Friday 29 Mar 2024
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ANXIETIES about future crude oil price trends have sent financial markets on a roller-coaster ride in recent months. Rising volatility in the equity, bond and currency markets has raised concerns over the impact on business sentiment, capital flow and interest rates, exerting pressure on macroeconomic conditions, especially in oil exporting countries.

Malaysia is not exempted from this. As it is a net crude oil exporting country, policymakers recently responded with revisions to the budget for 2015 that was unveiled last October, when crude oil was about US$100 per barrel.

The revision seems to have polarised public opinion. Some have applauded the government’s initiative, calling it a timely response to the changes in macroeconomic conditions as a result of the steep fall in crude oil price (at roughly US$50 per barrel, it will affect the government’s expenditure plans and its sources of revenue). Others have questioned certain components of the new budget and the revised targets set by the government.

If one were to examine the issue objectively and from a purely economic perspective, a crucial fact stands out — the review reflects the government’s approach to seeing things from a realistic viewpoint. This is positive from a credit rating agency’s standpoint.

Regardless of the new forecasts and targets that are being set for real GDP growth, revenue, expenditure and the budget deficit, the proactive approach in dealing with the reality of current market conditions should be welcomed. Think about how negative things would be if the government were unresponsive to the current developments that affect its budgetary position.

Whether the new projections materialise should not be overly debated, although economists, being economists, would have to do their job of scrutinising and providing their views on them. The fact remains that the situation is extremely “fluid”, as often described by economists, which is to say that the direction of the oil market is uncertain and that the impact of the divergence in policy direction between the US and the rest of the world will keep the financial markets on a bumpy ride, possibly throughout the year.

This will have implications for the macro outlook for the Malaysian economy this year. All in all, who is to say which direction is right or wrong? After all, the last time analysts, traders and economists mentioned the possibility of oil prices hitting US$200 per barrel, in early 2012, the market shocked them with price levels that went beyond their wildest imagination — less than US$50 per barrel recently.

What is more critical is not just 2015. It is the medium-term outlook and perspectives that can shape the Malaysian economy going forward. A single macro parameter loses its value, especially when seen within a short time frame.

The budget deficit, for instance, should be viewed from the perspective of its trend, economic cycles and sources of financing rather than by its magnitude and ratio alone. Deficits are supposed to increase when economic conditions worsen and decrease when the latter improve.

A temporary increase in the deficit does not imply any material change in economic fundamentals, although some media often put it in a different light. Just look at how the budget deficit of the US jumped to 10% of its GDP during the recent downturn and how it is now back to only 3% after the recovery.

But for Malaysia, even if the budget deficit were to climb from the initial target of 3% of GDP to, say, 3.5% of GDP in 2015, it should not be any cause for alarm. In the first place, the budget deficit trend in the past years has been encouraging, dropping from as high as 6.7% of GDP in 2009 during the global financial crisis.

Granted, it could have been reduced at a faster pace, but gambling with the possibility of generating slower economic growth if expenditure were reduced drastically also has its risk. An important question to ask is, will a budget deficit really have the adverse effects — high inflation, rising interest rates and high external debt — that economists invariably fear?

In Malaysia’s case, this has hardly happened, judging from past experiences. While domestic debt is undoubtedly of concern at this juncture, public external debt remains miniscule compared with that of other countries.

As for government expenditure, the fact that it was not slashed to the levels expected by some economists means that generating sufficient growth is the focus of the policymakers. This is to enable the government to achieve other macroeconomic targets. A significant decline in growth, for instance, will not only derail the amount of revenue the government hopes to generate but also boost the deficit and government debt ratios.

Juggling the need to avert a significant drop in nominal and real GDP and to curb unnecessary expenditure calls for cautious culling. This is partly why development expenditure was not touched in the budget review as it is considered an engine of future economic growth.

Of course, there are issues that have raised eyebrows, for example the current account (of the balance of payments). It is true that the current account entering deficit territory is a distant possibility, even if the current trends in trade performance persist.

While it may shrink throughout the year, especially if commodity prices remain depressed, it will likely take significantly adverse global trade conditions to bring it down to negative levels this year. Notwithstanding this, if history is any guide, the financial market may not be as considerate. Any significant downward movement in the trade balance (and hence current account surplus) will put Malaysia back on financial investors’ radar screen and induce capital outflow. The ringgit will once again bear the brunt of it.

On the whole, there is still lack of visibility in terms of the future direction of the oil and financial markets as well as the global economy. However, being less dependent on oil revenue and getting rid of the addiction to fuel subsidies are the right steps in strengthening the long-term macroeconomic foundations of Malaysia.

There will be short-term pain, no doubt, but long-term benefits are surely on the horizon?

Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd

This article first appeared in Forum, The Edge Malaysia Weekly, on February 2 - 8, 2015.

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