OVERVIEW

The Industrial Production Index (IPI) grew 5.3% YoY in June, surpassing market and our expectations (the consensus estimate was 2.5% while Kenanga is 3.1%) as well as May’s growth rate of 2.8% YoY (revised from 2.7% YoY). Manufacturing production, accounting for two thirds of the IPI, expanded at a faster rate of 4.7% YoY in June from 3.7% YoY (revised from 3.6%) in May thanks largely to a strong electrical and electronic (E&E) industrial output. However, manufacturing production remains on a declining trend, averaging growth of just 3.9% YoY in 2Q16 compared to 4.3% YoY in 1Q16. Thanks to the base effect, mining production rebounded 6.3% YoY in June in spite of a 0.7% MoM contraction after a 1.1% YoY decline in May. Electricity production appeared to moderate lower but remains unseasonably high, increasing by 8.7% in June. Expectation of an uncertain growth outlook in the 2H16 and the continued mining slump lead us to maintain our expectation for industrial production to grow at a slower rate of 4.3% in 2016 from 4.5% in 2015.

Industrial production as measured by the IPI was up 5.3% YoY in June after a 2.8% YoY increase in May. Growth surpassed market expectations; the consensus estimate was for 2.5% growth and the house estimate was 3.1%.

On a MoM basis, the IPI increased 2.4%, marking the second month that the index has risen on a MoM increase after a 3.6% rise in May. The seasonally adjusted index showed a 2.9% MoM increase, which corresponds with the headline rate coming in well ahead of expectations.

In 2Q16, growth averaged 3.7% YoY, up from 3.3% YoY in 1Q16 due to growth of the mining and electricity sectors more than making up for the slightly weaker performance of the manufacturing sector.

Manufacturing output, which accounts for a 65.9% share of the IPI, grew the fastest in eight months at 4.7% YoY in June. However the quarterly average was dragged down by poor performance of the sector in April and May and at just 3.9% YoY in 2Q16 is significantly lower than 4.3% YoY growth in 1Q16. On a MoM basis, manufacturing output rose 4.0% in June compared to3.1% in May.

The large, export-oriented electrical and electronic (E&E) manufacturing industry grew at a faster rate of 9.1% YoY in June compared to 8.3% YoY in May despite a global slowdown in semiconductor shipments. The petroleum, chemical, rubber and plastic manufacturing industry grew 5.0% YoY. However, the transport equipment and other manufactures category faced a deep slump.

In a separate report, manufacturing sales for June grew 2.9% YoY, extending a May rebound of 2.0% YoY after a contraction of 1.2% YoY in April.

Mining production, which makes up a 28.9% share of the IPI, rose by 6.3% YoY in June after a 1.1% YoY decrease in May. Electricity output, which has the smallest weightage in the IPI (5.2%), appeared to moderate lower but remains unseasonably high, increasing by 8.7% in June (May: 9.6%).

The Manufacturing Purchasing Managers’ Index (PMI) readings for the U.S. and Eurozone showed both economies remained in expansion territory with a lower rate of expansion. China and Japan markedly improved their manufacturing position in July, with China pulling out of a 16-month slump.

OUTLOOK

Growth in the IPI was slower in 2Q16 compared to 1Q16 but slightly ahead of our expectations. This presents a small upside to the size of the mining contribution to GDP and to a lesser extent manufacturing contribution. When read together with the Index of Services indicator for 2Q16 we assign a high probability of GDP exceeding our and consensus expectations which stands at 4.0% YoY currently.

Our GDP growth forecast for 2016 is maintained at 4.0%-4.5%, taking into account the uncertainty in global economic growth and slowing world trade

We maintain our industrial production growth target of 4.3% for 2016 compared to 4.5% in 2015 due to an extended weakness in the mining sector and moderating growth in manufacturing output amidst global growth uncertainty in the 2H16.

In the medium to long term view, the US economic recovery is the most convincing among major world economies but would not be able to provide sufficient lift to the local economy. It would take a cyclical recovery in China to boost demand in Malaysia. Hence, we expect to see Malaysia’s economic growth to remain below its potential growth of about 5.0% next year.

Source: Kenanga Research - 12 Aug 2016