Economic outlook for 2H09:Light at the end of tunnel?

Tags: MARC | Nor Zahidi Alias | outlook

Written by Nor Zahidi Alias

Wednesday, 01 July 2009 11:25

What started as an external shock for Malaysia has now cascaded into the domestic economy. As has been the case with most Asian economies, plunging exports led to massive cutbacks in production, resulting in weakened labour markets on increased layoffs particularly in the manufacturing sector. Following a contraction in domestic demand due to the weakening of private consumption, the economy contracted sharply in 1Q09 and is expected to experience an outright recession this year, its first since the Asian financial crisis.

Notwithstanding, the prospects for the second half of 2009 (2H09) and 2010 look more encouraging as improving global economic conditions will provide the impetus for an open economy like Malaysia.

On the domestic front, private consumption, while struggling to revive, will gain strength following better prospects in the labour market. The Malaysian ringgit will get some reprieve from a weakening US dollar (USD) as risk aversion diminishes. Monetary and fiscal policies are likely to remain status quo as policymakers try to gauge the impact of past measures.

Concerns that budget deficits could affect Malaysia’s macroeconomic landscape have been exaggerated given its favourable fundamentals.

Growth: Firmerrecovery in 2010
We foresee the economy shrinking by 3.8% in 2009 as opposed to our previous forecast of a 1.5% contraction. The latest revision is primarily based on the following factors — more severe contraction in exports and weaker-than-expected domestic demand.

The vulnerability of Malaysia’s external sector arises from its heavy dependence on electrical and electronic products (E&E)

segment which accounts for as much as 38.3% of its total exports. As such, a meaningful recovery in global demand for semiconductor products is critical for Malaysia’s export sector.

In addition, two other important export components — oil-related products and palm oil — are not likely to grow significantly as in early 2008 when prices hit all-time highs. In addition to the external sector, domestic demand has played an important role in magnifying economic weakness in 1Q09.

Notwithstanding that, a mild recovery in global economic activity, as envisaged by the World Bank and the International Monetary Fund (IMF) will lead to a rebound in the country’s exports. Moreover, the impact of the government’s RM67 billion fiscal stimulus will take effect in late 2009 and the first half 2010. As such, we foresee a milder contraction of 1.6% in the 2H09 before rebounding by 3% in 2010.

Private consumption will slowly gain strength
The contraction in private consumption in 1Q09 convinced us that consumers will no longer be able to withstand economic shocks associated with the crash in external sector.

Private consumption, an important pillar against a sharp downturn in economic activity, is now feeling the brunt of a deteriorating labour market particularly in the manufacturing sector which registered a 7.7% decline in 1Q09.

The significant drop in the level of consumer spending from +5.3% in 4Q08 to -0.7% in 1Q09 signified the sudden shift in consumers’ attitude towards spending. In addition, forward-looking indicator such as the MIER consumer sentiment index (CSI) has remained at near historical low since 3Q1998 while the MasterCard Worldwide Index of consumer sentiment recently dropped to the lowest level since 1H01.

Going forward however, we expect the deterioration in private consumption to moderate as labour market condition stabilises. Slowing inflation will also boost consumers’ appetite for spending.

Against such a backdrop, although we anticipate private consumption to grow at a much slower pace of 2.4% in 2009, we foresee it rebounding and registering a positive growth of 3.9% in 2010.

External sector willbenefit from improvement in global trade
The outlook for E&E products, Malaysia’s major export component, remains murky as global appetite for semiconductor has yet to improve. This is despite the recent improvement in two important forward-looking indicators for the sector: the US book-to-bill (BTB) ratio which rebounded from its low of 0.47 in January this year to 0.74 in May; and Institute of Supply Management’s (ISM) new orders index which recovered from its low of 33.1 in February to 51.1 in the recent month.

Nevertheless, we are of the opinion that it is too soon to conclude a meaningful recovery in export sector in 2H09 is underway, considering the unusual nature of the current economic cycle.

Improving global economic conditions envisaged in 2010 will help Malaysian exports to register a positive growth following an expected 11.2% contraction in 2009. With the collapse in imports, higher surplus in merchandise balance will likely result in another year of huge current account surplus.

Further improvement in the financial account will come on the back of a smaller net outflow of portfolio investment. This is evidenced by the first quarter statistics which showed a RM9.2 billion net outflow, as opposed to RM37.6 billion in the 3Q08.

Ringgit to gain fromweaker greenback
Weaknesses in Malaysia’s macro performance following the global economic crisis has led to a sharp depreciation in ringgit against the USD between December 2008 and March this year. The ringgit fell from as high RM3.13 in April 2008 to as low as RM3.73 in March this year, almost to the level it was pegged against the greenback in 1998.

However, since other major currencies also weakened excessively due to global economic malaise, the ringgit has not moved significantly against currencies like the Singapore dollar (SGD), Chinese yuan (CNY) and Thai baht (THB).

The outlook of ringgit is closely linked to the prospects of the greenback. We do not foresee a collapse in USD as some are predicting due to the fact that an excessive weakness in the greenback is not in the interest of not only the US but also other countries like Japan and China which are heavily invested in US Treasuries.

In addition, there are no other currencies or asset classes large enough to absorb the amount of global liquidity without creating another bubble. Against such a backdrop, we foresee a slight appreciation of the ringgit against the greenback as risk aversion among investors continues to abate.

Based on Nominal Effective Exchange Rate (NEER), the ringgit is about 3% undervalued against its major trading partners. Looking from a technical side, although the ringgit is about to break its short-term downtrend channel against the greenback, a downward breakout of the head-and-shoulder formation may bring the ringgit to RM3.37 in the medium term especially if net inflows into the financial market improve by the end of the year. We foresee a range of RM3.35-RM3.55 for the ringgit against the USD in the next six months.

Future policy response
We see a limited possibility of monetary intervention following an anticipated recovery in the global economy. As economic contraction becomes milder in 2H09, Bank Negara Malaysia (BNM) will leave its policy rate at the current level of 2% well until next year.

In addition, the authority has made it clear that it does not favour an extremely low interest rate environment. As mentioned, BNM is focused on ensuring credit availability rather than on the absolute financing cost.

Judging by recent government rhetoric to be more fiscally prudent in the medium term, there is also less likelihood of using fiscal policy to support the economy. This is not surprising as government budgetary position has been in the red since the Asian financial crisis in 1998.

We opine that the government’s projected budget deficit will exceed 7.6% of GDP as economic contraction will be more severe than had been originally expected. On that score, we think the government will take greater effort to trim budget deficit starting 2010 when economic recovery becomes firmer.

Budget deficit andsovereign rating
We beg to differ in respect of concerns on the budget deficit that certain quarters have taken into consideration in evaluating the country’s sovereign ratings.

First and foremost, the speed of reduction in budget deficit since the Asian financial crisis has been almost the same as other regional countries. The likely reason that Malaysia is still incurring a deficit is because the country had a bigger budget gap to start with in 2000.

Secondly, one of the plausible explanations for Malaysia to experience budget surplus in the mid-1990s was related to its high economic growth which averaged around 9% during that period — meaning that the growth has to be robust enough to put the budget back on track. Since Malaysia’s average growth has declined to an average 5.5% between 2000 and 2008, naturally the deficit could not be eliminated.

The question now is whether the deficit should be reduced through efforts to stimulate growth or measures to cut spending. Our fear is that measures that are meant to cut spending will dampen overall growth of the economy.

Thirdly, Malaysia’s macro condition remains generally healthy. For instance, international reserve position remains huge and sufficient to cover retained imports by more than eight months, way above the required level of three months, while external debt level stood at 31.8% of GDP in 2008 (1997: 57.6% of GDP), relatively low by historical standards. In addition, the fact that Malaysia is highly integrated with the global economy also reduces moratorium risk, the risk associated with the country’s decision to stop servicing its foreign debt. This is a stark contrast to a country like Argentina, which defaulted on its US$132 billion (RM464.64 billion) debt in 2001 and imposed moratoria on its foreign debt services.

This article appeared in The Edge Financial Daily, July 1, 2009.

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