Malaysia's GDP Growth Beats Expectations

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001403 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 SIPDIS E.O. 12958: N/A TAGS: ECON EFIN EINV MY SUBJECT: Malaysia's GDP Growth Beats Expectations REF: KUALA LUMPUR SUMMARY -------------- ¶1. (U) Malaysia's economic outlook remained positive in the second quarter of 2007 as GDP rose 5.7% year-on-year, easily exceeding the 5.3 % figure analysts had forecast. Services took the lead in driving the economy, and combined with expansion in mining and construction, they more than mitigated the anemic performance of the manufacturing and agriculture sectors. Malaysia's exports and imports remained weak in Q2 due to sluggish demand for electrical and electronics products. Total fixed investment, however, gained momentum, and public consumption rose, albeit slower than expected despite the implementation of the Ninth Malaysia Plan (9MP) projects. The financial position of the Government of Malaysia (GOM) reverted to a fiscal surplus of 2.4% of GDP in the second quarter. Foreign reserves remained healthy. ¶2. (U) Summary (continued): The Central Bank kept its key interest rate steady at 3.50% to support domestic growth. Bank Negara closely monitors inflation risk and fluctuations of the ringgit against the dollar and other regional currencies. The GOM continues to adhere to its forecast of 6% overall growth for 2007, while analysts predict a slower growth rate of between 5.5 to 5.8%. End Summary. Services Leads Growth -------------- ¶3. (U) Malaysia's GDP expanded 5.7% year-on-year in the second quarter of 2007 -- beating the 5.3% forecast of many analysts -- on strong domestic demand. The economy grew a revised 5.5% year-on-year in 1Q, and 5.9% year-on-year in 2006. ¶4. (U) On the supply side, services were the prime mover of the economy, expanding 9.2% year-on-year in 2Q. Consumption-related finance and business services, as well as the increasing demand for computer-related and other professional services, helped buoy growth of the sector. Similarly, the continuing momentum from the Visit Malaysia Year 2007 campaign has provided important support. Tourist arrivals reached 10.7 million and brought in RM 24 billion ($ 6.8 billion) of foreign exchange earnings in the first half of 2007. The government is optimistic in meeting the target of attracting 20.1 million tourist arrivals and gaining exchange earnings of RM 44.5 billion ($ 12.7 billion) for the year. ¶5. (U) Manufacturing, once the key driver of the economy, grew a meager 1.5% year-on-year due to continued weak demand for export-oriented industries goods, notably electrical and electronic products. Mining reversed its previous contraction to grow a strong 7.7% on higher output of crude oil and natural gas. The increased demand for natural gas by domestic electricity producers, and stronger external demand for liquefied natural gas from Korea and Japan, accounted for the surge in production. Agriculture contracted 0.9% on lower crude palm oil output due to unfavorable weather conditions. The construction sector continued its growth momentum, rising 4.8% year-on-year, as the infrastructure projects of the 9th Malaysia Plan (9MP) and the oil and gas industry were rolled out. Counting on Domestic Demand -------------- ¶6. (U) Domestic demand grew a solid 10.8% year-on-year in 2Q 2007, with private consumption rising 13.1% year-on-year. Higher disposable income and stable labor market conditions augmented by strong prices of palm oil and natural rubber buoyed consumer spending. Although the Malaysian Institute of Economic Research's (MIER) Consumer Sentiments Index (CSI) in 2Q showed a decline in optimism from the previous quarter, it was more upbeat from the same period a year ago, rising 11.7 points to 115.9. MIER's survey indicated that consumers are confident of their employment prospects, financial outlook and current income. Domestic spending increased almost immediately as the government raised the salary of the over one million civil service employees by between 7.5% to 42% and a doubling of the cost of living allowance on July 1. Public consumption also increased a strong 10.2%, mainly on higher spending for salaries and supplies and services. The government salary increase is expected to cost the GOM an additional RM 8 billion ($ 2.3 billion) annually. KUALA LUMP 00001403 002 OF 003 ¶7. (U) Total investment expanded at a slower 6.6% pace during the second quarter of 2007, as compared to 9.9% in the previous quarter. As the implementation of the 9MP projects picked up during 2Q, the government disbursed RM 6.2 billion ($ 1.8 billion),up from RM 5.3 billion ($ 1.53 billion) of development spending in 1Q. Government development spending focused primarily on high-multiplier impact projects, such as agriculture and rural development, transportation related infrastructure and public utilities. Private sector capital spending was mainly in the manufacturing, construction, oil and gas sectors. MIER's Business Conditions Index (BCI) rose to a 3-year high, climbing 16.6 points to 122.1 in 2Q from 105.5 in 1Q and reversing two previous quarters of consecutive declines. According to the MIER survey, manufacturing sales rebounded in the 2Q as local orders surged and export orders turned around despite the dismal performance of the electrical and electronic industry. ¶8. (U) Exports remained weak, growing just 3.0% year-on-year in 2Q. The sluggish demand for electrical and electronic products was compensated for to some extent by increased exports of primary commodities. Imports moderated to expand a mere 1.4% in the quarter on lower intermediate imports, reflecting slower growth in imported inputs for manufactured exports, particularly for electronic products. Fiscal Surplus -------------- ¶9. (U) The federal government recorded a fiscal surplus of RM 3.6 billion ($ 1.03 billion),or 2.4% of GDP in 2Q 2007, from a fiscal deficit of RM 2.6 billion ($ 743 million),or 1.8% of GDP in 1Q, resulting in an overall fiscal surplus of RM 1 billion ($ 286 million) or 0.3% of GDP in the first-half of 2007. Total government spending rose 15.7% year-on-year in the second quarter of 2007. Development spending rose 19% year-on-year, driven by the scheduled implementation of the ninth Malaysian Plan projects. Revenue collections rose 3.5% to RM 34.2 billion ($ 9.8 billion) in the quarter. The fiscal surplus is expected to evaporate with the disbursement of more development funds for the implementation of the 9MP and the increase in salaries for government employees over the next two quarters. The government has projected the fiscal deficit to reduce to 3.2% of GDP in 2007 from 3.3% in 2006. Reserves and External Debt Increase -------------- ¶10. (U) Malaysia's foreign exchange reserves accelerated to $98.4 billion as of the end of June 2007, from $82.5 billion at the end of December 2006. Reserves, however, declined 1.5% to $96.8 billion by end-August, sufficient to finance 8.8 months of retained imports. Reserves fell in conjunction with the downturn of the global stock markets triggered by the sub-prime problems in August when there were some outflows of foreign portfolio funds. Net portfolio investment remained positive with RM 14.5 billion ($ 4.1 billion) in 2Q, down from RM 25.6 billion ($ 7.3 billion) in 1Q. Net foreign direct investments (FDI) on a cash basis, however, rose substantially to RM 13.6 billion ($ 3.9 billion) in 2Q from RM 0.8 billion ($ 229 million) in 1Q. ¶11. (U) Malaysia's external debt increased (in ringgit terms) to RM 181.9 billion ($ 52.2 billion) at the end of June from RM 178.9 billion ($ 51.3 billion) at the end of March as short-term external borrowing rose 19% to RM 46.9 billion ($ 13.4 billion). Both public and private sector medium- and long-term external loans fell to RM 135 billion ($ 38.6 billion) as of end-June from RM 139.5 billion ($ 39.8 billion) as of end-March. The Non-Financial Public Enterprises made higher debt repayments as a dollar-denominated bond matured and several companies cut their foreign debt exposure. Key Interest Rate Unchanged -------------- ¶12. (U) Malaysia has maintained its key benchmark interest rate at 3.50% since April 27, 2006. That is unlikely to change unless the economy slows. Bank Negara Governor Zeti Akhtar Aziz said the current interest rate is at an appropriate level supportive of the Malaysian economy and will not be affected by a possible rate cut by the Fed. The Consumer Price Index (CPI) moderated to a 1.5% year-on-year increase in 2Q, the lowest rate observed since the third quarter of 2004. Inflation was 2.6% in 1Q. For 2007, Bank Negara maintained its outlook for inflation at 2% to 2.5%. KUALA LUMP 00001403 003 OF 003 Outlook for 2007 -------------- ¶13. (U) In her statement accompanying the release of Bank Negara's second quarter report, Governor Zeti said she expected economic growth in the second half to remain firm. The anticipated increase in tourist arrivals, additional output from new facilities in the oil and gas sector as well as the implementation of the 9MP projects will reinforce domestic demand, she said. Zeti is optimistic that the economy will expand 6% in 2007. ¶14. (U) Comment: Although analysts share the central bank's view that growth will be stronger in the second half, they predict that the Malaysian economy will grow between 5.6 - 5.8% in 2007. They are concerned about weak exports and the knock-on effects of the sub-prime crisis in the U.S. on Malaysia and other regional economies. End Comment. SHEAR