IT may seem that we are overdue for a recession, given the historical trend showing a recession for the past two decades. As the phrase goes, “All good things must come to an end”. But are we heading for a recession in the near term?
Recession refers to a business cycle contraction which results in a general slowdown of a nation’s economic activity, measured by the Gross Domestic Product (GDP). It occurs when there is a prevalent fall in spending – an adverse demand shock – more likely triggered by several events such as a financial crisis, bursting of the economic bubble, or an external trade shock.
In response to recession, the government has, in the past, enforced expansionary macroeconomic policies to raise money supply, lower interest rates, increase government spending, and reduce taxes.
To prepare us better for recession, we take cues from the lessons we learned when the world economy was hit by the global financial crisis (GFC) in 2009.
Recent global recession
While the GFC recession technically lasted from December 2007 to June 2009, many important variables did not regain its pre-recession (Q4 2007) levels until between 2011-2016. Real GDP fell by 4.3% or US$650bil and did not recover its US$15 trillion pre-recession level until the third quarter of 2011.
However, the recession was not evenly felt around the world. Where most of the world’s emerging economies, particularly in North America and Europe, fell into a recession, many of the newer developed economies suffered far less impact, especially China and India whose economies grew considerably well during this period.
Malaysia felt the pinch of recession in almost every decade since the 1960s. In the early 1960s and 1970s, the recession was caused by global rubber prices while in the 1980s, the recession was caused by outflow of funds and property bubble burst. In the 1990s, it was due to the asian financial crisis (AFC) that economic growth contracted to its lowest at minus 7.0% y-o-y.
During the GFC, Malaysia’s GDP growth shrank by 5.8% y-o-y in 1Q09, as impacted by the global headwinds via investment and trade activities.
However, the recession was brief and sharp. By 1Q10, the real GDP growth rebounded by 10.3% y-o-y.
While Malaysia has no direct exposure to the US market, it felt the shock from the slowing global economy through trade and investment linkages.
Industrial output contracted by 14.7% in six consecutive months from 4Q08 to 1Q09 as the export-oriented sectors faced diminishing demand.
Moreover, Malaysia’s reliance on a few primary products and the narrowed geographical focus of its international trade made it extremely vulnerable to economy crises with its trading partners – a vulnerability that still plague many developing countries with an equally narrow range of primary product exports.
Currently, major economies and emerging countries globally are hanging by the thread as they lack the fiscal and monetary tools to fight the next downturn.
From that perspective, the US economy is doing well but it is still in a fairly weak position to manage the imminent shock. Although US’ GDP growth expanded at a strong steady pace of 3.5% y-o-y in 3Q18 (against 4.1% in 2Q18), given a massive global corporate debt and a soaring US stock market, a negative shock could become a possible trigger for a downturn in the upcoming years.
Meanwhile, the US fiscal gap has continued to balloon, raising concerns on the country’s debt load, which is at US$21.9 trillion as of December 2018, and going off tangent. According to the latest Treasury Department figures, total public debt outstanding has jumped by US$1.36 trillion or 6.6% since the start of 2018, and by US$1.9 trillion since Trump took office.
In our view, the flattening yields of short-term and long-term papers are showing signs of a potential crisis in the making.
The spread between the short-term (2 years) and long-term (10 years) bond yields has declined close to zero during the AFC period before the crisis hit South-East Asia. Similarly, during the GFC period, the spread went into negative territory in 2005 for almost 18 months before the crisis hits.
At present, the narrowing of US Treasury yields gaps to its smallest in more than a decade could be an early indication of a potential recession. As a matter of fact, the 10-year and two-year US Treasury spread narrowed, while the two-year and five-year US Treasury spread turned negative as both the yields inverted in December 2018.
In the recent three months, the yield spread has collapsed by two-third from just over 30 bps.
That has coincided a tumultuous period on global equity market front since late-August 2018. However, there is no set pattern on how long it takes for a recession to hit once the yield curve has flipped.
On top of that, headwinds arising from ongoing negotiations between US and China on trade tariff matters, political instability in the Euro area, uncertainty in Brexit outcome, and the sliding of global commodity prices such as prices of aluminium, copper, tin, crude oil, and crude palm oil, has also been clouding the global economic outlook recently.
Unfortunately, the consequence of such triggers for US is likely to be grim as the US government continues to pursue procyclical fiscal, macro prudential and even monetary policies. Indeed, there is no why and wherefore for it to breakout from procyclical policy, it will be subjected to the performance of the US economy in upcoming quarters.
The clock is ticking
Malaysia is likely to feel the pinch of global recession with most of the sectors expected to slow down. In part, technical recession is already felt by the country as the economy suffers four consecutive quarters of negative performance reflected by the contracting y-o-y GDP growth from 5.9% in 4Q17, to 4.4% in 3Q18.
According to Bank Negara, supply disruption is the reason that resulted in slower economic growth. In line with that, the government lowered Malaysia’s economic growth forecast to 4.8% in 2018 (2019f: 4.9%) from its earlier forecast of 5.5% to 6.0% due to slower economic growth amid escalating global trade tensions.
Historically, Malaysia’s GDP growth trend has also been moving in tandem with China’s GDP growth.
Since July, the world’s two biggest economies, US and China, have slapped tariffs on a range of goods in a tit-for-tat approach and it is expected not to end anytime soon. As such, China’s GDP growth has slowed down to its pre-recession level in 2009, expanding 6.5% y-o-y in 3Q18 (1Q09: 6.4%).
Year-to-date October 2018, Malaysia’s exports to China amounted to US$27.68 billion or 13.9% of its overall exports. Within the manufacturing sector, China IPI growth recorded a 5.9% growth in October 2018, sending a signal that the manufacturing sector has already slowed down and nearing its GFC period levels (November 2008: 5.4%).
As such, the slowdown in China will most likely affect China’s demand for Malaysian exported goods such as electrical and electronic (E&E), which may lead to spillover effects towards Malaysia’s external sector performance.
Within the property market, the number of unsold completed units has been on the rise since 2015, reaching levels before the GFC period where it peaked at 28,827 units in 2006, while the latest data by the National Property Information Centre (NAPIC) showed that unsold units last stood at 29,227.
Despite that, property value has increased almost three to four times compared to pre-GFC, as prices of houses in Malaysia has soared since 2015 (2Q 2018: RM17.24bil vs. 3Q 2006: RM4.4bil).
As everything tails the history of recession back in 2008, it is time to ruminate what may shake out in the unforeseeable future and list the course of actions to each scenario, so that we are not taken by surprise.
Manokaran Mottain is the chief economist at Alliance Bank Malaysia Bhd.