OVERVIEW

The Nikkei Malaysia Manufacturing Purchasing Managers’ Index (PMI) in September rebounded matching the same level as in January this year. A smaller decline in production and new orders were the main contributors to the improved PMI reading. Subsequently, employment stabilized after falling in the previous two months. On the other hand, both export orders and purchase of inputs dropped at a faster rate due to further weakness in the manufacturing sector. Going forward, the prospect of a convincing uptick in domestic demand remains challenging, as businesses and consumers may take a cautious view of the economic outlook and reduce spending. Along with a murky outlook on global demand, we see limited upside to Malaysia’s manufacturing sector in 4Q16.

The PMI reading rose to 48.6 in September from 47.4 in August. The September index marked the highest reading in eight months. However, the index has stubbornly remained in the contraction mode for eighteenth consecutive month as indicated by the sub-50.0 reading. The slowing domestic economy combined with weak foreign demand weighed down on the PMI reading.

The sub-groups of new orders, output, and stocks of purchases stayed on downward trajectory in September. Meanwhile, employment stabilized after two consecutive months of decline. The weakness across the sub-groups has resulted in the weak PMI reading for the month.

New orders extended its downward trend in September. The decline in new orders was primarily attributable to weak global demand. On a positive note, however, the new orders were falling at the weakest pace in more than a year, offering some hope that recovery may soon be within sight.

Similarly, production failed to reverse its downward trend that has started since last year. Businesses reported the drop in new orders and uncertainty in the economy as the reasons behind lower production. Nevertheless, we see it as an encouraging sign of progress as the contraction abated the most in eleven months.

The employment condition stabilized in September, providing a breather to the hard-hit manufacturing industry. The industry has seen employment falling in the previous two months as manufacturers strive to reduce business costs. This may prove temporary if operating conditions fail to further improve in the coming months.

Stocks of purchases dropped in September at a faster pace. In addition, input prices surged at the steepest rate in the series history due to higher sales tax and weaker exchange rate. Nevertheless, manufacturers have largely chosen to absorb the rising costs and refrain from raising prices in an attempt to stay competitive and to improve sales.

Meanwhile, the Markit Global PMI edged up to 51.0 in September from 50.8 in August. The PMI among world major economies pointed to a steady growth momentum, contributing to the nascent recovery in global manufacturing. The Eurozone enjoyed a good run of manufacturing growth with a September PMI reading of 52.6. The Caixin China Manufacturing PMI gained slightly in September, edging up to 50.1 from 50.0 in August. Furthermore, Japan manufacturing sector returned to expansion mode for the first time in seven months with its PMI reading registered at 50.4 in September.

The Baltic Dry Index (BDI) climbed to 888 in September from a reading of 711 in August, mainly due to restocking activities before winter. The Baltic Dry Index, which measures the transportation cost of raw materials, like the PMI, is a leading indicator of global trade. As the recent surge in BDI reading is seasonal in nature, it might not necessarily translate into stronger performance for local manufacturing sector in the coming months.

Outlook

Going forward, the prospect of a convincing recovery in domestic demand remains challenging, as businesses and consumers may take a cautious view of the economic outlook and reduce spending. This is reflected in the weak MoM growth of narrow money supply in August as well. Along with a murky outlook on global demand, we see limited upside for Malaysia’s manufacturing sector in 4Q16.

If the current trend of deterioration in manufacturing condition as indicated by the sub-50 PMI readings continues unabated, we might see rising number of retrenchment in the domestic manufacturing sector. This will likely exert additional downward pressure on the already soft labour market, given that manufacturing sector still accounts for sizeable portion of Malaysia economic activities. However, we believe any possible impact on the overall labour market would remain manageable.

The prolonged slump in the manufacturing sector as indicated by the PMI data could portend a weak 4Q16 economic growth. Nonetheless, a lower base along with a relatively stronger services sector and the multiplier effect from the ongoing big infrastructure projects 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 - 4 Oct 2016