2021Q2: Malaysia’s Recovery Path: Realistic vs. Hopeful

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Executive Summary

A. World Economic Situation and Prospects

GLOBAL RECOVERY CONTINUES AMID PANDMEMIC FAR FROM OVER

• Global recovery continues amid the COVID-19 pandemic still weighs. Global economic prospects continue to improve. The global economy remains on track for a strong but uneven recovery in 2021 as the pandemic weighs.
• Global economic indicators still looking positive, albeit easing off from the high. So far, so good. Most advanced economies have reopened their economy as the vaccination rates accelerate. Global PMIs indicated that global economy expanded at a solid rate again in June, albeit slowed slightly, led by the service sector while manufacturing also continued to expand strongly. Global trade and industrial continued to rebound not only in sectors related to the COVID-19 (e.g. semiconductors, pharmaceuticals, communication and office equipment) but also increased for most other sectors, such as commodities, minerals and agro-food. Higher prices of commodities also helped to raise export earnings.
• Markets’ focus on inflation and the timing of interest rate normalisation. With the continued strength of growth rebound in the US economy, along with the inflation spikes and expectations, albeit perceived to be transitory in nature, due to the low base effects and supply bottlenecks, may eventually force the Fed starting to signpost tapering of asset purchases and eventually raise the short-term interest rates. We expect the Fed to commence tapering in late 2021, with the second half of 2022 the likely timing for the first interest rate hike, but on a measured pace.
• • Downside risks to outlook remain. The outlook is subject to considerable uncertainties. A more persistent pandemic as new more contagious variants are spreading fast, but the existing vaccines are not ineffective against these new variants. Stagflation risk (high inflation and low economic growth), a wave of corporate bankruptcies and financial stress, the prolonged sluggishness in labour market and renewed weakening consumer spending. Premature aggressive monetary withdrawal, including interest rate normalisation could result in tighter global liquidity conditions and asset prices volatility.

B. Malaysia’s Economic and Financial Conditions

THE RECOVERY PATH DISRUPTED AS LOCKDOWN AND RISING INFECTIONS BITE

• • Malaysia’s recovery path suffers a temporary setback in 2Q and early 3Q 2021. The Malaysian economy recovery, which saw real GDP’s contraction narrowed from -3.1% yoy in 2H 2020 to -0.5% in 1Q 2021, hit a speedbump in June-3Q 2021 as the worsening virus resurgence forcing the reimposition of lockdown and stricter containment measures led to fresh concerns about the risk of stalling the recovery path in 2H 2021.
• Starting on 1 June 2021, the Government has implemented a nationwide full lockdown (FMCO) under Phase 1 of the National Recovery Plan (NRP) to curb rising infections amid the slow vaccination rates. At this point of writing, movement restrictions remain in most states while six states in Peninsular Malaysia (Perlis, Pulau Pinang, Perak, Kelantan, Terengganu, and Pahang) and Sabah have moved into Phase 2 of the NRP, which has allowed more economic sectors and higher manpower capacity in the positive list of reopening.
• Deeper and longer economic scarring effects. The lockdown and restricted containment measures have taken a heavy economic toll on domestic demand and business activities via a cutback in demand, supply disruptions, reduced income, weakened consumer sentiment and restricted mobility.
• Maintained 2021’s GDP growth estimate at 4.0%, subject to downside risk. Our GDP growth estimate of 4.0% for this year is under threat, depending on the future path of virus containment, the pace of vaccination rate as well as how long it takes moving to Phase 2, 3 and 4 of the National Recovery Plan for the reopening of more economic and social sectors.
• The lockdown in June has punctuated the low-base effect aided annual comparison in 2Q 2021. July and August are important months to watch as the high level of vaccination rates will offer a glimpse of hope for a fast transition into phases 3 and 4, allowing more economic sectors in the positive list and also social sectors to start operations accordingly.
• We expect continued recovery in 4Q 2021 as a restoration of consumer spending will be supported by the progress of vaccination, and the containment of virus spread. Amid some pent-up demand, the continued cash aid and loan moratorium help to provide a temporary cash flow relief but a weak recovery in the labour market remains a drag on consumer spending. Lingering political uncertainty remains a drag on investors’ confidence.
• Exports still going strong. In the first five months of 2021, exports have bounced back strongly to grow by 31.1% yoy, partly aided by low-base effect last year (due to the lockdown induced demand and supply disruptions), and the improvement in global demand of electronics and electrical products, rubber products, chemical products, metal products as well as higher prices of commodities and crude oil have had helped to lift exports higher.
• We expect the renewed lockdown in June and July with a 60% manpower capacity for the export-oriented industries, manufacturing sector and plantation would hamper the delivery of exports shipment, and may result in the cancellation of future orders as the buyers are concerned whether their orders can be fulfilled without interruption. Amid a divergent recovery between advanced and regional economies, exports are expected to grow by 15.8%, with stronger 1H (estimated 26.7% yoy) before slowing to estimated 6.6% yoy in 2H 2021 as the low base effect dissipates. Global demand of electronics will be sustained by increasing usage of digitalisation, data solutions and applications, as well as the 5G development. Palm oil and crude oil prices are expected to hold at steady level, underpinned by firm global demand
• Inflation spiked in 2Q on low base effect. The Consumer Price Index (CPI) increased by 4.4% yoy in May (4.7% in April and 0.5% in 1Q), bringing the CPI growth to 2.1% in Jan-May 2021, due to the lower base effect last year.
• Headline inflation is expected to moderate to below 4.0% in the near-term as low base effect dissipates. Underlying inflation, as measured by core inflation (0.7% in Jan-May 2021), is expected to remain subdued amid continued spare capacity in the economy. Crude oil prices remain a wild card. Without the continued fuel price subsidy for RON95, headline inflation would have increased much higher. SERC estimates inflation to increase by 3.0%-4.0% in 2021 (-1.2% in 2020)
• Data driven monetary policy. DThe current appropriate and accommodative stance of monetary policy, supported by fiscal and financial relief measures (such as loan moratorium, EPF withdrawals, and cash payments) are expected to cushion the prolonged pandemic impact on businesses and households.
• During this pandemic and lockdown as well as restricted movements-induced supply and demand disruptions, monetary policy has its limitation relative to a quick and timely fiscal stimulus. Hence, further lowering of interest rate may not be effective to spur consumption and investment demand. Households’ cautious sentiment, worried about rising infections, restricted mobility as well as concerned about job security and income prospects due to the disrupted economic recovery, causing cautious discretionary spending. Businesses adopt a wait-and-see investment stance until more clarity amid lingering political uncertainty.
• We reckon that a reduction in interest rate can provide partial cash flow relief for borrowers but direct cash flow assistance, such as cash handouts to targeted households and automatic loan repayment moratorium would be handier. With the current restricted movements likely to be a temporary one, it is appropriate to reserve the monetary arsenal (a historic low interest rate) for future shocks. Hence, we expect BNM to keep the overnight policy rate (OPR) steady at 1.75% by end-2021.
• We expect Bank Negara Malaysia (BNM) to continue closely monitor developments surrounding the pandemic, including the incoming data and information to ascertain that the economic recovery is not stalled and derailed in the quarters ahead. The central bank also weighs on domestic inflation expectations, and also the implications on exchange rate and capital flows arising from the Fed’s tapering of bonds purchase and the eventual increase in interest rate in 2022-2023.

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