Where Does Malaysia Stand In This Backdrop Of Uncertainty in 2008?

Volatility in the equities put aside, the good news is that Malaysia's macro economic status remains stable. To sooth investors' nerves over rising oil prices, some market pundits point out that it is taking place due to surging demand which can only mean one thing – growth. And growth is always a good thing.

There is no denying. 2008 is likely to be a challenging year – of high volatility, a year when positive catalysts battle with major economic dampeners to take their spot on centre stage. Making it tougher for pundits to make their projections on the outcome is that the global dynamics have altered drastically with the emergence of China (and increasingly too, India) as a giant powerhouse.

People started out very cautiously on the back of the US having a big drag on the rest of the world. But this is the time where things may happen otherwise. The slowing growth in the US is a certainty. But can Asia decouple? Some think this is impossible, but others say some decoupling can happen this year (2008).

US makes up 5% of the world population, and over the last few years, it has become obvious that wealth is being shifted overseas. It is flowing outside. This is evident from high oil prices and high commodity prices. The slowdown in the US is irreversible. It is definitely seeing a structural decline.

With that the country has arrived at an inflection point. Can we live without the US? While 20% of Malaysia's exports still goes to US, and that is considered significant, but maybe the remaining 80% of exports can rise? The world might surprise.

Generally and historically, there is a tendency to be overly pessimistic when financial woes strike the US. That is largely because it is the world's largest economy and largest trading partner.

Increasingly, however, that status is being challenged by a weakening dollar and more so, the rise of two other Herculean-sized economies – China and India. In addition, there is more wealth transferring from the US to other parts of the world on the back of record high commodity prices.

The major worry is that countries that rely on the US for exports may see a weakening due to a slowdown in the US economy. This, in turn, it is feared may trigger a worldwide economic slowdown. For example, in an emerging economy such as Malaysia, where about 19% of total exports is channelled to the US, it is estimated that a 1% slowdown in the US could slash Malaysia's growth by 0.9% to 1%. Indeed, a frightening thought.

Increasingly, however, there are arguments that point to the fact that the impact of a slowing US economy on Malaysian economy may be more muted. This is largely premised on the possibility that in the event of a softening US economy, any slowdown in exports by emerging markets may be offset by the fact that more funds may flow into these economies, not only of Asia, but of Eastern Europe and South America. With that, demand in these growing economies could pick up and eventually make up for the vacuum left by the US.
With Asia being the fastest growing continent in the world, funds will continue to seek opportunities here. Coupled with its high reserves, high savings rate and an abundance of liquidity, Asian economies are seen as more resilient should external shocks occur.

US will continue to exert its huge influence on the world, but Malaysia would be rather shielded for 2008 because of its growth that is driven by domestic demand. No doubt the growth pace in Malaysia may slacken due to the slowdown in the US, notably on the exports side. But overall, this slowdown will be boosted by the services sector such as tourism, consumer spending and construction, which are going to pick up strongly. Stock market wise, investors always need to be stock selective to do well in Malaysia. Even in bad times, there are always good companies to look at.

With that, there is consensus that the Malaysian economy can comfortably chart a growth trajectory of just over 6% in 2008, largely bolstered by domestic factors – easy monetary policy to complement the fiscal spending under 9MP, civil servants pay hike and the EPF withdrawals for housing loans.

As people started the year (2008) more cautious, this is good as the market has yet to factor in any excessive bullishness and enthusiasm. Hence its downside risk is protected. This will enable our market to take the blow better if any disaster happens.

Risk this year (2008) is definitely higher than last year (2007).

Major measures and ambitious plans announced in 2007 are expected to roll out this year (2008). Effective Jan 1 2008, EPF contributors will be able to use their monies in Account 2 to pay their monthly housing instalments on top of the current bullet withdrawal every year to settle home loans. This move is expected to unleash some RM9.6bil into the system. The impact of this move will be greater on consumer, tourism, gaming and auto related sectors than the property sector. The move will help lighten the burden of consumers on the back of potential increase in electricity and petrol prices after the recent decision to increase toll rates for selected highways.

The investment exposure in Malaysia is slightly different. We have palm oil that is doing well, and you don't get palm oil in any other part of the world. The success of palm oil will filter down to society, to the Felda settlers first for instance, and then to the consumers. While consumers will feel the pinch from high oil prices, on a net basis, private consumption should be resilient.

Wages are also rising, and this is one reason why oil prices have held at current levels. Consumer's disposable incomes have risen, and that is why oil prices have held. If those incomes did not rise, oil prices would not be sustainable, and we would have seen a slowdown in the economy.

The slow pace of the 9MP implementation has turned out to be a blessing. Presently, less than a third of the RM200bil development spending allocated have been utilised. With robust private expenditure growth in 2007, the Government had the luxury to refrain from over-stimulating the economy. Given the higher downside risks to growth as we enter 2008, the Government can therefore use its outlays as a counter measure. In addition, there is the expected rollout and commencement of more major infrastructure projects from 2008 onwards.

In addition, the Government has unveiled three major economic regions – the Iskandar Development Region, Northern Corridor Economic Region and Eastern Corridor Economic Region with total development expected to exceed RM640bil over the next 13-18 years.

If the corridors are implemented efficiently, it can be a strong catalyst for the market. The Iskandar Development Region (IDR) looks good on paper, especially with some of their ideas, for example allowing qualified foreign professionals to come into the IDR without passports. That would make the IDR very attractive. The main issue here is when the Government will actually start the spending. Will it take another year, maybe 2009 or would all end-up in 2010?

The worry is that spending and approvals for some of the mega projects to be rolled out this year (2008) may not happen at the pace that is expected. The slow process would not only take its toll on construction players (as raw material prices keep escalating and PFI projects become more risky), the multiplier impact to the real economy would also be absent. This would put a huge speed bump on our overall economy growth amidst the volatile world economy.

Rising food, commodity and fuel prices worldwide and domestically is sparking major concern that inflation may spiral upwards. This is despite the fact that headline inflation in November 2007 actually retreated to a mild +2.3% year-on-year from a high of 4.8% in March 2006. It is projected that inflation rates to accelerate to 3.4% in 2008 and 3.9% in 2009 from the estimated 2% in 2007.

Even so, the juggling act of keeping a lid on inflation while encouraging growth is likely to get tough for the central bank this year (2008) on the back of a challenging external front.

Other domestic themes to sustain the market would include the extension of Visit Malaysia Year 2007 into 2008, which will provide a second wind for tourism-related industries and support consumer spending and services sector growth. It is expected that foreign tourist arrivals to be up by 7.8% to 22.5 million in 2008 from our estimated 18.9% growth to 20.8 million in 2007.

Higher capital outlays by the corporate sector and foreign direct investments are expected to help spur the market. Collectively, major government-linked companies are expected to spend RM38.1bil in 2008. There is also the stimulus from the progressive reduction in corporate income tax rates to 25% by 2009 from 28% in 2006.

Meanwhile, based on Bank Negara’s cash balance of payments reporting system, net FDI inflows to Malaysia amounted to RM21.2bil (US$6.1bil) in the first nine months of 2007 against the actual FDI of RM22.2bil (US$6.1bil) in 2006. The banking system is still sitting on RM210.5bil in excess liquidity (as of October 2007), based on the latest loan-to-deposit ratio.

Therefore, there is no drying up of the vital fluids that keep the financial system and economy functioning. This also means that Malaysia’s financial institutions’ direct and indirect subprime exposures appear to be small or negligible.