CIMB: Domestic Drivers to steady the ship in 2012

CIMB research remain cautious on Malaysia's growth outlook for 2012 as several factors will put the brakes on growth - slower export growth due to the fragile western economies as well as slower consumption and investment growth due to heightened uncertainty and volatile financial markets. The implementation of ETP and stimulus measures cannot take up all the slack left by weak exports.

Slowing growth, rising risks

We expect GDP growth to slow to 3.8% in 2012 from an estimated 5% in 2011. The factors that shape the prognosis are:

1. continuing weak global growth, pressured by volatile financial markets and Europe's sovereign debt worries;
2. a downturn in Malaysia's export cycle;
3. an expected slowing of consumption and investment due to worries over economic conditions

What to expect in 2012?

While not forecasting a global recession, a combination of fiscal tightening and a potential bigger financial shock from the debt crisis are expected to result in weaker global growth in 2012.

1. Limited growth for the US economy. Its recovery is fragile and could succumb to any big external shocks, especially from Europe. This could lead to a double-dip recession. The sluggish recovery of the labor market as well as housing deflation will dampen household spending.
2. The Eurozone is already in recession in 4Q11 and this will persist in 2012 as the persistent sovereign debt worries, volatility in financial markets and fiscal austerity will weigh significantly on growth. These braking factors will certainly raise the risk of more severe deleveraging, credit contraction and economic drag as the negative feedback loop between the banking system and the real economy becomes entrenched.
3. China and India to continue growing, albeit at a slower pace due to the laggard impact of monetary tightening measures as well as a less favourable external environment. There are still fears of a hard landing for China.

Domestic demand cushions against weaker exports

With the export engine throwing a spanner in the works, the pressure is on domestic demand to keep the economy going, underpinned by both private spending and public investment. The key drivers of consumer spending are stable income and favorable employment prospects. But concerns over weaker growth prospects and volatile stock markets will bite into discretionary spending. Also, global uncertainties will throw a damper over the investment activity.

Macroeconomic policies: What to expect?

For 2012, the government is not straying from its path of fiscal sustainability as it targets to bring down the budget deficit from 5.4% of GDP in 2011 to 4.7%. The high level of debt constrains the government's ability to take on additional risk on its balance sheet. If the country does not commit to a credible fiscal reduction plan, it runs the risk of a downgrade of its credit rating in the event of a major change that pushes the fiscal deficit off track.

Monetary policy will continue to support activity

There is still a risk of food inflation. For 2012, inflation was expected to moderate to estimated 2.2% due to:

1. weaker economic growth;
2. easing commodity prices;
3. a high base due to the fuel and sugar price hikes in 1H11

Persistent growth concerns, both global and domestic, coupled with expectations of easing inflationary pressures will enable the central bank to maintain an accomodative monetary policy. The tone of its policy statement on 11 Nov 11 suggests that growth is more of a worry than inflation, signalling the central bank's readiness to reverse its monetary course if domestic conditions deteriorate. An early rate cut in 1Q12 is still a possibility and end-2012 OPR to be targeted at 2.50-2.75% (3% at end-2011).

Source: CIMB Research

Key Highlights of BNM 3Q11 Report

Titled as "ECONOMIC AND FINANCIAL DEVELOPMENTS IN MALAYSIA IN THE THIRD QUARTER OF 2011", Bank Negara Malaysia (BNM) review some interesting facts on the status of our economy and the market outlook going forward. The announcement was chaired by Central Bank's governor to address the media after the closing of Bursa Malaysia.

Growth improved in the third quarter

Despite the challenging environment, Malaysian economy registered a higher growth of 5.8% (2Q11: 4.3%), due to stronger domestic demand. The robust  domestic demand was driven by an expansion in both household and business spending as well as higher public sector expenditure. Manufacturing sector recording a significantly better performance supported by firm regional  demand for resource-based products, coupled with the normalisation in supply chain disruptions arising from the Japan natural disaster.

The headline inflation rate, as measured by the change in the Consumer Price Index (CPI), rose to 3.4% on an annual  basis in the third quarter (2Q 11: 3.3%). The increase in consumer prices was largely the result of higher prices in the food and non-alcoholic beverages category.

Current  account recorded a larger surplus of RM26.6 billion, equivalent to 12.5% of GNI due to a higher goods surplus and lower income deficits. As at 31 October 2011, International Reserves position had increased to RM429.1 billion, equivalent  to USD134.8 billion, sufficient to finance 9.9 months of retained imports and is 4.1 times the short-term external debt.

Monetary policy is supportive of economic activity

The Overnight Policy Rate (OPR) was  left unchanged at 3.00% in the third quarter of 2011, following a 25 basis points increase in May. The stance of monetary policy is consistent with the assessment of heightened uncertainties arising from global developments that have created greater downside risks to growth.

The ringgit depreciated against the US dollar in the third quarter, in line with other regional currencies. The depreciation, mostly in September 2011, reflected mounting concerns over the European sovereign debt crisis and the sustainability of global economic recovery, which led to higher risk aversion and prompted some investors to unwind holdings of emerging market assets.

Please click here to read the full BNM report.

How to invest during HIGH Inflation era? (Sept 2011)

What is the main risk for Asian economy? None other than Inflation. Across the region, fast-growing countries such as Singapore, Indonesia, India and China are reporting faster than expected price increases in tandem with their economic success.

To fight inflation, many countries already carried out their tools of tightening. We have Singapore who fights imported inflation via stronger currency. Meanwhile, other countries are going for the traditional way of hiking interest rate and increasing bank reserve requirement since last year. At first, Bank Negara Malaysia called it as "normalization", but it seems to be "containerization" going forward to contain inflation.

Who's fault?

There are 2 causes for the problem, which I categorized them into international and national. Among the international contributing factors were:

1. Loose monetary policies practiced by US and Europe, who slashes interest rate to almost zero and carried out large scale of asset purchases. Yet, it failed to rejuvenate a sustainable economy.
2. As a result, these easy-money flushing into Asia in search of higher returns is fueling asset bubbles here. Then, we raised interest rates, and this had lured even more money into Asia together with an even stronger currency.
3. Other then equity, easy-money also flown to Commodity markets, including food staples and basic materials. Also, searching for higher return in view of greater demand by Asian countries to produce or consume more. This had pushed up inflation.

In the other end, we have National factors such as:

1. Consumer spending has risen much faster than supply. This is very obvious in populated countries such as China, India and Indonesia.
2. While western countries facing high unemployment rate, our side is not only hiring, but increasing wages too. Hong Kong and Malaysia are implementing a minimum wage for the first time. Thailand is the next to follow. Who is going to absorb the higher wages? Definitely not companies, it's consumers.

So, how to invest during high-inflation era?

Equities. Although higher inflation did not bode well for the economy, but, the revenue and earnings of companies shown in the balance sheet is greater. In other words, inflation can show up in earnings growth for some companies. To protect our investment, we should select those companies that have sufficient pricing power to pass on the additional cost to end clients.

3 Hints given by BNM (16 May 2011)

Bank Negara Malaysia (BNM) hiked the OPR by 25bps to 3% on 5 May as what some analysts said "Surprising". The OPR hike was a pre-emptive strike on inflation pressures as the output gap closes. Many analysts are expecting hikes to resume only in July as inflation remains largely supply side driven. However, BNM seems to act before demand pull pressures dominate and before the output gap turns positive. In our view, the OPR and SRR hike is indicating two things here.

Hints #1

Inflation is going to threaten the Malaysian economy in the near-term (at least). Recent increase in prices of petrol and sugar will further accelerate the numbers. With ongoing efforts by Government to reduce the subsidies, inflation numbers for sure will gone up.

Citi Research: Regional Policy Rates as at 10th May 2011

Hints #2

Related to inflation also, BNM is trying to reduce the increasing food and resources prices. If we can reduce the import price, by having a stronger currency, this would be a wise move. So, BNM is trying hard to cramp down our money spent on these import items. Not by reducing the quantity of imports, Malaysia are buying at a cheaper price. How to that? Of course, by raising the OPR rates, which will lead to a stronger currency RM.

Citi: Regional Currency Performances as at 10th May 2011

Hints #3

Maybe, BNM foresees that Malaysia economy is going to face some real challenges (Asian financial crisis?). If the situation really turns bad in a year or two, how are we going to reduce the rate to spur economy given the current low rates? We must have room for BNM to decrease the rate by that time. That's why BNM so pro-active now?

Extractions from BNM monetary policy statement

As expected, Bank Negara Malaysia (BNM) decided to maintain the Overnight Policy Rate (OPR) at 2.75% yesterday. This was the 3rd time in a row that BNM left it unchanged. Are there any hints by BNM on Malaysia's economy this year? We can explore the "hidden messages" from the monetary policy statement as below:

Regional Front:

• While advanced economies continue to register modest growth, most emerging economies have experienced strong growth.
• For Asian region, domestic economic activity continues to support the growth momentum amid weaker external demand.
• Shifts in global liquidity have resulted in significant capital flows into the emerging economies, in particular, Asian region, and have brought with it risks to macroeconomic and financial stability.
• The region is also being affected by global inflationary pressure arising from the higher commodity and food prices.

On Malaysia:

• Recent indicators point towards a sustained expansion in private sector activity.
• External demand, however, was affected by the slower global growth.
• Malaysian economy is expected to grow at a steady pace in 2011, underpinned by continue firm expansion in domestic demand.
• Private consumption will be supported by sustained employment and income growth.
• Private investment activity will be supported by domestic-oriented sectors and the expansion of new growth industries.

 On Inflation:

• Domestic headline inflation rose towards the end of 2010 albeit remained low at 2.2%.
• The increased was mainly on account of higher food and energy prices.
• Prices are expected to increase at a modest pace in the coming months, driven primarily by rising global commodity and food prices.
• The assessment is that inflation will continue to be driven by supply factors with limited evidence of excess demand exerting pressure on prices.

BNM Conclusions:

• BNM considers the current monetary policy stance as appropriate and consistent with current assessment of the economic growth and inflation prospects.
• The stance continues to remain accommodative and supportive of economic growth.
• Going forward, additional policy tools such as the statutory reserve requirement (SRR) and macro-prudential lending measures may be considered to avoid the risks of macroeconomic and financial imbalances.

Finance Malaysia view:

• We expected inflation to rise at a faster pace in 2011
• BNM to continue hiking interest rate in second-half 2011
• OPR potentially be raised by 50-75 basis points to 3.25-3.50%
• Bank's loan growth will slow if SRR was raised

Source: BNM website

For full BNM monetary policy statement, click here.


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How BNM OPR hiking affecting the market?

Malaysia to curb capital inflows?

Due to weakening USD and record low-interest rate in the US, Europe and Japan, emerging markets have been a popular spot for excessive liquidity to park their money. Main reasons being:

1. Emerging markets are the fastest growing economies currently
2. Emerging countries are having higher interest rate
3. Banking system of emerging countries are stronger (safer)

While develop countries are facing a currency downfalls, emerging countries are experiencing continuous inflow of hot money. This in turn causing a chaotic in currency exchange market, where emerging countries' currencies are hitting years high against developed nations. The imbalance forex market prompt central banks around the world to act or to curb any excessive flows of money which could jeopardised a particular countries, like 1997 Asian financial crisis.

In the latest developments on this hot topic, Thailand announced a 15% withholding tax on interests and capital gains on Thai bonds. In the meantime, South Korea, Taiwan, and Indonesia has been using "quasi-capital" control, in which encouraging outflows of hot money.

The billion dollar question... Will Malaysia follow?

Ringgit is the 2nd BEST performing currency in Asia, behind Thai Bath. I think when Bank Negara started its "triple" hike in overnight policy rate (OPR) this year, they already foresee the side effect of capital inflows. Due to large chunk of it went to Malaysia Government Securities (MGS), coupled with strong and effective domestic financial systems, Malaysia can safely mitigate the effect currently. However, we must act soon because I expect more hot money would pour in from countries which had imposed capital controls moving forward. We can expect a much stronger Ringgit soon.

Why Ringgit is so strong now?

Recently, many of my friends asking me why Ringgit suddenly is rising so fast in value?

Well, this is not a bad question though for Malaysians. In contrast, for those who working overseas, and converting to Ringgit regularly, would become poorer as a result. In fact, many Malaysians working in Singapore especially, might think that RM is generally weakening against SGD over the long-term. It's TRUE if you are saying since "Dot-Com" burst. 

Could this be a turning point now?

From the graph above, it shows clearly that the trend of decreasing value of SGD against RM. Reasons being that optimism of Malayisan economy is going to grow faster than many predicted. This has whetted foreign investors' appetite for local assets, including stocks and bonds.

World Bank recently raised its forecast for Malaysian economy to grow at a faster rate of 5.7% this year, compared with its earlier forecast of 4.1% made in November. As a result, local equity and bond markets are experiencing strong flowing-in of foreign money, spurred by strong growth prospects and favourable government policy moves. Malaysia goverment securities (MGS) is one of the ringgit-denominated asset which could give foreign funds liking to deposit, given its huge liquidity.

Anyway, the main reason behind the strengthening of Ringgit started when Bank Negara Malaysia (BNM) raised overnight policy rate (OPR) from 2% to 2.25%. And, many analyst are expecting another hike on May 13 meeting. The recent rate increase and the prospects for further hikes are supportive of the ringgit's further rise.

In Asia Pacific region, Bank Negara was among the first central banks to raise key interest rates, after Vietnam and Australia, as policymakers expect economic growth to strengthen further, or to prevent another asset bubble from being inflated. Consequently, ringgit is one of the best performing currency year-to-date.

Hint: Ringgit will strengthen further against USD, and SGD somemore...