OVERVIEW

The Index of Services was up 5.6% YoY in 2Q16, a much bigger increase than 4.7% YoY in 1Q16 and easily outperforming the previous four quarters

All three main categories of the Index of Services grew at a faster rate in 2Q16 than in 1Q16 led by the Index of Services (Distributive Trade, Food & Beverages and Accommodation) grew 6.3% YoY in 2Q16 compared to 5.1% YoY in 1Q16.

The index reading suggests that actual value-added services probably grew at a far higher rate than our and most other estimates

Based on historical correlation, value-added services probably grew an estimated 5.8% YoY in 2Q16 and this could translate into better than expected GDP data in today’s noon release

Thus, GDP growth for 2Q16 is expected to come in above our and the consensus estimate of 4.0% YoY and quite possibly higher than 1Q16 growth of 4.2% YoY.

As we believe there is still room for Bank Negara Malaysia (BNM) to cut its policy rate by another 25 bps this year, a higher-than-expected 2Q16 GDP growth could push back the rate cut timetable or delay any policy change indefinitely.

The Index of Services was up 5.6% YoY in 2Q16, a much bigger increase than 4.7% YoY in 1Q16 and the fastest rate of growth in five quarters. Growth measured on a QoQ basis was a small but respectable 0.4% in 2Q16, up from 0.1% in 1Q16.

The index points to a broad-based rebound for service sector growth, which is the main support for GDP expansion. The component indicators further suggest that previously lagging service sector industries returned to relatively more normal levels of growth in 2Q16.

The largest category of the Index of Services (Distributive Trade, Food & Beverages and Accommodation) rose 6.3% YoY in 2Q16 compared to 5.1% YoY in 1Q16. Within the category, retail trade accelerated to 7.4% YoY from 5.5% YoY in the previous quarter, while motor vehicle sales contracted for the second straight quarter.

The second largest category (Finance, Real Estate and Professional Services) grew 2.8% YoY in 2Q16 compared to 1.9% YoY in 1Q16. Within the category, financial services fell 0.1% YoY in 1H16, but this was a better performance than the 2.5% YoY decline in 2H15. The insurance sector grew 7.7% YoY in 2Q16 following four consecutive quarters of contraction.

The third largest category (Communication and Transport & Storage) increased by 7.3% YoY in 2Q16 from 7.0% YoY in 1Q16.

OUTLOOK

The Index of Services reading for 2Q16 suggests that value-added services probably grew at a far higher rate than our and most other estimates. Based on historical correlation, value-added services probably grew about 5.8% YoY in 2Q16, instead of our estimated 4.6% and this could translate into better than expected GDP data in today’s noon release, given the importance of the services sector (53.5% share of GDP in 2015).

When read together with the Industrial Production Index (IPI), which performed slightly above expectations, GDP growth for 2Q16 would probably show better than our and the consensus estimate of 4.0% YoY and quite possibly higher than 1Q16 growth of 4.2% YoY. The much better performance of the services sector in 2Q16 compared to 1Q16 suggests a cyclical recovery is underway.

As we believe there is still room for BNM to cut its policy rate by another 25 bps this year, a higher-than-expected 2Q16 GDP growth could push back the rate cut timetable or delay any policy change indefinitely. But that remains to be seen as the global economic outlook in the 2H16 is increasingly uncertain.

Source: Kenanga Research - 12 Aug 2016