: Super User; Malaysia; 05 December 2012; Hits: 1686

Hard Choices for the Malaysian Economy

DESPITE falling exports and high levels of political uncertainty, the Malaysian economy is continuing to do well. Official figures show that South-east Asia’s third largest economy expanded by a better-than-expected 5.2 per cent in the third quarter.

With low interest rates, inflation falling to just 1.4 per cent and unemployment declining to 3.3 per cent, this resilient economy is poised to chalk up another year of strong growth despite the difficult global economic environment. The economy grew by 5.1 per cent last year.

The main reason for the strong growth this year has been domestic demand, which expanded by 11.4 per cent in the third quarter, more than offsetting a fall in exports and consequent decline in the current account surplus. Net exports were at a record low in terms of both nominal value and contribution to gross domestic product (GDP).

Strong domestic demand has been partly due to continued high government spending on infrastructure. Thankfully, Malaysians have also been willing to spend, helped in part by higher salaries and pensions for civil servants.

Government stimulus measures, it seems, have been working, and consumers have not yet been spooked by the political uncertainty associated with the coming elections.

Lurking just over the horizon, however, are several possible developments that urge caution. Some, such as another recession in the United States as a result of the looming fiscal crisis, are beyond Malaysia’s control. But there are also others that may require policymakers to make some hard choices after the polls.

Among the most important of these is the need to deal with the country’s rising debt to GDP ratio. Currently, this stands at 55 per cent, a figure International Monetary Fund managing director Christine Lagarde last month described as “reasonably high”.

For some years now, the government has been running fiscal deficits in order to prop up growth. Part of the reason for this has been the perceived need to compensate for disappointing inflows of foreign direct investment. Various subsidies have also been introduced on fuel and basic commodities in order to hold down inflation and temper political unrest.

Increasing the national debt in order to sustain such policies ahead of national elections, which must be held by mid-2013, is understandable. But it is also risky. This is because serious financial problems in Europe are encouraging observers everywhere to focus on sovereign debt.

In such an environment, private sector confidence in Malaysia’s financial stability cannot be taken for granted.

Bank Negara, the central bank, argues that, since more than 90 per cent of government debt is domestically funded, Malaysia’s external exposure is minimal. International credit rating agencies, however, remain unimpressed. Both Standard & Poor’s and Moody’s warned earlier this year of a possible credit rating downgrade if Kuala Lumpur did not rein in its federal government debt.

Such a downgrade would make future borrowings more expensive. It would also send a very negative signal to investors in other sectors of the economy.

The real test will come in the wake of the elections. Few independent observers believe that Datuk Seri Anwar Ibrahim’s Pakatan Rakyat alliance will win power. But it could come very close.

If the ruling National Front coalition finds itself with a reduced majority in Parliament, or is unable to regain control of key states such as Selangor, Prime Minister Najib Razak will face even more pressure to compromise on economic reform.

Taking unpopular measures such as reducing subsidies would be very difficult, as would the implementation of long-delayed additional taxes.

In such a scenario, a ratings downgrade would be almost inevitable. And the national effort to return foreign investment levels to those Malaysia enjoyed prior to the 1997-98 Asian financial crisis would be even harder to achieve.

Malaysia could, of course, escape many of these negative effects. The National Front may win big. Or a resurgent opposition may prove willing to accept unpopular economic policy adjustments in return for important political concessions.

Either way, Malaysia should prepare now for the possibility that the global financial community will not see the country quite so positively in future.

One way of doing this would be to step up efforts to ensure that Malaysia is still regarded as a more attractive investment location than Thailand, Indonesia and the Philippines. In recent years, all three nations have been attempting to woo more foreign investment by reducing red tape.

Labour productivity is another area requiring attention if the country hopes to climb out of the middle-income trap. Potentially controversial changes in education policy may be needed.

A renewed attack on corruption would also win widespread support among foreign investors while helping to blunt opposition attacks.

The third-quarter GDP growth figures were a nice surprise. But they are no reason for complacency.

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Key Political Risks

Now that the general assembly of UMNO, the senior partner in the ruling National Front coalition government, is over, the long-awaited general election could be held at any time. Constitutionally, Prime Minister Najib Razak has to call elections before April 21st 2012, after which the Elections Commission must hold the election within 60 days.

Widely expected to be the most hotly contested in Malaysian history, the polls will pit Mr Najib's government against a rival political coalition led by charismatic opposition leader Anwar Ibrahim.

While the opposition Pakatan Rakyat alliance attacks what is says are the corrupt and authoritarian ways of the government, Mr Najib has been describing the opposition coalition as an unnatural alliance of Islamic fundamentalists and multi-ethnic and liberal parties.

The strong economy is likely to favour the government.

WATCH OUT FOR:

The size of the expected government victory, particularly the ability of the ruling party to retake control of key states such as Selangor. Mr Najib needs to win convincingly if he is to implement long-delayed economic reforms. These include reducing oil and food subsidies and introducing a goods and services tax to boost government revenue.
The ability of Mr Najib to placate conservative elements of his Muslim-based UMNO party who disapprove of his policy of boosting national unity through greater inter-faith and ethnic tolerance.
The extent to which the government is able to convince the public that the coming elections will be free and fair. If the election result is close, influential organisation such as Bersih could declare them illegitimate, and stage major protests.