Register now for a free trial to gain access to
this piece and see how
you can benefit from an RGE subscription.
Global Economic Outlook
Malaysia: Q1 2010 Outlook
By Arpitha Bykere
- The economic recovery will be weak and exports and industrial production will move sideways due to reliance on G3 demand and global commodity prices.
- Low inflation will accommodate loose monetary policy in 2010 but fiscal policy will become restrictive by mid-2010 due to budget deficit.
- Foreign investors will watch out for political stability and implementation of promised reforms, including liberalization and boosting private demand.
Malaysia has lagged other ASEAN economies in recovering from the economic downturn, as GDP continued to contract until Q3 2009. Weak global demand and credit conditions in 2009 led to sharp declines in private investment and manufacturing and commodity exports. Growth and consumer spending are cushioned by monetary policy and large fiscal spending. RGE forecasts that after contracting by 2.4% in 2009, the Malaysian economy will manage to grow by around 4.1% in 2010. Private consumption and investment will remain weak while government spending will be scaled back owing to deficit concerns, and net exports will be a drag on growth. Higher commodity prices and inventory restocking will sustain industrial activity and exports in 2010. But both industrial production and exports will remain well below their pre-recession levels in the coming years. With an export-to-GDP ratio of 90%, deleveraging in the West will constrain Malaysia’s growth, though commodity exports to Asia will be a plus. The government has proposed reforms to rebalance the economy toward domestic demand and continue with liberalization and economic development—a process that will take a couple years. Until then, Malaysia will not match the 5%-6% growth posted in the pre-recession years.
Can Commodities Boost Exports?
Exports and industrial production bottomed out in Q4 2009 led by improving exports of electronics and crude palm oil, and strong exports to China, Thailand and India. Chinese commodity demand has improved palm oil and mining output. Higher commodity prices, low base effects, inventory restocking, and exports to China and India will sustain exports in 2010. However, export recovery faces several risks: inventory restocking in Asia and the West will wane by H2 2010; demand recovery in the G3 economies remains uncertain; Chinese commodity stockpiling might slow relative to 2009; and global slowdown in H2 2010 might lead to commodity correction. As a result, exports will register weak growth during 2010. Faster recovery of imports will narrow the trade and current account surpluses. Despite support from inventory restocking, industrial production will grow sluggishly during 2010 due to large excess capacity and weak consumer and export demand.
Weak Domestic Demand Will Weigh on Growth
With improving industrial activity and commodity prices, job losses in the export manufacturing sector bottomed out by late 2009 and rural incomes got a boost, helping auto and retail sales. Fiscal stimulus, improved credit conditions and low inflation will sustain private consumption in 2010 but weak income growth and hiring will be challenges.
The withdrawal of fiscal stimulus and cutback in government spending by H2 2010 will somewhat ease government investment relative to 2009. Since domestic investment and foreign direct investment (FDI)—which are highly export dependent—fell sharply during this recession, Malaysia’s investment-to-GDP ratio has declined to levels far below those seen during the 1997-98 crisis. Weak FDI and export recovery and excess capacity will keep private investment extremely sluggish in 2010. Narrowing short-term interest rate spreads have revived corporate bond issuances and IPOs.
Credit to businesses has shown a marginal improvement starting late 2009 but banks see credit risk in lending to businesses amid weak corporate earnings and uncertain export and commodity outlook. Central bank measures such as loan guarantees and corporate debt restructuring have benefited businesses, especially small and medium enterprises. In order to raise the share of private investment in the economy, the government needs to attract more FDI into services, fasten financial sector reforms and improve credit intermediation. Ongoing reforms, including the liberalization of the financial and service sectors, might boost domestic and private foreign investment in the coming years.
Fiscal Consolidation Waiting
Malaysia’s aggressive fiscal stimulus of around 9.0% of GDP boosted the economy during H2 2009 and will continue to do so in H1 2010. About one-third of the stimulus will be spent in 2010 but the impact of government spending on growth will fade by H2 2010 as the government plans to reduce expenditures in 2010 relative to 2009. Large spending on fiscal stimulus and public services and lower commodity revenues raised the fiscal deficit to about 7.0% of GDP in 2009 and around 5%-6% of GDP in 2010. Due to concerns about high government borrowings and debt ratings, the government plans fiscal consolidation starting in 2010 by cutting operating and development expenditures, reducing subsidy spending, raising taxes and tariffs, and implementing tax reforms. The goods and services tax (GST) might be introduced in 2011. However, slower-than-expected economic recovery and political instability might delay the necessary fiscal reforms.
Weak Economic Recovery Will Delay Monetary Tightening
Malaysia moved out of deflation at the end of 2009. Inflationary pressures will start picking up during 2010 due to base effects, higher fuel and commodity prices, and the removal of food and fuel subsidies. However, overall inflation will remain subdued at 2.0% in 2010 compared to 0.6% in 2009 due to weak wages and large though narrowing excess capacity. Weak recovery in private demand, uncertainty about the global economic recovery and low inflation will allow the central bank to keep interest rates on hold at 2.0% until Q4 2010. But due to the risk of zero or negative real interest rates, Malaysia might hike rates by as much as 50 basis points in Q4 2010.
Asset Markets Less Attractive
Large capital outflows from the debt and equity markets during late 2008 and early 2009 have somewhat reversed due to improvement in global risk appetite and political stability in Malaysia. But capital inflows are weak when compared to other Asian economies. Going forward, foreign investors will watch out for the pace of reforms to increase domestic consumption, liberalization in services and financial sector, fiscal consolidation, and political stability.
The central bank will continue intervening in the FX market to prevent currency appreciation and maintain export competitiveness vis-à-vis China. Higher commodity prices and exports in 2010 are a plus for the currency. But delay in interest rate hikes, higher imports, and any weakening of risk appetite and capital inflows will limit large currency appreciation during 2010.
Planned fiscal reforms will help reduce the fiscal deficit only by 2012-13. In the meantime, the government will meet its high financing needs by issuing local and foreign currency bonds and sukuk bonds. Loose monetary policy will keep the short end rates low but rising bond issues and inflation will put upward pressure on long-term yields and steepen the yield curve in 2010. While foreign investor participation in the debt market is increasing, investors will seek higher yields going forward. Delaying fiscal consolidation could result in further debt downgrades.
Will Reform Promises Be Kept?
During the economic recovery, Malaysia's main challenge will be to rebalance growth away from exports toward domestic consumption and investment. Malaysia has the potential to increase domestic consumption, and consumer spending witnessed strong growth in the pre-recession years. Investment hasn't recovered much after plunging during the 1997-98 crises due to regulatory and structural hurdles for domestic and foreign private investors. Malaysia needs to improve its export and FDI competitiveness relative to other Asian economies, especially China. Greater exchange rate flexibility and reduction in subsidy spending are also required.
The government has committed to increase the share of consumption in the economy by boosting social safety nets, healthcare and other public services. It plans to reform Malaysia into a service-based and value-added manufacturing economy over the next decade by boosting human capital, productivity and technological development. Liberalization in services and financial sector are on their way. In 2009, the government eased the preferential treatment for ethnic Malays in businesses and employment—clearing a major hurdle for foreign investment in services and banking. However, the pace of reforms will depend on political stability as the tug of war between the government and the opposition parties will continue. Some parties inside and outside of the coalition government will be averse to drastic economic reforms.