Policy Matters - 2016: The economy that was

THE year 2016 has been rather eventful for the Malaysian economy, stimulated by colourful domestic events – not all happy – as well as those prompted by external shocks.

The growth rate, the one big indicator of macroeconomic health, has been crippled. From an average of 5% in real GDP growth, 2016 is likely to see something like 4.2% in 2016. That by itself is not terribly worrying since the overall global climate is experiencing a slowdown.

What is of more concern is the fact that growth in the country is mostly fuelled by domestic demand. That has its limits given the small size of the domestic economy and the length of period over which one can count on domestic demand to push growth. Nevertheless, domestic demand grew by 6.3% in the second quarter of the year, picking up from the 3.6% experienced in the first quarter.

External demand has taken a thrashing in the past months. Growth in net exports was in negative territory in 2015 (-3.8%), sank to -12.4% in the first quarter in 2016, and remained negative in the second quarter (-7%).

Not much good news is expected to emerge on the external demand side for some time now. The Japanese economy is not showing signs of a great pick-up. The Chinese economy is heading for a slowdown, and it is hoped that the slowdown in China is gentle. Europe is, again, not raising one's expectations as being a source of export demand for Malaysia, what with Brexit and the fear of other "exits" occurring. An improving American economy will help spur the export numbers. But the US, even if it will strengthen in a way that will be good for Malaysia's exports, has a flip side that is not positive to Malaysia, a point that we shall return to shortly.

It is, therefore, not surprising that export growth was at 2.7% in the first quarter of 2016, and dropped to 1.4% in the second quarter. Average export growth for the first eight months of this year has been a mere 0.9%. A poor show when compared with the average export growth of 6.3% in 2014. With export growth muddling along, there is some anxiety that if this trend is to persist, the trade balance would shrink.

Against this rather stark background, the rationale for Budget 2017 becomes understandable. The budget was primarily targeted at increasing domestic demand. As a consequence a broad range of stakeholders were provided incentives of various sorts that would have an effect of increasing consumption. These measures included more financial aid being extended under the 1Malaysia People's Aid (BR1M) at an expense of RM2.6 billion; various programmes to increase access to housing, particularly for those in the bottom 40 category; incentives for public servants; RM50 million to train 20,000 graduates to enhance their employability; and infrastructure projects.

While these efforts will increase domestic demand, their appropriateness is questionable. For instance, the intention of extending financial assistance to the B40 runs against the grain of upholding a market-oriented, subsidy-free economy. Then again, once financial aid is provided it will be difficult to withdraw it, and the culture of dependence on the government will be further entrenched. With a bloated civil service, attempts should be made to trim its size and increase its productivity, rather than offer it more incentives. As for graduate employability, the problem should be treated as a structural one, rather than an ad hoc one that is directed at only 20,000 graduates. Although access to affordable housing is a critical problem, the budget hardly addresses its enormity.

Nevertheless, it is noteworthy that the government is committed to fiscal discipline and is determined to close the fiscal gap. The government willy-nilly has to hold on to this benchmark against declining confidence in other areas. A widening fiscal deficit will be detrimental at this point, although if there had been a good record on this score in earlier years it might have been a convenient tool to reach out for.

The rapidly slipping value of the ringgit against the US dollar is another flashing point. Although most emerging markets have been experiencing a drop in their respective currencies against the US dollar, the ringgit has suffered the biggest relative fall in the region. This has been due to a variety of factors including falling commodity prices, weak global economic conditions, high household and public debt, domestic political uncertainties, and a perceived decline in good governance. Although the Malaysian authorities have cleared 1MDB of any wrongdoing, continued reporting in international media, as well as having the matter raised by the US Department of Justice, may have raised questions in the minds of foreign investors.

In the face of the falling ringgit, Bank Negara Malaysia (BNM) has had to remind market players that the ringgit is still not a fully internationalised currency. Thus, Bank Negara has requested non-resident foreign banks not to engage in non-deliverable forward (NDF) related transactions. In restricting NDF trade the central bank is only "re-enforcing" existing rules against offshore trading of the ringgit. However, there are reports that some analysts have been sceptical of the move.

Another measure to curb the falling ringgit has been to impose a requirement that exporters could only retain up to 25% of export proceeds in a foreign currency, while the remainder must be converted into ringgit. Bank Negara has stated that exporters are free to convert currency to meet up to six months of loan obligations not denominated in ringgit. The central bank has stoutly denied claims of these measures being tantamount to capital controls or being "proxy" capital controls. Nevertheless, they are interventions in the market and do disrupt the decision making process of exporters and could result in resource allocation patterns that are not optimal to individual exporters.

But what is to come in 2017 need not be comforting. The Trump administration may roll-up the TPPA, making it necessary to seek other ways of increasing trade and investment, the growth of both variables being crucial to the Malaysian economy at this juncture. However, that is not all that induces pessimism.

The Fed decision to hike interest rates on Dec 14, 2016 was, perhaps, not in Malaysia's favour. Fed rate hikes are not the most eagerly anticipated events for Malaysian markets, particularly with the ringgit on the slide. The hint that there may be at least three rate hikes to come in 2017 is certainly not welcome news. This raises the threat of the ringgit sliding to RM5.00 against the dollar.

The year 2017 may not be a rosy year for the Malaysian economy. Taking a pessimistic view, the growth forecast could slip to the range of 4-4.2% for the next year. It may help that the fuzzy edges of oncoming negative news can be vaguely seen in the distance. One can take solace in the fact that there may not be any unpredictable surprises that may shock the economy. It is easy to count on Malaysia's seasoned and expert policy makers to manage the predictable shocks.

Shankaran Nambiar is author of the recently published book, Malaysia in Troubled Times. Comments: letters@thesundaily.com