The 1Q14 GDP surpassed estimates and gained 6.2% YoY, following the previous quarter’s 5.1%. It was above market consensus of 5.8% and our own estimate of 5.1%. This better-than-expected growth can be attributed to an almost overwhelming rebound in net exports, despite the rather moderate global growth in the 1Q14. Additional public sector spending also helped mitigate moderation from private sector spending, which has had to undergo some penny pinching in light of higher costs. However, private investment remains strong, pivoting overall aggregate demand to 7.4% from 6.7%. Despite the stronger-than-expected annual rise, the quarterly comparison saw a 3.9% QoQ fall in overall growth, a rather significant decline from the 3.0% rise in the 4Q13. However, this is an expected turnabout as the first quarter of the year has historically been the weakest quarter of any given year. For a more accurate indication, the QoQ seasonally adjusted basis GDP posted a 0.8% growth, a more moderate pace compared to 1.9% seen in the last quarter of 2013. The residual effect of the stronger than-expected performance in the 1Q14 would likely elevate the growth prospects in the subsequent quarters. Hence, there is a higher probability now that the GDP growth for the whole year could hit the upper end of our target of between 5.0% to 5.5%.

Demand side

- One of the major improvements that is blatantly obvious is the remarkable rebound in net exports, despite the moderation in global growth. Net exports gained a double-digit rebound of 14.9%, after falling by 6.8% in the 4Q13. This added 6.2 percentage points (ppts) to the overall GDP, following a 5.1ppts gain in the previous quarter. Specifically, exports gained 7.9% YoY (7.1 ppts) from 5.7% (5.2 ppts) in the 4Q13 whilst imports expanded by 7.1% (5.8 ppts), the same pace as 4Q13.

- It is interesting to note the rapid improvement in exports, even though the first quarter of the year saw major economies around the world posting rather disappointing growth. China posted an 18-month low of 7.4%, the USA expanded a mere 0.1% and the Eurozone gained just 0.2%. The only exception was from Japan, which grew by 5.9% ahead of its consumption tax rise. This points to the possiblity of further slowdown but we are more inclined towards the other direction, that exports will continue to rise. It has been widely accepted that the sluggishness in the USA was predominatly due to frigid winter, which slowed down investment and spending. The slack is expected to pick up rapidly in the coming quarters which would likely benefit exporting nations, Malaysia included, both through direct trade as well as indirect transactions.

- Despite still being an exporting nation, the backbone of the economy remains domestically driven. Aggregate demand in the 1Q14 expanded by 7.4%, from 6.7% in the previous quarter. Overall consumption increased by 7.8% (4Q13: 6.8%), which contributed 4.9 ppts to the GDP, higher than the 4.6 ppts seen previously. This is on account of an increase in public sector consumption, which rose by 11.2% (4Q13: 5.2%) as the government increased spending on supplies and services, part and parcel of the Government Transformation Programme (GTP) blueprint. This gain in public sector spending helped mitigate the moderation in private sector consumption, which grew by 7.1% (4Q13: 7.4%). It’s a temporary consequence of increased costs as a result of fiscal consolidation and new policy implementation (ie. the minimum wage law).

- Total gross fixed capital formation moderated slightly, to 6.3% from 6.5% in the 4Q13. This is mainly due to a 6.4% decline (4Q13: -1.4%) in public sector investment, keeping to the government’s side of the deal to reign in public sector debt. On the other hand, private sector investment continues to strive, managing a 14.1% growth (4Q13: 16.6%) on account of on-going capital spending in the manufacturing and services sectors. This added 2.4 ppts to the overall GDP, compared to 1.9 ppts in the previous quarter. However, we do not think that this level of investment growth is able to maintain its pace in the long run. If anything, it will eventually taper off due to a high base effect. We reckon that it’ll expand at a more moderate pace in the second half of the year. By then though, we should start to see an uptick in consumption in anticipation of the implementation of the GST come April 2015.

Supply Side

- On the supply side, all the major sectors managed to record an improvement in the 1Q14. The manufacturing sector saw a gain of 6.8% (4Q13: 5.2%), which added 1.7 ppts to the GDP, compared to 1.3 ppts in the 4Q13. The main drivers were from electrical & electronics (+12.6%) on strong overseas demand and transport equipment & other manufactures (+11.1%), in relation to both exports and catering towards the domestic construction sector.

- The construction sector continues to strive, and has managed to gain 18.9% in the 1Q14 (4Q13: 9.8%), adding 0.7 ppts to the GDP. Though the main contributors are from the Residential sector (+29.7%) on mixed housing developments in the Klang Valley and Johor and from Special Trade (+27.4%), major infrastructure projects under the Economic Transformation Programme (ETP) also plays a contributive factor.

- Services the biggest contributor to the GDP (over 55% share of GDP) recorded an expansion of 6.6%, following a 6.4% gain previously. This added 3.6 ppts to the GDP (4Q13: 3.5 ppts). This was by and large supported by a fair gain in wholesale & retail trade (+8.6%), boosted by the many cultural and religious festivities at the start of the year. Retail gained 10.4% (4Q13: 10.2%), wholesale increased by 8.1% (4Q13: 7.9%) and motor vehicles by 4.0% (4Q13: 3.8%). Communication registered a 10.1% (4Q13: 10.3%) growth whilst finance expanded by 2.6% (4Q13: 1.9%) and insurance rebounded by 2.0% after falling by 3.7% in 4Q13. Real estate & business services expanded by 8.6% (4Q13: 8.3%).

- The agricultural sector gained 2.3% (4Q13: 0.2%), supported by a gain the food crops and palm oil. Palm oil rebounded by 1.6% (4Q13: -1.2%), marine fishing by 4.4% (4Q13: -3.0%) and other agriculture by 8.1% (4Q13: 7.0%). Meanwhile, the mining sector fell by 0.8%, a smaller decline from 1.2% in the 4Q13. This shaved off 0.1 ppts from overall GDP. The milder decline is due to a growth in the production of natural gas (+0.9%) and condensate (+4.9%).

Outlook

- With the 1Q14 churning out a better than expected growth, despite rising costs and a slower global growth, it lifts our optimism moving forward. Exports, along with the manufacturing sector, are expected to improve further and become the main drivers of the economy in 2014.

- Though we expect the 2Q14 growth would moderate as the base-effect starts to wear off as well as lingering global growth uncertainty, the economy may still show a better overall growth performance in 1H14. Hence, we expect GDP growth to possibly reach 5.5% in 1H14 compared to our earlier forecast of 5.1%. We continue to place our bets on global improvement, despite the slowdown from China on account of its internal restructuring and Japan’s expected moderation following the increase in consumption tax. The USA will be one of the major conductors of global growth this year. There are worries about the Eurozone and its latest deflation threat but looking at Malaysia’s exports figures, demand is slowly but determinately increasing from that region.

- Key to a better overall growth outcome for 2014 still lies in the 2H14. Though hopeful abroad, we foresee a slight moderation in the domestic demand in the 2H14. This is due to a high base effect mitigating any gains, in both consumption and investment in the 2H14. However, we may see a stronger uptick from consumer oriented sectors in preparation of the Goods and Services Tax that is to be implemented at the start of the 2Q15. Balancing both side of the coin we maintain our growth forecast for 2H14 at 5.6%. With GDP growth in the 1H14 likely to reach 5.5% we now project the full year GDP growth to hit 5.5% which was the upper end of our initial target of between 5.0% to 5.5%.