Wednesday, April 8

Waning economy: Are stimulus measures the magic wand?

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TA02359Current global markets are embroiled in a labyrinth of challenges.

Financial imbalances between major markets, decline in commodity prices, emerging market vulnerabilities, legacy issues from crisis in advanced economies, weak systemic market liquidity and other issues are stirring up a burst of volatility.

Structural changes have proven to be difficult with growth still seen softening across major economies including Malaysia.

According to the International Monetary Fund (IMF), although many emerging market economies have enhanced their policy frameworks and resilience to external shocks, several key economies face substantial domestic imbalances and lower growth.

IMF in its latest World Economic Outlook Update January 2016 revised downward the 2016 annual growth estimate for the world economy to 3.4 per cent, representing 0.2 percentage point lower than October 2015 estimate of 3.6 per cent.

The IMF also revised downward the global growth forecast for 2017 to 3.6 per cent, down by 0.2 percentage point, pointing to only modest recovery for the global economy in 2017.

For Malaysia, Malaysian Institute of Economic Research (MIER) in its economic outlook, viewed that while the country is naturally insulated from snowstorms, tornados and hurricanes, having to deal with only regular rains, floods and sometime landslides, the country grappled with severe headwinds on the economic front last year – following unanticipated global commodity and currency shocks, financial market turbulence and sudden reversal of capital flows.

“Most importantly, the country avoided oily slopes and dark corners, associated with domestic political upheavals and shocks, affecting both sides of political divide; entrenched social grievances; heightened racial tensions; and elevated religious and faith insecurities,” it pointed out.

It added, “Of greater significance for Malaysia, Fitch Ratings has affirmed Malaysia’s Long-Term foreign currency Issuer Default Rating (IDR) at ‘A-’ and local currency IDR at ‘A’, while interestingly the outlook on the Long-Term IDRs have been revised to ‘stable outlook’ from ‘negative’.

“Meanwhile, as reported by the Bloomberg, Moody’s Investors Service affirmed Malaysia’s A3 sovereign rating, but cut the outlook on the sovereign rating to ‘stable’ from ‘positive’, citing Malaysia’s weakening external position. The migration of rating outlook to the middle ground by the two sisters of international rating agencies indicates that the outlook for the Malaysian economy remains favourable.

“On the domestic front, major issues surrounding 1MDB operations have been successfully resolved and the company reported on January 12, 2016 that it was finally ‘out of the critical phase’.”

However, it highlighted that while these favourable developments augur well for the Malaysian economy, tough challenges are expected to crop up along the way this year.

“Investors and the citizenry as a whole are watching very closely new moves and policy actions by the government, as things are getting worse by the day, since the beginning of this year.

“Moreover, official growth forecasts, released during presentation of the 2016 Budget in Parliament on October 23, 2015 indicated that the overall growth of the Malaysian economy is expected to moderate to between four and five per cent this year (2015 estimated at 4.9 per cent).

“This growth forecast stands below the potential output growth of the Malaysian economy, estimated at about 5.5 per cent per annum, pointing to lower investment efficiency and to a certain degree deterioration in the country’s third factor growth, namely total factor productivity (TFP),” it said.

As such, to accommodate with the current changes in the external financial landscape, Malaysia’s government had introduced a revised Budget 2016.

Prime Minister Datuk Seri Najib Tun Razak had introduced 11 proactive measures that are imperative in order to ensure that the nation’s economy attains the desired growth level within the revised target range of four to 4.5 per cent this year, and the government’s fiscal deficit target to gross domestic product (GDP) of 3.1 per cent is not jeopardised.

AllianceDBS Research Sdn Bhd’s economist, Manokaran Mottain, in a report, said under the recalibrated Budget 2016, the government’s revised macro targets and revision measures look realistic and pro-growth.

“As expected, the government reduced the Brent crude oil price assumption to US$30 to US$35 per barrel (previously US$48 per barrel), but maintained the fiscal deficit to GDP target at 3.1 per cent for this year,” he said.

He added, “Overall, the government’s fiscal revision appears targeted at the key current macro headwinds – depressed crude oil prices weighing on fiscal position and subdued private consumption.”

Mottain also highlighted that the best policy strategy now is to focus on growth, rather than the fiscal deficit.

“Most of the measures announced intend to spur private consumption – more than 53 per cent of GDP is contributed by private consumption.

“Additionally, the three per cent cut in employee’s contribution to EPF could add RM8 billion annually to disposable income of the household sector. The individual income tax relief for individuals with monthly income less than RM8,000 is a boost to low to middle income group’s consumption via higher disposal income.

“Although the latest 4Q15 MIER consumer confidence index fell to a new low of 63.8 (3Q15 at 70.2) since 2008, there could be some upside to our private consumption growth forecast of 3.3 per cent this year (2015 estimated at 5.6 per cent) in light of these budget revision measures.

“In short, while the government was relatively silent on the specific operating and development expenditure they are targeting to slash, the commitment to achieve the 3.1 per cent fiscal deficit to GDP target should augur well for the country’s sovereign rating standings. We believe that the credit rating agencies would be content to see this commitment,” Mottain commented in a note.

Meanwhile, Moody’s Investor’s Service in its Credit Outlook Report this month, noted that Malaysia’s revised budget indicates strong commitment to fiscal consolidation.

The ratings agency further highlighted that the administration further demonstrated its credit-positive commitment to fiscal consolidation by retaining its deficit target at 3.1 per cent of GDP in 2016, and emphasizing that government debt will not exceed its cap of 55 per cent GDP.

BizHive Weekly takes a look at the possible impact of these measures on several sectors:

 

 

EPF reduction boon to consumer-linked industries

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To lighten the people’s financial burdens due to the rising cost of living, one of the measures announced by Najib in his Budget 2016 recalibration speech was the reduction of employee’s contribution to Employees Provident Fund (EPF) by three per cent while contributions by employers are retained.

The proposal is expected to be effective from March 2016 to December 2017.

This proposal is expected to provide a relief to the consumer sector as well as a number of consumer-linked sectors such as the automotive and healthcare sector.

More spending power will likely boost auto sector

In a report, the research arm of MIDF Amanah Investment Bank Bhd (MIDF Research) believes that the temporary relief of EPF will free up net income for consumers and improve their borrowing capacity.

However, it also noted that the impact might not be substantial as the automotive sector still highly depends on the consumer’s confidence and employment security.

It calculated that for those earning between RM3,000 to RM10,000 a month, the amount freed up is between RM90 to RM300 a month and as such, the purchasing power of a consumer could go up to RM29,000.

“In reality of course, we think the positive impact on borrowing capacity will likely be moderated given cautious consumer sentiment and the reluctance to build-up too much debt in an uncertain global economic environment,” it pointed out.

It also noted that despite the potential positive impact on the auto sector, the net impact might not be as substantial.

“A RM2,000 annual tax relief translates into the freeing up of circa RM475 in net income. We think this is too small to have an impact on car purchasing decisions on top of it being a one-off benefit (and does not enhance borrowing capacity), though it might reduce the burden of downpayments for cars in the cheaper price segment,” it added.

The research team also noted that based on the previous financial crisis, discretionary consumer goods such as cars is still very much swayed by consumer confidence and employment security, despite the freeing up of disposable income.

Positive contributions from recalibrated measures for private healthcare

For the healthcare sector, MIDF Research expects a potential marginal positive contribution to the private hospital operators from the recalibrated Budget 2016 measures.

It expects the general public to be able to flex their spending and potentially opt for quality medical treatments at private healthcare institutions instead of the government’s public hospitals.

“We think that this would especially benefit critical cases which require immediate medical attention,” it opined.

On the other hand, for pharmaceutical players, it opined that the impact might be neutral as medicines and health supplements are essential items for Malaysians.

“We do foresee a marginal increase in demand as purchasing power increase, especially for branded and imported medicines however, a steep increase in demand due to this is highly unlikely.

“All in, we think that despite being a potential beneficiary of the recalibrated Budget 2016 measures, we do acknowledge the possibility of this increase in disposable income will be channelled more towards easing day-to-day cost of living in terms of consumer spending. Of which, we think the overall sector would only benefit marginally from these new measures,” it commented.

Consumer sector – the main beneficiary to revised Budget 2016

The moves announced for the revised Budget 2016 will benefit the consumer sector, in general, analysts say.

In a report, the research arm of Kenanga Investment Bank Bhd (Kenanga Research) said the consumer food and beverage (F&B) sub sector will continue to be a safe-haven in this tough and rough investment environment while the consumer retail sub-sector could be a dark horse.

MIDF Research also believes that the EPF reduction will lead to higher household liquidity that will likely help encourage consumer spending which it opined is the intention of the government to sustain and to spur growth in the retail sector as the consumer sentiment index is currently at an all-time low.

 

Aviation sector to soar higher

The revised Budget 2016 had also introduced a visa waiver on Chinese tourists. This, analysts and experts believe, would open vast opportunities to boost Malaysia’s tourism industry as China is a huge market to tap into.

MIDF Research said, it is positive on the move to waive visa requirements (for tourists from China from March 1 to December 31, 2016 for visits of no longer than 15 days) following steps taken by the government to promote Chinese tourist arrivals in 2015 such as allowing evisa applications and free visa applications for group tourists travelling with tour operators.

Currently, tourists from China are required to apply for a visa with a fee of 40 renminbi and a processing fee of 120 renminbi, charged by travel agencies.

“We believe that the move bodes well for the travel industry after a decline of Chinese arrivals into Malaysia of one per cent year-on-year (y-o-y) from 1.27 million in 9MCY14 to 1.25 million in 9MCY15 following the MH370 incident which dissuaded Chinese tourists from visiting Malaysia.

“We note that China is an important market as it has the largest number of outbound tourists estimated at 139 million tourists in 2015 spending almost US$200 billion on their travels according to the China National Tourism Administration.

“Chinese tourists represent the third largest inbound market for Malaysia after Singapore and Indonesia. While, MAHB saw a decline in Chinese arrivals for the first-half of 2015, the second-half saw a double-digit improvement.

“The removal of visa requirements would help the positive trend continue into 2016,” MIDF Research said.

Meanwhile, in a previous news report, Malaysian Association of Tour and Travel Agents (Matta) lauded the move to scrap the visa requirement for Chinese tourists.

However, the association also believe that the visa-free policy should not be restricted to a minimum of two persons and tourists should be able to enter and leave from any entry/exit points in Malaysia as currently practiced by Indonesia and Thailand.

The association also hoped that the government would extend the visa-free initiative to Indian visitors, the news report said.

 

Dilemma in the telco sector over telecommunication spectrum

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On the other end, analysts believe that the telecommunication sector will likely see headwinds from the redistribution and bidding of the telecommunication spectrum.

Of note, in order to enhance the efficiency and amount of tax collection, the government will optimise revenue from the telecommunication spectrum through a redistribution and bidding process.

This will involve the reallocation of the lower spectrum band among the telecommunication companies.

Analysts say, the introduction of tender process on spectrum suggested that the authority may terminate its usual practice of allocating spectrums through the “beauty contests method”, of which, applicants for an assignment are assessed only based on their experience and technical and commercial proposal.

“At present, the 900MHz bandwidth is being allocated to Maxis, Celcom (Axiata) and Digi. With the spectrum reallocation, Maxis and Celcom could be negatively impacted due to the potential loss of spectrum portion.

“On the contrary, Digi, Umobile and/or Altel are potential beneficiaries should they be awarded with the spectrum. We could also see more intense bidding process as telecommunication companies would try to attach higher bidding prices in the hopes of retaining or gaining more spectrum band,” MIDF Research said.

On the other hand, Kenanga Research believes that the sector is rigged with uncertainties as details of the move are still unclear.

“While the details of the plan are yet to be unveiled, the latest decision of the authority suggested that operators may need to allocate more funds to retain spectrums. Thus, in view of the hefty funds required ahead, we scaled down our fairly neutral view on the sector operators’ prospects,” it added.

In a separate report, Kenanga Research said, “All the telco operators will be on the losing end should the authority impose a tender scheme under the upcoming spectrum re-farming exercise.

“Operators are expected to allocate additional capital expenditure (capex) if they intend to participate in the spectrum auction and thus, may leave operators no choice but to revise subscription plans in the future.

“On the fund raising capability front, unlike TM and Digi, both Maxis and Axiata’s latest gearing are close to their respective optimal capital structure, suggesting limited room to gear ahead. As a result, we do not discount that operators may consider raising fund through assets’ rationalisation or lowering their respective dividend payout to preserve cash moving forward.”

All in, it believed that the big cap telecom players could potentially surrender some spectrums to the authority, but the impact on earnings will depend on the auction results should they decide to participate.

Potential beneficiaries for these spectrums re-farming exercise will be Digi, U Mobile and some other smaller players given their relatively lesser spectrum in these frequencies, it noted.

 

Impact on tax

As for the impact of tax from the reduction of EPF contribution by employees, the research arm of Affin Hwang Investment Bank Bhd (Affin Hwang Capital) believes that private consumption expenditure could reach RM8 billion a year, if all were to opt for reductions in their contributions.

“A special tax relief of RM2,000 to individual taxpayers with a monthly income of less or equal to RM8,000 for 2015 is expected to provide individual tax savings of up to RM475 that will benefit two million taxpayers.

“Through this measure, the government will forego a revenue of RM350 million,” the research team noted.

 

A slight relief for the equities market

Following the announcement of the recalibrated Budget 2016, Bernama reported that on a weekly basis, the benchmark FTSE Bursa Malaysia KLCI (FBM KLCI) finished 42.59 points better at 1,667.30, as players reacted positively to the announcement.

However, analysts believe that while the measures announced would have a positive impact on consumer sector, of which accounts for circa 20 per cent of the aggregate earnings of FBM KLCI constituents, the impact might not be sizable and targeted enough to provide a material boost to the overall earnings.

“Hence, the direct impact of the new budget measures on the local equity market may be rather muted or mildly positive,” MIDF Research opined in a note.

Nevertheless, it said, premised on revised key budget assumptions and macro parameters which are now more realistic and attainable, it foresee a potential market fillip from lower risk of downward earnings revisions to FBM KLCI 2016 earnings estimates pursuant to the Budget recalibration.

“Another potential market fillip may emanate from the fact that, fiscally, Malaysia can no longer be considered as heavily oil dependent. As stated earlier, oil-related income is expected to decline further to less than 11 per cent of total revenue in 2016.

“The market may have beginning to take cognizant of this structural shift as evident by the performance of ringgit since the end of September last year,” it added.

Similarly, the research arm of TA Securities Holdings Bhd (TA Securities) believe that the revised budget impact on equity market as the proactive measures to reign on spending and sustain fiscal deficit did not sacrifice too much on growth.

As such, it maintained its end-2016 FBM KLCI target at 1,775 based on CY17 price earnings ratio of 15-folds.

 

The months ahead

The Budget recalibration clearly restate the key budget assumptions and parameters with regard to crude oil prices with average Dated Brent of US$30 to US$35 per barrel (from US$48 per barrel), GDP output growth range of between four to 4.5 per cent (as oppose to four to five per cent previously), and fiscal deficit target to be maintained at 3.1 per cent of GDP for 2016.

“The announcements are positive as the key budget assumptions and parameters are now more realistic and attainable. Based on our estimate, it must also be highlighted that the fiscal dependency on oil-related income is expected to decline further to less than 11 per cent of total revenue.

“Some of the new budget measures particularly the lowering of EPF contributions by employees by three per cent and tax relief of RM2,000 for income earner of up to RM8,000 per month, are arguably intended to help raise the aggregate disposable income of Malaysian consumers.

“These measures are directly positive to private consumption growth which is necessary in view of the announced cutbacks in public expenditures. Having said that, we reckon the full positive impact on consumer spending capacity may likely be moderated given cautious consumer sentiment due to an uncertain global economic environment which may explain the reduction in GDP output growth range,” MIDF Research opined.

In the months ahead, Affin Hwang Capital believes that the government might not require any further adjustments to the budget as global oil prices would likely recover in the second half of 2016.

It also pointed out that the country’s reliance on oil-related revenue has declined over the years, from 41 per cent in 2009 to about 20 per cent in 2015, where the implementation of GST will support the diversification of the sources of revenue.

“The announced measures directed at increasing disposable income as well as managing household cost of living are sufficient as the Malaysian economy is fundamentally sound, where consumer spending is supported by favourable employment conditions and income growth. We believe growth in private consumption will also be supported by higher tourist arrivals and spending in 2016,” Affin Hwang Capital opined.

“However, there are some downside risks to the country’s budgetary position, if shortfall in tax revenue from oil is also dragged down by lower receipts from direct and indirect taxation (GST), if the domestic demand slows down and external environment deteriorates more than expected.

“As such, some market observers argued that the revised Budget announcement lacked strong measures to stimulate domestic demand.

“There have been signs of moderation in domestic demand, which slowed from 4.6 per cent y-o-y in 2Q15 to four per cent in 3Q15 as private consumption moderated from 6.4 per cent to 4.1 per cent over the same period. In addition, recent release by MIER showed that consumer sentiment index (CSI) declined for sixth consecutive quarters, to 63.8 in 4Q15 (70.2 in 3Q15), signaling private consumption may likely moderate further into 2016,” it said.

Nevertheless, it believes Malaysia’s economic activities will continue to show healthy growth, where we expect real GDP growth to slow from 4.7 per cent y-o-y in 2H15 to around 4.3 per cent in 1H16, before recovering to 4.7 per cent in 2H16, supported by domestic demand.

“For 2016 as a whole, we expect Malaysia’s economy to likely expand by 4.5 per cent, slightly lower than five per cent estimated for 2015. This was also a downward revision from our earlier projection of five per cent for 2016,” the research team projected.

Looking ahead, AllianceDBS Research’s economist, Mottain, says albeit the announcement, the fiscal challenge of balancing the budget by 2020 remains.

“The government will have to keep future budgets lean as the depressed crude oil price level could remain for a while.

“For now, we maintain our expectation of 2016 GDP growth at 4.5 per cent (2015 estimate: five per cent), leaning towards the higher end of the government’s estimation,” he commented.