OVERVIEW

• Remains optimistic. BNM retained an upbeat tone on its 2018 outlook for Malaysia’s economy on the expectation that a positive global macroeconomic backdrop will continue to create a favourable external and domestic demand condition. It forecast Malaysia’s GDP to expand by 5.5-6.0% in 2018 from 5.9% last year.
• ..amidst uncertainty. Looming trade war, the increasingly volatile financial markets, the normalisation of interest rates by major central banks and signs of weak commodity market, are some of the issues that continue to feed towards the rising uncertainty in the world economy.
• External spill over to boost domestic demand. BNM’s rationale is based on the expectation that external demand would support domestic economic activity, thereby lifting wages, improving consumer sentiments and boosting private consumption. Meanwhile, public expenditure is expected to moderate as the government resumes fiscal consolidation agenda after the general election.
• Sustained expansion across all sectors. Growth is expected to remain sustainable across all sectors, led by the manufacturing and services sectors. However, construction and mining sectors are expected to register stronger growth.
• Trade to remain supportive of the current account. While exports are expected to moderate, it is expected to remain favourable at 8.4% (2017:18.9%), and able to sustain a reasonable level of surplus in the current account.
• Output gap turns positive, inflationary pressure abates. While the output gap is expected to turn marginally positive in 2018, inflationary pressure is expected to abate with BNM projecting headline inflation to moderate in 2018.
• Monetary policy to lean towards sustaining growth trend. While recognising looming risks from synchronised monetary policy normalisation across major economies, BNM’s monetary policy bias is likely to remain accommodative.

Remains optimistic. BNM retained an upbeat tone in its newly published Annual Report 2017 on the expectation that a positive global macroeconomic backdrop will continue to create a favourable external and domestic demand condition. It forecast Malaysia’s GDP to expand by 5.5-6.0% in 2018 from 5.9% last year and an upgrade from MoF’s 5.0- 5.5% forecast last October. Kenanga’s GDP projection is 5.5% or at the lower end of BNM’s GDP forecast range, reflecting an optimistic but a cautious view given the growing uncertainty.

Amidst uncertainty. BNM’s growth forecast appears to take the view that Malaysia is relatively immune to the growing uncertainty that is happening in the world today. Looming trade war, the increasingly volatile financial markets, the normalisation of interest rates by major central banks, signs of weak commodity market, are some of the issues that we believe would continue to feed towards the rising uncertainty in the world economy and would weigh on growth.

External spill over to boost private expenditure. BNM expects private consumption to edge higher to 7.2% in 2018 (2017: 7.0%). In particular, BNM expects external demand to support domestic economic activity, thereby lifting wages and improving sentiments. Further lending support to private consumption are the continued government measures to increase household disposable income including BR1M cash transfers, special payments to civil servants and retirees and review of minimum wage. Meanwhile, BNM expect private investment growth to be sustainable at 9.1% (2017: 9.3%), supported by manufacturing and services sectors, particularly export-oriented industries. Of note is the mining industry which is expected to exert a lesser drag as commodity prices stabilises.

Fiscal consolidation agenda to resume. Public sector expenditure is projected to decline in 2018 by 0.9% (2017: +3.3%) as the government is expected to resume its fiscal consolidation efforts after the general election which is mainly speculated to be held in May. Public consumption is projected to moderate to 0.6% (2017: 5.4%) following the government’s expected prudence on supplies and services to rationalise its non-critical expenditure. Similarly, public investment is projected to decline by 3.2% (2017: +0.1%) as completion of many large-scale infrastructure projects helps further reduction of capital spending. The lower spending is likely to be reflected in the government’s balance sheet which would help to reduce total government expenditure. This would help to reduce the fiscal deficit which is targeted to narrow to 2.8% of GDP this year from 3.0% in 2017.

Sustained expansion across all economic sectors. On the supply side, growth is expected to be sustained across all sectors, led by the services and manufacturing sectors. Growth in the services sector is projected to edged lower to 6.1% in 2018 (2017: 6.2%) while the manufacturing sector is expected to moderate slightly to 5.9% (2017: 6.0%) to reflect the anticipated slower global semiconductor sales growth this year. Meanwhile, the construction and mining sectors are expected to register stronger growth. Driven by increase in civil engineering projects the construction sector is expected to expand to 7.3% from 6.3% in 2017, while pickup of natural gas production would help the mining sector’s projected growth to nudge up to 1.8% from 1.1% in 2017. However, lower CPO output is expected to mainly contribute to the lower agriculture forecast growth of 3.6% this year compared to 7.2% in 2017.

Trade strength to sustain goods surplus. Continued expansion in global technology upcycle and broadly sustained commodity prices will remain supportive of export activities for the year. While exports growth is expected to moderate, it will remain above its long-term average trend at a projected 8.4% (2017:18.9%), lifting the goods surplus of the current account to RM120.5b (2017: RM118.1b). Aside from favourable demand for Malaysia’s exports, BNM also expects capacity expansions, particularly from the commencement of several approved investments in Malaysia, particularly the E&E and resource-based manufacturing industries to support trade activities. Additional support is expected to come from anticipated pickup in crude oil and LNG production. However, deficits in the services and income will continue to weigh on the current account balance. Hence, the current account balance as a percentage of GNI is projected to narrow to 2.0-3.0% (2017: 3.1%).

Output gap turns positive, inflationary pressure abates. The output gap is expected to turn marginally positive in 2018 in line with the continued growth momentum within the economy. However, inflationary pressure appears to be abating at the moment as growth in labour force and capital deepening is expected to lift the potential output and mitigate build-up of demand-driven inflationary pressure. Overall, BNM expects the headline inflation to moderate in 2018 to 2.0-3.0% (2017: 3.7%) as higher base of the 2017’s headline inflation is expected to impede any growth upside to headline inflation. Additionally, a stronger ringgit exchange rate is expected to reduce the impact of imported inflation.

Monetary policy bias towards sustainable growth. While recognising looming risks from synchronised monetary policy normalisation across major economies, BNM indicated that it would retained its monetary policy focus on ensuring the economic growth trend to remain sustainable. However, BNM is cognizant of the potential risks arising from monetary policy shifts in the advanced economies and reiterated that the domestic financial markets are capable and well-positioned to mediate and absorb large swings of capital flows in the event of heightened market volatility.

Banking sector remains healthy. Based on BNM’s assessment, the banking sector remained healthy with capital ratios surpassing the levels required under Basel III. With the banking system’s Common Equity Tier-1 (CET1) ratio of 13.3, Tier-1 Capital Ratio (Tier-1) of 14.3 and Total Capital Ratio of 16.5, a stronger buffer is laid against external risks to the banking system.

Household debt situation slightly improving, rising retail space a concern. On a separate note, the 2017 annual growth of total household borrowings moderated further to 4.9% (2016: 5.4%; 2010: 14.2%) to RM1,139.9b. As a result, the ratio of household debt-to-GDP declined to 84.3% from its peak of 89% in 2015. However, BNM highlighted the heightened risks in the office space and shopping complex segments, given the oversupply situation. Nonetheless, BNM’s analysis showed that the banks are assessed to be able to withstand a broad property slowdown, including from the oversupply situation in the office space and shopping complex segments.

CONCLUSION

Growth already passes its peak. Our 2018 forecast of 5.5% growth sits at the lower end of BNM’s growth range of 5.5-6.0%. This reflects our believe that growth already passes its peak in the 2H17 and the reason it is still riding high is because there is still no let-up in the growth momentum. This is primarily due to the extension of the tech upcycle and the higher fiscal spending run up to the upcoming 14th General Election (GE14). BNM’s forecast was more bullish on consumption and export activities, projecting private consumption to grow by 7.2% compared to our estimated 6.1% growth. However, our forecast assumes higher public expenditure activities of 1.6% compared to BNM’s 0.6%, in light of stronger fiscal push ahead of the upcoming GE14. Our exports growth forecast is also lower at 6.9% compared to BNM’s 8.4% as we expect trade to moderate in 2H18 as the tech upcycle is expected to taper and the higher base of last year. We are cautious on trade flows moving forward as we are concerned about the impact of Trump administration's tariffs on trade and the possibility of similar retaliation by other major economies.

OPR to stay at current level. We expect Bank Negara Malaysia's recent OPR hike and the solid economic fundamentals of the economy to be well supportive of a stronger Ringgit trend this year. However, we do expect some resistance to the Ringgit's potential upside on the back of lingering external risk. Therefore, we expect the USDMYR to see some volatility in the short term, or in a range bound between 3.80-4.00 before ending the year at 3.90. While BNM projects confidence in its ability to intermediate in the event of uncertainties, we expect no further changes to the OPR rate. Additionally, the Fed’s "dot plot" updates remains centred on another two more hikes by year-end, reducing the odds that a fourth Fed rate hike taking place this year and minimising risks to financial imbalances. Coupled with the projection for Malaysia's economic growth to moderate moving into the latter half of 2018, we see limited room for BNM to further raise interest rates in 2018.

Source: Kenanga Research - 29 Mar 2018