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Will the Middle East conflict derail our economy?

Geoffrey Williams-18 Apr 2024, 08:00 AM

Geopolitical tensions will weigh down the global economy and hold back growth and trade but domestic resilience and sound policy should help Malaysia weather the storm.

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The escalation of the conflict in the Middle East brings more countries into the regional belligerence and threatens to embroil the whole world.

While the loss of innocent lives and devastation of communities are our primary concern, questions on the economic implications have also been raised.

The immediate impact will increase risk and uncertainty and force investors into safe havens, mainly in the US, until things become clearer.

Bank Negara Malaysia has already issued a statement saying it will monitor the situation and adjust policy where necessary. This should reassure markets.

It is a good intervention which will include ensuring sufficient liquidity for the foreign exchange market, supported by recent initiatives to increase inflows and liquidity to buy ringgit.

The conflict will still put pressure on the ringgit and Bursa Malaysia but it does not reflect a weakness of Malaysian economic fundamentals. So far the market response is just speculative outflows of capital to markets seen as safer in the short-term.

If there is no Israeli retaliation and no further attacks from Iran then the situation might stabilise.

For the moment it is a shock to markets but the response has been muted. The ringgit weakened from RM4.77 on Friday to RM4.78 on Monday but we need to see what happens during the rest of the week.

The FTSE Bursa Malaysia KLCI fell by 0.6% on opening but it has been falling for the last week and net foreign investment has been falling for seven consecutive weeks so it will remain weak under current circumstances.

It closed down 0.45% but by comparison the stock market fell by 1.4% in Singapore and 1.2% in Hong Kong so in the region Malaysia has proven to be quite resilient.

One immediate concern comes from a possible increase in oil prices. The timing of any hike in oil prices could be especially detrimental to the economies in the region.

Oil prices have been rising all year and have been quite stable so far, settling at US$90 per barrel for Brent Crude on Monday.

There is no upper limit to oil prices, they were around US$133 in 2022 for example and US$147 in July 2008 but it is unlikely they will go to those levels again, especially if this current tension subsides.

This is a double-edged sword for Malaysia which benefits from higher oil prices through increased revenue for Petronas and the government. Higher oil prices are usually net positive, and anyway petrol and diesel prices are still subsidised in Malaysia and so there is no price change yet.

The danger is that subsidy rationalisation may be delayed because removing subsidies would cause pump prices to rise sharply if global oil prices are elevated. This would also put pressure on prices across the board.

The impact on consumer prices will take some time to pass through. Prices might be affected by supply restrictions or by longer transport routes and higher shipping costs. There might also be an exchange rate impact pushing prices up.

These will all be long-term effects and there should be no short-term hike in prices of goods and services for now.

So the immediate impact on Malaysia will be muted and the economy should withstand the short-term uncertainty. However a further escalation causing protracted disruption of supply-chains and shipping routes will have a negative impact on global trade and Malaysian exports.

An increase in oil prices could also raise costs, pushing up inflation and delaying further interest rate cuts around the world.

This will slow growth and put further pressure on the ringgit. So the official 4%-5% growth target for this year will be under pressure due to factors outside the control of Malaysian policymakers.