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Islamic Finance

The economic costs of the COVID-19 outbreak for Malaysia: A preliminary crude estimate and suggestion for solutions

This article is a chapter out of the e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" that is available as a pdf download from HERE. Read the article in the e-book for the complete set of tables, charts and references. 


Today, May 3, 2020 is the 46th since the movement control order (MCO) was put into effect by the Malaysian government to contain the spread of the COVID-19. Apart from China that claims it has succeeded in containing the virus outbreak that first started on its shores in December, the rest of the world is still actively fighting it at different levels of severity. Hence, most other governments have imposed “lockdowns”, or restrictions on movements, on their peoples. As of May 3, Malaysia registered a total of 6,298 cases, 1,780 under treatment (out of which 27 are in ICU), 4,413 recovered and total 105 deaths.

Accordingly, many employees and professionals work from home as a response to the MCO but businesses are either closed or operate below capacity, restaurants sell only takeaways and all forms of public gatherings are either cancelled or postponed, including religious activities like congregational prayers. Many individuals are out of work or underemployed. Hospitals handling the COVID-19 cases seem overwhelmed and hence medical and health workers are stressed out. While it is necessary  to slow the spread of the disease, the lockdowns, imposed by governments for four to six weeks simultaneously, have numerous and grave implications for the domestic and global economy. The trade-off is between health and economy.

Great concern

There have been pandemics in the past; SARS and MERS are also forms of coronaviruses, but COVID-19 is of a greater concern to the world due to its faster and higher rates of infections, and deaths. The timing of COVID-19 coincides with a severe global recession already expected for the year 2020, to emerge from the financial sector. However, this pandemic coming from the real sector is likely to accelerate the recession, making it larger, deeper and more pronounced.

The ensuing economic impact

The first initial disruption from the lockdown is to jolt the economy with simultaneous supply and demand shocks. This is because most of the labor force becomes either underemployed or unemployed. At the same time, income to the labor force also shrinks, causing a demand shock. The economy therefore shrinks by a multiplier effect, finding a new equilibrium at a lower quantity of output. This is a huge cost to the economy and can potentially devastate many small and medium-sized enterprises (SMEs) and households. The dynamics of the economic effects of a nationwide lockdown may be summarized as follows:

  1. Supply and demand shocks that shrink the economy by a multiplier effect. Economy reaches new equilibrium at a much lower quantity of output. The effect on price level depends on the relative size of the respective shocks.
  2. The aviation, tourism and hospitality industry is hard hit.
  3. Domestic and global supply chains are severely disrupted.
  4. Businesses and individuals would be hard-pressed for cash, hence LIQUIDITY crisis creeps in.
  5. Businesses and households default on loans – further crunching liquidity. Bankruptcies and foreclosures ensue.
  6. Liquidity injection needed to turn around the situation. This amount would be huge and the government’s concern is how to finance this.

Bank Negara Malaysia, the central bank, estimates real GDP to grow at between -2.0% to +0.5% for 2020, after taking into consideration the stimulus package from the government. However, the Malaysian Institute of Economic Research (MIER) expects that the real GDP growth of Malaysia in 2020 will  drop from the initially projected 4.0% to -2.9%2. The unemployment rate is expected to rise to 3.5%, that is about 2.4 million3 workers, mostly from the unskilled category (67%). Exports, Investment and Consumption growths are all expected to fall.

The disruption to aggregate supply is likely to cause shortages in some essential items and thereby cause panic-buying and hoarding among households. With people’s income dwindling, and SMEs failing, it can spell disaster for the country.

Therefore, while it is important to address the COVID-19 health crisis, it is equally important the economy is kept working as much as possible. Health is a priority but people have other needs too, such as food and shelter, all of which, including health, people can enjoy only if they WORK. We need to note that many in the world today live on meagre daily wages and many also rent their homes. Without income these people can be devastated. So saving households and the SMEs that employ almost 70% of the nation’s labor force is crucial. We cannot afford to let the SMEs fail due to this pandemic. The MCO for just two months can destroy 10% to 15% of GDP, some potentially permanently. In economic terms, it destroys LIQUIDITY in the economy. So the main concern for the government now is how to solve the health crisis and at the same time inject the lost liquidity back into the economy, as soon as possible.

This is indeed a “war time” crisis whose focus is first to secure the people and then the economy, national security, resources and sovereignty.

The socio-economic cost of MCO

A crude estimate of the total loss to Malaysian GDP due to a partial lockdown from March 18 to April 28 (40 days) is about 10% of GDP. The actual loss of economic output is likely to be more because productions may not resume immediately after the MCO is lifted. In fact, some production processes would be lost forever. 10% of expected 2020 GDP will be lost. The 2019 real GDP (2015 prices) was 1,420,492 million ringgit with the relative size of Agriculture, Industry and Services being 7.1%, 36.8% and 56.1% respectively.

We assume that every sector would produce 10% less even though there are sure to be differences in the subsectors. The sectors expected to be hard-hit are Tourism and Hospitality, Aviation and Logistics, Oil and Gas, and Agricultural exports, particularly palm oil. In 2018, Tourism brought in a revenue of 83.44 billion ringgit and Aviation 24.3 billion ringgit, but now these two industries are completely grounded by the pandemic. However, delivery services and online businesses have started to pick up.

The sectors that contribute to the above costs include:

1. Healthcare management is foremost to the government in handling this crisis. These include:

  • The healthcare capacity threshold needs to be enhanced. Critical items needed include hospital beds, ICU beds, ventilators, test kits, medicines, PPE (personal protective equipment), sanitiz ing retired doctors and nurses.
  • Quarantining those arriving into the country and those just recovered from the disease.
  • Additional immigration resources for screening, sanitizers etc.
  • Deploying police and army to enforce MCO.

1. Tourism and hospitality industry has been severely hit and brought almost to zero. The effects may continue for many months even after the MCO is lifted.

3. Aviation Industry is another that has been practically grounded.

4. Other transportation and logistics services have also been hit severely. However due to the MCO, food delivery business like Grab Food has seen substantial rise. The e-hailing service drivers are included in the Prihatin stimulus package given by the government.

5. Restaurants. The ban on social gatherings and movement restrictions have severely hit restaurants. Only takeaways are allowed.

6. Many SMEs and micro businesses have faced severe loss of business. Without government intervention, many of these businesses will go bust, bankrupt, foreclosed and so on. Some may never recover or resume business after the crisis is over.

7. Unemployment and underemployment have been rising. Many people have been forced to take unpaid leave and would remain unemployed even after the crisis is over.

8. Plantation and farms have also been operating under capacity. Many workers have been laidoff. There is a possibility the country would face food scarcity in certain items, particularly imported food. The price of food item might rise, but the lower demand due to restricted movement should check that a bit. Accordingly, due to low global demand, palm oil exports have fallen significantly.

9. Stock market collapses. The stock market being a major indicator of future economy has collapsed since businesses fare poorly.

10. Banking and Finance. Many banks, including Islamic banking, would be severely affected due to the expected loan defaults by SMEs and individuals. Therefore, bank failures are likely to happen, followed by bank mergers. However, banks will gain back from confiscation of collaterals and foreclosures.

11. Sales of durables have fallen. People tend to postpone purchase of vehicles like cars, electrical items etc.

12. Supply chains disrupted. Domestic and international supply chains are being disrupted and altered tremendously.

13. Oil and gas. This industry has been severely hit since much lowered economic activity worldwide from the lockdowns requires much less energy.

Effects on Islamic banking and finance

The COVID-19 crisis is expected to affect the banking sector severely, both Islamic and conventional. But this would only be a “paper” loss. As mentioned earlier, banking will gain back by confiscating collaterals and from foreclosures. The dynamics of bank “failure” will be as follows:

  1. Due to the shifts in aggregate demand and aggregate supply, liquidity in the country would shrink first. This would bring about loan defaults by businesses and individuals, causing further liquidity and credit crunch. Banks with NPLs will cut lending. The economy shrinks further by a multiplier effect.
  2. Bankruptcies and foreclosures would rise.
  3. Banking failures and mergers are likely to ensue.

The above scenarios are expected to happen to both conventional and Islamic banking and finance, since both are operating under a similar environment, regulated by Bank Negara Malaysia. However, being risk-free institutions (note that interest rate is indeed the risk-free rate) banks do not really lose even in recessions. In fact they gain.

Nonetheless the effects on the banking sector are of grave importance to the economy because the liquidity destroyed must be replenished. Hence government intervention is needed to solve the banking “crisis” too.

As expected, stock markets throughout the world plummeted due to the COVID-19 pandemic. For the first quarter of the year 2020 the KLCI index fell a whopping 15% while the Emas Index dropped 18.4%. Accordingly, the Shariah indices also plummeted, but less than their conventional counterparts. The Emas Shari’ah Index fell 3% lower, i.e. 15.4%. Clearly the markets are at their five-year low due to the pandemic.

As for the growth of Islamic banking and finance per se, one credit rating agency, Fitch Ratings, nevertheless, expects Islamic financing to still grow faster than its conventional counterpart but likely to fall short of Bank Negara Malaysia’s 40% market share target of total banking assets for 2020.

Government economic stimulus

In order to rejuvenate the economy it is essential for government intervention. The government must inject back into the economy lost liquidity so that there is enough liquidity for corporations, SMEs, small businesses and individuals to transact comfortably in the economy.

The Malaysian government was quick to come up with its Prihatin stimulus package to the size of 250 billion ringgit. However, the direct fiscal injection is only 22 billion ringgit.

From May 4, 2020 the MCO was gradually lifted allowing people to go to work. This is great news because we need to produce goods and services for life to continue. Malaysia responded with a Movement Control Order effective from March 18, 2020 in order to contain the spread of the COVID-19 pandemic. We started to test people entering the country, contact tracing people who were confirmed to have the disease, testing, quarantining, and monitoring treatments and those in ICU.

In the meantime people were basically confined indoors at home while social distancing and masks were required for those outdoors.

We are particularly thankful to our government authorities for correctly doing what had to be done and after realizing the true nature of the disease have decided to open the economy. This is very important and urgent in order to avert numerous socioeconomic and health problems that would otherwise ensue.

However, in our opinion the direct fiscal injection of 22 billion ringgit is not enough. Since about 10% of the GDP is expected to be “destroyed”, the government should inject as much as that amount, i.e. about 150 billion ringgit (about 10% of GDP).

A natural question that arises is how to finance the stimulus package. Our suggestion is that the government should never borrow the needed funds at interest, domestic or worse internationally, particularly from IMF, World Bank, JP Morgan etc. If funds are borrowed, it will have to be serviced later, i.e. paid back principal plus interest. The rakyat (people) will have to pay for this through higher taxes, GST etc. Therefore, in our opinion, in present circumstances countries should use Quantitative Easing (QE), i.e. printing new money (physically or electronically). Both borrowing and QE would create inflation but under QE it need not be paid back. However, the inflation created might not be big since the new money also compensates for the lost liquidity. The government should also consider crowdfunding to source funds from the wealthy in the country. Since this is a common crisis, countries should also consider counter-trades to boost trade and mitigate liquidity shortage, without having to borrow.

Opportune time for Islamic finance

The COVID-19 crisis provides an opportune time for Islamic finance to shift from credit-based financing to an equity-based one, i.e. a tectonic shift chance to move into true Islamic finance, basically a move from risk-free financing to risk-sharing modes. Fintech applications like digital money and crowdfunding would accelerate this. Hence real money payment systems, cryptocurrencies, mutual credit netting, Islamic micro-finance, waqf including family-waqf, sadaqah, agent-banking and cooperatives will become popular and grow in size. In particular non-bank Islamic finance like peer-topeer financing will rise tremendously post COVID-19.

Other opportunities post-COVID-19

The following are other areas that provide great opportunities post-COVID-19. Islamic finance should take advantage of these.

  1. Health Products. Countries will be encouraged to domestically produce health-related products so as to become as self-sufficient as possible. At least things like masks (homemade and reusable), hospital beds, ventilators, PPE (personal protective equipment), skin  protection, eye protection, gloves, sanitizers, herbs, traditional medicines etc. can be produced locally. Traditional medicines and practices will rise in popularity. Neem, black seed and honey have been said to help COVID-19 patients recover. Hydroxycloroquine which is said to be a cure, is derived from the barks of the Cinchona tree that grows very well in the hot tropical Malaysian climate. It should be noted that these traditional medicines have not been clinically proven to help the current COVID-19 patients. However, it has been a common belief for generations that these traditional medicines can improve health. Hence traditional medicines could be scientifically studied vis-.-vis modern medicine.
  2. Agriculture will be given its due importance, i.e. to target food security and self-sufficiency. Hence modern, automated farming, like vertical farming will rise. The production of herbs, traditional medicines and supplements too will provide abundant opportunities.

  3. Technology. Digital learning, e-businesses, e-meetings and conferences (like using Zoom), home schooling, e-education, selling online, home-based e-businesses, blockchain-based management for increased security, transparency, supply chain tracking, digital marketing etc. will all rise. So will applications of AI, robotics and 5G.

  4. Halal Industry. Halal industry is also poised to rise in tandem. Post-COVID-19 people are bound to become more health conscious, eat more healthy and wholesome food. The halal food industry is precisely about that and hence can be expetced to rise in popularity. Exotic animals that carry coronaviruses are not promoted by the halal industry. Also, post-COVID-19 economic crisis, Muslims are likely to engage more in non-bank Islamic financial activities to solve their common problems. Muslim retail outlets, like ASEAN Mall (Thailand) and Malakat Mall, will rise in number and popularity. In order to minimize the effects of the interest-based fiat money system, the rakyat (people) is likely to take the opportunity to free and enhance themselves through “People-Help-People” concepts using waqf, crowdfunding, peer-to-peer lending etc.

The full e-book, "Impacts of the COVID-19 outbreak on Islamic finance in the OIC countries" is available as a pdf download from HERE. The e-book is published by Indonesia's Islamic Finance and Economy Committee (KNEKS) in partnership with DinarStandard and Salaam Gateway. It was launched on May 27, 2020. The 12 countries covered are: Bahrain, Bangladesh, Brunei, Indonesia, Iran, Malaysia, Nigeria, Oman, Pakistan, Saudi Arabia, Turkey, and UAE. 


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Ahamed Kameel Mydin Meera; Yosita Nur Wirdayanti