In anticipation of further withdrawal of subsidies and the introduction of a new consumption tax, the GST, the government doesn’t seem to be getting their fiscal policy right .... There is a clear mismatch of encouraging domestic spending with both the fiscal and monetary policy of the BN government going in the opposite direction.

By Dr Dzulkefly Ahmad, Member of PAS Central Working Committee

Given the recent enormous drop in the nation’s FDI to a whooping 81% (World Investment Report, WIR 2010), the announcement of 8.9% GDP growth in the 2Q compared with -3.9% yoy in 2009, came as a great relief to many. It is the third consecutive quarter of growth. Though it’s slightly lower than the 10.1% of the 1Q, it nonetheless brings the much needed comfort and assurance. Overall, the economy grew by 9.5% for the first half of 2010.

More substantively, the growth has been essentially driven by stronger domestic demand due mainly to higher private consumption and continued improvements in both private and public spending. So it was claimed. Additionally robust growth in external demand and trade similarly spurred the supply-side of our domestic manufacturing and services sectors.

Just as we are about to be back on our bullish view of the economy, this writer unfortunately will gently remind us that not all is well, over and done with. Quite on the contrary, we are in fact dangerously treading a precarious path of recovery with the pending double dip always lurking devilishly ahead.

More importantly and on a longer timeline, some fundamental and structural problems need serious addressing. These are economic malaises that have entrapped us in a decade of stagnation with a negligible increase in real wages hence stuck in the prolonged middle-income trap, a low value-added activities and low productivity.

Global Economy is Slowing Down

Firstly, back to the issue of relying on a robust external demand to drive growth and domestic production. A robust growth in the second half of this year is not as promising. The global economy after receiving massive fiscal and monetary stimulus is now heading for a sharp slowdown as the multiplier effect of those measures wanes.

Worse still is the scenario where governments and consumers of the advanced economies – US, UK and Europe – will be spending less and are now concerned with de-leveraging their debts. Meanwhile nations saving too much – China, Asia, Germany and Japan – are not willing to spend and produce more for obvious reason to compensate for the fall in demand by the de-leveraging countries earlier. Hence you have a ‘double-whammy’ situation of diminishing global aggregate demand in the recovery exacerbating the softer and lower economic growth.

Even if the global economy is to escape a W-shaped double-dip recession, the likely scenario for advanced economies, is at best a U-shaped not a V-shaped recovery. In the Euro-zone meanwhile, the outlook will be even worse as governments’ austerity drives set in and stock market falls.

If we are to rely on China to drive our growth, we may be in for a disappointment as China is already slowing their growth for fear of economic overheating. With the other advanced economies and Euro taking a continued beating, it will have a further knock-on effect on China’s growth. This will be bad news for all other Asian economies shifting expectation to piggy-beg on China’s imports for sustaining their growth.

With the scenario of US growth decelerating to 1.5%, the Euro zone stagnating, while Japan’s economy continues to be in an L-shape recovery, even if the global economy were to escape a double-dip, the extreme downsides of these all acting in concert could similarly  trigger a recession-like shock.

Our Growth Curve is on a Downward Path

Besides, a closer look at the claim of the Bank Negara may not after all be that assuring. Bank Negara noted that the manufacturing sector registered the highest growth of 15.9 percent followed by the service sector at 7.3 percent.

However, the first quarter performance revealed that manufacturing registered a growth of 17 percent, while achieving 8.5 percent for the service sector. The growth for the construction sector has similarly dwindled from 8.7 percent to 4.1 in the second quarter. In other words these indicators are all on a downward path.

For the year-end outlook, Bank Negara said that the domestic demand was expected to increase and support growth in the second half of the year. If this writer recalls correctly, the consumer’s sentiment as recently reported by MIER is not as bullish as the government painted it to be, as to support domestic demand.

In anticipation of further withdrawal of subsidies and the introduction of a new consumption tax, the GST, the government doesn’t seem to be getting their fiscal policy right– subsidy and taxation- it seems to this writer, anyway. There is a clear mismatch of encouraging domestic spending with both the fiscal and monetary policy of the BN government going in the opposite direction.

Recent spate of OPR increases, though described as ‘normalisation’ may affect cost of funding and eventually affect domestic investment and spending. However, burdened with increasing debt and fiscal deficit, the degree of freedom in using such stabilizing measures is much stifled and limited.

Hence, it pays if the BN government is to be honest and truthful about the very cautious optimism, lest it has to eat humble-pie for the second half of the year.

Read more at: http://drdzul.wordpress.com/2010/08/21/the-malaysian-economy-%E2%80%93-a-misplaced-optimism/

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