Good Analysis: Lousy Recommendation

Kapil Sethi on Budget 2012 (excerpt):

A fool’s paradise?

OCT 24 — Spot on! Screamed out page after page in The Star the day after the Budget 2012 announcement by the prime minister. Barisan Nasional was at pains to paint it as a caring budget which emphasised its concern for the underprivileged through a number of cash handouts and maintenance of subsidies across the board.

But how quickly times change. Within a week, even The Star was forced to concede that a number of economists thought the growth forecast of 5 per cent to 5.5 per cent for 2012 was somewhat optimistic, without which premise the entire fiscal deficit reduction claim would appear to be a pipe dream…

…Already, volatility in the investment, stock and currency markets has reached such a level that Bank Negara recently reported that foreign investors sold Malaysian equities to the tune of US$439.6 million (RM1.36 billion) in August and September alone. This was reflected in a drop in Malaysian foreign exchange reserves to the tune of US$5.3 billion at the end of September. The ringgit has also been continuously weakening against all major currencies in the same period…

…When global demand and national GDP drops, government borrowing will increase to cover the revenue-expenditure gap. Combined with growing inflation due to rising food prices, this will lead to a rise in interest rates on lending.

So for the average Malaysian, this could mean much higher monthly debt service obligations and grocery bills on the back of stagnant or reducing income. In a nutshell, there may be an extremely unpleasant year ahead for the consumer. A prudent plan for 2012 would include making yourself indispensable to the boss in order to protect your income, avoid any increase in borrowing by not buying the new car or house, and boosting savings/ reducing debt by shopping wisely…

Though I won’t argue with the basic premise – the government’s forecast for 2012 is a little rosy given the current information that we have – there’s a number of things wrong here:

1. The Ringgit’s weakening is a direct cause of the drop in foreign exchange reserves at BNM. That’s because at every quarter BNM revalues international reserves based on current market rates. Don’t read too much into the drop.
2. Under the current floating rate exchange rate regime, changes in capital flows will not necessarily be reflected in international reserves – that will only happen automatically under a fixed rate regime.
3. Current market capitalisation of Bursa Malaysia stands at RM1.17 trillion. The drop in foreign holdings represents 1.16% of that. Again, don’t read too much into it.
4. I’ve covered the sensitivity of the 2012 budget deficit before (here). It’ll take an awfully bad 2012 before government debt gets anywhere near serious levels.
5. If global and domestic demand actually drop, food prices will drop as well – lower demand, lower prices. Does no one remember what happened in 2009? Overall inflation turned negative during the recession, and food inflation dropped to levels not seen since 2003.
6. And the assumption of higher market interest rates presumes BNM is only concerned with inflation. They’ve demonstrated repeatedly that growth is always the first priority.

But that last paragraph quoted takes the cake – boosting savings and reducing debt is the worst advice to give heading into a growth slowdown. It’s Keynes’ paradox of thrift again – what looks sensible for the individual turns into a self-fulfilling prophecy in aggregate.

You save for an umbrella when the sun is shining – but that advice makes no sense when it’s already raining.