Decline in Manufacturing PMI in February Likely to be Temporary

Malaysia’s manufacturing Purchasing Managers’ Index (PMI) fell by 0.6 points to 49.9 in February (50.5 in January). According to IHS Markit, the slowdown in manufacturing PMI was due to the decline in new orders as well as marginal expansion of output and employment during the month. This was reflected in lower demand from overseas, especially orders from Europe and US, which led to the slowdown in new export orders. Going forward, the question is, is this the beginning of a trend of slowing growth?

We believe the softening trend seen in Malaysia’s manufacturing PMI to be temporary, as the employment indicators during the month continued to reflect positive sentiment among manufacturers as they expect higher demand and production activity in the coming months. On a quarterly basis, the country’s manufacturing PMI remained unchanged at 50.2 in JanuaryFebruary 2018, the same level as in 4Q17, indicating also continued healthy manufacturing conditions in the sector. Similarly, the Caixin China General Manufacturing PMI rose by 0.1 point to 51.6 in February (51.5 in January), at its fourteen month high, pointing to sustain momentum in the global manufacturing activities. Malaysia’s real GDP rose strongly by 5.9% yoy in 4Q17 (6.2% in 3Q17), bringing the full year growth to 5.9% in 2017, significantly higher than 4.2% in 2016, also the sixth consecutive quarter where the country’s economic growth was higher than consensus expectations. The upside surprise was broad based with steady growth in both external and domestic demand. Favourable domestic macroeconomic conditions, which include the strong GDP growth and exports performance, also led to positive ringgit sentiments in 2017. We believe heightened risks of trade disputes remain under control. For 2018, the IMF raised its global GDP growth forecast by 0.2 percentage points from 3.7% to 3.9%, and we believe it may further raise the forecast to 4.0% in the upcoming report (3.2% in 2016). If so, this would be the third time the IMF would have raised its global GDP growth forecast for 2018. In view of the favourable global economic environment and healthy domestic demand, we have recently revised our real GDP growth forecast for Malaysia to 5.3% for 2018, from our earlier expectation of 4.9% (5.9% in 2017). President Trump announcement on tariffs on steel (25%) and aluminium (10%) will not derail global economic momentum significantly.

Malaysia’s manufacturing sector will benefit from the favourable external development, where the two biggest industries, namely electronic and electrical (E&E) sector, and the petroleum, chemical, rubber & plastic products sector, which are export oriented, will remain healthy in 2018.

Private Investment Another Main Driver of Economic Growth

Apart from healthy private consumption growth, the Malaysian economy will be reliant on private investment to drive growth in 2018. Growth in private investment has surprised on the upside in 2017. In the Eleventh Malaysia Plan (11MP), covering the period from 2016 to 2020, Government has projected earlier that private investment growth will expand at an average growth of around 9% per annum during this periods, as compared to 13% per annum from 2011-2015. In real terms, private investment grew 9.3% yoy in 2017 to about RM204bn and likely on track to achieve another RM220bn in realised private investment projected for 2018. The on-going implementation of infrastructure projects will support the country’s domestic demand, especially through private sector capital spending in the manufacturing, construction and services sectors.

Expectations of Monetary Policy Normalisation by BNM

Bank Negara Malaysia (BNM) raised its Overnight Policy Rate (OPR) by 25bps to 3.25% in January 2018, after holding the rate steady at 3.0% since July 2016. With manageable inflation going forward, where BNM guided that inflation will likely average lower in 2018 from a smaller effect from global cost factors, we expect the stance of the country’s monetary policy to be accommodative and supportive of domestic demand. As a result, we believe BNM will likely maintain its policy rate at 3.25% in 1H18 and wait until 2H18 to gauge the state of the Malaysian economy, before deciding on whether to raise OPR by another 25bps to 3.5% by end-2018.

Ringgit Likely to Strengthen to RM3.80/USD Towards End 2018

The Malaysian Ringgit (RM) has appreciated steadily vs. the US$ since early 2H17, following further liberalisation of the bond market and foreign exchange hedging requirements announced by the Financial Markets Committee of Bank Negara Malaysia (BNM) in 2017. Since early 2H17, the pace of ringgit appreciation vs. the US$ has accelerated, strengthening by 10.9% to a high of RM3.87/US$ on 26 January 2018 (currently at RM3.92/US$). According to the BNM Financial Market Committee update, conversion of forex from export proceeds to Ringgit was US$3.6bn from December 2016 to June 2017. Net export proceeds FX conversion rose stronger by US$5.6bn from June 2017 to December 2017. This brought the cumulative amount to US$9.2bn since December 2016 to December 2017.

With net value of exports around RM95bn in 2017, based on our rough calculation, this would translate to a net conversion ratio of 40.7%, sharply lower than BNM’s requirement of 75% of the export proceeds. However, we expect the compliance rate arising from the conversion of foreign currency export proceeds to Ringgit to improve further, possibly closer to around 55% in 2018, translating to a cumulative net FX conversion of about US$12-13bn for the full year 2018, therefore supporting the demand for Ringgit.

A Strong Basis for Ringgit to Strengthen to RM3.80/US$ by End 2018

As a result, due to higher net export proceeds FX conversion, we expect Ringgit to trade between RM3.90-3.95/US$ throughout most of 1H18. We now believe Ringgit may appreciate to RM3.80/US$ by end 2018 (from our earlier assumption of RM4.05/US$ by end-2018), supported by steady sustained economic growth in 2018, as well as expectations of higher oil prices and possible monetary policy normalisation in 2H18. Malaysia’s current account surplus widened to RM12.9bn in 4Q17 (3.7% of GNI), as compared to RM12.5bn (3.7% of GNI) in 3Q17. This was the largest quarterly surplus since 2Q14. Going into 2018, we believe that the trade surplus will remain healthy in the range of RM95-98bn (RM97.2bn in 2017). We expect the current account to remain in a surplus, but likely to narrow to RM30-35bn projected for 2018 (RM40.3bn or 3.3% of GNI in 2017). Similarly, based on the real effective exchange rate (REER), Malaysia’s ringgit remains relatively undervalued. As the appreciation is not limited to Malaysia alone, but other Asean currencies as well, we believe the impact of an appreciating Ringgit on Malaysia’s export competitiveness and the economy is likely to be small.

Maintaining Our Forecast for Fed’s Three Rate Hikes in 2018

On the US monetary policy, we believe the US Fed will be diligent in managing market expectation on the pace of subsequent rate hikes going into 2018. While we believe that the current weakness of US$ will eventually experience a reversal from its weak position, particularly as investors become cautious with the volatility of the financial markets, we do not expect the strengthening of the US$ to be significant in view of rising concerns relating to US budget deficit. At the same time, the US Fed’s Dot Plot analysis signalled that the FOMC members are maintaining their expectation of three rate hikes for 2018. Going forward, the US Fed is likely to continue with its gradual monetary policy normalisation process, where we expect only three rate hikes in 2018, no change from our earlier expectations.

Source: Affin Hwang Research - 2 Mar 2018