Economic Outlook - Risk Is A Sharper-than-expected Slowdown In In The 2H, Not A Double Dip - 18/6/2010

8/9/2019 Economic Outlook - Risk Is A Sharper-than-expected Slowdown In In The 2H, Not A Double Dip - 18/6/2010

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18 June 2010

Economic Outlook

Risk Is A Sharper-than-expected Slowdown InIn The 2H, Not A Double Dip

The countrys economic growth is likely to have peaked in the 1Q and will likely expand at

a slower pace in the 2H of the year, on account of slower global economic growth due to

dissipating fiscal spending and Europes austerity measures. These will likely be compounded

by policies tightening in some Asian countries. Locally, fiscal stimulus by the Malaysian

Government will also be running out of steam in the 2H of the year. As a result, we expect

real GDP growth to soften to 4.8% yoy in 2H 2010, from an estimate of +8.8% in the 1H.

For the full-year, real GDP is envisaged to recover to +6.8% in 2010, from -1.7% in 2009.

The global economic growth, however, will not fall off the cliff and into a double dip even

though there is a risk of a sharper-than-expected slowdown given that policy normalisation

and tightening remain gradual. Also, the global services sector has started to recruit workers

for the first time in more than two years in May, pointing to resiliency in the sector, while

we expect Eurolands sovereign debt problem to be manageable despite the lingering

concerns. As a whole, we expect the countrys real exports to slow down to 5.0% yoy in

2H 2010, from an estimate of +18.9% in the 1H.

Domestic demand will also turn softer in the 2H of the year, on the back of slower increases

in private consumption and investment, as sentiment turns cautious amidst slowing economic

activities. Public spending growth will also moderate in tandem with fiscal consolidation and

as the stimulus spending fades, but the pace of slowdown will not be as sharp as earlier

projected. At the same time, the fiscal deficit is projected to be lower at 5.3% of GDP in

2010, compared with the earlier projection of -5.6% and -7.0% in 2009.

We expect the current account in the balance of payments to record a smaller surplus in

2010 but will remain sizeable. The ringgit will likely be well supported by the economic

fundamentals but will remain volatile and fluctuate at between RM3.20-3.30/US$ in 2H 2010,

before settling at around RM3.20/US$ by end-2011.

Inflation will likely bounce back to an average of 2.0% in 2010, from +0.6% in 2009, on the

back of a pick-up in demand. However, it will unlikely be a major concern to policymakers.

As a result, we expect Bank Negara Malaysia to raise interest rates at a measured pace and

further rate hikes will likely be data dependent. We expect BNM to take a pause in July,

before raising the OPR by another 25 basis points to 2.75% in September.

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


Risk Is A Sharper-than-expected Slowdown In The2H, Not A Double Dip

Economic growth in the country is likely to have peaked in the 1Q and will likely

soften in the 2H of the year. This is on account of slower global economic

growth, as worldwide fiscal spending fades and austerity measures in some

European countries begin to bite. These will likely be compounded by policies

tightening in some Asian countries. Already, global manufacturing and services

activities are showing signs of weakness in May. Whilst we do not expect a

double-dip in the global economic growth, there is a risk of a sharper-than-

expected slowdown. Domestically, the Governments fiscal stimulus will be running

out of steam in the 2H of the year, and consumers and businesses will likely

turn more cautious. Already, the countrys industrial production has begun to

soften in April, after reaching a peak in March. As a result, we expect real GDP

growth to soften to 4.8% yoy in 2H 2010, from +8.8% estimated for the 1H.

For the full-year, real GDP is envisaged to recover to +6.8% in 2010, from -1.7%

in 2009. Meanwhile, the current account surplus in the balance of payments will

likely narrow during the year, 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. The movement of the ringgit, however, will remain

volatile and fluctuate at around RM3.20-3.30/US$ in the 2H of the year. Inflation

will likely trend up to an average of 2.0% in 2010, but will not be a major

concern to policymakers. The Central Bank will raise the OPR at a measured

pace and by another 25 basis points to 2.75% in September.

Signs Of Slower Economic Growth In The 2H Emerging

The Malaysian economy recorded a double-digit growth of 10.1% yoy in the 1Q, the

strongest in a decade, underpinned mainly by a strong surge in exports. However,

we believe the growth momentum is likely to have reached its peak in the 1Q and

the economy will likely expand at a slower pace in the 2H of the year. This is on

account of a more moderate global economic growth, as worldwide fiscal spending

dissipates and austerity measures in some European countries begin to bite. These

will likely be compounded by policies tightening in some countries, particularly in

Asia and other emerging economies. Already, global manufacturing and services

activities are showing signs of weakness in May and the countrys industrial production

and exports have begun to soften in April, after reaching a peak in March.

Domestically, the Governments fiscal stimulus will be running out of steam in the 2H

of the year, and consumers and businesses will likely turn more cautious. As a

result, we expect real GDP to grow at a slower pace of 4.8% yoy in 2H 2010,

compared with an estimate of +8.8% in the 1H. For the full-year, real GDP is

envisaged to recover to +6.8% in 2010, from -1.7% in 2009.

Slower growth will likely continue into 2011, particularly in the 1H of the year.

However, we expect the Government expenditure in the 10 th Malaysia Plan (10MP),

which has just been launched on 10 June, to be front loaded and provide some

cushion. During the plan, the Government would introduce a two-year rolling plan

amounting to RM91bn in 2011-2012 in order to provide greater flexibility on spending,

especially in response to changes in the global economic environment.

Global Economic Recovery Soften, But Will Not Fall Off The Cliff

On the external front, global manufacturing activities moderated in May, the first

easing in three months (see Chart 1), suggesting that a rebound from the worstglobal recession since World War II is beginning to soften. Indeed, Chinese

manufacturing activities, which led a rebound from the US to Japan, weakened to the

lowest level in three months in May. In the same vein, the US manufacturing index

eased in May, froma near six-year high in April, while manufacturing activities in

The country s economic

growth is l ikely to have

peaked in the 1Q and we

expect real GDP to slow

down to 4.8% yoy in 2H

2010, from an estimate of

+8.8% in the 1H

Slower growth will l ikely

continue into 1H 2011 but

t he 10MP w i l l l i k e l y

provide some cushion

Global manufacturing and

serv i ces ac t i v i t i es

modera t ed i n May ,

suggesting that a rebound

f rom the wo rs t g l oba l

recession since World War

II is beginning to ease


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ECONOMIC OUTLOOK3


Euroland showed its first signs of weakness in eight months during the month and

since it returned to positive growth in October last year. Similarly, global services

activities slackened in May, the first moderation in four months. The weakness was

reflected in slower increases in services activities in Japan, China and India, while

activities in the US remained stable during the month. Measured on a m-o-m basis,

another key indicator, the OECD composite leading indicator,has been trending

lower for the last few months before stabilising somewhat lately, indicating that

OECD countries economies are likely to expand at a slower pace in the monthsahead. Indeed, the leading indicators 12-month rate of change moderated to 9.7%

in April (see Chart 2), the first easing in eight months and from +10.2% in March

and +10.1% in February. Consequently, we believe global economic growth w ill

likely slow down in 2H 2010, after picking up steadily in the 1H.

Despite the weakness, we do not expect the global economy to fall off the

cliff and into a double dip even though there is a risk of a sharper-than-expected slowdown, given that policy normalisation and tightening remain gradual.

Also, the global services sector has started to recruit workers for the first time in

more than two years in May, indicating that the sector will be resilient in weathering

a slowdown in the months ahead. In Europe, we expect the sovereign debt problems

to be manageable despite the lingering concerns, following the announcement of an

emergency stabilisation loan of 750bn for countries under attack by speculators and

the 110bn rescue package for Greece. Although the sharp drop in euro might have

exacerbated concerns over a break-up of a single currency in the Euroland, it is

unlikely to happen anytime soon given that it would not bring any benefit to the

region at this juncture. In fact, the sharp drop in euro will likely boost the regions

exports due to improving export competitiveness. Already, factory orders in Germany,

the largest economy in the Euroland, grew by 2.8% mom in April, the third month

of increase in four months.

Meanwhile, a deepening in Europes sovereign debt crisis will likely affect Malaysias

exports to some extent given that 10.7% of the countrys exports, which grew by

28.9% yoy in January-April 2010, went straight to Europe. There would be indirect

impact as well since Malaysia exports 13% of its exports to China, which grew by

56.2% yoy in January-April 2010, and Europe is Chinas largest export market

(accounting for 19.7% of its total exports). As a whole, in tandem with a more

moderate growth in the global economy, we expect the countrys realexports to

slow down to 5.0% yoy in 2H 2010 , from an estimate of +18.9% in the 1H,

bringing the full-year growth to +11.5% compared with -10.4% in 2009.

Chart 1Global Manufactur ing And Serv ices

Activ it ies Showing Signs of Weakness

Index

P M IManufacturing

30

35

40

45

50

55

60

65

05 06 07 08 09 10

P M IServices

Chart 2OECD Composite Leading Indicator Points

To Slower Economic Activ it ies Ahead

% 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 Euro area China

We be l i eve g l oba l

economic growth w ill likely

s low down in 2H 2010,

after picking up steadily

in the 1H

We do no t expec t t he

g l oba l e conomy t o f a l l

i n to a doub le d ip even

though there is a risk of a

s ha rp e r - t han - ex p e c t ed

s lowdown in the g loba l

economy

The countrys exports will

l i ke ly s low down in 2H

2010, in tandem with a

weaker g lobal economic

growth


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ECONOMIC OUTLOOK4


Major Economies Showing Signs Of Softening

In the US, the economy moderated to an annualised rate of 3.0% in 1Q 2010, after

a strong growth in the 4Q of last year. Despite a weaker growth, the economic

recovery is becoming more sustainable, as its recovery which started from the

government stimulus and inventory rebuilding, has now spread to consumer spending.

Nonetheless, consumers have turned cautious and are beginning to take a pause in

view of rising economic uncertainties in Europe and the policies tightening in Asia.Consequently, real personal consumption expenditure stagnated m-o-m in April (see

Chart 3), the first in seven months. Furthermore, unemployment rate remains high

and job creation in the non-farm private sector slowed down rapidly in May, after

four consecutive months of picking up, implying that a recovery in consumer spending

will likely be gradual. Elsewhere, manufacturing activities slowed down in May (see

Chart 4), after reaching a near six-year high in April. Although services activities

held stable for the third straight month in May, there were signs of weakness,

indicating that activities in the sector might have peaked and will likely soften going

forward. As a whole, the US economy is projected to grow at a more moderate

pace of 2.8% in 2H 2010, compared with +3.2% in the first half, bringing the full-

year growth to around +3.0%, a rebound from -2.4% in 2009.

Similarly, the Euroland s economy is expected to sustain its slow pace of recovery

in 2010, as the deepening sovereign debt problems of late would force some countries

to cut government spending sharply. Already, manufacturing activities in the region

showed a first sign of weakness in eight months and since it returned to positive

growth in October last year (see Chart 5), while there were warning signs that

services activities may be peaking as well. Also, consumer confidence weakened to

the lowest level in seven months in May, after a temporary improvement in April

(see Chart 6). In the same vein, a slowdown in global export demand will likely

contribute to a slower growth in the Japanese economy in the 2H of the year. This

will likely be compounded by political uncertainties that could affect the countrys

efforts to shake off deflationary pressure facing the country. As it stands, Japans

exports softened to 43.5% yoy in March, from a high of +45.4% in February (see

Chart 7).

Chart 3US: Consumer Spending Turning Softer

% mom (Personal consumption expenditure)

Chart 4US : Manufacturing & Services Activ it ies Are

Likely To Have Peaked

Index

ISMManufacturing

30

35

40

45

50

55

60

65

70

05 06 07 08 09 10

ISMServices

-1.5

-1

-0.5

0

0.5

1

1.5

05 06 07 08 09 10

The US economic recovery

i s becom ing more

sustainable but growth w ill

be at a more moderate

pace in the 2H

The Eurolands economy is

expected to sustain i ts

slow pace of recovery due

to t he deepen i ng

sovereign debt problems,

while a slowdow n in global

exports will l ikely hurt the

Japanese economy in the

2H of the year


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ECONOMIC OUTLOOK5


In China, the countrys economy is showing signs of weakness following the

introduction of measures to control the rapid credit expansion and upward property

prices. As it stands, manufacturing activities slowed down to the slowest pace in

three months in May (see Chart 8), while fixed-asset investment in urban areas and

loans slowed down from growth of more than 30% to 25.9% and 23.2% respectively

in May (see Chart 9). Similarly, retail sales were off the peak in February, pointing

to easing local demand. These, however, will likely be supported by resilient exports.

As a whole, the key economic indicators point to a slowdown in the countrys

economic growth in the 2H of the year, though growth will likely remain resilient,

after recording a stronger growth of +11.9% yoy in the 1Q.

Chart 8China: Manufactur ing Act iv i t ies Moderat ing

Index

35

40

45

50

55

60

65

2007 2008 2009 2010

Chart 9China: Fixed Investment And Loan Growth

Easing, While Retail Sales Off The Peak

% yoy

10

15

20

25

30

35

40

08 09 10

0

5

10

15

20

25

30

35

40

% yoy

Fixed asset(RHS)

Retail sales

(LHS)

Total loans(LHS)

Chart 5Euro land: Manufactur ing And Serv icesActiv it ies Showing Signs of Weakness

Index

30

35

40

45

50

55

60

65

00 01 02 03 04 05 06 07 08 09 10

PMI Manufacturing

P M IServices

Chart 6Euroland: Consumer Confidence Fal l ing Back

But Business Confidence Holding Up

Index Index

Consumerconfidence

(LHS)

Business climateindicator

(RHS)

-40

-35

-30

-25

-20

-15

-10

-5

0

05 06 07 08 09 10

-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

Chart 7Japan: Exports Turning Softer

% yoy

- 6 0

- 4 0

- 2 0

0

2 0

4 0

6 0

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

Ch ina s e conomy i s

show ing s i gns o f

weakness fol lowing the

introduction of measures

to control the rapid credit

expans i on and upward

property prices


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ECONOMIC OUTLOOK6


Global Demand For Electronic Exports Will Likely Moderate

A sharp turnaround in demand for electrical & electronic (E&E) products, which

account for about 45% of Malaysias total exports in 2009, would boost the countrys

exports, particularly in 1H 2010. Demand, however, will likely be softer in the 2H

of the year, in line with a slowdown in global economic activities. As it stands,

worldwide semiconductor sales eased to 50.3% yoy in April, after reaching a high

of +58.3% in March, suggesting that sales are beginning to moderate after a spikeup in demand and inventory rebuilding.

Domestic Demand Will Turn Softer

A softer export growth in the 2H of the year, which will translate into slower increases

in jobs and production, will likely affect consumer spending and business investment

as well. As a result, we expect domestic demand to grow at a slower pace

of 3.7% yoy in 2H 2010 , compared with +6.2% estimated for the 1H, bringing the

full-year growth to 4.9% in 2010, a rebound from -0.5% in 2009 (see Table 1). This

will likely be reflected in slower increases in both private consumption and investment

during the period, as sentiment turns cautious amidst slowing economic activities. As

a result, we envisage consumer spending to grow at a slower pace of 4.6% yoyin the 2H versus +5.4% in the 1H. Consumer spending, however, will remain

resilient, on the back of high savings and rising consumerism. Furthermore,

manufacturers are still recruiting workers and for the 11th consecutive month in April.

For the full-year, consumer spending, however, will likely bounce back to +5.0% in

2010, from +0.7% in 2009.

Similarly, the private investment is projected to soften to 6.4% yoy in 2H 2010,

from +7.3% in the 1H, as businesses turn cautious when excess production capacity

builds up on the back of a slowdown in export demand. As a result, we believe

businesses will not be in a hurry to invest and they are likely to delay their investment.

As it stands, the imports of capital goods slowed down somewhat to 9.6% yoy in the

1Q, after recording its first growth of 17.4% yoy in six consecutive quarters in the4Q. Similarly, total approved manufacturing investment fell by 30.3% yoy in the 1Q,

after a rebound to +42.8% in the 4Q. In the same vein, public investment is

Demand for E&E products

will l ikely be softer in the

2H of the year

A softer export growth w ill

likely translate into slow er

i nc reases i n j ob s and

production, which will lead

to a slowdow n in domestic

demand as consumer

spending weakens

P r i va t e i nves tment i s

p ro j ec t ed t o so f t en as

wel l , as businesses turn

cautious

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

1Q 2Q 3Q 4Q 1Q

% Growth in Real Terms

GDP 6.5 4.7 -1.7 -6.2 -3.9 -1.2 4.4 10.1 6.8 5.0

Consumption:

Private 10.5 8.5 0.7 -0.6 0.3 1.3 1.6 5.1 5.0 6.0

Public 6.6 10.7 3.1 1.6 1.5 9.4 0.7 6.3 -1.5 4.5

Total investment 9.4 0.7 -5.6 -11.2 -9.6 -7.9 8.2 5.4 9.0 8.6

Private 13.1 1.0 -17.2 n.a n.a n.a n.a n.a 6.9 12.7

Public 5.3 0.5 8.0 n.a n.a n.a n.a n.a 10.8 4.9

Goods & services:

Exports 4.1 1.6 -10.4 -15.5 -17.9 -12.9 6.0 19.3 11.5 7.8Imports 5.9 2.2 -12.3 -23.0 -19.4 -13.2 7.0 27.5 18.0 10.5

Agg.domestic demand 9.6 6.8 -0.5 -3.1 -2.2 0.1 2.8 5.4 4.9 6.4

(f): RHBRI's forecasts

Table 1GDP By Demand Aggregate (2000=100)


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ECONOMIC OUTLOOK7


projected to expand at a slower pace of 10.2% yoy in the 2H of the year, compared

with +11.5% in the 1H, as the government stimulus fizzles out. Consequently, we

expect fixed capital formation to ease to 8.4% yoy in 2H 2010, from +9.5%

estimated for the 1H, bringing the full-year growth to 9.0% during the year, compared

with -5.6% in 2009. Public consumption, on the other hand, will likely contract by

5.4% yoy in the 2H of the year, compared with an estimate of +4.0% in the 1H, on

the back of a fiscal consolidation. As a whole, the public sector expenditure will

not exert a contractionary impact on the economy as earlier projected , asthe Government will not cut back as steeply as projected previously.

Fiscal Consolidation Would Be Less Severe Than Initially Thought

Although the Government scrapped its plan to restructure fuel subsidy in May, we

believe it would still be able to reduce its budget deficit according to the plan.

Indeed, the Government guided that its budget deficit will likely narrow to

5.3% of GDP or RM 40.3bn in 2010, slightly better than -5.6% of GDP or RM40.5bn

projected previously (see Table 2). This is because the Government has changed

the petroleum income tax to a current year assessment system beginning 2010,

implying that it could collect income tax from petroleum companies based on this

years earnings. On top of that, the Government would still be able to collect a 20%petroleum income tax or more based on 2009s income, if oil companies choose to

pay more upfront instead of over five years. The move, in our view, would help

to cushion a decline in petroleum income tax caused by a drop in crude oil prices

in 2009. As it stands, the Government expects crude oil price to average US$74.5/

barrel in 2010, compared with an average of US$60.5/barrel in 2009 and a high of

US$125.0/barrel in 2008.

Table 2Federal Government Financial Posit ion

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

(RM bil) (% , change)

Revenue 159.8 158.6 160.9 -0.7 1.5

Operating Expenditure 153.5 157.1 147.5 2.3 -6.1

Current balance 6.3 1.5 13.4

Gross development expenditure 42.8 49.5 54.2 15.5 9.5

Less : Loan recoveries 1.0 0.5 0.5 -40.0 -16.7

Net development expenditure 41.9 49.0 53.7 16.7 9.8

Overall balance -35.6 -47.4 -40.3

% to GDP -4.8 -7.0 -5.3

e : Estimates f : ForecastsSource : MOF's Economic Report 2009/2010, EPU

A smaller-than-expected drop in oil revenue could help the Government to reduce

its budget deficit more than the initial plan in 2010. However, the Government opted

to cut its operating and development expenditures by a smaller magnitude

than originally planned to ensure that a rollback of its expenditure would not

exert too much downward pressure on the economy given the risk of a sharper-

than-expected slowdown in the global economy in the 2H of the year. Already, the

Government has proposed a supplementary budget totalling RM12bn for 2010 in late

April. The extra spending was meant for the implementation of the six National Key

Result Areas (NKRAs) under the Government Transformation Programme (GTP),

which would raise the operating expenditure by around RM9.2bn from the initial plan

to RM147.5bn in 2010. At the same time, the development expenditure would be

raised by about RM3bn from the initial plan to RM54.2bn in 2010 to cater for the

Pub l i c deve l opment

expenditure will not exert

a contract ionary impact

on the economy as earlier

p ro jec ted , as the

Government wi l l not cut

back as s t eep l y as

projected previously

The Government guided

that its budget deficit will

l ikely narrow to 5.3% of

GDP in 2010

The Government opted to

cu t i t s ope ra t i ng and

development expenditure

by a smal l e r magni tude

than originally planned


8/14

ECONOMIC OUTLOOK8


additional funds that are required by the various ministries. A smaller-than-expected

cutback in the Governments expenditure suggests that the fiscal consolidation

will not exert a contractionary impact on the economy as previously feared.

In the 1Q of 2010, the Government recorded a budget deficit of RM10.2bn, compared

with -RM6.7bn in the 1Q of last year. On an annualised basis, the deficit was broadly

in line with the Governments target of a deficit of RM40.3bn, indicating that the

Government is on track to achieve its deficit target. Meanwhile the Governmentrecorded a smaller-than-expected budget deficit of 7.0% of GDP or RM47.4bn in

2009, compared with -7.4% of GDP or RM51.1bn estimated in October 2009, as both

operating and development expenditures came in lower than the previous estimates.

Manufacturing And Services Sectors Will Likely Moderate In The 2H

On the supply side, the manufacturing and services activities are likely to expand

at a more moderate pace in the 2H of the year, in line with slower increases in trade

activities, business and consumer spending. Similarly, construction and agriculture

sectors are envisaged to grow at a slower pace but mining output will pick up . Value

added in the manufacturing sector is projected to slow down sharply to

6.9% yoy in the 2H of the year, from +14.9% estimated for the 1H, as exportsslacken and private spending eases. Already, manufacturing activities in major

economies like China, US and Euroland have shown signs of weakness in May and

Malaysia will likely experience the same situation as well. This will likely be reflected

in slower growth in output of export-oriented industries, on the back of a slowdown

in global demand for the countrys exports, particularly the E&E products. Similarly,

output of domestic-oriented industries will likely expand at a slower pace in the 2H

of the year, as consumer spending and private investment moderate. As it stands,

the production of domestic-oriented industries expanded by 16.8% yoy in March, off

a high of 22.8% in January. For the full-year, the manufacturing sector, however, will

still chalk up a strong double-digit growth of 10.7% in 2010, after going through a

contraction of 9.4% in 2009 (see Table 3).

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

pace of around 5.1% yoy in the 2H of the year, compared with +7.7% estimated

for the 1H, in line with a slowdown in trade activities and private sector spending.

For the full-year, the services sector is projected to expand at a faster pace of 6.4%

in 2010, compared with +2.6% in 2009. The slowdown in services activities in the

2H of the year will likely be broad-based. As a result, we expect activities in utilities,

transport & storage, communications, finance & insurance and real estate & business

sub-sectors to weaken in the 2H of the year, as business activities turn softer.

Similarly, a slowdown in consumer spending will likely contribute to slower increases

in activities in wholesale & retail trade and accommodation & restaurants sub-

sectors, while government services will likely slacken during the period.

The Government recorded

a smaller-than-expected

budget deficit of 7.0% of

GDP in 2009

Growth o f t he

manufactur ing sector is

projected to slow dow n by

more than half in the 2H

of the year, as exports

s l acken and p r i va t e

spending eases

Table 3GDP By Industr ial Origin At 2000 Prices

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

1Q 2Q 3Q 4Q 1Q

% Growth in Real Terms

GDP 6.5 4.7 -1.7 -6.2 -3.9 -1.2 4.4 10.1 6.8 5.0

Agriculture 1.3 4.3 0.4 -4.4 0.4 -0.4 5.9 6.8 3.2 2.8

Mining 2.0 -2.4 -3.8 -5.2 -3.5 -3.6 -2.8 2.1 1.8 2.0

Manufacturing 2.8 1.3 -9.4 -17.9 -14.5 -8.6 5.0 16.9 10.7 8.0

Construction 7.3 4.2 5.8 1.2 4.5 7.9 9.3 8.7 4.8 2.8

Services 10.2 7.4 2.6 -0.2 1.7 3.4 5.2 8.5 6.4 4.6

(f) : RHBRI's forecasts

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

p ro jec ted to g row at a

slower pace in the 2H, in

l ine with a slowdown in

t rade ac t i v i t i es and

private spending


9/14

ECONOMIC OUTLOOK9


The agriculture sector is also envisaged to expand at a more moderate

pace of 2.2% yoy in 2H 2010, compared with an estimate of +4.3% in the 1H,

on account of slower growth in the production of rubber and saw logs. This will likely

be mitigated somewhat by an improvement in palm oil production during the period.

For the full-year, the sector will likely grow at a stronger pace of 3.2% 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 3.3% in 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.

Construction activities are likely to w eaken to 2.3% yoy in the 2H of the

year, from +7.7% estimated for the 1H, as the Governments stimulus spending

dissipates. This will likely translate into slower growth in civil engineering sub-sector.

Construction activities in the residential property sub-sector will likely soften as well,while construction activities in non-residential property sub-sector are still ongoing.

As it stands, new permits for sales and advertising of houses slowed down to 32.0%

yoy in the 1Q, from +100.8% in the 4Q, while renewal permits fell by 19.4% yoy,

compared with +37.8% during the same period. In the same vein, housing approvals

by the Ministry of Housing and Local Government softened to 13.9% yoy in the 1Q,

from +111.6% in the 4Q. For the full-year, construction activities are projected to

moderate to 4.8% in 2010, from +5.8% in 2009.

Mining output, however, is envisaged to bounce back to +1.9% yoy in the

2H of the year, from +1.7% estimated for the 1H. This is mainly on account of

a pick-up in the production of liquefied natural gas (LNG) due to higher demand.

Already, LNG output production rebounded to increase by 2.5% yoy in the 1Q of2010, after recording a smaller decline of 1.0% in 2H 2009 and compared with -6.4%

in the 1H. Similarly, crude oil production contracted by a smaller magnitude of 2.5%

in the 1Q, compared with -5.0% in 2H 2009. For the full-year, mining output is

projected to grow by 1.8% in 2010, after two consecutive years of contraction and

compared with -3.8% in 2009.

Money Supply And Loans To Continue Expanding In The 2H

The broader money supply, M3, eased to +8.1% yoy in April, from +8.7% in March

and compared with a peak of +10.0% in November last year. This was mainly on

account of a slowdown in government operations, in tandem with a slower increase

in disbursement of government funds after picking up strongly in mid-2009. Adecline in net external operations, on account of a devaluation losts as a result of

the appreciation of the ringgit, worsened the situation. This was, however, mitigated

by a pick-up in demand for funds by the private sector, on account of a stronger loan

growth and a pick-up in the issuance of securities. Going forward, we expect

monetary policy to remainsupportive 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.

Loans, however, grew at a stronger pace of 10.0% yoy in April, compared with

+9.8% in March and a low of +7.0% in November last year. This was the strongest

growth in a year, on the back of a pick-up in corporate and household loans during

the period. The stronger growth in corporate loans was driven by a pick-up in loans

extended to small and medium enterprises (SMEs), which grew by 4.6% yoy in

April, faster than +3.1% in March and compared with -6.0% in November. This was,

however, offset partially by a slowdown in business loans to 4.0% yoy in April,

from+ 4.3% in March but higher than +0.6% in November. In terms of sector, a

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

envisaged to expand at a

more moderate pace, on

account of slower growth

in the production of rubber

and saw logs

Construction activities are

l ikely to weaken during

the per iod , as the

Gove rnment s s t imu lus

spending dissipates

Mining output, however , is

envisaged to bounce back

in the 2H o f the year ,

mainly on account of a

pick-up in the production

of LNG

We expec t mone ta ry

po l i c y t o rema in

support i ve o f economic

growth and M3 growth will

l ikely pick up in 2010

Loan growth w ill pick up in

2010, in tandem with a

recovery in the economy


10/14

ECONOMIC OUTLOOK10


faster increase in loans was due to a turnaround in loans given to the manufacturing

and wholesale & retail trade as well as restaurant & hotel sectors. Stronger growth

in the construction, real estate and finance, insurance & business loans also helped.

These were, however, offset partially by a slowdown in loans extended to the

agriculture and mining & quarrying as well as a decline in loans extended to transport,

storage & communications sectors. Similarly, household loans grew at a faster

pace of 12.2% yoy in April, compared with +11.7% in March and +9.5% in November.

This was due to loans extended for the purchase of passenger cars and houses aswell as for credit cards during the month. Going forward, we expect the banking

systems loans to expand by 9.0% in 2010 , faster than +7.8% in 2009, in tandem

with the pick-up in the economy.

In terms of asset quality, the 3-month gross non-performing loan (NPL) ratio of the

banking system remained broadly stable at around 3.3-3.4% of total loans in January-

April and compared with 3.2% in December last year. Similarly, the 3-month net NPL

ratio hovered at around 1.8-1.9% of total loans during the same period and compared

with 1.8% in December. The slight uptick in NPL ratios was largely due to the

adoption of the FRS139. The comparison with the previous year number, however,

may not be meaningful as: 1) Under the FRS139, impaired loans include both

performing and non-performing loans (under previous GP3 guideline) and hence, thefigure would be higher as compared to the definition of NPLs previously; 2) Not all

banks have adopted FRS139. According to Bank Negara Malaysia (BNM), beginning

January 2010, loans are reported based on the FRS139, although the adoption by

the various banks would still depend on their respective financial year end. Thus

far, the data might have captured NPL trend of five banks that have started to report

NPLs based on the FRS139. Going forward, we expect the banking systems 3-month

gross and net NPL ratios to remain relatively stable at around 3.3% and

1.8%, respectively, by end-2010, compared with 3.2% and 1.8%, respectively, at

end-2009.

Smaller Current Account Surplus; Ringgit W ill Remain Range-Bound

Imports are expected to rise faster than that of exports, as economic activities pick

up and domestic demand improves. This will likely result in a smaller merchandise

trade surplus of RM136.9bn during the year, compared with a surplus of RM141.8bn

in 2009. At the same time, we envisage the deficit in the income account to widen

during the year, as non-resident controlled companies repatriate higher dividend on

the back of improving corporate earnings. Similarly, the services account is projected

to record a smaller surplus during the year due to higher payment for transportation

charges. These, however, will likely be mitigated by a smaller deficit in the current

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

in line with the Governments policy of reducing foreign workers in the country. As

a result, we expect the current account of the balance of payments to record

a smaller surplus of around RM100.8bn or 13.5% of GNI in 2010, comparedwith a surplus of RM112.1bn or 16.9% of GNI in 2009 (see Table 4). Whilst the

current account surplus will likely narrow, it remains large and will contribute to a

build-up in the countrys foreign exchange reserves and fuel domestic liquidity in the

financial system. Indeed, the excess liquidity (including repos) mopped up by the

Central Bank from the banking system inched up to RM226.3bn at end-May 2010,

from RM225.9bn at end-April and compared with RM223.3bn at end-2009.

The NPL ratios are likely

to remain r elatively stable

in 2010

The cu r ren t ac coun t

surplus of the balance of

payments is projected to

shrink in 2010


11/14

ECONOMIC OUTLOOK11


Outflow of capital, on the other hand, is envisaged to narrow to around RM56bn

in 2010, after recording a smaller outflow of RM80.2bn in 2009. This is on account

of a pick-up in portfolio investment in 2010, after recording a smaller inflow in 2009,

in line with an improvement in the countrys economic prospects. Similarly, net

direct investment is projected to record a smaller net outflow in 2010 due to higher

foreign direct investment (FDI), as investors resume their investment, in tandem

with an improvement in global economic prospects. Inflow of FDI slowed down to

RM5.0bn in 2009, from an inflow of RM24.1bn in 2008, due to the global economic

recession. 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 investment opportunities overseas.

As a whole and after taking into account a larger deficit in errors & omissions, the

overall balance of payments is projected to record a smaller surplus of around

RM9.8bn in 2010, compared with a surplus of RM13.8bn in 2009. The larger deficit

in errors & omissions reflects partly a revaluation loss due to a strengthening of the

ringgit against other major currencies. Consequently, the countrys foreign exchange

reserves will likely increase to US$99.7bn 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. The ringgit took a turn and began to depreciate against the US dollar

in recent weeks. This was due to the flight to safety as investors pulled out their

funds from emerging markets on the back of a deepening sovereign debt crisis in

Europe and policies tightening in Asia that threaten to derail the global economic

recovery. As a result, the ringgit fell by 4.5% against the US dollar between 1 May

and 7 June, after appreciating by 6.8% in the previous three months. Similarly, S$,

peso, rupiah and baht depreciated by 3.5%, 5.0%, 2.9% and 0.9% respectively

against the US dollar, after a gain of +2.8%, +3.9%, +3.6% and +2.1% respectively

during the same period. The euro also weakened by a whopping 10.2% but the

Japanese yen strengthened by 3.0% against the US dollar during the same period.

Meanwhile, the Chinese renminbi remained relatively stable, as it has been implicitly

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

remain volatile and it will likely fluctuate at around RM3.20-3.30/ US$ for

the rest of 2010 before settling at RM3.20/US$ by end-2011.

Table 4Balance Of Payments

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

1Q 2Q 3Q 4Q 1Q

(RMbn)

Current account 129.5 112.1 31.3 28.0 25.4 27.4 30.4 100.8 93.7

(% of GNI) (18.1) (16.9) n.a n.a n.a n.a n.a (13.5) (11.7)Goods 170.6 141.8 37.2 33.2 33.4 37.9 45.0 136.9 130.1

Services 0.2 4.7 2.7 1.5 0.6 -0.1 -0.1 1.1 1.7

Income -23.7 -14.6 -4.5 -2.9 -1.7 -5.6 -8.9 -22.2 -23.1

Current transfers -17.5 -19.6 -4.2 -3.9 -6.8 -4.8 -5.6 -15.0 -15.0

Capital account 0.6 -0.2 -0.0 -0.0 -0.0 -0.0 -0.1 0.0 0.0

Financial account -118.5 -80.2 -31.0 -22.3 -9.4 -17.4 -19.5 -56.0 -45.5

Errors & omissions* -29.9 -17.9 1.7 -2.4 -2.7 -13.0 -30.5 -35.0 -25.0

Overall balance -18.3 13.8 3.3 2.1 11.5 -3.0 -19.6 9.8 23.1

Outstanding reserves^ 317.4 331.3 320.7 322.9 334.4 331.4 311.8 341.1 364.2

(US$)^ 91.5 96.7 87.8 91.5 96.0 96.7 95.3 99.7 106.9

(f) : RHBRI's forecast ^ : As at end-period

* : Reflect mainly revaluation gains/losses from Ringgit depreciation/appreciation and statistical discrepancies

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

RM3.20 and RM3.30/ US$,

before settling at around

RM3.20 by end-2011

The ove ra l l ba l ance o f

payments is projected to

record a smaller surplus

during the year

Out f l ow o f c ap i t a l ,

however, is envisaged to

be smaller in 2010


12/14

ECONOMIC OUTLOOK12


Price Pressure Building Up, But Likely To Be Manageable

The headline inflation rate accelerated to 1.5% yoy in April, after hovering

at between +1.2 and +1.3% in the previous three months (see Chart 10). This was

the fifth consecutive month of increase and the fastest pace of increase so far this

year, indicating that price pressure is building up and as higher base effect gradually

wears off. The pick-up in inflation was on account ofhigher food & non-alcohol

beverage prices and a slight pick-up in the core inflation rate during theperiod. Food & non-alcohol beverage prices grew at a faster pace of 2.2% yoy in

April, the fastest in 10 months and compared with +1.7% in March. This was due

to rising commodity prices and as higher base effect gradually wears off. Recall that

food & non-alcohol beverage prices eased to 9.3% yoy in the 1Q of last year, from

+11.1% in 4Q 2008. Similarly, the core inflation rate inched up to 1.2% yoy in April,

after remaining stable at +1.1% in the previous two months. This was due to a pick-

up in the costs of healthcare, transport and recreation services as well as charges

at restaurants & hotels. These were, however, offset partially by slower increases

in the prices of furnishing & household products and the costs of education as well

as a sharper drop in the prices of clothing & footwear.

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

Wil l Likely Continue

% p.a

OP R(LHS)

% yoy

0. 0

0. 5

1. 0

1. 5

2. 0

2. 5

3. 0

3. 5

4. 0

05 06 07 08 09 10

-4

-2

0

2

4

6

8

10

TotalC P I(RHS)

Going forward, inflation will likely increase at a faster pace and we expect

it to trend up to 2.0% in 2010 , from +0.6% in 2009, in line with a pick-up in

domestic demand. A rise in international crude oil and commodity prices could also

exert some pressure on domestic inflation. 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. Also, it has

organised the Subsidy Rationalisation Lab on 27 May to get feedbacks from thepublic on its proposals to cut subsidies. However, we believe the removal of subsidies

will likely be gradual and separately in order to reduce the burden on the people.

Furthermore, given that output is recovering from low levels, the resultant pressure

on inflation from the narrowing output gap is expected to be limited.

Policy Normalisation To Be At A Measured Pace

Although inflation is expected to rise but it will not pose a major threat to the

economy at this stage, in our view. However, given that economic growth has

recovered and is gaining momentum, it would not be wise to maintain interest rates

at too low a level over an extended period as it could encourage excessive risk

taking behaviour and unhealthy build up of financial imbalances. As a result, thereis a need for Bank Negara Malaysia (BNM) to bring back interest rates to a more

normal level. Indeed, BNM already started to normalise its monetary conditions.

The Central Bank raised its overnight policy rate (OPR) for the second time this year

and by another 25 basis points to 2.5% on 13 May. Nevertheless, given that

In f l a t i on w i l l l i k e l y

increase at a faster pace

to 2.0% in 2010, in l ine

with a pick-up in domestic

demand

Inflation rate accelerated

i n Ap r i l , t he f i f t h

consecu t i ve month o f

increase and the fastest so

far this year, ind icat ing

tha t p r i c e p res su re i s

building up

Further rates hike to be

data dependent and BNM

will l ikely take a pause in

Ju l y s po l i c y mee t i ng

before resuming its rate

hike in September and by

25 basis points, bringing

the OPR to 2.75%


13/14

ECONOMIC OUTLOOK13


Malaysia is already ahead of the curve and faster compared to regional economies

in terms of normalising its monetary conditions, while the recovery in the global

economy will likely be uneven, we believe BNM will not be in a hurry to increase

interest rates. We expect further rate hikes to be data dependent and BNM

will likely take a pause in the next policy meeting in July before resuming

its rate hike in September and by 25 basis points, bringing the OPR to

2.75% . Thereafter, the OPR will likely stay at this level for the rest of this year.

We expect the Central Bank to raise its key policy rate again in the early part of2011 and by a total of 50-75 basis points during the year, pushing the OPR to a more

normal level of 3.25-3.50% by end-2011.


14/14

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Documents

Economic Outlook - Risk Is A Sharper-than-expected Slowdown In In The 2H, Not A Double Dip - 18/6/2010