A full assessment of the impact of the terror attacks has yet to be determined. In a preliminary report, the United Nations has estimated that the total damage to the world economy is likely to exceed US $350 billion; the pre-attack projected growth of the global economy for the year ahead of 3 percent, has now been revised downwards to 2 percent.
No country in all of the regions of the world is likely to be spared from the slower growth. The US economy was already in recession prior to the attacks; the Japanese economy was moribund; the EU was showing signs of a slowing down. The export driven ASEAN economies, still recovering from the devastating crisis of 1997, were already showing signs of a slow down prior to September 11th. Malaysia was no exception. Although, the Malaysian economy was not in a recession, expectations of a rebound in the near term were fast fading despite optimistic pronouncements from the Government.
During the first 8 months of the year, exports, especially of electronics were declining; flows of Foreign Direct Investment were declining; domestic private investment was at low levels; consumer confidence and spending were sagging; worker lay-offs were rising. A number of foreign firms were relocating to other countries. Malaysia was rapidly losing competitiveness.
Because of ill-advised economic policies, and increasing political uncertainties, business and consumer confidence were deteriorating rapidly. Economic policies followed by the Barisan Nasional Government contributed further to a crisis in-the-making, given its obsessive focus on pump priming through the launching of mega-projects and bailouts of crony corporate entities. The projected debt service ratio of 4.4 percent was recklessly raised in the course of the year through two so-called stimulus packages, firstly of RM4.3 billion in March and last month, another RM3 billion package.
THE CHICKENS COMING HOME TO ROOST
To understand fully the background to the economic scene prior to September 11, it is necessary to remind ourselves of the background.
Malaysia's economic vulnerabilities stepped up significantly from early 1997 through the period following the onset of the crisis in mid-1997, as market confidence increasingly diminished along with the rest of the region. The bubbles created by a loose monetary policy and the large debt overhang were recipes for the onset of crisis.
When the crisis broke, large portfolio outflows took place, and equity and property values declined substantially. The ringgit came under tremendous pressure. As currency traders took speculative positions in the offshore ringgit market in anticipation of a large devaluation, the offshore ringgit interest rates increased markedly relative to domestic rates. This heightened upward pressure on domestic interest rates, intensified outflows of ringgit funds, and exacerbated banks' liquidity problems and overall financial distress. The Malaysian corporate sector experienced significant loss of wealth as a result of sharp falls in the value of real estate and equities used as bank collateral. Corporate incomes and cash flows also declined, leaving some corporations unable to service their debt.
The initial response of the authorities to hike interest rates and tighten fiscal policy in an attempt to anchor market confidence in the financial system was reversed in early 1998. Fiscal policy was revised to a more expansionary stance, but was insufficient to correct external imbalances and bring about the needed economic adjustment. The contagion effects of the crisis and the associated economic contraction were far worse than anticipated. Domestic imbalances quickly emerged as growth rates slowed and then turned sharply negative in early 1998. Market confidence faltered amid adverse regional developments and uncertainties. Anticipation of further devaluation of the ringgit heightened. By the summer of 1998, the stock market had fallen to its lowest level in recent history.
In September 1998, following the sacking of Anwar Ibrahim, Mahathir launched a policy package designed to insulate monetary policy from external volatility. The ringgit was pegged to the U.S. dollar and selected exchange and capital controls introduced, complemented by a fiscal stimulus package that stepped up capital spending. These measures permitted the subsequent lowering of interest rates. No effort was made to address corporate restructuring.
Malaysia's recovery in 1999–2000 was led by buoyant world demand for electronics and supported by accommodating macroeconomic policies. The external current account turned into large surpluses, allowing a buildup of international reserves. Unemployment declined, and inflation remained low. Although the conditions existed, little was done to reduce vulnerability of the financial system or to restructure the corporate sector.
Since the latter part of 2000, however, downside risks for Malaysia have increased. Heavy dependence on electronic exports made Malaysia highly sensitive to the global slowdown in information technology. Sharp depreciations of the yen and other regional currencies have resulted in a large effective appreciation of the ringgit, particularly during late March and early April 2001, leading in turn to short-term capital outflows and reserve losses.
These developments, at a time when the economy was already being hit hard by the global slowdown, has adversely affected market confidence. Limited progress in financial sector restructuring has not improved the capacity of banks to manage risks. Non-performing loans are on the rise again.
Despite the writing on the wall pointing to a crisis in-the-making, no steps were taken to address deep-seated structural imbalances in the economy. Corporate restructuring was put on the back burner. The need for continued structural reforms to achieve healthy balance sheets of the banking and corporate sectors; further deregulation to promote competition and efficiency; and consistent macroeconomic policies to maintain financial stability and sustainable fiscal and external positions were largely ignored.
The recent attempts at corporate restructuring are too little too late. No corporate captain has had to take a “hair-cut”. What we have essentially seen is a re-nationalization of failed entities. This is no more than a socialization of private debt, which now has become public debt. The nation is now paying the price for ill-conceived and badly designed privatization of public assets.
GRIM PROSPECTS FOR THE MALAYSIAN ECONOMY
Malaysia is ill prepared to face the current global economic crisis, deepened by the events of September 11th. Most analysts including the US government acknowledge that the US economy is likely to remain in recession well into 2002. The prospects for the world second largest economy, Japan, remain bleak. The two of the largest export markets for Malaysian products are unlikely to provide the external stimulus that has contributed significantly to Malaysian economic performance in the recent past. Thus export performance in 2002 is likely to be a negative factor.
The political uncertainties arising from the new war inject further
uncertainties. especially in the South East Asian region. These uncertainties
and negative developments will undoubtedly impact adversely on investment
flows into Malaysia.
Mahathir has added negatively to investor perceptions by declaring Malaysia to be an Islamic state. The bogey of domestic fundamentalist elements seeking to undermine and topple the Barisan Nasional Government, repeated ad nausea by the Prime Minister, does not help. Nor does PAS, the largest opposition party, help matters by engaging in the rhetoric of Jihad.
Such posturing by both the BN and PAS sends negative messages to potential investors. Indeed, it may well lead to an exodus of existing investors. Beyond having a negative impact on investment, the chanting of Jihad and anti-US and anti-West slogans has the added effect of drying up tourist arrivals into Malaysia. The blow to tourism will undoubtedly affect the Malaysian service sector; laid-off workers from this sector will add to the swelling ranks of the factory workers.
The already weak consumer demand is likely to take a further hit as unemployment increases and incomes fall. Household spending will decline and its multiplier effects will reverberate across the entire economy. The current crisis is wholly dissimilar from the crisis of 1997. That crisis affected overextended and highly indebted corporations. It was a financial crisis, whereas the current crisis is a full-blown economic crisis. The current crisis is doubly serious as it will affect both the corporate sector and the consumer at large.
There is little evidence that either the Prime Minister or the Governor of Bank Negara or the technocrats advising Mahathir have comprehended the full implications of what is unfolding. If recent pronouncements by the Prime Minister and Tan Sri Dr. Zeti Akhtar Aziz are any guide, it would appear that the budget to be unveiled on Friday (19th October) will be based on rosy assumptions of recovery, and the continuation of present failed policies. The budget message will undoubtedly emphasis external factors as the immediate cause for the downturn. This would represent a distortion of the truth, as past policies are equally to blame. The domestic slowdown started well before the slowdown in the US in mid 2001.
The revenue measures likely to be incorporated in the budget for 2002
These measures are unlikely to contribute to either enhancing investment in the near term or provide a meaningful contribution to stimulating private consumption, given that the scope for tax giveaways is tightly limited by several factors which include:
a) reduced revenue intake;
b) mounting current expenditure needs to meet debt service and defense needs.
Thus the revenue changes likely to be incorporated in the budget for 2002 will be cosmetic in nature and do little to counter the recessionary effects.
On the expenditure side, the current budget is likely to see sharp increases to meet rapidly rising debt service. It is very likely that the current budget will go into deficit. The so-called development budget is likely to show increases and dressed up as “further economic stimulus”. The largest part of these allocations will inevitably be directed towards transfers to various agencies for bailouts in one form or another, funding for mega projects resulting in the creation of new white elephants, thus adding to the already bulging portfolios of such projects.
These have contributed little to enhancing the competitiveness of the economy, or boosting output in the near term, or restructuring the economy in a manner likely to improve the fundamentals. Putting it more bluntly, we are likely to see the continuation of failed policies driven by a blinkered view of realities. The budget to be unveiled by the Prime Minister will represent battle plans dusted from the past. Mahathir is likely to be like an old general fighting the last battle with blunt weapons.
Looking ahead, the issue is how Malaysia can weather another crisis while it seeks to regain competitiveness and return to sustainable growth. To these ends, its strategy should include structural reforms to achieve healthy balance sheets of the banking and corporate sectors; further deregulation to promote competition and efficiency; and consistent macroeconomic policies to maintain financial stability and sustainable fiscal and external positions.
In specific terms, the ringgit peg needs to be removed in favour of a floating exchange rate linked to a basket of currencies; the feeble corporate restructuring now underway must be accelerated and if need be banks and companies with unsustainable balances must be required to take “haircuts”. To lend credibility to the development of a “knowledge” based economy, it is necessary to put the money where the mouth is by channeling sizable resources into R&D, an area where neither the government nor the private sector have invested in the past. It is equally important to invest in human resources. The Government must introduce meritocracy into the education system.
To meet the immediate task of cushioning the impact of the recession, a number of policy initiatives are needed. These should be viewed from the over-riding need to sustain demand and protect employment. Actions are urgently needed in respect of each of the major components of demand.
To improve EXPORT competitiveness, the ringgit peg should be removed in favour of a floating exchange rate. Removal of the peg will also have the additional benefit of sending strong signals to the market that Malaysia is willing to jettison policies that are inappropriate and harmful to the long term health of the economy. Removal of the peg will also provide Bank Negara the means to follow more consistent monetary policies, not constrained by policies set by the US Federal Reserve. There would be other benefits including a reduction in capital flight from the country.
To counter the outflow of FDI and to sustain growth, the Government has indulged in massive pump priming over the past four years. Much of the resources have been channeled to mega projects and the building of white elephants. What the Government has failed to address is the quality of INVESTMENT and its direction.
Most investment has been channeled to projects that have low economic returns, are capital intensive and have led to the creation of bubbles. That nation does not for instance need a third link with Singapore as what is urgently required is more investment in schools, expansion of tertiary education, and in R&D. Given these considerations, the development budget should be carefully reviewed and reoriented.
The current recession, unlike the one following the 1997 crisis, will displace a large number of workers and see a sharp increase in unemployment. As a consequence PRIVATE CONSUMPTION will show a sharp decline. To address the twin problems of unemployment and the fall in consumption, the budget for the year ahead must contain bold measures. Amongst the actions that are needed are:
The fiscal changes outlined above should be seen as part of a larger programme of reforms to restore credibility and to improve the overall business climate. Amongst the areas requiring urgent action are:
The year ahead presents major economic and political challenges both globally and domestically. These challenges need to be met head-on if Malaysia is to ride the storm. The presentation of the Budget to Parliament on Friday should be occasion for the introduction of new policies and the opening of a new chapter in good governance. Pursuit of failed policies of the past will only bring about calamity and disaster - the nation deserves better.