Executive Summary

The 2015 Budget, presented in Parliament by the Prime Minister on 10 October 2014 was overwhelmingly welcomed by the rakyat. It was unveiled as budget for the rakyat or society as a whole, catering not only for the needs and aspirations of present generations, but also for future generations. More importantly, Budget 2015 continues to be growth-friendly, especially with increased allocations for development expenditure for 2015, the final year of the Tenth Malaysia Plan (10MP, 2011-2015) and the base year for the upcoming Eleventh Malaysia Plan (11MP, 2016-2020). Public infrastructure spending features prominently in the 2015 Budget, together with new regulatory measures to further enhance labour market efficiency and flexibility and, more importantly continued strong commitment for fiscal consolidation process and structural reform programs to enhance nation's competitiveness and improve declining total factor productivity. Of greater significance, macroeconomic policies remain generally supportive of domestic economic activities, though with less accommodative monetary policy to contain near-term financial excesses, and much stronger fiscal consolidation process to ensure that the goal of sustainable growth and balanced development can be achieved in the medium and long-term.

In relation to this, the decision to anchor overnight policy rate (OPR) at 3.25% by Bank Negara Malaysia (BNM) in its Monetary Policy Statement, released on 18 September 2014, is clearly a move in the right direction. Monetary policy actions must not be dictated by market bets and past actions, but by objective and thorough analysis, taking into consideration anticipated as well as unanticipated shocks to the economy. While the goals of price stability and sustained stable growth are being consistently pursued and the risk for home-grown crisis is to a large extent contained, BNM needs to be alert and on guard against potential contagion, arising from enhanced downside risks. These include geo-political risks, coming from escalating crisis in the Middle-East and eastern Ukraine. Most importantly, there are signs that economic recovery in the euro area is faltering and in the Asian region, the slowing down of growth in China, the world's second largest economy and also Malaysia's largest trading partner. There is clearly a need to provide the so-called "comfort zone", encompassing not only "interest rate smoothing" and gradual adjustment process, but also providing clear signal to economic agents at large that Malaysia needs more than stable consumer prices. The key goals of tightly coordinated macroeconomic policies are to sustain upward growth trajectory, ensure nation's competitiveness and continue maintaining strong commitment to medium-term macroeconomic stability. These efforts will undoubtedly help in enhancing long-term confidence and strengthen the belief function of the rakyat about good management of macro economy in Malaysia. In fact, monetary policy competency, integrity and accountability, coupled with its operational independence have allowed BNM to gain high mark among foreign investors and locals alike.

On the contrary, fiscal policy, another key component of macroeconomic policies, needs to be strengthened, ensuring that public finances are managed in a competent and sustainable manner through strengthening further the fiscal consolidation process. Efforts to further reduce fiscal deficit and manage successfully contingent liabilities will ultimately help to improve macroeconomic performance, especially in the medium and long-term. Additionally, regulatory policies to deal with major economic issues, such as suppressed wages, high cost of living, rising inequality, high taxes and excessive regulations, and a heavy dependence on foreign workers need to be examined and implemented in a comprehensive and competent manner. In this respect, short-term populist fiscal consumption transfers and non-productive and low quality expenditure need to be curtailed, as these expenditures are putting a lot of pressure on the Federal Government budget, and not in anyway helping to enhance either human capital development or physical capital formation. Post-fiscal disposable income derived from direct cash transfers, such as BR1M will be reduced by a combination of factors, such as higher inflation and rising cost of living, and unfortunately consumption-based indirect taxes, associated with upcoming GST implementation in April 2015. Mark-up in prices by traders and firms alone will see that the value of cash transfers in real terms diminish drastically, more so with upcoming consumption tax.

Of significance, fiscal policy institutions and associated regulatory authorities also need to be strengthened with greater fiscal discipline, wider technical and allocative efficiency, stronger accountability and, most importantly, good governance. The attainment of these positive attributes requires essentially rooting out rent-seeking activities and penetrating deeper into strongholds of vested interest and influential groups and removing powerful cables. Greater focus, together with more allocations, needs to be given on longer-term innovation-enhancing policies, especially in education and health sectors. Continued cut in development expenditures, as seen in 2013/2014 and private investment that is skewed toward residential structures, catering for affluent markets and mega projects by GLCs in specially designated areas would add very little in improving long-term growth dynamics, enhancing multiplier effects across-the-board and ensuring sustainable growth and balanced development in the country as a whole. Most worryingly, there are risks associated with capital accumulation through fast-track mega projects, as unveiled in the recent Budget 2015 - twin deficits, debt accumulation, weak currency, corruption, etc. In fact, substantial real estate investment, especially in residential structures and office buildings may lead to asset bubbles and also property collapse, as seen in the recent 2008 global economic and financial crisis.

Looking ahead, rising interest rates and heightened exchange rate volatility would add more to the Federal Government debt burden and raising potentially the possibility of debt monetization, as net claims on Government are substantial in recent years. While it is essential to maintain some form of macro policy flexibility, in view of fast changing economic circumstances, we also need to constrain excessive "fiscal discretion", as seen again in the 2015 Budget speech. Most important of all, we need to avoid short-term populist measures by adopting fiscal rules that put a small weight on output volatility relative to inflation volatility, which in the final analysis would help in enhancing investor confidence and avoiding the so-called risk of fiscal insolvency, and eventually taxpayer losses. The Federal surplus target, which is expected to be realized by the year 2020, needs to be reversed backward, necessitating achieving overall surplus to GDP ratio and rapid asset accumulation by the Government much earlier. This is really necessary, so as to provide enough fiscal space to support projected higher social commitments and to address rising contingent liabilities of the Federal Government. More so with enhanced downside risks on the international front. With liquidity-constrained households, distortionary taxes and other non-Ricardian features prevailing in the economy, fiscal policy actions that response systematically to business cycle shocks are clearly needed, as against presently an ad-hoc interventionist, and largely discretionary fiscal actions. Of greater importance, Malaysia needs "fiscal responsibility laws" and higher public sector spending, focussing more on education and health as well as in efficient infrastructure projects, covering every corner of the country and not just in well-developed areas. This is considered more equalizing than popular cash transfers that seems to become a permanent feature of annual Budget. Warm glow effects from goodies and other populist measures, as provided in the recent Budget will not last long, akin to throwing paper aeroplane that will come down fast and discarded.

Real GDP growth of the Malaysian economy grew surprisingly higher by 6.4% in the second quarter of 2014 (Q12014: 6.2%, Q42013: 5.1%), supported by continued robust aggregate domestic demand and exceptionally strong external demand. External demand accelerated in the second quarter of 2014, registering significantly high year-on-year growth of 91% (Q12014: 14.9%, Q42013: -6.8%). On the contrary, domestic demand (excluding change in stocks) moderated slightly to 5.7% in the second quarter of 2014 (Q12014: 7.4%, Q42013: 6.7%), with growth in private consumption trending downward to 6.5% (Q12014: 7.1%, Q42013: 7.4%), contributing only 3.4 percentage points to real GDP growth of 6.4% (Q12014: 3.7 percentage points, Q42013: 3.7 percentage points). Taking into account negative growth in "change in inventories", domestic demand contributed only 1.9 percentage points, substantially lower than positive contribution by the external sector at 4.5 percentage points, thanks to continued strong growth in exports and markedly lower imports of goods and services. While growth in private consumption is showing a moderation, households are generally able to continue sustaining their consumption habit, especially with continued easy access to credit. Nonetheless, they are also digging deeper into their assets and accumulated wealth, especially with rising inflation. Household indebtedness remains an issue that needs to be carefully examined, although house prices remain on the uptrend. Household debt stood at 86.8% at end-December 2013, and this latest available figure is clearly one of the highest for developing countries. Additionally, private investment is showing a deceleration, but remained in double digit growth of 12.1% (Q12014: 14.1%, Q42013: 16.6%), supported mostly by capital outlays in the manufacturing and services sectors. Latest available data showed that total investment approvals by MIDA in the manufacturing sector registered an impressive performance, totalling altogether RM53.2 billion in the first seven months of 2014 and representing 102.1% of total investment approvals for the whole of last year (2013: RM52.1 billion, 2012: RM41.1 billion). The share of foreign investment was at 57.8%, encompassing investment approvals for FDI from Japan, China and Germany, the big-three global manufacturing powerhouses, which augurs well for the Malaysian economy, moving forward. Growth strategies to improve investment climate to attract FDI in Malaysia have clearly been successful.

While the inflation rate in the first nine months of 2014 increased markedly by almost double the rate registered in the corresponding period last year (January-September 2014: 3.3%; January-September 2013: 1.8%), growth in domestic liquidity, as measured by the broad money supply (M3), has stabilised in recent months, attributed to a large extent by continued improvement in domestic credit extension to the private sector and also a sharp turnaround in net foreign assets of the banking system. Net claims on Government remained on an expansionary mode, offsetting the contractionary effect of "other influences". Growth in narrow monetary aggregate (M1), however, remained on the downtrend, registering a single digit growth of 9.1% in August 2014, the lowest since November 2012, pointing to increasingly tight liquidity conditions and limited access to credit markets. Growth in loans disbursed, the key metric for availability of financing in the banking system, decelerated markedly to 5.1% in August 2014 (December 2013: 24.7%, August 2013: 6.2%), while loans approved registered sharper negative growth at -9.1% (December 2013: 20.4%, August 2013: 6.1%), with the banking system reordering their financial priorities, especially with extremely tight liquidity conditions. While the dynamics of monetary aggregates in the current environment are difficult to monitor with advances in payments system and technology, and assumed as endogenously determined, they should also be monitored and examined carefully, especially with the hike in OPR by 25 basis points on 10 July 2014. With tighter domestic liquidity conditions, average 3-month interbank rate is trending up to reach 3.80% on 14 October 2014, representing 49 basis points (bps) higher than the prevailing 1-month interbank rate (3.31%) and also 69 bps higher than its lowest at 3.11%, recorded in April 2013.

Labour market conditions have improved in recent months and remained generally healthy, supported by an acceleration in external demand and a strong pick up in growth of the manufacturing sector in the first half of 2014. Unemployment rate improved to 2.8% in July 2014 (December 2013: 3.0%, July 2013: 3.0%), while seasonally adjusted figure was the same at 2.8%. However, the improvement in the labour market is masked by structural weaknesses that need to be urgently addressed by the relevant authorities. The overall labour force participation rate has declined to 67.4% in July 2014, down by 0.1 percentage point from the previous month, and remained well below the average of 69.0%, registered during the period August to November 2013. This decline is on the back of the decrease in the population size of labour force, which has persistently been on the downtrend since September 2013. As such, non-participation of eligible workers, weak "staying rate" and low "job finding rate" need to be examined and monitored carefully to account for real improvement in labour market conditions. Meanwhile, foreign workers amounted to 5.8 million persons (with 2.9 million persons being legal), representing about 41% of the labour force, or four out of ten workers in Malaysia. While there were new entrants to the labour markets, comprising of mostly young workforce aged between 20-24 years, senior workforce participation rate, especially local females has been declining, discouraged by longer duration of unemployment, de-skilling effects and also family commitments. The number of employed persons declined by 35,500 persons to 13.59 million persons in July 2014 (June 2014: 13.62 million persons), while the number of unemployed has increased by 8,300 persons to 394,100 during the same period. Latest data in June 2014 showed that total number of retrenchments has declined markedly to 570 persons, while total number of vacancies increased to 88,725 persons, pointing to increasingly favourable labour market conditions.

Bank Negara Malaysia (BNM) in its Monetary Policy Statement, released on 18 September 2014, anchored the Overnight Policy Rate (OPR) at 3.25%, maintaining the same rate as decided earlier at the Monetary Policy Committee (MPC) meeting on 10 July 2014. The decision to maintain the OPR is clearly the right move, taking into account emerging weaknesses in the external environment, falling commodity prices and continued moderation in aggregate domestic demand. While expected inflation remained above the long-term average inflation rate of 3%, as used by BNM, positive output gap as registered in the previous two quarters, is diminishing fast with expected slower actual output growth in the coming quarters, indicating that growth outlook matters, and inflation can wait a while longer and takes a back seat. Of greater significance, exchange rate which has been on an appreciating trend since early this year, has turned volatile in recent months, indicating that ringgit is again on the depreciating mode, especially against the stronger US dollar. Heavy foreign exchange interventions did little in strengthening the ringgit, as foreign portfolio investors are retreating from both equities and Malaysian Government securities alike. FBM KLCI declined by 20.54 points to close at 1,788.31 on 17 October 2014 (all-time high on 10 July 2014: 1,892.62), while bilateral ringgit exchange rate ended lower at RM3.2870 per US dollar (USD) on 17 October 2014, compared to RM3.1480 per USD on 28 August 2014. Meanwhile, BNM international reserves declined markedly to USD127.3 billion as at 30 September 2014 from USD132.0 billion on 29 August 2014 (end-December 2013: USD134.9 billion). While movements of the ringgit is determined to a large extent by real interest rate differentials and premiums, market microstructures, herding behaviour and possibly animal spirits in the short-term, we should see an appreciating trend in the medium and long-term, moving away from the legacy of tightly managed exchange rate regime to relatively flexible exchange rate system with a generally strong currency in the years ahead. Moreover, strong currency is normally associated with advanced economies that Malaysia aspires to be come 2020 and also a reflection of successful economic transformation from essentially manufacturing-based to services-oriented economy. This goal needs to be supported with sound domestic macroeconomic fundamentals, good governance and solid institutions. Moreover, the ringgit used to be strong, especially in the early 1990s, where it was traded at about RM2.50 per US dollar. Apart from using monetary policy instruments, such as FX intervention, interest rate (monetary policy) rule, open market operations and statutory reserve requirements (SRR), building up investor confidence and sustaining their so-called "belief function" about the good management of the economy is really necessary, especially in the medium and long-term. In the current fast changing financial and economic conditions, we need a lot more toolkits and much greater understanding, utilizing behavioural finance, experimental and evolutionary economics, among others. Financial markets do not operate or function based on full information, rational agents, liquid markets, efficient trading and are in equilibrium at all times, but occasionally subject to abrupt and discontinuous change far from equilibrium. We also need to understand the views of Kindelberger and Minsky as well. On the domestic front, views of our own Tun Dr. Mahathir with his fine surgical and medical techniques are also relevant.

Ms. Christine Lagarde, Managing Director of the International Monetary Fund (IMF) in her statement at the conclusion of the Group of 20 (G20) Finance Ministers and Central Bank Governors Meeting in Cairns, Australia on 21 September 2014 mentioned that the pace of global growth remains low and uneven, in part given increased geo-political tensions and risks of financial market turmoil. She argued that promoting economic policies that can contribute to a more robust and job-rich recovery is therefore critical. She promised that the IMF will continue to support sound monetary and fiscal polices, including through the analysis of spillovers, to promote broad and equitable growth. In general, global risks have intensified, and financial markets remain volatile, especially with tightening global financial conditions, slowing down in China, faltering German economy, falling commodity prices, and exponential growth in ebola cases.

The results of MIER's third quarter 2014 Consumer Sentiments Survey and Business Conditions Survey show that consumer and business confidence indices continue to move in tandem for fifth consecutive quarters, reflecting synchronization in both consumer and business sentiments. The third quarter 2014 Consumer Sentiments Index (CSI) down by 2.1 points quarter-on-quarter to settle below the threshold points of 100 at 98.0 points (2Q2014: 100.1 points), indicating consumers are wary about their future and becoming more cautious in their sentiments. The latest CSI is dragged down by both the current and expectational sub-indices, with current and expected finances have softened during the quarter. Additionally, employment prospects remained flat. Meanwhile, the Business Conditions Index (BCI), which was on the uptrend for two consecutive quarters, registered a slowdown, declining by 17.0 points quarter-to-quarter basis to 95.9 points in the the third of 2014, well below the 100.0 point threshold, indicating that that business conditions have deteriorated. The key factor behind the loss of momentum in the BCI is the slower growth of the Current Index (CI). The Current Index (CI) slipped by 23.2 points to read 88.1 points in the third quarter of 2014, compared with 111.3 points in the previous quarter. All six sub-indices that make up the CI, namely sales, production output, new local and export orders, investment as well as capacity utilization were weaker in the third quarter, compared to the second quarter. Meanwhile, the survey results indicate that manufacturers expect business conditions to improve slightly in the fourth quarter, as the Expectation Index (EI) gained 1.5 points to stay at 119.3 points in the third quarter of 2014 (2Q2014: 117.8 points). While expected production sub-index of EI declined by 4.1 points to read 56.8 points, expected export sales sub-index gained by 5.5 points to settle at 62.5 points, pointing to expected favourable external environment.

These sentiments are generally echoed in the latest third quarter 2014 Vistage-MIER CEO Confidence Index, released in August 2014. CEO were increasingly concerned about the economy and seemed to be pessimistic in their near-term outlook for their firms. The Vistage-MIER CEO Confidence Index slipped further below the 100-point demarcation level of confidence, registering 89.4 points (Q22014: 92.2 points), losing 2.8 points on quarterly basis, significantly lower compared with the corresponding quarter last year (Q32013: 100.9 points). Generally, chief executive officers (CEOs) were pessimistic in their sentiments in this quarter, compared to somewhat optimistic views in the previous quarter. Profitability and revenue are expected to slow down in the coming months, while hirings are likely to slow down. About 54% of CEOs expected an increase in revenue, down from 58% in the second quarter 2014 and 63% in the third quarter of 2013. Of significance, only 44% of CEOs expected higher profits, down by 2 points from the previous quarter (2Q2014: 46%, 3Q2013: 55%). Their major concerns include readiness of GST implementation, with only 14% have recently registered, while 52% saying they are currently ensuring that their accounting system is GST-compliant. Crime rate in Malaysia is a major concern for CEOs, with 68% of the CEOs believed that the crime rate in the country has increased, while only 29% thought that it has remained unchanged.

While there are clearly emerging weaknesses in domestic macroeconomic fundamentals and some of these have been factored in both MIER's CSI and BCI surveys as well as Vistage-MIER CEO Confidence Index, growth of the Malaysian economy is expected to be stronger than last year, supported by exceptionally strong growth performance in the first half of 2014, robust aggregate domestic demand and recovery in external demand, especially in key advanced economies. In this connection, we are upgrading MIER growth forecast to 5.7% for 2014, taking into account surprisingly strong growth rates registered in the first two quarters of 2014, continued supportive monetary policy stance, as seen in the anchoring of OPR at 3.25% and improvements in both domestic and global economic activities. As for 2015, real GDP growth is projected to move nicely along socially efficient output growth trajectory of 5.5% - 6.0%, driven by efficient allocation of nation's scarce resources, enhanced economic efficiency and continued strong social protection. The projected higher growth is in line with the 2015 Budget strategies, measures and programs, as outlined in the well-received PM Budget speech on 10 October 2014. In summary, strong commitment by the Government in implementing structural reform programs and fiscal consolidation actions will help to facilitate long-term growth dynamics of the Malaysian economy. While there are unavoidably short-term pains, associated with reform programs, overall benefits will far outweigh the costs in the medium and long-term. Most importantly, welfare of the society as a whole will be greatly enhanced, benefitting not only present generations, but also future generations.

Posted by suzy at 10:38 AM on October 21, 2014


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