Economic Outlook : A New Economic Model As Recovery Gains Pace - 11/03/2010

8/14/2019 Economic Outlook : A New Economic Model As Recovery Gains Pace - 11/03/2010

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11 March 2010

Economic Outlook

A New Economic Model As Recovery Gains Pace

The Malaysian economy emerged from a recession in the 4Q of last year, underpinned by

a recovery in exports and the Governments stimulus spending. We expect the export

recovery to be sustained in 2010 despite various challenges that threaten to derail it.

Similarly, we expect domestic demand to gain momentum, and consumer and business

spending will likely take up the slack left by the government stimulus spending when it fizzles

out in 2H 2010. As a whole, we expect the Malaysian economy to bounce back and expand

by 4.5% in 2010, from -1.7% in 2009.

As the Malaysian economic recovery gains pace, the Government is set to unveil its neweconomic model (NEM) by end-March. The NEM could contain key initiatives to move the

country towards a high-income economy through innovation, knowledge and R&D as well as

improve efficiency and productivity. It will also entail further liberalisation and a gradual

phasing out of subsidies to bring about a more competitive economy.

Meanwhile, the prospects of a sustainable global economic recovery have improved

significantly in recent months, in our view. As a result, policymakers around the globe have

begun to exit their extremely loose policies. However, these are normalisation measures and

will unlikely have a significant impact on global economic recovery. As a whole, a recovery

in external demand will likely lift Malaysias exports in 2010.

Domestic demand is projected to bounce back in 2010, in line with an improvement in

consumer and business confidence. However, public spending will likely fall during the year

in tandem with a fiscal consolidation. Consequently, the fiscal deficit will likely narrow to

5.6% of GDP, as planned, from a deficit of 7.0% estimated for 2009.

The current account in the balance of payments will record a smaller surplus in 2010 but will

remain large to fuel domestic liquidity and provide an underlying support to the ringgit. We

expect the ringgit to fluctuate at between RM3.30 and RM3.40 against the US dollar in the

1H of the year, before settling at around RM3.30/US$ by end-2010.

Inflation will likely trend up but remain manageable at 2.0% in 2010, from +0.6% in 2009.

The Central Bank, however, will continue to normalise monetary conditions and the overnight

policy rate (OPR) will likely be raised by another 25 basis points in July and stay at 2.5%

until the end of the year.

Executive Summary

Peck Boon Soon

(603) 9280 2163

[email protected]

Please read important disclosures at the end of this report.

Malaysia

PP7

767/09/2010(025354)

MARKETDA

TELINE

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ECONOMIC OUTLOOK2


A New Economic Model As Recovery Gains Pace

The Malaysian economy emerged from a recession in the 4Q of last year,

underpinned by the Governments stimulus spending and a recovery in exports.

We expect the export recovery to be sustained in 2010 despite various

challenges that threaten to derail it. Similarly, we expect domestic demand to

gain momentum, underpinned by a pick-up in consumer spending, on the backof an improvement in the job market, while businesses will likely resume their

investment during the year. As a whole, we expect the Malaysian economy to

expand by 4.5% in 2010, from -1.7% in 2009. Meanwhile, as the Malaysian

economic recovery gains pace, the Government is set to unveil its new economic

model (NEM), which would chart the direction for the countrys development

towards 2020, by end-March. The current account surplus in the balance of

payments will likely narrow, as the recovery of the economy will suck in more

imports. The surplus, however, will remain large and provide an underlying

support to the ringgit, which is projected to strengthen to around RM3.30/US$

by end-2010. Inflation will likely trend up but remain manageable at 2.0% in

2010. The Central Bank will likely raise the OPR by another 25 basis points to

2.5% in July.

Economic Recovery Strengthening

Like many other countries in this region and the developed economies, the Malaysian

economy emerged from a recession in the 4Q of last year, underpinned by a

recovery in exports and the Governments stimulus spending. We expect the export

recovery to be sustainable in 2010 despite various challenges that threaten to derail

it, including budget deficit and debt woes in some countries in the Euroland (see

Charts 1 & 2), concerns over a double dip in the global economic recovery as

government spending fizzles out and policy tightening on the back of asset price

inflation in Asia and emerging economies. Similarly, we expect domestic demand to

gain momentum, and consumer and business spending to gradually take up the slack

left by the fiscal stimulus spending when it fizzles out in 2H 2010. This will likely

be underpinned by a pick-up in consumer spending, which is improving steadily in

the last three consecutive quarters, on the back of an improvement in job market.

In the same vein, investors will likely resume their investment given brightening

economic prospects. As a whole, we expect the Malaysian economy to expand

by 4.5% in 2010, from -1.7% in 2009.

Chart 1High Defic it Levels In Some European

Economies

Greece

Source: European Commission

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

2005 2006 2007 2008 2009 2010f 2011f

% GDP

Spain

Portugal

Ireland

Chart 2High Debt Levels In Some European

Economies

% GDP

0

20

40

60

80

100

120

140

160

2005 2006 2007 2008 2009 2010f 2011f

Portugal

Ireland

Spain

Greece

Source: European Commission

We expect the economy

to expand by 4.5% in

2010, compared with a

recession in 2009, on the

back o f a p i c k -up i n

exports and strengthening

domestic demand


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ECONOMIC OUTLOOK3A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com

A New Economic Model To Lead The Country Forward

As the Malaysian economic recovery gains pace, the Government is set to unveil

its new economic model (NEM), which would chart the direction for the countrys

development towards 2020, by end-March. The NEM could contain eight key

initiatives for the country to achieve a high-income economy by the year 2020,

according to a recent news report citing certain sources. Among the proposed action

plans that are likely to be included in the NEM are strategies to create a morecompetitive and high-income economy, the phasing out of subsidies, the continued

gradual removal of affirmative action policies and restrict the employment of foreign

workers. Also, the NEM will include measures to promote green industry.

We understand that the NEM will likely be based on innovation, knowledge and

R& D to improve Malaysias productivity and efficiency to bring about a more

competitive economy. At the same time, the country will exploit new sources of

growth in high value-added industries and services through further

liberalisation to help the nation achieve a balanced and sustainable growth over

the longer term. The sectors that the Government will likely place more emphasis

on are the healthcare, leisure & tourism, creative industry & ICT, biotech & life

sciences, new agriculture & herbal and renewable energy industries (see our reportdated 28 January on New economic model What To Look For?). Similarly,

emphasis on branding to promote Malaysias products and services could be featured

in the NEM. On its part, the Government will embark on a new set of privatisation

initiatives called the Public-Private Partnership (PPP) in helping the Government to

implement its development projects. Under the PPP, the public sector will be the

main purchaser of output and funding will be provided by the private sector. The

Governments involvement is through enforcement of key performance index (KPI)

to ensure that high quality of output or services are delivered by the private sector.

The move could help the Government to contain its budget deficit and spread the

spending over the concession period as well as promote private investment.

Whilst the NEM will chart new direction for the economy, we believe the impact willonly be felt more significantly over the medium term given the challenges

that the country is facing. The country is suffering from brain drain and the shortage

of skilled manpower for it to move up the value chain and to be transform into a

services based economy. Meanwhile, Malaysian companies are venturing abroad in

search for growth and business opportunities, while the country is facing keen

competition in attracting foreign direct investment (FDI). As a result, the country

suffered a net outflow of direct investment in the last three consecutive years.

Indeed, we believe the successful implementation of the NEM still l ies with the

execution of key policy initiatives and the political will to force through

changes. Whilst the launching of a Government Transformation Programme on 28

January to improve the Governments delivery system is a good start, much remainsto be done to bring about a more competitive high-income economy.

Normalisation Of Extremely Loose Monetary Conditions Has Begun

In Some Countries

Meanwhile, the prospects of a sustainable global economic recovery have

improved significantly in recent months , in our view, despite various

challenges that threaten to derail it. This is primarily on account of a combination

of factors, including aggressive policy stimulus around the globe where policymakers

are unlikely to roll it back prematurely, significant improvement in financial markets

and risk appetite of investors and more importantly, asset prices have reached a

favourable inflection point. Unlike during the crisis, investors are no longer fearful

of catching a falling knife and more substantial weakness in asset prices will be taken

as investment opportunities. As a result, policymakers around the globe have

The NEM cou ld conta in

eight key initiatives aimed

at assisting the country to

ach i eve a more

compet i t i ve and h igh

income economy by the

year 2020

The NEM wi l l l i ke ly be

based on i nnova t i on ,

knowledge and R&D as

we l l as to exp lo i t new

sources of growth in high

va l ue -added i ndus t r i e s

and services

Prospects of a sustainable

global economic recovery

have imp roved

s i gn i f i c an t l y i n re cen t

months and t he

normalisat ion of pol ic ies

has begun i n some

countries

The Gove rnment w i l l

embark on a new set of

privatisation initiatives to

imp lement i t s

development projects

The impact of the NEM,

however, will only be felt

more s ign i f i cant l y over

the medium term given

the chal lenges that the

country is facing

The success of the NEM

still lies with the execution

and the pol it ical wi l l to

force through changes


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ECONOMIC OUTLOOK4


begun to exit their extremely loose policy and emergency lending

programmes, but the process remains gradual in our view, suggesting that its

impact on economic activities will unlikely be significant.

In the US, the normalisation of monetary conditions has already started when the

US Federal Reserve stopped buying the US$300bn US Treasury bills in October 2009

and raised its discount rate by 25 basis points to 0.75% with effect from 19 February.

In Euroland, the European Central Bank (ECB) outlined part of its exit strategy inDecember 2009 and it further phased out some emergency tools in early March. In

a number of countries in Asia, such as China, India, Taiwan, Hong Kong, South Korea

and Singapore, policymakers in these countries have taken measures to tighten

credit conditions to prevent asset bubbles from building up. In Malaysia, Bank

Negara Malaysia has begun normalising the countrys monetary conditions by raising

its key policy rate by 25 basis points to 2.25% on 4 March.

Global Economic Recovery Picks Up Momentum

Indeed, the global economic recovery is gaining momentum. As it stands,

global manufacturing activities picked up for the last seven consecutive months,

albeit at a more moderate pace in February, while services activities strengthenedduring the month (see Chart 3). Similarly, the OECD composite leading indicators

12-month rate of change strengthened to 9.6% in January, the fifth successive month

of increase and from +8.1% in December and +6.0% in November (see Chart 4).

The improvement was across the board, suggesting that prospects of OECD

countries economies are likely to improve in the months ahead.

In the US, the economy grew at a stronger pace in the 4Q, underpinned by inventory

rebuilding and an increase in business spending. Indeed, manufacturing activities

continued to expand in February, albeit at a more moderate pace, while services

activities picked up during the month. The improvement is gradually trickling

down to a better job market, as indicated by employment of temporary workers,

which picked up for the last five consecutive months up to February (see Chart 5).

As a result, non-farm payrolls recorded a significantly smaller drop of an average

of 31,000 jobs a month in January-February, compared with a loss of 557,000 a

month in 1H 2009, while the unemployment rate was stable at 9.7% in February, the

same level as in January, after hitting a peak of 10.0% in November-December. An

improvement in the job market helped to sustain consumer spending in the country.

As it stands, the personal consumption expenditure (PCE) strengthened to an

annualised rate of 2.1% in January, from +1.7% in December and after hitting a low

of +1.1% in November (see Chart 6). Although an improvement in the housing

sector has weakened somewhat, it will unlikely pose a major drag to the US

economic recovery. As a whole, the US economy will likely recover to around

+3.0% in 2010, from -2.4% in 2009.

Chart 4OECD Composite Leading

Indicator Points To Brighter EconomicProspects

% 12-mth annualised rate of change

-20

-15

-10

-5

0

5

10

15

20

25

30

00 01 02 03 04 05 06 07 08 09 10

Total OECD Japan US Euroarea China

Source: OECD

Chart 3Global Manufactur ing And

Activ it ies Picking Up

Index

Source: Markit Economics

ISMManufacturing

ISMServices

30

35

40

45

50

55

60

65

05 06 07 08 09 10

Bank Negara Malaysia has

begun no rma l i s i ng t he

coun t ry s mone ta ry

condit ions by raising itskey policy rate by 25 basis

po i n t s t o 2 .25% on 4

March

The g l oba l e conom i c

recove ry i s ga i n i ng

momentum

Improvement in the US

economy i s g radua l l y

trickling down to a better

job market and a

sus t a i ned i nc rease i n

consumer spending


5/14


Similarly, we expect the Euroland s economy to gradually recover, despite the

emergence of sovereign debt worries of late. As it stands, manufacturing activities

continued to expand and at a faster pace in February, although services activitiesmoderated somewhat during the month (see Chart 7). Similarly, business

confidence continued to improve, while consumer confidence held up at the highest

level in more than a year. Given its export dependency, the Japanese economic

recovery will likely be sustained into 2010 as well, in tandem with a recovery in

exports. Indeed, Japans exports surged by 40.9% yoy in January, after recording

a growth of 12.0% in December (see Chart 8), due partly to a lower base effect and

partly to a pick-up in global demand for the countrys exports.

In the same vein, Chinas economy will likely continue to expand in the months

ahead, after recording +10.7% yoy in the 4Q. As it stands, manufacturing activities

continued to expand for the last 12 consecutive months up to February, underpinned

by a recovery in exports, which strengthened to 45.7% yoy in February, from

+21.0% in January and +17.6% in December (see Chart 9). Although fixed-asset

investment in urban areas and money supply eased in January, growth remained

strong. Meanwhile, the Chinese authorities have stepped up their efforts to control

credit expansion, particularly to local governments, in a move to moderate the pace

of asset price inflation and reduce the potential risks of default.

Chart 5US: Job Market Gradually Improving

Source: US Bureau of Labor Statistics

(000) %

-1000

-800

-600

-400

-200

0

200

400

600

00 01 02 03 04 05 06 07 08 09 10

0

2

4

6

8

10

12

Employment in temporary help services (LHS)

Non-farm payrolls (LHS)

Unemployment rate (RHS)

Chart 6US: Consumer Spending

Head ing Up

%annualised

-4

-3

-2

-1

0

1

2

3

4

5

2005 2006 2007 2008 2009 2010

(Personal consumptionexpenditure)

Source: US Bureau of Economic Analysis

Chart 7Euro land: Manufactur ing And Serv ices

Activ it ies On Recovery Path

Source: Bloomberg

Index P M I

PMI Manufacturing

30

35

40

45

50

55

60

65

00 01 02 03 04 05 06 07 08 09 10

Chart 8Japan: A Strong Turnaround In Exports

% yoy

-60

-50

-40

-30

-20

-10

0

10

20

30

40

50

00 01 02 03 04 05 06 07 08 09 10

Source: Bloomberg

The Eurolands economy

will l ikely improve, while

exports recovery will l ift

the Japanese economy

Chinas economy will likely

continue to expand in the

months ahead ,

unde rp i nned by a

recovery in exports and

an increase in domestic

demand


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ECONOMIC OUTLOOK6


Index % yoy

Exports

PMI mfg.

3 5

4 0

4 5

5 0

5 5

6 0

6 5

2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0

- 4 0

- 3 0

- 2 0

- 1 0

0

1 0

2 0

3 0

4 0

5 0

6 0

Chart 9China: Exports Picking Up, While Manufacturing Activ it ies Easing

But Likely To Be Temporary

Source: Bloomberg

The global economic recovery in 2010 will, however, remain gradual and

uneven , in our view, given sustained high unemployment situation in the key

developed countries, debt problems in some of the European countries, and deflationin Japan.

Exports On The Path To Recovery

As a whole, we expect a pick-up in global economic activities to translate into higher

demand for the countrys manufactured goods and commodity products. Already,

worldwide semiconductor sales, one of the Malaysias key exports, strengthened to

47.1% yoy in January, the third consecutive month of increase and from +28.8% in

December. Also, the industry experts, the Semiconductor Industry Association and

Gartner, projected worldwide semiconductor sales to a record growth of 10.2% and

10.3% respectively in 2010, a rebound from -9.0% in 2009. As a whole, we expect

the countrys real exports to record a growth of 6.5% in 2010 , a rebound from-10.1% in 2009.

Domestic Demand Will Likely Improve

Domestically, consumer and business confidence will likely improve further and

translate into stronger spending, on the back of an improvement in economic

prospects. As a result, domestic demand is projected to rise by 3.2% in 2010

(see Table 1), from -0.4% in 2009. This will likely be driven by an increase in

consumer spending, which is envisaged to grow at a stronger pace of 4.8% in

2010, after slowing down to +0.8% in 2009. The pick-up in consumer spending will

be underpinned by an improvement in the job market, while firmer commodity prices

will encourage rural households to spend. Also, the Government has put in moreefforts to promote the tourism industry. As it stands, manufacturers have started

to recruit workers for the last seven consecutive months up to December, while

tourist arrivals held up at 1.9 million in January or an increase of 1.4% yoy. These

will be supported by the one percentage point reduction in personal income tax rate

and the increase in personal relief implemented in the 2010 Budget. Similarly, we

believe high savings and rising consumerism as well as pent-up demand will continue

to provide support to consumer spending in the country. Although the imposition of

a service tax on credit and charge cards could impact consumer spending to some

extent, we believe it would unlikely be significant.

Domes t i c demand i s

projected to rise by 3.2%

in 2010 , d r i ven by an

i nc rease i n consumer

spending

The countrys real exports

are projected to record a

growth of 6.5% in 2010, a

rebound from -10.1% in

2009

The g l oba l e conom i c

recove ry i n 2010 w i l l ,

however, remain gradual

and uneven


7/14


In the same vein, we believe the private investment will likely bounce back in

2010, albeit from a low base, as investors resume their investment on the back of

an improvement in global economic outlook. Also, a rise in capacity utilisation rate,

which rose to 74% in the 4Q, from 73% in the 3Q, will encourage some investors

to increase spending. These will likely be enhanced by an improvement in business

confidence as indicated by MIERs business confidence index, which rose to 118.8 in

the 4Q, the highest level in nearly two years and from 113.7 in the 3Q. Already,

businesses have begun spending as reflected in a pick-up in the imports of capital

goods, which turned around to record a growth of 17.4% yoy in the 4Q, the first

increase in six consecutive quarters and from -13.2% in the 3Q. Similarly,

manufacturing investment approvals by the Malaysian Industrial Development

Authority rose by 42.8% yoy in the 4Q, after four consecutive quarters of

contraction. Public investment, however, is projected to contract in 2010, in line

with a cutback in development expenditure by the Federal Government due to fiscal

consolidation. This will likely be made worse by a sharper drop in non-financial

public enterprises (NFPEs) development spending during the year. Still, fixed

capital formation is envisaged to increase by 3.0% in 2010, a rebound from -5.5%

in 2009, as a pick-up in private investment will mitigate the decline in public

investment. Meanwhile, public consumption will likely contract during the year, in line

with the governments efforts to cut its budget deficit.

Fiscal Consolidation Will Hold Back Growth

In its 2010 Budget, the Federal Government has undertaken a bold move to

reduce its budget deficit, after rising sharply due to the implementation of two

economic stimulus totaling RM67bn to cushion the Malaysian economy from a severe

global recession. This will be achieved via the improvement in quality and efficiency

of spending on subsidies, supplies & services and in other areas. Indeed, we

understand that the Governments procurement of goods and services will be based

on competitive bidding to ensure transparency and value for money. As a result,

the Federal Governments budget deficit is projected to narrow

significantly to 5.6% of GDP or RM40.5bn in 2010 (see Table 2), from a deficit

of 7.0% of GDP or RM47.4bn in 2009. Indeed, the budget deficit incurred in 2009

was smaller than the initial estimate of 7.4% of GDP or RM51.1bn due partly to a

smaller-than-expected development expenditure.

2007 2008 2009 2008 2009 2010(f) 2011(f)

4Q 1Q 2Q 3Q 4Q

% Growth in Real Terms

GDP 6.2 4.6 -1.7 0.1 -6.2 -3.9 -1.2 4.5 4.5 5.0

Consumption:

Private 10.4 8.5 0.8 5.3 -0.7 0.5 1.5 1.7 4.8 6.0

Public 6.5 10.9 3.7 12.7 2.1 1.0 10.9 1.3 -2.5 4.5

Total investment 9.6 0.8 -5.5 -10.2 -10.8 -9.6 -7.9 8.2 3.0 8.2

Private 11.8 0.8 -30.4 n.a n.a n.a n.a n.a 10.0 12.7

Public 7.1 0.7 22.6 n.a n.a n.a n.a n.a -1.5 4.9

Goods & services:

Exports 4.5 1.3 -10.1 -13.3 -15.2 -17.3 -13.4 7.3 6.5 7.7

Imports 6.0 1.9 -12.5 -10.2 -23.5 -19.7 -12.9 6.9 9.9 9.1

Agg.domestic demand 9.6 6.8 -0.4 2.8 -2.9 -2.2 0.4 3.0 3.2 6.3

(f): RHBRI's forecasts

Table 1GDP By Demand Aggregate (2000=100)

Pr ivate inves tment w i l l

also likely bounce back in

2010, albeit from a low

base, as investors resume

their investment on the

back of an improvement

in the g loba l economic

outlook

Public spending, however,

is projected to contract

during the year, in l ine

with a fiscal consolidation

The Federal Governments

budget deficit is projected

to narrow significantly to

5.6% of GDP or RM 40.5bn

in 2010, from a deficit of

7.0% of GDP or RM 47.4bn

in 2009


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ECONOMIC OUTLOOK8


Table 3GDP By Industr ial Origin At 2000 Prices

The bold move to contain its budget deficit, in our view, will prevent the countrys

sovereign credit rating from deteriorating . This remains a key concern to the

authorities, after the Fitch Rating Agency downgraded Malaysias long-term local

currency rating to single-A on 9 June 2009, from single-A-plus, on concerns over the

countrys ballooning budget deficit. The Governments move, together with a

cutback in development expenditure by non-financial public enterprises (NFPEs),

however, will contribute to a projected reduction of 0.8 percentage points from real

GDP growth in 2010.

Manufacturing Sector To Bounce Back And Services Sectors To

Strengthen

On the supply side, we envisage a broad-based recovery in economic activities from

manufacturing to services, construction, agriculture and mining sectors. Value added

in the manufacturing sector is projected to bounce back and expand by 7.5% in

2010, from -9.3% in 2009 (see Table 3). Growth will likely be driven by a pick-up

in output of export-oriented industries, on the back of an improvement in global

demand for the countrys exports. As it stands, output of the export-oriented

industries rebounded to increase by 5.0% yoy in the 4Q, the first increase in six

quarters and from -10.0% in the 3Q, on account of a pick-up in the production of

E&E products; chemical products; wood & wood products; rubber and pulp, paper &

board products as well as a smaller decline in the production of textiles, apparel &

footwear. Similarly, output of domestic-oriented industries will likely pick up, on

account of an improvement in consumer spending and private investment. Already,

the production of domestic-oriented industries grew by 5.5% yoy in the 4Q, a

rebound from -5.7% in the 3Q. This was the first increase after four consecutive

quarters of contraction, due to a pick-up in output of consumer-related products such

as food and beverages & tobacco as well as a smaller decline in the production of

transport equipment. A smaller drop in the production of building materials also

helped.

2007 2008 2009 2008 2009 2010(f) 2011(f)

4Q 1Q 2Q 3Q 4Q

% Growth in Real Terms

GDP 6.2 4.6 -1.7 0.1 -6.2 -3.9 -1.2 4.5 4.5 5.0

Agriculture 1.4 4.0 0.4 0.5 -4.3 0.3 -0.5 6.0 2.3 2.8

Mining 2.0 -0.8 -3.8 -5.7 -5.2 -3.6 -3.5 -2.8 1.2 2.0

Manufacturing 3.1 1.3 -9.3 -8.8 -17.9 -14.5 -8.6 5.3 7.5 8.0

Construction 4.7 2.1 5.7 -1.6 1.1 4.5 7.9 9.2 3.1 2.8

Services 9.6 7.2 2.6 5.7 -0.2 1.6 3.4 5.1 4.5 4.7

(f) : RHBRI's forecasts

Table 2Federal Government Financial Posit ion

2008 2009(e) 20101(f) 2009(e) 2010(f)

(RM bil) (% , change)

Revenue 159.8 158.6 148.4 -0.7 -6.4

Operating Expenditure 153.5 157.1 138.3 2.3 -12.0

Current balance 6.3 1.5 10.2

Gross development expenditure 42.8 49.5 51.2 15.5 3.5

Less : Loan recoveries 1.0 0.6 0.6 -40.0 0.0

Net development expenditure 41.9 48.9 50.6 16.7 3.6

Overall balance -35.6 -47.4 -40.5

% to GDP -4.8 -7.0 -5.6

1 Budget estimate, excluding 2009 tax measures e : Estimates f : Forecasts

Source : MOF's Economic Report 2009/2010

The Governments move,

together with a cutback in

development expenditure

by NFPEs, will contribute

to a projected reduction in

real GDP growth in 2010

Manufacturing sector will

rebound in 2010, on the

back o f a p i c k -up i n

expo r t s and domes t i cdemand


9/14


In the same vein, the broad services sector is projected to grow at a faster

pace of around +4.5% in 2010, compared with +2.6% in 2009, in line with higher

consumer spending and trade activities. Also, the Governments efforts to promote

the sector and a sustained increase in tourist arrivals as a result of an improvement

in confidence will boost activities in the sector. As a result, we expect activities in

transport & storage sub-sector to turn around during the year. At the same time,

activities in communications, wholesale & retail trade and accommodation &

restaurants sub-sectors will likely strengthen. We also expect activities in finance &insurance and real estate & business sub-sectors as well as output of utilities to pick

up, in tandem with an improvement in business activities during the year.

The agriculture sector is also envisaged to bounce back to +2.3% in 2010,

after slowing down to +0.4% in 2009. This is on account of a pick-up in palm oil

production due to the low base effect as well as expanded matured areas. As it

stands, palm oil production fell by 1.0% in 2009, compared with +12.1% in 2008.

At the same time, the decline in output of saw logs will likely narrow further, after

falling by a smaller magnitude of around 10.9% in January-November 2009,

compared with -14.8% in 2008. Similarly, the production of rubber will likely bounce

back during the year, given better pricing and after going through three consecutive

years of decline. Meanwhile, the non-commodity sub-sector such as fisheries,livestock and crops will contribute to growth as well, on the back of the

implementation of various projects by the Government.

Similarly, we expect mining output to record a modest growth of 1.2% in

2010, after two consecutive years of contraction and compared with -3.8% in 2009.

This is mainly on account of a pick-up in the production of crude oil and liquefied

natural gas (LNG) due to higher demand. Also, several new oil fields are expected

to start production, while the expansion of MLNG Dua is expected to increase

production of LNG during the year. Meanwhile, crude oil production contracted by

4.1% in 2009, after slowing down to +0.8% in 2008, while LNG output fell by 3.7%,

compared with +0.1% during the same period.

In tandem with a slower increase in the Governments development expenditure,

construction activities are projected to moderate to 3.1% in 2010, from

+5.7% in 2009. As a result, we expect the growth in civil engineering sub-sector

to moderate during the year. This, however, will likely be mitigated by a pick-up in

construction activities in the residential property sub-sector as demand conditions

have improved and property developers are coming up with more launches, while

construction activities in non-residential property sub-sector are still ongoing. As it

stands, new permits for sales and advertising of houses strengthened for the second

consecutive quarter to +100.8% yoy in the 4Q, after four consecutive quarters of

decline. Similarly, housing approvals by the Ministry of Housing and Local

Government surged by 111.6% yoy in the 4Q, the second consecutive quarter of

increase and after four straight quarters of contraction.

Monetary And Loan Expansion To Remain Supportive Of Economic

Growth

The broader money supply, M3, moderated to +7.9% yoy in January 2010, after

reaching a high of +10.0% in November. Despite the moderation, growth remained

commendable, indicating that the underlying economic activities are still expanding.

The slower growth was reflected in a slowdown in government operations due to a

more moderate increase in disbursement of government funds after picking up

strongly in mid-2009. This was, however, mitigated by a pick-up in demand for funds

by the private sector, mainly on account of a stronger loan growth, which was offset

partially by a slowdown in the issuance of securities. An improvement in net

external operations, on account of inflow of foreign portfolio funds, also helped. As

it stands, total holdings in fixed income instruments by foreign investors increased

to RM73.3bn in January 2010, from RM69.2bn in December. This was the seventh

consecutive month of increase and the highest level in 17 months. Going forward,

Min i ng va l ue added i s

p ro j ec t ed t o i n c rease

modes t l y , ma in l y on

account of a pick-up in the

production of crude oil and

LNG

Agr i cu l t u re sec t o r i s

env i saged t o rebound ,

mainly on account of a

p i c k -up i n pa lm o i l

production

The se rv i c es sec t o r i s

p ro jec ted to g row at a

faster pace, as consumer

spend i ng and t rade

activities pick up

Const ruc t ion ac t i v i t i es ,

however , w i l l l i k e l y

moderate due to f i sca l

consolidation

Monetary policy to remain

support i ve o f economic

growth and M3 growth to

expand at a faster pace


10/14

ECONOMIC OUTLOOK10


we expect monetary policy to remain supportive of economic growth and M3 will

likely pick up to around 10.5% in 2010, from+9.1% at end-2009, in line with

a pick-up in economic activities.

Loan growth, however, strengthened to 8.6% yoy in January, from +7.8% in

December and a low of +7.0% in November. This was the strongest growth in eight

months, underpinned by a pick-up in corporate and household borrowings during the

month. The stronger growth in corporate loans was driven by a pick-up in businessloans, which strengthened to 3.5% yoy in January, from +2.6% in December and

a low of +0.6% in November. This was aided by a smaller drop in loans extended

to small and medium enterprises (SMEs), which fell by 0.1% yoy during the

month, compared with -6.0% in November, suggesting that business activities of the

SMEs are gradually improving. In terms of sector, a faster increase in loans was

due to a pick-up in loans extended to agriculture, utilities, real estate and transport,

storage & communications sectors. These were aided by a smaller decline in loans

given to the manufacturing sector and a turnaround in loans channelled to wholesale

& retail trade and restaurant & hotel sectors. These were, however, offset partially

by a slowdown in loans extended to the mining & quarrying, construction and

finance, insurance & business sectors. Similarly, household loans grew at a faster

pace of 10.4% yoy in January, compared with +9.8% in December and +9.5% inNovember. This was reflected in loans extended for the purchase of passenger cars

and houses as well as for credit cards during the month. Going forward, we expect

the banking systems loans to expand by 9.0% in 2010, from 7.8% in 2009, in

tandem with the pick-up in the economy.

In terms of asset quality, the expansion in loan base, coupled with the recovery in

non-performing loans (NPLs) and bad debt written-offs, further reduced the banking

systems NPL ratios. As a result, the 3-month gross NPL ratio of the banking system

eased to 3.20% of total loans in January, from 3.36% in November and a high of

4.11% in January last year. Similarly, the 3-month net NPL ratio fell to 1.73% of

total loans in January, from 1.92% in November and 2.20% a year ago. Going

forward, NPLs will likely improve in 2010 , in line with the recovery in theeconomy. As a whole, we expect the banking systems 3-month gross and net NPL

ratios to ease to around 3.0% and 1.5%, respectively, by end-2010, compared with

3.2% and 1.8%, respectively, at end-2009.

Current Account Surplus To Narrow And Ringgit Will Likely

Appreciate

In tandem with a pick-up in economic activities, imports are expected to rise faster

than that of exports. This will lead to a smaller trade surplus and we expect the

merchandise trade account surplus to narrow to RM133.2bn in 2010, from a surplus

of RM141.5bn in 2009. At the same time, we envisage the deficit in the income

account to widen during the year, as non-resident controlled companies repatriatehigher dividend on the back of improving corporate earnings. These, however, will

likely be mitigated by an improvement in the services account, which is projected

to record a larger surplus during the year, in line with a pick-up in travel receipts.

Similarly, repatriations of salaries and wages by foreign workers are likely to drop,

in line with the Governments policy of reducing the employment of foreign workers.

As a result, we expect the current account surplus of the balance of payments

to narrow to around RM97.1bn or 13.4% of GNI in 2010, from a surplus of

RM112.7bn or 17.3% of GNI in 2009 (see Table 4). Still, the current account surplus

remains sizeable and will contribute to a build-up in the countrys foreign exchange

reserves and fuel domestic liquidity in the financial system. As at end-February

2010, excess liquidity (including repos) mopped up by the Central Bank from the

banking system remained sizeable at RM220.2bn, albeit marginally lower than

RM236.4bn at end-February last year.

Loans will pick up in 2010,

in tandem with a recovery

in the economy

The NPL ratios are likely

to improve in 2010

The cu r ren t ac coun t

surplus of the balance of

payments is projected to

narrow in 2010


11/14


Capitaloutflow , on the other hand, will likely ease further to RM35.5bn in 2010,

after slowing down to RM82.9bn in 2009. This is on account of a pick-up in portfolio

investment in 2010, after recording a small inflow in 2009, in line with an

improvement in the countrys economic prospects. Similarly, net direct investment

is projected to record a net inflow in 2010 due to higher inward direct investment,

as investors resume their investment, in tandem with an improvement in global

economic prospects. These, however, will likely be offset partially by an increase

in Malaysians other investments abroad, including loans and trade credits, as

businesses look for new opportunities overseas.

As a whole, the overall balance of payments is projected to record a larger

surplus of around RM36.6bn in 2010, compared with a surplus of RM13.9bn in 2009,

after taking into account a larger deficit in errors & omissions. Consequently, the

countrys foreign exchange reserves will likely increase to US$111.5bn by end-2010,

from US$96.7bn at end-2009.

The build-up in foreign exchange reserves will continue to provide an underlying

support to the ringgit. The movement of the ringgit, however, has been volatile in

recent months, as investors adjusted to changes in policy and the pace of economic

recovery. This was further complicated by concerns over Greeces deficit problem

that had weighed down the euro. Nevertheless, the ringgit has resumed itsappreciation against the US dollar by 1.2% from 1 February to 4 March, after

weakening by 0.5% in the previous two months and compared with a gain of 4.0%

in September-November. The stronger ringgit was partly reflecting of the hike in

interest rate by Bank Negara Malaysia on 4 March. This was also in line with the

appreciation of Singapore dollar, Japanese yen and the euro, which rose by 0.5%,

0.9% and 0.5% respectively against the US dollar from 1 February to 4 March, after

falling by the corresponding rates of 1.6%, 4.3% and 7.3% in the previous two

months. Chinese renminbi, however, remained stable during the period, as it has

been unofficially pegged to the US dollar since July 2008. As a whole, we expect

the ringgit to fluctuate at between RM3.30 and RM3.40 against the US

dollar, before settling at around RM3.30/ US$ by end-2010, as Asian

currencies (ex-Japan) strengthen against the US dollar on account of a strongereconomic recovery in Asia and a faster pace of policy normalisation. Based on the

real effective exchange rate (REER) model, the fair value of the ringgit is currently

estimated at around RM3.43/US$.

Capi tal out f low, on the

other hand, will likely ease

further in 2010, in line with

an improvement in the

coun t ry s e conom i c

prospects

The ove ra l l ba l ance o f

payments is projected to

record a l arger surp lus

and f o re i gn exchange

reserves will rise in 2010

The r i ngg i t w i l l l i k e l y

f l u c t ua t e a t be tween

RM3.30 and RM3.40

aga ins t the US do l l ar ,

before settling at around

RM3.30 by end-2010

Table 4Balance Of Payments

2008 2009 2008 2009 2010(f) 2011(f)

4Q 1Q 2Q 3Q 4Q

(RMbn)

Current account 129.5 112.7 29.6 31.4 28.8 25.3 27.3 97.1 98.5

(% of GNI) (18.1) (17.3) n.a n.a n.a n.a n.a (13.8) (13.0)Goods 170.6 141.5 38.8 37.0 33.1 33.4 38.0 133.2 132.9

Services 0.2 3.2 0.4 2.5 1.0 0.1 -0.4 1.1 1.7

Income -23.7 -12.6 -5.6 -3.9 -1.5 -1.6 -5.5 -22.2 -23.1

Current transfers -17.5 -19.4 -4.0 -4.2 -3.9 -6.7 -4.7 -15.0 -15.0

Capital account 0.6 -0.2 -0.0 -0.0 -0.0 -0.0 -0.0 0.0 0.0

Financial account -118.5 -82.9 -71.8 -29.8 -24.2 -11.1 -17.9 -35.5 -21.5

Errors & omissions* -29.9 -15.7 -19.6 1.7 -2.4 -2.7 -12.3 -25.0 -20.0

Overall balance -18.3 13.9 -61.9 3.3 2.1 11.5 -3.0 36.6 57.0

Outstanding reserves^ 317.4 331.3 317.4 320.7 322.9 334.4 331.4 367.9 424.9

(US$)^ 91.5 96.7 91.5 87.8 91.5 96.0 96.7 111.5 132.8

(f): RHBRI's forecast ^: As at end-period* : Reflect mainly revaluation gains/losses from Ringgit depreciation/appreciation and statistical discrepancies


12/14

ECONOMIC OUTLOOK12


Higher Price Pressure In 2010, But Manageable

The headline inflation rate picked up to 1.3% yoy in January, compared with

+1.1% inDecember and -0.1% in November (see Chart 10). This was the second

straight month of increase and at a faster pace, as the higher base effect is wearing

off and food prices as well as the core inflation rate are rising, on the back of rising

demand. Food & non-alcohol beverage prices inched up to 1.2% yoy in January,

from +1.1% in December and +0.9% in November, due to rising commodity prices.Similarly, the core inflation rate grew at a faster rate of 1.4% yoy in January,

compared with +1.1% in December. This was the second consecutive month of

increase due to a pick-up in the costs of transport, which rebounded to increase by

0.7% yoy in January, from -0.9% in December and -6.8% in November, as the

higher base effect is gradually wearing off. This was made worse by a faster

increase in the costs of recreation services and a smaller drop in the prices of

clothing & footwear. These were, however, mitigated by slower increases in the

prices of furnishing & household products, the costs of healthcare and education as

well as charges at restaurants & hotels.

Chart 10Inflat ion Trending Up And Normalisat ion Of Monetary Condit ions

Has Begun

0 .0

0 .5

1 .0

1 .5

2 .0

2 .5

3 .0

3 .5

4 .0

0 5 0 6 0 7 0 8 0 9 1 0

-4

-2

0

2

4

6

8

1 0

Source: Department of Statistics

% p.a

TotalC P I

(RHS)

O PR

% yoy

Going forward, inflation rate will likely inch up, on the back of stronger domestic

demand. Higher crude oil price, which is projected to fluctuate at between US$80-

100/barrel in 2010, compared with an average of US$62/barrel in 2009, and other

commodity prices will also contribute to a pick-up in consumer prices. In addition,

the Government plans to gradually remove some of the subsidies in order to reduce

its financial burden. Already, the Government has allowed sugar price to be

increased by 20 sen and it has removed the subsidy for white bread at the beginning

of the year. At the same time, it is reviewing whether to reduce or remove the

cooking oil subsidy. As a whole, we believe inflation will likely trend up to 2.0%in 2010, from +0.6% in 2009. Meanwhile, the Government has decided on 4 March

to scrap its petrol subsidy restructuring scheme, following negative feedback from

the public and after postponing its initial rollout plan in May. As a result, the

Domestic Trade, Cooperatives and Consumerism Minister said that the Government

has no plans to raise or reduce petrol pump prices for now.

Normalisation Of Interest Rates Will Continue

While the headline inflation is likely to gradually trend up, we believe it will likely be

manageable. Nevertheless, following the rate hike by the Central Bank on 4 March,

in a move to normalise interest rates from the current unprecedented low levels, we

believe it will raise it again, albeit at a measured pace. As a result, we expect BankNegara to raise its OPR by another 25 basis points in July 2010 to 2.5%

and the OPR will likely stay at this level until the end of the year. We believe the

Central Bank would not raise interest rates at every policy meeting given

expectation of a slow and uneven global economic recovery. Nevertheless, as the

Inflat ion rate wi l l l ikely

trend up to 2.0% in 2010,

on the back of stronger

domestic demand

We expect Bank Negara to

raise its OPR by another

25 bas i s po ints in Ju ly

2010 to 2.5% and the OPR

will likely stay at this level

until the end of the year

Head l i ne i n f l a t i on ra t e

p i cked up i n re cen t

months


13/14


economy has turned around in the 4Q of last year and is expected to improve

further in 2010, there is a need to bring interest rates back to a more neutral level

to prevent financial imbalances from building up. This is considered as

normalisation and not tightening per se, as a mild and gradual increase in interest

rates from an extremely low level would unlikely affect consumer spending and

business activities in a material way. Assuming that the Malaysian economy goes

back to trend growth of around 5-6% in the next few years, a more neutral level

of the OPR will likely be around 3.0-3.5%, in our view.


14/14

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Documents

Economic Outlook : A New Economic Model As Recovery Gains Pace - 11/03/2010