Economic Growth Weighed Down by Exports and Public Investment

Malaysia’s real GDP growth slowed from 5.4% yoy in 1Q18 to 4.5% in 2Q18, the slowest economic growth in six quarters and lower than market expectation of 5.2%. The sharp slowdown in the economy was attributed to declines in both output of mining sector (due to the supply constraints) and agriculture sector (due to adverse weather conditions). However, both growth in the manufacturing and services sectors, with a combined contribution of close to 77.5% of total GDP, still expanded steadily in 2Q18.

Growth in domestic demand rose strongly from 4.1% yoy in 1Q18 to 5.6% in 2Q18, supported mainly by sharp increase in private consumption growth, which rose from 6.9% yoy in 1Q18 to 8.0% in 2Q18, the strongest pace since 2Q15. This was partly due to the ‘tax holiday’ from June to August 2018, following the zerorisation of the Goods and Services Tax (GST) rate, before the likely implementation of sales and services tax (SST) in September this year, which led to improved consumer sentiment, as reflected in the MIER consumer sentiment index, which surged from 91 points in 1Q18 to 132.9 points in 2Q18. Growth in public consumption also rose sharply from 0.4% yoy in 1Q18 to 3.1% in 2Q18, due to higher spending in supplies and services along with sustained growth in emoluments.

During the quarter, growth in private investment was also higher at 6.1% yoy (0.5% in 1Q18), driven mainly by capital spending in the manufacturing and services sectors. The higher investment activity was in line with the improved MIER business condition index (BCI), which increased from 98.6 in 1Q18 to 116.3 in 2Q18, the highest level since 2Q12. Gross fixed capital formation increase from 0.1% yoy in 1Q18 to 2.2% in 2Q18, underpinned by investment in machinery and equipment, which expanded by 3.6% yoy in 2Q18 (-3.6% in 1Q18).

However, investment in structures slowed further to 2.1% yoy in 2Q18, the slowest in 28 quarters, due to weaker expansion in non-residential property, such as office and retail space. However, growth in public investment declined sharply by 9.8% yoy in 2Q18 (-1.0% in 1Q18), the third consecutive quarters of contraction. The decline in public investment was due to the near completion of ongoing projects combined with lower Federal Government development expenditure.

On the external demand, growth in real exports of goods and services slowed from 3.7% yoy in 1Q18 to 2.0% in 2Q18, but growth in imports increased from -2.0% yoy to 2.1% during the same period. The higher imports growth relative to exports led to a lower net balance of RM21.3bn in 2Q18 (RM29.5bn in 1Q18). As a result, this also led to a smaller contribution to the GDP at only 0.1 percentage points in 2Q18 from 4.0 percentage points in 1Q18.

Growth in Manufacturing and Services Sector Expanded Steadily

On the supply side, the services sector sustained its growth momentum, expanding by 6.5% yoy in 2Q18, driven mainly by steady growth in wholesale and retail trade sub-sector, which expanded by 7.3% yoy and 8.1% yoy respectively, due to higher household spending following the zero rating of GST rate. Growth was also supported by higher growth in restaurant (10% yoy), insurance (9.7% yoy) as well as communication sector (8.6% yoy), following continued demand for data and communication services.

However, growth in the manufacturing sector slowed from 5.4% yoy in 1Q18 to 4.9% in 2Q18, supported by continued strength in the electronics and electrical equipment (E&E), which increased slightly to 6.2% yoy (6.1% in 1Q18). These gains were partly offset by the slower performance in the primary-related cluster, particularly the petroleum, chemical, rubber & plastic products, which was affected by the upstream shocks. Going into 2H18, we believe the continued strength in the E&E sector, particularly in the semiconductor segment, will likely sustained growth in the sector. Semiconductor Industry Association (SIA) noted in its latest release that the global semiconductor sales in 2Q18 surge by 20.5% yoy, recording its highest ever quarterly sales.

On the other hand, growth in mining & quarrying sector turned to negative after making a rebound in the first quarter. The sector contracted by 2.2% yoy (0.1% in 1Q18), mainly due to a sharp drop in natural gas output, following the gas pipeline leak distruption, which transports gas from Oil and Gas terminal in Kimanis, Sabah to the Petronas LNG Complex Bintulu plant for processing. Similarly, growth in agriculture experienced its first negative growth after six quarters, contracting by 2.5% yoy in 2Q18, mainly due to the sharp drop in production of rubber (-20%) and palm oil (-6.0%), due to the declining prices, production constraints and adverse weather conditions.

Growth in the construction sector continued to slow by 4.7% yoy in 2Q18 (4.9% in 1Q18), its weakest yoy growth in 27 quarters. Growth in the sector continue to be supported by civil engineering activity, underpinned by the ongoing transportation, petrochemical and power plant projects. However, the sector was dragged by weakness in residential and non-residential subsectors, which continued to decline due to the high number of unsold residential properties and oversupply of office spaces and shopping complexes.

Revising Our 2018 and 2019 GDP Growth to 5.0%

Going into 2H18, we expect growth in private consumption to remain supportive of GDP growth, especially in 3Q18, due to the front-loading purchases by consumers and businesses alike, particularly prior to the implementation of the new sales and services tax (SST), which is expected to be implemented in September 2018. While there are some concerns of slowing down in consumer spending, we believe that households, despite having frontloaded their expenditure in 2Q18 and 3Q18, will unlikely cut spending significantly. This was also the case before the GST implementation in April 2015, where consumers have not cut back their purchases sharply in 2Q15 as earlier feared, partly reflecting the country’s stable labour market conditions and steady wage growth.

Going forward, despite healthy domestic demand, the country’s real GDP growth may be influenced by developments in the global environment. Global risks remain substantial, and are likely to be on the downside. We expect both Malaysia’s exports and manufacturing production to likely experience some slowdown in growth in 2H18, given the likely slower exports to China and EU countries, as well as concerns on the oncoming global trade tensions. The trade war tension, if escalated, will likely weigh on trade and business sentiment in export-related industries, possibly from higher input costs due to tariffs imposed, especially on China and US imports.

Due to the lower-than-expected real GDP growth in 2Q18 (5% in 1H18), we are revising our GDP growth forecast lower for 2018 from 5.3% estimated earlier to 5.0% currently, in line with the official projection of 5.0%. The flat growth envisaged for 2H18 at around 5% is also partly on account of the higher base effect in the corresponding period of last year (6.1% in 2H17), where growth of exports will likely moderate. While domestic demand remaining healthy, supported by private consumption, the strength and sustainability of Malaysia’s real GDP growth in the quarters ahead hinges importantly on developments in the global environment, where the risks to the global outlook have tilted to the downside. As such, we are also lowering our GDP growth forecast for 2019 to 5%, from 5.3% forecasted earlier.

Current Account Surplus Narrowed Sharply to RM3.9bn in 2Q18

From the balance of payment (BOP), Malaysia’s current account surplus narrowed to RM3.9bn in 2Q18 (1.2% of GNI), after widening to RM15bn in 1Q18 (4.5% of GNI). This was the narrowest quarterly surplus since 2Q16, and was largely contributed from smaller surplus in the goods account. The surplus in goods account slowed from RM35.7bn in 1Q18 to RM26.1bn in 2Q18, due to higher imports growth relative to exports, which resulted the trade balance to narrow, falling from RM33.4bn in 1Q18 to RM27.2bn in 2Q18.

Meanwhile, services account registered a higher deficit of RM6.2bn for the quarter (-RM5.8bn in 1Q18), driven by higher outlay for transportation, construction, insurance & pension, as well as charges of intellectual’s use. Similarly, deficit in the primary income was also higher in 2Q18, widened from -RM10.2bn in 1Q18 to -RM11.2bn, due to lower income accrued to foreign direct investors, while secondary account recorded a similar deficit of RM4.7bn as outward remittances were lower during the quarter.

Financial Account Recorded Net Inflows for the Third Quarter

Malaysia’s financial account recorded a lower net inflow of RM9.2bn in 2Q18 (RM15.2bn in 1Q18), but it remained as net inflows since 4Q17. This was attributed mainly from higher net outflow from portfolio investment, declining further from RM2.6bn in 1Q18 to RM38.3bn in 2Q18. This was in line with the some net foreign selling in equity market of RM9bn during the quarter. Likewise, foreign purchases of Malaysia’s debt securities also drop, falling by RM24.3bn in 2Q18 (+RM3.4bn in 1Q18), mainly concentrated in Malaysian Government Securities (MGS) and Government Investment Issues (GII). The selling by foreigners on Malaysia’s debt securities was recorded in May at RM12.9bn. Due to lower current account surplus and softer net inflow in financial account, the overall balance of payments recorded a deficit of RM0.9bn in 2Q18 (+RM18.2n in 1Q18). Malaysia’s international reserves fell from US$107.8bn as at end-1Q18 to US$104.7bn as at end-2Q18, but sufficient to cover 7.5 months of retained imports and 1.1 times short-term external debt. For 2018 as a whole, we believe that the trade surplus will remain healthy in a range of RM95-98bn (RM97.2bn in 2017). Nonetheless, as the downside risk remained on global trade and the possibility of lower demand for Malaysia’s manufactured goods, we believe the current account will remain in a surplus position, but likely to narrow to a range of between RM30-35bn range projected for 2018 (RM40.3bn or 3.3% of GNI in 2017).

Source: Affin Hwang Research - 20 Aug 2018