by Kevin Brown
Financial Times
August 17, 2011

Is Malaysia set for sustained economic growth this year, or exposed to serious potential problems if wobbles in the West turn into another slowdown? It depends who you ask.

The central bank is in no doubt that growth will continue, in spite of a fall in the annual pace of growth from 4.9 per cent in the first quarter to 4 per cent in the second.

In robustly positive comments issued with the numbers on Wednesday, Bank Negara acknowledged the impact of weakness in the advanced economies, but insisted that growth prospects remained underpinned by the expansion of private domestic demand and strong exports of commodities and resource-based products – for which read oil, gas and palm oil.

Part of this argument reflects the bank’s insistence that monetary policy remains supportive of economic activity in spite of a further increase in official interest rates to 3 per cent in May.

The bank paused the upward movement of interest rates in July, responding to growing fears about slowing growth, but wants to be free to start raising rates again to head off simmering inflationary pressures. The consumer price index hit 3.3 per cent on an annualised basis in the second quarter, up from 2.8 per cent in the first.

But the bank does also seem to believe that the global weakness in the second quarter was mainly due to temporary factors such as the supply chain impact of the Japanese earthquake in March. Resilient domestic demand will support growth amid sustained private consumption, strong private investment and faster progress on public works projects, it says.

The trouble is, the bank’s tone is at odds with rising uncertainty outside Malaysia about the country’s ability to keep growing. Goldman Sachs downgraded its GDP forecast for the full year from 5.4 per cent to 5 per cent last week, while Standard & Poor’s, the credit rating agency, said the country’s growth prospects were poor in the event of a crisis. Both referred to its relatively open, export driven economy combined with weak public finances still recovering from the 2008-09 crisis.

The point was made even more strongly on Wednesday by Kun Lung Wu, an economist at Credit Suisse in Singapore, who argues that Malaysia is one of the two Asian countries least well placed to withstand a sharp slowdown caused by financial worries in the US and the eurozone. (The other is India).

Although Malaysia ran one of Asia’s most expansionary fiscal policies during the 2008 crisis, equivalent to about 10 per cent of GDP, its toxic combination of high government debt relative to GDP and a big primary fiscal deficit means it could not do so again without endangering its ability to reduce the debt ratio, says CS.

On top of that, the country’s fiscal position is extremely exposed to a fall in global prices. Oil and gas revenues amount to about 40 per cent of total government revenues each year, and about 8 per cent of GDP. So a $10 fall in the oil price strips M$2bn (about 0.3 per cent of GDP) out of government revenues.

Of course, the advanced economies may quickly recover, and oil prices may go up again. But if they don’t, expect long faces in Kuala Lumpur.