This article first appeared in The Edge Malaysia Weekly on March 23, 2020 - March 29, 2020

IN January last year, legendary investor Jim Rogers predicted that a commodity boom was unlikely to happen for a while since “world economic problems are coming within a year or so”.

“We will soon have the worst recession in my lifetime. We had problems in 2008 because of too much debt. Since then, debt has skyrocketed everywhere in the world ... even China has debt now while it had little then.

“How can the next recession not be worse [as] the numbers are clear and there for anyone in the world to read?”

Fast forward to today, and Rogers could not have been more accurate. But instead of skyrocketing debt, the world economy has been brought to its knees by the Covid-19 pandemic.

Over 200,000 people in 178 countries have been infected thus far with close to 1,000 cases (at the time of writing) reported in Malaysia with two fatalities. The recent spike in the number of cases here forced the government to impose a two-week Movement Control Order (MCO) nationwide that started last Wednesday.

It is a given that the biggest casualties of the lockdown will be airline and tourism industries but in the globalised world that we live in today, the shutdown of a factory in one part of the world could have a domino effect in another, disrupting the integrated international supply chains.

Already, there have been reports of potential bankruptcies as a result of the lockdowns the world over, and the International Labour Organization estimates that almost 25 million jobs could be lost worldwide as a result of the novel coronavirus outbreak. Note that the unemployment rate in Malaysia ticked up to 3.4% in 1999 from 3.2% in 1998 after the 1997/98 Asian financial crisis (AFC), and this increased further to 3.7% in 2009 during the 2008/09 global financial crisis (GFC).

The global stock market rout saw the Dow Jones Industrial Average lose more than 1,300 points to close at 19,898.92 points last Wednesday — its first drop below 20,000 points since 2017.

At home, the benchmark FBM KLCI dropped below the 1,300 mark for the first time in a decade last Monday. Year to date, the index has lost more than 300 points or 23% and closed at 1,219.72 points last Thursday.

A tumble in crude oil prices, with the benchmark Brent crude plunging 60% year to date to trade at US$26 per barrel, drove the ringgit to a four-year low of 4.42 against the US dollar.

Given this scenario, a technical recession — defined as two consecutive quarters of negative year-on-year gross domestic product (GDP) growth — is inevitable for Malaysia right now but a pertinent question to ask here is, how bad will it be? Will we see a repeat of the AFC or the GFC?

“We believe the extent of GDP contraction could be somewhere between that during the GFC and the AFC. Malaysia’s GDP fell 1.5% in 2009 while in 1998, it declined at a rate of 7.4%. However, we also believe that the extent of contraction will hinge on how fast the spread of Covid-19 can be contained. That is the big unknown,” Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid tells The Edge.

“Our base case is a GDP growth of 0.4% [in 2020]. This is markedly lower than our earlier estimate of 4%. At this rate [of 0.4%], the economy will contract by 1.1% in 1H2020 before accelerating to 1.8% in 2H2020.”

The Socio-Economic Research Centre of The Associated Chinese Chambers of Commerce And Industry of Malaysia (SERC) estimates a baseline GDP growth of between 1% and 2% this year for Malaysia and in the worst-case scenario, a contraction of between 1% and 2%.

“[Like in the] previous two episodes of recession (the AFC and GFC), the Malaysian economy will be hit via both trade and financial transmissions. [However], the coronavirus pandemic has disrupted the movement of people and supply chains globally. So, the knock-on impact on domestic consumer spending and business investment will be more damaging if it takes longer to contain the virus outbreak.

“The magnitude of the fall in share prices is reminiscent of the GFC and a loss in wealth effect will further suppress consumption and [lead to] the crippling of retail and consumer businesses, [which] could quickly escalate into bankruptcies and cause impairment on the balance sheets of banks,” SERC executive director Lee Heng Guie tells The Edge.

On a brighter note, Affin Hwang Capital chief economist Alan Tan believes Malaysia can avoid an AFC-like situation. “In 1997/98, there was a series of infrastructure projects in Malaysia and the country was running a twin deficit at the time. But today, our fundamentals are a lot stronger with a current account surplus and our banking system today is much stronger than in 1997/98,” he tells The Edge.

Sunway University Business School economics professor Dr Yeah Kim Leng concurs with Tan’s assessment, saying that while a global recession is imminent, Malaysia will likely avoid a deep AFC-type downturn, judging by its current fundamentals.

“A U-shaped or V-shaped recovery will, however, depend on the success of the pandemic containment efforts in the country and those of its key trading partners, particularly the US, Europe, Japan and Asean.

“The severity of Malaysia’s recession during the [AFC] was caused by over-investment in the private sector, excessive lending to the corporate sector, a fragile banking sector and massive stock market and property speculation.

“Banking and corporate balance sheets are in a much healthier position currently. While household debt is high, the vulnerable segment is limited to the low-income group. The oversupply in the commercial and high-end residential property segments remains a concern in selected locations. While the developers and purchasers have the capacity to absorb it, the supply imbalance will pose a systemic problem only if the recession is prolonged,” he explains.

Well-capitalised banks

Weak regulation of the US banking system led to the escalation of the GFC and the collapse of Lehman Brothers, which, at the time, was one of the top investment banks in the country.

However, it is worth noting that banks today are better capitalised than they were during the GFC with the Basel III standard, which raised banks’ minimum capital requirements and promoted the build-up of capital buffers in good times that can be drawn down in periods of stress. The capital conservation and counter-cyclical buffers, for example, protect the banking sector from periods of excessive credit growth. Banks that have been identified as systemically important to the domestic market — which in Malaysia’s case are Malayan Banking Bhd (Maybank), CIMB Group Holdings Bhd and Public Bank Bhd — are expected to maintain higher capital buffers to meet regulatory capital requirements, which include higher loss absorbency.

“Currently, Malaysia is blessed with a strong banking system with high capital and liquidity buffers. This is positive, as it provides the local banks with the capability to extend financial assistance — such as a moratorium on monthly loan instalments — to individuals and businesses impacted by Covid-19,” Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias tells The Edge.

The road to recovery

On Feb 27, the government unveiled a RM20 billion stimulus package in the form of tax relief and targeted aid for sectors affected by Covid-19. Later, on March 16, additional measures, including discounts on electricity bills and a monetary assistance scheme for employees given no-pay leave, were announced.

“The RM20 billion package was unveiled when the outbreak was not expected to be this severe. I am quite sure that it would have been larger if it had been unveiled now. I think Malaysia can afford to spend a bit more,” says Nor Zahidi.

“Bear in mind that federal government debt, which is the amount financed by the issuance of Malaysian Government Securities, Government Investment Issues and Malaysian Islamic Treasury Bills, remained at around 49% of GDP at end-2019. Therefore, we still have that six-percentage-point leeway before we hit the 55% limit.

“Should the pandemic prolong, Malaysia’s fiscal consolidation plan may have to be put on the back burner for a while to make way for [a larger] stimulus package to avoid the economy from experiencing a deeper downturn.”

More cuts to the overnight policy rate (OPR) are also expected to help cushion the adverse effects of Covid-19.

“Given the widening spread of the coronavirus outbreak, we expect Bank Negara Malaysia to cut the OPR by 25bps each in May and July. This will bring the rate down to 2%, matching the low of the GFC period. The last monetary policy statement in March appeared to be more balanced than outright dovish, suggesting that the central bank is open to further easing but in a dependent manner,” Standard Chartered Bank Global Research says in a March 19 note.

Given the unfavourable combination of the Covid-19 pandemic, low oil prices and a global recession, it is highly likely that Malaysia will find itself in an economic crisis. But it is important to note that the country has withstood such adversities in the past.

In fact, Malaysia’s recovery during the AFC was swift, recalls Professor Datuk Dr Rajah Rasiah, Distinguished Professor of Economics at the Asia-Europe Institute of University of Malaya.

“This is due to the fact that much of our exposure was domestically denominated and we quickly introduced capital controls before our reserves got exhausted, and our exports to the West, especially electronic products to a booming US economy, helped the recovery fairly quickly.

“Also, we were able to lower interest rates, use the credit guarantee scheme effectively, and organised the disposal of non-performing loans well, which helped the economy fire up again. The [GFC] did not affect Asia much apart from slashing exports. We solved it through a fiscal stimulus that, inter alia, included lowering interest rates and collateral requirements to expand domestic expenditure, although the knee-jerk reaction caused a massive explosion in household debt later,” he says.

He adds that with Covid-19 roiling the whole world and crippling the movement of people and business transactions, things could get worse if a cure for the disease cannot be found quickly.

“Major economies will remain locked with minimal transactions, which will destroy the velocity of money circulation — a major driver of GDP growth. Thus, much depends on how the coronavirus growth curve is handled, especially its peak and decline.

“Our government should learn from China, South Korea and Taiwan to see how they have flattened the curve, including nipping the problem in the bud with effective screening and treatment equipment. It is critical that our government works as one national team to solve this problem.”

With the MCO having just come into force, it remains to be seen whether it will “flatten the curve” of Covid-19 infections in the country. Health Ministry director general Datuk Dr Noor Hisham Abdullah has warned of a tsunami-like third wave of infections if Malaysians fail to adhere strictly to the MCO.

Given such a grim prognosis, failure is not an option while economic growth takes a back seat.
 

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