The dawn of a new year has brought a glimmer of hope for better economic conditions ahead as OPEC together with some other non-OPEC bigger producers finally agreed on production cut. For the past two years the world economic community was made to believe that oil glut is the source of economic slowdown. Production control appeared to be a sound economic advice to many, against a conventional market economic doctrine of free entry and free exit. In a free market economy, price movement should lead to an allocative efficiency and eventually benefit everyone..
OPEC’s Algiers and subsequently Vienna Meetings were regarded as a success as OPEC members, as well as some big non-OPEC producers, finally agreed on production, arrangement for the first time in 15 years. Markets responded favourably as prices surged approaching the USD60 per barrel mark. This development is good for Malaysia on two counts. First, higher oil prices will increase export as well as government revenues. Second, global trade flows are expected to improve with better oil prices. Nevertheless, this development is expected to be unsustainable as the downward pressure on oil prices remains, among others, due to improved production technology and a decrease in demand as a result of substitution effect.
Another important development in the world economy that has strong bearing on global trade is the growing sentiment of protectionism. The protectionism sentiment in developed economies is gaining momentum following Trump’s presidential victory. Across the Atlantic, the contagious effect of Brexit is growing in the EU. This is a departure from the established ideology of free trade championed by powerful nations, transnational corporations and neo-liberal ideologues, which happen to be the prevailing dominant view in the contemporary international system. On the other hand, developing economies like Malaysia are intensely trying to liberalize their markets to maintain their WTO membership. The growing sentiment on protectionism will not necessarily assassinate free trade but it will add to uncertainty in the world economy. This is not a welcoming news to trading nations like Malaysia.
Meanwhile, economic growth of China and Japan, two of major Malaysia’s trading partners are moderating. The American economy is expected to continue growing healthily but uncertainty about Trump’s economic policy has an impact on Malaysian trade scenario. China, Japan and USA, these three countries represent one third of total Malaysia trade value. Thus it can be seen that current global economic conditions point to a prolonged weak external demand. Taking this into consideration, we have downgraded our forecast on exports for this year from 3.0% (December 6, 2016 publication) to 1.3%. Therefore, more weight is expected from domestic demand to drive economic growth for this year.
About 92% of real GDP for 2015 was attributed to domestic demand and the trend continued last year and it is expected to continue for the next two years. Therefore, the growth in domestic demand is the main source of GDP growth. For 2015, 4.7 percentage points of the 5.0% GDP growth, or about 94%, was contributed by domestic demand. A similar trend is expected for 2016 but the growth in domestic demand is slower at 4.6%, the lowest since 2008/2009 world financial crisis. The growth in domestic demand is expected to be flat at 4.6% for this year (downgraded from our earlier forecast of 5.0%) and rebounded slightly to 4.7% in 2018.
Slower growth in domestic demand is attributable to the slowdown in private expenditures, both for investment and consumption. The slowdown in private investment is more prominent mostly due to weakened investment flows globally. It is expected to grow at 5.5% in 2016 against an average growth of 13.3% a year for the past six years. Private investment is expected to improve to 6.0% this year (revised from our earlier forecast of 6.6%).
Private consumption is expected to grow at 5.4% in 2016, below an average growth of 7.1% a year for the past six years. It is not just slowing down, the contribution of private consumption towards GDP growth is getting more important to pick up the slack of private investment as can be seen by comparing the average growth for both for the past six years. High dependency on private consumption to boost domestic demand comes with a price. First, private debt level accumulated to almost 90% of GDP as a result of an easy consumption credit. This will increase debt servicing burden to households and this in turn will limit future spending prospects. Second, the current policy to boost consumer spending via transfer payments is good for improving current spending but it impedes future growth prospects. Direct income transfer crowds out competing public investment allocation particularly for productivity enhancement.
Consumer price inflation stays subdued despite an expansionary spending policy atmosphere. The average monthly CPI inflation rate for the first eleven months of 2016 is 2.1%. Nevertheless, food inflation remains higher than the overall inflation causing public anxiety particularly among low-to-middle income households. The fear of ringgit devaluation from imported inflation seems mitigated, as its direct impact is small in the context of CPI measurement. While, its indirect effect through input prices into domestic production is spread-out over time.
Consumer confidence level remains low as MIER fourth quarter’s Consumer Sentiments Index (CSI) continues to be below the demarcation level of 100 points. The fourth quarter 2016 CSI slipped further continuing its downward trend. It shows that in general consumers are still pessimistic about the economy. The survey results revealed that the situation of consumers’ current incomes in the fourth quarter 2016 deteriorated a bit from the previous quarter. Likewise, the survey indicated that consumers are feeling pessimistic about their future incomes as compared to the third quarter 2016. Consumers are also still pessimistic about the employment outlook. As their confidence level is still lacking, consumers indicated cautious and selective spending plans.
In line with CSI, MIER’s Business Conditions Index (BCI) also dropped further in the fourth quarter 2016 by 2.7% as compared to the previous quarter after took a double-digit quarter-to-quarter dive of 22.5% in the third quarter. It remained below the 100-point threshold of optimism, which was briefly achieved in the second quarter 2016. Expected index in the fourth quarter 2016 plunged by 12.4% as compared to the previous quarter. Both sub-indices on expected production and expected export sales declined from the previous quarter by 4.8% and 7.6%, respectively. New export orders also dropped significantly by 6.6% from the third quarter 2016. All in all, BCI sub-indices revealed that external demand is still weak. Nevertheless, domestic demand remains robust to compensate the sluggish external sector. The sub-index for new domestic orders in the fourth quarter 2016 rebounded by 8.2% as compared to the previous quarter. Overall sales and production improved due to strong domestic demand, but likely to drop later as capital investment sub-index dropped by 10.7% and capacity utilization rate declined from 79.3% in 3Q2016 to 76.5% in 4Q2016, responding to weakened export demand.
The fourth quarter 2016 Vistage-MIER CEO Confidence Index also remains below the 100-point threshold of optimism for 12 consecutive quarters since 3Q2013. Vistage-MIER CEO Confidence Index is based on quarterly surveys on CEOs of small and mid-sized businesses in Malaysia. The 4Q2016 index fell by 6.8% from the previous quarter, the second consecutive fall. This suggests that lack of confidence among businesses with overhanging negative sentiments in the Malaysian economy continues.
Index for all six components recorded a decline as compared to the previous quarter, except the expected change in employment index remains the same. The other five components are currents economic conditions, expected economic conditions, planned fixed investment, expected revenue growth and expected profit growth. Generally, CEOs continued to be negative about the current as well as the expected economic conditions, as both indices remained below 100-point threshold of optimism. Almost 70% of the CEOs surveyed were in the opinion that the overall domestic economic conditions have worsened in the 4Q2016, compared to 57.0% for the previous quarter. Indices for another four components, namely expected change in employment, planned fixed investment, expected revenue growth and expected profit growth, however, recorded above 100-point threshold of optimism, although not improving.
Bank Negara Malaysia (BNM) is expected to continue pursuing an accommodative monetary policy favouring businesses as household debts are creeping up. The expansionary monetary policy is expected to continue this year since the price level is kept under control to complement the expansionary fiscal policy. The government continues to pursue an expansionary fiscal measures to boost private consumption, mostly through transfer payments.
Last year witnessed a moderated net exports as external demand remained sluggish. On a y-o-y basis, net exports for 2016 are expected to contract by 0.5% on account of a slower growth of exports with the rate of 0.3% (downgraded from our earlier forecast of 2.5%). However, imports are also expected to slow down as ringgit continues to be weakened. We have revised downward import growth for 2016 to 0.4% from the earlier projection of 2.9%. As such, the growth of net exports of goods and services for 2016 is maintained at -0.5% despite a slowdown in exports.
MIER maintains Malaysia’s real GDP growth projection for 2016 at 4.2%. As the external sector remains sluggish, more weight is given to the domestic demand to steer growth. Growth will be driven largely by private sector expenditures, both on consumption and investment. The 2016 domestic demand growth, which have been revised upward by 0.1 percentage point in July from our April 2016 projection, is maintained at 4.6%, as a result of an improvement in private consumption. Meanwhile, the revised private investment growth is also maintained at 5.5%. Public investment is expected to pick up the shortcoming by growing at 1.4%, a turnaround from a negative growth of 1.0% last year. Public infrastructure development for last year continued as planned.
We have downgraded real GDP growth for 2017 to 4.5%, the lower bound of the range of our earlier forecast of 4.5 – 5.5% as some downside risks are beginning to emerge. External demand is not as strong as expected although commodity prices are showing sign of recovery. The slowdown in global trade and investment flows is expected to prolong. Oil prices are expected to be sticky upward as production agreement is believed to be fragile and fail to bring down the supply glut. Moreover, global oil demand is not expected to improve strongly either. Growth in major economies are slower than expected, particularly for China and Japan. The protectionism sentiment in developed economies is gaining momentum, thanks to recent political development across the word.
Domestic demand continues to be the engine of growth for this year but growing at a slower rate of 4.6% (initial forecast: 5.0%) as both private consumption and investment are expected to grow moderately by 5.5% and 6.0%, respectively (initial forecasts: 5.6% and 6.6%, respectively). Likewise, public consumption and investment are also expected to grow slowly. Export demand is also downgraded to 1.3% from initial forecast of 3.0% a year. Current account balances for this year as well as for 2018 are expected to improve, owing to a better commodity prices, estimated to be 2.0% and 2.4% of GNI respectively. The CPI inflation rate for 2017 is expected to average higher at 2.5%. The CPI inflation for 2018 is anticipated to be higher at 2.7%. Real GDP growth for 2018 is forecasted to be stronger at a range of 4.7 – 5.3%, as domestic demand as well as export demand are expected to improve further.