Slower External and Domestic Demand Envisaged for 2019

We expect Malaysia’s real GDP growth to slow from 5.0% yoy in 1H18 to 4.6% estimated for 2H18, where we expect an average of 4.8% for full-year 2018E (2017: 5.9%). Going forward, against the backdrop of modest but healthy growth in the global economy, we now look for Malaysia’s real GDP growth to rise by 4.7% in 2019E, down from our previous forecast of 5%, partly reflecting slower growth in both external and domestic demand.

Private Consumption Likely to Remain Supportive of GDP Growth

Some of the 2019 Budget measures to support consumer spending are the continuation of cash assistance, increase of the national minimum wage, together with several measures to ease the people's burden from rising cost of living. We remain positive that households will remain financially sound, supported by the country’s steady household earnings, positive employment outlook, steady commodity prices, with strong financial buffers to service debt obligations, supported by accommodative financing conditions going into 2019.

Private Investment to be Supported by Healthy Capital Spending

Growth in private investment will likely hold up in 2019, as major investment indicators suggested healthy capital spending patterns (as reflected in the manufacturing and services sectors), driven by applications approved from both foreign and domestic sources. Private investment is also expected to be supported by ongoing infrastructure projects. As announced in Budget 2019, we believe the Government’s decision to repay the tax refunds amounting to RM37bn will support and benefit businesses, and possibly lead to some investment and expansion activities by the private sector.

Still Substantial Amount of Development Expenditure to be Spent

Regardless of oil price level, we believe that it is highly unlikely that the Government will cut its budget allocation for development expenditure (DE) allocated for 2019, as this would provide a buffer from a possible economic slowdown if the external environment remains unfavourable for export growth.

Malaysia’s Inflation Will Likely Remain Low and Manageable in 2019

While the country’s headline inflation will likely rise gradually from October onwards, we expect the full-year inflation to average around 1.2-1.3% in 2018E (3.7% in 2017). Despite the proposed reintroduction of targeted fuel subsidies in 2H19, the impact would likely to be manageable, where we expect headline inflation to be in the range of 2.0-2.2% in 2019.

Stance of Monetary Policy Likely to Remain Accommodative

BNM cautioned that risks to the global growth outlook remain tilted to the downside, citing possible further escalation in trade tensions, where we believe BNM will likely hold its overnight policy rate (OPR) at 3.25% throughout 2019.

Economic Fundamentals to Support Ringgit Against USD

With the 10M18 trade surplus at RM102bn (RM98.5bn in 2017), we are expecting full-year 2018E to be around RM120bn, and still a substantial surplus of about RM100bn for 2019E. We also expect the compliance rate arising from the conversion of foreign currency export proceeds to Ringgit to improve further, therefore supporting demand for the Ringgit. With healthy current account surpluses, we continue to see the Ringgit trading at RM3.90 by end-2019E (vs. RM4.15/USD currently).

Downside risks on Malaysian economy remain external

Despite strong domestic demand, Malaysia’s real GDP growth slowed further from 4.5% yoy in 2Q18 to 4.4% in 3Q18, the slowest quarterly growth since 3Q16, dragged mainly by negative net external demand, which declined by 7.5% in 3Q18 (1.7% in 2Q18). This was reflected in the sharp decline of real exports of goods and services during the quarter, from 2.0% yoy in 2Q18 to -0.8% in 3Q18. However, growth in real imports of goods and services remained in positive territory, with a growth of 0.1% yoy in 3Q18, albeit lower than 2.1% in 3Q18, due to some distortion from the surge in domestic spending during the tax holiday period. Growth in domestic demand rose strongly in 3Q18, led by growth in private consumption, which rose sharply from 8% yoy in 2Q18 to 9% in 3Q18, the highest yoy growth in six years, as a result of the ‘tax holiday’ period from June to August 2018, following the zerorisation of the Goods and Services Tax (GST) rate, from 1 June 2018 to 31 August 2018. As a result, growth of durable goods such as motor vehicles and furnishings, as well as food and beverages rose sharply during the quarter. Growth in private investment also increased further from 6.1% yoy in 2Q18 to 6.9% in 3Q18 (from a low of 0.5% in 1Q18), underpinned mainly by capital spending in the manufacturing and services sectors.

Real GDP Growth Likely to Recover Slightly in 4Q18

As lower 3Q18 economic performance was partly distorted by higher imports, we believe growth in Malaysia’s real GDP growth will likely normalise and recover gradually to about 4.6% yoy in 4Q18 (4.4% in 3Q18). This view is supported by continued encouraging economic indicators, with positive growth in export performance, which rose sharply by 17.7% yoy in October, from 6.7% in September. The country’s industrial production index (IPI), especially the manufacturing sector, which covers about 64% of total IPI, has also expanded steadily in October.

Imports of intermediate goods turned around from -9.5% yoy in September to 1% in October, which provided some indication that Malaysia’s export growth should continue to remain steady in the coming months. As a result, with an increase in exports relative to imports, the negative contribution from net external demand on GDP growth should be smaller in 4Q18, as compared to the drag in 3Q18. Nevertheless, Malaysia’s real GDP growth is expected to slow from 5.0% yoy in 1H18 to 4.6% in 2H18E, where we expect an average of 4.8% for full year 2018E (5.9% in 2017).

Slower Economic Growth Envisaged for 2019

Going forward, against the backdrop of modest but healthy growth in the global economy, we expect Malaysia’s real GDP growth to expand by 4.7% in 2019. However, this is a downward revision from our previous forecast of 5% growth for 2019, partly reflecting slower growth in both external and domestic demand, see Fig 3.

Despite external uncertainty, we believe Malaysia’s economic growth is unlikely to slow sharply in 2019, with the anticipated modest (and healthy) growth in the global economy, as reflected in IMF’s global growth forecast of 3.7% next year. We expect Malaysia’s real exports of goods and services to improve from 1.4% estimated for 2018 to about 1.8% in 2019. On the domestic economy, with some slowdown in private consumption growth, real aggregate domestic demand is expected to slow but expand by 4.6% in 2019, slowing from 5.2% estimated for 2018 (6.5% in 2017).

Consumer and Business Sentiments Remain Positive

Malaysia Institute of Economic Research (MIER)’s consumer sentiment index (CSI) and business condition index (BCI) in 3Q18 showed continued optimism from both consumers and businesses on the current state of the economy and the prospects of economic growth. Both indicators remained above the 100-level threshold, with CSI at 107.5 and BCI at 108.8 in 3Q18. MIER noted that consumers are expecting higher employment prospects, while businesses are enjoying higher sales in 3Q18. Malaysia’s employment growth in 3Q18 rose by 2.6% yoy, the strongest in four years, which we believe will continue to provide a positive momentum for the domestic economy in 2019. Similarly, according to DOS, in the latest survey, businesses expect more favourable performance in the fourth quarter of 2018 compared with third quarter of 2018.

The confidence indicator rose marginally higher to +7.1% in 4Q18, as against +6.0% in 3Q18. A net balance of +12.3% shows that the establishment expects business performance to be more favourable for the period of October 2018 to March 2019, vs. April to September 2018.

Private Consumption Likely to Remain Supportive of GDP Growth

Some of the 2019 Budget measures to support consumer spending are the continuation of cash assistance, such as Bantuan Sara Hidup (BSH), with an allocation of RM5.0bn (RM6.8bn in 2018), as well as the increase of national minimum wage to RM1,100 per month for the whole of Malaysia effective January 2019, higher by an average of RM50 to RM130, from a range of between RM920 (Sabah and Sarawak) and RM1,000 (Peninsular Malaysia), together with several measures to ease the people's burden on rising cost of living (such as public transport passes). We remain optimistic that households will remain financially sound, supported by the country’s steady household earnings, positive employment outlook, steady commodity prices, with strong financial buffers to service debt obligations, supported by accommodative financing conditions going into 2019.

Private Investment to be Supported by Healthy Capital Spending

Growth in private investment will likely hold up in 2019, as major investment indicators suggest healthy capital spending patterns (as reflected in the manufacturing and services sectors), driven by applications approved from both foreign and domestic sources.

Private investment is also expected to be supported by ongoing infrastructure projects, such as the Pan Borneo Highway, MRT and LRT3 projects. As announced in Budget 2019, we believe the Government’s decision to repay the tax refunds amounting to RM37bn (RM18bn for income tax and RM19bn for GST), with one-off settlements to the private sector in 2019, will support and benefit businesses, and possibly lead to some investment and expansion activities by the private sector. For example, when businesses receive the tax refund, this would be a direct stimulus on the economy, especially on capital expenditure.

However, there are also some concerns on possible downside risk on private investment from the possible cut in capital expenditure (capex) by Petronas, especially after the national oil and gas (O&G) company pays its dividend to the Government amounting to RM54bn (which includes a special dividend of RM30bn) in 2019, from RM26bn in 2018. However, with Petronas’ cash balance remaining sound, supported by the current steady oil price environment, if sustained, we believe the impact on Petronas capex spending to be manageable.

SME Will Drive Investment in Manufacturing Sector

Efforts to drive investment also focused on small and medium enterprises (SMEs), as they accounts 98.5% of total establishments and 59% of total employment in the economy, in part to encourage domestic direct investment (DDI). Under the National Industry 4.0 Policy Framework, the Government aims to support industry transformation and develop local technology development by providing and aligning incentives with targeted outcomes to manufacturing firms and solution providers.

Fiscal and non- fiscal incentives for local firms, SMEs and start-ups as well as multi-national corporations (MNCs) that deploy or develop Industry 4.0 technologies and processes will be provided. In fulfilling the needs of diverse and innovative businesses, the Government and private sector will spur the implementation of Industry 4.0 through dynamic and innovative funding options for local firms, SMEs and start-ups as well as multi-national corporations (MNCs).

Based on the SME Input-Output analysis done by SME Corp Malaysia, it noted that the estimated allocation of RM17.94bn for SME development across all economic sectors was expected to generate an additional RM3.8bn of SME value-added in 2019, which is an increase of 0.3ppt in share of SME GDP to total GDP. Currently, SME represents 97% of the manufacturing sector, 42% of Malaysia employment and a total contribution to GDP of 37.1%.

Still substantial amount of development expenditure to be spent

Based on the new development expenditure figures reported in the mid-term review of 11MP, the Government cut its development expenditure by RM40bn from its original plan target of RM260bn to RM220bn, which will translate to an average spending of RM44bn per annum vs. RM52bn p.a. in the original plan. During the review period, RM92bn was allocated for development expenditure, while only RM86.9bn was actually disbursed compared to the overall allocation under the 11MP at RM260bn, reflecting an allocation of RM104bn for the two-year period (2016-17). Considering that, the Government will allocate another RM133.1bn for the 2018-20 period, there are still substantial amounts equivalent of RM44.4bn a year.

Regardless of the oil price level, we believe that it is highly unlikely that Government will cut its budget allocation for development expenditure (DE) allocated for 2019, as this will be crucial in supporting economic growth. A large share of development expenditure allocated for the economic sector, such as for the existing Light Rail Transit Line 3 (LRT3), housing, electrified double-track project (EDTP), government integrated radio network (GIRN) and highways will likely be carried out as scheduled, offsetting some slowdown in public consumption. We believe the substantial amount of development expenditure will still provide a buffer from a possible economic slowdown if the external environment remains unfavourable for export growth.

Exports likely to recover in 2019 on the back of healthy global growth

Given that the global economic slowdown is not synchronised, we expect exports of non-commodity products to remain healthy from stronger demand from advanced economies for E&E products in 2019, especially from the US. According to the Semiconductor Industry Association (SIA), as stated in the World Semiconductor Trade Statistics (WSTS), global semiconductor sales are expected to grow at a slower rate of around 2.6% yoy in 2019, after a strong double-digit growth of 15.9% estimated for 2018. However, we believe the slower growth in 2019 was partly distorted by high base due to strong sales of DRAM products in 2018.

Nevertheless, the global semiconductor industry is expected to remain positive in 2019, despite operating in a more challenging global macroeconomic environment, where in absolute term, the industry’s worldwide sales will still increase from USD477.9bn in 2018 to USD490.3bn projected for 2019, which would still mark the industry’s highest-ever annual sales.

In the October issue of the World Economic Outlook (WEO), the International Monetary Fund (IMF) expects global GDP growth in 2019 to remain strong, albeit slower. Both global GDP growth forecasts in 2018 and 2019 were reduced by 0.2 ppt to 3.7%, respectively, similar to the growth registered in 2017. Despite the downward revisions, global GDP growth would remain at its fastest pace since 2011.

Downside risks to global growth still abound

Nevertheless, the IMF cautioned that the downward revision of its forecast was due to expectations of tightening global financial conditions amid normalising monetary policy and protectionist trade measures implemented in 2018 between the US and China.

A dimmer outlook for key emerging market and developing economies is attributed to factors such as trade measures, weaker activity in Iran following the re-imposition of US sanctions, sharp projected slowdown in Turkey as well as subdued outlook for large Latin American economies like Argentina, Brazil and Mexico.

Unclear and no end in sight for trade war tensions

Despite both President Donald Trump and Chinese President Xi Jinping agreed recently to a 90-day truce, where US agreed not to raise tariff rates from 10% to 25% on USD200bn worth of Chinese imports from 1 January 2019, there are still market uncertainties if both parties cannot reach a compromise and trade deal after the 3 months deadline. According to US officials, both leaders had agreed to start talks on structural changes in China’s practices which includes forced technology transfer, trade secrets theft and nontariff barriers.

In the latest OECD’s Economic Outlook report, the OECD cautioned that even if no further tariffs are imposed on US and China (from the already imposed tariff increases), by 2020-21, global GDP growth is expected to decline by 0.1%, while global trade would drop by 0.4%. In this scenario, China’s is expected to be impacted more significantly, where its economic growth is projected to fall by 0.3% compared to US which would drop by 0.2% by 2021.

Again, if both US and China failed to arrive at an agreement once the 90- day window is up, where as a result, the US decides to raise tariffs to 25% on USD200bn of Chinese imports and escalates further, the OECD noted that with retaliatory action taken by China, both the US and China’s GDP will likely decline by 0.4pp and 0.6pp, respectively by 2021. As a consequence, global GDP growth is anticipated to decline by 0.2pp, while world trade growth will fall by 0.6pp by 2021. It further clarified that in these simulation, in the near term, most of the burden of higher tariffs will be on the US consumers due to the subsequent higher cost.

The trade war between US and China has also led to the revised 2019 global trade outlook by the World Trade Organisation (WTO) in its September issue of Trade Statistics and Outlook. It had also highlighted that restrictive trade policies and the ensuing uncertainty for businesses and consumers may already be affecting investment spending. Furthermore, the rebalancing of the Chinese economy away from investment and toward consumption may also hamper import demand. As a result, the WTO cut its merchandise trade volume projection by 0.3 percentage points to 3.7% in 2019 and reduced its 2018 projection by 0.5 percentage points to 3.9%. Despite the revisions, trade growth would still remain above 3% for the third consecutive year.

Impact on Trade War on Malaysia

According to Bank Negara Malaysia (BNM), in a report titled “Escalating Trade Tensions and Potential Spillovers to Malaysia,” the impact on Malaysia is manageable in the short term, where it noted that there is as much as US$140bn of potential trade diversion of US’ imports from China to other countries, which include to Malaysia, Thailand, Indonesia and Vietnam. From this amount, it is estimated that Malaysia could potentially gain from trade substitution of up to US$970m, in which this amount has taken into consideration the manufacturing capacity constraint and are products that have at least 5% of the US’ import market share. The products that Malaysia likely to gain from are mostly in the E&E industry, such as electrical machines, electronic integrated circuits and semiconductors for solar panel cells.

Overall, we believe that the trade substitution could benefit Malaysia economy from both export demand and private investment activity. Nevertheless, as cautioned by both OECD and IMF, the trade war tensions could get uglier, and there is a higher possibility that the trade dispute will have a net negative effect on Malaysia economy in the medium to longer term. The weaker trade activity could incur some spillovers on Malaysia’s domestic economy, especially those in the export-oriented industry. Moderation in export could affect income and employment activity, lowering household spending. The lower orders will have a negative bearing on firms’ profitability, affecting their investment decision which could have a repercussion on private investment activity.

BNM noted that final demand from China, the US and the EU, account for 38.4% of Malaysia’s final export demand. If trade tensions intensify further, the downside risk to export growth will be more severe. In the event that the downside risks materialise, with further escalation, the total impact to Malaysia’s exports growth could be a reduction of as much as 1.8–2.7pp. Taken altogether with its current form and possible additional tariffs, the overall impact on growth could also be as large as a reduction of 1.3–1.5pp on Malaysia’s economic growth.

Global trade remains steady while production has eased

In 2018 so far, global growth continued to be supported by healthy trade growth despite rising trade tensions. According to the August World Trade Monitor by the CPB Netherlands Bureau for Economic Policy Analysis, world export growth was steady in August 2018 at 3.9% yoy for the second consecutive month, maintaining its strongest growth since February 2018.

OECD CLI points to slower growth momentum

There are some signs of slowing down, where OECD’s Composite Leading Indicator (CLI), which is designed to provide early signals of turning points in business cycles showing fluctuations of the economic activity, fell lower to the 98.9 level in September, its weakest reading since September 2012, after maintaining a 99 level since December 2017. Similarly, November’s global manufacturing PMI (52) registered its lowest reading since November 2016 of 52.1 after continually falling since May 2018 due to softer output growth and new orders. Despite this, the manufacturing PMI has stayed above the 50-mark level since 2012.

Divergence in global monetary policies

The US economy may start to see some slowdown in 2019, where downward pressure will likely arise from global trade uncertainties, the Fed’s unwinding of its USD4.1trn balance sheet and widening budget deficit, which is projected by the Congressional Budget Office to widen to USD981bn in 2019 (USD804.2bn in 2018) partly due to the Tax Cuts and Jobs Act. This is in line with IMF’s outlook of softer growth where GDP growth is expected to ease to 2.5% in 2019 as well as the CBO’s projection of a slower growth of 2.4% in 2019.

The CBO also guided that the although US GDP growth is anticipated to be boosted by the fiscal stimulus in 2018 and 2019 by 0.3pp and 0.6pp, respectively, the resulting wider budget deficits will likely lead to higher federal borrowing which in turn would crowd out private investment, lowering GDP growth from 2020.

In the US Fed’s FOMC meeting in November, the federal funds rate was left unchanged at 2-2.25%, but the market expects the Fed to raise it at its next meeting in December by 25bps. According to the US Fed dot plot, following the December rate hike, the US Fed will continue to raise rates another three more times in 2019 to reach 3-3.25% followed by one rate hike in 2019 to 3.25-3.50%. However, Fed Chairman Jerome Powell recently guided that the central bank's current Fed Funds rate is "just below" neutral, possibly implying that the Fed will likely slow down on its rate hike cycle going into 2019.

The European Central Bank (ECB) may also be winding down on its quantitative easing, where in January 2018 it had reduced its monthly asset purchases from 60bn Euros to 30bn Euros. By the end of 2018, the ECB plans to stop its purchases completely. However, the ECB has left interest rates on the main refinancing operations, marginal lending facility and deposit facility unchanged at 0%, 0.25% and -0.4%, respectively at the latest monetary policy meeting in October. It also guided that interest rates will remain at their current levels at least through summer of 2019.

On the monetary policy in Japan, the Bank of Japan (BOJ) at its latest monetary policy meeting in October left its policy rate unchanged at -0.1%, while continuing its purchase of Japanese government bonds (JGBs) in order to keep the 1 year JGB yield at around 0%. BOJ guided that it will continue with its Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control in order to achieve price stability of 2%. We believe the BOJ will continue with its current accommodative monetary policy in 2019 due to headline inflation which remained below the 2% target.

China’s Growth Momentum Slowing Down

In 3Q18, China’s economic growth moderated for a second consecutive quarter to 6.5% yoy, from 6.7% in 2Q18, making this its lowest growth since 1Q09, given the government’s ongoing effort to reduce the country’s reliance on debt-fueled growth. Besides that, though domestic credit growth in China improved slightly in September to 10.7% yoy from 10.3% in August, it has stayed below 11% since May 2018 even with liquidity injections by the PBOC through its open market operations.

In China’s 13th Five-Year Plan, a roadmap for the country’s development from 2016 to 2020, the Chinese authority has set its initial target for annual GDP growth of 6.5% over next five years, where traditionally the Chinese Government has a strict growth target stipulated, always seem to meet or exceed it, but with trade tensions looming with the US, we believe China’s GDP growth will be slightly lower than 6.5% in 2019.

Going forward, we believe the downside risks on global growth will predominantly in China’s growth prospects. If China slows, there is a possibility of further slowdown in world economic indicators that may prompt the IMF to make another round of downward revisions to global GDP growth for 2019, from the current projection of 3.7%.

Malaysia’s Inflation Will Remain Manageable in 2019

Following the abolishment of goods and services tax (GST) from June 2018, the country’s headline inflation remained low at 0.5% yoy in 3Q18, but rose only slightly to 0.6% in October. This was despite the reintroduction of the sales-and-service tax (SST) in September after the tax holiday period (3 months of zero-rating GST in June-August 2018). This could be attributed to the SST covering a lower range of products as compared to GST.

On a cumulative basis, headline inflation rate rose by 1.1% yoy in 10M18, significantly below the 3.9% yoy in 10M17. While the country’s headline inflation will likely increase further from October onwards, we expect fullyear inflation to average around 1.2-1.3% in 2018 (3.7% in 2017). Despite the planned reintroduction of targeted fuel subsidy in the second half of 2019, the impact would likely to be manageable due to the level of global oil price at the moment. We expect headline inflation to be in the range of 2.0- 2.2% in 2019.

Stance of monetary policy likely to remain accommodative

BNM cautioned that risks to the global growth outlook remain tilted to the downside, citing possible further escalation in trade tensions, but also noted that the continued volatility in the international financial markets and monetary policy normalisation in some advanced economies could lead to a further capital outflows and financial market adjustments in emerging economies. As a result, we believe BNM will likely hold its overnight policy rate (OPR) at 3.25% throughout 2019.

Economic Fundamentals to Support Ringgit Against the USD

Malaysia’s fiscal deficit position will likely widen slightly by 0.7 percentage points to 3.7% of GDP in 2018E, from 3% of GDP in 2017, but the MOF expects the budget deficit to improve to -3.4% of GDP in 2019. We believe the Government is committed to maintain a path of fiscal consolidation, targeting -3% of GDP in 2020 and -2.8% of GDP in 2021. If the Government is successful to safeguard and prevent the country’s budgetary deficit position from getting larger next year, from the current projection of sustainable path of fiscal consolidation, and also avoiding possible shortfall in tax revenue receipts, Malaysia's sovereign outlook by international rating agencies will likely remain stable going forward.

With the 10M18 trade surplus at RM102bn (RM98.5bn in 2017), we are expecting full-year levels to be around RM120bn for 2018E, and a surplus of about RM100bn for 2019E. We also expect the compliance rate arising from the conversion of foreign currency export proceeds to Ringgit to improve further, therefore supporting the demand for Ringgit. The cumulative amount of net export proceeds FX conversion rose to USD13.6bn by September 2018 (from USD9.2bn as at December 2017). With healthy current account surpluses, we see the Ringgit trading at RM3.90 by end-2019 (RM4.15/USD currently).

Source: Affin Hwang Research - 7 Dec 2018