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Author: AmInvest   |   Latest post: Thu, 28 May 2020, 9:03 AM

 

Malaysia - Balancing between ‘technical’ & ‘full-fledged’ recession

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While a “technical” recession has been fully factored in, the question now is whether the economy will dip into a “full-fledged” recession. This suggests that the economy is now balancing between a “technical” and “full-fledged” recession, as it is hurt by a combination of supply and demand shocks due to the unprecedented impact of the coronavirus on the global environment.

1H2020 will should witness negative growth due to weak global demand, supply chain disruption, travel restriction, the movement control order (MCO), weak commodity prices and continued supply disruption in the commodity sector. Even when the MCO is lifted, demand will be weak due to travel aversion and social distancing. But the economy is expected to improve in 2H, supported by fiscal and monetary measures. Also, the ongoing improved engagement between policymakers and businesses should result in a faster implementation and better policy consistency. Besides, should China get back to normal before the US, that should also lend support to our economy. Still the downside risk remains. On that note, the GDP growth projected by BNM of +0.5% and -2.0% is well within our expectation.

Meanwhile, the risk of headline inflation tilting towards deflation is in our cards. The downward pressure on inflation suggests strong expectations for a significantly lower global oil and commodity prices. Current developments surrounding global commodity prices, particularly global oil prices, remain highly uncertain. Should headline inflation fall into deflation, this will be the first, according to data going back to 1983. However, core inflation is expected to remain positive, averaging 0.8–1.3%. It reflects subdued demand pressures with a negative output gap being expected this year. In addition, labour market conditions are expected to be weaker in 2020.

With a lack of inflationary pressure (+ 0.5% and -1.5%), added with BNM’s commitment to stay vigilant in the face of Covid-19 developments, there is still room for BNM to reduce the OPR. The possibility for another 25bps cut during the 5 May MPC meeting is there. It could complement the SP2 worth RM250bil (17% of GDP) where RM22–25bil or 1.7% of GDP will be in the form of direct fiscal injection that is unlikely to strain the fiscal deficit position. Even if the total government revenue rises by RM22bil, the fiscal deficit should reach RM74bil or 4.9% of the GDP, which is lower than the 6.7% reported in 2009. This is also lower than the 5% threshold. And there are possibilities for the fiscal deficit to reach 4% of GDP from revenue-offsetting initiatives:

A. More of a technical recession risk for now

  • Since 1980s, the domestic economy has fallen into recession three times. The first was in 1985 where the GDP contracted by 1.0% following the collapse of commodity prices while the second recession was in 1998 due to the Asian financial crisis (AFC) that saw the GDP contract by 7.4%. The third recession was in 2009 due to the global financial crisis (GFC) that led to a 1.5% contraction in GDP.
  • This time around, the global recession is a result of the Covid-19 impact will be worse than the 2008 global recession due to adverse “demand shock” where both monetary and fiscal stimulus measures were employed. In contrast, the 1970s global recession was driven by adverse “supply shock” triggered by an oil shock that caused stagflation.
  • Looking at Malaysia, while a “technical” recession has been fully factored in, the question now is whether the economy will dip into a “full-fledged” recession. Hence, the domestic economy is now balancing between a “technical” and “fullfledged” recession simply because the global economy is in an unprecedented environment, hurt by a combination of supply and demand shocks.
  • Companies halted production in a move to curb the spreading of this virus among their employees in a “sudden stop” to economic activities as a result of lockdowns, movement control order and social distancing. Thus, the global economy including ours was disrupted and dislocated from supply chains, shipping, total trade and markets disruptions.
  • Consumers are unable to spend on the usual purchases of goods and services due to the lack of availability and loss of confidence. With more people being retrenched, consumers decided to cut back on their spending as their purse strings tightened.
  • Besides the virus impact, the domestic economy is affected by the sharp decline and volatile shifts in crude oil prices. It is due to softer global demand as well as excess supply owing to the tension between Russia and Saudi that has resulted in a price war. As a result, oil price fell below US$30 per barrel. We have revised downwards the Brent average oil price to US$35–40 per barrel. (BNM: US$25–25 per barrel)
  • Crude palm oil (CPO) is expected to be relatively stable as weaker external demand is offset by a he decline in CPO production. Low oil palm production since end-2019 is expected to extend to the early months of 2020 due mainly to the lagged impact of severe dry weather conditions experienced in 2019 as well as output constraints arising from the MCO. But these disruptions are anticipated to dissipate gradually as weather conditions normalise and oil palm production benefit from higher fertiliser application in early 2020. CPO per tonne is projected to average RM2,300 (BNM: RM2,000–RM2,200/tonne)
  • Uncertainties remain high from the virus impact. And the difference this time is the speed of decline and the comprehensive economic hit caused by an unpredictable health scare that resulted in an “economic stoppage”. While the policy response will provide some downside protection, the underlying damage from the virus attack will deliver material shocks. Also, the economy is hurt by the soft commodity prices.
  • Hence, we believe the economy will likely grow at 0.4%, a tad lower than BNM’s projection of 0.5% while the downside of our -2% GDP for 2020 is in line with BNM’s. We have factored in a technical recession with a negative 1H2020 growth and expect the economy to improve in 2H2020. An uplift to the economy will take place when the health crisis is eventually addressed.
  • The 2H2020 growth will be supported by domestic demand activities coming from the gradual improvement in household spending and further progress in the implementation of transport-related projects and higher public sector expenditure. Besides, the Stimulus Package 2 (SP2) of RM250 billion is expected to support to growth as it is poised to add 2.8 percentage points to GDP. The healthy engagement by the new government with businesses implies faster implementation and a greater level of policy consistency likely to emerge.
  • Private consumption in 1H is expected to be weighed by weak labour market conditions, mobility restrictions and subdued sentiments in the 1H2020. However, it should start to improve in 2H2020 when the virus impact eases and the measures targeted for households in SP2. Thus, we foresee the services sector, which is that main growth driver in 2019 on the back of robust consumer spending, will remain weak mainly due to the virus impact which is more pronounced in tourism and tourism-related activities. Even when the MCO is lifted, services activities will likely stay weak due to travel aversion and social distancing in 1H. We foresee room for pent-up demand due to the postponement of consumption following the lifting or further relaxation of MCO regulations. That should potentially benefit the services sector in the 2H.
  • Meanwhile, the public sector expenditure will play a key role in supporting the economy. It should see the construction sector playing a bigger role in 2H of the year and provide strong positive multiplier to the economy. The continuation of large-scale transport-related projects like the MRT2 (RM30.5bil), LRT3 (RM16.6bil), and Pan Borneo Highway (RM32.5bil) and the implementation of upstream oil and gas, telecommunication and power generation projects by public corporations underpin the improvement in investment by the public sector. Higher spending by the federal government on the economic stimulus packages will lend further impetus to growth. These include the implementation of more small-scale projects worth RM4 billion, higher special allowances for medical personnel, the hiring of temporary contract nurses and increased allocation for the Ministry of Health.
  • Meanwhile, exports will remain weak due to weaker global demand following the spread of Covid-19 across many major economies. Manufacturing activities in the electrical and electronics (E&E) cluster will be adversely affected by weak external demand. Post-MCO period, external demand will continue to stay subdued due to weak demand from key export markets. Commodity exports are expected to contract from lower prices of crude oil and LNG, as well as weaker commodities production.
  • Imports are also expected to remain soft due to poor exports and domestic demand. Intermediate imports are projected to decline in line with the weakness in manufactured exports. Capital imports will register a smaller contraction as slower domestic investment activity will be partially offset by the delivery of the Petronas Floating Liquified Natural Gas 2 (PFLNG2) in 1H. Consumption imports are to fall from slower domestic demand conditions.

B. Risk of tilting into deflation

  • Headline inflation is envisaged to average between + 0.5% and -1.5% which is well within our projection of +0.3% and - 1.5%. The downward pressure on inflation suggests strong expectations for a significantly lower global oil and commodity prices. Current developments surrounding global commodity prices, particularly global oil prices remain highly uncertain. Should headline inflation fall into deflation, this will be the first based on data going back to 1983.
  • Without the direct downward impact from lower global oil prices, core inflation is expected to remain positive, averaging 0.8–1.3%. It reflects subdued demand pressures and a negative output gap is expected this year. In addition, labour market conditions are expected to be weaker in 2020.

C. Still room for monetary easing

  • Thus far, BNM has reduced the policy rate by 50bps to 2.50%, reducing 25bps each in January and March. Besides, the SRR was cut by 100bps to 2% and BNM will recognise MGS and MGII for SRR compliance only by the principal dealers. Thus, the cumulative liquidity injected amounts to RM30 billion into the banking system.
  • With a lack of inflationary pressure, added with BNM’s commitment to stay vigilant in the face of Covid-19 developments, there is still room for BNM to reduce the OPR. The possibility for another 25bps cut during the 5 May MPC meeting is there. It could a complement the SP2 worth RM250 billion (17% of GDP) where RM22–25 billion or 1.7% of GDP will be in the form of direct fiscal injection that is unlikely to strain the fiscal deficit position. Even if the total government revenue rises by RM22bil, the fiscal deficit should reach RM74bil or 4.9% of the GDP, which is lower than the 6.7% reported in 2009. Besides, it is lower than the 5% threshold. And there are possibilities for the fiscal deficit to reach 4% of GDP from revenue-offsetting initiatives.
  • With the direct spending amounting to RM22–25 billion, our MGS + GII supply could rise to RM145bil from previously RM125 billion. It is based on a 4.9% fiscal deficit with RM71.6 billion of financing needs. However, it does not take into consideration of potential debt switch by BNM and foreign debt issuance. BNM switching will lower gross issuances. And foreign debt issuance is limited at RM29.4 billion outstanding against RM35 billion statutory cap. The government only has a RM5 billion limit to issue foreign currency debt.
  • Meanwhile, the demand for government bonds will be influenced by the lower contribution from the EPF and the flexibility given to life insurance/takaful policyholders as they can now defer insurance premiums for 3 months between April and December. It will depend on the take-up rate and the timing. Also important is that large pension funds tend to invest counter-cyclically with a preference to riskier assets like equities when the asset price is in a down cycle. This could affect their demand for safe but relatively lower-yielding government bonds.
  • Besides, with greater measures coming from the non-fiscal side, our focus will now be on the “off-balance sheet” mode of funding. If we recall, during the period of 2009 and 2017, the government depended on government guarantees (GG) and public private partnership (PPP) to fund key government projects. It raised the government’s contingent liabilities to RM238 billion from RM84.3 billion in 2009. Although the government’s exposure to the “off-balance sheet” slowed substantially in 2018 and 2019, room for it to pick up could happen, especially with the need for higher public spending. Implications on the medium-term corporate bonds credit spread will depend on the size the off-balance sheet used.

D. Slight risk for household debt to rise

  • In 2019, household debt rose faster by 5.3% from 4.7% in 2018, mainly driven by an increase in the purchase of residential properties. The demand for residential loans was bolstered by the Home Ownership Campaign in 2019. As a result, the household debt-to-GDP ratio edged slightly higher to 82.7% of GDP from 82.0% in 2018.
  • Despite the rise in household debt/GDP, the debt-servicing capacity of the household remains stable as both outstanding household financial assets and liquid financial assets remained broadly stable at 2.2 times and 1.4 times of debt, respectively.
  • Nonetheless, there are some pockets of risk, in particular, among borrowers with monthly earnings of less than RM3,000 and housing loan borrowers with variable income. Still, the overall risk to household sector is contained as the debt-atrisk (DAR) remains low at 5.2% of total household debt and is well within the banks’ excess capital buffer. Besides, the share of borrowers from the vulnerable income group declined to 17.6% of total household debt, while the exposure-atrisk for housing loan borrowers with variable income remained low at 2% of total banking system loans
  • The non-financial corporate debt (NFC) debt fell below 100% of GDP for the first since 2015 to 99.4% in 2019 from 102.0% in 2018 mainly due to the redemption of maturing bonds and the settlement of intercompany loans by several oil and gas firms.
  • In addition, the overall business financial standings remained heathy despite challenging macro environment in 2019, added with commodity-supply disruption. The aggregate median operating margin, which is a measure of profitability, remained broadly stable at 5.7% (2018: 5.6%), while firms’ leverage and debt servicing capacity continued to remain above the prudent levels of 25.1% (2018: 24.9%) and 5.7 times (2018: 5.6 times). Meanwhile, the median cash-to-shortterm debt ratio rose to 1.0 times in 2019 from 0.9 times in 2018.
  • But the economic conditions today are far different when compared to those during end-2019. The effects of Covid-19 now question whether the current economic crisis can potentially threaten our macroeconomic and financial stability. The concerns are mainly concentrated on: (1) household borrowers due to the still elevated household debt and softening labour market; (2) tourism and manufacturing sectors as they represent about 44% of banks’ business loans; and (3) the overall banking sector outlook.
  • Given that banks have effectively implemented countercyclical measures, especially on loan moratorium for six months for SME businesses and households, this should help them manage their debt in the current environment. Also, the steady built-up of capital and liquidity in the banking system over the years has continued to support lending activities and contain broader risks to financial stability.
  • Based on a sensitivity analysis, the impact of severe stress scenarios (income, cost of living, and borrowing cost shocks) on household borrowers’ debt repayment capacity, potential losses to the banking system are estimated to be between 42.6% and 67.5% of banks’ excess capital buffers.

Source: AmInvest Research - 6 Apr 2020

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