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Malaysia: Shaky start to 2015

A market in the suburbs of Kuala Lumpur. Rising inflation in Malaysia has dampened consumer sentiment since the beginning of 2014 and prices are expected to surge further in the new year. (AFP)
This year will bring little cheer to Malaysia.
With export growth slowing due to a sluggish world economy and rising prices putting a damper on domestic consumption, the economy is expected to moderate after a rather robust 2014.

The Ministry of Finance (MOF), in its Economic Outlook Report 2014/15 released in October, projected GDP to grow between 5 and 6 percent. But sliding oil prices are casting doubts on the viability of this forecast, premised on a Brent crude oil price of between $100 and $105 per barrel.

The oil and gas sector accounts for about a third of the government’s revenue. This is mainly paid by Petronas as dividends to the state. The national oil company has warned it will scale back on payments if the price of oil continues to hover between $70 and $75 in 2015.

Oil prices already dipped below $60 before the close of 2014 and could drop further. This price malaise alongside poorer export performance calls into question Malaysia’s ability to meet its growth and fiscal deficit targets and maintain a current account surplus.

Economists and analysts, who earlier pinned growth at the lower end of MOF’s projected range, have revised their estimates further downward.

“Malaysia’s growth is expected to soften to 5 percent in 2015, slower than our previous forecast of 5.2 percent and an estimated 5.8 percent for 2014,” says Manokaran Mottain, chief economist at Alliance Bank Malaysia.

The World Bank has thus far been the most conservative, given its 4.7 percent target for Malaysia. Analysis firm FocusEconomics reports a consensus among economists polled of 5.1 percent growth.

At home, the economy is expected to continue on its decline. Private consumption should moderate to 5.6 percent as consumers adjust to higher prices from the implementation of the goods and services tax (GST) in April.

Private investments are forecast to grow 10.7 percent, led by investments in private education, health, transportation, manufacturing and mega-infrastructure projects like the mass rapid transit system and Petronas’ RAPID (Refinery and Petrochemicals Integrated Development) initiative.

“The downward trend is in line with dampening consumer and business sentiments. A high inflationary environment since the beginning of 2014 has weighed down on domestic consumption,” Manokaran says. He adds that price pressures are expected to surge even higher in 2015 because of the GST and the spillover impact of the fuel subsidy rationalization implemented in October.

“We expect inflation to peak as high as 4.5 percent in 1H15 (first half of 2015), before stabilizing to around 3 to 3.5 percent by end-2015. In this regard, we forecast inflation to average 4 percent in 2015,” Manokaran says.

This projection is in line with the official inflation forecast of 4 to 5 percent. However, with falling crude oil prices and the introduction of a managed float fuel-pricing system (in place of subsidies) based on market price, inflationary pressures could be mitigated.

Meanwhile, government spending will remain modest but will exceed the previous year’s. Public consumption is projected to grow 3.8 percent in line with ongoing fiscal consolidation initiatives while public investments are set to expand 4.7 percent on the back of infrastructure projects.

“In line with Budget 2015, the trend of public investment is expected to reverse (this year), with a larger allocation for development expenditure. The other potential boost for public investment (this year) will be from the implementation of the balance of the Tenth Malaysia Plan projects,” says Kristina Fong, head of research at RAM Ratings. The Tenth Malaysia Plan, also known as 10MP, is a comprehensive economic blueprint for 2011-2015.

A representative of Maybank Investment Bank, in an interview with Malaysian daily The Star, said critical and high-impact government-funded projects involving urban railway infrastructure and water facilities will continue in spite of pressure on the government’s oil revenues.

But the state does run the risk of failing to meet its fiscal deficit target of 3 percent of GDP if oil prices remain depressed for a protracted period as expected.

On the external front, export growth is likely to slow to 3.2 percent as a listless world economy continues to weigh down on demand. The narrowing trade surplus could result in a current account deficit, which, taken together with the fiscal deficit, would put the country’s sovereign credit rating at risk of a downgrade because of a twin deficit situation, Manokaran warns.

But Fong of RAM Ratings says forward-looking indicators of demand for electronics, machinery and equipment in industrialized economies still appear positive, which will help mitigate significant downside risks to sustained growth in external demand.

On the supply side, all sectors are expected to remain resilient but will grow at a slower pace. An exception is the mining sector, forecast to expand 2.8 percent because of higher production of oil and natural gas.

Construction leads the growth in sectoral performance with a 10.7 percent expansion, supported by 10MP projects, new infrastructure plans announced in the recent budget, and resilient residential and non-residential subsectors.

The services sector will grow 5.6 percent on the back of strong demand across all subsectors while the manufacturing sector will moderate to 5.5 percent, sustained by export activities. Meanwhile agriculture is set to benefit from increased production of palm oil, rubber and food commodities. It is expected to grow 3.1 percent.

Against this backdrop of subdued growth prospects, Bank Negara Malaysia is not expected to raise the overnight policy rate (OPR), consistent with Governor Zeti Akhtar Aziz’s stance that the central bank is growth-accommodative.

“The OPR is expected to be maintained at the current level of 3.25 percent until the second half of (2015), when it becomes clearer whether the second-round effects of inflation will be manifested,” says Fong.

With no rate hike to defend the ringgit and a stronger US dollar, the Malaysian currency is likely to continue weakening in the short term. But Manokaran believes it will hold steady this year at around 3.3 to 3.4 ringgit against the dollar in the short to medium term, trading around an average band of 3.3 to 3.35 ringgit per dollar.

On the upside, this year’s implementation of the ASEAN Economic Community (AEC) is expected to unlock new growth catalysts in the region, including Malaysia. The integrated economic platform will create a trade bloc with more than 600 million consumers and a nominal GDP value of $24 trillion. The Association of Southeast Asian Nations is expected to be the seventh largest economy in the world once it becomes a single market.

“However, it should be noted that the AEC itself is not a panacea the moment it is launched,” noted UOB Economic-Treasury Research. “It is just the beginning of a long process of integrating and leveraging each other’s strength.”

Yet the upsides are vast. UOB projects ASEAN’s total trade with China rising to $1.5 trillion and investment inflows from China rising to $185 billion in 2030, from $405 billion and $31 billion, respectively, in 2013.

But bringing the AEC to fruition requires more negotiations and implementations before it can be launched by the end of the year. So while Malaysia is in a good position to benefit from the single regional market, there will not be any immediate economic impact to lift the country out of its anticipated economic doldrums this year.

And yet, while the signs point to a challenging year ahead for Southeast Asia’s third-largest economy, the fact remains Malaysia still has “robust and strong growth for an advanced middle-income economy”, Ulrich Zachau, World Bank country director for Southeast Asia, told The Star.

“It compares well with other countries in the region, and we are positive about the outlook for Malaysia as good policies are in place to support the country’s economic stability and growth.”

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