economic update : ministry of finance economic report 2010/2011 – continuing fiscal consolidation,...

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15 October 2010

Economic Update

Ministry Of Finance Economic Report 2010/ 2011

Continuing Fiscal Consolidation, No Major

The MOF expects the countrys real GDP to ease to a range of 5.0-6.0% in 2011, from +7.0%

estimated for 2010. This is mainly on account of slowing export growth, but supported by resilient

consumer spending. The MOFs outlook projection is broadly in line with our expectation, as we

expect the economy to moderate to +5.0% in 2011, from +7.3% estimated for 2010.

The Federal Government expects its budget deficit to narrow slightly to 5.4% of GDP in 2011

(before imputing the proposed measures in the budget speech), from a deficit of 5.6% estimated

for 2010. This is higher than our expectation of a deficit of 4.2% of GDP for 2011, suggesting that

the Government intends to front load its expenditure during the initial period of the implementation

of various initiatives under the New Economic Model. This is prudent given tising risk of a sharper-than-expected slowdown in the global economy, which will in turn hurt the countrys exports.

The MOF expects real exports to slow down to +6.7% in 2011, after a rebound to +11.6% estimated

for 2010. The slowdown is consistent with a slowdown in the global economy projected by the

International Monetary Fund (IMF) and broadly in line with our expectation.

In tandem with a slowdown in the growth of exports, the MOF forecasts real aggregate domestic

demand to ease to +5.8% in 2011, from an estimate of +6.9% in 2010, as consumers and

businesses turn more cautious on spending. This will likely be compounded by a cutback in the

Governments development expenditure.

On the supply side, the slowdown in economic growth will be reflected in slower growth in the

manufacturing and services sectors, in tandem with a slowdown in the growth of exports and

domestic demand. Similarly, construction activities are projected to moderate, as the Government

reduces its development spending. These, however, will likely be mitigated by a pick-up in

agriculture and mining output during the year.

The MOF expects the current account surplus of the balance of payments to widen to RM114.2bn

or 14.1% of GNI in 2011. This is broadly in line with our expectation and the surplus will continue

to provide an underlying support to the ringgit. We expect the ringgit to trade at RM3.00-3.10/US$

in 2011.

The MOF expects inflation to rise to an average rate of +1.5% in 2010 but it did not provide any

forecast on the inflation outlook for 2011. We expect inflation to trend up to an average of 2.8%

in 2011, from +2.0% estimated for 2010. Meanwhile, we believe the Central Bank will likely resumeits policy normalisation in 2011 but the timing will depend on how soon the global economy

stabilises.

Executive Summary

Peck Boon Soon

(603) 9280 2163

[email protected]

Please read important disclosures at the end of this report.

Malaysia

P

P7767/09/2011(028730)

MARKETDA

TELINE

Surprises In Growth Forecasts

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2/12

ECONOMIC UPDATE2A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com

Ministry Of Finance Economic Report 2010/ 11

Fiscal Consolidation To Continue, No Major Surprises In Growth

Forecasts

The Malaysian economy is projected to grow at a more moderate pace in 2011, on

the back of a slowdown in exports growth, according to the Ministry Of Finance

(MOF). The MOF expects the countrys real GDP growth to ease to a range of

5.0-6.0% in 2011 (see Table 1), from +7.0% estimated for 2010. Based on the

data provided in the Economic Report, the growth works out to be 5.5%. This is

mainly on account of slowing export growth, but supported by resilient consumer

spending. The MOFs outlook projection is broadly in line with our expectation,

as we expect the economy to moderate to +5.0% in 2011, from +7.3% estimated

for 2010.

In its slightly more optimistic real GDP forecast, the Governments gross

development expenditure allocation for 2011 came in higher than the guidance

provided under the Tenth Malaysia Plan (10MP), which was released in June. In this

respect, the Government only cut the gross development expenditure allocation by

9.0% to RM49.2bn for 2011, compared to our expectation of a reduction of about

19% in 2011. This suggests that the Government intends to front load its

expenditure during the initial period of introducing the New Economic

Model (NEM) and the implementation of various initiatives under the model. Indeed,

a total of RM9.5bn will be allocated for the six National Key Result Areas (NKRAs),

mainly to cater for the need of rural basic infrastructure (RM6.4bn) and urban public

transport (RM1.4bn) spending. A total of RM6.0bn will be allocated for the 12

National Key Economic Areas (NKEAs), which include RM2.2bn for Greater KL (Klang

Valley), RM857m for electrical & electronics, RM821m for agriculture, RM447m for

palm oil, RM425m for tourism and RM234m for education sectors. The move also

suggests that the Government intends to gradually reduce its budget deficit to

ensure that the economy will sustain its growth amidst a slowdown in the global

economy. This is a policy that was adopted by the Government in the early 2000s

under a growth-based fiscal consolidation. In a growth-based fiscal

consolidation, the Government cuts back its expenditure gradually to ensure that

economic growth remains intact. The argument is that large fiscal consolidations will

The MOF expects real GDP

growth to soften to 5-6%

in 2011, broadly in line with

our expectation

The Government intends to

front load its expenditure

during the initial period of

t he imp l ementa t i on o f var ious in i t iat ives under

the NEM

I t i n t ends t o g radua l l y

reduce its budget deficit by

adopting a grow th-based

fiscal consolidation

2010(e) 2011(f)

Real GDP growth (%) 7.0 5.0-6.0

Agg.domestic demand (real,%) 6.9 5.8

Exports of goods&services (real,%) 11.6 6.7

Fed.Govt budgetary position(RMbn) -43.3 -45.5

(% of GDP) -5.6 -5.4

Public sec. budgetary position(RMbn) -60.1 -63.5

(% of GDP) -7.8 -7.6

Inflation rate (%) 1.5 n.a

Unemployment rate (%labour force) 3.6 3.5

Current account balance (RMbn) +103.8 +114.2

(% of GNI) +13.8 +14.1

Gross national savings (% of GNP) 35.6 35.7

External debt service ratio 7.6 n.a

(% of total export earnings)

e : Estimates f : Forecasts

Source : MOF's Economic Report 2010/2011

Table 1

Key Economic Indicators


3/12

ECONOMIC UPDATE3


lead to a revision in expectations about future tax burden. If consumers and

businesses anticipate long-run tax reductions, they may increase expenditure now,

so much so that it could potentially offset the demand-side effects of the fiscal

contraction. However, the growth-based fiscal consolidation policy has to be

implemented in a credible and decisive manner; and followed through by systematic

reforms. In contrast, if the fiscal contraction does not lead to the expectation of

significantly lower permanent government consumption expenditure and hence

taxes, then the conventional negative aggregate demand effect may dominate. Asa result, the Federal Government expects its budget deficit to narrow slightly

to 5.4% of GDP in 2011 (before imputing the proposed measures in the budget

speech), from a deficit of 5.6% estimated for 2010. This is higher than our

expectation of a deficit of 4.2% of GDP for 2011. Meanwhile, the Government also

revised up its budget deficit estimate for 2010 to 5.6% of GDP, from 5.3% of GDP

projected in the 10MP.

Apart from front loading its expenditure under the ETP, prospects of a slowdown

in the global economy, and hence the countrys exports, might have prompted the

Government to cut its gross development expenditure less than the guidance

provided under the 10MP, in our view. As it stands, the slowdown in the worlds

major economies, from the US to Japan and China, has become more widespreadsince the 2Q, after a strong rebound from the worst recession since the world war

II. The latest economic data releases suggest that the growth in these countries will

likely soften further in the 2H of the year and extend into 1H 2011 . Also,

the effect of the dissipating global stimulus spending will likely be felt in the 2H of

the year. Meanwhile, the austerity drive in the highly indebted European countries

is beginning to affect economic activities in the region. Already, global

manufacturing and services activities slowed down for the fifth straight month in

September (see Chart 1). Furthermore, manufacturing new orders weakened to the

slowest pace of growth in 15 months, indicating that global manufacturing activities

are likely to moderate further in the months ahead. Similarly, the OECD composite

leading indicators 12-month rate of change moderated for the fifth consecutive

month to 3.8% in August, the slowest pace of increase in 10 months and from +5.3%in July (see Chart 2),indicating that OECD countries economies are likely to expand

at a slower pace in the months ahead.

Chart 2Global Manufactur ing And

Services Activ it ies Slowing Down

Index

30

35

40

45

50

55

60

65

05 06 07 08 09 10

Chart 1OECD Leading Indicator Points ToA Slower Economic Growth Ahead

% 12-mth annualised rate of change

-20

-15

-10

-5

0

5

10

15

20

25

30

00 01 02 03 04 05 06 07 08 09 10

Total OECD Japan

US Euroarea

China

As a result, we believe the US Federal Reserve is moving closer to implement

a new round of quantitative easing as soon as on 2-3 November during the

forthcoming FOMC meeting. Similarly, the Bank of Japan (BOJ) stepped up its

monetary easing on 5 October by lowering its benchmark interest rate to a rangeof 0-0.1% and expanding its balance sheet to buy government bonds and other

assets. Although the European Central Bank (ECB) said that policymakers are in

the same mood a month ago, thus far they remained committed to phase out their

unlimited lending programme. With monetary policies leaning towards a loosening

The budge t de f i c i t i s

p ro j ec t ed t o na r row

slightly to 5.4% of GDP in

2011

Prospects of a slowdow n in

the global economy might

have p rompted t he

Government to cut its gross

development expenditure

l e s s t han t he amount

guided under the 10MP

The US Federal Reserve is

mov i ng c l o se r t o

implement a new round of

quantitative easing, while

Japan has stepped up its

efforts to ease its policy


4/12


bias, we believe developed countries are unlikely to fall back into a recession. In

Asia, we believe most central banks in the region are likely to slow down their policy

tightening or taking a pause in view of the risk of a sharper slowdown in the global

economy and a sharp appreciation in currencies due to inflow of foreign capital.

Still, the small reduction in the Governments budget deficit in 2011 indicates that

the Government has limited room to manoeuvre in the event the global

economy falls into a double-dip recession. This is especially the case given thatthe Government announced on 13 October that it will postpone the implementation

of a goods and services tax (GST), without specifying the length of the delay to

enable the Government to engage inclusively with all segments of society pertaining

to the GST. We believe without an introduction of the GST to broaden the tax base,

it would remain difficult for the Government to lower its budget deficit to a more

manageable and flexible level in the near future. This is reflected in the Government

revenue, which is projected to increase only modestly by 2.3% in 2011, while total

expenditure is forecast to increase by 2.8%. Also, oil revenue still accounts for a

sizeable 35% of the government revenue in 2011 based on our estimate, a drop

from around 40% in 2009.

Meanwhile, the Governments subsidies are projected to fall by 4.9% to RM23.7bnin 2011, indicating that the Government will cut its subsidies gradually as

indicated by the Performance Management and Delivery Unit (Pemandu). This is to

ensure that consumers would not be significantly affected by the reduction in

subsidies that will lead to higher prices of food and energy. Furthermore, the

economy needs a resilient domestic demand to cushion the slowdown in exports

which may turn out to be sharper than expected.

As a whole, we are maintaining our real GDP forecast unchanged at 5.0% in

2011, a more moderate growth than +7.3% estimated for 2009. For 2010, the MOF

expects the economy to expand by 7.0%, an upward revision from 6.0% projected

previously.

A Slowdown I n Exports In 2011

The MOF expects real exports to slow down to 6.7% in 2011, after a rebound

to +11.6% estimated for 2010. The slowdown is consistent with a slowdown in the

global economy projected by the International Monetary Fund (IMF). Indeed, the

IMF cuts its projection for the global economy to 4.2% in 2011, from +4.3%

forecast previously and compared with +4.8% estimated for 2010. This is broadly

in line with our expectations, as we expect real exportsto weaken to 7.6% during

the year, from +11.7% estimated for 2010.

As it stands, the US personal consumption expenditure (PCE) slowed down to an

annualised rate of 1.7% in August, from +1.9% in July and the peak of +2.6% inMay. This was the third consecutive month of easing and the slowest pace of

increase in seven months, suggesting that consumer spending is slowing down.

However, it will likely remain resilient given that non-farm private sector continued

to create jobs for the last nine consecutive months, albeit at a slow pace in recent

months. Similarly, manufacturing activities weakened to the slowest pace in 10

months in September, although services activities rebounded during the month. As

a whole, the US economic growth is projected to moderate to 2.5% in 2011, from

+2.7% estimated for 2010.

Similarly, Japans manufacturing activities contracted in September, the first in 15

months, and exports eased for the sixth straight month in August, suggesting that

the export-dependent Japanese economy will likely turn weaker in the months

ahead. In the same vein, the Euroland s economic growth is likely to have peaked

in the 2Q, as its export engine, which powered the 2Qs GDP growth, has started to

moderate.

The small reduction in the

Gove rnment s budge t

def ic i t in 2011 ind icatesthat the Government has

limited room to manoeuvre

The Government will cut itssubs i d i e s g radua l l y as

indicated by Pemandu

We are mainta in ing our

rea l GDP f o recas t

unchanged at 5.0% in 2011

The MOF expec t s rea l

exports to slow down in

2011 , b road l y i n l i ne

with our expectation

The US economic growth is

projected to moderate to

2.5% in 20 11, from +2.7%

estimated for 2010

The expo r t -dependen t

J ap ane s e e c o no m y w i l l

l ikely turn weaker and the

Eu ro l and e c o no m y w i l l

l ikely slow down as w ell


5/12

ECONOMIC UPDATE5


Chinas Purchasing Managers Index (PMI) for the manufacturing sector, on the other

hand, rose to 53.8 in September, from 51.7 in August and a 17-month low of 51.2

in July. This was the third straight month of picking up, suggesting that

manufacturing activities expanded at a faster pace during the month. Chinas money

supply, however, moderated in September. As a whole, the readings suggest that

economic activities in China have stabilised somewhat in the 3Q, after easing to

+10.3% yoy in the 2Q.

In tandem with a more moderate growth in the global economy, the demand for

electrical & electronic (E&E) products, which accounted for about 45% of

Malaysias total exports in 2009, and other non-E&E manufactured goods is likely to

soften in 2011. Already, worldwide semiconductor sales eased to +32.6% yoy in

August, from +37.0% in July and after reaching a high of +59.9% in March. Also,

the Semiconductor Industry Association expects chip sales to grow at a much slower

pace of 6.3% in 2011, compared with +28.4% in 2010.

Domestic Demand To Expand At A More Moderate Pace

In tandem with a slowdown in exports, the MOF forecasts real aggregate

domestic demand to ease to +5.8% in 2011, from an estimate of +6.9% in 2010,

as consumers and businesses turn less upbeat. This will likely be compounded by

a cutback in the Governments development expenditure. As a result, the

contribution from the private sector to GDP growth is projected to moderate to 4.5

percentage points in 2011, from +5.1 percentage points estimated for 2010 (see

Table 2). This is reflected in smaller contributions from both private consumption

and investment, which are projected to ease to 3.4 percentage points and 1.1

percentage points respectively in 2011, from +3.6 percentage points and +1.5

percentage points respectively estimated for 2010.

In this regard, the MOF projects total private expenditureto moderate to +7.0% in

2011, from +8.1% estimated for 2010. This is reflected in a slowdown in consumer

spending, which is projectedto expand at a slower paceof 6.3% in 2011, compared

with an estimate of 6.7% in 2010 (see Table 3). Already, the Malaysian Institute

of Economic Researchs (MIER) consumer sentiment index fell to 110.4 in the 2Q,

from a high of 114.2 in the 1Q. Similarly, manufacturers have turned cautious in

the recruitment for workers in recent months, in tandem with a slowdown in the

global economy and the countrys exports. In the same vein, private investment

is envisaged to ease to +10.2% in2011, from +15.2% estimated for 2010. This is

in line with a drop in business confidence as indicated by the MIERs businessconditions index, which fell to 119.6 in the 2Q, the first easing in more than a year

and from 124.0 in the 1Q. As a whole, the slowing growth trend in consumer

spending and private investment projected by the MOF is broadly in line with our

expectations but the MOFs projections are generally more optimistic.

Economic activities in China

have stabil ised somewhat

in the 3Q

Demand for E&E products

and o the r non-E&E

manu fac tu red goods i s

likely to soften in 2011

The MOF fo recas ts rea l

agg rega t e domes t i c

demand t o ease i n

2011, as consumers and

bus i nes ses t u rn l e s s

upbeat

Consumer spend i ng i s

p ro jec ted to expand at

a slower pace in 2011

P r i va t e i nves tment i s

env i saged t o ease t o

+10.2% in 2011

Table 2GDP By Demand Aggregates

(In 2000 Prices)

2009 2010(e) 2011(f) 2009 2010(e) 2011(f)

(%, change) (Contribution to GDPgrowth in percentage pt.)

Private Expenditure -2.7 8.1 7.0 -1.7 5.1 4.5

Consumption 0.7 6.7 6.3 0.4 3.6 3.4

Investment -17.2 15.2 10.2 -2.1 1.5 1.1

Public Expenditure 5.2 3.8 2.8 1.2 1.0 0.7

Consumption 3.1 0.2 4.6 0.4 0.0 0.6

Investment 8.0 8.3 0.6 0.8 0.9 0.1

e : Estimates f : ForecastsSource : Ministry of Finance Economic Report 2010/2011


6/12


In the same vein, the public sector contribution to GDP growth will ease to 0.7

percentage point in 2011, from 1.0 percentage point estimated for 2010. In

particular, the contribution from public investment is projected to slow down to a

mere 0.1 percentage point in 2011, from +0.9 percentage point estimated for 2010,

in tandem with a cutback in the Governments development expenditure. This,

however, is mitigated by a pick-up in public consumption contribution to GDP, which

is projected to contribute 0.6 percentage point in 2011, after recording a zero

contribution in 2010. The MOF forecasts public investment to slow down

significantly to 0.6% in 2011, after picking up to an estimate of +8.3% in 2010. This

is on account of a cutback in the Governments gross development expenditure, in

line with the fiscal consolidation to contain the Federal Governments budget deficit.

Similarly, non-financial public enterprises (NFPEs) development spending is

projected to slow down to 2.8% in 2011, from +9.2% estimated for 2010.

Nevertheless, the 2010s development spending of the NFPEs has been revised up

from a decline of 19.8% projected previously, suggesting that its spending in 2011

could also surprise on the upside. Public consumption, however, is projected to

grow at a faster pace of 4.6% in 2011, compared with an estimate of +0.2% in 2010.

As a whole, the MOF forecasts public expenditure to moderate to 2.8% in 2011, from

+3.8% estimated for 2010.

The slowdown in domestic demand contribution to GDP growth, however, will likely

be mitigated by a turnaround in contribution from net exports, which is projected to

record a positive contribution of 0.2 percentage point, compared with the subtraction

of 3.1 percentage points estimated for 2010. As a whole, the above analysis

suggests that the private sector, particularly consumer spending, will remain as

a key driver for the economy in 2011 .

2009 2010(e) 2011(f) 2010(e) 2011(f)

MOF RHBRI

(% Growth in real terms)

Consumption

Public 3.1 0.2 4.6 -0.4 4.5Private 0.7 6.7 6.3 5.6 5.4

Gross fixedcapital formation -5.6 11.6 5.3 9.7 6.3

Public 8.0 8.3 0.6 10.8 4.9

Private -17.2 15.2 10.2 8.6 7.8

Agg.domestic demand* -0.5 6.9 5.8 5.6 5.5

Exports of goods& non-factor services -10.4 11.6 6.7 11.7 7.6

Imports of goods& non-factor services -12.3 16.6 7.2 16.5 8.4

GDP -1.7 7.0 5.0-6.0 7.3 5.0

* : Excluding stocks

f: Forecasts e: Estimates


Table 3GDP By Demand Aggreg ates

Pub l i c consumpt i on i s

p ro j ec t ed t o bounce

back during the year

The MOF fo recas t s

pub l i c i nves tment t o

s low down s ign i f i cant l y

i n 2011 d ue t o a

cutback in development

spending

Consumer spending wi l l

remain as a key dr iver

for the economy in 2011


7/12

ECONOMIC UPDATE7


Manufacturing, Services And Construction Sectors Will Grow At A

Slower Pace

On the supply side, the slowdown in economic growth is reflected in slower growth

projected for the manufacturing, services and construction sectors. These, however,

are mitigated by a pick-up in output projected for the agriculture and mining sectors.

The MOF forecasts value added in the manufacturing sector to weaken to

6.7% in 2011, from +10.8% estimated for 2010 (see Table 4), on account of aslowdown in exports and domestic demand. We are slightly more upbeat about the

manufacturing sectors outlook, as we expect domestic demand to remain resilient

to cushion a slowdown in export growth. As a result, we expect the sector to grow

by 8.0% in 2011, albeit at a slower pace than +12.3% estimated for 2010.

2009 2010(e) 2011(f) 2010(e) 2011(f)

MOF RHBRI

(% Growth in Real Terms)

GDP -1.7 7.0 5.0-6.0 7.3 5.0

Agriculture 0.4 3.4 4.5 3 .3 3 .5

Mining -3.8 1.0 2 .9 2 .1 2 .3

Manufacturing -9.4 10.8 6 .7 12.3 8 .0

Construction 5.8 4.9 4 .4 4 .2 2 .8

Services 2.6 6.5 5.3 6 .3 4 .6

Table 4GDP By Industr ial Origin



In the same vein, the MOF expects the services sector to grow at a slower

pace of 5.3% in 2011, compared with +6.5% estimated for 2010, on the back

of a slowdown in consumer spending, business and trade activities . The slowergrowth projection is reflected in slower increases in activities in the transport &

storage, finance & insurance, real estate & business, utilities and wholesale & retail

trade sub-sectors. These will likely be made worse by a slowdown in government

services. A pick-up in activities in accommodation & restaurants and

communications sub-sectors, however, will help to mitigate the slowdown. This is

broadly in line with our expectation, as we expect the sector to slow down to 4.6%

in 2011, from an estimate of +6.3% in 2010.

Similarly, the growth in the construction sector is envisaged to moderate to

4.4% in 2011, from +4.9% estimated for 2010. This is in line with a cutback in

the Governments development expenditure during the year. Growth, however, will

likely be driven by the ongoing projects such as KLIA2, the Second Penang Bridge,

SKVE (package 3), Sabah-Sarawak Gas Pipeline and the LRT extensions.

Development projects in the five corridors as well as the implementation of new

projects under the 10MP will also help. These projects include Electrified Double

Track from Gemas-Johor Bahru, West Coast Banting-Taiping Expressway, Guthrie-

Damansara Expressway, Elevated Ampang-Pandan-Cheras Expressway, ITT in

Gombak and the 300MW Gas-Fired Power Plant in Sabah. Indeed, the Government

has allocated RM12.4bn under the 10MP and another RM22bn for completion of

projects under the Ninth Malaysia Plan (9MP). Meanwhile, the MOF expects the

residential sub-sector to recover in 2011. This is broadly in line with our

expectation.

The mining sector, however, is projectedto rebound to +2.9% in 2011 , after

recovering to a growth of +1.0% estimated for 2010. This is mainly on account of

a pick-up in the production of liquefied natural gas (LNG), on account of a robust

performance of domestic chemical industries as well as higher global demand,

particularly from China and India. This, however, will likely be offset partially by

The manufacturing sector

is projected to weaken in

2011 , as expo r t s and

domestic demand soften

The MOF expec t s t he

services sector to grow at

a slower pace in 2011, in

l i ne w i th a s lowdown in

consumer spend ing and

trade activities

Cons t ruc t i on sec t o r i s

envisaged to moderate, in

l i ne w i th a reduct ion in

government spending

The m in i ng sec t o r i s

p ro j ec t ed t o rebound

during the year, on account

of a pick-up in LNG output


8/12


a decline in crude oil production during the year due to scheduled plant maintenance

activities and the implementation of the Reservoir Management Plan by Petronas to

sustain its long-term crude oil production.

The MOF also expects agriculture output to record a stronger grow th of 4.5%

in 2011, compared with an estimate of +3.4% in 2010. This is due to a pick-up

in palm oil production on the back of increased matured areas, particularly in Sabah

and Sarawak. The production of rubber, however, is projected to moderate althoughfirm rubber prices will encourage tapping among smallholders. The non-commodity

sub-sector, mainly livestock and other agriculture, is projected to expand further

arising from the ongoing implementation of various high-impact projects.

A Gradual Reduction In Budget Deficit

The Federal Governments revenue is projected to inch up by 2.3% to RM165.8bn

in 2011, after a gain of +2.2% estimated for 2010 (see Table 5). This is on account

of a pick-up in direct tax revenue, underpinned by a rebound in petroleum income

tax, which is projected to increase by 19.1% in 2011 (-32.9% in 2010), due to higher

crude oil prices. This, however, will likely be offset partially by a slowdown in

corporate and individual income tax revenues, which are projected to moderate to8.9% and 5.8% respectively in 2011, from the corresponding rates of +10.1% and

+20.4% estimated for 2010, in line with a slowdown in the economy. Similarly,

indirect tax revenue is projected to ease, mainly on account of a slowdown in

revenue from excise duties. A decline in non-tax revenue, particularly investment

income, however, will offset a pick-up in direct tax revenue. Investment income is

projected to fall by 15.9% in 2011, after slowing down to 5.5% in 2010. We suspect

it could be due to a drop in other investment income, as Petronas is expected to

maintain its dividend at RM30bn.

Table 5

Federal Government Financial Posit ion

2009 2010(e) 20111(f) 2010(e) 2011(f)

(RM bil) (%, change)

Revenue 158.6 162.1 165.8 2.2 2.3

Operating Expenditure 157.1 152.2 162.8 -3.1 7.0

Current balance 1.6 10.0 3.0

Gross development expenditure 49.5 54.0 49.2 9.1 -9.0

Less : Loan recoveries 0.5 0.7 0.7 41.0 -6.8

Net development expenditure 49.0 53.3 48.5 8.8 -9.0

Overall balance -47.4 -43.3 -45.5

% to GDP -7.0 -5.6 -5.4

1 Budget estimate, excluding 2011 tax measures

e : Estimates f : Forecasts


Similarly, the Federal Governments total expenditure is projected to increase by

2.8% to RM212.0bn in 2011, after falling by 0.2% in 2010. The Federal Government

expects its operating expenditure (OE) to increase by 7.0% in 2011, after falling

by 3.1% estimated for 2010. A total of RM1.2bn and RM525m will be provided for

shovel-ready projects under the NKRAs and NKEAs, respectively. This is in line with

the Governments move to front load its expenditure for the implementation of

various initiatives under the NKRAs and NKEAs. The rise in pension & gratuities, debtservicing, grants to state governments and supplies & services will also contribute

to the increase in OE. The double-digit increases in these expenditures suggest that

the Governments OE will likely remain sticky downward. In particular, the

Federal Governments debt servicing burden is projected to increase by 16.6% in

The Federal Government

expects its operating ex-

penditure to increase by

7.0% in 2011

The Federal Governments

revenue i s p ro jec ted to

inch up modestly in 2011,

on account of a pick-up in

petroleum income tax

Ag r i c u l tu r e o u t p u t w i l l

record a stronger growth in

2011, due mainly to a pick-

up in palm oil production


9/12

ECONOMIC UPDATE9


2011, after rising by 11.7% in 2010 and +11.1% in 2009. This will increase the

share of debt servicing to 11.4% of total OE. The subsidy bills, on the other hand,

are projected to fall by 4.9% to RM23.7bn in 2011, after picking up by 22.5% in

2010. The bulk of the subsidies in 2010 would be spent on fuel (40%), assistance

for education (28.5%) and food (paddy, rice, sugar & flour) (8.1%).

The Federal Governments gross development expenditure, however, is

projected to fall by 9.0% to RM49.2bn in 2011, after easing to 9.1% in 2010 due tothe absent of stimulus spending. If we strip out the RM5.0bn economic stimulus

spending for 2010, the gross development would have inched up by 0.3% in 2011.

The drop in 2011 gross development expenditure is reflected in declines in

allocations for education and healthcare, while allocations for rural development and

housing sectors are projected to fall for another year in 2011. These, however, will

likely be mitigated by a pick-up in allocation for defence & internal securities, public

utilities, trade & industry and transport sectors. In particular, the allocations for the

latter three sectors are meant to facilitate the implementation of the NKRAs and

NKEAs.

Consequently, the Federal Governments budget deficit is projected to narrow slightly

to 5.4% of GDP or RM45.5bn in 2011, from a deficit of 5.6% of GDP or RM43.3bnestimated for 2010. We believe financing of the budget deficit in 2011 should not

be a problem given ample liquidity in the banking system. The excess liquidity

mopped up the Central Bank stood at RM225.3bn at end-September. In 2010, the

Government funded its budget deficit mainly through domestic borrowings.

Assuming that the Government finances all the 2011s budget deficit through

borrowings, the Federal Governments debt level is likely to rise to 54.1% of GDP

or RM453.7bn in 2011, from 52.7% estimated for 2010. About 96% of the total debt

in 2010 was financed from domestic borrowings.

Similarly, at the consolidated public sector , which includes the state

governments, statutory authorities, local governments and non-financial public

enterprises (NFPEs), fiscalspending will be less expansionary in 2011. As a result,the consolidated public sector is projected to record a smaller deficit of 7.6%

of GDP or RM63.5bn in 2011 , compared with a deficit of 7.8% of GDP or RM60.1bn

estimated for 2010 (see Table 6).

Table 6Consol idated P ublic Sector Financial Posit ion

2009 2010(e) 20111(f) 2009 2010(e) 2011(f)

(RM bil) (%, change)

Revenue 134.0 132.8 138.6 4.4 -0.9 4.4

Operating expenditure 170.3 168.0 176.8 3.2 -1.3 5.2

NFPEs current surplus 101.2 94.2 93.2 -15.2 -6.9 -1.1

Public sector current balance 64.9 59.0 55.0

% of GDP +9.6 +7.6 +6.6

Development expenditure 111.3 119.1 118.5 -10.5 7.0 -0.5

General government 54.5 57.1 54.8 7.9 4.8 -4.1

NFPEs 56.8 62.0 63.7 -23.1 9.2 2.8

Overall balance -46.4 -60.1 -63.5

% of GDP -6.8 -7.8 -7.6

1 Budget estimate, excluding 2011 tax measures

Source : Ministry Of Finance Economic Report 2010/2011

The gross development ex-

penditure is projected to

fall during the year due to

t he absen t o f s t imu lus

spending

The subs i dy b i l l s a re

projected to fall by 4.9%

to RM23.7bn in 2011

The budge t de f i c i t i s

p ro j ec t ed t o na r row

slightly to 5.4% of GDP in

2011

F i s ca l spend i ng a t t he

consolidated public sector

will be less expansionary


10/12


Widening Current Account Surplus Supportive Of A Stronger

Ringgit

The MOF expects the current account of the balance of payments to record

a larger surplus of RM114.2bn or 14.1% of GNI in 2011 , compared with the

surplus of RM103.8bn or 13.8% of GNI estimated for 2010 (see Table 7). This is

on account of a larger surplus in the merchandise trade during the year, as imports

are likely to slow down at a faster pace than exports, in tandem with a slowdown

in the economy. This, however, will likely be offset partially by a widening deficit

in the income account during the year, as repatriation of profits by non-resident

controlled companies is likely to remain large. Similarly, repatriation of salaries and

wages by foreign workers is likely to widen slightly during the year. Meanwhile, the

services account surplus is projected to remain relatively stable in 2011. This is

broadly in line with our expectation, as we expect the current account surplus of the

balance of payments to widen marginally to around RM98.6bn or 12.4% of GNI in

2011, from a surplus of RM97.1bn or 13.0% of GNI estimated for 2010.

2009 2010(e) 2011(f) 2010(e) 2011(f)

MOF RHBRI

RM(bil)

Current account 112.1 103.8 114.2 97.1 98.6

(% of GNI) (16.9) (13.8) (14.1) (13.0) (12.4)

Goods 141.7 145.9 159.6 143.1 145.2

Services 4.7 0.5 0.5 -1.4 -0.9

Income -14.6 -25.1 -27.2 -26.1 -27.2

Current transfers -19.6 -17.4 -18.8 -18.5 -18.5

Capital account -0.2 n.a n.a 0.0 0.0

Financial account -80.2 n.a n.a -53.0 -45.5

Errors & omissions* -17.9 n.a n.a -50.0 -25.0

Overall balance 13.8 n.a n.a -5.9 28.1

Outstanding reserves^ 331.4 n.a n.a 325.4 353.5

(US$)^ 96.7 n.a n.a 94.9 103.7

Table 7Balance Of Payments

* Includes errors & omissions and foreign exchange revaluation gains or losses

^ as at end of period



The widening current account surplus will lead to a build-up of foreign exchange

reserves and provide an underlying support to the ringgit. Indeed, the ringgitstrengthened against the US dollar in recent months. The ringgit appreciated by

5.4% against the US dollar between 18 June and 30 September, after depreciating

by 2.0% between 1 May and 18 June. Year-to-date, the ringgit has appreciated by

11.1% against the US dollar, the third strongest gain after the Japanese yen and Thai

baht. This was partly on account of a weakness in the US dollar as investors expect

the US Federal Reserve to announce its own big plan to buy government debt after

its 2-3 November FOMC meeting. The improving sentiment over regional currencies,

after China said that it would adopt a more flexible exchange rate on 18 June and

the liberalisation of administrative rules on foreign exchange transactions by the

Central Bank on 18 August further boosted the ringgit. A widening interest rate

differential in favour of Malaysia versus the US, after Bank Negara Malaysia raised

its key policy rate three times and by a total of 75 basis points this year, also helped.This has attracted a sizeable amount of inflow of hot money, which has risen to

a more than 2-year high in August. As the hot money could come and go at

anytime, we expect the ringgit to remain volatile and will likely fluctuate at around

RM3.10-3.20/US$ for the rest of 2010. Already, the gain in the ringgit against the

The MOF expec t s t he

current account surp lus

o f t he ba l ance o f

payment s t o w i den i n

2011

We expect the ringgit to

t rade a t RM3.00-3 .10/

US$ in 2011


11/12

ECONOMIC UPDATE11


US dollar has slowed down lately and it appreciated by 0.05% against the US dollar

between 30 September and 14 October. Further out, we expect the ringgit to

trade at RM3.00-3.10/ US$ in 2011.

Bank Negara Will Likely Resume Its Policy Normalisation In 2011

The MOF expects inflation to rise to an average rate of +1.5% in 2010, from +0.6%

in 2009. It, however, did not provide any forecast on the inflation outlook for 2011.Nonetheless, the MOF expects the accommodative monetary policy stance to

be maintained to support economic growth.

We expect inflation to trend up in 2011 due to the Governments move to

gradually reduce its subsidies once every six months that will lead to higher retail

fuel and food prices. Already, the Government raised fuel prices by around 3% and

sugar price by 16.7% on 16 July. As a result, inflation rate accelerated to 2.0% yoy

in July-August, from +1.6% in the 2Q. This, however, will likely be offset partially

by a slowdown in demand. As a whole, we expect inflation to pick up to an

average of 2.8% in 2011, from +2.0% estimated for 2010.

Although the change in administrative pricing will lead to higher inflationary pressure,

we believe Bank Negara Malaysia (BNM) will unlikely act on it. As it stands, its

interest rate hikes thus far were geared towards normalising monetary conditions in

the economy rather than controlling inflation. Indeed, we believe the Central Bank

is likely to have done with its interest rate hikes this year, after raising it by a total

of 75 basis points in three meetings and the overnight policy rate (OPR) will likely

stay at 2.75% until end-2010. Further out, we believe the Central Bank will likely

resume with its policy normalisation and the OPR w ill likely be raised by 50-75

basis points to bring it to a more neutral level of 3.25-3.50% in 2011. The timing,

however, will depend on how soon the global economy stabilises.

BNM is likely to resume its

po l i c y no rma l i s a t i on i n

2011 but the t iming wi l l

depend on how soon the

global economy stabilises

We expect the head l ine

inflation rate to pick up to

an average of 2.8% in 2011

The mone ta ry po l i c y

s t ance i s expec t ed t o

remain accommodative


12/12

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economic update : ministry of finance economic report 2010/2011 – continuing fiscal consolidation,...

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