Tomorrow Bank Negara is scheduled to release the 2nd Quarter economic data series. The median forecast of economists have the GDP number at 4.7%. The number itself is just a number and unless it is really bad , like under 4%, it will be largely ignored. My consensus forecast is for GDP Growth to be at 3.8% for Q2 13, as the collapse in the external sector will be unable to offset any pick up from domestic consumption.
In terms of the currency market, the Ringgit has sold off against the Dollar, partly due to the rising US dollar exchange rate and Treasury interest rates that reduces the yield pick up from doing repo based carry trades. This has been inline with the sell off in other regional markets as well with a general repatriation of cheap dollar liquidity back to the good ol USA where they can rest in relative comfort of 10 year yields touching 3%. (As to how they will hedge the price risk of an increasingly volatile 10Y is another matter altogether but perhaps they can lock in a positive carry by buying Interest Rate calls to coincide with the holding period).
The reason behind my bearish consensus is the apparent collapse in the net exports. For the period of Jan to March, net exports was already weak at RM 16.3 billion. But it got worse over the months of April and May, where net exports was a weak RM 3.4 billion. As the trade balance regionally has worsened over June, I do not export this number to have picked up and my final estimate is Net Exports at RM 6 billion for the quarter. That works out to a shortfall of RM 10 billion for the quarter, which can't simply be conjured up through domestic consumption.
Does this mark a beginning in the reversal of the so called "Asian econmic miracle?"
I think so because the old model of the West being a profligate consumer society buoyed by cheap credit and willing to buy any old thing produced in Asia has come to an end. The Western consumer is in retreat and the days of raking up personal debt at unsustainable levels are over. Asian countries like Malaysia cannot merely rely on foreign labour working in the factories, producing TVs, microchips and kettles for an overstretched Western consumer.
The question then becomes - the 2 magic words you will surely see plastered all over tomorrow's news release : DOMESTIC CONSUMPTION.
On the surface, growth from Domestic Consumption does not look bad. 5% growth that comes about because people buy more Proton Sagas and consume more food cannot be separated from 5% growth that comes from exports of the latest technology. But here in lies a catch - Domestic Consumption is only possible so long as there is a source of funds to provide credit to the economy. This source has to be strictly exogenous (i.e. from outside Malayia) unless of course, we are willing to see a reduction in terms of Investment (or "building new houses and office buildings"). And if we do reduce the volume in building houses and office buildings, that by itself reduces the chain volume of GDP as building houses and new buildings constitutes a component of GDP called "Investment."
So over an extended period of time, Domestic Consumption as the "engine" of growth is only possible if we run a surplus capital account - i.e there are people out there willing to fund our excess spending. In a strange twist of fate, one of the biggest funders of this actually came from good ol' Uncle Sam, because of the excess dollar liquidity floating around in the US Banking system without any good credit assets to acquire. But with US Dollar interest rates starting to rise up, Malaysia will need to pony up and raise its interest rates if it wants to attract this source of funding.
This may sound like complete news to most unsuspecting Malaysians, who have grown up in the closet race filled world. That a country like Malaysia actually relies on US dollar funding to support its own consumption patterns. Surely that's impossible?
My answer to that : RM 27 billion or 3% of GDP. That is precisely the increase in foreign holding of Malaysian Government debt from 1Q13 to 1Q12. This number excludes foreign holding of corporate debt or other Malaysian issued debt instruments. When foreigners buy debt, they provide the funds necessary for our Government to pay salaries, BRIM and other spending. So the situation already exists and given we have a structural deficit, it is not going to change anytime soon. (Unless they introduce GST!)
In the interim of course, local banks can easily step in to buy up local Government debt but that reduces their ability to make nice chunky mortgages at much higher spreads. And the second thing is that since the debt is projected to hit RM 1 trillion in about 5 years time, this method of bank led funding is simply unsustainable.
We now come to the crux of the matter. We operate three economies in Malaysia. The first is the external sector which is now going to go the way of the typewriter and become obsolete. We operate a services and domestic consumption sector that takes a lot of raw inputs, from sugar to iron to manufacture goods. And lastly we operate a domestic megacomplex called the Government which structurally spends more than it taxes.
Without a source of cheap funding the following can and will happen
1. Interest rates rise
2. Currency depreciates
3. Commercial real estate gets hammered.
4. Banks begin to suffer loan losses.
5. House prices depreciate as speculative borrowers cannot make payments
6. Consumer gets hammered.
7. Full blown banking crises
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