The economic truth

(© Sanja Gjenero/sxc.hu)

FOR many Malaysians, the economy is about putting food on the table, keeping the children in school, ensuring business is profitable, and saving for the future.

But we are very much affected by global price fluctuations, especially in regards to oil and food prices. As such, the sudden increase of petrol and food (especially rice) costs in June 2008 was a shock to the system. Yet, even as the inflation rate edged upwards to a 26-year high, our politicians seemed preoccupied with other concerns, namely staying in power after the 8 March general election results.

The government claims the country’s economic fundamentals are sound. Apparently, it is the Pakatan Rakyat’s plans to take over the government that is causing instability, and hence affecting investor confidence. The opposition camp, meanwhile, blames the ruling government for weak policies that do little for the rakyat and investors.

The Nut Graph speaks to Dr Yeah Kim Leng, group chief economist at RAM Holdings Bhd, Malaysia’s premier rating agency, to examine the political rhetoric and provide a clearer picture of what’s happening to our economy. He also explains how the present financial crisis differs from the situation we faced in 1998.

TNG: Datuk Seri Anwar Ibrahim says the Barisan Nasional (BN) government has not done enough for the economy, while the BN says Anwar’s takeover threats have destabilised the country and caused investor flight. How much of either claim is true?

Yeah: Whether the government of the day has done enough or not depends on whether you see the glass being half full or half empty. Economic development is a neverending process. And the government has been doing things; so given this perspective, the Pakatan is looking at the glass half empty.

The Pakatan Rakyat is also incorrect in the sense that Malaysia’s economic progress and achievements have been recognised by global institutions like the World Bank.

Malaysia has overcome what economists call the “twin curses” — one, the “resource curse”, whereby countries with abundant natural resources end up with overexploitation or with rampant corruption. This is classic for many resource-rich countries that still remain poor, like Nigeria. It is oil-rich but is one of the poorest countries and is racked with corruption.

The other is the “winner’s curse” — whereby power in a country held by a single group is actually a hollow victory because the economy or society is in such bad shape that you cannot develop it further. An example is Myanmar.

It’s not right to say that the government has not done enough for the economy because we have seen various development plans rolled out, like the Ninth Malaysia Plan, the Industrial Master Plan, and plans for various sectors of the economy. The government only accounts for a quarter of the economy and has to ensure that there is investor and consumer confidence. It does this by playing a facilitative role for the private sector, ensuring there are the right infrastructures and policies for investors to thrive.

That said, there is much more the BN government can do to achieve the country’s full growth potential. The BN made mistakes in imposing too large and sudden a hike in the fuel pump price (to RM2.70), and it appeared ill-planned in the imposition and subsequent withdrawal of the windfall tax on independent power producers.

What about the BN’s claims that Anwar’s takeover threats cause instability?

Not entirely true. Anwar’s threats have raised uncertainty, but this is not the only reason for the overall uncertain climate we are in. There are other sources which are largely economic-based, such as the oil and food and commodities price shock. Also, the United States’ subprime mortgage crisis, which is developing into a full-blown global financial crisis, and the threat of a global slowdown. All this is happening at the same time.

(© Robert Linder/sxc.hu) Where uncertainty can be attributed to the BN, it is because of its slow and hesitant response to contain racial issues. Perhaps also the inappropriate use of the Internal Security Act, because it gives the perception that it lacks the ability to withstand a Pakatan Rakyat takeover.

Are we seeing investors react to this situation?

Local and foreign investors have become more cautious, with many adopting a wait-and-see attitude before deciding whether to expand or invest. More importantly are the multinational companies (MNCs) that are operating here. We’ve not seen any large-scale exit of these MNCs. They are still comfortable as long as their operations are not affected, regardless of the ruling government of the states they are in.

Has this cautiousness been a trend since the general election in March?

Yes. Investors both domestic and foreign are spoilt for choice in deciding where to invest, so they are waiting to see how the situation develops further in Malaysia. That is why it’s important we ensure that we have political and policy certainty, as well as an investment climate that’s competitive and conducive for investors.

The BN may claim that political developments here have not affected investors, but in reality, investor sentiments and confidence take time to manifest in the economy.

But there is some truth that investors have not taken flight as evidenced by investment approvals by the Malaysian Industrial Development Authority in the first half of the year. So investments are still coming in.

Those who have left are the foreign portfolio investors in the Malaysian stock and bonds market. There was quite a strong outflow amounting to more than RM20 billion in the second quarter of this year, just after the general election and also due to the impact of record inflation.

But these are short-term capital; they move in and out of the country anyway, because we are now in an increasingly open and integrated capital market. These portfolio investors might have exited because they read the political uncertainty negatively and decided not to wait.

So what is the actual effect of all the political drama on the economy?

In the short term, there is uncertainty, but in the medium- to long-term, foreign investors think that it could be good for the country. It can actually create a more transparent, more stable democracy, provided we are mature about it.

(© Rafael Ortnman/sxc.hu)It is similar to what other tightly controlled economies with little political space are facing. Like in Singapore and China, as people’s income level increases, there is a greater call for freedom, human rights, good governance, and more openness and fairness in the administration.

In view of an economic slowdown, what should the government do about its economic development corridors? Should the government focus on one, instead of all the corridors?

Given the current environment, it is an opportunity for the present government to fast track the corridors to offset the slowing global economy.

It will result in unbalanced growth if we focus on a particular region only. Those who propose focusing on one corridor only because of the economic downturn are not being mindful of the need to avoid regional disparities. The west coast of the peninsula is heavily developed. It is important to shift towards the east coast and beyond to Sabah and Sarawak, where there are resources waiting to be tapped.

If we can increase the average growth of Gross Domestic Product (GDP, a common way of measuring economic growth) of each state, we can actually raise overall country growth.

How do investors view the transition of power from Datuk Seri Abdullah Ahmad Badawi to Datuk Seri Najib Razak?

Abdullah’s announcement that he will step down in March has removed one of the uncertainties for investors. Now it is a question of Najib’s style, policies, and execution. Investors will also watch to see if he can forestall the takeover threat by the Pakatan Rakyat. Najib will have to face both domestic and external challenges.

With this [transition plan] settled, hopefully the ruling party will channel its efforts to economic management. There should be a plan to increase the country’s resilience, in case we need to respond to a global financial meltdown.

How safe are we from such a meltdown? When will it hit us?

We’re not in crisis mode, we’re not suffering from any credit crunch or bursting of bubbles. What we’re facing now is a contagion effect on our stock market.

Other than that, I think companies and industries are sufficiently healthy, they are not in any crisis situation that warrants emergency measures like the bailout of financial institutions that is happening in the West. We are at the moment watching other crisis-hit countries grapple with the problems that we faced in 1998.

(© Gino Santa Maria/Dreamstime) How is 1998 different from now?

We are facing a global financial crisis in a relatively healthy economic position. We have a high savings rate, which is surplus liquidity; a full employment situation; and a relatively strong banking system with low non-performing loans. We do not have domestic imbalances or asset bubbles that can threaten the economy in certain sectors. We also have a strong current account surplus amounting to something like 15% to 16% of our GDP. That acts as a buffer against any global financial crunch.

We have also benefited from the commodity price bubble. Although the price has fallen, it’s to a level which only means less profit margins, but we are still profitable.

Fundamentally, this time our companies and banks are in a relatively sound position that we don’t foresee any bailout required. Some financial firms in the US and Europe have lost a lot of value because they were holding on to worthless assets. These were mortgage-backed security papers which became worthless because borrowers could not repay. But we are not in this kind of situation.

In 1998 there was excessive investment in the property market, excessive leverage financing of investment in the stock market, a lot of margin trading, as well as imprudent lending. Some banks were giving out massive loans, and a lot of them were to politically connected projects which did not have sound fundamentals.

Were less of these dubious loans given out during Abdullah’s administration?

After the 1998 financial crisis, the central bank tightened up regulations. There was consolidation of the banking system; smaller banks were consolidated into 10 major groups. Part of this was in response to the crisis, part of it in response to the growing need for bigger banks so as to compete in the regional market. This consolidation has put us in a stronger position now to withstand the global financial crisis.

Other than that, it’s also due to requirements by the Basel Committee on Banking Supervision. After the ’98 crisis, the Basel II Accord required banks to enhance their risk management practices, which improved corporate governance. By extension, we saw less politically connected loans being issued.

For how long is Malaysia secure?

I think we can withstand a year or two of a prolonged global economic downturn.

In terms of fiscal position here, the government has the resources, given that it is considered to be only moderately in debt. The government’s total debt to GDP is just above 40%. If need be, the government still can raise more borrowings to fund the deficit and to implement various projects. In the US, debt is projected to rise to 70% of the GDP after their recent bailout plan. Japan has hit 110% to 120% of GDP in terms of government debt.

A word of caution for Malaysia — we have been incurring 11 consecutive years of fiscal deficit. This has reduced our fiscal flexibility.

But given the current global financial turmoil, the market will be forgiving over any sharp 4% to 5% rise of fiscal deficit in the next one or two years. It would be considered normal in a crisis situation where the government needs to spend to offset the slowing economy. The concern is if the market feels that the rise in deficit is not sustainable, then the cost of borrowing money will increase because the risk premium for Malaysia will rise.

Isn’t domestic consumption dropping?

It is moderating. It’s still too early to say whether it will slow down sharply. It will face a very sharp slowdown only if we have massive layoffs, wage cuts by the private sector, or if a lot of companies or firms go into distress. That’s not happening yet.

For now we’re still holding up quite well under the current turmoil, but the next couple of quarters will be important. Hopefully during this time the global financial turmoil will have stabilised. We may just see slowing consumption and investment, but we may not hit the bottom and may ride it out. By the middle of next year we might see a modest pickup in consumption.

It will still be difficult for the poor, though.

The government has to step in with a social safety net, particularly for lower-income groups. Not by giving more subsidies, but direct income support and economic opportunities to raise their income level. However, with the threat of a global slowdown, inflation will also come down sharply.

What should Najib resolve when he becomes the prime minister?

The income gap between the rich and poor has widened over the last decade. When we open up the market, those who are more capable, who have more resources or access to resources… they will thrive better.

Our dependence on two million foreign workers also contributes to depressing wages, particularly for those in low-skilled jobs. The challenge is to reduce dependence on foreign workers, but at the same time raise wages to a level that will not derail our competitiveness.

On Abdullah’s list of reforms before he retires is to widen the social safety net. How much can he accomplish by March?

It will be challenging. An economic safety net requires intensive study, research and data collection. Our problem here, in terms of poverty targeting, is that we do not have sufficient data collected. We need to vet who is eligible or qualified to be held by the government. Compiling such a database is crucial to provide a targeted approach.

But first, these people must be identified and that is quite a challenge. Besides an information database, a social safety net needs a proper monitoring system. This takes times to create.