Malaysia Economic Note – Call It a Recession
➤ We slash our 2009 GDP growth forecast to 0.5% (from 3.1%), and now expect a technical recession in 1Q09. Our base case anticipates the trough in 1Q09, but the recovery will be tepid at best. Risks to our forecast are probably to the downside.
➤ Incoming data for Asia in the New Year continues to surprise on the downside, with key Asian tech exporters recording double-digit export contractions. As the cushion provided by high commodity prices has evaporated, Malaysia’s growth prospects could well converge with other regional tech exporters from here.
➤ The severity of the downturn will depend on the resilience of the domestic demand. Recent signs are not encouraging. First, the manufacturing slump has led to a spike in job losses, with more to come. Second, credit availability is tightening with loan approvals falling for the third consecutive month. The slowdown in domestic demand is reflected in the spread of weakness beyond manufacturing, into services and construction activity.
➤ A more aggressive policy response is needed to cushion the downturn. But the aggressiveness fiscal policy response is limited by the size of the deficit, which could exceed 5% of GDP even without additional fiscal stimulus in March. We expect at least a further 75bps in the OPR in 1H09, but see the possibility that the OPR could fall 100-125bps instead.
First Week of 2009 Reveals More Downside Surprises in 4Q08 Asian Data
It has not been a happy start to 2009 for Asia. Incoming economic data showed that the slowdown in Asia intensified sharply in the final months of 2008, as Asian exports essentially collapsed. Despite prior growth and inflation forecast downgrades after, the sheer extent of deterioration appears to have caught the market by surprise. Our Citi Economic Surprises Index for Asia suggests that even after recent forecast downgrades, analysts had not fully discounted the extent of economic weakness in the region. A similar story can be seen in the case of
Some examples of weak data since the start of the year include:
➤ In neighbouring Singapore, advance estimates for 4Q08 GDP showed a contraction of 2.6% from a year ago, from 0.3% the previous quarter. On a quarter-on-quarter seasonally adjusted annualized rate (QoQ SAAR) basis, fourth quarter GDP contracted 12.5% – the worst on record.
➤ Korea and Taiwan, the first two economies in the region to have released export data for December, showed further weakness. Korea’s exports fell 17.4% in December, following a 19% decline in November. Worse, Taiwan’s exports plummeted a staggering 41.9%, almost double the 23.3% decline in October, suggesting that the economic contraction probably deepened into 4Q08.
➤ In Malaysia and Indonesia, November exports fell 4.9% and 2.1%, respectively, for the second consecutive month. Slowing imports also point towards softening domestic demand in both these countries.
As Cushion from High Commodity Prices Evaporates, Malaysia’s Growth Performance Will More Likely Converge With Other Tech Exporters
The significance of the weak export numbers in Singapore, Korea and Taiwan is that these economies are exposed to the same demand dynamics in the electronics sector that is so critical for Malaysia’s economy. Monthly export data for these economies, which are released earlier than Malaysia’s, can also in a sense a reliable “leading” indicator for Malaysia’s exports in that month. Correspondingly, GDP in the tech exporters has been generally correlated with one another. While Malaysia has thus far avoided the recession suffered by its fellow Asian tech
exporters, this was largely because Malaysia was unique in having benefited from high commodity prices. Not only had high crude oil and CPO prices cushioned exports against the electronics slump, the favourable terms of trade shock significantly boosted income and consumption growth. While the CPO sector accounted for just 2.3% of real GDP in 2007, it accounted for fully one-fifth of nominal GDP growth – a proxy for income growth – in the Malaysian economy at its peak, and close to 40% of employment growth. Conversely, with the fall in commodity prices since 4Q08 and the consequent peak in terms of trade, Malaysia’s growth performance is more likely to converge with fellow Asian tech exporters.
Consumers Hurt by Rising Job Layoffs, Credit Tightening
The severity of the downturn will depend on the resilience of the domestic demand. In this regard, recent signs are not encouraging. Overall motor vehicle sales fell for the second consecutive month in November by 7% from a year ago, although motorcycle sales continued to hold up – suggesting that consumers may be switching to smaller ticket alternatives. Lower commodity incomes aside, two other key factors are critical in this regard.
First, labour market conditions are now deteriorating. The manufacturing slump has led to job losses, and this could over time spread to services. According to data by Bank Negara, around 11,560 workers were retrenched in 3Q08, up sharply from just 2821 workers retrenched in the previous quarter. This is the highest quarterly retrenchment number since the data series started in 2004. Of these, over 10,200 workers were from manufacturing. Separate data from the Department of Statistics shows that manufacturing employment has been falling since May-2008,
depressing labour incomes even as manufacturing wages appear to hold relatively well.
These numbers are all the more worrying because they are despite widely reported efforts to stave off retrenchments, including shift cutting, work days and salaries. In drastic cases, employees have been reduced to working eight days in a month, such as at an auto-related business in Johor, according to news reports. That the spike in retrenchments came even before the latest deterioration in manufacturing output is another cause for concern. In that context, we expect retrenchments to rise significantly over the next 3-4 quarters.
➤ According to the Human Resources Minister, based on feedback from 137 employers, some 4,700 workers, mainly in electronics, are expected to be laid off in 1Q09.
➤ Many observers think that there could a spike in retrenchments after the Chinese New Year Holiday.
➤ There are some 300,000 Malaysian workers in neighbouring Singapore who are at high risk of retrenchment. Returned workers will likely return to Malaysia and add to the army of unemployed.
➤ The Malaysian Employers Federation projects that job losses could reach 200K to 400K, mainly in the E&E and auto sectors. This compares to just 14K-20K job losses between 2004 and 2007. Simplistically adding these job loss projections to the current unemployment of around 340K and dividing it by the current labour force of around 11m (i.e., no discouraged worker effect) would imply that that the unemployment rate could shoot up to 5-7%, up from just 3.1% now. Taking into account retrenched foreign workers who would likely return home and not add to the unemployment numbers, would bring the unemployment rate to 4-6%. In the aftermath of the Asian Crisis, the reported unemployment rate peaked at 4.5% in 1Q09. We revise our 2009 average employment rate forecast to 4.7% (previous 3.5%).
A significant rise in unemployment would probably thwart other policy efforts to help the Malaysian consumer. The Economic Stabilization Package announced in early November for example saw cut in the employee EPF contribution rate by 3%, which is estimated to result in a net RM4.8bn injection into the economy over two years, potentially lifting consumption spending by 0.8%-pts each over the 2009-10, or GDP growth by 0.4% pts. But while the EPF cut can boost disposable incomes and more cuts could be deployed, an EPF cut will not help those are retrenched, or who have lost their incomes.
Second, with employment prospects dimming and credit risks rising, credit availability to households is tightening, despite Bank Negara’s efforts at moral suasion. Disbursements of loans to households have slowed significantly since the peak in April 2008, alongside non household loan disbursements. Loan approvals to households have also fallen for the third consecutive month, suggesting that loan disbursements are unlikely to recover significantly in the near future. The fact that household debt levels are fairly high, with household debt at over 60% of GDP, and debt service to income ratios at more than 40%, will probably give banks little incentive to speed up loan approvals when recession is on the cards.
Weakness Spreading Beyond Manufacturing to Construction and Services
Consistent with the slowdown in domestic demand, from a sectoral perspective, monthly indicators suggest that the slowdown is beginning to spread beyond manufacturing, into services, as we had earlier highlighted. Monthly indicators of trade-related services, including rail cargo and most tellingly, air cargo and passenger traffic, are all in the red. Air cargo in particular, reflects the fall in electronics production and exports, since air freight is the most common mode of transport for electronics. Tourism-related sectors, which had held up relatively well previously, are beginning to slow. Financial services are also poised to slow. The stock of loans will eventually slow, as loan disbursements and approvals slow further. Fund raising in the capital markets, which had been held up previously appears to have fallen sharply in November.
Construction activity is also slowing sharply. Thus far, much of the slowdown in construction activity has been due to the escalation in material costs, although the construction slowdown may have led to a peak in prices. Costs aside, a slowdown in private sector construction demand, especially in the housing market, could weigh more heavily in the sector’s prospects going forward. Housing approvals for construction by private developers have fallen to a six-year low, in line with clear signs of a slowdown in the private housing market, particularly at the high end. Oversupply of condominiums in the high-end segment (especially in the KLCC area) should put further pressure on market prices and rentals. Developers may be holding back construction on housing activity as a result. Fiscal pump priming, especially for smaller scale rural projects, could provide some cushion for the industry – but speed of implementation remains in question.
Downgrading 2009 GDP Forecast to 0.5%, from 3.1% – Technical Recession Likely in 4Q08 and 1Q09
Against this backdrop, we slash our 2009 GDP forecast further to 0.5% (from 3.1%) If we are correct, the current downturn would be equal in severity to the 2001 recession, when the economy managed just to grow just 0.5%. At this stage, we expect the trough of the contraction to be in 1Q09, given the relatively high base of comparison from the previous year, although this could still be pushed back one quarter to 2Q09. Once past the trough, the recovery will likely be tepid in the subsequent 2 quarters. We anticipate a dip in GDP growth to around 2% in 4Q08,
followed by a much sharper decline to negative growth in 1Q09, before a reversion to near zero growth in 2Q09 and 3Q09. In quarter-on-quarter seasonally adjusted terms, we expect two consecutive quarters of contraction in 4Q08 and 1Q09 – conforming to the definition of a technical recession. The technical rebound in QoQ growth in 2Q08 currently penciled in our forecasts is highly contingent upon external developments and we see the risk of yet another quarter of contraction.
Two leading indicators hint at the severity of the downturn in 1H09, and should be closely watched for clues about the timing and magnitude turnaround. The US ISM Purchasing Manufacturing Index has a good 3-6 month leading relationship with export oriented manufacturing production, and plunged to 32.4 in December, its lowest reading since 1980. Export oriented manufacturing production fell 4% in October 2008, and could well fall 10-15% in 1Q09 or 2Q09. The good news is that the PMI has historically seldom stayed near or below the 30 level for more than 2-3 consecutive months, although it may have stayed below the 50 boom
bust level in the subsequent months for an extended period. All in, based on historical odds, the ISM PMI suggests that the trough of the contraction will probably be reached within the next 6 months, although it does not tell us about the strength of the subsequent recovery.
The official composite leading indicator, which dates back only to 2000, has also typically lead the trough of previous business cycles by 3 to 6 months. The latest reading for the leading index in October showed a contraction of 2.9% – the first contraction since December 2004 and the sharpest on record. Past contractions in the leading index have been typically associated with slowdowns, but the index has had patchier record in forecasting the severity of the downturn For example, in 2000, the contractions between Feb-01 and June-01 preceded a GD contraction of 0.4% in 3Q01, whereas the 1.4% contraction in Dec 2004 only led to a mild slowdown to 4.4% in
2Q05. Given the prevailing economic conditions, we would not be surprised to see the leading index to fall till December at least – similar or worse than the 2001 episode – raising the possibility of an outright year GDP contraction within the next 6 months. All in, recession does appear to be on the cards.
Aggressiveness of Fiscal Stimulus Package Constrained By Low Petroleum Revenues
There has been much market talk that a fiscal package larger than the RM7bn announced in November is in the works – with some observers suggesting a package possibly as large as RM30bn (almost 5% of GDP). While we believe that political factors will favour an aggressive fiscal stimulus package, the reality is that the government’s generosity is capped by the size of the fiscal deficit and low oil prices. With petroleum-related revenues accounting for more than 40% of total fiscal revenues, lower crude oil prices materially raise the risk of a further widening of
Malaysia’s already large fiscal deficit of near 5% of GDP. Already, with its November downward revision of the crude oil price target to $70/bbl from $125/bbl in the initial budget estimates, fiscal revenue estimates for 2009 were lowered by a projected RM7.5bn in November, and the government raised its fiscal deficit forecast for 2009 to 4.8% of GDP (from 3.6% previously). We believe that a 5% figure is more likely given a good chance that oil prices will be below the budgeted estimate of $70/bbl. In essence, the process of fiscal consolidation put into train by PM Badawi since 2004 has been reversed, prompting Fitch to downgrade its outlook for local currency sovereign debt from positive to stable in November.
Given recent further falls in oil prices and if another fiscal stimulus package similar in size to in November is announced, the 2009 fiscal deficit could possibly exceed 6% of GDP – a level which could trigger a sovereign credit ratings downgrade. Further falls in oil prices would force the government into a tough choice between fiscal consolidation, or risking a credit ratings downgrade, sell-off by foreign holders of government bonds, a weaker currency and a spike in domestic interest rates.
Monetary Policy Response – Further 50-100bps Downside to the OPR
With fiscal policy constrained, monetary policy may have to pick up the slack. While monetary conditions are already accommodative given negative real interest rates, in practical terms, it is probably the nominal interest rate that matters, especially for Malaysian households whose debt service payments are more than 40% of their incomes. In the current environment, the impact of interest rate cuts on the currency is probably less of a concern, as interest rates were never a
strong reason supporting MYR appreciation in the first place. The key uncertainty lies with the extent of the rate cuts.
We now anticipate 50-75bps cut in the overnight policy rate in 1Q09, following the 25bps cut in November, but depending on incoming data , we see the possibility that policy rates could be brought down as much as 100-125bps by end 2Q09 instead. Given the recent deterioration in the outlook, there is a good case, in our view, for Bank Negara to front load the 50bps of cuts in the 25 January meeting, rather than wait for Malaysian data, which comes in with a lag. The spike in
retrenchments provides sufficient evidence that recession has hit Malaysia. However, given the wait and see approach to policymaking within the central bank, we would not be surprised if policymakers opt for an incremental 25bps cut instead.
Assuming our outlook for the economic backdrop is correct, the MGS market could see a story of two halves in 2009. The first half could see further modest downside to yields on expectation of further OPR cuts, and the fiscal deficit and associated supply risks will probably become less of a concern. But the fiscal deficit could gain prominence in market participants’ attention in the second half, when the economy recovers – unless of course oil prices stage a sharp recovery. At that stage we would not be surprised to see a sell off in the bond market.
Given that the bad economic news on Malaysia may not have been sufficiently discounted, the recession should not be supportive of the MYR in the next 6 months, although the USD-MYR trends would largely be dictated by broad USD strength, as well as movements in the SGD, which are in turn dictated by MAS policy action.
The USD would eventually weaken decisively at some point – the only question is when. This remains a source of uncertainty and, in our view, may depend on the timing of the global economic recovery. When this happens, risk appetite may return slowly investors may once again turn their attention to the US fiscal deficit and quantitative easing. At that point, the USD will probably weaken. This will more likely take place in 2H09, or 2Q09 at the earliest. The sharp downward moves in USD-MYR at the end of last year were in that sense, a “false dawn”, and
exaggerated by thin liquidity at year end.
In the meanwhile, until economic news flow improves decisively, we believe the tendency would be for MYR to weaken vs. the USD. A higher USD-MYR would be further supported by a likely weakening of the SGD vs. its basket of currencies, as the MAS re-centres its policy band downwards by the April policy meeting. This could imply a higher USD-MYR. The FX market will likely remain extremely volatile over the next 3-6months, but we see a good chance that that USD-MYR could hit the 3.70-3.80 levels in 1H09, before recovering more decisively to the 3.40-3.50 range by year end. This is based in out USD-SGD.
Even if we are wrong in our USD view (i.e., the USD weakens earlier than expected), that it may be harder for MYR and SGD to substantially outperform other Asian currencies vs. the USD, given the likelihood the MAS will re-centre the SGD NEER vs. the basket and the likelihood that MYR will largely track the SGD. This may still present opportunities to sell the MYR and SGD against Asian currencies that sold off strongly in 2008, for example the KRW and IDR.
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