Real GDP moderated sharply to +4.5% YoY (1Q18: +5.4% YoY), slightly lower than our revised estimate of +4.6% YoY and consensus estimate of +5.2% YoY. This was due to decline in commodity sectors and slower growth in manufacturing and construction. On the expenditure side, the moderation was driven by destocking activity, lower net exports contribution and decline in public investment. Nevertheless, private sector activity (consumption and private investment) grew at a faster pace which indicated underlying private domestic demand remained anchored. Following the sharp deceleration in 2Q18 GDP and expectations for continued weakness in commodity sector in the immediate term, we downgrade our GDP forecast to +4.8% YoY (previous: +5.2% YoY; 2017: +5.9% YoY).

DATA HIGHLIGHTS

Real GDP growth moderated sharply in 2Q18 to +4.5% YoY (1Q: +5.4% YoY). This was slightly lower than our revised estimate of +4.6% YoY and consensus estimate of +5.2% YoY. The moderation was due to decline in public spending expenditure, dampened net export growth and destocking activity that offset the acceleration in private spending activity.

Current account (CA) surplus narrowed to RM3.9bn (1Q18: RM15.0bn) driven by smaller goods account surplus (+RM26.1bn; 1Q18: +RM35.7bn), higher services deficit (-RM6.2bn; 1Q18: -RM5.8bn) and higher primary income deficit (-RM11.2bn; 1Q18: -RM10.2bn).

On the expenditure side, lower net exports contribution (+0.1 ppt; 1Q18: +4.0 ppt) and destocking activity (-0.9 ppt: 1Q18: -2.5 ppt) led to slower growth during the quarter. Domestic demand growth grew stronger (+5.6% YoY; 1Q18: +4.1% YoY), driven by private sector spending (+7.5% YoY; 1Q18: +5.2% YoY) that offset the decline in public spending activity (-1.4% YoY; 1Q18: -0.1% YoY).

I. Net exports contributed to overall GDP, but at a slower magnitude (+0.1 ppt; 1Q18: +4.0 ppt) following a rebound in imports (+2.1% YoY 1Q18: -2.0% YoY) amid moderation in exports (+2.0% YoY 1Q18: +3.7% YoY). Meanwhile, destocking activity led to contraction to overall GDP (-0.9ppt; 1Q18: -2.5ppt);

II. Public investment recorded a larger contraction of -9.8% YoY (1Q18: -1.0% YoY) due to the near completion of ongoing projects (e.g. RAPID) and lower Federal Government development expenditure due to transition in government leadership.

III. Private consumption rose strongly to +8.0% YoY (1Q18: +6.9% YoY). Marginal propensity to consume was higher at 0.96 during the quarter (1Q18: 0.70), as consumers took advantage of the tax holiday period that started in June 2018. In particular, MIER consumer sentiment shot up to 21-year high of 132.90 in 2Q18 after recording below the threshold level of 100 for 14 consecutive quarters. In addition, continued wage growth also lent support to strong consumption activity during the quarter (manufacturing sector: +10.1% YoY; 1Q18: +14.0% YoY; services sector +3.7% YoY; 1Q18: +3.5% YoY);

IV. Private investment accelerated to +6.1% YoY (1Q18: +0.5% YoY), driven by rebound in machinery and equipment investment that offset the deceleration in structure investment. This was also consistent with the rebound in capital imports (2Q18: +6.2% YoY; 1Q18: -9.2% YoY);

V. Public consumption grew by +3.1% YoY (1Q18: +0.4% YoY), supported by improvement in supplies and services and sustained growth in emolument;

Sectoral wise, the moderation emanated from decline in commodity sectors (-0.4ppt; 1Q18: +0.2ppt), namely agriculture and mining sectors. Other sectors such as manufacturing and construction sectors continued to grow, albeit at a slower pace:

VI. Agriculture declined by -2.5% YoY (1Q18: +2.8% YoY), dragged down by decline in palm oil production (-6.4% YoY; 1Q18: +12.8% YoY) following temporary factors such as labour shortages, shorter working days and some replanting activity;

VII. The manufacturing sector slowed slightly to +4.9% YoY (1Q18: +5.3% YoY), reflecting moderation in most sectors such as petroleum and chemical sub sectors that offset the faster increase in electrical, electronic and transport equipment sub-sectors. The increase in transportation equipment was in line with stronger vehicle car sales;

VIII. Mining sector contracted by -2.2% YoY (1Q18: +0.1% YoY) due largely to contraction in liquid natural gas production (-7.0% YoY; 1Q18: -1.0% YoY). According to industry sources, the cut in natural gas supply from the Sabah Oil & Gas terminal to the Petronas LNG Complex in Bintulu had led to reduction in production. On the other hand, crude oil petroleum grew at a slightly faster pace of +2.3% YoY (1Q18: +1.1% YoY);

IX. The construction sector continued to moderate to +4.7% YoY (1Q18: +4.9% YoY) due to decline in residential and non-residential subsectors.

X. Services sector grew at a steady pace of +6.5% YoY (1Q18: +6.5% YoY) as the faster increase in food and beverage (+9.9% YoY; 1Q18: +8.2% YoY), retail trade (+8.1% YoY; 1Q18: +7.4% YoY), rebound in motor vehicle (+3.8% YoY; 1Q18: -0.5% YoY) offset the sharp moderation in finance (+2.4% YoY; 1Q18: +6.7% YoY) and deceleration in government services (+4.5% YoY; 1Q18: +4.7% YoY).

HLIB’S VIEW

GDP: We attended the briefing session by Bank Negara Malaysia (BNM) on 2Q18 GDP performance. They shared that despite the deceleration in GDP, it was due mainly to supply disruptions in the commodity sector (-0.4ppt). Importantly, they were heartened by the strong spending in the private sector. Going into 2H18, they expect growth to be slightly higher as government spending normalises and private spending continues to be anchored by sound fundamentals. BNM’s new GDP projection is “around 5.0% YoY” (previous: 5.5%-6.0% YoY; 1H18: 4.9% YoY). Nevertheless, downside risks remain high. Escalation of trade tension and normalisation of monetary policy in the advanced economies remain key downside risks to their forecast. Following the sharp moderation in 2Q18, we downgrade our GDP forecast to +4.8% YoY (previous: +5.2% YoY; 2017: +5.9% YoY) due primarily to decline in commodity sectors. In the immediate term, while palm oil production is expected to recover on a month-to-month basis, it is still anticipated to record a negative contraction in annual terms. In the mining sector, according to industry sources, the unplanned supply outages are only expected to be resolved towards the end of the year at the earliest. On the other hand, services is anticipated to remain steady as consumption-related activities will continue to benefit from 0% GST tax holiday, high consumer sentiment and continued wage growth.

CPI: On inflation, BNM sees CPI coming in at the lower end of official forecast of 2.0%-3.0% YoY in 2018 (2017: +3.7% YoY). However, this is subject to changes as the final list of SST goods has yet to be finalised. In June, CPI was +0.8% YoY, higher than BNM’s internal estimate due to low pass-through to consumers. Nevertheless, while prices are sticky downwards during the zero-tax holiday period, the effect may not be the same when SST comes into effect as business may adjust the prices upwards instead. Following the tax holiday window in June-Aug, introduction of SST 2.0 in Sept, as well as lower food inflation pressure, we maintain our 2018 CPI forecast at 1.3% YoY pending final list of SST goods.

OPR: On OPR, we opine that any future policy direction will be data-dependent. Despite the slower GDP growth and lower inflation, our base case is for BNM to retain the policy rate at 3.25% for the rest of 2018, premised on the assumption that underlying demand (external sector and private spending) will remain steady.

Source: Hong Leong Investment Bank Research - 20 Aug 2018