assessment of the economy in 2017, likely modest pace of ... · pdf filemalaysia’s...

3 November 2016

Affin Hwang Investment Bank Bhd (14389-U)

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2017E GDP growth of 4.4%, a tad higher than 2016 Assessment of the economy in 2017, likely modest pace of growth

Malaysia’s real GDP growth is projected to recover gradually from 4.1% yoy in 1H16 to around 4.3% in 2H16, averaging 4.2% estimated for full-year 2016 (5% in 2015). Against a backdrop of modest but healthy growth in the global economy, we expect the country’s real GDP growth to improve to 4.4% in 2017, supported by domestic demand, especially from private consumption and investment. However, as a highly open and trade-dependent economy, Malaysia’s real GDP growth and external demand will likely be influenced by the health of the global economy in 2017. Downside risks to global growth should continue in 2017

The International Monetary Fund (IMF) expects some improvement in the global economy, with global GDP growth of 3.4% yoy in 2017, higher than its forecast of 3.1% in 2016 (3.2% in 2015). However, the global economy is still clouded by uncertainty from the Brexit vote and the sustainability of China’s economic growth, as well as tensions from the US political scene, with anti-trade sentiment on international trade. Government’s fiscal deficit to improve to 3% of GDP in 2017

The improvement in the government’s budget fiscal deficit from -3.1% of GDP in 2016 to -3.0% of GDP projected for 2017 can be achieved, but based on the assumption that the revenue target is attainable. Government revenue is projected to increase from higher collection from direct taxation and oil-related revenue (based on a crude oil price assumption of US$45/barrel in 2017 vs. US$40/barrel in 2016). Private consumption to remain supportive of economic growth

Consumer spending should be supported largely by support initiatives that were announced in the recent 2017 Budget, such as BR1M for low-income household groups. In addition to ongoing infrastructure projects such as the Pan Borneo Highway, RAPID, and MRT Line 2, the announcement of new projects in the latest Budget 2017, especially the new East Coast Railway Line (ECRL) project connecting Klang Valley to the East Coast, should provide a boost to private investment growth. Current account surplus to narrow to 1.0% of GNI in 2017

Export growth is expected to pick up from 0.1% yoy in 2016 to 2.5% in 2017, while import growth should rise from 1.4% to 2.7% over the same period, with the trade balance improving slightly to RM83.4bn in 2017 (RM82.7bn in 2016E). The current account surplus is expected to narrow from 1.3% of GNI in 2016 to 1.0% of GNI in 2017. The sustainability of Malaysia’s current account surplus position should be determined mainly by the trade surplus, as both a services deficit and an income deficit will likely persist in the quarters ahead. BNM expected to maintain overnight policy rate of 3.0%

We look for Malaysia’s headline inflation to average around 2.2-2.3% in 2016 (2.1% in 2015) before rising to 2.6% in 2017. The BNM is likely to leave its policy rate unchanged at the MPC meeting on 23 November. We think the BNM’s decision to cut its OPR rate by another 25bps at meetings in 1H17 would be data-dependent, especially on external uncertainties. Macroeconomic fundamentals should remain sound

Against any major downside risks from external developments, we believe Malaysia’s economic fundamentals will remain sound, supported by an improving economic outlook, lower fiscal deficit position, sustainable (though narrowing) current account surplus, healthy foreign exchange reserves as well as manageable inflationary pressure.

Economic Update

Malaysia - Economic Outlook 2017

Economic Research (603) 2146 7540

[email protected] [email protected]

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Real GDP growth of 4.4% in 2017E, a tad higher than 2016 Assessment of global economy in 2017, likely modest pace of growth

Malaysia’s real GDP growth is projected to recover gradually from 4.1% yoy in 1H16 to around 4.3% in 2H16, averaging 4.2% estimated for full-year 2016 (5% in 2015). Against the backdrop of modest but healthy growth in the global economy, we expect the country’s real GDP growth to improve to 4.4% in 2017, supported by domestic demand, especially from both private consumption and investment. However, as a highly open and trade dependent economy, Malaysia’s real GDP growth and external demand will likely be influenced by the state and health of the global economy in 2017. Fig 1: Malaysia GDP growth Fig 2: Trade to GDP ratio: Regional comparison

Source: Bank Negara Malaysia (BNM), CEIC, Affin Hwang estimates Source: World Bank

The International Monetary Fund (IMF), in its October issue of the World Economic Outlook (WEO), expects some improvement in the global economy, with global GDP growth rising by 3.4% in 2017, higher than its forecast of 3.1% in 2016 (3.2% in 2015). There is a possibility of some slowdown in world economic indicators that may prompt IMF to make another round of downward revisions to global GDP growth for 2017, which has already been revised downward three times from the earlier projection of 3.8% a year ago. Fig 3: IMF Global GDP growth forecast

Source: International Monetary Fund (IMF)

Downside risks to global growth likely to continue in 2017

The global economy is still clouded by uncertainty from the Brexit vote (i.e., possible reduction in trade and financial flows between UK and the rest of the European Union) and the sustainability of China’s economic growth, as well as financial volatility stemming from US monetary policy and capital flows on emerging markets.

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According to the IMF, the downside risks to 2017 would also be influenced by tensions from the US political scene, where anti-immigrant and anti-trade rhetoric has been prominent from the start of the current presidential election. Across the world, the IMF noted that protectionist trade measures have been on the rise. The World Trade Organization (WTO) also cautioned about rising concerns of growing anti-globalization sentiment, where anti-trade policy positions could worsen from the perspective of global trade as well as job creation and economic growth and development, which are closely linked to an open trading system. In the past, based on IMF’s definition, global growth of below 3% is “equivalent to a global recession.” However, global growth has not been weaker than 3% since 2009, when the world economy stalled in the wake of the Global Financial Crisis, and we believe the risk of global growth falling below 3% in 2016 and 2017 is relatively small. Growth in global trade and global production remains modest

So far, the strength of the global economy is still supported by a modest recovery in global exports and global production. Based on the world trade statistics published by the CPB Netherlands Bureau for Economic Policy Analysis, global exports rose and returned to growth of 1.2% yoy in August, from a decline of -0.7% in July. The global industrial production index (IPI) also rose from 1.1% yoy in July to 1.5% in August. Unlike in previous times, there was no significant mismatch between global manufacturing production and exports. Fig 4: World trade and production

Source: CPB Netherlands World Trade Monitor

Traditionally, these two economic indicators are highly correlated. In recent months, the divergence between manufacturing output and exports is still relatively small, reflecting that global manufacturers and exporters are increasing production to meet actual demand, alleviating some concern of excess overbuilding of inventories by manufacturers. If the November and December economic data releases on trade and production show continued improvement, this would reflect that the economic recovery has gathered momentum. According to the WTO, in its latest report, despite some downside risks from anti-trade sentiment on international trade, growth in global trade is projected to improve from 1.7% in 2016 to a range of 1.8-3.1% in 2017, with a mid-point of 2.5%. While higher, this would still be the sixth consecutive year with less than 3% growth for global trade, reflecting WTO’s cautious view of the global economy in 2017.

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Fig 5: Regional trade forecast 2012 2013 2014 2015 2016F 2017F

Volume of world merchandise trade 2.2 2.4 2.8 2.7 1.7 1.8-3.1

Exports

Developed economies 1.1 1.7 2.4 2.8 2.1 1.7-2.9

Developing economies 3.8 3.8 3.1 3.2 1.2 1.9-3.4

North America 4.5 2.8 4.1 0.8 0.7 1.6-2.9

South and Central America 0.9 1.2 -1.8 1.3 4.4 3.1-5.5

Europe 0.8 1.7 2.0 3.7 2.8 1.8-3.1

Asia 2.7 5.0 4.8 3.1 0.3 1.8-3.2

Other regions* 3.9 0.6 -0.1 3.9 2.5 1.5-2.6

Imports

Developed economies -0.1 -0.2 3.5 4.6 2.6 1.7-2.9

Developing economies 4.8 5.6 2.9 1.1 0.4 1.8-3.1

North America 3.2 1.2 4.7 6.5 1.9 1.9-3.1

South and Central America 0.7 3.6 -2.2 -5.8 -8.3 2.2-3.7

Europe -1.8 -0.3 3.2 4.3 3.7 1.8-3.1

Asia 3.7 4.8 3.3 1.8 1.6 2.0-3.3

Other regions* 9.9 3.5 -0.5 -6 -2.8 0.6-1.0

Real GDP at market exchange rates 2.3 2.2 2.5 2.4 2.2 2.5

Developed economies 1.1 1.0 1.7 1.9 1.5 1.7

Developing economies 4.7 4.5 4.2 3.4 3.4 4.1

North America 2.3 1.5 2.4 2.3 1.6 2.3

South and Central America 2.9 3.4 1.0 -1.0 -1.6 1.4

Europe -0.2 0.5 1.5 1.9 1.7 1.5

Asia 4.4 4.3 4.0 4.0 3.9 3.9

Other regions* 3.9 2.6 2.6 0.9 1.4 2.6 Note: *Other regions comprise the Africa, Commonwealth of Independent States and Middle East Source: WTO Secretariat for trade, consensus estimates for GDP

OECD CLI continues to gather pace and points to modest recovery

Nevertheless, the recent increase in OECD’s CLI and global PMI indicate that manufacturers have remained positive on a modest recovery in the global economy. The OECD Composite Leading Indicators (CLI), which is designed to give early signals of turning points in economic activity, continued to point to a recovery in OECD economies. The OECD CLI stood unchanged at 99.7 level for 6th consecutive month since March 2016, with some synchronized gradual recovery in most major global economies. The modest recovery in OECD CLI was also reflected in the non-OECD member countries, with the CLI for China staying flat at 98.9 for the second straight month, but still below the 100 mark for the 21st consecutive month. Fig 6: OECD Composite Leading Indicator

Source: OECD

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The monthly global Purchasing Managers Index (PMI), which is published by Markit Economics, has remained above the 50 mark in October and recent months, suggesting also that purchasing managers in the manufacturing sector globally are increasing production to match a continued recovery in demand for manufactured products globally. Fig 7: Global PMI

Source: Bloomberg, Markit

How sustainable is this modest global economic recovery?

While leading economic indicators are encouraging, pointing to a modest pace of growth in the global economy, the question remains as to the recovery’s degree of sustainability. With headwinds persisting, we believe the risks to the growth projections for 2017 are mainly to the downside, especially when macroeconomic conditions remain unsettled, with fundamental economic weakness persisting in Europe and China. Strength of global outlook hinges on health of US economy

As a result, we believe the recovery in the US economy, which is still the largest importer in the world, with private consumption of about 70% of total GDP, remains the key to the sustainability of global growth. We believe that the US economy will remain on a path of recovery into 2017, albeit at a gradual pace. According to the Bureau of Economic Analysis (BEA), the US economy surprised on the upside, with its advance estimate of real GDP posting annualized growth of 2.9% qoq in 3Q16 (1.4% in 2Q16), the strongest pace in two years, supported by growth in exports, personal consumption expenditures (PCE) and business investment. We believe recent economic indicators, such as orders for durable goods and sales of existing homes, may also signal that growth momentum in the US economy is improving. Fig 8: US durable goods Fig 9: US home sales

Source: Bloomberg

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US household wealth rises to record high in 2Q16

According to the US Federal Reserve’s (US Fed) Flow of Funds Accounts report, published on 16 September 2016, the net worth of American households (such as home equity, equities and mutual funds), which took a total loss of about 27% during the US recession in 2008-09, has since recovered by 54% to a record US$89.1trn in 2Q16, which we believe will likely translate into improving consumer spending and confidence due to gains in equity and real estate prices. Household net worth rose by US$1.1trn from US$88.0trn in 1Q16 to US$89.1trn at the end of 2Q16, far above the historical low of US$54.4trn in 1Q09. The US household debt-to-GDP ratio, which was above 95% of GDP during Global Financial Crisis 2008-09, has trended lower and stabilized, at 78.3% of GDP as of 2Q16. With US labour market conditions improving, as well as increasing signs of improvement in leveraging at the consumer level and higher net worth of US households, we believe the improvement in US consumer spending will likely be sustained. Fig 10: US household wealth Fig 11: US household debt

Source: CEIC

Consistent with the IMF forecasts, the US Fed expects the US economy to be a tad higher, as household spending has continued to advance, and the housing sector has shown further signs of improvement. For 2017, GDP growth forecast has been maintained at the range of 1.9-2.2%. However, the US unemployment rate was revised higher to 4.7-4.9% range for 2016, which was higher than 4.6-4.8% previously forecasted, but likely to improve to 4.5-4.7% in 2017, slightly better when compared to the US Fed’s long-term average of 4.8%. Fig 12: Economic projection by the US Fed

Variable Central tendency

2016 2017 2018 2019 Longer run

Change in real GDP 1.7 to 1.9 1.9 to 2.2 1.8 to 2.1 1.7 to 2.0 1.7 to 2.0

June projection 1.9 to 2.0 1.9 to 2.2 1.8 to 2.1 n.a 1.8 to 2.0

Unemployment rate 4.7 to 4.9 4.5 to 4.7 4.4 to 4.7 4.4 to 4.8 4.7 to 5.0

June projection 4.6 to 4.8 4.5 to 4.7 4.4 to 4.8 n.a 4.7 to 5.0

PCE inflation 1.2 to 1.4 1.7 to 1.9 1.8 to 2.0 1.9 to 2.0 2.0

June projection 1.3 to 1.7 1.7 to 2.0 1.9 to 2.0 n.a 2.0

Federal funds rate 0.6-0.9 1.1-1.8 1.9-2.8 2.4-3.0 2.9-3.0

June projection 0.6-0.9 1.4-1.9 2.1-2.9 n.a. 3.0-3.3 Source: US Federal Reserve

While the sustainability of the recovery in US economic activity, especially in the housing market, still require accommodative monetary policies in place to support growth, we believe the US Fed will likely raise the Fed Funds Rate (FFR) at the 13-14 December FOMC meeting. In the November meeting, US Fed leave its FFR unchanged at 0.25-0.50%.

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According to the latest Wall Street Journal's monthly survey, about 81.7% of

the economists have predicted that the US Fed will likely raise the FFR in December. However, judging from the dot plots of FFR expectations, the FOMC members are guiding that any increase in the FFR is likely to be gradual, where it indicated one rate hike for 2016, and possibly a gradual two hikes in 2017. We believe the gradual increase in the US policy rate signals that the US Fed is not looking solely at the performance of the US economy, but also at global financial developments. Fig 13: US FOMC dot plots (announced in September meeting)

Source: US Federal Reserve

China’s economy is slowing, but no hard landing

With the recent improvement in economic indicators in China, the country’s economy is likely to expand modestly, alleviating earlier concerns of a sharp slowdown. China’s official PMI rose from 50.4 in September to 51.2 in October, remaining above the 50 mark in seven of the past eight months, signaling some recovery in business conditions across the Chinese manufacturing sector, supported by domestic demand. China's GDP growth rose by 6.7% in 3Q 2016, the same level compared to the first half of the year, and still within the annual growth target range of 6.5% to 7.0%, official data showed. According to the Political Bureau of the Communist Party of China (CPC) Central Committee, China's economy had posted stable growth in the past three quarters with concrete progress made in structural reforms, as evidenced by rapid high-tech sector development, strong service sector growth, a stable financial market and better-than-expected employment. Fig 14: Sustained China growth

Source: IMF, World Bank. ADB, Chinese official

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The government agency has also introduced strategies to ensure fiscal expenditure and support for underdeveloped areas and provinces needing financial support, as well as expanding domestic demand. While most international agencies like the IMF, World Bank, and Asian Development Bank (ADB) are expecting decent economic growth in 2017 of above 6%, the concern remains the volatility of capital flows, where China has continued to experience capital outflows and some loss in foreign exchange reserves. EU likely to face negative economic consequences from Brexit

Despite some positive economic developments and indicators pointing to an ongoing economic recovery in EU countries, such as the closely watched EU Composite PMI, economic recovery in the EU region is still plagued by a possible negative outcome from Brexit and banking issues, which may affect economic growth rates among EU member countries. Fig 15: GDP growth rates of major EU economies

Source: IMF

The IMF already has cautioned that economic, political, and institutional uncertainty and the likely reduction in trade and financial flows between the UK and the rest of the EU over the medium term are expected to have negative macroeconomic consequences. We believe this uncertainty as well as lingering concerns about Brexit and the political contagion in the EU may hurt business and consumer sentiment, which would eventually hurt the real economy, especially in the UK. Fig 16: Eurozone sentiment index

Source: Bloomberg

However, with the easy monetary policy still in place to support economic growth in the Euro area, we expect GDP growth for the area to be 1.7% in 2016 and 1.5% in 2017.

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At the recent October meeting, the European Central Bank (ECB) Governing Council decided to keep its monetary policy unchanged, alleviating some concerns of possible tapering. The ECB has targeted to maintain its policy interest rate at 0%, while rates for the marginal lending facility and the deposit facility remain at 0.25% and -0.40%, respectively. The ECB also decided to keep the pace of monthly asset purchases at €80bn, and the buying program is to continue to March 2017. The Bank of England (BOE), at its recent MPC meeting, also kept its monetary policy unchanged, but we believe the BOE may still lower its bank rate by 0.25% and expand its current pace of asset purchases, if necessary in 2017, to support the UK economy after the triggering of Article 50, possibly by the end of March 2017. Japan economy to remain modest in 2017

As for Japan, an accommodative monetary policy should also provide some support to economic growth, as GDP growth is expected to post modest gains in 2017. The business climate in Japan has improved somewhat in recent months. The latest Bank of Japan’s Tankan survey for forward-looking business sentiment stayed flat at 6 in 4Q16, the same level as in 3Q16, but was an improvement from 3 in 2Q16, which will likely translate into higher output in the manufacturing sector. In its latest announcement, the Bank of Japan (BOJ) decided to maintain its policy interest rate at -0.1% as well as leaving asset purchases unchanged, where BOJ will continue to buy Japanese Government Bonds (JGBs) at an annual pace of about ¥80trn, as well as previous plans for purchases of other assets, such as exchange-traded funds (ETF) and Japanese real estate investment trusts (J-REITs). However, while the BOJ is delaying further easing measures, after the announcement in September, we believe the central bank remains committed towards further monetary stimulus if the recently announced fiscal stimulus and construction activity measures are not strong enough measures to boost Japan’s economy and commitment to CPI inflation exceeding 2%. Fig 17: Japan GDP growth forecast

Source: IMF, World Bank, ADB, OECD

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What’s in store for the Malaysian economy in 2017? Against this backdrop of the external environment, examining the balance between upside and downside risks to Malaysia economic growth outlook, we believe there are still signs for the Malaysian economy to record slightly stronger positive growth in 2017. In the latest Economic Report 2016/2017, the government expects Malaysia’s underlying real GDP growth to be at a range of 4-5% in 2017, an improvement from 4.0-4.5% in 2016. Taking the computations at the mid-point, the real GDP growth forecast at constant price is expected to improve from 4.2% in 2016 to 4.6% in 2017, also slightly higher than our 2017 forecast of 4.4%. The key variance lies in the higher growth projection on private sector spending, where private consumption and private investment are projected to expand by 6.3% and 5.8% respectively in 2017 (against Affin Hwang’s 5.4% and 5.0%). However, we concur with the MOF that the recovery in exports should remain largely intact in 2017, which is forecast to expand by 2.5% in 2017 (against Affin Hwang’s 2017 2.0%). This also reflected in our cautiously optimistic view of a modest recovery in the global economy. Fig 18: Malaysia Ministry of Finance vs Affin Hwang forecast

%yoy 2016E

Affin Hwang 2017E

Affin Hwang 2016E

MOF 2017E

MOF

GDP (2010 real prices) 4.2 4.4 4.2 4.6

Domestic Demand 4.5 4.6 4.7 4.9

Private consumption 5.5 5.4 6.1 6.3

Public consumption 3.0 2.5 0.2 0.4

Private investment 4.5 5.0 5.3 5.8

Public investment 1.5 2.0 1.7 1.1

Exports 1.1 2.0 0.7 2.5

Imports 1.3 1.9 1.4 2.6

Agriculture, Forestry and Fishing -2.8 2.0 -3.3 1.5

Mining and Quarrying 1.6 1.5 1.1 1.3

Manufacturing 4.3 4.5 4.0 4.1

Construction 8.3 8.0 8.7 8.3

Services 5.2 5.1 5.6 5.7 Source: MOF, Affin Hwang

The Malaysia’s leading index (LI), a forward-looking indicator designed by the Department of Statistics (DOS) to predict the direction of economic activity, on a six-month smoothed growth rate, turned around from -2.5% yoy in July to +0.2% in August. The rebound was supported by major economic indicators such as money supply, real imports of other metals, as well as new company registration, reflecting that domestic economic activities are showing signs of further recovery into 2017. Fig 19: Leading index

Source: CEIC

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However, as reflected in the Malaysian Institute of Economic Research (MIER) surveys, both the business confidence index (BCI) and the consumer sentiment index (CSI) moderated in 3Q16. Nevertheless, the average for both indicators in the first three quarters in 2016 still represented a step up from the 2015 average. The BCI trended higher at 94.4 in 9M16 compared to an average of 92.5 in 2015, while the CSI rose to an average of 75 compared to 69.6 over the same period, suggesting that conditions remain positive. Fig 20: MIER index

Source: CEIC

Private consumption to remain supportive of economic growth

Consumer spending should be supported largely by the temporary income support initiatives that were announced in the recent 2017 Budget, such as BR1M, where cash assistance was raised by between RM50-200 to the low-income household groups. The programme, which is expected to benefit 7m recipients with a higher allocation of RM6.8bn, should translate into higher disposable income for the bottom 40% household income group (B40), which have a slightly higher marginal propensity to spend. Furthermore, special assistance of RM500 to civil servants, as well as RM250 to government retirees are also expected to provide some support to private consumption growth in the country. While acknowledging that the level of household debt is concerning, which may have some negative implications for consumer spending, we are cautiously optimistic that households will remain financially sound, with strong financial buffers to service debt obligations and cushion against income shocks. The debt servicing capacity of households continue to be supported by favourable employment conditions and rising incomes. For now, the extent of consumer debt seems manageable and unlikely to derail spending. Fig 21: Slowdown in household debt growth Fig 22: Impaired loan

Source: CEIC

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Over the years, the country’s labour market conditions have been relatively stable in Malaysia amid the increase in the share of the working age population to total population. This is despite some recent retrenchments announced by corporates both in the services and manufacturing sectors, which have led to a rise in the unemployment rate from 3.1% in 2015 to 3.6% currently. However, the unemployment rate in Malaysia remained relatively low compared to international standard. Meanwhile, employment has remained at a healthy level. Fig 23: Employment vs unemployment rate

Source: Department of Statistics (DOS), CEIC

With the consistent increase in the proportion of the population aged 15-64 in Malaysia in the past three decades, where the percentage-point increase is the largest compared to other Asean countries in the past 10 years, we believe private consumption will remain healthy going into 2017. This has contributed to private consumption growth of 6.9% during the same period (2006-2015), the strongest pace among the Asean countries. Fig 24: Population aged 15-64 (% of total population) Fig 25: Private consumption vs GDP growth (2006-2015)

Source: World Bank Source: CEIC, Affin Hwang calculation

Revival in private investment to continue into 2017

In addition to ongoing infrastructure projects such as the Pan Borneo Highway, RAPID, MRT Line 2, the announcement of new projects in the latest Budget 2017, especially the new East Coast Railway Line (ECRL) project connecting Klang Valley to the East Coast with an estimated cost of RM55bn over 2017-2022, will likely provide a boost to private investment growth. An allocation of RM2.1bn is to be channeled into the five economic corridors, namely Iskandar Malaysia, Northern Corridor Economic Region (NCER), East Coast Economic Region (ECER), Sabah Development Corridor (SDC) and Sarawak Corridor of Renewable Energy (SCORE), for infrastructure and socioeconomic development.

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Fig 26: Projects announced in Budget 2017 Project Cost (RMbn)

East Coast Rail Line 55.00

Pan Borneo Highway 28.90

East Coast railway line restoration 0.10

Purchase of 19 set train to increase ETS frequency 1.10

Installation of lights at crossroads NA

Enchancing connectivity of village roads and bridges 1.20

Maintain state roads 4.60

Refurbish Orang Asli houses 0.35

1Malaysia Maintenance Fund (TP1M) 0.30

People-Friendly Projects 0.80

Flood Mitigation Plans 0.50

Water supply 0.73

MySuria Programme 0.28

Second Generation House 0.40

Urban Transformation Center (UTC) & Rural Transformation Centers (RTC) 0.10

Football Academy Phase II in Gambang, Pahang 0.05

Total 94.40 Source: Budget 2017

The Malaysian Investment Development Authority (MIDA) has also been allocated RM522m to identify high-end manufacturing industries to enhance competitiveness through R&D and the adoption of technology. We think this will lead to further approved investment in the country, where total approved investment was RM88.5bn in 1H16 (2015: RM193bn). Fig 27: Nominal private investment Fig 28: Total approved investment

Source: Department of Statistics (DOS), CEIC

Positive contribution from net exports expected in 2017

On the external front, the net export of goods and services is projected to contribute +0.2 percentage points to Malaysia’s GDP growth, a turnaround from -0.1 percentage points estimated for 2016. This was on account of stronger growth in the real export of goods and services of 2.0% in 2017, compared to 1.1% estimated in 2016. Broad-based positive growth across all sectors to support 2017 GDP

On the supply side, the country’s real GDP growth is expected to be supported by expansion across all major economic sectors. Revival in private investment and infrastructure projects are expected to lead to healthy growth in construction (8% in 2017 vs 8.3% in 2016E). Steady private consumption should support services sectors (5.1% in 2017 vs 5.2% in 2016E), supported by wholesale and retail trade, as well as the food, beverages and accommodation subsectors. We believe the manufacturing sector will be driven by both export- and domestic-oriented industries, in view of the improving external environment and resilient domestic demand. Additionally, in the absence of adverse weather conditions (such as El Nino in 1H16), we expect the agriculture sector to rebound from -2.8% yoy in 2016 to +2.0% in 2017.

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Tax and expenditure of 2017 Budget is still expansionary

While generous measures were introduced for citizens and businesses, the tax and expenditure programme of the Federal Government in Budget 2017 also involves striking the appropriate balance between fiscal consolidation and supporting the economy. However, a total expenditure allocation of RM260.8bn is 3.4% higher than decline of 2.2% estimated expenditure for 2016, where operating expenditure is projected to increase by 3.7% to RM214.8bn in 2017, while development expenditure is expected to increase by 2.2% to RM46bn in 2017. We believe the focus of sustaining economic growth in Budget 2017 (through handouts and stimulus measures) still takes slightly more precedence over fiscal deficit reduction; therefore we believe the Budget is supportive of the economy. Fig 29: Federal Government finance

RM bn (unless stated otherwise) Original

Budget 2016 Budget 2016 Recalibrated Budget 2017

2015A 2016F 2016R 2016E 2017F

Brent (US$/bbl) 52.0 48.0 35.0 30.0 40.0 45.0

Revenue 219.1 225.7 217.9 216.3 212.6 219.7

Operating expenditure 217.0 215.2 211.2 210.7 207.1 214.8

Current balance 2.1 10.4 6.7 5.6 5.5 4.9

Gross development expenditure 40.8 50.0 46.0 45.0 45.0 46.0

Loan recoveries -1.5 -0.8 -0.8 -0.8 -0.8 -0.7

Net development expenditure 39.3 49.2 45.2 44.2 44.2 45.2

Overall balance -37.2 -38.8 -38.5 -38.7 -38.7 -40.3

% of GDP -3.4 -3.1 -3.1 -3.1 -3.1 -3.0 Source: MOF Economic Report 2016/2017

Government’s fiscal deficit to improve to 3% of GDP in 2017

We believe the projected improvement in the government’s budget fiscal deficit from -3.1% of GDP in 2016 to -3.0% of GDP can be achieved, but based on the assumption that the revenue target is attainable. Government revenue is projected to increase by 3.4% to RM219.7bn in 2017 (RM212.6bn estimated for 2016), with oil-related revenue likely to recover, due to a 25% increase in the petroleum income tax (based on a crude oil price assumption of US$45/barrel in 2017 as against US$40/barrel in 2016). However, dividend income from Petronas is expected to be lowered to RM13bn in 2017 from RM16bn in 2016. Fig 30: Oil-related revenue breakdown Fig 31: Oil-related revenue

Source: MOF

We believe there are some downside risks to the Government’s projection of an improvement in the budget deficit in 2017, but only in the event that the external environment deteriorates sharply. Revenue sources from direct taxes are vulnerable to external influences and can fluctuate in response to the performance of the world economic situation.

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This may lead to a possible shortfall in tax revenue receipts, especially from direct taxes. However, with GST providing a more steady stream of revenue, as collection is less subject to business cycle fluctuations, this should provide better management of government finances. The GST collection has reached nearly RM30bn as at mid-October 2016, which is only RM8.5bn short of the full-year target of RM38.5bn (RM27bn in 2016). GST collection is expected to increase to RM40bn in 2017. Setting up of Collection Intelligence Arrangement (CIA)

To enhance long-term fiscal sustainability, after incorporating the Medium-term fiscal framework (MTFF) into fiscal policy in 2016, the government has proposed establishing an agency called the Collection Intelligence Arrangement (CIA) under the Ministry of Finance in Budget 2017. It involves collaboration between the Inland Revenue Board (IRB), Royal Malaysian Customs Department (RMCD) and Companies Commission of Malaysia (SSM) in the sharing of data and information, which would improve efficiency in tax collection, tax auditing and tax compliance, where the move may encourage companies to be more transparent. With the establishment of the MTFF and CIA, we believe the government will continue with strategies and implement plans to achieve an average medium-term fiscal deficit of 2.7% of GDP over 2016-2018, as well as the target set in the 11th Malaysia Plan (11MP) of achieving 0.6% of GDP or RM9.9bn by 2020. Please refer to our associated report, Budget 2017 and MOF Economic Report 2016/2017, dated 24 October 2016, for assessment on 2017 Budget analysis. Current account surplus to remain, but smaller in 2017

We expect persistent episodes of current account surpluses to continue to be the feature of economic fundamentals in Malaysia going forward. While some market observers have continued to caution that there is potential risk of the country’s current account surplus turning to a deficit, we believe the risk is low and is unlikely to be structural. We expect export growth to pick up from 0.1% yoy projected for 2016 to 2.5% in 2017, also supported by expectations of higher commodity prices and non-commodity products. Import growth is also projected to accelerate from 1.4% to 2.7% in 2017, with the trade balance improving slightly to RM83.4bn (RM82.7bn in 2016E). We look for Malaysia’s trade surpluses to continue to be supported by electrical & electronic (E&E) products, liquefied natural gas (LNG) and palm oil. Trade surpluses of these products were on a rising trend in the early 2000s, before levelling off in 2011. Fig 32: Main trade surplus components

Source: BNM, DOS

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Malaysia’s E&E sector has benefitted from global demand in the usage of mobile devices, storage devices, optoelectronics, and embedded technology. Given Malaysia’s participation in the global E&E value chain, E&E exports are expected to trend higher following the projection of a turnaround in worldwide semiconductor market. The World Semiconductor Trade Statistics (WSTS) organization expects global semiconductor sales to improve to US$331bn in 2017 (2% higher than US$325bn in 2016), supported by increases from the Americas and Asia Pacific markets.

The allocation of RM522m to MIDA in Budget 2017 to provide funding to identified industries to improve competitiveness through R&D and the adoption of technology and innovation should also strengthen Malaysia’s E&E industries. On the other hand, we expect exports of palm-oil and palm-oil based products to trend higher in 2017 from a lower base in 2016, when palm oil production was disrupted by El Nino. As such, trade surpluses in palm oil (crude and processed) are likely to remain resilient. Downside risks relating to the recovery in the LNG surplus

Recall that the LNG surplus has been dragged down by lower LNG prices since 2015, in tandem with declining oil prices. This is because Asian LNG prices are determined through the pricing system indexed to crude oil prices, with a lag of 3-6 months. In tandem with our expectation of a higher crude oil price in 2017, LNG exports are expected to recover as well, supporting overall export growth. Fig 33: Average export unit value Fig 34: LNG net export

Source: BNM Source: BNM, DOS

Nevertheless, we are also wary of the fundamental changes in the global LNG market, where there are concerns of oversupply in the global LNG market. The US started exporting LNG in February 2016, while more supply is also expected to come from Australia, which has overtaken Malaysia as the second-largest LNG exporter after Qatar. The International Energy Agency (IEA) in its Medium-Term Gas Market Report 2016 noted that global LNG export capacity is projected to increase by 45% between 2015 and 2021, 90% of which originates from the US and Australia. While Malaysia’s long-term LNG contract ensures a certain volume of LNG exports for the country, there are still risks that oversupply in the LNG market may add to downward pressure on LNG prices, potentially weakening the correlation between oil and gas prices.

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Fig 35: Trade excluding E&E, LNG and palm oil

Source: BNM, DOS

Imports to be supported by capital goods and consumption goods

Despite a sizeable net export position from E&E, LNG and palm oil, as

growth of imports to continues outpace that of exports, Malaysia’s overall

trade surplus has trended down since 2008. This can be attributable to

stronger import growth (relative to export growth) in goods other than E&E,

LNG and palm oil, resulting in a higher trade deficit from RM14.4bn in 2006

to RM52bn in 2010 and RM108.6bn in 2014 before narrowing slightly to

RM92.5bn in 2015, see Fig 35.

Fig 36: Trade performance

Source: BNM, DOS The launch of the Economic Transformation Programme (ETP), which aims at revitalising private investment in order to achieve a high-income nation by 2020, has seen the rollout of major infrastructure projects such as the Pan Borneo Highway, MRT Line 2, LRT Line 3, East Coast Railway Line, and so on. This has also led to higher demand for capital goods, resulting in higher growth in imports of capital goods. Looking ahead, with continued investment in these major infrastructure projects, demand of capital goods will likely sustain its growth. Imports of consumption goods accelerated from an average of 7.2% yoy in 2006-2010 to 12.8% in 2011-2015. This, we believe, could have arisen from the growing working population, where people aged 15-64 rose from 64.6% of the total population in 2005 to 69.1% in 2015. With the increasing share of the working population, household numbers are also rising, as well as household incomes. This has in turn led to higher consumption in the country, including the consumption of semi-durable imported goods such as clothing and furniture.

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With the increasing penetration of international brands in the domestic consumer market, as well as rising e-commerce activity, we expect imports of consumption goods to sustain strong growth, in tandem with our expectation that private consumption will remain resilient in view of the favourable population profile. Fig 37: Breakdown in the imports of consumption goods

Source: CEIC, DOS

Current account surplus to narrow to 1.0% of GNI in 2017

As a result, we expect the current account surplus to narrow from 1.3% of GNI in 2016 to 1.0% of GNI in 2017. Overall, the sustainability of Malaysia’s current account surplus position will likely be determined mainly by the trade surplus, as both the services deficit and income deficit will likely persist in the quarters ahead. Despite the expiry of visa-free entries (effective 1 March to 31 December 2016) for Chinese tourists staying in Malaysia for a period not exceeding 15 days, surpluses in the travel account should be supported by higher tourist arrivals due to the 2017 SEA and Para ASEAN Games. However, this should be offset by higher net payments for trade-related and investment related services. With the revision to the minimum wage from RM900 per month to RM1,000 per month, effective 1 July 2016, outward remittances by foreign workers are likely to trend higher, resulting in larger deficits in the secondary income account in 2017. Fig 38: Trade and current account forecast

2014 2015

2016 2017 2016E 2017F

(RMbn, unless stated otherwise)

Affin Hwang

Affin Hwang

MOF MOF

Gross exports (%yoy) 6.3 1.6 0.1 2.5 1.1 2.7

Gross imports (%yoy) 5.3 0.4 1.4 2.7 1.3 3.4

Trade balance 82.5 91.6 82.7 83.4 91.4 88.3

Current account 48.6 34.7 15.2 12.5 16.4 14.8

(% of GDP) 4.4 3.0 1.2 0.9 1.3 1.1

(% of GNI) 4.5 3.1 1.3 1.0 1.4 1.1

Goods 113.3 109.5 97.3 98.6 97.9 100.1

Services -10.7 -21.0 -25.2 -26.0 -22.1 -23.1

Primary income* -36.6 -32.0 -36.4 -39.0 -35.4 -37.4

Secondary income** -17.4 -21.9 -20.5 -21.1 -23.9 -24.8 Source: BNM, DOS, MOF, Affin Hwang Forecast * primary income includes investment income, employee compensation, dividends, rent and taxes ** secondary income includes current transfers between residents and non-residents (ie. personal transfers, social contributions, benefits, insurance claims, current taxes on income, wealth)

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Exchange rate, inflation and interest rate assumptions Against any major downside risks from external developments, we believe Malaysia’s economic fundamentals would continue to remain sound, supported by an improving economic outlook, lower fiscal deficit position, sustainable (though narrowing) current account surplus, healthy foreign exchange reserves as well as manageable inflationary pressure. After the sharp drop in late 2015, BNM’s international reserves have continued to increase steadily on a monthly basis to RM405.6bn (US$97.8bn) as at 14 October 2016, from RM390.4bn (US$97.2bn) as at end-June 2016, whereas the reserves position is sufficient to finance 8.5 months of retained imports and is 1.2 times the short-term external debt. Based on macro fundamentals, we believe the Ringgit should appreciate gradually against the US$ by end-2016, trading at RM3.95-4.00/US$ and appreciate to RM3.90-3.95/US$ by end-2017 (RM4.20/US$ currently). However, we believe the performance of the Ringgit will also be influenced by global and regional developments, such as decision by the US Fed to raise the policy interest rate and monetary policy normalization, which may increase volatility in the financial markets. The other downside risk to our forecast for the Ringgit could also be possible renewed speculation on a further devaluation of the Chinese Yuan (CNY) by the People’s Bank of China (PBOC). When the PBOC devalued its currency by 1.9% to CNY6.2298 against the US$ on 11 August 2015, market observers were of the view that the devaluation will be a one-off and unlikely to be aggressive going forward. However, since 11 August 2015, the PBOC has devalued the CNY to CNY6.80/US$ currently, where a further devaluation in CNY may hurt regional currencies, including the Ringgit. Fig 39: Devaluation by PBOC on renminbi daily reference rate

Rank Date RMB/USD Depreciation vs USD

1 11-Aug-15 6.230 1.86%

2 12-Aug-10 6.802 0.36%

3 12-Mar-12 6.328 0.33%

4 20-Oct-10 6.675 0.30%

5 6-Dec-07 7.421 0.30%

6 25-Jun-12 6.323 0.30%

7 17-Dec-07 7.379 0.27%

8 15-May-07 7.695 0.27%

9 26-Jul-07 7.579 0.26%

10 14-Aug-06 7.993 0.25% Source: Bloomberg & other sources

While the recent depreciation of the Ringgit against the US$ should have some impact on Malaysia’s currency competitiveness, the country’s real effective exchange rate (REER) has also moved in tandem with regional currencies, see Fig 40. Fig 40: MYR/USD vs REER

Source: Bloomberg

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Inflation to remain manageable at 2.7% in 2017, with some upside risk

Malaysia’s headline inflation improved from 1.9% yoy in 2Q16 to 1.4% in 3Q16, attributed mainly to improvement in food prices as well as cost of transport, reflecting lower petrol prices (RON95 and diesel). On a cumulative basis, headline inflation rate rose by 2.2% yoy in January-September 2016, slightly higher than 1.9% yoy in the corresponding period of last year. Fig 41: Malaysia’s headline inflation

Source: CEIC

We expect the country’s headline inflation to increase in October and November. The price of the more commonly used domestic RON95 petrol price was raised by 10 cents to RM1.80 per litre in October and 15 cents to RM1.95 per litre in November, while prices of RON97 and diesel rose by 10 cents and 5 cents respectively in October and 15 cents for both in November. We estimate that Petrol (RON95 & 97) and diesel, which contribute a weight of about 8.5% to the CPI basket, will likely add about 1.0 percentage points to CPI and raise headline inflation to around 2.0-2.5% in 4Q16. For full-year 2016, we expect headline inflation to average around 2.2-2.3% (2.1% in 2015) before trending higher to 2.7% in 2017. The concern on inflation going forward is that a recovery in global commodity prices could put some upward pressure on domestic food inflation, especially with sustained expansion in the growth of domestic private consumption and economic activity. BNM likely to maintain its overnight policy rate at 3.0%

With a dual mandate to ensure a balance between inflation and economic growth, we believe BNM will focus on providing support for the sustainability of economic growth in the months ahead. Fig 42: Malaysia’s overnight policy rate with FFR

Source: CEIC

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The interest rate differential between the US FFR and Malaysia’s OPR remains wide and positive. If the US Fed raises the policy rate by 25bps in late 2016 from the current level, as expected by the consensus surveyed by Bloomberg, we believe BNM would prefer to leave its policy rate unchanged at the next and last MPC meeting for the year on 23 November, in order to keep the interest rate differential between the US and Malaysia at around 225bps. This is despite some regional central banks continued with their easing of monetary policy, such as Bank Indonesia (BI). However, any possibility that the BNM may cut its OPR rate by another 25bps at the MPC meetings in 1H17 will likely be data-dependent on external uncertainties especially, as we believe the BNM will put more focus on economic growth, if both the European slowdown from Brexit and the global economic growth deteriorate. Fig 43: Ringgit against major currencies

End period Currency performance against MYR (% change)

2015 1Q16 2Q16 3Q16 1-Nov-16 2015 1Q16 2Q16 3Q16 1-Nov-16

MYR per USD 4.29 3.90 4.03 4.14 4.18 -18.56 10.12 -3.21 -2.65 -0.96

MYR per EUR 4.69 4.43 4.48 4.63 4.60 -9.38 5.93 -1.17 -3.17 0.65

MYR per GBP 6.37 5.61 5.43 5.36 5.12 -14.46 13.52 3.27 1.27 4.67

MYR per 100JPY 3.57 3.46 3.90 4.08 4.01 -18.18 3.12 -11.29 -4.39 1.80

MYR per AUD 3.14 2.99 3.00 3.15 3.21 -8.79 5.02 -0.20 -4.83 -1.79

MYR per SGD 3.04 2.90 2.99 3.03 3.01 -12.91 5.01 -3.06 -1.47 0.76

MYR per HKD 0.55 0.50 0.52 0.53 0.54 -18.61 10.22 -3.18 -2.70 -0.97

MYR per RMB 0.66 0.60 0.61 0.62 0.62 -14.77 9.43 -0.28 -2.34 0.48

MYR per INR 0.06 0.06 0.06 0.06 0.06 -14.48 10.19 -1.34 -3.86 -0.80

MYR per 100IDR 0.03 0.03 0.03 0.03 0.03 -9.37 5.77 -3.47 -3.84 -0.91

MYR per 100KRW 0.37 0.34 0.35 0.38 0.37 -12.28 7.16 -2.50 -6.93 2.52

MYR per PHP 0.09 0.08 0.09 0.09 0.09 -14.54 7.90 -0.70 0.00 -1.16

MYR per TWD 0.13 0.12 0.12 0.13 0.13 -15.46 7.93 -3.04 -5.38 -0.30

MYR per 100THB 11.92 11.11 11.47 11.96 11.93 -10.83 7.27 -3.17 -4.08 0.28

MYR per NZD 2.94 2.70 2.86 3.00 3.00 -6.80 9.01 -5.76 -4.64 0.11 Source: Bloomberg

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Focus Charts Chart 1: Asean-5 countries GDP growth forecast Chart 2: 2017 IMF forecast

Chart 3: Global trade Chart 4: Manufacturing PMI

Chart 5: Brent price forecast by EIA Chart 6: World commodities price forecast

Source: All data for charts sourced from IMF, CEIC, Bloomberg,EIA

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Focus Charts

Chart 7: MYR versus major currencies Chart 8: Malaysia trade

Chart 9: Manufacturing approved Chart 10: Index of services

Chart 11: Balance of payments Chart 12: Household debt by purpose of financing

Source: All data for charts sourced from IMF, CEIC, Bloomberg, BNM

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Focus Charts Chart 13: Breakdown of Malaysia exports

Source: CEIC, DOS

Chart 14: Exports by country

Source: CEIC, DOS

Chart 15: Trade balance by SITC

Source: CEIC, DOS

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Equity Rating Structure and Definitions

BUY Total return is expected to exceed +10% over a 12-month period

HOLD Total return is expected to be between -5% and +10% over a 12-month period

SELL Total return is expected to be below -5% over a 12-month period

NOT RATED Affin Hwang Investment Bank Berhad does not provide research coverage or rating for this company. Report is intended as information only and not as a

recommendation

The total expected return is defined as the percentage upside/downside to our target price plus the net dividend yield over the next 12 months.

OVERWEIGHT Industry, as defined by the analyst’s coverage universe, is expected to outperform the KLCI benchmark over the next 12 months

NEUTRAL Industry, as defined by the analyst’s coverage universe, is expected to perform inline with the KLCI benchmark over the next 12 months

UNDERWEIGHT Industry, as defined by the analyst’s coverage universe is expected to under-perform the KLCI benchmark over the next 12 months

This report is intended for information purposes only and has been prepared by Affin Hwang Investment Bank Berhad (14389-U) (formerly known as HwangDBS Investment Bank Berhad) (“the Company”) based on sources believed to be reliable. However, such sources have not been independently verified by the Company, and as such the Company does not give any guarantee, representation or warranty (express or implied) as to the adequacy, accuracy, reliability or completeness of the information and/or opinion provided or rendered in this report. Facts, information, views and/or opinion presented in this report have not been reviewed by, may not reflect information known to, and may present a differing view expressed by other business units within the Company, including investment banking personnel. Reports issued by the Company, are prepared in accordance with the Company’s policies for managing conflicts of interest arising as a result of publication and distribution of investment research reports. Under no circumstances shall the Company, its associates and/or any person related to it be liable in any manner whatsoever for any consequences (including but are not limited to any direct, indirect or consequential losses, loss of profit and damages) arising from the use of or reliance on the information and/or opinion provided or rendered in this report. Any opinions or estimates in this report are that of the Company, as of this date and subject to change without prior notice. Under no circumstances shall this report be construed as an offer to sell or a solicitation of an offer to buy any securities. The Company and/or any of its directors and/or employees may have an interest in the securities mentioned therein. The Company may also make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences and hence an independent evaluation is essential. Investors are advised to independently evaluate particular investments and strategies and to seek independent financial, legal and other advice on the information and/or opinion contained in this report before investing or participating in any of the securities or investment strategies or transactions discussed in this report. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Company’s research, or any portion thereof may not be reprinted, sold or redistributed without the consent of the Company. The Company, is a participant of the Capital Market Development Fund-Bursa Research Scheme, and will receive compensation for the participation. This report is printed and published by: Affin Hwang Investment Bank Berhad (14389-U) (formerly known as HwangDBS Investment Bank Berhad) A Participating Organisation of Bursa Malaysia Securities Bhd Chulan Tower Branch, 3rd Floor, Chulan Tower, No 3, Jalan Conlay, 50450 Kuala Lumpur. www.affinhwang.com Email : [email protected] Tel : + 603 2143 8668 Fax : + 603 2145 3005

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