Economy: As rosy as it looks?

KUCHING: It has been a tough year so far for the global economy.

With growth prospects remaining shady since the start of the year, amid concerns of a more subdued recovery in the US and Chinese economies, specialists note that global gross domestic product (GDP) will not likely to meet targets.

Global GDP growth is likely to average around three to 3.5 per cent this year, which is not much of an improvement compared to 2012, outlined OCBC Bank (Malaysia) Bhd economist Selena Ling in a statement to the press.

“More importantly, there is still some distance away from the 4.8 per cent average in the five-year period before the onset of the 2008 Great Financial Crisis,” she highlighted.

Ling noted that the path of recovery looks to be more divergent than ever among the developed economies.

While financial markets have stabilised in the eurozone and risks of another sovereign default in the region are significantly lower compared to six months ago, the real economy remains in the doldrums, she affirmed, with record high unemployment still weighing on any probability of a quick turnaround story.

“Malaysia’s growth prospects have also come under pressure, with performance missing market expectations,” Ling commented.

OCBC consequently downgraded its 2013 GDP forecast for the Malaysian economy to five per cent year-on-year (y-o-y) from 5.4 per cent previously.

Elections caused slowdown

RHB Research Institute Sdn Bhd (RHB Research) director Lim Chee Sing in his report on the 2H13 outlook attributed the slowdown in economic growth – from a positive 6.5 per cent y-o-y in 3Q12 to 4.1 per cent in 1Q13 – to the sharp slowdown in business investment due to the uncertain election outcome.

“This was made worse by sustained soft external demand for the country’s exports, at a time when resilient domestic demand continued to suck-in imports,” Lim further added.

“Post-election, anecdotal evidences are, however, pointing to a gradual recovery in business investment, which coupled with the progress in the implementation of long gestation infrastructure related projects, would point to a stronger economic growth in the 2H of the year.

“As external demand for the country’s exports picks up and private investment gains further traction, we envisage real GDP growth to pick up to 5.4 per cent in 2014, from 5.1 per cent estimated for 2013.

“Meanwhile, the removal of election overhang should lead to a pick-up in business activities, which is positive for both news flow and earnings growth for the sector as banks finance various sectors in the economy.”

Still demonstrating resiliency

Nevertheless, OCBC’s Ling noted that in Malaysia, the domestic economy has remained robust so far this year as investment growth continued to be strong (at 13.2 per cent y-o-y in 1Q13), supported by strong growth in both private and public investment (at 10.9 per cent y-o-y and 17.3 per cent y-o-y respectively.)

“Despite earlier concerns that political uncertainties might have weighed on investment growth in the country, the 1Q GDP data indicated that Malaysia’s longer-term growth potential has been the more important driving factor of domestic growth,” Ling said.

“The government’s commitment to deliver the targets embedded in the Economic Transformation Programme (ETP) remains firmly in place, and we expect the frontloading of infrastructure projects to sustain economic growth towards the year-end.

“This is also evident from the fact that monthly data of capital good imports continue to suggest sustained demand for infrastructure-related goods.”

Ling also underscored the importance of the spillover impact from Malaysia’s investment growth since 2012 which would continue be the underlying support for private consumption, whose growth is likely to sustain at more than 7.5 per cent this year.

Meanwhile, RAM Ratings Services Bhd (RAM) senior economist Jason Fong also painted a rosy picture for the Malaysian economy within the first six months, noting that the country saw healthy private debt issuances and optimistic labour market conditions.

“THE Malaysian economy demonstrated its resiliency in 1H13, underpinned by robust domestic demand conditions despite intermittent periods of external volatility and the uncertain investment climate in the lead up to the general elections.

“Domestic economic activity is underscored by healthy private debt issuances, which at RM44.5 billion in the first six months of this year (1H12: RM58.2 billion) is within our expectations; and growth in business loans as well as rising capital imports.

“Furthermore, labour market conditions remain supportive of domestic consumption due to ongoing ETP-related projects.”

Exports

Turning our focus towards exports, OCBC’s Ling was not surprised by the lacklustre export growth so far in the first half of the year as demand for manufacturing exports remained weak.

“In addition, global commodity prices have hit another soft patch in 2Q13,” Ling stated. “Malaysia’s trade balance hit a 16-year low of RM0.9 billion in April 2013, highlighting the sharp divergence between the domestic vis-a-vis the external economic momentum.

“We expect the drag from export growth to persist in 2H2013, given that a significant turnaround in global economy is still unlikely to occur while pressure on global commodity prices may persist especially if concerns over China’s growth prospects continue to persist going forward.”

Meanwhile, RAM’s Fong appended that structural weakness in the advanced economies – as evidenced by high unemployment rates in Europe and the US as well as the short-lived banking crisis in Cyprus – had caused Malaysia’s export earnings to contract by 2.7 per cent in the first four months this year (year-to-date April 2012: 2.6 per cent growth).

“As the economic recovery remains fragile in most advanced economies (the exception being the European Union, which is expected to undergo a recession due to its fiscal austerity measures), commodity prices had been depressed and had adversely affected various sectors of the Malaysian economy.”

Inflation pressures rising

Notably, inflationary pressures have ticked up in 1H2013 but at a slower pace from what OCBC’s Ling had expected earlier this year.

“A combination of low base effects, rising prices and supply-side pressures from rising wages is likely to mean that inflation will inch back towards three per cent at the year-end, although this is still within the official comfort zone,” she opined.

Coupled with the fact that growth momentum has slowed this year, Ling expected the authorities to maintain its benchmark overnight policy rate (OPR) steady for the rest of the year.

That said, it is interesting to note that financial conditions have continued to tighten in the Malaysian economy, driven largely by the relative outperformance of the ringgit since the latter half of last year.

“The implicit tolerance of a strong ringgit has been partly driven by the need to support domestic demand, particularly to bolster investment growth in the economy.

“This means that there is some potential room for the authorities to provide some monetary stimulus on the currency front, particularly considering the downside risks to growth stemming from the lacklustre external demand.”

Fong from RAM noted the possibility of widespread US dollar strength amidst the anticipated third quantitative easing (QE3) tapering by the US Federal Reserve is likely to be the dominant factor that will dictate global currency markets towards the year-end.

“The possibility of widespread US dollar strength amidst the anticipated QE3 Market movements may remain volatile as policy uncertainties loom at this juncture, as already witnessed in the first two weeks of June.”

Considering the fact that the QE3 tapering prospect is highly dependent on data from the US in the coming couple of months, financial markets could remain on tenterhooks until there is greater clarity as to the Fed’s exit strategy, Fong said.

“Of late, we have been pencilling in a widespread USD strength in our foreign exchange forecasts and at this juncture, we think that the US dollar-ringgit may remain supported above 3.1000 at year-end.”

Expectations for the economy for 2H2013

Looking ahead, RAM believed Malaysia will continue to exhibit its resilience in the second half of 2013, with domestic demand being a key growth driver for the remainder of this year backed by supportive labour market and monetary conditions.

“Ongoing – both private and public sector – projects are expected to increase domestic productive capacity and provide some positive economic multiplier impact,” the senior economist added.

“While Europe is expected to undergo a recession this year, other advanced economies such as the US and Japan are expected to recover on the back of supportive policies and contribute to Malaysia’s export sector.

“Currently, RAM is maintaining a forecast of 5.3 per cent GDP growth for 2013 but we are cognisant of the heightened downside risk to the forecast arising from a weaker-than-anticipated global recovery this year.”

As domestic economic activity remains relatively robust this year, interest rates are expected to remain stable for 2013, he added.

However, there is a possibility of an interest rate hike of 25 basis points if domestic credit or asset prices grow beyond a sustainable pace.

Currently, inflationary expectations remain below our initial forecast of 2.5 per cent but remains sensitive to the domestic policy environment – in particular with regard to the prices of controlled goods – and the pace of economic expansion in the second half.

The fundamental strength of the ringgit remains intact, but is still subject to global monetary conditions.

The key risk to RAM’s forecast is the latest economic developments from China, where policymakers are currently implementing plans to rebalance their economic structure.

The rebalancing of the Chinese economy will make it less trade-dependent and may have some bearing on domestic exports as China is Malaysia’s largest export destination.

“Some structural weaknesses in China are also evident, especially through their rapid growth in credit from both formal and informal sources. Policies to slow credit growth to a sustainable pace may negatively impact China’s economic performance.

“Separately, Europe’s debt crisis remains a key risk to Malaysia’s growth. Should the region’s economic conditions deteriorate, it may negatively affect global capital flows and may heighten risk aversion in Malaysia’s capital markets.

“In sum, volatility in the global economic environment still presents the most significant risk to RAM’s forecasts.”

Sector by sector outlook

Banking

“We believe banking stocks will continue to hold up relatively well amid volatile market conditions, which we think would likely persist in the near term,” Lim said.

“We view the valuations of banking stocks as inexpensive, relative to both the market and historical trends. This will be supported by accelerating earnings momentum as we head into 2H13, which tends to be a seasonally stronger period for earnings reporting.”

Logistics and Ports

“Certain projections suggest that the global economy is stabilising and is poised for stronger growth in 2014. This is in line with our expectations that the freight forwarders and port operators – whose fortunes are strongly correlated with global economic conditions – should register significant growth in 2014.”

Construction

“While we acknowledge that the easy money has been made (on the back of a sector-wide re-rating following the victory of the ruling coalition in the 13th general election in May 2013), we believe there is still money to be made from construction stocks at current levels, given the right investment strategy.

“We advocate a two-pronged stock-picking strategy, firstly to go for high-beta highly liquid big-cap will take the lead in terms of reaction to new price catalysts and, secondly, to go for undervalued and under-researched mid- and small-cap stocks.”

Insurance

“The insurance sector has been trading at higher valuations following the conclusion of the general election. However, we believe that the re-rating is justified on fundamental grounds, taking into account the upward climb in the industry’s underwriting cycle.

“Furthermore, the general insurance industry recorded its best underwriting margins in seven years last year, at 12.9 per cent. We believe the trend is sustainable moving forward.

“We note that loss ratios have declined across almost all product segments, reflecting efforts by the industry to enhance administrative efficiencies and improve claims settlement.”

Consumer

“We think that domestic consumer spending will still be solid although growth would be at a more moderate pace this year due to rising inflation and household debt.

“We see consumers spending more prudently as they try to keep within their household budgets. Consumers are also becoming more demanding – they are price-sensitive yet demand better product quality at the same time.

“However, the demand for food and beverage products, which are generally inelastic, is unlikely to be affected by changes in consumer sentiment or spending habits. In the retail segment, we see consumers bargain-hunting for good deals and value purchases.”

M-REITs

“We believe that the M-REITs will still be able to maintain decent earnings growth of about five per cent per annum,” Lim opined.

“The listing of KLCC Stapled group on May 9 (comprising of KLCC Property Holdings and KLCC REIT) has added more breadth and depth into the M-REIT sector, keeping it on the investors’ radar.

“Although the market has largely priced in the catalyst of major rental renewals, we are still looking forward to more inorganic growth and asset enhancement plans that could excite the sector, as earnings and dividend growth will be enhanced.”

Healthcare

“We continue to believe that Malaysia’s healthcare industry will experience resilient annual growth of eight to 10 per cent, on the basis that the Barisan Nasional-led government will implement its proposals to increase income per domestic household to transform the country into a developed nation by 2020. This, in turn, will help spur demand for private medical and healthcare services in the long run.”

Plantations

“While we believe crude palm oil (CPO) price will be well supported, we do not see catalysts for a sustained price upswing. Based on Malaysian Palm Oil Board (MPOB)’s West Malaysia price, year-to-date average CPO price is RM2,323 per tonne, still below our average price assumption of RM2,400 for the year.

“We may need to slightly trim our price assumption come end-3Q.

“However, we highlight that the market is probably pricing in higher CPO price assumptions, given that our earnings forecasts are 10 to 30 per cent lower than street estimates, indicating that there is room for consensus estimates to be trimmed in the months ahead. This could mean that the sector is unlikely to perform in the next few months.”