OVERVIEW

• Transitory August recovery. Malaysia’s Manufacturing Purchasing Mangers’ Index (PMI) dipped back to slightly below the 50.0 neutral threshold in September to 49.9 after August’s 50.4 reading.
• Weak new orders a drag on the index. New orders remained weak with declines observed for both domestic and export demand. However, despite weak new orders, output growth continued to rise, albeit at a slower pace from August. With new orders remaining weak overall, purchasing activity declined, along with stock of purchases and finished goods.
• Still optimistic on longer-term prospects. Despite weak new orders and the more modest increase in new orders, respondents were overall confident on the 12-month outlook, likely prompting manufacturers to raise employment. Respondents also pencilled in improvements in demand moving forward, prompting some planned expansions.
• Input and output prices rise again. Input price growth rose by a weaker pace in August, both input and output prices quickened to its fastest pace since May on a general increase in prices for raw materials.
• In search for domestic demand. September’s readings confirm our narrative of lacklustre domestic demand weighing against the case for sustained manufacturing sector growth. Indeed, with September’s weak export orders ultimately tilting the PMI to a mild contraction, we see a relatively precarious growth outlook for Malaysia with growth projected to taper off to 5.3% for 3Q17 after a strong 5.8% expansion in 2Q17.

Teetering on pessimism. Malaysia’s manufacturing PMI dipped below the 50.0 threshold at 49.9 from 50.4 in August. It stood above the 50.0 neutral threshold in August for the first time after three consecutive months of sub-50 reading prior. While the 49.9 reading suggests that business conditions are largely unchanged, September’s readings represent a disappointing retreat after August’s prior optimism. However, September’s numbers brings the 3Q17 average reading to 49.5 (2Q17: 48.8), its highest since 1Q15.

New orders weaken further. New orders continued to be a disappointment, particularly for domestic demand. Export orders likewise fell after expanding during August (from demand in China, Southeast Asia and Middle East). Respondents suggest that this may be due to weak underlying demand; the respondents also noted poor sales volume elsewhere in the report.

Manufacturing output up. Continued growth in manufacturing output, albeit at a slower rate from August’s 6-month high, likely softened the blow on September’s headline PMI.

Weak purchasing activity. However, ultimately, weak sales volume, and likely new orders, was an overall drag to purchasing activity hence subsequently lower stock of purchases. At the same time, respondents also reported continued decline in their stock of finished goods for the sixth consecutive month as they sought to streamline inventories.

Employment expands despite weak order books. Notwithstanding the disappointment in new orders, manufacturers boosted hiring, resulting in modest employment growth during the month. With ample labour resources, backlogs continued to decline for the fourth consecutive month. Declining backlog, in particular, was largely anticipated given the lack of new orders, despite flat to higher employment.

Price pressure intensifies. Input prices rose again, after easing to a 10-month low in August, on dearer raw material prices. With margin protection remaining the theme of respondents’ pricing strategies, selling prices was likewise raised further. Inflation on both inputs and output prices rose to the highest level since May.

Optimism remains. Respondents’ assessment on the coming 12 months remain rosy overall with expectations on coming improvement on market demand (translating into better new orders) prompting some of these respondents commenting on planned expansions.

Industrial production to expand 4.6%. With three quarters of the year passing, IHS Markit anticipates industrial production to expand by 4.6% for 2017 (2016: 3.8%). However, we note that the manufacturing PMI may not necessarily reflect overall industrial production (as measured by the industrial production index (IPI) published by the Department of Statistics) which includes a mining and electricity generation component (accounting for 34.1% of the headline IPI).

ASEAN PMI slightly less optimistic. The Nikkei ASEAN Manufacturing Purchasing Managers’ Index was recorded at 50.3 (Aug: 50.4), just a notch lower than the previous month. The marginal decline in the PMI came as just four out of seven ASEAN countries covered by Nikkei reported above-50 readings compared to five out of seven during the previous month. However, among countries with above-50 reading, these countries mostly reported a sharper upturn relative to August. These four countries include Vietnam (53.3), Philippines (50.8), Indonesia (50.4) and Thailand (50.3) while the remaining countries reporting sub-50 reading include Malaysia, Myanmar (49.4) and Singapore (48.6). This comes as both Singapore and Malaysia PMI deteriorated to a sub-50 growth while Thailand’s PMI improved. Improvements in the PMI largely came from both an improvement in new orders and output though buying activities, strangely, remained stagnant. This was likely sparked by the decline in business confidence, in particular the future output index.

Global outlook remains buoyant. Globally, the PMI was unchanged from August’s 75-month high of 53.2. This coincided with strong and sustained PMI readings among the advanced market economies (AME). The Eurozone sustained sharp PMI improvements with a reading of 58.2 (Aug: 57.4) while the US clocked a PMI of 53.0 (Aug: 52.8), pointing to further strength in the AME growth story. Back in Asia, both China and Japan likewise saw above-50 reading at 51.0 and 52.9 respectively (Aug: 51.6 and 52.2 respectively).

OUTLOOK

Precarious growth. Malaysia’s return to a sub-50 reading highlights the precarious growth mentioned in the previous PMI report especially as export orders retreat too. With September’s PMI report confirming weakness in domestic new orders, we remain overall cautious on manufacturing sector expansion moving into 3Q17. Our house forecast on 2017 manufacturing IPI growth is 5.7% (2016: 4.3%; 2Q17: 6.2%). This will likely translate to a 5.3% manufacturing GDP growth (2016: 4.4%; 2Q17: 5.9%). Overall, we expect this to play out as a relatively precarious growth trajectory for Malaysia with growth projected to taper off to 5.3% for 3Q17 after it jumped 5.8% in 2Q17, its highest since 1Q15..

Cost pressures likely to normalise but still elevated. While respondents are likely to see a squeeze from higher cost push factors along with flailing demand – as represented by falling new orders – we expect cost considerations to ease somewhat moving forward, in part from seasonal factors, hence placing a cap on cost growth. However, even if cost pressures eases, we are cautious if this will translate into any meaningful decline in output prices as margin protection remains a concern for manufacturers.

Slower external support. We are cautious if September’s decline in export orders represents a one-off moderation, given relatively strong PMI readings globally, and to an extent, regionally. However, we are cognisant of possible monetary tightening among the AMEs and some of the emerging market economies (EMEs); a more bullish outlook tends to lend support to policy tightening initiatives. As such, we reiterate our reservations on further external growth support to the region and by extension the Malaysia economy.

Source: Kenanga Research - 3 Oct 2017