Current volatility a good check-and-balance mechanism for M’sia

GLOBAL oil prices are still falling, impacting Government coffers. Malaysia’s reserves are falling and so is the ringgit. The Government has snipped a little off its operating expenditure, something that has not convinced the investment community that enough is being done to rectify public finances.

The economic growth for 2015 has been revised slightly lower to a maximum of 5.5% compared to 6% when Budget 2015 was unveiled in October. This is based on the assumption that Brent crude would average at US$55 per barrel for this year and the ringgit would trade at 3.55 against the US dollar.

Since the announcement by Prime Minister Datuk Seri Najib Tun Razak and several top officials from the Government on the adjustments to Budget 2015, crude oil has tumbled below US$50 per barrel, with the ringgit going above the 3.60 mark against the US dollar before settling down at a lower mark.

So, is there any reason to be optimistic about the Malaysian economy?

Yes, there are several reasons to be.

For one, the stock market is holding up better than expected. The reason could be that investors may be seeing some stabilisation in emerging-market currencies – the ringgit included – considering several developments in the external sector.

There are increasing signs that the United States might not raise interest rates in the second quarter of this year as widely believed a month ago. Although the US economy is on the mend, it needs to ensure that the rest of the world is stable for it to sustain growth.

A rise in US interest rates will cause more volatility to the already unstable capital markets and wreak havoc on the movements of major currencies. As it is, most major currencies have depreciated against the US dollar, with the ringgit among the worst-performers in this region.

Adding credence to the belief of the United States not raising rates is that Canada, which is also dependent on oil just like Malaysia, has reduced interest rates. So has India, which is a net importer of oil, to reflect the lower energy cost.

The European Central Bank’s move to embark on a massive bond-buying programme until inflation hits 2% is a sure sign that central bankers around the world are more concerned about the deflation effect that the collapse in the oil price has brought about. And Europe is an important export market for the United States.

The International Monetary Fund has also predicted a lower growth for the global economy to 3.5% this year, lowering it by 0.3 percentage points. Everything points to a period of slower economic growth amidst minimum inflationary pressures.

With so many warning signals and uncertainties, a rate hike in the United States could just be the catalyst that could roil global financial markets worldwide. So, why would the United States risk it?

But the best reason to be optimistic of the falling crude oil prices and weakening ringgit is that it has – hopefully – forced the Government to instil some discipline into how it handles public finances.

For starters, it has postponed the National Service, which from the start has been frowned upon by many and viewed as a major “leakage” to reward the well-connected. But it went on in the name of promoting unity. Right from day one, the argument has been that unity cannot be forged by a three-month training stint.

But no – the policymakers refused to listen to reason. Now, they are forced to do so due to financial constraints.

There are a lot more excesses that can be cut from the operating expenditure and even more from the development expenditure. For instance, do we really need a high-speed rail project when even the double-track from Gemas to Padang Besar has yet to see optimum utilisation?

Since 2005, the Government has been enjoying the luxury of super profits from oil and gas (O&G) activities to continue with its public-spending spree – in the name of pump-priming the economy.

The contribution from Petroliam Nasional Bhd (Petronas) and the O&G segment towards Government coffers has been rising to almost one-third of its revenue – thanks to the high oil prices. However, there has been persistent deficit in the Federal Government budget, something that would not go unpunished in times of economic volatility.

That is what a macro-economic check-and-balance mechanism is all about.

Now, the biggest concern for investors on Malaysia is the possibility of the ringgit weakening further and its impact on foreigners holding Government debt papers.

The Government debt papers generally comprise three categories – Treasury Bills (T-Bills), Government Investment Issues and Malaysian Government Securities (MGS).

As at the end of the third quarter of last year, the total Federal Government debts issued domestically was RM553.3bil, of which MGS formed RM319.1bil. There is nothing wrong in the Government issuing debt papers, considering that the gross domestic product of the nation was in excess of RM800bil for 2014.

However, the problem arises because according to the data, foreigners were holding close to 47% of the debt papers as at the end of the third quarter of last year.

The amount would have come down significantly in the last few months, considering that Bank Negara’s reserves have trimmed and the rise in the yields of MGS – indicating that there is more selling than buying activities.

The foreigners only started to come into emerging markets such as Malaysia in a big way after the United States started its quantitative easing programme in 2009. Prior to that, foreigners held less than 12% of the Government debt papers issued domestically.

As foreigners took up the local debt papers, the ringgit started to appreciate. It was at a low of RM3.72 against the US dollar on March 5, 2009, and within two years, had appreciated to almost RM3 against the greenback.

Now, when they see signs of Malaysia’s economic fundamentals weakening due to the drop in oil revenue, they are taking the money out again.

They will only stop when they start to see some improvements in the economic fundamentals. A key indicator is the trade numbers that will be reflected in the balance of payment accounts. The weaker ringgit must translate into higher exports and imports must be checked.

Another area they like to see improvements is reforms in public-sector spending. It will take a long time before oil goes back to its good old days of US$100 per barrel. Fat dividends from Petronas will dry up for 2016 if the oil price continues to trade at below US$60 per barrel.

The Government cannot afford to keep on issuing debt papers like how it is used to. It has to make every ringgit count. Leakages must be plugged or else, the foreigners will keep selling the ringgit.

That’s the beauty of public finance. If it is abused, it will not go unpunished.