to balanced growth”. As such, fiscal and structural tools will have to play a greater role to boost growth.

Using fiscal policy sounds like a good idea. In an ideal world, many will resort to fiscal measures and hope that direct government spending can compensate for any weaknesses of monetary policy measures. Studies show that fiscal measures, when properly implemented, work well. This is simply because spending goes straight to the economy when the multiplier effects start to manifest. In fact, John Maynard Keynes acknowledged that in a “liquidity trap”, direct spending is required to kick-start the economy.

Unfortunately, in the case of Malaysia, the fiscal space is rather limited at present. Lingering budget deficits since 1998 are considered a “rating constraint” by rating agencies when it comes to evaluating Malaysia’s sovereign rating. And budget deficits feed into government debt, which is now above 50% of the national output.

It comes as no surprise, then, that the government is exercising demonstrable caution in its spending plans. The evidence of this can be seen in the recent recalibration of Budget 2016, whereby the budget deficit target was maintained at 3.1% of gross domestic product in 2016, despite an expected significant decline in revenue.

Notwithstanding this, from a pure macroeconomic perspective, a slight increase in budget deficits does not hurt a country’s long-term prospects. Just as history has shown, deficits during a low-growth period or a recession are needed to support the economy. Of course, the tricky question is how to properly spend to stimulate the economy while avoiding wastage. Another hassle is how the financial market would react if the deficit target is tweaked at this juncture.

Fortunately for Malaysia, we have some heartening news: monetary policy space is still available. Thanks to Bank Negara Malaysia, interest rates are at a level that can be reduced further, if conditions truly warrant this move. In addition, the statutory reserve requirement (SRR) — the amount that banks are required to keep at the central bank — can be further trimmed if needed.

But again, life is not as simple as it used to be. As elucidated by global central bankers, the effectiveness of monetary policy is diminishing. The theory that says “dropping money out of a helicopter” (as espoused by Milton Friedman and Ben Bernanke) helps to stimulate the economy through spending has raised more questions than answers in the current economic scenario.

For instance, cutting interest rates, in theory, would incentivise banks to lend more to individuals and businesses. But in the case of Malaysia, banks are already being very cautious in their lending practices, partly due to macroprudential measures implemented to address financial imbalances (including high household debt) and partly to avoid further stress in their balance sheets. From the bankers’ perspective, giving out money to those who may not be able to pay is not the wisest thing to do if one is concerned about rising non-performing loans.

This is not to say that the recent cut in the SRR is uncalled-for. As mentioned by Bank Negara in its recent quarterly report, liquidity concerns arose at the end of 2015 due to capital outflows and weaker corporate earnings. The three-month interbank rates were on the uptrend and hit nearly 3.9% in December 2015 before moderating to below 3.8% recently. Hence, the injection of liquidity into the banking system was needed to allay fears of a possible credit crunch.

But in the end, the argument centres on the issue of money in the banking system that does not end up in the pockets of individuals or businesses. This, then, leads us to question the possible costs and benefits of interest rate reductions, for example how much the economy will benefit in terms of overall growth or prevention of an economic collapse, and how much we need to take on in terms of financial imbalances caused.

These are tough questions indeed. But if the economic slowdown in Malaysia is worse than expected, Malaysia could see greater volatility in its financial markets. And if the government is not willing to see that happen, there could be greater likelihood of monetary tools being used to combat the slowdown. We will just have to wait and see.

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

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