Malaysia: Subdued growth prospects for 2017 Asia Pacific Economic Outlook, Q2 2017

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A slowdown in export growth, a weak ringgit, and rising interest rates in the United States, along with fiscal consolidation putting a brake on government consumption, are likely to persist over the medium term. As a result, growth prospects for Malaysia in 2017 remain subdued.

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The Malaysian economy grew 4.2 percent in 2016, its slowest rate of growth since the global recession in 2009.1 Growth in private consumption expenditure, though having slowed over the past four years, remains relatively healthy. In contrast, government expenditure and overall capital formation have slowed rapidly over the same period, reflecting fiscal consolidation and reduced business confidence. Export growth has petered out over the last two years due to weak global demand. The challenges confronting the Malaysian economy are likely to persist. The ringgit is weak and is likely to remain under pressure due to capital outflows; price pressures due to a weak ringgit along with rising interest rates in the United States could push domestic interest rates higher in 2017, burdening private consumption. Furthermore, fiscal consolidation is likely to keep government spending in check, and uncertainties in the global economy, particularly related to trade, are likely to persist over the near to medium term. As a result, Malaysia’s growth prospects in 2017 are expected to remain subdued.

Defending the ringgit

The Malaysian ringgit has been one of the worst performing emerging market currencies against the dollar since the US presidential election in November 2016. It has depreciated nearly 50 percent against the US dollar since mid-2013 (as of February 24, 2017) (figure 1).2 Weak crude oil prices, a financial and political scandal involving a sovereign investment fund, and slowing economic growth linked to external factors such as a slowdown in China have all contributed to the slide in the currency.

The Bank Negara Malaysia (BNM) is most concerned with offshore non-deliverable forward (NDF) trading of the ringgit. NDF trading allows foreign investors to hedge against sparsely traded, nonconvertible currencies. Settlement of an NDF at maturity is in US dollars via an international financial center, which eliminates the need for physical delivery of the sparsely traded, nonconvertible currency. Foreign investors own more than a third (36 percent) of Malaysian government debt, and hedge their exposure to the ringgit by using NDFs.3 However, in November 2016 the BNM clamped down on NDF trading by directing foreign banks to stop trading the ringgit in offshore NDF markets.

The BNM’s concern is that possible speculation in offshore NDF markets could affect onshore deliverable forward trading of the ringgit. Onshore trading of the ringgit follows offshore NDF trading as indicated in a study by the Bank of International Settlements in 2013.4 The study of nine NDF markets found that both offshore and onshore markets influence each other except in the case of the Malaysian ringgit where the onshore market follows offshore trading.5 The BNM’s measure, seen as a proxy capital control to defend the currency and protect the country’s dwindling foreign exchange reserves, is likely to keep foreign investors wary of exposure to the ringgit, especially as domestic dollar liquidity for forward trading remains insufficient for investors to hedge.

A bond sell off in the final quarter of 2016 saw the yield on 10-year government bonds jump from 3.5 percent in September to 4.4 percent in November 2016.6 Bonds have regained some ground since then, with 10-year yields declining slightly to 4.2 percent in January 2017.7 Nevertheless, tighter ringgit controls, potentially quicker monetary policy tightening in the United States, and continued global uncertainty are all likely to have a negative impact on foreign investment in the Malaysian economy in the near to medium term.

The ringgit has depreciated nearly 50 percent against the US dollar since mid-2013

The ramifications of a weaker ringgit

A potential upside to the weak ringgit is that Malaysia’s export volumes might get a boost. Improved competitiveness of exports along with stronger global demand for key products such as semiconductor equipment could support a resurgence in export growth experienced at the end of 2016. However, uncertainties regarding global trade are likely to persist through the near and medium term. Furthermore, a weak ringgit and relatively healthy domestic demand will likely contribute to dearer imports and increased price pressure. In the event of inflation edging up and US interest rates rising through 2017 the BNM could come under pressure to raise domestic interest rates in the second half of the year. Higher interest rates, however, are likely to add to the debt burden of leveraged households and businesses. Household debt as a percentage of GDP is estimated to stand at 88.5 percent in 2016.8 Similarly, corporate debt is also sizeable at about 70 percent of GDP.9 An increase in the debt servicing costs for the private sector would likely dampen private consumption expenditure.

Fiscal policy is likely to remain tight

Potentially, tighter monetary policy in 2017 is highly likely to be accompanied by an effort to consolidate government spending. The Malaysian government’s debt to GDP ratio rose from less than 40 percent in 2008 to 54.5 percent at the end of 2015 (figure 2).10 An additional 15 percent of GDP in debt is in the form of contingent liabilities to state-owned companies.11 Malaysia’s relatively high debt exposure to foreign investors makes the economy vulnerable to capital outflows, which would result in higher yields on government bonds. What might work in favor of the government’s budget is improved revenue from oil exports due to an uptick in global crude prices. The newly introduced goods and services tax system is also likely to boost government tax revenues.

Nevertheless, government spending is likely to remain tight in 2017 in order to restrict the budget deficit to a target of 3 percent of GDP.

Malaysia’s debt to GDP ratio rose from less than 40 percent in 2008 to 54.5 percent at the end of 2015

GDP growth unlikely to speed up

Given the current scenario, overall GDP growth in Malaysia is unlikely to accelerate in 2017. Growth is likely to be approximately 4.3 percent, marginally higher than in the previous year.12 Downside risks in the form of a slowdown in China and increased global trade protectionism could add to the list of challenges that Malaysia faces in becoming a developed nation by 2020.