Pre-emptive action to mitigate effects of downturn

In an interview with Business Times, Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz says at prevailing rates, there is flexibility for further monetary stimulus to support the economy.

QUESTION: How vulnerable is Malaysia, at this point, to the global financial crisis?

Answer: Despite the increased volatility in the global financial markets, Malaysia's financial system remains solid and resilient.

The impact on the financial system is manageable - with low exposures to foreign currency denominated assets, a well-capitalised and profitable banking system, ample liquidity, and a stress test which reaffirms the capacity to withstand the higher risk levels.

The global crisis, which has turned into an economic crisis, is likely to be more prolonged than earlier envisaged and the recovery will likely be delayed as impact on the rest of the world is likely far-reaching.

Asia, including Malaysia, will be adversely affected but likely to record positive growth. Malaysia's economy will record a positive growth due to current account surplus, continued financial intermediation, strong foreign reserves and a resilient banking system.

Q: The Malaysian economy is not ailing but there are growing fears that Bank Negara Malaysia and Ministry of Finance could be underestimating the severity of the downturn which would adversely impact our growth. Your comments Tan Sri Governor.

A: We recognise the severity of the global problem and impact on Malaysia.

Indeed, as early as in the July (2008) monetary policy statement, we already stated that the Malaysian economy was expected to experience a more challenging environment in 2009.

As the global problems deepen, the impact on Malaysia is expected to be more substantial.

The government came up with the RM7 billion stimulus package while Bank Negara eased the monetary policy in November 2008 - all these measures are aimed to support domestic demand and avoid a more severe economic downturn.

Given the uncertainty on the depth and length of the global slowdown, Bank Negara has identified three scenarios on the outlook of the Malaysian economy and is developing policy responses for each scenario.

Q: Malaysia's international reserves have been on a declining trend. Is this a concern?

A: In the first half of 2008, our international reserves increased by about US$25 billion, raising it to US$125.8 billion. During this period, the exchange rate appreciated to RM3.15 against the US dollar.

A major factor explaining this trend was the inflow of short-term capital.

The decline in reserves is mainly due to a reversal of short-term capital flows following the deleveraging process by investors following the financial distress experienced in the US and in Europe.

In the first quarter alone, the inflow of short-term capital amounted to about seven per cent of gross domestic product (GDP). Such short-term capital does not represent a permanent part of our reserves. Reversals may happen at any time.

Our high level of reserves, which are more than seven times retained imports and more than three times our short-term debt, continue to be well-positioned to cope with such out flows.

The heaviest outflow occurred in October (2008) and has since continued to subside.

Our reserves are still high for a country like Malaysia.

Q: There is the risk of Malaysia's current account surplus weakening in the second half of the year, to below 16.7 per cent of the GDP. What happens in a situation when it (C/A surplus) falls below 10 per cent in the coming months?

A: Even if we were to apply a significant contraction in exports under a more extreme scenario for 2009, Malaysia's current account balance would remain in surplus at about 10 per cent of GDP (or RM68.8 billion), which is still very large by global standards.

The trade surplus is expected to remain sizeable as moderation in exports would be mitigated by slowdown in imports. About 70 per cent of Malaysia's imports are intermediate goods, which are mainly used as inputs for manufactured exports. Therefore, any decline in exports would also lead to import compression.

Malaysia's trade linkages with the rest of the world have become more diversified. Exports to Asia account for about two-thirds of Malaysia's total exports. This is noteworthy as parts of the Asian region are expected to continue experiencing positive economic growth in 2009.

Q: While Malaysia can handle a slowdown in 2009, brewing external risks could mean that Malaysia may have to lower its growth target again. What could be the engine of growth with a backdrop of a weakening external demand as well as a weaker domestic demand? Are current low interest rates enough to support the economy?

A: We are not projecting a recession for 2009. Although domestic demand is expected to moderate, it is still expected to be able to contribute to GDP growth in 2009. Key to achieving this is sustained private consumption and increased government expenditure.

Private consumption is supported by factors such as that there has been no widespread unemployment and that there has been continued access to financing. The lower inflation will also add to purchasing power. However, should external conditions deteriorate further, the government and the central bank have the flexibility to provide further stimulus to our economy.

Factors that will support private consumption in 2009 are:

* No widespread unemployment;

* Growth in income;

* High level of savings;

* Availability of credit;

* Lower prices that will add to purchasing power; and

* Fiscal stimulus package.

On the supply side, the manufacturing sector is expected to be most affected by the weaker external demand. While other sectors are expected to moderate, overall growth is expected to remain positive.

Agriculture will be supported by expansion in food production and sustained growth of palm oil and rubber production.

Growth in the construction sector will benefit from the stimulus package and the infrastructure projects under the Ninth Malaysia Plan while there will be continued expansion in crude oil production and consumption activities in the services sector.

Given the heightened downside risks to growth and diminishing inflationary pressures, Bank Negara reduced the Overnight Policy Rate (OPR) and Statutory Reserve Requirement (SRR), as a pre-emptive measure aimed at providing a more accommodative environment to ensure domestic demand is sustained and supportive of growth.

Bank Negara will undertake the appropriate monetary policy action and respond pre-emptively to mitigate a severe economic downturn. At prevailing rates, there is flexibility for further monetary stimulus to support the economy.

Q: Given that the services sector has been a significant contributor to Malaysia's economic growth, will the decline in tourism numbers by nine per cent (in 2009) have a significant impact in the services input in the real GDP?

A: The services sector, which has been the key driver of growth, has been largely domestically driven. As such, the anticipated decline in tourism activity is not likely to have severe impact on the services sector.

The services sub-sectors that are influenced by tourism are wholesale and retail; accommodation and restaurants; and transport and storage (18 per cent of GDP). However, the contribution of tourism to these sub-sectors is very small.

Although we do foresee some moderation in domestic demand, we believe that the services sector on the whole will remain resilient, and will be the key sector to support GDP growth in 2009.