• Growth accelerates, beating estimates. Gross Domestic Product (GDP growth for 2Q17 accelerated to 5.8% (1Q17: 5.6%), surpassing both the house and Bloomberg’s median consensus estimates of 5.4%. While growth in domestic demand moderated somewhat during 2Q17, strong performance in the external sector propped the headline GDP.
• Domestic demand moderating somewhat. Domestic demand continued to see modest growth, albeit at a slower clip of 5.7% (1Q17: 7.7%) as both public and private expenditure saw slower growth during the period. Combined, domestic demand provided a 5.3 percentage points (ppts) to headline growth (1Q17: 7.0 ppts).
• Broad-based sectoral growth. On the supply side, most sectors continued to see broad-based growth, led by the services sector. The manufacturing, services and construction sectors, in particular, saw faster growth relative to 1Q17 while the agriculture and mining sector saw slower growth, though mining sector growth was just enough to avoid contraction.
• Downside risks present despite better growth. Despite better-than-expected growth in 2Q17, moderation in domestic demand, the relatively low GDP growth post-seasonal adjustment and weak (albeit improving) consumer sentiments points to the possibility of Malaysia approaching a downturn. We remain confident with Malaysia’s fundamentals overall and revise our full year growth upwards slightly to 5.3% from 5.2% previously.
• Monetary policy stance likely to remain neutral. Bank Negara’s commentary suggests that it is overall positive on the economy while recognising some risks for slower growth in domestic demand. With no immediate threat to underlying inflation, we believe that Bank Negara will err on the conservative side and maintain a neutral monetary policy stance with OPR remaining at 3.00% for the rest of the year.

GDP growth surpasses estimates. Real GDP growth expanded by a faster clip of 5.8% YoY in 2Q17 beating Bloomberg’s median consensus and the house estimates, both projecting a 5.4% growth. 2Q17’s numbers sit comfortably at the upper end of the 4.9-6.0% range of estimates compiled by Bloomberg. These numbers were consistent with signs of growth upsides, hinted by stronger monthly production and retail numbers, suggesting a continuation of the cyclical upturn that we have posited during our prior report. This brings 1H17’s growth numbers to a stronger 5.7% (2H16: 4.4%). On a QoQ basis, GDP grew by a modest 2.5% (1Q17: -3.6%), an uptrend typical of the second quarter. Post-seasonal adjustment, GDP expanded by a more moderate 1.3% QoQ (1Q17: 1.8%).

Moderation in domestic demand components. Higher headline GDP growth belies a slightly weaker growth in domestic demand. While domestic demand remains the key driver of growth, both public and private expenditure clocked a slower growth rate after a sharp growth uptick during 1Q17. However, stronger net export numbers and slower drawdown in inventories were more than sufficient to pick up the slack from weaker domestic demand growth. On a growth contribution basis, domestic demand contributed 5.3 ppts to headline GDP growth (1Q17: 7.0 ppts).

Private sector growth sustained. Private consumption expanded at a slightly faster rate of 7.1% (1Q17: 6.6%), buoyed by higher consumption in food and non-alcoholic beverages, communication and restaurant and hotel components. However, slower growth in private sector investments of 7.4% (1Q17: 12.9%) resulted in overall private sector expenditure growth to moderate to 7.2% (1Q17: 8.2%). Notwithstanding the growth moderation in private expenditure, it is worth noting that at 7.2%, private expenditure growth remained elevated relative to the 4.4-6.0% growth clocked between 2Q15 to 4Q16. Overall, private sector growth contributed a combined 5.3 ppts (2Q17: 5.9 ppts) to headline growth, comprising a 3.8 ppts and 1.5 ppts contribution from private consumption and investments respectively (1Q17: 3.6 ppts and 2.3 ppts respectively).

Public expenditure flattish. After a stellar 1Q17, public expenditure was somewhat flat with a 0.2% growth (1Q17: 5.8%) as public consumption grew by a slower clip while public investments trended lower. Public consumption grew at a sharply lower 3.3% (1Q17: 7.5%) on account of lower expenditure on emoluments and, supplies and services. However, gross

capital formation by the public sector shrank by 5.0% (1Q17: +3.2%). The lower public investments effectively mitigated the growth in public consumption, resulting in a negligible contribution of the public sector to headline GDP growth.

Slower inventory drawdown. Lower inventory drawdown in 2Q17 (1Q17 saw inventory accumulation instead), relative to 2Q16, contributed to a modest 0.4 ppts growth to headline GDP (1Q17: -0.2 ppts). This led to a 5.7% expansion in domestic demand sans inventories, or 6.2% expansion with inventories (1Q17: 7.7% and 7.4% respectively).

External sector upside. Growth in imports and exports remained elevated by historical standards, consistent with general trends in external trade statistics during April to May. While import growth continued to outpace export growth, import growth moderated significantly relative to exports. Exports and imports grew by 9.6% and 10.7% respectively (1Q17: 9.8% and 12.9% respectively). This led to net exports contributing to a mild 0.1 ppts to headline growth (1Q17: -1.2 ppts contribution). These numbers confirm our prior suspicion that the external sector would play a greater role for headline growth in 2017.

Continued broad-based growth led by services. By economic sectors, growth remained broad-based overall though some economic sectors saw growth tapering somewhat. As with the previous quarters, growth was largely driven by the strengthening services sector. The services sector expanded by 6.3% (1Q17: 5.8%), largely driven by robust growth in retail trade (2Q17: 11.4%; 1Q17: 7.8%) and communications (2Q17: 8.5%; 1Q17: 8.2%), along with some support from wholesale trade (2Q17: 6.0%; 1Q17: 5.5%) and government services (2Q17: 4.5%; 1Q17: 5.1%). Improved retail and wholesale numbers are consistent with stronger numbers from the distributive trade indices during the quarter while the stronger communications subsector was spurred by augmented activities for data communication, computer services and information services. Combined, these sectors contributed 2.0 ppts to headline GDP with the services sector, as a whole, contributing 3.4 ppts to GDP (1Q17: 3.1 ppts). However, post-seasonal adjustment, the sector’s growth moderated somewhat to 1.5% QoQ (1Q17: 1.8%).

E&E sector continues to lead growth. Manufacturing sector growth remained robust with a 6.0% growth during the quarter (1Q17: 5.6%). Manufacturing sector growth largely lent its strength from stronger expansion in the electrical and electronic (E&E) subsector during the quarter, along with support from sustained growth in the food and beverage processing (FB) subsector and petroleum, chemical and rubber and plastic product (PC) subsector. The E&E sector expanded by a strong 9.8% (1Q17: 7.9%) while the F&B and PC subsectors expanded by 10.4% and 3.0% respectively (1Q17: 8.2% and 3.1% respectively). These expansions were largely consistent with the stronger numbers in the manufacturing production index which expanded 6.2% during the quarter (1Q17: 5.6%). As a whole, the manufacturing sector contributed 1.4 ppts to headline GDP (1Q17: 1.3 ppts).

Agriculture sector growth moderates. Growth in the agriculture sector moderated significantly during the quarter. While agriculture sector growth remained modest at 5.9% (1Q17: 8.3%) by historical standards, elevated growth may be partially influenced by low base effect – on a seasonally adjusted basis, agriculture grew by a slower 0.9% QoQ (1Q17: 5.4%). The slowdown in the agriculture sector came as both rubber and palm oil sectors, the two major constituents of the agriculture sector, demonstrated slower (albeit still double-digit) growth at 17.0% and 12.1% respectively (1Q17: 23.5% and 17.7% respectively). Overall, agriculture sector added 0.5 ppts to headline GDP growth (1Q17: 0.6 ppts contribution).

Construction sector sees stronger expansion. The construction sector saw growth edging higher at 8.3% (1Q17: 6.5%). This is consistent with our observation of an uptick in civil engineering and non-residential construction works during the quarter. Civil engineering activities, in particular, sustained its double-digit growth at 14.9% (1Q17: 12.1%) largely from transportation and utilities-related projects. Stronger construction sector growth led to a stronger contribution of 0.4 ppts to headline GDP growth (1Q17: 0.3 ppts).

Mining growth sharply lower but avoids contraction. The mining sector GDP was practically flat with a marginal 0.2% growth (1Q17: 1.6%), though it avoided a contraction implied by the 0.6% decline in the mining production index during the quarter (1Q17: +1.2%). Nevertheless, the moderation in mining GDP growth was likewise attributed to decline in crude oil production and moderating growth in natural gas production, as implied by the mining production index, consistent with Malaysia’s voluntary participation in the Organization of Petroleum Exporting Countries production cut. Given marginal growth in the mining sector, its contribution to headline GDP was likewise negligible.

OUTLOOK

Recovery sustained but likely approaching a turning point. While 2Q17’s results stood at the higher end of the Bloomberg’s consensus estimates, we are cautious of nascent hints of moderation in the coming quarters. It is noteworthy that domestic demand, traditionally the most resilient driver of growth, slowed significantly during the period with growth in private expenditure likewise falling. Similarly, we note that the surprisingly higher 2Q17 numbers may belie the more moderate growth after seasonal adjustment. This would mean that the growth cycle may have peaked and the economy growth rate is expected to taper in the 2H17. As such, we project 3Q17 and 4Q17 growth at 5.2% and 4.7% respectively (from our previous estimate of 5.2% and 4.8% respectively). This would still bring 2H17 growth to a similar 5.0% though culminating in a healthy full year growth of 5.3%, a slight upward adjustment from our previous forecast of 5.2%, and a substantial gain from 4.2% recorded in 2016.

External sector support. Cognisant of the taper in the 2H17 growth forecast, we expect that the positive contribution to growth from the external sector may continue into 2H17 albeit on a moderating trend as we initially posited during our commentary of 1Q17 GDP. External trade remains vibrant despite moderating sharply in June. This may serve as a catalyst for sustaining manufacturing sector growth, translating into a more optimistic slant for 3Q17.

Awaiting more convincing growth narrative. In Bank Negara Malaysia’s (BNM) commentary of the second quarter economic performance, private sector spending helped anchor growth while public sector remained supportive of growth. It further noted improvements in labour market growth supporting growth and improving consumer sentiments indicators. However, it also noted that consumer sentiments remained below the optimism threshold. On price growth, it noted that while core inflation will be sustained by a more robust domestic demand, “underlying inflation is expected to remain contained”. As such, we continue to believe that in the absence of threats to growth and higher core inflation, BNM will likely default to maintaining a neutral monetary policy stance with a mild tightening bias, sufficient to justify holding the OPR at the prevailing 3.00% for the rest of 2017.

Source: Kenanga Research - 21 Aug 2017