PublicInvest Research

BNM 2022 Annual Report - Amelioration of Output Gap in 2H23

Publish date: Thu, 30 Mar 2023, 10:38 AM
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The current state of the global economy is marked by a confluence of multiple, complex, and interconnected crises. These crises, including inflation, climate change, the ongoing war in Ukraine and supply chain disruptions, among others, have coalesced into what experts are terming a "polycrisis". Despite targeted policy measures and initiatives, which have helped to mitigate the effects of the war in Ukraine, this conflict remains a significant challenge to global economic recovery and stability. One particularly concerning impact of the war in Ukraine has been a reversal in the decades-long process of global economic integration, with disruptions to existing regional and global supply chains. The long-term cost of this trade fragmentation could be significant, ranging from 0.2% to almost 7% of global GDP, according to IMF scenarios. This fragmentation would stem from reduced global trade flows, technological decoupling, sectoral misallocation, lower innovation diffusion, and slower productivity growth, among other factors. Beyond the war in Ukraine, other factors threaten to prolong the polycrisis. Tighter-than-anticipated labour markets and higher commodity prices resulting from China's reopening may keep inflation elevated for an extended period, necessitating tighter monetary policy. High borrowing costs, unstable exchange rates, and disorderly capital outflows could lead to debt distress among vulnerable emerging market economies. Moreover, tight financial conditions could exacerbate existing imbalances within the financial sector.

Despite the many challenges that continue to weigh on the global economy, there is reason for optimism in the form of China's earlier-than-expected reopening. The resumption of economic activity in the world's second-largest economy is a positive development, as it will not only re-integrate China with the rest of the world but also ease fears of a potential recession. This is especially good news for export-oriented economies that have been severely impacted by the pandemic, as rising demand from China will help to buoy their economies. Although the full impact of this development may not be felt immediately, it is expected to be significant in the later part of the year. Furthermore, this positive development will help to offset some of the weight on the global economy, thereby providing a glimmer of hope for a brighter future. As the risks and uncertainties surrounding the global economy continue to moderate, the IMF has raised its global growth forecast by 0.2ppts to 2.9% in 2023, although the balance of risks remains tilted to the downside, in line with BNM's view.

On the local front, amidst the rapidly-evolving uncertainties that surround the global economic landscape, Bank Negara Malaysia (BNM) has tempered its expectations for GDP growth in the coming year. With an annual growth forecast ranging from 4.0%-5.0% for 2023 (8.7% in 2022), BNM is exercising caution in light of external risks that could impact the economy. Taking the computations at mid-point, calculated based on GDP forecast at constant price, BNM is cautiously optimistic and expects the country’s underlying real GDP growth to be around 4.5% for 2023, which is higher than our in-house forecast of 3.8%. The primary driver of this variance is BNM's stronger growth projection for public investment, which is expected to expand by 7.0% compared to PIVB's estimate of 4.0%. This growth is anticipated to be driven by sustained support from the government and public corporations, including the implementation of projects outlined in the re-tabled Budget 2023. While downside risks remain, particularly from external factors, BNM's projection for stronger domestic demand is expected to offset these risks and maintain a balanced outlook for Malaysia's economic growth.

Moreover, the negative output gap is set to turn positive in the second half of 2023, as actual output is anticipated to average close to potential output for the year. This anticipated closure of the output gap is primarily driven by a higher actual output growth rate of 4.0%-5.0%, which is expected to outpace potential output growth of 3.5%-4.5% following the normalisation of the latter from its high base in 2022. Looking ahead, potential output is projected to return to pre-crisis levels of 4.0%-5.0% over the medium-term, aided by the ongoing implementation of automation and digital infrastructure projects that will boost productivity.

Key highlights of Bank Negara Malaysia’s (BNM) 2022 Annual Report, include:

  • Demand Side Economy: As the economy continues to return to pre pandemic levels, it is expected that growth in domestic demand will remain strong in 2023, supported by expansionary measures outlined in the 2023 Budget. Specifically, domestic demand is projected to increase by 5.4% in 2023 (compared to 9.2% in 2022), with private expenditure remaining the primary driver of GDP growth. Notably, private consumption is expected to grow by 6.1% in 2023 (11.3% in 2022), boosted by improving employment and income levels. Measures included in the 2023 Budget, such as Sumbangan Tunai Rahmah (STR), a special financial assistance program for civil servants and pensioners, upskilling initiatives, tax exemptions, and other cash transfers, are expected to bolster domestic demand. In particular, the expansion of coverage for overtime pay, the revision of individual income tax rates, and the increase in minimum wage for small firms will boost household income, providing further support to private consumption. The Budget includes a total of RM8bn in STR aid, which will benefit 8.7 million recipients through cash assistance, food baskets, and vouchers for staple food items.
    BNM expects private investment growth will experience a 5.8% expansion in 2023, a decrease from 7.2% in 2022. The expansion is expected to take place amidst the realisation of new and ongoing investments in crucial economic sectors. BNM has noted the continuous efforts of companies to embrace automation and digitalisation, which will be complemented by the progress of large-scale transportation and digital infrastructure projects. These efforts will act as a catalyst for further support in investment activities. Additional investment support will come from the progress made in crucial infrastructure projects such as the Malaysia Digital Economy Blueprint (MyDIGITAL) and the continued drive for automation and digitalisation. The improvement of construction work in both residential and non-residential subsectors is also noteworthy. Investment intentions continue to emerge, with RM265bn of investment approvals in 2022, compared to RM309bn in 2021. Additionally, the government's ongoing initiatives under the New Investment Policy to attract and facilitate investment projects will provide further support to investment activity.
    It is expected that public investment activity will continue to grow (7% in 2023 compared to 5.3% in 2022), driven largely by the progress made in several large-scale infrastructure projects, including the East Coast Rail Link, Light Rail Transit Line 3, and Pan Borneo Highway. Additionally, the government will prioritise fixed asset spending on key areas such as transportation, education, public utilities, and healthcare projects. Furthermore, significant investments by major public corporations to support the transition to net zero carbon emissions by 2050 are expected to provide an additional boost to economic growth. The government's proposed allocation of RM97 billion for development expenditure in 2023 (compared to RM71.6 billion in 2022) is expected to further support construction-related and infrastructure projects.
    BNM anticipates a deceleration in the growth of public consumption to 1.3% in 2023, compared to the 3.9% recorded in the preceding year. The moderation is attributed primarily to the contraction in supplies and services expenditure due to the lull in Covid-related outlays. However, it is noteworthy that emoluments spending is expected to increase, propelled by the government's Special Additional Annual Salary Increment of RM100 for civil servants and the absorption of contract officers into permanent positions, particularly in the health and education services. It is essential to highlight that the pace of public consumption growth, while slower in 2023, remains an essential driver of domestic demand, which is a crucial component of the country's economic growth trajectory. Thus, we believe that the government needs to ensure that the contraction in supplies and services spending does not undermine the momentum of the economic recovery.
  • Supply Side Economy: On the supply side, BNM projects a moderation in the pace of economic expansion across most sectors in response to slower global growth and the normalisation of high growth rates from the previous year. Despite this, the consumer and tourism subsectors are expected to continue expanding, while export-oriented industries will experience some slowdown. Additionally, resolving supply chain disruptions and labour shortages will further bolster economic activities.
    Specifically, the services sector is expected to grow at a rate of 5% in 2023 (10.9% in 2022), with consumer- and tourism-related activities being the primary driver, supported by a rebound in global tourism. Business-related services will also continue to contribute to growth, albeit at a slower pace, in tandem with the construction and external demand expansion. Finally, there is anticipated sustained demand for data services, particularly in the context of e-commerce and e-payment activities, which is expected to further bolster growth in the information and communication subsectors.
    BNM expects the manufacturing sector to experience a slowdown, projecting a growth rate of 4.0% for 2023, in contrast to the 8.1% growth for 2022. The electronics and electrical (E&E) cluster's growth is expected to fall below its long-term average of 6.2%, in line with the projected decrease in global semiconductor sales. Additionally, the consumer-related manufacturing cluster's growth is likely to decrease due to the normalisation of household spending activities. In contrast, the construction-related manufacturing cluster is anticipated to record modest growth, supported by investments in structures. The primary-related cluster is projected to expand at a faster pace, with support from increased capacity utilisation at a major oil refinery in Johor.
    In the agriculture sector, BNM is expecting the sector to register a growth of 0.7% in 2023, higher growth than 0.1% in 2022. The projected growth is set to be driven by higher oil palm production, enabled by an improved labour supply. Moreover, the expected heavier rainfall during the early part of the year is predicted to enhance soil moisture, resulting in increased oil palm yields in the later part of the year. The sector's recovery in raw material supplies, particularly fertilisers and animal feed, is also expected to contribute to the growth of livestock and other agriculture subsectors.
    The mining sector is expected to experience a modest growth rate of 2.0% in 2023, down from the projected growth rate of 3.4% in 2022, according to BNM's forecasts. The anticipated growth is expected to be driven by the operationalisation of new facilities in Peninsular Malaysia, as well as increased production in existing oil and gas facilities, such as the Block SK320 located in offshore East Malaysia. These developments are expected to counterbalance the expected loss of output resulting from maintenance-related closures in several facilities and maturing oil and gas fields. Overall, the mining sector is expected to continue to play a vital role in the country's economy, contributing to the growth and development of the nation's natural resources.
    The construction sector is projected to experience a robust growth rate of 6.3% in 2023, up from the growth rate of 5.0% in 2022, driven by continued improvements in civil engineering and residential construction activities. Advancements in existing large transportation and utility projects are expected to accelerate growth in the civil engineering subsector, while higher new housing launches and an anticipated expansion in demand due to improved income and employment prospects will bolster the residential subsector.
  • Current Account Balance Outlook: BNM's projection for the current account balance is that the surplus position will continue to register between 2.5% – 3.5% of GDP in 2023, as compared to a surplus of 2.6% of GDP in 2022. The anticipated outcome is due to the persistent goods surplus and lower services account deficit despite the expectation of weakened external demand. BNM forecasts that the goods account will increase to RM173.1bn in 2023 from RM169.3bn in 2022. Moreover, BNM expects that the services account will show a reduction in deficit from RM45.4bn in 2022 to RM33.6bn in 2023 due to a rise in the travel account. In particular, the travel account is projected to record a surplus position after three years of deficits, reflecting the increasing recovery in tourist arrivals, nearing pre-pandemic levels. The reopening of China's international borders is also expected to propel inbound tourist arrivals and expenditure. Despite these developments, the overall services account is still likely to remain in a deficit due to the continued reliance on foreign services, particularly in the transportation sector.
  • Headline inflation is forecast to average between 2.8% and 3.8% in 2023 (PIVB: +3.0% to 3.5%; 2022A: 3.3%). The moderation of global cost factors is expected to persist in 2023, as prices of key commodities are projected to decline on account of improving supply constraints and softening global demand. This, in turn, is likely to contain inflationary pressures to some extent, aided by price controls and subsidy measures. However, despite the deceleration, headline and core inflation are anticipated to remain elevated for a prolonged period due to the continued robustness of domestic demand and the labour market. Furthermore, core inflation is envisaged to average between 2.8% and 3.8% in 2023 (3.0% in 2022).
    BNM has indicated that the future of inflation in 2023 is fraught with uncertainty and skewed towards inflationary pressures. Contributing to this outlook are several upward risks, including elevated global commodity prices brought on by geopolitical tensions, adverse weather patterns, stronger-than-anticipated Chinese demand, and elevated input costs resulting from exchange rate developments. In addition, modifications to domestic subsidy and price control policies may pose as additional inflationary pressures. Nevertheless, we believe that the subsidy ceiling for RON 95 and diesel, set at RM2.05 and RM2.15 per litre, respectively, may be subject to review and potentially increased gradually in the latter part of the year. Without petrol subsidies, it is estimated that the actual price of RON95 has reached approximately RM3.22 per litre compared to the present RM2.05 per litre. Hence, we anticipate that gradual adjustments to subsidised prices of RON95 and diesel in 2H23 could result in the country's headline inflation approaching the upper limit of the official projection range of 2.8% to 3.8%. Nonetheless, the likelihood of a wage-price spiral is deemed to be remote since long-term inflation expectations remain well anchored. Furthermore, productivity growth is likely to surpass any wage catch-up. Meanwhile, downside risks to the outlook to the outlook may stem from dampened global commodity prices consequent to a frail global economic climate, coupled with a reduction of price forces ensuing from a hastened dissipation of pent-up domestic demand.
  • Monetary Policy Outlook. In light of BNM's recent cautionary message on the elevated downside risks stemming from a confluence of internal and external factors adversely affecting economic growth, alongside the persisting impact of subsidies, we contend that BNM will adopt a prudent stance by refraining from making any further adjustments to the MPC meeting. While forthcoming decisions hinge upon pertinent data, we envisage that a plausible scenario in 2H 2023 would entail a 25bps uptick to 3.00%, restoring pre-pandemic levels, conditional on the potential rationalisation of fuel subsidies, with possible exemptions for the T20 income cohort, as hinted in the 2023 Budget, as well as the trajectory of global commodity prices and price controls.
  • BNM highlighted that the economic landscape is likely to remain in a state of flux, with uncertainty pervading global growth and financial markets due to tightening monetary policies in significant economies, recent banking sector challenges, geopolitical tensions, and disruptions to supply chains. Despite these challenges, BNM has reaffirmed its commitment to preserving price stability as a key driver of long-term sustainable domestic economic growth. As such, BNM has emphasised that any potential shifts in the degree of accommodation will be contingent on the latest data and will be informed by evolving conditions and their ramifications on the domestic inflation and growth outlook.

Source: PublicInvest Research - 30 Mar 2023

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