Twin deficits risk?

Downside risk: UOB’s Goh thinks Malaysia’s current account will come under pressure due to lumpy imports, driven by investments in infrastructure, while exports are expected to remain weak.

Economists say Malaysia’s exports may remain sluggish with the imports of capital goods on the rise

MALAYSIA’S narrowing current account surplus, driven by its deteriorating net-export receipts, has once again raised the spectre of twin deficits in the country.

According to some economists, there is a risk of Malaysia’s current account slipping into a deficit next year, as the country’s exports are expected to remain sluggish, while its imports of capital goods are likely to accelerate to meet the requirements for the completion of several construction and infrastructure projects.

Malaysia has been running a fiscal deficit for the past 18 years, as government spending has consistently exceeded its revenue under the annual budgets.

If the country’s current account also turns negative, there will be twin deficits, which will have adverse implications on the country’s credit ratings and currency value.

“The risk of twin deficits is not so apparent for this year, but as we move into next year, Malaysia will face the likelihood of twin deficits,” says Hong Leong Investment Bank Research (HLIB) economist Sia Ket Ee.

“A combination of lower export proceeds and higher imports of capital goods will result in the further narrowing of the country’s trade surplus, which in turn, will exert pressure on its current account balance,” he tells StarBizWeek.

Noting that the exports of liquefied natural gas (LNG) are a key contributor to Malaysia’s current account, Sia points out that despite crude oil prices having come off their lows, LNG prices continue to trend lower.

“If this is extended into next year, we will definitely see lower net proceeds from the tonnage of LNG exports, and this will likely coincide with the time when the imports of capital goods are expected to increase to reflect higher investments, hence the negative impact on the country’s current account balance,” he explains.

According to Sia, the expected increase in the imports of capital goods will be driven by ongoing construction projects, such as the Mass Rapid Transit (MRT) Sungai Buloh-Kajang Line, which are entering the final stages of completion between the second half of 2016 and the first half of 2017.

Sharing the same sentiment, UOB Malaysia says the country’s current account for this year overall will likely remain in a surplus, but uncertainties will set in next year.

“The downside risk has certainly increased because the picture of the external environment is very negative,” UOB Malaysia economist Julia Goh says.

“So, we think Malaysia’s current account will come under pressure due to lumpy imports, driven by investments in infrastructure, while exports are expected to remain sluggish,” she adds.

Concerns over the risk of twin deficits in Malaysia were once raised at end-2013, but the risk never materialised, thanks to a rebound in net-export earnings in the subsequent year.

However, with the country’s current account surplus rapidly shrinking in recent months, the risk of twin deficits has once again been raised, with the Malaysian Institute of Economic Research (Mier) being the first to highlight the issue.

It told a local daily over the week that Malaysia’s current account surplus could decline further, or even risk slipping into a deficit, as a result of declining exports. It pointed out that a twin deficits situation could trigger a credit rerating for Malaysia.

Theoretically, a downgrade in the sovereign debt rating will trigger a capital outflow and lead to a weakening of the country’s currency.

As at the first quarter of 2016, Malaysia’s current account surplus stood at RM5bil, or 1.7% of gross domestic product (GDP), compared with RM10.5bil, or 3.5% of GDP, in the preceding quarter.

The narrowing of the current account surplus during the period in review was mainly attributable to a lower trade surplus and wider services account deficit.

“We observe that the trend (of shrinking current account surplus) has been going on for some time... we are a bit concerned that if it continues, the country’s current account will be in deficit,” Mier executive director Dr Zakariah Abdul Rashid says over the phone.

“In the past, Malaysia’s trade surplus has always been strong enough to address and offset the outflow or deficits in other segments that make up the current account in the balance of payments... but this time, the strength of our trade surplus is diminishing fast because of the weakening external sector,” he adds.

Malaysia’s current account covers international transactions in goods, services, income and current transfers. The income account is consistently in deficit due to remittances by foreign workers in the country.

According to Mier’s projection, Malaysia’s current account surplus for 2016 in total will likely narrow to RM11.3bil, or 1.2% of the country’s gross national income (GNI), from RM34.7bil, or 3% of GNI, last year.

The institution also expects Malaysia’s GDP growth to slow to 4.2% in 2016 from 5% last year due to the weak external environment.

The 2016 GDP-growth estimate is in line with that of the Government at 4%-4.5%.

Limited options to pump prime

The slowing GDP growth has prompted policymakers to undertake measures to boost the country’s economy.

For instance, Bank Negara has slashed interest rates, reducing the overnight policy rate by 25 basis points to 3%.

Over the week, the country’s Second Finance Minister Datuk Johari Abdul Ghani announced that the Government might introduce a stimulus package to bolster Malaysia’s economy. He, however, did not elaborate.

He only said that the new measures would be based on the Government’s financial capacity, and without the need to increase its borrowing.

As at end-2015, Malaysia’s debt-to-GDP level stood at 54.5%, which was just a hair’s breadth from the self-imposed limit of 55%.

And with a fiscal-deficit-to-GDP target of 3.1% to meet for this year, the options to pump prime Malaysia’s economy are likely limited, and economists differ in their views over the potential measures that the Government could undertake.

“We are in challenging times. The biggest risk ahead is external headwind, which is getting stronger and resulting in our trade weakening faster, and investment flows getting increasingly more competitive. This is beyond our control, so the most viable option is to undertake measures to spearhead domestic demand through private consumption,” says Alliance Bank chief economist Manokaran Mottain.

Manokaran asserts that the Government should consider revising the goods and services tax (GST) rate lower.

He estimates that a 100-basis point reduction in GST rate to 5% from 6% currently will release up to RM6.5bil directly into the rakyat’s pockets.

“A GST review will complement existing measures, such as those announced in the recalibrated Budget 2016, to boost private consumption and hence GDP growth,” Manokaran argues.

“Any reduction in GST revenue for the Government can be offset by the gain in oil revenue, as crude oil prices have rebounded above the US$30-US$35 per barrel level as assumed by the Government under the recalibrated Budget 2016,” he says, noting that as long as oil prices remain above US$40 per barrel, there should be no risk of the country missing its 2016 fiscal deficit target.

Meanwhile, HLIB’s Sia says the Government is unlikely to cut the GST rate.

He, however, reckons that the Government will likely fine tune the GST exemption list so that more products will be exempted and benefit lower income group.

Sia argues that there is some room for the Government to pump prime the economy, as its financial position has improved in tandem with the rebound of global crude oil prices to levels higher than the assumed price of US$30-US$35 per barrel under the recalibrated Budget 2016.

“The financial position of the Government has improved because oil prices have rebounded and it has stuck to its promise to cut operating expenditure, which have resulted in some savings. So, overall, we believe the Government can afford to undertake a mini stimulus to boost the economy,” Sia says.