Recent QET

Recent QET

2018Q3: Growing but challenges still ahead

25 September 2018

Executive Summary


World Economic Situation and Prospects for 2019

  • Continued global growth, albeit less synchronised. The global economy continued to expand in the first half-year as firm labour market conditions remained supportive of private consumption. But, the growth is less even in advanced and Asian economies due to patchy pace of growth drivers. Private investment strength in some advanced economies have moderated while domestic demand in Asia has remained resilient. While global growth is expected to continue, albeit moderately in 4Q18 and for 2019 but the outlook is less rosy as the risks have increased.
  • High frequency indicators point to peaking and moderating growth. Composite leading indicators are pointing tentatively to easing growth momentum in the OECD area as a whole. The rate of global manufacturing expansion slowed again at the start of the third quarter. Global trade contracted in June amid there are early signs that the trade battles have begun to weigh on the global outlook as reflected in slower growth of PMIs in several economies. Strong consumer spending, rising wages and high energy prices have caused headline inflation in some advanced economies to move closer to the central banks’ comfort zone.
  • Solid US economy; weaker growth in euro area; Japan bounces back. The US economy recorded the best quarterly growth of annualised 4.2% qoq in 2Q18 in four years, supported firmly by solid consumer spending, rising wages amid rising inflation risk. But, the strong growth could diminish as fiscal stimulus fades after two years as well as being challenged by the on-going trade spat with China. The eurozone economy’s soft start to the year carried through in the third quarter, as rising inflation took a bite out of household spending while the political and trade concerns also likely weighed on momentum. For Japan, available data for the third quarter indicates continued growth. China’s economic growth softened further in early third quarter, weighed by continued financial deleveraging, the authorities’ crackdown on shadow banking and spillovers from its trade spat with the US.
  • The Fed will continue to raise interest rates gradually. The strong US economy and rising inflation have strengthened the case for the Federal Reserve (Fed) to continue hiking interest rates in September and December respectively, taking the Fed funds rate to 2.25-2.50% by end-2018 (1.25-1.50% by end-2017). Despite the eurozone growth was now passed its peak, the European Central Bank (ECB) has signalled that it remains on track with plans to halt bond purchases after December. Bank of Japan (BOJ) pledged to keep rates at extremely low levels for an "extended period". Some central banks in Asia have hiked interest rates either in bid to fight inflation or stem capital outflows due to higher US interest rates. Pressures on emerging markets’ foreign exchange and equities continue unabated as investors pulled out cash amid concerns that the strong US dollar and rising interest rate will pressure the cost of servicing some of the US$3.7 trillion in debt taken on in the ten years since the 2008-09 Global Financial Crisis.
  • Global risks have elevated. Alongside the continued economic expansions, downside risks to global growth have also been building up momentum. Investors are concerned that the likely inverted US yield curve could presage a recession in the US economy over next 12 months. Key risks include the intensification of trade war between the US and China as well as with other major economies; increasing geopolitical tensions; the Fed’s more aggressive interest rate hikes; higher market volatility and currencies pressure in emerging markets; elevated and rising levels of debt in both developed and developing countries.


Malaysia’s Economic and Financial Conditions

  • Weaker GDP growth in 2Q; moderate improvement expected in 2H18. The Malaysian economy moderated sharply to 4.5% yoy in 2Q from 5.4% in 1Q, taking GDP growth to average 4.9% in 1H18. The slowdown was caused by contractions in public investment, mining and agriculture sectors. Bank Negara Malaysia (BNM) revised 2018’s economic growth estimate to 5.0% from 5.5-6.0% previously. SERC remains cautious about growth in 2H18 and prospects for 2019, taking into account the implications of deferment or cancellation of mega infrastructure projects on private investment as well as the spillovers from the on-going escalation of trade war between the US and China. Accordingly, SERC revised this year’s GDP growth estimate to 4.8% from 5.2% previously. 2019’s real GDP growth was also revised to 4.7% from 4.9% previously. We will review our estimates after the tabling of 2019 Budget on 2 November.
  • Solid consumer spending. The numbers from consumer side of things continue to show spending buoyancy, with consumer spending rising by 8.0% yoy in 2Q (6.9% in 1Q), the highest since the first quarter of 2015. Will this strong household spending resiliency continue? The 3 months (Jun-Aug) “tax holiday” following the zerorised of the Goods and Services Tax (GST), which helped to boost consumer spending could be a one-off effect and will normalise somewhat in the last quarter of 2018 and in 2019. The record high consumer sentiments index (132.9 in 2Q vs. 91.0 in 1Q) in two decades was largely a reflection of Malaysians’ high enthusiasm on New Malaysia post 14th General Election (GE14). Overall, private consumption growth will normalise to 7.2% in 2018 and 6.8% in 2019 (7.0% in 2017).
  • Private investment growth bounces back but remains cautious. It was a relief that private investment growth has rebounded to 6.1% yoy in 2Q from a trough of 0.5% in 1Q, driven mainly by capital spending in the manufacturing and services sectors. But, there remain challenges to sustain its strength through providing greater clarity on domestic policies, including the status of on-going projects and new projects amid the dampened sentiments from the intensified external headwinds. We now estimate private investment to grow by 3.9% this year and 4.1% in 2019.
  • Exports fare well but beware of trade tensions risk. Malaysia’s exports expanded at a faster pace of 8.2% in the second quarter compared to 5.8% in 1Q18, supported mainly by firm demand of electronics and electrical products. In July, exports grew by 9.4%, bringing the cumulative growth to 7.3% in the first seven months. Amid the heightened risk of trade tensions on the export outlook, it is the high exports value technical base effect averaging RM80.6 billion per month in 2H17 that will challenge the annual growth of export performance in 2H18. We estimate exports to grow by 6.5% this year and 5.9% in 2019 (18.9% in 2017).
  • Inflation numbers to stay low for quite some time. Inflation rate, as measured by the Consumer Price Index (CPI) has been staying on a subdued trajectory (0.2% yoy in August; 0.9% in July; 1.3% in 2Q vs. 1.8% in 1Q18), reflecting largely the technical impact of high base effect, the zerorisation of GST for three months (June-August) and the stabilisation of fuel price (RON 95) as well as moderated food prices. With the reintroduction of Sales and Service Tax (SST) on 1 September, some pick up in prices are expected and along with higher minimum wage increases between 5.0-14.1% to RM1,050 in 2019 as well as the possible rationalisation of fuel subsidy for targeted groups, headline inflation will trend higher from estimated 1.3% this year to 2.0-2.5% in 2019 (3.7% in 2017).
  • Policy levers to shrug off weaker growth. Malaysia retains some buffers, including policy space, to cushion against adverse shocks. While the fiscal space is somewhat capped by continued fiscal and debt consolidation, high national savings about 29% of GNP, considerable foreign exchange reserves of US$104.4 billion as at end-Aug, a current account surplus, albeit smaller, a deeper and more developed financial markets should help to absorb as well as contain risks arising from capital flows reversal.
  • Faced with RM1.0873 trillion debt and liabilities or 80.3% of GDP (comprises RM686.8 billion direct debt and RM400.5 billion liabilities) at end-2017, and had endured unbroken 21 consecutive years of fiscal deficit since 1998 Asian Financial Crisis, this leaves new Government with no choice other than to return to “austerity” to keep the budget deficit and debt under sustainable and comfortable zone.
  • BNM to keep monetary arsenal for now. It is expected that a rate cut is “off the table” in the foreseeable future, restrained by rising US interest rates and hence, exerting downward pressure on the ringgit. Bank Negara Malaysia is expected to watch economic growth data closely to see whether an expected pick-up in GDP growth materializes in 2H18. Despite the weaker-than-expected second quarter GDP growth, the central bank is convinced the factors dragging down growth will dissipate in 2H18. SERC expects BNM’s Overnight Policy Rate (OPR) to hold steady at 3.25% for the rest of the year. The hurdle rate prompting a cut in interest rate is when real GDP growth slipping to around 4.0%.
  • Bearish outlook for ringgit at least in 1H19. The ringgit continues to trade lower by between RM4.0085 and RM4.1495 against the US dollar between the period July and 14 September, marking a depreciation of 2.5% when compared to end-June (-4.4% in 2Q) and 1.9% year-to-date (as of 14 Sep). Along with the pressures on emerging markets’ currencies on large capital reversals induced by the prospects of higher US interest rates and strong US dollar, the outlook for ringgit is expected to remain weak in 4Q18 and most of 1H19 before gathering strength towards 4Q19. Externally, the Fed’s interest rate cycle could be peaking in 3Q19 and hence, would take some pressure off the ringgit. Domestically, our economic and financial fundamentals must be kept strong to counteract the external pressures on the ringgit. These include continued surplus in the current account, healthy reserves accumulation, stable fiscal and debt path and the affirmation of Malaysia’s sovereign ratings.

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