We believe that the V-shaped narrative highlighted in our 2021 Outlook report remains intact but will be more highly uneven than anticipated. The pandemic will pull down the per capita incomes of developing and least developed countries away from that of developed countries, resulting in a sizeable income gap between rich and emerging nations. This scenario is primarily driven by the speed of resumption of economic activities and the size of fiscal response against lockdowns.

Looking at major global economies, we believe that the Biden Administration has done well to get the economy back on track. The massive fiscal responses and rapid vaccine deployment since 2Q2020 have allowed the labour market to readjust swiftly, as seen in the big drop in the unemployment rate from 11.1% in June 2020 to 5.9%, a year later.

We observed that much of the European Union (EU)'s recovery is debt-led, where it spiked from 77.59% in 2019 to its highest level of 90.07% a year later. Belgium, Cyprus, France, Montenegro and Spain have seen their debt-to-GDP breach the 100% level while Greece surpassed 200% whereas Italy saw its debt grew higher than 150%. Debt has always been the EU's long-standing problem due to the disconnect in monetary and fiscal priorities, and this is expected to be prolonged in the foreseeable future.

Back home, our January 2021 GDP growth forecast for Malaysia came in at 6.4%. Since then, back-to-back mobility restrictions have prompted us to shave off our earlier forecast to 3.9% y-o-y for 2021, which is even lower than the previous review of 5.1%. This implies that the economy will perform 2% below the pre-pandemic level this year. Moving forward, Malaysia's growth outlook is solely dependent on how stringent mobility restrictions are.

Private consumption, the main driver of economic growth, will be hard hit in the near term due to the strict lockdown measures which include the closure of non-essential services. The ominous labour market has deeply impacted consumer confidence. Notably, the unemployment rate could see an uptick in the coming months and remain elevated for the rest of the year. Spending by low-income households, which experienced higher job and income losses, will likely remain below pre-pandemic levels for a more extended period, especially when stimulus support expires.

Meanwhile, businesses have been grappling with persistent supply chain disruptions and falling domestic demand since MCO 1.0. The challenging business operating environment would push firms to delay or even cancel their investment decisions. It does not help that some quality foreign direct investments (FDI) bypassed Malaysia and instead made a beeline towards our regional neighbours. Ongoing political uncertainties, in addition to the pandemic, have shaken FDI confidence.

Given the significant revenue shortfalls and rising expenditures to finance various stimulus packages, the fiscal deficit will likely breach the current target set by the government of 6.0% of GDP in 2021. Instead, we anticipate the fiscal deficit to come in at 6.3% of GDP. We believe that more fiscal support could still be forthcoming, albeit in smaller sizes amid the increasingly constrained fiscal space, until the recovery path is clear.

Given the deteriorating economic and fiscal metrics, we see a higher risk of a rating downgrade by another international credit rating agency; S&P's A- rating on Malaysia has a negative outlook. Having said that, a sovereign rating downgrade may not necessarily translate into lower overall economic sentiment/confidence per se throughout a historically low interest rate environment.

As the current monetary stance remains adequately accommodative, we opine that Bank Negara Malaysia (BNM) will continue to retain the overnight policy rate (OPR) at a historical low of 1.75%. In any case, monetary policy is a blunt policy tool. Rigorous fiscal policy is more plausible than monetary policy during a low interest rate environment. Expansionary fiscal policy remains the primary vehicle to boost and accelerate economic growth. The resumption of economic activities is the only silver bullet that will improve the country's economic performance in the remaining months of the year.

The Macroeconomic Outlook Update report can be accessed in full here.