Executive Summary

The IMF, in its September 2011 World Economic Outlook Report, lowered its forecast for 2012 global growth to 4 per cent, down from 5.1 per cent it had forecasted earlier. By early January 2012, its chief economist had announced that the IMF would on 24 or 25 January 2012 make a "fairly substantial" cut to its forecast for global economic growth this year.

The still unfolding euro zone debt crisis is at the centre of these downgrades. It is hurting the region's growth outlook and weighing on the exports of the European Union's key trading partners, which includes China. All this will weigh down on the near-term outlook of the Malaysian economy.

The Malaysian economy was resilient especially during the first three quarters of 2011, growing 5.1 per cent (1Q11: 5.2%, 2Q11: 4.3%, 3Q11: 5.8%). Growth in the last quarter of 2011 is expected to be much lower on account of external developments. Latest monthly economic indicators are already suggesting that.

The industrial production index grew just 1.8 per cent year-on-year in November 2011, compared to 2.8 per cent in the previous month. In the same month, Malaysia's total trade grew 8.2 per cent year-on-year but fell a significant 8.1 per cent month-on-month.

Inflation moderated slightly in November 2011 to 3.2 per cent year-on-year, an indication that inflationary pressures could cool going forward on account of expected slower global growth.

The results of MIER's fourth quarter Business Conditions Survey indicate declining manufacturing sector sentiments. The Business Conditions Index ended the fourth quarter below the 100-point threshold level at 96.6 points, 7.9 points below the previous quarter's level. Consumer sentiments too seem to have fallen, albeit slightly. MIER's fourth quarter Consumer Sentiments Survey results indicate a marginal worsening of sentiments. The Consumer Sentiments Index fell a marginal 2.4 points quarter-on-quarter to settle lower at 106.3 points.

The Retail Trade Index meanwhile went below the 100-point threshold to settle lower at 92.6 points. Both the Residential Property Index and the Automotive Industry Index also declined in the fourth quarter, the former settling lower at 120.1 points, the latter at 100.0 points. The Tourism Market Index however rose 10.8 points to settle higher at 126.0 points.

Given all of the above, we can only conclude that fourth quarter 2011 real GDP growth moderated both year-on-year and quarter-on-quarter and that economic growth will likely get bumpier in the months ahead.

The global economic outlook remains fluid and increasingly worrying. Further deterioration in the economic and financial environment in the Eurozone will likely weaken U.S. further, with repercussions for international trade. Further monetary policy easing beside the "operation twist" will be necessary in 2012 to revive the U.S. economy. China and other emerging economies are heading for a soft landing in the near term. Weaker global outlook, which reduces demand for commodities, will bring about lower inflationary pressures ahead. In turn, this may provide leeway for policy easing in selected economies, such as China.

In Malaysia, the 2Q11 GDP growth edged lower to 4.0 percent year-on-year due to a weaker domestic demand. By sector, services (6.3 percent) and manufacturing (2.1 percent) were the main growth engines. Economic growth momentum will probably moderate from 2H11 onwards arising from a weaker exports outlook. Further implementation of ETP projects and Budget 2012 handouts will boost domestic demand, but unlikely to offset underperformance in net exports. Against this background, MIER downgrades 2011 GDP growth rate to 4.6 percent year-on-year. For 2012, MIER revises the GDP growth forecast to 5.0 percent.

As a result of protracted slowdown in global and regional economic outlook, MIER's Business Conditions Index (BCI) and CEO Confidence Index (CEO) eased to 104.5 points and 93.3 points, respectively in 3Q11. In contrast, the Consumer Sentiment Index (CSI) edged up marginally to 108.7 points, on receding inflationary expectations. Seasonal factors lifted Retail Trade Index (RTI) higher to 128.4 points. Easing supply disruptions pushed Automotive Industry Index (AII) higher to 150.0 points.

Recent foreign exchange liberalization measures will be neutral on the performance of ringgit since higher direct investment abroad will be offset by inflows from more trade finance and easier borrowing rules from nonresident related companies. Thus, RM/USD is projected to average around 3.00 in 2011. Improving macroeconomic fundamentals will see an average RM/USD of 2.95 in 2012.

Heightened global risk aversion resulted in sudden reversal in government bond market and sell-off in Asian currencies and equity markets. The ringgit fell 3.3 percent in NEER terms, while the FBMKLCI sagged 4.2 percent in Sep-11. With further unwinding of USD carry trades, the RM/USD is forecasted to average around 3.20 in 2011, before appreciating to 3.10 in 2012.

The world economy continues to be led by developing Asia, with advanced nations lagging behind. Developed economies are slowly recovering with little price pressures. In contrast, developing Asia remains robust with strong domestic demand and rising inflationary pressures. The recent disaster in Japan is felt by numerous countries, particularly through the manufacturing chain. With the end of the U.S. quantitative easing in Jun-11, the global economy will be influenced by the European debt crisis and volatile commodity prices. Major currencies will likely consolidate against the U.S. dollar, while emerging currencies to appreciate further..

In Malaysia, the 1Q11 GDP growth recorded a healthy 4.6 percent year-on-year, with private (6.7 percent) and public (6.1 percent) consumption offsetting a larger drag from net exports (-24.2 percent). By sector, services (5.9 percent) and manufacturing (5.4 percent) were the main growth drivers. Economic growth momentum will probably moderate in 2Q11 on supply disruptions from the Japan disaster, pullback in commodity prices, rising cost-push inflation, and higher debt servicing burden. Rebound is expected in 2H11 due to the reconstruction of Japan and implementation of ETP projects. Hence, 2011 GDP growth will reach 5.2 percent year-on-year, before propelling higher to 5.5 percent in 2012

Reflecting the ongoing uncertainties in global and regional economic outlook, the in-house Consumer Sentiments Index (CSI) declined slightly to 107.9 points in 2Q11, while the Business Conditions Index (BCI) edged up marginally to 114.0 points. Retail Trade Index (RTI) and Tourism Market Index (TMI) followed the trend exhibited by BCI to 124.8 points and 125.4 points, respectively. Conversely, Automotive Industry Index (AII), CEO Index, and Residential Property Index (RPI) moved lower to 120.8 points, 111.9 points, and 128.0 points, respectively.

Overall CPI increased 3.3 percent year-on-year in May-11 and is likely to peak at 3.8 percent by Jun-11 due to recent hikes on electricity tariffs (average 7.12 percent) and gas prices (28.0 percent). During 2H11, inflation will probably be around 3.5 percent with upside risks from indirect second round effects. Consequently, MIER expects another hike in the OPR by 25bp. CPI will average 3.3 percent in 2012 prompting further hikes in OPR to 3.50 percent.

Recent foreign exchange liberalization measures will be neutral on the performance of ringgit since higher direct investment abroad will be offset by inflows from more trade finance and easier borrowing rules from nonresident related companies. Thus, RM/USD is projected to average around 3.00 in 2011. Improving macroeconomic fundamentals will see an average RM/USD of 2.95 in 2012.

Recent statistical data indicate that the world economy seems to be gaining momentum and price pressure slowly building up. Inflation is expected to trend upwards due to the effects of quantitative easing in the U.S., geopolitical tensions in the Middle East and North Africa, and on the reconstruction of Japan. In addition, the sovereign debt issue continues to affect parts of the Eurozone with repercussions on the global economy. Meanwhile, major currencies will consolidate against the USD, while emerging currencies likely appreciate further.

In Malaysia, economic growth is projected to moderate to 5.2% yoy in 2011, before rising to 5.5% in 2012. Structural impediments in net exports will drag down overall GDP growth in 2011, while domestic demand likely strong due to supportive government policy measures.

Meanwhile, the in-house CSI moderated to 108.2 in 1Q11 on weaker access to finances and firming inflationary expectations. In contrast, firms' outlook remains bright as suggested by stronger BCI of 113.3 and CEO of 118.1. The property sector is reasonably healthy (RPI of 130.0), while tourism weakened on more frequent occurrences of natural disasters (TMI of 113.1). Mimicking the trend in CSI, RTI also eased to 99.1. The automotive industry (AII of 140.0) continues to be supported by favourable policy measures.

With GDP growth within the potential level of 5.0-6.0%, coupled with manageable CPI forecast of 3.2% yoy in 2011; the BNM is expected to lift the OPR marginally higher to 3.25% by end-2011. As the economy gathers momentum in 2012, CPI may edge higher to 3.3% prompting further hikes in OPR to 3.50%.

The RM/USD is projected to hit 3.05 in 2011 on larger capital inflows. Improving macroeconomic fundamentals will see an average RM/USD of 2.95 in 2012.

Economic recovery, which started in mid-2009, will continue in 2011. Developing Asia with better economic fundamentals and stronger domestic demand is set to lead global growth. Developed economies will suffer from ongoing sovereign debt issue and deleveraging prospect. High growth economies of developing Asia will face rising inflationary pressures, leading to further policy tightening measures. Inflation will be contained in the developed nations, delaying interest rate hikes to possibly end-2011. Developing Asia currencies will appreciate against the USD, while other major currencies likely consolidate vis-a-vis the USD.

In Malaysia, economic growth is projected to moderate to 5.2% yoy in 2011, before rising to 5.5% in 2012. Structural impediments in net exports will drag down overall GDP growth in 2011, while domestic demand likely strong due to supportive government policy measures. Moreover, this is also supported by the in-house CSI which surged to 117.2 in 4Q10. Other upward trending indices include CEO, RPI, and TMI. In contrast, AII, BCI, and RTI declined in 4Q10, possibly due to somewhat cautious outlook ahead.

With GDP growth within the potential level of 5.0-6.0%, coupled with manageable CPI forecast of 2.8% yoy in 2011; the BNM is expected to lift the OPR marginally higher to 3.00% by end-2011. As the economy gathers momentum in 2012, CPI may breach BNM's implicit target of 3.0% prompting further hikes in OPR to 3.25%..

The RM/USD is projected to hit 3.05 in 2011 on larger capital inflows. Improving macroeconomic fundamentals will see an average RM/USD of 2.95 in 2012..

After a blistering pace in the 1Q10, the global economy softened in 2Q10. This cyclical slowdown is expected to persist in 2H10, given weaker global trade conditions and the ongoing sovereign debt problem in the Eurozone. Nevertheless, developing Asia continued to lead global growth through their resilient domestic demand. Similarly in Malaysia, economic growth decelerated to 8.9% yoy in 2Q10 on slower growth in net exports. Domestic demand was strong with private investment gradually recovering. All key sectors moderated, but were dominated by manufacturing and services.

Using this data, MIER maintains 2010 and 2011 economic growth of 6.5% and 5.2%, respectively. Importantly, these forecasts are also supported by recent in-house surveys. The Business Conditions Index (BCI) fell sharply to 104.9 pts in 3Q10, which more than offsets the surge in the Consumer Sentiment Index (CSI) to 115.8 pts. Other indices also painted a similar gloomy environment ahead.

In terms of interest rates, MIER anticipates the OPR to be kept at 2.75% until end-2010. This is useful in order to assess the effects of previous rate hikes and the possible impact from economic fallout in the Eurozone. The OPR will trend higher to 3.25% in 2011, in tandem with a higher overall CPI forecast of 2.5% yoy (2.2% in 2010).

Recent foreign exchange liberalisation measures have lifted RM sentiment and should be conducive for further development of the financial market. However, these measures also generated more volatility to exporters. MIER forecasts average RM/USD of 3.20 in 2010 before strengthening further to 3.10 in 2011.

During the 1Q10, the global economy improved further with developing Asia as the leading engine of growth. This was made possible through sustained domestic demand and better global trade conditions. In tandem with regional economies, GDP growth strengthened to +10.1% y-o-y in Malaysia. The recovery was led by strong revival in the manufacturing sector, especially export-oriented industries.

However, sentiments have turned sour recently. The sovereign debt crisis in Europe has led to doubt on the sustainability of global economic recovery. Furthermore, continued policies tightening measures by China have sent adverse shocks to economic agents worldwide. News flow from BP's accident in the Gulf of Mexico and Australia's proposed Henry Tax also heightened uncertainty among global investors. Other risks include possible implications from the US financial reforms and capital issues from the proposed Basel III banking sector regulations. Together these have negatively affected sentiments towards numerous sector, particularly the exporters

To confront these issues, measures were proposed under the 10th Malaysian Plan based on strategies articulated earlier in the Government Transformation Program (GTP) and the New Economic Model (NEM) to sharpen the competitive edge of Malaysia. These along with further liberalisation efforts on the services sector will attract more investors' participation in the long-run. In terms of addressing the burgeoning fiscal deficit problem, subsidies will be reduced progressively and the tax base widened over the next five-year period.

Against this background, MIER will be revising upwards its 2010 GDP growth rate to +6.5% y-o-y from previously +5.2%. Economic growth is forcasted to reach +5.2% y-o-y in 2011. This is supported by still firm consumer and business confidence, as measured by MIER's Consumer Sentiment Index (CSI) and MIER's Business Conditions Index (BCI), of 110.4 points and 119.6 points, respectively in 2Q10. All sectoral indices recorded mix performances during the period, however.

In tandem with economic recovery and higher global commodity prices, overall consumer price inflation is expected to grow by +2.2% in 2010. MIER anticipates the Overnight Policy Rate (OPR) to maintain at 2.75% by end -2010. This is especially useful in order to assess the effects of previous rate hikes as well as the repercussions from Europe sovereign debt problem. Firmer economic expansion will further lift the OPR to 3.25% in 2011.

The world economy has recovered since the 4Q09 following numerous national policy measures, which enhanced private demand and global trade condition. However, the recovery path is uneven with developing Asia leading global growth, while advanced nations trailing behind. The strong economic expansion from developing Asia was led by China, India, and Indonesia with their relatively large domestic demand. Policymakers have begun to normalize policy rates, given rising inflation expectations and the emergence of asset bubbles.

The Malaysian economy too has rebounded in the 4Q09 by +4.5% yoy, leading to a smaller contraction of 1.7% yoy in 2009. The recovery was broad-based with all economic sectors registering strong turnaround. This along with improving consumer and business confidence allowed MIER to raise the GDP growth rate to +5.2% yoy in 2010. Economic growth is forecasted to reach +5.0% yoy in 2011..

Consumer and business confidence, as measured by MIER's Consumer Sentiment Index (CSI) and MIER's Business Conditions Index (BCI), were higher by +4.6 pts qoq and +5.2 pts qoq, respectively in 1Q10. Meanwhile, all sectoral indices also recorded modest gains in 1Q10, with the exception of Retail Trade Index (RTI) and CEO Confidence Index (CEO).

In tandem with economic recovery and higher global commodity prices, overall consumer price inflation is expected to grow by +2.2% in 2010. Since core inflation has been rising faster than overall inflation, MIER anticipates the OPR to settle at 2.75% by end-2010. Firmer economic expansion will further lift the OPR to 3.25% in 2011.

Various economic indicators continued to show improvement ahead, albeit being subjected to occasional pullbacks. This progress is brought about by the efforts of numerous national policy stabilisation measures. Some countries may start to normalise their policies first, while others, depending on their economic conditions among other things, may opt to do so later.

In Oct 09, the IMF anticipated the global economy to expand by 3.1% yoy in 2010, from a 1.1% yoy decline in 2009. For 2010, the U.S. is projected to grow by 1.5% yoy, the euro zone at 0.3% yoy, Japan at 1.7% yoy, and China 9.0% yoy. The comparable yoy figures in 2009 are -2.7% (U.S.), -4.2% (euro zone), -5.4% (Japan), and +8.5% (China).

Regionally, the ADB has also lifted its GDP growth forecast for developing Asia to +3.9% yoy in 2009 and +6.4% yoy in 2010. The regional economies are seen to be more resilient to the downturn than initially feared. Underpinning the region's growth prospects is China, whose aggressive monetary easing and fiscal stimulus could accelerate the GDP growth rate to +8.2% yoy in 2009 and to +8.9% yoy in 2010.

In 3Q09, Malaysia's GDP improved to -1.2% yoy (2Q09: -3.9%) due to rebound in manufacturing, construction, and services sectors. Stabilising global and domestic demand conditions resuscitated manufacturing output, while large public expenditure contributed to expansion in both construction and services activities. Nevertheless, the external sector remained relatively weak in 3Q09.

To enhance the image of Malaysia to foreign investors, liberalisation measures were implemented on 27 services sub-sectors in Apr 09 and the 30.0% Bumiputra equity requirement for newly listed companies was removed in Jun 09. Moreover, the personal income tax rate will also be reduced from 27.0% in 2009 to 26.0% in 2010. Special income tax rate of 15.0% will be given for local residents and foreigners who work and stay in Iskandar Malaysia.

In tandem with regional economic performances, monthly Malaysian indicators have also signalled improvement. Overall CPI declined at a slower rate of 0.1% yoy in Nov 09 (-1.5% in Oct 09) due to effects from higher transportation cost. Sequentially, CPI increased by +0.3% in Nov 09 (+0.1% in Oct 09). Consumer inflation remained in positive at 0.5% on a year to month basis. Meanwhile, core CPI also declined at a slower rate of 0.6% yoy in Nov 09 (-2.6% in Oct 09).

Meanwhile, the Central Bank of Malaysia (BNM) has left the Overnight Policy Rate (OPR) unchanged at 2.00% for the sixth consecutive meeting in Nov 09. While the economic contraction is expected to decrease from 3Q09, the monetary policy stance is expected to be fairly accommodative until the economy recovers. This is also facilitated by the absence of inflationary expectations in the near term. Hence, MIER expects the OPR to be relatively unchanged at least until end-2010.

Against this background, both the in-house Consumer Sentiments Index (CSI) and Business Conditions Index (BCI) continued to show improvement. In the 4Q09, CSI rose 4.2 points qoq to settle at 109.6 points (3Q09: 105.4), while the BCI was higher by 5.1 points qoq to 118.8 points (3Q09: 113.7). Nevertheless, the hardship posed by the global financial crisis, domestic labour market rigidity, rising inflation, and early policy exit strategy may affect sentiments ahead.

There are glimmer signs that the global downturn has stabilised somewhat, but the recovery is expected to be sluggish and uneven. The healing from the current crisis will be difficult compared to previous ones because of the synchronised nature of the downturn. It will take time and huge resources to revive the deeply entangled US financial sector, while policy options are running out. The weak external sector will impede a faster recovery, and the lower commodity prices are not helping either. Banks are becoming more cautious as bad loans could rise soon, limiting the flow of funds to firms. The services sector will be the pillar of strength amidst a glum manufacturing sector. The technical recession is likely to end in 4Q09. However, Malaysia may not regain more strength until the global economy is back on track, which is going to be at a disappointingly slow pace.

In view of improving macroeconomic indicators, and better CSI and BCI as well as the sectoral indices, MIER is maintaining for now, its GDP growth forecast of -3.3% yoy in 2009 and +3.7% yoy in 2010, while concomitantly projecting 2011 GDP growth forecast of +5.0% yoy. Downside risks are still prevalent and might perturb the road to recovery, but there are stronger positive influences that led to MIER's projections.

The road to global recovery appears to be sluggish and uneven, facing many daunting challenges along the way. Both the World Bank and the IMF are projecting the world economy to slide into a deeper recession in 2009. In Jul'09, the IMF revised its global economic forecast to -1.4 per cent in 2009 ('08: 3.1%), while the global contraction in 2009 is estimated at -2.9 per cent by the World Bank. According to the latest IMF revision, the US ('09: -2.6%) will experience a less severe recession in 2009 compared to Europe which may face a deeper one ('09: -4.8%). The IMF projects the world economy to recover to around 2.5 per cent growth in 2010, with the US recording a meagre 0.8 per cent growth in 2010, slightly higher than the previous zero per cent growth forecast..

As the external sector tumbles, Malaysia's GDP contracted by a steep -6.2 per cent in 1Q09, following a stagnant 0.1 per cent growth in 4Q08. As external demand nose dived, Malaysia's exports dipped sharply in 1Q09, while investment was severely affected as well. Given the deteriorating global economic prospects, a second stimulus package amounting to RM60 billion (about 9% of GDP) was unveiled in Mar'09. Although the second package appears larger, the actual direct spending is only RM15 billion (or 25% of total) to be spent over a two-year period. The recurring concerns have been the speed and efficiency of implementation and the potential leakages. A notable point is the greater attention given to retrenched workers and unemployed graduates. With the second stimulus package, the fiscal deficit is estimated to rise to 7.6 per cent of GDP in 2009, up markedly from 4.8 per cent in 2008.

In a move to make Malaysia more attractive to investors, liberalisation measures have been announced. Starting 22 Apr'09, 27 services sub-sectors were fully liberalised to foreign investors, on the premise that Malaysia lacks expertise and local investments in many of these sub-sectors. Among the sectors opened up are computer and related services, health and social services, tourism services, transport, recreational, business services and shipping. On 30 Jun'09, the long standing 30 per cent bumiputra equity requirement for newly listed companies was removed, making investment conditions less restrictive. This will bring Malaysia's equity market closer to regional benchmarks, but the impact remains to be seen since there are many factors influencing investment decisions

Monthly indicators up to May'09 are still losing momentum markedly, but the rate of decline has eased slightly in some sectors. Industrial output registered a sharp contraction in May'09 (-11.1% year-on-year), but subsiding from a steeper fall (-17.9% ) in Jan'09. Exports have yet to show any stabilising signs, nose diving by -29.7 per cent in May'09, while imports dipped -27.8 per cent. Thanks to reduction in local oil prices and slower rise in food prices, inflation has eased to 2.4 per cent in May'09, down from 3.9 per cent in Jan'09. Inflation will likely subside further in tandem with the softening economy. .

In the wake of the deteriorating global economy and its adverse effects on domestic conditions, Bank Negara reduced the Overnight Policy Rate (OPR) by 50 basis points to 2.00 per cent on 24 Feb'09, the third time in five months. Bank Negara has slashed 1.50 percentage points from 3.50 per cent since Nov'08 and cut the statutory reserve requirement (SRR) to 1.0 per cent, effective Mar'09. Bank Negara has noted that lower rates could hurt savers and those who rely on incomes from deposits. The latest policy meeting on 26 May'09 has decided to leave the policy rate unchanged in view of the persistent effects of the crisis amid early signs of stabilisation in some indicators.

Consumer and business confidence has improved in 2Q09, possibly influenced by the measures taken to support the economy. These include the fiscal stimulus packages, the historically low interest rates, and the recent liberalisation measures. Both the Business Conditions Index (BCI) and the Consumer Sentiments Index (CSI) have passed the 100-points threshold that separates expansion and contraction. The BCI, which is based largely on firm-level information, has gained 44.1 points to stand at 105.2 points in 2Q09, up from 61.1 in 1Q09, indicating that business confidence has regained some strength. Likewise, the CSI has notched up 26.9 points to 105.8 points in 2Q09, up from 78.9 points in 1Q09. Despite the still sharp declines in monthly indicators, the rise in sentiments could have been propped up by the perception that recent measures would stabilise the economy.

TThere are glimmer signs that the global downturn has stabilised somewhat, but the recovery is expected to be sluggish and uneven. The healing from the current crisis will be difficult compared to previous ones because of the synchronised nature of the downturn. It will take time and huge resources to revive the deeply entangled US financial sector while policy options are running out. The weak external sector will impede a faster recovery, and the lower commodity prices are not helping either. Banks are becoming more cautious as bad loans could rise soon, limiting the flow of funds to firms. The services sector will be the pillar of strength amidst a glum manufacturing sector. It is certain that Malaysia's growth will slide into a technical recession in the first half of '09, as it takes the hit from the knock-on effects of a flagging global economy. Malaysia may not regain more strength until the global economy is back on track, which is going to be at a disappointingly slow pace.

In view of the deep declines in macro indicators, the fragile business and consumer confidence, and the still dismal sectoral indices, we have revised Malaysia's growth forecast for 2009 downwards to -4.2 per cent, from -2.2 per cent earlier. If exports and FDI shrink severely, the downturn could be more damaging. We have also downgraded the 2010 growth forecast to 2.8 per cent, from 3.3 per cent previously, in anticipation of a gradual or a ''u-shaped'' global recovery.

The global growth prospects are reviewed almost every month in reaction to the release of grim data. Both the World Bank and the IMF are projecting the world economy to slide into a deeper recession in 2009. The US Federal Reserve stated that until the financial sector malaise is resolved, it is unlikely that the US economy will show improvement. In Mar'08, the IMF has slashed its global growth forecast to between -0.5 to -1.0 per cent in 2009 ('08: 3.7%), from +0.5 per cent in its Jan'09 projections. The latest revision projects the three major economies of US, Europe and Japan falling into deeper recessions in 2009. Japan is foreseen to contract the most (-5.8%) in 2009, trailed by Europe (-3.2%), and the US (-2.6%). The IMF projects the world economy to recover to around 1.5-2.5 per cent growth in 2010, with the US recording a meagre 0.2 per cent growth in 2010.

Not shielded from the global crisis, the impact of the global downturn on the Malaysian economy has worsened. As the external sector tumbles, Malaysia's GDP growth came to a grinding halt in 4Q08, registering a paltry 0.1 per cent growth. In 4Q08, resilient but easing private consumption and higher fiscal spending compensated the sharp contraction in real exports as external demand nose-dived. Given the deteriorating global economic prospects, a second stimulus package amounting to RM60 billion (about 9% of GDP) was unveiled in Mar'09.

The RM7 billion in the first package (Nov'08) was deemed to be insufficient to counter the deepening crisis. Although the second package appears larger, the actual direct spending is only RM15 billion (or 25% of total) to be spent over a two-year period. Other measures introduced are in the form of loan guarantees, investment through Khazanah and tax incentives. The loan guarantees will only work if there is demand from businesses, which is lacking at this point of time. The recurring concerns have been the speed and efficiency of implementation and the potential leakages. A notable point is the greater attention given to retrenched workers and unemployed graduates. With the second stimulus package, the fiscal deficit is estimated to rise to 7.6 per cent of GDP in 2009, up markedly from 4.8 per cent in 2008. The funding will mostly be sourced domestically, which is not a problem, given the ample liquidity in the system.

Monthly indicators up to Feb'09 have been losing momentum markedly, but the rate of decline has eased slightly. Industrial output registered a sharp contraction in Feb'09 (-14.7%), as the export-oriented sectors faced diminishing demand. Even the domestic-oriented sectors have felt the ill effects of the crisis. Exports have declined for five months in a row, but the decline in Feb'09 (-15.9%) has narrowed from -27.8 per cent in Jan'09. With imports showing steeper declines than exports, the trade surplus has been sustained. Thanks to reduction in local oil prices and slower rise in food prices, inflation has eased to 3.7 per cent in Feb'09, down from a peak of 8.5 per cent in Aug'08. Inflation will likely subside further in tandem with the softening economy.

In view of the deteriorating global economy and its adverse effects on domestic conditions, Bank Negara reduced the Overnight Policy Rate (OPR) by 50 basis points to 2.00 per cent on 24 Feb'09, the third time in five months. Bank Negara has slashed 1.50 percentage points from 3.50 per cent since Nov'08. To add liquidity into the system and reduce the cost of funds, the statutory reserve requirement (SRR) has been progressively cut from 4.0 per cent in Nov'08 to 1.0 per cent, effective Mar'09. Bank Negara has noted that lower rates could hurt savers and those who rely on incomes from deposits.

Consumer and business confidence has remained depressed in 1Q09, but the indices have registered minor gains. Both the Business Conditions Index (BCI) and the Consumer Sentiments Index (CSI) have stayed way below the 100-points threshold that separates expansion and contraction. The BCI, which is based largely on firm-level information, has inched up 7.2 points to stand at 61.1 in 1Q09, up from 53.8 points in 4Q08, but shedding 58.8 points from 119.9 points in 1Q08, indicating that business confidence still remains gloomy. Likewise, the CSI has notched up 7.5 points to 78.9 points in 1Q09, from 71.4 points in 4Q08, but down 36.6 points from 115.5 points in 1Q08. Despite the sharp declines in monthly indicators, the minor rise in sentiments could have been propped up by the release of the second stimulus package. MIER's sectoral indices have all remained far below the 100-points demarcation line.

The recovery from the current crisis will be difficult compared to previous ones because the scale has reached global proportions. It will take time and huge resources to revive the deeply entangled US financial sector, while policy options are running out. The weak external sector will impede a faster recovery, and the lower commodity prices are not helping either. Banks are becoming more cautious, limiting the flow of funds to firms. Domestic demand would be shored up by fiscal pump-priming and easier monetary policy, providing a partial cushion to the sagging Malaysian economy. The services sector will be the pillar of strength amidst a glum manufacturing sector. It is almost certain that Malaysia's growth will slide into a technical recession in the first half of '09, as it takes the hit from the knock-on effects of a flagging global economy.

In the light of the deep declines in macro indicators, the gloomy business and consumer confidence, and the dismal sectoral indices, we are obliged to revise Malaysia's growth forecast for 2009 downwards to -2.2 per cent from +1.3 per cent earlier. If exports shrink severely, the downturn could be more harmful. We have also downgraded the 2010 growth forecast to 3.3 per cent, from 3.8 per cent previously, in view of the anticipated gradual recovery in the global economy.

Despite concerted interest rate cuts and massive liquidity injection, the global credit crisis continues to deepen with little signs of abating. In November, the IMF has revised its global outlook to be even grimmer, taking into account the deteriorating economic trends. The IMF has slashed its global growth forecast to 2.2 per cent in 2009 (2008: 3.7%), from 3.0 per cent in the earlier projections. The latest revision projects the three major economies of US, Europe and Japan heading into recessions in 2009. The US is foreseen to contract the most (-0.7%) in 2009, followed by Europe (-0.5%), and Japan (-0.2%). The World Bank projects the world economy to recover to a 3.9 per growth in 2010, from 1.9 per cent in 2009, with major economies returning to positive growth.

The Malaysian economy has been resilient in the first-half of 2008, but is not going to be insulated from the global downturn. As the external sector worsened, GDP growth has subsided to 4.7 per cent in 3Q08 after a strong 7.1 per cent gain in the first-half of '08 (revised upwards from 6.7%), bringing growth to an average of 6.3 per cent in the first three quarters of '08. Resilient private consumption, steady public investment and higher fiscal spending supported the growth in 3Q08. Malaysia has no direct exposure to the US market but is increasingly feeling the shock from the slowing global economy through trade and investment linkages.

Fearing a dismal global outlook that would hurt the domestic economy, the government stretched its fiscal deficit to 4.8 per cent in '08, reversing a 7-year progressive deficit reduction. A RM7 billion stimulus package, to be financed by savings from subsidy reduction, was unveiled in Nov'08 as a measure to stimulate domestic demand. The deficit fiscal target for 2009 has also been raised to 4.8 per cent of GDP, from 3.6 per cent previously. This may be justified as difficult times call for drastic measures. However, there are concerns that government revenue would be adversely affected by the falling commodity prices, which could subsequently enlarge the deficit to even exceed 5.0 per cent of GDP, especially now that there is a possibility of an additional stimulus package being introduced by mid-2009. There is also the longer-term worry over the high dependency on oil revenue to finance fiscal spending. With most spending going into construction projects, there are questions over the delivery speed and the potential leakages from payments to foreign workers and the imports of construction materials, which would blunt the multiplier effects.

Monthly indicators up to Nov'08 are losing momentum markedly. Industrial output has contracted in three successive months, as the export-oriented sectors faced diminishing demand. Total exports have declined for two months in a row, with imports showing steeper declines, resulting in sustained trade surplus. With prices climbing down, export revenues from commodities are growing at a slower pace. Thanks to reduction in domestic oil prices, inflation has eased to 5.7 per cent in Nov'08, down from a peak of 8.5 per cent in Aug'08. Inflation will likely subside further in tandem with the softening economy.

In view of the deteriorating global economy and its adverse effects on domestic conditions, Bank Negara has reduced the Overnight Policy Rate (OPR) by 25 basis points to 3.25 per cent on 24th Nov'08. To add liquidity into the system and reduce the cost of funds, the statutory reserve requirement (SRR) has been cut from 4.0 per cent to 3.5 per cent effective Dec'08. If domestic conditions worsen, amid subsiding inflation, the OPR may be slashed to 3.0 per cent or even lower. The reduction of interest rate has to be done cautiously as it may unintentionally lead to a weaker ringgit that would push up the cost of imports.

Consumer and business confidence indices have both dropped sharply below the 100-points mark in the final quarter of 2008, the dividing line between optimism and pessimism, as indicated by the results of MIER's 4Q08 surveys. The Business Conditions Index (BCI), which is based largely on firm-level information, has plunged to 53.8 points in 4Q08, shedding 45.8 points from 99.6 points in 3Q08, indicating that business confidence has deteriorated significantly. Though not as bad, the Consumer Sentiments Index (CSI) has fallen to 71.4 points in 4Q08, down 17.5 points from 88.9 points in 3Q08, as households start to feel the pinch from a softer economy. In addition, MIER's sectoral indices for retail trade, residential property, tourism and the auto industry have all dropped below the threshold level. The sharp fall in both macro indices and the sectoral indices suggests that the outlook for the Malaysian economy would be dimmer than earlier expected.

In hindsight, when the internet bubble burst in 2001 and OECD countries languished to a 1.2 per cent growth, Malaysia's growth came to a halt ('01: 0.5%). The IMF predicts the OECD to contract by 0.3 per cent growth in '09, putting Malaysia's prospects in jeopardy. The internet crash in 2001 did not lead to a banking crisis and so the recovery was faster. The current crisis has done extensive damage and is nowhere near the bottom. Nonetheless, there are mitigating factors that Malaysia can rely on such as a sound banking system, a sizeable foreign reserves, and consistent surplus in the current account.

Given the worsening external conditions, it is likely that Malaysia's growth would deteriorate in 2009, as it takes the hit from the knock-on effects of a flagging global economy. With limited room for policy flexibility, domestic demand can be propped up by fiscal pump-priming and easier monetary policy, providing a partial cushion to the uncertain global economy. Falling commodity prices are not helping either, but may help put a lid on inflationary pressures. The services sector will be the pillar of strength amidst a weak manufacturing sector.

In light of the deeper declines in macro indicators, the tumble in business and consumer confidence, and the dismal sectoral indices, we are compelled to adjust our estimated 2008 GDP growth to 5.1 per cent from 5.5 previously and to revise our forecast for 2009 downwards to 1.3 per cent from 3.4 per cent earlier. Provided that the global economy bottoms out, as projected by the World Bank with global growth recovering to 3.9 percent in 2010, a marginal improvement is foreseen for Malaysia's growth to inch up to 3.8 per cent in 2010.

The global economy is under threat of a recession with the contagion from the US financial chaos spreading worldwide. Despite concerted interest rate cuts and massive liquidity injection, the credit crisis continues to deepen without signs of abating. Confidence has been badly dented with banks fearing to lend out while governments have raised the limits of deposit insurance to shore up confidence. Conditions would deteriorate further if the credit squeeze dries up funds for investment and household spending. The IMF foresees the impact on the global economy becoming more severe in 2009, with global growth projected to slow down to 3.0 percent, the slowest rate since 2002 ('08: 3.9%). In view of the ailing US economy, the IMF has drastically lowered the US growth forecast to a stagnant 0.1 per cent in 2009 ('08: 1.6%). The spillover effects are predicted to slash Europe's growth to 0.2 per cent in '09 ('08: 1.3%), and to soften Japan's expansion to 0.5 per cent ('08: 0.7%).

The Malaysian economy has been resilient in the first-half of 2008, but is increasingly being affected by the global downturn. GDP growth has moderated to 6.3 per cent in 2Q08 after a strong 7.1 per cent gain in 1Q08, bringing growth to a high average of 6.7 per cent in the first-half. The growth was driven by high commodity prices, strong private consumption and steady investment, partly supported by fiscal spending. Malaysia has no direct exposure to the US market but is increasingly feeling the shock from the slowing US economy through trade and investment linkages. The external downturn has not reached bottom yet. The US economy is on the brink of a recession, Japan has reported a contraction and Europe is coming to a standstill. Singapore has gone into recession in 3Q08 based on quarter-on-quarter growth.

Fearing a dismal global outlook and hit by rising prices of raw materials, the government stretched the fiscal deficit to 4.8 per cent in '08, reversing a 9-year progressive deficit reduction. This may be justified as difficult times call for drastic measures. The longer-term worry is the high dependency on oil revenue to finance fiscal spending. Government revenue will be affected by the decline in commodity prices if other sources of revenue are not sought. Given the heightening pressure on the economy and decreasing oil prices, the budget deficit is likely to exceed 5.0 per cent of GDP in '08. The deficit may even exceed 4.0 per cent of GDP in '09 with the increasingly unnerving outlook.

Monthly indicators up to Jul/Aug'08 are starting to lose momentum. Industrial output is flattening further as the export-oriented sectors faced diminishing demand. Total exports have decelerated with electronics exports stalling, while commodity revenues are growing at a slower pace. The leading index is creeping up at its slowest pace this year, suggesting sluggish growth ahead. Inflationary pressures have gathered steam, with elevated food prices lifting inflation to 8.5 per cent in Aug'08. Despite small reductions in oil prices, domestic inflation has remained sticky so far.

Despite soaring inflation, the Overnight Policy Rate (OPR) has been kept at 3.5 per cent in view of the worsening downturn in the US economy and its potential negative effects on the domestic economy. With the risk of a severe economic slowdown exceeding that of inflation, the policy rate has been kept unchanged. The backlash to demand conditions will likely lead to the softening of inflation. Oil prices have fallen as demand subsides with the increasing slack in economic activity.

Consumer and business confidence indices have both dropped below the 100-points mark, the dividing line between optimism and pessimism, as indicated by the results of MIER's 3Q08 surveys. The Business Conditions Index (BCI), which is based largely on firm-level information, has slipped to 99.6 points in 3Q08 from 114.1 points in 2Q08, down 14.5 points, indicating that business confidence has deteriorated. Though still below 100-points, the Consumer Sentiments Index (CSI) has stabilised somewhat in 3Q08, rebounding to 88.9 points from the historical low of 70.60 in 2Q08, aided by recent moves to lower domestic oil prices and bonus payment to public servants. With both indices staying below the threshold, the outlook for the Malaysian economy appears to be lacklustre.

With the financial crisis still unfolding and confidence failing, the bigger fear is the credit squeeze. Tight credit will have grave implications on consumer spending and investment activity, crippling the already slowing economy. The damage to the global economy will be deeper in 2009 with all major economies expected to slow down markedly. In hindsight, when the internet bubble burst in 2001 and OECD countries languished to a 1.2 per cent growth, Malaysia's growth came to a halt ('01: 0.5%). The IMF predicts the OECD to weaken to 0.5 per cent growth in '09, putting Malaysia's prospects in jeopardy. The internet crash did not lead to a banking crisis so the recovery was faster. The current crisis has done extensive damage and is nowhere near the bottom.

The US has managed to post a good growth in 2Q08 (2.8%) and delay a severe slowdown thanks to tax rebates, a previously weak dollar, and the cut in interest rates. In light of the resilient US economy and the higher-than-expected domestic growth during the first-half of 2008 during that period, we are adjusting our estimates for GDP growth in '08 to 5.3 per cent, from 4.6 per cent previously. It is likely that growth would deteriorate in late '08, as the Malaysian economy takes the hit from the knock-on effects of a flagging global economy. Domestic demand will be propped up by fiscal spending, providing a partial cushion to the uncertain global economy. Falling commodity prices are not helping either, but may help soften inflationary pressures. The services sector will be the pillar of strength amidst a weak manufacturing sector. With the outlook for the global economy turning increasingly dismal, Malaysia's GDP growth could decelerate to 3.4 per cent in '09 ('08 5.3%). The downside risks of further fallout from the financial woes have amplified, meaning that unpleasant possibilities are not totally excluded.

In April 2008 (Apr'08), under the assumption of oil price at US$96 per barrel, the IMF lowered the world economic growth estimate by 0.5 percentage point to 3.7 per cent in 2008 ('07: 4.9%), while edging up marginally the 2009 forecast to 3.8 per cent. With oil prices breaching US$140 per barrel, the risks of slower global growth have risen. Despite aggressive interest rate cuts and massive liquidity injection, the US credit crisis continues to deepen and spread to the real sector of the US economy. In view of the flagging US economy, the IMF has drastically lowered the US growth forecast by 1.0 percentage point to 0.5 per cent in 2008 ('07: 2.2%). The spillover effects through trade and financial linkages are predicted to reduce Europe's growth to 1.4 per cent ('07: 2.6%), and to soften Japan's expansion to 1.4 per cent ('07: 2.1%). Due to surging oil prices, many Asian countries have slashed fuel subsidies in view of worsening national budgets.

The Malaysian economy has been surprisingly resilient in spite of the global slowdown. In fact, GDP growth was sustained at a strong 7.1 per cent in 1Q08, following a brisk 7.3 per cent expansion in the last quarter of 2007. The growth was driven by high commodity prices, strong private consumption and steady investment, and supported by fiscal spending. So far, Malaysia has only felt a minor impact from the slowing US economy, but emerging challenges in the form of soaring food prices and the persistent rise in global oil prices are weighing down heavily on economic prospects. Fearing a ballooning fiscal deficit, the government announced a revamp in oil subsidy in Jun'08, pushing up petrol prices by 41 per cent and diesel by 63 per cent. This will have adverse implications for inflation and economic growth going forward. Even with the subsidy cut, the fiscal deficit may reach 3.5 per cent of GDP this year as oil prices have increased further, drastically reducing the savings from the subsidy revision.

Monthly indicators up to Apr/May'08 have displayed some surprising movements. Industrial output grew moderately on the back of a fragile rebound in electronics as construction-related sectors powered on. Exports have recorded double-digit growth owing to windfall gains from commodities and the recent upturn in electronics demand. The leading index is rising cautiously, suggesting moderating growth ahead. Inflationary pressures have gathered steam, with elevated food prices lifting inflation to 3.8 per cent in May'08, almost a 2 year high. On account of the oil subsidy review on 5th Jun'08, inflation is expected to jump to about 7.0 per cent in Jun'08, bringing the whole year inflation to 5.0 per cent, if not higher.

The combined effects of higher food and fuel prices have led to increased price pressures, posing a challenge to policymakers amid downside risks to growth. The Overnight Policy Rate (OPR) has been kept at 3.5 per cent in view of the downturn in the US economy and its potential negative effects on the domestic economy. With the rising inflationary pressures amidst steady economic activity, the OPR may be raised gradually, depending upon how serious the secondary effects of inflation will turn out to be from Jun'08 onwards.

Consumer and business confidence has shown downwards movements, as indicated by the results of MIER's 2Q08 surveys. The Business Conditions Index (BCI), which is based largely on company performance, has slipped to 114.1 points in 2Q08, down 5.8 points from a reading of 119.9 points in 1Q08, indicating a surprisingly resilient confidence level in spite of the higher oil prices. Given the resilient domestic demand and the recent rebound in exports, business conditions have been holding ground fairly well. The higher oil prices will lift business costs and this would affect profit margins in subsequent quarters. Shocked by the magnitude of increase in oil prices, the Consumer Sentiments Index (CSI) has fallen very sharply to an all-time low of 70.5 points in 2Q08, from 115.5 in 1Q08, a signal of strong public displeasure. The BCI would be a better indicator of current economic activity as it relies on firm-level information, while the CSI exhibited the collective public reaction to the recent subsidy cut.

There are no clear signs that the external sector is going to turn around any time soon. However, the recent upturn in electronics owing to strong demand in non-US markets has benefited Malaysia's exports. The turmoil currently facing the US economy is part of the adjustment process to rectify the global imbalance. The correction could have happened earlier, had it not been delayed by the prolonged support of the US consumption drive. The greater concern is the impact of higher food and oil prices on the global economy, which will consequently influence domestic conditions. Although some mega projects have been shelved, the allocated fiscal spending for the 9MP has been revised upwards and reviewed to be more people-centred. Strong commodity prices would ensure stable spending power of rural households, but there is a greater concern that prices would reverse once the global growth weakens further.

Taking into account the trends in MIER indices and the impact of higher food and oil prices that could dampen consumption and reduce business profits, we are compelled to lower our growth forecast for the Malaysian economy to 4.6 per cent this year, from 5.4 per cent earlier. It is likely that growth would deteriorate in the second-half of 2008, as the Malaysian economy takes the hit from the knock-on effects of higher oil prices and a slower global growth. Domestic demand will be propped up by sustained 9MP spending, providing a partial cushion to the faltering global economy. In the baseline scenario, as the global economy stabilises and inflation subsides, the Malaysian economy could improve next year, expanding by 5.0 per cent in 2009.

Despite aggressive measures to cut interest rate and pump massive liquidity into the financial system, the US credit crisis continues to deepen and spread to the real sector of the US economy. Large reputable banks have been adversely affected due to exposure to instruments tied to sub-prime loans. US consumer confidence has fallen to a 16-year low and labour market indicators continue to deteriorate. In view of the deteriorating US economy, the IMF has drastically lowered the US growth forecast by 1.0 percentage point to 0.5 per cent in 2008 ('07: 2.2%). The sluggishness is expected to extend into 2009 (0.6%), as great efforts are required to heal the financial mess. The spillover effects through trade and financial linkages are predicted to reduce Europe's growth to 1.4 per cent ('07: 2.6%), and to soften Japan's expansion to 1.4 per cent ('07: 2.1%). In the background, high oil prices breaching US$100 per barrel constantly puts pressure on inflation, making it difficult for central banks to lower rates too much. Asia will not be spared from the US turmoil, but economies with large domestic sectors such as China and India would be able to withstand the onslaught better than others. The IMF has lowered the world economic growth estimate by 0.5 percentage point to 3.7 per cent in 2008 ('07: 4.9%), edging up marginally to 3.8 per cent in 2009.

The Malaysian economy has been surprisingly resilient in facing the global slowdown. In fact, GDP growth accelerated to 7.3 per cent in the last quarter of 2007, from 6.6 per cent in 3Q07 and 5.7 per cent in the first-half. The growth was driven by high commodity prices, strong private consumption and investment outlays, and further supported by fiscal spending. The services sector has expanded at an impressive pace, buoyed by growth in wholesale and retail trade and the finance sectors. So far, Malaysia has only felt a minor impact from the slowing US economy, mainly through slower export growth.

Monthly indicators up to Feb'08 have exhibited some surprising movements. Industrial output grew moderately on the back of a fragile rebound in electronics as construction-related sectors powered on, while exports have recorded double-digit growth owing to windfall gains from commodities. The leading index is rising cautiously, suggesting that some moderate growth is ahead. Inflationary pressures have gathered steam again, with elevated food prices lifting inflation to 2.7 per cent in Feb'08, a 12-month high. The combined effects of higher commodity prices and the festive period have led to increased price pressures, posing a challenge to policymakers amid downside risks to growth. The relief is that the Government has decided to delay an oil price hike, as announced prior to the elections. The Overnight Policy Rate (OPR) has been kept at 3.5 per cent in view of the downturn in the US economy and its potential negative effects on the domestic economy.

Consumer and business confidence is still holding up, as indicated by the results of MIER's 1Q08 surveys, reversing the slip in the preceding quarter. The Business Conditions Index (BCI) has improved to 119.9 points in 1Q08, up 14.4 points from 105.5 in 4Q07 and 105.5 points in 1Q07, indicating a surprisingly resilient confidence level. Given the rebound in output and exports in the first two months of 2008, business conditions have been holding ground fairly well. This may not last long as the heat from the US fallout could reach our shores soon enough. Possibly excited by the election promises and the halt on oil prices, the Consumer Sentiments Index (CSI) has climbed up to 115.5 in 1Q08 from 110.7 in 4Q07, although it has slipped by 8.6 points from 1Q07. The two surveys are still above the 100-points benchmark, pointing that the Malaysian economy could still sustain its growth pace in the first-half 2008, before cooling in the second-half.

The fear is that the US turmoil is getting deeper and nobody is certain when it will bottom out. The US Fed has reduced interest rates again in Mar'08 to 2.25 per cent in a desperate move to prop up the faltering US economy. This is on top of large liquidity injections into the system and the financial backing over the buyout of Bear Stearns. The credit crisis is spilling over into the real sector, and if the latter caves in, this could spell a greater disaster to the US economy. The severity of the crisis has prompted the US Fed to implement measures to engineer a soft landing. In the worst-case scenario, this could backfire by making the slowdown last longer, which could mean a U-shape recovery rather than a V-shape turnaround. The turmoil currently facing the US economy is part of the adjustment process to rectify the global imbalance. The correction would have happened earlier, had it not been delayed by the prolonged support of the US consumption drive.

The post-election scenario seems to point to a drop in investor confidence, but our surveys show that this is not the case in 1Q08. The ruling government can still implement economic programmes so long that there is a simple majority. The allocated fiscal spending for the 9MP and the regional corridors continues to be the mainstay of growth. Strong commodity prices would ensure stable spending power of rural households, but there is concern that prices would reverse once the US dollar stops falling and the global growth weakens further. The stronger presence of the opposition in parliament could strengthen the checks and balances in the system and could actually lead to better governance in the longer term.

On balance, taking into account the gains in MIER indices and that indicators are still generally resilient, we stick to our earlier growth forecast of 5.4 per cent this year for the Malaysian economy until there is clearer evidence that the economy has lost momentum. It is likely that growth would remain sound in the first-half, but conditions would deteriorate in the second-half of 2008, as the Malaysian economy takes the hit from the knock-on effects. Domestic demand will be propped up by sustained 9MP spending, providing a partial cushion to the faltering global economy. In the baseline scenario, as the global economy stabilises, the Malaysian economy could shift towards its potential growth trajectory, expanding by 5.7 per cent in 2009.