INSTITUT PENYELIDIKAN EKONOMI MALAYSIA (149064-U)

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MALAYSIAN ECONOMIC OUTLOOK


MEO4Q13


Executive Summary




Empirical studies show that budget deficit and fiscal indiscipline ultimately affect macroeconomic performance, particularly inflation. This phenomenon has been so clearly evidenced in Malaysia, whereby long-delayed fiscal deficit corrective measures, although are undeniably necessary, but is now being implemented in a chained manner, one after another akin to shock therapy, resulted in overshooting of consumer prices and rising cost of living. With expectations that other measures are also in the pipeline, coupled with almost across-the-board ringgit depreciation and rising wages, the inflation genie is clearly rearing its ugly head again and could turn bigger this time around, fuelled simultaneously by both cost-push and demand-pull factors, creating an almost a perfect scenario for persistently high inflation, not yet accustomed to members of the public or rakyat in Malaysia. Inflation is expected to be higher this year and also next year (2015), on account of mostly policy-driven arising from fiscal structural adjustment measures through subsidy rationalization and broadening of the tax base by implementing goods and services tax (GST), effective on 1 April 2015. Minimum wage policy and currency depreciation, aimed at boosting exports and avoiding shrinking current account surplus provide additional sparks for rising prices and cost of living in the country.


While spikes in world oil prices were the main contributory factors for higher inflation rates in 2008 and 2011, and easily dismissed as an exogenous external event, the current inflation phenomenon is to a large extent domestic policy-driven, triggered by fiscal structural adjustment and consolidation process to lower overall balance of Federal Government finance, which has been persistently in deficit for more than 15 years. Rising cost of living is the key concern of the rakyat, and therefore, controlling runaway inflation should be a national priority of the Government. Members of the public and rakyat as a whole need to be fully informed of what the government is planning to do with its fiscal structural adjustment, which is now gaining momentum and is undisputedly the right way to go forward to ensure economic efficiency and sustainable economic and social development in the long-term. However, the government should not renege on its commitment to adopt a gradual approach and staggered implementation, as promised earlier. More importantly, greater openness and transparency are necessary to ensure there is strong public support for the fiscal consolidation process, as envisaged earlier in the new economic model (NEM), economic transformation program (ETP) and more recently in the 2014 Budget. Distributional conflict in terms of welfare gains and losses among the rich and poor needs to be managed in a careful manner, so that members of the public will not be easily swayed by fringe elements who organise demonstrations or protests that would inevitably result in social chaos and disrupt the good social cohesion that we presently enjoy. In this respect, public advocacy groups, including NGOs, consumer associations and more importantly, youth movements need to be engaged as partners in government's efforts to calm down fears and anxiety about the escalating cost of living and hopefully minimize social tension.

In general, Malaysians can expect the year 2014 to be a challenging year, while not only facing rising cost of living and deteriorating standards of living, but also other economic costs and welfare losses, arising from rising unemployment, tightening credit conditions and slowing down of real economic activity. Nonetheless, fiscal structural adjustment, if properly sequenced and implemented in a credible manner, though painful and unpopular will yield net benefits in the medium and long-term and this will surely help to improve wellbeing of our future generations. Therefore, it is incumbent upon the present administration to take fiscal corrective actions now, rather than delaying it to a later date, by which time fiscal issues snowball and become much more difficult and painful to rectify, as evidenced in the "stressed economies" in the euro zone. With fiscal consolidation process now clearly underway and fiscal structural adjustment measures being forcefully implemented, monetary policy needs to take a centre stage, focussing on short-term stabilization measures, such as fighting the elevated inflation expectations, arresting sharp depreciation and excessive volatility in ringgit exchange rate, avoiding destabilizing capital flows, ensuring adequate domestic liquidity of the banking system, and avoiding potential cash crunches and financial instability, among other pressing things. This is so important because usually a period of rising inflation will be followed by a period of rising unemployment, as output growth slows down and domestic currency weakens. Inflation expectations are generally slow to disappear and monetary policy will affect only prices and not real economic activity in the medium and long-term, as evidenced in competitive economies.

As such, there is an urgent need to educate members of the public, especially the younger generation about the impacts of macroeconomic policies, especially fiscal and monetary policies on key macro aggregates, by showing them impulse response functions or economic dynamics as well as costs and benefits of new measures currently being implemented through simulation and policy analysis exercises. In this connection, computer simulation of state of the art economic models and games, targeting youths and interested parties should be uploaded at the Treasury and BNM portals for them to "role-play" as finance minister or governor, taking charge and being aware of the complexities and difficulties in managing the Malaysian economy. With strong commitment and intelligent communications, in tune with internet age and democracy, educating and engaging the public in the public policy process will hopefully result in public support or buy-in, thereby helping to maintain strong credibility and ensure good reputation of authorities and policy-makers, especially in this challenging and difficult economic environment.

Apart from rising inflation and cost of living, growth in domestic liquidity as measured by the broad money supply (M3) continued to decelerate, attributed to a large extent by sharply lower net foreign assets, although domestic credit situation remained generally supportive of economic activities. Nevertheless, it is somewhat at a lesser amount in recent months. Interestingly, there is a marked increase in M1 (narrow monetary aggregate), reflecting that economic activities are presently being financed to a large extent through cash and demand deposits, akin to self-financing by both firms and households, pointing that cash is king (money matters), especially in credit-constrained environment and limited access to asset markets by consumers as seen in recent months. Real balances now become input to the production process of firms, affecting marginal cost and ultimately will be passed through to consumer prices. Of significance, loans approved and disbursed declined in November 2013, while loans repaid also recorded a decline during the month, indicating that consumers need cash in advance and firms are digging deeper into their internal resources, as availability of credit and access to finance are being constrained by increasingly tight liquidity conditions. In this respect, the dynamic of monetary aggregates should also be given greater attention, apart from OPR which is considered as the foremost metric of monetary policy, while monetary aggregates are assumed to be endogenously determined in recent years.

Unemployment is undisputedly on the rise, adding further to the current misery of the rakyat. Unemployment rate stood at 3.4% in November 2013, while seasonally adjusted figure was much higher at 3.5%. More importantly, overall labour force participation rate now exceeded 69% (August to November 2013), indicating that previously discouraged workers, especially housewives with working experience are now joining back the labour force to supplement diminishing purchasing power of family incomes. Full implementation of minimum wage policy, effective January 2014 is expected to further encourage labour force participation, resulting in higher number of workers seeking employment in the months and years ahead. Labour in-migration is also on the increase, not only from foreign countries, but also from rural to urban as well as from Sabah and Sarawak to Peninsular Malaysia. Youth and graduate unemployment are emerging issues that need to be tackled fast, as unemployment rates among these categories are very much higher than the national average, as seen in the "stressed economies" in the euro zone. Issues pertaining to migrant workers, especially from Sabah and Sarawak need to be tackled in a careful manner.

Growth of the Malaysian economy moderated to 4.5% in the first three quarters of 2013 (Jan-Sept 2012: 5.3%, Jan-Sept 2011: 5.1%), supported largely by domestic demand, especially private consumption and investment. Of greater significance is the turnaround in the external demand in the third quarter of 2013, representing first quarterly positive growth after seven consecutive quarters of declines. Domestic demand (excluding change in stocks) expanded by 8.0% year-on-year in the first three quarters of 2013 (Jan-Sept 2012: 11.7%, Jan-Sept 2011: 7.4%), while external demand as measured by net exports of goods and services contracted by 27.5%, but an improvement compared to -37.8%, recorded in the corresponding period of 2012 (Jan-Sept 2011: -5%). The major contributory factor was the turnaround in exports of goods and services which grew by 1.7% in the third quarter of 2013, after contracting for five consecutive quarters, indicating improvement in the external environment. Nonetheless, private consumption continued to be the key driver of growth in the first three quarters of 2013, growing steadily by 7.7% (Jan-Sept 2012: 8.2%, Jan-Sept 211: 6.7%), and contributing 4.0 percentage points to real GDP growth of 4.5% in the first three quarters of 2013. We ought to take note that consumption-driven growth for a prolonged period is not sustainable, as it is usually associated with rising consumer inflation and demand for higher wages, and more importantly an accumulation of household debt. Private investment, however remained strong with double digit growth of 12.9% in the first three quarters of 2013 (Jan-Sept 2012: 22.4%), and grew sharply in the third quarter of 2013 by registering growth of 15.2% year-on-year, pointing to continuing strong investor confidence in the country.

While presently low interest rate environment and easy access to consumer credit helped to continue fuelling private consumption in Malaysia, it is expected not to last long, especially with emerging signs of tightening domestic liquidity situation. Moreover, there is also a prospect of monetary tightening in key advanced economies, especially in the US. The US Fed has recently announced to scale back its direct liquidity injection through bond purchases on staggered basis by January 2014, resulting in rising long-term bond yields in the US and Malaysia as well while ringgit again saw sharp volatility and depreciated against US dollar along with other regional currencies. As such, with weakening domestic economic fundamentals, external shocks need be managed carefully and in a prudent manner. Malaysia needs to be extra vigilant, minimizing downside risks to growth and employment, while adopting new measures and strategies to avoid financial instability. Currency depreciation should not be the easy way out for improving external competitiveness, as this strategy essentially lowers the standards of living of the rakyat, who will not only end up paying for higher import prices but also costlier for parents whose children study overseas. In fact, Malaysia needs to avoid overly competitive (significantly undervalued) exchange rate and ensure the ringgit exchange rate is not too far distance from "fundamental equilibrium exchange rate".


Looking back, Bank Negara Malaysia (BNM) kept the Overnight Policy Rate (OPR) unchanged at 3.0% at its Monetary Policy Committee Meeting on 7 November 2013 and the next monetary policy statement will be on 29 January 2014. While the earlier move was in line with the need to support growth of the Malaysian economy, especially with enhanced financial risks on the external front, concrete measures for short-term stabilization are urgently needed, as ringgit depreciation and weakening terms of trade both affect headline inflation and cost of living. With core inflation (adjusted CPI, excluding food and non-alcoholic beverages) has been edging upward in recent months, there is a need to curb demand-induced inflation and anchor expectations of inflation in the medium and long-term. Monetary policy needs to be tightened, if not exchange rate continues to depreciate, due to narrowing of real interest rate differentials and then inflation could get out of control. If necessary, BNM should start using inflation targeting framework and gradually raise OPR to anchor expectations of inflation in the medium and long-term, especially with declining weighted average lending rate (ALR) and thankfully improving external demand which will help to offset adverse shock on aggregate domestic demand. In most cases, moderately higher interest rates help to facilitate structural adjustment, although its effects on inflation take longer to materialize than its immediate negative impacts on output growth and employment. In this respect, firm commitment in fiscal structural adjustment and better communication are the key attributes to successful monetary policy stabilization, and this also needs to be supported with greater openness and transparency.

In its latest world economic outlook (WEO) Update, released on 21 January 2014, the IMF indicates that global economic recovery is gaining strength, especially in the US, the world's largest economy. The IMF forecasts global growth at 3.7% this year, a significant improvement compared to 3.0% estimated for 2013 and moving closer to world potential output growth. This reflects an upward revision by 0.1 percentage point in global growth estimate for 2013 and forecast for 2014. While recovery in the key advanced economies is a good thing to happen, it also comes with a threat of financial market turbulence and elevated volatility in financial markets, as seen recently in June and December last year. Inflation remains low in key advanced economies, but high unemployment continues to be a major concern, and therefore, monetary accommodation may last a little bit longer.

The results of MIER's fourth quarter 2013 Consumer Sentiments Survey and Business Conditions Survey showed that consumer and business confidence indices move in tandem for two consecutive quarters, reflecting synchronization in both consumer and business sentiments. The fourth quarter 2013 Consumer Sentiments Index (CSI) plunged a hefty 36.3 points quarter-on-quarter to settle lower at 82.4 points, the lowest reading in almost five years. Consumers are becoming increasingly perturbed by both the current economic conditions and expected conditions in the first half of this year. The Business Conditions Index (BCI), which gained strongly by 21.6 points to settle above the 100-point threshold at 114.2 points in the second quarter of 2013, extended its earlier downtrend, declining to 98.6 points in the third quarter of 2013 and further to 92.0 points in the fourth quarter of 2013. With both indices hovering well below the 100-point threshold, we can generally conclude that consumers are getting cautious in their spending and that business confidence is generally weak in the fourth quarter of 2013, although seasonal factors may also affect business activity, especially in the last quarter of the year. Latest FMM-MIER Business Conditions Survey results (28 November 2013) also point to less favourable business conditions, with local and export sales on the decline, cost of production continues to rise and capacity utilization slows down. Nonetheless, capital investment is on the uptrend, on account of more positive outlook about China, Malaysia's largest trading partner and Myanmar, Laos and Cambodia, emerging developing economies in Southeast Asia. Additionally, fourth quarter 2013 Vistage-MIER CEO Confidence Index shows that almost half (49%) of chief executive officers (CEO) saw no change in the economy, while another 44% thought that it was worsened in the fourth quarter 2013. As such, adding 7% of them that viewed overall economic conditions have improved, fourth quarter 2013 growth performance would be sustained or slightly better than in the previous quarter.

Taking into account the weak growth performance in the first three quarters of 2013, and emerging weaknesses in both MIER's CSI and BCI surveys, especially consumer spending and generally weak performance of Malaysia's other key macroeconomic indicators, domestic demand is expected to moderate slightly in 2013. While domestic demand will continue powering growth of the Malaysian economy, improving external demand as seen in recent months and a slightly better performance of private investment will help to ensure that 2014 Budget's growth estimate at 4.5 - 5.0% for 2013 will be achieved. We are maintaining our 2013 growth estimate of 4.8% for 2013, taking into account factors such as rising consumer inflation, tighter credit conditions and moderation in financing on the domestic front, and better-than-expected global market environment.

Growth in real GDP for 2014 is projected to be at 5.5%, on account of expected fiscal consolidation measures to rein in budget deficit, generally tight monetary conditions and enhanced downside risks, especially on domestic front. External demand, however, is expected to provide strong support for growth, especially with accelerating expansion in the world economy, although global risks remain on the horizon. These include risks arising from volatility of capital flows and deflation in key advanced economies, especially with inflation running below many central banks' targets. As for the year 2015, real GDP growth is projected to move back nicely along the potential output growth path of between 5.5 to 6.0% in 2015, driven by economic efficiency and innovation, especially with expected enhanced competition in both product and services markets, less market distortions and imperfections, greater labour market flexibility and more importantly productivity gains as well as more efficient allocation of scarce resources. This projection takes into account the likely positive impacts as described above, under the so-called "transformation or reform scenario". Nonetheless, the achievements under this scenario require strong "political will" on the part of the Government, solving not only tough "politico-economic" issues, but also mending Malaysia's emotionally charged matters, such as "religious and ethnic" relations, perception of corruption and mismanagement, among other things. As a whole, political struggles in solving current fiscal issues must be won with strong commitment, intelligent communications, and rock solid credibility. These "Three C's" can only be delivered by the establishment of "National Fiscal Council", an independent body free from day-to-day politics, established with an overarching goal of achieving fiscal sustainability and prudence management of public finances. The ultimate goal is achieve sustainable economic and social development. Budget deficit reduction is a necessity and leisurely approach as practiced in the past is not the best option for this blessed country, going forward.


Posted by suzy at 12:37 PM