Global and Domestic Economic Expansion Likely to Sustain in 2018

Bank Negara Malaysia (BNM) maintained its Overnight Policy Rate (OPR) at 3.25% in the Monetary Policy Committee (MPC) meeting, after raising it by 25bps in the last MPC in January 2018. The pause in rate hike signalled that the current level of OPR and degree of monetary accommodativeness is consistent with the policy stance to support the economy on a steady growth path amid lower inflation. As a result, we believe any further normalisation of OPR will likely take place only in 2H2018.

In January 2018, BNM decided to adjust the degree of monetary accommodation by raising rate was in view of steady economic growth, where BNM also noted that the increase was pre-emptively to prevent the build-up of risks that could arise from interest rates being too low for a prolonged period of time. In the latest forward looking paragraph on the economic growth, BNM remained positive on the outlook of the global economy, where it will continue to strengthen amid improving global trade. Economic growth in Asia is also supported by sustained domestic activity and robust external demand. Despite recent trade tensions, BNM believes that risks to the global growth outlook remain balanced, pointing towards continuity in global economic expansion.

On the current state of internal economic environment, following the strong 2017 GDP growth of 5.9% yoy, BNM expects economic growth to remain strong in 2018, supported by the positive global growth outlook and spillovers from the external sector to the domestic economy. Meanwhile, favourable income and labour market conditions as well as new and ongoing infrastructure projects and sustained capital investment by firms in the manufacturing and services sectors, are set to benefit domestic demand.

On the inflation front, BNM continues to expect Malaysia’s headline inflation rate to average lower in 2018, on expectations of a smaller effect from global cost factors. BNM also states that the stronger Ringgit will mitigate import costs (which has appreciated against the US$ by 3.5% year-to-date to RM3.90/US$), where global energy and commodity prices are expected to trend higher in 2018. However, BNM noted that the underlying inflation, as measured by core inflation, is also projected to moderate due to improving labour productivity and ongoing investments for capacity expansion.

We believe the trend of the country’s headline inflation rate will be dependent on global oil prices and the adjustment to domestic retail petrol prices, especially when latest weighting of fuel prices in the CPI basket, has been revised higher to about 8.5% from 7.8% previously. This was based on the new basket of goods and services released by Department of Statistics effective from January 2018.

Going forward, as the country’s monetary policy statement is “forward-looking”, where wordings by BNM that “it will continue to monitor and assess the balance of risks surrounding the outlook for domestic growth and inflation,” may imply that OPR will likely stay unchanged at 3.25% in 1H18 MPC meetings. However, we believe this does not rule out the possibility for another 25bps rate hike in 2H18, if domestic economic conditions improve, in tandem with a stronger global economic expansion. However, downside risks to the global growth are increasing due to global trade tensions.

BNM Latest Annual Report to be Released on 28 March 2018

Despite the strong real GDP growth in 2017, we believe that BNM, in presenting its assessment on the economic prospects for the country in the upcoming Annual Report, to be released on 28 March 2018, will remain optimistic on the economic outlook for this year. However, BNM is likely to maintain the country’s real GDP growth target range of between 5.0% to 5.5% for 2018 (5.9% in 2017), reflecting the positive view on the country’s domestic demand.

Reserves Increased to US$103.7bn as at End-Feb

Separately, the international reserves of Bank Negara Malaysia (BNM) rose slightly by US$0.1bn to US$103.7bn in the second half of the month ending 28th February 2018, compared with US$103.6bn as at 15th February. The current level of reserves is sufficient to cover 7.2 months of retained imports, whereas reserve coverage of short-term external debt remained unchanged at 1.1 times.

We believe the flattish movement of the reserves during the month was attributed partly to the higher net outflow from foreigners in the domestic equity market. In the month of February, the net foreign selling in equity market amounted to about RM1.1bn, the first net outflow in 3 months and the highest since November 2016, due to concerns of faster tightening of monetary policy by the US Federal Reserves from rising inflationary pressure. Malaysia’s 10-year MGS yield in February was higher by 10bps at 4.00% while the 1-year MGS increased by 18bps to 3.22%, both are the highest monthly average since May 2017. Despite the outflow in equity market and some sell down in the bond market, Ringgit continue to appreciate against the US$, improving from RM3.95/US$ in January 2018 to RM3.91/US$ in February 2018.

With strong Malaysia’s economic fundamentals and healthy external trade, we expect reserves to hover around US$100-US$105bn by end 2018 (US$102.4 as at end-2017). Following forex measures announced by the Financial Markets Committee of BNM in 2017, a recent update noted that conversion of forex from export proceeds to Ringgit 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 (US$3.6bn from December 2016 to June 2017). We expect the compliance rate arising from the conversion of foreign currency export proceeds to Ringgit to improve further, therefore supporting the demand for Ringgit. We expect Ringgit to trade between RM3.90-3.95/US$ throughout most of 1H18, but may appreciate to RM3.80/US$ by end 2018, supported by steady sustained economic growth in 2018, as well as possible monetary policy normalisation in 2H18.

Source: Affin Hwang Research - 8 Mar 2018