economic outlook : slowing growth, but recovery on track- 08/09/2010

8/8/2019 Economic Outlook : Slowing Growth, But Recovery On Track- 08/09/2010

1/13

8 September 2010

Economic Outlook

Slowing Growth, But Recovery On Track

The economy softened to 8.9% yoy in the 2Q, after hitting a peak of +10.1% in the 1Q.

We expect the growth to decelerate further in the 2H of the year and this will likely continue

into 2011, on the back of a slowdown in exports. The surge in the ringgit in a short span

of time, coupled with the removal of subsidies and rising borrowing costs which happened

at around the same time, is likely to slow down exports and business spending further.

This, in turn, will likely affect job prospects and consumer spending as well. Consequently,

we expect real GDP growth to normalise to around 5.0% in 2011, after a strong rebound

to an estimate of +7.3% in 2010.

Developed nations policies have titled toward loosening bias given prospects of a sharper

slowdown in the global economy. We believe policy tightening in Asia will slow down as

well. Furthermore, the strengthening of regional currencies against the US dollar will

naturally dampen these countries exports, resulting in indirect tightening effect on the

economy. This is especially the case for Malaysia. As a whole, we expect the countrys

real exports to slow down to 7.6% in 2011, from an estimate of +11.7% in 2010.

Domestic demand will likely soften in 2011 as well, on the back of weaker consumer and

business spending as well as public investment. Growth, however, will likely be resilient

due to the sustained increase in consumer spending, on account of rising consumerism and

high savings. Fiscal consolidation will likely continue into 2011 and the Federal Government

is projected to cut its budget deficit to 4.2% of GDP or RM34.5bn during the year.

The current account surplus in the balance of payments is envisaged to widen as the

economy slows. This will provide an underlying support to the ringgit, which will likely

fluctuate at between RM3.10-3.20/US$ for the rest of this year, before settling at around

RM3.10/US$ in 2011.

Inflation will likely trend up to an average of 2.8% in 2011, from an estimate of +2.0%

in 2010, on the back of a gradual reduction in subsidies by the Government. Meanwhile,

Bank Negara Malaysia is expected to resume its policy normalisation in 1H 2011 and the

overnight policy rate will likely be raised by 50-75 basis points to 3.25-3.50%.

Executive Summary

Peck Boon Soon

(603) 9280 2163

[email protected]

Please read important disclosures at the end of this report.

Malaysia

PP

77

67/09/2010(025354)

MARKETDATELINE


2/13

ECONOMIC OUTLOOK2

Slowing Growth, But Recovery On Track

The economy softened to 8.9% yoy in the 2Q, after hitting a peak of +10.1% inthe 1Q. We expect the growth to decelerate at a faster pace in the 2H of the yearand this will likely continue into 2011, on the back of a slowdown in exports. Thesurge in the ringgit in a short span of time, coupled with the removal of subsidies

and rising borrowing costs which happened at around the same time, is likely toslow down exports and business spending further, as they adjust to higher coststructure. This, in turn, will likely affect job prospects and consumer spending aswell. Consequently, we expect real GDP growth to normalise to around 5.0% in2011, after a strong rebound to an estimate of +7.3% in 2010. Meanwhile, thecurrent account surplus in the balance of payments is projected to widen as theeconomy slows. This will continue to provide an underlying support to the ringgit,which we expect it to fluctuate at around RM3.10-3.20/US$ for the rest of theyear before settling at RM3.10 in 2011. Inflation will likely trend up to an averageof 2.8% in 2011, on the back of a gradual removal of subsidies. The Central Bankwill likely resume its policy normalisation in 1H 2011, after taking a pause for therest of this year.

Economic Growth Likely To Normalise To Around 5.0% In2011

The slowdow n in the w orlds major economies, from the US to Japan and China,

has become more widespread since the 2Q, after a strong rebound from the

worst recession since the world war II. Indeed, the latest economic data releases

suggest that the growth in these countries will likely soften further in the 2H of the

year and extend into 1H 2011. Also, effect of the dissipating global stimulus spending

will also likely be felt in the 2H. Already, the annualised personal consumption

expenditure in the US moderated further in July, while manufacturing activities in

Japan and China turned softer in July-August. Although the Euroland, India and

Indonesias economies picked up in the 2Q, their economic activities are likely to

have peaked and will likely soften going forward, in our view. In particular, theEurolands economy will likely feel the pinch when the austerity measures start to bite

in the 2H of the year.

Back on the home front, the economy softened to 8.9% yoy in the 2Q, after hitting a

peak of +10.1% in the 1Q. We expect the growth to decelerate further in the 2H of the

year and this will likely continue into 2011, on the back of a slowdown in exports. The

surge in the ringgit in a short span of time, coupled with the removal of subsidies and

rising borrowing costs which happened at around the same time, is likely to squeeze

companies earning and make the business environment more challenging to operate,

especially for exporters. As a result, businesses are likely to turn cautious in recruiting

workers and for expansion, in our view. This, in turn, will likely affect job prospects

and consumer spending as well. Already, the countrys exports slowed down furtherin July, the fourth consecutive month of slowing down and the slowest pace of growth

in eight months. Consequently, we expect real GDP growth to normalise to

around 5.0% in 2011, after a strong rebound to an estimate of +7.3% in 2010.

Developed Nations Ready To Ease Policies, If SituationWarrants

Sensing the renewed weakness in the economy, the US Federal Reserve has acted

fast and shifted its policy towards a loosening bias on 10 August whereby it

pledged to roll over Treasury securities and reinvest proceeds from mortgage-related

securities as and when it matures to prevent its balance sheet from shrinking. While

the direct effect of the Feds move is not significant, it shows its willingness and ability

to go further if economic conditions worsen. This will likely prevent the US economy

from falling back into a recession , in our view, even though it is slowing down

and the recovery will likely be uneven and gradual.

The slowdown in the worlds

major economies, from the

US to Japan and China, has

become more widespread

since the 2Q

We expect Malaysias real

GDP growth to normalise

to around 5.0% in 2011,

after a strong rebound to

an est imate of +7.3% in

2010

The US Federa l Reserve

has sh i f t ed i t s po l i c y

towards a loosening bias


3/13

ECONOMIC OUTLOOK3

Similarly, the Bank of Japan (BOJ) conducted an emergency meeting on 30 August

and stepped up its monetary stimulus for the first time since March by

expanding a bank-loan programme by 10 trn (US$116bn) to a total of 30 trn, after

the economys recovery weakened and the yen surged to a 15-year high recently.

The strong gain in yen at a time when global demand is weakening will likely hurt the

countrys exportsand the export-dependent Japanese economy the most. We believe

Japan will likely do more to help the economy, particularly in addressing the

sharp rise in yen. It is an irony that investors still prefer to buy the yen even though

Japans economic fundamentals are weaker than its counterparts such as the US or

the Euroland. The most prominent among the reasons why investors prefer to buy

yen is that while it may not be the best investment in the world, it beats the alternatives,

offering a relative safe haven in a treacherous global economy.

Meanwhile, the Euroland has already eased its policies in May by reactivating its

unlimited 3-month fixed-rate loan offers to financial institutions and unveiling an

unprecedented emergency stabilisation loan package of as much as 750bn (US$962bn)

when the sovereign debt crisis in the region deepened. These, coupled with the

austerity measures undertaken by the highly-indebted nations in the region and the

subsequent release of the stress test results in late July, have successfully stopped

the sovereign debt crisis from deepening. Although the Euroland has yet to feel the

effect of the austerity drive, it will likely come back to haunt the economy and theeuro towards the end of the year. This suggests that monetary conditions are

likely to remain loose in the region in the near term. Already, the European

Central Bank (ECB) said that it will extend its offer of unlimited liquidity to

banks into early 2011, while keeping its key policy rate at a record low of 1.0% for

the 17th straight month in September. Earlier in May, the ECB has committed to lend

banks unlimited cash until at least 12 October.

Policy Tightening In Asia Likely To Slow Dow n

Asian central banks, on the other hand, continued to normalise/tighten monetary

conditions in recent months. Singapore for instance, tightened its mortgage policy

on 30 August. The curbs marked the third set of major measures Singapore hastaken in 12 months to cool the property market. Similarly, Hong Kong tightened its

mortgage lending rules to cool down the property market in early August. Thailand

also started to normalise its monetary policy and it raised its key policy rate for the

second time in August to 1.75% given that its interest rates are still too low, while

India raised its benchmark interest rate for the fourth time this year to 5.75% in July

in a move to curb rising inflation. In the same vein, South Korea raised its key

policy rate in July by 25 basis points to 2.25%, before taking a pause in August. The

countrys central bank indicated that it plans to raise it again in September given that

its interest rates are still low.

China, on the other hand, has introduced a series of tightening measures to cool

down its property market and rapid credit expansion since last year. The measures

have yielded positive results and we believe the country will unlikely tighten further

for the rest of this year and investors are now expecting the authorities to ease back.

Similarly, we believe most central banks in the region are likely to slow dow n

their policy tightening or pause in view of the risk of a sharper slowdown in the

global economy.

Malaysia will likely follow suit after it took a pause and maintained its overnight

policy rate (OPR) at 2.75% on 2 September. Bank Negara Malaysia (BNM) raised its

OPR three times this year and by a total of 75 basis points. We believe BNM is likely

to have done with its interest rate hikes for the rest of this year. The Central Bank,

however, will likely resume its policy normalisation in 1H 2011 and we expect

the OPR to be brought to a more neutral level of 3.25-3.50%.

Furthermore, regional currencies have appreciated quite sharply against the US dollar

due to inflow of foreign capital in search for higher returns in recent months. The

strengthening of their currencies wil l naturally dampen these countries

exports , resulting in indirect tightening effect on the economy (see Charts 1 & 2).

The Bank of Japan stepped

up its monetary st imulus

fo r t he f i r s t t ime s i nce

Ma r c h b y e x p and i ng a

bank- loan programme in

August

The European Central Bank

said that it will extend its

offer of unlimited liquidity

to banks into 2011

Asian central banks, on the

other hand, continued to

tighten policies in recentmonths...

... but most central banks

are likely to slow dow n or

pause in view of the risk of

a sharper slowdown in the

global economy

Malaysia has also taken a

p au s e and w i l l l i k e l y

resume i t s po l i c y

normalisation in 1H 2011

Strengthening of regional

cu r renc i e s w i l l d ampen

expo r t s , re su l t i ng i n

indirect tightening effect


4/13

ECONOMIC OUTLOOK4

This is especially the case for Malaysia as the ringgit has appreciated by 9.9% against

the US dollar year-to-date, one of the strongest gains in the region after the yen.

Signs Of Slow ing Global Growth Become More Apparent

Meanwhile, signs of slowing global growth are becoming more apparent. Already,

global manufacturing (see Chart 3) activities have slowed down for the fourth

straight month in August and it was the slowest pace of increase in nine months. In

particular, manufacturing new orders weakened to the slowest pace of growth in 14

months and since it turned into positive growth in July 2009, indicating that global

manufacturing activities are likely to moderate further in the months ahead. Similarly,

global services activities slowed down for the fourth consecutive month in August.

In the same vein, the OECD composite leading indicator ,has been trending lower

for the last few months (see Chart 4), indicating that OECD countries economies are

likely to expand at a slower pace in the months ahead.

In the US, the economy grew at a weaker-than-expected annualised rate of 1.6% in

the 2Q. Also, personal consumption expenditure (PCE) slowed down to 1.7% in July,

from +2.0% in June and the peak of +2.5% in April-May, suggesting that consumer

spending is losing momentum (see Chart 5). However, the PCE grew m-o-m for the

third month out of four months, indicating that consumer spending is likely to remain

resilient in the months ahead in supporting the US economy. Indeed, personal incomehas been on the rise given that the economy has been creating jobs for the last eight

consecutive months even though it has weakened somewhat. As it stands, a total of

67,000 jobs were created by the private sector in August, albeit lower than 107,000

jobs created in July but off a high of 241,000 jobs recorded in April (see Chart 6). As

Signs o f s low ing g loba l

growth are becoming more

apparent

The US economy i s

projected to moderate to

2.8% in 20 11, from +3.0%

estimated for 2010

Chart 3

Global Manufacturing And

Services Activities Heading South

Index

P M IManufacturing

30

35

40

45

50

55

60

65

05 06 07 08 09 10

P M IServices

Chart 4

OECD Composite Leading

Indicator Points To A Slowing

Economic Growth

% 12-mth annualised rate of change

-20

-15

-10

-5

0

5

10

15

20

25

30

00 01 02 03 04 05 06 07 08 09 10

Total OECD Japan US Euro area China

Chart 1

Ringgit Gained The Most Against

The US Dollar In The Region

% YTD Vis-a-Vis US$

10.0

0

2

4

6

8

10

12

MYR SGD THB Peso Rupiah

4.2

7.3

4.44. 1

Chart 2

Chinese Yuan Hardly

Move Despite Adopting A More

Flexible Exchange Rate

% YTD Vis-a-Vis US$

-2

0

2

4

6

8

10

12

Yen Yuan KRW TWD INR

10.3

0. 5 -1.3 0. 1 -0.3


5/13

ECONOMIC OUTLOOK5

a whole, the US economy is projected to moderate to 2.8% in 2011 , from

+3.0% estimated for 2010.

Similarly, Japans manufacturing activities weakened to the slowest pace in 14 months

in August and exports eased for the fifth straight month in July (see Chart 7), suggesting

that the export-dependent Japanese economy will likely remain weak. In the

same vein, the Eurolands economy is likely to have peaked in the 2Q , as its

export engine, which powered the 2Qs GDP growth, has started to moderate. As a

result, manufacturing and services activities have begun to trend down (see Chart 8).

In China, retail sales moderated for the second consecutive month to 17.9% yoy in

July and fixed-asset investment in urban areas slowed down to 24.9% yoy in January-

July, from the corresponding period of +32.9% in 2009 (see Chart 9). Similarly,

industrial production headed south for the fourth straight month to 13.4% yoy in July,

while growth of money supply has been easing since December last year. Although

the PMI manufacturing index rebounded in August, manufacturing activities remained

weak. As a whole, Chinas economyis l ikely to slow down further in the 2H of

the year and in 2011, after recording a more moderate growth of +10.3% yoy in the

2Q.

J ap ane s e e c o no m y w i l l

l ikely remain w eak and the

Euro l and s e conomy i s

likely to have peaked in the

2Q

Chinas economy is likely to

moderate further in the 2H

of the year and in 2011,

after record ing a s lower

growth of +10.3% yoy in

the 2Q

Chart 6

US: The Economy Is Still Creating

Jobs, Albeit At A More Moderate

Pace

( 000)

Chart 5

US: Consumer Spending Slowing

But Resilient

% yoy

-4

-3

-2

-1

0

1

2

3

4

5

2005 2006 2007 2008 2009 2010

(Personal consumption expenditure)

-1000

-800

-600

-400

-200

0

200

400

600

05 06 07 08 09 10

Chart 8

Euroland: Manufacturing And

Services Activities Moderating

Index

Chart 7

Japan: Manufacturing Activities

And Exports Weakening

Index

0

10

20

30

40

50

60

2007 2008 2009 2010

-60

-40

-20

0

20

40

60

Exports(RHS)

PM imanufacturing

(LHS)

% yoy

30

35

40

45

50

55

60

65

05 06 07 08 09 10

PMI Manufacturing

P M IServices


6/13

ECONOMIC OUTLOOK6

Exports Of E&E Products Will Likely Moderate

In tandem with a more moderate growth in the global economy, demand for electrical

& electronic (E&E) products, which accounts for about 45% of Malaysias total exports

in 2009, and other non-E&E manufactured goods is likely to soften in 2011. Already,worldwide semiconductor sales eased to 37.0% yoy in July, from +42.6% in June and

after reaching a high of +59.9% in March. This suggests that a sharp rebound in sales

due to a spike-up in demand and inventory rebuilding are normalising. As a whole, in

tandem with a slowdown in the global demand, we expect the countrys realexports

to slow dow n to 7.6% in 2011, from an estimate of +11.7% in 2010.

Domestic Demand Will Likely Be Resilient

While exports are likely to slow down, domestic demand will likely be resilient, on the

back of a sustained increase in consumer and business spending, albeit at a more

moderate pace. As a result, we expect domestic demand to hold up at 5.5% in

2011, albeit at a more moderate pace, compared with +5.6% estimated for 2010 and

-0.5% in 2009 (see Table 1). In line with a weaker export growth, which will likely

translate into a slowdown in production and employment, consumers are likely to turn

cautious in spending. As a result, consumer spending is projected to moderate to

5.4% in 2011, but remain relatively strong compared with +5.6% estimated for 2010.

Apart from weaker job prospects, the reinstatement of employees contribution to the

Employees Provident Fund (EPF) back to 11%, from 8% when it was cut in 2009, will

likely affect consumer spending somewhat. Consumer spending, however, will likely

remain resilient, on the back of high savings and rising consumerism.

In tandem with a slowdow n

in g l oba l demand , we

expect the countrys real

exports to s low down to

7.6% in 2011

We expec t domes t i c

demand to hold up in 2011,

albeit at a more moderate

pace

Consumer spend i ng i s

projected to moderate in

2011

2007 2008 2009 2009 2010 2010(e) 2011(f)

2Q 3Q 4Q 1Q 2Q

% Growth in Real Terms

GDP 6.5 4.7 -1.7 -3.9 -1.2 4.4 10.1 8.9 7.3 5.0

Consumption:

Private 10.5 8.5 0.7 0.3 1.3 1.6 5.1 7.9 5.6 5.4

Public 6.6 10.7 3.1 1.5 9.4 0.7 6.3 6.9 -0.4 4.5

Total investment 9.4 0.7 -5.6 -9.6 -7.9 8.2 5.4 12.9 9.7 6.3

Private 13.1 1.0 -17.2 n.a n.a n.a n.a n.a 8.6 7.8

Public 5.3 0.5 8.0 n.a n.a n.a n.a n.a 10.8 4.9

Goods & services:

Exports 4.1 1.6 -10.4 -17.9 -12.9 6.0 19.3 13.8 11.7 7.6

Imports 5.9 2.2 -12.3 -19.4 -13.2 7.0 27.5 21.9 16.5 8.4

Agg.domestic demand 9.6 6.8 -0.5 -2.2 0.1 2.8 5.3 9.0 5.6 5.5

(f): RHBRI's forecasts (e): RHBRIs estimates

Table 1

GDP By Demand Aggregate (2000=100)

Chart 9

China: Fixed-Asset Investment, Retail Sales And

Industrial Production Softening

% yoy % yoyRetail sales(LHS)

0

5

10

15

20

25

00 01 02 03 04 05 06 07 08 09 10

0

10

20

30

40

50

60

Fixed asset

Ip i(LHS)


7/13

ECONOMIC OUTLOOK7

Similarly, we expect businesses to slow down their investment due to economic

uncertainties. In addition, the surge in the ringgit in a short span of time, coupled with

the removal of subsidies and rising borrowing costs which happened at around the

same time, is likely to squeeze companies earning and make the business environment

more challenging, especially for exporters. As a result, the private investment is

envisaged to soften to 7.8% in 2011, after recovering to +8.6% estimated for 2010.

In the same vein, public investment is projected to expand at a slower pace of

4.9% in 2011, after two consecutive years of strong growth, as the previous two

years growth was boosted by the Governments stimulus spending which will unlikely

be repeated next year. Consequently, we expect fixed capital formation to ease

to 6.3% during the year, from +9.7% estimated for 2010. A stronger growth in public

consumption, however, will likely help mitigate the slowdown. We expect public

consumption to grow by 4.5% in 2011, after slipping into a contraction of 0.4% estimated

for 2010.

Further Cut In Budget Deficit Likely

The budget deficit reached a high of 7.0% of GDP in 2009, the highest in 22 years,

caused mainly by the implementation of two economic stimulus packages to cushion

the economy from the severe global recession. However, the Government has begun

to consolidate its fiscal position in 2010. As a result, the Government expects itsbudget deficit to be reduced to 5.3% of GDP or RM40.3bn in 2010. We expect the

fiscal consolidation to continue into 2011 and the Government will likely

cut its budget deficit further to 4.2% o f GDP or RM34.5bn during the year

(see Table 2). This is likely to be carried out through a reduction in the Governments

expenditure, particularly development spending, as we believe it is not ready to

broaden its tax collection via an introduction of the Goods & Services Tax (GST).

We believe the Government is likely to cut its gross development expenditure

by about 19% in 2011. This will bring the total development expenditure to

RM43.8bn, compared with an estimate of RM54.2bn in 2010. During the year, we

believe the Government will likely shift its expenditure on physical hardwareto

soft infrastructure where the latters share has been raised to 40% of its totaldevelopment spending in the 10th Malaysia Plan (10MP), from 22% in the 9MP. This

implies that construction companies, particular small- and medium-sized contractors

that are involved in building construction and utilities works, are likely to be affected,

in our view. On the other hand, we expect companies that provide training & upgrading

of skills to benefit from the Governments development spending in 2011.

Businesses will slow dow n

the i r i nves tment due to

economic uncertainties

Pub l i c i nves tment i s

projected to expand at a

slower pace in 2011

We expec t t he f i s ca l

consolidation to continue

i n t o 2011 and t h e

Government will l ikely cut

its budget deficit to 4.2%

of GDP during the year

The Government is likely to

cut its gross development

expenditure by about 19%

in 2011 and sh i f t i t s

expenditure to build soft

infrastructure

Table 2

FEDERAL GOVERNMENT FINANCIAL POSITION

2008 2009 20101(e) 2011(f) 2010(e) 2011f)

(RM bil) (% , change)

Revenue 159.8 158.6 160.9 167.3 1.4 4.0

Operating Expenditure 153.5 157.1 147.5 158.6 -6.1 7.5

Current balance 6.3 1.5 13.4 8.7

Gross development expenditure 42.8 49.5 54.2 43.8 9.5 -19.2

Less : Loan recoveries 1.0 0.6 0.5 0.6

Net development expenditure 41.9 49.0 53.7 43.2 9.6 -19.5

Overall balance -35.6 -47.4 -40.3 -34.5

% to GDP -4.8 -7.0 -5.3 -4.2

1 Budget estimate, excluding 2009 tax measures

e : Estimates f : RHBRIs ForecastsSource : MOF's Economic Report 2009/2010, EPU


8/13

ECONOMIC OUTLOOK8

After a sharp cutback in operating expenditure (OE) in 2010, we do not expect the

Government to do the same in 2011. Instead, we expect the Government to raise

its OE by 7.5% in the 2011 Budget, in tandem with a pick-up in its revenue as the

economy returns to growth. This is likely to be reflected in a pick-up in its expenditure

on emoluments, debt servicing, supplies & services, grants & transfers and other

expenditure. These are likely to be partially offset by a slight drop in subsidies.

Manufacturing And Services Sectors To Lead The Slowdown

On the supply side, the manufacturing and services activities are likely to lead the

slowdown, in line with weaker trade activities, while business and consumer spending

are likely to moderate as well. Also, construction activities will likely ease but will

likely be mitigated by a pick-up in agriculture and mining output during the year.

Value added in the manufacturingsector is projected to ease to 8.0% in 2011,

after picking up to +12.3% estimated for 2010 (see Table 3), on account of a slowdown

in exports and domestic demand. Already, output of the export-oriented industries

moderated to 12.3% yoy in June, from +16.8% in May and after reaching a high of

+21.3% in March. This was on account of a moderation in the production of E&E

products; wood & wood products; rubber products; petroleum products; and paper,

pulp & board products. These were, however, mitigated by a pick-up in the production

of chemical products and a smaller decline in the production of textile & apparelsduring the period. Similarly, output of domestic-oriented industries softened to 16.6%

yoy in June, the slowest in four months and after reaching a high of +24.0% in May.

This was due to a slowdown in the production of construction-related materials,

particularly iron & steel and fabricated metal products, consumer-related products

such as food, and transport equipment.

Similarly, we envisage the broad services sector to expand at a more moderate

pace of 4.6% during the year , after a rebound to an estimate of +6.3% in 2010, as

businesses and consumers turn cautious in spending and trade activities slow. The

slowdown in services activities will likely be reflected in slower increases in activities

in utilities, transport & storage, communications and real estate & business sub-sectors.

Similarly, a slowdown in consumer spending and tourist arrivals will likely result in a

slowdown in wholesale & retail trade and accommodation & restaurants sub-sectors.

In the same vein, government services will likely slacken during the period due to

fiscal consolidation. Activities in finance & insurance sub-sector, though moderating,

will likely be resilient in 2011.

Construction activities are also likely to slow dow n to 2.8% in 2011 , after

moderating to +4.2% estimated for 2010 and compared with +5.8% in 2009, as growthin the previous two years was boosted by the Governments stimulus spending. As a

result, the civil engineering sub-sector is projected to grow at a more moderate pace

during the year. Similarly, construction activities in the residential property sub-sector

will likely ease somewhat in 2011, after picking up for about one-and-a-half years,

W e ex p e c t t h e

Government to raise its OE

in 2011 , in tandem with a

pick-up in its revenue as

the economy returns to

growth

The manufacturing sector

g rowth i s p ro j ec t ed t o

ease , on ac coun t o f a

slowdown in exports and

domestic demand

Table 3

GDP By Industrial Origin At 2000 Prices

2007 2008 2009 2009 2010 2010(e) 2011(f)

2Q 3Q 4Q 1Q 2Q

% Growth in Real Terms

GDP 6.5 4.7 -1.7 -3.9 -1.2 4.4 10.1 8.9 7.3 5.0

Agriculture 1.3 4.3 0.4 0.4 -0.4 5.9 6.8 2.4 3.3 3.5

Mining 2.0 -2.4 -3.8 -3.5 -3.6 -2.8 2.1 1.9 2.1 2.3

Manufacturing 2.8 1.3 -9.4 -14.5 -8.6 5.0 17.0 15.9 12.3 8.0

Construction 7.3 4.2 5.8 4.5 7.9 9.3 8.7 4.1 4.2 2.8

Services 10.2 7.4 2.6 1.7 3.4 5.2 8.5 7.3 6.3 4.6

(f): RHBRI's forecasts (e): RHBRIs eatimates

Serv i ces ac t i v i t i e s a re

likely to moderate, as busi-

nesses and consumers turn

cautious

Construction sector is also

projected to slow down, as

growth in the previous two

years was boosted by the

Gove rnment s s t imu lus

spending


9/13

ECONOMIC OUTLOOK9

while construction activities in non-residential property sub-sector are still ongoing.

As it stands, new permits for sales and advertising of houses strengthened to 22.6%

yoy in 1H 2010, from +12.3% in 2009, while renewal permits fell by 21.0% yoy, after

rising by 15.0% during the same period. In the same vein, housing approvals by the

Ministry of Housing and Local Government gained another 10.3% yoy in 1H 2010,

after picking up by 4.2% in 2009.

The agriculture sector, however, is envisaged to strengthen to 3.5% during

the year, after a gain of 3.3% estimated for 2010. This will likely be driven by a pick-

up in palm oil production during the year, after going through two consecutive years

of lacklustre performance. In 1H 2010, palm oil production grew modestly by 0.7%

yoy, after slipping into a contraction of 1.0% in 2009 and from +12.1% in 2008.

Slower growth in the production of rubber and saw logs, however, will likely offset

part of the gain. In 1H 2010, rubber and saw logs output bounced back strongly to

increase by 17.4% and 25.0% yoy respectively, after two consecutive years of

contraction in 2008-09. Meanwhile, the non-commodity sub-sector such as fisheries,

livestock and crops will contribute to growth as well, on the back of the implementation

of various projects by the Government.

Similarly, we expect mining output to inch up to 2.3% in 2011, from +2.1%

estimated for 2010. This is mainly on account of a pick-up in the production of liquefiednatural gas (LNG) due to higher demand. Already, LNG output rebounded to increase

by 9.3% yoy in 1H 2010, from -3.7% in 2009 and +0.1% in 2008. This will likely be

aided by a smaller drop in crude oil production, which contracted by a smaller magnitude

of 2.8% yoy in 1H 2010, compared with -4.1% in 2009 and +0.8% in 2008.

Softer Monetary And Loan Growth Envisaged In 2011

The broader money supply, M3, moderated to +8.1% yoy in July, from +8.8% in June

and after reaching a recent high of 9.3% in May. This was the second straight month

of easing, suggesting that the underlying economic activities have softened. The

slowdown was in line with a slowdown in government operations, as the Governments

stimulus spending is dissipating. This was made worse by a slowdown in demand forfunds by the private sector, on account of a more moderate loan growth and a slower

increase in the issuance of securities. These were, however, mitigated by a pick-up in

net external operations, on account of an inflow of foreign portfolio funds. Going

forward, we expect M3 growth to moderate to around 8.0% in 2011, from+8.7%

estimated at end-2009, in line with a slowdown in economic activities. Despite the

softer growth, monetary policy wil l l ikely remain supportive of economic

growth in 2011.

Similarly, loan growth eased to 11.9% yoy in July, after rising to a high of +12.5% in

June. This was the first easing after three consecutive months of picking up, suggesting

that loan growth is beginning to soften in line with a more moderate increase in

economic activities. This was attributed to a slowdown in corporate loans, which was

mitigated by a pick-up in household loans during the period. Our estimate shows that

corporate loans eased to 14.0% yoy in July, after reaching a peak of 15.6% in June.

This was the slowest pace of growth in three months due mainly to a slowdown in

loans given to the agriculture, utilities, construction, real estate and education &

healthcare sectors. These were, however, mitigated by a pick-up in loans extended to

the mining & quarrying and manufacturing industries. Household loans, on the

other hand, strengthened to +13.2% yoy in July, the highest in more than three years

and compared with +12.9% in June. This was due to a pick-up in loans extended for

the purchase of passenger cars and houses as well as for credit cards during the

month. Going forward, we expect the banking systems loans to moderate to around

8.5% in 2011, from 10.5% estimated for 2010, in tandem with the slowdown in the

economy.

In terms of asset quality, the 3-month net impaired loan ratio of the banking system

remained stable at 2.2% of total loans for the third consecutive month in July, after

rising from 1.9% in March and compared with a low of 1.8% in December last year.

The slight uptick in net impaired loan ratio might have been caused by a deterioration

M3 g ro w t h w i l l l i k e l y

moderate in 2011, but the

monetary policy will likely

be supportive of economic

growth

Mining output w ill likely inch

up due t o h i ghe r LNG

outpu t and a sma l l e r

dec l i ne i n c rude o i l

production

Agriculture output is envis-

aged to s t rengthen due

mainly to a pick-up in palm

oil production

We expec t t he bank i ng

systems loans to ease in

2011, in tandem with the

slowdow n in the economy


10/13

ECONOMIC OUTLOOK10

in asset quality system wide due to the lagged effect of the recession in 2009, and

banks adopting the FRS139. According to Bank Negara Malaysia (BNM), beginning

Jan 2010, loans are reported based on the FRS139, although adoption by the various

banks would still depend on their respective FYE. Going forward, we expect the

banking systems 3-month net impaired loan ratio to ease slightly to 2.0% by

end-2011, from 2.2% estimated for end-2010.

Sustained Large Current Account Surplus Which Will

Remain Supportive Of The Ringgit

In tandem with a slowdown in the economy, we expect merchandise trade balance to

record a larger surplus during the year. At the same time, we envisage deficit in the

services account to narrow due to lower payment for transportation charges as imports

slow down. These, however, will likely be offset partially by a widening deficit in the

income account during the year, as repatriation of profits by non-resident controlled

companies is likely to remain large, while Malaysian corporations will likely bring back

less profits into the country. Repatriation of salaries and wages by foreign workers,

on the other hand, is likely to remain stable during the year. As a whole, we expect

the current account surplus of the balance of payments to widen marginally to

around RM98.6bn or 12.4% of GNI in 2011, from a surplus of RM97.1bn or 13.0%

of GNI estimated for 2010 (see Table 4). This will help to build up the countrysforeign exchange reserves and fuel domestic liquidity in the financial system. Indeed,

excess liquidity (including repos) mopped up by the Central Bank from the banking

system inched up to RM218.1bn at end-August, from RM214.4bn in mid-August 2010

and compared with RM223.3bn at end-2009.

In the same vein, the financial accountwill likely record a smaller outflow of

capital , as Malaysian investors turn cautious on the back of rising economic

uncertainties. As a result, we envisage outflow of capital to narrow to around RM45.5bn

in 2011, from -RM53.0bn estimated for 2010. This is on account of a slowdown in

Malaysians other investments abroad, as they turn cautious given prospects of a

slowdown in the global economy. Similarly, we expect outward direct investment toslow down, leading to a net inflow of foreign direct investment (FDI) during the year,

a turnaround from a smaller net outflow estimated for 2010. These, however, will

likely be offset partially by a smaller inflow of portfolio investment in 2011, as economic

growth in the investing country turns softer.

The banking systems 3-

month net impaired loan

ratio is projected to ease

sl ightly to 2.0% by end-

2011

The cu r ren t ac coun t

surplus of the balance of

payments is projected to

widen marginally in 2011

The financial account will

l i k e l y re co rd a sma l l e r

outflow of capital in 2011

Table 4

Balance Of Payments

2008 2009 2009 2010 2010(e) 2011(f)

2Q 3Q 4Q 1Q 2Q

(RMbn)

Current account 129.5 112.1 28.0 25.4 27.4 30.4 16.2 97.1 98.6

(% of GNI) (18.1) (16.8) n.a n.a n.a n.a n.a (13.0) (12.4)

Goods 170.6 141.8 33.2 33.4 37.9 45.0 30.8 143.1 145.2

Services 0.2 4.7 1.5 0.6 -0.1 -0.1 -0.4 -1.4 -0.9

Income -23.7 -14.6 -2.9 -1.7 -5.6 -8.9 -8.6 -26.1 -27.2

Current transfers -17.5 -19.6 -3.9 -6.8 -4.8 -5.6 -5.6 -18.5 -18.5

Capital account 0.6 -0.2 -0.0 -0.0 -0.0 -0.1 -0.1 0.0 0.0

Financial account -118.5 -80.2 -22.3 -9.4 -17.4 -19.5 0.8 -53.0 -45.5

Errors & omissions* -29.9 -17.9 -3.5 -4.5 -13.0 -30.5 -18.8 -50.0 -25.0

Overall balance -18.3 13.8 2.1 11.5 -3.0 -19.6 -1.9 -5.9 28.1

Outstanding reserves^ 317.4 331.4 322.9 334.4 331.4 311.8 309.8 325.4 353.5

(US$)^ 91.5 96.7 91.5 96.0 96.7 95.3 94.8 94.9 103.7

(f): RHBRI's forecasts (e): RHBRIs estimates ^As at end-period

*Reflect mainly revaluation gains/losses from Ringgit depreciation/appreciation and statistical discrepancies


11/13

ECONOMIC OUTLOOK11

The ove ra l l ba l ance o f

payments is projected to

record a surplus in 2011

We expect the ringgit to

f l u c t ua t e a t a roundRM3.10-3.20/ US$ for the

res t o f 2010 , be fo re

settling at RM3.10/ US$ in

2011

Inflation rate picked up to

t he f as t es t pace i n 14

months in July

As a whole and after taking into account a smaller deficit in errors & omissions, the

overall balance of payments is projected to record a surplus of around RM28.1bn

in 2011, compared with a decline of RM5.9bn estimated for 2010. Consequently, the

countrys foreign exchange reserves will likely increase to US$103.7bn by end-2011,

from an estimate of US$94.9bn at end-2010.

The build-up in foreign exchange reserves will continue to provide an underlying

support to the ringgit. As it stands, the ringgit has already turned around and

strengthened against the US dollar in recent months. Between 18 June and 9

September, the ringgit appreciated by 4.4% against the US dollar, after falling by

2.0% between 1 May and 18 June. Year-to-date, the ringgit has appreciated by 9.9%

against the US dollar, the strongest gain in the region. This was due partly to the

improving sentiment over regional currencies, after China said that it would adopt a

more flexible exchange rate on 18 June. A widening interest rate differential in

favour of Malaysia versus the US, after Bank Negara Malaysia raised its key policy

rate three times and by a total of 75 basis points this year, also helped. The liberalisation

of administrative rules on foreign exchange transactions by the Central Bank on 18

August and the move by China to add the ringgit to a small group of currencies that

are allowed to be traded directly against the renminbi on 19 August further boosted

the ringgit. Before the addition of the ringgit, the only few currencies with that privilege

were the US dollar, pound sterling, yen, euro and Hong Kong dollar. The news sentthe ringgit to a near 13-year high of RM3.1288/US$ on 19 August, before easing back

slightly the next day. Also, the ringgit has been pushed up by the inflow of hot

money, which has risen to a 2-year high. As the hot money could come and go at

anytime, we expect the ringgit to remain volatile and w ill likely fluctuate at

around RM3.10-3.20/US$ for the rest of 2010. Going forward, we expect the

ringgit to settle at RM3.10/US$ in 2011.

Change In Administrative Pricing Will Lead To Higher Inflation

Inflation rate picked up to 1.9% yoy in July, from +1.7% in June and a low of

+1.2% in February (see Chart 10). This was the fastest rate of increase in 14 months

and the fifth consecutive month of rising, due partly to the removal of fuel and sugarsubsidies in mid July by the Government and partly the lower base effect given that

inflation contracted by a larger magnitude in the same month last year. As a result,

the core inflation rate inched up to 1.4% yoy in July, after remaining stable at 1.2% in

the last three consecutive months. This was attributed to a pick-up in the costs of

transport, which accelerated to 2.0% yoy in July, from +1.3% in June, on the back of

the increase in fuel prices by around 3%. A pick-up in the costs of housing, water,

electricity, gas & other fuels; and recreation services as well as prices of alcoholic

beverage & tobacco and furnishing & household products worsened the situation.

Similarly, the prices of clothing & footwear and the costs of communications fell by a

smaller magnitude during the month. In the same vein, food & non-alcohol beverage

prices grew at a faster pace of 2.9% yoy in July, compared with +2.7% in June and a

low of +0.8% in October last year.

Chart 10

Inflation Inching Up, But Not A Major Threat

% yoy

CoreC P I

Total

-6

-4

-2

0

2

4

6

8

1 0

1 2

0 5 0 6 0 7 0 8 0 9 1 0


12/13

Going forward, inflation is expected to increase at a faster pace due to the

Governments move to gradually reduce its subsidies once every six months that will

lead to higher retail fuel and food prices. Already, the Government raised fuel prices

by around 3% and sugar price by 16.7% on 16 July. Our estimates showed that the

increase would add 0.2 percentage point and 0.08 percentage point respectively to

the CPI. This, together with some spill-over effect, will likely push up the CPI in 2H

2010 to around 2.6% yoy, from +1.4% recorded in the 1H. Further out, we expect

inflation to trend up to an average of 2.8% in 2011, from +2.0% estimated for

2010 and +0.6% in 2009.

Policy Normalisation To Resume In 1H 2011

Although the change in administrative pricing will lead to higher inflationary pressure,

we believe Bank Negara Malaysia (BNM) will unlikely act on it. As it stands, its interest

rate hikes thus far were geared towards normalising monetary conditions in the

economy rather than controlling inflation. Indeed, we believe the Central Bank is

likely to have done with its interest rate hikes this year, after raising it by a total of 75

basis points in three meetings and the OPR will likely stay at 2.75% until end-2010.

Further out, we believe the Central Bank will likely resume with its policy normalisation

and the OPR w ill likely be raised by 50-75 basis points in 1H 2011 to bring it to

a more neutral level of 3.25-3.50% by mid-2011.

We expec t i n f l a t i on t o

trend up in 2011, due to the

reduction of subsidies

BNM w ill likely resume with

its policy normalisation and

the OPR w ill likely be raised

by 50-75 basis points in 1H

2011


13/13

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This report does not provide individually tailored investment advice. It has been prepared without regard to the individual financialcircumstances and objectives of persons who receive it. The securities discussed in this report may not be suitable for all investors.RHBRI recommends that investors independently evaluate particular investments and strategies, and encourages investors to seekthe advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investors individual

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RHBRI and the Connected Persons (the RHB Group) are engaged in securities trading, securities brokerage, banking and financingactivities as well as providing investment banking and financial advisory services. In the ordinary course of its trading, brokerage,banking and financing activities, any member of the RHB Group may at any time hold positions, and may trade or otherwise effecttransactions, for its own account or the accounts of customers, in debt or equity securities or loans of any company that may beinvolved in this transaction.

Connected Persons means any holding company of RHBRI, the subsidiaries and subsidiary undertaking of such a holding companyand the respective directors, officers, employees and agents of each of them. Investors should assume that the Connected Personsare seeking or will seek investment banking or other services from the companies in which the securities have been discussed/coveredby RHBRI in this report or in RHBRIs previous reports.This report has been prepared by the research personnel of RHBRI. Facts and views presented in this report have not been reviewedby, and may not reflect information known to, professionals in other business areas of the Connected Persons, including investmentbanking personnel.

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economic outlook : slowing growth, but recovery on track- 08/09/2010

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