Malaysian Economic Outlook: Executive Summary

In April 2008 (Apr’08), under the assumption of oil price at US$96 per barrel, the IMF lowered the world economic growth estimate by 0.5 percentage point to 3.7 per cent in 2008 (’07: 4.9%), while edging up marginally the 2009 forecast to 3.8 per cent. With oil prices breaching US$140 per barrel, the risks of slower global growth have risen. Despite aggressive interest rate cuts and massive liquidity injection, the US credit crisis continues to deepen and spread to the real sector of the US economy. In view of the flagging US economy, the IMF has drastically lowered the US growth forecast by 1.0 percentage point to 0.5 per cent in 2008 (’07: 2.2%). The spillover effects through trade and financial linkages are predicted to reduce Europe’s growth to 1.4 per cent (’07: 2.6%), and to soften Japan’s expansion to 1.4 per cent (’07: 2.1%). Due to surging oil prices, many Asian countries have slashed fuel subsidies in view of worsening national budgets.

The Malaysian economy has been surprisingly resilient in spite of the global slowdown. In fact, GDP growth was sustained at a strong 7.1 per cent in 1Q08, following a brisk 7.3 per cent expansion in the last quarter of 2007. The growth was driven by high commodity prices, strong private consumption and steady investment, and supported by fiscal spending. So far, Malaysia has only felt a minor impact from the slowing US economy, but emerging challenges in the form of soaring food prices and the persistent rise in global oil prices are weighing down heavily on economic prospects. Fearing a ballooning fiscal deficit, the government announced a revamp in oil subsidy in Jun’08, pushing up petrol prices by 41 per cent and diesel by 63 per cent. This will have adverse implications for inflation and economic growth going forward. Even with the subsidy cut, the fiscal deficit may reach 3.5 per cent of GDP this year as oil prices have increased further, drastically reducing the savings from the subsidy revision.

Monthly indicators up to Apr/May’08 have displayed some surprising movements. Industrial output grew moderately on the back of a fragile rebound in electronics as construction-related sectors powered on. Exports have recorded double-digit growth owing to windfall gains from commodities and the recent upturn in electronics demand. The leading index is rising cautiously, suggesting moderating growth ahead. Inflationary pressures have gathered steam, with elevated food prices lifting inflation to 3.8 per cent in May’08, almost a 2 year high. On account of the oil subsidy review on 5th Jun’08, inflation is expected to jump to about 7.0 per cent in Jun’08, bringing the whole year inflation to 5.0 per cent, if not higher.

The combined effects of higher food and fuel prices have led to increased price pressures, posing a challenge to policymakers amid downside risks to growth. The Overnight Policy Rate (OPR) has been kept at 3.5 per cent in view of the downturn in the US economy and its potential negative effects on the domestic economy. With the rising inflationary pressures amidst steady economic activity, the OPR may be raised gradually, depending upon how serious the secondary effects of inflation will turn out to be from Jun’08 onwards.

Consumer and business confidence has shown downwards movements, as indicated by the results of MIER’s 2Q08 surveys. The Business Conditions Index (BCI), which is based largely on company performance, has slipped to 114.1 points in 2Q08, down 5.8 points from a reading of 119.9 points in 1Q08, indicating a surprisingly resilient confidence level in spite of the higher oil prices. Given the resilient domestic demand and the recent rebound in exports, business conditions have been holding ground fairly well. The higher oil prices will lift business costs and this would affect profit margins in subsequent quarters. Shocked by the magnitude of increase in oil prices, the Consumer Sentiments Index (CSI) has fallen very sharply to an all-time low of 70.5 points in 2Q08, from 115.5 in 1Q08, a signal of strong public displeasure. The BCI would be a better indicator of current economic activity as it relies on firm-level information, while the CSI exhibited the collective public reaction to the recent subsidy cut.

There are no clear signs that the external sector is going to turn around any time soon. However, the recent upturn in electronics owing to strong demand in non-US markets has benefited Malaysia’s exports. The turmoil currently facing the US economy is part of the adjustment process to rectify the global imbalance. The correction could have happened earlier, had it not been delayed by the prolonged support of the US consumption drive. The greater concern is the impact of higher food and oil prices on the global economy, which will consequently influence domestic conditions. Although some mega projects have been shelved, the allocated fiscal spending for the 9MP has been revised upwards and reviewed to be more people-centred. Strong commodity prices would ensure stable spending power of rural households, but there is a greater concern that prices would reverse once the global growth weakens further.

Taking into account the trends in MIER indices and the impact of higher food and oil prices that could dampen consumption and reduce business profits, we are compelled to lower our growth forecast for the Malaysian economy to 4.6 per cent this year, from 5.4 per cent earlier. It is likely that growth would deteriorate in the second-half of 2008, as the Malaysian economy takes the hit from the knock-on effects of higher oil prices and a slower global growth. Domestic demand will be propped up by sustained 9MP spending, providing a partial cushion to the faltering global economy. In the baseline scenario, as the global economy stabilises and inflation subsides, the Malaysian economy could improve next year, expanding by 5.0 per cent in 2009.