Friday 29 Mar 2024
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THE current account of the balance of payments (CA) is the latest economic buzzword when one discusses the prospective risks in the Malaysian economy. The financial market, in particular, is keeping close tabs on the latest trends of Malaysia’s CA to assess the possibility of it slipping into the red in the near term, after having recorded surpluses since the 1997/98 Asian financial crisis.

Indeed, last year’s total CA surplus of RM49.5 billion, equivalent to 4.6% of gross domestic product (GDP), came as a welcome, albeit temporary, respite to the financial market, as it represented an increase from the preceding year’s level of 4%. It was, nevertheless, a stark difference from the 17% recorded in 2008, prior to the global financial crisis.

But why are sovereign analysts and the general financial market so fixated on this CA ratio in the first place? To start with, the CA balance, by definition, is a summation of the trade balance, net income from abroad and net current transfers (dividend payments, remittances, and so on). Normally, the bulk of the CA balance is accounted for by the trade balance, which essentially reflects a country’s trade performance.

While CA deficits can occur because of various reasons, a common argument relates the deficit to the declining trade competitiveness of a country. Since a large portion of the CA represents trade balance, weaker export performance might, but not necessarily, imply declining competitiveness against other countries. Deficits can also be attributed to an overvalued currency due to, for example, a fixed or a periodically adjusted currency-peg regime adopted by a country against an anchor currency (for example, the US dollar).

History reveals that countries with persistent CA problems (huge and persistent CA deficits) are more prone to capital flight, a massive outflow of capital that often takes place within a relatively short period. An example would be the Tequila Crisis (Mexico Crisis) in the mid-1990s, when Mexico was mired in a deep recession due to an economic crisis that caused massive outflows of capital, following the general loss of confidence after posting huge trade and CA deficits.

In 1994, for instance, Mexico’s CA and fiscal balances were in deficit to the tune of roughly 6% and 1% of GDP respectively. As a result, its currency, the peso, was hard hit and eventually devalued in December 1994, exacerbating the outflow of capital. Interest rates were raised to alleviate the pressure on the peso, inadvertently causing economic growth to tumble in the following year.

Similarly, prior to the Asian financial crisis, some economies in the region experienced a few straight years of CA deficits. For instance, Malaysia incurred CA deficits from the beginning of 1990 and hit a peak of nearly 10% of GDP in 1995. Only from 1998 onwards did the balances turn into surpluses. Thailand, having experienced a de facto devaluation of the baht in July 1997, also recorded an average deficit of roughly 8% of GDP in 1995-1996 while Indonesia’s CA balance had been in the red since the early 1980s. Although it is now widely accepted that CA deficits were not the primary reason some Asian economies plunged into a crisis in the late 1990s, they were commonly discussed during the crisis itself.

From another perspective, the CA balance also represents the savings and investment (S-I) gap in an economy. The CA balance of a country with a positive S-I gap will be in surplus while a negative S-I gap means it will be in deficit.

Going by this measure, one can see that Malaysia’s shrinking CA balance is partly due to the adjustments in its S-I gap as the country enters a phase of massive investment. In fact, the International Monetary Fund estimated that two-thirds of Malaysia’s CA adjustment during the 2011-2013 period resulted from a surge in private investment and investment projects related to the government’s Economic Transformation Programme. Therefore, from a longer-term perspective, this bodes well for the country’s future growth capacity despite prevailing concerns about the shrinking CA surplus.

Contrary to Malaysia’s experience, the deterioration in the CA balances of Mexico and Argentina prior to their economic crises was primarily attributed to their fixed exchange rate regimes. Argentina introduced a fixed exchange rate regime in the 1980s and early 1990s to kill the hyperinflation that had ruined its economy. As for Mexico, its large S-I gap prior to the crisis was primarily attributed to public sector overspending. Compounding matters was Mexico’s extremely low level of foreign exchange reserves at just about US$6 billion.

Although there is widespread talk of the possibility of a sovereign downgrade, most rating agencies normally look beyond the CA trend when assessing external risks. For instance, deficits in both the CA and government fiscal balance would raise concerns about the prospect of capital outflows due to the anticipated downward pressure on the currency.

Although this may not be the case for Malaysia at this juncture, the fact that its CA surplus has shrunk from more than 17% of GDP in 2008 has sounded the alarm on the possibility of a twin deficit in the future. Again, such a conclusion is debatable as the primary reason for the smaller CA surplus is the surge in investments meant to strengthen future growth capacity.

Unfortunately, Malaysia’s shrinking CA balance has coincided with deficits in the government’s fiscal balance in recent years. While the possibility of a twin deficit is quite remote at this juncture, the financial market is widely known for its speculative behaviour when predicting future outcomes.

While there are other positive factors that support the economy, for example low foreign public debt as well as measures to broaden the revenue base through the implementation of the Goods and Services Tax, the pressure from financial market investors continues unabated. Thus, only a meaningful turnaround in Malaysia’s trade performance would ease the pressure in the near term.


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

This article first appeared in Forum, The Edge Malaysia Weekly, on April 13 - 19, 2015.

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