The State of the Nation: Widening services deficit puts pressure on current account surplus

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MALAYSIA’S overall balance of payments (BOP) deficit widened to RM6.7 billion in the third quarter of 2014 (3Q2014), from a deficit of RM3.6 billion in the previous quarter, mainly due to a lower current account surplus and continuous outflow in the financial account.

The current account balance recorded a surplus of RM7.6 billion or 2.8% of gross domestic product (GDP) in the same quarter, down from RM16 billion or 6.1% in 2Q2014. Cumulatively, the current account had a surplus of RM43.4 billion or 5.5% of GDP in the first three quarters of the year, higher than the RM25.1 billion in the previous corresponding period.

The current account records all payments and receipts for goods and services as well as the total transfer of money to and from overseas. It is divided into four components — goods, services, primary income and current transfers. As the goods balance, being the biggest component in the current account, has been widely discussed, this week our focus is on the other components.

The services account measures the value of services exported and imported. Malaysia has experienced a services account deficit for the longest time, although it did record a small surplus from 2007 to 2010. However, it went into the red again in 2011 and the deficit has continued to widen. Going forward, this deficit is expected to come under further pressure.

Malaysia recorded a higher services account deficit of RM6.4 billion in 3Q2014, compared with RM3.6 billion in 2Q2014. Most economists believe the deficit will continue to increase, looking at the respective components in the services account balance.

The situation could worsen if the ringgit continues to weaken. Affected by falling oil prices, the ringgit dropped 2.4% to as low as 3.4340 against the US dollar on Dec 1. RHB Research economist Peck Boon Soon says this will widen the services account deficit as the import of services will be more costly.

“However, if the currency continues to remain weak, Malaysians will engage fewer foreign services. This could mitigate the magnitude of the deficit,” he adds.

Why the deficit has widened

The services balance comprises four main components — transport, travel, government transactions and other services. The travel account is the largest component, contributing the highest positive inflow to the services balance until recently.

The travel net inflow grew steadily to reach a high of RM31.62 billion in 2010, according to Bank Negara Malaysia’s statistics. The number fell in 2011 and 2012. Last year, the net inflow rebounded slightly to RM28.57 billion from RM26.89 billion in 2012.

Travel outflows have outpaced inflows. Over the past seven years, inflows grew at a compound annual growth rate (CAGR) of 5.41% while outflows grew at a CAGR of 11.8%. Inflow growth fell in 2011 and 2012, recording only 3.19% and 3.94% respectively.

Industry observers says the lower growth in foreign tourist spending is not surprising as the country’s tourism industry has remained stagnant for the past few years. According to Tourism Malaysia’s website, tourist arrivals grew 2.8% to 25.72 million in 2013 from 25.03 million in 2012. This is considered an improvement as the industry only achieved sluggish growth of 0.5% and 1.3% in 2011 and 2012 respectively.

Interestingly, local tourism has seen a significant jump this year. Tourist arrivals for the first seven months of the year grew 9.7% to 16.1 million from 14.68 million in the previous corresponding period.

Akmal Hafiz, assistant director of Tourism Malaysia’s research division, says the improvement was due to its strong marketing and promotional activities overseas. According to its statistics, Singaporeans were the largest group to visit Malaysia, followed by Indonesians and Chinese nationals.

From January to July, there was a higher number of visitors from many countries, except China and Taiwan, which saw 11.8% and 2.9% fewer tourists visiting Malaysia respectively.

“The number of Chinese tourists has fallen since flight MH370 went missing. We have switched our focus to other markets, such as New Zealand, India and Australia. We are seeing good results and we believe it will take some time for the Chinese market to normalise,” Akmal says.

He believes that Malaysia will achieve 28 million tourist arrivals for the full year, with an estimated growth of 8% to 9%. He is confident the growth will be sustainable if Tourism Malaysia continues to promote the country aggressively overseas.

RHB Research Institute Sdn Bhd chairman Lim Chee Sing says it will be difficult to increase the overall travel net inflow. Travel outflow is growing at a much faster rate, underpinned by the growing affluence of Malaysians.

“Corporates in Malaysia have been expanding abroad. This will indirectly increase travel and accommodation costs, as more Malaysians travel frequently.”

The services account deficit has also been pressured by the widening gap between the inflow and outflow of transport services since 2007. The number of receipts from local logistics companies is falling while payments to foreign shipping companies are on the rise.

Transport is the second largest component in the services balance. It includes all charges for transporting goods, payment for services such as those provided to foreign companies, and receipts by national airlines and shipping companies. Hence, exports and imports have significant influence on the transport component of the services balance.

Industry experts say the issue is mainly due to the continuous reliance on foreign logistics companies to export or import goods as there are not many established local companies providing such services in Malaysia.

“For instance, one of our largest companies — MISC Bhd — is mainly involved in shipping liquefied natural gas, chemicals and petroleum, which are not major exports for Malaysia. Shipping of other products, which will be placed into containers, is still dominated by companies from Europe, Japan or China,” says an industry observer.

There is a lack of development in the transport industry by both the public and private sector, says an economist with a local research house. The industry is very competitive and a huge amount of capital is required for the business, he adds.

Furthermore, the growth of local logistics companies is closely related to the development of ports in Malaysia. “Local ports are facing many challenges, such as strong competition from other regional logistic hubs, like Singapore, and compliance with the carbon footprint guidelines,” he notes.

The logistics sector was given some attention in Budget 2014. A Logistics Sector Master Plan is being formulated to improve the country’s performance in this sector, from its current ranking of No 29 in the World Bank Logistics Performance Index Report 2012. The plan is to develop more infrastructure and the supply chain as well as review the laws and regulations that are relevant to the industry.

The government has also allocated RM3 billion in soft loans under the Maritime Development Fund through Bank Pembangunan Malaysia. This is to encourage the development of the shipping industry, shipyard construction and maritime-related support activities.

Services outflows emanated from consultancy and professional charges received from or paid abroad as well as charges for the use of intellectual property.

Lee Heng Guie, an independent economist formerly with CIMB Research, believes that payments for other services will continue to increase, given the ongoing Economic Transformation Programme. “We still need to engage foreign experts for their professional services as the locals still have to catch up,” he says.

The services account deficit is widening. On the other hand, the current account surplus is narrowing. The primary account and the current transfer account contributed to the narrowing of the current account surplus this year. In 3Q2014, the primary account and current transfer account saw a higher deficit of RM9.4 billion and RM5.3 billion respectively, compared with a deficit of RM7.7 billion and RM2.8 billion in the previous quarter.

The primary account records compensation of employees and investment income from direct, portfolio and other investments. Economists believe the bigger outflow of investment income is mainly driven by high foreign holdings in the equity and bond markets. The view is that the outflow will moderate in the near term as the foreign ownership base will be smaller.

Primary account inflows are recorded only if money is repatriated back to Malaysia. Most corporates that have expanded abroad, say economists, have chosen to retain their earnings for reinvestment.

Current transfers, which is also known as secondary income, measures net transfers made by the public and private sector. They include items such as remittance by immigrants to relatives living abroad, personal pensions received from or paid abroad, and gifts of money to and from overseas residents.

The net current transfers deficit dropped from a high of RM21.79 billion in 2010 to RM15.82 billion last year. Looking at the growing number of foreigners in Malaysia, some economists believe that the figures may not be a true reflection of the situation.

“It is getting more difficult for the authorities to track the amount of funds transferred out of the country. Many foreigners choose to deposit their funds with illegal money lenders and siphon out the money through different channels. When the money cannot be tracked, the balance of payment cannot be reconciled — and that goes into the errors and omissions account,” says an industry observer.

Malaysia’s services account deficit, coupled with a narrowing trade surplus, is expected to continue widening. This will put pressure on the current account surplus.

This article first appeared in The Edge Malaysia Weekly, on December 8 - 14, 2014.