OVERVIEW

The Nikkei Malaysia Manufacturing Purchasing Managers’ Index (PMI) showed continued deterioration in operating condition for the manufacturing sector, offering no fresh signs of improvement. The headline PMI reading was 47.1 in June, a tad lower than 47.2 in May. The PMI has stubbornly stayed in contraction mode for the 15th consecutive month. Similar to the previous month, production deteriorated at a steepest rate in more than 3.5 years, while new orders stumbled at the fastest pace of the year. Meanwhile, employment stagnated in June and new export orders fall for the first time since the beginning of the year. We expect Malaysia’s manufacturing sector to remain weak in 2016 as there is yet any clear sign of sustained improvement in the domestic economy, Global PMI trend as well as in the Baltic Dry Index.

The PMI reading fell marginally to 47.1 in June from 47.2 in May, marking its fifteenth consecutive month of contraction as indicated by the sub-50.0 reading. The June reading is not far from the lowest point since the series began in July 2012. The sluggish domestic economy, tepid domestic demand and volatile global markets were the main factors behind the poor PMI reading.

The contraction in June was almost across the board. The sub-groups of new orders, output, and stocks of purchases all suffered contraction in June, with employment stagnated at best. The weakness across the sub-groups is reflected in the disappointing PMI reading of 47.1 in June, which remains under the 50.0 reading separating expansion from contraction.

New orders in June failed to reverse its downward trend that started in March 2015. Moreover, new orders extended its contraction in an uninspiring fashion, falling at a sharpest rate since December 2015. The fall is largely due to slowing foreign demand amidst challenging global economic environment. Foreign demand fell for the first time in the year. Businesses reported unfavorable market conditions and reduced competitiveness from higher sales tax as the main reasons behind the fall in orders from abroad.

Unsurprisingly, production in June suffered continued deterioration that has persisted for more than a year following a decline in new orders and international demand. This suggests more evidence of declining business and economic activities especially in the manufacturing sector amid unstable global economic conditions.

The June employment index failed to extend growth registered in May. Employment growth stagnated as the production slowed and subsequently reduced the demand for manpower.

Stocks of purchases slipped in June at the second-sharpest drop rate since the beginning of the series. The drop in stocks of purchases is likely due to lower demand and production. The rising input cost can be attributable to higher sales tax and unfavorable exchange rate. Following rising input cost and sales tax burden, manufacturers increased their charges in June.

Meanwhile, the Markit Global PMI was higher at 50.4 in June from 50.0 in May. The PMI among world major economies also showed a mixed signal for the global manufacturing sector. The Eurozone enjoyed higher PMI reading of 52.6, compared to 51.5 in May. Conversely, the Caixin China Manufacturing PMI stumbled to 48.6 in June from 49.2 in May, as the Chinese economy endures pain from economic restructuring and adjustments. Meanwhile, Japan saw an improvement in its June PMI reading of 48.1, compared to 47.7 registered in May.

On a closely related trend, the Baltic Dry Index (BDI) rose in June after a brief downturn in May. The Baltic Dry Index, which measures the transportation cost of raw materials, like the PMI, is a leading indicator of global trade. It started its downtrend around November 2014, when Malaysia’s manufacturing sector was beginning to slow. The BDI climbed higher at 660 in June from a reading of 612 in May. This suggests a possibility that global trade is in an early stage of recovery. Still, we need to closely monitor the BDI reading in the coming months before a more credible trend of recovery can be confirmed.

Outlook

The June PMI performance capped the 1H16 on a weak note. It could also that domestic manufacturing would likely remain weak for the coming months. Sluggish domestic demand and poor consumer sentiment may present a high hurdle for a full recovery this year. Although the latest narrow money supply growth trend, a reflection of consumer spending, showed some improvements in May, we have yet to see a firm recovery trend, dimming prospects of near term recovery in global manufacturing output.

Meanwhile, we see the recent UK’s vote to leave the European Union to have a limited impact on local manufacturing due to the relatively small bilateral trade volume between UK and Malaysia. However, we believe the referendum result will likely exert downward pressure on global manufacturing performance. In view of the still weak manufacturing sector performance in major economies, we expect heightened uncertainties in local manufacturing performance in the months ahead.

As manufacturing production makes up two-thirds of the Industrial Production Index (IPI), the prolonged weakness in local manufacturing activities is a sign that the IPI would settle at a more moderate pace this year. The weak PMI readings reaffirm our view that industrial production is to grow at a slower rate of 4.3% in 2016 from 4.5% in 2015. Similarly, GDP growth in the 2Q16 is estimated to have slowed further to 4.0% in 2Q16 from 4.2% in the preceding quarter.

The current Manufacturing PMI primarily reflects weak consumer sentiment and domestic demand. The persistent weakness in global as well as domestic demand would raise market expectations that BNM’s monetary policy bias may tilt towards easing. At the same time, the Brexit referendum result and widely expected US Federal Reserve rate hike in 2H16 would heighten volatility of international capital flows. As such, it would be counter intuitive for BNM to cut the overnight policy rate (OPR) as it would heighten volatility and exert unnecessary pressure on the ringgit. Hence, we maintain our view that the OPR would remain unchanged for the year.

We see the continued contraction of the manufacturing sector as indicated by the PMI to be a sign of downward pressure to the country’s GDP growth in Year 2016. The weak global manufacturing performance may also adversely affect Malaysia’s trade performance. Combined with negative consumer sentiment and uncertain global economic outlook our GDP growth projection for 2016 is slower at 4.5% compared to 5.0% last year.

Source: Kenanga Research - 4 Jul 2016