Posted Date: March 13, 2020

On March 9, oil markets tumbled after the Organisation of the Petroleum Exporting Countries (OPEC) and non-OPEC allies failed on the previous Friday to agree on the quantum of oil production cuts amid the COVID-19 outbreak, as well as on the rolling over of existing oil supply cuts. The international benchmark Brent crude, for example, plummeted by roughly 30%, reaching a low of around USD31 per barrel, before stabilising to circa USD35 per barrel. At USD35 per barrel, the Brent crude oil price stood at almost two standard deviations (SD) below its long-term mean (20-year mean from the year 2000).

This is not the first time the Brent crude has fallen below the one SD threshold. In 2015 and 2016, prices fell to this level due to a global oil glut following the rapid increase of shale production in the US. Prices subsequently recovered to end the year at 110% higher than the trough recorded in January 2016. Nevertheless, experience shows that depending on subsequent economic and political developments, crude oil prices could stay below the one SD threshold for between two to 15 months. In any case, MARC does not rule out the possibility of some sort of cooperation among oil producers in the near future given the economic pain an oil price war can inflict.

If the downturn in crude oil prices lasts longer than expected, the Malaysian economy, which currently faces headwinds following weaker global growth and softer domestic demand, will be impacted. These sometimes fast-paced developments make it necessary to constantly assess and reassess forecasts. Given that these are early days in the oil price war, it is difficult to speculate on the ultimate scale of its impact on Malaysia's economic outlook.

In our most recent report following the announcement of the economic stimulus published before the oil price war, we pointed out that the impact on the Malaysian economy could be more pronounced than currently anticipated if global economic weakness continues. Our rough estimate indicates that Malaysia's headline growth could moderate by 0.3 percentage point if global economic growth softens from 3.3%, as currently projected by the International Monetary Fund, to 3%. A significant weakness in China's economy – Malaysia's largest trading partner – will add to the downside risk.

As oil-related products account for about 9% of total exports in 2019, there is strong likelihood of Malaysia registering a narrower net trade balance following the drop in global crude oil prices, and consequently experiencing slower GDP growth. In addition, a sharp and sustained decline in oil prices also tend to curb investments in the oil and gas sector.

From another perspective, given the importance of oil-related income to the government's overall revenue, a sharp decline in crude oil prices will also mean reduced resources to spend on development activities at a time when domestic demand needs support. Depending on how long crude oil prices remain below their historical trend and the severity of the COVID-19 outbreak, the final growth outcome in 2020 could be anywhere within or even outside the range that economists are currently projecting.

At the same time, oil-related income continues to make up a significant proportion of government revenue (2014-2018 average: 21.0%). Given this, we expect the government revenue target for 2020 to remain in the limelight if crude oil prices remain below the historical average for long, especially against the backdrop of the COVID-19 pandemic. Our experience in 2015 shows that a 50% plunge in global crude oil prices within a year reduced the government's oil-related revenue by almost 30%. Consequently, total government revenue contracted for two consecutive years. Fortunately, revenue from direct taxes remained resilient, as evidenced by the amount of corporate taxes which declined by only 2.4% while individuals' income taxes grew by almost 8% in 2015.

Given the likelihood of a material drop in oil-related revenue – should crude oil prices remain low – the focus would then be on the current budget deficit target of 3.4% of GDP. The target is based on the government's oil price assumption of circa USD62 per barrel in 2020. In addition, the government also projected a nominal GDP growth of 6.0% during Budget 2020. Achieving this growth target could prove to be challenging if the global economy does not improve in the near term.

We also expect an increased focus on the ringgit as its performance affects business and consumer confidence, and in turn, the real economy. Historically, the ringgit moves in tandem with crude oil prices. In general, lower crude oil prices are associated with a weaker ringgit. Nevertheless, history shows that while a sustained weakness in crude oil prices will dampen ringgit sentiment, a short-term oil price war will not likely have a lasting or significant impact on the currency. Again, the key to the future trend of the ringgit will be the duration crude oil prices remain below their historical average.

On balance, although the oil price war has clouded Malaysia's 2020 economic outlook, we believe that credible fiscal plans and coordination strategies to ensure an optimum fiscal-monetary mix that is consistent with growth and financial stability can provide the necessary support to the Malaysian economy.

Quah Boon Huat, +603-2717 2931/ boonhuat@marc.com.my;
Nor Zahidi Alias, +603-2717 2936/ zahidi@marc.com.my.