Five years to Vision 2020: Can we get there?

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SONG SENG WUN, executive director and regional economist at CIMB Research in Singapore, will spread some of the benefits he is seeing from a stronger Singapore dollar when spending in his hometown in Sarawak this year-end holiday season. Some of the holiday spending may well end up at a Metrojaya department store, which appears to be employing soft suasion to validate consumer spending, going by a tagline spotted near some of its check-out counters: “I’m not a shopaholic, I am helping the economy.”

With retail sales possibly coming in below the 6% year-on-year growth or RM97.2 billion turnover projected by the Retail Group of Malaysia for 2014, retailers, from department stores to the regular hypermarket and speciality stores, understandably want to see more people shopping and are stepping up efforts to woo a bigger share of the spending spree expected ahead of the implementation of the 6% consumption tax next April before something of a lull ensues.

As it is, Malaysia household indebtedness (87.1% of gross domestic product as at September 2014) is the highest in Asia by the World Bank’s estimates. Having ballooned to RM854.3 billion (86.8% of GDP) in 2013 versus RM243.2 billion (67.2% of GDP) in 2002, the high debt burden is expected to dampen domestic consumption, which helped power Malaysia’s economic growth the past seven years during the easy and cheap credit era brought about by the US Federal Reserve’s recently ended mega stimulus package.

Excluding contingent liabilities, government debt had escalated to RM539.9 billion or 54.7% of GDP in 2013 and is projected to reach RM568.9 billion (52.8% of GDP) this year — so much so that public debt servicing cost is projected at RM24 billion this year, about half the amount originally slated for development spending in 2015, which is expected to be cut for Malaysia to meet its 3% budget deficit target.

That Malaysia has spent around 90% of its revenue on operating expenditure and needs to borrow to fund development expenditure is one reason observers say the government has under-invested on future growth and, thus, lags its more developed peers in terms of competitiveness in knowledge and advanced technology that can lift a country out of the middle-income trap.

 Now, new challenges are emerging as Malaysia enters its last leg to its Vision 2020 high-income nation status. The high level of debt racked up in recent years and the high foreign holdings of ringgit-denominated debt issued by locals, could pose problems to the country’s policymakers even as the US mulls over the timing to begin raising interest rates while Japan and some countries in the eurozone move in the opposite direction. To remain attractive, Malaysia needs to maintain a meaningful interest rate differential to the US and higher yields or cost of debt would hurt the highly leveraged.

“Whilst the high debt level of the country is not alarming, it is definitely an area of concern. Indeed, BNM’s (Bank Negara Malaysia) foreign exchange reserves have been trending down. They had dropped US$14 billion to US$125.7 billion as at Nov 28 from US$139.7 billion as at end-2012. At current levels, they merely cover 1.1 times the nation’s short-term external debt,” says Lim Chee Sing, executive chairman and chief economist at RHB Research Institute in Kuala Lumpur.

The RM8 billion decline in Bank Negara’s reserves in October alone as foreigners withdrew funds from emerging markets, including investments in Malaysia’s equities and ringgit-denominated sovereign debt, is but one sign that policymakers will be tested next year. While Bank Negara’s RM411.7 billion reserves as at Nov 28 are three times the RM147 billion worth of Malaysian government securities (MGS) held by foreigners in October, a sharp decline in reserves could trigger panic and further selling, experts say.

“The balance sheets of sovereign and pension funds, such as Khazanah, the EPF, PNB, KWAP and LTAT, are strong and can lend some stability to the MGS and equities. However, the impact on MGS and equity prices, and in turn the ringgit, would be huge should foreign portfolio investors decide to liquidate their positions in a significant manner within a relatively short time,” Lim says, adding that the possibility of the latter scenario happening is weighing on investor sentiment and consumer confidence. The uncertainties surrounding it would also affect the economic environment, dampening growth.

Be that as it may, CIMB’s Song doesn’t think Malaysia needs to consider taking “extraordinary measures”, such as the capital controls seen during the 1997/98 Asian financial crisis, just yet. “We’re not talking about a free fall in the ringgit... the level of indebtedness is an issue but there are no severe structural concerns leading to a crisis of confidence,” he says.

Taking the Asean chair

Incidentally, as Malaysia takes on the Asean chair in 2015, the country will also be rolling out the eleventh Malaysia Plan (11MP) for years 2016 to 2020, its final five-year plan for the last leg of the race to Vision 2020, introduced by former prime minister Tun Mahathir Mohamad more than two decades ago in 1991.

When asked about the state of the nation, Mahathir says the government’s high wage bill is taking away money that should have been spent on developing the economy. “When you reduce development, then of course you don’t stimulate the economy,” he tells The Edge.

He also believes the government should rein in its borrowings. “Be careful with your finances. I have always been careful with my finances. During my time, I try not to borrow, but I did borrow from the Japanese, but the Japanese charged us 0.7% repayable over 40 years, so it’s like free money. But now we are borrowing at very high rates of interest. And that is not good for the country,” Mahathir adds (see Q&A on Page 64).

With major world economies such as the eurozone, Japan and China struggling to revive growth in a disinflationary environment that will affect their demand for Malaysia’s exports, RHB’s Lim says the country’s “policymakers may need to be proactive in their policy orientation in favour of bolstering domestic demand in support of growth”.

“What is of concern, perhaps, is the sharper-than-expected slowdown in private investment to 6.8% y-o-y in 3Q2014, from a high of 25.8% in 2Q2012. Not only has investment in machinery and equipment (particularly in the transport sector) slowed, we have also seen a slowdown in investment in the property sector after the government introduced measures to cool down property speculation.

“To make matters worse, the rapid collapse in oil prices has caused Petronas to cut its capital expenditure by between 15% and 20% next year and this will snowball into other oil and gas investments in the country. The potential shortfall in oil revenue may affect the government’s ability to spend and support economic growth as well,” Lim says, adding that the key concern for 2015 will centre around the downside risks to economic growth.

It remains to be seen just how much additional discretionary spending will be spurred in Malaysia by the ringgit hovering near its March 1998 low of 2.69 to the Singapore dollar. Tumbling to 2.6802 to the Singapore dollar on Dec 17, the ringgit had depreciated 6.4% in 3½ months from 2.5193 on Aug 28.

CIMB’s Song, for one, will not be surprised if the ringgit momentarily slips past 2.70 to a new all-time low against the Singapore dollar, should oil fall further. The ringgit’s slide against the greenback was even more pronounced, at 11.6% over the same period, from 3.1415 on Aug 28 to 3.5073 on Dec 8.

“Surviving these few months, maybe a year of weak oil prices would be the No 1 challenge for Malaysia in 2015,” Song says. Malaysia — which has about 30% of its revenue coming from national oil company Petronas — will need to not only keep its budget deficit in check but “ensure the overall investment climate remains conducive to foreign investment”, he adds.

While there is some knock-on benefit from improving spending power in developed economies cheering the lower crude oil prices, Malaysia is singled out by economists as Asia’s only loser from lower oil prices because it is a net energy exporter when liquefied natural gas (LNG) exports are included. Prices of LNG, crude palm oil (CPO) and natural rubber — all key commodity exports of the country — broadly track the movements of crude oil, albeit in varying degrees. The

RM12 billion savings from petrol subsidy cuts are likely less than the loss in oil revenue at current Brent crude prices, economists say. The World Bank estimates US$64 per barrel for Brent to be the level fiscal savings from subsidy cuts are wiped out by lower revenue.

“Lower oil prices may also force fiscal cutbacks to contain the deficit from ballooning. Year 2015 has not even started, but is already emerging to be even more challenging than 2014,” says Bank of America Merrill Lynch (BaML) head of emerging Asia economics Chua Hak Bin.

Economists are also split on just how much a cheaper ringgit would boost exports, which in October contracted 3.1% year on year — the first time since July 2013.

The World Bank expects exports to only grow 4.1% next year largely on softer commodity prices — lower than Malaysia’s projection of 6% (RM762.8 billion) and below the 5.4% growth the bank forecasts for this year. The World Bank’s 4.7% GDP forecast for 2015, which was just cut from 4.9%, is also below the official guidance of 5% to 6%.

BaML’s Chua, who expects both investments and exports to weaken, on Dec 16 cut his 2015 GDP forecast for Malaysia to 4.6% from 5%. He also expects Malaysia’s current account deficit to come in at 3.8% next year. In a Dec 16 note, he points out that a 10% decline in oil prices could worsen the current account by 0.1% of GDP and a similar 10% decline in LNG prices could worsen the current account by 0.5% of GDP.

Two sides of the same coin

Minister in the Prime Minister’s Department and head of the Economic Planning Unit (EPU) Datuk Seri Abdul Wahid Omar insists Malaysia can achieve at least 5% growth next year despite Brent crude oil hovering some 43% below the US$105 a barrel that Budget 2015 was based upon.

 “There are always two sides of the same coin. As long as our fundamentals are strong, I believe we will be able to adapt to changing circumstances,” Abdul Wahid tells The Edge, relating how Malaysia has diversified its economy and is expanding its revenue base to cut dependency on oil-related income.

“It is important to note that in Malaysia, we always work on medium-term planning and we always focus on fundamentals. Global equity markets, oil prices and currencies will be subject to market fluctuations but it is our belief that if we focus on fundamentals, in the medium term, things will be okay,” he says.

Even with Brent crude at US$60, Abdul Wahid insists Malaysia’s GDP can grow at least 5%, keep to its 3% fiscal deficit target and retain a current account surplus. At its recent low of US$58.50 on Dec 16, Brent had tumbled 49.4% over six months from its recent end-June peak.

“We’ve reduced our dependency on natural resources and primary-based industries. We’ve moved on to the services sector and manufacturing — these two sectors combined make up about 80% of the economy and that will provide some stability and therefore enable us to achieve decent growth next year,” Abdul Wahid says.

While 76% of Malaysia’s gross exports in 2014 is projected to be manufactured goods, larger than agriculture’s share of 9.1% and mining’s 13.8%, some 12.8% of manufactured goods are from petroleum products while another related sector — chemicals and chemical products — make up another 8.7%, according to Malaysia’s Economic Report 2014/2015. Growth in exports of petroleum products has shored up exports of manufactured goods, with the segment only contributing RM8.97 billion or 4.3% of manufacturing exports in 2005 but the projection for 2014 is RM43.1 billion (12.8%).

Still, Rahul Bajoria, regional economist at Barclays, thinks Malaysia can still meet its projected growth targets. “Lower oil prices do pose a bit of concern over the long term. We see some downside risk to our GDP growth target of 5.5% but we think this is still achievable … private consumption and investment remain fairly robust. Projects such as the Klang Valley MRT are ongoing and expected to continue,” he says.

A minimum of 5% GDP growth is something that Malaysia must generate every year between now and 2020 for it to join the ranks of developed countries in five years.

Commenting on the 11MP, Chua says it should focus on building resilience and investing in its people and preparing Malaysia for a period with permanently lower oil prices.

Widening inequality

In tabling Budget 2015 in October, Prime Minister Datuk Seri Najib Razak spoke on inclusiveness or the need to ensure all Malaysians enjoy the wealth created from the country’s economic growth. This is just as well, given that three recently released studies — Khazanah Research Institute’s The State of Households, the United Nations Development Programme (UNDP) Malaysia Human Development Report 2013 and the World Bank’s Malaysia Economic Monitor 2014 — flagged concerns over inequalities in distribution of income and wealth as well as rising indebtedness hampering wealth accumulation for old age.

The income gap between the rich and the poor jumped 13 times from RM659 in 1970 to RM10,312 in 2012, according to the UNDP report, which also said the income gap between the urban and rural folks widened 11 times from RM228 in 1970 to RM2,262 in 2012. While improvements are seen when conventional measures like Gini coefficient are used, the researchers say the income share of the top one-tenth of the population in 2012 — at 32% — was higher than the 21.5% owned by the bottom 50%, and the gap between them “has remained steady for the past three decades”.

“The problem of household debt among the poor and vulnerable may also turn into debt bondage when it is obtained from informal money lenders,” reads the UNDP report, which concludes that “the majority of Malaysians would be without any savings for more than a decade after retirement” based on the average life expectancy and current levels of savings with the EPF.

Low savings and the inability to accumulate wealth are the result of low income, the Khazanah Research Institute says of the low EPF savings of the bottom 20% of members that are likely to not have adequate savings for retirement. (About 60% of the private labour force contributes to the EPF.)

While withdrawals made for home purchases imply that members have other assets, the fact that more than 62% of EPF savers earn less than RM2,000 a month means there is little left over every month after paying the home and car mortgages, with the rising cost of living. That more than 96% of EPF members earn less than RM6,000 a month also shows most Malaysians are not commanding the kind of high salaries aspired by citizens in a developed nation, observers say.

RHB’s Lim says the inability of the country to move up the value chain is, in part, caused by the shortage of skilled labour due to the brain drain and low wages. “The skills mismatch between labour availability and industry requirement is widening as time progresses and this needs to be addressed in an effective manner. Education and training or re-training — via technical and vocational institutes, polytechnics — are fundamental, but there is also a need to improve the work environment to attract, nurture and retain talent,” he says.

Malaysia needs to make changes to address these issues, say researchers at the World Bank: “Lower levels of inequality can reinforce and accelerate economic growth by increasing social cohesion, reducing political support for more distortionary redistributive policies and creating a large consumer class that generates scale economies for local businesses.”

While Malaysia is confident of achieving the US$15,000 gross national income (GNI) per capita target by 2020, the World Bank says “advanced economies not only have high levels of GNI per capita, but also large middle classes that enjoy a ‘comfortable living’ afforded by the nation’s high income”.

Policymakers are aware of the concerns. Without divulging details of the 11MP, Abdul Wahid says the plan will be comprehensive and address all the pertinent issues, from inequalities in wealth and income to an action plan to maximise the use of the country’s resources (see accompanying story).

Incidentally, the slide in Brent crude oil seems to have stalled at the time of writing, gaining as much as 4.1% to US$63.70 intraday on Dec 18. Sentiment across emerging markets was buoyed by Fed chairman Janet Yellen’s Dec 17 statement that the central bank’s first interest rate hike since 2006 is “unlikely” to happen “for at least the next couple of meetings” and that “monetary policy will still be very accommodative for a long time” even after rates rise.

While Brent went on to close at US$59.44 on Dec 18 — just below the US$60 level that oil prices reportedly need to stay above for shale production to be commercially viable with today’s technology — the Fed’s message provides a temporary respite for Malaysia, which, experts at the World Bank say, needs to de-leverage its balance sheet and expand its social safety net.

“Policymakers know what needs to be done … but politics makes it difficult. GST was mentioned as far back as 1988 and was to be implemented in 1993 and 2007 but was twice deferred. This time, it is being done because it has become necessary,” an observer says.

With only five years to 2020, tough decisions need to be made for Malaysia to move up the competitiveness ladder. Surely, any aspirant to a high-income nation cannot be satisfied being ranked 47th out of 60 countries in terms of productivity in the World Competitiveness Yearbook 2014?


This article first appeared in The Edge Malaysia Weekly, on 22 - 28 December 2014.