Embracing A.I.

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Growth may await Penang in the short term, but adapting to Industry 4.0 has to happen now.

Campaign period in Malaysia can get rather overzealous.

According to the World Bank, Malaysia’s economic growth will continue at a moderate pace over the next two years. This goes together with the bank’s expectation of lower capital expenditure growth in Malaysia.

The country’s 2018’s budget deficit is expected to hit 2.8% of GDP (vs. 3% in 2017), and higher expenditure will be offset by an increase in revenue, which is mainly driven by stronger economic growth and the recovery of oil prices. While economic growth for 2018 is projected to reach an impressive 5-5.5%, this forecast is propelled by the positive projection of the global economy rather than by sound fiscal and economic policies at the federal level of government.

The Election Budget

Malaysia has big dreams of becoming a developed nation in the near future, but to have any chance of achieving this, the coordination of operating and development budgets needs to be improved. In the 2018 Budget, as much as 83.6% was allocated for operating expenditure (OE), leaving only 16.4% for development expenditure (DE). There is clearly a growing imbalance in favour of OE – in 2008 the allocation was at 73% and 27% respectively. Emolument makes up 34%, the largest proportion, of total OE and 28.2% of the total 2018 Budget.

Prime Minister Datuk Seri Najib Razak. In his 2018 Budget speech, as much as 83.6% was allocated for operating expenditure.

Considering the engorged size of the civil service in Malaysia, it is no surprise that a significant percentage of the country’s finances is spent on public employees. This should soon prove unsustainable if no reform is made to this sector. The huge sums going to the civil service is an indicator that elections are not far off and that the federal coalition feels a strong need to please its strongest electorates. In this, it fails to recognise that a reformed civil service will not only help address the budget deficit, but also release talent and labour into higher-paying private sector jobs, keeping unemployment in the country low.

Last year’s private consumption saw a steady increase, supported by positive income growth amid stable labour market conditions that further improved consumer confidence, and by continued government incentives. This is expected to remain at 6.3% year-on-year (YoY) in 2018, and as the country gears up for the elections, government incentives should increase as election gifts are distributed to select constituents.

Stronger economic growth most likely resulted from higher collection of GST as well as corporate taxes. Government revenue is also expected to rise as the Royal Malaysian Customs Department and Inland Revenue Board’s joint audit programme seek to improve the country’s tax collection. Improvements in revenue collection are likely to lead to a humble increase in public spending and investments.

Headwinds and Tailwinds

Last year’s faster-than-expected GDP growth was the result of a number of factors that may not continue in the near future. It is expected that China’s economic growth in the medium term remains at only a moderate pace, directly impacting Malaysia’s economy given the significant trade relation between both countries.

More explicitly, when compared to the currencies of other developing economies in East Asia and the Pacific region, the ringgit will remain exposed to higher exchange rate risks. Bank Negara’s foreign exchange reserves currently appear satisfactory, but this is mainly the result of significant external debts in corporates and banks.

An offshore oil platform. The country’s headline inflation rate, mainly the result of stable fuel prices, is expected to ease.

Malaysia’s robust GDP growth in the first half of 2017 was borne by strong private sector expenditure, with additional support from improved external demand. This is likely to continue: the general outlook remains positive across a range of diversified sectors. Domestic demand is expected to remain the primary anchor of growth.

As spillover effects from strong external demand becomes more broad-based, domestic demand is expected to edge higher to 6.4% YoY in 2018, from 6.3% in 2017 and 4.3% in 2016. A report by RHB Research Institute states that the country’s exports is set to grow at a persistent pace of 5.6% YoY in 2018, backed by strong demand for commodity products, robust growth in international semiconductor sales and improving worldwide trade activity.

Malaysia’s export of electrical and electronics (E&E) products is expected to grow by 5.1% in 2018. As the fastest-growing emerging market for semiconductor devices, the automotive sector continues to be a key driver for demand – a good indicator for Penang.

Sustained growth in petroleum, rubber and chemical exports means that non-E&E exports are expected to remain robust in 2018; these products account for 51.2% of Malaysia’s total exports. Commodity export represented about 12% of total exports in 2017; RHB Research Institute’s report estimates a sustained growth to 13.3% in 2018, as oil prices continue to increase.

RHB Research Institute states that the country’s headline inflation rate, mainly the result of stable fuel prices, is expected to ease to 2.7% YoY in 2018 from the projected 3.5% in 2017. Malaysia’s inflation rate has been on a downward trend after reaching an eight-year high of 5.1% in March 2017. It slowed to 3.2% YoY in July before bouncing back to 3.7% in August.

Government revenue is also expected to rise as the Royal Malaysian Customs Department and Inland Revenue Board’s joint audit programme seek to improve the country’s tax collection. Improvements in revenue collection are likely to lead to a humble increase in public spending and investments.

Researchers at RHB expect Bank Negara Malaysia to increase the Overnight Policy Rate to 3.25% in 2018, after having kept it at 3% until the end of 2017. This increase follows the trend among major global central banks, which are slowly tightening monetary policies amid stronger global growth.

Private investments have enjoyed confident growth rates, reflecting continued capital spending in the manufacturing and services sectors. Backed by government infrastructural projects and the inflow of foreign direct investments (FDI), private investment is estimated to grow at 8.6% YoY in 2018, and Penang can expect to retain its prime position among the country’s FDIreceiving states.

Focus: Penang

According to the 2017/2018 Economic Report issued by the Finance Ministry, manufacturing sectors will increase by 5.3% in 2018, corresponding to the International Monetary Fund’s (IMF) economic report in October last year which stated that the global economy is recovering from weak momentum in 2016.

Both emerging and advanced economies performed well in the first half of 2017; Penang had the highest investments in manufacturing in the entire country. Approved direct investments in manufacturing amounted to RM7.7bil – a huge increase from RM4.3bil in 2016 – and made up 45% of Malaysia’s RM17bil approved investments in the first half of 2017. “This gives us hope that Penang can get a higher amount of investments during the second half of this year,” stated Lim Guan Eng, Chief Minister of Penang, at the end of 2017.

The services sector surpassed the manufacturing sector since 2010, and in 2015 made up 49.1% of GDP share, while manufacturing was at 44.7%. Although a few major manufacturing firms have left Penang – such as Seagate, Western Digital and Rubicon – the manufacturing sector in Penang is still estimated to grow based on global trends as well as new investments coming from existing firms.

Automated assembly line for cars.

An upgrade for the Penang International Airport was announced in Budget 2018.

Hotayi Electronic recently spent RM1bil for a new facility at the Batu Kawan Industry Park, creating 1,000 job opportunities along the way – a mark of confidence for Penang’s talent pool. Broadcom Limited opened a new RM59mil global distribution warehouse at Batu Kawan in September 2017. In addition, halal manufacturing’s future looks bright: Penang has initiated the Penang International Halal Hub, which aims to attract the clustering of halal-related industries such as food, pharmaceutical and services companies.

Stronger growth is largely endorsed by the construction of infrastructure megaprojects impelled by the government under various economic programmes and supported by upcoming inflows of FDIs. In his Budget speech, Prime Minister Datuk Seri Najib Razak revealed some details about these projects – the Penang International Airport upgrade is one such example, and it will have greatly positive impacts on Penang’s future competitiveness; however, no details on the investment volume and timeline have been disclosed.

Preparing for an Automated Future

While there are many promising developments, local manufacturers in Penang have to cope with the development of Industry 4.0, which is the digitalisation and automation of manufacturing processes. Industry 4.0 includes 3D printing, autonomous robots, big data analytics, the Internet of Things (IoT), horizontal and vertical integration, augmented reality, and cyber security, to name a few.

Most SMEs in Penang are not yet ready for the change – huge investment costs and lack of expertise being the main reasons. Efforts to remedy this are on the way – the inception of the Penang Automation Cluster (PAC), linking local SMEs with segmented tasks and lifting their production process, is one such plan. More attention and investments are needed not only in uniting local SMEs and local large companies (LLCs), but also in advanced technology such as robotic arms and cloud-integrated storage.

While projections for the manufacturing sector in Penang are promising this year, with high likeliness of more investments in the near future, manufacturers should note that now is the time to put more effort into ameliorating capital and equipment.

The Digital Economy

More than just providing nifty innovations, the digital economy has great power to disrupt. The battle between ride-hailing apps and conventional taxis is a vivid example: in an industry long characterised by high capital requirements and a monopoly of taxi conglomerates, new competitors often fail given the high barriers to market entry.

This, however, changed with the advent of digital technology. Grab, for example, owns none of the vehicles in their fleet and their nimble workforce is a far cry from being the size of a conglomerate despite dominating the domestic market share for passenger transportation.

Uber office in KL.

The intricacies of this disruption are farreaching across different layers. Caught offguard, taxi drivers find themselves having to continue serving expensive contracts with their employers amid dwindling ridership, resulting in feelings of resentment. On the other hand, Grab drivers enjoy flexible driving hours and a stable source of income. Riders feel empowered – they now have a close estimate of their fare before accepting a service – while the rate and review feature incentivises drivers to provide high quality service.

The speed and magnitude of change is incredible, but in hindsight, there were warning signals: Uber was already disrupting the industry in other countries long before they penetrated our market, yet little was done by taxi conglomerates to adapt and prepare for this disruption.

The reluctance of businesses to adopt digital technologies – or digital strategy, for that matter – is understandable: many established SMEs in Malaysia are familyowned and more likely than not have their decisions made by a single person, if not a handful of managers. These decision makers, who tend to be tied down with day-to-day operations, lack resources to strategise and plan. They are also not necessarily in the know about the latest digital technologies.

Adopting a digital strategy is therefore much more difficult for established firms than for new start-ups or younger, more nimble firms. One has to be clear: a digital strategy is not an extra edge; it is the bare minimum for surviving in the digital economy, and for using technology to complement everyday activities.

As in the case of ride-hailing start-ups and traditional taxi conglomerates, the digital economy will produce winners and losers. The portents point to an impending shakeup of the Malaysian economy. Businesses need to begin actively adopting digital strategies, and the best time to do so is now, when the business environment is still positive.

Timothy Choy is an economic analyst at Penang Institute. He reminisces the good old days when McD sold popcorn.
Ng Peng Zui interned with the Economic Studies Programme at Penang Institute. His interest in observing economic and political phenomena stemmed from backpacking in India.
Tim-Niklas Schoepp is a visiting analyst in Economics at Penang Institute.



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