- After expanding strongly by 5.2% in 4Q11, the Malaysian economy grew more moderately by 4.7% yoy in 1Q12, hampered by weakness in the external sector.  We had expected a stronger showing of 5.0% for the quarter but were stymied by the sharp moderation in exports.  Moreover, the change in base year from 2000 to 2005 also distorted our forecast.

- Growth in 1Q was primarily driven by domestic demand, particularly investment.  Investment expenditure rose nearly doubled that of 4Q by 16.1% yoy, most likely on the back of ETP and infrastructure projects like the MRT.  Private consumption remained resilient, rising 7.4% yoy in 1Q, little changed from 4Q.  Government spending did not keep pace with the double-digit growth of the previous two quarters, instead expanding by a slower 5.9% yoy in 1Q.  The weak external environment took a toll of exports, resulting in an expansion of just 2.8% yoy vs. 5.5% in 4Q.  On the supply-side, more moderate yoy growth in the agricultural sector (1Q: 2.1%; 4Q: 6.9%), manufacturing (1Q: 4.2%; 4Q: 5.2%) and services (1Q: 5.0%; 4Q: 6.6%) helped to slow overall growth in the quarter. Bright spots were mining, which recovered to expand 0.3% yoy in 1Q from -3.8% in 4Q, and construction, which surged 15.5% yoy in 1Q vs. 7.5% in 4Q.

- On an even brighter note, headline inflation moderated to 1.9% yoy in Apr from 2.1% in Mar on the back of slower food price increases (Apr: 2.3% vs. Mar: 2.9%) and lower transport cost (Apr: 1.0% vs. Mar: 1.3%).  We continue to expect inflation to average 2.7% in 2012, compared to 3.2% in 2011.  However, there are upside to our forecast not only from the implementation of minimum wage but also when civil servant pay are raised, and in particular, when fuel subsidy are cuts (probably coming after the general elections).  These could add 100-150 bps to our baseline forecast.  With growth coming in still relatively healthy this year and with upside to inflation, we still think that there is a possibility that BNM would normalize rates in the latter half of the year with a 25 bps h in the OPR.

- While the weakness in the external environment is a downside risk for the economy, we believe that stronger government spending in the quarters ahead plus the continued resilience in domestic demand should be able to mitigate the weakness in external demand.  We expect greater government spending on cash handouts (including civil service pay increases and payouts to Felda farmers etc.) and accelerated spending on infrastructure and ETP-related projects ahead especially in the lead up to the general elections (which must be called by early 2013).  We think that 1QGDP represents the bottom, and stronger growth is likely ahead.  We are maintaining our real GDP growth outlook at 5.2% for 2012 for the moment.

Source: OSK