Domestic demand – growth locomotive.  Though there will be little momentum from the tepid 1Q13, domestic demand will be the engine of growth from 2Q13 onwards with GDP growth estimated to hit 5.0%. Momentum build up in 3Q13 is aided by recovery in external demand supporting our growth projection of 5.6% for the quarter.

Global outlook – uneven growth pace. Hopefully the worse is behind the Eurozone, but far from a true recovery. Austerity measures being relaxed will hopefully mean they can concentrate more on growth. The US economy continues to push forward but at cruising speed. Abenomics will face its biggest challenge come Fall but have so far proved its worth whilst China is facing hurdle after hurdle of domestic

No more GE uncertainties, time to fulfill promises. With no more GE uncertainties and ruling power remain status quo, there is assured of policy continuity. A smaller win means a stronger commitment towards corruption free administration. ETP projects will carry on unhindered and the multiplier effect will continue to work its way through the economy.

Exports recovery to support 2H13 growth. Recovery in global demand to drive up exports and spur manufacturing growth in 2H13. GDP growth is projected to accelerate to 5.6% in 3Q13 helped by the summer season in the northern hemisphere. The momentum brought about by the recovery and expectations for a strongest quarter of the year should bring 4Q13 GDP growth to 6.3%.  This will bring about to our full-year projection of 5.3%.

Subsidy cuts to start in 4Q13 but fiscal opex set to rise. No longer held up by the GE, now comes the time for fiscal consolidation and to implement policies to manage fiscal debt and deficit. As BN promised to fulfil their manifesto including its cash hand out schemes (BR1M) it may raise operating expenditure and risking wider deficit.

Monetary policy to stay pat. Fundamentally, the 2Q13 is showing improvement in comparison to the lacklustre growth it experienced in the 1Q13. Even with so much uncertainty, investment had remained strong. There is no reason to adjust the OPR, as the current level is, has been and will be accommodative at least for the next six months.

Ringgit outlook – under pressure but fundamentally strong: We remain firm on the fundamentals supporting the ringgit; strong domestic economy and improving external demand in 2H13. We foresee the USDMYR to remain volatile in the next three months or so and would likely trade in a range of 3.10-3.20. To reflect the heightened volatility and the regional currency weakening we have revised our USDMYR year-end target to 3.05 from 2.97.

Overview

Lacks momentum. Though slightly below our target of 4.5%, the sharply below-than-expected 4.1% YoY GDP growth in the 1Q13 is still within our boundaries of expectation. Despite the strong 4Q12 of 6.5%, the momentum wasn’t quite enough to push the 1Q13 to hit 5.0%. There were just too many circumstances of wait-and-sees that had surrounded the General Elections (GE) alongside apathy on the external front impacting exports. That being said, the 1Q13 could have been worse, and it was the strength of domestic demand that had managed to pull the country through and this is what will predominantly pull the country through for the rest of the year.

Domestic demand rules. It is undeniable that investment played a significant role in the 1Q13, with total investment growing by 13.2% (4Q12: 16.0%). Under investment, the private sector pulled back considerably, growing by 10.9% after a whopping 20.1% in the previous quarter whilst the public sector expanded  by 17.3% following a 12.9% increase in the 4Q12. Despite the moderation, one can’t doubt that investment growth was still quite a feat having still managed double-digit expansion, but it was really the power of consumption that took the limelight in the 1Q13. Managing to post a 6.1% growth (4Q12: 4.9%). Specifically, it was almost entirely the strong private consumption  growth of 7.5% (4Q12: 6.2%) that boosted the GDP whilst public consumption winded down to just 0.1% (4Q12: 1.2%). Strong investment and consumption added up to an 8.2% boost in aggregate demand (4Q12: 7.8%).

Post GE growth uptick. Now that the GE is over and with BN still holding on to the reigns, investors can at the very least be assured of policy continuity. With an even slimmer win this time round, the ruling party will need to buck up and fulfill a long list of economic and social welfare promises outlined in its manifesto. One thing for certain, the continuity of BN’s leadership remains intact to ensure the Economic Transformation Programme (ETP) projects and policy reforms are implemented without delay or disruption. We estimate that construction could remain strong in the 2Q13 at double digit growth of 11.7%. Though slightly slower than 1Q13’s 14.7% its percentage point (pp) contribution to GDP remains relatively high at 0.4 (1998-2011 average: -0.02). With signs of external demand picking up we expect that manufacturing could stage a rebound in 2Q13 at 3.5% from 0.3% in the 1Q13. Mining will also play a bigger role, returning to positive territory of 1.5%.

2Q13 back on growth track. The real strength will still come from domestic demand, mainly in the form of private consumption and investment. We are estimating that private consumption in the 2Q13 will expand by 7.7% from 7.5% in the 1Q13 and this is ultimately linked to the growth of imports, which we estimate will grow by 4.1% after 3.6% in the 1Q13. Similarly, we are also looking at a revival of external demand, which we reckon would reflect in our exports’ growth estimate of 0.5% after three consecutive quarters of contraction. Despite the see-saw growth overseas, it cannot be denied things have picked up from our major export markets – the USA and Japan – and we have been seeing very strong intraregional trade from our ASEAN neighbours. All in all, things should gradually get back on track, unhindered by election uncertainties, hence supporting our higher GDP growth estimate of 5.0% in 2Q13.

Setting the stage. Data is looking slightly tepid in the 2Q13 but we still hold our ground that domestic strength and the resilience of the ASEAN-trading partners would be able to take up any slack from external demand. By the 2H13 however, we are generally more optimistic about circumstances abroad. Though fraught with all sorts of skepticism, the USA and Japan are heading the right direction and the worst of the Eurozone seems to finally be behind them. However, the risk of a steeper slowdown in China seems to have arisen with many economists revising their forecast to below the 8.0%-threshold (IMF is projecting China GDP to hit 7.75% in 2013). Having taken all these variables into consideration, we forecast the GDP to accelerate to 6.0% in 2H13 from a slower average growth of 4.5% in the 1H13 and maintaining our full year 2013 GDP forecast at 5.3% (2012: 5.6%).

Reforms and fiscal challenges. Further ahead, there is a possibility that growth will be mitigated by the probability of the Goods and Services Tax finally being rolled out and with no election to worry about, the government will be set on the narrowing deficit by reducing subsidies. This would put a damper on the overall growth upside for the economy next year. Barring any unforeseen external shock and based on our preliminary forecast, GDP growth could be capped below 5.5% in 2014.

Global outlook 

Three-speed indeed

Different speed. Back in April, the director of the International Monetary Fund (IMF) warned of a 3-speed growth recovery, and quite right she was. There is the Eurozone, still slugging their way through. Then there’s the US, who are rebounding as well as can be, facing bumps along the way. And then there are the emerging economies, of which the debt crises seemed like eons ago. At the end of it all though, despite favourable outlook for emerging economies, their fate does hinge on the top four economies of the world; the Eurozone, the US, China and Japan; a combination of which contributes nearly 65% of total global GDP (IMF estimates for 2012) .  

The Eurozone – Still Muddling Through

Growth risk abound. One could practically hear the scoffs of indignation when François Hollande announced that the “Euro crises is over”, but one has to take the French President’s words with a pinch of salt. With Eurozone’s unemployment rates hitting record highs month after month (12.2% in April) and youth unemployment ballooning to 24.4%, it is very difficult, especially for the 19.4 million jobless, to accept that the crises is over. Nonetheless, there may be some truth behind his words, that maybe the worst is at the very least behind them. 

Remains weak. Looking at fundamentals, it is difficult to say things are rebounding in the Eurozone. 1Q13 GDP shrank by 1.1% YoY, the 5th straight quarter of contraction. At 48.8 in June, the Eurozone manufacturing PMI remains well below the expansion level of 50 and makes it the 23 contraction, whilst the PMI services business activity index in May recorded at 47.2, 16th month of consecutive contraction. European car sales hit 20 year low and retail sales faced a 1.1% YoY decline. 

Still hope. But not all is doom and gloom. Amid concerns over growth, the European Commission has said that EU member states are given more time to complete their austerity plans. France, Spain, Poland and Slovenia will get two more years to achieve their budget deficit targets and the Netherlands and Portugal will be given an extra year. This is a sigh of huge relief, as countries can concentrate on boosting growth rather than stringently trying to implement austerity that ends up impeding growth. As a result, benchmark bond yields of most eurozone economies have tapered off on optimism moving forward. 

Glimpse of recovery. Though manufacturing PMI is still below expansion level, at 48.8 it is the highest level seen in 16 months, with Spain’s and Italy’s PMI reading of 50.0 and 49.1 respectively at over 2-year highs. The ZEW Center for European Economic Research recently said that its index of Investor confidence (aims to predict economic developments 6 months in advance) in Germany rose to 38.5 from 36.4 in May whilst its indicator of euro-area investor confidence climbed to 30.6 from 27.6.

A long road ahead. Consensus seem to agree that things will pick up in the 2H13 but they remain cautiously optimistic. The summer season is expected to boost employment and retail sales and this would hopefully help start off growth momentum moving forward. If negotiations between the United States and European Union for the free-trade agreements follow through, it could boost the EU economy by €119b a year and the US economy by €95b (estimates by the Centre for Economic Policy Research). But it will be a long hard road filled with potholes and jagged rocks.  

USA – Recovery re-accelerates

Of recovery and noise. There have been a lot of kerfuffle going about because of the US Federal Reserve of late. When Ben Bernanke commented on May 22 that the central bank may gradually start to ease their bond-buying programme this year and possibly end it by next year, it roiled the global financial markets.  This is however, merely short-term noise. What it really indicates is that the US is recovering, proper. As a whole though, the USA is faring far better than their European counterparts and have a much better outlook ahead. This is reflective of its AA+ credit-rating outlook being raised to stable from negative by S&P recently.

Housing rebound. One particular sector is seeing a recovery in leaps and bounds – the housing sector. Housing starts rose to a five-year high, climbing by 6.8% in May as homebuilder confidence rose to a seven-year high. Prices of homes increased by 12.1% in April, the biggest YoY change since March 2006. Supply shortage and record-low mortgage rates are few reasons for this housing rebound. The fact that people are willing once again to look into investing big ticket items means that they are indeed taking advantage of the low interest rates and somewhat optimistic about job security. 

Shale gas boom. Evidently, automakers are selling more trucks in Texas, the Dakotas, Montana and elsewhere thanks to increased drilling for shale gas. In May, US oil production increased by 18.0% to 7.3 mil bpd, according to the Energy Department. This led to more hiring and significant recovery in auto sales, led by full-size pickup – as small businesses are willing once more to invest in new capital and workers. US consumers bought 4.1 million vehicles in May, up 8.0% YoY. Additionally, automakers are once again hiring (Ford said that they were adding 2,000 workers to their Missouri plant) and the sector is expected to add 35,000 jobs over the full year. Lower gas prices has also helped keep inflation under control, averaging around the 1.5% level for the first 5 months of the year.

Downside risk abound. But not all is sunshine and flowers in the States. The low inflation rate could also mean there is a lack of demand-pull inflation. Manufacturing is also looking rather tepid, with the PMI barely skimming the 50 mark at 50.9 and industrial output gaining by just 0.1% following months of decline. The 1Q13 GDP has also turned out to be worse than initially expected, growing by just 1.8% annualised pace, a revision from 2.4%. The main drag was the revision on consumer spending, to 2.6% from an earlier estimate of 3.4%. Keep in mind that consumer spending makes up about 70% of total GDP. Going forward, if interest rates eventually increase and unemployment remains high, consumer demand would likely fall.

Jobless rate remains high. In addition to that, though unemployment rates have been edging downwards, at 7.6% in May, it is still far above the 6.5% rate of which the Fed is willing to start to raise interest rates. This means that it needs to add in excess of 150,000 jobs each month for the next nine to twelve months to reach the 6.5% target. There is also the worry that the reasons for the falling rates is due to the falling number of people still willing to seek jobs. Plus the civilian labour participation rate remains the lowest since 1979 at 63.4% in May. 

Japan – Reforms hits a hurdle

Two shots fired. Though many remain sceptical, one can’t doubt that the first two arrows of Abenomics (aggressive monetary policy and flexible fiscal policy) have so far proven their worth. 1Q13 GDP grew by 4.1% annualised (1.0% QoQ), the Nikkei went up by 80% in 6 months and the Yen fell by over 20% against the US$. The yen value of Japan’s exports rose by the biggest margin in three years in May, fetching ¥5.7t (US$60.5b), an increase of 10.1% YoY and industrial output advanced by 2.0% in April followed by 1.5% gain in retail sales. The Tankan survey, a quarterly survey of business sentiment, turned positive for the first time in nearly two years, recording a +4 in the 2Q13 from -8 in the previous quarter.

Growth strategy = structural reforms. But that is all the easy part. What will truly test Abenomics is the third arrow, executing the growth strategy. This is the tough part. Pumping in money and relaxing policies will seem like a walk in the park when compared to the monumental climb that Prime Minister Shinzo Abe and his reformists will face after the Upper House  of the National Diet elections come July 21.

Misfired. Abe was initially supposed to fully announce the 3th but little was said about reforms. However, he did set about to June 5 tackle income levels (lift income levels by 3.0% per annum in the next decade) and set a series of deregulated and lightly taxed zones around the country. There was little about labour market reforms, healthcare, agriculture and broader business deregulation. The disappointment from the market was immediate as the Nikkei dropped 20%. However, there was mention of further legislative push come the fall and the Nikkei edged up once more. 

Structural issues. There is a myriad of problems that Japan has yet to address; from their archaic style of management, inflexiblee labour practices, enormous public debt (IMF forecasted this to balloon to 245% of GDP in 2013), their dwindling and aging population, mislocation of investment and an uncompetitive agriculture sector; amongst other things. 

Unrealistic target? After more than a decade of growing less than 1.0%, the BoJ’s 2.0% inflation target seems to be unrealistic. Plus there is no guarantee that achieving such a target would led to higher growth or solve its deflationary malaise. Actually, what Japan need is a demandpull inflation which reflect a steady economic growth trend and not the cost-push variety. Some companies are also wary of the 2.0% inflation target set by the BoJ. Case in point: the Japan Iron and Steel Federation, with nine other industry organizations, submitted a request to Toshimitsu Motegi, minister of trade and industry,  for tax breaks and financial assistance to cushion the impact of higher utility bills pushed up by nuclear-plant shutdowns and a weaker currency. On the other hand, a survey published by the Nikkei newspaper this week found 55% of respondents approved of Abe’s economic policies, and 66% supported the cabinet. While it seems that most are supportive of Abenomics, we will just have to wait and see what happens after July 21^st.

China – Elephant in the room

Paying the price. After decades of posting “miracle growth”, China is now facing some serious troubles of their own. They were left unscathed in comparison to the West during the 2009 crises and have been wading above the water in the years afterwards where most  economies were fraught with a debt crisis. Domestically, the new Chinese leadership has got a lot dumped onto their plates – urban property inflation, lagging production, rising labour cost, slacking exports and recently the liquidity crunch. But its strong financial and trade links with the US, which has partly help to elevate it to become the second largest economy in the world, would also determine its economic fate going forward.

Trigger point. Based on latest data, foreign central banks hold almost 50% more of US government debt (US$2.93 trillion) than the Federal Reserve (US$1.93 trillion). China is estimated to hold the biggest slice of the total or about US$1.3 trillion, according to the latest TIC data. While foreign holdings of US treasuries assets has fallen by 1% (from US$2.97 trillion) to its lowest in five months, there was a slight increase in Fed purchase of government bonds (from US$1.92 trillion). It is little wonder that liquidity issues of China’s overleveraged banking system make Beijing the prime suspect in dumping some of its holdings on US Treasuries. This could have an impact on Fed’s decision to scale down its US$85b aggregate monhtly purchase of treasuries and mortgage backed securities.

Growth engine slowing. Both external and internal factors are affecting  growth trend. Industrial production moderated further to 9.2% in May, the weakest for a January-May period since 2009. Fixed-asset investment excluding rural areas rose 20.4% in the first five months from a year earlier, down from a 20.6% pace in January-April. Meanwhile, exports rose a mere 1.0% YoY, down from 14.7% in April whilst imports dropped 0.3% YoY. But what is really worrying is that many years of excessive credit (much from shadow banking) caused China’s fragile financial system to experience its worst liquidity crunch in a decade at the end of June. As a result, China’s financial institutions stopped lending to each other, resulting in interbank interest rates to briefly soar to 25% and forcing the People’s Bank of China to intervene and inject more liquidity.

The new normal. The cash crunch in late June has increased the chances that China would miss its 7.5% growth target this year. China’s President Xi Jinping and his comrades would have to accept that average GDP growth would remain below 8.0% or 9.0% from now on. Both the World Bank and the IMF have cut China’s GDP growth this year, forecasting 7.7% from 8.4% and 7.75% from 8.0% respectively. Both cited that it is the government’s dire need for reforms from their current growth model. Though China may be the globe’s factory, how long can they sustain that sort of model? The rise of its middle income group means that the government will need to shift its priority to cater for domestic needs. While the USA has a much better chance of surviving without China the same cannot be said about China. Their dependency on exports will be their downfall if they continue on their current trajectory and not address issues at home. 

3Q13 and 2H13 Growth Prospects  

Time to buck up. The GE is at long last over and as we had hoped, the ruling Barisan Nasional still holds the reigns. This is a sigh of relief for those who are dependent on policy continuity and it removes the uncertainties of policy changes in the next five years. In addition to that, the smaller win this time round means that it’s high time to buck up and seriously address issues of corruption and archaic policies in order for major projects and investments to run smoothly without the scandals of preferences and cost overruns. The loss of the state of Kedah for the opposition also means that Pakatan has to further prove their abilities to run their respective constitutions. Either way, this is advantageous to the rakyat.

Construction play. Either way, with the worst quarter (1Q13) behind us, we believe there is nothing but upwards growth trajectory for the rest of the year. ETP projects will continue unhindered and the multiplier effect will continue to spread throughout the economy. Though construction will continue pushing ahead and we foresee a smaller growth of 9.7% in the 2H13 (3Q13: 10.3%, 4Q13: 9.1%) compared to an estimated 13.1% in 1H13 because many of the major projects would have reached the next stage of development, meaning a slight slower trajectory as well as facing a high base effect. Nonetheless, we expect the construction sector to contribute 0.4 percentage point to the overall GDP growth in 2H13, still above the 12-year average of zero.

Manufacturing picks up. Manufacturing, however, should start to pick up by the 2Q13 with an estimated rebound of 3.5% (1Q13:  0.3%) before expanding further to 5.6% in 3Q13 and 7.1% in 4Q13 as global trade and consumer demand improve globally. All in, GDP growth is projected to accelerate to 5.6% in 3Q13 helped by the summer season in the northern hemisphere from 3.5% in 1Q13. The momentum brought about by the recovery and expectations for a strongest quarter of the year should bring 4Q13 GDP growth to 6.3%.

Exports picks up in 2H13. With policy continuity, investor and consumer confidence along with sustained private spending should able to keep aggregate demand growth sustainable. But post GE means the end of the fiscal binge. This may cause domestic consumption and investment to slow. Hence, aggregate demand growth is projected to moderate to 5.9% (3Q13: 5.5%, 4Q13 6.3%) in 2H13 from an estimated 7.4% in  1H13. Improving global demand would help exports growth to rebound by 4.6% in 2H13 from virtually no growth in 1H13. With the 1Q13 GDP growth within our expectation and things picking up quickly after the GE we agree with the general consensus that the 2H13 can only see further improvement. Barring unforeseen external shock, we maintain our full year 2013 GDP forecast at 5.3%.  

Fiscal Policy - Consolidation

Subsidy cuts to start in 4Q13. No longer burdened by the GE, now comes the time for fiscal consolidation and the start of implementing policies to manage fiscal debt and deficit. The government’s target is to save up to RM4.0b; and the most likely starting point would be oil & gas (O&G) subsidy rationalization. Already the cost of petrol and gas subsidies are expected to exceed RM30.0b this year  from an estimated RM25.2b in 2012, which is more than half  of the total subsidy of RM42.4b. There’s every possibility that the reduction of oil subsidies will commence in 4Q13. However, with prices of US crude and Brent crude tapering off, the money saved from the reduction of subsidies could be channelled into fulfilling the promises made in BN’s manifesto. 

Opex on the rise. But promises come with a price. BN has promised to continue with their Bantuan Rakyat 1 Malaysia (BR1M) schemes and subsidizing the construction of  affordable homes nationwide. They have also begun funding the upgrading of schools and hospital nationwide. This would further raise the fiscal operating expenditure (opex) in the near and medium term. It has already reached a record high of RM205.5b in 2012, up 12.6% (21.8% of GDP). Though they’re no longer as aggressive with dishing out fund, we feel that there’s every possibility that the opex will increase by another 3.0% to 5.0% this year, as opposed to the official target of a reduction of 0.3%.  This is mainly on the assumption of delay in subsidy cuts.

Risk of widening deficit. The risk of widening deficit is on the rise given  the expected increase in opex and the high dependency on O&G revenue (30%-40% of total fiscal revenue). Even if the government do manage to roll out subsidy rationalization by the 4Q13, it may not be enough time to mitigate all the spending that was already done and reduce the deficit to 4.0% (official target) from 4.5% of GDP this year. At best, we project the deficit will overrun to 4.2%. This is also dependant on the performance of both domestic and global economy; the latter of which we now worry may not be rebounding as fast as we had hoped. 

Managing debt. So far, the global economic performance has been weak. Trade numbers in April saw the narrowest trade surplus in over a decade and a half of which mean less income coming from the export sector. However, with the US dollar gaining strength once more, it will be advantageous to exporters but not so much for importers. This is strength in domestic expansion now that it is no longer hindered by GE uncertainties and corporate earnings will continue to play a significant role to achieve a lower deficit and managing sustainable debt levels. Hence,  we highly doubt that public debt will overshoot the self-imposed debt-to-GDP of 55% (2012: 53.5% of GDP). This is an achievable target by ways of opting for off balance-sheet funding via the Government-Guaranteed (GG) bond market.  Though this will see a rise in debt guaranteed by the government, the risk is mitigated by deep liquidity in the domestic bond market. Furthermore, risk towards credit rating downgrade is slowly diminishing as economic fundamentals continue to improve going into 2H13. 

Monetary Policy - Steady

Status quo. So far, each monetary policy meeting has been more or less the same; current rate levels are supportive of the domestic economy. But there is cautiousness when it comes to external circumstance. And we agree with Bank Negara. With many neighbouring countries slashing rates, there has been a lot of speculation that BNM will follow suit. However, we  hold our stance that such speculation is just that, speculation. So soon after the GE, keeping the rates as they are is the least that BNM can do to reinstall confidence amongst both domestic and foreign investors. 

Basis for no rate cuts. Fundamentally, the 2Q13 is showing improvement in comparison to the lacklustre growth it experienced in the first quarter of the year. Even with so much uncertainty in the 1Q13, investment had remained strong, managing to grow by 13.2%, if slightly tapered down a bit compared to 16.0% in the 4Q12 and the 1Q13 is supposed to be the slowest quarter of the year. By that reckoning, with GE over (remaining status quo hence a continuity of policies), it can only improve hereon. On this basis, there is no reason to cut rates, as the current level is, has been and will be accommodative at least for the next six months.

… no hike either. On the other hand, there may be some inflationary risks on commodity prices. However, due to a low base effect offsetting the increase, the rate of inflation should remain somewhat subdued. There is also the possibility of subsidy cuts in the 2H13, something that has already been expected and we are certain that BNM is very aware of it. Presently, oil prices have tapered off with US crude floating about the US$90+/barrel and Brent Crude  at the low US$100/barrel and could fall even further ahead. Therefore, the government may not need to slash the petrol subsidy as much. But they may stick to their original plan of raising petrol prices by RM0.10/litre every six months. Nonetheless the impact of the price hike will only be in the short-term as many businesses would have already expected the cuts. Plus the economy will adjust, just as they did during the previous price hike. In conclusion, we stand firm on  our view that the Overnight Policy Rate will remain at 3.00% for the rest of 2013. 

Ringgit outlook – Rising Volatility

Under pressure. The downward pressure on the ringgit mounts as a result of the large redemption of foreign capital from the equity and bond market. Following the post FOMC meeting statement made by Fed Chairman Ben Bernanke’s on June 26, the ringgit weakened to 3.21 against the US dollar, its lowest since July last year. It also depreciated by as much as 8.4% since the year’s high of 2.97 on May 6. We maintain that the level of volatility would remain high from now till the Fed starts to scale back its quantitative easing policy or QE3. The market expects that to happen after the September FOMC meeting. But that would depend on whether the US economy would continue to improve especially with regards to employment and consumer spending.

Capital outflows manageable. So far, we did not see massive outflow of portfolio capital relative to the weak performance of the bond and equity market. As at end of May, the foreign holding of Malaysian Government Securities (MGS) reached another high of RM240.1b. It was up by RM3.4b in May in spite of the global market rout triggered by Bernanke’s little experiment to gauge market’s reaction of possible reversal of QE3 on May 22 and Bank of Japan’s failure to deliver a “third arrow” (structural reforms) in early May. We reckon that the bulk of the outflow of hot money would occur in June resulting in a large reduction of foreign holdings of MGS and equities. However, we reckon the amount is that not that substantial as to shake the overall financial system given that there is ample liquidity to absorb the sell off. Given that the foreign funds have been buying the MGS when USDMYR was at an average of 3.10-3.15 over the pass 6-12 months, it is likely that they may turn net buyers and take arbitrage position so long as the ringgit continue to remain weak. This could likely dampen the impact on the outflow of capital.

Fundamentals intact. However, we remain firm on the fundamentals supporting the ringgit; strong domestic economy and improving external demand in 2H13. We foresee the USDMYR to remain volatile in the next three months or so and would likely trade in a range of 3.10-3.20. To reflect the heightened volatility and the regional currency weakening we have revised our USDMYR year-end target to 3.05 from 2.97.