Malaysia's Minsky Moment

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Niresh Manoheran's picture

Oil is arguably the most important commodity in the world. In Asia, home to many of the historically big producers of oil as well as many of the big consumers of it, the near 60% drop in oil prices since July 2014 has already had a massive effect on the economic and social policies of local governments, and with the advent of fracking technology changing the face of the industry permanently, we can expect more changes to follow over the course of the next 12 months. And with every major change that occurs, the first question invariably should be: ‘Is this Good?’. In this essay, we consider this question in relation to many of the countries in the vast continent of Asia, which we take to comprise of the regions of East Asia, Southeast Asia, South Asia, Central Asia and the Middle East.

We start by considering the broad macroeconomic effects of the falling oil prices, and we can break this up into levels based on how we can expect the world economy to respond to the oil glut. We consider as well the current setting as a global economy where inflation is generally subdued and growth has slowed down and is starting to pick up slightly after the events of the Great Recession. At the first and most obvious level, it means less revenue into the pockets of oil producers. It also means that consumers- governments, corporations and individuals alike- all spend less than before for a given quantity of oil or oil product. Putting these together, countries that are big net exporters can expect to be worse off for the loss in revenue, while big net importers can expect to be better off for the increase in disposable income. This change will have huge impacts on how governments plan their budgets for the rest of the year, and how they’ll shape their policies to cope this modified relationship with the world. This extends to corporations and individuals as well, all of whom will one way or another feel the effects of the fall in oil prices. The falling oil price has also pushed down the price of most other highly traded commodities such as competing sources of energy, minerals and metals, and other grown crops like corn and cotton, further compounding the effects of the fall in oil prices for producers and consumers alike.

The second level of impact is how consumption and investment patterns are affected by the increase or decrease spending power. For the average consumer, the lower oil price means an increase in disposable income. What this means for the rest of the economy largely depends on how much and how quickly that extra income gets spent. This is a much more complicated question.  The key input here is the marginal propensities of consumption, investment and savings (MPC, MPI and MPS respectively) is for the various social classes and governments in the region. These numbers however are hard to predict, but there are clues as to how they might shape up. Hong Kong and Singapore for example are both highly industrialized economic entities with several similarities in culture, economic activity and relative location, however the savings rate for Singaporean households is traditionally higher than those in Hong Kong, perhaps suggesting that Singaporeans might not necessarily use the additional income quite as willingly as their northern counterparts thus reducing the immediate boost to growth they might otherwise expect. There are also further complications, such as ageing populations and overall government debt. Countries with older populations generally need to have higher levels of savings and economies with more debt are less inclined to invest.

This leads us the third level, which is how governments and central banks alter their policies to contend with the falling oil prices. Ignoring the producer-consumer dynamic for the time being, we expect the short term bias for most countries to be towards lowering inflation expectations- thus necessitating action, perhaps pre-emptive, to boost inflation either by easing monetary policy or expanding fiscal policy. Outside of Japan, Brunei and arguably South Korea, most countries in Asia have relatively healthy levels of inflation that shouldn’t fall drastically due to the fall in oil prices.

Considering these impacts, our candidate for the country that has the most to gain from the lower oil prices is the Philippines, due to its heavy reliance on imported energy sources, lack of mineral resources and traditionally high levels of personal consumption and a relatively young population, with only 10.3% of the population above the age of 55. Other countries that could stand to gain significantly from the fall in oil prices are big net importers like Thailand, Hong Kong and Singapore, although they all have historically higher savings rates as well as older populations despite being big net importers of energy resources. The wild card candidate is perhaps China, whose growth in this new energy price dynamic is in getting its burgeoning middle class to change its spending patterns to one more in line with those of industrialized economies. China is also a heavy net importer of energy resources and other minerals however it has seen demand decrease significantly over the past 2 years, amid a repositioning of its economy to one more dependent on services, rather than manufacturing.

For the economies in Asia worse off due to the fall in oil prices we focus on heavy oil and gas exporters, namely Saudi Arabia, Iran, the UAE, Malaysia and Indonesia. Saudi Arabia as the largest exporter of oil in the world stands to lose the most in terms of revenue from the fall in oil price, but while the kingdom will inevitably face increasing economic pressures in 2015, it is very well placed to deal with the falling oil price due to its huge stockpile of foreign reserves, totalling USD736 billion- something it could eat into for more than a decade, if taking as constant next year’s projected deficit of USD39 billion. Countries like Kuwait and the UAE, who both record regular government surpluses, are also in good enough financial condition to not feel overly concerned as yet by the low oil prices. Indonesia, an OPEC member until 2009, is precariously placed however its status as a net importer of oil and the removal of oil government oil subsidies means that it could still be a significant net positive to the Indonesian economy. If the government comes good on its promise to increase infrastructure expenditure at a time of depressed commodity prices, the overall picture could become rosier still; at least in the long term.

Iran and Malaysia on the other hand, have much bigger problems. Iran is in a unique position. Its economy is highly dependent on oil exports and has pretty high inflation; however it has made huge strides since 2013 and the election of Hassan Rouhani as President, in bringing down the rate of inflation and diversifying its economy. It is also making attempts to reduce the sanctions imposed on its economy by the United States and the EU over its nuclear program. There has to date been progress on these talks, but these have so far meant the unfreezing of roughly 4billion worth of assets, with a further USD100billion still under lockdown. For Malaysia, the fall in oil prices could prove to be the Minsky moment for the fiscally irresponsible government of Najib Razak for whom, the importance of oil and natural exports is hard to understate. Approximately 30% of government revenue is from payments to it from PETRONAS, the state owned oil and gas company which holds the rights to the drilling of all such assets in Malaysia. A more painful hit to the economy could come from the drop in the prices of crude palm oil, which should affect low income households, many of whom are dependent on the palm oil industry. In the midst of all this is the relatively quick depreciation of the Ringgit, due to rising inflation and falling oil prices. Malaysia also has financial concerns unrelated to oil, with the implementation of the Goods and Services Tax this year and  possible duress due to the missed payments to two major local banks, CIMB and Maybank, which could have broader implications for the economy. While the country should not fall into a recession, the drop in oil prices could have a huge effect on the economy as a whole resulting in growth slipping 3-4%, with inflation and inequality both rising, and the government deficit as a percentage of GDP swelling far beyond the self-imposed 55% limit, possibly as high as 75%.

Thus the country that stands to gain the most from lower oil prices is the Philippines while the country that stands to lose the most is Malaysia. In particular, the biggest gainers are the Filipino middle and lower class, and the biggest loser is the government of Malaysian Prime Minister Najib Razak. 




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