Tough balancing act to reform Malaysia's economy

Prime Minister Datuk Seri Najib Tun Razak accompanied by Second Finance Minister Datuk Seri Ahmad Husni Muhd Hanadzlah after delivering the 2015 Budget in Parliament. AZMAN GHANI / The Star

PRIME Minister Datuk Seri Najib Tun Razak has a challenging task ahead.

Having inherited a “weakened” economy, laden with legacy issues and structural challenges, amid the onslaught of the 2008/09 Global Financial Crisis when he took up the premiership in 2009, Najib knows time is not on his side to realise the nation’s Vision 2020.

With barely six years to transform Malaysia into a high-income economy, his administration has little choice, but to take up the mantle and do the unpopular move of speeding up the necessary reforms and sustain it beyond that momentous year.

There is still much work to be done, as being an advanced economy is more than just achieving the numbers as set by the World Bank to qualify as one, but it is also about ensuring a better quality of life for the people, a more equitable distribution of wealth and resources to society, as well as a sustainable growth pattern for the country.

Budget 2015 is the final one under the 10th Malaysia Plan, hence it is crucial to move faster before the country embarks on development blueprint the next five-year – the 11th Malaysia Plan (11MP).

The 11MP, which will mark the final lap towards developed nation status by 2020, will be unveiled next year.

As it stands on paper, most of the headline numbers of the Malaysian economy are quite encouraging and seem to indicate that the country is progressing on the right track.

Its economic growth, for one, has been relatively strong in recent years despite the challenging global environment. Also increasing in tandem at a healthy pace is the country’s gross national income (GNI), while its fiscal deficit, which has long been a contentious issue, is narrowing as per target.

The positive numbers aside, a closer scrutiny of the state of the economy will unveil some long-standing structural weaknesses and renewed risks that the country faces. These concerns include the country’s huge debt burden, over-reliance on commodity income, and narrowing current account balance.

The call is for the Government to address these structural weaknesses through various reform measures for the betterment of the country’s long-term economic health and boost investor confidence.

But it is a tough balancing act for Najib to reform the country’s economy, while ensuring minimal impact on the well-being of the rakyat.

Reform measures such as subsidy rationalisation and the implementation of Goods and Services Tax (GST) will help strengthen the country’s finances to better face future crises, but they are like bitter pills for the rakyat as they will consequently have to contend with the rising cost of living.

Following recent subsidy cuts, Malaysia’s inflation is expected to increase to 3.3% this year from 2.1% in 2013. The inflation rate will likelygo up to between 4% and 5% in 2015.

Economists, however, point out that the painful reforms are necessary to strengthen the country’s financial position to boost investor confidence and afford sufficient space to manoeuvre and support the country’s economy.

Hence, the call for the Government to play its part in being more accountable for its fiscal management, and to intensify its fight against corruption and stem the leakages has never been greater.

On another note, despite the criticisms, Najib seems adamant to use cash handouts under the 1Malaysia People’s Aid (BR1M) to mitigate the impact of the rising cost of living on the lower income household.

Critics say the one-off cash handouts are not only unproductive, but a temporary stop-gap measure that could have a lasting impact on the lower-income group.

One of the strongest critics of the BR1M is former prime minister Tun Dr Mahathir Mohamad, who has repeatedly called for the policy to be scrapped. Noting that BR1M will only increase the people’s dependence on the Government, Mahathir has urged the Government to replace the “unproductive” policy with measures to equip people with skills that could help them earn their own living.

The need to address Malaysia’s fiscal position has never been as urgent since Fitch Ratings downgraded its outlook for the country “stable” to “negative” in July last year.

Years of excesses and a lack of fiscal discipline have resulted in the ballooning of the Government debt and budget deficits over the years.

The Government debt-to-GDP ratio currently stands at 52.8%, compared with only 32% before the 1997/1998 Asian Financial Crisis. While that is a decline from the ratio of 54.7% in 2013, the government debt level is still considered high vis-a-vis its self-imposed limit of 55% of GDP.

High government debt levels are unsustainable as they could pose downside risks to the country’s long-term growth.

With the fiscal deficit, the Government says the ultimate aim is to have a balanced budget by 2020, which most economists now reckon is an achievable target, as long as the Government sticks to its fiscal consolidation measures and effectively implement the GST, while maintaining fiscal discipline.

Malaysia, which has been in deficit since 1998, has managed to trim its fiscal-deficit-to-GDP ratio from a high of 6.7% in 2009 to 3.9% last year.

The recent rationalisation of fuel subsidies, which has resulted in the 20-sen-per-litre increase in the prices of RON95 and diesel, is expected to help the Government save up to RM1.3bil this year and RM10bil next year.

These savings are expected to help the Government trim the country’s fiscal-deficit-to-GDP ratio further to 3.5% in 2014 and 3% next year.

Fitch has yet to revise its “negative” outlook for Malaysia despite recent measures by the Government to strengthen its fiscal health, while the other two international rating agencies - Standard & Poor’s (S&P) and Moody’s – have a “stable” and “positive” rating for Malaysia, respectively.

Credit assessments by Fitch, S&P and Moody’s are taken seriously by investors, and their ratings could affect the cost of borrowing or the interest rate that the Government will have to pay investors for buying the bonds that it issues.

Meanwhile, the theory of “twin deficits” has been revisited in recent months due to the declining trend of Malaysia’s current account surplus.

Already in fiscal deficit, Malaysia saw its current account surplus narrowed from a peak of 16.6% of GDP in 2008 to only 3.7% last year due mainly to its dwindling trade surplus and continued investment outflows.

Several economists have voiced concerns over the rising risk of Malaysia registering a current account deficit in the coming years if its trade balance deteriorates amid continued investment outflows.

Containing the risk of twin deficits is important for emerging economies like Malaysia to help reduce financial stress and minimise the risk of sudden capital outflow that could lead to sharp movements of the ringgit.

One can recall how Malaysia found itself in the firing line when there was a widespread capital withdrawal from emerging Asian economies to developed nations last year.

Foreigners currently own about 47% of Malaysian government bonds, thus making the country vulnerable to sudden capital outflow.