OVERVIEW

- GDP growth continued to perform strongly in 2Q14, surprisingly up 6.4% YoY outpacing 6.2% in 1Q14 on strong net exports, boosting manufacturing and trade-related service.

- Strong momentum in the 1H14 is likely to spill over into the 2H14, giving higher probability of the GDP to exceed our projection of 5.5%. Hence, we are revising our 2014 GDP growth forecast to 6.0% (previously 5.5%).

- A stronger GDP in the 2Q14 also means a higher probability for BNM to hike interest rate by another 25 bps in September.

Once again, Malaysia’s GDP surpassed estimates and posted a 6.4% YoY growth in the 2Q14, following the previous quarter’s 6.2%. This is against market estimates of 5.8% and our own 5.7% mainly on account of very strong net exports, boosting manufacturing and trade related services. However, strong private sector investment was not enough to boost aggregate demand, which moderated to 5.7% from 7.4% previously, as a result of slower growth in overall consumption, still undergoing normalization due to higher costs. On a quarterly comparison, the GDP increased by 3.5%, following the 3.9% decline in the 1Q14. For a more accurate gauge, the QoQ seasonally adjusted growth saw a 1.8%, a faster pace compared to 0.8% seen in the 1Q14.

Demand side

Strong momentum from the 1Q14 continues to bulldoze into the 2Q14 and net exports surged 91.0% YoY, following a 14.9% increase in the previous quarter. This added 4.5 percentage points (ppts) to the 2Q14 YoY GDP growth, after a 1.3 ppts gain previously. This was brought about by an 8.8% annual rise in exports (1Q14: 7.9%), which added 7.8 ppts (1Q14: 7.1 ppts) whilst imports gained 3.9% (3.3 ppts), a slower pace from 7.1% (5.8 ppts) seen in the 1Q14. For the whole of 1H14, exports rose by 8.3% (1H13: -3.9%) and imports gained 5.5% (1H13: -1.8%).

Regardless of the rather mixed global growth in the 2Q14, exports continued to expand and became a major contributing factor to Malaysia’s GDP growth. On an annual basis, we saw the Eurozone’s GDP expanding by just 0.7% as Germany posted a 1.2% growth, France by just 0.1% while Italy’s growth declined by 0.3%. Deflationary threats and sanctions against Russia surrounding the tension in Ukraine dragged growth in the region, leading to uncertainties remaining instilled deep in consumer and business confidence. In Asia, Japan’s GDP fell by 0.1% following the consumption tax rise in April. From other major economies, we saw China’s GDP rising by 7.5%, slightly higher than the 18-month low of 7.4% seen in the 1Q14, well within range of achieving the government’s target of 7.5% for 2014. Across the Pacific, the US economy has managed to recover in the 2Q14, beating consensus and posting a 2.4% growth, driven largely by consumer spending. This has benefited exporting nations, including Malaysia, through direct trade and indirect transactions.

It was fortuitous that exports growth remained particularly strong in the 2Q14 and was able to mitigate moderation felt within the domestic economy itself. Aggregate demand in the 2Q14 expanded by 5.7%, down from 7.4% in the 1Q14. This is mainly the result of moderation in overall consumption, which gained 5.0%, lower than 7.8% seen previously. This only added 3.2 ppts to the GDP compared to the 4.9 ppts seen in the 1Q14. Though private consumption moderated to 6.5% from 7.1%, it was the 1.3% decline in public consumption that dragged overall consumption. However, after an 11.2% rise in the previous quarter on increased spending for supplies and services, it should be expected that the government trimmed down spending as part of the on-going fiscal consolidation. The government has to play their part to reduce deficit, especially whence the private sector has had to bear the brunt of increased cost as a result of fiscal consolidation and new policy implementation.

On the investment side, total gross fixed capital formation increased by 7.2%, stronger than 6.3% seen in the 1Q14. This is largely on account of robust private sector investment, which expanded by 12.1% (1Q14: 14.1%) on continuous expansion in manufacturing and services sectors. This added 2.4 ppts to GDP, the same amount of contribution as previously. Though we do believe that private sector investment will continue to grow, it will be difficult for it to maintain this level of expansion. Eventually, the pace will begin to taper, even if it’s only due to a higher base effect. The public sector investment on the other hand saw a smaller decline of 3.3%, from a 6.4% contraction registrered in the 1Q14, as the government commits to reign in on public sector debt. This shaved off 0.3 ppts from the GDP, a smaller decline compared to 0.7 ppts from the GDP in the 1Q14.

Supply Side

On the supply side, all major sectors continued to expand, spearheaded by the manufacturing sector, which gained 7.3% (1Q14: 6.8%) adding 1.8 ppts to the 2Q14 GDP growth, little difference compared to 1.7 ppts in the 1Q14. The main drivers continue to be electrical and electronics (+11.4% YoY) as per overseas demand and transport equipment & other manufactures (+18.1% YoY), for both exports as well to fulfil the need from the domestic construction sector. There was also significant growth coming from the manufacturing of food, beverage & tobacco (+10.8% YoY) and textiles, wearing apparel and leather products (+15.8%), supported by domestic use.

The construction sector remains robust, though as expected, the trajectory is no longer as steep as a higher base starts to come into effect. Nevertheless, a 9.9% growth (1Q14: 18.9%) is still expansion on the high side, as major infrastructure projects under the Economic Transformation Programme (ETP) and building works under the 2014 Budget goes underway. In detail, the support came from a 15.5% rise from the residential sector, 11.7% increase from non-residential and 10.1% growth from special trade. The construction sector added 0.4 ppts to the 2Q14, compared to 0.7 ppts in the 1Q14.

At nearly 55% share of GDP, the services sector saw a 6.0% growth, a slower pace compared to 6.6% gained previously. This added 3.3 ppts to the GDP (1Q14: 3.6 ppts). Much of the growth was supported by trade related services, which had partly mitigated moderation in domestic-oriented services. In detail, wholesale trade gained 8.4% (1Q14: 8.1%) and retail trade by 9.9% (1Q14: 10.4%), which makes up to over 23% total of the services sector. The finance sector, which makes up 11.9% share, grew by just 0.2% (1Q14: 2.6%) whilst real estate & business services, which makes up 10.8% share, gained 7.4% (1Q14: 8.6%). Government services (14.7% share), increased by 6.6%, from 7.7% previously.

The agricultural sector managed a growth of 7.1% (1Q14: 1.6%), which added 0.5 ppts to the 2Q14 GDP growth (1Q14: 0.2 ppts). It was largely supported by a 14.9% jump in palm oil production. Meanwhile, the mining sector turned positive, gaining 2.1% after declining by 0.8% previously, on higher production of natural gas and crude oil, adding 0.2 ppts (1Q14: -0.1 ppts) to the 2Q14 GDP growth.

Outlook

Following two consecutive quarters of better than expected growth, it may be hard set for the 2H14 to keep pace with the 1H14. However, the momentum for the first part of the year will help mitigate downside effects, especially following the 25 basis points (bps) hike in the Overnight Policy Rate last month, bringing the interest rates to 3.25%. A stronger GDP in the 2Q14 also means a higher probability of another 25 bps hike in the OPR, perhaps as soon as the next MPC meeting in September.

Exports, along with the manufacturing sector, will continue to be the main driver to growth as the economic situation in the USA continues to improve. With improvement in the US, China will also benefit from improved exports. Similarly, despite the slowdown in Japan’s growth in the 2Q14, businesses remain optimistic moving forward as the BoJ and its government continue to boost the economy with stimulus packages and policy changes. However, there are concerns over the situation in Europe, especially in Ukraine, Europe’s relationship with Russia and deflationary threat surrounding the whole region. Though the ECB cut rates, there may be a need for further action to turnaround the European economy, which cannot rely solely on Germany’s economic strength.

Though we are more hopeful than not when it comes to demand abroad boosting Malaysia’s exports, high costs is a thorn on the side of the domestic economy. The effects of fiscal consolidation are far from removed and this has affected domestic consumption. There is also the issue of a high base effect. However, we may see a boost in consumption in preparation for the Goods and Services Tax that will be implemented in the 2Q15 but the effects may be dampened if BNM decides to increase the OPR and if there is another round of fiscal consolidation (fuel price and electricity tariff hike). Strong momentum in the 1H14 is likely to spill over into the 2H14, giving higher probability of the GDP to exceed our projection of 5.5%. Hence, we are revising our 2014 GDP growth forecast to 6.0% from our initial target of 5.5%.

Source: Kenanga