OVERVIEW

The Nikkei Malaysia Manufacturing Purchasing Managers’ Index (PMI) fell in August, as the improvement in July proved to be short-lived. The headline PMI reading slid to 47.4 in August from 48.1 in July, marking its seventeenth consecutive month of contraction as indicated by the sub-50.0 reading. The index showed accelerated pace of decline in production and new orders. Consequently, employment stumbled at the fastest rate in more than three years and manufacturers reduced their stocks of purchases. The recent Bank Negara Malaysia (BNM) decision to cut OPR by 25 bps in July and fiscal development spending could potentially help to underpin domestic demand. However, we continue to see rough operating conditions for Malaysia’s manufacturing sector in 2016 as outlook remains highly uncertain on both the domestic and external front.

The PMI reading fell to 47.4 in August from 48.1 in July. The index has stubbornly stayed in the contraction zone for seventeen consecutive months, as indicated by the sub-50.0 reading. The unimpressive PMI reading is consistent with the sluggish domestic economic conditions and volatile international demand.

Across the board, the sub-groups of new orders, output, employment and stocks of purchases all suffered contraction in August. All the sub-groups besides stocks of purchases experienced quicker pace of contraction in August. Stocks of purchases fall in August but at the softest rate in more than a year. The overall sub-index contraction has contributed to the weak PMI reading in August.

New orders in August stayed on a downward trend that has lasted for more than a year. Adding to the worries, new orders fell at a sharper rate compared to previous month. The decline in foreign demand for the third consecutive month has added downward pressure to the new orders performance in August.

The decline in new orders has certainly affected production negatively. Production extended its downward trend that has started since last year. Furthermore, the fall in production intensified for the month. This indicates a high hurdle for production to rebound to a level indicative of a healthy manufacturing sector growth in the near term.

Manufacturers appeared to rev up their cost saving efforts amid unfavorable operating conditions, as evidenced by the employment stumbling at the fastest rate in more than three years. Furthermore, employment has been falling for two consecutive months.

Stocks of purchases dropped in August but at the slowest rate in more than a year. In addition, higher sales tax and unfavorable exchange rate was again cited as the leading factors for the rising input cost. As a result, manufacturers increased their charges in August.

Meanwhile, the Markit Global PMI inched lower to 50.8 in August from 51.0 in July. The PMI among world major economies showed that the outlook for the global manufacturing sector remain volatile. Eurozone PMI edged down to 51.7 from 52.0 in July. The Caixin China Manufacturing PMI slid to 50.0 in August and was on the verge of falling into the sub-50.0 contraction zone. Furthermore, Japan manufacturing sector remained in contraction mode despite its August PMI reading improvement to 49.5 from 49.3 registered in July.

On a closely related trend, the Baltic Dry Index (BDI) resumed its upward trend in August after a brief downturn in the previous month. 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 rose to 711 in August from a reading of 656 in July. The BDI reading will likely trend higher in the coming months supported by restocking activities before winter.

Outlook

The dismal August PMI performance has weakened hopes for a recovery in the domestic manufacturing sector before the end of the year. Domestic demand will likely stay tepid as businesses and consumers adopt a cautious approach in their spending decision. This is reflected in the MoM decline of money supply in July as well. Combined with volatile external conditions, manufacturing sector may face headwinds for a convincing recovery this year.

We believe the July OPR cut of 25 bps as well as fiscal development spending could help to underpin domestic demand. However, we see limited impact of the OPR cut on domestic manufacturing sector in the near term, due to the weak consumer spending constrained by high household debt and tight lending activities from banking institutions. As such, we see limited upside for Malaysia’s manufacturing sector for the remainder of the year.

The prolonged slump in the manufacturing sector as indicated by the PMI could provide further downside risk to the country’s GDP growth for the year. Nonetheless, we expect GDP growth for the whole of 2016 to comfortably stay within our forecast range of 4.0%-4.5% as Malaysia’s economic fundamentals have remained intact thus far.

Source: Kenanga Research - 2 Sep 2016