Economic outlook 2009: Hazy days ahead

THE recession in advanced economies will set the tone for global economic outlook in 2009. Of importance is the extent of fiscal pump priming and monetary easing measures and how the combined action can help to bring the world economy back on its feet.

Against this backdrop, the prospects for the Malaysian economy will to a large extent depend on the strength of the domestic demand.

According to Malaysian Rating Corp Bhd’s chief economist Nor Zahidi Alias, the Malaysian government will remain vigilant and keep a close watch on how the global economy, particularly the US, evolves owing to the correlation between the US and Malaysian economy.

“The last time when the US succumbed to a recession in 2001, Malaysia’s growth almost screeched to a halt. We do not anticipate a quick recovery for the US economy as lethargic consumer sentiment will magnify weak business conditions. At the same time, we expect poor macro visibility to persist for Asian economies in 2009,” Nor Zahidi said.

MARC does not foresee the global economy plunging into a depression, as central banks around the world have been able to avoid the major mistake of restricting money supply that was made during the Great Depression in the 1930s, and with the strenuous efforts being made by the US government and the Fed to prevent the world’s largest economy from a total collapse.

Growth could decelerate more than expected

With huge stimulus packages and a Zero Interest Rate Policy (ZIRP) being implemented in the US, a mild recovery can be expected at the end of 2009 or the early part of 2010, MARC noted, adding that despite this, it remains cautious as possible risks may emanate from the weaknesses of other major economies, particularly the Euro Zone and Japan.

“Given the circumstance, we are penciling in a 2.5% GDP growth as our base case for 2009 while anticipating a 0.5% expansion in our worst case scenario,” Nor Zahidi said.

The downward pressure in export growth will also be magnified by sharp declines in prices of crude oil and crude palm oil, the country’s two major export commodities from record highs in 2008

Private consumption is our hope

According to MARC, the sustainability of domestic demand is the key assumption of its GDP forecast for 2009, in particular, the strength of private consumption will be a major factor in determining the overall performance of the economy over the next one year.

Should, for any reason, private consumption collapse in 2009, Malaysia’s GDP growth will drift away from MARC’s base case target of 2.5%. MARC anticipates a decline in the growth of private consumption to 4% in 2009 from an estimated 8.2% in the preceding year.

Private investment to slide on falling sentiments and rising risk aversion

Private investment will remain vulnerable when growth deceleration starts to gain momentum, Nor Zahidi said as two major factors – deteriorating business sentiment as evidenced by the decline in MIER’s business conditions index and rising risk aversion among investors – could cause a sharp decline in private investment.

Based on past experience, volatility in private investment increased immensely during periods of economic uncertainty, he added, citing an example in 2001 when private investment plunged by -15.7% from an expansion of 32.6% in the preceding year when the economy suffered a mild recession.

Similarly, in 1998 during the Asian Financial Crisis, private investment contracted sharply by 55.2% compared with a 9.4% expansion in 1997.

As for 2009, MARC anticipates private investment to stagnate after posting a 6.5% growth in 2008.”

Exports will bear the brunt of external weakness

Being an open economy, Malaysia will likely bear the brunt of slumping global demand, particularly for electrical and electronic products, MARC noted.

Highlighting major indicators such as the semiconductor book-to-bill ratio which has remained below unitary level since February 2007 and are expected to remain lacklustre following the rapid declines in major economies in the US, Eurozone and Japan.

With the global demand for PCs and cell phones expected to contract in 2009, Malaysia will likely experience a sharp decline in its exports of E&E products.

In addition, the downward pressure in export growth will also be magnified by sharp declines in prices of crude oil and crude palm oil, the country’s two major export commodities from record highs in 2008, despite some recent price gains on account of the tensed situation in Gaza.

With recession curbing the appetite for both commodities, MARC believes that real export will contract by 0.5% in 2009.

Inflation to moderate throughout 2009

On inflation, as measured by the CPI, MARC expects it to taper off in the coming months, mainly because of slower increases in transportation index and weaker consumer demand, although food prices will remain at elevated levels as “sticky downward” phenomenon persists.

Going forward, inflation rate is expected to moderate to an average of 5.0% in the 1H09 following slower consumer demand.

MARC envisages, stating that in the 2H09, however, year-on-year growth in CPI will likely decline drastically as the base effect sets in, leading to an annual average of 3.5% in 2009 from an estimated 5.5% in 2008.

Sovereign rating likely to stay unchanged

The current sovereign rating of A-/A3 from S&P/Moody’s for Malaysia is likely to be maintained in 2009 despite the many challenges faced by the country, Nor Zahidi opined, citing the commendable government debt-to-GDP ratio of 38.4% in the 3Q08 (2007: 41.6%) as a key reason.

One factor for any likely change in the rating outlook is a reversal in the declining trend of government debt to GDP, Nor Zahidi said, pointing out that “It is noteworthy that the downward trend in the debt ratio has continued since early 1990s.”

Nevertheless, given the high correlations between rating outlook and macro indicators such as growth, fiscal deficit, government debt level and current account balance, a change in the rating outlook by the big three cannot be ruled out, Nor Zahidi added, as conditions for a sharper-than-expected slowdown of the economy and higher fiscal deficit persists.

Fiscal policy remains expansionary

Up until the 3Q08, the government had been prudent in its spending. This is reflected in the budget deficit ratio which, in the first nine months, stood at only 3.1% of GDP compared with the full year target of 4.8%.

Unutilised allocations from 2008 carried forward to 2009 will give the government a bigger leeway to ramp up its spending in 1H09.

MARC foresees such a scenario will unfold as the recent RM7bil worth of stimulus package only represents about 1% of the country’s nominal GDP.

Although the fiscal deficit is expected to remain large in 2009, MARC does not foresee any major obstacle in financing the fiscal deficit as the country’s bond market should remain supportive of the growing fiscal deficit.

Monetary policy will likely ease further

In terms of monetary policy, MARC believes that the BNM will be flexible in using its tools to complement the fiscal measures in supporting the economy.

With declining inflationary threat, BNM will have more room to ease its monetary stance should global economic weakness continue to drag Malaysia’s economic growth, he said.

Against such a backdrop, MARC anticipates the overnight policy rate (OPR) to be reduced by a total 50 bps, bringing the key rate to 2.75% by the 1H09 which is expected to put additional downward pressure on the ringgit particularly against the US dollar in the near term.

As a result, MARC anticipates the ringgit to depreciate between RM3.55 and RM3.70 against the US dollar in the 1H09 but in the second half, the ringgit’s movement will likely hinge on the extent of the recovery of the Malaysian economy.

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