Domestic Demand Surprised on the Upside Led by Private Sector

Malaysia’s real GDP growth rose by a better-than-expected 4.9% yoy in 2Q19 (4.5% in 1Q19), higher than market expectation of 4.7% yoy. This was mainly supported by the expansion in domestic demand, led by the private sector, especially from private consumption and private investment. However, public consumption slowed by 0.3% yoy in 2Q19, after a sharp increase of 6.3% in 1Q19, due to lower spending on supplies and services. Similarly, growth in public investment continued to register a negative growth of 9% yoy in 2Q19, albeit a slower decline than -13.2% in 1Q19, supported by higher fixed asset spending by the Federal Government, which partly mitigate the continued weak investment by public corporations.

Growth in domestic demand rose by 4.6% yoy in 2Q19 (4.4% in 1Q19), led mainly by stronger household spending. Private consumption rose strongly by 7.8% yoy in 2Q19 (7.6% in 1Q19), driven by steady income growth as well as higher festive spending during the quarter. The improvement in household spending was lifted by selected government measures, including special Aidilfitri assistance and Bantuan Sara Hidup. After a slow start in 1Q19, growth in private investment recovered to a higher level of 1.8% yoy in 2Q19 (0.4% in 1Q19), supported by higher capital spending in the services and manufacturing sectors, but weighed down by uncertainty surrounding global trade tensions and prevailing weaknesses in the broad property segment. Total gross fixed capital formation (GFCF) declined by 0.6% yoy in 2Q19 from -3.5% in 1Q19, as reflected in public investment growth, which contracted by -9.0% yoy in 2Q19 (-13.2% in 1Q19).

On the external front, growth in real exports of goods and services was flat at 0.1% yoy in 2Q19, the same rate of increase as in 1Q19. However, real imports of goods and services declined at a faster rate of 2.1% yoy in 2Q19 (-1.4% in 1Q19), due to lower imports of capital goods. With the increase in exports relative to imports, net exports added 1.4 percentage points to GDP growth in 2Q19 (0.9 percentage points in 1Q19), and remained in a positive territory for the third straight quarter.

Strong Turnaround in Mining and Quarrying Growth in 2Q19

On the supply side, growth in the mining and quarrying sector turned around to a positive growth of 2.9% yoy in 2Q19, after declining by 2.1% in 1Q19, its first positive growth since 3Q17. This was mainly due to higher production of natural gas (LNG), which recovered steadily in 2Q19, following the pipeline disruptions in 2018.

The sharp turnaround in natural gas output also helped to offset the drag to mining sector growth caused by lower oil production, amid the planned facility shutdowns in East Malaysia.

The manufacturing sector rose by 4.3% yoy in 2Q19 (4.1% in 1Q19), underpinned by better performance in the domestic-oriented industries, in tandem with the country’s strong domestic demand. This was reflected in the production of motor vehicles, which recorded higher sales during the festive season. Similarly, higher output in the construction related segment was supported by demand for metal related materials for existing transport and infrastructure projects.

The services sector rose by 6.1% yoy in 2Q19 (6.4% in 1Q19), supported by sustained growth in the wholesale and retail sales trade due to household spending. Growth in the finance and insurance sub-sector was supported by the fee-based income segment following a major initial public offering (IPO) in the capital market. Higher air passenger traffic and port activity in transhipment and gateway segments also supported growth in the transport and storage subsector.

The construction sector improved slightly by 0.5% yoy in 2Q19 (0.3% in 1Q19), attributed to growth in the residential and special trade subsectors. The agriculture sector expanded at a slower pace of 4.2% yoy in 2Q19, from 5.6% in 1Q19, amid the decline in fishing and forestry activities, as well as slower natural rubber production growth. This was mitigated by the sustained recovery in oil palm yields from the adverse weather in 2018.

Revising Our Real GDP Growth Higher to 4.7% for 2019

Due to the better-than-expected real GDP growth in 2Q19, we are revising our 2019 GDP growth forecast higher by 0.2 percentage points from 4.5% to 4.7%, which is at the upper end of the official projection of between 4.3%- 4.8%. However, this also takes into account some slowdown in quarterly growth for 2H19, from 4.9% in 2Q19 to an estimated 4.7%. The more moderate growth envisaged for 2H19 is mainly on account of the slower growth in exports, but the country’s domestic demand remains healthy. Nevertheless, we believe the sustainability of real GDP growth in the quarters ahead hinges importantly on developments in the global environment, and as we are cautious of the downside risk from the trade war between US and China, we are maintaining our 4.5% real GDP growth forecast for 2020.

We believe the country’s domestic demand, especially private consumption, will continue to be the main driver for the Malaysian economy. For instance, the cash handout of the third phase of Bantuan Sara Hidup (BSH), which will be distributed on 28th August 2019, will likely support Malaysian household spending. Moreover, we believe other selected government assistance, such as the targeted petrol subsidies with some cash assistance, which will likely be implemented by this year, is expected to support private consumption.

If domestic demand can be sustained to support economic growth, we also believe growth in total investment will likely recover in the quarters ahead, supported by the improvement in the residential property segment and higher capital spending in the services and manufacturing sectors. Moreover, we believe the Federal government will increase its spending on development expenditure to support public investment and domestic demand in the quarters ahead.

However, going into 2020, the global economy still faces substantial downside risks emanating from global trade war. The International Monetary Fund (IMF), in its latest issue of the World Economic Outlook (WEO), downgraded its growth forecast on the world economy by 0.1 percentage points to 3.5% for 2020 (3.2% in 2019). Global manufacturing PMI deteriorated further from 49.4 in June to 49.3 in July, its lowest level since October 2012. Global semiconductor sales contracted for the sixth consecutive month in June by 16.8% yoy, following a drop of 14.6% in May. With recent weak external data, this may suggest that manufacturers will remain cautious on new orders and international trade going forward.

Current Account Surplus Narrowed to RM14.3bn in 2Q19

As for the balance of payment (BOP), Malaysia’s current account surplus narrowed in 2Q19 to RM14.3bn (3.9% of GNI) from RM16.4bn (4.7% of GNI), after widening for three consecutive quarters. Although this was its smallest surplus since 4Q18, the surplus has remained above RM10bn since 4Q18. The narrower current account surplus during the quarter was mainly due to the lower surplus in the goods accounts of RM28.1bn in 2Q19, from RM33.8bn in 1Q19. This was reflected in Malaysia’s external trade performance during the quarter, where the trade surplus narrowed to RM30.1bn in 2Q19 from RM37bn in 1Q19, its smallest surplus since 3Q18. This was due to gross imports which registered a smaller decline of 1.2% yoy from -2.5 in 1Q19, while gross exports rebounded to 0.2% yoy from a contraction of 0.7% yoy in 1Q19. Furthermore, the primary income account registered a lower deficit of RM5.5bn in 2Q19, from a deficit of RM10.1bn in 1Q19, driven by higher receipts on direct investment assets. Likewise, the secondary income account posted a smaller deficit of RM4.9bn during the quarter from a deficit of RM5.5bn in 1Q19 due to outward remittances by foreign workers.

However, the services account registered a higher deficit of RM3.4bn in 2Q19 compared to a deficit of RM1.8bn in 1Q19, led by the lower surplus in travel as well as higher net payments to foreign providers for transport services.

Financial Account Registered a Net Outflow of RM18.6bn in 2Q19

Malaysia’s financial account recorded a net outflow for the third consecutive quarter of RM18.6bn in 2Q19, compared to a net outflow of RM13.8bn in the previous quarter. This was attributed to the net outflows in portfolio investment of RM10.2bn in 2Q19 (compared to net inflow of RM2.1bn in 1Q19), direct investment of RM8.2bn (compared to net inflow of RM16.3bn in 1Q19) and financial derivatives of RM0.5bn (compared to net outflow of RM0.2bn in 1Q19). Meanwhile, other investment registered saw a net inflow of RM0.3bn, rebounding from a net outflow of RM31.9bn in 1Q19.

Net outflow in the financial account also reflected the net foreign selling in the equity market, which increased further to RM3.3bn in 2Q19 from a net outflow of RM1.4bn in 1Q19, making this the fifth consecutive quarter where foreign investors have been net sellers. Similarly, in the bond market, foreign investors turned into net sellers of Malaysian debt securities with a net outflow of RM7.4bn (net inflow of RM5.1bn in 1Q19), after two consecutive quarters of net inflows, mainly concentrated in Malaysian Government Securities (MGS) and Government Investment Issues (GII).

In an effort to provide greater flexibility and efficiency for businesses to better manage their foreign exchange risk and conduct their daily operations, BNM announced further liberalisation of the foreign exchange administration (FEA) policy. We believe that with these measures, on top of the initiatives introduced by BNM in May 2019, will enhance market liquidity and accessibility, whilst preserving an orderly and transparent onshore financial market, the country’s risk of exclusion from the FTSE Russell’s World Government Bond Index (WGBI) has reduced. We believe FTSE Russell will maintain Malaysia in the WGBI and continue to assign a “2” for Malaysia, which represents the highest level of accessibility. The upcoming review by FTSE Russell will be in September 2019.

With Malaysia’s healthy fundamentals supporting possible inflows into the bond market in 2H19, we believe Malaysia’s balance of payment will stay resilient.

Steady Current Account Surplus Anticipated Despite External Headwinds

Despite ongoing trade war uncertainties, and its implication for the country’s current account balance, especially for the goods account, we believe export demand for Malaysian goods (such as E&E products) to stay healthy. The diversified nature of Malaysia’s exports should enable the country to benefit from some trade diversion. Besides that, steady commodity prices, such as global oil prices, will also support export of petroleum-related products. Therefore, with steady export growth over import growth, we expect the trade surplus to remain large at around RM115bn for 2019 (RM120.3bn in 2018) and the current account surplus to also remain healthy at around RM30bn in 2019 (RM33.5bn or 2.4% of GNI in 2018).

As shown in Fig 5, BNM announced further liberalisation of the foreign exchange administration (FEA) policy.

Source: Affin Hwang Research - 19 Aug 2019