Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 22 July 2016 Higher oil prices may provide some fiscal flexibility Fiscal deficit likely to improve to 3.1% of GDP in 2016 and 3% in 2017 There are some concerns being raised by foreign and domestic rating agencies on the country s economic activity and fiscal position going forward, especially as the government may need to raise its spending (i.e. operating and development expenditures) to stimulate domestic demand, in an uncertain external environment. Malaysia's sovereign rating will continue to be the focus, especially if the government needs to prop up the economy through a stimulus package given downside risks in the global economy, which may lead to deterioration in Malaysia s fiscal deficit position. Despite this concern, we believe the improving trend in Malaysia s fiscal position over the years will stay on track with the recent improvement in global crude oil prices. Economic Update Malaysia- Fiscal policy The International Monetary Fund (IMF) recently downgraded its global GDP growth to 3.1% for 2016 following Brexit, but expects global growth to improve to 3.4% for 2017, only slightly below the long-term average growth trend of 3.5%. Malaysia s Second Finance Minister, Datuk Johari Abdul Ghani, was recently quoted by the press as saying that the government had cut back on its expenditure to maintain the fiscal deficit, emphasizing that it remains committed to safeguarding the country s sovereign rating. Global oil prices have recovered since early 2016 to cushion deficit It is also comforting to note that global oil prices have recovered strongly since reaching a 12-year low of between US$26-28 per barrel in mid- January 2016. Since the low of US$27.88 per barrel on 20 th January 2016, the Brent crude oil price has increased by 67% to about US$47 per barrel currently, while WTI rose by nearly 68% to US$45 per barrel over the same period. Between January and mid-july 2016, Brent crude averaged around US$42 per barrel, and is likely to remain at around the US$48-50 level in the remaining months of 2016, bringing the full-year average to around US$45 per barrel. Given that about 14% of the Malaysian government s revenue for 2016 is likely oil-related, we believe the recovery in oil prices has lifted some pressure on the country s fiscal position. Fig 1: Oil prices and volatility US$/bbl 75 65 55 45 35 CBOE Oil ETF VIX Index WTI Brent Index 85.0 75.0 65.0 55.0 45.0 35.0 25 25.0 Source: Bloomberg Recalibrated Budget 2016 focused on lowering opex and DE Recall that on 28 th January this year, the government announced the recalibrated Budget 2016, in response to low oil price environment. Economic Research (603) 2146 7540 alan.tan@affinhwang.com yeeping.lim@affinhwang.com Page 1 of 5
Two case scenarios were presented, based on the average oil price assumption of US$30 and US$35 per barrel, a downward revision from US$48 per barrel in the original Budget 2016 (announced in October 2015). Under these two scenarios, 1. Revenue is projected to decline by RM600m on average for every US$1 decline in the oil price between US$48 and US$35 per barrel; 2. Revenue is projected to decline by RM300 on average for every US$1 decline in the oil price between US$35 and US$30 per barrel. However, even with the slightly better revenue expected from the recovery in oil prices, as compared to the revised Budget, the Malaysian government has already guided that it has no immediate plan for a budget revision to reinstate expenditures to spur the domestic economy. In our opinion, the slightly higher revenue will likely act as a backup stimulus plan, if needed, to be implemented in 2H16, without having to raise Malaysia s fiscal deficit position, see Fig 2. Fig 2: Original and recalibrated Budget 2016, unless stated otherwise Original (Oct-15) Recalibrated (Jan-16) Projected average change per US$1/bbl Oil price (US$ per barrel) 48.0 35.0 30.0 48-35 35-30 Revenue 225.7 217.9 216.3 0.6 0.3 Total expenditure 264.4 256.4 254.9 0.6 0.3 Opex 215.2 211.2 210.7 0.3 0.1 Net DE 49.2 45.2 44.2 0.3 0.2 Gross DE 50.0 46.0 45.0 0.3 0.2 Loan recoveries -0.8-0.8-0.8 0.0 0.0 Fiscal balance -38.8-38.5-38.7 0.0 0.0 Fiscal balance (% of GDP) -3.1-3.1-3.1 0.0 0.0 Government unlikely to raise OPEX and DE, if economy holds up Back in early January, in response to the lower collection of oil-related revenue, as well as to maintain the fiscal deficit position at 3.1% of GDP, the government had resorted to optimising both the operating expenditure (OPEX) and development expenditure (DE), through cost-cutting in noncritical spending, such as supplies & services, see Fig 3. Fig 3: Fiscal adjustment measures in 2016 Budget Recalibration Expenditure optimisation measures 1 2-5% scale down in supplies & services 1.7 2 Rationalisation of grants and transfers 1.0 3 Lower subsidy on LPG and diesel 1.0 4 Delay asset purchase 0.2 5 Reprioritisation of development expenditure 5.0 Total 9.0 Source: BNM, Prime Minister s Speech on 28 January 2016 Development expenditure still supportive of growth DE was reduced to RM46bn and RM45bn on average oil price assumptions of US$35 and US$30 per barrel, respectively. This was done through rescheduling non-physical projects and projects still under study, reducing the cash flow commitment by RM4-5bn, while infrastructure projects with larger multiplier effects will be prioritised and carried out. Page 2 of 5
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015* 22 July 2016 Based on our estimates, with recent oil prices having rebounded to the US$46-48 per barrel range, and averaged at around US$42 per barrel (comfortably above US$30-35 per barrel), the government has some flexibility to increase the DE budget towards RM50bn. However, we believe the government will wait for a clearer economic outlook on Malaysia s domestic demand, given the recent slowdown in both private consumption and investment, before deciding on reinstating some of the cutback in development expenditure. Despite warranting the flexibility, we think the DE budget is unlikely to be fully utilised. A look back at government finance for 2015 showed that, even though the government did not cut the DE allocation in the revised Budget 2015, actual spending was lower at RM40.8bn, translating into an utilisation rate of 84.1%. For 2016, with allocation in emolument and pension charges, in tandem with salary increases for civil servants, we believe OPEX will be slightly higher than the allocation in the revised Budget, in a similar trend to 2015. Fig 4: 2015 government finance 2015 Budget Announcement Oil price Fiscal Fiscal balance Revenue OPEX DE, unless stated otherwise date (US$/bbl) balance (% of GDP) Original budget 2015 10-Oct-14 100.0 235.2 223.4 48.5-35.7-3.0 Revised budget 2015 20-Jan-15 55.0 222.9 212.4 48.5-37.2-3.2 2015 estimates in Budget 2016 9-Oct-15 55.0 222.5 213.3 47.4-37.2-3.2 Actual 52.0 219.1 217.0 40.8-37.2-3.2 As there is no urgent need for a higher allocation for development expenditure, if the Malaysian economy continues on its current steady pace, the expected improvement in oil revenue may be necessary to accommodate the slightly higher OPEX. The government has underspent the DE allocation in the past five years, with the utilisation rate ranging between 84-95%, see Fig 5. The underutilisation of the DE allocation primarily came from economic services, especially within trade and industry, as well as transport. Economic services account for more than 60% of gross DE, which was spent on major infrastructure projects. Fig 5: Development expenditure Actual (LHS) 60 Actual spending relative to budget (%) 50 40 30 20 10 % 110 105 100 95 90 85 Fig 6: Operating expenditure (actual vs budget) 250 Actual Original budget 200 150 100 50 0 80 0 Overall, the government will stay on its fiscal consolidation path, where we believe the country s fiscal deficit will be lower by 0.1 percentage points to 3.1% of GDP in 2016 and likely to improve further to 3.0% of GDP in 2017 (3.2% of GDP in 2015), barring any significant downturn in the global economy. Page 3 of 5
Focus charts Table 1: Breakdown of oil-related revenue 2009 2010 2011 2012 2013 2014 2015 2016F* Oil related revenue (RMmn) 65,576.3 56,534.5 66,362.1 70,172.1 66,634.4 66,315.4 44,367.3 31,783.2 PITA 27,231.2 18,713.3 27,747.8 33,933.7 29,753.1 26,956.1 9,529.0 9,331.0 Petronas dividend 30,000.0 30,000.0 30,000.0 26,260.3 27,000.0 29,000.0 26,000.0 16,000.0 Petroleum royalties 4,805.4 4,855.1 5,147.7 6,423.3 6,186.3 6,531.8 4,415.0 3,169.0 Other oil-related 3,539.7 2,966.1 3,466.6 3,554.7 3,695.0 3,827.5 4,423.3 3,283.1 Oil related revenue (% of total revenue) 41.3 35.4 35.8 33.8 31.2 30.1 20.2 14.1 PITA 17.2 11.7 15.0 16.3 13.9 12.2 4.3 4.1 Petronas dividend 18.9 18.8 16.2 12.6 12.7 13.1 11.9 7.1 Petroleum royalties 3.0 3.0 2.8 3.1 2.9 3.0 2.0 1.4 Other oil-related 2.2 1.9 1.9 1.7 1.7 1.7 2.0 1.5 *Original Budget 2016 Chart 1: Breakdown of DE (actual relative to budget) Chart 2: Government revenue (actual vs budget) Chart 3: Oil related revenue Chart 4: Government fiscal balance Source: CEIC, DOS, MOF Page 4 of 5
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 : research@affinhwang.com Tel : + 603 2143 8668 Fax : + 603 2145 3005 Page 5 of 5