Malaysian Economy Improves - Growth May Resume by Year End

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TAGS: ECON EFIN EINV PREL EXIM MY
SUBJECT: Malaysian Economy Improves - Growth May Resume by Year End

Ref A: Kuala Lumpur 2465, Ref B: 08 Kuala Lumpur 987


1. (SBU) SUMMARY and COMMENT: Bank Negara (BN) released second
quarter 2009 (Q2) economic data August 26 showing a better than
expected year-on-year quarterly GDP contraction of just 3.9 percent.
GOM policy responses since November 2008 to the financial crisis
including cutting reserve interest rates from 3.5 percent to 2.0
percent, reducing bank capital requirements, implementing two fiscal
stimulus packages, liberalizing investment in some service sectors,
and relaxing discriminatory Bumiputra investment laws have helped to
stabilize the economy. Leading local economists project that the
Malaysian economy is currently at the bottom and will return to
growth before the end of the year. Those same economists, however,
remain concerned with the potential future inflationary effects from
growing GOM budget deficits, though inflation is low and there
appears to be strong local demand at present for GOM securities.
The GOM's real worry is the potential impact on GDP growth of
dramatically reduced FDI flows and lower levels of domestic
investment. We therefore anticipate more GOM reform initiatives
targeted at stimulating FDI in the coming year, such as additional
liberalization of the services sector. END SUMMARY and COMMENT.

Q2 GDP Results not as Weak as Expected
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2. (SBU) Bank Negara released Q2 economic data August 26, announcing
a Q2 GDP year-on-year contraction of 3.9 percent. This was far
better than the 6.2 percent decline Q1 2009 GDP and led BN to
project a cumulative 5 percent decrease in GDP for 2009. In
meetings with Econoff, leading Malaysian economists and bankers have
expressed a similar view that the worst of the economic crisis is
behind Malaysia and that the economy is now at the bottom of the
cycle. Rating Agency of Malaysia Chief Economist Dr. Yeah Kim Leng
forecasts GDP growth to be zero or slightly negative in the third
quarter 2009 and to increase to slight positive growth in the fourth
quarter. Yeah predicted positive 2010 GDP growth of 2-3 percent but
noted it would be well below pre-financial crisis levels. Malaysian
Deposit Insurance Corp. (PIDM) Senior Economist Kevin Chew added
that he expected GDP growth to begin to show improvement in Q3 and
Q4, leaving Malaysia with a cumulative decline of 4.5 percent for
the year. Chew also expects subpar growth in 2010. Malaysian
Institute of Economic Research (MIER) Executive Director Dr. Mohamed
Arif forecasts somewhat better cumulative results for 2009 at a 4.2
percent GDP decline, weak but steady growth for 2010 and 2011, with
a return to pre-crisis growth levels in 2012.

Rising Unemployment Predictions Manageable
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3. (SBU) Malaysia began the financial crisis one year ago at
essentially full employment with a 3.3 percent unemployment rate.
As of June 2009, official unemployment reached 4.0 percent but is
not raising concerns for policymakers because consumption has
remained strong. MIER's Arif projected official unemployment will
peak in mid-2010 at 4.5 percent to 4.8 percent but he does not view
this level as a major cause for concern. The 1.2 million legal
foreign national guest workers in Malaysia, apparently took the
brunt of lay-offs as export-driven manufacturers cut 7 percent of
their pre-crisis workforces, according to Arif. Arif added that many
of those job losses do not appear in official statistics, which only
include Malaysian nationals.

Exports and Imports Rebounding
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4. (SBU) Malaysian exports continued their poor performance in Q2
2009 declining nearly 30 percent from the previous year and 0.7
percent from the previous quarter. However, export performance in
June was an improvement over April and May. Citibank Malaysia CEO
Sanjeev Nanavati told us that Citi's exporter customers are seeing
rapid improvements in orders and deliveries and he expects a much
improved export performance in Q3. Because Malaysian imports have
declined at the same pace as exports, there has been no pressure on
the balance of payment accounts and GOM reserves improved to 91
billion dollars, a substantial 9 months of import coverage.

Inflation Plummets in Q2 Spiking Real Interest Rates
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5. (SBU) Arif noted a steep drop in inflation in June caused a spike
in real interest rates, removing the incentives to borrow and
potentially derailing the stimulus effects of lower reference
interest rates. The core CPI fell from 2.2 percent inflation in May
to 1.8 percent year-on-year disinflation in June. As a result, real
interest rates increased from slightly negative to nearly 4 percent,
tightening monetary policy in real terms. BN reported disinflation
also occurred in July and their Capital Markets Committee announced
August 25 no change to the BN reference interest rate at 2.0
percent. BN cited substantial improvements in both Malaysian
business confidence and consumer confidence indexes in support of
its view that disinflation will not last long.


6. (SBU) Causes of the disinflation could include lag effects from
the decrease in manufacturing activity and continuing reductions in
Malaysia's money supply growth. M1, M2, and M3 money supply
indicators are growing at significantly lower rates than prior to
the crisis and BN announced that M3 grew during Q2 at a lower rate
than during Q1. When asked about restricting monetary growth in the
midst of a financial crisis, BN monetary policy officials responded
that it is normal for BN to remove excess liquidity in the system
during economic slowdowns.

Banks Stable and Well-Capitalized
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7. (SBU) The Malaysian banking system appears solid and ready to
lend, according to PIDM Senior Economist Chew. Banks have better
capital adequacy and non-performing loan levels are down since the
beginning of the crisis and were profitable in Q2. Credit approvals
and loan disbursements started to grow again in Q2 and Chew
anticipated single digit credit growth for all of 2009. Nanavati
added that Citi's portfolio is strong and its commercial and
consumer customers initially used cash balances to pay down debt but
have recently started borrowing again as economic conditions have
improved.

Fiscal Deficit Possible Looming Problem
--------------


8. (SBU) The MOF officially projects Malaysia's 2009 fiscal deficit
at 7.6 percent of GDP. Arif and Yeah project a higher 2009 deficit,
in the 8 percent to 8.5 percent range, and a 2010 deficit in the 9
percent to 10 percent range or higher unless the GOM substantially
reduces subsidies or increases taxes, both politically difficult
options. The economists expressed concern that the high deficits
will eventually be inflationary and weaken the Malaysian currency.
Nanavati, however, asserted that there was great local demand for
GOM debt and that the government will have no trouble funding its
deficits. In support of his view, he cited a recent Citibank-led 4
billion dollar Petronas bond issue which was four times
oversubscribed. Nanavati noted that Malaysia had plenty of
investable capital with a 40 percent savings rate and Malaysians
prefer investing in safe GOM securities.

Fall in Foreign and Domestic Investment Causing Real Concern
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9. (SBU) While there are mixed views on the growing fiscal deficit,
Malaysian policymakers are deeply concerned about the precipitous
fall in both foreign and domestic investment in 2009. MIER
statistics show FDI approvals are down 76 percent to 1.2 billion
dollars for the first five months of 2009 compared to 5.1 billion
dollars during the same period in 2008. Domestic investment
declined 42.7 percent to 1.4 billion dollars from January to May

2009. Actual foreign investment flows during the first six months
of 2009 are 90 percent below the first six months of 2008, according
to MIER. GOM investment officials fear that once the recovery takes
hold, foreign investors will bypass Malaysia in favor of lower cost
options in China or Vietnam. They expressed hope the recent
investment liberalization measures would bring new investment, but
have not yet seen any significant new investments since the
announcement.

KEITH