[977] Of the Malaysian economy in 2007

How would the Malaysian economy perform in 2007?

It would most likely depend on several major issues.

First, in no particular order, is the spur of government spending due to the Ninth Malaysia Plan.

Second, the Visit Malaysia Year.

Third, a slowdown of demand for electronics.

I can’t think of a fourth factor but I’d be grateful for reasonable suggestions.

Here, I’d like to make a connection between government spending and the reduction in demand for electronics good.

The Malaysian government spending, which includes the second Penang bridge, a number of highways as well as a new city nearby Port Tanjung Pelepas, should provide students of economics some interesting natural experiment. Why?

It will test the Mundell-Fleming model.

According to the model, an increase in government spending has a negative effect on the net export component of the GDP. Let me explain.

A government spending increase will temporarily increase the GDP. This makes sense because government expenditure is one of the four components of GDP and as such, it directly affects the GDP. That increase however will cause the local interest rate to go above the world interest rate. Higher local interest rate vis-a-vis global interest rate will cause capital to flow into the local economy. That inflow will make the local currency, the Malaysian Ringgit in this case, to appreciate. Such appreciation will encourage import and discourage export. In other word, net export should see a reduction once the economy reaches some sort of equilibrium.

Earlier this week, the New Straits Times talk about the possibility of a bull run. In its reports, several analysts predict that the Kuala Lumpur Stock Exchange would hit 1,300 in 2007:

The KL Composite Index is expected to hit 1,300 points next year — a high last reached in 1994. Analysts say the stock market can sustain its rally on the back of a positive economic outlook, implementation of the 9MP projects and a stable interest rate…

What do I think of that?

I haven’t made up my mind yet but I’m more interested to see how the Malaysian net export component would behave in 2007 and 2008. According to Mundell-Fleming and keeping in mind that there’s a demand slowdown for electronics — Malaysia is a big export of electronics — we are set to see a reduction in Malaysian trade balance. Ceteris paribus, of course.

p/s – somebody pointed out to me that instead of just testing Mundell-Fleming, it would also test a variety of other things. True. But here, I’m interested in this particular subject.