This article first appeared in Forum, The Edge Malaysia Weekly on August 23, 2021 - August 29, 2021

The latest economic data for Malaysia shows that there are significant headwinds still to face. Bank Negara Malaysia has slashed its forecast for economic growth in 2021 in half, from 6% to 7.5% in May to 3% to 4% now.

While this is in line with our forecasts earlier in the year, the new data suggests that a downward revision is still required. Market forecasters are also quickly revising their growth forecasts and the consensus for 2021 has been cut from around 5%. At least one forecasts zero growth for this year.

Based on the most recent analysis from Bank Negara, we think its recovery scenario is optimistic and the best among the three that we consider. In our assessment, we see further structural weakness dragging the economy for some time and we expect negative growth in the third quarter and a 2.5% year-on-year (y-o-y) contraction in the fourth quarter.

For the year as a whole, we expect annualised growth to be between 1% and 2%, probably around 1.8%. This is largely due to the higher level of GDP in 2Q2021 compared with 2Q2020.

We also expect inflation to be modest following the spike in oil prices, headline inflation to be around 2.6% for the year, and core inflation to be around 0.9%.

The labour market is likely to remain difficult for many people and we expect unemployment to be around 5%, but a significant level of underemployment of between 2.4 million and 2.6 million people, or 15% to 16% of the workforce, will also persist until the economy begins to recover in 2022.

We look at three different growth paths based on the timing of the reopening of the economy and in the effects of any additional intervention through a stimulus package. The baseline scenario assumes no further stimulus and a progressive reopening of the economy according to the timeline set by Bank Negara. This is the most likely, with a 60% probability, compared with 20% for the recovery scenario from Bank Negara. The recession scenario assumes a continuation of the lockdown for the rest of the year.

The revised Bank Negara forecasts assume that with a faster pace of vaccination, all states can progress to Phase 3 of the lockdown by October and Phase 4 by November, opening up the economy relatively quickly. They also assume a favourable external trade scenario to help lift GDP.

Our baseline scenario differs from Bank Negara for four reasons. First, the recent economic data is not as positive as the headline 16.1% y-o-y growth in 2Q2021 suggests. This rebound is wholly a result of the low-base effect from 2Q2020 and masks the worsening picture in underlying growth.

On a quarterly basis, which is a better measure of the traction of the economy, all of the components of GDP contracted. Private consumption fell 10.5% and fixed investment fell 7.5% in 2Q compared with 1Q.

Second, the weakness is now structural and the likelihood of a quick rebound once lockdowns are lifted looks increasingly distant. It will be a long and difficult recovery.

In contrast to Bank Negara, we do not expect a strong pent-up demand effect because average salaries fell 9% and median salaries fell 15.6%, so more than half of salaried employees earn less than RM2,062 per month now. In addition, household savings are exhausted and Employees Provident Fund savings have been wiped out for 6.3 million Account 1 holders and nine million Account 2 holders. Debt has risen, the loan moratorium will end and repayments will begin again at higher rates.

In terms of employment, around 3.4 million people are unemployed or underemployed — which is 19.8% of the workforce. According to industry estimates, as many as 150,000 firms may already have closed, while some will have lost markets and customers permanently. So we do not expect the labour market to rebound with firms rehiring retrenched employees quickly because many of these firms are just not there anymore.

Third, Bank Negara is optimistic about the contribution of external demand but we are more neutral, taking into account the slowdown and additional difficulties in other Asian countries, including China. We also think that this will affect inventories, which had a positive impact in 2Q, reaching very high levels and offsetting the downturn in other GDP components. This effect will be reversed in 3Q.

Finally, we differ with Bank Negara in our view of the effect of the vaccination programme. We share its optimism that a high percentage of the population will be vaccinated quickly, but the reduced efficacy of the vaccine experienced in other countries, especially the UK, has shown that even with high vaccination rates, cases may not fall quickly.

The strain on the healthcare system due to new variants may require further Movement Control Order restrictions and prolonged tight containment measures, with Phase 4 starting only in 2022, unless there is a significant change in attitude and approach from the new government. Policy uncertainty is also likely to affect the progress of large investment projects and investor confidence and we will see slower recovery in the labour market.

So what is more important than the change in personnel will be the urgent need for a change in policy. If we have different people with the same policy, then things would not improve. We hope that there is a clear and smooth transition to a new administration so that we can focus on the economic crisis.

Given our forecast scenarios, the immediate priority must be to lift the lockdown — this is a prerequisite for economic survival, not just economic recovery. We are at a critical point now with a risk of tipping into a deep contraction.

Even when we open up the economy, we will require continuous support for households and firms. For households, we support direct cash transfers of RM1,500 for B40 and M40 for the rest of the year. This would cost about RM35 billion if it started in September.

For firms, we feel that following the example of Sarawak, a recovery grant of RM10,000 for small and medium enterprises would be helpful and would cost less than RM10 billion. This, and opening up for customers again, will spur recovery.

The wage subsidies and rehire grants should also continue to help the unemployed and underemployed return to work until they can be safely phased out.

This is the immediate priority. In the long term, a focus on rebuilding and reforming the economy must be put in place using social market principles. This should support businesses and markets, reform government-linked companies and reduce crowding out through a process of responsible privatisation to promote competition locally and internationally.

The government should have less involvement in businesses and instead focus on social welfare, rebuilding pensions, reforms in education, restructuring healthcare and social equity.

Dr Paolo Casadio is an economist at HELP University and Professor Geoffrey Williams is an economist at Malaysia University of Science and Technology. The views expressed are those of the writers.

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