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
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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
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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.


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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%.


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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