Is Malaysia prepared for the next recession?

Warnings of an imminent global recession have been ringing louder than before. With key economic data worldwide continuing to disappoint amid the novel coronavirus (Covid-19) outbreak, experts say the worst is yet to come.

S&P Global Ratings expects the global economy to enter into recession in 2020, and says a recession across Asia-Pacific is "now guaranteed." On the home front, Malaysia is highly vulnerable to the global economic slowdown.

Being a trade-reliant country, with trade accounting for 131% of its gross domestic product (GDP) in 2018 according to the World Bank, Malaysia has minimal chance - if any - to escape a recession if the world plunges into economic turmoil. After all, several major trading partners of the country have been severely affected by Covid-19. These include China, the United States (US) and Singapore.

Speaking with StarBizWeek, Asian Development Bank's former lead economist Jayant Menon says Malaysia has all the co-factors for a significant negative impact from Covid-19. "It is a small, open economy, highly dependent on international trade, heavily integrated into regional and global supply chains, and an oil exporter that relies on its revenue to fund a significant portion of government spending.

The next recession will be unprecedented in modern history. The principal trigger of the downturn is a virus outbreak that has since morphed into a pandemic and forced the halt of production activities in many countries. This is in stark contrast with the Great Recession, the 2008 financial crisis that transpired following the collapse of the subprime mortgage market in the US. Malaysia was dragged into a recession in 2009, even though the cause of the crisis did not emerge from within the country.

However, this time around, Malaysia faces a bigger threat considering that Covid-19 is debilitating the economy domestically and across the other countries. Alliance Bank's Manokaran warns that Malaysia's GDP could likely decline in the second quarter of 2020 (2Q20), following a weak growth of about 0.2% to 1% in 1Q20. "While we forecast a small positive growth in the first quarter, there are chances for the growth to slip into negative territory. If that happens and followed by a decline in the economic growth in 2Q20, Malaysia will enter into recession, " he says.

Generally, recession is defined as two consecutive quarters of declines in a country's real gross domestic product.

So, looking at the cloudy outlook ahead, is Malaysia prepared for a recession?

Socio-Economic Research Centre (SERC) executive director Lee Heng Guie believes that the country's economic and financial fundamentals are in a position of strength to confront the perfect storms. Malaysia, he says, enjoys a diversified economic structure, significant natural resources and human capital endowments. It also has a strong external position, backed by still unencumbered foreign reserves accumulation. The financial institutions remain robust with strong capital backing to support financial intermediation to households and businesses.

Generally, a country is deemed to be in a favourable position to better withstand a global recession, if it enjoys a good current account surplus, which also mirrors a positive savings investment gap.

This applies in the case of Malaysia. In 2019, the country posted a healthy current account surplus of RM49.7bil, the highest since 2012. It is worth noting that the ability of a government to mount counter-cyclical spending is a key measure of the country's resilience in avoiding a deeper recession as well as in rebounding quickly when economic conditions normalise.

(a) With the Covid-19 crisis, Ringgit Malaysia (MYR) is showing a depreciating trend with to date (30 April 2020) exchange rate is at USD=RM4.35.

(i) Do you think we should reverse back to pegged exchange rate system that pegged MYR at US$1=RM3.80 in September 1998? Discuss the rationale of your opinion. (4 marks)

(ii) Should Malaysia impose capital control which is similar to the action taken in 1998 to overcome the global financial crisis in 2007-2008? Discuss this statement. (4 marks)

(b) Based on the case study, Malaysia reported a current account surplus.

(i) Explain the impacts on the country's financial account and its position as a net creditor or debtor. (4 marks)

(ii) Elaborate current account surplus relationship with positive savings investment gap that mentioned in the above article. (6 marks)

(c) Based on the case study, Malaysia still unencumbered foreign reserves accumulation. Explain how Malaysia's balance of payment surplus could lead to an accumulation of official reserve assets. (7 marks)