On the basis of economic recovery on a global scale and continued strength from domestic demand, Bank Negara Malaysia (BNM) is forecasting the GDP of the Malaysian economy to grow between the range of 4.5% and 5.5%. This is however, of a wider range than the Ministry of Finance’s and our own forecast of 5.0% to 5.5%. This seems to be largely due to the fact that BNM is taking into further consideration the uncertainties pertaining to the economic situation in the developed economies rather than the downside risks of a moderating domestic demand.

 These downside risks are due to structural issues, particularly in the developed economies. Though the global GDP trend has been recovering, the trend is still slow of pace and problems with employment in Europe (high employment rates in bailout countries) and low labour participation rate in the US is still a thorn on the side of economic recovery. On emerging economies, which they believe will continue to be the main driver of global growth this year, also faces problems such as high indebtedness in both the private and public sector and a lag of demand from the developed economies to spur on industries dependent on external demand. Nonetheless, BNM is still rather optimistic when it comes to the outlook of the global economy. Based on the continued tapering of the QE in the US, the Fed too share a similar sentiment on the revival of their economy. As with the case in China, which increasingly becoming a very important economic partner to Malaysia, the necessary restructuring of policies, though expected to dampen growth, will less likely be at a level that jeopardize economic expansion as a whole and Malaysia will continue to benefit from its economic relation to the middle kingdom.

 Therefore, this reinforces BNM’s expectation that exports will again play a dominant role to support the economy. After two consecutive years of contraction, BNM sees a rebound in exports, growing by 2.1% this year (-0.3% in 2013). Similarly, this also leads to an increase in intermediate imports for the purpose of exports, which, coupled with those needed for the continued usage for major infrastructure projects currently undertaken and expected to begin commencing this year, could very well mean that certain quarters of the year may be looking at current account (CA) deficit. However, these are expected to be temporary spikes due to the sheer bulk of one-off imports (forecasted to expand by 3.1% versus 1.9% in 2013). For the year as whole though, CA is projected to remain comfortably in a surplus albeit narrower at 3.0% of GNI from 3.9% in 2013.

 However, the impact of the rebound in external trade seems to have little effect on the supply side of the economy. BNM projects the manufacturing sector to just edge up to 3.5% from 3.4% in 2013. This could possibly mean that growth in the domestic-oriented industries may be taking a breather. Construction is expected to continue on a double-digit expansion of 10.0% (2013: 10.9%) on projects in the transports, utility and oil & gas sectors but a slower rate than the previous year due to completion of large civil engineering projects. Services, which is the biggest contributor to the GDP, is expected to expand at a rate of 6.2% (2013: 4.7%), on domestic investment and consumption as well as industries in relation to external recovery such as tourism (also aided by Visit Malaysia Year). The agriculture sector is foreseen to improve on higher production of palm oil whilst the mining sector is projected to expand on higher crude oil and natural gas production.

 Though the domestic economy will continue its momentum to be the main driver of growth, fiscal consolidation in efforts to balance the nation’s accounts will put a damper on domestic consumption, both on the private and public sectors. Consumption is projected to moderate to 6.1% from 7.3% seen in 2013. The moderation on wages increase in addition to tapering of disposable income (on higher inflation) also plays a significant role. However, investment is expected to remain strong, expanding by 8.8% from 8.2%, on a 12.6% increase in private investment (2013: 13.6%) and a 2.9% in public investment (2013: 0.7%). On the confidence that the government will see through on their promise of more prudent spending, public expenditure is to moderate to 2.9% from 3.7% previously.

 As a result of price adjustment from fiscal consolidation, which BNM believes the government will stay true to their word, cost-push inflation is of a concern this year and BNM is projecting that the inflation rate would be on the higher side of historical average, ranging from 3.0% to 4.0%. Though this higher than average inflation rate has put pressure on real interest rates in recent months, dipping it to a negative level, BNM believe it is not pervasive. Barring any external shocks such as unwarranted weather conditions or geopolitical risks, BNM sees negative real rates will eventually taper off and normalize. The closest hint of when a hike in interest rate would even be considered is when inflationary pressures are demand pull, and this is not expected to be the forefront of inflation until past the implementation of GST, of which we reckon won’t be until the later part of 2015. Therefore on that basis, we maintain our stance that BNM will keep the Overnight Policy Rate (OPR) at 3.00% for the rest of the year. This is also further backed by their more moderate outlook on the Brent Crude average of US$105/barrel and CPO price of US$2250/tonne.

 Since the very first mention the QE tapering in May 2013, there has been a huge outflow of capital from emerging economies and triggering high volatilities in the financial markets. With the case of Malaysia, as continuously proven, even at its peak of foreign holdings sellout, local institutional investors have more than easily stepped in to fill the gap left, stopping yields from increasing to an unwarranted level. Even after stress testing a worst-case scenario of every cent of inflow since 2009 and 2013 as well as a percentage share of resident holdings flowing out of the country, liquidity within the financial system would remain ample and would only knock off 5.0% of total reserves. BNM reiterates that due to the maturity of the financial system, strong diversification, high international reserves along with deep-seated domestic institutional players, the fundamentals of the system has also managed to keep the ringgit at a manageable level despite its current volatility. In the short term, they expect continued volatility but will eventually strengthen again in the long term. This also justifies our MYRUSD year-end forecast of 3.21 with an average of 3.25 in 2014.

 Last year, household indebtedness was a particular concern but macro prudential measures to reign in it seem to by and large, proven to be effective. Household borrowings grew at its slowest pace since 2010, at 11.7%, particularly due to slower expansion from non-bank financial institutions (NBFI). The increase in income level (an average of 8% for civil servants – the bulk of borrowers from the NBFI) also helped improve repayments. Measures instilled by BNM towards banks and financial institutions also led to a better quality of loans, and concerning to the property market, better (stricter) valuation practices to strip out distortions to get a more realistically reflective rates.

 Nonetheless, household debt continues to increase to 86.8% of GDP at the end of last year from 80.5% in 2012. Slower growth of its denominator, the nominal GDP, which moderated to 4.5% from 6.4% in 2012, was partly to be blame. But apart from rising credit growth of civil servants, it is also largely due to the demographics – a young, urban, salaried educated population (well eligible for loans) would mean continued demand for housing and car loans. BNM will continue to keep a close eye on this sector, to ensure that loans dished out are of a higher standard but that they are not too concerned on an increasing debt to GDP ratio so long as repayments remain steady and manageable.

 In a nutshell, BNM is still rather confident on continued strength of the domestic economy being a driver for growth though at a more moderate pace this year. However, the external front is still going through a stage of restructuring and they are optimistic that it will pave the way for better recovery this year. This will have a positive spillover effects on industries and related sectors such as exports (of both products and services) and tourism. However, they do caution on uncertainties of recovery being undermined by structural issues (taking longer than expected), geopolitical issues or weak sentiment destabilizing the financial system. BNM also mentioned that it will continue to strengthen their relations with their Asian counterparts by having in place an early warning system to ensure immediate action and containment procedures in the light of any possibly crises infecting their respective financial systems as well as the region as a whole.

Source: Kenanga