Long journey ahead to full economic recovery

 

From Paolo Casadio and Geoffrey Williams

The acceleration of the Malaysian economy in Q4 2021 and Q1 2022 has been exceptional. So exceptional in fact that it raises questions about whether the numbers can be taken at face value – due to the volatility of the data – and whether this growth can be sustained into the second half of 2022.

For example, we noticed that there was a sharp revision of the GDP data where the 6.6% quarterly growth reported in February for Q4 2021 was revised to 4.6% in the latest data in May. This brings down the final revised gross domestic product (GDP) figure in Q4 2021 and makes the figure for the quarterly growth rate in Q1 2022 look higher.

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There is also uncertainty about the seasonal adjustment process and whether or not this has been affected by the structural change due to two years of Covid-19 lockdowns.

One example is sufficient to understand this problem – when we look at the raw GDP data for Q1 2022, the quarterly growth compared to Q4 2021 shows a 3% contraction but when it is adjusted it becomes a 3.9% expansion. This adjustment process is normally uncontroversial and normally leads to an upward adjustment of the first quarter every year. In the current data it looks uncertain and may lead to a “virtual” number which does not represent the underlying dynamics in the economy.

Another important contribution to the strong GDP performance in Q1 2022 comes from inventories. This is an effect that we noticed before in 2020 and 2021. Inventories or stocks add to the high GDP number by factoring in some goods that are produced but not sold on the market. This has continued for the last three quarters and affects GDP in an important way.

If we measure economic growth with the traditional GDP indicator we arrive at a 5% annual growth in the latest numbers. If we measure growth as the increase in final demand or sales excluding inventories we get growth of 2.5%. This is exactly half of the official rate because it excludes products produced but not sold.

It is useful to keep this in mind when we are interpreting the GDP growth figures because in future quarters the contribution from inventories will be reversed and this will drag growth down toward the average rate.

Our outlook for the Malaysian economy for the second half of 2022 is based on three scenarios.

First, the most positive scenario with growth around 5% in line with official forecasts by the government, Bank Negara and the World Bank. The assumption is that “everything will go smoothly” converging to a pre-pandemic scenario. This scenario in our view has a 10% probability.

Our baseline scenario, to which we give a 50% probability, is positive overall but with some international factors suppressing growth in the global markets as has been signalled by the International Monetary Fund and others. Our growth forecast in the baseline scenario is for 3.5% growth in 2022 and 4.5% growth in 2023.

The downside scenario, to which we give a 40% probability, factors in a “catastrophe” affecting the international economy. There are many factors which include worsening geopolitical issues due to the conflict in Ukraine, financial concerns on stock markets and the dollar, political turmoil especially in the United States before the mid-term elections and economic volatility with a full-blown recession forecast in the US and Europe.

In the catastrophe scenario, the Malaysian economy may slide into a technical recession in Q2 and Q3 with growth close to zero for the whole year, like in many countries around the world.

We expect that the negative external scenario will partially disrupt the recovery in Malaysia, as well as in other countries, in the second half of the year. Our estimate for overall growth of 3.5% for 2022 in the baseline scenario implies a contraction of GDP in 2Q or 3Q of this year.

The slowdown of economic activity in China has already caused the World Bank to cut its growth forecast by 0.8% to 4.3% in 2022 and some commercial forecasters have cut their forecasts to below 4%. This already has an important effect on exports and inventories in Malaysia and, in our analysis, will bring a contraction of growth on a quarterly basis.

The worst-case scenario takes into account the 0.75% interest rate hike by the US Federal Reserve and possible recession repeatedly forecast by many analysts which has not been ruled out by the IMF. This will not only affect Malaysia but will be worldwide.

Internal factors that might disrupt Malaysian growth include further hike in energy tariff. This already happened earlier in the year, raising inflation in some sectors. In hotels and restaurants for example, as well as other sectors that benefited from the increase in demand due to the reopening of the economy, we saw higher price increases compared to other sectors which did not pass through the increase in tariffs onto the customers due to weak demand.

It is important to avoid such factors that could increase inflation because the price stability that Malaysia is enjoying plays a key role in protecting the purchasing power of households. Facing possible increases in the oil price, the government should consider redistributing profits from GLCs such as Petronas which gains from the high oil price and Tenaga Nasional which is gaining from increasing use of electricity as production expands, so that consumers and businesses are not slapped with higher bills.

There is also a risk that increases in interest rates will expose the still-fragile economy to additional cyclical costs, especially as far as investment is concerned. Investment is the engine of the economy and that the engine has not been working for a long time and has only now started slowly to move on. It should not be stalled by higher interest rates too soon. - FMT

Paolo Casadio is an economist at HELP University and Geoffrey Williams is an economist and provost for research and innovation at the Malaysia University of Science and Technology.

The views expressed are those of the writers and do not necessarily reflect those of MMKtT.