Category: Economics

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Economics

[2768] Just a debt redefinition and deplorable reporting

And so, in the media, it is reported that Malaysia’s external debt (some were more careless by giving the impression that it was total debt, just to make a sexy, alarmist headline for the clicks) increased by more than three folds. This is one of those deplorable reporting:

Malaysia’s external debts grew by more than three-fold in less than a year, from RM196 billion at the end of 2013 to a whopping RM740.7 billion in the third quarter of last year. In a written reply to William Leong (PKR – Selayang), Finance Minister Datuk Seri Najib Razak attributed the spike to “new definitions” for external debts in 2014. Almost two-thirds of the increase was due to foreigners holding on to Malaysian bonds, now considered as part of the external debts. Leong warned that this is the scenario currently taking place with debt-laden 1Malaysia Development Berhad (1MDB) where a huge chunk of its RM42 billion debt is allegedly being held by foreigners. [Eileen Ng. The Malaysian Insider. Malaysia’s external debt tripled to RM740 billion last year]

From there on comes various accusations by a whole lot of laypersons, at a time the government is already under severe attacks for the fiasco that is 1Malaysia Development Berhad. I am not a fan of this government but in this particular case, the focus is misplaced and the criticism on external debt is based on a misunderstanding. The supposedly massive rise in the external debt is a non-issue, unless you are a wonk excited about the most technical of things. This is what it is, a technical matter.

The truth is that there is really no increase of that magnitude in Malaysia’s debt, totally, externally or internally. Malaysia has always owned all of those debts. What happened was that the term “external debt” was redefined to include all debts held by foreigners. Previously, the term was used to describe all Malaysian debts denominated in foreign currencies, regardless of ownership. The former is big, the latter is small. If you need a Venn diagram to understand them, here it is (the graph does not exactly correspond with the definitions but it is good enough to highlight the difference in definitions):

Malaysia's new external debt definition

This redefinition exercise had been recommended by the International Monetary Fund for the longest time and Malaysia only recently decided to adopt the proposed nomenclature. This in fact was announced last year, as early as March. When I first learned that last year, I made a joke that somebody would scream murder. Indeed, a year later, here we are. MP William Leong definitely fell into the layman’s trap, and a whole lot of others too.

There was only an increase if you used one definition at one point and then switched to another definition at the next point, and pretend the two definitions refer to the same thing. This is wrong. You need to compare points from the same definition for the growth figure to make sense. The supposedly dramatic jump-growth as reported in the media is just a garbage figure of no value. It was calculated by including a significant, large structural break.

While the media is utterly in the wrong and clueless even as they wrote the word “redefinition” in quotation marks as if it is a meaningless term, the Ministry of Finance is the cause of this misunderstanding. While it mentioned the redefinition exercise, the ministry compared the old definition with the new one and voila, a drastic increase just because they naively calculated the growth rate, despite, knowing a redefinition had occurred. So, it is a horrible answer, as horrible as the way the Finance Minister is handling the 1MDB issue. The media was just playing the role of a loudspeaker here, with no thinking in the middle.

I repeat. There is no increase as reported. If you keep the old definition and apply it forever, you will find any change from that will not come anything close to the sensationalist headlines featured by Malaysiakini and The Star all the way to, disappointingly, The Edge, which I consider as the most economic-financially literate Malaysian publication. I like The Edge but a mistake is a mistake. If you use the new definition and then stretch it backward, there will be no big change as well. Just keep the definition consistent if you want to calculate the growth.

Finally, there is really nothing sinister about the redefinition.

The reason for the redefinition has something to do with the evolution and the maturity of the Malaysian debt market. Twenty or thirty years ago, Malaysia did not have a big bond market and it was relatively unimportant to the economy, especially compared to today. So the old definition made sense then, in some ways. But since the 1990s, the Malaysian bond market has expanded rapidly to become one of Asia’s biggest. Foreign ownership of government debts also shot up as foreign investors searched for relatively safe assets. The debt market has become so large, that the newer definition becomes the more attractive one to use.

As in a lot of stuff out there, which definition to use really depends on your purpose. Just understand the data before using it.

So, ladies and gentlemen, please do not get too excited here. On this front, there is nothing to see really. Go, instead, to the next stage right across the road. Yes sir. A much more entertaining play called 1MDB is running there. Get your tickets. Sit back, and… be angry with 1MDB and not with the technicalities of debt redefinition.

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Economics

[2767] Deflation is coming to Malaysia. Is it bad?

January inflation clocked at only 1.0% from a year ago while in December it was 2.7%. That was a pretty drastic slowdown that I bet someone will cry deflation wolf somewhere soon.

The cause of the slackening is easy to explain. It is unambiguously due to the drop in retail petrol and diesel prices. RON95 fuel price, the most popular fuel in Malaysia by far, in January dropped from MYR2.26 per liter to MYR1.91 in December. Diesel went down 30 sen to MYR1.93 per liter in the same period. In January 2014, RON95 was MYR2.10 per liter.

At this rate, Malaysia might be seeing actual deflation this month. In February, both RON95 and diesel went down further to MYR1.70 per liter. The drop in yearly terms in February 2015 is greater than that seen in January because in February 2014, RON95 was MYR2.10 still. In January 2015, it fell 9% YoY. In February 2015, it decreased 19% YoY.

In fact, on monthly terms, we are already in deflation. This is not your monthly, seasonal price fluctuation that people usually ignore and say, ah, it is nothing. This is a clear deflation.

Is this deflation something to worry about?

No. I do not think so.

Deflation these days connotes bad news. Japan and Europe are trying hard to avoid deflation. In Singapore, deflation played a role in convincing the monetary authority there to loosen up its forex policy, which is their monetary policy. And the last time Malaysia had a deflation, it was during the 2009 recession.

But not all deflation are the same.

In Japan and Europe and Singapore today, and Malaysia in 2009, deflation came about from reduced economic activities. There was less demand and so, price pressure was weak and that pulled prices down. It was demand-driven. In fact, we really are worrying about demand rather than price itself. Price changes — inflation or deflation — are usually a symptom of something else.

Unlike in 2009, the (possible) February deflation would be supply-driven. The weakening in prices has been supply-driven in the sense that technological improvement — all the talk about shale mining that is turning the US into the world’s largest oil producer — has created oil glut in the market.

I do not worry because this is the same pressure that forced computer prices down over the decades. It is a kind of pressure that makes a typical person feels richer because he or she could now buy something else with the same amount of money and still afford the same quantity of fuel or more. Or save them. I do not see a price-wage spiraling down out of control here. The price deflation does not make them feel poorer because the deflation does not come about from them losing them job or suffering a pay cut. There are news of some retrenchment in the oil and gas sector but the size is small so far, as far as I know and besides, the sector is not the biggest contributor to the Malaysian economy. Indeed, the biggest sector, electronics, is having swell of a time and being ignored by the press.

I also do not worry about deflation because fuel is not something a typical consumer can live without for too long. Deflation can be disastrous to the economy in the sense that people would stop buying or postpone their purchases until prices fall further to stabilize at some low prices. But with fuel, I do not think you can do that to the point it would adversely affect growth. Fuel is an essential good and you just have to use them, especially in a society that is so dependent on combustion-type vehicles. If you do wait out, then you might not be able to drive or get to somewhere at all. You just need them and you will keep buying it even when you know prices are falling.

More importantly, the postponement of purchase is dangerous to growth especially when consumers do not know when prices would bottom out. So, they keep holding back and then not making purchases at all. This can be particularly devastating for fixed assets like homes and durable goods. In the case fuel prices, it does appear prices have bottomed out, especially since the prices used for the determination of petrol prices in Malaysia is lagged by a month, as I have explained previously. If global crude prices hold at the current level at about $60 per barrel compared to $45 in mid-January, it is very likely that retail petrol prices will be higher in March next month. So, a February deflation will be temporary. This also means people would line up at the gas stations at the end of this month preempting the loophole that comes with Malaysia’s imperfect dirty float system. So, instead of being encouraged to postpone purchases, they will hoard them instead.

Before I end, I am not saying there is no problem with demand. I still worry that consumption growth is slowing despite the surprisingly strong expansion last quarter. But the possible deflation in February is very much driven by the supply-side, and not demand.

So, do not worry about the deflation.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
p/s — I am tempted to say yet another reason why I was not worried about deflation, but decided the argument is problematic. That argument goes: core inflation is still more than 50 basis points above headline inflation. Since core inflation is more reflective of demand, and since it strips fuel away and therefore free from supply-driven inflation/deflation seen in January, it suggests demand is going well. But I checked the data from 2008-2009 and core inflation was somewhat healthy despite the fact there was a recession. This probably shows core inflation is an imperfect measurement of demand change.

I am putting it at the postscript to catalog my own thoughts on the matter and revisit it later.

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Economics

[2765] If pre-GST spending was that high, how low would it be post-GST?

The Malaysian GDP figures released yesterday suggest there was indeed a pre-GST spending spree.

Private consumption growth was phenomenal especially if you consider the fact that previous quarterly growth figures have been slowly dropping gradually over the past year from 8% year-on-year to all the way down to mid-6% in the third quarter of 2014. The latest consumption figure grew 7.8% year-on-year, which is crazy. It is so red hot that if the overall situation had not been so gloomy, Bank Negara would surely have panicked and raised its rates by another 25 basis points. This is quite a surprise even if you had believed the pre-GST spending spree hypothesis.

As a result, 2014 growth was at 6%, which is higher than most (well, all) economists watching Malaysia had projected.

But the central bank would not hike rate because the feeling is that the jump is temporary. I think it would last into this quarter before growth takes on a drowsy mode. The GST should depress consumption growth from April onwards. This is the danger. If consumption could jump so high pre-GST, how low would it get post-GST?

That is a scary thought.

This also gives more proof that consumers do expect prices to increase post-GST. I should add ceteris paribus, I guess, because the low retail fuel prices could make the net effect somewhat a wash. As for the recent electricity tariff cut, do not bother. I did a simulation and it hardly changed my headline projection.

Regardless of expectations, I am unsure there would be an actual net price hike. Last year, somebody told me the authorities expected (ranging from the Department of Statistics to the Treasury) inflation would hit 6% with GST, after months of official drive by the mainstream press that inflation would rise. Then it fell to about 4%. (You could understand why most banks are projecting about 4% inflation previously. They took the government’s guidance to heart) Now? I was informed the government expected it to be about 2%, mostly because of fuel prices. My own projection is about 3.3% YoY monthly average where I assume the GST will hit the economy in full force without any exception-zero rated stuff, but I keep several projections in the spirit of scenario analysis with the lowest at about 1.5% YoY where I pretend GST is the spoon in The Matrix.

My confidence in my models is  at an all time low and I have resigned to the fact that we will only know it in June or July when the Department of Statistics will release the April-May inflation figures. The crazy demand fluctuation, the retail fuel flotation and the GST make projections go everywhere.

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Economics

[2764] Will there be a spending spree before the GST?

I think the general consensus is that there will be a spending spree before the GST, which will be implemented on April 1. The idea is that a lot of consumers would expect price hikes of various degrees on or after April Fools’ Day. So, people would rush on to capitalize on current cheaper prices. This is much like how each time the government slashed petrol subsidies and hiked petrol prices previously, private vehicles would line up at the gas stations as consumers try to save the tiniest bits that they could.

I used to agree with that idea despite holding that the effects of GST would not be the same across all goods. A hike sounds likely for new homes but for some others, it does sound like a price reduction. In fact, I am unsure about a lot of stuff.

But in the end, it is expectations that affect current behavior and not actual future prices. The expectations might be wrong, but it will be wrong on the day consumers see the actual price, not before. So until then, expectations would still drive the spending spree. But of course, I am forming an expectation about people’s expectations, which can be problematic.

I am unsure about that spending spree now because I saw a piece of data from a survey at my workplace. I cannot reveal it because it is proprietary data. I would probably get into trouble for this (haha) but the result is quite different from my earlier expectation. I think all I can say is that more respondents expected to spend less instead of more before the GST!

The implications can be big. If you believe the consensus story, growth would be relatively strong in the first quarter and weak for the rest of the year. They spend first and spend less later.

Now, the survey result sounds like a straight up Ricardian equivalence, or at least close to it where consumers save to fund their near future spending (Ricardian is actually more than this but the saving story is similar). So, if the survey is right, there will be no spike in spending this quarter. Maybe even a slump.

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Economics

[2763] Is the new 3.2% deficit target achievable?

People are asking me if the Malaysian government’s new 3.2% deficit ratio target is achievable.  I have read in the news that several politicians are skeptical about the target. I do not remember who said that but I feel the sentiment is shared by many.

But the only way to really answer this objectively is to run a sensitivity analysis.

It is relatively easy to do a sensitivity analysis and I have done one last week under the assumption of no expenditure cut. That one shows how the deficit ratio would react if the government had not changed its budget under a range of NGDP and revenue assumptions. I think it somewhat presents the realistic worst-case scenario. The government said its fiscal deficit would have gone up to 3.9% of GDP in 2015 without any expenditure cut. I think that would come close to my expectation (4.0%-4.1%), which is based on no revenue growth (not unreasonable) and at about 4%-5% NGDP growth. I am not reproducing the table here because I do not want to confuse the readers. If you are interested in that sensitivity analysis, you should revisit the post.

But that sensitivity analysis does not indicate whether the new 3.2% target is realistic. To answer that, it requires a bit more moving parts added into it. One additional dimension is required to be exact.

I am doing that here by showing 3 cases of revenue change under a range of NGDP and expenditure assumptions (note the not-so-small difference from the above model). To cut through the graphics, I think the 3.2% fiscal deficit ratio target is achievable if revenue grows by about 2% (I said about because I am too lazy to run a differential equation).

Before that, some legends for the three charts at the bottom. The yellow-highlighted cells describe the would-be situations if the expenditure was not cut (yes, it is a funny coincidence that the government had planned to increase its expenditure by 3.2% from 2014 in the original budget). The red-highlighted cells show the deficit ratio under the January 20 revised budget expenditure figures (Under revised budget, expenditure would still grow 1.2%. So, please do not call this austerity).

Here is the deficit ratio if 2015 revenue does not change from last year. Achieving 3.2% target seems impossible under this scenario (I wrote impossible because it would require a very strong NGDP growth at a time the GDP deflator appearing weak. If government revenue is flat this year, then my projection for the deficit would be about 3.6%):

No revenue change

Things would look a bit better if the government revenue would grow by 1% this year, but it would miss the deficit target still as 9% NGDP growth is beyond our reach, given current constraints:

Revenue growth 1%

Under 2% revenue growth case, the 3.2% deficit ratio looks achievable:

Revenue increases 2%

So, after reading through this, do you think the 3.2% deficit is achievable?

Ultimately, your answer must rely on revenue and NGDP growth. I think the reasonable NGDP growth assumption is about 4%-5%. As for revenue, I am unsure at the moment. There are just too many moving parts that require further investigation but the original budget had it grown at 4.5%. It will definitely be lower than that this year.