Global Trends by Martin Khor
Monday 16 January 2017
Three economic issues that preoccupy Malaysians in 2017
As the new year gets under way, ordinary Malaysians are preoccupied with three economic issues – the rising cost of living, the ringgit’s low level and the outflow of capital.
This week will be historic due to Donald Trump’s inauguration. The world is waiting to see whether the new US President will continue with his unconventional ways and carry out his promises such as pulling the US out of the TPPA, officially terming China a currency manipulator and building a wall at the border with Mexico.
Who knows, he might instead be statesman-like and strike a middle-of-the-road stance on various issues, now that he is President. But few if any are betting on that happening.
While Trump will hog the headlines, to the man and woman in the street it is still the bread and butter issues of daily life that preoccupies them as the new year gets into stride.
In Malaysia, the major talking point (second only to politics and maybe even overtaking it) is the state of the economy.
Three economic issues are worrying the ordinary Malaysian – rising prices, the fall of the ringgit and the outflow of capital. Each is an issue in its own right, but they are also all interlinked.
Inflation has become a hot issue because it is accelerating and will continue to do so. There are one-off factors influencing retail prices, such as the removal of the cooking oil subsidy, the weather affecting vegetable output or the slight recovery of the world oil price.
But prices across the board are affected by the weakening of the ringgit since this increases the prices of imports. Malaysia is very dependent on imports for a wide range of products, from food and household utensils to machinery and components for making cars, computers and all kinds of other goods.
As the most recent ringgit plunge started in mid November, prices of products that have high import content may not have fully risen yet because the shops are still clearing stocks bought earlier. But you can expect the new prices to kick in more and more.
The second issue is the ringgit decline itself, which has bad and good effects, with some sectors and people losing and others benefitting. The negative effects include:
· Consumers having to pay higher prices for imported goods and services;
· Traders and retail shops getting less business as the demand for the dearer imports go down;
· Manufacturers and construction firms paying higher costs for parts and production inputs, which will translate into higher consumer prices and eventually higher house prices;
· Parents with children studying abroad must fork out more ringgit even if the fees and hostel rent remain the same;
· The government and its enterprises and private companies that took loans in foreign currencies lose significantly as they have to spend more ringgit to service their loans.
Among the good effects:
· Smallholders and companies exporting palm oil, rubber, petroleum and other commodities will receive more revenue in ringgit terms;
· Local manufacturers exporting goods such as rubber gloves and furniture become more competitive as they can reduce their prices in foreign currency or else they receive more in ringgit if they retain their international prices;
· The tourism and hotel business should thrive since it’s cheaper for foreigners to visit Malaysia. Locals who now can’t afford to travel abroad may also spend their holidays in the country.
On balance will the gains outweigh the losses? From a public perspective this is unlikely as the higher cost of living will affect all Malaysians especially the poor and middle classes, and the higher external debt repayment will affect the public and the economy overall.
The prospect of further depreciation also has a bearing on capital flows, the third issue. Malaysia is one of the countries most vulnerable to the shocks of foreign funds moving out because so much capital was allowed to move in.
In recent years a new type of vulnerability emerged when foreign funds were welcomed to invest in government bonds denominated in ringgit.
It was originally thought that foreign loans in ringgit would be safe as the borrower would avoid the foreign exchange risk, as contrasted with loans denominated in US dollars.
This is true but the sheer volume of bonds now owned by foreigners makes the economy vulnerable to large outflows in a short period.
Comparison is usually made between potential capital outflows and the level of foreign reserves. The reserves as at 30 December 2016 were US $94.6bil or equivalent to RM424bil.
The total foreign debt outstanding was RM865bil at the end of September 2016. Of this, offshore borrowing (in foreign currency) was RM472bil, and ringgit-denominated government bonds held by non-residents were worth RM211bil, according to Bank Negara data.
Some of the investors have a longterm commitment and not everyone will move in the same direction at the same time, but in recent weeks external conditions such as a rise in US interest rates (and anticipation of more rises in 2017) have prompted capital outflows from emerging economies, including Malaysia.
The country also has high foreign participation in the stock market (22.6% in November 2016), and in recent months there has also been a net withdrawal of equities by foreigners.
November 2016 was a bad month, as foreigners withdrew from the country RM19.9bil of government securities, and RM4.2bil of equities, according to a report in The Star (7.1.16).
The potential and probability of more capital outflows in 2017 is a factor weighing on the perception of the ringgit’s prospect.
A high trade surplus has previously acted as a strong buffer against potential large capital outflows. The trade and current account balances are still positive but the surpluses have been declining.
Government measures could help, such as the requirement that exporters convert 75% of their export proceeds from foreign currencies to ringgit.
Other measures can be considered if the situation does not improve. For example, companies and funds, starting with government linked ones, can be discouraged from investing abroad for the time being at least.
Malaysia has ruled out more drastic measures such as capital controls and pegging of the ringgit.
Developments in these three economic issues will be closely watched, not least by the public whose pockets are affected, as the year progresses.
External events could improve the situation, such as if prices of Malaysia’s export commodities increase, or could worsen it, especially if the US raises its interest rates further and if Trump really pursues protectionist policies.
However, domestic policies to respond to the problems are crucial and there should be a comprehensive plan to tackle these issues, since they may persist as 2017 progresses.