Things may get worse before they get better

(published in The Edge)

These are extraordinary times we are living in. Malaysia is engulfed in a perfect storm, economically and politically. The conditions for a change in the magnitude of “once in a generation”, if not “once in a lifetime”, are now visible. Most probably, things would get worse in 2016 before the change occurs.

1996 was the last happy year where most Malaysians genuinely felt that the nation and themselves were in unstoppable upward mobility and progress. The Asian financial crisis in 1997 shattered the collective sense of pride, purpose, and destiny. I was 19 in 1996. My generation left school with lofty dreams but walked straight into crisis, stagnation and decay, a scenario that continues to plague Malaysia until today.

Anywhere in the world, politics and the economy are closely intertwined. Malaysia is no exception. Contradictions in the economy can often be attributed to the decaying political structures and institutions. Likewise, global economic and financial factors exacerbate political conflicts among the ruling elites.

There have been no major reforms since the last crisis. The Malaysian economy is heavily saddled with rent-seeking and corruption practices built into the system, highly dependent on unskilled foreign labour, and overly reliant on the oil and gas, commodities and real estate sectors. The manufacturing sector suffers from the “Dutch disease” of pre-mature de-industrialization.

Low skills, low wages, and low productivity form a vicious cycle that has characterised the Malaysian economy for the past two decades.

Against such a backdrop, Malaysia muddled through the years since the 2008 global financial crisis and its subsequent environment of cheap and easy credit created by the US Federal Reserve’s Quantitative Easing and other unconventional monetary policies.

The government, government-linked corporations, private sector and households all accumulated debts that made the nation collectively highly vulnerable to changes in global economy and finances.

For instance, Malaysia’s household debt is approaching 90 percent of GDP in 2015. A quarter of the household debts are at the hands of those earning less than RM3,000 a month – a sign of households borrowing for consumption.

Four issues to shape 2016

Oil price, GST, commodity prices and currency, are the four major factors that will shape Malaysian politics in 2016.

First, the era of high oil prices since the Iraq war in 2003 (punctured briefly in 2008 by the Global Financial Crisis and resumed as US Fed loosened monetary policies in 2009) is now officially over. When Budget 2015 was presented in October 2014, Brent (reference oil price) was estimated to be at USD 105 per barrel. The Government had to adjust the budget in January 2015 to bring the estimate Brent price to USD 55. The 2016 budget estimated that Brent would be about USD 48, which many think is too optimistic.

Prime Minister Najib Razak started his budget speech on 23rd October 2015 by acknowledging that petroleum revenue amounted to RM62 billion in 2014, and is expected to be RM 44 billion in 2015 and RM 31.7 billion in 2016.

The sharp decline of oil revenue constrained the Government’s ability to distribute largesse to the UMNO construction and contractors lobby, which at some point will breed revolt against the leadership internally. To the ordinary citizens, the collapse of oil revenue for the Government means less government services and more taxes.

Second, troubles linked to GST. When outlining the oil revenue troubles, Najib – in the same breath – said that the collection from GST has helped to cover a major portion of the shortfall.

“In 2016 based on the Government’s calculation, if GST was not implemented and we had to rely on Sales Tax and Service Tax (SST), as previously, Government revenue would be lower by RM 21 billion. If SST was retained, collection would have been only RM 18 billion compared with GST revenue of RM39 billion.”

In other words, Malaysians are now taxed RM 21 billion more which effectively means less disposable income for families and inevitably less consumption from them. This in turn would mean declining domestic economic activities and potentially less corporate taxes for the Government to collect – a “kill the golden goose” situation.

More than 60 percent of families are classified as low income and receiving BR1M handouts. They are now forced to pay tax for the first time in their lives. There will be huge political consequence.

Third, commodity prices are low. It is not an exaggeration to suggest that palm oil prices are more tied to UMNO’s electoral fortunes than that of oil.

UMNO won 88 parliamentary seats in the 2013 general election, of which 73 are in the peninsula. 35 of these seats, especially those in semi-urban districts of the west coast states, are marginal.

A swing of 10 percent would wipe them all and thus UMNO’s power. Palm oil is an integral part of the economy in these marginal seats. Palm oil is also a crucial political commodity in the remaining UMNO strongholds as they are fortified by FELDA Schemes.

Palm oil and other commodity prices were high during the 2004, 2008 and 2013 general elections, guaranteeing semi-urban and rural support for UMNO. This is no longer the case.

Fourth, currency devaluation. The ringgit has fallen by nearly a quarter against the greenback in the last year. If the US economy improves further, there may be some positive impact on Malaysian exports. But Malaysia is but one among many exporting nations competing to export to the US, and competing to devalue their currencies. Further, the potential increase in exports will not make up for the shortfall in expected depreciation of the Ringgit.

The impending US rate hike is likely to mean the US dollar appreciating against currencies of emerging markets like Malaysia’s. Imported inflation is probably the least of the problems, although ordinary folks would be hurt while costs increase for corporations. The government, government-linked corporations, private enterprises and households with high debts are at risk.

The tightening of global liquidity is certainly going to dampen further property speculation. Federal Government, state governments, local authorities, GLCs and GLICs that had grown used to dependence on tax and income from property development may face a financial crunch sooner than expected, not to mention individuals who own multiple units of properties for speculative purposes.

The Government seems very weak as a result of the political economic factors outlined above, as well as Najib’s personal scandal and issues arising from the 1MDB scandal. The Prime Minister has neither the political will nor the political capital to initial deep and meaningful structural reforms. The next year is likely to see things getting worse before they get better.