July 2008 »



MEO 1Q 2008

Executive Summary

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.

Posted by suzy at 12:47 PM