Preparing for challenging times ahead

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With the Malaysian economy badly affected by external factors, some planning should help to cushion the blow.

The external macro environment for 2016 remains challenging for Malaysia. Being a small and open economy, Malaysia – and Penang along with it – is highly dependent on the health of the global economy. Key risks in 2016 include the prolonged slump in oil price, the effects of El Nino, the full impact of the GST implementation, ringgit vulnerability due to US interest rate increases and the slowdown in China.

Headwinds from external global developments

In 2015 Malaysia had to face up to the oil price collapse, the slowdown in the Chinese economy, the fall of the ringgit to its lowest levels since 1998, the loss of international confidence in Malaysia's political and economic landscape as a result of the 1MDB scandal and, of course, the introduction of the GST. Collectively, these factors have put downward pressure on Malaysian business sentiment and reduced the low and middle income households’ spending power.

As Malaysia aspires to become a high income country, these challenges are likely to continue affecting the economy in 2016 and beyond. In Budget 2016, tabled last October, the government forecasts a GDP growth of four per cent to five per cent in 2016. The expected budget deficit will marginally fall to 3.1% of GDP. While the government will levy tax increases for the highest income households, a higher BR1M will be given, resulting in an increase from RM4.9bil in 2015 to RM5.9bil in 2016. There will also be an RM100mil cut in subsidies, which can be seen as another tax rise for Malaysian consumers. On the other hand, minimum wage is increased to RM1,000 per month in West Malaysia and RM920 per month in East Malaysia. The government expects to collect RM39bil in revenue from GST.

Inflation is expected to increase slightly to two per cent to three per cent from two per cent to 2.5% in 2015. As of November 30 last year, Bank Negara Malaysia’s international reserves stand at US$94.6bil (RM420.1bil). This is sufficient to finance 8.6 months of retained imports and is 1.1 times the shortterm external debt.

Source: Petronas Annual Report 2014; calculation by Penang Institute, 2015, 2016.

Oil and gas-related income has dropped to 14% of the government's total revenue in 2015. The government’s move away from this income is welcomed but belated – it shows Malaysia's over-reliance on income from natural resources over the past decades. As shown in Figure 1, we expect Petronas’ contribution to the government’s coffers to drop from RM75bil in 2014 to as low as RM38bil in 2015. As it is unlikely that oil prices will recover soon, we estimate an even lower contribution of RM31bil through dividends, taxes, cash payments and import duties for 2016.

More significantly, at the last Organization of the Petroleum Exporting Countries (Opec) meeting in December 2015, the oil cartel has effectively abandoned the decadeslong principle of production limits. While individual Opec members have, in many instances, produced more than their quotas, this is the first time that no production limits are stated at all.

The value of the ringgit dropped significantly against the US dollar in the last half of 2015 – the lowest since 1998.

To defend its market share from US shale producers, Opec accepts low commodity prices at the cost of lower oil revenues. Together with the lifting of sanctions on Iran and the increasing efficiency of shale oil producers in the US, the world’s crude oil market is expected to have surplus oil for the whole of 2016. For example, Iran has promised to lift its production to as much as four million barrels a day by the end of 2016 – up from about 3.3 million barrels a day currently. This will put further downward pressure on the international oil price; Goldman Sachs forecasted that the oil price could potentially drop to US$20 per barrel. Should this happen, Petronas and Malaysia will be significantly affected and the sovereign credit rating for Malaysia will come under pressure again.

The El Nino weather phenomenon typically brings dry weather to South-East Asia, impacting palm yields and lowering output. Indonesia’s palm oil association forecasts a five per cent drop in the country’s 2016 output due to El Nino, while leading analysts see the 2016 global palm oil output growing by one million tonnes less than expected. According to Malaysia’s Felda Global Ventures (FGV), the world’s third largest palm plantation operator, palm oil output in 2016 could drop by one per cent to three per cent year-on-year if the El Nino does hurt yields.

The GST, falling ringgit and the TPPA

Source: x-rates.com.

This year will mark the first full year of the GST’s contribution to government coffers. With a contribution of RM39bil in 2015, it helped cushion the effects of lower oil and gas revenue; without the GST, the effect of falling oil prices – and therefore lower dividends and tax contributions from Petronas – would mean that the government would be even further from its fiscal targets for 2015. Therefore, the contribution from GST has kept Malaysia from being downgraded by international rating agencies.

Along with growing uncertainties and as shown in Figure 2, the value of the ringgit dropped significantly against the US dollar in the last half of 2015. The slide of the ringgit along with Opec’s decision to not cut production show that the devaluation of Malaysia’s currency is caused by a combination of internal and external factors. For sure, the lower oil price will have an impact on the development of Malaysia’s fiscal position this year. Indeed, oil prices will remain a key risk factor for the ringgit this year, alongside the risk of a slowdown in domestic demand. However, given that the ringgit was already the worst performing currency in Asia in 2015, it is unlikely that it will be the same in 2016.

The ringgit remains highly vulnerable due to Malaysia’s exposure to commodities (oil and palm oil), the Chinese economy, the end of low interest rates in the US, the high proportion of foreign ownership of domestic debts and uncertainties due to domestic politics. We believe that the ringgit’s decline will be slower this year, but a recovery to previous exchange rates of around 3.6 in January 2015 is unlikely.

Chinese worker in a factory. Malaysia has had to face up to the slowdown in the Chinese economy.

While the consequences can be complicated for Malaysian households and businesses, a depreciating Malaysian currency engenders winners and losers. Exporters with substantial US dollar revenue, for example, are among the winners of a declining USDMYR exchange rate. Additionally, the tourism sector can benefit from a continuous low MYR exchange rate to other currencies, as Malaysia becomes a cheaper tourist destination for overseas travellers. This will likely benefit the country’s top holiday destinations such as Penang, Langkawi or KL this year. Similarly, domestic holiday destinations get more attractive as travelling overseas remains expensive due to unfavourable exchange rates in 2016.

However, it is not all positive even there as certain costs, such as imported food and beverages, in the tourism sector are affected by a depreciating ringgit. Nonetheless, as oil and gas are traded in US dollars and Petronas reports its accounts in ringgit, the negative impact from low oil prices remains cushioned by a falling ringgit.

Among the losers of our depreciating currency are savers with private assets measured in ringgit. Besides, due to the falling currency, GST and the reduction of subsidies, it is likely that upward inflationary pressure will be more pronounced this year. For local businesses, imported goods in foreign currencies will remain less profitable compared to previous years. These companies are likely to be hit this year as domestic consumption cools when consumers become cautious. Along with a loss of purchasing power, Malaysian households will continue to suffer. This will reduce their standard of living, especially for parents with children studying abroad, who will find it costlier compared to previous years. In addition to this, a cut in the power tariff rebate for Peninsular Malaysia will see consumers paying RM0.73 more per kWh – at least for the first six months of 2016.

Another significant development in 2016 is Malaysia’s participation in the Trans Pacific Partnership Agreement (TPPA). The TPPA is likely to be ratified by Parliament at the end of this month and will enter into force after all other participating countries have ratified it within the next two years. This agreement will surely have a huge impact on the economy as it puts the competitiveness of Malaysian businesses to the test. Nongovernment linked companies which are not temporarily protected will need to proactively plan for the positive and negative impacts of TPPA.

How will Penang fare?

All these challenges affect Penang’s development as well. Just like all Malaysians, Penang's lower and middle income groups are forced to spend more on consumption goods; the individual impact of the depreciating currency affects Malaysians throughout the country.

Source: Department of Statistics, 2015.

However, Penang’s manufacturers, especially the E&E sector, will likely continue to benefit from the recovery of the US economy and the favourable exchange rates. Penang's tourism industry may also benefit from a weaker USDMYR exchange rate as it attracts more foreigners – along with Malaysians – to spend their vacations here. However, uncertainties remain on the extent of the slowdown of the Chinese economy (Figure 5), as China is Penang’s biggest trade partner (Figures 3 and 4).

Source: International Monetary Fund, 2015.

In 2015 direct investments in the manufacturing and services sectors helped sustain economic growth with GDP growth In 2015 direct investments in the manufacturing and services sectors helped sustain economic growth with GDP growth states, accounting for RM59.9bil or 88.5% of total approved investments.

Palm oil mill near Sepang, Selangor. Palm oil output could be adversely affected by the El Nino phenomenon.

With the many initiatives by the state government, it is likely that Penang will remain a preferred investment destination this year, and FDI will continue to push Penang’s economy ahead. However, as Penang’s economy matures, domestically driven economic activities remain increasingly important for the years ahead. This can be seen from the composition of Penang’s economy, where services are now a bigger slice of the local economy compared to manufacturing.

In conclusion, 2016 is likely to be a more challenging year for Malaysians compared to 2015. Nevertheless, there will undoubtedly be opportunities for those who are well prepared.






Lim Kim-Hwa, PhD, is CEO and head of Economics at Penang Institute, fellow in Finance and Financial Reporting at University of Cambridge and associate chartered accountant of the Institute of Chartered Accountants in England and Wales.
Tim-Niklas Schoepp is Chief Operating Officer and visiting analyst in economics at Penang Institute.



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