Explained: The shrinking surplus
THE current account balance of the balance of payments is a barometer of how a country earns its income (exports of goods and services) and spends (imports of goods and services).
When a country runs narrowing current account surpluses or current account deficits, market investors are often quick to raise concern: is the country spending beyond its means; and is it structural or cyclical and unsustainable?
A persistent and widening current account deficit is deemed as unsustainable if it relies heavily on short-term capital or foreign borrowings to bridge the gap.
Heavy reliance on external financing makes the economy vulnerable to external shocks as a change in investor sentiment could result in a sudden stop of capital flows as occurred during the 19971998 Asian Financial Crisis.
As a result, the country is forced to deplete its foreign reserves to fund the deficit.
Fast-depleting foreign reserves will change investors’ perception about the sustainability of the current account, fuelling concerns about the fundamental value of the exchange rate.
This will trigger market speculation and betting on currency devaluation. It will get worse if the country incurs twin deficits – both a budget deficit and current account deficit.
Malaysia’s substantially shrinking current account surplus to Rm253mil in the fourth quarter (4Q) of 2023 from an average of Rm7.5bil per quarter in Januaryseptember, bringing the full-year surplus of Rm22.8bil or 1.2% of gross domestic product (GDP) in 2023 (Rm55.1bil or 3.1% of GDP in 2022), has stirred investors’ concern about whether the country will incur twin deficits in both a budget deficit and current account deficit in the years ahead.
While Malaysia has been running 26th successive years of current account surpluses since 1998, the surpluses have been dwindling fast from an average of Rm70.3bil per year or 12.7% of GDP in 1998-2011, to an average of Rm43.3bil per year or 3.3% of GDP in 2012-2023.
The current account surplus of 1.2% of GDP in 2023 was the smallest surplus in 26 years since 1998 and also the smallest in 12 years since the surpluses shrank to a single low digit of GDP trajectory starting in 2012.
Should we be alarmed by this shrinkage of current account surpluses? Are pressure points developing?
The current account surplus is likely to stay in the low range estimated at 2.2% of GDP in 2024.
A deterioration of current account balance or a deficit in itself need not be a cause for alarm. It is the speed, magnitude and causes of deterioration that should warrant pre-emptive actions.
We need to have a clearer picture about the sources causing the shrinking surpluses because, sometimes, looking at the current account as a whole could be misleading.
We take note of the following developments that might influence the current account and overall balance of payments position over the medium term:
> Merchandise exports of goods (gross exports) had displayed weakening momentum from 6.7% per annum (pa) in 1998-2011 to 4% pa in 2012-2023.
This was due to the cyclical nature of global demand and semiconductor cycle, commodities and crude oil prices fluctuation as well as exports competition.
With Malaysia’s electronics and electrical products (E&E) accounted for 40.4% of total exports in 2023, controls 7% of global market share and 13% of the global market for packaging, assembly and testing services for semiconductors, the E&E industry will continue to be a dominant driver of overall exports, given semiconductor components found in a wide range of consumer electronics and commercial products, including vehicles.
The New Industrial Master Plan (NIMP) 2030 will enhance the E&E ecosystem by attracting more wafer fabs, IC design, advancing packaging in assembly and testing.
The resource-based industries such as palm oil, crude oil and natural gas, chemical and chemical products, and petroleum products, also played a pivotal role to boost the nation’s exports via more downstream and value-added production.
Domestic manufacturers and exporters have to increase the utilisation of Regional Comprehensive Economic Partnership and Comprehensive and Progressive Agreement for Trans-pacific Partnership to have a wider market reach.
Malaysia External Trade Development Corp (Matrade) must work with the trade association and chamber to devise effective exports promotion strategies through trade facilitation and financing, better understanding of trade rules, products and market development.
Merchandise imports also expanded by 4.9% pa in 2012-2023 (7.1% pa in 19982011), contributed by intermediate (58.1% share of total imports), capital (12.8%) and consumption goods (8.4%).
The construction of ongoing and new public transportation projects, highways, ports and airport expansion etc, have high import content, and will diminish the trade surplus in the years ahead, but this will contribute to the expansion of productive capacity to raise the nation’s competitiveness and bodes well for both public and private investment.
> The services account has been mired in large deficits for 14 consecutive years since 2010, mainly in the transportation sector, insurance and pension services, charges for the use of intellectual property, telecommunications, computer and information services, and other business services etc.
We have to enhance our capability in logistics and shipping, It-related and information as well as consultancy and insurance services to help reduce the services payment for engaging foreign shippers and professional services.
Payment for the use of intellectual property averaged Rm11.6bil in 2021-2023. Tap the fullest potential of domestic tourism and travel as well as education services to increase services inflows.
> Another component contributing to lower current account surplus is the persistent widening investment income outflows averaging Rm33.9bil per year in 2012-2023 due largely to:
(i) The influx of foreign direct investment (FDI) led to rising obligations to pay investment income owed to foreign investors as they repatriated interest, profits and dividends earned to their parent companies (an outflow of Rm66.1bil per year).
But some earnings will be retained and reinvested. This was more than offset the Rm28.9bil of profits and dividends repatriated back to home by the Malaysian companies investing abroad;
(ii) The repatriation of dividends and profits earned on portfolio investment in domestic equities, investible funds and bonds amounting to Rm16.5bil per year.
> Secondary income outflows averaging Rm16bil per year in 2012-2023 was largely attributable to the repatriation of foreign workers’ remittances back to their home averaging Rm33.1bil per year in 2012-2023 (Rm15.8bil per year in 19992010), which was 1.95 times of the remittances sent back by Malaysians working abroad (an average of Rm17bil per year).
Over time, the reduced dependency on foreign workers (1.8 million foreign workers at end-october 2023) would ease the foreign remittances outflow.
The strength of the financial account (which measures the foreign money flowing into the country and domestic residents’ money investing abroad) has improved as net outflows have narrowed from an average of Rm33.9bil per year in 1999-2010 to Rm19.6bil per year in 2011-2023.
This was due to a reversal in net direct investment from an outflow of Rm2.7bil per year in 1999-2010 to an inflow of Rm3.2bil per year.
It is encouraging that gross FDI inflows have expanded to an average of Rm42.5bil per year in 2011-2023 from Rm16.8bil per year in 1999-2010.
Notably, after declining to Rm16.9bil in 2020’s Covid-19 pandemic year, gross FDI rebounded to Rm84.3bil in 2021 and Rm64.9bil in 2022 before falling to Rm37.6bil in 2023, reflecting the impact of slowing global economy and high interest rates globally.
We see positive prospects of FDI inflows, given the high approved FDI of Rm163.3bil in 2022 and Rm188.5bil in 2023 and the implementation of NIMP 2030 and National Energy Transition Roadmap.
Malaysia must enhance its investment climate and emerge regionally competitive as a contender for reshoring and nearshoring investment under China Plus One strategy.
Malaysia’s outward investment abroad also increased substantially to Rm39.4bil per year in 2011-2023 from Rm19.5bil per year in 1999-2010.
A similar trend was observed in outward investment after the Covid-19 pandemic crisis, which saw Malaysian corporates increase their investment abroad to an average of Rm45bil per year in 20212023 from Rm13.8bil in 2020.
After printing net inflows of Rm18.8bil in 2021, portfolio investment in equities and bonds saw net outflows of Rm45.7bil in 2023 and Rm50.6bil in 2022.
On average, portfolio investment suffered wider net outflows of Rm16.7bil per year in 2011-2023 from mere net outflows of Rm393mil per year in 1999-2010.
Foreign portfolio investment recorded net inflows averaging Rm16.9bil per year in 2010-2023. Domestic residents’ outflows were larger at Rm28.9bil per year for the same period.
Malaysia has to offer compelling economic, investment and corporate earnings prospects to lure more foreign investors and domestic investors investing in domestic asset classes.
While a shrinking current account surplus, or, indeed, a deficit, is not a bad thing, we have to strengthen the current account balance, along with reforming fiscal, leading to lower net debt and liabilities as well as enhance our investment climate to attract FDI, retain domestic money and increase the exports of goods and services.
The sustained inflows of foreign capital and a large war chest of foreign reserves would provide a strong buffer against the weakness in the current account balance and support the ringgit.