MALAYSIAN ECONOMIC OUTLOOK
This year started with a glimmer hope of global economic recovery after the lacklustre performance of last year. Economies are gathering the broken pieces and trying to put their house in order preparing a trajectory for better recovery this year. All economies in the world are watching each other's moves with full of hope, as the degrees of dependency among the world economies are higher than ever. All in all, this year is expected to be a better year with all the numbers are pointing to a stronger footing recovery. The momentum is expected to continue until next year.
The collapse in oil prices in mid-2014 has shaped the performances of world economy for last year. The supply glut is blamed to be the cause, and subsequent development of a slowdown of many economies further reinforced lacklustre performances of the world economy. The causes of an oil oversupply are still lingering without any clear counter measures taken by bigger producers, particularly from OPEC. Among the causes of production glut are coming from American shale production, Iranian production after the sanction lift-off and the middle-east black market particularly from Iraq and Libya. To exacerbate the problem, some oil producing countries are pumping more volume to compensate for the drop in prices.
Following the historical trend, oil price is negatively correlated with the value of US dollar (USD). Among others, the correlation is due to the fact that oil trading is denominated in USD and US is the biggest world net oil importer. The trend continues, USD appreciated against all world currencies. Meanwhile, the surge in US domestic demand amid its robust economic growth further increase the upward pressure on USD. Robust US economic growth leads to the expectation for a tight monetary policy to come. Therefore, the Federal Reserve (Fed)'s interest rate normalization is in the backdrop of world economies. On the other hand, weak economic growth of Japan and euro area triggered their central banks to favour an easy monetary policy. This monetary policy divergence among major economies influenced world capital flows in favour of the US.
At the same time, the performances of emerging economies, particularly China, are weak. China's economy is heavily driven by external demand, and currently under pressure for rebalancing it by improving its domestic demand. China's National People's Congress, which concluded on March 16 targeting lower growth of 6.5 percent this year as stated by Prime Minister Li Keqiang as 'a relatively painless cure that avoids hard choices between spurring growth and restructuring'.
Such global economic development coupled with pockets of noneconomic geopolitical factors influencing global trade and capital flows. For Malaysia, external demand was weak last year and is expected to continue to be weak this year. China's slower growth is not forthcoming to the Malaysia's external front to add to the already lacklustre euro zone performances and the US Federal Reserves' slowing down policy. Malaysia's net exports declined by 3.7% last year. Inevitably, domestic demand was the engine of growth for 2015. Nevertheless, last year's domestic demand was moderated, grew by 5.1% as compared to 5.9% a year before. Hence real GDP growth was moderated to 5.0% in 2015 as compared to 6.0% in 2014.
The moderation in domestic demand, however, kept the inflation rate in 2015 below the long-run average of 3.0%, despite high inflationary expectation due to ringgit depreciation. Net capital outflows coupled with slower demand for Malaysian exports, as the world economy weakened, pushed down the value of ringgit. Ringgit has remained depreciated since September 2014 until now, by as high as about 20% at one point. Although ringgit is showing a sign of recovery, it is not expected to get to the pre-crisis rate soon or at least to the psychological threshold of RM3.80 per USD, the rate that was pegged on the September 2, 1998 during the Asian financial crisis in 1997/98. Private consumption weakened as liquidity in the economy declined from RM269.9 billion at the end of 2014 to RM205.1 billion at the end of last year, household debts rising and inflationary expectation was high.
Moving forward, domestic demand is expected to continue to be the engine of growth for the Malaysian economy for this year amid still somewhat sluggish global economy. Weak commodity prices remains as a stumbling block for the growth of developing economies, which in turn, slows down the developed economies, hence the IMF has revised its global growth projection for 2016 downward by 0.2 percentage point from earlier projection. Nevertheless, the growth of 3.2% is still marginally above last year's growth of 3.1%. The growth momentum will be picking up and IMF global growth projection for 2017 is higher at 3.5%. According to IMF's World Economic Outlook, April 2016 world trade volumes grew by 2.8% last year and is expected to grow stronger at 3.1% this year and 3.8% in 2017. Consequently, Malaysia's net exports is expected to improve by growing at 1.2% this year (2015: -3.7%).
Although still driving the economy, the domestic demand is expected to moderate further this year. The surge in private and public investment is much needed to offset the dwindling both private and public consumption. Domestic demand is expected to grow by 4.5% slower than last year with the growth of 5.1%, underpinned by private investment growth of 5.6% and private consumption growth of 5.2%. Private consumption is expected to grow moderately as compared to last year growth of 6.0%. The growth in private investment, however, is still below last year's rate of 6.4%. The public sector's investment is expected to pick up the shortcoming by growing at 1.4%, a turnaround from a negative growth of 1.0% last year.
Malaysia's real GDP is expected to grow moderately at 4.2% this year. Growth will be driven largely by private sector expenditures, particularly on investment in the environment of tighter liquidity condition. BNM is expected to manage the liquidity favouring businesses. Public sector expenditure is projected to be influenced by continuing fiscal consolidation process as the depressed oil prices is expected to persist.
As for 2017, real GDP growth is expected to edge up moderately, registering a growth of between 4.5 - 5.5%. Domestic demand continues to be the engine of growth by growing at 5.0%. However, the export demand is expected to improve further growing at 3.0% a year. Current account balance is expected to deteriorate this year estimated to be 1.8% of GNI, but it will rebound in 2017 as export demand improve further.
MALAYSIAN ECONOMIC OUTLOOK
While Malaysia is naturally protected from snowstorms, tornados and hurricanes, having to deal with only regular rains, floods and sometime landslides, the country grappled with severe headwinds on economic front last year, following unanticipated global commodity and currency shocks, financial market turbulence and sudden reversal of capital flows. Most importantly, the country avoided oily slopes and dark corners, associated with domestic political upheavals and shocks, affecting both sides of political divide; entrenched social grievances; heightened racial tensions; and elevated religious and faith insecurities. Meanwhile, the long-awaited lift-off in the United States (US) Federal Funds Rate (FFR) that finally occurred on 16 December 2015 and the inclusion of China"s currency, the Renminbi or Yuan into the IMF basket of SDR reserve currencies on 30 November 2015, have to a certain extent reduced the intensity of uncertainty, prevailing in global financial markets last year. These widely-anticipated episodes have been considered as healthy developments for the world economy, which was reinforced further by the global consensus on climate change, culminating in the adoption of United Nations Global Agenda 2030 for Sustainable Development (UNGA 2030). Of greater significance for Malaysia, FitchRatings has affirmed Malaysia's Long-Term foreign currency Issuer Default Rating (IDR) at "A-" and local currency IDR at "A", while interestingly the outlook on the Long-Term IDRs has been revised to "stable outlook" from "negative". Meanwhile, as reported by the Bloomberg, Moody's Investors Service affirmed Malaysia's A3 sovereign rating, but cut the outlook on the sovereign rating to "stable" from "positive", citing Malaysia's weakening external position. The migration of rating outlook to the middle ground by the two sisters of international rating agencies indicates that the outlook for Malaysian economy remains favourable. On the domestic front, major issues surrounding 1MDB operations have been successfully resolved and the company reported on 12 January 2016 that it was finally "out of the critical phase".
These favourable developments augur well for the Malaysian economy, although tough challenges are expected to arise along the way this year. On the real economy, real GDP growth for 2015 is estimated to register close to 5%, a respectable growth considering weak and uneven global economic recovery, while headline inflation remained benign, averaging 2.1% for 2015 as a whole (2014: 3.2%), which is only 0.1 percentage point above the price stability inflation target of many central banks in advanced economies. Meanwhile, fiscal deficit of the Federal Government financial position improved considerably, estimated to register 3.2% of GDP in 2015, which is a significant achievement compared to the ratio of 6.5% of GDP recorded in 2009, when the country was hit hard by the global economic and financial crisis. The implementation of goods and services tax (GST), effective on 1 April 2015 and removal of fuel subsidy system were certainly the right policy actions by the Government, despite years of delay and decades of deep-rooted subsidy mentality. The implementation of consumption-based GST is certainly a blessing in disguise for the country, providing strong fiscal safeguard and acting as a built-in stabilizer for the economy. Successful implementation could also be viewed as reform dividends for the rakyat, which could possibly be in deep economic troubles, especially with plummeting crude oil prices, as seen in many oil exporting countries. In fact, the share of oil-related revenue in the total revenue of the Federal Government has been reduced significantly by more than half, from about 40% in 2009 to an estimated 18% last year.
The rosy picture, as described above is not all beautiful or picture perfect, in fact both blemishes and dark spots can be found. For example, labour market conditions, while remained generally favourable in the first eleven months of 2015, are showing signs of weakening, especially with rising number of retrenchments, stagnating job vacancies and higher labour force participation rate (LFPR), although overall unemployment rate remained well below the 4% threshold of full employment (November 2015: 3.2%, October 2015: 3.1%). More worryingly, youth and graduate unemployment is becoming a source of social concern, triggered by increasing participation rate of the young and educated workforce, in an environment where there is increasing fragility and sluggishness in business and economic prospects. On the external front, there are certainly many warning signals or red flags, reflected by continuing net portfolio investment outflows, narrowing of net current account surplus of the balance of payments (NCAB), significant depreciation of the ringgit exchange rate, and declining net international reserves. In this connection, Malaysia must act fast, taking appropriate actions to protect the currently vibrant economy and ensure the well-being of the rakyat. We certainly need to be vigilant, pro-active and forward-looking, especially on external economic and financial developments. Economic pressures are building up and tough challenges are looming on the horizon, as seen in the falling crude oil prices as well as global stock markets sell-off, which started from the first trading day of the year and lasted until recent weeks. Competitive devaluation of currencies are rearing their ugly heads again, pointing to diminishing international policy coordination. Therefore, maintaining financial stability and improving investors' confidence need to be the key priority of the Government.
Investors and rakyat as a whole are watching very closely new moves and policy actions by the Government, as things are getting worse by the day, since the beginning of this year. Moreover, official growth forecasts, released during presentation of the 2016 Budget in Parliament on 23 October 2015 indicated that the overall growth of the Malaysian economy is expected to moderate to between 4% and 5% this year (2015est: 4.9%). This growth forecast stands below the potential output growth of the Malaysian economy, estimated at about 5.5% per annum, pointing to lower investment efficiency and to a certain degree deterioration in the country's third factor growth, namely total factor productivity (TFP). This important component refers to the power of new ideas, entrepreneurship, creativity and innovativeness in tackling new challenges, apart from adding raw labour and technology-embodied capital. Most importantly, rakyat should not be asked to fend for themselves. They need strong and supportive guiding hands. Surprisingly, official forecast indicates that ringgit exchange rate is expected to remain stable at the average level of RM4.20 per US dollar this year (2015: RM3.91; 2014: RM3.27; 2013: RM3.15 per US dollar), pointing to continued undervaluation or misalignment of the ringgit exchange rate in terms of its fair value or "fundamental equilibrium exchange rate". This forecast unfortunately points to higher "risk premium" in the country, somewhat pessimistic, as if moving along with conditional forecasts by vested-interest groups, like FX market strategists and speculators.
Realities in the FX market, however, indicate that exchange rate movements are driven by a combination of dynamic forces, encompassing not just short-term speculative activities, changes in market sentiments, unverified news, perceptions and unanticipated events, but also possibly rookie actions and misplaced interventions by the authorities, together with long-established distortions and imperfections in market microstructures. These speculative and technical factors amplify the short-term movements, reinforced further by current as well as expected future directions of the economy, as recently seen in China. As such, policy makers need to be pro-active and forward looking, avoiding being influenced too much by FX asymmetric and idiosyncratic behaviour and its non-linear tendencies. Greater efforts are needed in improving and nurturing economic agents' sentiments, investors' confidence and reversing their negative perceptions about the good management of the macro economy and political situation in the country. These actions include removing the distortions and imperfections in the medium and long-term term and strengthening further domestic macroeconomic fundamentals in the immediate and near-term, by implementing appropriate fine-tuning actions and macroeconomic stabilization measures without any further delays.
The easy way out is just leaning with the wind or letting things sort out over time, as the external sector is slowly but surely picking up in the medium and long-term, as the bottoms would certainly be reached, especially for crude oil prices. Meanwhile, major uncertainties in the global economy are also being gradually removed, although policy coordination seems to be diminishing at the global level. These included the recent lift-off in the US interest rates, an adoption of market-based approach in China's financial and capital markets, the strengthening of Yen and Euro currencies as against the US dollar in recent weeks and continuing easy monetary policy in the Euro Area, Japan and other advanced economies. As such, the US dollar would not be on the upside for a long period, without inviting serious economic repercussions on the US economy. Moreover, looking from a long-term perspective, US dollar on trade-weighted basis has been on the declining path, except in recent years.
In trying to understand these developments, Olympic games offer a better guidance with its strict rules, level playing fields and most importantly, its unifying force and strong coordination among competing nations. Size and strength matter in international economic and politics, as displayed by the two economic giants, namely the US and China, the world's first and second largest economies. Unlike in sports, these two countries are certainly competing in the global economic and political arena, taking calculated risks and adopting "intelligent strategy". They are building up their military power and flexing their muscles militarily, as seen recently in the South China sea and above DMZ in the Korean Peninsular. Meanwhile, China is learning by doing, emphasizing on gradualism by allowing for a smooth transition in its structural adjustment and reform programs and building up slowly but surely its soft-international infrastructures. China is certainly avoiding knee-jerk reactions, shock therapy and other cookie-cutter policies as used to be implemented in the past under an orthodox economic policies. In fact, China is learning fast, dismantling the circuit breakers and mending its rookie actions, as seen recently in its stock market interventions. Interestingly, as part of the IMF governance reforms and new funding programs, China's voting right in the IMF will rise from 3.8% to 6%, reflecting its increasing influence and rising power. China has also embarked on Asia Infrastructure and Investment Bank (AIIB), a new multilateral development bank in Asia, which will be under its domain. TPPA and RCEP are another two examples of non-cooperative games, using game theory terminology, pointing to strong competition between the two economic rivals with totally different political regimes, initial economic conditions and operating standards. China is embarking on regionalization, and barring any military conflicts, the sheer size and its strength, combined with "intelligent strategy" plus "strong technocratic leadership", neutrality and non-interference, China will most likely emerge stronger and powerful, reasserting its past glory. Nuclear deal and lifting of sanctions in Iran will also see that low oil prices will not last that long, since oil prices are always used as a strategic and bargaining tools and prone to sharp spikes. Supply disruptions and strategic decision by OPEC will certainly affect oil production and global oil supply conditions, in an environment where oil demand is slowly but surely picking up, moving forward.
In this respect, Malaysia as a trade-oriented and financially-integrated economy, but lacking in both economic size and strength, needs to observe and play the economic and political game well, so as not to be trampled by these two competing and non-cooperating giants. Follow-the-leader, leaning with the wind, placing more weight on business interests, relying less on indigenous capability and gambling on the welfare of the society as a whole are certainly not the first-best-option or "optimal approach", especially for the country that aspires to be a developed nation by the year 2020. The Malaysian economy has to be operationally independent, and we need to have a strong policy safeguards, protecting our institutional sovereignty and its people, national interests and accepted social values and norms. In this respect, we need to be strong, independent, resilient and agile, while adjusting pro-actively and flexibly to the so-called "new normal" in new international economic landscape, where competition is intense and policy coordination is clearly diminishing. We have to be creative and innovative, employing "smart strategy" and with "intelligent communication", in dealing with these new realities. We need to not only adjust to the new environment, but also think creatively about solutions, rather than taking an easy way out, adjusting passively to adverse circumstances and acting as if "business as usual". More importantly, we should not burden future generations with new "economic imperialism" and allow for the so-called "economic genocide", imposed by the rich and powerful nations with mercantilist tendencies. Apart from enhancing economic efficiency, we need to ensure that adequate attention is given to distributional aspects, environmental concerns and social issues. More importantly, we need to take into account both market and non-market values, as opposed to only values from market transactions, derived using economic impact analysis, such as dynamic computable general equilibrium model (Dynamic CGE). Actual cost-benefit analysis (CBA) captures all non-market benefits, social as well as environmental costs. Furthermore, we need to take into account welfare changes of all beneficiaries, encompassing society as a whole, identifying the gainers and losers and more importantly, future generations.
Meanwhile, as suggested in the previous reports, we need to continue examining in-depth all binding constraints to economic and social development, existing distortions and imperfections in market microstructures, most notably in the labour market and FX market with its non-internationalization of ringgit, rigid administrative rules and thin liquidity. Political spats and racial rhetoric unfortunately add to the worsening economic and business conditions, as stabilization measures and new policy actions require strong ownership and support by all stakeholders, irrespective of political affiliations, racial and religious associations. There are certainly social costs and in fact welfare losses to the society as a whole, associated with delays in structural adjustments, lack of openness and transparency, gap in policy credibility, weak institutions, poor governance and, worst still low ethical and moral standards. In this respect, there must be a strong guiding hand, good signalling mechanism and certainly credible policies for market participants to react adequately in this trying times, while extensive consultations with relevant stakeholders will ultimately help to avoid uncertainty and negative perceptions of stakeholders, consumers, investors and rakyat alike. More importantly, we need to ensure continued happiness and good life for the rakyat by encouraging greater kindness and showing strong compassion and mercy to others, especially those with different ethnic backgrounds and religious beliefs. We need to avoid playing with people's insecurities by encouraging greater openness, tolerance, social justice and fairness in the country.
Short-term Issues and Stabilization Measures
Real GDP growth moderated to 5.1% in the first three quarters of 2015, declining by one percentage point from 6.1% in the corresponding period of 2014. Meanwhile, net current account of the balance of payments (NCAB) also moderated, registering a smaller surplus of about RM22.6 billion in the first three quarters of 2015 (January-September 2014: RM41.7 billion), pointing to a reduction by almost 50% compared to the amount in the corresponding period of 2014. The marked improvement in trade balance position, as seen in recent quarter could be traced back to significant depreciation of the ringgit exchange rate, supported by continued strong expansion in the US economy and also recovery in both the Euro Area and Japan. Despite these transitory improvements, the slowdown in China's economic growth, which is now Malaysia's largest trade partner and also falling prices of commodity exports, especially for crude oil, are expected to weigh heavily on the position of NCAB in the coming quarters. As such, the possibility of "twin-deficit", as predicted earlier could possibly be extended well beyond 2016, leaving only fiscal deficit of the Federal Government, which is expected to deteriorate considerably (2015: 3.2% of GDP, 2016est: 3.1% of GDP), if appropriate actions are not being implemented.
Meanwhile, labour market conditions remained generally favourable with the unemployment rate stabilised at 3.2% of the total labour force during the period from July to November 2015, reflecting full employment situation in the country (threshold at 4%). In addition, headline inflation, which registered the peak at 3.3% in July 2015, decelerated markedly to 2.7% in December 2015, on account of continued decline in transport charges, brought about by downward adjustments in fuel end-user prices and also partly helped by lower non-food prices. Headline inflation for 2015 as a whole, remained low at 2.1%, markedly lower compared to 3.2% in 2014. Apart from weather conditions that affected supply of food items, demand conditions remained generally stable, as measured by contribution of core inflation (excludes food, transport and energy prices), which averaged about 1.7 percentage points last year. Cost push from significant ringgit depreciation and demand-pull by low energy prices could possibly see that inflation is on the uptrend this year. Tough fiscal actions could also push consumer prices to higher levels.
Looking ahead, Malaysia remains susceptible to both anticipated as well as unanticipated external developments, especially in the asset markets. These include continuing net outflows in portfolio investment, especially from debt securities and equities, declining prices of commodity exports and rising volatility and uncertainty in global financial markets. Terms-of-trade (TOT) continued to register losses in the last four quarters, exacerbated by declining commodity export prices and, most worryingly continued depreciation in the ringgit exchange rates. Moreover, import price index has been showing an uptrend in the last five years, pointing to the fact that ringgit has been depreciating for a long time, but took a turn for the worse in recent months. In fact, bilateral ringgit exchange rate with the US dollar has been depreciating all the way in the last six years with rising volatility and finally breaking to register sharply lower value since September 2014 until very recently. Sadly for Malaysians, the ringgit has been allowed to cross the psychological threshold of RM3.80 per USD on 6 July 2015, and touched its lowest external value in the last 17 years at RM4.4725 per USD on 29 September 2015 and hovering at about RM4.37 per US dollar in recent weeks. Meanwhile, domestic interest rates, external borrowing costs and external debt services are all trending up, despite unchanged OPR at 3.25% in the recent MPC meeting on 21 January 2016. Further hike in the Fed funds rate in the United States (US) is expected to exert pressure on domestic policy rate, as the US dollar is expected to continue its strengthening pace in the coming months. While there is still divergence in monetary policy stance between the US with the rest of the world (ROW), particularly with the ECB and Bank of Japan, among others, Bank of England is expected to raise its policy rate sooner than later, with its strong economic recovery and the transmission of monetary policy contagion is already being felt in Latin American countries, South Africa and other countries that have strong financial linkages with the US economy, of which Malaysia is included.
The year 2016 will certainly be a very challenging year for the Malaysian economy, as downside risks on the external front have increased, while global growth forecasts have been revised downwards by both the IMF and World Bank. Oil-exporting and commodity-dependent economies, encompassing both developing as well as developed countries, will be adversely affected not just by plunging commodity export prices, but also by rising borrowing costs and debt servicing charges, associated with higher interest rates and strengthening of the US dollar in the global financial markets. Moreover, economic activity in advanced economies is expected to pick up only modestly this year, according to the latest statement by the IMF, with the exception of currently robust growth in the US and sterling performance of the UK economy and India as well. The latter is an emerging tiger in Developing Asia, which is expected to register tigerish growth of 7.5% this year (2015: 7.3%), overtaking growth in China.
Macroeconomic and Financial Policies
Bank Negara Malaysia (BNM) again decided to maintain the Overnight Policy Rate (OPR) at 3.25% in its latest Monetary Policy Committee (MPC) statement, released on 21 January 2016. This was actually the tenth time the OPR remained unchanged since BNM raised the OPR more than one and half year ago on 10 July 2014. The MPC decision was undeniably behind the curve and certainly not forward looking and proactive as practiced in the past. The US Federal Reserve Bank (Fed) decisively raised the new target range for the Fed Funds Rate (FFR) at 0.25% to 0.5%, a quarter percent up from zero to 0.25%, which was the first hike in nearly a decade since 2006. The Fed's unanimous decision taken on 16 December 2015 was based on solid deliberations during the FOMC's two-day meeting, putting greater emphasis on gradual adjustment in the stance of monetary policy this year. The FFR will be adjusted on a stepwise basis, reaching the upper ceiling of the target range at 1.5% by the end of 2016. While the recent Fed hike in FFR was widely anticipated and already priced-in by financial markets, the adjustments in the coming meetings will still pose uncertainty, as part of monetary policy rituals follow-the-leader by other central banks, although with a time lag.
While domestic interest rates remained generally low, growth in broad monetary aggregates weakened considerably, especially in recent months. The tight liquidity situation could potentially push interest rates to higher levels, especially with monetary policy contagion, coming from planned increases in the US FFR this year. There was a marked reduction in broad money supply, as the net foreign assets (NFA) continued its downwards trend, resulting in tight domestic liquidity situation in the country, although domestic credit (DC) remained generally favourable. While the tightening of liquidity condition was not reflected in the sharp upside movements of key interest rates, in view of stable interest rate environment both at home as well as abroad, ringgit exchange rate unfortunately took the brunt of adjustment, depreciating markedly against the currencies of most of Malaysia's major trading partners. Meanwhile, BNM ceased to be active in conducting foreign exchange interventions (FXI) to influence the level of exchange rate, as ringgit exchange rates have stabilised in recent months, after losing its value by whooping 20% against the US dollar in 2015. Strong FX interventions, especially during the months of August and September last year also saw that the net international reserves of BNM declined substantially to USD93.3 billion as at 30 September 2015, and stabilised at USD95.1 billion as at 15 January 2016.
Looking from a longer term perspective, net international reserves continued its downward trend, registering USD95.1 billion as at 15 January 2016, well below the so-called "psychological threshold" of USD100 billion (end-December 2014: USD116.0 billion; end-Dec 2013: USD134.9 billion). Fortunately, the ratio of international reserves to short-term external debt stood at 1.1 times, marginally above the standard international threshold of 1, as short-term debt also changes with financial market developments. While both direct and portfolio investment positions have improved in the third quarter of 2015, "other investments" continued to register substantial net outflows (deficit). The turnaround was on account of rising acquisition of foreign assets, classified under direct investment, especially debt instruments as well as equity and investment fund shares abroad, as part of international diversification by Malaysian firms and high net worth individuals. They were essentially protecting their assets from ravages of plunging ringgit, taking out their money and accumulating assets overseas in an unprecedented manner. This explained why Malaysia suddenly turned into a net creditor under IIP within just a short span of time, running essentially three months from July to September 2015. While foreign investors were ditching Malaysian equities and debt securities and reallocating their portfolio back towards dollar-denominated assets, Malaysian firms and high net worth individuals were also busy acquiring assets overseas, as if escaping from difficult and trying times as experienced earlier during global economic and financial crisis in 2008/2009. Strong exchange market pressure, as experienced in the third quarter of 2015 could possibly explain this phenomenon, turning into one-way flows as opposed to two-way flows, envisaged by the authorities.
Global Economic Developments and Prospects
The global economy started the year 2016 with global equity selloff, triggered by circuit breakers that tripped in the Shanghai and Shenzhen equity markets. While China's slowdown has been translated into dramatic movements in its equity prices and Yuan exchange rate movements, the strengthening of the US economy provides a new locomotive engine for the global economy, as reflected by modest recovery in the Euro Area and Japan. Despite that, monetary policy normalization in the US, which has been hailed as an important event in the history of monetary economics has its own repercussions on the global economy, although the lift-off in the FFR was essentially a healthy development. The expected higher interest rates in the US, though at a measured pace and gradual, and continuing strong US dollar could well see that borrowing and debt servicing costs for many highly-indebted nations will be on the rise, exerting significant pressure on both Government finances and corporate balance sheets. Monetary policy contagion is also a new source of concern and could possibly be unavoidable, as central banks in Latin America, such as Chile, Columbia and Peru as well as South Africa have already raised their policy rates. As such, the US Fed next move and the pace of its normalization is very critical, because higher interest rate and a stronger dollar in an environment of weak global demand hurts US firms and exporters, which in the final analysis hire less workers, pushing unemployment rate back to above 5%. For emerging market and developing economies, financial volatilities and economic vulnerabilities are expected to persist, more so if there are "surprises" that would contribute to tightening of global financial conditions, reversal of capital flows and continuing depreciation in their currencies.
With these two major episodes, involving two largest economies in the world, combined with global economic events, which are still unfolding, such as declining commodity prices, rising equity market volatility, increasing pressure for competitive devaluation and growing indebtedness in many nations, global growth outlook is expected to remain weak and uneven this year. Moreover, there is a high probability of an intensification of factors that dragged down the global economy, estimated at 3.1% last year (2014: 3.4%). Of greater significance, WTI crude oil prices, which have declined by about 70% since January 2014, touched the lowest in 13 years (December 2003) at USD28.32 per barrel on 20 January 2016. Ms Christine Lagarde of the IMF, in her recent statement on 8 January 2016 in Yaounde, Africa has indicated that the global growth, which was modest and uneven last year, will most likely remains fragile this year. She elaborated on this by mentioning three significant transitions in the global economy, firstly the increased divergence in monetary policy in major advanced economies; secondly, the unfolding events in China; and lastly the turn in the commodity super cycle. While the first two transitions are somewhat anticipated, the latter is certainly relevant for emerging market and developing economies, especially commodity exporters, such as Malaysia.
The World Bank in its latest publication Global Economic Prospects, 2016, released on 30 December 2015, cuts global growth projections by 0.4 percentage point for 2016 and 0.2 percentage point for 2017 from its June 2015 projections to 3.6% and 3.8%, respectively. The World Bank mentioned about substantial downside risks, including sharper-than-expected slowdown in key emerging market and developing economies (EMEs), a rise in financial market volatility and a substantial decrease in capital flows. Currency pressures and borrowing costs are expected to rise, following monetary policy normalization in the US, while geopolitical tensions are also on the rise, especially with diplomatic disputes between Saudi Arabia and Iran and nuclear politics in the Korea Peninsular.
Despite the gloomy outlook for the world economy this year, recovery in advanced economies is holding well, albeit at a moderate pace, especially in the Euro Area and Japan, while economic activity is expected to remain robust in the US and UK as well. Meanwhile, emerging market economies (EMEs) and low-income developing countries are facing severe economic and financial difficulties, following China's growth slowdown and expectation of higher interest rates in the US. Declining commodity prices and strengthening of the US dollar have resulted in weakening growth in many EMEs, especially commodity exporters and resource-based economies. There are also el-Nino effects, combined with heightened geopolitical tensions, especially in the Middle East.
Looking ahead, medium-term prospects for the global economy remain on bumpy road, especially with continuing low productivity growth, particularly in EMEs, population aging in advanced economies, such as Japan and long-delayed structural adjustment and reform measures to address high public sector and household debts, low percentage share of private investment to GDP and low female labour force participation rate, among others. India is certainly an exception, benefitting a lot from low crude oil prices, while pursuing seriously its structural adjustment and reform programs. Growth in India surpassed China's growth last year, registering 7.3% (2014: 7.3%) and expected to register 7.5% this year.
The International Monetary Fund (IMF) in its latest World Economic Outlook Update (WEO Update, January 2016), released on 19 January 2016, revised downward the 2016 annual growth estimate for the world economy to 3.4% (2015: 3.1%), representing 0.2 percentage point lower than October 2015 WEO estimate of 3.6%. The IMF also revised downward the global growth forecast for 2017 to 3.6%, down by 0.2 percentage point, pointing to only modest recovery for the global economy in 2017. Meanwhile, growth in advanced economies is expected to be on the uptrend, growing slightly higher by 2.1% in 2016 (2015: 1.9%; 2014: 1.8%; 2013: 1.1%), but slightly lower when compared to October 2015 WEO forecast of 2.2%. Growth rate in 2017 is projected to remain unchanged at 2.1%, reflecting a downward revision of 0.1 percentage point. Similarly, growth in emerging market and developing economies as a group is projected to improve modestly to 4.3% this year (2015: 4.0%; 2014: 4.6%; 2013: 5%), which is also 0.2 percentage point less than earlier forecast at 4.5%. While growth is expected to be on the uptrend, registering 4.7% in 2017, it is a downward revision by 0.2 percentage point from the previous forecast, indicating moderate pace of expansion, especially in countries currently in economic distress, notably Brazil and Russia.
While the US economy continued to register robust growth, moving away confidently from the worst recession experienced in recent years, the pace of expansion in the Euro Area remained weak, in fact showing sign of weakening in recent quarters. Moreover, risks to recovery seem to be on the rise, as inflation rate is stubbornly low. The IMF in its January 2016 WEO Update lowered the growth forecast for the Euro Area at 1.7% in 2016 (2015: 1.5%; 2014: 0.9%), representing 0.1 percentage point reduction from October 2015 WEO forecast, while forecast for 2017 has been maintained 1.7%, as before. Apart from severe short-term headwinds, especially with declining exports to China, Japan is undeniably facing a lot of economic challenges, especially long-term structural issues, such as shrinking labour force, low productivity growth and low potential output growth. Related to these developments, Japan's growth forecast for 2016 has been maintained by the IMF (WEO Update, January 2016), projecting growth of 1.0% in 2016 (2015: 0.6%; 2014: 0%), which is the same as in October 2015 WEO. Growth is expected to be supported by fiscal stimulus, continuing lower oil prices, accommodative monetary policy and rising wages. Meanwhile growth forecast for 2017 has been similarly revised to 0.3%, marking a downward revision from previous forecast of 0.4%, on account of weaker external environment and moderating private consumption spending.
Meanwhile, China is transiting gradually to a new growth model, relying more this time around on human resources rather than raw inputs, like natural resources and capital. Growth of the China's economy is estimated to record nearly 7% last year, according to recent statement by Chinese Premier Li Keqiang. This growth estimate is somewhat close to 6.9% growth predicted for 2015 (2014: 7.3%, 2013: 7.7%) by the IMF. The IMF projected growth to slow down further to 6.3% this year, which was the same growth forecast as in October 2015 WEO as well as in WEO Update in July 2015. These growth forecasts seemed to be in tandem with an ongoing structural reform programs in China, moving steadily to a more market-based economic system. China's continued growth slowdown this year, the lowest since 1990 (3.8%), is unfortunately driving downward growth in other emerging market and developing economies, especially exporters of raw materials, such as oil, metals, minerals and other commodities. Brazil, Russia, Malaysia and even developed economies like Australia and Canada will be affected, although with a varying degrees.
India's economy has certainly outperformed other emerging market and developing economies last year, registering growth of well above 7%, which was 3.3 percentage points higher than the average for the group. Growth in India is estimated at 7.3% in 2015 by the IMF, the same growth rate as experienced in 2014. The IMF maintained India's growth forecasts for 2016 and 2017 at 7.5% in its latest January 2016 WEO Update. India has overtaken China's growth rate last year and certainly this year, especially with China's growth continued to slow down. Meanwhile, in Latin America and the Caribbean, Brazil another BRIC country, is expected to remain in recession this year (2015: -3.8%, 2016: -3.5%), sharing similar economic difficulties with Russia (2015: -3.7%, 2016: -1.0%), due largely to lower commodity export prices.
ASEAN-5 (Indonesia, Malaysia, Philippines, Thailand and Vietnam) is projected to grow at 4.8% in 2016 and 5.1% in 2017 (IMF WEO Update, January 2016), pointing to downward revisions of 0.1 percentage point and 0.2 percentage point, respectively as compared to forecasts in October 2015 WEO. Meanwhile, inflationary pressure is moderating across ASEAN-5, underpinned by falling commodity prices, especially crude oil, although currencies of these countries simultaneously depreciated against the US dollar, although at varying degrees. WTI crude oil plunged to the lowest in 13 years at USD28.32 per barrel on 20 January 2016 (26 January 2015:USD45.06). Looking back, on 20 January 2015 the Malaysian Government decided to restructure the 2015 Budget, unveiled in October 2014, cutting operating expenditure for 2015 by RM5.5 billion and setting slightly higher fiscal deficit target at 3.2% of GDP, as against earlier target of 3.0% in 2015. The same thing will be repeated on 28 January this week, whereby the 2016 Budget will be revised by the Government, involving recalibration of expenditure, spending cuts and studying of privatisation projects, according latest news reports.
There are warming signs that the world economic outlook is worsening especially in recent months. Crude oil prices, declined markedly by about 50% last year, averaging about USD50.92 per barrel (2014: USD95.25 per barrel). Most worryingly, crude oil prices remain on the downtrend, touching a 13 year low of USD28.32 per barrel on 20 January 2016. There are also heightened volatility and uncertainty in the global financial markets, especially with equity market interventions by the Chinese authorities early this year. Global risk aversion is undeniably on the rise, especially with worsening near-term global economic prospects. Geopolitical factors have certainly added to worsening economic conditions, especially with continued fighting in the Middle East, intensified airstrikes by Russia in Syria, continued fighting in Yemen and escalating tensions between Saudi Arabia and Iran, the two bedrocks of Sunnis and Shiites. Migrant refugee crisis in Europe and nuclear politics in North Korea could also be added as downside risks, together with military tensions between the US and China in the South China sea.
Medium-term risks include near stagnation in advanced economies and consequently below-target inflation rates, as seen in the US, Euro Area and Japan in recent months. Low potential output growth, faster-than-expected growth slowdown or "hard landing" in China will affect economic performance of resource-based economies and commodity exporters, including high-income nations and, most worryingly low-income developing economies in Africa as well as Developing Asia. Looking from longer-term perspective, low fixed capital formation and aging population are expected to lower potential output growth in advanced economies, such as Japan. The fourth industrial revolution in the years ahead could potentially result in declining labour force participation rate, especially among females in the advanced economies as well as in EMEs.
On the domestic front, near-term risks are expected to originate mostly from the external front, associated with China's growth slowdown and its financial market turbulence. The US Fed next move and uncertainty about rate increases would affect the volatility in the global financial markets, especially interest rate sensitive bond markets, as the expected slower monetary tightening cycle has been priced in by the markets. Meanwhile, domestic-oriented risks include rising cost of living; elevated foreign exchange market pressures; and continued portfolio investment outflows, associated with expected higher interest rates in key advanced economies, particularly in the US.
Apart from abrupt tightening of financing conditions on the monetary front, tough "belt-tightening" fiscal policy actions and knee-jerk reactions, associated with revised 2016 Budget, are expected to elevate downside risks, hitting hard on private consumption expenditure, which is already on a moderating pace. Meanwhile, weak performance of private investment, which is presently being tested with rising production costs, declining revenue, lower profitability (real return to capital) and less hirings, could possibly turn for worse, especially with higher-than-expected borrowing costs and uncertain investment-adjustment costs. Households, producers, exporters, importers and retailers are adjusting to higher import prices and rising debt service charges, following significant depreciation of the ringgit. As such, sharper-than-expected ringgit depreciation and sharply lower commodity export prices would elevate existing pressures and represent new round of threats and vicious cycles. As reported in the previous reports, rising household debt and Federal Government debt crossing the legal limit of 55% could pose serious downside risks and economic threats in the medium and long-term. Additionally, "off-budget" expenditures and "contingent liabilities" could exert pressure on fiscal sustainability and Malaysian sovereign credit ratings.
Long-Term Issues and Policy Directions
Looking ahead, Malaysia needs to adjust quickly to the new normal in the world economy, especially with monetary policy normalization from zero lower bound (ZLB) in the US. There is also growth realignment in China, the world's second largest economy. Window of opportunity is getting less over time, as the world economy is moving out of post-crisis easy monetary conditions, starting in early this year and moving towards a more sustainable economic growth and social development in the years ahead. The Paris Agreement on Climate Change added to the need for climate change initiatives in the country, focussing on sustainable production and consumption.
Medium and long-term structural adjustment and reform programs must continue to be the key priority of economic policy, supported by appropriate short-term stabilization measures and macro-prudential arrangements. Accommodative monetary policy is certainly not an option in the coming months, less so with massive fiscal stimulus package, as fiscal space is being constrained by lower oil revenue and rakyat is being squeezed hard by consumption-based Goods and Services Tax (GST). Tax incentives and financial support for private investment, which is on a moderating path, are urgently needed to boost business confidence and enhance potential output growth of the economy. While downward adjustment in public consumption is certainly required as part of an ongoing fiscal consolidation process, public investment in key infrastructure projects and human capital development remain necessary in order to remove infrastructure bottlenecks in the economy, such as traffic congestion and frequent supply cuts in basic utilities, but also to ensure ready pool of healthy and skilled workers in the medium and long-term.
On the supply side, new long-term measures need to be undertaken to further enhance total factor productivity (TFP) and improve nation's long-term competitiveness. These include removing structural impediments and binding constraints to sustainable growth, reducing further market imperfections and distortions that inhibit the growth process, especially in the product, services and labour markets. Energy market also needs to be improved with greater competition. While we certainly need to lower barriers to entry in the labour market by encouraging greater female labour force participation rate and by the elderly, greater efforts need to undertaken to lower the cost of doing business and facilitate entry of new entrepreneurs and young talents in product and services 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.
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