Diminishing returns of stimulus aid

Govt policy of doing ‘whatever it takes’ to save the economy has its limitations

CLEARLY the smart money managers were outsmarted in the past three months. They stayed away from the stock market, which has recovered to its post-covid-19 highs. They missed out on the run in glove stocks, which has taken a breather.

But do they have any regrets?

No, they don’t because smart money managers see a big disconnect between the stock market’s roaring performance and the deteriorating underlying economy due to the chaos caused by the Covid-19 pandemic.

The smart money managers, who made millions from picking the right stock at the right time, are generally less exposed to the glove stocks. The sector, they say, is not a barometer of the state of the Malaysian general economy.

The glove sector is not the flag bearer for the Malaysian economy that is dependent on services and commodities. The manufacturing sector, where the glove sector is one of the components, contributes to one-third of the gross domestic product (GDP).

From the United States to Malaysia, the policies of governments to put money into the system inflated stock markets. Markets cheered on the various stimulus packages unveiled even though there was an explosive rise in government debts.

Undeniably, it created a sense of comfort that governments will not allow the economy to deteriorate to the extent that it destroys businesses. Fears of companies going bankrupt because of disruption to businesses and rising unemployment, which seemed very real in March, dissipated.

Bursa Malaysia hit a high of 1,574 points earlier this week, which is not far off the year’s high of 1,611 points reached before the Covid-19 pandemic. Trading volume also hit record highs.

On Wall Street, the technology-heavy Nasdaq hit an all-time high of just above 10,000 points, which surpassed its previous high reached in February. The Dow Jones Industrial Index and broader S&P 500 index were all roaring.

The exuberance came to a screeching halt when Federal Reserve chairman Jay Powell said on Wednesday that he expected the US economy to contract by 6.5% this year and recover by 5.5% next year. He also had said that they were not looking at raising interest rates until 2022, meaning the recovery will be slow.

To its credit, the US is the first among major economic powers to categorically state its dim outlook for the year.

China, which is the second biggest economy, has shied away from forecasting its economic growth numbers for this year citing great uncertainty due to the Covid-19 pandemic. China recorded a year-on-year contraction of 6.8% in its economy in the first quarter this year. The International Monetary Fund (IMF) has forecast China’s growth this year to be 1.2%, much lower than the average of 6%.

On Bursa Malaysia, the market is going through a correction after rising almost 30% since hitting a low of 1,217 points on March 19, which was a day after the movement control order was imposed. Traders are going gaga over glove stocks and any other counter that has a product to prevent the Covid-19 virus.

So far the government’s various stimulus packages amounting to Rm295bil, has eased the burden for the man-on-the street. Out of the amount, the government’s direct cash injection is estimated at Rm45bil while the rest are mainly in the form of relief from paying loans and offering support loans to corporates.

Companies have kept their workers but pay cuts is a norm. After September when repayment for housing and car loans resume, the effects of the stimulus is expected to wane off. Nobody knows how many will continue to service their loans after September.

Banks are still grappling on how to assess the existing risk profile of borrowers taking cognisant of the fact that many would not be able to meet payments. All banks have recorded lower earnings in the first quarter.

Analysts are expecting lower earnings in the next two quarters. With earnings on the decline and risk profile of existing customers on the rise, it is of no surprise if one has difficulty in getting a loan.

In the latest stimulus package, the government gave several incentives to the people. It included reduction in public transport fares, relief from paying stamp duty and property gains tax.

The measures should further ease the burden of the people and spur some activity in the housing sector, which is a key component to the economy because of its high multiplier effect. But there is a great deal of uncertainty on how many people will transact properties even with the incentives thrown in.

Although the government has stated that it would borrow more money, if it needs to, to keep the economy going, there are limitations to stimulus packages.

The ratio of government debt to GDP is 51% now, lower than the globally acceptable threshold of 55%. Thailand has burst the 55% limit and Malaysia has alluded that it could exceed the threshold.

The federal government deficit is closer to 5% this year, up from 3.2% last year. In the 2009 crisis, it went as high as 6.7%. Finance Minister Tengku Datuk Seri Zafrul Tengku Abdul Aziz has said that they still have some room to borrow.

Malaysia is not alone in bursting the acceptable debt limits. The US federal government debt is US$26 trillion and it is implementing a US$2 trillion stimulus package, which is the biggest in its history.

The danger of having too many stimulus packages funded by debt is that it impacts interest rates. Countries with high debt levels cannot afford to have high interest rates because the government’s debt servicing will be high.

In theory, low interest rates should ease the cost of doing business and improve the underlying economy. But a low interest rate environment also allows money to be ploughed into unproductive and risky investments such as speculative trading in the stock market. Moreover, it benefits the rich corporates more than the poor ones. Also, coming out of a low interest rate regime is difficult.

Hence, the marginal benefits of stimulus packages tend to diminish over time. It spurs growth. But a bigger danger is it creates a false sense of complacency that the government will always step in to save the economy.