• Sharp contraction during the quarter due to declines in both domestic demand and exports; services sector contracted sharply by 16.2% yoy in 2Q20 (3.1% in 1Q20), as a result of restrictive MCO nationwide
• Our forecast shows real GDP growth contracting to -4.5% in 2020 (revised lower from -3.5%), compared to official forecast of between -3.5% to -5.5%
• For 2021, we are projecting real GDP growth to expand by 6.0%, as compared to the official forecast of between 5.5% to 8%.

GDP growth weighed down by domestic demand and exports in 2Q20

Malaysia’s real GDP growth contracted sharply to -17.1% yoy in 2Q20, compared to +0.7% in 1Q20, its worst quarterly yoy decline since 4Q1998 and first contraction since 3Q09. The sharp contraction was due to sharp declines in both domestic demand and net exports in 2Q20. During the quarter, growth in domestic demand declined sharply from 3.7% yoy in 1Q20 to -18.7% in 2Q20, dragged down significantly by declines in total investment and total consumption. Net exports contribution to GDP growth contracted by -2.7 percentage points in 2Q20, albeit slower than -3.2 percentage points in 1Q20. On a quarterly seasonally adjusted basis, real GDP growth contracted to - 16.5% in 2Q20 compared to -2.0% in 1Q20.

As highlighted by Bank Negara Malaysia (BNM), the sharp decline in the country’s economic growth was due mainly to the impact of containment measures both globally and domestically. In the country, the Movement Control Order (MCO), which began on 18th March until 3rd May resulted in a sharp drag on the economy, due to demand and supply shocks from production and consumption restrictions, while closure of international borders and restricted interstate travel caused a decline in tourism. Based on monthly GDP estimates by DOS, during the MCO period, real GDP growth contracted to -28.6% yoy in April followed by -19.5% in May, and as the country moved into Conditional (CMCO) and Recovery MCO (RMCO), the economy posted a smaller decline of -3.2% in June.

Domestic demand contracted sharply by 18.7% yoy in 2Q20 (3.7% in 1Q20), weighed down by declines in both total investment and total consumption. Total investment contracted by 28.9% yoy in 2Q20 (-4.6% in 1Q20), declining for the sixth straight quarter. This was reflected in the sharp decline in public investment, which contracted by 38.7% yoy in 2Q20 (-11.3% in 1Q20), due to lower capital spending by the government and public corporations. Similarly, private investment declined by 26.4% yoy in 2Q20 (-2.3% in 1Q20), where MCO restrictions and heightened uncertainty impacted negatively business sentiment and investment intentions, as well as halted implementation of some projects temporarily.

Total consumption declined by 15.1% yoy in 2Q20 (+6.5% in 1Q20), its first contraction since 1Q09 due to the 18.5% yoy decline in private consumption (6.7% in 1Q20), its first decline since 1Q09 as household spending was also dragged down by movement restrictions in the early part of 2Q20 as well as income losses.

Growth in public consumption was at a slower pace of 2.3% yoy in 2Q20 (+5% in 1Q20) with sustained rises in emoluments amid lower spending on supplies and services. On the external front, in tandem with weak global trade from supply chain disruption, Malaysia’s real exports of goods and services contracted by 21.7% yoy in 1Q20 (-7.1% in 1Q20). Similarly, real imports of goods and services contracted for the sixth consecutive quarter by 19.7% yoy in 2Q20 (-2.5% in 1Q20). Due to a sharper decline in exports relative to imports, contribution from net exports to GDP growth contracted by 2.7 percentage points in 2Q20 (-3.2 percentage points in 1Q20).

Declines across all sectors except agriculture

On the supply side, growth in the services sector contracted sharply by 16.2% yoy (3.1% in 1Q20), as during the restrictive MCO nationwide, essential services such as food-related retail, utilities, banking, transportation as well as information and communication entities were allowed to operate but with very limited capacity. Most significant was that the lockdown led to declines in wholesale and retail trade, as well as food and beverages and accommodation, from weak consumer spending and tourism activity. The finance and insurance sub-sector was weighed down by lower net interest income and lower fee-based income due to subdued capital market activity.

The manufacturing sector contracted by 18.3% yoy in 2Q20 (+1.5% in 1Q20) as reflected in production activity across all industries due to MCO restrictions and weak demand. For example, some sectors such as transport equipment and textile-related industries were closed during the MCO. However, during the quarter, the decline in manufacturing sector was cushioned by some backlog of orders, especially in June, which bolstered a quicker production recovery in the E&E industry. The mining sector also declined sharply for the fourth straight quarter by 20% yoy in 2Q20 (-2% in 1Q20), as oil and gas output was dragged down by a sharp decline in demand due to the MCO and maintenance works in East Malaysia.

The construction sector declined for the second consecutive quarter, falling sharply by 44.5% yoy in 2Q20 (-7.9% in 1Q20) as nearly all activities were halted in April. BNM noted that most construction sites faced challenges in restarting following the gradual easing of restrictions due to strict standard operating procedures. However, towards the end of 2Q20, additional measures implemented by the government assisted in the restarting of construction activities. In contrast, the agriculture sector grew by 1% yoy in 2Q20 (-8.7% in 1Q20), after contracting for two quarters in a row, due to the recovery in oil palm production supported by higher harvesting activities.

Real GDP growth projected to decline by -3.5% to -5.5% for 2020

After assessing the set of economic forecasts presented by BNM, we concur with the view that the country’s domestic demand will gradually improve and gain momentum from 2H2020, especially after the transition from MCO to CMCO in May and RMCO in June. Going forward, BNM expects the country’s real GDP growth to turn around and recover strongly in the range of 5.5% to 8.0% projected for 2021, after estimating a sharp decline of between -3.5% to -5.5% in 2020 (a revision from between –2.0% to +0.5% for 2020). Real GDP growth has hit bottom at -17.1% yoy in 2Q20, and likely to improve gradually from 2H2020.

Our estimate shows that real GDP will likely decline at a gradual pace of around 0.8% yoy in 2H20, from -8.3% in 1H20, and average around -4.5% for 2020 (revised lower from our previous estimate of -3.5%), at the mid-range of the official forecast between -3.5% and -5.5%. This was premised on anecdotal evidence signalling some revival in the global economy from 2H20, as reflected in the global PMI. Domestically, the economy will be supported by fiscal stimulus packages and monetary policy easing. Improvement in economic activity has also already been reflected in manufacturing PMI (50 in July), leading index (+4.9% mom in May), export growth (+8.8% yoy in June) and unemployment rate (4.9% in June). For 2021, we are projecting real GDP growth to expand by 6.0%, compared to the official forecast of between 5.5% and 8%.

Downside risks to our GDP growth projection include external economic conditions, given that Malaysia is an open economy. In particular, export-oriented sectors could be dragged by weak external demand amid slower global growth, where the occurrence of a further waves in many countries may dampen the recovery in global growth especially if lockdown measures are re-imposed. However, some support for the country’s trade performance could arise from the sustained growth in global semiconductor sales. In 2Q20, the Semiconductor Industry Association (SIA) guided that sales had increased by 5.1% yoy (+6.9% yoy in 1Q20) and it is expected to rebound by 3.3% yoy in 2020 from a decline of 12% in 2019.

On domestic demand front, as business continues to resume during the RMCO phase, we expect this to provide some cushion and support economic growth in 2H20. Large public construction projects like the MRT and high multiplier smaller projects will also support growth in 2H20, while improvement in the services sector of the economy will contribute to growth.

BNM noted improvement in economic activity expected in 2H 2020 and 2021

BNM guided that Malaysia’s economic growth in 2H20 and 2021 will be underpinned by recovery in global growth while sustained policy support through fiscal measures and low interest rate environment will support consumption and investment activities. Furthermore, investment activity will also be bolstered by new investment projects such as the National Fiberisation and Connectivity Plan. Besides that, the gradual normalisation in economic activities is expected to lead to an improvement in labour market conditions. In addition, higher demand for technology and healthcare products such as remote working devices and cloud computing will further support Malaysia’s manufacturing production and exports. Lastly, it was also highlighted that 2H20 economic growth will also be boosted by the expansion in commodity-related production capacity through the acceleration of Petronas Floating LNG 2 (PFLNG2) and RAPID.

Current account surplus narrowed to RM7.6bn in 2Q20

As for the balance of payments (BOP), Malaysia’s current account surplus narrowed to RM7.6bn in 2Q20 (2.5% of GNI) from RM9.5bn (2.6% of GNI) in 1Q20. The narrower current account surplus during the quarter was due to a lower surplus in the goods accounts of RM25.9bn in 2Q20 (RM28.9bn in 1Q20). This was reflected in Malaysia’s external trade performance during the quarter, where the trade surplus narrowed to RM27.6bn in 2Q20 from RM37bn in 1Q20, its smallest surplus since 3Q18. Furthermore, the services account registered a wider deficit of RM12.5bn from a deficit of RM8bn in 1Q20, its largest deficit on record, led by the travel deficit. The primary income account registered a lower deficit of RM4bn from a deficit of RM6bn in 1Q20, led by higher direct investment income from Malaysian investments abroad. The secondary income account posted a lower deficit of RM1.9bn in 2Q20 compared to RM5.4bn in 1Q20, as outward remittances by foreign workers were lower due to broad-based weakness in economic activity.

Financial account recorded a larger net outflow of RM19.8bn in 2Q20

Malaysia’s financial account registered a larger net outflow of RM19.8bn in 2Q20 compared to a net outflow of RM13.3bn in 1Q20, as other investment account registered a large net outflow of RM41.3bn compared to an inflow of RM22.1bn, which reflected net interbank lending abroad by the domestic financial sector. Direct investment account also saw a net outflow of RM1.2bn (from a net inflow of RM3.4bn in 1Q20) amid higher outflow of direct investment abroad and lower foreign direct investment inflows. In contrast, portfolio investment registered its first inflow since 1Q19 of RM22.2bn in 2Q20 (compared to net outflow of RM41.3bn in 1Q20), led by inflows from non-residents on the back of a moderation in residents’ portfolio investments abroad. The net outflow in the financial account was in line with the higher net foreign selling in the equity market of RM8.7bn in 2Q20 compared to a net outflow of RM7.6bn in 1Q20, the highest quarterly outflow since 2Q18. On the bond market, there was foreign buying of debt securities of RM11.3bn in 2Q20 from a net outflow of RM17.1bn in 1Q20, it largest quarterly inflow since 4Q19. Due to the lower current account surplus and sustained net outflow in the financial account, the overall balance of payments recorded a deficit of RM6.4bn in 2Q20 (-RM8.7bn in 1Q20).

Malaysia’s international reserves rose to US$103.4bn as at end-2Q20 from US$101.7bn as at end-1Q20. It was sufficient to cover 8.3 months of retained imports and 1.1 times short-term external debt. Going forward, we believe that the country’s current account balance will remain in surplus. However, it may continue to be under some pressure from weaker trade performance as well as lower tourist arrivals and receipts in the near to medium term. As the economy continues to reopen, we expect Malaysia’s current account to remain in a comfortable surplus alongside healthy economic fundamentals in 2H20 and 2021.

Source: Affin Hwang Research - 17 Aug 2020