Priming a pumpBY ANITA GABRIEL
THE government plans to pull on the pump. The objective is simple – to mitigate the risks in the external environment by creating adequate domestic growth drivers.
In a nutshell, it plans to put more money in the pockets to fuel the economy.
Indeed, there is enough historical precedent and a long tradition of using taxes and spending to prop up the economy in stressful times. For Malaysia, the “fiscal” option, it is hoped, will sooth the national unease somewhat given the imminent military stand off between the US and Iraq and its dour implication on world and home economies.
The steps, to be revealed end February or early March, are meant to cushion the blow from any possible downside rather than stimulate the economy with the focus being on private expenditure and public spending.
But as economists and market strategists ponder on what these off-budget measures are likely to envelope, their predictions have inadvertently turned into a wish list (refer to side story).
Malaysia’s fiscal dynamics allows for such short-term potency. JP Morgan senior economist Rajeev Malik says the government can easily manage annual budget deficits of around 3-4 per cent of gross domestic product (GDP) in the next two to three years. The government also has a low debt position of 46 per cent of GDP and the country, a high savings rate of over 30 per cent.
In addition, the government can also increase its development spending given that Malaysian crude oil is currently selling at US$32 dollar per barrel compared to US$26/b in 2002.
Oil and gas account for a quarter of government revenue. (The government had in September last year actually planned to lower development spending by 2 per cent in 2003 to RM32.96 billion). The 2003 budget involves a deficit of RM14.9 billion or 4.2 per cent of nominal gross national product.
Rajeev estimates that the multiplier for government expenditure is about 1.2, meaning that for every additional dollar spent, GDP rises by 1.2. To the extent the government substitutes locally made goods for imported goods in its expenditure, and targets lower- to middle-income households, the multiplier impact would be higher because there would be fewer leakages via imports
CIMB Securities economist Lee Heng Guie expects the measures to focus on sustaining spending momentum and domestic consumption. This being the case, he says, policy moves will be short-term in nature and those that can result in fast and immediate impact on the economy.
But not all market analysts are thrilled. “I don’t think there’ll be a lot of pump priming because of budgetary constraints. Bear in mind the government’s target to achieve fiscal balance in 2005. If it continues to go deeper into deficit, it may raise some concern,” says a sceptic.
Size and composition
The impact and extent of the planned pump priming will be determined by two factors – the size and composition of the package.
Generally, the market is expecting a fiscal stimulus package between RM2 billion and RM4 billion – at 1 or 1 and a half per cent of GDP.
An economist from Mayban Securities takes another wild stab. “Roughly speaking, the size of the package will be based on the higher than expected revenue the government will get which will be used to finance the extra spending.”
It seems more prudent for the government to come out with a modestly sized package given the uncertain times and if need be, carry out such stimuli on an incremental basis.
This way, if things have not improved after the package has been tabled or by the middle of the year, it can always come back with another package.
As such, Rajeev says, having a significantly big package at this point is unwarranted.
Back in 2001
It’s certainly not the first time the government is employing its “spare bullet.” In fact, it was one of the earliest in the region to introduce the first stimulus package of RM3 billion back in March 2001 and added another RM4.3 billion towards the end of 2001 after the Sept 11 terrorist attacks in the US.
The “fiscal windfall” had worked too. The surge in public spending in tandem with positive private consumption over most of that year had averted a recession.
Clearly, 2001 was a tough year for Malaysia as it experienced its second major slowdown in four years and that too, as it was still grappling with the consequences of the 1997 Asian financial crisis.
Waning exports, the global plunge in demand for information and communication technology products and the Sept 11 terrorist attacks had dealt a blow to the Malaysian economy crippling it from achieving a full recovery.
While a fall in disposable income (to partly address this, contribution to the Employees Provident Fund (EPF) was cut from 11 per cent to 9 per cent) and a sluggish labour market exerted downward pressure on consumption spending, this was cushioned by retail discounts, tax deductions, a turnaround in palm oil prices in the middle of the year, low interest rates and a sharp increase in public spending, owing much to the aggressive stimulus efforts.
In addition, private consumer spending growth, accounting for about 80 per cent of total consumption, fell to 2.4 per cent in 2001 from 12.2 per cent in the previous year. Public consumption spending accelerated to 14.1 per cent from 1.7 per cent in 2000, as the government adopted stimulus measures. The economy grew by 0.4 per cent in 2001.
Better or worse
Most say the current scenario is not as bad as that in 2001, while there are a few detractors who reckon it is tougher now as it is more difficult to fathom the impact of a war in the Middle East will have on the world. The answer to that rests in how long the military standoff between the US and Iraq will persist, hence the numerous case scenario studies put out by research houses in recent weeks.
Meanwhile, the country’s industrial production numbers are showing signs of slowing down. The industrial production index which measures the production rate in the manufacturing, mining and electricity generation sectors, declined by 3.6 per cent in November although year-on-year it rose 6.4 per cent. It was the slowest growth rate since the 5.9 per cent registered in August last year.
“There’s a bit more uncertainty in the global economy than in 2001. This uncertainty (over the war) may be short-term but if it drags on, the stimulus package may not work,” says an analyst.
All agree on one thing though. If the war is short followed by an ideal outcome, there is likely to be a huge relief rally in all stock markets including the Kuala Lumpur Stock Exchange (KLSE).
In turn, it could also ignite economic growth and bring forth a return to sequential growth prospects, says Seow Choong Liang, head of research at K&N Kenanga.
On the other hand, if the outcome of war is less than satisfactory or the war prolonged, it could prove to be a drag on economic growth, as uncertainty will continue to dominate.
Even so, Seow adds: “Most importantly, markets expect and have largely discounted a war. For the KLSE, this also means that foreign investors have mostly gone underweight once again hence the next round can only be up.”
The immediate picture, however, looks less rosy. The US economy is still flirting with a possible double dip and a war would be negative. This means consumer sentiment will be dragged, pick up of business inventories postponed and recovery will become sluggish, pressuring companies to slash prices to boost sales. All these, says SJ Securities, will dampen profit outlook.
The local research house adds, however, that war does not necessarily translate into lower financial markets. “Risk premium will increase in selected markets when war takes place. But in most circumstances, the shock to financial markets is largely transitionary.”
To cap the potential downside in the stock market, however, is Valuecap Sdn Bhd with its coffers of RM10 billion. Since its inception two weeks ago, the key barometer KLCI has gained 44.21 points or 7 per cent to close Thursday at 670.79 while the market has been chalking up an average trading volume of 500 million shares.
Valuecap is a clear signal that the government is intent on pump priming the stock market as well as the economy.
Simply put, there are two things the government can do – boost public spending and encourage private expenditure. The quickest way to give the economy a “fiscal” shot is to ignite consumer demand by freeing up disposable income via tax incentives, wage increase or further cuts in EPF contributions.
“I wouldn’t be surprised if they temporarily cut EPF contributions by one or two per cent again this time,” says JP Morgan’s Rajeev. This Singapore-based economist is clearly a strong proponent of such moves.
“I would also urge the government to consider this as a permanent move in order to lift disposable income, thereby engineering a structural shift to boost private consumption,” he adds. Quelling the impact of higher disposable income on the economy, however, is Malaysians’ general propensity to save. Having more cash in your pocket and spending it are two different issues. These dynamics, says Rajeev, are quite important.
Therein lies the importance of pump priming efforts not merely focussed on creating a demand side stimulus but to also help the supply side by enhancing productivity and output.
Mayban Securities does not rule out tax exemptions on dividends to enhance investments in capital market instruments. Other moves bandied about in the market include making interest payments on mortgage tax deductible.
Others expect the key intervention rate in the banking industry to be cut to reduce borrowing cost for corporates and consumers. OCBC Research says lower borrowing costs will result in higher net disposable income for the masses and higher profits for corporation. However, an analyst does not expect this move to be done anytime soon.
More construction activities
Generally, fears of a slowdown are an appropriate time to initiate badly needed but long postponed public spending. For this reason, a large number of market participants are expecting an increase in construction jobs.
OCBC Research says for a greater immediate impact on the masses, speeding up of outstanding construction and infrastructure projects is important. This way, it says, domestic consumer confidence could improve as the construction sector is regarded to possess the highest multiplier effect on the economy in terms of employment.
It adds that projects with either short implementation periods or that are of a small-scale basis would be most favoured.
Reality, however, dictates that a substantial amount of public expenditure has already been ploughed into this sector. Another analyst says: “I don’t think very much can be done compared to the situation in 2001, when there had been little construction going on. How many schools do you want?”
As such, construction analysts are not jumping in to upgrade their rating (if they have not already) on construction stocks. If anything, the focus is likely to be on smaller projects as they have shorter gestation period and hence, have a “quicker kicker”.
“To me, if you look at last few years' pump priming, infrastructure projects are already on the cards and are ongoing. Now the government may continue to focus on smaller projects as they are faster to take off and have a faster multiplier effect,” says CIMB’s Lee.
But what the government really needs to do, says another analyst, is to speed up the implementation of projects already announced namely the Bakun Hydroelectric dam, Kuala Lumpur Convention Centre and KL-Putrajaya Highway projects. The spin-off from expediting these projects will be substantial and will put money in consumers’ pockets.
It should be pointed out, however, that in some instances, higher government spending could result in inefficiencies, waste and non-productive use of resources. As such, short-term panaceas could result in long-term structural weaknesses or excesses.
Ignite private investments
The government can also ignite private investments by faster loan disbursements, and in this area, most are saying, the focus could well rests in small- and medium-scale enterprises (both the prime minister and deputy prime minister have strongly expressed in recent weeks that these small enterprises including rural economies need to be given sufficient attention.)
In this regard, Lee expects certain aspects of Budget 2003 to be re-emphasised such as the timely and speedy implementation of projects and disbursement of funds. The issue of minimal disruption in supply of foreign construction workers may also be addressed as it has proven to be a drag.
On the other hand, a market observer stresses that more important than increasing construction activities is the issue of reviving foreign direct investments and consumption.
“FDIs are falling and we are facing greater competition. The government has to identify new growth areas and figure out how to draw more investments. Even if the impact is not immediate, the government has to do something now.”
His concern was addressed over the week. Deputy Prime Minister Datuk Seri Abdullah Badawi had announced that the country would accord tax breaks, cut red tape and ease labour restrictions to lure foreign investments.
The issue of lag time before the measures kick in, however, is harder to predict. “That is more difficult to get a handle on. It all depends on the composition of the package itself that will determine the speed in which it filters through,” says Rajeev.
A potential salary increase for civil servants will kick in faster as opposed to additional spending in infrastructure related spending.
This is because the latter would require a budget process, issuance of contract and actual implementation.
It is also unclear at this stage if the measures would have to be tabled in Parliament.
All said and done, could there be consequences to pushing the fiscal option too far? All but one say no. “The policy risk is always there. At the end of the day, what translates policy shift into actual spending is really consumers and business and if sentiment does not improve, and they remain tight fisted, the effect would be much lower.”
Until then, however, the old fashioned Keynesian way will just have to do. “It’s more about managing confidence and the government needs to show that it will do whatever it takes,” a market observer wraps it up. He’s right too.
Ultimately, whether or not a stimulus package can resuscitate economic growth depends on its ability to boost consumer, business, and investor confidence. Only a credible public spending plan will be able to do that. Policy makers need only to keep that in mind while they pull on the fiscal lever.