Explaining Malaysia’s deflation since the 2009 crisis

Malaysia’s economy has moved on from 2009. But is there a fresh cause for concern?

Since 2009, Malaysia has seen solid recovery from the global financial crisis that sent it catapulting into deflation. Deflation usually occurs in times of economic crisis and causes stock and purchase inventories to stall. With consumers and investors preferring to keep money reserves instead, less money is spent, decreasing demand even further.

In January 2019, with a CPI of 0.7%, the Malaysian economy returned to its lowest levels of inflation since that crisis. Why has this happened and are there any similarities between 2009 and 2019?

Malaysia’s economy has recovered from 2009

In 2009, Malaysia injected US$16 billion into its economy as part of a stimulus package to combat slowing growth and rising unemployment. In particular, the palm oil, rubber, and oil and natural gas sectors were the hardest hit due to the impact of the global financial crisis. With falling commodity prices, Malaysian exports and, in particular, its electronics industry, were equally affected by a decline in global demand.

Economic growth slowed to -6.2% in the first quarter of 2009, contracting the economy by 1.7%. But, by the end of 2009, thanks to substantial financial stimulus packages and a new government, growth figures had rebounded to 5.9%, which was helped by the government decision to cut fuel subsidies and a rise in domestic demand.

The outlook for 2019 is much brighter

According to the Malaysian authorities, recent GDP figures indicate no risk of deflation. Malaysia’s economy is expected to expand by 4.9% in 2019 with Finance Minister Lim Guan Eng confirming that, “[those] strong economic growth numbers, immediately dispel any deflationary fears following the drop in January CPI (Consumer Price Index) by 0.7%, the lowest in nearly ten years”.

Mr Eng’s argument is that the conditions that caused the drop in the CPI in 2009, are not present in the Malaysian economy in 2019. Lower input costs, notably cheaper fuel prices (through recent changes to government subsidies and drops in global crude oil prices) create a vastly different economic environment this time around. The central bank has also resisted the urge to raise interest rates from its current 3.25%. Interest rates have averaged 3% since 2004 (reaching a high of 3.5% in 2006 and a record low of 2% in 2009).

However, the effect of the US-China trade war (China is Malaysia’s biggest trading partner) is apparent. The December manufacturing Purchasing Managers’ Index (PMI) contracted due to declining export orders.

The decline in exports has meant a greater reliance on domestic demand. Yet, Malaysians remain cautious spenders amid rising high costs of living and high household debt burdens.

Falling export demands has weakened the ringgit. In the past, a weak ringgit has stimulated exports, but this hasn’t occurred this time around.

In the 1990s, the central bank in Malaysia, The Bank Negara Malaysia, was a major player in the forex and had a significant influence on the direction of the local currency markets. Malaysia has rapidly established a reputation as an emerging market economy; it has seen major improvements and enjoyed rapid economic expansion in recent years and this has also expanded into the forex market too. Bank interference with the forex ended in 1994 after large amounts of currency reserves were sold and a separate commission was set up to handle exchange commodities.

Why is the CPI lower?

Falling exports and a drop in price for its commodities like crude oil and palm oil have left the ringgit trading at similarly low levels to the Asian Financial Crisis of 1997, Malaysians have seen the cost of food and non-alcoholic drinks rise. But this rise in food prices has been outweighed by the bigger impact of falling fuel prices. The demand for petroleum products is slower globally, encouraged by overproduction from Saudi Arabia, Russia and the US through its shale oil boom.

Oil is a major input in the Malaysian economy fuelling transport and homes. As the cost of oil comes down, the cost to manufacture and deliver goods also drops, leading to reduced costs to the consumer. These lower prices reduce inflation and increase deflation.

Is there cause for concern?

While the US-China trade war has sent Malaysian exports falling, they are nowhere near as low as 2009 levels. In the first quarter of 2009, Malaysian exports plummeted by 20% in reaction to the global financial crisis. 2019 has no such crisis and Malaysian exports are under no such threat.

The Malaysia government will rely on the same mechanisms it did in 2009 to drive growth. In 2009, the former finance minister, Nor Mohamed Yakcop, who led the government’s economic planning unit, drew up plans to expand domestic consumption and increased Asian trade to revive Malaysia’s economy and counter the worldwide financial crash.

This is remarkably similar to the calls of Mr Eng. The Malaysian Finance Ministry, in 2019, is using similar rhetoric, citing budgets remaining on track, increased domestic consumption and an overreaction to reducing oil prices.

This approach risks overestimating the power of the domestic economy to counter the effect of decreased exports. After 2009, Malaysia relied heavily on increased domestic consumption before world markets recovered. With Malaysian consumer debt in 2019 much higher than it was in 2009, the domestic market may be unable to fill the economic void.

External factors could also hamper Malaysia’s economic growth. The ongoing trade war between the US and China, the slowing of the Chinese economy and the role of Brexit in the wider European trading market have yet to be fully realised and could represent major obstacles to reviving Malaysian exports.

The Malaysian central bank isn’t easing fiscal policy. It is confident the fall in fuel prices is sufficiently offsetting the rise in food prices. The government agrees and with oil prices beginning to creep back up in February and March it should begin to ease deflation worries. With no major panic in either the forex or the stock market, Malaysia remains hopeful that this period of deflation is temporary.