2022Q2: Malaysia Braces for A Bumpy Ride in 2H 2022

12 July 2022

A. WORLD ECONOMIC OUTLOOK UPDATE

US RECESSION FEARS DARKEN OUTLOOK FOR GLOBAL GROWTH

Inflation has been higher than expected in many economies, compelling most major central banks to raise interest rate. Both the financial and foreign exchange markets continue to remain volatile and the geopolitical tensions have increased.

In the US economy, a recession seems inevitable. Both the exogenous supply shocks and the Fed’s aggressive interest rate hikes to tame persistent high inflation (both cost-driven and wage-price spiral are at play) are expected to damp consumer spending and restrain business activity. The US GDP contracted by 1.6% annualised qoq in 1Q 2022.

The eurozone’s subdued economic growth in 1Q 2022 is leaning more towards more downside risks with a recession risk is rising. Consumers’ purchasing power are being squeezed by surging inflation, dampening their willingness to spend. A prolonged period of supply chain disruptions and high energy prices poses a high downside risk to the industrial sector.

While the Japan economy contracted slightly lower than expected by 0.5% annualised qoq in 1Q 2022, persistent supply chain disruptions remain a risk to economic momentum in April-June. Soaring raw materials cost and the faster-than-expected US monetary tightening will impact the economy.

In China, multiple indicators (sales, industrial production, and fixed investment) have either weakened or contracted in recent months, indicating a grim economic outlook. The zero COVID-19 strategy and the lockdowns in some cities/provinces as well as the troubled real estate sector not only have disrupted the supply chains but also stalled economic and business activities in 2Q. We see China’s reduction of quarantine period to 7+3 days for all inbound travellers as a positive sign. While the rolling out of a package of 33 measures covering fiscal, financial, investment and industrial policies, easing of liquidity and credit measures would help to shallow the magnitude of economic slowdown, but the uncertainties in the global environment will pose a big hurdle to China economy.

Central banks bite the bullet on rate hikes as taming inflation takes priority. Against the challenging backdrop of higher and longer inflationary pressures, weaker economic growth, tighter financial conditions, weakening emerging market currencies, the central banks are confronted with a difficult task to act forcefully on inflation while not risking of sapping their economies.

If the central banks hold back to hike interest rates or raise interest rate gradually and endure the supply-crunch inflation, it will result in entrenched higher inflation expectations, prompting companies and employees to push up prices and demand higher wages, respectively. If this happens, it is extremely costly to bring inflation down if inflation expectations don't come down. The central banks may later be compelled to pump the brakes on the economy even harder to get inflation under control.

B. MALAYSIA ECONOMIC OUTLOOK UPDATE

BRACES FOR A BUMPY RIDE IN 2H 2022

A good start in 1Q 2022. The Malaysian economy off to a good start in 1Q 2022 as real GDP increased by 5.0% yoy and 3.9% qoq. This was attributable to three reasons: (a) Recovery in domestic demand, which added 4.2 percentage points to 1Q GDP growth, thanks to the reopening of economy, and also continued expansion in exports though was offset by higher imports; (b) Low-base effect; and (c) Changes in inventories, which added 2.2 percentage points to GDP growth in 1Q, are expected to remain a tailwind for economic growth this year. Faced with the persistent supply disruptions, businesses had been relying on inventories to keep up with the recovery consumer spending amid rising inflation. However, increased costs; higher cost of raw materials; and the shortage of workers would restrain companies to bolster production and restock.

Recovery momentum continued into 2Q 2022. Despite restrained by a high base in 2Q 2021 (+15.9% yoy), we estimate real GDP growth to increase by 6.0%-6.5% yoy in 2Q due to: (a) The reopening of economy, including international borders help to revive international tourists and boost demand for local services; (b) Hari Raya festive celebration spending effect; and (c) The EPF’s fourth withdrawal amounting to at least RM40.1 billion, of which 40% of the withdrawal will be for the purpose of supplementing daily/monthly essential expenditure.

But, rising inflation and increased business costs are dampener. Consumer inflation is creeping higher from 2.2% in 1Q to 2.3% in April and 2.8% in May, with food inflation increasing from 3.8% in 1Q to 4.1% in April and 5.2% in May. Core inflation, which measures the underlying inflation trends exclude volatile food and energy, has increased steadily to 2.4% in May (April: 2.1% and 1.8% in 1Q). Bank Negara Malaysia (BNM) also tracks core inflation when setting the monetary policy.

We are keeping our GDP estimate of 5.2% in 2022 (3.1% in 2021), expecting a moderate pace of economic growth between 4.5%-5.0% in 2H vs. estimated 5.0%-6.5% in 1H 2022. Entering the 2H 2022 and 2023, there is a growing danger of global stagflation and the US economy could slip into recession. Stronger consumer prices and costs pressure as well as rising cost of living are expected to weigh on domestic demand.

Bank Negara Malaysia to maintain a delicate balancing act between growth and inflation. Both the headline and core inflation have been trending up in recent months, due to supply constraints cum cost driven and partly due to recovering consumer demand.

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