Malaysia: Struggling to get out of the loop Asia Pacific Economic Outlook, Q4 2016

Malaysia may not perform as robustly this year as in the past few years. Its Q2 GDP growth was the slowest since the global financial crisis hit the economy in 2009, and macroeconomic fundamentals are under stress. In such a scenario, will the central bank step in with measures to help the economy maintain growth? More importantly, can such measures mitigate the effect of external factors pushing down growth?


Special Topic: ASEAN Economic Community

The Philippines

Malaysia’s economic growth is moderating. The outlook is muddled by political and global factors, and strong economic performance seems unlikely this year despite resilient domestic demand. While the Bank Negara Malaysia (BNM) announced an unexpected rate cut in July to support consumer spending and investment, it may decide not to ease monetary policy further for the rest of the year to contain risks emerging from highly leveraged households and capital outflows.

Macroeconomic fundamentals under stress

In Q2 2016, GDP increased at the slowest pace since the global financial crisis hit the economy in 2009. Annual growth slipped to 4.0 percent in Q2, extending the trend of slowing growth to five straight quarters. Net exports and the agricultural sector continued to be a drag on growth, although a sharp run-down in inventories also contributed.

Domestic demand continued to remain resilient, and grew 4.9 percent year over year. Private consumption grew 6.4 percent in Q2 due to continued income growth and a government stimulus program for low-wage employees. The growth in consumption was primarily driven by spending on food and beverages, transportation, and communication. Fixed investment growth saw a sharp jump in Q2, from 0.1 percent in Q1 to 6.1 percent in Q2, the fastest increase in the past five quarters. Growth was primarily driven by a strong revival in machinery and equipment investment. Both public and private sectors registered strong investment growth, with public spending contributing the most to growth in Q2. That said, growth in investment has remained highly vulnerable since late 2014.

The external sector continued to remain a worry as net exports of goods and services contracted for the second consecutive quarter. Exports recovered marginally and grew 1.0 percent in Q2. However, global uncertainties and weak demand continued to weigh on trade prospects. Right now, the current account surplus is at record low levels. Net exports are expected to remain a drag on growth this year, as sluggish global trade will limit export opportunities.

The external sector continued to remain a worry as net exports of goods and services contracted for the second consecutive quarter.

The other worry is that of rising fiscal deficit as the government boosts spending to prop up growth. The government has been spending robustly on infrastructure, while revenues from corporate taxes, goods and services taxes (GST), and oil continue to disappoint. Over the past year, both government consumption and investment have increased significantly to support growth. In addition, the government will likely have to take responsibility for the debt held by the state-owned 1Malaysia Development Bhd. (1MDB), which defaulted on a $1.75 billion bond. A part of the borrowed sum is guaranteed by the Malaysian government, and repayment of the debt will likely increase the risk of fiscal slippage this year. The fiscal deficit may widen and could be 0.5 percentage points higher than the projected deficit of 3.1 percent.

One more risk is that of high household debt, which may weigh on future consumption spending. The household debt-to-GDP ratio has increased by 1.5 times between 2008 and 2014, from 60.4 percent to 89.9 percent. Favorable credit conditions reinforcing high consumer demand led to a ballooning of household debt during this period. On the other hand, financial assets to total household debt have been falling steadily. Non-performing and impaired loans for personal use increased by over 32.0 percent year over year, while for credit cards, they increased by over 7.0 percent year over year in July 2016. All this indicates that overleveraged households are at risk and may pose a threat to growth.

However, there is a silver lining to the data. The industrial production index jumped 5.3 percent year over year in June, which is the fastest growth rate since July 2015. The growth was fairly broad based, which suggests the economy remains resilient. At the same time, the consumer price index fell to a 16-month low in July.

Monetary policy to the rescue

Emerging risks, such as a weaker external position due to lower oil prices and weakened global trade, excessive leverage of key sectors, and pressure on public finance are impacting the economic outlook for Malaysia. In addition, external factors such as China’s slowdown, poor demand growth in advanced countries, volatile capital flows, a potential Fed rate hike, and Brexit are also adding to the uncertainty. The economy needs policy initiatives to counter the repercussions of external headwinds.

However, there is limited room for the government to act in order to boost the economy, as it may fail to meet its deficit target as budgeted for the year. With the expectation that the government may keep a tight rein on spending, the central bank may try to step in through monetary policy easing to revive growth prospects. In fact, BNM surprised the market when it announced a rate cut in July for the first time in seven years in a bid to keep the country on a “steady growth path.” Low inflation rates and a relatively strong currency also helped the BNM to ease monetary policy.

The interest rate cut by BNM in July is likely to provide some support for private investment and household spending. That said, the BNM will remain cautious about providing additional stimulus to the economy this year, as it may result in excessive leveraging in the highly indebted household sector. Besides, too much easing might give the wrong signal to investors and increase the risk of capital outflows.