Malaysia: Pushing the pedal faster through turmoil Asia Pacific Economic Outlook, Q4 2017

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The Malaysian economy registered the fastest growth in two years for two consecutive quarters, due to stronger private spending and exports. While the growth outlook for the economy has been revised up, there are considerable risks, primarily from political uncertainty and the economy’s continued dependence on oil exports for its growth and revenue.

Introduction

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After starting the year on a firm note with first quarter growth of 5.6 percent, Malaysia posted even stronger growth of 5.8 percent in the second quarter of 2017, beating market expectations of a slight slowdown (Reuters poll forecast).1 Backed by strong domestic demand, particularly due to private sector spending, exports, and broad-based expansion across all major sectors, economic growth was the fastest in two years.

Private consumption grew 7.1 percent and private investment grew 7.4 percent annually in Q2 2017. In large part, the unexpected strength was probably because of the government cash handouts and subsidies to low-income households and housing packages to the country’s majority ethnic group, which cushioned the fall in total personal income due to weaker wages. On the other hand, improving global conditions and strong demand for electronics boosted exports, which grew strongly for the second consecutive quarter, at a rate of 9.6 percent.

On the supply side, the manufacturing and services sectors performed robustly, registering annual growth of 6.0 percent and 6.3 percent, respectively, in Q2. Double-digit growth in manufacturing product sales and retail trade since February 2017 and an above-20.0 percent growth in goods exports in the last two quarters boosted the manufacturing sector.

Improved asset quality and profitability of financial institutions and favorable funding conditions improved investors’ sentiments, which was reflected in reduced volatility in financial market performance. Credit growth remained strong as financing to the private sector, including the housing market, continued to improve.

Headline inflation declined steadily since April, primarily due to lower domestic fuel prices, although core inflation remained relatively stable. This decline is of significance because prices had escalated threefold between December 2016 and March 2017 due to the retraction of subsidies from cooking oil, rising retail prices of fuels, and appreciation of the domestic currency. The steady decline is likely a sign that their effects on prices may now be diminishing.

Spending controls and a modest rebound in global oil prices helped the government contain the fiscal deficit this quarter. At the same time, the current account surplus improved to 3.4 percent of GDP due to a larger goods surplus and smaller services and primary income deficits. Strong economic performance, together with improving fiscal and external balances, led to an improvement in the economy’s credit rating.

Outlook revised up

Following the economy’s strong performance, Malaysia’s central bank revised its growth forecast for this year from 4.3 percent to above 4.8 per cent. Domestic demand is projected to underpin this expansion. On the external front, exports are expected to benefit from the stronger-than-expected improvement in global growth. Headline inflation is expected to moderate further in the second half of 2017, reflecting the waning effect of the factors mentioned above. Inflation is expected to average within the forecast range of 3.0–4.0 percent.

That said, the economy still faces a number of headwinds, most importantly from political uncertainty ahead of elections. Prime Minister Najib Razak tweeted almost immediately after the GDP release and reaffirmation of a stable credit rating: “It is another recognition for the country’s economic management.�?2 In other words, the prime minister attributed the strong economic performance to his good governance and policy making. There is rising speculation over whether the prime minister will call for early elections to take advantage of strong economic performance and a relatively weak opposition. However, it might not be an easy election for him because of his possible connection to a scandal involving state-owned fund 1Malaysia Development Berhad (1MBD).

The economy continues to remain heavily dependent on oil exports for its revenue and growth. With oil prices expected to remain low for long, Malaysian growth will likely remain highly contingent on external factors such as global demand for oil and supply by US shale gas producers. Foreign direct investment has remained low and volatile in the past several quarters, which may point to low investor confidence in committing to long-term investments in the country, and may impact economic investment in the months ahead.

Private sector spending and exports have been the strongest contributors to growth in the past two quarters. However, the latest monthly data shows some tapering in imports of capital goods, signaling that private investment growth may have slowed down lately. Consumers are expected to continue to spend cautiously as real wages grow modestly and the effects of government handouts wane. Besides, unemployment has steadily increased in the past few quarters and currently hovers around post-global financial crisis highs. This will likely have an impact on consumer demand and may limit growth momentum.

Although strong, Malaysia’s exports grew slower in June than in previous months. Gains in shipments of electrical goods and electronics were partly offset by a drop in exports of timber and refined petroleum products, which probably implies that export growth was not broad-based. In addition, China is Malaysia’s largest trading partner, and a slowdown in China might impact trade growth.

That said, the government is aiming to achieve developed nation status by 2020 through public and private investment, primarily in infrastructure. This will likely result in higher investment in the long run. Malaysia’s working-age population is also expected to grow consistently over the forecast horizon, which will likely aid long-term growth.