The State of the Nation: Adjusting to the new normal of slow growth and greater volatility

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A MONTH into the year, 2015 is turning out to be even more challenging than expected for the Malaysian economy. Falling commodity prices, a weakening ringgit and a high level of indebtedness continued to be key risks.

In this interview with The Edge, Tan Sri Andrew Sheng, former central banker and current president of Hong Kong-based think tank the Fung Global Institute, shares his views on the global and local economy.

Sheng does not see a financial crisis like a repeat of 2007 and 1997. He believes that 2015 will be a year of adjustments to the new “normality” of slower growth, more volatility and adjustments. “In my book, whichever economy reforms the fastest in the region will emerge the strongest after this patch of slow growth,” he says.

Read on to find out his views on a myriad of issues, ranging from the fall in oil price, a weaker ringgit, what is the right policy on foreign exchange to what Malaysia must do to get back on the growth track.

The Edge: As we enter 2015, where do you see the economy going, from a local and regional standpoint?   

Tan Sri Andrew Sheng: My own sense is that 2015 will be a year of adjustment to the “normality” of slower growth, more volatility and structural [change].

The oil price cut gives the Malaysian government an opportunity to rationalise and reduce energy subsidies, and get fiscal targets back on track. We had a good run in oil prices during which the benefits went to subsidies rather than to structural adjustments that lead to a more energy-efficient future.

Malaysia is entering a period when there will be more regional competition — AEC (Asean Economic Community) 2015 will be under the chairmanship of Malaysia, but within Asean there will be greater competition for inward foreign direct investment and market share in a number of areas.

I do not see a financial crisis that is like [what happened in] 2007 or 1997. Malaysia has favourable demographics and will continue to grow, but at a slower speed. Whichever economy reforms fastest in the region will emerge the strongest after this patch of slow growth.

There are many conspiracy theories on the causes of the oil and gas crisis. What is your take on it?

In hindsight, the oil price adjustment should not have caught people by surprise. Analysts did not call the supply glut even in the face of a global slowdown. New production kept on coming on stream while economies were becoming more energy-efficient. Once the price started dropping, exchange-traded funds (ETFs) that speculated on continual high prices had to unwind, causing a sharper drop in prices. This phenomenon is happening across ETF bets on commodities.

Oil prices as represented by Brent crude were at US$107 per barrel in January 2014 with most analysts calling for roughly US$100 per barrel by year end. After peaking in mid-June at about US$115, Brent prices kept on dropping and ended the year at around US$50 per barrel.

My sense is that oil will trade between US$50 and US$60 per barrel for a while, probably edging towards US$70 if the world recovery is better.  

The impact on the real economy of lower energy prices depends on producers and consumers. There is a worldwide US$1 trillion transfer from producer to consumer countries in terms of benefits from lower oil prices. Inflationary pressures are reduced by roughly 0.5% to 1%. Where governments have to adjust their energy subsidies, there may even be some upward pressure on prices.

 I am not totally convinced that lower oil prices would boost GDP growth for everyone. We are going through a worldwide balance sheet recession, where people are cutting back debt in anticipation of higher borrowing costs and real interest rates. To the extent that the US consumer starts spending, this may have some impact on exports to the US. Broadly speaking, the lower oil prices will only cushion the downward pressure on growth.  

What is your take on the recent weakening of the ringgit against the US dollar and lower oil prices?

The weakening of the ringgit is a natural outcome of the strengthening of the US dollar. If the leading economy in the world is recovering, most investors will go back to the US economy, so some reverse flow is natural. The weakening therefore is in response to the oil price effect — the strengthening of the dollar and portfolio rebalancing on the part of both foreign and domestic investors.  

Whether your foreign portfolio does well depends on its currency [of denomination] and also investment allocation. Those who were long USD did better than those who were long euro or yen.

Different currencies adjust to different flows in a different manner. There may be very good reasons why the ringgit moves in the current fashion relative to neighbouring currencies. My view is that the flexibility of the exchange rate is the right policy move.

The whole purpose of a flexible exchange rate is to be able to adjust [the currency] to meet market conditions. There is considerable volatility in the currency markets, with uncertainty in the policy stance of the reserve currency central banks. Hence, flexibility in the exchange rate mechanism is the right way to handle this.  

Bank Negara’s intervention in the forex market has cushioned the fall of the ringgit. How long can it possibly keep this up for?

Malaysia’s reserves are very ample relative to the external debt and current account situation. There should be no concerns about the exchange rate when the country is still running a current account surplus.

Interest rates are already beginning to rise, so I sense that Bank Negara is keeping its policy options and tools very flexible. Bank Negara has considerable experience in handling this kind of volatility.

Although the US Federal Reserve has discontinued its quantitative easing (QE) programme, the Bank of Japan announced the expansion of its own money-printing programme. Do you believe that “helicopter money” will impact us eventually? And is Malaysia equipped to handle the impact?

Japanese QE has already impacted us. The weaker yen at lower interest rates has made the yen carry trade very attractive to hedge funds and currency speculators in the last two years. Will there be more Japanese QE? My own view is that the impact of that on the Japanese economy is losing its shock-and-awe effect. The lower yen is not necessarily going to help Japanese manufactured exports in an environment when you can only own so many more cameras and smartphones. Japanese inward tourism is increasing, which will help revive the economy through services and employment growth.   

If Japan emerges from this adjustment stronger, it will help the region. Japanese outward investments are increasing. However, the problem in Japan is the ageing population, which is irreversible without more immigration.

In the midst of so much uncertainty, what is the biggest risk to our local economy? And what are the implications of current developments in investing?

Uncertainty is about unknown unknowns, whereas risks are identifiable and measurable. There are internal risks and external risks. There are certainly a lot of unknowns — no one predicted there would be three air crashes last year. To manage uncertainty, you need cushions, such as foreign exchange reserves, low leverage and higher capital, and so on. The external environment is very uncertain at the moment, whereas domestic risks are more understandable.

Smart investors make money even in a bear situation and not-so-smart investors lose money even in a bull market. With bank deposit rates rising, it is time to reflect on whether we should re-balance our portfolios to meet our individual needs. Older people need more dividends and income to maintain lifestyles. Younger investors can take more risks and look for capital gains. Investing is very personal, a trade-off between risks, return and liquidity.

Life is not just about opportunities, but the ability to grasp them.  Learning to execute and profit from opportunities is a process — it is painful to make mistakes in investing, but a learning process nevertheless.

With so many external risks and uncertainty, do you think Malaysia is still on track to becoming a high-income nation by 2020?

Part of the progress towards higher income was through the exchange-rate effect, so if the ringgit remains weak, achieving the target becomes tougher. There is still considerable debate within the country on where to find its new growth drivers. The government has done a lot, but in my view, there are divided views, unfortunately along ethnic lines, on whether we can work together as a nation of different communities, to achieve higher income. The current debate on moderation versus extremism reflects that sentiment. Once the debate hinges on religion and ethnic lines, strong emotions are evoked. As long as this debate is continuing, without national consensus, it is not easy to achieve unity in policy direction and execution.

So, in your view, what needs to be done for Malaysia to get back on track?

Personally, I believe that religion is very good for the soul, but too much debate on religion will detract from the need to feed ourselves. Resentment against inequality is directed not at God but man. Moderation means balance in everything we do in life and criticising each other’s failings and mistakes will get us nowhere. Tolerance means accepting our weaknesses and mistakes and working on how to avoid conflicts.  

If we look carefully at what is happening globally, the opportunities for job creation and value creation lie in the cities. It is the urban-rural divide that is both the problem and the opportunity. Knowledge and wealth creation are all in the cities, and rural people are pouring into cities at unprecedented speed, seeking new opportunities but also face huge disparities [in income and living standards].

Thus, we need to create not only jobs in the urban areas, but encourage entrepreneurs — many of whom may come from rural areas — to succeed. The nurturing of entrepreneurship is often family and community-based. None of the [global] IT giants were state-owned enterprises. But if rural communities suddenly become urbanised, the social adjustments are huge.

This is where the differences in social beliefs become entrenched and people start insisting on drawing the line on standards, such as those of religion and race. The dilemma is that these standards are changing not just locally but also globally. We are caught in this global debate and competition in standards whether we like it or not.   

Technology has an analogy for this. DVD machines work on different standards. The DVD machine that works best is the one that has a fuzzy logic chip that can read different standards.  Fuzzy logic tolerates differences in standards. By insisting on one standard, we may end up with the wrong standard. Fuzzy logic means that tolerance of diverse standards will enable us to shift to the next standard without breaking the system.  

Malaysia’s strength is its diversity in culture, being neutral in global politics and moderate in its policies. Our “fuzzy logic” actually works and may even be the pioneer of the development of global standards.

One of the problems is that our education system is not responding to this rapid change in technology and business needs. We used to think that giving our youth a liberal university education is a way to prosperity and a middle-class income. The result is more university graduate unemployment, dissatisfied youth and resentment. This is a worldwide problem, not unique to Malaysia.  

However, Steve Jobs was the son of a Syrian immigrant and rose to become a game-changer in the IT business. Obama is a son of a Kenyan who rose to become president. They achieved these heights in spite of race and religion because they did it on their own abilities. They achieved this in cities rather than in rural areas.

How we create jobs for our newly urbanised youth through entrepreneurship is the challenge of the 21st century — true not only of Malaysia, but across the world, which is urbanising at an unprecedented rate.

IT giants like Bill Gates and Jack Ma have created US$250 billion to US$300 billion companies out of virtually nothing but their own vision and execution abilities. Apple has a market cap that is twice the size of the Malaysian economy in terms of GDP. It took years of consolidation in Malaysia to create companies of more than US$10 billion in market capitalisation.  

With the Internet, I believe that the opportunities exist for the next Steve Jobs to be a Malaysian, but the nurturing of such a person will have to be done in the cities, where we can build the right ecosystem to nurture our talent. The person may even be freshly out of the rural areas, but he or she must have the right support systems. These are clustered in cities with better IT infrastructure and knowledge and commercial bases.     

If you look at our young, Malaysians, irrespective of race, have achieved world class [wins] in sports, such as go-karting, archery, squash and wushu. Talent does exist — it’s how we nurture it.

Historically, it happened that most of the non-bumiputeras were in the cities, so there is an income and wealth divide. As long as policies were driven by the state, the private sector assumed that inequalities would be taken care of by the state. But the social problems of the 21st century can no longer be solved by the state alone. There must be close involvement of family, community and civil society, working in partnership with the state and with each other.  

I strongly believe that the urban business community must do more to help young bumiputera entrepreneurs succeed. That is where the future wealth creation will come from. Indeed, my firm belief is that the next breakthrough will be from truly Malaysian SMEs, working without an ethnic dimension, but will arise from talent in our diversity.     

Despite our differences, we must realise that we share a common fate — Malaysians have only ourselves to blame if we are unable to unite and deal with our common challenges. Blaming each other gets us nowhere.

You recently co-wrote an article with Xiao Geng in Business Standard, where you strongly propose that China’s policies need to encourage innovation. Do you believe the same is needed for Malaysia?

It sounds like a cliché, but innovation is actually development through change. Innovation is critical to our development. If we look back, Malaysia’s growth came initially from rubber and tin; both were created from innovation and made fortunes from research and development. Rubber seeds were transferred to Malaysia from Brazil, but research into rubber created new value [from] new products. Similarly, tin became valuable because of tin cans to preserve food, but today its use has become much more widespread, including in the IT industry. Malaysia was a leader of R&D in palm oil that created wealth for many, especially rural farmers. The farmers themselves cannot undertake R&D in rubber, palm oil or even tropical fruits. Much of this R&D is conducted in the urban areas.

So innovation is critical to our continued growth. We still do not spend enough on R&D, either at the government or even private sector levels. Some of our brightest graduates who are interested in R&D are moving to Singapore and elsewhere because our companies are still not investing enough in continual innovation. Those who do not change will lose out. That is our common challenge. You just have to go across the Strait of Malacca to Indonesia to see what is happening to Indonesian companies; they are beginning to emerge as regional champions and, later, global champions. No company or country can rest on its laurels.  

The thing that I learnt from my study of technology and innovation is that innovation is a collaborative process. An individual is a genius, but he or she operates in an ecosystem that either kills that talent or nurtures it to greatness. If Steve Jobs had grown up and lived in Syria, he would have been caught in a civil war. Family and community therefore help to nurture talent far more effectively than the state.  

Apart from lagging behind in innovation, what other challenges exist in our local landscape? What can be done about them?

Having lived in Hong Kong for the last 10 years, I learnt about the importance of getting communal agreement to get things done. A lot of people in Hong Kong think that innovation is about finding the next light bulb, but if the politics becomes polarised, even if you find the latest light bulb, you can’t switch it on. The politics is such that the legislature may turn down anything proposed by the government. We are nowhere near this stage in Malaysia, but getting the community to be on the same page is, in my view, critical to our future success.   

The world is at a tipping point. We have seen how religious and ethnic differences have torn countries apart, creating untold losses and human misery. There is a non-zero risk that the geopolitical game will create turbulences that will drag Malaysia into the new global Cold War. We have to avoid that by looking after our national interests.   

We are a wonderful country that has inherited its diversity, located in the most strategic [area] of geopolitical and economic opportunity, and endowed with abundant natural resources and talent. If we transcend our differences in religion and race, we will be able to compete and match the best. I am convinced that family and community are the right solution to the complex challenges of the 21st century. That means that our community leaders will have to talk it out and find the right social compact.

This article first appeared in The Edge Malaysia Weekly, on January 26 - February 01 , 2015.