EARTH TRENDS by Martin Khor

8 January 2001


As the year begins, many Malaysians are asking how the economy will perform:  will the recovery be sustained, or will growth slow down, bringing problems like job retrenchments?   No one can predict for sure, since it is still uncertain whether the US economy will have a hard or soft landing.  MARTIN KHOR reviews the situation and the possible scenarios.


As the new year begins, many people are wondering what will happen to the economy.  Will the "good times" of recovery (in 1999 and 2000) continue for a while longer?  Or will there be a relapse in the economy?

Whilst many predictions are being made, and you can read them in news reports, the truth is that no one can be sure what is going to happen.

What can be confidently predicted is that 2001 will not see the same level of high growth of the Malaysian GDP of the past year, which had been 7.5 to 8 per cent, one of the highest in the world.

The growth had already been decelerating, from 11.9 percent in the first quarter to 8.8 percent in the second quarter and around 6 percent in the second half of the year.

According to the Finance Ministry's Economic Report, issued on Budget Day 27 October last year, overall economic growth in 2001 will be sustained at 7 percent.

This was based on the assumption that "external demand will continue to support domestic activities generated by a broad-based recovery." 

It was expected that continued strong export growth (of 8.5 percent) together with high government spending (fueled by a federal deficit of RM$16.1 billion or 4.9 percent of GDP) would pull the economy on a high-growth path.

This expectation might have been justified in October.  In the two months since then, the external situation has worsened, with increasing signs that the United States economy is slowing down fast.

Whilst a majority of economic analysts optimistically predict a "soft landing" (meaning the continuation of growth but at a lower level of about 2 to 3 percent), several others are talking of outright recession (defined as actual decreases in output for at least two quarters).

Part of the reason for the US slowdown is the bursting of the stock-market bubble, especially of high-technology stocks.  There is a "wealth effect" from this:  people owning shares now feel poorer and thus reduce their spending, slowing down sales at the shops and causing firms to produce less.

The US is also suffering from very high trade deficits, as a result of so many years of high growth.  These have been financed by large inflows of foreign capital attracted by faith in the seemingly never-ending American boom. The US dollar thus grew stronger, propped up by the inflows and by increases in interest rates.

The US is now looking like East Asia just before the 1997 crisis struck.  Everything on the surface had seemed to be going super well, with foreign funds swamping into the booming "miracle economies."

When speculators struck, and the investors' mood suddenly changed, funds flew out faster than they had come in, the currencies and stock markets plunged, and recession followed.

Of course the US economy is made of "sterner stuff" than the developing economies of East Asia, and it is in no danger of suffering such a traumatic shock.

Nevertheless, it now looks as if the US will not be able to sustain such a scorching pace of growth this year. 

Last week, the Federal Reserve reduced its key federal funds interest rate by half a per cent to 6 per cent.  It was a surprise move, and caused the US stock market to jump, followed by rallies around the world.

Further interest rate cuts are expected.  This is good news for the stock markets and for businesses and consumers that can borrow more cheaply. Thus, Alan Greenspan's move can be seen as countering recessionary forces.

But despite the initial euphoria of the markets, news reports of the past few days show that most investment-fund analysts and economists do not believe that the interest rate cuts by themselves will prevent a weakening of the economy or the stock market.

Moreover, a decline in interest rates would make it less attractive for foreign funds to park in the US, and this could weaken the US dollar.

Thus, we must still expect a US slowdown.  In the past three years, the high US growth had acted as one of the major engines pulling Malaysia and other Asian countries out of recession, as high US demand for imports meant increased exports for Asia.

With US demand slowing, we have to rely less on that engine.  Of particular concern is the expected reduced demand for computers, which could affect orders for electronic components, which is the most important manufactured export item for Malaysia and other Asian developing countries.

There are thus good reasons to be more cautious for this year's economic prospects.  Compared to the Treasury's 7 percent growth forecast (made in October), the Malaysian Institute for Economic Research had a forecast of 6.3 per cent.

And with the US slowdown being more severe, MIER executive director Dr Mohamed Arif, in a newspaper column last Saturday, said that a 5 to 6 percent growth rate for Malaysia in 2001 would be quite creditable.

Indeed, if we could attain such a level, it would be still be one of the highest in the world. 

As stated at the beginning of this article, it is impossible to know what will happen, overall, this year, since so many factors beyond our control are involved.

In an optimistic scenario, the US economy will slow down but not sharply and will not spin into a recession.  Its imports would still grow, though more slowly.  Meanwhile, the European economies will do better than the US, thus to some extent offsetting the slowdown in the US.  Malaysian manufactured exports would thus still increase, at a reduced rate. 

Even if the US dollar falls, and the ringgit with it (assuming its peg against the dollar is retained) against other currencies, this may have a positive effect as it would make our exports more competitive.

Meanwhile, the budget expansion and continued low interest rates would help keep domestic demand chugging along.  Unemployment and inflation would remain low.  The economy will have a 5 to 6 percent growth path, along the MIER revised projection.

In a more pessimistic scenario, the Federal Reserve's interest-cutting measures prove to have less than expected results, as the US stock market weakens and the "wealth effect" on consumers cuts into retail sales.

The US economy suffers sharply reduced growth (one percent) or even recession.  The US dollar falls sharply and there is a reverse flow outwards of foreign funds.  Demand for imports goes into low growth or no-growth.

Asia's manufactured exports are hit, and retrenchment takes place.

In such a situation, it would require a greater boost to domestic demand, or a boost in trade within the region, to offset the loss of the demand from the US. 

To anticipate this, it would be wise to already re-start or intensify measures for expanding economic activities aimed at the domestic market, such as growing more food to cater to Malaysians, and in the process reducing the huge food import bill.

Whether or not the optimistic or pessimistic scenario unfolds (or something in between), there is no harm and instead much benefits to intensify those domestic-demand boosting measures, like local food production, low-cost housing and rural small-scale projects, that provide jobs and enhance the quality of life at the community level.

There are already some worrying trends at the start of this new year, such as the glut of rice in the market and the sharp decline in palm oil prices (both affecting rural incomes) and the increasing over-supply of office and shopping-complex space.

The level of demand and orders for products in the electronics sector has to be closely monitored.

In short, 2001 begins on a more sombre note than last year.  With some skillful management and a dose of luck, it could still be a "rather good" year.  However, it would be prudent to also anticipate some problems along the way, especially if the US economy performs worse than expected.