CHAPTER ONE

INTRODUCTION

1.1 Introduction

Gross domestic product (GDP) is the common indicator of economy performance in a country. GDP is the market value of all final goods and services produced within a country in a given period of time (Mankiw, Goh, Ong, Yen, Cheng, Mustafa, and Lee, 2013). GDP can be measured in three ways which are expenditure basis, income basis, and output basis. For expenditure basis, it calculates how much money was spent in a country. For income basis, it calculates how many income (profit) was earned. For output basis, it calculates how many goods and services were sold.

Forecasting in general is the process of estimating the future value of a variable. Forecasting is an extremely complex activity that could influence the setting up of an organization. Forecasts of macroeconomic variables are also crucial to many agents of the economy and that include Central Bank, commercial banks, investors, speculators, government, policy maker and individual which includes household. For individuals, economic forecast helps them connect to the economic affairs as they will get brief and fair ideas on how the things are going to be in the future. As the business environment is constantly changing, forecast could help company to foresee the future which is important in enabling the management to change operation at the right time in order to reap greatest benefit. Forecasting also plays an important role especially for Government strategic planning and when it is required to do certain long term projects and evaluation of the economy.

This study attempts to forecast the GDP of Sarawak which is one of the states in Malaysia. Forecasting is a process of predicting or estimating the future based on past and present data. The objectives in this study are to forecast the Sarawak GDP, to examine the determinants of Sarawak GDP to estimate the forecasting accuracy of the forecast models. The factors considered include export in which according to the theory of Economic-Led-Growth (ELG) hypothesis, inflation rate (consumer price index) in which according to the theory of Fisher effect, import and state government expenditure in which are important components of GDP. Forecasting could help anchor the expectation of the firms and households which could help financial institution to become more effective in fulfilling the demand of the individual and businesses. Forecasting also plays an important role especially for Government strategic planning and when it is required to do certain long term projects and evaluation of economy.

In order to produce forecasting results with high accuracy, Autoregressive Integrated Moving Average (ARIMA) time series models, fundamental models and random walk model are estimated. Based on the previous study, fundamental models performed the best from ARIMA time series model and random walk model whereas random walk model performed the worst among the three models. Apart from that, previous study shows that export, population growth, inflation rate, investment, consumption, exchange rate, interest rate, and government expenditure are crucial determinants of economy in many countries.

Chapter 1 is differentiated six sections. Section 1.1 gives a brief overview on the background of study. Section 1.2 states the motivation of the study. This is followed by section 1.3 in which discusses the problem statement. Section 1.4 mentions the objectives of this study. After that, section 1.5 discusses the significant of study. Finally, section 1.6 provides the organization of the study.

1.1 Background of Study

1.1.1 History of Sarawak

The history of modern Sarawak is closely related to the adventures of an Englishman, James Brooke.

In 1839, when Sarawak was rebelling against the Brunei Sultanate, an English adventurer named James Brooke arrived and volunteered to quell the revolt (State Planning Unit, 2014). Brooke was successful, and as a reward the Pengiran Mahkota of Brunei made Brooke the Rajah of Sarawak in 1841 (State Planning Unit, 2014).

According to Sarawak Government (2014), James Brooke died in 1868 and he was succeeded by his nephew, Charles Brook in 1867. Charles Brooke ruled Sarawak from 1868 until 1917 and he passed to his second son, Charles Vyner Brooke who ruled Sarawak from 1917 until 1941 (Sarawak Government, 2014).

In 1941, Sarawak was occupied by Japanese forces but it was subsequently ceded to Britain after the war and became a British Crown Colony in early 1946 (Sarawak Government, 2014). Sarawak joined Malaysia in 1963 and today observes a democratic system of government.

1.1.2 Geography

Sarawak is the largest state in Malaysia. Sarawak Government (2014) mentioned that Sarawak is located immediately north of the Equator between latitude 0° 50’ and 5°N and longitude 109° 36′ and 115° 40′ E, it stretches some 800 km along the northwest coast of Borneo, covering an area of 124,449.51 . South China Sea separated Sarawak from Peninsular Malaysia with a distance of 600 km and directly joins the state of Sabah to the northeast where the Sultanate of Brunei also forms a double enclave (State Planning Unit, 2014). Inland, the boundary between the State and Kalimantan Borneo is formed by the watershed dividing those rivers flowing in a southerly direction into the Java and Celebes Seas (State Planning Unit, 2014). The detail is shown in the map below:

Figure 1: Map of Malaysia

Source: Central intelligence Agency (CIA), 2014.

1.1.3 Economy Background of Sarawak

Natural resource is the key driving force of Sarawak economy. Her wealth was being built up from exportation of natural resource mostly in the form of timber, oil, and gas since independence in 1963. In 2011, 50 % of state output came from the industries that involved in the extraction and processing of these commodities. Emerging business of Sarawak is exportation of crude palm oil. Competitive advantage of Sarawak in this economically-significant segment of the primary sector is guaranteed through the commitment of both private and public resources. Production of crude palm oil in 2011 exceeded well over 2 million tonnes and it was exported primarily to China and India. Premium grade peppers and rubber are other important products of Sarawak. Sarawak GDP is contributed approximately 40 % by services sector. In terms of monetary contributions, trades and hospitality is as crucial as finance/insurance, and utilities/ transport/storage/.communication.

(adapted from State Planning Unit, 2014)

The trend of Gross Domestic Product (GDP) in Sarawak from 1980 until 2012 is shown in Figure below:

Figure 2: Trend of Gross Domestic Product (GDP) from 1980 until 2012.

Source: Yearbook of Statistics Sarawak (1981 – 2012).

In overall, the Gross Domestic Product (GDP) of Sarawak grew from RM 5317 million in 1980 until RM 102887 million in 2012. During 1980s, it rose from RM 5317 million in 1980 until RM 11377 million in 1989. From 1980 to 1984, it increased slowly from RM 5317 million to RM 8897 million. However, GDP in Sarawak slumped in 1985 because of international economic recession that happened during early of 1980s. Due to international economic recession, goods and services were difficult to sell out because the purchasing power of peoples declined. When the demand of goods and services declined, the production of goods and services declined also. As a result, the GDP of Sarawak in 1985 increased in a decreasing rate with 5.3 %. The GDP growth rate in 1985 is slower when compared to the growth rate of 14.3 % in 1984. The international economic recession continued to impact the Sarawak GDP from 1987 until 1988. In 1988, GDP of Sarawak declined from RM 10388 million in 1987 to RM 10271 million with a decreasing rate.

In 1990s, GDP of Sarawak rose from RM 12314 million in 1990 to RM 25475 million in 1999. GDP declined slowly from RM 13951 million in 1991 until RM 13203 million in 1993 with a decreasing rate of 5.4 %. After 1993, the GDP of Sarawak grew rapidly until RM 22097 million in 1997 with a growth rate of 67.4 %. However, a slower growth rate of 1.93 % had been recorded in 1998. Uddin and Ahsan (2014) mentioned that Asian Financial Crisis that originated from the devaluation of Thai baht in 1997 had caused the depreciation of Malaysian currency which rendered a heavy outflow of foreign capital.

After a slight decrease in GDP because of Asian Financial Crisis, the policy makers managed to bring Malaysia out of the financial crisis and GDP grew rapidly until RM 32006 million in 2000 but it started to drop again to RM 30140 million in 2001. The decrease in GDP from 2000 to 2001 is as a result of the global economic downturn. An economic downturn suggests the rate of economic growth is slowing down and possibly entering into recession. A downturn is part of the economic cycle. After that, GDP of Sarawak climbed up speedily until RM 89387 million in 2008 and it began to drop sharply until RM 76663 million in 2009 because of the global financial crisis that happened in 2008. According to McKibbin and Stoeckel(2009), the collapse of Lehman Brothers in September 2008 induced a wave of fear around world financial market which in turn causes the banks virtually stopped lending to each other. McKibbin and Stoeckel (2009) also mentioned that difficulty in borrowing had caused the falling in investment. Nonetheless, the policy makers still managed to recover the economy after 2009. Thus, GDP in Sarawak increased from RM 76663 million in 2009 until RM 102887 million in 2012.

1.2 Motivation of Study

The motivation of forecasting the Sarawak GDP is rendered by the high potential of economy growth in this state. The high potential economy growth of Sarawak is mainly due to the abundant resources in Sarawak and its strategic location.

Barbier (2003) stated that environmental resources should be viewed as important economic assets, which can be called natural capital. Sarawak consist a lot of natural resources which have a very high contribution towards the Sarawak GDP. According to State Planning Unit (2014), since independence in 1963, Sarawak has built up her wealth on the exportation of natural resources, largely in the form of timber. Sarawak Government (2014) also stated that Sarawak is rich in both metallic and non-metallic mineral resources which offer huge potential for value-added processing. Vast reserves of natural resources promise great opportunities in the field of biotechnology, and forest resources may yet prove to be a major source of discovery (Sarawak Government, 2014).

Apart from that, Sarawak Government (2014) also mentioned that Sarawak is suitable for development due to its large tracts of land. It is easily accessible from the major cities of the world, Sarawak can be reached within three hours by air from Hong Kong, six hours from Japan, four hours from Australia and two hours from Indonesia and about an hour from Singapore and Brunei (Sarawak Government, 2014). The State is emerging as a very profitable investment hub offering cost-competitive advantages with good transportation linkages because it is located at the heart of the Asia-Pacific (Sarawak Government, 2014).

1.3 Problem Statement

In overall, GDP of Sarawak has a fluctuating trend from 1980 until 2000. In the year of 1988, 1992, and 1993, it showed a drop although there is no any serious economic and financial crisis happened. Besides, the GDP growth rate of Sarawak is fluctuating also. The fluctuating trend of Sarawak GDP created an issue to policy maker that renders the prediction of Sarawak GDP difficult.

The future of Sarawak is uncertain because the fluctuation of GDP growth rate in Sarawak is frustrated. For example, the GDP growth rate of Sarawak increased from -5.8 % in 2001 to 34.3 % in 2002. Other than that, a small but sudden decrease of GDP in 1988, 1992, and 1993 also create a risk in the future that the GDP of Sarawak might drop suddenly.

GDP can be influenced by many factors. It cannot be simply predicted without doing a research. Therefore, this study in the end attempts to solve:

1. What are the driving forces that determine the Sarawak?
2. What is the future trend of Sarawak GDP?

1.4 Objective of Study

1.4.1 General Objective

The aim of this study is to forecast the Gross Domestic Product (GDP) of Sarawak.

1.4.2 Specific Objective

The specific objectives of the study are:

1. To examine the determinants of GDP in Sarawak.
2. To forecast the future trend of Sarawak GDP.
3. To estimate the forecasting accuracy of the forecast models.

1.5 Significance of Study

Forecasting the Sarawak GDP could predict the future values of GDP and these predicted future values can estimate the future economic condition of Sarawak.

Economic forecasting of Sarawak is very crucial to federal and state governments in policy implication. By knowing the future values of Sarawak GDP, federal government will know how much revenue will likely to be earned by state government and thus federal government can allocate fund to state government with a sufficient and suitable amount. Besides that, economic forecasting could help state government in framing budget. This is because the state government can know how much revenue is likely to earn after forecasting the GDP and thus the allocation of public resources could be conducted properly.

Other than that, the predicted future GDP can also alert federal and state government if there is going to be slump in the Sarawak GDP. Then, governments can make well-informed decision or take precaution in order to reduce the negative effect of economic downturn in the future.

Forecasting the Sarawak GDP is particularly important for businesses with long production cycles. The longer it takes to source raw materials, prepare them for production, manufacture the products, market and sell them, the more the overall economy can change. These enterprises will be impacted significantly if economic downturn happens. Economic forecasting helps to protect businesses against loss by anticipating how to respond to economic downturn in advance.

1.6 Structure of the study

This paper is organized into five chapters in which Chapter One will briefly discuss on the background of Sarawak, problem statement, motivation of study, objectives of study, and also significance. Then, Chapter two contains literature review of the theoretical studies of forecasting GDP and determinants of GDP and also review on previous empirical studies. Chapter three will describe on the research methodology used in the study. Later, Chapter four explains and reports the result of the empirical analysis. Lastly, Chapter Five concludes the study conducted along with some policy recommendation.