Despite concerted interest rate cuts and massive liquidity injection, the global credit crisis continues to deepen with little signs of abating. In November, the IMF had revised its global outlook to be even grimmer, taking into account the deteriorating economic trends. The IMF slashed its global growth forecast to 2.2% in 2009 (2008: 3.7%), from 3.0% in the earlier projections. The latest revision projects the three major economies of US, Europe and Japan heading into recessions in 2009. The US is foreseen to contract the most (-0.7%) in 2009, followed by Europe (-0.5%), and Japan (-0.2%). The World Bank projects the world economy to recover to a 3.9% growth in 2010, from 1.9% in 2009, with major economies returning to positive growth.

The Malaysian economy has been resilient in the first-half of 2008, but is not going to be insulated from the global downturn. As the external sector worsened, GDP growth has subsided to 4.7% in 3Q08 after a strong 7.1% gain in the first-half of 2008 (revised upwards from 6.7%), bringing growth to an average of 6.3% in the first three quarters of 2008. Resilient private consumption, steady public investment and higher fiscal spending supported the growth in 3Q08. Malaysia has no direct exposure to the US market but is increasingly feeling the shock from the slowing global economy through trade and investment linkages.

Fearing a dismal global outlook that would hurt the domestic economy, the government stretched its fiscal deficit to 4.8% in 2008, reversing a 7-year progressive deficit reduction. A RM7 billion stimulus package, to be financed by savings from subsidy reduction, was unveiled in November 2008 as a measure to stimulate domestic demand. The deficit fiscal target for 2009 has also been raised to 4.8% of GDP, from 3.6% previously. This may be justified as difficult times call for drastic measures. However, there are concerns that government revenue would be adversely affected by the falling commodity prices, which could subsequently enlarge the deficit to even exceed 5.0% of GDP, especially now that there is a possibility of an additional stimulus package being introduced by mid-2009. There is also the longer-term worry over the high dependency on oil revenue to finance fiscal spending. With most spending going into construction projects, there are questions over the delivery speed and the potential leakages from payments to foreign workers and the imports of construction materials, which would blunt the multiplier effects.

Monthly indicators up to November 2008 are losing momentum markedly. Industrial output has contracted in three successive months, as the export-oriented sectors faced diminishing demand. Total exports have declined for two months in a row, with imports showing steeper declines, resulting in sustained trade surplus. With prices climbing down, export revenues from commodities are growing at a slower pace. Thanks to reduction in domestic oil prices, inflation has eased to 5.7% in November 2008, down from a peak of 8.5% in August 2008. Inflation will likely subside further in tandem with the softening economy.

In view of the deteriorating global economy and its adverse effects on domestic conditions, Bank Negara has reduced the Overnight Policy Rate (OPR) by 25 basis points to 3.25% on 24 November 2008.

To add liquidity into the system and reduce the cost of funds, the statutory reserve requirement (SRR) has been cut from 4.0% to 3.5% effective December 2008. If domestic conditions worsen, amid subsiding inflation, the OPR may be slashed to 3.0% or even lower. The reduction of interest rate has to be done cautiously as it may unintentionally lead to a weaker ringgit that would push up the cost of imports.

Consumer and business confidence indices have both dropped sharply below the 100-points mark in the final quarter of 2008, the dividing line between optimism and pessimism, as indicated by the results of MIER’s 4Q08 surveys. The Business Conditions Index (BCI), which is based largely on firm-level information, has plunged to 53.8 points in 4Q08, shedding 45.8 points from 99.6 points in 3Q08, indicating that business confidence has deteriorated significantly. Though not as bad, the Consumer Sentiments Index (CSI) has fallen to 71.4 points in 4Q08, down 17.5 points from 88.9 points in 3Q08, as households start to feel the pinch from a softer economy. In addition, MIER’s sectoral indices for retail trade, residential property, tourism and the auto industry have all dropped below the threshold level. The sharp fall in both macro indices and the sectoral indices suggests that the outlook for the Malaysian economy would be dimmer than earlier expected.

In hindsight, when the internet bubble burst in 2001 and OECD countries languished to a 1.2% growth, Malaysia’s growth came to a halt (2001: 0.5%). The IMF predicts the OECD to contract by 0.3% growth in 2009, putting Malaysia’s prospects in jeopardy. The internet crash in 2001 did not lead to a banking crisis and so the recovery was faster. The current crisis has done extensive damage and is nowhere near the bottom. Nonetheless, there are mitigating factors that Malaysia can rely on such as a sound banking system, sizeable foreign reserves, and consistent surplus in the current account.

Given the worsening external conditions, it is likely that Malaysia’s growth will deteriorate in 2009, as it takes the hit from the knock-on effects of a flagging global economy. With limited room for policy flexibility, domestic demand can be propped up by fiscal pump-priming and easier monetary policy, providing a partial cushion to the uncertain global economy. Falling commodity prices are not helping either, but may help put a lid on inflationary pressures. The services sector will be the pillar of strength amidst a weak manufacturing sector.

In light of the deeper declines in macro indicators, the tumble in business and consumer confidence, and the dismal sectoral indices, we are compelled to adjust our estimated 2008 GDP growth to 5.1% from 5.5% previously and to revise our forecast for 2009 downwards to 1.3% from 3.4% earlier. Provided that the global economy bottoms out, as projected by the World Bank with global growth recovering to 3.9% in 2010, a marginal improvement is foreseen for Malaysia’s growth to inch up to 3.8% in 2010.