We are upgrading our 2010 GDP forecast from 4.6%Y to 5.8%Y but leave our 2011 forecasts unchanged at 4.8%Y. The upgrade is more an incorporation of 1Q10's strong data than a reflection of greater optimism on our part for the coming quarters. The economy grew by 12.0%Y in 1Q10, the strongest quarterly percentage year-on-year increase since 2Q95, as healthy external demand and restocking lifted momentum for ASEAN economies. As a result, in our 2010 GDP upgrade we have lifted our export forecasts more significantly than those for domestic demand (excluding inventories). To a lesser extent, domestic demand also recovered in 1Q10 on the back of strong farm income (20.1%Y in 1Q10) in an economy where 36.5% of those employed are in the agricultural sector, led to higher spending. Healthy final demand also prompted an exit from the capex recession which has taken hold in the past five quarters (4Q08-4Q09) despite the capex momentum being relatively subdued before.
...but Mind the Trajectory Ahead
The strong 1Q10 notwithstanding, we think the incoming trajectory is likely to be more bumpy than originally expected (though the strong 1Q10 provided an offset, hence the headline upgrade). Specifically, 2Q10 domestic demand will see an impact from the Red Shirt rallies that started on March 12 and came to an end only in the third week of May. This is also why we have been less enthusiastic in terms of our revisions of domestic demand growth. Political events such as the potential dissolution of the Democrat Party and the implications on their party executives, the annual army reshuffle and potential elections and its aftermath are also factors to watch out for.
For now, high-frequency macro indicators provide a first glimpse into how April domestic demand was affected. The conclusion? Domestic demand decelerated from a high base but this seems to be taking place in several steps. The first step was a deceleration in consumer spending and inventory addition. Fixed capex had remained resilient in April but, if business sentiment (which leads actual investment outlays) is anything to go by, we may see an impact on capex in upcoming datapoints. Below, we outline recent trends in macro indicators which tend to give an accurate representation of what is happening with the economy:
Consumer confidence fell; spending decelerated: Even though farm income stayed elevated at 21.9%Y in April, the index of private consumption decelerated slightly to 7.0%Y in April (versus +8.7%Y in March and a peak of +9.7%Y in February) likely as sentiment took a hit and consumer confidence softened to 75.0 in Apr-10 (versus a peak of 79.3 in Mar-10). Similarly, imports of consumer goods decelerated to 16.5%Y in Apr-10 (versus 23.9%Y in Mar-10 and a peak of 36.0%Y in Feb-10).
The retail sector was also likely further affected as tourist arrivals slowed sharply to 2.3%Y (versus +18.0%Y in March). On a seasonally adjusted sequential basis, tourist arrivals are down 11.8%M, worse than the +1.1%M for AXJ ex Thailand but slightly better than the -15.1%M seen in 1992 Black May, but we think the declines could persist longer as tension aggravated in May. Hotel occupancy rates for Thailand fell from 52.7 to 50.8 in April, with the most significant decline coming unsurprisingly from hotel occupancy in the Central region (48.4 in April versus 55.4 in March).
Inventory slowing; fixed capex likely to see some softening ahead: Even adjusting for the seasonal effect from the Song Kran festival, capacity utilization fell somewhat in April to 65.9 from 70.4 in March. On the other hand, the private investment index surprisingly continued to accelerate to 20.3%Y in April (versus +18.1%Y in March). We suspect that this is because of the nature of capex spending, i.e., plans which have been started can often not be halted midway. Yet, business sentiment tends to be a leading indicator for actual investment outlays and the former has dipped from 55.7 in March to 46.0 in April, possibly heralding some softening in capex trends in the near term.
Meanwhile, imports of raw materials & intermediate goods (+39.4%Y in April versus +59.2%Y in March) and capital goods (+28.8%Y versus +40.2%Y), which typically tend to correlate well with gross capital formation, saw slower growth. This, taken together with the lower capacity utilization and still resilient private capex, implies that restocking is unlikely to be a big contributor to momentum for 2Q10, unlike 1Q10.
Export Support in 2Q10; Risks in 2H10
As we highlighted in our last note (see ASEAN MacroScope: Thailand: Political Impact & The Dual Track Economy, April 13, 2010), with the poor political climate hindering domestic demand, non-tourism exports is likely to be the key dependable bright spot in the near term. Indeed, the global tide has led Thailand exports to expand 23.9%Y (3MMA) (local currency, custom basis) in April, a touch lower than the 27.2%Y (3MMA) seen in AXJ-ex Thailand in March. In particular, in terms of destination, this is on the back of stronger growth in AXJ and in terms of segment, agricultural products and manufactured products such as vehicle parts & accessories have seen healthy momentum. With May US ISM New Orders, which leads exports by four months given the time needed from point of order to actual production shipments, still remaining at elevated levels of 65.7 in May, we think export data are likely to stay healthy for the next few months. However, on this front, risks are skewed to the downside in 2H10, given sovereign debt concerns in EU.
Delaying Monetary Policy Normalization
Despite the GDP upgrade, we think the BoT is likely to want to err on the side of caution in order to assess the political impact on the economy in 2Q10 as well as the risks from the EU sovereign debt turmoil before embarking on policy rate normalization. In this regard, we are pushing out our expectations for the first rate hike from July 2010 to October 2010.
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10th Malaysia Plan: Two Steps Forward, One Step Backward?
June 14, 2010
By Deyi Tan, Chetan Ahya & Shweta Singh | Singapore
What's New?
PM Najib tabled the 10th Malaysia Plan (10MP) (2011-15) yesterday. The 10th Malaysia Plan lays out the development expenditure to be made by the federal government in the next few years and sets out the broad strategic thrusts. The New Economic Model (NEM) recently announced in March 2010 was supposed to provide a skeletal framework for the 10MP. Below, we highlight some of the key takeaways and our thoughts.
1) How big is the 10MP? What are the expected implications for fiscal deficit and public debt?
Fiscal consolidation and expenditure efficiency are the targets here, in our view. The development expenditure allocation for the 10MP stands at RM230 billion, unchanged from the RM230 billion expected for 9MP. As we highlighted in previous research (see Malaysia: Where Are the Structural Gaps?, April 23, 2009), Malaysia had overemphasized hard infrastructure, where returns on marginal investment are likely diminishing, at the expense of softer infrastructure (e.g., competitiveness and productivity).
What was encouraging in the 10MP was the shift away from physical towards non-physical infrastructure, with the share of the latter rising from 22% in 9MP to 40% in 10MP. With the cap on development expenditure, fiscal deficits are expected to narrow from -7.0% of GDP in 2009 to -2.8% by 2015. This is expected to bring the public debt ratio from 53.3% of GDP in 2009 down to 49.9% by 2015.
2) Are the numerical targets achievable?
We think the revenue forecasts look easily achievable. Government revenue growth tends to correlate strongly with nominal GDP growth, almost on a one-for-one basis on a longer-term historical perspective. Policymakers are expecting an average 6.1% growth in government revenue via a 6% target in real GDP growth.
We think 6% real GDP growth for the next five years may be difficult unless the global economy continues to grow at the speed of 2004-07, significant reforms are undertaken to improve productivity and encourage private sector investment. However, nominal GDP growth of 6% looks easily achievable. On expenditure, we note that policymakers have tended to spend 5.5% on average more than what was budgeted in 2001-09. The potential overshoot may add about 1.2-1.3% of GDP (using government GDP forecasts) to fiscal deficit. If this happens, the scope for reducing public debt ratios will be lower.
3) NEM was well-articulated - but what is the follow-through in 10MP?
The 10MP is the execution blueprint of the NEM. The NEM encapsulates the eight strategic reform initiatives of:
1) re-energising the private sector to lead growth;
2) developing quality workforce and reducing dependency on foreign labour;
3) creating a competitive domestic economy;
4) strengthening the public sector;
5) putting in place transparent and market-friendly affirmative action;
6) building the knowledge base and infrastructure;
7) enhancing the sources of growth; and
8) ensuring the sustainability of growth.
The 10MP takes on the broad thrusts of the NEM but with varying degrees of enthusiasm, in our view. They are:
1) creating the environment for unleashing economic growth;
2) moving towards inclusive social-economic development;
3) developing and retaining a first-world talent base;
4) building an environment that enhances quality of life; and
5) transforming government to transform Malaysia.
Some thrusts were more critical, without which others cannot be established. As we highlighted in previous research (see ASEAN MacroScope: NEM - Making the Right Noise, March 31, 2010), building the right talent base is one area which addresses one of the root problems in Malaysia. Without a suitably qualified labour force, the environment for unleashing growth and government transformation would be tougher to achieve.
Indeed, what we liked about 10 MP is that now there is much focus on the soft infrastructure of talent base. For example:
• Quality of teachers - at the primary to tertiary levels - will be raised.
• Private-public partnership will be enabled via a trust school framework whereby there would be greater autonomy and accountability to improve student outcomes.
• Employability of graduates has been set as a KPI for universities, which will have implications for financial allocations to the schools.
• A Talent Corporation will also be set up to attract foreign talent and develop local talent base.
Building a critical mass of reforms on this front will help to arrest the structural growth decline we have seen in Malaysia. Yet, retooling the labour force is a long-gestation effort and the results will be reaped only 5-10 years down the road.
Indeed, as we highlighted in previous reports (see again ASEAN MacroScope: NEM - Making the Right Noise, March 31, 2010), the fact that such labour force-related measures are not politically charged is likely to have reduced the hurdles to introducing them. We were watching out for reforms on this front more so than others. As expected, other politically unfriendly reforms have not been adopted with such ease.
What we didn't like about 10MP - policymakers seem to have backtracked in terms of ‘affirmative action' policy. In 2Q09, policymakers scaled back on the 30% bumiputra equity requirement to 12.5% as it became subsumed within the public spread requirement where to-be-listed companies had to offer 50% of the required 25% to bumiputra investors. Now in the 10MP, policymakers maintained that the target of 30% bumiputra corporate equity ownership remains intact. What will be altered is only the mechanism to achieve that. While corporate equity stakes were allocated directly to bumiputras in the past, this is now to be achieved via more market-oriented ways such as the Ekuiti Nasional Berhad (EKUINAS), which will receive additional funding to undertake investments in competitive growth-stage bumiputra companies.
The problem with the ‘affirmative action' policy in the past was that while it was aimed at income redistribution in an expanding economic pie, the system had been abused and did not benefit the lower-income bumiputra group. It remains to be seen whether the new mechanism will alleviate the original shortcomings.
Yet that aside, we think that policymakers' ‘backtrack' on this was likely in order not to alienate the related electorate. It also suggests that the reform agenda is driven by political as well as economic needs. Politically unfriendly measures which make economic sense may not be implemented as easily.
What we also didn't like was the lack of near-term time targets on the rollback of retail fuel subsidies. This was despite the subsidy rationalization roadmap announced earlier in late May. The subsidy system had been an embodiment of how Malaysia has leveraged on revenue provided by its commodity resources and indirectly impeded on progress on the competitiveness front via such pricing distortions. The 10MP had only stated that the target was to achieve market pricing for energy by 2015. This reaffirms our view that it may be difficult to see significant change on this front in the near term, especially with the upcoming state elections in Sarawak (July 2011) and then the general elections by 2013.
4) How does the 10MP affect our views on Malaysia?
March 2008 election results and the changing global competitive landscape have set the reform wheel turning in Malaysia. However, the 10MP takes the reform agenda further in key areas such as education and labour force but falters on other important areas which would reduce allocative inefficiencies such as subsidies. For reform measures which have been laid out, full execution remains the critical next step, without which plans will remain merely plans.
Malaysia's public sector economy had been the largest within ASEAN. With the fiscal consolidation, federal government expenditure is targeted to decline from 26.5% of GDP in 2010 to 21.1% by 2015. This means growth momentum provided by the public sector economy will invariably slow in the interim.
However, to the extent that policymakers are now shifting focus towards expenditure on non-physical infrastructure which helps to improve the long-term structural outlook, the short-term growth impact would be mitigated by better growth prospects in the medium term. That is, if policymakers get their execution right.
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Just Say No to the Double-Dip
June 14, 2010
By Joachim Fels, Manoj Pradhan & Spyros Andreopoulos | London
A 5% handle for global output growth? Notwithstanding the sovereign debt crisis that is rattling Europe and unnerving global financial markets, global economic growth has continued to surprise on the upside over the past few months, pretty much as we envisaged in last quarter's Global Forecast Snapshots (March 10, 2010). In fact, the cyclical momentum over the past couple of quarters has been even stronger than we anticipated in our above-consensus forecast, with global GDP growing at a very solid average annualised pace of more than 5% during 4Q09 and 1Q10, and probably only a touch less (4.6% saar) in the current quarter. As a consequence, our forecast for full-year 2010 global GDP growth has moved up from 4.4% last quarter to 4.8% now, and we wouldn't be surprised if it turned out to be 5% or higher eventually. So, defying the scepticism that was so popular and widespread this time last year, the global economy has staged an impressive rebound from the deepest post-war recession, thanks mostly to massive and unconventional monetary and fiscal stimulus.
Made in EM: True, the global rebound has been largely driven by Emerging Market (EM) economies, while Developed Market (DM) economies have lagged. On our calculations, although they account for only around 50% of global GDP (using PPP weights), EM countries accounted for around 75% of global GDP growth over the past four quarters, supporting our ‘tale of two worlds' theme from the start of the year. However, even DM economies have surprised on the upside so far this year, and our teams have accordingly lifted their full-year 2010 GDP forecasts for, among others, the US (up two-tenths of a point to 3.4%), Japan (up 1.6 points to 3.4%) and even for the crisis-rattled euro area (up three-tenths to 1.2%) since the March GFS.
Fears of a double-dip... Yet, notwithstanding (or because of) the strong global rebound over the past year, the doomsayers are beating the drums again, warning of a double-dip recession later this year or in 2011. The rebound is water under the bridge and the sovereign debt crisis, the coming fiscal tightening, the banking sector problems and tougher regulation and government intervention could abort the recovery, or so the story goes.
...are overdone, we think: We agree that past (cyclical) performance is not a good guide to future performance and, in fact, we do believe that the cyclical momentum probably peaked in 1Q10. This view is consistent with the manufacturing PMIs topping out in major economies such as the US, China and the euro area recently, and it is fully reflected in our forecasts showing a moderation of sequential GDP growth over the next several quarters and during 2011. However, we believe that the widespread fears of a very sharp slowing of growth or even a double-dip recession are overdone, for three reasons.
Trend versus cycle: For starters, we agree that the European sovereign debt crisis (which is by far not over yet), the ongoing banking sector woes, higher taxes and increasing government intervention are important negatives for economic growth. However, they are more likely to depress developed economies' growth potential and thus the trend rate of growth over the medium-to-long term, rather than causing a sharp cyclical downturn from one quarter to the next. Ever since the start of the credit crisis, we have argued that potential growth would be lower in this cycle due to rising structural impediments. However, just as we didn't expect these headwinds to prevent a strong cyclical recovery last year, we don't expect them to be strong enough to cause a double-dip recession anytime soon.
Austerity ain't aggressive at all: Second, apart from the countries in the eurozone periphery and potentially the UK, where the new government will only announce details on June 22, fiscal policy looks unlikely to tighten very aggressively over the next 12-18 months. Fiscal deficits in large economies such as the US, Japan, Germany, France and Italy are projected to decline by less than one percent of GDP, on our forecasts. Moreover, fiscal tightening in countries where unsustainably large public sector deficits weigh down on private sector confidence and spending may actually crowd in private sector spending.
Don't forget easy monetary policies: Third, but not least, monetary policy has remained super-expansionary across the globe, thus supporting cyclical growth. Moreover, the worries related to the sovereign debt crisis and its potential fall-out will keep the Fed and the ECB on hold for longer than previously thought, in our view. This, in turn, has delayed or even aborted further monetary tightening in many EM countries which aim to prevent (excessive) appreciation of their currencies against the dollar or the euro, and thus keeps propelling domestic demand in EM, which in turn supports DM countries' exports.
Bottom line: There are plenty of things to worry about: a sovereign crisis that in our view will eat its way through the European periphery into the core and eventually move across the Atlantic; lower potential growth due to tougher regulation, higher taxes and weak banking systems; and potential global inflation surprises in EM countries due to excessively loose global monetary policies. However, the double-dip recession and the resulting deflationary pressures that many worry about right now are merely tail risks, in our view.
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