MALAYSIAN ECONOMIC OUTLOOK
Looking back at official publications for long-term economic and social development plans, national unity, peace and security are undisputedly the ultimate goals of Malaysia, while structural adjustment programs and stabilization measures are the policy actions, implemented through a variety of instruments to ensure that these long-term goals are ultimately achieved. Meanwhile, the welfare (social wellbeing) of the rakyat as a whole and racial ties are the guiding lights, achieved through a long period of political stability, enhanced harmony and a high degree of racial and religious tolerance, thereby allowing the country to successfully progressed since independence in 1957. Of greater significance, Malaysia has been able to successfully weathered adverse external economic shocks, particularly the Asian financial crisis in 1997/1998 and most recently, the global economic and financial crisis in 2008/2009. Another key milestone that will be achieved, is that Malaysia has not much problem in graduating to a high income economy, according to the latest study by the Asian Development Bank (ADB, ADF2015). Economic development is a continuing process and therefore, income metric alone is not deemed a significant achievement, especially for resource-rich countries, like Malaysia. Most importantly, Malaysia has met her obligations under millennium development goals (MDGs, 2015) and recently adopted the United Nations Agenda for sustainable development (Agenda 2030), while working hard on climate change initiatives. Despite these stellar performances, intergenerational equity, income distribution, social protection and access to education and skills remain key challenges for the Malaysian economy, according to latest country profile on key performance indicators (KPI), compiled by the World Economic Forum. These challenges are important for enhancing national unity, peace, security and most important of all, political stability.
While we have certainly built world class physical infrastructure, well-endowed with well-trained labour force, enjoying strong social capital and living in undeniably a vibrant and blessed country, we need to ensure the high standards of the so-called an advanced economy that we aspire to be by the year 2020 are also embraced and consistently nurtured. These include good governance, strong institutions, civil liberty, social justice, racial harmony and tolerance, equality among citizens, fair and just society, among others. These are norms, values and standards that need to be sustained for a long period of time as a prequalification for the graduation process. Attaining high income is a necessary condition, but its achievement certainly needs to be complemented with good moral and ethical values, better quality of life and higher living standards for the rakyat. Unfortunately, political tensions seem to be on the rise, affecting not only sentiment and confidence of economic agents, particularly consumers, producers, investors and markets as a whole, but also undermining the existing strong social fabric of the society, which we have carefully nurtured in the last 58 years. This unfortunate phenomenon surfaced only very recently, triggered by advances in information and communication technology (internet and social media), unfair review by foreign analysts with vested interests and also undeniably poor governance, weak institutions, lack of public transparency and accountability, among others. These emerging concerns certainly need to be addressed fast and should not be allowed to gain ground under any circumstances. Economic booms and busts; investment bankers and corporate executives gone wild and corporate failures are normal occurrences in matured democracy and deep-rooted capitalist system, especially in advanced economies, as seen recently in "distressed economies" in the euro area and the US sub-prime crisis. These things are unfortunately happening in Malaysia, providing a negative backdrop to economic distress and financial difficulties, triggered not only by greed, fear and panic, but also adverse developments on the external front. These include growth slowdown and market re-alignment in China, and a widely anticipated monetary policy normalization in the United States (US).
These two widely expected events actually represent a healthy development, providing opportunities for achieving the goal of sustainable development for the world economy. As such, we need to quickly adjust to these "new normal", by implementing vigorously structural adjustment and reform programs and correcting whatever mistakes or misadventures on the domestic front. Prudent macroeconomic management should be the key priority, especially in attaining fiscal sustainability and encouraging greater role for private sector investment. We need to minimize maximum loss to the society, taking into account current constraints by implementing "new policy actions", especially through appropriate stabilization measures. Apart from ongoing commodity and currency declines, we are nowhere near the previous crisis in 1997/98, as our FBMKLCI remained well above 1,700, with real GDP growth estimated at about 5%, inflation below 2.5% this year and unemployment rate below the full employment threshold of 4%. Malaysia is certainly not a "failed state" as labelled by critics, and far from a situation where people are risking their lives, seeking asylum in foreign countries; having worthless currency; inflation hitting the roof; bank closures and empty shelves in the supermarkets, as previously seen in authoritarian regimes and countries in conflict.
Nonetheless, the second half of 2015 is expected to be very challenging for the Malaysian economy, having to face not only continued plunge in the prices of commodity exports and foreign exchange (FX) market turbulence, but also bracing for tough political turmoil and unfortunately rising racial and religious tensions. Domestic political turmoil certainly affect consumer sentiment and investor confidence at home as well as abroad. Therefore, protecting Malaysia's good reputation overseas and ensuring policy credibility and predictability at home are urgently needed tasks, while preserving national unity is undisputedly "the mother of all necessity" in Malaysia. We are hopeful that there will be no political earthquakes or draconian measures imposed on the rakyat and society as a whole, which are currently suffering a lot from economic distress and financial difficulties as well as political fatigue. There is also unhealthy haze, resulting in real life suffering, for rich and poor as well as young and old.
Meanwhile, commodity-currency shocks are presently affecting resource-based emerging market economies (EMEs), like Brazil, Malaysia and Mexico as well as advanced economies, such as Australia, Canada, New Zealand and Norway. Adding to these shocks, there are "dark corners", associated with monetary policy normalization in the US, which remain an ongoing and never-ending challenge for many central banks around the globe, despite only a tiny increase expected later this year. The slowdown in China, Yuan devaluation and its financial market turmoil could potentially trigger the worst-case-scenario for the global economy, in terms of "hard-landing" in China. The US Fed has certainly agreed on this long-delayed risk, based on its latest FOMC decision, delaying the hike in its rock-bottom policy interest rates towards the end of this year. On the domestic front, there are unfortunately "dark clouds" hovering over Malaysia's economic landscape, together with unhealthy haze blowing from neighbouring country, Indonesia. These so-called "dark clouds" include increasing net outflows of portfolio investment, downward overshooting of the ringgit exchange rates, rising cost of living, elevated Federal Government and household debts, rising probability of default and increasing likelihood of downgrading of ratings for Malaysian Government debt. Most worryingly, domestic macroeconomic fundamentals are showing signs of weakening, as seen in moderating aggregate domestic demand, in particular gross fixed capital formation (most notably private investment), continued contraction in net exports of goods and services, plummeting net foreign reserves of BNM, increasing outflows of portfolio investment by foreign investors, elevating foreign currency exposures of GLCs and corporations, rising number of non-performing loans, more job cuts and retrenchments, and financial sector weaknesses, among others. As such, near-term outlook looks gloomy, especially with crude oil and other commodity prices are expected to be "low for long", following especially weaker demand from China and steady increase in supply, most notably for crude oil. Oil price decline is now not a transitory phenomenon anymore, becoming almost permanent, declining consistently for more than a year and by over 50%. Familiar economic jargons seen in literature like structural change, breakpoints and regime switching are becoming realities.
Related to these developments, there is clearly a need for "new policy framework", focussing on short-term stabilization measures by putting greater efforts at renewing Government's commitment, restoring market sentiment and confidence, enhancing policy credibility and protecting Malaysia's good reputation both at home and overseas. Most importantly, there is a need to arrest sovereign bond rating transition from investment grade to speculative or "junk bonds" status, as exaggerated by credit default swap (CDS) investors in August 2015. Well-established international rating agencies seemed to be lagging behind, becoming loosely disciplined and taking extra time in incorporating latest financial market information and expectations. We need to be mindful that foreign investors are not just looking at current macroeconomic conditions or existing macroeconomic fundamentals, which are generally okay, but financial market conditions and more importantly, future direction of the economy together with domestic political factors. These involve to a large extent "forward looking" and long-term expectations, scenario planning, stress testing and other exotic risk management toolkits. Algorithmic modelling and big data analysis are being used to identify key predictors on default probability, encompassing economic variables, social indicators, political thermometers, trends as well as wavelets in the social media, among others. These are broken into several category of risk factors, namely insolvency, illiquidity, macroeconomic, political as well as systemic risk factors. The latter include financial market contagion, regional as well as global.
While specific measures have already been announced by the Government, based on the recommendations by the Special Economic Committee (SEC) on 14 September 2015, and more are expected in the Budget 2016 tomorrow, greater efforts need to be geared because warning signals and red flags are there, pointing to the fact that unfavourable economic conditions are on the way. Conditions will certainly get worse, if appropriate stabilization measures or policy actions are not being implemented in the near-term. Meanwhile, we need to continue examining in-depth all binding constraints to economic and social development, existing distortions and imperfections in market microstructures, the breakpoint and structural change, correlations among macroeconomic variables, fat tail risks and copulas, among others. Political spats and racial rhetoric unfortunately add to the worsening conditions, as stabilization measures and 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, associated with delays in economic 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 strong guiding hand, good signalling mechanism and certainly credible policies for market participants to react adequately, 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 to others, especially in this difficult times.
Short-term Issues and Stabilization Measures
Real GDP registered a moderate growth of 4.9% in the second quarter of 2015 (1Q2015: 5.6%), performing better-than-expected in an environment of fragile global recovery and renewed uncertainty, associated with enhanced financial market volatility and continued decline in commodity prices. Consequently, economic growth moderated in the first half of 2015, registering about one percentage point lower at 5.3%, as against 6.4% registered in the corresponding period last year. Meanwhile, net current account of the balance of payments (NCAB) also moderated, but still remained in surplus, registering about RM17.6 billion in the first half of 2015 (2H2014: RM12.8 billion, 1H2014: RM34.5 billion), declining by almost 50% compared to the amount in the corresponding period last year. With anticipated slowdown in China's growth and continued decline in prices of commodity exports, especially crude oil and also palm oil, expectations about the likelihood of "twin-deficit" problem have again resurfaced in recent months, pointing to weakening domestic macroeconomic fundamentals.
While overall unemployment edged upward slightly to 3.2% of the total labour force in July this year, indicating full employment situation (threshold at 4%), consumer price inflation moderated slightly in August 2015, registering 3.1% year-on-year compared to 3.3% in the previous month (June: 2.5%, May 2015: 2.1%, April 2015: 1.8% and March 2015: 0.7%), on account of mostly policy-driven domestic cost-push factors. These included the cumulative direct and indirect effects of GST implementation, adjustments in fuel end-user prices in August 2015 and also partly by higher import prices, following almost across-the-board declines in bilateral ringgit exchange rates, especially against Malaysia's major trading partners. Fortunately, pricing behaviour of firms and strong market competition, especially in the distribution and marketing channels, helped to minimize sharp increases in domestic consumer prices. Moreover, traders or retailers are not allowed to increase their net profit margin for any goods or services for 18 months from January 2015 to June 2016, as required under the Price Control and Anti-Profiteering Act 2011.
Moving forward, Malaysia continues to be susceptible to both unanticipated and anticipated external shocks. These include sharp reversal in portfolio investment flows, declining prices of commodities and heightening volatility in financial assets prices. Terms-of-trade (TOT) of the country has been trending down in the last four quarters, exacerbated by declining commodity prices and, most worryingly continued depreciation in ringgit exchange rates, which seemed to be unabated. Import price index has been showing an uptrend in the last five years, pointing to the fact that ringgit depreciation is not just a recent phenomenon. In fact, bilateral ringgit exchange rate with the USD has been depreciating all the way in the last five years with rising volatility and finally breaking to sharply lower value since September 2014 until recently. Sadly for Malaysia, 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. Meanwhile, domestic interest rates are expected to increase, especially with a widely anticipated hike in interest rates in the United States (US) later this year. Looking at the medium-term macroeconomic perspective, downside risks have generally increased, while growth prospects have weakened, especially in commodity-dependent emerging market economies. Activity in advanced economies is expected to pick up only modestly this year, according to the latest statement by the IMF. Nevertheless, strong recovery in the US economy will hopefully help to sustain export earnings of goods and services as well as foreign exchange earnings from tourism activities and receipts from educational services, as Malaysia becoming centre of educational excellence in the region.
Macroeconomic and Financial Policies
Bank Negara Malaysia (BNM) decided to maintain the Overnight Policy Rate (OPR) at 3.25% in its latest Monetary Policy Committee (MPC) statement, released on 11 September 2015. This was actually the seventh time the OPR remain unchanged since BNM raised the OPR more than a year ago on 10 July 2014. The MPC decision was also on the same path with the US Federal Reserve Bank (Fed) recent decision to delay the increase in the Fed Funds Rate (FFR) from its almost zero percent since December 2008. The Fed decision on 19 September 2015 was reportedly data-driven, although external parameters also entered into their monetary policy reaction function, especially growth slowdown in China, Yuan devaluation and China's financial market turmoil. Meanwhile, the Fed Funds Rate is expected to be raised later this year and most likely to be delayed to early 2016, as requested earlier by both the IMF as well as World Bank.
While domestic interest rates remained low, growth in monetary aggregates have weakened considerably, especially in recent months. This emerging situation could potentially push interest rates to higher levels, especially with contagion effects, expected to come from a widely anticipated hike in the US interest rates later this year. BNM has been active in conducting foreign exchange interventions (FXI) to influence the level of exchange rate, which came under strong exchange market pressures, especially during August and September 2015. The unsterilized interventions have resulted in a marked reduction in broad money supply, as the external value of ringgit continues to take a severe beating. This indicates that FXIs in recent months were not effective and intervention is certainly not a valid toolkit in the present environment. "Leaning against the wind", especially in abnormal and difficult times resulted in net foreign reserves losses, almost like fighting a losing battle. While the tightening of liquidity condition was not reflected in the upside movements of key interest rates, following stable interest rate environment both at home as well as abroad, ringgit exchange rate continued to take the brunt of adjustment, depreciating markedly against the currencies of most of Malaysia's major trading partners.
Net international reserves continued its downward trend, registering USD93.3 billion as at 30 September 2015, well below the "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 1.2 times, marginally above the standard international threshold of 1.0, as short-term debt also changes with financial market developments. However, Malaysia international investment position (IIP) continued to record deficit, totalling RM13.1 billion as at end of 2014 (end-2013: -RM47.2 billion, end-2012: -RM17.8 billion), indicating that Malaysia is a net debtor on international front, running for three years in a row. This unfavourable stock position is expected to continue this year, despite significant surplus of RM33.9 billion registered as at end-June 2015, helped by a smaller deficit in equity and investment fund shares under portfolio investment as well as increasing surplus or net inflows in debt instruments within direct investment in Malaysia. While both direct and portfolio investment positions have improved in the second quarter of 2015, "other investments" continued to record substantial net outflows (deficit). Net outflows of portfolio investment for equity and debt instruments are estimated to persist in the third quarter of 2015 and also in the coming quarters. Consequently, we could well see that Malaysia again register a net debtor position under IIP for the year as whole in 2015. Moreover, debt securities markets continued to be under strong selling pressures in recent months, as foreign investors are ditching Malaysian debt securities and reallocating their fixed-income portfolio back towards dollar-denominated assets on expectations of hikes in interest rates in the US later this year and strengthening of the US economy.
Global Economic Developments and Prospects
The global economy is currently being shaped by two widely anticipated, but opposing events, which are creating a lot of economic uncertainty and sharp volatility in the global financial markets. Firstly is the expected growth slowdown in China, the world's second largest economy and also global manufacturing powerhouse. Then, there is also an increasing indebtedness in a large number of developed as well as emerging market and developing economies, of which Malaysia is included. Secondly is the strengthening of the US economy, boosted by strong consumer spending and also recovery in the housing market. As a result, monetary policy normalization is widely expected in the US later this year, described by many analysts as an important event the history of monetary economics. The projected higher interest rates in the US and stronger US dollar could 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. Terms of trade losses and currency declines have also resulted in narrowing of fiscal space for many commodity exporters, and here again Malaysia included. Window of opportunity for strategic reform initiatives and structural adjustments is certainly getting less and less, according to the President of the World Bank in Lima recently.
The International Monetary Fund (IMF) in its latest World Economic Outlook (WEO, October 2015), released on 6 October 2015, revised downward the 2015 annual growth estimate for the world economy to 3.1% (2014: 3.4%), representing 0.2 percentage points lower than July 2015 WEO Update estimate of 3.3%. The IMF also revised downward the global growth forecast for 2016 to 3.6%, down by 0.2 percentage points, pointing to only modest recovery for the global economy next year. Nonetheless, growth in advanced economies is expected to be on the uptrend this year, growing slightly higher by 2.0% (2014: 1.8%, 2013: 1.4%), but slightly lower when compared to July 2015 WEO Update forecast of 2.1%. Meanwhile, growth rate in 2016 is projected to be 2.2%, reflecting a downward revision of 0.2 percentage points. Growth in emerging market and developing economies as a group is projected to moderate slightly to 4.0% this year (2014: 4.6%, 2013: 5%), which is 0.2 percentage points less than earlier forecast at 4.2%. While growth is expected to be on the uptrend, registering 4.5% in 2016, it was a downward revision by 0.2 percentage points, indicating modest pace of expansion, especially in crisis-affected countries.
Growth in the US economy is gaining momentum, registering 3.9% year-on-year in the second quarter of 2015, well above 0.6% recorded in the first quarter of 2015. Inflation rate in the US remained below the Fed's 2.0% target, creeping up by only 0.2% year-on-year in August 2015, the same rate as in the previous month, supported to a large extent by continuing low energy prices as well low import prices, as the greenback has been strengthening since early this year. Interestingly, US unemployment rate is moving close to 5% rate, registering 5.1% in September 2015 (August 2015: 5.1%), indicating that labour market conditions are generally improving, but job creation is seen as moderating in recent months. While the twin goals of monetary policy, namely keeping inflation under control and promoting "maximum employment" remain on track, the Fed is clearly shifting its goal post, focussing more on the impact of strengthening US dollar, especially with Yuan devaluation and the projected growth slowdown in China and other emerging market economies.
The pace of expansion in the euro area is weakening and risks to recovery seem to be on the rise. Fears of deflation became a reality, as the euro area inflation rate slipped below zero at minus 0.1% in September 2015, the first negative rate in six months, attributed largely to lower energy prices. The IMF in its October 2015 WEO maintained the growth forecast for the euro area at 1.5% in 2015 (2014: 0.9%), while forecast for 2016 has been revised downward slightly by 0.1 percentage point to 1.6%. The euro area is still struggling with high unemployment and high Government debt and deflationary situation remains a threat, especially with lower energy prices. Abenomics is certainly not performing well in Japan, especially its third arrow, namely structural reforms. There is a high probability that Japan enters into a technical recession in the third quarter of this year, especially after real GDP growth contracted by 0.3% quarter-on-quarter in the second quarter of 2015. Growth has been constrained to a large extent by continuing high public debt, which stood at about 250% of GDP and aging population. Meanwhile, China is transiting gradually to a new growth model, growing more sustainably at 6.8% growth predicted this year (2014: 7.3%, 2013: 7.7%) and 6.3% in 2016, which are the same growth forecasts as in April 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, moving steadily to a more market-based economic and financial system. There are efforts by the authorities at re-aligning the sources of growth of the economy, from essentially export-led and investment-driven to consumption-based and services-oriented economy. These are good evolution and legitimate, according Ms. Lagarde of the IMF. China's growth slowdown this year, the lowest in 25 years, is certainly 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 are also affected, although with a varying degree.
Growth in India remains strong, representing a truly bright spot in Developing Asia, which certainly put India in the same league as the US and UK for advanced economies. India is benefitting a lot from a persistently low energy prices, supported by its continued structural adjustment and reform programs. Nonetheless, the IMF revised downward India's growth forecast for 2015 to 7.3%, which is the same growth rate achieved last year (2014: 7.3%, 2013: 6.9%), while maintaining India's growth forecast for 2016 at 7.5%. As such, India is overtaking China's growth rate this year as well as in 2016. Meanwhile, in Latin America and the Caribbean, Brazil another BRIC country, is in deep recession (2015: -3.0%, 2016: -1.0%), sharing similar economic difficulties with Russia (2015: -3.8%, 2016: -0.6%), due largely to lower commodity-export prices. Countries in the Middle East and parts of Africa are certainly in deep political turmoil, especially in Syria, Iraq and Yemen. Airstrikes by Russia in Syria could escalate the current conflict, driving more refugees into Europe and possibly forcing NATO to protect its member country, Turkey.
The balance of risks is still tilted to the downside, according to the IMF in its latest October 2015 WEO. There are warming signals and red flags that the world economic outlook is worsening, especially in recent months. These include across-the-board declines in oil and other commodity prices, sharp appreciation of the US dollar, sudden reversal of capital flows out of emerging market and developing economies and greater volatility in global financial market. Crude oil prices are expected to remain low this year as well as in 2016, averaging about USD51.62 per barrel in 2015 and USD50.36 per barrel in 2016, according to the latest projections by the IMF. Meanwhile, there is an increasing volatility in the global financial markets, which started again in mid-August 2015, resulting in downward overshooting for currencies of commodity exporters, such as Brazil, Russia, Australia, Canada and Malaysia as well. Global risk aversion is reported to be on the rise, especially with worsening near-term global economic outlook. This situation is being reflected in increasing dollar bond spreads, declining equity prices and sharp movements in exchange rates. Declining oil and other commodity prices, wider acceptance of flexible exchange rate regime, together with existing market distortions and imperfections have resulted in downward overshooting of exchange rates, as portfolio investors were reallocating their short-term investment to dollar-denominated assets, especially in the US, UK and recently in Japan. Geopolitical factors have also added to worsening economic conditions, especially with continued fighting in the Middle East, recent airstrikes by Russia in Syria and continued fighting in Yemen.
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, slower-than-expected growth or possibly "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.
Long-Term Issues and Policy Directions
Looking ahead, Malaysia needs to adjust quickly to the so-called new normal in the world economy, associated with continuing growth realignment in China, the world's second largest economy and monetary policy normalization from zero lower bound (ZLB) in the US. Window of opportunity is getting less over time, as the world economy is clearly moving out of post-crisis easy monetary conditions, starting in early 2016 and moving towards a more sustainable development in the years ahead. 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 currently on a moderating path, are urgently needed to boost business confidence and enhance potential output growth in the long-term. 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 are 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 economy.
On the supply side of the economy, new long-term measures need to be undertaken to further enhance total factor productivity (TFP) and improve overall nation's 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. 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.
MALAYSIAN ECONOMIC OUTLOOK
Risk, uncertainty and volatility are the key factors undermining confidence of economic agents, irrespective which group they belong to, ordinary domestic households, profit-maximizing producers, entrepreneurs, retailers, financial intermediaries or smart and sophisticated foreign investors in the rest of the world (ROW), with the exception of risk lovers. Loss of confidence and growing anger over increasing financial difficulties, especially by low income households and ordinary citizens alike are warning signals of an economic distress. While the warm glow effects, associated with favourable sovereign credit ratings, which have been upgraded and reaffirmed at "A-" with "stable" outlook by Fitch and S&P, respectively in July 2015 disappeared quickly, new headwinds are on the way and risks remain tilted on the downside, especially on the international front. These include Greek debt crisis, which is still unfolding and China's financial market turmoil. These two countries share one common feature, that is a strong presence of Government in the economy, as indicated by a large number of state-owned enterprises and state-controlled banks and financial institutions. They could potentially trigger the worst-case-scenario for the global economy.
On the domestic front, there are discernible "dark clouds" hovering over Malaysia's economic landscape, while political storms are brewing and "dark forces" rearing their ugly heads again, sparked by advances in communication technology (internet and social media), growing inequality in both income and property ownership, urban poverty and also racial divide. Economic dark clouds include the rising cost of living; severe misalignment in the value of ringgit exchange rate, which cannot be simply left to unrestrained FX market forces; elevated Federal Government and household debts; rising contingent liabilities and significant exposure at default (EAD). While default probability is low and loss given default manageable, EAD remains substantial, especially with increasing risk of a "multi-notch downgrade" or migration of rating to lower investment grade, as reported by BNP Paribas.
Related to these developments, there is clearly a need for new "optimal policy framework", focussing on short-term stabilization measures by putting greater efforts at renewing Government's commitment, restoring market sentiments and confidence, enhancing policy credibility and protecting Malaysia's good reputation overseas. While current economic conditions are somewhat different from initial conditions of the Asian financial crisis in 1997/98, we need to start examining in-depth all binding constraints, external shocks, domestic weaknesses as well as strengths to economic and social development in the country. We need to fully maximize social welfare gains and avoid deadweight losses, associated with weak institutions, poor governance, entrenched vested interests, pervasive corruption and lack of openness and transparency, as recently seen in "distressed economies" in the euro area, developing economies in the US dollar zone and even some "developed economies" in Asia. More importantly, we need to ensure continued happiness and good life for the rakyat, encouraging greater kindness and compassion and avoiding to a large extent "tyranny of the majority" and prosperous fools. As noted by the ancient Greek Philosopher Aeschylus "a prosperous fool is a grievous burden".
Short-term Issues and Stabilization Measures
Real GDP registered a strong growth of 5.6% in the first quarter of 2015, performing better-than-expected in an environment of fragile global recovery and uneven observed growth across country classification and regions. Meanwhile, net current account of the balance of payments (NCAB) remained in surplus, registering almost RM10 billion in the first quarter of 2015. This helped to alleviate undiminished concerns, especially by foreign rating agencies, market analysts as well as non-resident investors about the likelihood of "twin-deficit" phenomenon, which could materialize on quarterly basis. While overall unemployment remained at 3.1% of the total labour force in May this year, indicating full employment situation (4%), consumer price inflation accelerated higher in June 2015, registering 2.5% (May 2015; 2.1%, April 2015: 1.8% and March 2015: 0.7%), on account of mostly policy-driven domestic cost-push factors. These included a cumulative direct and indirect effects of GST implementation, upward adjustments in fuel end-user prices and also partly higher import prices, following almost across-the-board declines in ringgit exchange rates against Malaysia's major trading partners. Fortunately, pricing behaviour of firms and strong market competition, especially in the distribution and marketing channels, helped to minimize sharp increases in domestic consumer prices.
In fact, worries about full pass-through effects from sharply lower ringgit more or less dissipated, as intermediate producers absorbed higher imported costs, focussing their efforts more on raising productivity, while final producers, wholesalers, distributors and retailers searched for alternative sources of materials and final products around the globe, therefore avoiding excessive mark-ups and hikes in consumer prices. Although GST price effects are unavoidable, as part of the transitional process of taxation reform in the country, firms and traders are dictated more by competitive market forces, working hard to protect their market shares and willingly accept lower profit margins. Moreover, traders or retailers are not allowed to increase their net profit margin for any goods or services for 18 months from January 2015 to June 2016, as required under the Price Control and Anti-Profiteering Act 2011. 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 as well as in the years ahead. Generally, there is a wider acceptance and public ownership of this important fiscal reform program, except probably the GST initial tax rate, which many considered excessive to start with. Taxation reform is for the long haul of the economy and not to increase revenue and reduce deficit, especially in the short-term. While long-term benefits will far outweigh the short-term costs or pains, and the gainers will ultimately be the rakyat in the long-term, there must be a binding commitment on the part of the Government, not only to raise revenue but also to spend it wisely and in a prudent manner. The implementation of GST together with removal of decades-old fuel subsidy regime need to be complemented with strong fiscal discipline and more importantly, good governance on the Government side. There must also be greater transparency and enhanced public integrity, better and more predictable policies and sustained reform process, which altogether help in removing aggregate domestic uncertainty and in the final analysis improving policy credibility and predictability.
As a trade-oriented and financially integrated economy, Malaysia continues to be susceptible to both unanticipated and anticipated shocks, such as reversals in portfolio flows, fluctuations in the prices of commodities and sharp volatility in financial assets prices. Commodity terms of trade (CTOT) losses, depreciating ringgit and anticipated higher interest rates in the United States (US) are negative shocks that will affect adversely Malaysia's currently favourable domestic macroeconomic fundamentals. The reversal in portfolio investment flows, as seen previously in the fourth quarter of 2014, accelerated markedly in the second quarter of this year, involving mostly non-resident portfolio investors, who are still holding significant amount of Malaysian equities (about 24%) as well as Malaysian Government Securities (MGS, about 47%). These investors are generally smart, rational and forward looking, always searching for better returns for their portfolio investment around the globe. They are also fickle-minded investors who subscribe to herd mentality, gradually and partially moving out from emerging market economies (EMEs), including Malaysia 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 rock bottom interest rates, which could come sooner than expected, despite continued monetary easing in both developed and emerging market economies. Moreover, global economic prospects remain uncertain, especially in the euro area and China, the world's second largest economy. Meanwhile, external risks remain tilted on the downside, especially with an ongoing Greek debt crisis and continued fighting in the Middle-East. There are also reports about cross-border conflicts and threats posed by extremist groups in Africa as well as in Asia. These so-called geopolitical factors affect market sentiments, pushing portfolio investors to look for a safe haven in the US and more recently Japan, as investors are becoming more risk-averse and also home bias in their international portfolio diversification.
Looking at the medium-term macroeconomic perspective, downside risks remain manageable, while strong recovery in the US economy will hopefully provide a "shot in the arm", sustaining the country's export earnings of goods and services as well as foreign exchange earnings from tourism activities, following greater number of tourist arrivals. Generally, markets remain the best allocators of nation's scarce resources, providing unbiased judgements about good management of the macro economy. As such, misguided government interventions result in market imperfections and distortions, while weak and uncoordinated policy actions, especially in strategic and important areas create uncertainty among economic agents and affect policy credibility as well as predictability. There are social costs and in fact welfare losses to society, associated with lack of openness and transparency, gap in policy credibility, weak institutions, poor governance and, worst still low ethical and moral values. These are "soft" elements, affecting public sentiments and investor perceptions and, therefore, need to be managed intelligently and further strengthened. There must be good signalling mechanism for market participants to react adequately, while "gradualism" and extensive consultations with key stakeholders will ultimately help to avoid idiosyncratic uncertainty and negative perceptions of stakeholders, investors and rakyat alike.
Macroeconomic and Financial Policies
BNM through its Monetary Policy Committee (MPC) again anchored the Overnight Policy Rate (OPR) at 3.25% in its latest MPC statement on 9 July 2015, the sixth time since BNM raised the OPR on 10 July 2014. The decision certainly provides financial comfort and continued easy monetary conditions for local economic agents, who are presently being burdened with rising cost of living and declining disposable income, associated with the implementation of GST in April 2015, upward adjustments in retail fuel pump prices and expectation of more subsidy rationalization actions in the coming months. These included recent increase in fares for taxis (43%) and 23% for express buses, which seemed unreasonable and burdensome. The MPC decision was also in line with the US Federal Reserve Bank (Fed) decision to delay the increase in the Fed Funds Rate from its almost zero percent since December 2008, on account of benign observed inflation, negative output gap and prevailing long-term structural issues. The Fed Funds Rate is expected to be raised only in September 2015 and most likely to be delayed to early 2016, as requested earlier by both the IMF as well as World Bank. Most importantly, the European Central Bank (ECB) and the Bank of Japan are currently implementing the US Fed-inspired quantitative easing and continuing with their accommodative monetary policies. Advanced countries in the Asian region, such as Australia, New Zealand and Korea have recently reduced their policy rates to arrest their moderating economies, while India has maintained its current policy rate. Of greater significance, the Bank of England is expected to delay tightening of its monetary policy, despite registering strong recovery in the economy. The US neighbour up north, Canada has also eased monetary policy stance.
As such, the MPC decision to maintain the OPR at 3.25% seemed appropriate and relevant in the current circumstances, as average consumer price inflation remained low at 1.4% in the first six months of 2015, while output gap is expected to be negative for the year as a whole (socially optimal potential output: 5.5% per annum). Nonetheless, inflation expectations are seen as gathering momentum, rising almost across-the-board in recent months, on account of policy-driven domestic cost-push factors, while demand-induced inflation remained largely benign, as private consumption expenditure is on a moderating path. The uptick in consumer prices, associated with the GST implementation seemed minimal and well under-controlled, as seen in June's inflation rate, which edged upwards by only 2.5% on year-on-year basis (May 2015: 2.1%, April 2015: 1.8%, March 2015: 0.7%). The uptrend in inflation rate is expected to be a transitory phenomenon, looking like a chi-square probability distribution with higher degree of freedom (impulse response function), which is expected to quickly decline over time, barring other new or planned back-to-back mark-up in prices or wages. As such, inflationary pressures associated with domestic cost-push factors, especially GST are expected to be well-contained, supported to a large extent by a persistently low crude oil prices (as seen in moderating transport charges) and continued low inflation environment on the international front.
Private sector liquidity or broad money (M3), which bottomed-out in August 2014 with a growth of only 4.8%, moved up steadily to record a strong growth of 7.9% in March 2015, but it took a turn in May and June 2015, decelerating by 5.7% and 6.0%, respectively. This tightening of monetary condition was partly contributed by a slowdown in quasi-money (M2), registering only 6.5% in June 2015 (May 2015: 6.2%, April 2015: 7.0%, March 2015: 8.5%). Meanwhile, growth in M1 accelerated to 9.5% in June 2015 (May 2015: 8.7%). The easing of domestic liquidity as seen in the first three months of 2015 seemed to be short-lived, although there was a continued expansion in domestic credit (DC) extended to the private sector, particularly to businesses. In terms of factors influencing M3 annual growth, the slowdown in recent months was attributed to an improvement in Government operations, in which net claims on Government declined substantially on account of rising Government deposits with the banking system. Meanwhile, net foreign assets (NFA) continued to weaken, exacerbated by declining trend in NFA of the banking system, following persistent outflows of portfolio investment from both equity and debt securities markets. While the tightening liquidity situation was not reflected in the movements of key interest rates, in view of presently stable interest rate environment both at home and abroad, exchange rate clearly took the brunt of adjustment, depreciated markedly against the currencies of most of Malaysia's major trading partners in May as well as June 2015.
Unfortunately, the ringgit continued its depreciating trend in July and early August 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. 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 elevated concerns on high Federal Government debt and exposure at default (EAD) of Government guaranteed bonds. Deterioration in commodity terms of trade (CTOT), increasing percentage share of Federal Government debt to GDP, widening of real interest rate or yield differentials, rising country risk premium and widening credit spreads are the key concerns of portfolio investors. As such, ringgit will remain under strong exchange market pressures by traders, arbitragers, hedgers and speculators, as crude oil prices are on the downside (31 July 2015: USD47.12 per barrel). Similarly, liquefied natural gas (LNG) prices are also on the downside, as both supply and demand conditions turned negative. The outcomes of the Iran nuclear deal dictate the movements of both crude oil and LNG prices.
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 up to 30% of Federal Government revenue in recent years. Meanwhile, oil-related exports accounted for 13.6% of total exports, and together with LNG (8.4%), another resource-based commodity export, the share remained significant at 22% in 2014. Meanwhile, the share of manufactured exports more or less stagnated at about 70% of total export earnings. This was triggered by the "premature deindustrialization" phenomenon, as the country moved aggressively to unfortunately low value-added and low wages services sector (2014: 53.5% of GDP), relying heavily on low-wage foreign workers. Latest available DOS data show that compensation of employees (COE, labour share) accounted for only 34.3% of nominal GDP in 2014, while gross operating surplus of firms remained large at 62.6%. Prices of other commodity-based exports, such as palm oil and rubber are also falling. In the short-term, persistently low crude oil prices, financial market frictions, together with existing price stickiness and wage rigidities in the product and labour markets will see that ringgit continues its undershooting, as predicted decades ago by the economist, Rudi Dornbusch in his celebrated overshooting exchange rate paper.
The prevailing imperfections in market microstructures, foreign exchange (FX) key-board and chart-based electronic trading together with almost instantaneous transactions 24/7 around the globe will also see that ringgit exchange rates are being influenced stochastically by non-economic process. These include waves of unanticipated news and political events that affect investor sentiments and perceptions of market participants. In addition, there are also herd mentality and behaviour among portfolio investors, including local institutional investors, subscribing to one-way destabilizing flows, especially in abnormal or difficult times. In terms of fair value or fundamental equilibrium exchange rate, there is clearly severe misalignment in the value of ringgit, which is being backed by strong underlying domestic macroeconomic fundamentals. In fact, the ringgit external value is presently being backed by substantial amount of BNM's unencumbered net international reserves, which remained above the "psychological" threshold of USD100 billion (or equivalent to about 34% of nominal GDP and 7.9 months of retained imports).
While the ringgit is currently misaligned, in view of its extreme undershooting, it is expected to revert back to its equilibrium fair value of between RM3.50 to RM3.70 per US dollar in the medium term, as exchange market pressures subside and the two-way flows return back to the FX markets. This mean-reverting process, however, will take a while longer to materialize as negative surprises keep popping up, affecting market sentiments and investor perceptions. In this respect, we need to nurture back the confidence of economic agents and FX market participants as well, encompassing both locals and foreign portfolio investors. Moreover, 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 not only by yield differentials, country risk premium and credit spread, but more importantly by US monetary policy and its associated uncertainty. These included taper tantrum seen in May 2013 and currently the difficulty of the US Fed in moving out smoothly from its rock bottom interest rate policy environment.
While BNM earlier adopted passive reserve management strategy, allowing ringgit to adjust flexibly through FX market forces when US dollar was clearly strengthening on the other side, BNM is recently seen as intervening heavily to arrest further decline in the value of ringgit exchange rate. Despite strong FX interventions (FXI), however, the ringgit crossed the "psychological" level of RM3.80 per US dollar on 6 July 2015, closing slightly lower at RM3.8070. In fact, the ringgit was the worst performing currency in Asia on that day, depreciating across-the-board against other major currencies, including the Euro and Japanese Yen as well as with Thai Baht and Vietnamese Dong. Although the trigger point was clearly the deepening of Greece's debt crisis, that culminated in a "No" votes to tough IMF and ECB bailout austerity measures, domestic non-economic factors were also at play that day, depressing further the external value of ringgit. Meanwhile, the ringgit remained below the "psychological" threshold of RM3.80 in recent weeks, indicating excess supply of ringgit in the FX markets, as confidence remained weak. Extreme undervaluation of ringgit, if not stabilized in the medium and long-term, could well see that external debt services, especially by the private sector get bigger and bigger and import bills get higher as import shares for both home production and consumption are quite significant. Moreover, import of intermediate and capital goods are closely linked with both exports and domestic investment. If ringgit depreciation persists, social costs and welfare losses to the society could far outweigh the benefits of improving export competitiveness and greater number of tourist arrivals in the country.
With a managed floating exchange rate regime, following the dismantling of fixed exchange rate regime in July 2005 and together with free flow of capital, ringgit continues to take the brunt of adjustment, especially with expected continuing unchanged OPR in the coming months. Meanwhile, fiscal policy remains at a centre stage, especially with worsening fiscal space, as oil prices remain in doldrums. As such, fiscal affairs need to be managed in a credible and prudent manner, as increasing Federal Government debt and rising contingent liabilities are the topical concerns of portfolio investors, FX strategists and sovereign rating agencies and citizenry alike. This is especially so with the expected decline in oil-related revenue (2015 est: 29% of total Federal revenue), moderating private spending and elevated borrowings to finance mega infrastructure projects, as unveiled under the 11MP. Moreover, about 47% of ringgit-denominated Malaysian Government securities (MGSs) are owed to non-residents, and tenors are mostly medium-dated (more than 5 years to 10 years). Meanwhile, borrowings by GLCs and private corporations are mostly in US currency, but fortunately tenors are mostly medium to long-dated.
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. Short-term exchange rates move largely with news and expectations, whereby market participants are rational and forward looking, placing greater weight on unanticipated events. On a positive note, net international reserves position remained substantial (34% of nominal GDP), providing adequate 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 idiosyncratic uncertainty and volatility, associated normally with macroeconomic mismanagements, weak governance or simply pure mistakes by the authorities. More so, if they have in their possession relevant information that can materially provide basis for one-way speculative activity, which more often than not is destabilizing.
Net international reserves continued its downward trend, touching USD100.5 billion as at 15 July 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 financial market developments. However, Malaysia international investment position (IIP) continued to record deficit, totalling RM13.1 billion as at end of 2014 (end-2013: -RM47.2 billion, end-2012: -RM17.8 billion), indicating that Malaysia is a net debtor on international front, running for three years in a row. This unfavourable position is expected to continue this year, despite smaller deficit of RM1.2 billion registered as at end-March 2015. Persistent and significant outflows of portfolio investment in the second quarter of 2015 and possibly in the coming months could well see that Malaysia again register a net debtor position in 2015.
Global Economic Developments and Prospects
The global economy is clearly on shaky ground this year, caught by increasing indebtedness in a large number of developed as well as emerging market economies (Malaysia included). There is also uncertainty and enhanced volatility in the global financial markets. These factors affecting not only presently "distressed economies" like Greece in the euro area and Puerto Rico in the US dollar zone, but also extending to emerging market economies, such as Brazil, Russia, India and China (termed as BRICs). The latter is the world's second biggest economy and also global manufacturing powerhouse, absorbing substantial amount of resource-based materials from other developing countries, particularly in Africa, Asia and the Middle-East.
While Greek economy is relatively small to affect the world economy, economic and political events, associated with Greek debt crisis could potentially provide a trigger point for negative surprises, affecting not only "stressed economies" in the euro area, but also other emerging market and developing economies around the globe. China is currently struggling hard with a slowdown, engineered initially by the authorities as part of the efforts to rebalance their sources of growth. The authorities have recently intervened to arrest plunging share prices, which remained out of sync with underlying domestic market fundamentals. The stock market meltdown in China resulted in USD3.2 trillion being wiped out from market capitalisation within a period of only three weeks. As such, a full blown stock market crash and financial market turmoil in China could possibly trigger much wider effects, not only to the global financial markets, tightening global liquidity situation, but also affecting the real side of the economy in emerging market and developing economies as well as advanced countries. Resource-based economies, such as Australia and Canada, and many countries in Asia and Africa, will be adversely affected, again Malaysia is included. Moreover, higher interest rates in the US and stronger US dollar could also see that borrowing and debt servicing costs for many highly-indebted nations will be on the rise, exerting significant pressure on Government finances.
While continuing lower oil prices, easy monetary conditions and roaring boom in the US economy helped to support global economic recovery, global growth remained uneven, across country grouping as well as regional classification. The International Monetary Fund (IMF) in its latest World Economic Outlook Update (WEO Update, 9 July 2015), released on 9 July 2015, revised downward the 2015 annual growth estimate for the world economy to 3.3% (2014: 3.4%), representing 0.2 percentage point lower than April 2015 WEO estimate of 3.5%. Meanwhile, the IMF maintained the global growth forecast for 2016 at 3.8%, indicating that global economy will somehow strengthen next year. Growth in advanced economies is expected to be on the uptrend this year, growing slightly lower by 2.1% (2014: 1.8%, 2013: 1.4%), compared to April 2015 WEO forecast of 2.4%, while growth rate in 2016 is projected to be 2.4%, the same rate as predicted before. Growth in emerging market and developing economies as a group is projected to moderate slightly to 4.2% this year (2014: 4.6%, 2013: 5%), which is only 0.1 percentage point less than earlier forecast at 4.3%. However, growth is expected to gain momentum, registering 4.7% in 2016, supported by a rebound in economic activity, especially in crisis-affected countries.
Recovery in the US economy remains on track, despite temporary setbacks that occurred in the first quarter of 2015 in the form of severe winter conditions and strikes by port workers in the west coast. While growth declined by 0.2% in the first quarter of 2015, latest estimates indicate that growth has strengthened in the second quarter 2015. Private consumption expenditure (PCE) as well as private investment continued to be the key drivers of growth, supported by healthy labour market conditions, strong wage growth, continued easy monetary conditions, lower fuel pump prices and improving housing market conditions, among others.
There are also positive signs emerging from the euro area with growth prospects improving in recent quarters, especially with ECB's quantitative easing. Domestic demand is on the rise and fears of deflation dissipated as inflation is beginning to come back. The IMF in its July 2015 WEO Update maintained the growth forecast for the euro area at 1.5% in 2015, while forecast for 2016 has been revised upward by 0.1 percentage point to 1.7%. While growth forecasts for major countries, especially Germany and France have been maintained as in April 2015 WEO, projections for Spain and Italy have been revised upward in both 2015 and 2016, pointing to robust recovery in these previously "stressed economies", except Greece. Economic and political events are still unfolding in Greece, and these events could have serious implications to the euro area. Moreover, the euro area is still struggling with high unemployment and high Government debt. Looking at geopolitical factors, there are still tensions between Russia and Ukraine, while Russia and the Commonwealth of Independent States (CIS) are facing economic difficulties, especially with continuing lower oil prices and 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 245% of GDP. Abenomics has triggered bubble in asset prices, with the stock markets closed markedly higher in May 2015, while the real economy remained weak, as growth last year was at -0.1% (2013: 1.6%). Weaker Yen and uncertain economic outlook, especially in China are affecting private consumption expenditure which remains sluggish. Moreover, growth in real wages is weak. In this connection, Japan's growth forecast for 2015 has been revised downward by the IMF (WEO Update, July 2015), projecting growth of 0.8% in 2015. Meanwhile growth forecast for 2016 has been maintained at 1.2%, in tandem with favourable growth projections for the majority of advanced economies.
Meanwhile, China is growing slowly, but more sustainably at 6.8% growth predicted this year (2014: 7.4%, 2013: 7.7%) and 6.3% in 2016, the same growth forecasts as in April 2015 WEO. These growth projections are in line with enhanced structural reforms and efforts by the authorities at rebalancing the economy. However, according to the IMF, there are still difficulties in China's transition to a new growth model, as seen by the recent stock market swings and the intervention by authorities, resulting in enhanced market volatility and greater uncertainty. 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, together with its continued reform programs. The IMF maintained India's growth forecasts for 2015-2016 at 7.5%, which is clearly on the uptrend (2014: 7.3%, 2013: 6.9%) and overtaking China's slowdown in growth rate in recent years. Meanwhile, in Latin America and the Caribbean, Brazil another BRIC country, is in deep recession, sharing similar economic difficulties with Russia, due mainly to lower commodity-export prices. Growth projections for these two countries have been marked down to -1.5% and -3.4%, respectively in 2015 (2014: 0.1% and 0.6% respectively), while growth in these two countries are expected to improve, but remain below 1% in 2016. Countries in the Middle East and parts of Africa are certainly in deep political and economic turmoil, especially in Syria, Iraq and more recently Yemen.
While world oil production remains on the uptrend, especially with successful conclusion of the Iran nuclear deal, coupled with expectations of rising interest rates in the US, weak recovery in the euro area and slowdown in China, commodity price movements will continue to be on downtrend, especially crude oil, while US dollar getting stronger. Meanwhile, crude oil prices, which declined by almost 50%, rebounded in the second quarter of 2015, supported partly by higher demand. Nonetheless, crude oil prices are expected to register only small increases this year as well as in 2016, averaging about USD59 per barrel in 2015 and USD64.22 per barrel in 2016, according to the latest projections by the IMF. While global oil supply is on the rise, global oil inventories are accumulating, as world oil demand remains weak, following fragile global recovery. Additionally, geopolitical factors 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 the possibility that pendulum swing to the extreme left, throwing away tough austerity and reform measures in many "stressed economies" in the euro area. While distressed economy like Greece accepted its third bailout package, despite "No" votes by the Greek people, tough austerity measures and less money actually being channelled for real productive purposes, point to continued vicious cycle with potentially severe economic implications and political repercussions. Sovereign bond yields with long tenors have already increased by 80 bps in the euro area (excluding Greece) since April 2015, according to the IMF. Meanwhile, longer-term sovereign bond yields and country risk premiums are also on the rise in emerging market economies, reflecting increased uncertainty, especially with sooner-than-expected hike in the US interest rates, altering the term structure of interest rates more to the upside, as term and risk premium on longer-term bonds are still low, as observed by the IMF.
While global risk, uncertainty and volatility remain about the same as in the previous reports, short-term risks are tilted on the downside, especially with recent events in Greece and China, which are still unfolding. The IMF in its July 2015 WEO Update again mentioned about disruptive asset price shifts and further increase in financial market volatility as major near-term risks to the global economy. Meanwhile, financial market turmoil; a further US dollar appreciation; re-emergence of financial stress; financial market turbulence in China and geopolitical tensions in Ukraine and fighting in the Middle East as key short-term risks, mentioned earlier in April 2015 WEO. Meanwhile, fiscal imbalances in the euro area and in many emerging market economies, misalignment of currencies and mismanagement of fiscal stimulus also remain as short-term risks. Medium-term risks include low potential output growth and secular stagnation in advanced economies and consequently lower potential growth in emerging market economies. Lower commodity export prices will affect economic performance of resource-based economies, including high-income nations and, most worryingly low-income developing economies in Africa as well as Developing Asia. Looking from longer-term perspective, aging population is expected to lower labour input in advanced economies, especially in Japan.
Long-Term Issues and Structural Adjustments
Looking on medium and long-term perspective for economic and social development in the country, the Eleventh Malaysia Plan (11MP, 2016- 2020) was unveiled in Parliament on 21 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. With multidimensional goals, the Eleventh Malaysia Plan focuses on enhancing inclusiveness towards an equitable society and improving wellbeing for all, among others. The adoption of sustainable consumption and production concept in pursuing green growth strategy for sustainability and resilience is clearly on the right direction. Meanwhile, the Eleventh Malaysia Plan also giving greater focus on strengthening infrastructure to support economic expansion, which is clearly necessary to enhance connectivity and easy access for wellbeing of the rakyat.
With outlook for global economic activity remains uncertain and strong headwinds are expected in the coming years, especially with recent setbacks, attaining real GDP growth target of 5 to 6% per annum in the next five years is undisputedly a tough challenge, but the target seems achievable, barring negative surprises. Real GDP grew by an estimated 5.3% per annum in the Tenth Malaysia Plan (2011 - 2015), while nominal per capita income in US dollars stood at USD10,796 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 "advanced economies" averaged well above USD35,000 in recent years. 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.
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