Amid economic challenges brought about by COVID-19, oil price collapse and a change in government, we reviewed our economic forecasts and provide an update on what the new government might do to provide counter-cyclical supports. Our main conclusions are that fiscal deficit will weaken sharply without extraordinary incomes, current account surplus to come under stress as international tourism collapses and net exports weaken, which set to weaken the MYR. Among the most effective counter-cyclical supports in our view are further easing of monetary policy, the acceleration/reinstatement of sensible infrastructure projects and expansion of the stimulus budget. Funding will remain a challenge, with the government possibly calling for another special dividend from Petronas, asset sales or even reinstatement of the GST.

Growth outlook to moderate further. External demand is expected to remain weak in the immediate term, dragged by the escalating COVID-19 outbreak and the global oil price war, thus weighing on Malaysia’s GDP growth in the 1H20. Hence, GDP growth is projected to slow sharply by 2.3% in the 1H20 from 3.6% in 2H19 before gradually rebounding to 3.9% in the 2H20. This brings the overall average 2020 growth to slow further to 3.1% (2019: 4.3%) from our initial forecast of 4.0%. The revision to the GDP forecast is mainly attributable to the potential economic fallout in the services sector as transportation, and the tourism-related industry will be the most substantially hit from the outbreak as well as the impact of oil supply shock.

Economy came off a weak base at the end of 2019: Even before COVID-19 and the collapse of oil price impacted the 1Q20, the economy was already slowing as evidenced by the 4Q19 GDP report that revealed an expansion of just 3.6% which was well below expectations. With exports to be badly impacted in 1H20 by falling LNG values, as are electronics exports by supply chain disruptions (especially those affecting China) and lower CPO output affecting export volumes, we see 1Q20 GDP slowing further to 2.1%; the sluggishness likely to stretch into 2Q20 with growth expected at 2.5%. Besides exports, the decline in international tourism will impact the services sector. Malaysia’s international tourism revenue earned in 2019 was some US$20b and in terms of travel-related services trade surplus, it was US$7.5bn (close to 2% of GDP vs our base case current account balance being 2.2% of GDP) - an important source of foreign exchange for Malaysia.

Stimulus package widens budget deficit from an estimated 3.3% to 4.3%: The COVID-19 stimulus budget announced on 27th February will be partly funded by a budget deficit set to widen from 3.3% to 3.7%, by our estimates. That is only taking into account RM3.5b of government direct contribution to the total RM20.0b stimulus package to address the COVID-19 impact (as about half or RM10bn is funded by a 4% reduction in employees’ EPF contribution and much of the balance by BNM’s balance sheet). However, as COVID-19 has been declared a global pandemic, we reckon fiscal expansion is crucial in supporting the growth trajectory from further setbacks. Hence, we reckon the government need to add at least another RM3.0b to the fiscal stimulus. As a result, the budget deficit is expected to widen by just 0.6% to 4.3%. This poses a challenge to fiscal consolidation and raises the risk of sovereign ratings downgrade. While some of the measures act to relieve the burden of those most directly affected by drop in tourism activities, half the measures of up to RM10bn from reduced employees’ EPF contribution is potentially released for private consumption or c. 0.6% of GDP by our estimate. There were also other measures to stimulate infrastructure investments, rural development and human capital development.

Repercussions from weak oil price: Adding to the mix is the sharply lower crude oil prices, following Saudi Arabia’s decision to flood the market by jacking up production in a battle for market share against Russia and US producers. This would adversely impact and severely reduce oil revenue which currently account for 20-25% of fiscal revenue. Given such uncertainty, our base case forecast for the fiscal deficit is between 4.0% and 4.6% of GDP for 2020 (2019E: 3.4% of GDP). Every $10 drop in Brent reduces oil-related revenue by some RM7b. However, after factoring in savings from lower subsidy, the impact on the revenue is closer to RM5bn. Hence, each $10 drop in the price of Brent would widen the budget deficit by close to 0.3%.

Possible measures to jump start economy: Given the urgency to address the current economic weakness, the government will likely come up with several countercyclical measures soon. An expanded stimulus could perhaps could include emphasis on workers welfare especially those in the B40 and M40 categories in the form of temporary financial assistance for workers whose wages are effected by cost cuts or unpaid leave. The government may also inject additional grants for SMEs as they are a major source of employment in the country.

Accelerate the implementation of infrastructure projects: The construction sector being a major source of employment for the country of some 1.3m, contributes a high multiplier impact to the economy. Large scale infrastructure projects that are currently suspended will probably be back in focus namely the KL-Singapore High Speed Rail (HSR), Johor Bahru-Singapore Rapid Transport System (RTS) and the MRT3. Reviving at least one of them, the funding which is not beyond means at it comes under the 12MP will inject much confidence to an already moribund construction sector. Given the limited fiscal room to manoeuvre, we reckon that instead of direct funding, at least a significant part will be via Public Private Partnership in which the Federal government will provide the debt guarantee.

BNM likely to cut interest rates further: Fortunately, BNM started the year with an OPR of 3.00%, leaving it more room for monetary easing. The central bank signalled an accommodative stance to support growth amid price stability and slashed its OPR down to 2.50%, its lowest since 2011 in March MPC meeting. We view that BNM still has space to lean towards further rates cut backed by a subdued inflation in the absence of demand-pull pressure and the impact of supply-side shock from the sharply lower oil prices as well as the potential economic downturn due to COVID-19 impact. Hence, the next MPC decision will depend on COVID-19 implications as well as potential global crisis or recession brought on by the outbreak. Should the global or domestic economy weaken more than expected, it would not surprise us if BNM were to cut OPR by another 50bps to take it down to 2.00% which was the GFC low. A cut of 25bps may inject around RM3b into incomes of households and in a worst case scenario of a full 100bps cut this year (from where it started at 3.00%), this could increase spending power by as much as RM12bn or 0.7% of GDP.

Talk of GST to be reinstated: The previous government move to replace the GST with SST has impacted the government revenue by some RM20bn by our estimates. The government may do well to consider reinstating the GST which is broader based versus the SST. We estimate that GST implement at 6% could have fetched the government around RM48.6b in revenue for a whole year (based on pro-rating what was earned for the 5 months when it was in force in 2018) versus RM26.8b in SST. Hence, the surplus revenue that the government could potentially earn is RM22b if GST was implemented at 6%. This is some 1.3% of GDP by our estimates. As GST had been a major source of dissatisfaction among the electorate in the last election, reinstating the GST may need to be handled with more empathy, perhaps on a reduced scale but not below 3.3% which we estimate is the breakeven rate. And in terms of timing, it should come at a time when the economy is much improved, when the pandemic is finally contained and the government more stable. Because of the propensity for vendors to profiteer if GST is reinstated, chances are that CPI will rise more than we currently expect (2020 base case of 1.0 – 1.5%).

Another special dividend by Petronas: Without a special dividend from Petronas or other extraordinary source of incomes, we project the budget deficit for 2020 to range between 4.0% - 4.6% (with 4.3% the base case) which were levels experienced in 2011/12. Like in 2018, the government may once again call on Petronas to pay a special dividend above the usual RM24bn a year. The special dividend of RM30bn announced in 2018 was paid in 2019 and such sum could narrow the deficit by 1.8% of GDP. We believe that Petronas is financially in a comfortable position to pay given its net cash position of RM82b. Besides Petronas, GLCs would likely be encouraged to pay higher dividends as well.

Time for PR machinery to get back to work and engage actively with investors: The change in government and lack of clarity on policies as well as risk of greater uncertainties if fresh polls are called bode badly for investors’ (both portfolios and direct investments) confidence which could deter FDIs inflows. The government could do well to provide policy clarity or even engaging investors via road shows abroad to regain some lost confidence. This comes at a critical time when FTSE Russell decides on whether to exclude Malaysia from the WGBI (World Government Bond Index) in April. Based on Malaysia’s weight of around 0.4% with US$2t passive funds tracking the index, its exclusion may lead to an outflow of as much as US$8bn. The MYR is thus vulnerable to risk of outflows given that BNM’s FX reserves is relatively low sitting at around US$100b in terms of gross reserves. Excluding short-term FX liabilities, net reserves may fall to just US$86b – a minimum level of the IMF’s ARA (Assessing Reserves Adequacy) level. This poses downside risk to our USD/MYR exchange rate forecast of 4.30.

Source: Kenanga Research - 16 Mar 2020