The State of the Nation: A challenging time for policymakers

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THE 2015 Budget will be the final one under the five-year Tenth Malaysia Plan (10MP). The annual budget is one of the important building blocks in Malaysia’s five-year development blueprints. It provides an allocation for the creation of the desired structural changes envisaged in the five-year plan (human capital development, raising productivity, promoting innovation, and so on).

Under the 10MP, RM230 billion, to be spread over five years, was allocated for development purposes. Four years into the plan, some RM190 billion has been allocated under four budgets.

Given that it is the last budget under the 10MP, it is pertinent to look at how the plan has performed after running for four years; that is, to what extent have the targets set in 2011 been achieved and what the gaps are that need to be filled in preparation for the Eleventh Malaysia Plan (11MP).

“The development programmes in the 2015 Budget should lay the groundwork and strategies for a smooth transition into the 11MP, which will cover the crucial final leg in Malaysia’s transformation into a high-income nation by 2020,” says RHB in a recent research report.

Head of research at RAM Ratings Kristina Fong agrees, opining that initiatives to facilitate the country’s high-income nation target will be an underlying trend in this budget.

Dean of the School of Business at Malaysia University of Science and Technology Dr Yeah Kim Leng says it is more important that the 2015 Budget provides the right direction in this regard and sets the pace for achieving the targets.

The consensus view is that the coming Budget will not be an easy one to craft, as 2015 is expected to be a challenging year, both domestically and externally.

“In 2015, we expect the government to face a handful of macroeconomic challenges, including rising cost of living, declining housing affordability, rising inflation and high levels of fiscal debt,” says an economist at a local investment bank.

And although growth has been robust during the first half of 2014, it is slowing down in the second half.

Barclays Research notes in a report that risks to private consumption growth are emerging in the background. Palm oil prices have fallen 30% in the past six months and this will impact private consumption as palm oil is a key sector for the Malaysian economy. Furthermore, it says, the rebound in exports is weakening, largely because of the weakening industrial production in China and Europe.

Most economists expect 2015 to be even tougher for policymakers to navigate. The thrust of the 2015 budget is fiscal discipline and pro-growth, but given the economic headwinds, policymakers will have to tread cautiously.

On the one hand, fiscal consolidation measures such as the Goods and Services Tax will cause inflation to rise and hurt growth in the short term; hence, much will depend on the policy measures implemented to cushion this impact.

Fong of RAM Ratings believes that it is “fiscal deficit management” rather than “cutting the deficit” that should be the primary aim, and therefore, proper management and understanding of the macro environment should lead to the orderly reduction of the deficit without adversely affecting economic growth. “After all, deficit management will ultimately lend support to sustainable economic growth, thus it can be seen as achieving the same outcome,” she opines.

At the same time, policymakers, in coming out with the 2015 Budget, will also have to look at the longer-term picture. If we look at the targets set under the 10MP, achievements have mostly fallen short (see charts). For example, the plan expects the current account surplus to stand at around 11% of gross domestic product (GDP) by 2015, but contrarily, the surplus has been shrinking, standing at just 3.8% of GDP in 2013.

Indeed, some economists have opined that there is a possibility that the current account could go into a “short-term” deficit situation in 2015.

One of the 10 big ideas in the 10MP is unleashing productivity-led growth and innovation. Yet, productivity levels have remained flat and the economy continues to grapple with talent issues.

Over the four years, GDP growth has also not met the target of an average 6% over the five-year plan. In fact, there is concern that growth in the last five years has been fuelled mostly by debt, as reflected in rising household and government debts. Yeah notes that government debt has risen from about 40% of GDP to the current 54%.

While steps have been taken to deal with the financial imbalances, economists say more needs to be done, given that 2015 will likely mark the end of the cheap liquidity era, with the US poised to raise rates as its quantitative easing programmes come to an end.

Today, there are views that Malaysia’s vulnerability to the vagaries of the external economy has increased and could pose a threat to long-term sustainable growth.

“A goal of the Malaysia Plans is to build up Malaysia’s economic reience but we see signs that render us vulnerable to financial shocks, and the Budget should address these short-term issues,” says Yeah.

These issues include rising household debts, high government debts and a large part of Malaysian assets that are in the hands of foreign investors. But he says that while this may be the case, there is no need to press the panic button yet, given that there are some buffers — trade surplus, current account surplus and high savings.

Much will depend on the actions taken now to address the weak links in the economy.

Under such circumstances, economists hold the view that while 2015 Budget’s focus is on fiscal discipline and increasing government revenue, it is also critical that an enabling environment be put in place to spur private sector growth.

Yeah thinks that with the constraints in the fiscal space, the government should focus on enhancing private sector participation, which means getting the policies right on issues such as deregulation and enhancing Malaysia’s competitive edge.

RHB Research notes: “The government will likely facilitate the continued implementation and delivery of the economic reforms under the ETP and the strategic reform initiatives (SRIs) ... we expect incentives in R&D [research and development] and product development, as well as tax and capital allowance to encourage more investments from the private sector, in particular, the SMEs [small and medium enterprises].”

The government, it adds, may also want to roll out more incentives to attract higher value-added, export-oriented foriegn direct investments, as well as tax deductions and incentives for certain high value-added industries.

RAM Ratings’ Fong says “the underlying primary objectives outlined in the ETP and GTP (Government Transformation Programme) will continue to be a mainstay and form the foundation for future policy at this stage of economic development. We will probably see more ‘business-enabling’ initiatives to take centre stage and hopefully gain more traction in the run-up to 2020,” she notes. “Given the momentum in multilateral cooperation, it will become more and more imperative for government policy to strive towards meeting international standards in terms of competitive practices and economic governance.”

“Another area on which the government may focus is boosting trade competitiveness. With global growth gaining momentum and regional players becoming more prominent in global supply chains, it will be important for industrial policy initiatives to ensure that the move towards higher value-added activities is materialising and domestic producers stay relevant in the global market,” she says.

This article first appeared in The Edge Malaysia Weekly, on September 29 - October 5, 2014.