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Can Malaysia Survive Oil Slump?

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Oil prices are plummeting and right now most of the focus is on shale oil companies in the United States. Facing higher production costs than more traditional oil companies, fracking companies could certainly face some lean times. Countries highly dependent on oil will also face tough times.

Oil rich countries with already strong finances and huge sovereign wealth funds, such as Saudi Arabia, will be able to survive the lean times and likely not suffer much. Countries like Malaysia, however, which are already buried in debt and depend heavily on oil revenues to fund day-to-day spending, could struggle as oil prices drop.

Malaysia Is Dependent On Oil Revenues

In the past, oil revenues were estimated to contribute about half of all government revenues in Malaysia. The government has used oil revenues to fund major projects, such as the Petronas Towers, the country’s highly developed infrastructure, and other things. With oil revenues shrinking the government will have a tough time funding these projects.

Now, oil revenues are believed to contribute about 14% of government revenues. The Malaysian government has worked hard to diversify its dependence on oil, but oil revenues are still extremely important for government funding. The situation is exacerbate by the fact that Malaysia has already been struggling to tighten its belt.

Further, the Malaysian government, and its ruling coalition in particular, has long been accused of corruption. Arguably, UMNO has used a patronage system that involves handing out bloated government contracts to cronies who then support the government. High oil prices have helped to reduce the impacts of this inefficient system, but as oil prices decline it’ll become harder to maintain this patronage system.

UMNO has also bought votes with an expensive welfare system that will likely be unsustainable as oil prices continue to decline. Declining welfare could cost the ruling coaltion party support, and also lead to potential social instability and rising poverty.

Malaysia has also been spending heavily on attempts to modernize the economy. Malaysia is stuck in a middle income trap with rising costs making it difficult to compete with cheaper regional neighbors. At the same time Malaysia’s economy isn’t advanced enough to compete with Singapore, S. Korea, Japan, and other advanced countries.

Bond Prices Could Soon Climb

Malaysia has also enjoyed access to cheap bonds. The country has long been a highly rated country, often receiving Triple A ratings. This is less due to the country’s strong fiscal management and instead the fact that the government’s debt has essentially been backed by oil revenues.

With oil prices dropping, however, Malaysia’s sterling credit rating could soon be at risk. Malaysia’s official debt levels weigh in at about 54% of the GDP, and the country has a constitutionally mandated debt ceiling tied to 55 percent of the GDP. The government has used loop holes to get around this limit, however, and some analysts believe that debt has reached 75% or more.

Rising bond prices will only exacerbate the already mentioned challenges Malaysia could face as oil revenues decline. At the same time, the Malaysian ringgit has fallen to a five year low.

Outlook: Malaysia Faces Tough Times Ahead

Unlike Saudi Arabia and other oil rich countries, Malaysia doesn’t have the massive sovereign wealth funds to tide the country over until oil prices rise again. Further, Malaysia’s middle-income trap challenge and reliance on low-value added industrial production are creating immediate challenges that Malaysia must confront now, rather than later.

If the UMNO led government is forced to make drastic changes, and especially cut its welfare and patronage networks, it could also darken the already dim political outlook for the ruling party. UMNO’s primary supporters are the people and businesses used to easy government hand outs, and as those dry up loyalties could change very quickly.

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