The post-Covid economic crisis – Carmelo Ferlito for Dato Johari (this section is part of a

more comprehensive paper on Covid-19 and how to fight it in Malaysia)

As mentioned earlier, policies have consequences, intended and – often – unintended. One
of the main tasks of economics is precisely to study human actions and interactions with their
intended and unintended consequences.

As explained in Ferlito (2021b), COVID-19-related stay-at-home orders produced the worst

economic crisis since 1929. Unemployment in Malaysia reached the peak of 5.3%, while it is
now between 4.5 and 5%. Malaysia’s unemployment rate reached “only” 4.5% at the peak of
the 1998 financial crisis, while it was around 3.3% before the Covid-19 emergency exploded.

While the government struggled to identify a consistent and effective strategy to address the
healthcare emergency, the consequences of lockdowns have been heavily weighing on the
economic performances of the country, both in terms of Gross Domestic Product (GDP) and
Foreign Direct Investments. Malaysia's economy contracted by 0.5% yoy in Q1 of 2021, after
a 3.4% decline in Q4 2020 and better than market expectations of a 2.0% fall, due to the
reopening of more economic activities in the wake of the Movement Control Order and
following massive various stimulus packages by the government and central bank to support
the recovery.

Figure : Malaysia’s GDP annual growth rate – 2018-2021.

Source: https://tradingeconomics.com/malaysia/gdp-growth-annual.

For 2020 as a whole, the economy shrank by 5.6%, the steepest contraction since the 1998
Asian financial crisis, reversing from a 4.3% expansion in 2019.

Figure : Malaysia’s GDP quarterly growth rate – 2018-2021.

Source: https://tradingeconomics.com/malaysia/gdp-growth.

Despite the economy grew by 2.7% in Q1-2021 when compared to the previous quarter,
expectations are rising about a negative performance in Q2-2021, due to the prolonged
movement restrictions and business shut down orders. In fact, despite Bank Negara Malaysia
remains convinced that the country is on the right track to achieve an annual growth between
6.5 and 7.5% in 2021 (The Star, 2021), Minister in the Prime Minister's Department (Economy)
Datuk Seri Mustapa Mohamed stated that the forecasts may be revised soon (NST, 2021). This
is in line with what the Center for Market Education declared in several occasions since the
end of 2020; in fact, CME CEO, Dr Carmelo Ferlito judged Budget 2021 as overly optimistic
already in November 2020 (Kaur, 2020) and he asked for a forecast revision in January 2021
after the implementation of MCO 2.0 (Chung, 2021).

In such a scenario, we argued in several circumstances that the more realistic prediction is to
expect a “reverse square root recovery”, described in the figure here below.

Figure : The “reverse square root recovery”.

Source: Sraders (2020).

In fact, BNM forecasts would have been realistic only by assuming an immediate end of the
pandemic and the reopening of international borders. The main message that the reverse
square root shape conveys can be described as it follows:
- A sharp economic decline caused by the containment measures;
- A physiological rebound following the reopening of the economic activities, or at least
of part of them;
- A stabilization process around a new structural dimension of the economy, re-adapted
in order to take into account the life with the virus;
- Flat or moderate growth for a certain period of time, equivalent to the time required
for the health emergency to be over, confidence to be re-established and the
production structure to re-adapt to a new situation from the demand side.

The last two stages can last years, according to the evolution of the different variables to be
taken into account, among which the overcoming of the virus power is only one of them.
Ignoring time and its importance for expectations adaptation and production structure
restructuring is misleading.

Furthermore, however, we need to add to the current analysis the effects created by the
expansive fiscal and monetary policies implemented by the Malaysian government and by the
Central Bank, policies which also have unintended consequences. We believe that an
economic crisis may hit Malaysia and the world precisely in the moment when we will think
to be at the inversion point. Such considerations arise from the uncomfortable news we have
about inflation, and the emerging of stagflation as a mix of rising unemployment and rising
prices. The pressure on producer prices is already visible in Malaysia, where they grew by 10
percent since June 2020.
Figure: Malaysia Producer Prices – 2020-2021.

Source: https://tradingeconomics.com/malaysia/producer-prices.

The trend is already translated on consumer prices, with inflations reaching 4.7 percent with
a radical inversion to the deflationary tendencies produced by the economic crisis related to
Covid and the lockdowns.

Figure: Malaysia inflation – 2020-2021.

Source: https://tradingeconomics.com/malaysia/inflation-cpi.

As mentioned, in the attempt of slowing the spread of the virus, the Malaysian government
(together with most of the world ruling classes) imposed movement restrictions which have,
in turn, worsen the economic conditions of the nation. In order to address the wounds
created by the lockdowns, the government intervened in the economy with expansive fiscal
policies (which is not here the place to debate). At the same time, Bank Negara has
maintained a low interest policy in the belief that such a policy would be beneficial for the
economy (although I do not believe in the automatic and magical powers of low interest rates,
as I argue here.
Unfortunately for us, economic policies do have consequences, intended and unintended.
The main problem generated by these expansive policies is that they created a dichotomy
between the real economy and the monetary or financial situation. In fact, on one side we
have a real economy in troubles: jobs are destroyed, capital investments abandoned,
businesses closed for good; these phenomena create deflationary tendencies. On the other
hand, instead, fiscal stimuli and low rates created an excess of financial means available in
the market, in contradiction with the situation of the real economy (or, as it is more
appropriate, of the production structure); this is creating inflationary pressures.

Such a dichotomy is clearly visible in the basic monetary aggregate – M1 – trend.

Figure: Malaysia Money Supply M1 – 2016-2021.

Source: https://tradingeconomics.com/malaysia/money-supply-m1.

This dichotomy is what is creating the premises for the next economic crisis, which will hit
Malaysia and the world after the pandemic, when the deflationary tendencies created by the
lockdowns are over. In fact, the artificial creation of financial means will impede the
deflationary process which we need in this moment. First of all, the availability of financial
resources will drive entrepreneurs toward investments that would had not happened
otherwise. However, consumers will not necessarily save more to finance the new investment
decisions (their purchasing power is still compromised and further weakened by inflation). At
the same time, however, entrepreneurs regard the present supply of capital and the present
rate of interest as an indication that approximately the same situation will continue to exist
for some time.

As we are observing for ten months now, this situation initially brings about an increase in
prices of raw materials and of the capital goods produced with them. At the same time,
demand for labour increases, to attract workers towards the new investments, making
relative wages to increase: this in turn encourages demand for consumer goods and their
prices also increase. The inflation initially seen only for raw materials spread toward
consumer prices.
In order to be sustained, this process requires further credit expansion which would bring
about a cumulative increase in prices that sooner or later would exceed every limit. At a
certain point, the interest rate cannot but rise, forcing investment projects to be abandoned
(capital destruction).

We may find ourselves in the situation that, at the peak of the recovery, the economy
discovers that it is unable to sustain a production oriented beyond its possibilities (because it
was on artificial support). Demand for capital goods runs out. Many economic initiatives set
up relying on excess liquidity cannot be completed, although the debts still have to be paid.
Many companies have to be expelled from the system. Capital is scarce and banks raise
interest rates. The period of readjustment that follows is called economic crisis or depression.

The economic trajectory that we can imagine beyond the reverse square-root path is,
therefore, even more unstable. The way in which we see the future economic path of
Malaysia is as per the following graph.

Figure: The post-Covid economic crisis.

This will add tensions to the fragile situation of Malaysian households, whose debt already
reached 93.3% of the GDP. During the recovery, furthermore, innovative debt practices and
speculative excesses are encouraged and an unrecognised system fragility can emerge.

Our economy is therefore on the verge of a perilous turn. If the inflationary tendencies are
not taken seriously and instead the dichotomy between the structure of production and the
financial system is further incentivised, we may experience a severe economic crisis precisely
when the post-Covid recovery will seem to be walking on solid ground.

We need to allow deflation to happen in order to restore purchasing power and to rebalance
the financial situation with the real economy. This will allow investments to be driven by
consistent saving decisions and the recovery to move on to more stable territory.