FIRST-quarter statistics and the latest high-frequency data confirm that Malaysia’s economic growth momentum will continue in the second half of this year (2H10), albeit at a slower pace.
We maintain our growth forecast for private consumption at 3.8% in 2010, as spending is anticipated to recover from last year’s level but remain below its long-term average following increases in the prices of selected consumer goods.
On the other hand, private investment is anticipated to remain muted and contract for the second year due to persistent risk aversion in the global economy.
This is not surprising as past experience indicates that private investment remained in negative territory in the year following the recession and a slowdown in 1998 and 2001 respectively.
While exports are anticipated to moderate in 2H10, judging by the recent softness in demand for electrical and electronic (E&E) products, they are likely to register a commendable 19.2% growth after slumping by 10.4% in 2009. For the whole of 2010, we envisage nominal exports to expand by 18%, down from 30.7% in 1Q10.
Against such a backdrop, we now anticipate the overall economy to expand by 6.8% in 2010 and 5% in 2011 after contracting by 1.7% last year.
The recovery story — impressive but still lagging previous cycle
We are encouraged by 1Q10’s GDP expanding 10.1% year-on-year (y-o-y), the strongest since 1Q2000. Notwithstanding this, the rebound in industrial production in the past several months still lags the speed of the recovery in 1999.
After more than two years since its downturn, the industrial production index (IPI) has not regained its peak recorded in January 2008. In contrast, during the 1999 recovery phase, the IPI surpassed its previous peak about 23 months after the downtrend started.
This phenomenon could be partly explained by the fact that the contraction in the IPI in 1997/98 was sharper than the one we experienced in 2009.
We think that a milder rebound in the IPI during the current phase of recovery suggests that manufacturers are still cautious about their production levels and are trying not to overproduce against a backdrop of shaky European economies. This slower expansion in global trade may imply a weaker-than-expected expansion in 2H2010.
Back to the global economic equation
We opine that external demand will remain the primary catalyst for the Malaysian economy in the next few years, given its degree of openness to world trade.
This is not to say that Malaysia’s domestic demand is not a force to be reckoned with, but domestic and external economies are linked.
Another interesting feature about the ongoing recovery in Malaysia is that trade activities – defined as the amount of cargo loaded and discharged at ports — have rebounded at a stronger pace than industrial production, contrary to what happened during the recovery phase in 1999.
Such a phenomenon may suggest that exporters, while responding to higher external demand, remain cautious about their production levels.
More rollercoaster rides in financial market
The relationship between Malaysia’s equity market performance and the real economy is significant enough that the former leads the latter by about four months. Thus, the impact of the equity market on the real economy should not be underestimated.
A significant decline in the equity market will affect businesses and more importantly, the banking sector, which in turn will influence their lending activities. This eventually will trickle down to companies (through reduction in credit lines) and individuals, which then affects business activities and consumer spending.
While we do not anticipate a hard landing for the global equity market, we are less sanguine about the prospects of the Malaysian equity market in the immediate term, as the FBM KLCI is still trading at one-standard deviation above its long-term regression line.
Even fundamental valuation based on the price-earnings ratio (PER) does not look too appealing when compared with its historical average since 2001.
The US equity market, which is positively correlated with the FBM KLCI, is also not doing too well. The Dow, S&P and Nasdaq all have been trading below their 200-day moving averages since May 2010, a level which is considered undesirable by many technical traders.
There appears to be no indication that the recent run-up in the FBM KLCI until April has led to any anomalies that preceded major stock-market corrections in the past.
Such anomalies can be seen through exceptional gains recorded in both equity and bond markets.
The implications of such a backdrop are that growth in private consumption, while positive, will not be exceptional this year (hence we stick to our previous estimate of a 3.8% expansion in 2010); and second, businesses will continue to be cautious as banks remain vigilant about lending to the corporate sector.
The ringgit — not a one-way bet
Although general belief holds that the ringgit will test the strongest resistance level of RM3 against the US dollar in the long term, we see a bumpy road ahead.
For one thing, the rollercoaster ride of risk appetite among international investors will likely lead to rising volatility of the ringgit, while the widening deficits in Malaysia’s financial and capital account (FCA) of the balance of payments (BoP) suggest that capital outflows have risen in recent months.
In 1Q10, although the current account (CA) of the BoP increased to RM30.4 billion (4Q09: RM27.4 billion), the BoP registered a deficit of RM19.6 billion due to a RM19.5 billion deficit in the FCA. Should for some reason this trend persist, the ringgit will likely weaken against the US dollar in the near term.
Third, although China had once again abandoned its currency peg against the US dollar on June 19, such a move will not necessarily lead to a strong appreciation of the yuan as the Chinese authorities will likely control the yuan within a tight band so not to destabilise the real sector.
We maintain our forecast that the ringgit will average between RM3.20 and RM3.30 against the US dollar in 2010.
Moderate growth in consumer price index (CPI), but rising cost of living
According to news reports, farmers claimed that prices of vegetables have doubled since April due to difficulties in getting workers, while prices of chicken, steel round bars and cement are expected to trend upwards following the abolition of retail licences on July 15 to allow market forces to determine their prices.
Additionally, the government’s push for lower subsidies will likely cause a general rise in consumer prices. With about 60% of households reportedly earning a monthly salary of RM3,000 or less, price increases may dent private consumption in the near term.
This is to be expected despite the government’s assertion that the dismantling of the subsidies will be done gradually. On that score, we maintain our call that the CPI will rise moderately at a 2.4% pace after growing 0.6% in 2009.
Budget deficit – no big deal
Although Malaysia’s fiscal balance has come under close scrutiny in the past year following a surge in its ratio to GDP to 7% in 2009, its future trend does not suggest any critical threat to the country’s macro condition.
The important fact remains that the deficits are easily financed by domestic resources which do not lead to hyperinflation or a big jump in government debt. Additionally, although the federal government debt level is anticipated to remain above 50% of GDP this year, its external debt portion remains at a minuscule 4% of total debt.
Using the fiscal-current account matrix, it becomes evident that Malaysia’s position is not the most untenable when compared with other Asian countries, as its current account ratio to GDP has remained favourable since the 1997/98 Asian financial crisis. In fact, history shows that Malaysia’s fiscal and current account matrix has actually improved over the decades.
With the government continuing to promote private-sector participation in the implementation of projects through public-private partnerships as well as through open tenders, we are optimistic that its target of shrinking the fiscal deficit to 5.3% of GDP is attainable in 2010.
Similarly, for the debt level, we are positive that the government’s target of bringing down its percentage of GDP to 49.9% by the end of the 10th Malaysia Plan (10MP) can be surpassed, based on past policy trends.
Interest rates — measured pace in normalisation
We believe that there is a high probability that Bank Negara Malaysia (BNM) will raise the overnight policy rate (OPR) by another 25 basis points (bps), bringing the policy rate to 2.75% in 2H10 as officials have consistently said that low interest rates might lead to financial imbalances that could threaten the overall economy.
Additionally, higher rates will ensure depositors a positive real rate of return to offset rising living costs. Thus, an interest-rate normalisation process is warranted.
By this, another 25bps hike should not compromise the BNM’s objective of supporting the growth of the economy while keeping tabs on developments that may trigger financial imbalances.
This is particularly true when the so-called neutral rate is still higher than the present OPR level. Our estimate indicates that the neutral rate is somewhere between 3.25% and 3.5% at this juncture.
Written by A report by MARC
This article appeared in The Edge Financial Daily, July 5, 2010.
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