CLICK TO ENLARGEn
THIS time last year, we anticipated a sharp V-shaped recovery in 2021 based on the assumption that nationwide lockdowns would be a thing of the past. Given the prolonged lockdowns in 2021, we see the shape of the economic recovery coming in as a smaller “V”.
In 2022, however, we anticipate that fiscal and monetary policy normalisation will be the central theme of the year. As far as the fiscal side is concerned, it is all about debt management.
Therefore, we expect state-owned enterprises to play a more prominent role in public finance as the total outstanding of government bonds get closer to the RM1 trillion mark (See chart 1).
As of November 2021, the total outstanding of the Malaysian Government Securities and Government Investment Issues was RM895.3bil. Ringgit lost a bit of its value when foreign holdings of local bonds dipped by merely 0.3% in the month.
CLICK TO ENLARGE
To be clear, debt accumulation is not a concern if the multiplier effect is evident. The so-called RM1 trillion mark is not a magic number by any means. Instead, it is to emphasise that debt accumulation has not been able to provide the required growth rates amid present circumstances.
Government spending in 2022 will likely go up to tame rising producer and consumer prices. Considering that the political capital to raise taxes is extremely low amid incomplete recovery, any revenue-raising efforts outside the realm of taxes are likely to be more prominent.
In essence, fiscal policy normalisation is about how quickly the Malaysian economy “graduates” from all Temporary Measures “Covid-19 Acts”. If deficient recovery remains, the government will likely extend the shelf life of these acts, thus affecting future growth rates and the overall efficacy of the 12th Malaysia Plan along the way.
Fiscal policy will have to do most of the heavy lifting in 2022 to allow monetary policy to pull the right lever when they need to.
Perhaps the biggest anticipation of the year is the monetary policy normalisation amid rising prices and the risk of capital flight.
On Nov 3, 2021, Bank Negara indicated that its monetary policy stance “will continue to be determined by new data and information and their implications on the overall outlook for inflation and domestic growth.”
The question is, for how much longer should the Malaysian economy lie in wait for policy tightening to kick in when real interest rate has been negative since April 2021? In fact, inflation has been trending higher since September 2021 amid supply pressures, putting the central bank between a rock and a hard place to hold on to its dual-mandate.
It is important to note that producer inflation, based on the Producer Price Index (PPI), has been running in double digits since April 2021. As PPI measures the cost of producing consumer goods, producer inflation should correlate with consumer inflation.
However, the gap between their growth rates has been widening. In January, the divergence was 0.2 percentage points; it had widened to 10.3 percentage points by October (See chart 2).
The divergence indicates that firms have yet to pass all their higher costs to customers. For producers, this means worsening profit margins. Hence, we see producer inflation to eventually seep through to consumer inflation.
Rising inflation has been stoking concerns among central bankers. On Dec 16, the Bank of England became the first among major central banks to start the anti-inflation fight when it raised its benchmark interest rate to 0.25% from 0.10%. Consumer prices had risen by 5.1% in the previous month.
And in the United States, Federal Reserve (Fed) officials have started signalling aggressive anti-inflation moves after consumer prices shot up by 6.8% in November. The Fed has indicated that it will raise interest rates faster in 2022 and end its asset-buying programme earlier.
We think Turkey’s current economic problems can serve as an essential policy lesson for all. On Dec 16, despite galloping annual inflation (November: 21.3%), Turkey’s central bank cut interest rates for the fourth successive month in efforts to encourage growth ahead of the elections 18 months away.
As lowering borrowing costs typically decreases the value of a currency, the Turkish lira, which had already lost nearly 50% of its value against the US dollar this year, plunged by 5% in the hours after the rate was cut to 15.6%. Turkey faces an imminent crash due to its policy uncertainty, worsening inflation dynamics, high external financing requirements and depleting external buffers.
However, with the emergence of the more easily transmissible Omicron variant, there is a high chance that the road to recovery could become bumpier. A resurgence of the pandemic could cause the recovery to stumble and keep unemployment elevated and entrench inflation more firmly on its uptrend.
With many emerging economies also facing incomplete recoveries amid rising inflation, it is likely that our policymakers will not be the only ones facing this potential policy conundrum.
Based on the above, it is evident that the nature and timing of crisis exit strategies of each economy will be different because of their unique situations.
In Malaysia, many expect the economy to recover to its pre-pandemic size by the second half of 2022, which is why most expect Bank Negara to hike its benchmark interest rate. If fiscal policy cannot move faster than it should, a painful trade-off between price stability and growth is inevitable.
After all is said and done, the government has a lot on its plate, and the situation will only get more challenging in the year ahead. This is because any response either way could put more pressure on our pandemic-battered weakened economy.
The supply side of the economy, among other things, has yet to fully recover; and macro-financial vulnerability has skyrocketed what with government debt having risen significantly and banks delaying to recognise non-performing loans.
For sure, the multi-dimensional impact of the Covid-19 pandemic has made policy compromise become increasingly more complex; and for sure, policy mistakes will become more costly.
One thing is certain, though; as far as economic recovery is concerned, we know more about what we ought not to do rather than what we should do. At the very least, we should steer clear of another lockdown while we find other means to address the spread of Covid-19 and allow the economy to find its new equilibrium point.
On that note, we wish our readers a productive year ahead!
Firdaos Rosli is chief economist while Quah Boon Huat is senior economist at Malaysian Rating Corp Bhd (MARC). The views expressed here are the writers’ own.