Highlights

• Real GDP growth eased to 4.9% yoy in 2Q15 (1Q: +5.6% yoy) amid GST implementation in April and softer external demand. The reading came in better than our (+4.3%) and market expectations (+4.5%), primarily on account of decent services growth and a revival in agriculture output. On the expenditure front, the higher-than-expected GDP growth was driven by stock buildup and still respectable consumption growth. On a seasonally adjusted basis, the economy grew by 1.1% qoq (1Q: +1.2% qoq).
• Current account (CA) surplus narrowed to RM7.6bn or 2.7% of GDP in 2Q (1Q: +RM10.0bn or 3.6% of GDP) given falling commodity prices and lacklustre global economy. Key culprits to the slimmer CA surplus include: (i) reduction in goods account surplus to a 8-quarter low (+RM23.3bn; 1Q: +RM27.5bn); (ii) larger deficit in services account (-RM4.6bn; 1Q: -RM3.8bn); and (iii) historical high deficit in secondary income account (-RM6.0bn; 1Q: -RM5.3bn).
• On the expenditure side, domestic demand softened to 4.6% yoy (1Q: +7.9% yoy), the slowest growth since 1Q10. The weakness was cushioned by a sizeable stock accumulation (+1.7ppt; 1Q: -0.4ppt) and, to some extent, a smaller net drag from net exports (-1.0ppt; 1Q: -1.1ppts).
• Despite the general negativity of GST imposition, private consumption growth was surprisingly resilient in 2Q (+6.4% yoy; 1Q: +8.8% yoy). This was chiefly credited to stable income, personal tax cut and BR1M payouts. Marginal propensity to consume (MPC) fell to 0.66 from 0.81 in 1Q.
• Total investment growth faltered to almost six years low of 0.5% yoy (1Q: +7.9% yoy), triggered by both public and private investments. Public investment contracted 8.0% (1Q: +0.5%) due to the near completion of a few projects by public enterprises that more than offset the continuing development expenditure. Private investment lost its robust growth momentum, rising by just 3.9% in 2Q (1Q: +11.7%), the slowest rate since ETP implementation (4Q11) on account of declining spending on machinery and transport equipment as well as slower investment in residential properties.
• Exceptional case was seen in public consumption, which recorded a stronger growth of 6.8% (1Q: +4.1%), driven by higher supplies and services expenditure, second payout of BR1M and emoluments.
• Sectoral wise, most sectors inked a more moderate growth, except agriculture sector, in line with our forecast. The agriculture sector returned to a positive growth of 4.6% in 2Q (1Q: -4.7%), primary thanks to strong recovery in palm oil output (+10.4%; 1Q: -11.7%) that had been hit during massive flood in East Cost since Dec last year, and increase in food crops, albeit moderate (+2.5%; 1Q: +4.0%).
• Construction sector posted further growth deceleration to 5.6% (1Q: +9.7%), the slowest expansion since 4Q11. The weak performance was largely due to the slowdown across all sub-segments (residential, non-residential and civil engineering).

• Services sector growth slowed to new low of 5.0% (1Q: +6.4%) post global recession in 2009. We consider it better than expected as the services sector was the hardest hit by GST imposition as evident in the CPI reaction. Sub-sectors that came to the rescue were ICT services (+9.3%; 1Q: +9.6%) and tourism relatedindustries such as accommodation (+3.9%; 1Q: +3.4%), which helped to offset the pullback in wholesale & retail trade (+5.9%; 1Q: +9.8%). The tourism sector benefited from low base of last year’s airline incidents and weak MYR.
• The manufacturing sector also pencilled in a 8-quarter low growth of 4.2% (1Q: +5.6%) on account of sluggish export-oriented industries (+4.0%; 1Q: +7.0%), offsetting the improvement in domestic-oriented industries (+4.5%; 1Q: +2.8%).
• Growth in mining sector eased to 6.0% (1Q: +9.6%), implying a diminishing effect of robust oil output (+14.4%; 1Q: +20.4%) from new oil field, Gemusut-Kakap field that commenced in late last year. Natural gas plant shutdown and lower demand from Japan during the quarter also curbed the performance of mining sector. Natural gas production dropped by 2.7% in 2Q (1Q: -1.2%). Near-term Economic Outlook: Maintain our conservative 5.0% GDP growth forecast; BNM to stand pat
• Notwithstanding higher-than-expected GDP growth of 5.3% recorded in 1H15, we opt to stay conservative for 2H15 outlook and retain our 2015 full-year GDP growth target of 5.0%, given that both external and domestic downside risks have escalated in 3Q15. Furthermore, the signi ficant inventory accumulation and further deterioration in consumer and business confidence may dampen local production in 3Q15. Consequently, we now envisage that GDP growth may only bottom in 3Q15, before normalising gradually in 4Q15.
• For 2H15, domestic demand would remain the key growth engine, albeit at a moderate pace. Private consumption is expected to continue its adjustment to GST impact while capital investment would switch to a lower gear in the face of gap in cont ract flows, depreciating MYR and renewed volatility in global financial markets. Net exports are expected to remain a drag on GDP growth, albeit smaller, mainly on economic weakness in major trading partners (i.e. China, EU and Japan). Due to the sharp inventory buildup in 2Q15, we are also cautious on a potential stock drawdown in 2H15 that could pull down headline GDP growth.
• To reflect the above developments, we fine-tune our 2015 full-year growth projection for some sub-components:
• i) Forecast of private consumption is lifted by +0.5ppt to 7.0% due to the smaller-than-expected GST impact in 2Q, stable household income and employment prospects;
• ii) Public consumption is likely to ink a better growth of 5.5% (from previously 3.5%) on the back of increase in supplies and services expenditure as well as emoluments;
• iii) Total investment is now projected to rise at a more moderate pace in the face of heightened economic uncertainties and renewed volatility in global financial markets. Private investment growth estimate is cut to +6.0% from +9.8% while that of public investment is trimmed to -3.5% from +1.5% previously. Capex cut in the NFPEs in the wake of falling energy prices and lack of new infra contract flows are main culprits to the contraction in public investment;
• iv) We shave our export growth forecast to +0.5% on account of the more moderate E&E outlook as well as further weakening of the Chinese economy and commodity prices. Import growth projection is also reduced to +0.8% (vs. +4.0% previously) as we expect lower elasticity of imports in view of the sharp MYR depreciation;
• v) Sectoral basis, we raise our growth forecast for agriculture to +0.7% (-1.5% previously) to reflect the strong output recovery from 1Q15 flood impact;
• vi) Growth of services sector is nudged up by 0.2ppt to 5.5% as a result of upward revision in consumption forecast and expectations of strong tourism-related activities buoyed by MYR depreciation; vii) We revise down construction growth forecast by 2.5ppts to 7.0% on account of sharp slowdown in residential activities and gap in infra project awards. We understand that most major infra projects in the pipeline (i.e. MRT2, LRT3 and Pan Borneo Highway) would only kick off in 2H16; and viii) Mining growth target is lowered to 7.0% from earlier forecast of 8.0%.
• On inflation, we maintain our 2015 average CPI growth forecast at 2.5% with the anticipation of upward trend to peak in 3Q15. Our inflation target has factored in RON95 retail price of RM2.00/litre based on Brent oil price assumption of US$60/bbl. GST spillover effects have been fading faster than expected amid subdued consumer confidence and renewed volatility in the financial markets. However, cost push factors (i.e. MYR depreciation and hike in transport fare due to rising operating costs) remain a wildcard that may drive the headline inflation higher.
• During the GDP press briefing, BNM Governor Tan Sri Dr. Zeti Akhtar Aziz said that ringgit will not be pegged and capital controls will not be introduced despite the volatile forex environment. In this regard, we understand from BNM that ringgit depreciation thus far has not resulted in financial distress in the broad economy that will disrupt financial intermediation and affect soundness of the banking system. We maintain our MYR forecast range of RM3.55-4.20/US$ for 2H15.
• On monetary policy, the stronger-than-expected 2Q15 GDP growth reaffi rms our view that BNM will extend its OPR pause until end-2015. Despite rising external uncertainties, the resilient GDP growth prospects coupled with manageable inflation outlook provide greater comfort for the central bank to maintain its OPR.

Source: Hong Leong Investment Bank Research - 14 Aug 2015