Malaysia - Economic Outlook 2H18

Transcription

1 Slower but still steady economic growth of 5.3% in 2018 Still credible global growth despite external headwinds Following the escalation of global trade tensions with rising threats of protectionist measures by President Trump, both the global business sentiment and consumer confidence indexes have started to trend lower in recent months, which will likely affect the growth momentum of the global economy going into 2H18. However, the International Monetary Fund (IMF) kept its forecast for global growth unchanged at 3.9% for both 2018 and 2019, World Bank (WB) remains optimistic on the global economic outlook. Economic Update Malaysia - Economic Outlook 2H18 Malaysian economic growth maintained at 5.3% for 2018 We are currently maintaining Malaysia s real GDP growth at 5.3% in 2018 (5.9% in 2017), supported by domestic demand, especially from private consumption, but lower than BNM s forecast of between %. We see Malaysia s real GDP growth slowing to around 5% yoy for 2H18, from 5.5% estimated for 1H18, but there will be some downside risks. We believe economic uncertainty surrounding the global economy, following the global trade war tensions, may lead to some businesses cutting spending and delay their investments. This was also reflected in the MIER s Business Confidence Index (BCI), which dropped by 2.9 points to 98.6 in 1Q18, from in 4Q17. Domestic demand holds the key to sustain growth However, the country s domestic demand is expected to gain some momentum from higher private consumption as households increase their purchases, following the reduction of the Goods and Services Tax (GST) to 0% effective 1 June The three-month tax holiday from the announcement of GST zero-rating in June to the reinstatement of SST in September will somewhat boost consumer spending in 2Q18 and 3Q18 as consumers are likely to front-load consumption before SST. Private investment remains a drag to GDP growth The Malaysian Government has indicated that it plans to review public-sector projects and cancellations of various mega projects under planning, ranging from the multi-billion Kuala Lumpur-Singapore high-speed rail (HSR) and Klang Valley Mass Rapid Transit Circle Line (MRT 3), East Coast Rail Link (ECRL) and the Gemas-JB double-tracking rail project, which will impact private investments. Fiscal deficit of 2.8% of GDP for 2018 can be achieved The fiscal deficit target of 2.8% of GDP can be achieved for 2018, as the Government is currently expecting higher revenue, amongst others, the RM5.4bn from higher oil prices and another RM5bn from higher dividends by Government Linked Companies (GLCs) as well as expenditure rationalization exercise. We believe the 2019 Malaysian Budget, to be presented on 2 November 2018, will remain supportive of consumer spending, where the budget proposals will be generous and people-friendly, especially for the lower-income households. Ringgit is likely to strengthen gradually against US$ on fundamentals The Ringgit, which appreciated to the year high of RM3.82 against the US$ on 2 April 2018, has weakened since then by -4.0% to RM4.01/US$ recently, due to heightened uncertainties over the global trade war and international investors expectation of a sharper appreciation of the US dollar. However, with Malaysia s healthy economic fundamentals, including ample current account surplus and foreign reserves, we see the Ringgit gaining strength and trade at RM3.80/US$ by end-2018, but the forecast is premised on the development in US monetary policy, such as the direction of the Fed Funds rate and reduction in the Fed s balance sheet. Economic Research (603) alan.tan@affinhwang.com izzuddin.yussof@affinhwang.com maisarah.razali@affinhwang.com Page 1 of 14

2 Still credible global growth despite external headwinds Following the escalation of global trade tensions with rising threats of protectionist measures by President Trump, both the global business sentiment and consumer confidence indexes have started to trend lower in recent months, which will likely affect the growth momentum of the global economy going into 2H18. This has already been reflected in the global Purchasing Managers' Index (PMI), which slowed to 53.1 in May, as compared to 53.5 in April, the lowest level since August Major subcomponents of the global PMI, such as expansion in new businesses as well as new export orders, are showing signs that global manufacturers are turning slightly more cautious on the uncertainty over the global economic outlook. Fig 1: Global PMIs Source: Bloomberg Similarly, the OECD Composite Leading Indicator (CLI), a monthly forwardlooking measure of economic activity, fell to 99.9 in April, dropping below 100 for the first time in 14 months. This was due to the drop in the indicators from major economies including UK (99.1) and Japan (99.9). However, Euro area stayed at a healthy level of 100.1, supported by stable growth from Germany (100.3) and Italy (100.3). Fig 2: Global GDP growth forecast comparison Fig 3: OECD Composite Leading Index (CLI) Source: IMF, World Bank Source: OECD The OECD consumer confidence index (CCI) fell from a high of in March 2018 to in May, while OECD business sentiment index (BSI) fell from to during the same period. Page 2 of 14

3 WTO cautioned for a slower but still steady global trade in 2018 Based on the world trade statistics published by CPB Netherlands Bureau for Economic Policy Analysis, there are already signs of some slowing in global trade volumes. Measured on an average of 3-mths over the preceding 3-mths, global trade volume fell from 1.1% in March to -0.6% in April, while global industrial production was unchanged at 0.7% during the same month. This was also reflected in the global PMI trends, where manufacturers in the advanced economies lowered production and slowing down in building up inventories in anticipation of some deterioration in external demand. According to the World Trade Organisation (WTO), the latest World Trade Outlook Indicator (WTOI) value fell from in February to in May. The WTO guided that the drop in export orders, international air freight and agricultural raw materials, may have been driven by rising global trade tensions. However, WTO expects merchandise trade volume growth of 4.4% in 2018, as measured by the average of exports and imports, roughly matching the 4.7% increase recorded for Uncertainty due to severity of tariff threats The trade tensions between the US and China escalated on 15 June 2018, when the US announced that the Government would impose a 25% tariff on 818 Chinese imports worth US$34bn with effect from 6 July President Trump had earlier announced a tariff of 25% on US$50bn worth of Chinese imports, where tariffs on an additional US$16bn worth of Chinese imports will need to undergo public review. China retaliated immediately, declaring a 25% tariff on US$34bn of US imports, which will also take effect on 6 July China plans to impose additional tariffs of 25% on chemical products, medical equipment and energy, with a value of US$16bn imported from the US at a later date, which was not specified. President Trump has not backed down since, having requested the United States Trade Representative (USTR) to identify US$200bn worth of Chinese imports for additional tariffs at 10%. He also threatened to slap tariffs on another US$200bn if China proceeds to retaliate. According to Peterson Institute for International Economics (PIIE), most of the products on the initial list proposed on 3 rd April 2018 are still subject to Trump s 25% tariffs. This will bring the products that are now subject to the new tariffs to 95% (mainly consisting of intermediate inputs or capital equipment), as compared to 84% previously. The list raises costs for many US companies sourcing components from overseas. Fig 4: Chinese imports subject to tariffs (June 15 lists) Fig 5: Chinese imports subject to tariffs (April 3 list) Source: PIIE, USITC Source: PIIE, USITC Page 3 of 14

4 As for China s list of US imports subject to the 25% tariffs, they are mainly agricultural and food products, such as fish & crustaceans and dairy products were included into the list, while petroleum products and medical equipment were among the 144 items added to the China s pending retaliation list, while aircraft were removed from the list. PIIE argues that since most of the targeted products in the list are capital and intermediate goods used for domestic production, the tariffs are ultimately taxing the manufacturing sector in the US. Fig 6: US & China tariff lists (Trade statistics 2-digits Harmonized System) US China Inorganic Chemicals Meat and Edible Meat Organic Chemicals Fish and crustaceans, molluscs and other aquatic invertebrates Pharmaceutical Products Cereals Chemical Products Dairy produce Rubber and Articles Thereof Malt, Wheat Gluten etc Iron and Steel Oil Seeds, Misc. Grains, Seeds and Fruit etc Iron or Steel Articles Vegetable products Metal Preparation of Vegetables, Fruits, Nuts etc Nuclear Reactors, Boilers, Machinery and Mechanical Appliances; Parts Thereof Beverages, Spirits and Vinegar Electrical Machinery and Equipment and Parts Thereof Food Industries, Prepared Animal Fodder Railway and Parts Thereof Tobacco and Manufacture Tobacco Substitutes Vehicles (other than railway) Mineral Fuels, Mineral Oils etc Aircraft, Spacecraft and Parts Thereof Organic Chemicals Ships, Boats and Floating Structures Soap, Lubricating, etc Optical, Photographic, Cinematographic, Medical or Surgical Instruments and Parts and Accessories Albuminoidal Substances, Modified Starches etc Clocks and Watches and Parts Thereof Chemical Products Arms and Ammunition and Parts Thereof Plastics and Articles Thereof Furniture, Bedding etc Rubber and Articles Thereof Mineral Fuels, Mineral Oils, etc Cotton Plastics and Articles Thereof Vehicles (Other than Railway) Source: USTR, Commerce Ministry and various medias According to another study by CPB Netherlands Bureau for Economic Policy Analysis, based on a trade policy scenario analysis, the threats of unilateral steel and aluminium tariffs by the US, plus retaliatory tariffs by China, the EU, Canada and Mexico, together with a US-China trade war, showed that China s GDP could fall by 1.2%. As the US economy will also be negatively impacted, its real GDP is projected to fall by 0.3%, but its overall trade will see a loss of around 14%, see Fig 7. Fig 7: Steel and aluminium tariffs & retaliations, plus a US-China trade war US China EU Netherlands Canada Mexico Japan World GDP (%) Export volume (%) Import volume (%) Terms of trade (%) Source: CPB Netherlands Bureau for Economic Policy Analysis, WorldScan simulations Based on the study, the difference in outcomes was due to the US market power, which consumes a large share of China s exports. Therefore, if China does retaliate, its impact on US exports is small in comparison. The study added that other OECD countries, including the EU, will benefit from the loss of bilateral trade between US and China where real GDP is projected to expand by 0.4% as EU countries fill in the gap from lower Chinese exports to the US. Page 4 of 14

5 However, CPB Netherlands Bureau for Economic Policy Analysis also highlighted that in an extreme global trade scenario of a full blown trade war, with the US and its trading partners increasing the tariffs on all imports, the outcome will be a strong negative economic effects, even with modest increases in overall tariffs of 5%, see Fig 8. The US is likely to be a big loser, if the trade war includes other OECD countries as well as EU and China, namely Canada and Mexico, since these two countries have strong trade ties with the US. However, across all possible trade war scenarios (5% to 15% tariff), China will be most significantly negatively affected. Fig 8: Scenario analysis of trade war impact US China EU28 Netherlands Japan Korea Canada Mexico 5% on all goods between US and the OECD GDP (%) Export volume (%) Import volume (%) Terms of trade (%) % on all goods between US and the OECD GDP (%) Export volume (%) Import volume (%) Terms of trade (%) % on all goods between US and the OECD GDP (%) Export volume (%) Import volume (%) Terms of trade (%) Source: CPB Netherlands Bureau for Economic Policy Analysis, WorldScan simulations IMF is cautiously optimistic on global growth for 2018 The International Monetary Fund (IMF), in the April World Economic Outlook Update (WEO) report, kept its forecast for global growth unchanged at 3.9% for both 2018 and Similarly, in the latest June Global Economic Prospect publication, World Bank (WB) remains optimistic on the global economic outlook, maintaining its global growth rate projections unchanged at 3.1% for 2018 and 3.0% for 2019 from its earlier projection in January Fig 9: IMF GDP forecasts Source: IMF Nevertheless, World Bank noted that trade protectionism and geopolitical tensions are among the main downside risks that could drag the global growth outlook downward. The IMF, which is due to release the World Economic Outlook Updates report in July 2018, is likely to cut its outlook for global growth this year and Page 5 of 14

6 However, even if there is a revision in global GDP growth forecast, we believe any downward revision in global growth by IMF is likely to be small, due to the healthy US GDP growth. US economy to remain strong in 2018 The IMF raised its US GDP growth forecast by 0.2 percentage points to 2.9% for 2018 (2.3% in 2017), and maintained the same growth forecast in its latest 2018 Article IV Mission to the US, which was published on 14 June. This was in view of strong economic growth and job creation in the nearterm, supported also by the increase in government spending following the Bipartisan Budget Act passed in February 2018, while the Tax Cuts and Jobs Act enacted last year will encourage additional discretionary expenditures. The IMF also projects the expansionary fiscal policy to add to domestic growth through to This was also in line with World Bank s growth forecast, which was lifted by 0.2 percentage point to 2.7% this year as well as US Federal Reserves (US Fed) recent upward revision of its real GDP projection to 2.8% in 2018 from 2.7% previously. Overall, despite the cautious optimism, IMF also noted that increasing trade tensions between US and China is a key downside risk to global growth. China s GDP growth has been resilient, expanding to 6.8% yoy for the third consecutive quarter in 1Q18, supported by the expansion in construction and manufacturing sectors. However, IMF also anticipates growth to be slower at 6.6% yoy in 2018 (6.9% in 2017) on the back of increasing borrowing costs, slowing credit growth, crackdown on government spending and penalties imposed on pollution. China is Malaysia s largest trading partner, accounting for around 12% of the country s total exports, while US contributes close to 9%. Based on our estimate, if both US and China proceed with their 25% tariff threat on US$50bn worth of imports, global trade growth could slow down by approximately %, which may drag Malaysia s economic growth in the range of %. As such, Malaysia s growth projection for GDP in 2018 will be in the region of 4.9% from our base case of 5.3%. Malaysian economic growth maintained at 5.3% for 2018 We are currently maintaining Malaysia s real GDP growth at 5.3% in 2018 (5.9% in 2017), supported by domestic demand, especially from private consumption and investment, but lower than BNM s forecast of between % this year. Fig 10: Real GDP growth & 2018 forecast F F F %yoy % of GDP % point to GDP growth GDP by Expenditure Components Total Consumption Private consumption expenditure Public consumption expenditure Total Investment Private investment expenditure Public investment expenditure Domestic Demand Net exports Exports Imports Changes in inventories GDP (2010 real prices) GDP By Kind of Economic Activity Agriculture, Forestry and Fishing Mining and Quarrying Manufacturing Construction Services Import duties GDP (2010 real prices) Source: BNM & AffinHwang s forecast Page 6 of 14

7 We see Malaysia s real GDP growth slowing to around 5% yoy for 2H18, from 5.5% estimated for 1H18, but there will be some downside risks. Malaysia s real GDP growth slowed from 5.9% yoy in 4Q17 to 5.4% in 1Q18 for the second consecutive quarter, after registering a high growth of 6.2% in 3Q17. This was partly due to a slower growth in domestic demand as well as higher base effect in the corresponding period of last year. Growth in domestic demand slowed from 6.2% yoy in 4Q17 to 4.1% in 1Q18, due to the sharp drop in both public and private investments, which slowed sharply from 4.3% yoy to 0.1% during the same period. We believe economic uncertainty surrounding the global economy, following the global trade war tensions, may led to some businesses to cut spending and delay their investments. This was also reflected in the Malaysian Institute of Economic Research (MIER) s Business Confidence Index (BCI), which dropped by 2.9 points to 98.6 in 1Q18, from in 4Q17, falling below the 100 for the first time since 4Q16, indicating that conditions have started to slow. Fig 11: Malaysia s MIER BCI Fig 12: Malaysia s Leading Index Source: DOSM, Affin Hwang Source: DOSM, Affin Hwang Malaysia s leading index (LI) also slowed from 1.8% yoy in February to 0.3% in March, averaging around 1.4% yoy in 1Q18, significantly lower than 3.1% in 4Q17, as reflected in slower money supply, weak performance of KLCI, reduced expectation of manufacturing sales and lower number of new companies registered. Nevertheless, we do not expect Malaysia s economic growth to slow down sharply in 2018, given that the global economic slowdown is not synchronised. Malaysia s exports supported by global trade and semiconductors As Malaysia is a highly open and trade dependent economy, with strong exposure to the semiconductor industry, the steady growth in the global economic development and semiconductor demand will support Malaysia s exports. Export growth rose strongly by 14% yoy in April (2% in March), due mainly to higher demand for manufactured goods, which increased from 3.7% yoy in March to 16.8% in April. This was supported by higher exports of electrical & electronic products, which rose sharply by 21.2% yoy in April (8.8% in March). Going forward, exports of E&E products (such as data processing equipment) are likely to show signs of steady growth in tandem with the latest statistics from Semiconductor Industry Association (SIA) on global production and sales of semiconductors. The global semiconductor sales rose further by +1.2% yoy to US$24.7bn in May (US$23.62bn in April), the highest level since December This was also the largest sequential monthly increase in sales for the industry since March Page 7 of 14

8 Fig 13: Malaysia s Export vs E&E Growth Fig 14: Global Semiconductor Sales Source: DOS, MATRADE Source: SIA Domestic demand holds the key to sustain growth However, the country s domestic demand is expected to gain some momentum from higher private consumption as households increase their purchases following the reduction of the Goods and Services Tax (GST) to 0% effective 1 June There are some concerns that when SST (Sales and Services Tax) is introduced in September 2018, consumers will adjust their buying behaviour from the impact of SST, where private consumption will slow again. However, we believe this will unlikely be the case as consumer spending will be supported by favourable labour market conditions and Government measures to assist low- and middle-income households. Furthermore, judging from the RM2bn a month of tax collection from SST, which was guided by MOF, the tax base will still be narrowed, as compared to a more broad-based tax system of GST, which is able to collect RM3.5bn a month. The implementation of GST since 1 April 2015 had a negative impact on consumer sentiment and domestic demand, where the MIER s consumer sentiment index (CSI) slowed sharply from 83 in 4Q14 to 72.6 in 1Q15 and fell to a low of 63.8 in 4Q15, and has remained below 100 since 2Q14. Therefore, we believe the cancellation of GST will improve consumer sentiment and spending in the country. The three-month tax holiday from the announcement of GST zero-rating in June to the reinstatement of SST in September will somewhat boost consumer spending in 2Q18 and 3Q18 as consumers are likely to front-load consumption before SST is reimplemented in September. This will also be supported by short-term expenditure programme aimed mainly at stimulating consumer spending. Private investment remains a drag to GDP growth While private consumption stays strong, we believe the government s announcement on the delay or sequence of major infrastructure projects with high import content and a low multiplier effect on the economy will put some downside risks to growth in private investment, which is also highly correlated with external conditions. Hence, the possible slowdown in global economy may lead to some postponements and delays in the actual implementation from investments approved in the manufacturing and services sectors. Similarly, the Malaysian Government has indicated that it plans to review public-sector projects and cancellations of various mega projects under planning, ranging from the multi-billion Kuala Lumpur- Singapore high-speed rail (HSR) and Klang Valley Mass Rapid Transit Circle Line (MRT 3), East Coast Rail Link (ECRL) and the Gemas-JB doubletracking rail project, which will also impact on private investment activity. Page 8 of 14

9 Fiscal deficit of 2.8% of GDP for 2018 can be achieved We believe the 2019 Malaysian Budget, to be presented on 2 November 2018, will remain supportive of consumer spending. Being the first budget by the Pakatan Harapan Government after the 14th General Election (GE), expectations are that the budget proposals will be generous and peoplefriendly, especially for the lower-income households. According to Malaysia s Finance Minister YB Lim Guan Eng, the Government is confident to achieve the fiscal deficit target of 2.8% of GDP for 2018, even after the zero-rating of GST from 6% to 0%, effective from 1st June There are a number of measures, such as reallocation of expenditure priorities, which will likely make up for some revenue loss from GST. The Government projected that the zero-rating of GST will result in lower revenue but on the re-introduction of Sales and Services Tax (SST) on 1 September 2018, roughly RM17bn will be channelled back to the consumers after the offset. There are other measures to support consumer spending, such as the petrol price stabilization program, which will cost the Government RM3bn for this year. We believe fiscal deficit target of 2.8% of GDP can be achieved, as the Government is currently expecting higher revenues, amongst others, the RM5.4bn from higher oil prices and another RM5bn from higher dividend by Government Linked Companies (GLCs) such as Khazanah, Bank Negara Malaysia (BNM) and Petronas. The Government highlighted that based on the assumption of an average global oil price of US$70 per barrel, from the US$52 per barrel used in the Budget 2018, oil revenue will increase by close to RM5.4bn. [Based on the assumption, every US$1 per barrel increase in the price of global crude oil will likely translate into a gain of about RM300m in Federal Government s revenue.] As for higher dividend from GLCs, we believe around RM3bn to RM4bn will likely come from higher Petronas dividend, which is estimated to increase from RM19bn in the 2018 Budget to about RM22bn to RM23bn for this year. To further balance the fiscal position, Government also announced that it will review, defer and renegotiate at least RM10bn worth of identified high-priced projects. These include: i) projects awarded via direct negotiation or limited tender exercise, ii) non-essential operating expenditure, iii) certain big-ticket budget allocations for mega projects and iv) other expenditure items such as special projects, capital injections etc. Nevertheless, there is some downside risk where the country s budgetary position could worsen slightly, due to possible shortfall in tax revenue receipts, especially from direct taxes, with the external environment remaining uncertain. Fig 15: MOF budget projection for 2018 Items Value (RM billion) Revenue Impact Zero-rating GST Increase in corporate taxes due to the rise in global oil prices 5.4 Higher dividends from GLCs 5.0 Proceeds from SST 4.0 Net Revenue Impact -6.6 Expenditure Impact Hari Raya Special Assistance -0.7 Petrol price stabilization program -3.0 Expenditure Rationalization Exercise 10.0 Net Expenditure Impact 6.3 Net effect of the overall budget -0.3 Projected fiscal deficit 40.1 Projected fiscal deficit (%GDP) 2.8 Source: MOF Page 9 of 14

10 As of end-2017, Malaysia s external debt stood at RM883.4bn (RM916.1bn in 2016) while government debt was RM686.8bn (RM648.5bn in 2016). However, as guided, the country s revenue requirements can be met by prioritising main/mega projects, through staggering their implementation in the future. For example, in the mid-1990s during Tun Dr. Mahathir s prime ministership, the current account deficit fell to 4.6% of GDP in 1993 from over 10% previously (13.4% in 1982 and 11.5% in 1983). Fig 16: GST collection estimation Fig 17: Current Account Balance Source: MOF, PH Manifesto Source: CEIC Amount includes contingent liability and Public Private Partnership Malaysia s Ministry of Finance (MOF) has guided earlier that the Federal Government debt and liabilities amounted to a total of RM1.087 trillion or 80.3% of GDP as of 31st December The official total Federal Government debt is RM686.8bn as at end 2017, where the debt to GDP ratio was 50.8%. However, the revised Government s debt and liabilities, which establish the true baseline on the state of financial affairs, included debt committed by Government for government guarantees (GG), where various entities are deemed unable to service their debts. This amounts to RM199.1bn (14.6% of GDP), with committed GG for entities such as Danainfra Nasional Bhd (RM42.2bn), Govco Holdings Bhd (RM8.8bn), Prasarana Malaysia Bhd (RM26.6bn), Malaysia Rail Link Sdn Bhd (RM14.5bn) as well as an estimated RM38bn for 1MDB. In addition to the above, the federal government also added lease payments (including rental, maintenance and other charges), for a whole list of "Public- Private Partnership" (PPP) projects such as the construction of schools, hostels, roads, police stations, hospitals, et cetera as government debt, which amount to RM201.4bn (14.9% of GDP). Fig 18: Malaysia s contingent liability by Federal Government Source: National Audit Department Page 10 of 14

11 We believe major sovereign rating agencies have cautioned about Malaysia s weakness in public finances under the previous BN government, where contingent liabilities were rising to an alarming level. Over the years, the Government s off-balance sheet financing of mega-projects led to contingent liabilities (loans guaranteed by the federal government) amounting to RM238bn or 17.6% of GDP as at end MOF highlighted that the government may likely need to pay for government guarantees for these identified entities, where their operating revenue will not be sufficient to cover their debt obligations, where it will require the Government to step in to guarantee and make payments on the debt, if necessary. However, we believe some of the Government Guarantees debts are borne by Government Linked Companies (GLCs) and Statutory Bodies, which may have their own sources of revenue to serve their debt obligations. Similarly, the depth of Malaysia's local capital markets also supports the sovereign's domestic financing needs. While Federal debt and contingent liabilities are relatively high and remains an underlying risk, we believe the risk is manageable. The Government has assured that Malaysia is committed to honour its debt obligations, which we believe will alleviate some concerns raised by sovereign rating agencies. Inflation likely to trend lower in second half of 2018 In the first five months of 2018, the country s headline inflation averaged 1.7% yoy, compared to 4.1% in the corresponding period of last year. We expect some inflationary pressure during the month of Ramadan and Eid al- Fitr festival (May and June), especially in the prices of food. However, the fixing of domestic retail petrol prices (RON95 at RM2.20/litre) will cap the impact of global oil price on consumer price index. The direction of the headline inflation would not be affected by global oil prices, as expenditure on fuel which carries a significant weight of about 7.5% in the overall consumer price index basket, will remain stable. Even with the GST rate being reduced from 6% to 0%, effective from 1 June 2018, to be replaced by sales and services tax (SST) in September 2018, we believe inflationary pressure will remain manageable, supported by declines in producer price index. We believe the country s headline inflation will likely improve from 3.7% in 2017 to average around % in 2018 (as compared to the official forecast of 2-3%). This was revised lower from our previous forecast of % for Fig 19: GST and RON95: impact to inflation Source: BNM, Affin Hwang Page 11 of 14

12 As the country s domestic demand remains strong, we believe BNM will likely continue to provide a neutral and supportive monetary environment, by ensuring stable policy interest rates. BNM will likely leave its OPR unchanged at 3.25%, possibly throughout There are downside risks from uncertain external demand on the manufacturing and services sectors, as businesses may turn cautious on the economic outlook. Fig 20: Interest rate differential between Malaysia and other countries Source: Bloomberg, Affin Hwang Even with US Federal Reserve raising its Fed Funds rate, while some regional central banks have raised policy rates, we believe BNM will likely wait until late 2H18 to gauge the state of the Malaysian economy, before deciding on whether to raise OPR further by 25bps to 3.5% (3.25% currently). The government is targeting domestic demand growth to sustain the country s real GDP growth. Fed now anticipates two more rate hikes in 2018 The Fed Funds Rate (FFR) was hiked twice in March and June by 25bps each to % amid the tightening labour market and higher than expected inflation rate. Based on the Fed s current assessment on the US economy, the latest dot plots, signals four rate hikes in 2018, revised from the three rate hikes guided earlier. As a result, we believe the US Fed will likely raise its FFR two more times (likely in September and December s FOMC meetings) to % by end The Fed guided that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labour market conditions, and inflation near the Committee s symmetric 2% objective over the medium term. Fig 21: US FOMC dot plot Source: US Federal Reserve Page 12 of 14

13 Ringgit is likely to strengthen gradually against US$ on fundamentals The Ringgit, which appreciated to the year high of RM3.82 against the US$ on 2 April 2018, has weakened since then by -4.0% to RM4.01/US$ recently, due to heightened uncertainties over the global trade war and international investors expectations of a sharper appreciation of the US dollar. This has also prompted some foreign investors to unwind their holdings of emerging market assets back to US denominated assets. Fig 22: Ringgit against dollar vs REER Source: Bloomberg However, with Malaysia s healthy economic fundamentals, including ample current account surplus and foreign exchange reserves, we see the Ringgit gaining strength and trade at RM3.80/US$ by end-2018, but the forecast is premised on the development in US monetary policy, such as the direction of the Fed Funds rate and reduction in the Fed s balance sheet. We expect the current account surplus to remain substantial at RM39bn for 2018 or 2-3% of gross national income (GNI) compared to RM40.3bn or 3.1% of GNI in The international reserves of Bank Negara Malaysia (BNM) rose to US$107.9bn as at 14 th June 2018, still ample as compared to US$108.5bn as at end-may. The reserves level was supported by higher net export earnings, where trade surplus widened to RM46.4bn for the first four months of 2018, (RM27.5bn in Jan-April 2017). The current level of reserves is sufficient to cover 7.5 months of retained imports, while reserve coverage of short-term external debt was at 1.0x. Page 13 of 14

14 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, Kuala Lumpur. research@affinhwang.com Tel : Fax : Page 14 of 14