Malaysia's Economy Slows in Q1

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001108 SIPDIS STATE PASS USTR - WEISEL AND JENSEN STATE PASS FEDERAL RESERVE AND EXIMBANK STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN USDOC FOR 4430/MAC/EAP/J.BAKER TREASURY FOR OASIA AND IRS GENEVA FOR USTR CANBERRA FOR ECON - MATTHEWS SIPDIS E.O. 12958: N/A TAGS: ECON EFIN EINV MY SUBJECT: Malaysia's Economy Slows in Q1 REF: KUALA LUMPUR -------------- Summary -------------- ¶1. (U) Malaysia's economic growth slowed to 5.3% in the first quarter of 2007, down from an average of 5.9% in 2006. Services led the way with 9.6% growth and construction continued to recover as development funds from the Ninth Malaysia Plan (9MP) finally started flowing in significant amounts. The agriculture and mining sectors recorded puzzlingly weak results, in view of the strong world demand for commodities. Government fiscal stimulus should generate stronger growth as the year progresses, with continued implementation of 9MP programs, and spending associated with expected elections and Malaysia's 50th anniversary of independence. Nevertheless, Finance Minister (II) Nor Yakcop expects the government's deficit target of 3.4% of GDP. End summary. -------------- Services Lead the Way -------------- ¶2. (U) Malaysia's GDP growth slowed in first quarter 2007 to 5.3% from an average rate of 5.9% during 2006. Nevertheless, the first quarter exceeded the expectations of many analysts who had forecast 4.7% growth. ¶3. (U) On the supply side, services led the way, expanding 9.6% year-on-year in Q1, partly due to increased tourism under the GOM-sponsored promotion campaign "Visit Malaysia Year 2007." Growth in the finance, insurance, real estate and business services sub-sector expanded a strong 17.6%. Manufacturing, the traditional backbone of Malaysia's economy, grew a scant 1.7% year-on-year on weak global demand for electrical and electronic products. Agriculture also disappointed, growing 2% year-on-year on lower output of crude palm oil and rubber. Mining shrank 1.1% year-on-year because of lower crude oil production, which slipped 3.8% to 680,153 bpd in Q1 2007 from 707,294 bpd in Q1 2006. The construction sector rose 4% as government projects commenced under the Ninth Malaysia Plan. (Comment: The fact that both agriculture and mining recorded such slow growth, despite high world prices for palm oil, rubber and petroleum, is somewhat surprising.) -------------- Domestic Demand Pulls the Train -------------- ¶4. (U) Domestic demand grew a steady 7.6% year-on-year in Q1 2007. Private consumption rose a stronger 8.6% year-on-year. A stable labor market and high commodity prices of palm oil and natural rubber helped buoy consumer spending. The Malaysian Institute of Economic Research's (MIER) Consumer Sentiments Index (CSI) rose 13.2 points to 124.1 points in the first quarter, its highest level since Q3 2000. MIER's data indicates consumers have increased confidence regarding employment and income prospects. Public consumption increased 7.3%, primarily due to higher government spending for salaries, supplies, and services. This is expected to increase further with the implementation of recently announced civil service pay raises ranging from 7.5% to 35.0%, and a doubling of the cost of living allowance (COLA) for more than one million government employees which takes effect July 1. The pay increase will cost the government an additional RM 8 billion (US$ 2.35 billion) annually. ¶5. (U) Total investment expanded by 5.4% during the first quarter of 2007, down from 9.8% in the fourth quarter of 2006. The government disbursed an estimated RM 5.3 billion (US$ 1.53 billion) of development spending in Q1. Although the development expenditure was 2.5 times that of the last corresponding quarter, the rate of disbursement is expected to speed up in the second-half of the year as 9MP projects heat up. MIER's Business Conditions Index (BCI) eased by 1.7 points to 105.5 in the first quarter, but still stayed above the 100-point (business neutral) benchmark. According to the MIER survey, manufacturers were slowing production in reaction to disappointing domestic and external orders. However, manufacturers' outlook for the near-term remains positive and increased output is planned for next quarter. ¶6. (U) Exports slowed significantly, growing only 1.9% year-on-year KUALA LUMP 00001108 002 OF 003 in Q1, due to weak demand for electronic and electrical products. Imports remained moderate, expanding 3.5% over the first quarter supported by higher imports of intermediate and consumer goods. -------------- Lower Fiscal Deficit, For Now -------------- ¶7. (U) The federal government recorded a fiscal deficit of RM 2.6 billion (US$ 754 million),or 1.8% of GDP in Q1 2007, compared to a fiscal surplus of RM 4.9 billion (US$ 1.3 billion),or 3.6% of GDP in Q1 2006. In 2006, the overall fiscal deficit was 3.5% of GDP. Total government spending rose 38.7% year-on-year in the first quarter of 2007. Development spending rose 148% year-on-year with the starting of the 9MP projects. Revenue collections remained flat at RM 24.2 billion (US$ 7.2 billion) in the quarter. According to press reports, Finance Minister (II) Nor Mohamed Yakcop expressed confidence that the government would meet its fiscal deficit target of 3.4% of GDP in 2007. -------------- Reserves Escalate as External Debt Declines -------------- ¶8. (U) Malaysia's foreign exchange reserves rose to US$ 88.6 billion as of the end of March 2007, from US$ 82.5 billion at the end of December 2006. Reserves rose further to US$ 98.4 billion by end-May, sufficient to finance 9 months of retained imports. In May alone, reserves rose by US$ 6.8 billion, accounting for 43% of the net increase year to date. Large foreign inflows prompted by the inclusion of Malaysia in a widely followed global investment index contributed significantly to the surge. Net inflows of portfolio investment rose from RM 5.4 billion (US$ 1.6 billion) in Q4 2006 to RM 26.9 billion (US$ 7.8 billion) in Q1 2007. Two-thirds of the inflows were invested in shares and corporate securities, 21.3% in monetary instruments and 7% in Malaysian government securities. ¶9. (U) Malaysia's external debt declined (in ringgit terms) to RM 178 billion (US$ 51.0 billion) at the end of March from RM 183.1 billion (US$ 51.4 billion) at the end of 2006 as the ringgit appreciated against major currencies, particularly the dollar. The volume of medium- and long-term external loans fell. Public sector debt declined as the federal government borrowed less and repaid external debt. Private sector debt remained unchanged. Both public and private short-term debt declined 6.9% to US$ 38.9 billion (US$ 11.3 billion). -------------- Key Interest Rate Unchanged -------------- ¶10. (U) Malaysia has kept its key benchmark interest rate unchanged at 3.50% since April 27, 2006. Slower GDP growth in Q1 had raised expectations that Bank Negara might consider cutting rates to stimulate the economy. However, the central bank signaled it was unlikely to reduce rates, stating that they are at the appropriate level to support domestic demand. ¶11. (U) The ringgit appreciated against the major currencies during the first quarter. The ringgit reached its 10-year high of RM 3.388 to the dollar on May 28, but weakened to RM 3.4835 on June 27 as the dollar regained its strength. -------------- Inflationary Pressures Ease -------------- ¶12. (U) As measured by the Consumer Price Index (CPI),inflation was moderate at 2.6% year-on-year in Q1. In March, Malaysia's inflation eased to its lowest level (1.5% year-on-year) since August 2004. For January through May, the CPI rose 2.2% year-on-year as compared to 3.6% during the same period in 2006. Bank Negara forecasts that inflation will average around 2.0% to 2.5% in 2007. (Comment: Malaysia's CPI statistics are misleading because they are based largely on fixed-price items, including highly-regulated food products.) -------------- -- Signs Point to Faster Growth in the Second Half KUALA LUMP 00001108 003 OF 003 -------------- -- ¶13. (U) Comment: With the government opening the spending taps, economic activity undoubtedly will strengthen over the 5.3% recorded in the first quarter. Such stimulus is not, however, a good foundation for diversified long-term term growth. Prime Minister Abdullah has said he wants the private sector to drive the economy, but Malaysia remains highly dependent on government spending to sustain its development. The poor results in the agriculture and mining sectors are puzzling given the strong worldwide demand for these commodities. They bear watching to see if this is a one time event, or if capacity constraints may be preventing Malaysia from taking full advantage of the favorable conditions for its basic commodity exports. LAFLEUR