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Dr Yeah Kim Leng Group Chief Economist

Briefing to Heads of Department. Malaysia’s Economic Outlook for 2012 and 2013: How resilient to a global slowdown?. RAM Economics Research. 4 th June, 2012. Dr Yeah Kim Leng Group Chief Economist. Outline. 1. Global conditions. 2. Domestic growth expectations. 3.

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Dr Yeah Kim Leng Group Chief Economist

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  1. Briefing to Heads of Department Malaysia’s Economic Outlook for 2012 and 2013: How resilient to a global slowdown? RAM Economics Research 4th June, 2012 Dr Yeah Kim Leng Group Chief Economist

  2. Outline 1 Global conditions 2 Domestic growth expectations 3 Assessment of key risks and potential impact

  3. Outline 1 Global conditions 2 Domestic growth expectations 3 Assessment of key risks and potential impact

  4. Global conditions Overview • Global manufacturing activity remains weak… • Symptomatic of easing global demand • Exacerbated by rising risk aversion Minimal growth in manufacturing and trade activity in the past 10 months

  5. Global conditions Overview • Commodity prices have stabilized but remain elevated • Risks of supply shocks (Middle East) had heightened speculation • …but is mitigated by easing global demand pressures Food prices 8.5% below April 2011 peak Oil prices 16.1% below July 2008 peak

  6. Global conditions United States • Employment situation has improved, but the American economy remains weak… • Lack of fiscal support in the economy due to political deadlock and fiscal constraints • Risk aversion remains high as a result of the European debt crisis Public sector drag on the US economy

  7. Global conditions Europe • Poor demand conditions and extended austerity programmes coupled with policy constraints will push Europe into a recession • Traditional fiscal remedies to stimulate the economy are hindered by poor public finances and restrictive legislation • Outlook for most non-exporting European nations are likely to deteriorate in the near-term as funding sources become limited. Market confidence has deteriorated since the start of 2012, increasing the relative cost of deficit funding Source: IMF and Bloomberg

  8. Global conditions China • China’s growth remains robust, but is undermined by poor external conditions and the need for structural reform… • China’s external sector is expected to slow considerably, as a substantial proportion of its exports are directed to the weakened advanced economies • This will have strong implications on its economic development – should domestic demand weaken – as well as regional growth and commodity prices

  9. Outline 1 Global conditions 2 Domestic growth expectations 3 Assessment of key risks and potential impact

  10. Domestic growth expectations GDP • Economy expanded by 4.7% in 1Q 2012 • Supported by robust private sector growth • Substantial improvements in gross fixed investment growth • However, weak external conditions had slowed growth

  11. Domestic growth expectations GDP (cont.) • Near-term growth outlook supported by private investments • Domestic demand conditions still remain adequately stable • Weak external sector may slow certain sectors of the economy, but is mitigated by China’s robust growth Substantial growth in private investments and construction activity

  12. Domestic growth expectations Consumption • Consumption supported by healthy employment levels and policy measures • Relatively steady employment generation had enabled the robust growth in private consumption • The increases in public sector wages and enactment of minimum wage will boost domestic consumption Significant employment generation in 2011

  13. Domestic growth expectations Investments • Domestic private sector investment activities had picked up • Spurred on by Government initiatives to boost investments • An accommodative interest rate environment had supported capital formation • Lower investor risk aversion had supported financing capability through domestic banks and the bond markets Lower and more stable market risk aversion

  14. Domestic growth expectations Public sector • Pre-election expenditure and development programmes will ensure public sector growth in the near-term • Commitments to various ETP projects and supporting infrastructure will likely cause Government development expenditure to increase • Boost to public sector wages has already affected the growth in operating expenditure in 2011, and is likely to continue this year

  15. Domestic growth expectations External sector • As commodity prices stabilize, export earnings have decelerated • The uneven growth conditions in Malaysia’s major export destinations had caused some volatility in export earnings • Speculation of weaker global demand had slowed the growth of commodity prices and had suppressed export earnings as well Deceleration of commodity export earnings growth

  16. Domestic growth expectations Key industrial indicators • Slight rebound in export-oriented manufacturing in 1Q 2012 • However a more sustainable growth would require external conditions to normalize • Domestic-oriented industries benefit from robust domestic demand growth and Government initiatives to promote private investments Currently, industries are only operating slightly above their long-term capacity rates

  17. Domestic growth expectations Construction activities • Construction activity grew significantly in 1Q 2012 • Supported by robust domestic demand and various Government initiatives • A relatively accommodative interest rate environment had also allowed sufficient demand for construction activity, especially with regard to residential and non-residential construction Source: DOS Significant residential and non-residential construction activity

  18. Domestic growth expectations Services activities • Sustained growth in the services sector • Robust domestic demand through rising wages and employment continues to support the services sector • However, recent BNM responsible lending guidelines may have slowed domestic consumption activity in 1Q 2012. This effect is expected to normalize over time as banks adopt more sustainable lending practices.

  19. Domestic growth expectations Inflation • With the subsidy scheme intact, domestic price pressures are driven by improving demand conditions • Price pressures from food and transport components of the CPI have been minimal as subsidies remain intact • However, demand pressures had accelerated other components of the CPI Clear and sustained divergence in growth rates in recent months

  20. Domestic growth expectations Interest rates • BNM has held the OPR at 3.00% since April 2011 • The benign pace of inflation has pushed the adjusted OPR to near pre-crisis levels • In-house calculation suggests that Malaysia currently operating at its potential output • BNM not seen to adjust interest rates as it has to balance the risk of domestic growth from the European debt crisis against the recent acceleration in household loans

  21. Domestic growth expectations Exchange rate • High global risk aversion to growth suppressed the appreciation of the ringgit • Heightened risk aversion in recent months had caused the demand for safe haven assets such as the US Treasury to increase; thereby depreciating the ringgit • There have been some exchange rate effects on Malaysia’s trade balance since mid-2010 Inverse relationship between REER and trade balance

  22. Domestic growth expectations Banking sector • Banking system remains stable • Well positioned to meet Basel III requirements • Non-performing loans ratio remains low at 2.5% but is unevenly distributed across sectors • Relatively rapid growth in loans is a potential risk, but mitigated by BNM’s responsible lending guidelines

  23. Domestic growth expectations Bond market • Bond market experienced healthy growth • Increased risk appetite for longer-tenured Malaysian Government Securities • Increased participation in the PDS market in 2011 with RM69.6 billion issued (33.6% increase from the previous year). Large issuances in 1Q 2012 suggest that bond markets will continue to be a stable funding source for the private sector • Improving domestic demand conditions coupled with Government initiatives are likely to spur the bond market this year Increased in foreign participation in the MGS market

  24. Domestic growth expectations Fiscal conditions • Pre-election spending and government initiatives to spur growth prevent substantial fiscal consolidation • Commitments to ETP projects and the continuation of the subsidy programmes limit Government’s efforts to reduce the fiscal deficit despite efforts to improve the delivery system • However, domestic financing conditions remain sufficiently healthy for medium-term deficit financing

  25. Domestic growth expectations Key domestic policy announcements • BNM responsible lending guidelines • Will have a short-term adverse impact on consumption and lending activity • Unlikely to cause a significant structural setback • Various ETP & GTP announcements • Will enhance investor confidence • Spur domestic demand activity through multiplier effects of the investments • Budget 2012/13 • Growth-oriented budget is likely to be announced • However, much needed structural reforms are needed to sustained ETP-target growth rates • Minimum wage • Unlikely to have significant labour market impact in urban areas • May heighten inflationary expectations going forward

  26. Domestic growth expectations Key assumptions for growth projections • No Eurozone breakup, but weak global conditions • Quite likely a ‘kick-the-can-down-the-road’ scenario will occur until sufficient structural adjustments are made in Europe • As a result global demand conditions are expected to remain weak • Stable commodity prices • Due to the reduced risk of supply shocks and slower China growth • Assumes that global manufacturing activity will not be adversely affected by it • Growth-oriented domestic public policy • The Government is likely to step in and provide sufficient support to domestic growth prior to the elections. Further stimulus – monetary and fiscal – will be warranted should external conditions deteriorate

  27. Domestic growth expectations Key estimates

  28. Outline 1 Global conditions 2 Domestic growth expectations 3 Assessment of key risks and potential impact

  29. Assessments of key risks and potential impact External risks • Eurozone breakup • A possibility – the degree of impact depends on the ability of policy makers to ensure an orderly breakup and limit contagion risk • Regardless, will adversely affect investor confidence and may cause an appreciation in safe haven assets • Further fiscal drag in America • Will further slow consumption in the world’s single largest economy affecting global demand • Political brinkmanship will delay much needed fiscal assistance during this weakened period • Commodity price shock • While commodity price shocks in the short-term benefit Malaysian (a net commodity exporter), over the long-term it can suppress industrial activity and may thus affect global demand

  30. Assessments of key risks and potential impact Domestic risks • Unwarranted spikes in inflation • Heightened inflationary expectations – due to minimum wage and robust domestic demand – may cause domestic prices to remain on the upward trend • Will have significant implications on public finances which maintain domestic subsidies • Policy mis-steps • Mistiming or underestimating the severity of a possible external demand shock can reduce the potential output of the economy • The relatively accommodative monetary policy stance may have to be reviewed should the domestic economy grow faster than anticipated

  31. Thank you Thank you RAM Economics Research Level 19, The Gardens South Tower Mid Valley City, LingkaranSyed Putra 59200 Kuala Lumpur Tel: (603) 7628 1000 www.ram.com.my

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