? Production data suggests upside to GDP forecast. Monthly production and auxiliary data confirms the continued strength of Malaysia’s growth trajectory. This data may indicate some upside to 2Q17’s GDP growth to approximately 5.6% (1Q17: 5.6%) from our base case forecast of 5.4%.

? Services sector to remain key growth driver.Stronger numbers from both retail and wholesale trade suggests that the service sector may expand at a faster clip of 6.0% (1Q17: 5.8%) than our base case estimate of 5.7%. Indeed, this supports the narrative of stronger private consumption growth.

? Robust manufacturing sector. Strong 2Q17 growth in the manufacturing production index points to sustained manufacturing sector growth of 5.6% (1Q17: 5.6%) against our base case forecast of 5.1%, This upside will be driven by stronger E&E production, supported by the F&B sector and the petrochemical sector.

? Mining sector dampener. However, notwithstanding our more bullish outlook on manufacturing and services, mining data points to a mild deterioration in the sector’s growth. These statistics suggest that the mining sector may contract by 0.7% (1Q17: +1.6%), in contrast with our base case estimates calling for a 1.9% expansion.

? Growth likely to taper in 2H17. Despite the possible upside to 2Q17’s GDP figures, we believe that it may be premature to revise our prior growth trajectory for 2H17. We continue to see growth tapering in 2H17 pending signs that confirms manufacturing and service sector strength moving into the second half. On the contrary, we believe that the mining sector will continue to weigh against growth in 2H17. Our full year GDP growth forecast remains at 5.2%.

Possible upside to forecast. Monthly production data and other auxiliary datasets point towards continued strength in Malaysia’s 2Q17 GDP numbers. While we retain our forecast of 5.4% growth in 2Q17 (1Q17: 5.6%; 2016: 4.2%), we believe that the monthly data suggests significant upside to the forecast, translating to a higher average growth rate of 5.6% instead. This is largely grounded on stronger performance in the services sector and sustained manufacturing sector growth.

Vibrant services sector. The services sector appears poised to see relatively stronger performance in 2Q17. Our “upside scenario” estimates for the services sector at a slightly faster clip of 6.0% (1Q17: 5.8%), relative to our base case estimate of 5.7%. Stronger services would translate into a 3.2 percentage points (ppts) contribution to headline growth (1Q17: 3.1 ppts) compared to our base case contribution of 3.1 ppts.

… driven by strong private spending. Faster services sector growth will be largely driven by continued strength in retail trade and wholesale trade, which may see an upside to growth at 11.3% and 6.4% respectively (1Q17: 7.9% and 5.6%). This compares with our base case forecast of 7.5% and 6.3% for retail trade and wholesale trade respectively. A more bullish tilt on the retail and wholesale trade comes as both the distributive trade index of retail trade and wholesale trade came in at a stronger 8.7% and 13.5% for 2Q17 (1Q17: 8.4% and 10.1%). These figures also support the narrative of a stronger private consumption growth, possibly sustained going into 2H17.

Manufacturing sector growth likely robust. Statistics from 2Q17’s index of industrial production suggests that the manufacturing sector growth rate may match or edge slightly higher relative to 1Q17. While our base case projection places manufacturing GDP growth at a modest but slightly tapering 5.1% (1Q17: 5.6%), manufacturing production expanded at a slightly faster clip of 6.2% during the quarter (1Q17: 5.6%). This may translate into a stable 2Q17 manufacturing sector growth of 5.6%, contributing 1.3 ppts to headline GDP growth (1Q17: 1.3 ppts). This upside will likely be driven by continued strong growth of the electrical and electronic (E&E) segment with additional support from the “petroleum, chemical, rubber and plastic products” subsector and the “food processing” subsector.

…but mining sector downside likely. However, despite the rosier outlook in the manufacturing sector, mining sector outlook is likely to be biased on the downside. While our initial base case estimate placed mining sector expansion at 1.9% for the quarter (1Q17 1.6%), persistent weakness in the mining production index suggests that the mining sector may be headed to a mild 0.7% deterioration instead. The mining production index was dogged by weaker oil production, particularly during April to May, largely due to Malaysia’s participation in OPEC’s oil production cut. This, along with slower expansion in the natural gas index, suggests that the mining sector will be a drag to growth, shaving off around 0.1 percentage point off headline GDP growth.

Broad-based growth elsewhere. With the exception of a possible downside to the mining sector, growth will be mostly broad-based. Our projection on the agriculture sector remains relatively high at around 7.0%, tapering slightly from 1Q17’s 8.3% on account of moderating palm oil and rubber production growth. We see some possible upside from the construction sector as well given the slight uptick in civil engineering construction work and non-residential construction works during the quarter, notwithstanding slower residential construction during the quarter. Combined, both agriculture and construction sector may contribute around 0.8-0.9 ppt to headline GDP growth (1Q17: 0.9 ppt).

A positive upside possibility. Following all the preceding arguments and supportive empirical evidence there is a reason to expect a positive surprise to the 2Q17 GDP growth to be announced by the Department of Statistics this Friday (18th Aug). Assuming 0.1-0.2 ppt contribution from import duties, our upside scenario puts 2Q17 GDP growth at an average of 5.6%. This compares to our base case forecast of 5.4% and Bloomberg’s consensus estimates of 5.4% (ranging from 4.9-6.0%).

Reiterate narrative of tapering growth. Notwithstanding these upsides, we reiterate our view that growth is likely to taper in 2H17. Our 3Q17 and 4Q17 remains at 5.2% and 4.8% respectively, in absence of convincing signs that manufacturing and services sector strength will persist. At present, survey of sentiments are somewhat mixed with Markit PMI suggesting a downturn in the near term. Furthermore, with mining production expected to remain on the downside relative to our base case forecast (the OPEC voluntary production cut is expected to persist to March 2018.), the deterioration in the mining sector may serve as a dampener to GDP growth moving into 2H17. Assuming that the 2Q17 GDP growth came in higher than our estimate or 5.6% and we maintain our 2H17 growth trajectory the upside to the whole year growth is relatively marginal at 0.1 ppt. Hence, for now we maintain our 2017 GDP forecast at 5.2%.

Source: Kenanga Research - 17 Aug 2017