OVERVIEW

Optimistic April PMI reading. The Nikkei Malaysia Manufacturing Purchasing Managers’ Index (PMI) broke the 50.0 mark at 50.7 points (Feb: 49.5). This was the first time PMI broke the 50.0 point threshold since March 2015, suggesting a turning point for business sentiments as Malaysia’s economy picks up pace.

Output and new orders driver. The above-50 reading of April was largely attributed to the improvements in the output and new orders sub-index. The output sub-index extended its strength for the third consecutive month while new orders rose for the first time in twenty five months, indicating higher output growth in the coming months.

Flattish employment and cost pressures persist. Extending the previous months’ theme, the employment sub-index remained staid overall while panellists continue to report increasing input prices from depreciating currencies. Similar to the previous month, firms appear to favour margin protection, passing on these increased costs to clients.

Administrative obstacles an impediment? Separately, some panellists note some issues in the recruitment of foreign workers as an impediment in boosting employment. Others point to difficulties in custom clearance, in turn affecting supplier delivery times.

Higher than expected upside from exports. Improved new export orders and higher export growth, suggesting substantial upsides from external demand driving overall growth. Along with a sharp turnaround in palm oil output, we believe that this justifies an upward revision of our GDP growth forecast to 4.8% for 1Q17 (previous: 4.4%), culminating in a 4.8% full year growth for 2017 (previous: 4.5%).

Fresh optimism in April. Malaysia’s manufacturing PMI saw a sharp improvement and the first above-50 reading since March 2015 with a headline reading of 50.7 points (Mar: 49.7). The PMI has recorded sub-50 reading for 24 consecutive months prior to April. The optimism implied by the PMI was largely driven by improvements in the output and new orders.

Output volume sustained strength. The output sub-index continued to rise for the third consecutive month, albeit at a relatively modest scale. Improvements in output sub-index were credited to a combination of new project start-ups and new orders (as implied by the new orders sub-index).

New orders trickling in. The new order index rose for the first time in 25 months, attributed largely to growth in new export orders. This, however, was contrasted by the continuously anaemic orders from domestic businesses. Overall, however, output volume continues to outpace the increase in new orders. The interplay of these factors led to an overall reduction in the

backlog of outstanding work – indeed, backlog fell for the first time in 2017. All this indicates a further improvement to growth in the coming months.

Employment remains flattish. Employment figures remain largely unchanged compared to the previous month. This is especially so given output levels outpacing new orders along with the accompanying fall in the number of backlog work. Firms also pointed to issues in recruiting foreign workers. It is uncertain if these issues will lead to a material substitution of foreign labour with that of the domestic labour force.

Ringgit depreciation and red tape a drag on costs. Once again, the depreciating ringgit led to an increase in prices of raw materials, hence pushing up the average input prices. Similar to that of the previous month, manufacturers have opted to pass on these costs downstream, driving up the overall average output costs. However, given the improvements on new orders relative to the previous month – particularly from abroad – manufacturers may enjoy greater leeway for manoeuvre between costs rationalisation and margin protection. Additionally, firms have also reported deterioration in suppliers delivery speed – some of these firms commented that this was partially attributed to delays in obtaining Customs clearance.

Mixed PMI across the region. The ASEAN PMI will not be released before this Friday as data for some of the ASEAN economies continue to trickle in, most notably from that of Vietnam, Singapore and Myanmar. Among ASEAN economies with released PMI data, Thailand reported a marginal drop into a sub-50 reading at 49.8 (Mar: 50.2) while PMI for Indonesia and the Philippines remained above the threshold at 51.2 and 53.3 respectively (Mar: 50.5 and 53.8 respectively). Elsewhere, the global PMI fell slightly to 52.8 compared to March’s 70-month high of 53.0. PMI growth in the US moderated for the second consecutive month at 52.8 (Mar: 53.3) though the levels remain consistent with healthy manufacturing sector growth. Growth in the Euro Area, meanwhile, sped up to 56.8 (Mar: 56.2) to a 72 month high. Elsewhere in Asia, China’s PMI remained barely above the threshold at 50.3 (Mar: 51.2).

OUTLOOK

Confirmation of growth. The addition of the above-50 PMI levels signals above-expected growth that we have been observing from higher IPI growth (Feb: 4.7%) and export growth (Feb: 26.5%). This, along with the overall improvements in our regional peers in Southeast Asia and Asia alike, justifies a more aggressive growth target for 1Q17 from our former 4.4% growth forecast. The uptick in both the output and new orders sub-index (mainly on exports) suggests a resurgent economy, especially given the prolonged sub-50 reading. Coupled with the sharp rebound in palm oil production we are revising our 1Q17 GDP estimate to 4.8%.

Cost issues to plateau. While panellists continue to report adverse currency movements as a persistent issue in driving up input costs and by extension, average output price, we note that these adverse currency movements have since moderated. In fact, the trend has somewhat reversed towards

the end of April, as the ringgit steadily appreciates, particularly against the US Dollar. This, along with the recovery in commodity prices, further suggests that rising input costs may not just be symptomatic of the weaker ringgit weighing in but instead reflective of an overall improvement in global demand that tend to be preceded by a commodity uptick.

Burgeoning demand impetus for inflation? As a corollary to the improved global demand recovery, we are observing if this could translate into higher demand push inflation, hence prompting BNM to exercise its tightening bias. For now, core inflation figures have appeared to be subdued overall at 2.5% and as such, we do not see any immediate need for BNM to raise the OPR above the prevailing 3.00%. Furthermore, the PMI presently suggests that domestic new orders remain weak overall. We believe that multi-period reading of above-50 may serve as an early signal of budding demand pull inflation, hence strengthening BNM’s case for a rate hike. At present, however, a 3.00% OPR is supportive of present levels of demand and yet, sufficient in managing inflation.

Source: Kenanga Research - 3 May 2017