This article first appeared in The Edge Malaysia Weekly on April 18, 2022 - April 24, 2022

AS major cities in China continue to endure severe lockdowns in response to the nation’s zero-Covid policy, the ensuing shocks on Malaysia’s trade and economy are growing, given the sizeable bilateral relations.

“The importance of the Chinese market to Malaysia has risen during the pandemic over the last two years. The lockdowns in China will dampen supply and demand in the country, while the negative shocks will be reflected in Malaysia’s trade with China given its sizeable contribution to Malaysia’s exports and imports,” Sunway University Business School economics professor Dr Yeah Kim Leng tells The Edge.

Data provided by the Department of Statistics Malaysia shows that the country’s exports to China grew 12% in 2020 and 22.6% in 2021, raising its share of total exports to 16.2% in 2020 and 15.5% in 2021, up from 14.2% in 2019.

“As the Chinese economy accounts for 25% to 30% of global growth, any impact from its slowdown due to prolonged lockdowns will be transmitted to the world and the regional economy through the trade channel. Further downward revision of up to 0.5 percentage point of the growth forecasts for Asean economies will be on the cards should the China lockdowns persist,” says Yeah.

Note that total bilateral trade between China and Malaysia measures about one-eighth of Malaysia’s GDP, with more exports from China to Malaysia than the other way round, says Dr Ray Choy, head of economics and research at Opus Asset Management.

“Experience suggests that while China’s lockdown has some impact on the Purchasing Managers’ Index (PMI) in both Malaysia and China, the impact on Malaysia is diluted, given its many trade partners. Furthermore, trade can continue since these goods are shipped from a distance, rather than services requiring social interaction, which are more sensitive to the effects of Covid-19,” he says.

As for Asean’s trade, close to a quarter of the region’s imports are sourced from China, says UOB Bank Malaysia senior economist Julia Goh.

“Shanghai’s lockdown has affected some of the shipments to Malaysia. Malaysia’s imports from China totalled 23% of total imports last year, 53% of which were machinery and transport equipment, 14% manufactured goods and 11% chemicals.

“The bulk of these imports are channelled as input for production of intermediate or final goods for domestic use or exports. Hence, a prolonged disruption of the supply chain owing to China’s lockdowns and potential secondary effects from the Russia-Ukraine conflict could magnify the risks for Malaysia’s exports.”

She highlights that the potentially affected sectors include the electrical and electronics sector which, in turn, spills over to the automotive, telecommunications, medical and machine equipment industries. The consumer sector could also be hit due to shortages of imported food and ingredients, as well as cuts in online purchases from China. “The supply shortages could further widen existing cost pressures from higher global commodity and food prices,” says Goh.

A sensitivity simulation by UOB Bank shows that a slowdown in China’s economic growth by 1% could directly affect Malaysia’s GDP by 0.3% to 0.5%.

“However we are cautious on the final impact, given that downside risks from potential weakness across Malaysia’s key trade partners have yet to be priced in,” says Goh, stressing the need for exporters to continuously manage their supply chain risks, diversify demand and digitalise business processes under the current new normal of endemic management and heightened geopolitical risks.

If it is any consolation, these issues are not new to Malaysia.

Choy explains that many businesses have adapted to the new normal by setting up new distribution models and relying on technology. “The challenge and opportunity from such disruptions imply the need for sellers to be more competitive with better prices and more dynamic with better customisability so as to adapt to the new normal.

“While some sectors that rely on supply chains with origins in China will see a temporary setback, the upshot of that is a broadening of substitute goods, which is healthy for supply diversification.”

Sunway’s Yeah concurs, predicting that the decline in exports to China is not expected to be too severe, given Malaysia’s high vaccination rate and strong administrative capacity to contain the pandemic. He explains that exporters, in mitigating the risks, can shift their focus to other regional markets, including the domestic market, which is expected to “expand on the back of Malaysia’s strengthening recovery”.

The Regional Comprehensive Economic Partnership (RCEP), which came into force this year, presents an opportunity to explore member countries’ markets, given the lower tariff barriers and other benefits conferred by the regional trade pact, says Yeah.

“And since Malaysia imports more from China than it exports, the implication for investors is that a decline in overall trade from China suggests a slight improvement to Malaysia’s trade balance. This adds to the narrative that Malaysia’s trade balance is benefiting from high commodity prices, adding a sheen to the Malaysian ringgit and its assets,” Choy remarks.

Another inevitable effect of the further delay to China’s long-awaited border reopening is the lack of outbound tourists to other countries.

As many travel destinations in the region bank on Chinese tourists to revive their pandemic-ravaged retail, hospitality, tourism and related sectors, the travel curbs are also affecting investment activity and flow of international students to and from China, Yeah points out.

Socio-Economic Research Centre Malaysia data shows that Chinese tourists to Malaysia made up about 11.9% of total tourist arrivals in 2019. “It can be interpreted to indicate that a smaller rebound in Malaysia’s tourism sector compared with pre-pandemic levels is to be anticipated despite Malaysia reopening its borders,” says its executive director Lee Heng Guie.

“As Malaysia transitions to endemic management of Covid-19, we tread cautiously with the hope that our tourism sector regains its pre-pandemic strength. However, note the numerous global risks, such as the tightening of monetary policies, stagflation, climate change and geopolitical tensions, compounding the recovery.”

Yeah says that given Malaysia’s diversified economy, the impact of a slowdown in the Chinese economy on GDP growth could be offset by strengthening domestic demand, particularly private consumption and investment that is supported by the full opening of the economy on April 1, as well as an expansionary Budget 2022.

While China’s economic slowdown is seen to impact April activity numbers such as the PMI, more saliently, Choy sees more impact on the traded goods sector. He notes that the services sector in Malaysia will provide a buffer to the GDP impact, given Malaysia’s economic reopening and progression towards endemicity.

“Malaysia’s private domestic consumption is more than half of GDP, therefore the nature of the present recovery will, after all, depend significantly on the thrust from consumer spending,” says Choy.

“Generally, such lockdowns in China are usually resolved swiftly. Successive periods of lockdowns also showed a diminishing negative impact, given the adaptation of economies. Assuming no further outbreaks, we should see conditions normalise by the middle of the year.”

Meanwhile, the risk of a US recession has ratcheted up due to surging inflation and anticipated aggressive monetary response via the raising of interest rates to prevent runaway inflation.

“A soft landing remains possible if the domestic food and energy pressures can be curbed in tandem with stabilisation in the global markets rocked by the war in Ukraine and sanctions imposed on Russia,” says Yeah.

“Coupled with lockdown woes facing the Chinese economy and shocks to Europe caused by the ongoing war, the outlook for Malaysia’s external sector has deteriorated. [More positively,] Malaysia’s sizeable commodity exports will help to mitigate the external shocks while strengthening domestic demand on the back of a fuller opening of its economy will partially offset the shocks emanating from a US downturn, should it materialise this year. It can still manage positive growth this year but [potentially at only] half the projected pace.”

Opus Asset Management’s Choy points out that a US recession would remove the major engine of growth driving today’s post-pandemic recovery. As the US imports three times more than Malaysia imports from it, a recession in the powerhouse would not only affect Malaysia, but globally debilitate markets, erode economic confidence and devalue investments.

“Present economic indicators lean towards the positive for now, but that has been declining. Should the US Federal Reserve pull through six or more rate hikes this year, the likelihood of a recession in 2023 is greater than ever,” he says.

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