Commentary: COVID-19 slaps a stress test on the Malaysian economy

SINGAPORE: With the COVID-19 outbreak, Malaysia’s new Perikatan Nasional (PN) government has entered a perfect storm of global and national economic challenges with serious socio-political implications.

Given the sudden and forced economic slowdown globally, Malaysia, like most countries across the world, may be heading towards a sharp recession.

The Malaysian government has responded swiftly with two monetary easing and economic stimulus packages. However, given Malaysia’s fiscal constraints, the policy tools available to promote economic growth are limited.

Further stimulus also may not fundamentally resolve underlying factors of slower growth and areas of weaknesses, such as high debt levels.

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POOR ECONOMIC OUTLOOK BEFORE OUTBREAK

Malaysia’s economy had slowed even before the COVID-19 outbreak, due to lower palm oil, crude oil and natural gas output, and a fall in exports amid the US-China trade war.

GDP growth in Malaysia during the fourth quarter of 2019 softened to 3.6 per cent, marking the slowest growth rate in a decade. Malaysia’s annual GDP grew by 4.3 per cent in 2019, lower than the 4.7 per cent in 2018.

This is despite positive economic indicators in late-2019 suggesting signs of a recovery prior to the pandemic.

Malaysia’s manufacturing production had expanded on the back of increased export orders in December 2019, with manufacturing’s Purchasing Manager Index (PMI) at 50.0 points, the highest in 15 months, injecting much optimism on the eve of the COVID-19 outbreak.

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Domestically, household consumption was a key driver behind the 3.6 per cent growth in the fourth quarter, contributing 4.5 percentage points. Consumers loosened their purse amid an improving labour market, which saw a slight improvement in unemployment at 3.4 per cent in 2019 from a high of 3.6 per cent in 2016.

Malaysians’ wages in 2019 also kept ahead of inflation, with an average growth of 2.7 per cent in real wages compared to an annual inflation rate at 2.4 per cent.

At the same time, however, the Malaysian economy is a highly leveraged one, with the household debt-to-GDP ratio significantly high at 82.8 per cent in June 2019, a figure surpassing that of high-income nations, including the US (75 per cent) and Japan (58.2 per cent).

Residential property loans was a key driver of debt growth. Surging household debt has been a longstanding concern, and more so now. Doubts have grown over how average Malaysians can continue to service their loans in the coming months.

Corporate debt levels are also high. Total credit to the non-financial private sector as a percentage of GDP stood at 134 per cent by end-2018, inching closer to the high of 167.2 per cent during the height of the Asian financial crisis.

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UNRAVELLING OF EXCESS IN CREDIT MARKETS

The COVID-19 outbreak has led to growing concerns over high debt levels in many economies, including Malaysia’s.

Shutdowns on economic activity and weak external demand for goods and services will clearly hurt corporate profitability. If companies are unable to service their debts, bankruptcies could be on the rise.

There could be direct pressure on the PN government, given government guarantees on private loans amounted to RM132.7 billion as at July 2019. With the recent announcement of an RM50 billion government guarantee scheme under the stimulus package, this total amount will be higher.

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Government guarantees for private companies, where the government undertakes the repayment obligations in the event of defaults, nevertheless continue to be critical in encouraging lending.

With businesses struggling to hold on to their bottom line, we could see a sharp rise in unemployment in Malaysia. Job losses could reach 2.4 million, while household incomes are projected to fall by 12 per cent, according to the Malaysian Institute of Economic Research.

As unemployment rises, so will default rates on household debt, while consumer spending could plunge by as much as 11 per cent, according to recent studies.

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A WIDENING FISCAL DEFICIT

The Malaysian government recognises the risks that closure of businesses and job losses could pose to its economy.

Amid tighter restrictions on movements imposed by the Movement Control Order, which has been extended this week, Prime Minister Muhyiddin Yassin has introduced an RM250 billion (US$57 billion) economic stimulus package to provide cushion for businesses and households. 

Much of this package will be financed through other means apart from direct government funding, such as through allowing Malaysians to withdraw from their savings held by the Employees Provident Fund (EPF) and the six-month deferment of loan repayments to be borne by financial institutions announced by Bank Negara Malaysia, thereby easing the stress on Malaysia’s fiscal position.

The collapse in oil prices is already testing Malaysia’s fiscal position amid declining tax revenue in preceding years. Budget 2020 projected RM50.5 billion revenue from oil and gas, a significant 20.7 per cent of the total revenue (RM244.5 billion) but this was premised on an oil price of US$62 per barrel.

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Stiff competition among Russia, Saudi Arabia and Qatar has now threatened to push the oil price down to below the average OPEC production cost of US$30 a barrel. Meanwhile, global oil demand is projected to drop by 20 million barrels a day.

Alliance Bank chief economist Manokaran Mottain has said in early March that the oil price plunge is estimated to cost the Malaysian government a revenue loss of RM12.6 billion.

LOOKING AHEAD

Overall, Malaysia’s fiscal deficit is expected to widen to as much as 4.5 per cent of GDP in 2020 compared to 3.4 per cent in 2019.

Malaysia has consistently run a fiscal deficit every year since the Asian financial crisis, reaching as high as 6.7 per cent of GDP at the height of the global financial crisis in 2009, before progressively narrowing to 3.4 per cent last year.

Although business owners and some economists have argued for more targeted stimulus to be directed at SMEs and other groups, this will only be achieved at the cost of delaying medium-term fiscal consolidation and triggering negative reactions from credit rating agencies.

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All eyes will be on how the PN government manages this economic crisis. Business and investor confidence has taken a hit following the political drama that saw the former Pakatan Harapan government removed from power.

Limiting the damage caused by COVID-19 and the collapse of oil prices will restore some level of confidence.

As a short-term measure, the PN government has responded with an economic stimulus package aimed at mitigating damages caused by the MCO in the next three months. The modest cash injections, however, are unlikely to have a multiplier effect on household consumption.

Moreover, Malaysia’s economy may enter into negative growth territory if key export markets, such as the US and Japan, cannot bring the outbreak under control. Already, the World Bank has lowered Malaysia’s GDP growth in 2020 to – 0.1 per cent.

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Apart from introducing short-term stimulus to smoothen the impact of COVID-19 and maintain social order, the PN government has reiterated its commitment to continue development projects under Budget 2020, such as the East Coast Rail Link.

However, should more stimulus be needed, operating expenditures may need to be controlled, meaning expenditures on massive projects like the ECRL could be revised.

In addressing the fall-out from COVID-19, the PN government will also have to balance relief for Malaysians’ financial pain against tackling the deeper weaknesses of its fiscal position and the economy.

For Malaysia to achieve sustained growth in the medium term, it must introduce structural measures that promote fiscal sustainability and reduce its over-reliance on debt to spur expansion.

The key for now is that there must be a positive perception that Prime Minister Muhyiddin Yassin and his coalition can stay in power and deliver economic relief and security.

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Eugene Mark is an Associate Research Fellow with the Malaysia Programme at S Rajaratnam School of International Studies (RSIS), NTU.