MALAYSIA

Prevention Is Better Than Cure

With its two key economic drivers, electronics and palm oil, hit by falling U.S. demand and weak global commodity prices, the government's fiscal-stimulus package is a timely move to stave off recession


By Lorien Holland/KUALA LUMPUR

Issue cover-dated April 12, 2001


CRUNCH TIME IS COMING again to Asia. Just as crisis-hit economies are getting back on their feet, fresh winds of recession are blowing through the region. Malaysia's central banker says the nation is ready for the onslaught. And it needs to be: Two key industries--crude palm oil, or CPO, and electronics--that were riding high during the Asian financial crisis and helped Malaysia make its recovery are now in the doldrums. Along with corporate restructuring and boosting domestic consumption, these two industries must be revived if Malaysia is to pull through the obstacles ahead.

The good news is that Malaysia has the capacity to address these problems. On one side the government has already started to address oversupply in the CPO market and is looking at plans to restructure landholding in rural areas. In electronics, the Penang Development Corporation is promoting new-generation photonics technology. The bad news is that politics and market sentiment may get in the way of efforts to fend off recession. Malaysia went into the last economic crisis with a strong and unchallenged government. This time economic uncertainty could fan the fires of dissent within the United Malays National Organization, the leading party in the ruling coalition, at the grassroots level. The race is on to see whether good policies and nimble entrepreneurs can beat the onset of recession and deprive the squabbling politicians of a focus of discontent.

In 1998, when most urban Malaysians were reeling from the effects of the Asian financial crisis, Khairol Hashim was bringing home an unparalleled 2,000 ringgit ($526) a month from his small oil-palm plantation to the north of Kuala Lumpur. "I put an extension on the house, I bought a small car, almost anything I wanted I could afford," says the 38-year-old. But since world CPO prices came crashing down from their historic highs, Hashim and his four small children have to make do with 400 ringgit a month. And because he didn't save when he could, there is little to cushion his fall. "We've had to tighten our belts, we only spend on the very basics now," he says with a wry smile.

Malaysia has around 800,000 smallholders similarly dependent on export markets, making up around one-tenth of the workforce. High global commodity prices in 1998 and 1999 ensured that palm-oil and rubber exports made a small but significant contribution to the country's balance sheets, and a large contribution to social stability. At the other end of the economic scale, Malaysia's electronics industry also experienced a boom, largely led by United States demand for hi-tech components. Last year exports made up one-fifth of GDP growth, which was a healthy 8.5%.

Now, local analysts joke that last year's "V" shaped recovery is becoming a "W" as growth estimates are slashed. And the belt-tightening is not just confined to Malaysia. Across the region, signs of economic malaise are setting in, as a result of weakness in the U.S. and Japanese economies. In mid-March, the Asian Development Bank warned that average forecast growth for the five countries worst affected by the Asian Crisis--South Korea, Thailand, Indonesia, Malaysia and the Philippines--would fall to around 4% this year, compared with 7.1% last year and 6.9% in 1999. "External risks have heightened because of the faster-than-expected slowdown in the U.S. and global economies, accompanied by a rapid fall-off in the growth of electronics," it warned.

But as in the 1997 crisis, Malaysia's government is not sitting idle. Last week it unveiled a 3 billion ringgit ($789.5 million) pump-priming package to spur domestic demand and counter the global downturn by creating an additional 1.1 percentage points of growth. And it left the door open for additional measures should the global economy deteriorate further. "It wouldn't be prudent to allow negative expectations to gather momentum and become self-fulfilling," says Zeti Akhtar Aziz, governor of Bank Negara, the central bank.

Both foreign and local analysts welcomed the measures as a sign that the government is preparing Malaysia for hard times ahead. But Kuala Lumpur-based iCapital, an independent investment adviser, warned that the measures would only be effective if monetary growth is sufficient to accommodate growth in domestic demand. "We need to urgently attract more foreign direct investment and to ensure that more export earnings are being repatriated and not hoarded abroad," it said in a recent report.

Under the new fiscal-stimulus package, the government will start building more schools and staff quarters for the armed forces to try to sustain the economy's momentum. Spending will also be encouraged, with an 8% loans-growth target, and looser purse strings for the consumer at large, including a cut in mandatory contributions to the Employees Provident Fund to 9% from 11%.

However, the stockmarket, which has been making a steady descent through the mid-600 range, did not react positively to the news, with many analysts fearing that the package was too little, too late. The cut in EPF contributions, for example, will only add an extra 40 ringgit to the average monthly pay package, leading to concerns that the government's forecast of a 12.3% hike in domestic consumption (compared with 1.7% last year) is too high. "We feel this is short-term gain for long-term pain; the feel-good factor will wear off after a while," says Nicholas Tan of Merrill Lynch Securities in Kuala Lumpur.

But the package includes a 600 million ringgit injection of funds to reduce oil-palm-planted areas and plans to burn oil for electricity to reduce stockpiles. In the long run this management of CPO prices could prove more significant to Malaysia's economic health than school building or consumer-spending incentives, as it affects such a wide swathe of the rural population. And as Malaysia is the world's largest CPO producer, it should be possible. "I have to be realistic, prices can only be pushed up to a par with soya-bean oil," says Lim Keng Yaik, minister of primary industries. Big increases in soya-bean-oil production in the U.S. are part of the reason why CPO is now trading close to historic lows, way off the 1998 high of 2,400 ringgit a tonne. "But no other [cash] crop is as remunerative for us as palm oil, especially now that we have a method of managing our stock," says Lim.

The government put its stock-management plans into operation after CPO prices fell to a low of 650 ringgit per tonne in February, below the average 800 ringgit per tonne production cost for smallholders. With grants of 1,000 ringgit per acre to replant old trees and shave off current production levels, prices have recovered to 850 ringgit, but question marks remain over the second part of the management plan, which involves burning CPO along with medium fuel oil to generate electricity. Lim says tests have proved successful, and the current high prices of petroleum and low prices of CPO make it economically viable.

For all Lim's confidence, the plans leave analysts appalled. While the price difference between CPO and petroleum has fallen, there is still a 100 ringgit per tonne premium on CPO, which adds up if Tenaga Nasional, the nation's state-owned utility, is to buy 500,000 tonnes this year. The government will likely provide a subsidy for this, but going forward, it isn't clear how much Tenaga will have to pay to refurbish its plants after prolonged burning of less-efficient vegetable oils. One estimate, from ABN-Amro in Singapore, puts it at 200 million-300 million ringgit, a considerable cost for an already loss-making company. Even without CPO, Teh Chi-Cheng, a utility analyst at SG Securities in Kuala Lumpur, estimates that Tenaga will be "at least 2 billion ringgit negative for the next three years," because of infrastructure and fuel costs. The rescue of the palm-oil industry, say others, would be better served if the government directly handed its subsidies to the smallholders.

Still, burning CPO looks likely to go ahead. The government hopes farmers like Hashim can earn enough, not only to keep afloat but also to spend, and take Malaysia a step closer to fending off recession. If not, there could be big repercussions ahead, especially as the ruling coalition's lead in many smallholder constituencies has already been reduced, and support for the opposition is growing. "Part of our political problem is that rural Malays don't feel the government has done enough to lift them out of poverty," says Lim.