Background

Crude palm oil (CPO) export price has experienced an extended downtrend after hitting a temporary peak of RM2,922/tonne on 11 Mar 2014. CPO futures (KO3) traded as low as RM1,999/tonne last Friday (Figure #1).

The recent pullback in CPO price is mainly on account of: (i) expected bumper harvest of other edible oil (i.e. soybean & corn); (ii) slow demand recovery from palm importing countries (i.e. India & China); and (iii) slowerthan- expected biodiesel implementation in both Malaysia and Indonesia

Consequently, our plantation sector analyst has lowered the CPO price assumption for 2014 and 2015 to RM2,400/tonne and RM2,300/tonne (from RM2,700/tonne) to reflect the above developments.

Insights

We expect weakening of CPO export price to result in lower current account surplus and hence a weaker MYR outlook in the near term.

Malaysia exported 25.7m metric tonnes of palm oil in 2013 (Figure #2), which in turn accounted for 9.0% of total merchandise exports (RM61.4bn in nominal value). As imported inputs are minimal (i.e. mostly fertilizers of which imported value was ~RM200m per year), export selling price directly influences the net trade surplus derived from this sector.

To recap, Malaysia’s current account surplus narrowed to a quarterly average of RM8.4bn in 1Q-3Q 2013 (Figure #3), compared with an average of RM25.6bn and RM13.6bn in 2011 and 2012 respectively. Besides the culprit of high imports of capital goods, low CPO export price during this period (average of RM2,330/tonne) also contributed to the lower pile-up of trade surplus.

Our calculation shows that a lower CPO price assumption of RM300/tonne for CPO selling price for 2014 could potentially erode the annual current account surplus by RM7.4bn.

Meanwhile, imports of capital goods are expected to surge again in 2H14 as Rapid project gathers pace while overall ETP maintains its momentum.

If the weak CPO price is sustained into 4Q, we believe monthly trade data will begin to show narrowing surplus from August onwards. This development may lead to uneasy feeling among investors given the threat of “twin deficit”.

Notwithstanding the boost from an imminent OPR hike in September, near-term outlook for MYR may weaken should macro risks stage a resurgence. As we believe BNM will stay pat after bring the OPR to 3.50%, any aggressive Fed rate hike in early 2015 may narrow the interest rate differential that has been to Malaysia’s favour since 2008. All-in-all, we expect USDMYR rate to range RM3.15-3.25/US$ and drift towards the upper-end of RM3.25/US$ once the market starts the guessing game of US rate hike as Fed finishes its QE3 tapering in 4Q.

Source: Hong Leong Investment Bank Research - 25 Aug 2014