THE Malaysian economy has not fully recovered from the deep scarring effects of the long two years COVID-19 pandemic crisis amid lingering concerns about the highly transmissible Omicron virus.
Our external sector remains susceptible to any persistent shocks that would threaten the world economy as a sharp economic slowdown in Malaysia’s major trading partners would weigh on our export’s engine growth.
Russia’s invasion of Ukraine has triggered massive negative supply and oil price shocks which pose a double-blow to the world economy.
This perfect storm can further dent growth prospects and driving inflation higher at a time when inflation expectations are already becoming unanchored. Businesses are struggling with the supply chain disruptions, increased input and logistic costs.
The risk of global stagflation and recessionary conditions have risen in some advanced economies, especially in the US and European countries.
The US Fed’s resolve of reining in persistent surges in inflation pressure through possibly aggressive interest rate hikes could slow the US economy sharply and may tip it into recession.
China’s zero-Covid approach’s triggered lockdown in some provinces and property debacle has bitten its growth:
External trade
On the first order of trade-enhancement effect, Malaysia will benefit from higher oil and gas prices, albeit declining production in recent years.
Both crude oil and liquefied natural gas (LNG) contributed to 4.6% of total exports (RM56.6 bil) in 2021.
Malaysia’s net exporter of crude oil surplus has narrowed from 2.6% of GDP in 2008 to between 0.1% and 1.5% of GDP in 2009-2021.
Likewise, the surplus of LNG also shrank from 5.3% of GDP in 2008 to 2.2% of GDP in 2021.
If the combined impact of persistent supply chain disruptions, inflation and oil shock cause a sharp slowdown in the global economy, it will have a knock-on bearing on our exports via the second order effect.
This will reduce demand for Malaysia’s exports. Higher prices effect would be negated by lower export volume.
Sustained revival in domestic demand holds the key
A sustained revival in consumer demand holds the key to ensuring a durable domestic economic recovery.
But we should be wary of the impact of elevated inflation pressures on consumption and increased costs as well as the worker shortages on business investment.
The year-long supply chain disruptions, price and cost pressures which continued into 2022 have dampened the sentiment of both consumers and businesses.
Amid a gradual improvement in jobless rate and income growth, consumers are expected to spend more discretionary due to shrinking purchasing power.
Households find their bills rising and spending power squeezed by costlier food, household expenses and rising cost of living.
Businesses are expected to invest cautiously on increasing cost of doing business and supply disruptions as well as against the backdrop of global uncertainty due to Russia’s invasion of Ukraine.
In addition, businesses’ margin was squeezed, albeit some partial pass-through of increased costs to consumers. Businesses may put on hold their investment commitment plans given the uncertainty over the supply and prices of raw materials and inputs.
While the Government’s ballooning fuel subsidies will buffer domestic consumers and businesses, soaring energy prices and related negative supply shock on commodities and industrial materials will spill over onto Malaysia in the form of higher input costs such as fertilisers, cooking oil, animal feeds, pesticides etc.
On the financial market impact, we expect to see persistent volatility in domestic stock and bond markets due to the spill-over effect from the gyrations in global financial markets.
This will have resultant effects on consumers’, businesses and investors’ sentiment and confidence. The ringgit will remain on a weakening bias against the US dollar
The overall impact of the oil shock and other related consequences on the Malaysian economy will be mildly negative.
We may see a scenario of slow growth and high inflation risk as the underlining external and domestic headwinds inflict on domestic demand and exports.
Budget deficit
We estimate high oil prices would be negative to overall fiscal deficit.
In the 2022 Budget, oil related revenue and PETRONAS dividend is estimated to amount to RM43.9 bil or 18.8% of total revenue based on an oil price assumption of US$66 per barrel.
Assuming an oil price of US$100 per barrel, it means that a difference of US$34 per barrel, this will translate into additional oil-related revenue of RM10.2 bil (excluding PETRONAS dividend of RM25.0 bil in 2022 Budget).
But fuel subsidies will increase to an estimated RM27.0 bil as RON95 retail price is being capped at RM2.05 per litre and diesel price at RM2.15 per litre since late February 2021.
Hence, higher oil price is a negative fiscal deficit estimated at RM16.8 bil unless PETRONAS raises its dividend contribution higher from the budgeted RM25.0 bil.
The overall impact of high crude oil prices may widen 2022’s Budget deficit estimated 6.0% of GDP by 0.5 percentage points to 6.5%, assuming that PETRONAS would up its dividend contribution by extra RM10.0 bil to RM35.0 bil.
Other negative metrics on the fiscal deficit are probable higher subsidies for cooking oil, food prices, fertilisers etc. Climate change risks such as unexpected flood damage could incur more contingency relief funding.
Should fuel subsidies be rationalised in this current environment where inflation risk has risen considerably?
If the current fuel prices ceiling is maintained, the subsidy bill will balloon to unsustainable level, compelling the reprioritisation of the Government’s spending and expenditure programmes.
If fuel subsidies are rationalised, fuel inflation and second round of inflationary and cost pressures would ensue, having a knock-on impact on consumers and businesses.
We think a viable fiscal sustainable approach now is to raise the fuel prices gradually and eventually move towards a managed float regime for RON 95 and diesel.
The managed float regime will be accompanied by a targeted fuel subsidy for the low-income households.
Interest rate
Should Bank Negara Malaysia raise interest rates to tame inflation risk and anchor inflation expectations?
Some would argue that it is a supply shock and cost-driven inflation risk and that interest rate hikes cannot affect exogenous negative supply shock.
If the central bank’s priority is to save growth, and decides to delay interest rate hikes or a gradual pace of monetary tightening this could accelerate the de-anchoring of inflation expectations, which will be incorporated into decisions and contracts.
The situation today is different as the inflation risk already rising, and continued business costs have compelled them to partially pass through onto consumers.
Core inflation, which measures the underlying inflation trend is expected to trend higher due to the pick-up in economic activities.
Another financial risk consideration is that keeping interest rates low for too long might encourage a build-up of excessive risk-taking in the financial markets, households and companies taking more debt. – March 22, 2022
Lee Heng Guie is the executive director of the think-tank, Socio-Economic Research Centre (SERC).
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
