The war in Ukraine and the de-coupling of Russia from major economies are expected to dampen economic recovery and generate inflationary shocks. If inflation in Malaysia worsens, policymakers may have to implement a more restrictive monetary policy combined with fiscal stimulus funded by debt and petroleum royalties.
In October last year, official forecasts projected the Malaysian economy to grow by 5.5 to 6.5 per cent in 2022. More recently, Bank Negara Malaysia has downgraded its forecasts for the country’s economic growth in 2022 to 5.3 to 6.3 per cent. This minor adjustment of a mere 0.2 per cent belies the uncertainties generated by recent events that cloud the prospects of the country’s continuing recovery in the coming months. These include the impact of the war in Ukraine, the ongoing un-coupling of the Russian economy from the global economy and inflationary pressures in developed economies.
Given these uncertainties, what are the prospects of recovery for the Malaysian economy in the coming months and beyond? A good place to start is an assessment of how far the Malaysian economy has recovered thus far.
THE ECONOMIC RECOVERY SO FAR
The Malaysian economy suffered a severe contraction of -5.6 per cent in 2020. This was a consequence of the implementation of a series of control measures starting from the lockdown (Movement Control Order) from 18 March 2020 to 3 May 2020. As a result, the country’s real GDP plunged by 16 per cent (quarter to quarter) in the second quarter of 2020 (Figure 1). Subsequent relaxation of control measures brought about a sharp economic recovery in the third quarter of 2020. Further relaxation of the control measures in 2021 generated a further though modest 3.1 per cent recovery in 2021. As a whole, the economic recovery in 2021 was very uneven: the economy was still relatively weak in the second and third quarters of 2021, but showed a strong recovery in the fourth quarter.
Government fuel subsidies are expected to increase from RM11 billion in 2021 to RM28 billion in 2022 if oil prices remain above USD$100 per barrel. This will shrink the country’s fiscal space further.
At the time of writing, the Malaysian economy has not fully recovered. Before the pandemic, between 2016 and 2019, the economy grew at a compound annual growth rate (CAGR) of 5.0 per cent per annum. Comparing the actual 2021 GDP with a counterfactual GDP derived by assuming a five per cent CAGR growth rate, the “lost output” amounts to about 11.8 per cent of the GDP (Figure 2). This figure is a measure of the economic cost of the pandemic for the past two years. The real GDP in 2021 is estimated to be 97.3 per cent of the level attained in 2019. Thus, the level of economic activity at the end of 2021 is still slightly below the level achieved before the pandemic began.
Based on components of GDP by expenditures, the recovery in 2021 was driven primarily by private consumption (Figure 3). The external sector’s contribution was mixed given the sharp decline in export in Q3-2021, which was due to the lockdown from June 2021 to August 2021. This took place amidst a growing global demand for electrical and electronic goods in 2021. Investment recovered slightly in Q4-2021 but was below the historical average.
From a sectoral perspective, the services sector is the main component of the GDP. Examining trends in the sectoral components of GDP, the services sector only recovered in the second half of 2021 (Figure 4). The sector’s future trajectory remains uncertain as the sector already began plateauing in 2019 before the pandemic. The manufacturing sector also picked up in the second half of 2021.
More recent trends in economic recovery can be partially inferred from the mobility of the population. Population mobility for business-related activities increased since mid-2021 driven by gradual relaxation of Covid-19 restrictions, especially in the last quarter of 2021 (Figure 5). However, mobility associated with these activities declined slightly in January and February 2022.
Labour market conditions also provide some indication of the extent of recovery achieved so far. Before the pandemic, the unemployment rate was hovering around 3.3 per cent (Figure 6), but increased to 5.1 per cent in Q2-2020. By early 2022, this rate had declined and stabilised around 4.1-4.2 per cent.
In terms of the composition of the unemployed, workers in the 15-24 age group account for the largest share despite a slight decline in the past two years. The weakness in the labour market is also reflected in the sharp decline in wages experienced in 2020; median salaries and wages declined by 15 per cent (Figure 7). This decline has been particularly steep for younger workers (20-29) and older workers (60-64). Workers with a lower level of education are also more severely affected (Figure 8). More recent data are not available. However, given that the unemployment rate only declined slightly from late 2021 to early 2022, median salaries and wages are unlikely to have fully recovered to pre-pandemic levels. This can also be seen in the job creation figures which only increased in the last quarter of 2021 (Figure 9). The level of job creation is still about one-third below levels observed before the pandemic. Also, though job creation in the manufacturing sector has rebounded, the services sector remains a laggard.
UNCERTAINTIES IN THE HORIZON
Surveys conducted in early 2022 are optimistic about Malaysia’s growth prospects in 2022. The Business Confidence Indicator (BCI) published by the Department of Statistics in late February 2022 showed that economic activities were expected to increase in the first quarter of 2022 (Figure 10). Whilst the floods in January and March 2022 are likely to have short-term impact on growth in this quarter, they are not likely to have a large impact for the rest of the year. In contrast, two factors will determine the trajectory of the economy in the coming months. The transition to the Covid-19 endemic phase, which began on the first of April 2022, is expected to boost domestic sources of growth. However, the growth induced by the Covid-19 endemic phase may be neutralised by adverse and inter-related developments abroad, such as the war in Ukraine and inflationary pressures in developed economies.
Covid-19 Endemic Phase
Malaysia is currently undergoing its fifth wave of the Covid-19 pandemic. The number of daily new Covid-19 cases in this current wave is higher than during previous waves (Figure 11). However, the number of daily new Covid-19 deaths has remained relatively low (compared to the number of new cases). This is likely to be due to the high vaccination rate in the country. About 79 per cent of the country’s population have been vaccinated with two doses. This has prompted the Malaysian government to relax the control measures further. The country officially entered the Covid-19 endemic phase starting 1 April 2022.
How much will the economy be boosted by the implementation of the endemic phase? In theory, an increase in population mobility for retail activities is likely to increase private consumption. Though the endemic phase will impact domestic economic activity positively, the size of this impact is difficult to ascertain in any precise manner. For starters, the mobility indicators for economic activities such as retail and work have been increasing since June 2021 (Figure 12). It already peaked in late December 2021, before declining slightly – mostly likely due to the floods and seasonal effects. Hence, the domestic economic gains from transitioning to the Covid-19 endemic phase may be smaller than expected.
However, there is one potential silver lining – the move to the Covid-19 endemic phase may be able to support the revival of Malaysia’s tourism industry. In 2019, the sector supported about 3.5 million workers, or 23 per cent of total workers in Malaysia. The pandemic has had a severe impact on the sector, with tourist arrivals and tourism receipts both plunging by more than 80 per cent in 2020 following border closures (Figure 13).
While the revival of the tourism sector is likely to take a long time, it might be possible to achieve faster gains in some markets, such as tourists from Singapore. Before the pandemic, Singapore accounted for the most significant number and share of inbound tourist arrivals (Figure 14). The reopening of the land borders between Singapore and Malaysia for fully vaccinated travellers on 1 April 2022 is expected to provide a near-term boost to the recovery of the tourism sector.
War in Ukraine
The war in Ukraine and economic sanctions on Russia have created some uncertainties. There are several dimensions to these uncertainties, which are all still evolving. The war and the de-coupling of the Russian economy continue to worsen the supply shocks in various commodities markets such as crude oil, natural gas, wheat, and sunflower oil. Both Ukraine and Russia are major exporters of these commodities, with a combined global export share of 69 per cent for sunflower oil, 25 per cent for wheat, 18 per cent for barley, and 14 per cent for corn. Russia is a major exporter of fertilizers (13.1 per cent), crude petroleum (12.5 per cent global trade share), and refined petroleum (9.62 per cent). Expectations of supply shocks – either through reductions induced by war destruction or trade sanctions on Russia, have driven up the prices of food commodities (Figure 15). Food prices had already been trending upwards since mid-2020 due to drought and recovery in demand, but the more recent price increases are driven mainly by supply shocks. In mid-May 2022, India’s decision to ban wheat exports has exacerbated food prices further. Oil price has also been increasing since April 2020. The war in Ukraine, which began in February 2022, increased the level and volatility of oil prices (Figure 16).
The annual CPI values showed that Malaysia transitioned from a deflationary (-1.2 per cent) economy in 2020 to an inflationary one (+2.5 per cent) in 2021. Looking at the price changes in the CPI components, the inflation in 2021 was driven by sharp increases in transport and food costs (Figure 17). The increase in transport costs would have been higher without fuel subsidies (for RON95 petrol and diesel). This can be seen from the increasing gap between the prices for these fuel products and the price of RON97 petrol (which is not subsidised) (Figure 15). With the relatively high weightage of the transport and food costs in the CPI, the inflation rate is likely to be higher in Malaysia in 2022. Recent inflation data suggest that inflation has remained moderate on the whole but food prices have risen significantly. Comparing 2022 to 2021, the price of food has risen by 3.6 per cent in January 2022, 3.7 per cent in February 2022 and 4 per cent in March 2022 (Table 1).
On the production side, the price shocks in the commodities market could benefit producers and exporters of crude oil, liquefied natural gas (LNG), and edible oils (e.g. palm oil). The rise in the price of oil and gas will positively impact the value of Malaysia’s exports of crude oil, LNG and palm oil. However, in the case of crude oil, the net benefit from higher prices might be smaller than expected, seeing how the country’s net exports for crude oil has declined in recent years (Figure 19).
Expectations of shortages of edible oil have also driven up the demand for and prices of palm oil. The current settlement price for palm oil futures rose by 42.9 per cent between 3 February 2022 and 1 March 2022. Prices have since declined slightly but remain 25-30 per cent higher than before the commencement of the Russian invasion of Ukraine. Palm oil prices are expected to remain high until the third quarter of 2022.
The war in Ukraine and sanctions on Russia are also expected to increase the risk of a slowdown in global economic growth. In April 2022, the IMF revised downward its growth projection for the world economy in 2022, from 4.4 per cent to 3.6 per cent. As an open economy, Malaysia’s growth prospects will also be adversely affected by a global economic slowdown. This effect is an indirect one through weakening demand by its major trading partners (such as China, the US, and the EU).
Malaysia’s direct exposure to Ukraine and Russia in terms of trade is relatively small. Ukraine and Russia account for only 0.05 per cent and 0.31 per cent of the country’s total exports in 2020, respectively. Ukraine and Russia’s shares of Malaysia’s total imports in 2020 are 0.12 per cent and 0.41 per cent, respectively. However, about 25 per cent of Malaysia’s wheat imports is from Ukraine. Thus, the war is likely to affect Malaysia’s wheat imports in terms of both quantity and price.
Another global development that will impact Malaysia is the Federal Reserve’s response to inflationary shocks in the US. The current inflation rate in the US is close to double the earlier forecast for 2022. The Federal Reserve raised the federal funds rate by a quarter of a percentage point in March 2022, and further hikes in interest rate are expected in the coming months. Aside from slowing down the US economy, further increases in US interest rates will likely trigger short-term capital outflows from Malaysia, which will weaken the Ringgit. The Ringgit has depreciated by about four per cent from Mid-March to late April. Though this will make Malaysia’s exports more competitive, such an effect might be dampened by a more sluggish global economy. One downside of a weaker ringgit will be higher import costs which can exacerbate inflationary pressures in Malaysia.
ECONOMIC STABILISATION CHALLENGES AHEAD
With external headwinds on the horizon, the growth prospects of the Malaysian economy will also depend on what policymakers can do. Malaysian policymakers will face several challenges in stabilizing the country’s economy. At present, there are still significant uncertainties about the trajectory of global economic growth and inflation. The global economic slowdown and inflationary pressures are imminent, but their quantum and duration are unknown. Irrespective of these uncertainties, the global economic slowdown, and inflation shocks will undoubtedly impact the Malaysian economy in the coming months.
In terms of policy responses, the near-term goals of economic stabilisation should continue to focus on supporting domestic demand and, at the same time, neutralising the effects of imported inflation (driven by higher fuel prices and weaker exchange rates). These will be challenging times for monetary policy. If inflation becomes a severe problem in the coming months, a gradual upward adjustment in the interest rate might be needed. This process has begun with Bank Negara decision to raise the overnight policy rate (OPR) from 1.75 per cent to 2 per cent on 11 May 2022.
In 2019, the [tourism] sector supported about 3.5 million workers, or 23 per cent of total workers in Malaysia. The pandemic has had a severe impact on the sector, with tourist arrivals and tourism receipts both plunging by more than 80 per cent in 2020 following border closures.
Fiscal stimulus might be required to mitigate the effects of this rate hike and support economic growth. The fuel subsidy is a double-edged sword – it helps keep down the cost of fuel for consumers but also saps the government’s fiscal resources. Government fuel subsidies are expected to increase from RM11 billion in 2021 to RM28 billion in 2022 if oil prices remain above USD$100 per barrel. This will shrink the country’s fiscal space further. The Federal government’s debt-GDP ratio was reported to be at 63.3 per cent in June 2021 against the 65 per cent threshold set by the parliament.
Thus, unless the limit for the debt-GDP ratio is raised further, the fiscal resources from additional borrowings could also be limited, especially if the economic recovery is lacklustre. One temporary fix is the drawing of royalties from Petronas, which is made feasible by higher prices of oil exports. Tax reforms could be another medium-term policy option but this is unlikely to take place soon, given the imminence of a general election.
Malaysia’s prospects for a more robust economic recovery in 2022 have been clouded by a number of uncertainties. The transition to the Covid-19 endemic phase will undoubtedly increase domestic economic activities; however, the economic gains from greater mobility might be lower than expected. A weak labour market and sluggish domestic consumption could affect the country’s growth prospects.
A slowdown in the global economy and inflationary shocks will adversely impact the country’s growth despite the higher market prices for some of the country’s exports. Inflationary shocks could be worsened by a weakening Ringgit if the Federal Reserve raises its interest rates further to battle domestic inflation in the US. If inflation in Malaysia worsens, policymakers may have to implement a more restrictive monetary policy combined with fiscal stimulus funded by debt and petroleum royalties.
This is an adapted version of ISEAS Perspective 2022/53 published on 19 May 2022. The paper and its references can be accessed at this link.
Cassey Lee is a Senior Fellow and Coordinator of the Regional Economic Studies Programme, ISEAS – Yusof Ishak Institute.