The Pakatan Harapan win comes as a major surprise and will likely be a shock to the market given that the change in ruling government is unprecedented. The BN coalition party has been the ruling government since Malaysia’s independence in 1957. Although BN’s majority votes have been on a declining trend, especially over the previous two general elections, the GE-14 is an outright upset (for BN) and a total surprise. A negative impact on the market is likely over the near term but we expect market and RM weakness to be only temporary. Longer term, we remain positive as a stronger middleincome segment and having the right policies in place suggest that the economy will be on a better footing. We upgrade the Consumer and Autos to Overweight to play the revival in the consumer but downgrade Construction to Neutral on project uncertainty and delays. We maintain our Overweight on the FBMKLCI with a year-end target of 1,923.

Pakatan Harapan Storms to Victory

Pakatan Harapan (PH) has created Malaysian history by winning the 14th Malaysia General Election (GE14), taking over the Barisan Nasional (BN) coalition, which has ruled Malaysia since its independence in 1957. Of the total 222 Parliamentary seats, PH took a majority of 122 seats while BN and PAS, 79 and 18 seats respectively. The results strongly affirm the population’s preference for PH, which garnered a 55% victory compared to BN’s previous control of 60% of Parliamentary seats in GE13.

Likely Sustained Economic Growth

From a macro perspective, the immediate focus will be on how the new government addresses policies and strategies to improve business and consumer sentiment and private investment growth trends. The market will also be focusing on PH’s strategies to fix the government’s fiscal deficit position, with the abolishment of the goods and services tax (GST), as highlighted in its manifesto for GE14. We, however, believe that the PH Government will likely maintain its real GDP growth forecast range of between 5.5-6.0% in 2018 (5.9% in 2017), as compared to our forecast of 5.3%.

Maintain Overweight and 2018 FBMKLCI Year-end Target of 1,923

While we acknowledge the possibility of short-term capital outflows because of policy uncertainties, we firmly believe the newly formed government presents an opportunity as it is comprised of a group of senior ministers with strong credibility. Once the dust settles, focus should return to: 1) the country’s fundamentals, in which we see negligible negative impact from the PH-run government; and also 2) corporate earnings, which should continue their positive momentum and register a second consecutive year of growth (2018E KLCI growth of 7.0% from 2017: 9.5%). Our positive thesis on the market is still underpinned by our belief that the RM remains undervalued. Maintain Overweight and our year-end FBMKLCI target of 1923 (based on a PE of 18.6x or +1SD mean).

Upgrading Consumer and Autos, Cautious on Construction

Post a potential near-term market shock, we expect focus to be on the stronger middle-income segment, and thus benefiting the Consumer (Upgrade to Overweight from Neutral) and the Auto & Autoparts (Upgrade to Overweight from Neutral) sectors. We also make changes to our stock selection, removing Hong Leong Bank and Genting Malaysia from our top Buys and replacing them with Sime Darby (Automotive exposure), which we upgrade to BUY in this report, and Aeon Co (Consumer exposure).

Macro Implication

Pakatan Harapan Wins Federal and Seven Other States

Pakatan Harapan (PH) has created Malaysian history by winning the 14th Malaysia General Election (GE14), over-taking the Barisan Nasional (BN) coalition, which has ruled Malaysia since its independence in 1957. Of the total 222 Parliamentary seats, PH took a majority of 122 seats while BN and PAS captured 79 and 18 seats respectively. The results strongly affirm the population’s preference for PH, which garnered a 55% victory compared to BN’s previous control of 60% of Parliamentary seats in GE13. The number of states controlled by BN has also been reduced to 3, from the 9 states previously. Joining the previously PH-controlled states of FT Kuala Lumpur, Penang and Selangor are Perak, Kedah, Malacca, Negeri Sembilan and Johor. Sabah would also fall under PH should the Warisan party (under Others in Fig 1) fall under the PH coalition. In short, up to 9 of the 14 Malaysian states are under the PH coalition.

Impact on the Economy

With Pakatan Harapan (PH) winning the GE14 election, from the market's perspective on the future country’s economic growth and financial market performance, the immediate focus of investors will be on how the new government addresses policies and strategies to improve the business and consumer sentiment and private investment growth trends. This is due to concerns that some of the government-funded construction/infrastructure projects may be reviewed going forward. PH has indicated that it plans to review public-sector projects to ensure transparency in contract awards, which will likely lead to delays in the implementation of planned projects such as the Klang Valley MRT Line 3 (MRT3), Gemas-Johor Bahru Electrified Double Tracking (EDT) and KL-Singapore High Speed Rail (HSR).

The market will also be focusing on PH’s strategies to fix the government’s fiscal deficit position, with the abolishment of the goods and services tax (GST), as highlighted in its manifesto for GE14. GST has become an important source of the BN Government’s revenue since its introduction from April 2015, following the decline in government oil revenue. While the PH government has unveiled its fiscal reform review plan, we believe any fastaction plans to address the deficit position concerns will safeguard and maintain the country’s sovereign credit rating outlook by the international rating agencies. In our opinion, the risk of the country’s sovereign rating outlook being downgraded is small, as we believe the PH government will likely cut operating expenditures and demonstrate its commitment to fiscal consolidation as well.

All this also depends on how the PH government initiates immediate actions to generate economic activities in taking steps toward long-term economic growth and sustainability.

There is a possibility that the PH Government may recalibrate the 2018 Budget to reflect the impact of possible abolishment of the GST, possibly acknowledging the revenue loss from GST collection, with possible measures to reduce government expenditures to cover for the shortfall of government revenue. Based on the Budget 2018 report, the collection from GST will increase from the RM41.5bn estimated for 2017 (which was revised to RM44.3bn) and remain high at RM43.8bn projected for 2018.

Based on our rough estimates, even with the reintroduction of a sales and services tax (SST), the revenue collection from an SST will likely amount to about RM21.7bn, reflecting a possible shortfall of revenue of approximately RM22.1bn from GST collection. However, based on our assumption that crude oil prices come in higher than the Budget 2018’s projection of an average of US$52 per barrel and will increase to an average of US$72 per barrel in 2018, the Government’s oil revenue is likely to increase by about RM8bn. Every US$1 per barrel increase in the price of crude oil will likely translate into a gain of about RM400m in the Federal Government’s revenue per year. Dividend income from Petronas will also likely be maintained. As a result, we expect any deterioration in the country’s budget deficit position will be small and manageable, and likely to be temporary from the abolishment of the GST.

With the possibility of GST revenue as a source of revenue from 2018 and beyond abolished, we believe the PH government may need to depend on collection from direct taxation (even with the reintroduction of an SST). Therefore, we believe that apart from cutting operating expenditures (such as optimising further the outlays on supplies and services), the development expenditures may not be reduced as it will remain supportive of construction and economic activities.

Real GDP Growth Likely to be Maintained at 5.5-6.0% for 2018

We believe the PH Government will likely maintain its real GDP growth forecast range of between 5.5-6.0% in 2018 (5.9% in 2017), in line with the BNM official forecast, as compared to our forecast of 5.3%. Going into 2018, we expect Malaysia’s economy to still rely more on internally generated growth, especially from private consumption, which benefits from a favourable labour market, steady income growth and positive credit environment. On the Ringgit front, there are some short-term concerns on the volatility in short-term capital flows due to the shift in investor sentiment. However, with the PH government likely to initiate immediate strategies to generate economic activities, as well as measures on fiscal reform, we expect the Ringgit to trade between RM3.90-3.95/US$ throughout most of 1H18, before appreciating to RM3.80/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 Will Remain Attractive for FDI

We believe Malaysia will remain attractive as a destination for FDI inflows. Malaysia will benefit from the recovery in global FDI flows as well as higher intra-ASEAN and intra-Asia FDI flows. The PH government will likely pursue trade agreements with many parts of the world, from the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which was signed on 8 March 2018, the Regional Comprehensive Economic Partnership (RCEP) and the ASEAN-EU Free Trade Agreement (AEUFTA). It is worth noting that the PH Government in general agrees with this, and they highlighted in their manifesto that their policies will be “geared towards competitive open economy, encourage investment and productivity.”

Source: Affin Hwang Research - 14 May 2018