• 1Q14 GDP growth of 5.6% YoY exceeds early forecasts, but came in largely within market expectations after upwards revision to estimates.
• Domestic demand, measured by a 7.9% YoY expansion in aggregate demand, got a boost from pre- GST spending.
• The numbers further confirm that economic growth is moderating and will slow down further in 2Q15, which we forecast to be the worst-performing quarter.
• Better growth outlook seen in 2H15 on sustained recovery in the global economy while domestically the adverse impact of GST would have mostly dissipated.
• Based on current trajectory, we maintain our 2015 GDP growth forecast at 5.1%.

Malaysia’s GDP growth for the first quarter of the year came in largely within market expectations but is significantly higher when compared to forecasts made earlier in the year. A late April briefing on the rebasing of reported GDP numbers and better-than-expected performance of the Industrial Production Index (IPI) and new Index of Services prompted many analysts to revise up their 1Q15 growth estimates.

The 1Q15 rate of growth of 5.6% YoY nonetheless confirms that economic expansion is slowing. In 4Q14 the economy grew 5.7% YoY (pre-revision: 5.8%) and 6.0% for 2014 as a whole. Our estimate for the quarter was growth of 5.5% YoY, which matched the consensus. Our earlier estimate prior to the week of the release of GDP data was 5.0% YoY on expectations that growth across the important services sector would moderate significantly. We added 0.5 percentage points to our estimate following the release of the Industrial Production, Services and Construction indices showing good growth in sectors of the economy that count the most, particularly in Services, which in 2014 made up 55.3% of the economy in real terms.

Adjusted to 2010 prices, 1Q15 GDP totalled RM254.4b. Areas of the economy that excelled during the quarter was private consumption from pre-GST spending and healthy growth in the services, manufacturing and mining sectors.

Demand side

Private consumption and investment were the drivers of economic growth on the demand side in 1Q15. Overall domestic demand expanded 7.9% YoY (4Q14: 5.7%, pre-revision: 5.9%) backed by private consumption growth that is the highest since 2012 at 8.8% YoY (4Q14: 7.6%) and private investment growth of 11.7% (4Q14: 11.1%).

The increase in private consumption can be largely attributed to the increased consumer spending in the lead up to the implementation of the Goods and Services Tax (GST). Consumers brought forward purchases of items thought to increase in price once GST is charged. Not all goods and services increased in price. Some big-ticket purchases such as residential property and motor vehicles did not see price hikes when the consumption tax came into effect on April 1 along with most basic goods and services. This is due to GST-free status of a large number of goods and services and the concurrent removal of the Sales and Service Tax.

Public-sector growth in 1Q15 was well below that of the private-sector. Government expenditure grew 4.1% YoY during the quarter, which is below the average of 4.4% for 2014. Public investment expanded 0.4% YoY after contracting 4.7% in 2014. We continue to expect public-sector growth to be weak as the government plans to cut RM5.5b from operating expenditure this year to counter the fall in oil-derived income and ensure that fiscal consolidation is able to continue to take place this year as in previous years.

As expected for the trade numbers, exports of goods and services shrank 0.6% YoY (4Q14: 1.9%) while imports of goods and services expanded 1.0% YoY (4Q14: 2.6%). The slump in exports dragged down real GDP growth by 0.4 percentage points as measured by the percentage point contribution of the sector to demand-side output.

Supply Side

Numbers for GDP by economic activity show continued growth in the mainstay services sector of 6.4% YoY (4Q14: 6.6%) and the other three major economic sectors of manufacturing, mining and construction picking up pace. Manufacturing edged up 5.6% YoY from 5.4% in 4Q14. The typically volatile and high-growth construction sector expanded 9.6% YoY from 8.8% in the preceding quarter. Interestingly, the mining sector grew in size by 9.5% YoY seemingly unaffected by the slump in oil prices and far higher than average growth of 3.1% in 2014 and 0.7% in 2013. The reason for this surprising improvement in the mining sector is higher production and sales volume of crude oil that more than made up for the lower prices.

Going further into detail in the services sector, growth in retail trade quickened to a high of 10.7% YoY in 1Q15 largely due to pre-GST consumer spending. Other services sub-sectors that saw rapid growth during the quarter are wholesale trade at 9.6% YoY, information & communication at 9.6% and food & beverage at 8.5%.

The next most important economic sector, manufacturing, grew at a faster rate during the first quarter. The highgrowth electrical, electronic & optical products sub-sector did not disappoint with growth of 9.3% YoY. The other subsector with high-growth is beverages & tobacco products at 12.9% YoY.

The construction sector continues to be resilient with 9.7%. Although there were initial worries about the possibility of a cut in development expenditure in the recent revised budget, developers were reassured that there were no changes from the initial 2015 Budget when it concerns development expenditure. Therefore this sector is expected to continue to perform this year though we are expecting a slower pace as we have to consider a high base effect as well as maturity period of some major developments of which expansion may not be as fast.

Due to severe flooding in parts of Peninsular Malaysia at the end of last year and the beginning of this year and low commodity and food prices, the agriculture sector suffered a 4.7% YoY contraction (4Q14: -3.7%). Upon further scrutiny, there was an 11.7% YoY fall in oil palm and a 20.4% decline in forestry & logging. At over 40% of total share of the agricultural sector, the drop in palm oil production due to East Coast flooding was the main drag for the whole sector.

Outlook

Looking forward, growth is expected to moderate further and at a quicker pace. We project that growth will fall below 5.0% YoY in the next two quarters, before a year-end recovery. The worst performing quarter is likely to be 2Q15, dragged down by the implementation of the Goods and Services Tax (GST) from April. External factors such as a slowdown in China’s economy and uncertain growth in the U.S., Eurozone and Japan will also weigh on growth. The third quarter, 3Q15, is expected to be equally as weak. However we see mid-year as a turning point for the economy’s growth trajectory and this will ensure that 4Q15 will outperform. Dependent on how the impact on GST would show in 2Q15 economic performance, for now, we maintain our 2015 full-year GDP growth forecast of 5.1%.

Given that BNM maintained its assessment of a “steady growth path” we reckon that it would likely err towards no change in its monetary policy stance. We agree with BNM’s opinion and view that Malaysia may see a temporary moderation in consumption growth, implying that the impact of GST should not derail economic growth. With economic activity still resilient, the GST exerting inflationary pressure and BNM’s concern about financial imbalances we continue to see little reason for BNM to change its policy rate of 3.25% this year.

Source: Kenanga Research - 18 May 2015