Friday 29 Mar 2024
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This article first appeared in The Edge Malaysia Weekly, on November 30 - December 6, 2015.

 

For years, Malaysia’s economic rhetoric and policymaking have been preoccupied with reducing the national fiscal deficit. But the release of the central bank’s report on the country’s third quarter (3Q2015) performance has raised the spectre of a less-talked-about deficit — the one of the current account.

Conversations about this possibility were renewed after Bank Negara Malaysia reported a dwindling surplus in the national current account for the second consecutive quarter.

In 3Q2015, Malaysia’s current account surplus stood at just RM5.1 billion, falling from the second quarter’s RM7.6 billion to its lowest level since 2Q2013. This brings the total surplus for the first nine months of the year to RM22.6 billion, just slightly more than half of the RM41.7 million achieved in the same period last year. Barring a brief growth spurt at the start of this year, the current account surplus has been declining since 1Q2014.

Also, compared with Thailand, the Philippines and Singapore, Malaysia’s current account surplus-to-GDP ratio in 3Q2015 was lower (see  Table 1).  

Before taking any of these facts as a forecast of deteriorating economic health for Malaysia, it is worth taking a close look at what the current measures are and where the country is falling short.

In a nutshell, the current account has three components — the difference between the value of Malaysia’s exports and imports, net income from investments abroad (primary income) and net current transfers (secondary income).

Of the three, Malaysia’s strength in trade has often been credited with keeping the current account in surplus. Bank Negara reported that in the third quarter, Malaysia’s gross exports registered an expansion of 5.5% compared with a contraction of 3.7% the quarter before, thanks to growth in manufactured exports — electrical and electronics and non-resource-based products. Exports to the US and China, in particular, stood out as they grew 20.3% and 25.7% year on year during the quarter. Gross imports saw a 2.9% growth compared with a 5.2% contraction in 2Q2015.

Much of the revival in exports was due to the depreciation of the ringgit, says Dr Yeah Kim Leng, the dean of Malaysia University of Science and Technology’s School of Business. As long as exports remain healthy, talk of a twin deficit is premature, he adds.

“The likelihood of a deficit in the current account is lower now that we have a weaker ringgit, exports are cheaper and imports are more expensive. The concern that Malaysia will have a twin deficit in the short term may be exaggerated.

“I expect that in some months, Malaysia may see lumpy imports, such as aircraft and heavy machinery, and a spike in consumer good imports. But that deficit effect would be temporary and, on the whole, the current account should still be in surplus,” Yeah explains.

It is encouraging that Malaysia can keep its exports up despite its major trading partners facing slower economic growth and commodity prices trending downwards but trade resilience alone is not enough to ease Malaysia’s twin deficit fears.

To start with, Malaysia cannot always count on exporting itself into a surplus because most of what it sells are low value-added products. Economists warn that the mileage Malaysian goods have over low-cost manufacturing economies like China will erode, especially as the latter seeks to turn its export-centric economy into one that is driven by domestic consumption. For instance, China will manufacture component parts rather than assembling imported parts. In other words, Malaysia’s biggest customer could become its biggest competitor.

“We need to have higher value-added products in our exports … that are not easily substituted by competitors … Without any significant change in the structure of our economy, I am afraid a current account deficit is likely in the future, although not as soon as 2016,” says an economist, adding that efforts to push exports up the value chain and investment in R&D have so far been lacking.

That aside, Malaysia has a persistent deficit in its services trade balance. The last time the country saw a surplus in this area was in the third quarter of 2011. Indeed, a widening deficit in the services trade balance can hurt. Bank Negara pointed to a larger deficit of RM5.9 billion in 3Q2015 compared with RM4.6 billion in the preceding quarter as one of the reasons for the narrowing current account surplus. A “lower travel surplus amid higher outbound travel” takes the blame for 3Q2015.

Things might not look better as travel industry players are expecting Malaysia to miss the tourist annual arrival target of 29.4 million this year. The worry is that the prospects for achieving the target of 36 million in tourist arrivals and RM168 million in tourist receipts by 2020 may be bleak due to factors like the triple air tragedies, Malaysia Airlines Bhd’s route rationalisation and a weaker ringgit eroding the tourism ministry’s marketing budget abroad.

Trade, while in surplus, is unlikely to be the biggest threat to the current account. Data shows that the primary and secondary income accounts have been in deficit for the last five years, indicating that Malaysia is seeing more funds flow out of the country than in. In 3Q2015, income accrued by Malaysian corporations from investments abroad was disappointing, hence the primary income account’s deficit doubled to RM10.3 billion from a quarter ago. On the other hand, income accrued by foreign companies in Malaysia remained sizeable, especially in the manufacturing and services sectors.

At the same time, current transfers (primarily remittances by the migrant workforce) in 3Q2015 were broadly sustained at a deficit of RM5.9 billion. But the expectation is that the secondary income deficit will grow rapidly in line with the country’s requirement for labour in the construction, agriculture and manufacturing sectors. Already, migrant remittances have grown fourfold in the last seven years to RM32 billion.

Countries like the Philippines have shown that remittances can be a powerful source of fund inflow. Last year, the country received US$26.9 billion of personal remittances — an all-time high — which accounted for 8.5% of GDP.

The opposite was true for Malaysia with remittances boosting a fund outflow. This  shows that the country has not benefited much from the remittances of its citizens working abroad.

Yeah says the numbers are not showing a serious capital flight from the country, although the risk is “ever present”. “Liquidity has tightened but there is no indication that capital flight is systemic in nature so far.”

IHS economist Rajiv Biswas takes the view that factors such as the US Federal Reserve’s interest rate policy and further deceleration of Chinese economic growth could exacerbate the situation, although it is a problem facing most emerging markets.

Perhaps, as an acknowledgement of the risk of further capital outflows, Prime Minister Datuk Seri Najib Razak asked government-linked companies to cash in their foreign investments and repatriate profits to Malaysia. The rationale was that a weaker ringgit gave companies with substantial assets abroad the opportunity to capitalise on foreign translation gains when bringing funds home. However, a challenging operating environment, especially in the oil and gas and services sector, caps the potential of huge returns.

Yeah also reckons that corporations will only repatriate profits if they “see a better business or investment opportunity in Malaysia”.

To stem further outflow, the government is looking to set up a mechanism to limit migrant remittances but MIDF Research says the effort would be better spent on reducing the country’s dependency on a migrant labour force. Malaysia currently has 2.2 million documented migrant workers.

“The economic growth model of cheap labour cannot be the engine of growth in the future and will not enable us to compete at global level because technology is becoming cheaper and more efficient compared with low-skilled labour,” it adds.

The consensus among economists is that Malaysia will see another year of current account surplus, although in a smaller amount. But the risks of deficit are plain. A current account deficit creates the uninviting prospect of Malaysia borrowing more to fund its future growth. Policymakers should probably not go down that slippery slope because there is no saying when the country will recover.

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