MALAYSIAN ECONOMIC OUTLOOK


Executive Summary




The Malaysian economy performed exceptionally well last year, despite adverse external shocks and traumatic floods that occurred in the fourth quarter of 2014. The par excellence performance seemed like "divine coincidence", especially with real GDP growing right on the target of 6% per annum, as envisaged earlier in the Economic Transformation Program (ETP). Similarly, Federal overall fiscal deficit as a percentage of nominal GDP also hit the bull's eye, as if making a birdie, right at the 3.5% target, as committed earlier under the fiscal consolidation plan, thereby moving closer to reach the goal of a balanced-budget by the year 2020. Of greater significance, net current account of the balance of payments (NCAB) improved substantially last year, touching almost RM50 billion, boosted by a significant improvement in the external trade account. This helped to a large extent diminish earlier concerns, especially by foreign rating agencies, market analysts as well as non-resident investors about the likelihood of twin-deficit problem, which will undoubtedly take a while longer to materialise, although NCAB is undisputedly trending downward. While overall unemployment remained below 3% of the total labour force, indicating a full employment phenomenon, consumer headline inflation accelerated fast last year, touching 3.2% (2013: 2.1%), which was above the long-run average of 2.5%, on account of mostly policy-driven domestic cost-push factors.


Related to these developments, the BNM Monetary Policy Committee (MPC) decision to hike the overnight policy rate (OPR) to 3.25% on 10 July 2014 seemed appropriate, largely pre-emptive and clearly forward looking, as realized output gap was positive and inflation expectations were seen as gathering momentum, especially in the first half of 2014. Fortunately, domestic cost-push factors took a turn for the better, following a sharper-than-expected decline in crude oil and other commodity export prices, while low inflation environment on the international front helped to mitigate building up of domestic inflationary pressures. Meanwhile, worries about full pass-through effects from ringgit depreciation also dissipated, as firms mostly absorbed higher imported costs, focussing their efforts more on raising productivity, while traders searched for alternative sources of materials, therefore avoiding excessive mark-up in consumer prices. In fact, firms and traders were dictated more by competitive market forces or simply market realities rather than pursuing unethical trading and business practices or profiteering, as claimed in the media. This augurs well for the Malaysian economy, providing a solid window of opportunity in ensuring smooth implementation of the Goods and Services Tax (GST) in the coming months, and more importantly ensuring wider acceptance and public ownership of this important fiscal reform program. Persistently low energy prices is a "blessing in disguise", providing a rare opportunity for the Government to implement major taxation reforms, such as GST, which will ultimately help to uplift growth trajectory through more efficient allocation of nation's scarce resources. Long term benefits will far outweigh the short-term costs or initial pains, and the gainers will ultimately be the rakyat in the medium and long-term. However, there must be a binding commitment, whereby this major taxation reform program, coupled with removal of fuel subsidy is also being complemented with strong fiscal discipline and more importantly, good governance. Additionally, there must be greater transparency, better and more predictable policies and sustained reform process, which altogether help in removing aggregate uncertainty and in the final analysis improving policy credibility and reputation.



Looking ahead this year (2015), the underlying domestic macroeconomic fundamentals and initial conditions for continued transformation and structural reform programs remain intact and solid. Most importantly, macroeconomic stabilization and financial policies are well in-place to fine-tune the effects of transitory shocks and minimize short-term fluctuations in the economy. Confidence and belief function of the citizenry or rakyat about good management of macro economy also remained intact, especially among domestic households, firms, traders and other economic agents as well as society as a whole. We do not see major economic disruptions, social unrests and worst still chaos, as seen in other countries at the same stage of economic development. Nevertheless, the reversal in portfolio investment flows, as seen in the last quarter of 2014 and in the early months of this year, needs to be intelligently managed, especially those that involve non-residents. While they are mostly rational and forward looking, it is a known fact that they also having herd mentality, scanning around the globe and searching for better returns on their portfolio investment. They have gradually and partially retreated from emerging market economies (EMEs), Malaysia included, by reallocating their portfolio to dollar-denominated assets, especially in the US. They are in fact riding on new optimism, taking advantage of roaring boom of the US economy and betting on the hike in the US interest rates. Moreover, global economic prospects remain uncertain, especially in the euro area and Japan, while downside risks are on the upside, especially with heightened geopolitical concerns in Yemen, eastern Ukraine and continued fighting in the Middle-East, pushing portfolio investors to look for a safe haven and becoming more risk-averse.

As a trade-oriented and financially integrated economy, operating in an interconnected and globalized world, Malaysia continues to be susceptible to external headwinds, such as fluctuations in the prices of commodities, reversals in portfolio flows and sharp volatility in financial assets prices. Real GDP growth is expected to moderate slightly this year, depending on the magnitude of fluctuations in crude oil prices and also movements of the ringgit exchange rate against currencies of Malaysia major trading partners. Commodity terms of trade (CTOT) shock, ringgit depreciation and anticipated higher interest rates in the US are expected to adversely affect Malaysia's presently strong underlying domestic macroeconomic fundamentals, especially in the short-term. Looking at longer-term macroeconomic perspective, downside risks remain manageable, and in fact there are more opportunities, especially with persistently low energy prices, which is quite a rare phenomenon, moving forward. Lower oil prices for a prolonged period, if it persists will undoubtedly provide expansionary effects in the medium-term, in the forms of lower energy and production costs, boosting not only growth in net oil-importing countries, but also encouraging consumer spending worldwide. Strong recovery in the US economy will provide another positive externality or "shot in the arm", boosting the growth of the Malaysian economy.

On the domestic front, ringgit depreciation will undisputedly help in improving nation's export competitiveness, encouraging wider import substitution activities and most importantly facilitating greater number of tourist arrivals into the country. Merchandise trade balance is expected to improve, albeit with a time lag and foreign direct investment (FDI) is expected to accelerate further, taking advantage of lower costs of doing business and other attractive investment features and tax incentives in the country. However, these so-called opportunities or expected growth dividends need to be strategically communicated and complemented with enhanced good governance, greater transparency as well as strong public accountability in other public policy angles. Markets remain the best allocators of nation's scarce resources, providing unbiased judgements about good management of the macro economy. Misguided government interventions result in market imperfections and distortions, while weak and uncoordinated policy actions, especially in strategic and important areas create uncertainty and affect policy credibility and reputation. There are social costs and in fact welfare losses to the society, associated with lack of openness and transparency, gap in policy credibility, weak institutions, poor governance and low ethical and moral values. These are "soft" attributes, affecting public and investor perceptions and, therefore, need to be managed intelligently and further strengthened. There must be good signalling for market participants to react adequately, while "gradual approach" and extensive consultations will surely help to avoid uncertainty and negative perceptions of stakeholders and rakyat as a whole.

Real GDP was exceptionally strong in 2014, growing by 6% (2013: 4.7%), supported by continuing robust domestic demand, especially private consumption. Expenditure on this component remained strong, growing by 7.1% (2013: 7.2%), underpinned by favourable labour market conditions, Federal income transfers and also continued habit consumption. Meanwhile, public consumption moderated, registering growth of 4.4% (2013: 6.3%), while public investment contracted by about 5.0% (2013: 2.2%). Private investment also moderated last year, but remained at double digit growth at 11.0% (2013: 13.1%). Additionally, external demand which has been registering negative growth rates for seven years in a row rebounded by 19.7% in 2014 (2013: -12.6%), pushing real GDP on the expenditure side to register exceptionally strong growth last year. Exports in real terms grew markedly higher by 5.1% (2013: 0.6%), while imports maintained its steady expansion pace, registering 3.9% in 2014 (2013: 2.0%).

Another widely monitored key indicators, namely net current account of the balance of payments (NCAB) recorded significant improvement last year, registering substantial surplus of RM49.5 billion (2013: RM39.9 billion), supported mainly by improvement in the merchandise balance account, albeit continuing deficits in the services as well as in the primary and secondary accounts. While capital account registered a small surplus of RM281 million last year, financial account deteriorated further, recording substantial deficit, totalling RM76.5 billion (2013: -RM15.8 billion), on account of largely outflows of portfolio investment (2014: -RM37.9 billion, 2013: -RM3.0 billion). As a consequence, together with continuing deficit in "net errors and omissions", overall balance of payments registered a deficit to the tune of RM36.5 billion last year (2013: +RM14.6 billion, 2012: +RM3.9 billion). This was reflected to a large extent in the net BNM international reserves level, which has declined to RM405.3 billion at end-December 2014 (end-December 2013: RM441.9 billion). Large and persistent outflow of portfolio investment is a cause of concern, especially with an expectation of rising interest rates in the US, the world's biggest economy, causing ringgit to depreciate further.

While NCAB of BOP will remain in surplus, albeit with a smaller amount this year, on the back of J-Curve effects on trade balance and also improving services deficit, notably on the travel component, falling crude oil and other commodity export prices are expected to lower total export value, while continued RM depreciation will result in higher import bills. As such, together with continuing outflows in financial account, overall BOP is expected to weaken further this year, adding more pressure on the ringgit exchange rate. NCAB is expected to continue moderating in 2016, but will remain in surplus, thereby avoiding the twin-deficit problem, as predicted by some analysts in the past as well as in recent years.

Inflationary pressures were generally strong last year, resulting in higher headline inflation, which stood at 3.2% (2013: 2.1%). Inflation rate averaged 3.4% in the first eight months of 2014, driven mainly by domestic cost-push factors. Fortunately, headline inflation moderated in September 2014 (2.6%), but edged up marginally to 2.7% in December 2014, after registering high rate of 3.0% in November 2014 (October: 2.8%), on account of pass-through effect of a cut in fuel subsidy on 2 October 2014. Transport charges remained high at 4.0% in December 2014, barely moving from 5.0% registered in November 2014. However, with lower fuel prices, following a sharp fall in crude oil price and implementation of a managed float system, headline inflation decelerated markedly to 0.1% in February 2015 (January 2015: 1.0%), with transport index registering a double digit decline by 11.8% in February 2015. Meanwhile, food index with a share of 30.03% in the CPI increased moderately by 2.7% (January 2015: 2.8%). Moving forward, consumer headline inflation will be triggered by both domestic as well as external factors. The smooth implementation of GST, effective on 1 April 2015, together with mandated review of the minimum wage policy and rising demand for higher wages and benefits will provide sparks for a new round of inflation expectations. Fortunately, falling crude oil prices and lower energy costs will help to offset domestic cost-push factors, especially for transport charges, but that is dependent on degree of pass-through effects and price stickiness in the economy. Additionally, low inflation environment in key advanced economies and less than full pass-through effects from ringgit depreciation will also see that inflation remains under control (Inflation forecasts - 2015: 3.5%, 2016: 3.0%).

Monetary aggregates moderated in 2014. M1 has been trending down since early 2014, while M3 bottomed-out in August 2014 and started to edge upward steadily up to November and December 2014, and accelerated in February 2015, attributed to an improvement in both M1 and quasi money (M2). Growth in broad money (M3) or private sector liquidity was driven by continued availability of credit, extended to the private sector and higher net claims by the Government. The influence of net foreign assets remained contractionary in 2014 and also in the early months of 2015, and could possibly showing unfavourable position again this year. A tighter domestic liquidity condition is reflected in the upward trends of key interest rates. Average weighted interbank rates (3-month) increased significantly, touching 3.77% in February 2015 (2014: 3.51%, 2013: 3.16%), indicating generally higher interest rates this year. BNM again anchored the OPR at 3.25% in its latest MPC meeting on 5 March 2015, the fourth times since BNM raised the OPR on 10 July 2014. The decision provides extra "comfort zone" to economic agents, especially with the rising cost of living and building up of inflation expectations. With growth is expected to moderate this year and inflation not rearing its ugly head, monetary policy stance is expected to remain accommodative and continued to be supportive of domestic economic activity, at least until end-September 2015. Total net financing and loan growth, however, are expected to continue their moderating trends, following tightening of domestic liquidity conditions and also expectations of higher interest rates in the coming months.

The ringgit continued its depreciating trend in April 2015, which generally started in September 2014, as US dollar gained strength on the back of roaring boom for the US economy and expectation of US monetary policy normalization from practically zero benchmark interest rates. Depreciating ringgit exchange rates, especially against US dollar which is heavily used in the international trade and financial transactions will likely cause higher import bills and also add sparks to domestic cost-push factors, following GST implementation, upward adjustment in fuel prices and higher taxi fares. Portfolio outflows by non-residents are expected to continue, reducing further net international reserves of BNM, especially with expectations of continuing flat OPR in the coming months, weakening domestic macroeconomic fundamentals and heightened concerns on debts of Government-linked companies. Deterioration in commodity terms of trade (CTOT), declining share of Government expenditure to GDP, widening of real interest rate or yield differentials, and rising risk premium are key concerns of investors. The shares of total trade and total private gross flows to GDP are expected to weaken, but only moderately, especially with offsetting effects and dynamic interactions, associated with negative external shocks. As such, ringgit will remain under strong exchange market pressures by traders, arbitragers, hedgers and to large extent speculators, as crude oil prices remain on the downside. While we have successfully diversified our economy away from commodity-based exports, our nominal effective exchange rate (NEER) tracks closely crude oil prices, as oil-related revenue account for close to 30% of Federal Government revenue in recent years. Meanwhile, oil-related exports accounted for only 13.6% of total exports, and together with LNG (8.4%), the share remained low at 22% in 2014, while the share of manufactured exports remained significant at about 70% of total export earnings. The remainder are other commodity-based exports, such as palm oil and rubber, in which their export prices are also falling.

In the short-term, persistently low crude oil prices, financial market frictions, together with continuing price stickiness and wage rigidities in the product and labour markets will likely cause ringgit to continue its undershooting. These imperfections in market microstructures are being amplified further by unverified news, rumours as well as negative perceptions. There are also herd mentality and behaviour among portfolio investors, including local institutional investors, subscribing to one-way destabilizing flows, instead of two-way stabilizing flows in tranquil times. In terms of fair value or fundamental equilibrium exchange rate, the ringgit is clearly misaligned against strong underlying domestic macroeconomic fundamentals. The ringgit exchange value is being backed by significantly large outstanding amount of net international reserves of BNM, which remained above the "psychological" threshold of USD100 billion, although this key principal component has already been discounted and reflected in the spot price, as investors are largely rational and forward looking. The ringgit is presently being termed as undervalued, in view of extreme undershooting, but it is expected to revert back to its equilibrium fair value of about RM3.50 per US dollar, as exchange market pressures subside and the two-way flows return back to the FX markets. Portfolio flows have been very volatile, since the global economic and financial crisis in 2008, moving in and out of Malaysian equity and capital markets, dictated mainly by US monetary policy and its associated uncertainty, such as taper tantrum seen in May 2013 and currently the difficulty of the US Fed in moving out smoothly of zero interest rate policy environment.

While BNM earlier adopted passive reserve management strategy, allowing ringgit to adjust flexibly when US dollar was clearly strengthening on the other side, BNM is recently seen as intervening heavily to arrest further decline in the ringgit exchange rate, thereby ensuring the ringgit exchange rate remains above the "psychological" level of RM3.80 per US dollar. In the early months of 2015, BNM's "leaning with the wind" strategy saw greater flexibility of the ringgit, which depreciated well above RM3.50 per US dollar to the low of RM3.7225 on 15 April 2015, but appreciated significantly against other major currencies, especially the Euro and Japanese Yen, respectively. There is clearly now heightened "fear on depreciation", which could also see that external debt services, especially by private sector get bigger and bigger and imported inflation moves on the upside. Social costs and welfare losses could far outweigh the benefits of improving export competitiveness and greater number of tourist arrivals. While maintaining monetary policy independence under free flow of capital is considered important, allowing exchange rate to take the brunt of adjustment (greater exchange rate flexibility), fiscal affairs also need to be managed in a credible manner and prudently, as continued fiscal deficit, high Government debt and rising contingent liabilities are the topical concerns of portfolio investors, FX strategists and sovereign rating agencies. This is especially so with the expected decline in oil-related revenue (2015est: 29% of total Federal revenue), moderating private spending and elevated borrowings to finance public infrastructure projects. Moreover, about 40% of ringgit-denominated Malaysian Government securities (MGSs) are owed to non-residents, and borrowings by GLCs and private corporations are mostly in US currency.

Although bilateral ringgit and US dollar exchange rate moves in tandem with crude oil prices, based on high frequency real time data, this transitory relationship is expected to weaken in the medium term. Exchange rates move largely with news and expectations, whereby market participants are rational and forward looking, placing greater weight on unanticipated events. Moreover, net international reserves position remained substantial (44% of nominal GDP), providing solid buffer and "insurance cover", depending on reserve management strategy of BNM and also external developments. Speculators like to get their fair share of accumulated reserves, taking calculated risks and profiting from macroeconomic mismanagements, poor governance or simply pure mistakes. Net international reserves continued its downward trend, touching USD105.1 billion as at 31 March 2015 (end-December 2014: USD116.0 billion; end-Dec 2013: USD134.9 billion). Fortunately, the ratio of international reserves to short-term external debt remained at 1.1 times, marginally above the standard international threshold of 1.0, as short-term debt also changes with market developments. Most worryingly, Malaysia international investment position (IIP) continued to record deficit, totalling RM47.2 billion in 2013 (2012: RM17.8 billion), indicating that Malaysia was again a net debtor in 2012 and 2013, and this position is expected to continue in 2014. Persistent outflows in portfolio investment in recent years, especially for debt securities contributed to the existing situation.

On the international front, the global economy continued to expand, registering 3.4% last year, the same growth rate as recorded in 2013. Lower oil prices and strong recovery in the US economy, the world's largest economy, helped to support global economic recovery, although growth remained uneven, across advanced economies as well as regions. Despite sluggish first quarter performance, world growth is expected to rebound in the second quarter, as business sentiments improve, downside risks decrease and the US economy continues on its expansion path. The International Monetary Fund (IMF) in its latest World Economic Outlook (WEO), released on 14 April 2015, maintained the 2015 annual growth estimate for the world economy at 3.5%, while the global growth forecast for 2016 is revised upward by 0.1 percentage point to 3.8%. Growth in advanced economies is expected to be stronger this year, growing by 2.4% (2014: 1.8%), and this growth rate is projected to be maintained in 2016. Meanwhile, growth in emerging market and developing economies is projected to moderate slightly to 4.3% this year (2014: 4.6%), but to gain momentum with 4.7% growth in 2016.

Recovery in the US economy is clearly gaining momentum, supported by strong private consumption expenditure (PCE). There are also good signs emerging from the euro area, with growth prospects improving in recent months, especially with ECB's quantitative easing. Nonetheless, the euro area is still struggling to get out of the two inter-twined contours, namely low growth and low inflation, and high unemployment and high Government debt. On geopolitical side, there are still tensions between Russia and Ukraine, while Russia and the Commonwealth of Independent States (CIS) are facing economic difficulties, especially with lower oil prices and also declining confidence. Structural reforms are clearly needed in Japan, as Japan is growing at a very slow pace, constrained largely by high public debt, which stood at 230% of GDP. Abenomics has triggered bubble in asset prices, with the stock markets closed higher in March 2015 while the real economy remained weak, as growth last year was at -0.1% (2013: 1.6%). Weaker Yen and consumption tax hike in April 2014 are affecting consumer spending and their sentiment as well. Nonetheless, Japan's growth forecasts for 2015-2016 have been revised upward by the IMF (14 April 2015), projecting growth of 1.0% in 2015 and 1.2% in 2016, up by 0.4 percentage point compared to January 2015 WEO Update. Meanwhile, China is growing slowly, but more sustainably at 6.8% growth predicted this year (2014: 7.4%) and 6.3% in 2016, in line with enhanced structural reforms and efforts at rebalancing the economy. Growth in India is on the uptrend, representing a truly bright spot in developing Asia. India is benefitting a lot from a persistently low energy prices and its continued reform programs, while Brazil another BRIC country, is stagnating due to lower commodity-export prices. Countries in the Middle-East are in deep political and economic turmoil, especially in Syria, Iraq and more recently Yemen.

The strengthening of the US economy and expectations of rising interest rates, weak recovery in the euro area and Japan and slowdown in China saw that commodity prices suddenly fall, especially crude oil and US dollar getting stronger-than-expected. Latest data show that the US dollar strengthened by about 12% since September 2014. Crude oil prices declined by almost 50%, underpinned not only by excess supply and slowdown in demand, but also political economy considerations. Geopolitical risks have gained prominence, especially with continued fighting in the Middle East, sanctions against Russia and its retaliatory actions and also changes in the political landscape. The latter include political uncertainty and possibility that pendulum swing to the extreme left, throwing away tough austerity and reform measures in many "stressed economies" in the euro area. Greece is now having a close link with Russia, and recently paid its bailout loans to the IMF. Surprisingly, the old issue of Nazi occupation is also being raised with Germany, the world's fourth largest economy and a champion of European integration.

While global downside risks have decreased, global short-term risks are on the rise, especially with continued economic and financial imbalances. The IMF in its latest report outlined the short-term risks as follows: disruptive asset price shifts and financial market turmoil; a further sizeable strengthening of the US dollar; protracted low inflation or deflation; geopolitical risks and near-term growth risks in China. Fiscal imbalances in the euro area and in many emerging economies, misalignment of currencies and mismanagement of fiscal stimulus could also lead to increase in risks. Medium-term risks include low potential growth and secular stagnation in advanced economies and consequently lower potential growth in emerging market economies and hard landing in China. Looking from longer-term perspective, aging population is expected to lower labour input in advanced economies, especially in Japan.

On medium-term perspective for economic and social development in the country, the Eleventh Malaysia Plan (2016- 2020) is scheduled to be unveiled in the Parliament in May 2015. While Malaysia aspires to join the four Asian tigers, its country classification remains as one of the emerging market economies (EMEs) in Southeast Asia with an upper middle-income category. Malaysia is a small trade-oriented and financially integrated economy, not being able to influence commodity export prices, but largely a price-taker in the world export markets, and susceptible to the vagaries of global economic and financial developments. Nonetheless, we provide good example in terms of economic development experiences and also social engineering, whereby growth has been integrated with the goals of income distribution and growth is increasingly becoming inclusive and with greater quality. In fact, environmental protection is adopted as one of the key agendas of sustainable development in the New Economic Model, released in 2010. Malaysia is also in the top 10 countries in terms of quality growth, but its ranking has declined slightly in recent years (see IMF WP/14/172)

Moving forward to 2020, Malaysia's "catch-up" endeavour through economic transformation and reform programs requires not only greater sophistication and technical skills in managing macro economy, but more importantly, support and ownership by all stakeholders, encompassing society or rakyat as a whole. While advances in technology, skilled labour force, strong entrepreneurial talents and efficient labour, product and service markets are often mentioned as the key factors or conditions in enhancing total productivity, innovation and potential output of the economy; the "soft elements" that comprise good governance, strong institutions, high moral values, deep-rooted social capital and entrenched "collective action" of the citizenry are also mentioned as necessary prerequisites for the country's quest to be a high-income and developed nation status. Disneyland in Los Angeles, USA may be the happiest place on earth, while Bhutan has been recognized as the happiest country and Costa Rica is said to be the greenest country in the world. Adding on, the cleanest city is undisputedly Singapore, and the safest city is Melbourne in Australia. Meanwhile, Malaysia has promoted herself as "truly Asia", and for nearly three decades, aspires to be an advanced nation by the year 2020. Despite significant materialistic gains and physical infrastructure improvements, the people seem to be generally insecure, having third world mentality and recently with violent tendencies, focussing largely on petty issues and neglecting to a large extent mega trends and big picture that affect planet and people - the key pillars of sustainability, and more importantly social and distributional issues, especially equity, justice, civil liberty, fairness and compassion, among others. With the era of "Government knows best" is over, we have been obsessed with "Big Fast Results (BFR)" and "quick wins", implementing corporate-inspired strategies and observing faithfully to new classical tenets of free market and having generally liberal economic mindsets, where greed and fear override maximization of social welfare, among others. The pressing issues, such as strong institutions, good governance, suppressed wages, rising inequality, higher cost of living and rampant corruption are being addressed in an ad-hoc interventionist and haphazard manners. What the country urgently need is the "whole-of-Government" approach to economic and social development, focussing more on enhancing the wellbeing of the rakyat, as have been persistently pursued in a number of advanced economies, such as Australia, Canada, New Zealand and in many Nordic countries. We are hopeful that the upcoming Eleventh Malaysia Plan (11MP, 2016-2020), will address these pressing issues, removing barriers to rakyat quest for happiness, especially with declining standards of living and eroding quality of life, as seen recently.

The five year development plan, which is scheduled to be unveiled in May 2015, is reported to be focussing more on high-impact projects and programs, together with low cost as well as efficient and rapid implementation. Therefore, fast-track high-impact projects and Blue Ocean Strategy tools will feature prominently in terms of prioritizing the projects and programs. With outlook for global economic activity remains gloomy and strong headwinds are expected in the coming years, especially with anticipated higher interest rates environment, tighter domestic liquidity conditions, persistent falling in commodity export prices and lowering of potential output growth, both in developed as well as emerging market and developing economies, attaining real GDP growth target of 6% per annum in the next five years is achievable, but surely a tough challenge. Real GDP grew by only 4.74% per annum in the last eight years (2006 - 2013), while nominal per capita income in US dollars stood at USD10,426 in 2014, which is far below the current minimum threshold of USD12,746 under World Bank classification as a high income country.

Moreover, per capita incomes of the so-called "advanced economies" averaged well above USD35,000 in recent years. Preliminary estimate shows that the Malaysian economy needs to grow by at least 6.5% in the next six years (including 2015), in order to achieve per capita income of USD15,244 by 2020. This estimate requires that the Malaysian ringgit reverting back to an appreciating mode, strengthening to at least RM2.68 per US dollar in 2020, which is clearly a tough challenge (average 2014: RM3.54, 2013: RM3.28 per US dollar). In addition, net factor payments abroad needs to be reduced drastically and turnaround quickly to positive, while GDP deflator, a broad measure of domestic inflation to remain moderate at about 3.0% per annum, among others. Looking on the supply side, long-term structural reforms and adjustment programs need to be strengthened, focussing more on enhancing total factor productivity (TFP) and improving overall nation's competitiveness. These include removing structural impediments to sustainable growth, infrastructure bottlenecks, market imperfections and distortions that inhibit growth process, especially in the product, services and labour markets. Greater focus needs to be given on adoption of new technologies, research and development (R&D), innovation and greater power of new ideas, through upgrading of skills and reducing out-migration of talents.


Posted by suzy at 10:33 AM on April 22, 2015

MALAYSIAN ECONOMIC OUTLOOK


Executive Summary




Looking back, we were very fortunate that external shocks occurred mainly in the fourth quarter of 2014. Commodity export prices were falling, especially crude oil, while the ringgit exchange rate depreciated across- the-board against currencies of Malaysia's major trading partners, most notably against the US dollar, Chinese Yuan, Thai Baht and Singapore dollar as well. While short-term demand imbalances (weak demand and excess supply) in the world oil market explained to a large extent the plunging crude oil prices, portfolio re-allocation by foreign investors and acquisition of foreign portfolio assets by local institutional investors, taking advantage the strengthening of the US economy and expectations of higher real interest rates were seen as the major contributory factors to depreciating ringgit. As a matter of fact, foreign investors were reallocating their portfolio towards dollar-denominated assets, shifting out of commodity-based contracts, while local firms were adjusting to a higher interest rate environment. In the oil industry, oil firms are pumping more today, revising downward their outlays for investment, while traders are cutting down on their inventories, as carrying costs are expected to rise with anticipated higher interest rate environment. Apart from these sudden economic clouds, heavy rains and severe flooding also occurred in late December 2014, affecting many states in both Peninsular Malaysia and in Sabah as well. Fortunately, Malaysia has more or less escaped the El- Nino phenomenon, which was predicted to happen in 2014.


If not managed properly and in a timely manner, the external shocks and traumatic events like severe flooding could affect productivity and potentially lower the potential output of the economy. Moving forward, these events could also possibly affect the projected growth trajectory of the Malaysian economy. Fortunately, growth is estimated to be exceptionally strong at 5.9% in 2014 (2013: 4.7%), which is very much close to the required growth of 6.0% per annum for Malaysia to escape the prevailing "middle-income trap". Moreover, actual growth remained well above the "socially efficient level of output" growth, estimated at 5.5% per annum, and output gap remained positive, supported largely by robust aggregate domestic demand. Additionally, there was a strong contribution from external sector in 2014, although moderating aggregate domestic demand continued to be the key engine of economic growth. Of greater significance, overall unemployment rate remained below the threshold of 4%, suggesting full employment situation in the country, while consumer inflation rate increased moderately by 3.2% last year. As such, moving forward, initial economic conditions are strong, as domestic economic fundamentals remain generally good and most importantly, confident and belief function about good management of macro economy still intact, especially among domestic households and firms and other economic agents as well as society at large. Fickle-minded and short-term portfolio investors, who are almost always acting in concert and following herd behaviour seem to be retreating, reallocating their portfolio to dollar-denominated assets and also searching for safe haven, especially in presently uncertain global economic and political developments.

This year will be a very challenging year for the Malaysian economy. Real GDP growth is projected to moderate, depending on the magnitude of fluctuations in crude oil prices and also movements of the ringgit exchange rate against currencies of Malaysia major trading partners. Commodity terms of trade (CTOT) shock, ringgit depreciation and anticipated higher interest rates environment are expected to adversely affect Malaysia's domestic macroeconomic fundamentals, particularly in the short-term. Looking from macro perspective, there are clearly less risks, but in fact more opportunities, especially with lower energy prices, which is quite a rare phenomenon, moving forward. These shocks can be considered transitory and as always are expected to dissipate in the medium and long-term, as part of business cycle dynamics and also global economic and political developments. In contrast to spikes in oil prices in the previous episodes, there will undoubtedly be expansionary effects in the medium-term, in the forms of lower energy and production costs, boosting not only growth in oil-importing countries, but also encouraging consumer spending worldwide. On the domestic front, ringgit depreciation will definitely help in improving export competitiveness, encouraging wider import substitution activities and most importantly facilitating greater number of tourist arrivals into the country. Of significance, trade balance is expected to improve, albeit with a time lag and foreign direct investment (FDI) could possibly accelerate further, taking advantage of lower costs of doing business in the country. However, these so-called expected opportunities need to be complemented with good governance, greater transparency as well as enhanced public accountability. There are social costs and in fact welfare losses, associated with lack of openness and transparency, gap in policy credibility and weak reputation. These "soft" attributes need to be nurtured and strengthened, providing good signalling, forward guidance and better public communication strategies.

Real GDP grew 6.1% in the first three quarters of 2014, driven mainly by robust private consumption, which grew by 6.8% (January-September 2013: 7.1%), underpinned by favourable labour market conditions. Public consumption remained strong, registering growth of 5.3% (January-September 2013: 6.9%), while public investment contracted by 6.3% (January-September 2013: 4.1%). Meanwhile, private investment has moderated, growing by only 10.9% during January to September 2014 (January - September 2013: 12.2%). External demand rebounded by 32.2% during January to September 2014 (January-September 2013: -14.8%), pushing real GDP growth markedly higher.

Exports expanded by 6.4%, while imports grew slightly slower at 4.5% during the period. Consequently, balance of payments (BOP) current account surplus improved, registering RM43.4 billion (January-September 2013: RM25.1 billion), supported by substantial improvement in goods account, albeit continuing deficits in the services as well as in the primary and secondary accounts. Overall BOP registered a surplus of about RM25 billion in the first nine months of 2014 (January-September 2013: -RM17.32 billion), underpinned largely by a strong merchandise balance. Financial account has also improved in the recent quarter, but has been offset to a large extent by continued deficit in "net errors and omissions". Current account (CA) surplus of BOP is projected to remain in surplus, albeit at a smaller amount in 2015, on the back of J-Curve effects on trade balance and also improving services deficit. Falling commodity prices are expected to lower exports value, while RM depreciation is expected to increase import bills, but at the same time enhance export competitiveness in the medium-term and long-term. With generally improving financial account, overall BOP is expected to remain favourable this year. BOP CA surplus is projected to moderate further in 2016, escaping to a large extent the "twin-deficit" problem, as predicted by many analysts.



Inflationary pressures remained strong for the twelve months of 2014, averaging 3.2% (2013: 2.1%). Inflation rate moderated in September 2014 (2.6%), but edged up slightly to 2.7% in December 2014, after registering moderately high rate of 3.0% in November 2014 (October: 2.8%), on account of pass-through effect of a cut in fuel subsidy on 2 October 2014. Transport charges remained high at 4.0% in December 2014, barely move from 5% registered in November 2014. Moving forward, consumer headline inflation will be triggered by both domestic and external factors. The scheduled implementation of GST in April 2015, together with mandated review of the minimum wage policy and rising demand for higher wages and benefits will provide sparks for a new round of higher inflation expectations. Fortunately, falling crude oil prices and lower energy costs will help to offset domestic cost-push factors, especially for transport charges, but that depend on degree of pass-through effects and price stickiness. Additionally, low inflation environment in key advanced economies and less than full pass-through effects from ringgit depreciation will also see that inflation remains under control (Inflation 2015: 3.5%, 2016: 3.0%).

Monetary aggregates moderated in the first eleven months of 2014. M1 has been trending down since early 2014, while M3 bottomed-out in August 2014 and started to edge upward steadily, attributed to an uptrend in quasi money (M2). Growth in broad money (M3) were driven by continued credit, extended to the private sector and also higher net claims by the Government. The influence of net foreign assets remained contractionary during January to November 2014, and could possibly showing unfavourable position for the year as a whole. Tighter domestic liquidity conditions is reflected in the upward trends of key interest rates. Average interbank rates (3-month) increased significantly, reaching 3.86% (22 January 2015), indicating generally higher interest rates this year. BNM anchored the OPR at 3.25% in its latest MPC meeting on 6 November 2014, providing extra "comfort zone" to economic agents and adopting the so-called "gradual adjustment approach". With growth is expected to moderate and inflation remains under control, monetary policy will continue to be accommodative, at least until mid-2015. Nonetheless, net financing activity is expected to moderate, especially with tightening of domestic liquidity conditions and higher interest rates in the coming months.

The ringgit continued its depreciating trend in January 2015, which started in September 2014, as US dollar gained strength on the back of an improving US economy and expectation of US monetary policy normalization. Unfortunately, depreciating ringgit exchange rates, which are almost across-the-board will likely cause higher import bills and add sparks to domestic cost-push factors, especially with the oncoming GST implementation in April 2015. Portfolio outflows by non-residents are expected to continue, thereby reducing further foreign exchange reserves, especially with expectations of continuing flat OPR in coming months and weakening in domestic macroeconomic fundamentals. These include deterioration in commodity terms of trade (CTOT), declining share of Government expenditure to GDP, widening of real interest rate or yield differentials, and also rising risk premium. The shares of total trade and total private gross flows to GDP are expected to weaken, but only moderately, especially with offsetting effects and dynamic interactions, associated with negative external shocks. As such, ringgit will remain under strong exchange market pressures by traders, arbitragers, hedgers and to a large extent speculators, as crude oil prices continue to take a severe beating. While we have successfully diversified our economy away from commodity-based exports, our nominal effective exchange rate (NEER) tracks closely crude oil prices, as oil-related revenue account for close to 30% of Federal Government revenue in recent years. Oil and gas exports constitute only 13% of total exports, while the share of manufactured exports is significant at about two-third of total exports.

In the short-term, continuing low crude oil prices, financial frictions, price stickiness and wage rigidities in the product and labour markets will cause ringgit to continue its undershooting. These are amplified by unverified news and rumours, herd behaviour and short-term fickle-minded portfolio investors. In terms of fair value or fundamental equilibrium exchange rate, the ringgit is presently being supported by strong domestic macroeconomic fundamentals, although good news have already been discounted and reflected in the spot price. The ringgit is now seemed to be below its fair value or undervalued, due to extreme undershooting, and it is expected to revert back to its equilibrium fair value of about RM3.50 per US dollar, as selling pressures subside. Portfolio flows have been very volatile, since the global economic and financial crisis in 2008, moving in and out of Malaysian equity and capital markets, dictated mainly by US monetary policy and its associated uncertainty, such as taper tantrum seen in May last year.

BNM's "leaning with the wind", constrained by trilemma, as explained in the international finance textbooks, saw that ringgit depreciated well above RM3.50 per US dollar, moving in tandem with regional and other emerging market currencies. Passive reserve management strategy could well see the ringgit continue to slide, as there is clearly "less fear on depreciation", since the situation is expected to help improve export competitiveness. While maintaining monetary policy independence under free flow of capital is considered important and letting exchange rate taking the brunt of adjustment (greater exchange rate flexibility), fiscal affairs need to be managed in a credible manner and prudently, as continued fiscal deficit, high Government debt and rising contingent liabilities are the topical concerns of portfolio investors, FX strategists and sovereign rating agencies. This is especially so with the expected sharp decline in oil-related revenue (2014est: 29% of total Federal revenue), moderating private spending and elevated borrowings to finance public infrastructure projects. About 40% of ringgit-denominated Malaysian Government securities (MGSs) are owed to non-residents, and borrowings by GLCs and private corporations are mostly in US currency. Although bilateral ringgit and US dollar exchange rate moves in tandem with crude oil prices, based on high frequency real time data, these transitory relationship is expected to weaken in the medium term. Exchange rates move with news and expectations, whereby market participants are mostly rational and forward looking, placing greater weight on unanticipated events. Moreover, external reserves position remained substantial (44% of nominal GDP), providing solid buffer and "insurance cover", depending on reserve management strategy of BNM and external developments. Speculators like to get their fair share of accumulated reserves, taking calculated risks and profiting from macroeconomic mismanagements, poor governance or pure mistakes. Net international reserves continued its downward trend, touching USD111.2 billion as at 15 January 2015 (end-December 2014: USD116.0 billion; end-Dec 2013: USD134.9 billion). Fortunately, the ratio of international reserves to short-term external debt remained at 1.1 times, marginally above the standard international threshold of 1.0 time, as short-term debt also changes with economic developments. Most worryingly, Malaysia international investment position continued to record deficit of RM47.2 billion in 2013 (2012: RM17.8 billion), indicating that Malaysia was again a net debtor in 2012 and 2013, and this position is expected to remain in 2014. Continued outflows in portfolio investment, particularly debt securities contributed to the existing situation.

On the international front, the World Bank in its latest publication on Global Economic Prospects (GEP) report, released on 13 January 2015 mentions that the global economy is still struggling, with economic activities in many large developing economies are less dynamic than in the past years. This assessment is in line with the International Monetary Fund (IMF) in its latest update of the World Economic Outlook (WEO Update), released on 20 January 2015. While the IMF maintained the 2014 annual growth estimate for the world economy at 3.3%, the global growth projections for 2015 and 2016 are revised downward to 3.5% and 3.7%, respectively. The reductions by 0.3 percentage point for 2015-2016 forecasts reflect a reassessment of prospects in China, Russia, the euro area, Japan and also weaker activities in oil-exporting countries. Recent economic developments, particularly lower oil prices and shifts in sentiments and enhanced volatility in global financial markets are the risks facing the global economy and opportunities as well. The IMF maintained the 2014 growth rate estimate for the advanced economies at 1.8%, but revised the 2015 growth projection up slightly by 0.1 percentage point to 2.4%, while maintaining the prediction for 2016 at 2.4%. Among the advanced economies, economic activities in the United States and the United Kingdom are expected to gain momentum this year, supported by improving labour market conditions, while their monetary policies remain generally accommodative.

Recovery in the US economy is clearly gaining momentum, supported by strong domestic economic fundamentals. However, the euro area is still grappling with low growth, low inflation, high unemployment and high Government debt. The recovery has been sputtering in the euro area, according to the World Bank's latest GEP (13 January 2015). The report mentions that there is a possibility of prolonged stagnation in the euro area, especially with growing tensions between Russia and Ukraine and the ensuing economic sanctions. Japan is also growing at a very slow pace, almost similar to the euro area, constrained largely by high public debt, which stood at 230% of GDP. Japan's growth forecasts for 2015-2016 have also been revised downward by the IMF (20 January 2015), projecting growth of 0.6% in 2015 and 0.8% in 2016. Meanwhile, China is struggling hard with the slowdown, especially with cooling property market and Russia is battling hard with an economic crisis, as the rubble took a severe beating. Expectations of rising interest rates in the US saw that commodity prices suddenly fall, especially crude oil and US dollar getting much stronger-than-expected. Crude oil prices declined by almost 50%, underpinned not only by excess supply and slowdown in demand, but also political economy considerations. Geopolitical risks have gained prominence, especially with continued fighting in the Middle East, sanctions against Russia and its retaliatory actions and also changes in the political landscape. The latter include political uncertainty and possibility that pendulum swing to the extreme left, throwing away tough austerity and reform measures in many "stressed economies" in the euro area.

Most worryingly, short-term risks are on the rise, following continued economic and financial imbalances. These include sharper-than expected financial market correction, arising from bubbles in asset markets, a spike in household debt and a faster-than-expected US monetary policy normalization. Fiscal imbalances in the euro area and in many emerging economies, misalignment of currencies and mismanagement of fiscal stimulus could also lead to increase in risks. Medium-term risks include low potential growth in advanced economies and consequently lower potential growth in emerging market and developing economies. Looking from longer-term perspective, aging population is expected to lower labour input in advanced economies, especially in Japan, while the possibility of "hard landing" in China remains on the horizon, despite its largely engineered slowdown.

Looking at medium-term economic and social development, the Eleventh Malaysia Plan (2016- 2020) is scheduled to be unveiled in the Parliament in May 2015. While Malaysia aspires to join the four Asian tigers, its country classification remains as one of the emerging market economies (EMEs) in Southeast Asia with an upper middle-income status. Malaysia is a small trade-oriented and financially integrated economy, not being able to influence commodity export prices, but largely a price-taker in the world export markets, and very much susceptible to the vagaries of global economic and financial developments. Nonetheless, we provide good example in terms of economic development experiences and also social engineering, where growth has been integrated with the goals of income distribution and growth is now increasingly becoming inclusive, while environmental protection is adopted as one of the key agendas of sustainable development in the New Economic Model, released in 2010.

Looking forward to 2020, Malaysia "catch-up" endeavour through economic transformation programs requires not only greater sophistication and technical skills in managing macro economy, but more importantly, support and ownership by all stakeholders, encompassing society or rakyat as a whole. While advances in technology, skilled labour force and strong entrepreneurial talents are often mentioned as the key factors in raising productivity and potential output of the economy; good governance, strong institutions, high moral values, deep-rooted social capital and wider "collective action" of the citizenry are also mentioned as prerequisites for the country's quest to be a high-income and developed nation status by the year 2020.

These so-called "soft attributes", especially strong "social capital and collective action" have been fully tested in recent months, following negative external shocks that came down like a perfect storm, almost simultaneously through a plunge in commodity prices and a sharp depreciation in ringgit exchange rate. Consequently, foreign reserves fell by almost USD23.7 billion to settle at USD111.2 as at 15 January 2015 (end-December 2013: USD134.9 billion). On top of that, there were heavy rains and severe flooding that occurred in many states in Peninsular Malaysia as well as in Sabah, affecting thousands of households and causing a lot of damages to crops, houses and infrastructure facilities. The estimated total costs of damages exceeded RM2 billion. There are clearly lessons to be learned here, especially from key advanced economies that we spare to emulate, like Japan and the US, which have managed successfully their worst natural disasters by focussing more on advanced warning systems, pre-emptive measures, strong enforcement of rules and regulations, especially for design of buildings and public infrastructure facilities. The hallmarks are their strong environmental protection and disaster or emergency management authorities. In addition, social capital and collective action have almost always played their parts, very much stronger than what we have seen recently in Malaysia.

These efforts seemed parallel to the macroeconomic management of the economy, whereby the relevant economic central agencies are trying hard to insulate the economy from adverse external shocks by adopting anticipatory and forward looking approach, implementing pre-emptive measures and having in place good macro-prudential rules and regulations, enhancing monetary policy credibility and ensuring fiscal sustainability, among others. Economic shocks come in a variety of forms, such as productivity slowdown, terms of trade and interest rate shocks and mark-up in prices and wages. As such, we need to be vigilant and most importantly, must be able to withstand and adjust successfully to these negative shocks with all available toolkits, especially with good modelling and forecasting capabilities. Mental models and using other people forecasts that have their own vested interests are not adequate and may also be counter productive. We need to be hands on, pay attention to details and have more intensive consultations, so that welfare of the society continues to protected and avoid welfare losses. We also need full confidence and possibly having strong emotional intelligence (EI), together with solid social capital and collective action to face these external challenges. Most importantly, we must work together, stay calm and maintain our much-needed patience, as we are not in an economic crisis yet, just a temporary setbacks.

Posted by suzy at 11:38 AM on January 28, 2015






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