Thursday 28 Mar 2024
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This article first appeared in The Edge Malaysia Weekly on May 4, 2020 - May 10, 2020

MALAYSIA is unlikely to experience a twin deficit even though oil prices have crashed and business activities have been paralysed in the past six weeks by the Covid-19 Movement Control Order (MCO), which has cost the economy RM2.4 billion a day.

Analysts say the chances of a twin deficit are “quite low”.

Bank Islam chief economist Dr Mohd Afzanizam Abdul Rashid tells The Edge: “The prevailing economic conditions suggest that domestic demand may not be too strong [as before] and that’s the reason most economists, including us, are looking at Malaysia’s gross domestic product (GDP) to contract this year. This, in essence, would reduce imports, and therefore the current account balance would remain in surplus.”

A twin deficit occurs when a country experiences a deficit in both its budget and current account on the balance of payments.

Malaysia has run a budget deficit since 1998, as the total expenditure of successive administrations exceeded total revenue — even when oil prices surpassed US$100 a barrel.

Fortunately, the current account has provided a measure of comfort in past years, as the country enjoys a surplus, the export of its goods and services exceeding its imports.

But should the scenario be reversed, the current account will end up in a deficit and put Malaysia on course for a twin deficit and subsequent consequences, including a weaker ringgit.

Malaysia was last in a twin deficit in the late 1980s leading up to 1992, recalls Lee Heng Guie, executive director at the Socio-Economic Research Centre of the Associated Chinese Chambers of Commerce and Industry of Malaysia.

“Malaysia has incurred current account surpluses, albeit narrowing since the 2008/09 global financial crisis (GFC), while the budget deficit continued after enjoying a brief five years of fiscal surplus between 1993 and 1997,” he tells The Edge.

In 2019, Malaysia’s budget deficit narrowed to RM51.5 billion, or 3.4% of GDP, from RM53.4 billion, or 3.7% of GDP, in 2018. The current account surplus widened to RM49.7 billion, or 3.3% of GDP, from RM30.6 billion, or 2.1% of GDP, in 2018.

Though Malaysia is an oil exporter, the slump in crude prices by more than 60% from a year ago to US$25 a barrel is not expected to pose a threat to the current account balance, as oil exports accounted for only 2.3% of the country’s total exports in the first two months of the year.

Lee believes other exports can offset the difference. “This can be compensated by the exports of electrical products and electronics, which made up 33.7% of total exports; palm oil and palm oil products, at 7.3%; and liquefied natural gas, at 4.5%.

“As imports are likely to fall more relative to sluggish exports during the economic downturn as seen in the 1997/98 Asian financial crisis and the GFC, the risk of slipping into a current account deficit is small.”

Prof Datuk Dr Rajah Rasiah, distinguished professor of economics at the Asia-Europe Institute of Universiti Malaya, concurs. “I do not see the current account becoming negative, especially when we still enjoyed a current account surplus over January and February 2020. [However,] a worrying trend is the sharp contraction in palm oil exports in March,” he tells The Edge.

According to a statement from the Ministry of Plantation Industries and Commodities, the exports of crude and processed palm oil from Malaysia, the world’s second largest producer, plunged 41.7% to 890,331 tonnes in the first month of the MCO period, which was from March 18 to April 14.

 

What does a twin deficit entail?

OCBC Bank economist Wellian Wiranto says that, if the current account does indeed tip into deficit territory, Malaysia would find itself a “lot more dependent on external funding”.

“Such dependence, in turn, would make Malaysia more of a hostage to the ebbs and flows of global market sentiment. This would be similar to what the country experienced in the boom time of the 1990s, with its current account deficit running as high as 9.7% in 1995, for instance.

“It was a period of investment boom, when the sky seemed to be the limit. Of course, it all ended with the Asian financial crisis, where a painful macroeconomic readjustment had to be undertaken, including a boost to exports as a way to get more foreign exchange receipts to plug the current account gap,” he says.

Lee adds that a current account deficit is not necessarily a bad thing if the magnitude of deficit does not widen on a sustained basis.

“Persistent widening of a current account deficit could reflect that the economy consumes more than it is saving, and thus requires a corrective adjustment if there is excessive unproductive demand while exports continue to pace slower, owing to the loss of competitiveness in both markets and products.

“If the widening current account deficit [continues], it will eventually put pressure on the accumulation of foreign exchange holdings and the ringgit, if there is also a shrinking of capital inflows. Thus, a dependable [stream of] long-term capital inflows is vital to augment the domestic pool of savings,” he says.

In a twin deficit, the consensus is that liquidity will be an issue, given the dependence on foreign capital to fund economic activities. Not all quarters agree, however, that a twin deficit would also lead to exchange rate volatility.

In fact, Afzanizam says the link between a twin deficit and a volatile exchange rate is “blurry”.

“We ran some simple tests by looking at the daily [movements] of the exchange rate from 2010 to 2020 for the Indonesian rupiah (IDR), Indian rupee (INR) and ringgit (RM) versus the US dollar (USD).

“We found that the coefficient of variation for USD/RM is 41 times, which means for every 1% average daily change in the exchange rate, the standard deviation would be 41.1 times. This is much higher than USD/INR and USD/IDR of 23.7 times and 23.6 times respectively. Therefore, USD/RM is much more volatile than Indonesia and India, where both countries are twin deficit economies and we are not. Therefore, a twin deficit may not be the focal point if our concern is on the volatility [of the exchange rate],” he says.

 

Lessons from the past

Malaysia managed to solve its twin deficit problem in the past, but it was a painful and lengthy process.

“In the 1980s, not only [did we have] the unsustainable large twin deficits, but we also incurred an operating deficit in the federal government’s financial account, [which] had compelled painful structural adjustment policies to correct the twin deficits,” says Lee, noting that measures taken back then included rationalisation, trimming and reordering of public sector expenditure, including that of non-financial public enterprises.

In addition, operating expenditure was rationalised, and revenue enhancement measures were needed to correct the budget deficit.

Lee adds: “Other measures to address the current account deficit of the balance of payments were transport, shipping and tourism-related policies to improve the services account outflows, encourage imports substitution to reduce overdependency on imported capital and intermediate goods as well as exports promotion to strengthen the trade sector.”

Afzanizam says that in the past, twin deficit problems have led to macroeconomic imbalances, especially when the capital markets were not really developed and the banking system was very fragile.

“Recognising that, the government and the central bank have been [actively] fixing the financial system, which led to capital controls, banking mergers, the creation of Danaharta and Danamodal and so on,” he says, adding that the banking system is on a firm footing now after proving itself capable of withstanding the GFC in 2009, as bank capitalisation and asset quality were not compromised.

 

Diversifying our revenue base

Even though a twin deficit seems unlikely, some quarters are urging a further diversification of revenue streams, even reintroducing the Goods and Services Tax (GST).

The consumption tax may not have been popular with the public, especially low to medium-income earners, but the more than RM40 billion collected every year helped buoy the government’s coffers.

Wiranto believes, however, that the timing for the reintroduction of the GST has to be right.

“Apart from the heavy political cost of reinstituting the GST, the timing does not help as well. Consumers are likely already going to be on a belt-tightening mode for some time, even beyond the Covid-19 outbreak, as wariness of any big-ticket item purchase will linger amid employment and debt servicing concerns. It is hard to imagine how consumers can stomach GST in the near term,” he says.

Rajah believes that introducing the GST at a lower rate of 2.5%, against 6% before, would be acceptable, but he cautions: “The government must also have an instrument to offset payments by the B40 [bottom 40% income] group through some form of subsidy.”

As for greater diversification of government revenue, Rajah observes that Malaysia should reduce its dependency on oil and gas for two reasons. “First, overdependence on these commodities exposes the country to the vicissitudes of volatile trade swings. Second, [as it is a] fossil fuel, we should reduce reliance on a fuel that pollutes the environment. We could still export these commodities, but must impose export taxes to finance Malaysian society and R&D.”

A twin deficit may not be in the picture at present, but much still needs to be done to ensure that both the fiscal and current account balances are maintained at levels favourable to the economy. In short, the government will need to walk a fine balance as it navigates both the economic and health crises.

 

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