Cheaper oil is not great for everyone: Our Kuala Lumpur MD looks at the impact of falling oil price on the Malaysian economy.
Malaysia, a major oil producing country in Asia, draws a big chunk of its government revenue from the energy industry. In order to minimise the effect of plunging oil prices on the economy, Southeast Asia’s third-largest economy took a reality check to revise its budget and growth targets.
Falling oil price
For the past four years, crude oil was selling at an average price of US$109 per barrel before it started to plunge more than 50% seven months ago. In fact, the first 20 days of 2015 saw the commodity trading at only US$49.662 on average. This is mostly due to the weak energy demand amid a slowdown of the global economy, the oversupply of the commodity caused by the booming US shale oil industry, and OPEC’s decision to defend its market share by maintaining existing production capacity.
Oil prices are expected to remain low for the rest of 2015 and the conditions may drag on for years if the economic outlook remains unchanged.
While tumbling oil prices tend to be a windfall for Asia Pacific - most countries are net energy importers, and so set to leverage the low energy price to stimulate domestic growth - Malaysia's high dependency on energy-related revenue means it emerges as the unprecedented economic loser at times like this.
As the second-largest exporter of liquefied natural gas (LNG) and a major oil producer in Asia, Malaysia draws a big chunk of its government’s revenue from the energy industry. In 2013, Petronas (the state-owned petroleum company) contributed US$20.2 billion in tax, royalties and dividends to the Malaysian government, making up 30% of the national budget. Late last year Petronas warned that its payment in 2015 might be 37%, or US$7.4 billion, lower than the previous year if the oil price hovered around US$75 a barrel. Today, it is trading below US$50.
On a positive note, this year Petronas will settle its payout to the country based on 2014’s crude oil price ($97 per barrel in average), so a nosedive in Malaysian government revenue is not expected at least for this year. But Malaysia still faces the threat of a current account deficit with the drop of revenue from commodity exports.
The country’s budget has been in the red since 1999; cheap oil would significantly undercut export income and drag it into a current account deficit. If the oil price deteriorates, Malaysia’s risk of twin deficits (running on both fiscal and current account deficits) is real. A mass capital outflow would be set off in the worst case scenario and break the already-weakened ringgit. That possibility sends shivers down the spines of foreign investors currently holding US$45 billion worth of sovereign bonds with a total exposure of US$208 billion on the country’s debt.
The low confidence in Malaysia’s revenue base among investors contributed to the depreciation of the local currency, seen since the beginning of the oil plunge; the ringgit has fallen about 14% against the greenback in the past six months, making it the worst-performing currency in Asia. As a matter of fact, the last quarter of 2014 actually saw the steepest single quarter decline of the country currency since the 1998 Asian financial crisis.
The governor of Malaysia's Central Bank, Dr Zeti Akhtar, reassured the market that the country’s current account is still intact with continuous inflow of foreign direct investment (FDI). Therefore, a mass outpouring of capital from Malaysia is not anticipated in the near term. She also added that a weaker currency would not curtail the country’s competitiveness and undermine its attractiveness to foreign investors.
In order to regain investors’ confidence, Malaysia revised its 2015 budget and growth targets to reflect the current economic reality. The revision was timely because the original budget (based on the oil price of US$100 per barrel) would have led the country into a deficit of US$2.3 billion with the oil slump despite saving US$3 billion from fuel subsidies.
The budget revision is based on the new oil price projection of US$55 and foresees the gross domestic product (GDP) growing between 4.5% and 5.5% as opposed to the previous 5% to 6%. After the review, the fiscal deficit would be broadened to 3.2% of the GDP from 3% originally. The government would trim RM5.5 billion from the initial operating expenditure while the implementation of a GST in April is expected to contribute an additional RM1 billion to its revenue.
The Malaysian government has decided to maintain the US$13.4 billion allocated for development spending to keep the country’s economic engine churning. On top of that, up to US$470 million is being set aside for reconstruction of the areas affected by the country's worst flood in 50 years back in December and related flood mitigation projects. The government’s move to maintain its infrastructure expenditure will benefit the construction sector and create a spillover effect to the whole economy.
The silver lining
In reality, the softening of currency against the US dollar is not exclusive to Malaysia. Almost all the regional currencies experienced similar weakening since the fourth quarter of 2014 due to the gloomy global economy outlook. Some shrewd businesses are actually leveraging on the depreciation of ringgit to pump up their investment in Malaysia.
Last month, Greenland Holdings Group Ltd (China’s largest integrated real estate developer) acquired 128 acres of land for US$670 million in Iskandar Malaysia, a Special Economic Zone bordering Singapore. This is the developer’s second deal in the southern state of Johor in a bid to capture the great interest in property investment shown by Singapore due to the favourable exchange rate.
The cheap ringgit is not all bad as it would also increase market demand for Malaysian goods. From January to November 2014, Malaysian exports rose 6.8% to reach US$196 billion on the back of a strong demand in electronics products from the US. A weak currency has also made Malaysia a more affordable destination for tourists and is spurring growth in the tourism industry. In the first 10 months of 2014, Kuala Lumpur International Airport was the fastest-growing major airport in Asia Pacific, registering more than 40 million in passenger arrivals (4.2% growth from 2013).
While the falling oil price may be hurting the Malaysian government’s income, there hasn’t been a better time for foreign investors who look for long term value to enter the country.
Read more about investing in Malaysia