OVERVIEW

• Gradual cyclical recovery to continue. Malaysia is expected to maintain a gradual recovery trajectory in 1H17, as it ends the year with an estimated 4.2% growth for 2016. Growth is expected to edge higher to 4.5% in 2017, though weak sentiments and soft external sector constrains a more robust recovery.
• Domestic demand driven. Growth will continue to be driven by domestic demand notwithstanding weaker consumer and business sentiments. Private expenditure grew by an estimated 5.8% in 4Q16, bringing the 2016 growth estimate at 6.0%; private expenditure is expected to further expand 6.6% in 2017.
• Oil price recovery likely sustained. Despite downside risks against OPEC’s production cut, its explicit goal of relieving inventory overhang is likely to materialise, sustaining oil prices at USD50-60/barrel or around USD55/barrel in 2017.
• Inflation rising but manageable. Rising commodity prices and subsidy rationalisation will likely translate into a modest upward pressure on inflation. However, inflation will remain low and stable at around 2.3% notwithstanding.
• Fiscal consolidation on track. The government is likely to achieve its 3.0% fiscal target based on improved tax collection, recovery in oil prices, successful budget rationalisation and gradual cyclical recovery in 2017. A more aggressive fiscal thrust is possible to help speed up growth.
• OPR to stay pat; room for further loosening. OPR is expected to remain at 3.00% as the BNM evaluates the full impact of global event risks. However, with manageable inflation, BNM has some leeway for monetary easing assuming a significant deterioration of growth trajectory or perceived spill over threat.
• Risk-off stance in the capital markets. Rising global event risks and BNM’s attempt to stifle offshore ringgit have sparked capital flight and weak performance of the ringgit. These volatilities are expected to be the mainstay with USDMYR expected to trade within the 4.40-4.60 range in the near term.
• Ringgit volatility ahead. On the expectation of diminishing negative sentiments and economic shocks along with a more stable economic environment we expect the USDMYR to settle around 4.35 by end of the year.
• Pockets of growth; potholes of risks. While 2017 will likely see a continuation of Malaysia’s recovery theme, without a strong growth catalyst, the momentum may falter somewhat in 2H17, especially given a constellation of global risks in play.

Summary

Path to recovery ridden with risks. Malaysia is likely to see a relatively stronger recovery in 1Q17 compared to 2H16 as it continues to ride on cyclical recovery. However, the recovery pace will remain subdued due to poor sentiments and soft external sectors. Event-specific risk, both domestic and external, cast further doubt into the pace of Malaysia’s recovery trajectory. While growth will largely be driven by domestic consumption, Malaysia remains vulnerable to external headwinds as consumer and business sentiments are somewhat muted. U.S. continues to be among the best performing developed economy though policy uncertainties and nascent anti-trade rhetoric limits its upsides to global growth. Elsewhere, improving prospects will help support gradual recovery in Western Europe and other Asian economies though these recoveries remain vulnerable to a constellation of event risks in 2017.

Global outlook

Global growth to improve in 2017. Despite some hiccups to growth, global recovery continues to trudge on, backed by modest fiscal push and cyclical upswing, at least for some countries. However, event-specific risks cloud outlook, threatening to throw a wrench into the recovery engines. The International Monetary Fund places growth forecast for 2017 at 3.4%, up from a downwardly revised 3.1% (revised from 3.2% due to the Brexit referendum and weaker-than-expected US growth). OECD, meanwhile, forecasts the global economy to grow 3.3% in 2017 after bottoming out at 2.9% in 2016 (2004- 2013 average growth: 3.9%).

Pivot towards fiscal policies. With many economies seeing limited scope for further monetary easing, governments are increasing turning towards fiscal options to help spur recovery

or supporting growth. Indeed, with low (zero or near zero, in some economies), a more active fiscal stance is prudent, at least in securing growth trajectory. Japan, for one, has proposed an USD880b budget for the 2017 fiscal year. Other countries have followed suit with a greater fiscal thrust and a more permissive deficit target, indeed, suspending fiscal consolidation objectives. However, while the pivot towards fiscal policies in favour of further monetary accommodation may help jump-start or indeed, accelerate recovery, reinvigorated enthusiasm for fiscal thrusts brings about unique risks, particularly for economies already at or near the peak of its business cycle. For China, while its long term fiscal stimulus has helped sustained growth in excess of 6.5%, cracks are starting to emerge. Rising property prices and high leverage in both its corporate and household indebtedness spells some medium-to-long term risks to China’s economy. Elsewhere, strong indications of a more aggressive fiscal policy, by the incoming Trump Presidency, on an already-upbeat US economy may prematurely accelerate US business cycle down its peak.

Nascent anti-establishment sentiments. Rising tide of populism has been a major disruptive influence, emerging as a leading source of event risks. This has already given rise to various insular politics including “Brexit”, rejection of the prevailing free trade agenda, the election of anti-establishment figures (including Donald Trump in US and Rodrigo Duterte in Philippines) and strongly anti-immigration stances, among others. These sentiments introduces new elements of uncertainties as these populist forces tend to invoke ambitious structural overhauls, be it on regulation, movement of goods, services and labour or increased cross border tensions.

Trump slump vs. Trump bump? One of the major “victories” of populism, the election of Donald Trump introduces a whole gamut of uncertainties to the global economy. This is further complicated by mixed messages, swinging from stinging campaign rhetoric to a reconciliatory victory speech and back to controversial post-election policy hints and political nominations. However, markets remain overall buoyed by prospects of greater fiscal spending, especially on infrastructures and deregulation of financial and energy sector. While initial sentiments are positive, given policy and implementation lag, the real effect of these stimuli will likely kick in around the beginning of 2H17. However, expansion of fiscal policy during an economic upswing may ultimately be counterproductive, potentially accelerating the business cycle into a downturn. The Chair of Federal Reserve, Janet Yellen, opined in one of her more hawkish statements, that “fiscal policy is obviously not needed to provide stimulus to help us get back on full employment”.

China overdosed on stimulus? On the other side of the globe, China’s growth continues to defy expectations, supported by aggressive stimulus, sustaining growth above 6.5%. Growth is further supplemented by expansion in private consumption, especially given rising income levels and urbanisation. However, high household and corporate leverage highlights possible structural risks inherent in China’s high growth over the years. While some prudential measures have temporarily allayed the possibility of a hard landing of the Chinese economy, structural reforms remains relatively slow, posing some medium-to-long term risks for its growth engine with notable hotspots including a potentially overheating property market and increasing incidences of “zombie firms”, which may send its high debt burden out of control. With attempts to move the growth drivers towards greater private consumption, particularly with weaknesses in its external sector, China’s growth is likely to moderate to the lower end of 6.0-6.5% range by 2017, especially as it weans the economy away from stimulus.

Regional tensions a damper on confidence. Additionally, the escalation of rhetoric between China and US, along with territorial squabbles, heightens concerns on regional stability. While the risk of outright military conflict remains remote at this juncture, sabre-rattling – particularly between China, US and an increasingly assertive Japan (given its record high defence budget) – may unnerve investors and ultimately weigh down on sentiments in the region. At a more economic level, this may exacerbate anti-trade sentiments at the regional level, damaging prospects for a successor of the TPPA (a plan explicitly opposed by the incoming President Trump).

Crude oil prices to rebound. In December 2016, OPEC’s decided to cut production by around 1.76m bpd in a bid to ease high inventory levels. The move, which includes participation by both OPEC and non-OPEC members has seen Brent crude oil breaking the USD55/barrel mark mid-to-late December. While OPEC’s recent initiative will be contingent on various supply and demand side risks – including compliance of participants, the non-participation of shale oil and softer demand, among others – the oil prices are likely to sustain itself at USD50-60/barrel levels on the back of a short term relief of supply overhang and a stronger 2017 recovery. As an oil exporter, this places Malaysia well within grasp towards achieving its 3.0% fiscal deficit targets; fiscal deficits can go as low as 2.3-2.8%, ceteris paribus, assuming no subsequent fiscal expansion or impairment to demand (Refer Table 1).

Overview 4Q16 and 2016

Challenges to strong recovery. Increasing global uncertainties will cap upside to growth in 2016. The economy has been rocked by the surprise election of Donald Trump as the US president and the surprise result of the Brexit referendum; these events are expected to continue playing out well into 2017. However, 3Q16’s growth suggests a cyclical recovery to the prolonged slowdown in growth trend.

Domestic demand supporting growth. Private consumption continues to prove itself surprisingly resilient, notwithstanding shaky economic recovery. We estimate that private consumption grew by 5.8% in 4Q16 albeit smaller than 6.4% in the 3Q16 due to the uncertainty as well as the seasonal year-end taper. However, in terms of share to economic growth it remains large at around 51.7% of total GDP. It is also the biggest component of percentage point (ppt) contribution to YoY GDP growth as well as domestic demand at 3.0 ppts. Combined with total public expenditure and investments as well as changes in stocks, the total aggregate domestic demand’s contribution to GDP growth in 4Q16 is estimated at 3.8 ppts

External trade to remain soft. We expect exports to remain weak for the rest of the year, mainly due to high base year effect from the previous year as well as the slower trend in global trade. Weaknesses in commodities and softer demand abroad will be a damper on Malaysia’s export growth. While the odds of a current account deficit are unlikely, we do foresee current account to close the year narrower. Overall, we project the current account balance for 2016 to narrow to 1.6% of GDP from 3.0% in 2015.

Slightly better 2H16 vs 1H16. In real terms, we estimate net exports contribution to 4Q16 GDP growth to be minus 0.3 ppt. By adding this to aggregate demand’s contribution to GDP growth (4.6 ppts), we derive at our 4Q16 GDP growth forecast of 4.3% which matches 3Q16 growth. Worsening business and consumer sentiments during 3Q16 could have clouded the growth prospects for 4Q16. However, we still expect 2H16 GDP growth to edge higher at 4.3% compared to 4.1% in 1H16. This brings the (2016) full year growth to 4.2% well within the official forecast of 4.0%-4.5% and compared to 5.0% during the previous year. Private consumption (3.1 ppts) and investments (0.7 ppts) remains the biggest contributor to GDP growth in 2016.

Inflation manageable. Inflation remains manageable after accounting for the final impact of the low base effect in 1Q16. In consideration of the cooking oil subsidy rationalisation in November, disruption in food production and supply chains from the monsoon season, weaker ringgit and year-end festivities, we project inflation to edge upwards in December, bringing 4Q16 inflation to 1.7% and the full year (2016) inflation to 2.1% YoY.

Outlook 1Q17 and 2017

Challenges to strong recovery. As in 2016, growth recovery in 2017 is expected to be largely driven by a projected 6.6% expansion in private consumption from an estimated 6.0% last year. However, recovery will be bounded by weak sentiments. MIER’s 3Q16 consumer sentiments index stood at 73.6 points, falling 5 points from 2Q16, as job and income concerns dampen spending plans, especially on big ticket items. The business sentiments are likewise weak at 83.9 points in 3Q16, after breaking the 100 point threshold in 2Q16 at 106.4 points as overall sales and orders slowed down. This implies a more gradual recovery than expected, amidst likewise weaknesses in the external sector.

External sector weaknesses. Malaysia’s external sector will continue to be vulnerable to global event risks. However, gradual stabilisation of commodity prices will help stem downward pressures on exports. Furthermore, improvements in the E&E by the end of 1Q17 will support exports moving forward, buoyed by slight increase in competitiveness from the Ringgit depreciation. However, on overall weakness in the external sector, the current account surplus is expected to narrow slightly in 1H17, though the threat of swinging into a deficit continues to be remote.

A challenging start. As in the 4Q16, we believe that any further improvement in the economy in the beginning of 2017 would be dampened by more geopolitical and economic uncertainties. Elections in major economies namely Germany, France and Netherlands to name a few may spur populist uprising that could shake current establishments and bring about political change and disrupt stability. Meanwhile, the global financial markets would remain volatile on Fed’s indicative three rate hikes for this year and how the U.S. and global economy would respond to President-elect Donald Trump’s expansionary fiscal plan (large infrastructure spending and tax cut).

Putting a cap on 1Q17 growth. We still believe that the growth momentum is intact in spite of the prevailing geopolitical and macro risk. This would put a cap on economic growth in 1Q17. Nonetheless, we still expect a slight upturn in the GDP growth for 1Q17 at 4.4% from an estimated 4.3% in the preceding quarter thanks in part to the lower base in the corresponding period a year ago. With the exception of the agriculture sector, growth in the 1Q17 would largely be broad-based, driven further expansion in services, construction, mining and the manufacturing sectors. On a QoQ-basis, GDP growth is expected to contract by 4.5% in 1Q17 which is almost comparable with -4.6% registered in 1Q16.

Domestic demand push. The main factor that may push for the better outlook for 2017 is sustained domestic demand growth driven by private consumption. Domestic demand is projected to grow by 5.1% this year from an estimated 4.6% in 2016. It contributes about 4.5 ppts to GDP growth in 2017 which means net exports’ contribution is a marginal -0.1 ppt given our projection for GDP growth is 4.5%. In other words growth is expected to come almost entirely from domestic demand.

more conservative from its earlier target of 10%-13% increase from its estimated collection of RM38.0b last year. Nonetheless we are confident that it may be able to collect more than what it has indicated given it had reached 97% in GST collection delivery forms early December 2016, a feat it most likely could replicate if it continues with its aggressive enforcement measures.

Higher oil revenue? The possibility of higher oil-related revenue is much better now given that OPEC members have recently reached an agreement to cut production which has enable oil prices to remain above USD50.0/barrel since end of November last year. Hence, we believe that total oilrelated revenue would likely be higher than an estimated RM28.0b for this year. Based on our assumption that average oil price for this year to be at USD55.0/barrel we expect it would add at least RM5.0b to total revenue this year (Refer to Table 1).

Exercising fiscal space? Weak consumer and business sentiments, along with soft external sector provides a strong case for a temporary departure from Malaysia’s fiscal consolidation exercise. While a 3.0% deficit target for 2017 remains well within reach, a more aggressive fiscal thrust could help kick-start Malaysia’s recovery momentum, with relatively minor implications on government finances. This, along with a potential recovery of oil prices sustained at least into the 2H17, may enhance the government’s ability for a fiscal expansion while maintaining the 3.0% fiscal target. At the same time, a possible 2017 general election may nudge the government to loosen its purse-strings with possible election goodies handed out as early as mid-1Q17.

Monetary Policy

Gradual ascent of Fed’s Interest rates. As expected, the Federal Open Market Committee (FOMC) officials of the US Federal Reserve raised interest rates by 25bp in its December meeting, just its second hike since the 2008 Financial Crisis. The FOMC further implied three further rate hikes of 25bp each in 2017. However, inertia from its prolonged exposure to low and near zero interest rates suggests that further hikes in 2017 may lean on dovishness. This will be further reinforced by continued sub-2.0% core PCE reading which may reinforce the dove’s case for monetary accommodativeness – two 25bp rate hikes remains on the cards, especially if key employment metrics falters in 2017. However, the “Trump factor” meant that FOMC members will likely await clarity from the impact of Trump’s maiden fiscal measures before raising rates which is likely in its mid-March meeting, at the earliest.

Pre-emptive OPR cut in July. BNM’s Monetary Policy Committee (MPC) surprise decision to cut the overnight policy rate by 25bp to 3.00% in July 2016 indicates the MPC’s willingness to respond pre-emptively to global uncertainties and to support growth. While the BNM has since stood pat on OPR for the rest of 2016, manageable inflation meant that the BNM has sufficient leeway in cutting rates, especially if growth trajectory shows a massive downward shift.

BNM likely to exercise restraint. Notwithstanding its leeway for further interest rate cuts, we believe that BNM is not likely to exercise further cuts in the OPR, at least in 1Q17 as they will continue to evaluate the full impact of global uncertainties on Malaysian growth. Moreover, the debilitating impact of lower interest rates on capital outflows will likely be a consideration. However, we expect BNM to undertake a more active open market operations as part of its current objectives of maintaining exchange rate stability.

Current Account Position

Better external position. Following a rather weak external position last year we expect a more stable outlook on Malaysia’s current account balance in 2017 on the back of better global growth outlook as well as improvement in global trade. Better growth prospects in the European Union, sustainable growth trend in the US as well as a more stable and an upward bias on commodity prices would further support Malaysia’s current account balance. Hence, we expect gross exports to expand to about 2.5% from an estimated 0.7% in 2016. Meanwhile, we expect gross imports to similarly expand by around 2.1% due to increase in imports of capital goods driven by new and ongoing construction and infrastructure projects.

Resilient. Given the expectation of better prospects in the economy, we expect the deficit of the services and income account to increase as well. Nonetheless the surplus in the goods and services account will be more than offset the deficit in the services and income accounts. As a result, the current account is expected to remain in surplus albeit smaller at 1.3% of GDP from an estimated 1.6% of GDP in 2016.

Capital Flows and Ringgit Outlook

Outflow from risk-off stance. Rising global event risks meant that capital is likely to be on a risk-off mode, rebalancing towards less risky assets and location. Malaysia’s relatively more stable and resilient domestic economy may help stem some outflow, or at least cope with these outflows. However, capital flight and speculative pressures have translated into ringgit’s weak performance, indeed emerging as one of the worst performing currencies in the region. Volatility is expected to be the mainstay with USDMYR expected to trade within the 4.40-4.60 range in the near term.

Curbing offshore ringgit trade. BNM’s decision to stifle the offshore ringgit, particularly for non-deliverable forwards (NDF) – market along with the Financial Market Committee’s (FMC) move to expand Malaysia’s onshore ringgit market, further exacerbated the ringgit downside bias in the short term. While initial action has further reinforced downside bias on the ringgit, in the longer term, these measures may afford the BNM with greater control over its exchange rate levers, Its move to further oblige exporters to convert export proceeds will provide BNM with greater ammunition in stabilising exchange rate levels.

Further intervention on the cards? As part of its market development measures in expanding depth of the onshore ringgit market, FMC is expected to provide further build on the onshore ringgit framework (possibly laying the groundwork for a robust futures market) while continuing to clamp down on facilitation of the offshore ringgit market. However, given that NDF is effectively outside BNM’s jurisdiction, pockets of NDF transactions are likely to persist.

Volatile 1H17, Stable 2H17. Though it’s a cliché to say that the value of the ringgit would get worse before it gets better, that is what we believe it may have to endure in the next six to twelve months. For sure, we expect the ringgit would still be susceptible to further downward pressure judging by the Fed’s highly probable three 25 bps rate hikes this year and the lingering uncertainty in the global economy. Hence the expected USDMYR trading range of 4.40-4.60. Negative events will still cloud over investors’ sentiment as well as other factors such as People’s Bank of China’s recent intervention following a spike in offshore yuan, the upcoming court decision on Brexit and President-elect Trump’s ascent among others. On the expectation of diminishing negative sentiments and economic shocks along with a more stable economic environment on the back of better exports we expect the USDMYR to settle around 4.35 by end of the year.

Beyond 2017

At the crossroads. Despite resilient private consumption as a driver of growth, Malaysia’s recovery momentum hinges on further recovery of the global economy, particularly from its trading partners. Global event risks may also exert significant influence on Malaysia’s recovery momentum. Weak consumer and business sentiments likewise puts to question the sustainability of private consumption as the primary growth driver. A more convincing growth catalyst will be required to push Malaysia to the upper end of the Ministry of Finance’s 4.0-5.0% growth estimates.

Source: Kenanga Research - 9 Jan 2017