2020Q2: Getting the Economy Back on Track

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Executive Summary

A. World Economic Situation and Prospects

NAVIGATING UNCHARTERED WATERS

• Navigating unchartered waters. Governments and central banks worldwide have unleashed unprecedented fiscal and monetary stimulus as well as other financial supports to limit job and income losses and “do whatever it takes” to tackle the pandemic and limit the economic damage. Amid lingering virus concerns and the availability of vaccine, there’s growing sense global economic recovery will be slow, depending on the effectiveness of countermeasures and policies to forestall the worse economic and financial outcomes, and to reduce contagion as well as support household and business recovery.
• IMF cuts further global outlook for 2020. The International Monetary Fund (IMF) again downgraded its already pessimistic outlook for the global economy, lowering this year’s GDP estimate to a larger decline of 4.9% from -3.0% predicted in April. The coronavirus impact and lockdown have had more economic damages in 1H 2020 than anticipated. A further decline in consumption, more job losses and the risk of a fresh wave of bankruptcies have heightened concerns about the path and shape of recovery. It expects global growth to recover by 5.4% in 2021.
• Reopening from the Great Lockdown. Now that governments worldwide have eased economic restrictions, mobility and activity in the US and Europe are starting to restart, albeit slowly as consumers and businesses will engage in more social distancing in a new normal. There are a lot of concerns about an occurrence of a second wave of coronavirus. High frequency indicators have showed mixed performance though we anticipate a more severe economic output contraction will hit the peak in 2Q 2020. There are three key areas that should serve as reliable indicators to ascertain a sustained economic revival: (a) Consumer sentiment and spending; (b) Unemployment and wage growth; and (c) Purchasing Managers’ Index (PMI) for manufacturing and services.
• Global interest rates to stay low for years. With the path forward for the global economy remains highly uncertain and subject to downside risks, long and short-term interest rates in the US and eurozone will likely staying low for some time until their coronavirus pandemic decimated economies getting back on a solid state of recovery. Interest rate normalisation, including the unwinding of central banks’ balance sheet expansion, if any will start at small steps, at the earliest in late 2021 or early 2022. The Fed has convinced markets that interest rates will stay low for a long time as it outlined two possible scenarios for the US economy: (a) Baseline forecast calls for an improvement in the second half-year and beyond; (b) Under a more pessimistic view, a second wave of the virus damages the economy around year-end.
• A number of risks that bear close watching: (a) A longer-than-expected global recovery due to the possible risk of a second wave of coronavirus; (b) Permanently demand and output destruction due to massive jobs and income losses as well as rising businesses’ bankruptcies; (c) Lingering uncertainty concerning the US-China’s trade conflicts; (d) Continued tightening of global financial conditions, rising bond yields could stall global economic recovery; and (e) Volatile movements in crude oil and commodity prices.

B. Malaysia’s Economic and Financial Conditions

GETTING THE ECONOMY BACK ON TRACK

• Malaysia reopens economy. After nearly three months hiatus due to the coronavirus, a full-fledge economic restart has begun in May-June. A RM35.0 billion PENJANA Short-term Economic Recovery Plan was rolled out, which is primarily aimed at protecting jobs and helping businesses recover from the adverse impact of the coronavirus pandemic. In total, PRIHATIN Economic Stimulus Package and PENJANA amounted to RM295.0 billion or 21.1% of GDP in 2020. It is estimated that these packages will contribute 3.0-4.0 percentage points to overall GDP growth.
• The deepest shock to economic activity will be concentrated in 2Q. We expect the large economic contraction estimated at 11.5% yoy to hit the peak in 2Q 2020 (+0.7% in 1Q), reflecting the full impact of Movement Control Order (MCO) in April and a gradual reopening in May-June. Exports have plunged by 25.5% yoy in May and 23.8% yoy in April. Retail sales and wholesale slumped by between 32.4% and 27.6% in April. Car sales have crawled back slowly in May and strongly on a month-on-month basis in June. Consumer spending and businesses are slowly on the mend. A smaller magnitude of GDP decline (-3.4%) is expected in 3Q before reverting to +2.2% in 4Q. Overall, SERC estimates 2020’s GDP to decline by 3.0% (4.3% in 2019) and will recover by 5.5% in 2021.
• Post COVID-19 and MCO recovery track. High frequency data and indicators (industrial production, exports, manufacturing sales, retail and wholesale) have declined sharply in April and May, which are in line with our assessment that the worst economic contraction will hit the peak in 2Q.
• Our recent channel checks indicated that a slow pick-up in business and economic activities post MCO though 15 million employees (98.8% of total workforce) have returned to workplace:

1. Overall manufacturing capacity rate is currently running at 70%-80% and 90%-100% for some high demand industries (gloves, electronics) while wearing apparels remained low at 30%-50%;
2. Footfall in major shopping malls are about 50%-70% while sales are up to 40%. About 10% retail outlets in some mid-tier malls have closed down (out of business);
3. Hotels’ average occupancy rates still low at below 30%, albeit has increased from below 20% previously. Allowing interstate travel, a pick-up in inbound tourism and the anticipated removal of cross borders’ restriction via “Travel Bubble” among green zones’ countries are expected to help revitalise the hardest hit tourism and hospitality sector, albeit gradually. We expect a firmer revival in 2H 2021, at the earliest; and
4. The resumption of construction activities has been slowed. It is hoped that all construction sites would be fully restored in the months ahead. During the sites’ inspection conducted between 22 June and 1 July, about 9%-29% of construction sites have not started operations while 56%-82% have complied with Standard Operation Procedures (SOP).

• Severe hit to the labour market would dent consumer spending. As widely expected, steep decline in activity comes with a catastrophic hit to labour market conditions, especially during the MCO.

1. Unemployment rate spiked to 5.0% (778,800 persons) in April, the highest since 1990. We expect the jobless rate to rise further to 5.5%-6.5% in the months ahead before stabilising towards end-year.
2. The Employment Insurance System (EIS) reported 53,952 employment loss in Jan-4 Jul 2020, with 23% in manufacturing sector, 15% in accommodation and food and beverages industry and 14% in wholesale and retail services. Professionals, managers, executives and technicians made up 58% of total employment loss while workers’ earning monthly wage below RM3,000 made up 62% of the total.
3. A total of 2.5 million employees have received wage subsidy and about 200,000 employees were placed under the Employment Retention Program (ERP) receiving a 6-month wage subsidy on no paid leave.

• It’s essential to track whether the inevitable increases in wage subsidy and employment retention will see a decline as sectors have reopened because people are returning to work or because they are losing their jobs definitively.
• While the loss in income due to layoffs (temporary or permanent) would dent consumer spending, a raft of financial assistance and cashflow relief measures (Bantuan Prihatin Nasional, EPF’s i-Lestari, loans moratorium, etc.) are expected to ease income and financial pressure to continue spending on discretionary items. Overall, SERC expects private consumption to slow to 1.5% in 2020 (6.7% in 1Q 2020; 7.6% in 2019 and 8.0% in 2018; an average growth of 7.1% pa in 2005-2017).
• Exports contraction to narrow in 2H 2020. Exports, which had grown by 1.1% yoy in 1Q, reversed to contract sharply by 23.8% in April and 25.5% in May, reflecting notable declines in electrical and electronics, petroleum products, chemicals, and LNG as well as palm oil.
• Global trade outlook remains dim, with the World Trade Organization (WTO) now saying that 2020 could see the worst collapse in international trade since the Great Depression. The WTO's optimistic scenario saw a 13% drop in the volume of international in 2020 (2009 GFC: -12%) while its pessimistic scenario sees a plunge by as much as 32% this year.
• With a gradual reopening of our major trading partners, especially the US and Europe and regional economies, including a lifting of lockdown in China in early April along with the lifting of domestic MCO in stages since May are expected to mend the sluggish exports demand at a measured pace. For now, we maintain our estimated exports decline of 11.2% in 2020 (2019: -1.7%).
• Deflation (not broad-based decline in prices) trend will last longer. Headline inflation, as measured by the Consumer Price Index (CPI), declined by -2.9% yoy in both April and May (+0.9% in 1Q), due to continued declines in prices of transport, utilities, clothing and footwear and non-essential items, especially household-related products and services.
• In Jan-May 2020, 27.3% of goods in the CPI basket saw decreases in prices. Core inflation, which excludes most volatile items (such as fresh food and administered prices (petrol) and services), still staying above 1.0%. Though fuel prices have increased month-on-month in May-Jun, the annual rate of decline will persist, albeit narrower throughout 2H 2020.
• Malaysia is expected to experience sustained months of deflation, which may last longer this time round when compared to the previous episode of deflation (Jan-Nov 2009). As long as there is no broad-based decline in prices for a sustained period, says at least more than a year, it is a lesser concern about a deflation.
• That said, the decrease in overall CPI will narrow in the months ahead and not all main groups will register decreases in prices. Electricity discounts for domestic users will be extended by another three months to end-Dec 2020 from Apr-Sep. Any price increases will likely to be at moderate pace as capped by the presence of slack capacity. Our estimated headline inflation is between -0.5% and -1.0% in 2020.
• There were ups and downs in the main groups of overall CPI basket, depending on demand and supply conditions, policy-induced (as in the case of 100% sales tax exemption on CKD motor vehicles and 50% exemption on imported passenger cars as well as electricity discounts), demand shock (fuel prices), etc. Volatile crude oil prices remain a wild card.
• Accommodative interest rates to support recovery. Bank Negara Malaysia (BNM) slashed the overnight policy rate (OPR) further by 25 basis points (bps) to a record low of 1.75% on 7 July, keeping some ammunition for buffer should the threat to economic growth accelerate.
• Further rate cuts underscore the need to provide additional stimulus to safeguard economic activities, which have begun to recover from the trough in the second quarter. This is to ensure that a firmer recovery amid the expiry of loan moratorium in September.
• BNM will continue to monitor economic conditions and credit market, and provide additional support and appropriate financial measures if necessary, which may not be confined to further cut in interest rates for now. Fiscal policy may be useful in speeding recovery from a deep recession and reducing the burden on monetary policy.
• A cumulative reduction of 150 bps in OPR since May 2019 (YTD: 125 bps) as well as RM295.0 billion PRIHATIN and PENJANA economic stimulus packages (fiscal, monetary, financial assistance and credit measures) have helped to limit economic damage of the COVID-19 and lift financial sentiment, which in turn supports a gradual economic recovery.
• Since May, most economic sectors and businesses have gradually reopened from a lockdown amid the compliance of SOP, paving the way for the resumption of activities. Amid a restoration of confidence and continued wary about the coronavirus, consumer spending is slowly on the mend.

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