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Who To Spend?
Malaysia Perspective | 08 January 2009
By:

As we enter 2009, it is no longer imperative the level of GDP growth Malaysia registered in the year that just passed – either 5.5%, 5.0% or even 4.5%. What is more important is the level of economic growth one foresees this year.

The official forecast is for a growth of 3.5%. Although we do not disagree that the level of economic activity in 4Q08 – a figure which we will know only by the end of February – may suggest the extent of slowdown going forward, changes in the local and global economic landscape especially in the first six months may affect the projection in both ways.

As we mentioned last month, many governments have already announced their stimulus packages to manage the impact of the slowdown with the intention to avoid a recession this year, Malaysia included. The question is whether it is only the government that should increase spending.

With Malaysia aiming to be a developed nation by year 2020 with aggressive expansion in the manufacturing sector, the significance of public sector spending is now at low levels. If one analyses contribution of the components of the “three-sector closed economy”, public consumption in Malaysia is relatively insignificant.

By definition, a “three-sector closed economy” comprises public consumption, private consumption and gross fixed capital formation (or investments). By adding net exports (exports less imports), it then becomes a “four-sector open economy”.

Between 2001 and 2007, public consumption or in other words, government spending, constituted only between 14% and 16% of spending of the three sectors. The more significant one has been private sector consumption, representing 55% – 59% of the three sectors, while investments comprised 27% to 31%. (available figures on investments are not divided into that of public and private sectors.)

12This observation means that for every 1% reduction in private sector spending, it can only be mitigated by a hefty 4% increase in government consumption to ensure total private and public sector consumptions remain unchanged, assuming status quo on other sectors. But for every 1% reduction in investments, it can be moderated by a 2% increase in public consumption.

For this reason, we see the decision to reduce employees’ contribution to the Employees Provident Fund (EPF) by three percentage points to 8% for two years starting this month as an acceptable policy measure to maintain private sector consumption. Yes, it may affect employees’ savings for retirement but such a measure is only for two years. If this option is not exercised, more damages may await everyone if the economy succumbs to a prolonged slowdown or recession.

This however does not mean that the RM7b stimulus package announced recently is sufficient. While the government’s move, intentionally or otherwise, to reduce public consumption to 13.8% of the three-sector closed economy in the first nine months of 2008 is a good move, the “savings” should now be used to increase its contribution.

In 2000 when the global economies experienced a technical recession, public spending in Malaysia only constituted 12.8% of the three sectors. But this was raised to 14.4% in 2001 with a reduction in contribution from investments but status quo on private spending.

The investments component may also be affected this year in view of the bleak economic outlook that may affect new private direct investments, not to mention possible closedown of some existing operations. In addition, loans growth may also be peaking as financial institutions may impose stricter guidelines on new approvals and drawdowns.

We hope the same policy measures to be repeated, i.e. raising public sector contribution to the three-sector closed economy to 14.5% – 15.5% levels this year. This measure is necessary not only to maintain the level of economic activities in the three-sector closed economy but also to overcome any shortfall in net exports, which represented 14.6% of Malaysia’s four-sector open economy last year.

Especially so when the world output is expected to moderate significantly to only 2.2% this year from an estimated 3.7% last year as predicted by the International Monetary Fund (IMF) in its latest projections. It expects the US, Euro area and Japan going into recession this year with forecasted GDP contraction of 0.7%, 0.5% and 0.2% respectively.
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This means that Malaysia’s future exports is at stake as these countries represent 35% of its total exports, which dropped 2.6% yearon- year in October 2008. This has not included Malaysia’s other trading partners that may also reduce imports as they are also affected from the global slowdown.

And finally, a reduction in imports in semi-finished products in line with the anticipation for a drop in exports in finished products will also impact manufacturing companies especially those in free trade zones. Any retrenchment exercise arising from this, which we are beginning to hear and read, will then affect private consumption.

So, while consumers will be able to spend more (in aggregate) but wisely following the reduction in EPF contributions, the government will also need to step up its stimulus packages in an effective and efficient manner to weather the current storm.

Stimulus packages can be in various forms, such as important infrastructure projects especially those that were delayed earlier due to high materials costs at that time, agriculture projects that can make us self sufficient on our basic food needs in 5-10 years, developing disbursement of a new fund for selected small and medium scale industries, as well as education grant for retraining retrenched employees.


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