OVERVIEW

• Real GDP growth expanded 4.3% YoY in 3Q16 from 4.0% in 2Q16, marking a cyclical recovery after five consecutive quarters of slowing growth trend. Though it was below market consensus, it matched the house forecast.
• A further expansion in private consumption growth along with a large drawdown in stocks helped boost domestic demand and mitigate slowing public spending and exports in 3Q16.
• With the exception of the agriculture sector which knocked off 0.6 percentage points to the 3Q16 GDP growth due to mainly sharp fall in palm out output, the supply side saw a relatively broad based growth expansion led by the services sector.
• With the expectation of a tepid growth trend in manufacturing along with weak services, construction and mining output, we expect that it would weigh on GDP growth in 4Q16. Hence, we are revising down our 4Q16 GDP forecast to 4.3% from 4.7%.
• However, we still maintain our view that GDP growth in the 2H16 would be higher, with projection of 4.3% versus 4.1% in the 1H16. Though our GDP growth forecast for the whole of 2016 would be adjusted slightly lower to 4.2% from 4.3%, it is within the forecast range of 4.0% to 4.5%.
• With a cyclical upturn factored into the growth trajectory along with a sustainable current account surplus it would further strengthened the fundamentals of the Malaysian economy and probably reduce the probability that Bank Negara Malaysia would have to cut interest rates in the near term.

Real GDP growth expanded 4.3% YoY in 3Q16 from 4.0% in 2Q16, marking a cyclical recovery after five consecutive quarters of slowing growth trend. While it was below market consensus of 4.0%, it matched the house forecast. On a QoQ seasonally adjusted basis, the economy expanded by 1.5% from 0.7% in the 2Q16. While GDP growth matched house prediction for the second time, it has been interesting to note that it differs when it comes to the performance breakdown. For the third quarter running, the agriculture sector recorded a sharper than expected contraction of 5.9% YoY in the 3Q16 following a 7.9% drop in 2Q16. It exclusively dragged down the GDP growth, knocking off about 0.6

percentage points (ppts). This time, however, it was not enough to cancel out the excellent performance of the main services sector (6.1%), which grew at the fastest pace since GST was introduced in April 2015. This came in timely as the manufacturing sector growth appeared to be tapering off as global demand for electrical and electronics along with commodities slowed. Meanwhile, on the demand side of the equation, private consumption continued to perform better while investment slowed largely due to slower public sector activity.

Demand Side

Domestic demand growth remains healthy but appears to be tapering off due to slower growth in public expenditure. However, private sector spending continues to support domestic demand and took up the slack left by the public sector, reflecting a relatively robust consumer and business sentiment. Meanwhile, net exports contributed positively to GDP growth as real imports contracted at a faster pace than real exports.

Private consumption continue to expand at a stronger than expected 6.4% YoY in 3Q16, edging up from 6.3% YoY in 2Q16. As a result it represented the biggest single contributor to GDP growth at 3.3 ppts in 3Q16. Given the uncertainties arising from the shocking US Presidential Election outcome and the possibility that the Fed would raise interest rates, we remain cautious of the trend in consumer confidence going forward.

Meanwhile, total public expenditure growth decelerated sharply to 0.3% in 3Q16 from 6.9% in 2Q16 as the Government continue its consolidation discipline. As a result, its contribution to GDP growth falters to 0.1 ppt from 1.4 ppts in 2Q16. This had also affected total investment expenditure growth which decelerated to 2.0% from 6.1% in 2Q16 as public investment fell 3.8% while private investment was up by 4.7%.

All in all, aggregate demand grew at a much slower pace of 4.7% compared with 6.3% YoY in 2Q16 reflecting largely the fall in public spending while private consumption and investment appeared to be taking up part of the growth slack. As a result, the aggregate demand’s contribution to GDP growth shrank to 4.3 ppts in 3Q16 from 5.7 ppts of GDP growth in 2Q16.

Meanwhile, external sector performance was not entirely disappointing. Though both value-added exports and imports recorded negative growth rates, the rate of decline of imports (-2.3% YoY) outpaced that of exports (-1.3%), bringing about a positive net export growth 5.9%, a rebound from -7.0% in 2Q16. As a result, net exports contributed 0.5 ppt to GDP growth in the 3Q16 as opposed to -0.6 ppt in 2Q16.

Supply Side

By main economic sectors, the growth trend was generally healthier and more expansionary led by the services sector, followed by mining and to a certain extent, manufacturing. While construction growth tapered off, it was largely due to a higher base effect and still remains at a high single digit growth rate. The exception was the agriculture sector which continued to face a severe decline due to the residual effects of the El Niño weather phenomenon.

The main drag to the fall in agricultural sector was the sharp decline in palm oil output which fell 13.8% in 3Q16 following a 19.3% YoY contraction in 2Q16. Combined with the 9.2% YoY decline in the rubber plantation industry, the agriculture sector fell by 5.9% YoY (2Q16: 7.9%). The fall was large enough to have a pronounced effect on economic growth, equivalent to a cut of 0.6 ppt to GDP growth in 3Q16.

The main economic activity sector of services grew at a bigger than expected 6.1% in 3Q16 from 5.7% YoY in 2Q16. This was the fastest rate of growth for the sector since the 1Q15 (6.4% YoY) or after the April 2015 introduction of the GST, indicating that the impact of GST on consumer confidence has normalised and reflected the better performance of the services sector, in particular retail trade. Although the rate of growth of the services sector remains below the long run average of 6.5% (four years between 2011 and 2014), the current rebound appears to be solid.

The manufacturing defied current trend by edging up 4.2% in 2Q16 from 4.1% in 2Q16 in spite of slowing external demand for manufactured goods. However, its contribution to GDP was smaller at just 0.9 ppt compared with 1.0% in the preceding quarter. Nonetheless it was an upside surprise, though we do not expect it to continue going forward due to growing global economic uncertainty.

The mining sector also grew at a faster rate of 3.6% in 3Q16 from 2.6% YoY in 2Q16 on the back of increased production of oil & gas and a slight improvement in global demand. The typically volatile sector faced a slump since 4Q15 after four consecutive quarters of above 5.0% growth. Meanwhile, the construction sector growth tapered slightly to 8.5% in 3Q16 from 8.8% YoY in 2Q16, due to a higher base effect but remained largely supported by strong civil engineering activity.

Outlook

Although private consumption has been resilient thus far and is expected to partly offset the weakness in external demand in 4Q16, the expectation of a moderation in manufacturing output will pose a downside risk to the overall economy in 4Q16. Along with an expectation of weaker services, construction and mining output, we expect growth moderation in manufacturing to weigh on GDP growth in 4Q16. Hence, we are revising down our 4Q16 GDP forecast to 4.3% from 4.7%.

However, we still maintain our view that GDP growth in the 2H16 would be higher, with projection of 4.3% versus 4.1% in the 1H16. Though our GDP growth forecast for the whole of 2016 would be adjusted slightly lower to 4.2% from 4.3%, it is within the forecast range of 4.0% to 4.5%. For 2017, our projection is for the economy to grow between 4.5%-5.0% on the back of a clearer picture of the US economic policy under the new Presidency, slightly bigger fiscal spending and possibly a gradual recovery in the global economy.

With a cyclical upturn factored into the growth trajectory along with a sustainable current account surplus it would further strengthen the fundamentals of the Malaysian economy and probably reduce the probability that Bank Negara Malaysia would have to cut interest rates in the near term.

Source: Kenanga Research - 14 Nov 2016