OVERVIEW Monetary conditions weaken further in July due to declining Claims on Government and Net Foreign Assets. This is captured by a MoM contraction of the broad money supply or M3 by 0.8% in July. But thanks to the low base effect from large capital outflow last year, M3 grew at a five-month high of 2.3% YoY. Narrow money supply or M1 shrank 2.6% MoM after two consecutive months of growth, suggesting the vulnerability in consumer spending. Total deposits in the banking system fell by 1.2% MoM in a low interest rate environment. On a yearly basis, loan growth moderated for the eleventh month to 5.1% YoY. As a result, loan-to-deposit ratio rose to a six-month high of 88.8%. Although an expected mild recovery in the economy in 2H16 may offer some support to the domestic money supply and credit growth, we expect money supply to largely stay on moderating trend for the remainder of the year. We maintain our projection for the loan growth to shrink to 5.0% - 6.0% in 2016 in line with weaker GDP growth (2016 forecast: 4.0-4.5%)

Broad money supply or M3 contracted 0.8% MoM in July, which is the worst monthly drop in a year. This translates into RM13.3b shrinkage in M3 from previous month. The last comparable deterioration in M3 was in July of last year, when capital outflows were mounting. On a yearly basis, however, M3 grew at a five-month high of 2.3%, thanks to the low base effect from the impact of large capital outflow last year.

The MoM contraction of M3 was largely attributed to 0.6% MoM decline in the net foreign assets category. In addition, Net Claims on Government fell 1.7% MoM, mainly due to the declining holdings value of government debt securities by BNM and banking institutions. This led to a further drag on MoM performance of M3

Narrow money supply or M1 shrank 2.6% MoM in July, ending a two consecutive months of solid growth. The MoM fall in M1 is the most intense in four months. M1 grew 2.0% YoY in July largely due to low base effect. The recent improvement in consumer sentiment as indicated by the MIER Consumer Sentiment Index has not translated into actual spending, as global and domestic economic outlook remain uncertain. Similarly, M2 fell 1.0% MoM but was up by 2.0% YoY.

Loan growth moderated for the eleventh consecutive month to 5.1% YoY in July from 5.6% YoY in June. The poor loan growth was within expectation as financial institutions tightened their lending activities in an effort to tackle liquidity and loan impairment issues amidst weak deposit growth and consumer sentiment.

Private sector financing growth edged down to 6.8% YoY from 6.9% in June, due to moderation of loans provided by the banking system and financial institutions. This is mainly reflected in the slower business loans growth of 3.7% YoY in July (June: 4.2%). Other sectors that faced a slower loan growth include construction; education and wholesale and retail trade, and restaurants and hotels. Similarly, household loans slowed to 5.7% in July from 6.0% in June.

Total bank deposit rose 1.0% YoY in July after a negative 0.5% growth in June. However, deposit dropped 1.2% MoM compared with 0.2% growth in June. The weak deposits growth is expected as it faces additional challenges in an environement of lower interest rates following BNM’s decision to cut its Overnight Policy Rate (OPR) in July.

The gap between system-wide loan growth and deposit growth widened in July. Consequently the loan-to-deposit ratio rose to a six-month high of 88.8% in July from 87.8% in June a reflection of receding liquidity trend.

OUTLOOK

We expect a tough road ahead for the recovery of domestic money supply conditions. Although an expected recovery in the economy in 2H16 is to offer some support to the domestic money supply and credit growth, we see money supply to remain in a moderating trend for the remainder of the year. This is in view of the tepid consumer spending growth constrained by high household debt, weak business investment and volatile global market conditions. This is also reflected in our latest downward revision of inflation forecast by 0.2 percentage points to 2.1% YoY.

Market expectations for another US Fed Funds rate hike soon have been growing following hawkish remarks from Fed Chairman Yellen in August. Most likely this will increase the volatility of capital flows and may exert additional downside risk to the recovery momentum of domestic monetary conditions. However, we view that a relatively stable ringgit, sound sovereign debt ratings and positive yield spread against U.S. assets to minimise the Impact of large capital outflows as well as domestic monetary conditions in the event of a US rate hike.

We believe the impact of the July OPR cut of 25 bps on domestic monetary conditions in the near term would likely be insignificant, due to the tight lending activities resulting from on going efforts to improve loans portfolio quality in the banking industry. This may provide BNM the justification to cut the OPR by another 25 bps in the event of further deterioration of growth expectations. But for now we expect the OPR to stay at 3.00%. Meanwhile, we maintain our projection for the average banking system loan growth to shrink to 5.0% - 6.0% in 2016 from 7.9% recorded in 2015.

Source: Kenanga Research - 1 Sep 2016