Malaysia’s 2H24 Economic Outlook

The Malaysian economy is progressing well to a position of strength. As the first-quarter GDP results of 2024 aligned closely with our projections, we are confident in maintaining our GDP forecast for the entire year at 4.7%, compared to the previous year's growth of 3.6%. Looking ahead, we anticipate even more promising signs of economic growth in the second quarter, with expectations of it reaching as high as 5.5% YoY. The feel-good factor is supported by various measures in all the blueprints and masterplans that have been announced since last year i.e. the Madani Economy Framework, the National Energy Transition Roadmap, the New Industrial Master Plan. The latest was the National Semiconductor Strategy launched on 28 May 2024.

The private consumption growth could cross the 7% YoY growth threshold in the 2Q24 and 3Q24. The impending increase in civil servants, the pick-up in tourist arrivals and strong employment market are expected to support consumer spending in the coming quarters. Tourism in Malaysia is experiencing an upward trend, with 5.8mn tourists visiting in the first quarter of 2024. This increase can be attributed in part to the 30-day visa exemption for Chinese and Indian tourists, which has boosted arrivals in Malaysia.

Recently, the Malaysian government had a mutual agreement with China to extend the visa exemption programme for visitors from both countries to enhance bilateral ties. China had agreed to extend its visa exemption facility for Malaysian citizens until the end of 2025 while Malaysia will extend the visa exemption for Chinese citizens until the end of 2026. Visa facilitation, alongside improved accessibility and flight connectivity, plays a crucial role in achieving the goal of attracting around 36mn tourists and generating RM150bn tourism receipts for Visit Malaysia 2026. Prior to that, Tourism Malaysia is confident of achieving the 27.3mn foreign tourist arrivals this year (2023: 20.14mn; 2022: 10.07mn)

However, we anticipate the economy to switch into a low gear in the second half of the year (2H24E: 4.5% YoY; 1H24E: 4.9% YoY). The uncertainty of inflationary impact of subsidy rationalisation will remain a key concern, especially once the government starts to rationalise the RON95 fuel, which could happen in the fourth quarter of this year. Consumers may stay cautious until there is a clear visibility on the execution of such initiative and the potential introduction of new consumption taxes. Nonetheless, continued government assistance for lower-income segment, such as the Sumbangan Tunai Rahmah (STR), is likely to cushion some of the negative impact.

Part of the labour market reforms involves the implementation of a progressive wage model (PWM), which will be pivotal in raising individual incomes levels and productivity. Still in the pilot project, the government has agreed to allocate RM50mn, involving 1,000 employers, which will run from June 2024 until August 2024. The selected company will receive incentives of up to RM200 per month for each entry-level employee and up to RM300 per month for each non-entry-level employee.

The government is also due to review the minimum wage this year. The last time the government reviewed the minimum wage was in May 2022, increasing it from RM1,200 to RM1,500. According to the Ministry of Human Resource (MoHR), the minimum wage review is almost completed and is set to be tabled at the National Wages Consultative Council (NWCC) soon. We expect the new rate would be between RM1,700 and RM1,800. Though it is still lower than the living wage of RM2,700 as proposed by Bank Negara Malaysia, we find it fair for both employers and workers.

Key domestic wildcard would be the effect of the introduction of Account 3 by the Employees Provident Fund (EPF) in May 2024, which permits members for flexible withdrawal. While it is expected to boost consumption, we expect it to have a less profound impact compared to the RM10,000 withdrawal in 2022. Even if we assume full participation in Akaun Fleksibel, the total withdrawals during the first year are estimated at only RM25bn compared with RM44.6bn as in the previous withdrawals.

On the upside, a significant recovery in the export-oriented industries is expected later this year, with a potential upturn in the technology cycle especially in the 2H24. The latest data from the Semiconductor Industry Association (SIA) showed that the global semiconductor industry posted double-digit sales increases on a year-to-year basis during each month of 2024, and worldwide sales in April increased on a month-on-month basis (1.1%) for the first time this year. technology cycle.

Additionally, the recovery in the global demand is evident, spurred by improvements in the Chinese manufacturing sector. China contributes about 12.3% of our total exports. Malaysia and China will continue to promote the high-quality implementation of the Regional Comprehensive Economic Partnership (RCEP) agreement, and to accelerate the ASEAN-China Free Trade Area (FTA) 3.0 upgrade negotiations towards conclusion as soon as possible. This has been pledged during the recent Chinese Premier Li Qiang’s visit to Malaysia. About RM13.2bn in potential investments is expected following the exchange of 11 MoUs between Malaysia and China.

We also believe that Malaysia stands in a unique position amidst the recent tariff hikes imposed by the US. While the escalation of trade tensions between the US and China might seem detrimental to Malaysia due to its close economic ties with China, there are ways for Malaysia to benefit from this situation. Malaysia has been striving to diversify its export markets beyond its traditional reliance on China. For instance, the imposition of tariffs by the US on Chinese goods, including electric vehicles (EVs) and related components, could create an opportunity for Malaysia to step in and fill the gap left by Chinese manufacturers.

In addition, Malaysia’s bid to join BRICS (Brazil, Russia, India, China and South Africa) group, should augur well for our trade and FDIs amid intensifying economic race among global superpowers. In addition to these five countries, the group also comprises of Iran, Egypt, Ethiopia, the United Arab Emirates and Saudi Arabia. Together, they make up about 30% of the world’s land surface and 45% of the global population. First established in 2006, it was to counter and balance decisions made by the International Monetary Fund, World Bank and the Group of 7 (G7). Apart from Malaysia, Thailand and Vietnam also voiced out their intention to join the group.

Greater investment realisation following higher approved investments last year, progress of new and ongoing projects such as the construction of the JB-SG Rapid Transit System (RTS), the Pan-Borneo highway, the East Coast Rail Link (ECRL) network, and policies under the Madani Economy framework, will further drive a more robust economic growth. In the first quarter of 2024, Malaysia recorded RM83.7bn of approved investments, marking a 13% YoY increase. Foreign investments (FI) contributed 56.2% or RM47bn, while domestic investments (DI) contributed 43.8% or RM36.7bn. Last year, approved investment rose 23% to a record high of RM329.5bn, of which 57.2% was from foreign capital while 42.8% from domestic.

On supply side, we forecast growth across all sectors led by the manufacturing and services sectors. We are optimistic about Malaysia’s industrial production and manufacturing sector due to robust global economic conditions, rising export demand, and positive domestic economic indicators. As for the services sector, it will be driven by stable labour market, expectation of higher disposable income and the positive chain effects from higher tourist arrivals in Malaysia.

Nevertheless, geopolitical risk would dominate the macro narrative and potentially disrupt the growth momentum. Weaker-thanexpected global trade and the elevated trade tensions between the US and China, especially following the recent tariff hike announcement, could impede global economic growth. This is in view of recent US decision to impose tariff hikes to be phased in over 2024-2026 on products imported from China i.e.semiconductors, lithium-ion batteries, solar cells, critical minerals (e.g. natural graphite), and medical equipment. This comes about as US seeks to pre-empt deluge of imports from China, which are accused by the US of employing “unfair” industrial policy that also resulted in overproduction and excess inventory. The upcoming US Presidential election in November 2024 could have some bearings on US-China geopolitics.

This situation is exacerbated by the ongoing conflict in Ukraine and the continued Israel-Gaza war, which could negatively affect global trade activities due to the diversion of sea shipments. Meanwhile, the prevailing tight monetary policy adopted by most of the advanced economies poses downside risks to Malaysia, given the potential risk of a global economic downturn.

On the domestic side, the downside risks could come from the expected cost-push inflation, which we will explain in the next section, due to the implementation of the targeted fuel subsidy rationalisation this year, pending details on the timing, quantum and mechanics. This, in turn, could lead to upside risk in Bank Negara’ OPR outlook, which we currently expect to remain stable at current level of 3.00% until end-2024, and possibly throughout 2025 as well.

Upside Risks of Inflation

The headline and core inflation were milder-than-expected at 1.8% in 5M24, with limited spillover effect from electricity and water tariff hikes and the 2%- point increase in sales and services tax. Nevertheless, the inflation is expected to pick up pace from June 2024 onwards due to potential cost-push factors following subsidy rationalisation measures. Low-base effect will also play some role as headline inflation was up by just 1.8% YoY in the second half of last year versus 3.2% in 1H23. In summary, our CPI model indicates that the headline inflation will grow by 4.5% YoY in 2H24 (1H24E: 2.1% YoY). Our 2024 headline inflation projection remains at 3.3% YoY.

In summary, the inflation trajectory would be pivoted on few factors:

1) Low base effect;

2) Second-round effects or indirect pass-through impact following recent diesel price adjustment;

3) The lagged impact from consumption tax measures such as the 2% service tax revision and the implementation of low value goods tax (LVGT);

4) Potential upside in demand from Account 3 EPF withdrawal;

5) Spillover impact from higher global commodity prices; and

6) The timeline of RON95 subsidy rationalisation and the quantum of adjustment.

As highlighted in our previous CPI report, we calculated that the direct impact of the recent diesel subsidy rationalisation on headline inflation would be marginal, with the potential upside of only 0.1%. Since 10 June 2024, diesel retail price has increased by a whopping 56% to RM3.35 per litre and now subject to weekly price adjustments. The direct impact of diesel price adjustment is marginal.

This is because the government is still providing subsidies for most of the diesel-powered commercial vehicles and public transportation. These are given through the Subsidies Diesel Control System, or widely known as the SKDS programme, on top of the monthly cash aid of RM200 to eligible individuals under the Budi Madani Programme. Government is still providing subsidies for eligible users.

So far, the government has approved 100,000 applications for the targeted diesel subsidy cash aid under the Budi Madani initiative. Expect more applications in the future. With no due date for applications, the current submissions are still below the government’s target of 700,000 diesel vehicle users – 400,000 commercial vehicles and 300,000 private vehicles.

Further, the diesel weight to overall headline CPI is a mere 0.2%, indicating a minimal potential for significant inflationary effects. Further, the CPI weightage of fuel has been reduced from 8.5% in 2018 to 5.9% in 2024. We calculate that for every 1% increase in diesel prices, fuel inflation will only increase by 0.04%. That will translate into 0.002% of headline inflation. Hence, the 55.8% hike in the retail diesel price is expected to push the headline inflation only by 0.2%.

All eyes now would be on the RON95 subsidy rationalisation, which we believe may not happen that soon. We view that the government would like to assess the lagged impact of diesel price adjustments and the readiness of the central Database Hub (PADU) in determining the eligibility for the cash aid.

RON95 is currently sold at RM2.05 per litre. Gauging from the nonsubsidised petrol station, the RON95 is currently sold at a market price of RM3.30 per litre. That indicates roughly about RM1.25 being subsidised for each litre of RON95 sold. It was last revised on 15 February 2021, up by 4 cents. It remains at this level until now.

In our opinion, the RON95 subsidy rationalisation is likely to be implemented on a gradual and measured approach to limit the shock. We believe the rationalisation of RON95 is more complicated, given that it affects the bulk of >36mn registered motor vehicles (source: Transport Ministry) and accounted for RM66.7bn in retail sales of automotive fuel in 2023 (source: DOSM). Thus, it should not be rushed until a proper system is in place. Probably, the earliest would be in the fourth quarter of this year and revised in stages until next year.

We fear that the price hike of RON95 will have a significant impact on inflation. It carries higher weightage than diesel, 5.5% of the overall CPI. Thus, expect a wider impact of RON95 subsidy cuts on inflation. The direct contribution of a 10% increase in RON95 retail price on headline inflation is estimated at around 0.5%-points, compared to diesel’s 0.02% points.

Expect more details on fuel subsidies in the upcoming Budget 2025, scheduled to be in October 2024. By that time, the government may have few months of inflation data (June – September 2024) to assess the impact of the diesel mechanism.

Slightly Positive Impact on Our Fiscal Position

Fiscal consolidation remains as top agenda this year given the Fiscal Responsibility Act (FRA) targets for budget deficits and government debt reductions. We maintain our budget deficit forecast of 4.2% of GDP this year, a tad lower than the government’s target of 4.3% deficit. The aim is to lessen our deficit to 3.0% by 2025 and cap total debt-to-GDP ratio at no more than 60%.

During the first half, the government has rolled out several revenue-enhancing tax measures, as mentioned during Budget 2024 last year. These include 1) the imposition of Capital Gains Tax (CGT) on unlisted shares with effective 1 January 2024; 2) the introduction of Low Value Goods Tax (LVGT) at 10%; 3) expansion of services tax base; 4) increase service tax by 2%-point to 8%; and 5) 10sen increase in the excise duty imposed on premixed sugary beverages. The additional revenue from these measures are expected to be roughly RM4bn, or 0.2% of GDP. The amount could be higher if the High Value Goods Tax (HVGT), or widely known as the Luxury Tax, has not been deferred. It was supposed to be implemented on 1 May 2024. Several revenue-enhancing tax measures have been announced.

Other fiscal reforms also include further strengthening of tax compliance to enhance revenues via the adoption of “e-invoice”, which has been rolled out in stages. The pilot programme has already started on 1 June 2024, and will be done by phases - Phase 1 on 1 August 2024 and Phase 2 on 1 January 2025 - before it is fully applicable to all businesses on 1 July 2025.

However, there are also other “un-budgeted” expenses in the government’s operating expenditure (OE) announced this year. Namely, the Special Financial Aid for Eid celebration of RM500 for civil servants of Grade 56 and below and RM250 for pensioners, announced in early April 2024, with allocation of RM900mn. In addition, the government has also announced more than 13% salary increase for civil servants, expected to be implemented in December this year. We assume, it will cost RM0.83bn this year (pro-rated from RM10bn annual cost to emoluments). These “un-budgeted” expenses will total up about RM1.73bn, or equivalent to 0.1% of GDP. It leads to a net fiscal effect (from the above mentioned RM4bn additional revenue tax measures) of RM2.3bn or 0.12% of GDP.

Part of the fiscal consolidation and reforms also involves reducing spending on subsidies. In May 2024, the Cabinet approved the targeted subsidy rationalisation, which will save the government RM4bn annually. The aim is to deal with leakages in blanket diesel subsidy system and exclude the high-income groups and foreigners. Since the implementation starts in midJune 2024, the pro-rated savings are expected to be at RM2.1bn (assume 6.5 months impact).

Other savings from the subsidy retargeting measures would include savings of RM4bn from retargeting of electricity subsidy as well as RM1.2bn from the floating of chicken prices. Together with the targeted diesel rationalisation, the government has roughly saved about RM7.3bn (Figure 18).

More can be saved if the RON95 fuel subsidy rationalisation takes place this year. Using the assumption of 20bn liters of fuel usage this year, we estimate that for every 10 sen hike in fuel prices, it will save roughly about RM2bn in fuel subsidy per annum. As mentioned in our inflation assumptions, we have priced in about 40 sen of price adjustment for RON95 this year, pushing it to RM2.45 per litre. But, the full RM8bn fuel subsidy savings would only be seen next year, which of course depends on the quantum and timing of the adjustment. More can be saved if the RON95 fuel subsidy rationalisation takes place this year.

These savings can be rechanneled into lowering government debt, upgrading of infrastructure or other important agenda such as improving our healthcare and education system or boosting the development expenditure (DE).

However, we do not rule out the potential upsides in the social assistance in tandem with the subsidy retargeting. The Budi Madani aid programme has been introduced on top of other existing aid programmes such as the the Sumbangan Asas Rahmah (SARA) programme and the Sumbangan Tunai Rahmah aid, or widely known as the STR. The government has allocated RM52.8bn subsidies and social assistance under Budget 2024.

Bank Negara to Stand Pat for the Rest of the Year

Juggling between moderate growth pick up, continued tame inflation and weakening Ringgit, Bank Negara (BNM) kept its key interest rate at 3.00% in the first half of the year. The central bank confirms that the current policy stand is supportive of the economy. We believe that BNM will maintain the current Overnight Policy Rate (OPR) until year-end and perhaps for the whole of 2025 as well. The central bank has kept the OPR unchanged for more than a year now, having last raised it in May 2023 by 25 bps. We believe that the central bank may want to assess the lagged impact of the fiscal policy adjustments on overall inflationary trajectory and economic momentum while maintaining the interest rate.

At this juncture, we see a lack of impetus for BNM to tweak its policy rate considering the rosier domestic economic prospects amid uncertainties in the inflation trajectory. While the depreciation of the Ringgit against the US dollar is a concern, we believe that BNM is unlikely to follow Bank Indonesia in hiking its rates to support the currency. Further, the availability of alternative policy tools such as encouraging government-linked entities to repatriate their foreign investment income to strengthen the ringgit has also helped preserve the monetary policy space.

Much also depends on how the government manages future inflationary pressure as well as the struggling ringgit. For now, the perceived risk of inflation is modest. A wide official inflation target range of 2.0% to 3.5% should provide sufficient room against future price movements.

As the economic prospect is anticipated to remain robust in 2024, there is limited room for easier monetary policy either. Further, we still register 250 bps negative interest rate differentials with the US and a still firm US dollar, which may not be good for our Ringgit and capital flows.

While local fundamentals were the primary driver for rate hike decisions in 2022-23, the US Federal Reserve (Fed) next decision is still in focus. In March 2024, the US central bank predicted three-quarter point cuts by the end of the year. As time goes on, however, that has become less of a certainty. The US policymakers noted that there has been modest further progress toward its 2% inflation objective, which they foresee may not happen until 2026, and limited signs of weak job market. Jobless rate is seen hovering around 4% level this year.

We forecast one cut in the US Federal Funds Target Rate (FFTR) this year. According to Bloomberg, market is pricing in roughly 35.4% probability of a rate cut in the November FOMC meeting and 77% probability of FFR cut by 25 bps in the December FOMC meeting. If materialised, that would bring the FFTR to 5.00% to 5.25% by year end.

Policymakers from major central bank are also signaling that they are still not convinced enough about disinflation. While Canada did deliver the first such move of the Group of Seven (G7) on 5 June 2024, followed by the European Central Bank (ECB) a day later, both showed limited enthusiasm for further easing. In the UK, a looming election and lingering price pressures are adding to the case for the Bank of England to wait at least until August before lowering rates.

Ringgit to Gradually Strengthen by Year End

The Malaysian Ringgit has stabilised in recent weeks. Since mid-May 2024, it traded within a tight range of RM4.68 – 4.71 against the USD, improving from the earlier low of 4.80 on 20 February 2024 and 16 April 2024. We believe the improvement was due to Bank Negara’s forex market interventions and supporting measures. These include ongoing coordinated efforts with government-linked companies (GLCs) and government-linked investment companies (GLICs) as well as private companies and exporters to repatriate their foreign exchange earnings and overseas investment income. These measures were also extended to private companies and exporters.

The repatriation and conversion are reflected in the current account surplus. In 1Q24, the surplus was significantly strong at RM16.2bn (3.5% of GDP) as compared to RM0.9bn (0.2% of GDP) in the fourth quarter of last year. This is amid the increase in gross inflows of investment income to RM26.4bn in 1Q24 (4Q23: RM19.3bn). According to BNM, the foreign exchange market volume and two-way flows have improved significantly, indicating a higher level of liquidity. The average daily FX turnover has risen from USD15.5bn in 2023 to over USD17bn year to date.

The Ringgit stabilisation is also a reflection of the improvement in Malaysia’s economic conditions and fundamentals. In the first half, the government has launched the National Semiconductor Strategy (NSS) and signed the MoU with Singapore on the Johor-Singapore Economic Zone. Further, 1Q24 real GDP turned out stronger than expected while monthly key economic indicators such as the IPI and exports were reported to be on the uptrend. The implementation of diesel subsidy rationalisation would also supplement other existing fiscal consolidation measures, which is expected to improve the fiscal position in relative to 2023.

An expected cut in the US interest rate while BNM is maintaining its OPR should be positive for Ringgit as the interest rate differential will narrow by 25 basis points 225%. This has been the Ringgit’s Achilles heel since 2022 when the US Fed embarked on its aggressive interest rate hikes.

The central bank is still exploring other measures to preserve Ringgit’s stability and prevent excessive depreciation in the market. The OPR hike, or capital controls seen during the 1998 Asian Financial Crisis, are not among its options. Not only it will harm the economy, it can also hurt our investment landscape, thus potentially cause capital flight. In May 2024, total foreign debt holdings rose to RM271.9bn (April 2024: RM266.4bn), the highest since November 2023. Net foreign inflows in the debt market rose for three consecutive months to RM5.5bn during the month, while net foreign equity inflows exceeded RM1bn in May 2024 – the only ASEAN country to achieve this milestone in the month (Figure 26 and 27).

Hence, there is a strong possibility for the Ringgit to strengthen to RM4.50 by year end. This is based on expectations that Bank Negara will maintain its current monetary stance for the rest of this year and the government is committed to fiscal discipline. Our proprietary model suggests the Ringgit will gradually improve to an average of RM4.59 in the second half, versus the RM4.71 average in the first half. That would lead to an average rate of RM4.65 for the whole year.

Source: TA Research - 2 Jul 2024