Malaysia: Cautiously walking the tightrope Asia Pacific Economic Outlook, Q2 2016

The Malaysian economy continues to deteriorate. Despite stable growth momentum, global uncertainties and political developments and weak domestic fundamentals, are weighing on the economic outlook.

When we last took a look at the Malaysian economy, the country was reeling under the impact of falling oil prices, a depreciating currency, and rising inflation. The situation has continued to significantly decline since. Although the growth momentum has been stable so far, global uncertainties, together with political developments and weaker domestic fundamentals, are weighing on the overall economic outlook. A predominance of downside risks has prompted a few credit rating agencies to cut Malaysia’s sovereign ratings outlook.

Concerns from all corners

Government revenues from oil and gas income have been under pressure for some time now due to falling global oil prices. Any further descent in prices, and the government will likely miss its fiscal deficit target of 3.1 percent of GDP, which is required to rein in public debt, this year. At the same time, falling export receipts of energy producers are causing the current account surplus to shrink. In addition, global events, such as the economic slowdown in China, the appreciation of the US dollar, and the recent Fed funds rate hike in the United States, have led to large capital outflows, sharp currency depreciation, and fall in reserves in Malaysia.

Alongside external shocks, domestic fundamentals and imbalances pose significant risks to economic growth. Malaysia’s public debt has been on the rise, and debt affordability has seen limited improvements despite the government’s recent initiatives for fiscal consolidation. Although the goods and services tax (GST), implemented as a part of fiscal reforms, is expected to improve the government’s revenue, its impact on consumption demand has been adverse so far.

Private consumption has been slowing, and consumer confidence is waning in response to rising prices stemming from higher taxes and imported inflation, falling government subsidies, declining personal financing by non-bank lenders, and softening of the labor market. In addition, the household sector is highly leveraged—its debt-to-GDP ratio has almost doubled between 2008 and 2014. Favorable credit conditions reinforcing high consumer demand led to a ballooning of household debt during this period.

Falling demand for exports and a depreciating domestic currency have adversely impacted business sentiments. Consequently, growth in private fixed expenditures has shown signs of vulnerability. The industrial production index increased 1.7 percent year over year in November 2015, the slowest rate of growth since July 2014. Growth revived in the following month, but only modestly. Weak global demand and a decline in mining production were the primary factors behind poor growth.

Inflation has been inching up, primarily due to the impact of the GST. That said, even as the GST effect tapers over time in the near future, inflation is expected to remain high due to the depreciating ringgit and the impending rise in minimum wages effective from July 2016.

A more realistic budget

The sharp decline in government revenues due to falling oil prices, strong capital outflows, and depreciating currency prompted the government to announce a revised budget on January 28. It announced a series of restructuring measures that are likely to save the government 9 billion ringgit (US $2.1 billion). Several development projects have now been reprioritized in order to cut government expenses. The government has announced lower employee pension contributions and tax relief for low-income earners in order to boost consumer spending—the key driver of economic growth. At the same time, it has assured that there will be no capital controls to check domestic currency depreciation, which shows the government’s confidence in the economy.

The measures announced by the government in the revised budget were necessary, given the changing economic conditions and external uncertainties. However, these actions may not be sufficient to contain the fiscal deficit within the target range. Downside risks to growth are significant and are impacting economic outlook. That said, the government has made a sincere effort to consolidate its expenses for this year and to present a more realistic budget as global uncertainties continue to challenge economic growth. This will likely boost investors’ confidence during these troubled times.