Highlights

• Real GDP growth eased for the fifth straight quarter to +4.0% yoy (1Q16: +4.2% yoy), matching ours and market estimates. Growth was supported by stronger domestic demand, in particular private consumption and private investment. However, growth was affected by decline in agriculture sector, which knocked off -0.7ppt from 2Q16 GDP. On a SA basis, the Malaysian economy expanded by +0.7% qoq (1Q16: +1.0% qoq).

• Current account (CA) surplus narrowed to RM1.9bn or 0.6% of GDP in 2Q16 (1Q16:+RM5.0bn or 1.8% of GDP) due to lower goods account surplus (RM19.8bn; 1Q16:RM23.5), larger deficit in primary income (-RM8.2bn; 1Q16:-RM6.7bn) and secondary income (-RM5.1bn; 1Q16: -RM4.9bn) amid a smaller deficit in service account ( -RM4.6bn; 1Q16: -RM6.8bn). 1H16 CA surplus (RM6.9bn) is ahead of our full - year forecast of RM10bn but we deem in line as we expect smaller surplus in 2H16.

• On expenditure, the drawdown in stocks (-1.2ppts; +2.0ppts) and continued drag in net export contribution (-0.6ppts; 1Q16: -1.2ppts) weighed on growth. These factors offset the faster growth in domestic demand (+5.7ppts; 1Q16:+3.3ppts).

i. Private consumption picked up for the third consecutive quarter to +6.3% yoy (1Q16: +5.3% yoy), following government support measures (EPF rate cut and Aidil fitri assistance), increase in consumer sentiment (78.5; 1Q16: 72.9) amid normalisation in spending post-GST effect. Marginal propensity to consume improved further to 0.83 (1Q16: 0.69); the highest since 3Q 2013.

ii. Private investment growth rose to +5.6% yoy (1Q16: +2.2% yoy) due to a rebound in machinery & equipment (+8.1%yoy; 1Q16: -7.1% yoy) and further expansion in structure spending (+5.9%yoy; 1Q16: +5.7%yoy);

iii. Growth in public consumption accelerated to +6.5% yoy (1Q16: +3.8% yoy), attributed to continued spending in supplies and services;

iv. Public investment turned around to record a growth of +7.5% yoy (1Q 16: -4.5% yoy) on account of higher spending by Federal Government and public corporations.

• On sectoral front, the decline in agriculture activity and slower growth in manufacturing sector offset the faster expansion in services sector and improvement in mining output.

i. Agriculture sector contracted by a larger magnitude at -7.9% yoy (1Q16: -3.8% yoy), affected by lagged impact of El Nino on CPO production. This was reflected in double-digit cont raction in palm oil output (-20.3% yoy; 1Q16: -10.2% yoy);

ii. Mining sector recorded a marginal growth of +2.6% yoy, an improvement from previous quarter (+0.3% yoy) as crude oil and natural gas production rose during the quarter.

iii. The manufacturing sector pencilled in a slower expansion of +4.1% yoy (1Q16: +4.5% yoy) following a cont raction in domestic-oriented sector (-1.7% yoy; 1Q16: +4.9% yoy) that more than offset an improvement in export-oriented sector (+5.3% yoy; 1Q16: +3.1% yoy);

iv. The construction sector expanded at a faster rate of +8.8% yoy (1Q16: +7.9% yoy), contributed by double-digit expansion in civil engineering (+18.9% yoy; 1Q16: +17.5% yoy) and stronger growth in residential building sub-sector (+9.2% yoy; 1Q16: +4.9% yoy);

v. The improvement in services sector (+5.7% yoy; 1Q16:+5.1% yoy) was supported by higher retail trade (+7.2% yoy; 1Q 16: +5.4% yoy) benefitting from continued strength in household spending. Similarly, food & beverage also improved further to +7.9% yoy (1Q16: +6.8% yoy) in tandem with a gradual improvement in consumer sentiment. Information & communication sub-sector also continued to increase at a strong pace of +8.8% yoy (1Q16: +8.5% yoy) backed by data communication.

• We maintain our 2016 full-year GDP growth at 4.2%. We continue to expect a gradual recovery in 2H 2016 (+4.3% yoy) supported by strength in domestic demand, particularly consumption and infrastructure projects. However, there is still a risk that external sector would weigh on overall GDP growth as external downside risks remain high and uncertain (i.e. China rebalancing, weak commodity prices). For 2H16, factors leading to continued recovery in domestic demand include:

i) A continued recovery in private consumption boosted by a series of measures to boost household disposable income (EPF contribution, civil servant pay rise, minimum wage hike & OPR rate reduction in July).

ii) Pick-up in construction activity following the larger-than-expected value of contracts awarded. Year-to-date, domestic contract awards to listed contractors compiled by our research team came in at a robust RM46bn, already surpassing 2015 full year contract of RM22bn.

iii) Gradual improvement in agriculture output as the effect from El Nino weather tapers off, leading to smaller decline in production on an annual basis.

• Headline inflation is expected to average at 2.2%. Underlying inflation is expected to remain stable, consistent with moderate domestic consumption and commodity prices.

• Given the surprise strength of domestic demand in 2Q16 and expectations of a gradual recovery in 2H16, we now expect BNM to leave the OPR at 3.00% for a longer period of time (i.e. no rate cut during Sep & Nov MPC meeting). That said, the only risk that can derail the overall GDP growth and prompt BNM to ease monetary policy is a sharper-than-expected deterioration in the external sector.

Source: Hong Leong Investment Bank Research - 15 Aug 2016