Economic recovery: an elusive thought?

Much has been said about the state of the economy this year. To put it simply, the economic recession has already here. The reason was none other than the Covid-19 pandemic which have sent the ripple effects to the entire world. Jobless rate has skyrocketed as a result while businesses especially those operated in the realm of tourism related industries and aviation sector are the one who are struggling with their cash flows.

Thus far, the cure or the vaccine has yet to be found although the research and development has reached at an advanced stage. Not to mention those who have been infected also experiencing a relapsed as the antibody developed was transitory in nature. So it is not going to be a smooth sailing for all of us.

The government across the globe have been acting tirelessly to prescribe fiscal stimulus. The central banks have done their level best to bring the cost of borrowings lower in order to stimulate the credit markets. The standard text book demand management policies or the IS-LM curve have been effected rigorously. The outcome from such policy responds have been tangible nonetheless.

China’s economy accelerated to 4.9% year-on-year during the third quarter, the second consecutive quarters of positive increases after contracting 6.8% during the first three months of this year. Similarly, Singapore’s GDP also declined at a slower pace to -7.0% in the third quarter from a massive 13.3% plunged in the preceding quarter.

Malaysian economic recovery was also visible. The total industry volume (TIV) for the automotive sector has jumped to 166,796 units during the third quarter from 67,796 units in the preceding quarter. The Leading Economic Index (LEI) has risen by 7.6% year-on-year in August, representing the fourth consecutive months of increases.

However, confluence of factors are at work which could potentially derail the pace of the economic recovery. The US Presidential election slated on November 3 is something that we need to be mindful of. Will the incumbent President stay for another term or Joe Biden would be elected instead.

Thereafter, what would be the foreign policy especially towards China going to be like. Not to mention the domestic political landscape which has added an interesting colour to the whole equation. And it remains to be seen whether the net outflows in foreign funds in Malaysian equities which has happened for almost three years now can be reversed anytime soon.

So is the economic recovery an elusive thought? The immediate answers is yes. No one really knows how quick the present situation can be turned around. The next question then, what should be the policy response? Thus far, the government has prescribed RM305 billion worth of fiscal stimulus. Perhaps, the government should do more of that. At the end of the day, it’s about making the right choice.

The Economics 101 says that we cannot have the best of both worlds. You cannot have strong economic recovery but at the same time, want to maintain a fiscal discipline. You need to choose and there will be trade off as a result of the decision that you make. Pretty standard to some degree.

Some may argue that the government debt would rise and the cost of servicing such debt would also move in the same direction. Exactly true. The debt service charges have been rising at a rate of 6.7% per annum between the year of 2000 and 2019. The absolute amount stood at RM32.9 billion last year and accounted for 12.5% of total operating expenditure.

However, think about who would be getting the debt service charges of RM32.9 billion. Judging from the holders of Malaysian Government Securities (MGS) which is the main instruments of government debt, 62.9% are from domestic institutions. This would be the likes of Employees Provident Fund (EPF) which holds 22.8% of total outstanding MGS in the second quarter of 2020. This followed by banking institution (23.4%), insurance companies (5.7%) while foreign institutions accounted for 37.1% of total outstanding MGS. Institutions like banks and insurance are required by law to hold certain percentage in this liquid assets for their liquidity management.

Apart from liquidity requirement, MGS is deemed as risk-free assets as the government will not default on its debt obligation issued in domestic currencies. There is also a chance that the investors could make capital gains especially during declining interest rate environment as fixed income securities or bond prices are inversely related to the interest rate direction.

Therefore, government debts tend to be held by the local institution such as pension funds, banks, insurance and asset managers which then would help them to manage their liquidity requirement, investing in risk-free assets and a chance to make capital gains. Another important point to note is that more than one-third of MGS is held by the foreign investors. This goes to show their confidence in the government ability to repay its debt.

Otherwise they would have place their money elsewhere. Notwithstanding that, the government should not ramp up its debt recklessly as this will have negative implication to its credit rating. A downgrade in credit rating could spell trouble especially in the capital flows and the exchange rate.

Therefore, expansionary fiscal policy is not a sin especially when it is executed during crisis. However, the measures has to be targeted, outcome based and time bound. As such, we believe that the Budget 2021 would continue to be expansionary as the economic recovery remain highly uncertain in the face of Covid-19 pandemic spread.