• PMI still pessimistic. The Nikkei Malaysia Manufacturing Purchasing Managers’ Index (PMI) remained under the 50.0 threshold with a reading of 48.3 in July though the deterioration was significantly slower than June’s 46.9 PMI reading.
• Weak demand weighed against output and new orders. Weaker demand, particularly from domestic markets, weighed against both new orders and output. This, in turn, led to faster completion of work backlog, hence lower stock of purchases and finished goods.
• Continued optimism of long term prospects. While respondents were cautious on short term prospects, their long term outlook remained positive, resulting in a small uptick in the employment sub-index.
• Cost pressures dissipating but still present. Respondents pointed to lower input price inflation, hence resulting in a lower increase in output prices. However, respondents also noted that the weaker exchange rates and rising raw material prices continued to be a factor.
• Tapering in the manufacturing sector. July’s PMI reading is consistent with our overall view that manufacturing sector growth may well be tapering from its 1Q17 highs. However, our view is a touch more optimistic with regards to the support from Malaysia’s resilient E&E industry, along with relatively stable external demand.

A slower deterioration. Malaysia’s manufacturing PMI stood at 48.3 in July, after falling to 46.9 in June. June’s PMI was its lowest point since the inception of the series’ fiveyear history. However, July’s results extend Malaysia’s streak below the sub-50 threshold for the third consecutive month since May. July’s result was also just a touch lower than the average PMI reading of 48.8/49.0 for 2Q17/1H17.

Output declines at a slower pace. As with the previous month output continued to register deteriorations relative to June, the third consecutive decline of these sub-indices. However, Markit notes that the pace of deterioration in output was slower than that of June, though the slowdown was still significant.

Weak domestic demand weighing against new orders. New orders were likewise weaker, weighed down by poor market demand, particularly in the domestic market. Markit reported that foreign sales were largely unchanged in July. However, poor new orders were a drag against many of the sub-indices, particularly the stocks of purchases.

Purchasing activity a victim of tepid new orders. Continued weakness in new orders saw firms shift gears towards the completion of unfinished work, hence reducing overall work backlog. Indeed, the reduction in backlog was the highest in record since the series inception five years ago. At the same time, this led to a reduction in purchasing activity for the third month running. Combined with the relatively bleak prospects on demand, stock of both purchases and finished goods declined in July.

Negative in the short term; positive long term. Despite the relatively bleak assessment of the prevailing manufacturing situation, manufacturers continue to exhibit optimism over the future longer-term prospects of the sector, translating into a mild bump in employment numbers, after a flattish employment index in June. Respondents anticipated improved production over the coming 12 months despite being more pessimistic on near term prospects.

Falling cost pressures but inflation remains a concern. Cost pressures remain a concern among respondents as they cited continued weaknesses in exchange rates and rising raw material prices continue to weigh against them. However, respondents also noted that inflation has receded for the fifth successive month to its lowest levels since October 2016. Combined, this flowed down to dearer output prices, albeit at its weakest rate in 2017. On the exchange rate, the ringgit plateaued against the USD in July after running off an appreciating trend for six consecutive months since January. The ringgit averaged MYR4.290/USD in July (June: MYR4.277/USD), appreciating from MYR4.461/USD in December 2016.

ASEAN PMI falls below the threshold. Regionally, Malaysia is among the worst performer among the seven countries covered by the Nikkei ASEAN Manufacturing PMI. The ASEAN PMI declined to 49.3 after teetering at the 50.0 threshold in June. This was its lowest PMI reading in 9 months and its first sub-50 reading since 2017. Singapore was the worst performer with a preliminary reading of 47.9 (Jul: 50.7). Overall, five out of the seven ASEAN economies covered reported sub-50 reading including Indonesia (48.6), Myanmar (49.1) and Thailand (49.6). Only Philippines (52.8) and Vietnam (51.7) reported reading above 50.0, albeit at a slower rate relative to June. Declines in the regional index were sparked by a fall in new orders and output though unlike Malaysia, these declines weighed against employment.

Global outlook remains upbeat. Beyond ASEAN, the global PMI was slightly higher at 52.7 (Jun: 52.6) as the slowdown in output growth was compensated by expansion in new orders. Major economies, meanwhile, were likewise upbeat with many of these major economies reporting above-50 PMI reading including Eurozone (Jul: 56.8; Jun: 57.4), the United States (Jul: 53.2; Jun: 52.0), China (Jul: 51.1; Jun: 50.4) and Japan (Jul: 52.1; Jun: 52.4). This retains the prevailing narrative for synchronous global growth, despite the disparity between PMI in these major economies and that of ASEAN.

OUTLOOK

Confirms tapering from 1Q17 highs. July’s PMI continues the narrative that manufacturing growth may well be tapering from its highs in 1Q17. Manufacturing IPI growth stood at 5.6%, its highest for the eighth consecutive quarters since 1Q15. While 2Q17 IPI growth is expected to remain above the 5.0% mark, we expect growth to be significantly more moderate than that of 1Q17, in turn, resulting in a modest dialling back in the headline GDP numbers. Reflecting a more subdued manufacturing growth trend, our projection for 2Q17 GDP remains at 5.4% (1Q17: 5.6%).

Overstated pessimism? While we share PMI’s finding of a weaker manufacturing sector relative to the beginning of the year (after hitting its 26-month peak of 50.7 in April), we are significantly more positive on the overall outlook of the manufacturing IPI. Indeed, despite PMI falling below the 50.0 mark in May at 48.7, we note that manufacturing IPI instead grew at its fastest rate in 29 months at 7.2% in May, driven by a resilient electrical and electronic (E&E) sector with further broad based support from other major manufacturing sectors including “food and beverages

(F&B)” sector and “petroleum, chemical, rubber and plastic (P&C)” sector being two of the standouts. In the absence of any immediate downturn to these sectors, we believe that any moderation to the manufacturing sector will likely be modest.

Possible rocky patch for global growth. Continued positive global outlook is certainly a bright spot especially given the continued resilience of external demand (poor new orders were largely a function of weak domestic, rather than external demand). However, with global growth possibly taking a breather as Central Banks in major economies begin their tightening cycle, we expect support from synchronous growth to stutter somewhat, though the timing of these major Central Banks’ tightening moves will be of essence. For now, we do not expect ECB to tighten before the end of 2017 while Japan is likewise less likely to end its ultra-loose monetary policy by this year. While the Fed has indicated three rate hikes for 2017, with inflation remaining soft, we believe that the third rate hike may at the very least be postponed to December. This will provide some additional leeway for synchronous global growth to lift ASEAN and, by extension, Malaysia.

Possible return in cost pressures. With raw material prices reported as among the two key sources of rising input prices (alongside ringgit value), we believe that recent increase in oil prices – partly from sanctions against Venezuela – may emerge as a catalyst for higher input costs though on the balance, we believe that the recent rally in oil prices is likely to be transitory, especially once US shale producers ramp up production. It is worth noting that even with Brent at just above USD52/barrel, it remains below its recent peak of around USD54/barrel late-January to early March. On the balance, with price stickiness, we believe that the (likely) transitory oil spike will result in minimal cost pressures, in the absence of long term deterioration in oil supply chains.

Source: Kenanga Research - 2 Aug 2017