MARKET DATELINE

PP 7767/09/2010(025354)

18 June 2010
Malaysia

Economic Outlook

Risk Is A Sharper-than-expected Slowdown In

In The 2H, Not A Double Dip

Executive Summary
The countrys economic growth is likely to have peaked in the 1Q and will likely expand at
a slower pace in the 2H of the year, on account of slower global economic growth due to
dissipating fiscal spending and Europes austerity measures. These will likely be compounded
by policies tightening in some Asian countries. Locally, fiscal stimulus by the Malaysian
Government will also be running out of steam in the 2H of the year. As a result, we expect
real GDP growth to soften to 4.8% yoy in 2H 2010, from an estimate of +8.8% in the 1H.
For the full-year, real GDP is envisaged to recover to +6.8% in 2010, from -1.7% in 2009.

The global economic growth, however, will not fall off the cliff and into a double dip even
though there is a risk of a sharper-than-expected slowdown given that policy normalisation
and tightening remain gradual. Also, the global services sector has started to recruit workers
for the first time in more than two years in May, pointing to resiliency in the sector, while
we expect Eurolands sovereign debt problem to be manageable despite the lingering
concerns. As a whole, we expect the countrys real exports to slow down to 5.0% yoy in
2H 2010, from an estimate of +18.9% in the 1H.

Domestic demand will also turn softer in the 2H of the year, on the back of slower increases
in private consumption and investment, as sentiment turns cautious amidst slowing economic
activities. Public spending growth will also moderate in tandem with fiscal consolidation and
as the stimulus spending fades, but the pace of slowdown will not be as sharp as earlier
projected. At the same time, the fiscal deficit is projected to be lower at 5.3% of GDP in
2010, compared with the earlier projection of -5.6% and -7.0% in 2009.

We expect the current account in the balance of payments to record a smaller surplus in
2010 but will remain sizeable. The ringgit will likely be well supported by the economic
fundamentals but will remain volatile and fluctuate at between RM3.20-3.30/US$ in 2H 2010,
before settling at around RM3.20/US$ by end-2011.

Inflation will likely bounce back to an average of 2.0% in 2010, from +0.6% in 2009, on the
back of a pick-up in demand. However, it will unlikely be a major concern to policymakers.
As a result, we expect Bank Negara Malaysia to raise interest rates at a measured pace and
further rate hikes will likely be data dependent. We expect BNM to take a pause in July,
before raising the OPR by another 25 basis points to 2.75% in September.

Peck Boon Soon

Please read important disclosures at the end of this report. (603) 9280 2163
bspeck@rhb.com.my
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Risk Is A Sharper-than-expected Slowdown In The
2H, Not A Double Dip

Economic growth in the country is likely to have peaked in the 1Q and will likely
soften in the 2H of the year. This is on account of slower global economic
growth, as worldwide fiscal spending fades and austerity measures in some
European countries begin to bite. These will likely be compounded by policies
tightening in some Asian countries. Already, global manufacturing and services
activities are showing signs of weakness in May. Whilst we do not expect a
double-dip in the global economic growth, there is a risk of a sharper-than-
expected slowdown. Domestically, the Governments fiscal stimulus will be running
out of steam in the 2H of the year, and consumers and businesses will likely
turn more cautious. Already, the countrys industrial production has begun to
soften in April, after reaching a peak in March. As a result, we expect real GDP
growth to soften to 4.8% yoy in 2H 2010, from +8.8% estimated for the 1H.
For the full-year, real GDP is envisaged to recover to +6.8% in 2010, from -1.7%
in 2009. Meanwhile, the current account surplus in the balance of payments will
likely narrow during the year, as the recovery of the economy will suck in more
imports. The surplus, however, will remain large and provide an underlying
support to the ringgit. The movement of the ringgit, however, will remain
volatile and fluctuate at around RM3.20-3.30/US$ in the 2H of the year. Inflation
will likely trend up to an average of 2.0% in 2010, but will not be a major
concern to policymakers. The Central Bank will raise the OPR at a measured
pace and by another 25 basis points to 2.75% in September.

Signs Of Slower Economic Growth In The 2H Emerging

The Malaysian economy recorded a double-digit growth of 10.1% yoy in the 1Q, the The countrys economic
strongest in a decade, underpinned mainly by a strong surge in exports. However, growth is likely to have
we believe the growth momentum is likely to have reached its peak in the 1Q and peaked in the 1Q and we
the economy will likely expand at a slower pace in the 2H of the year. This is on expect real GDP to slow
account of a more moderate global economic growth, as worldwide fiscal spending down to 4.8% yoy in 2H
dissipates and austerity measures in some European countries begin to bite. These 2010, from an estimate of
will likely be compounded by policies tightening in some countries, particularly in
+8.8% in the 1H
Asia and other emerging economies. Already, global manufacturing and services
activities are showing signs of weakness in May and the countrys industrial production
and exports have begun to soften in April, after reaching a peak in March.
Domestically, the Governments fiscal stimulus will be running out of steam in the 2H
of the year, and consumers and businesses will likely turn more cautious. As a
result, we expect real GDP to grow at a slower pace of 4.8% yoy in 2H 2010,
compared with an estimate of +8.8% in the 1H. For the full-year, real GDP is
envisaged to recover to +6.8% in 2010, from -1.7% in 2009.

Slower growth will likely continue into 2011, particularly in the 1H of the year. Slower growth will likely
However, we expect the Government expenditure in the 10th Malaysia Plan (10MP), continue into 1H 2011 but
which has just been launched on 10 June, to be front loaded and provide some the 10MP will likely
cushion. During the plan, the Government would introduce a two-year rolling plan provide some cushion
amounting to RM91bn in 2011-2012 in order to provide greater flexibility on spending,
especially in response to changes in the global economic environment.

Global Economic Recovery Soften, But Will Not Fall Off The Cliff

On the external front, global manufacturing activities moderated in May, the first Global manufacturing and
easing in three months (see Chart 1), suggesting that a rebound from the worst services activities

global recession since World War II is beginning to soften. Indeed, Chinese moderated in May,

manufacturing activities, which led a rebound from the US to Japan, weakened to the suggesting that a rebound
from the worst global
lowest level in three months in May. In the same vein, the US manufacturing index
recession since World War
eased in May, from a near six-year high in April, while manufacturing activities in
II is beginning to ease

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 Euroland showed its first signs of weakness in eight months during the month and We believe global
since it returned to positive growth in October last year. Similarly, global services economic growth will likely
activities slackened in May, the first moderation in four months. The weakness was slow down in 2H 2010,
reflected in slower increases in services activities in Japan, China and India, while after picking up steadily
activities in the US remained stable during the month. Measured on a m-o-m basis, in the 1H
another key indicator, the OECD composite leading indicator, has been trending
lower for the last few months before stabilising somewhat lately, indicating that
OECD countries economies are likely to expand at a slower pace in the months
ahead. Indeed, the leading indicators 12-month rate of change moderated to 9.7%
in April (see Chart 2), the first easing in eight months and from +10.2% in March
and +10.1% in February. Consequently, we believe global economic growth will
likely slow down in 2H 2010, after picking up steadily in the 1H.

Chart 1 Chart 2
Global Manufacturing And Services OECD Composite Leading Indicator Points
Activities Showing Signs of Weakness To Slower Economic Activities Ahead

Index PMI % 12-mth annualised rate of change

65 Services 30

25

60
20
55 15

10
50
5
45
0

40 PMI -5
Manufacturing -10
35
-15 Total OECD Japan US Euro area China

30 -20
05 06 07 08 09 10 00 01 02 03 04 05 06 07 08 09 10

Despite the weakness, we do not expect the global economy to fall off the We do not expect the
cliff and into a double dip even though there is a risk of a sharper-than- global economy to fall
expected slowdown, given that policy normalisation and tightening remain gradual. into a double dip even
Also, the global services sector has started to recruit workers for the first time in though there is a risk of a
more than two years in May, indicating that the sector will be resilient in weathering sharper-than-expected
a slowdown in the months ahead. In Europe, we expect the sovereign debt problems slowdown in the global
to be manageable despite the lingering concerns, following the announcement of an
economy
emergency stabilisation loan of 750bn for countries under attack by speculators and
the 110bn rescue package for Greece. Although the sharp drop in euro might have
exacerbated concerns over a break-up of a single currency in the Euroland, it is
unlikely to happen anytime soon given that it would not bring any benefit to the
region at this juncture. In fact, the sharp drop in euro will likely boost the regions
exports due to improving export competitiveness. Already, factory orders in Germany,
the largest economy in the Euroland, grew by 2.8% mom in April, the third month
of increase in four months.

Meanwhile, a deepening in Europes sovereign debt crisis will likely affect Malaysias The countrys exports will
exports to some extent given that 10.7% of the countrys exports, which grew by likely slow down in 2H
28.9% yoy in January-April 2010, went straight to Europe. There would be indirect 2010, in tandem with a
impact as well since Malaysia exports 13% of its exports to China, which grew by weaker global economic
56.2% yoy in January-April 2010, and Europe is Chinas largest export market growth
(accounting for 19.7% of its total exports). As a whole, in tandem with a more
moderate growth in the global economy, we expect the countrys real exports to
slow down to 5.0% yoy in 2H 2010, from an estimate of +18.9% in the 1H,
bringing the full-year growth to +11.5% compared with -10.4% in 2009.

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Major Economies Showing Signs Of Softening

In the US, the economy moderated to an annualised rate of 3.0% in 1Q 2010, after The US economic recovery
a strong growth in the 4Q of last year. Despite a weaker growth, the economic is becoming more
recovery is becoming more sustainable, as its recovery which started from the sustainable but growth will
government stimulus and inventory rebuilding, has now spread to consumer spending. be at a more moderate
Nonetheless, consumers have turned cautious and are beginning to take a pause in
pace in the 2H
view of rising economic uncertainties in Europe and the policies tightening in Asia.
Consequently, real personal consumption expenditure stagnated m-o-m in April (see
Chart 3), the first in seven months. Furthermore, unemployment rate remains high
and job creation in the non-farm private sector slowed down rapidly in May, after
four consecutive months of picking up, implying that a recovery in consumer spending
will likely be gradual. Elsewhere, manufacturing activities slowed down in May (see
Chart 4), after reaching a near six-year high in April. Although services activities
held stable for the third straight month in May, there were signs of weakness,
indicating that activities in the sector might have peaked and will likely soften going
forward. As a whole, the US economy is projected to grow at a more moderate
pace of 2.8% in 2H 2010, compared with +3.2% in the first half, bringing the full-
year growth to around +3.0%, a rebound from -2.4% in 2009.

Chart 3 Chart 4
US: Consumer Spending Turning Softer US : Manufacturing & Services Activities Are
Likely To Have Peaked

% mom (Personal consumption expenditure)

Index
1.5
70 ISM
Manufacturing
1 65

60
0.5

55
0
50

-0.5 45

40
-1
35 ISM
-1.5
Services
05 06 07 08 09 10 30
05 06 07 08 09 10

Similarly, the Eurolands economy is expected to sustain its slow pace of recovery The Eurolands economy is
in 2010, as the deepening sovereign debt problems of late would force some countries expected to sustain its
to cut government spending sharply. Already, manufacturing activities in the region slow pace of recovery due
showed a first sign of weakness in eight months and since it returned to positive to the deepening
growth in October last year (see Chart 5), while there were warning signs that sovereign debt problems,
services activities may be peaking as well. Also, consumer confidence weakened to while a slowdown in global
the lowest level in seven months in May, after a temporary improvement in April exports will likely hurt the
(see Chart 6). In the same vein, a slowdown in global export demand will likely
Japanese economy in the
contribute to a slower growth in the Japanese economy in the 2H of the year. This
2H of the year
will likely be compounded by political uncertainties that could affect the countrys
efforts to shake off deflationary pressure facing the country. As it stands, Japans
exports softened to 43.5% yoy in March, from a high of +45.4% in February (see
Chart 7).

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 Chart 5 Chart 6
Euroland: Manufacturing And Services Euroland: Consumer Confidence Falling Back
Activities Showing Signs of Weakness But Business Confidence Holding Up

Index Index
Index
PMI 0 10
65 Services Business climate 5
-5
indicator

60
-10
(RHS) 0

55 -5

-15
-10
50
-20 -15

45 -20
-25

40 Consumer -25
-30
confidence
35
PMI Manufacturing (LHS)
-30
-35
-35

30 -40 -40
00 01 02 03 04 05 06 07 08 09 10 05 06 07 08 09 10

Chart 7
Japan: Exports Turning Softer

% yoy
60

40

20

-2 0

-4 0

-6 0
05 06 07 08 09 10

In China, the countrys economy is showing signs of weakness following the Chinas economy is
introduction of measures to control the rapid credit expansion and upward property showing signs of
prices. As it stands, manufacturing activities slowed down to the slowest pace in weakness following the
three months in May (see Chart 8), while fixed-asset investment in urban areas and introduction of measures
loans slowed down from growth of more than 30% to 25.9% and 23.2% respectively to control the rapid credit
in May (see Chart 9). Similarly, retail sales were off the peak in February, pointing expansion and upward
to easing local demand. These, however, will likely be supported by resilient exports. property prices
As a whole, the key economic indicators point to a slowdown in the countrys
economic growth in the 2H of the year, though growth will likely remain resilient,
after recording a stronger growth of +11.9% yoy in the 1Q.

Chart 8 Chart 9
China: Manufacturing Activities Moderating China: Fixed Investment And Loan Growth
Easing, While Retail Sales Off The Peak
Index
% yoy % yoy
65 40 40
Fixed asset
(RHS) 35
60 35

30

55 30
25

50 25 20

Retail sales
15
(LHS)

45 20

10

40 15
Total loans 5

(LHS)
10 0
35
08 09 10
2007 2008 2009 2010

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Global Demand For Electronic Exports Will Likely Moderate

A sharp turnaround in demand for electrical & electronic (E&E) products, which Demand for E&E products
account for about 45% of Malaysias total exports in 2009, would boost the countrys will likely be softer in the
exports, particularly in 1H 2010. Demand, however, will likely be softer in the 2H 2H of the year
of the year, in line with a slowdown in global economic activities. As it stands,
worldwide semiconductor sales eased to 50.3% yoy in April, after reaching a high
of +58.3% in March, suggesting that sales are beginning to moderate after a spike
up in demand and inventory rebuilding.

Domestic Demand Will Turn Softer

A softer export growth in the 2H of the year, which will translate into slower increases A softer export growth will
in jobs and production, will likely affect consumer spending and business investment likely translate into slower
as well. As a result, we expect domestic demand to grow at a slower pace increases in jobs and
of 3.7% yoy in 2H 2010, compared with +6.2% estimated for the 1H, bringing the production, which will lead
full-year growth to 4.9% in 2010, a rebound from -0.5% in 2009 (see Table 1). This to a slowdown in domestic
will likely be reflected in slower increases in both private consumption and investment demand as consumer
during the period, as sentiment turns cautious amidst slowing economic activities. As spending weakens
a result, we envisage consumer spending to grow at a slower pace of 4.6% yoy
in the 2H versus +5.4% in the 1H. Consumer spending, however, will remain
resilient, on the back of high savings and rising consumerism. Furthermore,
manufacturers are still recruiting workers and for the 11th consecutive month in April.
For the full-year, consumer spending, however, will likely bounce back to +5.0% in
2010, from +0.7% in 2009.

Table 1
GDP By Demand Aggregate (2000=100)

2007 2008 2009 2009 2010 2010(f) 2011(f)

1Q 2Q 3Q 4Q 1Q

% Growth in Real Terms

GDP 6.5 4.7 -1.7 -6.2 -3.9 -1.2 4.4 10.1 6.8 5.0
Consumption:
Private 10.5 8.5 0.7 -0.6 0.3 1.3 1.6 5.1 5.0 6.0
Pu b lic 6.6 10.7 3.1 1.6 1.5 9.4 0.7 6.3 -1.5 4.5
Total investment 9.4 0.7 -5.6 -11.2 -9.6 -7.9 8.2 5.4 9.0 8.6
Private 13.1 1.0 -17.2 n.a n.a n.a n.a n.a 6.9 12.7
Public 5.3 0.5 8.0 n.a n.a n.a n.a n.a 10.8 4.9
Goods & services:
Exports 4.1 1.6 -10.4 -15.5 -17.9 -12.9 6.0 19.3 11.5 7.8
Imports 5.9 2.2 -12.3 -23.0 -19.4 -13.2 7.0 27.5 18.0 10.5
Agg.domestic demand 9.6 6.8 -0.5 -3.1 -2.2 0.1 2.8 5.4 4.9 6.4

(f): RHBRI's forecasts

Similarly, the private investment is projected to soften to 6.4% yoy in 2H 2010, Private investment is
from +7.3% in the 1H, as businesses turn cautious when excess production capacity projected to soften as
builds up on the back of a slowdown in export demand. As a result, we believe well, as businesses turn
businesses will not be in a hurry to invest and they are likely to delay their investment. cautious
As it stands, the imports of capital goods slowed down somewhat to 9.6% yoy in the
1Q, after recording its first growth of 17.4% yoy in six consecutive quarters in the
4Q. Similarly, total approved manufacturing investment fell by 30.3% yoy in the 1Q,
after a rebound to +42.8% in the 4Q. In the same vein, public investment is

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 projected to expand at a slower pace of 10.2% yoy in the 2H of the year, compared Public development
with +11.5% in the 1H, as the government stimulus fizzles out. Consequently, we expenditure will not exert
expect fixed capital formation to ease to 8.4% yoy in 2H 2010, from +9.5% a contractionary impact
estimated for the 1H, bringing the full-year growth to 9.0% during the year, compared on the economy as earlier
with -5.6% in 2009. Public consumption, on the other hand, will likely contract by projected, as the
5.4% yoy in the 2H of the year, compared with an estimate of +4.0% in the 1H, on Government will not cut
the back of a fiscal consolidation. As a whole, the public sector expenditure will
back as steeply as
not exert a contractionary impact on the economy as earlier projected, as
projected previously
the Government will not cut back as steeply as projected previously.

Fiscal Consolidation Would Be Less Severe Than Initially Thought

Although the Government scrapped its plan to restructure fuel subsidy in May, we The Government guided
believe it would still be able to reduce its budget deficit according to the plan. that its budget deficit will
Indeed, the Government guided that its budget deficit will likely narrow to likely narrow to 5.3% of
5.3% of GDP or RM40.3bn in 2010, slightly better than -5.6% of GDP or RM40.5bn GDP in 2010
projected previously (see Table 2). This is because the Government has changed
the petroleum income tax to a current year assessment system beginning 2010,
implying that it could collect income tax from petroleum companies based on this
years earnings. On top of that, the Government would still be able to collect a 20%
petroleum income tax or more based on 2009s income, if oil companies choose to
pay more upfront instead of over five years. The move, in our view, would help
to cushion a decline in petroleum income tax caused by a drop in crude oil prices
in 2009. As it stands, the Government expects crude oil price to average US$74.5/
barrel in 2010, compared with an average of US$60.5/barrel in 2009 and a high of
US$125.0/barrel in 2008.

Table 2
Federal Government Financial Position

2008 2009(e) 2010(f) 2009(e) 2010(f)

(RM bil) (%, change)

Revenue 159.8 158.6 160.9 -0.7 1.5

Operating Expenditure 153.5 157.1 147.5 2.3 -6.1
Current balance 6.3 1.5 13.4
Gross development expenditure 42.8 49.5 54.2 15.5 9.5
Less : Loan recoveries 1.0 0.5 0.5 -40.0 -16.7
Net development expenditure 41.9 49.0 53.7 16.7 9.8
Overall balance -35.6 -47.4 -40.3
% to GDP -4.8 -7.0 -5.3

e : Estimates f : Forecasts
Source : MOF's Economic Report 2009/2010, EPU

A smaller-than-expected drop in oil revenue could help the Government to reduce The Government opted to
its budget deficit more than the initial plan in 2010. However, the Government opted cut its operating and
to cut its operating and development expenditures by a smaller magnitude development expenditure
than originally planned to ensure that a rollback of its expenditure would not by a smaller magnitude
exert too much downward pressure on the economy given the risk of a sharper- than originally planned
than-expected slowdown in the global economy in the 2H of the year. Already, the
Government has proposed a supplementary budget totalling RM12bn for 2010 in late
April. The extra spending was meant for the implementation of the six National Key
Result Areas (NKRAs) under the Government Transformation Programme (GTP),
which would raise the operating expenditure by around RM9.2bn from the initial plan
to RM147.5bn in 2010. At the same time, the development expenditure would be
raised by about RM3bn from the initial plan to RM54.2bn in 2010 to cater for the

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additional funds that are required by the various ministries. A smaller-than-expected
cutback in the Governments expenditure suggests that the fiscal consolidation
will not exert a contractionary impact on the economy as previously feared.

In the 1Q of 2010, the Government recorded a budget deficit of RM10.2bn, compared The Government recorded
with -RM6.7bn in the 1Q of last year. On an annualised basis, the deficit was broadly a smaller-than-expected
in line with the Governments target of a deficit of RM40.3bn, indicating that the budget deficit of 7.0% of
Government is on track to achieve its deficit target. Meanwhile the Government GDP in 2009
recorded a smaller-than-expected budget deficit of 7.0% of GDP or RM47.4bn in
2009, compared with -7.4% of GDP or RM51.1bn estimated in October 2009, as both
operating and development expenditures came in lower than the previous estimates.

Manufacturing And Services Sectors Will Likely Moderate In The 2H

On the supply side, the manufacturing and services activities are likely to expand Growth of the
at a more moderate pace in the 2H of the year, in line with slower increases in trade manufacturing sector is
activities, business and consumer spending. Similarly, construction and agriculture projected to slow down by
sectors are envisaged to grow at a slower pace but mining output will pick up . Value more than half in the 2H
added in the manufacturing sector is projected to slow down sharply to of the year, as exports
6.9% yoy in the 2H of the year, from +14.9% estimated for the 1H, as exports slacken and private
slacken and private spending eases. Already, manufacturing activities in major spending eases
economies like China, US and Euroland have shown signs of weakness in May and
Malaysia will likely experience the same situation as well. This will likely be reflected
in slower growth in output of export-oriented industries, on the back of a slowdown
in global demand for the countrys exports, particularly the E&E products. Similarly,
output of domestic-oriented industries will likely expand at a slower pace in the 2H
of the year, as consumer spending and private investment moderate. As it stands,
the production of domestic-oriented industries expanded by 16.8% yoy in March, off
a high of 22.8% in January. For the full-year, the manufacturing sector, however, will
still chalk up a strong double-digit growth of 10.7% in 2010, after going through a
contraction of 9.4% in 2009 (see Table 3).

Table 3
GDP By Industrial Origin At 2000 Prices

2007 2008 2009 2009 2010 2010(f) 2011(f)

1Q 2Q 3Q 4Q 1Q
% Growth in Real Terms

GDP 6.5 4.7 -1.7 -6.2 -3.9 -1.2 4.4 10.1 6.8 5.0

Agriculture 1.3 4.3 0.4 -4.4 0.4 -0.4 5.9 6.8 3.2 2.8
Mining 2.0 -2.4 -3.8 -5.2 -3.5 -3.6 -2.8 2.1 1.8 2.0
Manufacturing 2.8 1.3 -9.4 -17.9 -14.5 -8.6 5.0 16.9 10.7 8.0
Construction 7.3 4.2 5.8 1.2 4.5 7.9 9.3 8.7 4.8 2.8
Services 10.2 7.4 2.6 -0.2 1.7 3.4 5.2 8.5 6.4 4.6

(f) : RHBRI's forecasts

In the same vein, the broad services sector is projected to grow at a slower The services sector is
pace of around 5.1% yoy in the 2H of the year, compared with +7.7% estimated projected to grow at a
for the 1H, in line with a slowdown in trade activities and private sector spending. slower pace in the 2H, in
For the full-year, the services sector is projected to expand at a faster pace of 6.4% line with a slowdown in
in 2010, compared with +2.6% in 2009. The slowdown in services activities in the trade activities and
2H of the year will likely be broad-based. As a result, we expect activities in utilities,
private spending
transport & storage, communications, finance & insurance and real estate & business
sub-sectors to weaken in the 2H of the year, as business activities turn softer.
Similarly, a slowdown in consumer spending will likely contribute to slower increases
in activities in wholesale & retail trade and accommodation & restaurants sub-
sectors, while government services will likely slacken during the period.

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 The agriculture sector is also envisaged to expand at a more moderate Agriculture sector is
pace of 2.2% yoy in 2H 2010, compared with an estimate of +4.3% in the 1H, envisaged to expand at a
on account of slower growth in the production of rubber and saw logs. This will likely more moderate pace, on
be mitigated somewhat by an improvement in palm oil production during the period. account of slower growth
For the full-year, the sector will likely grow at a stronger pace of 3.2% in 2010, after in the production of rubber
slowing down to +0.4% in 2009. This is on account of a pick-up in palm oil and saw logs
production due to the low base effect as well as expanded matured areas. As it
stands, palm oil production fell by 1.0% in 2009, compared with +12.1% in 2008.
At the same time, the decline in output of saw logs will likely narrow further, after
falling by a smaller magnitude of around 3.3% in 2009, compared with -14.8% in
2008. Similarly, the production of rubber will likely bounce back during the year,
given better pricing and after going through three consecutive years of decline.
Meanwhile, the non-commodity sub-sector such as fisheries, livestock and crops will
contribute to growth as well, on the back of the implementation of various projects
by the Government.

Construction activities are likely to weaken to 2.3% yoy in the 2H of the Construction activities are
year, from +7.7% estimated for the 1H, as the Governments stimulus spending likely to weaken during
dissipates. This will likely translate into slower growth in civil engineering sub-sector. the period, as the
Construction activities in the residential property sub-sector will likely soften as well, Governments stimulus
while construction activities in non-residential property sub-sector are still ongoing. spending dissipates
As it stands, new permits for sales and advertising of houses slowed down to 32.0%
yoy in the 1Q, from +100.8% in the 4Q, while renewal permits fell by 19.4% yoy,
compared with +37.8% during the same period. In the same vein, housing approvals
by the Ministry of Housing and Local Government softened to 13.9% yoy in the 1Q,
from +111.6% in the 4Q. For the full-year, construction activities are projected to
moderate to 4.8% in 2010, from +5.8% in 2009.

Mining output, however, is envisaged to bounce back to +1.9% yoy in the Mining output, however, is
2H of the year, from +1.7% estimated for the 1H. This is mainly on account of envisaged to bounce back
a pick-up in the production of liquefied natural gas (LNG) due to higher demand. in the 2H of the year,
Already, LNG output production rebounded to increase by 2.5% yoy in the 1Q of mainly on account of a
2010, after recording a smaller decline of 1.0% in 2H 2009 and compared with -6.4% pick-up in the production
in the 1H. Similarly, crude oil production contracted by a smaller magnitude of 2.5% of LNG
in the 1Q, compared with -5.0% in 2H 2009. For the full-year, mining output is
projected to grow by 1.8% in 2010, after two consecutive years of contraction and
compared with -3.8% in 2009.

Money Supply And Loans To Continue Expanding In The 2H

The broader money supply, M3, eased to +8.1% yoy in April, from +8.7% in March We expect monetary
and compared with a peak of +10.0% in November last year. This was mainly on policy to remain
account of a slowdown in government operations, in tandem with a slower increase supportive of economic
in disbursement of government funds after picking up strongly in mid-2009. A growth and M3 growth will
decline in net external operations, on account of a devaluation losts as a result of
likely pick up in 2010
the appreciation of the ringgit, worsened the situation. This was, however, mitigated
by a pick-up in demand for funds by the private sector, on account of a stronger loan
growth and a pick-up in the issuance of securities. Going forward, we expect
monetary policy to remain supportive of economic growth and M3 will likely
pick up to around 10.5% in 2010, from +9.1% at end-2009, in line with a pick-up
in economic activities.

Loans, however, grew at a stronger pace of 10.0% yoy in April, compared with Loan growth will pick up in
+9.8% in March and a low of +7.0% in November last year. This was the strongest 2010, in tandem with a
growth in a year, on the back of a pick-up in corporate and household loans during recovery in the economy
the period. The stronger growth in corporate loans was driven by a pick-up in loans
extended to small and medium enterprises (SMEs), which grew by 4.6% yoy in
April, faster than +3.1% in March and compared with -6.0% in November. This was,
however, offset partially by a slowdown in business loans to 4.0% yoy in April,
from+ 4.3% in March but higher than +0.6% in November. In terms of sector, a

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faster increase in loans was due to a turnaround in loans given to the manufacturing
and wholesale & retail trade as well as restaurant & hotel sectors. Stronger growth
in the construction, real estate and finance, insurance & business loans also helped.
These were, however, offset partially by a slowdown in loans extended to the
agriculture and mining & quarrying as well as a decline in loans extended to transport,
storage & communications sectors. Similarly, household loans grew at a faster
pace of 12.2% yoy in April, compared with +11.7% in March and +9.5% in November.
This was due to loans extended for the purchase of passenger cars and houses as
well as for credit cards during the month. Going forward, we expect the banking
systems loans to expand by 9.0% in 2010, faster than +7.8% in 2009, in tandem
with the pick-up in the economy.

In terms of asset quality, the 3-month gross non-performing loan (NPL) ratio of the The NPL ratios are likely
banking system remained broadly stable at around 3.3-3.4% of total loans in January- to remain relatively stable
April and compared with 3.2% in December last year. Similarly, the 3-month net NPL in 2010
ratio hovered at around 1.8-1.9% of total loans during the same period and compared
with 1.8% in December. The slight uptick in NPL ratios was largely due to the
adoption of the FRS139. The comparison with the previous year number, however,
may not be meaningful as: 1) Under the FRS139, impaired loans include both
performing and non-performing loans (under previous GP3 guideline) and hence, the
figure would be higher as compared to the definition of NPLs previously; 2) Not all
banks have adopted FRS139. According to Bank Negara Malaysia (BNM), beginning
January 2010, loans are reported based on the FRS139, although the adoption by
the various banks would still depend on their respective financial year end. Thus
far, the data might have captured NPL trend of five banks that have started to report
NPLs based on the FRS139. Going forward, we expect the banking systems 3-month
gross and net NPL ratios to remain relatively stable at around 3.3% and
1.8%, respectively, by end-2010, compared with 3.2% and 1.8%, respectively, at
end-2009.

Smaller Current Account Surplus; Ringgit Will Remain Range-Bound

Imports are expected to rise faster than that of exports, as economic activities pick The current account
up and domestic demand improves. This will likely result in a smaller merchandise surplus of the balance of
trade surplus of RM136.9bn during the year, compared with a surplus of RM141.8bn payments is projected to
in 2009. At the same time, we envisage the deficit in the income account to widen shrink in 2010
during the year, as non-resident controlled companies repatriate higher dividend on
the back of improving corporate earnings. Similarly, the services account is projected
to record a smaller surplus during the year due to higher payment for transportation
charges. These, however, will likely be mitigated by a smaller deficit in the current
transfer, as repatriations of salaries and wages by foreign workers are likely to drop,
in line with the Governments policy of reducing foreign workers in the country. As
a result, we expect the current account of the balance of payments to record
a smaller surplus of around RM100.8bn or 13.5% of GNI in 2010, compared
with a surplus of RM112.1bn or 16.9% of GNI in 2009 (see Table 4). Whilst the
current account surplus will likely narrow, it remains large and will contribute to a
build-up in the countrys foreign exchange reserves and fuel domestic liquidity in the
financial system. Indeed, the excess liquidity (including repos) mopped up by the
Central Bank from the banking system inched up to RM226.3bn at end-May 2010,
from RM225.9bn at end-April and compared with RM223.3bn at end-2009.

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 Table 4
Balance Of Payments

2008 2009 2009 2010 2010(f) 2011(f)

1Q 2Q 3Q 4Q 1Q

(RMbn)

Current account 129.5 112.1 31.3 28.0 25.4 27.4 30.4 100.8 93.7
(% of GNI) (18.1) (16.9) n.a n.a n.a n.a n.a (13.5) (11.7)
Goods 170.6 141.8 37.2 33.2 33.4 37.9 45.0 136.9 130.1
Services 0.2 4.7 2.7 1.5 0.6 -0.1 -0.1 1.1 1.7
Income -23.7 -14.6 -4.5 -2.9 -1.7 -5.6 -8.9 -22.2 -23.1
Current transfers -17.5 -19.6 -4.2 -3.9 -6.8 -4.8 -5.6 -15.0 -15.0

Capital account 0.6 -0.2 -0.0 -0.0 -0.0 -0.0 -0.1 0.0 0.0

Financial account -118.5 -80.2 -31.0 -22.3 -9.4 -17.4 -19.5 -56.0 -45.5
Errors & omissions* -29.9 -17.9 1.7 -2.4 -2.7 -13.0 -30.5 -35.0 -25.0
Overall balance -18.3 13.8 3.3 2.1 11.5 -3.0 -19.6 9.8 23.1

Outstanding reserves^ 317.4 331.3 320.7 322.9 334.4 331.4 311.8 341.1 364.2
(US$)^ 91.5 96.7 87.8 91.5 96.0 96.7 95.3 99.7 106.9

(f) : RHBRI's forecast ^ : As at end-period

* : Reflect mainly revaluation gains/losses from Ringgit depreciation/appreciation and statistical discrepancies

Outflow of capital, on the other hand, is envisaged to narrow to around RM56bn Outflow of capital,
in 2010, after recording a smaller outflow of RM80.2bn in 2009. This is on account however, is envisaged to
of a pick-up in portfolio investment in 2010, after recording a smaller inflow in 2009, be smaller in 2010
in line with an improvement in the countrys economic prospects. Similarly, net
direct investment is projected to record a smaller net outflow in 2010 due to higher
foreign direct investment (FDI), as investors resume their investment, in tandem
with an improvement in global economic prospects. Inflow of FDI slowed down to
RM5.0bn in 2009, from an inflow of RM24.1bn in 2008, due to the global economic
recession. These, however, will likely be offset partially by an increase in Malaysians
other investments abroad, including loans and trade credits, as businesses look for
new investment opportunities overseas.

As a whole and after taking into account a larger deficit in errors & omissions, the The overall balance of
overall balance of payments is projected to record a smaller surplus of around payments is projected to
RM9.8bn in 2010, compared with a surplus of RM13.8bn in 2009. The larger deficit record a smaller surplus
in errors & omissions reflects partly a revaluation loss due to a strengthening of the during the year
ringgit against other major currencies. Consequently, the countrys foreign exchange
reserves will likely increase to US$99.7bn by end-2010, from US$96.7bn at end-
2009.

The build-up in foreign exchange reserves will continue to provide an underlying The ringgit will likely
support to the ringgit. The movement of the ringgit, however, has been volatile in fluctuate at between
recent months. The ringgit took a turn and began to depreciate against the US dollar RM3.20 and RM3.30/US$,
in recent weeks. This was due to the flight to safety as investors pulled out their before settling at around
funds from emerging markets on the back of a deepening sovereign debt crisis in RM3.20 by end-2011
Europe and policies tightening in Asia that threaten to derail the global economic
recovery. As a result, the ringgit fell by 4.5% against the US dollar between 1 May
and 7 June, after appreciating by 6.8% in the previous three months. Similarly, S$,
peso, rupiah and baht depreciated by 3.5%, 5.0%, 2.9% and 0.9% respectively
against the US dollar, after a gain of +2.8%, +3.9%, +3.6% and +2.1% respectively
during the same period. The euro also weakened by a whopping 10.2% but the
Japanese yen strengthened by 3.0% against the US dollar during the same period.
Meanwhile, the Chinese renminbi remained relatively stable, as it has been implicitly
pegged to the US dollar since July 2008. As a whole, we expect the ringgit to
remain volatile and it will likely fluctuate at around RM3.20-3.30/US$ for
the rest of 2010 before settling at RM3.20/US$ by end-2011.

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Price Pressure Building Up, But Likely To Be Manageable

The headline inflation rate accelerated to 1.5% yoy in April, after hovering Inflation rate accelerated
at between +1.2 and +1.3% in the previous three months (see Chart 10). This was in April, the fifth
the fifth consecutive month of increase and the fastest pace of increase so far this consecutive month of
year, indicating that price pressure is building up and as higher base effect gradually increase and the fastest so
wears off. The pick-up in inflation was on account of higher food & non-alcohol
far this year, indicating
beverage prices and a slight pick-up in the core inflation rate during the
that price pressure is
period. Food & non-alcohol beverage prices grew at a faster pace of 2.2% yoy in
building up
April, the fastest in 10 months and compared with +1.7% in March. This was due
to rising commodity prices and as higher base effect gradually wears off. Recall that
food & non-alcohol beverage prices eased to 9.3% yoy in the 1Q of last year, from
+11.1% in 4Q 2008. Similarly, the core inflation rate inched up to 1.2% yoy in April,
after remaining stable at +1.1% in the previous two months. This was due to a pick-
up in the costs of healthcare, transport and recreation services as well as charges
at restaurants & hotels. These were, however, offset partially by slower increases
in the prices of furnishing & household products and the costs of education as well
as a sharper drop in the prices of clothing & footwear.

Chart 10
Inflation Trending Up And Normalisation Of Monetary Conditions
Will Likely Continue

% p.a % yoy

4.0 10

3.5
OPR 8

3.0
(LHS)
6
2.5
4

2.0
2
1.5

1.0
0
Total
CPI -2
0.5
(RHS)
0.0 -4
05 06 07 08 09 10

Going forward, inflation will likely increase at a faster pace and we expect Inflation will likely
it to trend up to 2.0% in 2010, from +0.6% in 2009, in line with a pick-up in increase at a faster pace
domestic demand. A rise in international crude oil and commodity prices could also to 2.0% in 2010, in line
exert some pressure on domestic inflation. In addition, the Government plans to with a pick-up in domestic
gradually remove some of the subsidies in order to reduce its financial burden. demand
Already, the Government has allowed sugar price to be increased by 20 sen and it
has removed the subsidy for white bread at the beginning of the year. Also, it has
organised the Subsidy Rationalisation Lab on 27 May to get feedbacks from the
public on its proposals to cut subsidies. However, we believe the removal of subsidies
will likely be gradual and separately in order to reduce the burden on the people.
Furthermore, given that output is recovering from low levels, the resultant pressure
on inflation from the narrowing output gap is expected to be limited.

Policy Normalisation To Be At A Measured Pace

Although inflation is expected to rise but it will not pose a major threat to the Further rates hike to be
economy at this stage, in our view. However, given that economic growth has data dependent and BNM
recovered and is gaining momentum, it would not be wise to maintain interest rates will likely take a pause in
at too low a level over an extended period as it could encourage excessive risk Julys policy meeting
taking behaviour and unhealthy build up of financial imbalances. As a result, there before resuming its rate
is a need for Bank Negara Malaysia (BNM) to bring back interest rates to a more
hike in September and by
normal level. Indeed, BNM already started to normalise its monetary conditions.
25 basis points, bringing
The Central Bank raised its overnight policy rate (OPR) for the second time this year
the OPR to 2.75%
and by another 25 basis points to 2.5% on 13 May. Nevertheless, given that

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 Malaysia is already ahead of the curve and faster compared to regional economies
in terms of normalising its monetary conditions, while the recovery in the global
economy will likely be uneven, we believe BNM will not be in a hurry to increase
interest rates. We expect further rate hikes to be data dependent and BNM
will likely take a pause in the next policy meeting in July before resuming
its rate hike in September and by 25 basis points, bringing the OPR to
2.75%. Thereafter, the OPR will likely stay at this level for the rest of this year.
We expect the Central Bank to raise its key policy rate again in the early part of
2011 and by a total of 50-75 basis points during the year, pushing the OPR to a more
normal level of 3.25-3.50% by end-2011.

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