For one thing, Malaysia’s economic performance has always been closely tied to crude oil price trends. Plunging prices in mid-2014 and in 2015 had caused growth to soften to nearly 4% in 2016, below its long-term trend. The over-100% recovery in prices in 2017, partly explained the rebound in Malaysia’s economic growth to nearly 6%. This is not surprising given that the total combined export value of crude oil and LNG amounted to RM70 billion in 2017. This metric registered at close to RM95 billion in 2013-2014.
The initial positive sentiment in the global oil and gas industry, sparked by favourable supply-demand dynamics, pushed up Brent crude oil prices to above USD85 per barrel in early-October this year. That sentiment suddenly fizzled out in late-November. Not surprisingly, several major global banking institutions (i.e. JP Morgan) scaled down their crude oil price forecasts for 2019 by 10% to 15% from their earlier projections of above USD70 per barrel.
The sudden jitters in the global oil market are understandable. This is the first time that prices dipped below USD60 since October 2017, more than 20% from the recent peak, pushing prices into ‘bear market’ territory. Prospects for 2019 are now more uncertain, although many forecasters have not budged from their earlier projections. The US-based Energy Information Administration (EIA), for example, reiterated its average price forecast of USD72 per barrel for 2019 in its November publication.
As for the Malaysian economy, the government’s medium-term price assumption set in the Medium-Term Fiscal Framework of between USD60-USD70 per barrel between 2019 and 2021 looks fairly reasonable. Although prices have dipped below USD60 per barrel, it is too early to be overly pessimistic about prospects going forward. And though prices may not be as high as in recent months, their average could remain in the low-USD60s per barrel in 2019. Worries about an oversupply resulting from high US production, the US-China trade war, China’s economic soft landing and rising US interest rates are among the factors that cast a dampener on the oil market’s bullish sentiment earlier. Some of these concerns could fade if the trade war eases up, and the Fed starts to soften its stance going forward.
The medium-term outlook remains relatively unperturbed, at least at this juncture. However, price swings are to be expected in the near term as the sentiments of greed and fear run wild. In fact, independent projections are even looking at an average price of below USD60 per barrel in 2019, although this price level may not be sustainable, especially if the US economy continues to flex its muscles in 2019. A quick check through various publications, however, revealed that global forecasters are still comfortable with average prices ranging from USD60-USD70 per barrel in the next one to two years.
So, are our budget deficit targets still attainable against this backdrop? Can deficits be financed domestically? At least for 2018 and 2019, things look pretty safe for the moment. Contributions from Petronas, as mentioned in Budget 2019, will provide some cushion to the government’s financial position. This is needed at a time when the growth of other revenue sources is not expected to be overly robust next year. From the expenditure side, plans to further rationalise certain expenditures (i.e. petrol subsidies) and trim public investments would certainly ease the fiscal burden in 2019. And if Brent prices do not take as deep a dive as they did in 2014-2015, then the RM50-odd billion deficit projection for 2019 looks attainable.
Of course, another issue the financial market is concerned about is the way the deficit is going to be financed. After all, the deficit, in and of itself, does not really mean anything. Certain means of financing the deficit can cause borrowing costs to rise, while other ways could lead to higher foreign currency risk (if done through external borrowing) or inflation (in the case of monetisation). For Malaysia, domestic funding is not really a problem. Issuances of Malaysian Government Securities and Government Investment Issues are highly sought after by local institutions. There is thus still room for such funding. After all, Malaysia’s debt level remains below the self-imposed limit of 55% of GDP.
There is one important factor worth monitoring, though, i.e. Malaysia’s economic performance in the near term, as this could affect overall revenue collection. We have seen how real gross domestic product growth was adversely affected in the second and third quarters of 2018. Exports bore the brunt due to a supply shock (disruption of gas production in East Malaysia) and this is expected to last until mid-2019. This does not bode well, especially when crude oil prices are not expected to be as high as in 2018.
Adding to this is the moderation in other commodity prices that are now taking a toll on the overall export sector. If one were to scrutinise recent statistics, for instance, the third quarter’s contraction in real exports (of goods and services) partly reflects the downward pressure on other commodities such as palm oil and rubber. In the first three quarters of 2018, gross exports of both commodities fell by 15% and 23% respectively in value terms, when compared with amounts recorded in the corresponding period last year. The fact that palm oil prices have now slipped below RM2,000 per tonne is rather disturbing, as this can have negative repercussions on rural household incomes and the economy at large.
The point here is that a weaker-than-expected headline economic growth, if it materialises, will exert pressure on government tax revenue. This would, in turn, affect the government’s fiscal position. Even the government projects a mild tax revenue growth of 0.8% in 2019. If this happens, it would raise eyebrows among investors who are already paying close attention to Malaysia’s sovereign rating. Defending headline economic growth will likely be the government’s priority if the global environment proves to be unfavourable in 2019.