When the future is uncertain, economists use scenario analysis to help identify possible economic scenarios and outcomes with a probability attached to each. We ran a scenario analysis in this column last year (Issue 1347, Nov 30), in which we predicted that a continuation of the lockdown would risk a long phase of recession during 2021. This article aims to refresh our ideas with new data and the new strict lockdown as the current context.
The key point of our earlier scenario analysis was that after a period of sluggish growth in the first half of the year, which we have already seen, by mid-2021, there would be a “tipping” point for the economy, a clear bifurcation between a weak recovery scenario and a recessionary scenario.
We believe that we are approaching that point now and that the announcement of a further MCO 1.0-type lockdown from June 1 to 14, and a further MCO 3.0-type lockdown for a month after that, makes the chances of a weak recovery more likely and even raises the chances of a mild recession.
The basic idea behind the two central scenarios is whether the economy has the capacity to gain traction in an independent and self-sustaining way, for example, by leveraging on private investment and consumption as the two pillars of the recovery.
Contrary to rosy market expectations of consistent and robust recovery that predict 6%-7.5% average growth for 2021, we believe that the most likely outcome for the economy is given by the two central scenarios: a weak recovery, with a probability of 55%, and a mild recession with a probability of 35% (see chart).
Current data on growth and inflation, which are essential in our scenarios, are biased because of a strong base effect in gross domestic product (GDP) and an oil price effect on headline inflation. To avoid this bias, we measure growth for 2021 as the annual average compound quarterly GDP growth rate, which is 3% in our most likely scenario. For inflation, we use core inflation as a more informative indicator of underlying trend inflation. This is 1.5% in our most likely scenario.
Our more pessimistic scenario is because we still see the current performance of the economy as a rebound, reflecting different external impulses on the economy, rather than as a sustainable underlying recovery phase. This was seen in some good results in the data for the first quarter of 2021. Nonetheless, we do not find a consistent and solid pattern for a sustained recovery in this data.
For example, we did not see any autonomous growth in the two pillars of investment and private consumption nor in the fundamental variables behind them — disposable income and company profits. Whatever improvement we saw was purely policy driven and not due to an underlying, self-sustaining recovery.
Second, we are at the end of the “buffer effect” on private consumption coming from the depletion of household wealth through the i-Sinar Employee Provident Fund (EPF) withdrawals that will support consumption only in the short term. There is also less additional impact from the government to support the economy as the previous stimulus measures begin to end.
Now, we have a new strict lockdown phase that is expected to cause a further deterioration in the scenario we anticipated, increasing the probability of a mild recession. The new lockdown scenario will likely freeze the nascent recovery in employment and the gradual re-absorption of underemployed and retrenched workers. It will also crush the timid expansion in wages in manufacturing which we were just beginning to see in recent months.
So far this year, based on government estimates, the cost of lockdowns from Jan 13 to May 31 has been around RM57.6 billion. Conservatively, the current lockdown from June 1 to 14 will have a similar impact as MCO 1.0 in 2020, which the government puts at RM2.6 billion per day. This means the cost will be RM33.6 billion. The one-month MCO 3.0-type lockdown after June 14 will add another RM15.5 billion. So the total cost will be RM107 billion, give or take.
Given this background, the mix of fiscal and monetary policy will play a key role in determining the upward (weak recovery) or downward (mild recession) route of the economy. If our interpretation is right, the government and Bank Negara Malaysia have to set out a fully specified recovery plan of at least RM100 billion to be injected into the economy.
Any allocation of money must support the different components of GDP to provide traction and support for the long-term growth of the economy.
The stimulus packages so far have targeted the basic needs of the weakest part of the population and aim to provide the most vulnerable with strategic resources. The wage subsidy programme and the employment creation programmes have tried to help the reabsorption of the underemployed.
Finance has been provided for investment and business expansion through the loan moratorium and fiscal incentives to invest, but also needs to target scaling up project grants to remove the barriers to growth, especially for small and medium-sized enterprises (SMEs). It is also necessary to help companies integrate their new e-commerce platforms with analytics.
Human capital and education have been only timidly supported by small grants for students and needs more programme support for reskilling and upskilling, integrating free online training through the e-LATiH scheme with the Human Resources Development Fund (HRF) and others.
These programmes are well-intentioned, particularly the wage subsidy programme, but it must be recognised that these specific project and scheme-based policies are not particularly effective as we approach the tipping point. Companies in need of e-commerce help will already have had it, companies in need of soft loans will already have applied and been approved, and people in need of training will already have completed their programmes and are hoping to find work.
At this point, companies are in need of sales and revenues to provide income to keep their staff and pay their wages. Consumers are in need of income support so they can cover their expenses and recover their lost savings.
These dual aims can be solved to some extent through a social market approach that would provide direct cash transfers, enhancing the role of the wage subsidy programme but also finding new ways of putting money directly into the hands of consumers and firms.
The social market approach would target those in need and strategic groups to help sustain and create new sources of growth. The basic idea would be to sustain the one-off effect of an increase in consumption and growth through supporting fundamentals, particularly disposable income and creating partnerships with businesses to slow down business closures, save existing jobs and create new ones.
A social market economy approach — which combines a free market economic system with social policies that establish fair competition, equality of opportunity and social equity — is the foundation for successful market-driven economic growth.
The role of international trade and net exports, also essential in a social market context, should also not be overlooked because trade is an important source of growth for Malaysia. The government must produce an expansion plan reinforcing existing trade networks, especially within Asean and Europe, attracting new foreign direct investment (FDI) and leveraging on local and international collaboration opportunities.
Finally, the social market also emphasises the importance of keeping inflation low, controlling prices if necessary and reducing tariffs, especially on oil, food and utilities to protect household purchasing power and ensure equitable access as the economy grows.
Dr Paolo Casadio is an economist at HELP University and Professor Geoffrey Williams is an economist at Malaysia University of Science and Technology. The views expressed are those of the writers.