Sunday, August 20, 2017

Myanmar risks overheating: IMF

Myanmar's economy is showing strong signs of overheating and has become increasingly vulnerable over the past 12 months amid rising macroeconomic imbalances, according to the International Monetary Fund (IMF).

An expansionary budget and limited monetary policy tools will see inflation at 13 percent by year-end, the IMF said in its annual 2015 Article IV Consultation report, which advises authorities to urgently tighten monetary policy.

By the end of the year, Myanmar will also have a fiscal deficit of almost 5pc and a current account deficit of around 9pc of GDP, with foreign currency reserves falling to 2.5 months of imports.

However, medium to long-term prospects remain “favourable”, assuming continued structural reforms, foreign direct investment and macroeconomic stability. Industry sources said this outlook is somewhat optimistic.

The economy is set to grow by 8.5pc this year – reflecting expansionary macroeconomic policies, including a widening fiscal deficit. Myanmar is likely to be the world’s fourth fastest growing economy until 2017, according to the World Bank’s Global Economic Prospects report, published in June.

In financial year 2015 (FY2015), Myanmar’s fiscal deficit grew to 3pc of GDP and its current account deficit widened to 6pc of GDP. As deficits continue to grow, the Central Bank of Myanmar (CBM) will require significant financing at around 1pc of GDP and credit growth will accelerate, resulting in strong inflationary pressures.

Credit to the private sector grew by 35pc last fiscal year. Inflation rose to 8pc year-on-year in May, up from 4pc last October, and will continue to rise this fiscal year to reach 13pc, said the IMF.

A senior CBM official told The Myanmar Times yesterday that while the economy is not yet overheating, “signs of economic overheating may be evident due to constantly high economic growth”. As a side effect, inflation is inevitable, he added.

The IMF notes the exchange rate has also been under strong downwards pressure, depreciating by around 25pc this year, to K1292 to the US dollar yesterday, according to the CBM rate.

In a private briefing on the foreign exchange market seen by The Myanmar Times in July, the IMF raised concerns that the CBM had moved away from its managed floating exchange rate system introduced three years ago, and that economic reforms were stalling.

At the time, the CBM was keeping the exchange rate artificially low, leading to a flight to US dollars and a widening gap between the official and unofficial exchange rates. However, since then, the President’s Office stepped in and adjusted the official rate to meet the market rate.

The IMF said in the September 18 report that it welcomed this move, and noted the importance of maintaining exchange rate flexibility, adding that further reform is needed to bolster regulatory capacity at the “relatively weak” CBM, particularly in light of nine licences granted to foreign banks this year.

It also stressed the “urgency” of allowing interest rates at Treasury bill auctions to rise, to attract more bidders and reduce the CBM’s role in financing fiscal deficits. The government offers 8.75pc for two-year, 9.0pc for three-year and 9.5pc for five-year bonds, and state-owned Myanma Economic Bank dominates the fortnightly auctions, buying up to 80pc of each issue.

The IMF also believes the CBM should also push ahead with plans to enforce higher reserve requirements at banks, to withdraw liquidity from the banking system.

Minimum paid-up capital is set to rise to K20 billion (US$15.5 million), with statutory reserves of another K10 billion. Furthermore, the CBM “should be prepared to increase this further and scale up deposit auctions if signs of second-round effects from food price increases on inflation emerge”, said the IMF.

Prudential measures should be enforced and state-owned banks and non-bank financial institutions should be a priority for reform, as should tackling money laundering and the financing of terrorism.

The IMF also recommends wide-ranging tax reforms. A report released earlier this month by US non-profit Global Financial Integrity finds that illicit, un-taxed inflows from trade misinvoicing average over $8 billion each year. Between 2010 and 2013, lost income from technical smuggling was the equivalent of 129pc of health spending and 42pc of spending on education.

Authorities should also tighten monetary policy to reduce macroeconomic vulnerabilities, said the IMF, noting that some flexibility may be needed due to nationwide flooding over the past few months, which could lead to a “spike in demand for liquidity.”

The floods have affected 34.6 million of Myanmar’s 51.4 million people, according to a September 16 snapshot by the United Nations. An estimated US$75.5 million is needed to repair the damage, though the indirect impact on the economy is likely to be much higher.

Additional downside risks to growth and stability include lower natural gas prices – which have fallen from $3.85 per million British thermal units (MMBtu) this time last year to $2.61 yesterday.

Natural gas is Myanmar’s largest export commodity and is a key driver of government revenues and economic growth. Senior official from the Ministry of Energy told The Myanmar Times earlier this year that income from natural gas exports could decrease by $1.5 million a day as the effects of the global price slide kick in.

Myanmar’s trade channels are also likely to be impacted by slowing growth in China. Chinese President Xi Jinping’s corruption crackdown in Yunnan province has also made many cross-border traders wary, according to U Shine Zaw Aung, country analyst at Myanmar-focused research firm New Crossroads Asia.

“Myanmar’s rice exports have been halted at the border, while Yunnan tycoons – traditionally large buyers of Myanmar’s gems and jade – are trying to be more modest than before,” he said.

As the United States tightens monetary policy, the US dollar will strengthen further against the kyat, pushing the costs of imports higher. The Federal Reserve may raise its benchmark rate from the 0-0.25pc range in December for the first time since the global financial crisis in 2008.

“A combination of potential shocks – if materialised amid political uncertainty related to the general elections – could severely strain the economy,” said the IMF. In the worst case, the fiscal deficit could rise to over 6pc, the current account deficit could widen to 10pc and CBM reserves could fall to 1.3 months of imports by the end of this fiscal year.

“On the other hand, a well-received election outcome and peace process may provide an upside surprise, resulting in higher-than-expected FDI inflows,” said the report, which did not elaborate on this.

Foreign investors say FDI inflows will depend on a stronger Central Bank and a potentially protectionist new Foreign Investment Law, which is slated to be passed soon. However, U Aung Naing Oo, director general of the Directorate of Investment and Company Administration last week dismissed concerns of undue protectionism, saying that the government wants to “create a better investment climate”.

Others say political and non-commercial issues, such as the political environment, ongoing economic sanctions and human rights concerns will hold back foreign investment.

The IMF noted that continued structural reform – including improvement to the business environment, financial inclusion, health services and education – is essential.

Sean Turnell, an expert on Myanmar’s economy at Sydney’s Macquarie University and an economic adviser to Daw Aung San Suu Kyi, wrote in a post on Facebook yesterday that the macro economy “is set for a wild ride”.

He also voiced fears that the IMF report is too sanguine in a number of areas.

The first is that it assumes a new banking law will be in place to guard against financial sector instability. “But this will not be in place. Moreover, most banks ignore prudential directives anyway. Significant vulnerabilities here remain,” he said.

The second is that IMF urges monetary tightening. “This misses the major issue, which is not monetary in nature, but fiscal. The budget deficit is driving monetary creation, but this in turn is driven by excessive spending on Burma’s coercive apparatus. Military spending ... not a word from the IMF!”

Military spending has continued to increase, accounting for 27pc of government spending for fiscal year 2013, according to a July report by the Asian Development Bank.

However, the IMF does note that reducing the fiscal deficit is “urgently needed to contain immediate inflationary pressure and anchor exchange rate expectations”, recommending it remains within 4pc of GDP in FY2016, through reducing low-priority spending, “including on goods and services, and travel expenses”.