• Brighter outlook amid lingering caution. BNM notes that Malaysia is likely to enjoy a more upbeat outlook though external and domestic headwinds that were prevalent in 2016 are likely to weigh in during 2017. GDP growth is expected to see an uptick at 4.3-4.8% from 4.2% in 2016.
• Private consumption driver. The private sector is expected to remain resilient, driving growth. Public sector consumption is expected to be muted from the government’s fiscal consolidation efforts but overall, public expenditure is expected to contribute positively to growth from a 1.5% expansion of public investments.
• External demand to provide support to growth. With the global economy set to improve overall in 2017, the external sector is expected to lend greater support to growth, contributing 0.4 percentage points (ppt) to overall growth. However, current account surplus is expected to narrow somewhat to 1.0-2.0% of GNI in 2017 (2016: 2.1%)
• Cost-driven inflation but inflation manageable overall. Inflation is likely trend higher at around 3.0-4.0% in 2017 (2016: 2.1%) largely from pass through effect of higher crude oil prices. However, its impact on broader inflation trend is manageable as domestic demand conditions remain stable.
• Policy focus: sustaining growth and maintaining price stability. As with the previous years, BNM reiterated its stance of balancing between maintaining Malaysia’s recovery narrative while monitoring and, if required, managing higher inflation. Additionally, in view of recent (but receding) volatility in capital flows. This would suggest that BNM maintains its accommodative monetary policy stance and the OPR likely to remain at 3.00% barring re-emergence of external shocks

Upbeat outlook tempered by caution. The 2016 BNM annual report kicks off with a relatively more optimistic outlook to the previous year. However, the report retains a cautious tone, warning of downside risks arising from global events, particularly among the major economies. Furthermore, lingering domestic risks (higher cost of living, weak sentiments, among others) may also weigh against Malaysia’s recovery. In consideration of these risk factors, BNM expects Malaysia’s GDP to expand by 4.3-4.8% in 2017, substantially narrower than the 4.0-5.0% band projected by the Ministry of Finance but above the projected 2016 growth of 4.2%.

Sustained private consumption amid cautious sentiments. BNM sees continued resilience of private consumption in 2017, growing by 6.0%, supported by increases in disposable income from higher wages and pro-growth Government measures (such as BR1M transfer payments, tax relief to low-income tax payers, the optional 3% reduction in employees’ statutory EPF contribution and other special assistance). Private investment will be tempered by more cautious business and consumer sentiments though it will maintain a modest 4.1% growth (2016: 4.4%) from implementation of projects, particularly in the manufacturing (largely from export-oriented industries, such as the E&E subsector) and the service sector (mainly from capacity expansion in domestic oriented industries such as the telco and real estate subsector).

Positive public sector contribution amidst fiscal consolidation. In contrast, public consumption is expected to see a marginal contraction of 0.2% for 2017 as the Government is expected to maintain its fiscal consolidation efforts. Overall, however, the public sector is projected to see net contribution to headline growth figures with an estimated 1.5% expansion of public investments from higher Government and public sector capital expenditure, reflecting implementation of key infrastructure projects in various sectors including utilities and transportations and downstream oil and gas sectors.

Soft labour market. Despite expansionary overtones, BNM expects somewhat tepid labour market conditions moving into 2017 largely from new entrants to the labour force outpacing job creation. This will push unemployment rates higher at approximately 3.6-3.8% though wage growth will continue to expand moderately backed by domestic and external demand. In line with BNM’s narratives on private investment, wage growth is expected to be more prominent in export-oriented manufacturing industries and domesticoriented service sector.

Domestic demand sustained; external demand strengthened. Overall, growth will be supported by a blend of sustained domestic demand (forecasted at 4.4% similar to 2016 preliminary outcome) and improved external sector demand (net exports growing by 5.3% compared to 1.8% contraction in 2016). Combined, domestic demand is expected to contribute to 4.0 ppt to growth with a further 0.4 ppt estimated to come from net exports.

Slight contraction in current account surpluses. However, notwithstanding stronger growth contribution from the external sector, the current account surplus is expected to narrow somewhat (though likely to remain in surplus). BNM expects current account surplus to decline to RM17.4b in 2017 (2016: RM25.2b). BNM attributes the divergence between the positive contribution from net exports and narrower current account surpluses to recovering domestic demand which will likely see imports rising at a faster rate than exports. Continued surplus will be driven by gradual improvements in external demand and higher commodity prices though this is counterbalanced by a corresponding increase in imports from improved domestic and export demand.

Broad based expansion albeit moderating somewhat. Growth is expected to remain broad-based across all sectors (including the previously contracting agricultural sector) though BNM expects some slight moderation in the services and manufacturing sectors with annual growth of 4.9% and 4.3% respectively (2016: 5.6% and 4.4% respectively). Moderation in the services sector is likely to come from a more subdued finance and insurance sector, in tandem with restrained loan growth. However, consumption-related services (retail trade, food and beverages, among others) will help carry service sector expansion. The manufacturing sector expansion, meanwhile, will largely be driven by export-oriented industries, such as the electrical and electronic subsector (E&E), riding on the recovery of global demand.

Narrow output gap. The output gap is expected to remain negligible in 2017 with potential output expanding around 4.5-5.0% (2016: 4.8%) relative to forecasted real output growth of 4.3%-4.8%. The narrow output gap is reflective of manageable price pressure as demand-driven inflation remains benign. Labour force expansion will be instrumental to 2017s growth narrative while sustained capital accumulation will help provide additional support to growth.

Cost-driven outflanked demand-driven inflation. BNM expects inflation to average between 3.0-4.0% in 2017, a significant step up from 2.1% in 2016. However, inflation is primarily driven by pass-through impact of higher oil prices (in tandem with lowbase effect) and, to a lesser extent, an uptick in commodity prices. However, this is likely to have a limited impact on underlying inflation, which is only expected to see a modest increase in the absence of a convincing uptick in demand. Nevertheless, BNM warns of some upside to inflation in the event of an above-average increase in oil prices, a sharper depreciation in the ringgit with larger pass-through impact on domestic prices and relative strength of growth in Malaysia and its trading partners.

Managing the balance of growth and price stability. As with the previous year, BNM emphasised that its dual objectives, on ensuring sustainable growth and stable inflation, will help guide monetary policy. The cost-driven nature of prevailing headline inflation suggests that it is unlikely to influence monetary policy as long as its impact on broader price trends remain contained. However, BNM notes that monetary policy will also be guided by its mandate to manage financial imbalances from volatility in capital flows. This would suggest that BNM maintains its accommodative monetary policy stance and the OPR likely to remain at 3.00% barring re-emergence of external shocks.

Household debt rein in, for now. BNM’s effort to curb the alarming rise in household borrowing has finally bore fruits. Last year, for the first time in many years the upward trend of household debt has reversed. Its ratio to GDP has lowered slightly to 88.4% from 89.1% in 2015. It is partly the result of the slowdown in economic growth as well as the banking sector’s stricter rules and requirements for borrowing. Other than home purchases for own occupation (which account for the bulk of household debt at 62.6% share) households have generally scaled back in line with loan affordability

CONCLUSION

House outlook within BNM projections. Our 2017 forecast of 4.5% growth sits roughly in the midpoint of BNM’s growth range of 4.3-5.1%. BNM’s forecast was substantially more bullish on net exports, projecting a 0.4 ppt contribution of net exports to headline growth compared to our estimated net export contribution of 0.1 ppt. However, our forecast assumes a more bullish private expenditure push with a 3.5 ppts and 0.8 ppt contribution from private consumption and private investment respectively compared to BNM’s forecast for 3.2 ppts and 0.7 ppt contribution respectively. Our forecast also places a mild contribution from public sector consumption from expectation of a stronger fiscal push ahead of a likely election year; BNM expects public sector consumption to see marginal deterioration instead.

Gradual shift in monetary policy bias? The prospect of Malaysia’s economic growth, barring unforeseen shocks, appears to have improved. This may compel us to believe that it could be a start of a gradual shift of monetary policy bias to slightly tightening from the current neutral standing. That shift, however, may only happen provided the perception of political risk subsides along with the reversion of the ringgit towards its fair value. For now, we reiterate our viewpoint that BNM would retain the OPR at 3.00% at least in the 1H17 in the absence of any deterioration to growth amid cost-push inflationary uptrend. The possibility of a highly-anticipated General Election in the second half of the year would also add to the likelihood that rates would remain unchanged. That being said, we believe the OPR is both accommodative of growth while sufficient in keeping inflation in check.

Source: Kenanga Research - 24 Mar 2017