Recent global macro data suggests that economic uncertainties have continued to rise. Numerous signs are there – June’s global manufacturing Purchasing Managers’ Index (PMI) fell to its lowest level since the second half of 2012. The PMI report further revealed that business optimism plunged to a record low, while new orders contracted at the fastest pace in nearly seven years. Global exports also took a hit: new export business fell for the 10th straight month in June, according to the report.

The world’s largest economy has also begun to feel the heat. Its second-quarter GDP growth, while slightly higher than expected, pointed to a much weaker momentum in the second half of the year. The latest reading for the US leading index in June also registered the sharpest decline since 2016, suggesting that a softer patch is on the way. All these prompted the Fed to finally give in to the market’s call for a rate cut. The fed funds rate was trimmed by 25 basis points in early-August – the first since the onset of the Global Financial Crisis (GFC) in 2007.

There is also downbeat news in Europe as new UK Prime Minister Boris Johnson is sparking more uncertainty with his call for a ‘no-deal Brexit’ by end-October, if the present deal with the European Union does not go through. This will certainly put investors on their toes at least until the end of the year. Similarly, in China, trade deal issues with the US linger, especially after President Trump unexpectedly announced his intention to impose a 10% tariff on an additional US$300 billion worth of Chinese imports starting September 1st. That led China to retaliate by suspending agricultural product purchases from the US. The renminbi also weakened beyond its psychological 7.0 RMB/per US dollar, prompting the US to label China as a currency manipulator.

All these will make global policymakers extra cautious in the next one year or so. After all, it has been 10 years since the world witnessed the last economic crisis that morphed into a global crisis. Hence, it is time for policymakers to dust off their playbook to see what the options are at this juncture.

News flow suggests that in many countries, monetary authorities are no longer comfortable with the usual tools that they utilised during the last crisis a decade ago. Who could blame them? Interest rates were driven down to the limit – into negative territory in some cases, even – to spur economic recovery.

The Quantitative Easing (QE) initiative that came about after major US and Euro-area central banks hit the zero-lower bound (ZLB) on nominal interest rates was a big gamble. Still, it was probably the best option available amidst the panic in 2009. To some extent, QE had its merits because without it, the world could have been driven into unchartered territory that could mirror the Great Depression in the 1930s. QE eventually managed to revive the so-called animal spirit, no doubt. But it came with a heavy cost of surging asset prices, rapid changes in capital flows, and increased volatility in exchange rates. Stock and property prices in many countries like Hong Kong, China and Singapore were bid up to unsustainable levels.

With the current global downturn gaining momentum, central banks will undoubtedly be extra cautious. Their policy mix will likely be reconfigured to account for changing global macro conditions. In particular, policies would continually adjust to the changing nature of capital flows due to their increasing speed and volume. This is especially true for open economies like Singapore and Malaysia, where trade openness is a key feature. For Malaysia, having one of the most developed and dynamic bond markets in the region means that it is highly susceptible to rapid movements of portfolio capital.

Times have changed, and so have transmissions of global shocks to open economies. Gone are the days when economists were fixated solely on the repercussions on trade and investments during a global downturn. These considerations are no longer on the top of the list. A more important channel of transmission today is the financial market. An important lesson learned from the Asian Financial Crisis is that rapid portfolio capital movements, induced by investors’ herd mentality, can be so disruptive as to bring a regional economy down to its knees.

What it all boils down to is that a monetary response, through policy rate adjustments, is not expected to be prominent in the coming days – unless, of course, the slowdown exceeds expectations. This is not to say that further downward adjustments are not possible. They could happen, but probably not as aggressively as in past downturns. The economic crises in the late-1990s and 2009 have clearly illustrated that in an interconnected financial market, rapid adjustments in policy rates could exacerbate financial market volatility, inflicting more harm on the real economy than one could possibly imagine.

As such, many investors are now expecting Malaysia to be on the same page when it comes to weighing the policy mix, in anticipation of the economic downturn gaining momentum in the near term. While there are expectations of further reductions in the Overnight Policy Rate (OPR), not many are anticipating a sharp drop like we saw during the GFC. Moreover, a significant reduction in the OPR does not support the central bank’s aim to alleviate high household indebtedness. A shift towards a fiscal policy bias will probably take place as the government attempts to soften the blow from global shocks. There will no doubt be challenges as piling government debt constrains policy space. But if one has to make a choice between the two, the likelihood of a fiscal bias emerging is far greater this time.

Only time will tell.


This article was first published in The Edge Malaysia Weekly dated Aug 5, 2019 – Aug 11, 2019.