MALAYSIAN ECONOMIC OUTLOOK
The 2014 Budget, unveiled in Parliament on 25 October 2013, has introduced several bold measures to strengthen the management of public finances, focussing largely on reducing the overall deficit of the Federal Government account (as a percentage to GDP) to 3.5% in 2014 and 3.0% in 2015. More importantly, the estimated overall deficit in ringgit terms is also being reduced, reflecting really a strong commitment to budget consolidation process by the Federal Government. As a result, Moody's investors service has recently affirmed Malaysia's Government bond and issuer ratings at A3 and changed the outlook to positive from stable. While the Federal's deficit reduction is clearly on track and moving rightly on target (2013: 4.0% of GDP), it is still inadequate and not broad enough.
Looking at the recent performance of the consolidated public sector account, its overall deficit as a percentage to GDP is estimated to increase by three folds, rising from -4.5% of GDP in 2012 to double digit figure at -13.5% of GDP in 2013 (2014: -9.4% of GDP). The estimated higher public sector overall deficit, which should really be the prime target, is largely due to markedly lower operating surplus and substantially higher development expenditures of non-financial public enterprises (NFPEs). This is actually a recent phenomenon, as crude oil prices stabilized, and public sector account covers only 30 big NFPEs, excluding essentially other quasi-public GLCs, off-budget entities and state-dependent concessionaires, which are also entrusted and tasked for economic and social development of the country. Interestingly, in Malaysia, public debt is associated with the debt of the Federal Government and national debt is used interchangeably as external debt. External debt is estimated at 28.8% of GDP in 2013, of which short-term external debt and non-guaranteed NFPEs debt, accounting for altogether 17.3% of GDP (2012: 15.8% of GDP).
As such, greater efforts need to be focussed in arresting deterioration in the public sector consolidated account, particularly NFPEs account which should be the next target in terms of good macroeconomic management, as part of monitoring the savings-investment or fiscal balance-external balance of the country. In addition, emerging public finance issues, such as rising debt of NFPEs, off-budget commitments and contingent liabilities, also need to be addressed to ensure really strong and sound management of public finances. Empirical studies show that budget deficit affects macroeconomic performance, while greater fiscal accountability and transparency help in promoting inclusive growth and ensuring sustainable development in the medium and long-term. The current practice of tight-lipped and secretive approach in the preparation of the Budget, followed by the subsequent dazzling presentation of the Budget Speech in Parliament needs to be complemented with online budget documents, downloadable spreadsheets and user-friendly budget programming toolkits. In addition to specific focus group discussions, intensive stakeholders' consultations and open public forum are the good attributes of better public policy, especially in budgeting and management of public expenditure. Consolidated public sector account should be prepared on quarterly basis, complementing other macroeconomic accounts, such as national accounts and balance of payments.
Apart from an annual budget and medium-term expenditure framework, the nation's long-term economic transformation process and structural reform programmes need to proceed at a faster pace. More importantly, stabilization measures should be ready when the need arises, especially with changing economic circumstances and growing uncertainty in the external environment. In this respect, monetary policy should be more pro-active, forward-looking and taking the leading role in exacting necessary measures to smooth excessive exchange rate volatility and curb mounting inflationary pressures and manage inflation expectations in the medium and long-term. Real policy rates have been on the rise in key advanced economies, and these expectations have already been factored in their sovereign bond yields, indicating that financial risks are looming on the horizon. These could significantly dampen aggregate domestic demand, especially private consumption and investment.
With fiscal consolidation process now clearly underway and fiscal belt-tightening measures also being considered, monetary policy needs to be more dominant, focussing on fighting the elevated inflation expectations, smoothing excessive volatility in ringgit exchange rate, avoiding destabilizing capital flows and ensuring continued strong net foreign assets position of the banking system, among other things. Moreover, growth in domestic liquidity, as measured by the broad money supply (M3) is decelerating fast, attributed to a large extent by contraction in net external operations, although domestic credit situation remains generally supportive of domestic economic activities. While the current account surplus of the balance of payments (BOP) has improved during the third quarter of 2013, strangely the improvement in the overall BOP position has been attributed mostly to "net errors and omissions", a statistical discrepancy which turned around to register significant surplus, and the figures are the largest since the third quarter of 2011. Without that substantial turnaround, arising from discrepancies due to various data sources and valuation factors, overall balance of BOP could have easily slipped into deficit, as our BOP financial account has deteriorated, especially with significant outflows of portfolio investment during the third quarter of 2013. The reduction in reserve assets has affected domestic liquidity, leading to tighter monetary conditions.
Latest data show that economic activity is improving in major advanced economies, especially the US and Japan. The IMF, in its latest World Economic Outlook (7 October 2013), projected the US economy to grow by 2.6% in 2014 (2013: 1.6%) and euro area to register positive growth of 1.0% in 2014, after experiencing two consecutive years of recession. The Japanese economy is expected to record strong growth of 2.0% this year, while its growth is projected to remain in positive territory of 1.2% in 2014, depending on the progress of its fiscal consolidation plan under the so-called third arrow of Abenomics. Growth in emerging market and developing economies is expected to improve in 2014, with India and ASEAN-5 registering growth of 5.1% and 5.4%, respectively. Nonetheless, growth in China continues to decelerate, but at 7.3% in 2014 (2013: 7.6%), it is still a respectable growth, providing required support for other emerging market and developing economies, including Malaysia. As a whole, global growth is projected higher at 3.6% in 2014 (2013: 2.9%), which is 0.6 percentage point above the global long-term potential output growth of approximately 3.0% per annum, indicating a stronger world economy next year.
As mentioned in the previous quarterly reports, Malaysia could be facing premature de-industrialization, made worse with depleting natural resources, migrating talents and increasingly tough competition from neighbouring countries and other key emerging economies. Moreover, Malaysia is no more in the low-cost category, moving away from assembly-type manufacturing operations. As such, expanding market access and maintaining high standards, in terms of product and service quality as well as integrity of key institutions in an increasingly competitive global marketplace, are the necessary conditions in ensuring there is an increase in the overall standard of living and, most importantly nation's long-term competitiveness. Natural resources, such as oil and gas need to be managed in an optimal and sustainable manner, avoiding excessive exploitation for short-term gains. Malaysia needs to be pro-actively engaged in shaping global trade and investment, at both bilateral and multilateral levels, and ever ready to tackle tough and increasingly complex issues with more forward looking and move forward with determination and zeal. We cannot win in all the deals or negotiations, but at least we could ensure that the overall benefits far outweigh the costs from a long-term perspective and key performance indicators, namely present value of net benefits, economic internal rate of return (EIRR) and benefit-cost ratio (B/C ratio) are favourable to the nation, benefiting not only present generation, but also future generations. More importantly, inter-generational equity and interests of major stakeholders, especially households and consumers are fully protected.
Growth of the Malaysian economy improved significantly to 5.0% in the third quarter of 2013 (2Q2013: 4.4%, 1Q2013: 4.1%), supported mainly by robust domestic demand, especially private investment and consumption. Of greater significance is the turnaround in the external demand. Growth in private investment, which bottomed out in the first quarter of 2013, accelerated strongly by 15.2% year-on-year (2Q2013: 12.7%, 1Q2013: 10.8%), on account of improved overall business conditions, thereby providing the necessary support for domestic demand, as inventories declined significantly. Public investment declined again by 1.3% in the third quarter (2Q2013: -6.4%, 1Q2013: 17.3%), on the back of mainly lower Federal Government development expenditure, although non-financial public enterprises continued to expand their capital outlays, especially in physical infrastructure projects, oil and gas and utilities. Higher development expenditure of NFPEs, as reflected in the consolidated public sector account has not been fully translated into strong public investment, indicating the possibility of leakages or unproductive expenditures, which need to be carefully examined and monitored by the relevant authorities.
In terms of demand components, domestic demand (excluding change in stocks) expanded strongly by 8.3% year-on-year (2Q2013: 7.3%, 1Q2013: 8.2%), while external demand, as measured by net exports of goods and services rebounded, registering growth of 1.6% in the third quarter of 2013 (2Q2013: -41.6%, 1Q2013: -36.4%), representing first quarterly positive growth after seven consecutive quarter of declines. The major contributory factor was the turnaround in exports of goods and services, which grew by 1.7% in the third quarter, after contracting for five consecutive quarters, indicating improvement in the external environment. While it is really a good sign, it could be a flypaper effect or transient, as exports growth in September 2013 has already decelerated. Nonetheless, private consumption continued to be the key driver of growth, growing significantly by 8.2% (2Q2013: 7.2%, 1Q2013: 7.5%), the highest since the fourth quarter of 2012, contributing 4.3 percentage points to real GDP growth of 5% in the third quarter of 2013. Consumption-driven growth for a prolonged period is not sustainable in the medium and long-term, as it is usually associated with rising consumer inflation and demand for higher wages. Worst still is the rising imports, especially import of consumption goods, which has registered strong increase by 6.6% in September 2013 (August 2013: 0.3%).
While low interest rate environment and easy access to consumer credit helped to continue fuelling private consumption in Malaysia, ironically lower interest rates in key advanced economies have not fully translated into higher private investment and consumption, as investors are still worrying about weak sales and export orders, while households are experiencing stagnant or lower incomes. Inflation in the euro area has fallen to well below the ECB target of 2%. Actual output remains below potential output, while their key target, namely unemployment rate is well above the natural rate of unemployment. As such, interest rates in key advanced economies are expected to remain generally low in the short-term, although the prospect of monetary tightening, especially after large-scale monetization of debts by the central banks, would pose serious challenges to emerging market and developing economies. These challenges include exchange rate overshooting and financial market vulnerabilities and, most likely a reversal in capital flows. As such, monetary tightening in key advanced economies and weakening economic fundamentals on domestic front require that these potential risks be managed carefully and in a prudent manner. Malaysia needs to be extra vigilant, minimizing downside risks to growth and employment, while adopting new measures and strategies to avoid financial instability, especially with a likelihood of rising interest rates, possibly in the second half of 2014 and continuing volatility in the financial asset markets. Forward looking economic agents, especially in the financial markets have already took that in their investment decisions in the asset markets and that caused sudden reversal in capital flows during July to September 2013.
Headline inflation is on the uptrend, rising persistently from the lowest of 1.2% in December 2012 to 2.6% year-on-year in September 2013, attributed to continuing higher food and energy prices. Core inflation increased sharply to almost 2.0%, signaling that demand-induced inflation is clearly flexing its muscle, especially with enhanced inflation expectations and sustained wage growth. Cost push factors are definitely playing their part in pushing headline inflation higher, especially with significant markup in costs, triggered by fuel subsidy adjustments in early September and continued rising world crude oil prices, and also palm oil prices in recent months. While selective price controls, price standardization across states in Malaysia, better distribution and strong enforcement during the festive season helped to dampen price increases, inflationary pressures are largely on the rise, especially with the forthcoming full scale implementation of minimum wage in early January 2014 and the planned GST implementation on 1 April 2015. Despite that, Bank Negara Malaysia (BNM) kept the Overnight Policy Rate (OPR) unchanged at 3.0% at its Monetary Policy Committee Meeting on 7 November 2013. This OPR remains unchanged, spanning 28 months in a row and almost two and a half years since May 2011. While the move is in line with the need to support growth of the economy, especially with enhanced risks on the horizon, concrete measures for short-term stabilization are urgently needed, as continuing sharp volatility in ringgit and weakening terms of trade both affect domestic consumer prices and headline inflation. Moreover, the flat OPR has been there for so long, while growth is expected to further improve in the remaining quarter of 2013 and strengthen in 2014.
The results of MIER's third quarter Consumer Sentiments Survey and Business Conditions Survey showed that consumer and business confidence indices move in tandem, reflecting some synchronization in consumer and business sentiments. The third quarter 2013 Consumer Sentiments Index (CSI) declined by 7.7 points quarter-on-quarter to settle lower at 102.0 points, the lowest reading since the first quarter of 2009. The Business Conditions Index (BCI), which gained strongly by 21.6 points to settle above the 100-point threshold at 114.2 points in the second quarter of 2013, had also declined in the third quarter of 2013 to settle at 98.6 points, extending its earlier downtrend. With both indices currently hovering at about the 100-point threshold, we can broadly conclude that consumers remain cautious in their spending and that business confidence is generally weak in the third quarter of 2013.
Taking into account the weak growth performance in the first three quarters of 2013, and emerging weakness in MIER's CSI, especially private spending and generally weak performance of Malaysia's other key macroeconomic indicators, domestic demand is expected to moderate slightly in 2013. While domestic demand will continue powering growth of the Malaysian economy, improving external demand as seen in recent months and a slightly better performance of private investment will help to ensure that 2014 Budget's growth estimate at 4.5 - 5.0% for 2013 will be achieved. We are maintaining our 2013 growth forecast of 4.8% for 2013, taking into account factors such as rising consumer inflation, tighter credit conditions and moderation in financing, amid improving global market environment. Growth outlook for 2014 is projected to be between 5.0 - 5.5%, on account of expected fiscal belt-tightening measures to rein in budget deficit, generally tight monetary conditions and also enhanced downside risk. As for the 2015, real GDP growth is projected to move back nicely along the potential output growth path of between 5.5 to 6.0% in 2015, driven by efficiency and innovation. This projection takes into account the likely positive impacts or reform dividends, arising from structural adjustments and bold reform measures that are currently being pursued by the Government, as part of the so-called "transformation or reform scenario". The achievements under this scenario require strong "political will" on the part of the Government, forcefully braving troubled waters to tackle tough "politico-economic" issues, such as income inequality and regional disparities, and more importantly, stamping out entrenched rent seeking activities, corruption and dismantling powerful special interest groups, among other things. The country needs to invest, not only in physical infrastructure, but more importantly in political capital, focussing on national unity as well as social capital, that includes racial tolerancy and inter-faith harmony which have eroded in recent years.
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