Lessons From Malaysia: The Art of Trade-off


Wednesday January 10, 2018 05:35PM / Proshare Research  

India and China dominated the economic headline given their individual strong macro performance coupled  in 2017. Shockingly, other economic narratives in the Asia region was left untold or not told enough. 

Just like most economies in the region, Malaysia’s macroeconomic feat in 2017 was not told enough. The ability to stem the increase in output gaps to eventual reach output levels. Regarded to be higher than when the cycle turned negative, obviously such feat makes Malaysia worth studying. 

Fig 1: Malaysia’s Composite Leading Indicators in 2017
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Source: Department of statistics, Malaysia

The persistent expansions in Malaysian composite leading indicator provided the needed precursor for bolstering growth. Therefore, the 3
rd quarter GDP growth in 2017 stood at 6.2%.  Evidently such robust growth beat the World Bank and IMF forecast of 4.5% and 4.9% growth.  

Fig2: Malaysia and Nigeria growth trajectory from Q4 2014 to  Q3 2017
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Source: Trading Economics

In addition, the ringgit turned out to be one of East Asia’s best performing currency behind the Taiwanese Baht (fig3) at the end of the 3rd quarter of 2017.  

For a country like Nigeria which was growing faster than Malaysia by the last quarter of 2014.  All of a sudden the same nation is struggling to come out of a growth break coupled with substantially diminished fiscal capacity. How much can we learn from Malaysia? 

Fig 3: Regional Currencies Performance against the American Dollar
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Source: Bank of Negara, Malaysia

Therefore What Is There To Learn?

Lesson 1:  Let the Dogs go after the thin air!!!
At the end of 1997 Malaysia was the poster boy for capital controls, daring to cheat on the rules of capital mobility: A counterfactual that defiled the holy trinity, the joke was on Mundel this time. Contrary to 1997, Malaysia   took a different path this time, as it allowed the Ringgit to partly absorb the shock. 

The divergence   steam from the current reality that capital controls will be less resilient and why? 

The present structure and size of the economy, the present chunk of debt and technological advancement leaves the peg with no chance (Fig 3).

Fig 4: Malaysia debt to GDP and Federal Government Deficit
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Source: IMF, Bank Negara   

The end product will become self-inflictive on both the short term and long term. Thus, a repeat of the 1997 economic script will only amount to carrying a knife to a gun fight, especially for a $997 billion economy.

Besides the Bank Negara was not ready to stake its reputation on the line again, thus capital controls will be an unnecessary burden. ‘Thereby let the dogs go after the thin air denying them the pleasure of waggling their tail’. In reality that was the only real option, anything different was suicide.

For a long time the joke was on the Naira in 2015, as it tried to circumvent the only option.

Lesson 2:  Setting Targets for Exports
Malaysia’s export to GDP ratio stands at 71% while Nigeria export to GDP ratio stands at 10%. Nigeria export to GDP ratio is below the individual average trio of global, MINT, BRIC, which are 28%, 29.75% and 19.25%. 

Fig 5:  Export to GDP Ratio
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Sources; World Bank

Nigeria has the lowest export to GDP ratio, thus it doesn’t take long to see why the Nigerian economy is frequently caught up in a revolving door scenario.

Malaysia’s high export to GDP ratio coupled with a more diversified export mosaic diluted the potency of shocks. That provided the needed cushion for Malaysia as oil and cash crop prices dipped: Malaysia still remains a producer and net exporter of crude.

Such external dynamics made recovery from monetary and negative shocks easier, compared to other emerging economies like Nigeria and Brazil.  For a country like Malaysia with a robust export to GDP ratio and a diversified export composition, bottoming out of trade might not necessarily mean plunging the cycle into a recession.

Apart from having a low export to GDP ratio, Nigeria has a high export concentration. The probability of the external trade bottoming out in the recessionary line becomes higher compare to many of its peers either in MINT or BRIC.

Especially when it involves readjusting to permanent short falls to revenue.  Moving forward, targets should be set with regards export to GDP ratio. Countries which have set such targets have been able to diversify their exports better off. Concurrently it identifies the nation’s position on the global supply chain. Our inability to set targets with regards export to GDP ratio just like non- oil revenue to GDP could be dire for our export diversification policy.

Lesson 3: The Need for Robust Private Capital
Malaysia has maintained a steady growth in its gross capital formation (GCF); however what is gross fixed capital formation?  Gross fixed capital formation is referred to as investment in physical asset of a nation such as land.  Strikingly it’s a parameter for  how much of total income is reinvested.  Sustained expansion in the growth of such assets has a positive knock off effect on output, tempering down unemployment.

Fig 5:  GCF growth in Malaysia from Q1 2016 t0 Q3 2017
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Source: Bank of Negara, Malaysia 

Nations such as Malaysia and China which has sustained high level of gross fixed capital formation have enjoyed high output with a steady growth pattern. Gross fixed capital for is largely driven by private contribution to the Malaysian economy.

Fig 6: Public and Private Contribution to Gross Fixed Capital Formation

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Source: OECD

Nigeria’s  Gross Capital Formation (GCF) to GDP ratio is 14.5% due to the combination of high government consumption coupled with lean private contribution to GCF. More over the nation’s diminished fiscal capacity would certainly limit the growth of GCF.  Thus a more endearing approach aimed at nursing private capital has become inevitable.

Government has begun to stir up private contribution in recent times. Through widening the pioneer tax status and introduction of the investment promotion council, regardless a lot more is needed to drive private contribution to GCF.

Measures such as, improved land administration, Investment tax’s allowance, reinvestment tax’s allowance and specific tax’s exemption for firms carrying out research and development, such measures will  foster’s growth in GCF.

Encouraging more PPP penetration in infrastructure, improving the quality of human capital, coupled with the proper legal frame work and regulation is essential for private contribution to thrive.Rolling over capital expenditure by the fiscal side stalls the growth of GCF, eventually   reducing potential productivity.

Presently, Nigeria needs at-least 7% annual growth in GCF to reduce unemployment, avoiding roll overs in capital expenditure has become a necessity. 

Lesson 4: Dear, Growth not Price is the Holy Grail
The Bank Negara had pointed out that inflation will be above 3% for some time, thereby inflation on the short to medium will be higher than it its long run path. In reality the bank let go a positive real savings rate as at January 2017 in-order to reinforce growth. 

Tightening rates will weigh down private capital down, which will adversely affect both consumption and further weaken external trade.  The bank’s tolerance was further tested when inflation hit 5.8% in March 2017, the bank left it anchor numb stating inflation was externally driven.

Fig 7: Inflation, Interest rate and changes in Producer Prices

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Source: Bank Negara, Trading Economics

Such position hinged on the trajectory of the curve of producer prices, “obviously what comes up must come down” (Fig7). Certainly, money was neither a major factor nor one of the factors driving this particular inflation. By such action the bank obviously shunned the temptation to go on an inflation targeting path.  

Apparently understanding, that rate hikes create friction to aggregate supply, the bank chooses to shave its anchor. Why risk a rate trap, in attempt to retain rate differential?

The bank’s policy was justified when the good and services account neutralized the dip in the financial account at the end of the 3
rd quarter 2017.The end product was a widening in trade surplus, which is responsible for the strengthening of the leading composite also rubbing positively on the ringgit (Fig 1).

Truth be told, there are no easy choices in economics because they do come with cost. One could argue that for a nation which had its inflation below 2% in 2016, reaching 5.8% inflation over a short span is worth losing sleep over.

Regardless, the bank chose growth and employment ahead of inflation in order to dent poverty further. Thereby, reaching potential growth levels remains the Holy Grail not price. So far, the cost of shunning accommodation in Nigeria has resulted into tepid growth levels and high unemployment. The urgency for monetary accommodation is inevitable in 2018.

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