Brace for second wave of economic bad news

Under the movement control order, people were prohibited from going more than 10km from their homes to buy essential items.

With the number of Covid-19 cases in Malaysia apparently under control and the number of deaths at zero for nearly three weeks, attention is turning to the economic cost of the lockdown or movement control order (MCO).

Based on new data, it is becoming clear that the economic cost is substantial and getting bigger. We can now expect the Malaysian economy to face two different waves of negative economic impact in the coming months.

The first wave is the immediate consequence of the lockdown. The second wave will come when most of the measures in the Prihatin and Penjana programmes end in September and is likely to be more severe and last longer than the first.

The impact of the first wave will be clear from the next round of data for gross domestic product (GDP) in the second quarter release on Aug 12.

Our forecast for Q2 GDP – in line with those recently published by the World Bank – are for a contraction of 10.4% year-on-year followed by a slow recovery that will signal a contraction of 7.1% for the whole year.

If we are correct, the economy will contract by RM107.2 billion compared to 2019, with a loss of RM179.7 billion compared to where the finance ministry expected us to be at the end of 2020.

Other new data from both Malaysia and our main global markets are turning downwards. Industrial production fell by 32.0% year-on-year in April against market expectations of a 15.4% contraction.

The May and June trade data showed a mixed picture, confirming the weakness in the international trade with another contraction in exports of 25.5% year-on-year and imports falling 30.4% year-on-year due to weakness in domestic demand.

Headline inflation showed a deep deflation of 2.9% for the second month running in May and we expect prices to fall by 2.5% during 2020 before returning to a more normal 2.0% inflation in 2021. This pushes short-term real interest rates to around 4.9% and long-term real interest rates to 5.8%, which are the highest in Asia and a significant drag on the economy.

Unemployment figures in April were at 5.0% — the worst figures for 30 years and expected to continue at 5-7% for the remainder of the year.

Add to that forecasts by the Malaysian Employers Federation (MEF) of unemployment at two million and factor in the economic and social impact of lost jobs, lost income, depleted savings and closed businesses and the real cost of the first wave of economic damage caused by the MCO are becoming clear.

The second wave of economic damage is likely to start once the wage subsidies end and firms begin to cut wages or more likely start widespread retrenchments, which are currently discouraged under the MCO regulations. We expect a surge in unemployment which is already at historic levels.

Official statistics of 778,800 unemployed Malaysians in April understate the actual number of people without work. We agree with other economic analysts that the number of Malaysians without jobs may exceed two million or 12.7% of the labour force. This will seriously cut consumption, both directly, because of lower incomes but also indirectly as consumers become more cautious and save more.

We also expect a substantial negative shock to consumer spending when the six-month loan moratorium ends because household debts are now more than 80% of GDP. The contraction in GDP will push the household debt ratio above 90%, which is unprecedented.

Housing market conditions will also hit household balance sheets. Forecasts of aggregate house prices range from sluggish growth around 1.1% to a collapse of 10-15%. Households with large housing loans risk negative equity which may force sales and downward pressure on house prices. We are also likely to see downward pressure on prices in commercial, office and retail properties.

This will all have an effect on businesses and we expect revenues and investment to fall and indebtedness to rise, which will likely cause a surge in business defaults and closures as owners see debts they cannot service and bills they cannot pay all falling due after the payment moratorium.

Any downtrend in the ratio of investment to GDP implies a reduction in the long-term growth potential of the economy as we saw in the 1997 financial crisis.

The scope for policy is already limited and we expect the spending capacity of the government to hit a constraint as tax revenues fall and stimulus costs take hold. The finance minister already predicts that the government deficit may reach 6.0% of GDP this year and we predict it may reach 9.0% due to lower revenue and growth.

We also predict that the government debt ratio will breach the 55% limit and come in around 61% by the end of the year.

In response to the crisis and based on relatively sanguine economic forecasts, the government has announced three economic packages in March, April and June, adding to a smaller stimulus by the previous government in February.

We estimate that the direct cash injection from these packages is RM50 billion, which is not enough to cover the expected loss of RM107.2 billion compared to 2019 or the loss of RM179.7 billion compared to where the finance ministry expected us to be by the end of 2020.

We expect that a further injection of around RM50 billion may be necessary before the end of the year and recommend that this should be in the form of mixed monetary and fiscal policy options, including a zero real interest rate target to boost investment.

The current number of new cases of Covid-19 in Malaysia is so low that the argument – economic or otherwise – for any form of economic and business restrictions is now unsustainable.

The government must recognise the economic devastation caused by the lockdown and the risks of a second wave of economic damage unless all remaining restrictions on economic activity are lifted and the focus shifts clearly toward structural recovery.

Dr Paolo Casadio, Dr Hui Hon Chung and Dr Geoffrey Williams are economists at HELP University based in Kuala Lumpur.

The views expressed are those of the author and do not necessarily reflect those of FMT.