Affin-Hwang Investment Forum 2017

I will be at the Affin-Hwang Investment Forum this Saturday morning for a panel discussion on the Malaysian Economic Outlook. It’s not free, but it’s open to the public. Details here.

IMF Country Report On Malaysia: Reading Between The Lines

The latest Article IV Consultation between the IMF and Malaysia has some rather flattering language (excerpt):

IMF Executive Board Concludes 2012 Article IV Consultation with Malaysia

…Executive Directors commended the authorities for their skillful policies, which have underpinned Malaysia’s strong macroeconomic performance despite a weak external environment…Looking ahead, Directors considered that Malaysia’s medium term prospects are favorable, as the authorities continue to focus on safeguarding financial stability, strengthening fiscal sustainability, and securing high and inclusive growth.

Directors endorsed the current settings for monetary policy and the mildly contractionary fiscal stance in the 2013 budget. They nonetheless encouraged the authorities to further develop their medium­ term [sic] plans to restore a prudent level of federal government debt and rebuild fiscal space…

What The IMF Thinks About Malaysia In 2012

From the transcript of Monday’s press briefing on the World Economic Outlook Update for Asia, with Anoop Singh, Director of the IMF’s Asia and Pacific Department (excerpt):

Transcript of a Press Briefing on the Economic Outlook For Asian Countries

MS. UTSUNOMIYA: Okay. If I may, the last questions from online. What are some of the external risks you foresee for Malaysia for 2012 when the bulk of the government's transportation program projects will be rolled out, which should boost domestic demand?

And also, briefly, shouldn't Japan's rebuilding process, as well as transfer of some of the production basis out of Thailand, provide growth momentum, too?

MR. SINGH: So on Malaysia, I think we should also recall what Governor Zeti said just, I think, a few days ago -- they're clearly watching it closely. The governor was very clear in her assessment that monetary policy is still accommodative and it is widely accepted that growth will likely moderate a bit this year, and also that the current level of interest rates, in her view, are supportive of growth.

National Debt Update

I haven't covered this topic in a while, so with the government's borrowing program now in full swing, an update is timely.

The federal government's fiscal balance has been negative now since 2Q 2007 (RM millions):



Because expenditure has largely kept track with revenue, the deficit has largely been due to an increase in net development expenditure. The trends are even clearer on a seasonally adjusted basis (RM millions):



An obvious culprit is petrol subsidies, which the latest statements by the Minister of Domestic Trade and Consumer Affairs suggest is running at RM304 million a month for the newly introduced RON95 fuel alone - I'd guess that total petrol subsidies would be in the region of RM400+ million when all is said and done, but that doesn't include the subsidies for diesel, or the hidden subsidy for natural gas which is paid for by Petronas. Total annual cost at current crude oil price levels will therefore be over RM5 billion, or rather more than the country is paying for national healthcare - talk about misplaced priorities.

But development expenditure has accelerated far beyond those levels, which we can probably partly attribute to the two stimulus packages, as well as the planned deficit spending already incorporated in this year's budget. Government borrowing really ratcheted up in February this year, but that was mostly due to the need to meet maturing MGS and GII issues. On a net basis, borrowing didn't really accelerate until May, when a net RM13.8 billion was tapped from the local market:



Up to the end of 2Q 2009, the national debt stood at RM335.7 billion, the bulk of which (RM 228 billion) comprised MGS:




A further RM18 billion was tapped in July and August (gross: I'm not sure how to check on redemptions for August), which brings the grand total to RM353 billion. I'm expecting the rate of borrowing to continue at this pace for most of the rest of the year, and we should see the total to stand at around RM375-380 billion by the new year.

The fiscal deficit has of course continued to deteriorate (4-quarter moving average; ratio to nominal GDP):



...as has the Debt to GDP ratio (4-quarter moving average; ratio to nominal GDP):




The end result is also a significant increase in debt per capita (nominal RM, projected line based on RM380 billion):



My original estimate was that we would see debt per capita reaching RM13,500 inclusive of the two stimulus packages - based on the current rate of borrowing, we're going to see that by the end of this year.

Technical Notes:
1. Federal Government finance and public borrowing data from BNM's MSB
2. August public borrowing data from FAST

Down The Slippery Slope: January IPI

A picture is worth a thousand words (log changes in IPI over the same period last year):



and here's the month on month (log changes in IPI over the previous month):



Unfortunately, DOS have changed the base of the index to 2005 starting this month, which precludes any deeper analysis until I get my hands on the complete time series and splice it into the old one. It's clear however that the carnage is largely in manufacturing.

Malaysian Mini-Budget and National Debt Implications

I won't make any commentary on the mini-budget - there's been enough in the blogosphere today, both for and against. But here's some of the implications for the national debt that I covered yesterday. Only RM35 billion out of the RM60 billion total package will be direct spending, and a further RM7 billion will be PFIs or off-balance sheet expenditure which won't be financed by the government.

That leaves a net increase of RM28 billion additional borrowing required, on top of the original RM21.8 billion projected budget deficit plus last year's RM7 billion stimulus package. Assuming next year's (2010) deficit is around the same ballpark figure as this year's (I'm leaving aside for now potential revenue shortfalls), we're looking at an increase of the national debt to about RM365 billion by the end of 2010 (net of the new Savings Bond scheme), or just under 50% of 2008 nominal GDP. In per capita terms, the increase is approximately RM3,000 per person.

As far as the increase in gross debt is concerned, there's really no historical precedent. However, in terms of the debt to GDP ratio, the two year increase is on par with the increase in debt after the severe 1981 recession. Let's hope we don't follow the same trajectory this time - debt to GDP peaked at 69.7% in 1987.

Funding the borrowing shouldn't be too much of a problem, as there is enough excess liquidity in the banking system to take the whole lot. But at this scale we're now in crowding-out territory where considerably less funds will be available for the private sector, not to mention the impact on monetary policy. RM80 billion of MGS, even spread as it is over two years, is going to significantly contract the money supply - in fact, yields on MGS have already increased in anticipation (thanks satD!) - unless BNM monetizes the debt i.e. print money.

At this stage, I don't think we have much choice in either fiscal spending or quantitative easing to cushion the downturn, but interest rates and MGS yields will bear close watch from now on - yields on 5 year MGS has already jumped 20 basis points yesterday, and are over 100 basis points above January levels.

The Malaysian National Debt or How Much Is Everybody On The Hook For

Since the mini-budget is going to be tabled in the Malaysian Parliament today, I thought I'd put up a historical view of Malaysian government debt up to 2008. The following is gross government debt from 1970 to 3Q2008, which is the latest data point (RM Millions):



Note the faster rate of increase since 1997; not surprising given the deficits run up during that period until now. Next is the level of government debt adjusted for inflation in 2000 prices (CPI:2000=100):



And on a per-capita basis:



Translating back to current prices, that's approximately RM10,389 for every man, woman and child, and at least 2.5 times that amount for every potential taxpayer. Luckily, external government debt is less than 10% of the total, so there's little foreign exchange risk.

To counterbalance this frightening looking increase in debt, here's gross government debt scaled to nominal GDP:



This is easier to stomach: as of 3Q2008, the debt to GDP ratio has fallen below 40%.

A word of caution here: while the numbers look a little daunting at an individual level, national debt should ideally be viewed against national assets (both balance sheet items), of which there really isn't a good measure. The debt to GDP ratio is essentially comparing a stock variable (debt) against a flow variable (national income), and is more a measure of repayment capability rather than solvency. There is a lot of idiotic misuse of GDP numbers in that respect, such as statements that Bill Gates or Microsoft are worth more (net worth: stock again!) than many countries GDP (income!). Be warned.

I haven't time to look at how the numbers above compare with our peers, or any of the advanced economies, but I'll update this post when and if I do.

Technical Notes:
1. Government debt and GDP data is from BNM's MSB; CPI and population data is from DOS
2. The CPI series, due to changes in weights is a spliced index with a base year of 2000

Managing liquidity and the money supply

As a follow-up to my previous post, here's what happened to Malaysia's international reserves over the last year (RM millions):

I don't have a good explanation as to why international reserves continued to rise in the early part of 2008. Net foreign portfolio investment had already turned negative by Q2 (which partly explains the fall in the KLCI), and gains from trade don't remotely offset the loss. My first instinct, that revaluation of reserves were responsible, turned out not to be true - the Ringgit fell 2% on a trade weighted basis in the first half of 2008, and 8% against gold. A close reading of the BOP statistics are in order here.

The second half is easier to explain, and actually makes for a pretty compelling story. Between June and December 2008, forex and gold reserves fell RM95 billion from a peak of RM409.5 billion. The cumulative impact on BNM's balance sheet was even greater (total assets in RM millions):

We're seeing here a balance sheet shrinking by over 30%! The fall in forex reserves accounted for two-thirds of the drop, with the other third coming from a drop in deposits in financial institutions. Ordinarily these would ceterus paribus imply a massive contraction in the money supply. While growth in monetary aggregates did slow and was probably sub-optimal in August and October, at no point did growth turn negative or fall below the rate of inflation (as measured by the CPI).

How'd BNM manage this? The liabilities side of the balance sheet offers the answer. First interbank deposits with BNM fell RM100 billion between April and November 2008. I'm not sure how much control BNM has over this component, apart from the SRR. In any case, the SRR rate was not cut until December and the total only amounted to about RM19 billion, which means either the banks or BNM responded to the fall in liquidity by withdrawing these interbank deposits into the system. More under BNM's control is the issue of BNM bills and bonds, the holdings of which fell RM60 billion between May and December last year. The reduction implies two things - either BNM chose not to rollover maturing bonds, or they bought back bonds on the open market and cancelled them. Either way, it's a net injection of liquidity into the system.

While these movements have helped sustain monetary looseness in 2008, I'm rather more concerned over the future path of monetary policy. At this point the OPR is set at 2.0%, with a cut in the SRR to 1.0% effective March 1 - neither is going to have much of an impact in an environment of falling demand. The slowdown in growth of monetary aggregates in 2008 may have an impact on loan supply, but I think the picture here too is of slowing demand - in other words, a drop off in velocity may leave monetary policy too tight relative to what we need.

What are BNM's options in such a case? There's still another RM50 billion in BNM bills that can be taken off the market, as well as approximately RM140 odd billion in interbank deposits. Utilising these options should not be inflationary, as neither imply an expansion in BNM's balance sheet. Alternatively, BNM could start buying MGS, of which there's over RM40 billion in the banking system, although this move would be inflationary. That's nearly RM200 billion in ready ammunition.

This whole discussion might be moot, though. Despite relatively strong loan growth (over 9% throughout 2008), the banks are still sitting on piles of cash. The banking system's LD ratio is below 80%, so there's plenty of lending capacity without BNM goosing liquidity further.

GDP Data

The 2008:04 GDP and January MSB release last Friday basically confirms what everybody knew - a deep fall in trade was the primary channel for the slowdown in growth. Both exports and imports fell off a cliff into double-digit declines. Paradoxically, the net effect was still a positive for the Malaysian economy, with (X-M) at around RM10.6 billion, although lower than the RM19 billion plus in 2008:03 (now tell me that exports and imports aren't cointegrated!).

The real killer though was the consequent sharp fall in investment with capital formation falling to the lowest level since 2006:01 and the worst growth reading since 2001:03 (chart shows log percentage change y-o-y):


The net rGDP growth figure is sure to be revised downwards, and we may find that Malaysia entered a technical recession at this point. Trade data for January is so far not very encouraging, and the RM7 billion stimulus package does not seem to have been fully implemented yet from what I'm hearing. So fiscal policy has yet to gain traction. Monetary easing? Despite the 150bp cut in the OPR, money supply growth is also dropping:



The worse is yet to come? You bet. To be fair, there's not much that BNM could have done in 2008:04 to expand the money supply. Net portfolio investment (BOP data) fell a whooping RM 56 billion in 2008:03, and I can't imagine the fourth quarter to be any better, if the depreciation of the Ringgit is any indicator.