Strong economy gives ample room for Malaysia to make changes for growth sustainability over the long term

THE Malaysian economy is looking up – at least as far as the headline numbers suggest.

Growth in recent quarters has been impressive, and indicators are pointing to continued expansion through 2018, albeit at a slower pace, due in part to an unfavourable base factor.

But as some experts claim, headline numbers such as the gross domestic product (GDP) growth rate can sometimes be misleading, as they belie some of the underlying weaknesses a country faces. And these are challenges that need to be addressed through structural reforms, lest they pose a negative impact on the country’s long-term growth potential and economic competitiveness, and ultimately, the well-being of the rakyat.

The World Bank, in its latest semi-annual Economic Monitor Report on Malaysia, says the current strong growth environment offers an opportunity to focus on structural reforms that will facilitate the country’s transition towards a high-income economy in the coming years.

“With the more favourable domestic growth outlook over the coming years, there is a window of opportunity for Malaysia to increase its initiatives to address the deeper structural challenges that limit the economy’s growth potential,” the World Bank says.

“A key area of policy focus is measures to increase productivity growth and strengthen competitiveness, as Malaysia faces diminishing returns from its factor-accumulation-led growth model,” the global development institution argues in its report entitled “Turmoil to Transformation: 20 Years after the Asian Financial Crisis”.

It explains that reforms to enhance productivity could be intensified to address the key constraints, such as a lack of competition in key markets and critical human capital and skills deficits.

In addition, it says it is also important for Malaysia to continue to implement measures to ensure that “growth is inclusive and provides access to opportunities for all its citizens”.

“While Malaysia has made good progress in sustaining economic growth and reducing poverty in recent years, there remain concerns regarding the distribution of economic gains and the perceived inequality of opportunity,” the World Bank says.

“Continued efforts to raise the rate of productivity growth and create high-quality jobs are especially critical as Malaysians aspire to become a middle-class society,” it adds.

As for managing Malaysia’s persistent fiscal deficit, the World Bank argues, “achieving a near-balanced federal budget over the medium term would necessitate a second, deeper wave of reforms to enhance revenue collection and improve public sector efficiency.”

It explains that while Malaysia has successfully implemented a series of fiscal reforms to narrow the deficit through a range of revenue diversification and expenditure rationalisation measures since the 2008/09 Global Financial Crisis and the 2014 oil price slump, further fiscal adjustments in the coming years will become increasingly challenging, as the scope for further reductions to operating expenditures narrows, the goods and services tax collection plateaus, and stabilising oil prices limit oil-related revenue growth.

Similarly, economist Lee Heng Guie says further reforms are necessary, after having already picked most of the low-hanging fruits of reforms, to unleash Malaysia’s potential.

“While commendable reforms have been achieved in the areas of fiscal, financial and corporate sectors, Malaysia needs to strengthen ongoing structural reforms as well as stepping up the reforms to boost the country’s growth potential.

“This would improve the sustainability of growth over the medium run and help to accelerate the country’s transition to a high-income nation,” says the executive director of the Socio Economic Research Centre.

Lee points out that structural reforms to increase productivity, foster competition and liberalisation as well as balanced development are needed to ensure the growth inclusiveness.

These will require measures to improve the labour market’s functioning, the quality of education, vocational skills training and upskilling, promote innovation and the adoption of digital and information technology.

He notes boosting productivity growth is essential to raise competitive and overall living standards.

“Achieving high-income status is meaningless without making the growth more inclusive,” Lee says.

Hence, he calls for reforms to raise the income and opportunities of the Bottom 40 households with respect to access to quality education and employability, social safety nets and income protection to support the vulnerable groups when the economy and labour market softens.

Other helpful initiatives include those that encourage the participation of women in the labour force, providing affordable and equitable healthcare, sustaining the viability of pension adequacy for retirement and the inclusiveness of the tax, transfer and subsidy system based on needs and merits.

As for the private sector, Lee points out that the regulatory and policy framework must be further streamlined to ease the cost of doing business and lower the compliance cost, while fostering competition for small and medium-sized enterprises, and facilitating economic and business integration with foreign players. This will help private-sector growth.

Malaysia is now on a solid springboard from which to grow its economy into 2018.

With both the domestic and external engines firing, the country’s GDP is expected to grow between 5% and 5.5% next year, according to the Government’s forecast.

Predictions by most private-sector economists also fall within the range of the official forecast.

For instance, Lee expects Malaysia’s 2018 GDP growth to be 5.1%, while the World Bank, CIMB Research and RHB Research Institute expect a growth of 5.2%. Maybank Investment Bank Research, on the other hand, pegs its 2018 growth forecast at 5.3%, while Nomura Research and AmBank Research expect growth to reach 5.5%.

What’s clear is, economists are in consensus that the pace of growth next year will be slower than in 2017.

They attribute the slower pace of growth next year in part to the “technical” high base effect from 2017. In addition, economists say, it also reflects the moderate export growth expected for 2018 as well as slower public spending in line with the Government’s fiscal consolidation drive.

In general, private-sector spending will underpin growth next year, supported by continued growth in exports, albeit at a slower pace.

These are similar factors driving Malaysia’s economy in 2017.

According to Bank Negara governor Tan Sri Muhammad Ibrahim, the country’s economy is poised to register strong growth that is close to the upper end of the official target of 5.2%-5.7% for 2017.

Muhammad made an argument recently that it was even possible for the country’s full-year growth to exceed 5.7% following three consecutive quarters of impressive GDP growth. He, however, is cautious of external risks.

Malaysia saw its GDP expand at the fastest pace in three years at 6.2% for the third quarter of 2017, compared with 5.8% in the preceding quarter and 5.6% in the first quarter of the year.

The robust third-quarter performance has prompted several upward revisions on the full-year GDP growth forecast by private-sector economists.

Among institutions that expect Malaysia’s 2017 GDP growth to exceed the official forecast are the World Bank, Nomura and Maybank, which have projected a full-year expansion of 5.8%, as well as TA Research, AmBank and CIMB, which expect the number to be 5.9%.

Higher interest rates

With economic growth looking more entrenched, and inflation staying at a manageable level, Bank Negara is widely expected to raise the overnight policy rate (OPR) next year.

The timing of the potential rate hike, though, remains a debate.

Some economists such as Euben Paracuelles of Nomura expect the central bank to increase the benchmark rate, which commercial banks refer to in pricing their lending rates, by 25 basis points to 3.25% as early as January.

In a recent note, Paracuelles says the expected rate hike is driven mainly by concerns over financial imbalance risks.

“Recent strong GDP growth prints have likely opened a window for Bank Negara to normalise its accommodative monetary policy stance in January, which would coincide with the disbursement of a number of cash handouts announced in the 2018 budget,” he says.

“We believe this window will close after January due to the upcoming general election (GE),” he adds.

Paracuelles argues that rate hikes after the GE are unlikely because the Government will be forced to sharply tighten its fiscal stance to meet its 2018 fiscal deficit target of 2.8% of GDP after front-loading spending ahead of the election.

The 14th GE (GE14) is expected to be held sometime between March and May. The deadline for GE14 is August 2018.

Separately, rate hikes by the US Federal Reserve (Fed) are also putting pressure on other central banks to raise interest rates.

The US Fed has raised its interest rates from 1%-1.25% to 1.25%-1.50%. That was the third rate hike this year, and the fifth since late 2015, after keeping them near zero for seven years.

Next year will likely see the US Fed implementing three more rate hikes, bringing the interest rates to 2%-2.25% by year-end.

Appreciating ringgit

Anticipation of a rate hike by Bank Negara, coupled with improving crude oil prices as well as an increasingly positive outlook on Malaysia’s growth, have been a boon for the ringgit.

Having appreciated by about 10% against the US dollar since the start of 2017, the local currency stands as one of the top gainers in Asia.

The ringgit was quoted at 4.0858 against the US dollar yesterday.

This compared with 4.4975 against the greenback in the beginning of this year.

Economists believe there is still room for the ringgit to appreciate further against the weakening US dollar, potentially breaking below the psychological level of 4.00 against the US dollar next year.

UBS Investment Bank, for one, expects the ringgit to reach 3.90 to the US dollar by the end of 2018.

This, it says, will be underpinned by improvement in domestic demand and a hawkish interest rate outlook, and supported by higher inflows of foreign direct investment.

Similarly, RHB expects the ringgit to trade around 3.95 against the greenback by the end of next year.

It says the strengthening of the ringgit next year will likely be driven by Malaysia’s current account surplus, Bank Negara’s hawkish sentiment, and a resilient domestic economy as well as US dollar weakness.

UOB Malaysia, on the other hand, sees the local currency trading in the range of between 3.90 and 4.05 versus the dollar next year.

According to Nomura, Malaysia’s current account surplus next year will remain supported by the rise in oil prices and robust exports. It expects Malaysia’s current account surplus to be 2.5% of GDP next year, slightly down from the estimated 2.7% of GDP for 2017.

“As a net exporter of oil (0.3% of GDP) and an even larger net exporter of liquefied natural gas (2.6%) – the price of which is closely linked to oil – Malaysia stands out as a clear-cut winner in the region from higher oil prices,” Paracuelles says.

“We estimate that every US$10 per barrel increase in oil prices would widen the trade surplus by about 0.4% of GDP. However, we believe any boost to the trade surplus from higher oil prices would be offset by higher capital goods imports, as the Government will likely use the opportunity to increase public-sector investment,” it explains.

Crude oil prices have been on a recovery mode in recent months.

The US Energy Information Administration expects the benchmark Brent crude to average at US$53.88 per barrel in 2017, and US$57.26 per barrel in 2018.

Positive news is all around. Unfortunately, the man on the street and even businesses are not feeling any better off, and that is one thing that needs to be addressed to ensure that the positivities are filtered down to the masses.