Author: Ingeniumadvisors

Printed in The Edge, 27th. June 2022

The strengthening of the US Dollar (USD) against the Ringgit earlier this year had all parts of the Malaysian economy up in arms. It wasn’t anything new. The same level was reached in 2020 as the chart below shows but for different reasons:

Chart 1 Malaysian Ringgit vs. US Dollar

Source: US Federal Reserve

The volatility of the Ringgit caused former two-time Prime Minister Tun Dr. Mahathir to advocate pegging the Ringgit again, presumably against the USD like it was done from 1998 to 2005 during his first tenure. The central bank, Bank Negara Malaysia (BNM) responded by saying it was not in the country’s best interest.

How true is this? Given that inflation in the US is unabated at the time of writing, and the Federal Reserve is almost certain to combat inflation with raising its interest rates, this will likely see the Ringgit continually fall unless BNM raises rates in lockstep. It is worth relooking at this issue. Over the next two articles, we examine whether fixed exchange rates (pegging it to another currency) or free-floating exchange rates are (which many believe is what Malaysia is on) are best for the country. But wait! There is a third option, managed float regimes. Would this be the best? 

As we begin, it is worth remembering that economics is a game of perspectives and relativity; that an interpretation can often be biased towards the interpreter’s own background knowledge and purpose of writing. Whether the person interpreting the facts for a developed, developing or even a less-developed country’s perspective, for example, is a question that must be answered. This isn’t even going into the different schools of thought like Keynesianism, Neo-Keynesianism, Monetarist, Classical, Neo-Classical, Marxian, Austrian School, and so on. It would be quite extraordinary to find an economist who knows, never mind, understands the nuances of all these schools of thought.

Yet, much of economics is read as if it is in absolute terms, i.e., applicable to all. A clear example are the writings of Adam and Keynes, being done at a time when Britain was already the most developed nation on earth, and hence their writings and advice have had limited use and impact for developing and less-developed nations. It gets very confusing and obfuscating. Many things simply slip through the cracks. In the words of HM Queen Elizabeth of Great Britain when asking about the failure to predict 2007 and 2008 Great Financial Crisis, 

“Why did nobody notice it?”

The startled silence that followed is legendary.

Only recently have theorists given thought to these distinctions and impacts as to different levels of development of countries; the Mundell-Fleming model, for example, makes differences for how its model works, for example, for small, open economies as compared to large, developed economies.

Malaysia is indeed such an economy, open to trade to a fault and yes, it is small. In financial macroeconomics terms, nonetheless, “small, open economies” means, inter alia, that the economy has no ability to influence world interest rates.

To be blunt, small, open economies like Malaysia are buffeted by capital flows, be they caused by trade or by portfolio (aka “hot money”) flows. This then tends to cause the Ringgit to fluctuate, particularly against the world’s highest use currency, the USD (see the previous chart above). Fluctuations of the Ringgit caused by trade flows are easily visible, via its Current Account Balance

Chart 2 Malaysia Current Account Balance

Source: IMF WEO April 2022

Not so easy to see are hot money flows, as data on it is not collected by governments by and large. Perhaps they should.

Why would any of this be so important to the ordinary Malaysian? Two reasons: one is inflation. This chart below says it all; as the Ringgit falls, the CPI (Consumer Price Index) goes up (and vice versa). Goods, especially imported ones and even domestic final products with substantial imported components just gets more expensive (“cost push inflation” as economists call it). Chicken is an example, with its feed, corn, fully imported. Data scientists might note the 2 years or so lag between the Ringgit and inflation, most probably due to the inventory replacement cycle. Also note that the major outlier event in 2019 to early 2021 is, of course, the lockdowns caused by CoVid-19 when Malaysia went through a deflationary period. The 2007-8 CPI spike was during the Global Financial Crisis, and the one in 1997-8 was due to the Asian Financial Crisis.

Chart 3 Ringgit/ US Dollar exchange rate and Malaysian CPI 

Source: IMF WEO April 2022 and US Federal Reserve

The other source of concern for Malaysians are interest rates. The key strategy to combat inflation is to raise interest rates, making it more expensive for borrowers. While Malaysian corporates are renowned for having low gearing ratios (a 0.22 times debt to equity ratio based on BNM numbers recently), Malaysian households are highly geared, hence rising interest rates would add to their misery.

A free-floating currency regime simply means that the central bank of a country would allow its currency’s exchange rate to be determined by the market without intervention. This would essentially absolve the central bank of any responsibility for the exchange rate at any point. However, in reality it isn’t an absolute thing; no central bank will stand by and do nothing while its own currency collapses and wealth destruction razes the economy to the ground.

One of the key requirements for having a free-floating currency is that the country has a deep enough market for currency exchange such that the open market can absorb any transactions to be done, without substantially skewing the exchange rate in so doing. Otherwise, to maintain currency stability, the central bank has to step in. This is usually the province of developed countries. This explains why the United Kingdom, for example, the sixth largest economy in the world, has a measly forex (foreign exchange) reserve of US$31 billion at the end of March 2022, for a country whose GDP (Gross Domestic Product) is US$3.32 trillion in 2021. It is a forex reserve over GDP ratio of less than 0.01 times.

Without a deep currency market, the currency would fall to high volatility and be subject to predatory attacks, at the country’s expense.

For developing and less-developed countries to seek to have a free-floating currency regime might be very dangerous wishful thinking indeed. In the next article, we examine the fixed exchange rate and managed float regimes, as well as the results of statistical studies on which stands out best on volatility, inflation, and economic growth.

Printed in The Edge, May 16th 2022

China’s mercurial economic rise is seen as a modern miracle. It is now the world’s second largest economy and is expected to overtake the top world economy, the USA, in the not-so-distant future.

Many believe that the accelerating GDP (Gross Domestic Product) numbers are mainly due to the huge population. However, on a per capita basis, it is not a poor country as many think it is. 

The economics world uses GNI (Gross National Income) per capita as a measure of a country’s well-being. The World Bank has defined Middle Income Countries as economies with a GNI per capita of between US$1,036 and US$12,535. China’s stood at US$10,550 in 2020 based on World Bank’s data. On a PPP (Purchasing Power Parity) basis, it is an even more stunning number at US$17,2000 PPP Dollars.

 China’s GNI per capita is skyrocketing as this chart from World Bank shows:

It is quite obvious that they will pop through the top of the Middle-Income level soon, and in right smart fashion, too.

Here’s the thing: they are a hair’s breadth away from overtaking Malaysia, whose GNI per capita was US$10,570 in 2020. A glance at the chart of Malaysia’s GNI per capita shows that it has been stuck in the Middle-Income level for quite a while, since at least 2014. In other words, it is in the Middle-Income Trap.

Why is that?

There are many angles to approach answering this vexing question but let us start from the top: how each country does its economic planning.

Like Malaysia, China has their own 5-year development plans and Industrial Master Plans. The current 5-year plan for China is the 14^th, while Malaysia’s is the 12^th. All China’s 5-year plans have a Vision Statement of realizing the ‘China Dream of Rejuvenating the Nation’. That it has remained the same for many years provides stability in planning and execution thereof for the nation. 

It is the 13^th 5-year plan that is of interest for us in this question. The main target for this plan period is to build a ‘Moderately Prosperous Society in All Respects’. Importantly, realizing perhaps that they are in a transition period from being an FDI-led (Foreign Direct Investments) economy and part of the Global Supply Chain (GSC) towards being one that is turning mainly to local brands and final products, fueled by local consumption, they have a specific target NOT to fall into the Middle-Income Trap.

Embedded in China’s 11^th 5-year plan are 3 key requirements to guide the thinking (especially important during implementation), a 4-pronged comprehensive strategy and 6 principles to abide by. It has also 3 strong safeguards for itself. It has 6 key targets for the plan, most of which are social in nature (China being, of course, a socialist country). As we have further detailed in our paper “Malaysia’s 5-year Development Plan – How Does It Compare to China’s?”, the plan is for Supply Side reform, broadly meaning to improve its own final products and brand names. This is well within their powers and shows their practical nature. The plan objectives are cascaded down via 165 initiatives and programs organized into 23 areas. They are implemented by local governments, rather than Ministries.

Working hand in glove with the 5-year plans are the Industrial Master Plans. The current one is the “Made in China 2025” plan, popularly known as “MC2025”. When it was launched, MC2025 shocked the world. The two items that sent traumatic jolts were these:

1. To gain access to China’s domestic markets, foreign companies must surrender their technology as required, and
2. The key targets amounted to an import substitution strategy, squeezing out imported goods markedly.

As we had pointed out in our paper “China’s Industrialization – Are They Doing the Stepladder Sequence?”, the domestic market share targets drew gasps of disbelief from the world:

Clearly, China intends to launch its own Second Industrial Revolution via the hi-tech field. 

A clear distinction exists between its 5-year plans and their industrial plans: the industrial plans focuses on whichever segment of industry that had the plan’s spotlight on it (e.g., in MC2025, it was the hi-tech field), whereas the 5-year plans outlined the major construction plans, sectorial distribution, and the government’s strategy policy priorities over a multi-year time horizon, and sets targets and directions for national economic development.

China has enough local producers making final products and brands that they are powering ahead in national wealth generation. Brand names like Huawei, Lenovo, Geely, Haier, HiSense, TenCent, AliBaba, MouTai, MeiTuan, Xiaomi, Bank of China, and so on are now global household names. 

According to Statista, China’s share of global production by industry in 2018 is:

The United Nations Statistics Division noted that in 2019, China’s share of global manufacturing output was 28.7%, far higher than second placed US at 16.8%.

This then shows how China is powering its way to high-income levels: industrialization with local brands and final products.

By comparison, of Malaysia’s 5-year plans, called Malaysia Plans or ”MP”, the 11^th would be synchronous with the two China plans mentioned above. They leave a lot to be desired. It follows the nation’s Vision Statement, but changes in government meant that the Vision Statement changes, putting the MP out of synchronicity. During the MP11 period, there was a change in government.

The MP11 had 6 strategic thrusts when it was first written in 2016, with 6 “Game Changers”. Midway through, though, the government changed, and the 6 strategic thrusts disappeared, to be replaced by 6 policy pillars that had 19 priority areas and 66 strategies. Any planner will tell you that changing targets midway is a sure-fire way of ensuring non-success. 

Sadly, there were no strategic level target in either MP11 versions.

Malaysia’s MP11 sub-targets are then cascaded down to Federal Ministries to implement, rather than local governments like China’s. China’s practice would pull the entire nation along with their plan, but Malaysia’s causes disconnect between the Rakyat and the plan. Such fragmentation can only cause less than optimal achievements. 

Malaysia’s 3^rd Industrial Master Plan expired in 2020, and after more than a year, the new one is still not on the horizon.

Malaysia’s current industrial structure is built primarily on the FDI/ GSC components with intermediate goods value-add. That, we believe, has maxed out its benefits to the country. It’s hard to easily name Malaysian global brands.

Time to reindustrialize Malaysia and focus on local final goods and brand names.

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Edge Article April 2022. Published on 11th April 2022.

It is often said that the word for ‘crisis’ in Mandarin is written by using the characters for ‘danger’ and ‘opportunity’ together. The CoVid-19 pandemic since 2019 was indeed a global crisis; in order to halt the spread of the deadly virus, the entire world had to be brought into lockdowns of their countries, and consequently, their economies, that is in greater or smaller degree is still on today.

With the lockdowns came businesses shuttering, and the global supply transport infrastructure stood still. It sent authorities into panic mode to save their economies; most resorted to opening the monetary taps to keep economies breathing and people out of starvation. 

Much was ‘disrupted’, to use a wholly inadequate term, most importantly the Global Supply Chain (GSC) which Malaysia’s economy is very dependent upon. 

Indeed, Malaysia has built its economy to be dependent on Foreign Direct Investment (FDI) and being part of the GSC, ignoring conventional, centuries-old wisdom of building up a country’s industries with its own final products and brand names. The result? Malaysia is stuck in the Middle-Income Trap and the goal of being a High-Income Nation appears further than ever. With the World Bank recently raising the bar for High-Income Nations to US$12,695 a year in Gross National Income (GNI) from US$12,535 a year previously, Malaysia, whose GNI in 2020 was lower at US$10,570 from US$11,260 in 2019, it appears a daunting, if not impossible task (see our recent paper “Strengthening the Main Economic Aspect of Keluarga Malaysia”).

There are several aspects of following this strategy that is troubling. Any trainer will tell you that in order to inculcate good new habits into someone, the bad old ones need to be exorcised. Let’s look at 3 reasons why the FDI and GSC strategy is flawed:

The first is that, where Malaysia’s FDIs and GSC participation is concerned, they are mainly of the intermediate goods type, instead of the “whole value chain final products manufactured” type. This means thin margins and value-add to the domestic economy.

A very popular article in 2012 highlights the thinness of margins obtained by intermediate goods’ manufacturers. The article, penned by Matthew Yglesias (“FoxConn Getting By On $8 per iPhone”) noted that FoxConn which assembled all the iPhone 5 units in the world in 2012, made only US$8 each, while an unlocked iPhone 5 unit retailed for US$849 for the 64GB model. In other words, it made less than 1%.

This thinness filters upwards towards the value add to GDP (Gross Domestic Product). We compare intermediate goods producer Malaysia to South Korea, which has plenty of final products and brand names:

Table 1 Malaysia’s Foreign Sector Addition to GDP

Table 2 South Korea’s Foreign Sector Addition to GDP

It clearly shows that Korea gets a higher contribution to GDP from its foreign sector (C/A over GDP), never mind its far larger GDP figures. 

The second reason is that technological trickle down to the domestic economy from FDIs cannot be assured. Years of academic research on it is at best inconclusive as to whether FDI does spark such trickle downs and worse, most research does not make the critical difference between their samples being the FDI type that produces the whole chain that ends with a final product or whether they are the “stick part A to part B” type of intermediate goods production. Some examples below:

A study by Elvisa Torlak in 2004 on technology transfer in the transition countries of Hungary, Poland, Romania, Bulgaria, and the Czech Republic corroborated the theory that technology is transferred internationally through multinational firms within itself but provides no evidence of diffusion of technology from foreign to domestic firms. This means that XYZ in the US will transfer technology to its XYZ plant in Malaysia, but not to unconnected Pak Ali Satay and Microchips Sdn. Bhd. in Ulu Sembelit.

Lichtenberg and de la Potterie in their 2001 paper, “Does Foreign Direct Investment Transfer Technology Across Borders?” noted that: 

“The data indicates that FDI transfers technology only in one direction: a country’s productivity is increased if it invests in R&D-intensive foreign countries…. But not if foreign R&D-intensive countries invest in it.”

The third reason is that Malaysia has performed abysmally in attracting FDI, coming in last in 2018, and is next to Korea in a sample of Asian countries per the chart below. Korea honestly does not need that much incoming FDI as an already Developed Country. The chart below from our previous paper “Foreign Direct Investments in Malaysia, Part 1 – Has Malaysia Fallen Off the Beauty Parade?” with Malaysia right at the bottom in 2018 says it all:

Chart 1 Comparison of NET FDI Inflows Into Selected Asian Countries

Source: World Bank

The forecast for economic growth post the CoVid-19 pandemic is one of economic re-emergence for all countries. This is where each country will have to look after its own. Hence, while producers outside of the countries of origin will have a greater amount of orders from companies domiciled in their respective originating country (already evident recently), it is unlikely that new FDIs will come out. Rather, the movement, under US President Trump’s days was that of calling back US companies to produce within its borders. There is scant evidence that current President Biden has totally reversed that, given the benefits to the US’ own economy. China has turned inward, looking for its domestic economy to fuel its economic growth. Russia’s attack on Ukraine now adds the spectre of not only higher oil & gas prices, but also commodities, with Ukraine being huge global producers of wheat, corn, and sunflower oil. One doubts that with a war on, Ukrainian farmers can sow their crops in late Spring; this year’s harvest will likely be a poor one, driving up food prices globally. 

The setting for more FDIs globally is in poor light with tentative economic recoveries and global inflation on the near horizon; far better will it be to have local industries making final products for the needs of the people.

The case for de-emphasizing the current growth strategy for Malaysia of FDIs & GSC participation cannot be stronger. Time to emphasize local final products and brand names as a national economic strategy.

Huzaime Hamid is Chairman & CEO of Ingenium Advisors, Malaysia’s financial macroeconomics advisory.

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