The key highlights of Bank Negara Annual Report 2018 are:

1. Moderate growth supported by private expenditure

2. Manufacturing and Services will be the key drivers and recovery from commodity supply disruption

3. Upside pressure on inflation will be capped

4. Room for Overnight Policy Rate (OPR) cut

5. Broadly, our fiscal position is still on the right track

6. Risk for household debt to rise remains

7. Property market residential property should improve gradually while the risk in commercial space remains

Moderate growth supported by private expenditure

• Bank Negara Malaysia (BNM) projects the 2019 GDP to grow between 4.3% - 4.8%, which falls within our base case growth of 4.5%. However, BNM’s target GDP growth is 4.7% for 2019. Growth will continue to be supported by domestic activities, underpinned by sustained expansion in private sector activity.

• Private consumption is expected to moderate. Although household spending will be supported by stable labour market conditions, continued wage growth and the several government measures implemented to alleviate rising cost of living, especially by lower income households, their overall positive sentiment is being knocked down by the ongoing uncertainties coming from both external and also internal.

• In the case of private investment, it will benefit from the implementation of on-going multi-year projects, particularly in the manufacturing and services activities. Besides, the normalisation of destocking activities by firms following a strong demand during the tax holiday period in 2018 will serve as an additional impetus to growth. But the upside on private investment activities is curtailed by the weakening sentiments. Forward looking indicators are suggesting a slower rate of expansion, which mean delay in investment plans.

• Slower public sector expenditure is a result of lower investment by public corporations. This comes about following the completion of large-scale projects, while the expectations for a moderate growth in public consumption reflect the continued reprioritisation of government spending.

• Exports is also envisaged to moderate in tandem with the moderate global and trade outlook. Besides, the increasing stiff competition amongst its regional peers and lose of comparative advantage is expected to take a toll on exports. Adding on, the Electrical & Electronics sector is expected to ease in 2019 with global semiconductor sales projected to grow around 2%-3% from strong double digit growth in 2017 and 2018, implying the ‘semiconductor cycle’ has peaked and is on the downtrend. However, exports will be sustained from the still positive contribution from manufactured exports that will more than offsets the decline in commodity exports. Also, sustained demand from selected emerging economies, particularly in the ASEAN region, will mitigate partial impact from slowing demand from major economy.

• Thus, for the economy to move to a higher growth levels especially with the increasing erosion of our comparative advantage within our peers of ASEAN-6 (Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam), there is an urgent need to take stock of the current structural reform programmes and institute new measures and policies where necessary. New fast growth areas need to be identified, especially in the areas of technology and ideas. Businesses need to recognise their shortcomings and take quick measures to fix them. Besides, there must be a greater coordination between the MNCs and SMEs especially in the production of supply chain. Moving away from cost-minimizing model and produce more sophisticated product can demand higher premium and bode well from private investment too.

Manufacturing and Services will be the key drivers and recovery from commodity supply disruption.

• Although manufacturing activities is projected to be the main driver of growth in 2019, overall its performance is expected to moderate due to slower E&E growth. Demand for semiconductors is expected to soften as the global techcycle has peaked. But the downside is cushioned by the growing demand for more values added equipment from the automotive and medical sub-sectors. Also, normalisation of destocking activities by firms and the positive impact from other areas of manufacturing activities such as consumer-related, resource based export activities as well as ongoing construction-related activities will provide the positive cushion to the sector.

• Besides, the services activities will remain as a key growth driver. The segment of the economy will continue to benefit from the wholesale and retail trade, food and beverages and accommodation sub-sectors. Besides, positive impact will come from the information and communication sub-sector through higher demand for broadband services, due to lower subscription prices. The increasing focus on digital economy and digital marketing will further support the information and communication activities.

• Construction activities and businesses related to it will moderate in 2019. This is due to slower growth outlook envisaged from both the residential and non-residential segment owing to the issue of excess supply. Besides, with the completion of large projects petrochemical projects in the civil engineering sub-sectors, the sector is expected to stay the subdued.

• Meanwhile, the commodity-related sectors i.e. mining and agriculture should show some signs of turnaround but with a modest growth. Despite the recovery from the mining field which is expected to commence full production in 2H2019, its overall growth will be partially offset by the decline in crude oil output following production constraints and extension of voluntary supply adjustments by PETRONAS. Agriculture activities is forecasted to rebound in 2019 driven by the higher palm oil output as well as continued expansion in mature oil palm areas.

Upside pressure on inflation will be capped

• Headline inflation is envisaged to average between 0.7% - 1.7% in 2019 which falls within our project of 1.0% - 1.5%. Though there are some upwards domestic cost pressures such as the lapse impact from consumption tax, an increase in minimum wage, and higher electricity tariffs surcharged for businesses, it will be mitigated by blanket fuel price subsidy by mid-2019.

• Meanwhile, the underlying inflation will to continue to grow moderately, supported by sustained economic expansion as well as from the temporary tax holiday. But the upside should be contained from the improving level of labour productivity and ongoing capacity expansion by businesses to contain inflationary pressure.

• However, inflation risk will continue to track on the global crude oil prices, weather conditions that can affect food supply, and strength of global inflation.

Room for Overnight Policy Rate (OPR) cut

• After instituting 25bps hike to 3.25% in 2018, monetary policy remains accommodative and supportive to the real economic activities. Now, with inflationary pressure remaining benign and domestic growth is expected be sustained, monetary condition is expected to stay accommodative to support growth.

• But the downside risk to domestic growth is rising, coming from the growing on the global environment, commodity related supply disruption, persistent commodity-related shocks, and volatility in global capital flows. Added to it is the ongoing domestic challenges.

• So, on the OPR outlook, BNM has reiterated its commitment to rely on broad range of policy tool i.e. monetary policy, micro- and macro prudential measures, to manage emerging risk. Besides, BNM also said they will be data dependent when considering their policy options.

• And with the recent key macro data suggesting economic condition on the whole is turning weak, more importantly are the forward looking indicators, it supports our view for a 25bps rate cut in 2H2019 in a move to support growth. Besides, with lack of domestic inflationary pressure and now the US Fed has paused on its rate hike, that further opens the door for BNM to cut rate in 2H2019. Adding on, we expect the USD/MYR to stay firm around 4.06 to 4.10 end-period of 2019 which stands as our base case while best case for USD/MYR is between 3.85 -90 by end-period 2019, implies import cost pressure will be fairly muted.

Broadly, our fiscal position is still on the right track.

• Preliminary estimates on federal government finance shows fiscal deficit as percentage GDP stood at -3.7%. Moving forward, the fiscal position will gradually consolidate to -3.4% of GDP in 2019 and -3.0% in 2020. The path towards fiscal consolidation is attributed by (1) enhancing expenditure effectiveness through the implementation of zero-based budgeting; (2) proposal to broaden tax revenue; and (3) ensuring transparent debt management.

• With development expenditure targeted at RM54.7bil and incoming maturities at RM69.0bil, we estimate the gross issuance of government bonds at RM121bil. This will be the highest gross issuance since 2017’s issuance of RM107.5bil. Our estimation is done without taking into account of switch auctions that can trim maturities in 2019. However, prior to the BNM annual report meeting, the government tabled a supplementary budget of an additional RM15.5bil in funds for development expenditure. That said, the supply of bonds is expected to increase further should the government approved the supplementary budget.

• Looking at corporate bonds in 2019, we expect gross issuance to hover around RM80bil to RM90bil. Our projection is based on the notion that (i) softer public investment growth; (ii) a moderate domestic GDP growth of 4.5%; and (iii) slower pace of global investment. We expect a material decline in gross issuance of unrated GG and infrastructure-related corporate bonds as a result of the government’s reprioritisation efforts.

Risk for household debt to rise remains

• In 2018, household debt slowed down to 4.7% from 4.9% in 2017, mainly driven by slower growth in loans by non-bank financial institutions (NBFIs). Total household debt lower to 83.0% as a result of deceleration in housing loan and motor vehicle loan. While the household assets to debt ratio remained high at 4 times, the household financial assets expanded at a slower rate in 2018 despite its consistently outpace the growth of debt.

• The slower expansion of financial assets reflected the weaker equity market in 2018. Regardless, household continued to maintain comfortable levels of financial assets and liquid financial assets (LFA) at 2.1x and 1.4x of debt, respectively.

• The overall quality of loan to household remained sound with the impairment ratio improving to 1.2% while the delinquency ratio stabling at 1.2% for the year. Although household debt risk remains elevated, about two-third of household debt are secured by property or securities, thus reducing the net exposures of financial institutions. Moreover, 70% of the new-approved loans have remained below 60% of debt service ratio (DSR) along with the banks’ prudent lending and risk management practices.

• The risk, however, still skewed towards the lower income group, particularly, those earns less than RM3,000. With an LFA cover less than one time (0.6x) of total debt, borrower in this group face substantially higher risks of defaulting on their loans in the event of an income shock. However, their share of household borrowings has continued to decline in recent year (2018: 19.3%; 2017:19.9%).

• In 2019, room for the household debt to experience some upward pressure is on the cards. Upwards pressure on NPLs is evident with the economic outlook is expected to continue moderating as we foresee the softening sentiments from both investments and household besides anticipating rising unemployment.

Property market residential property should improve gradually while the risk in commercial space remains

• Housing prices moderated to 1.1% based on the preliminary data for 3Q2018 (1H2018: 4%). Easing house price growth was mainly due to the weaker demand for properties in higher prices segments, especially properties priced above RM500K which result in the further increase in the unsold housing units by 22.5%. It was also due to the adjustment in housing supply towards more affordable segments as firm demand was seen on house priced below RM500K.

• But speculative activities remained subdued as the numbers of borrowers with 3 or more outstanding housing loan grew 0.1% annually in 2018 from 1.0% in 2017. With several measured introduced by the Government and also the demand for affordable housing, the outlook for the housing market is expected to gradually improve along with greater alignment between demand and supply. Thus, a large and broad based decline in residential house price is not expected in 2019.

• Looking at the non-residential property segment, the large incoming supply of new and planned office space in Klang Valley and retail space nationwide is expected to amplify existing oversupply issues. This despite moderation in loans approved for the construction of office space and shopping complexes (OSSC) to 73.1% in 2018 from 2017’s 79.7%. With the risk of these additional commercial spaces being unabsorbed, given the deterioration in vacancy rates and potential headwinds to domestic economy, risk of property prices adjusting sharply lower remains elevated. Resultantly, banks are expected remain cautious in lending to OSSC segment as the loan approval rate lower to 66.7% in 2018 (2017:76.8%).

• Overall, the quality of banks’ loan for residential and non-residential properties remained sound, underpinned by prudent underwriting and valuation practices. The impairment ratio remained low with both residential and non-residential property up 0.1% to 1.1% and 1.3% respectively. Despite the liquidity position for property development being firm which is measured by median cash-to-short-term debt ratio to be at a low of 0.7 times, the debt servicing capacity remained healthy as the median interest coverage ratio (ICR) comfortably sits at 4x, two folds above the threshold.

• Exposures of banks to the OSSC segment remains small as it only attribute 3.4% and 6.5% of banks’ total outstanding loans and holding of corporate bonds respectively. Furthermore, 72% of outstanding housing loans have a loan-to-value ratio of 80% and below, this limiting potential losses to the banking system.

Source: AmInvest Research - 28 Mar 2019