Malaysia Strategy:Economic Report 2016/17,highlights

Highlights from MOF’s Economic Report 2016/17, released in conjunction withBudget 2017 (Budget 2017: a (very) broad audience), appear to forewarn onpotential macro slippage re government debt and GDP growth. Coupled withfiscal short-termism favouring operating over development expenditure and abarely positive current account, the governments’ window for holding the nextgeneral elections (GE14) ahead of the potential crystallisation of economicallydisruptive macro risks appears to be narrowing. As flagged in our July 2H16strategy outlook (Snap election driver), we reiterate expectation GE14 will becalled into 2Q17. We anticipate GLC restructuring / GLIC activism momentumin the run-up (GLIC activism will hasten GLC reboot) to support equity marketupside. Our top GLC picks are Tenaga, Telekom, Maybank, CIMB and SimeDarby, with mid-caps of interest including MyEG, MRCB, Felda and DRB.

Debt/GDP really 49%? Sustained deficit spending means a Jan 2016 transferof liabilities to the Public Sector Home Financing Board (LPPSA), which paredheadline debt/GDP ratio by 1.8ppts (see fig 1), is only short-term relief. It wasclarified various legislations (Acts 637 and 275) set the debt ceiling at 55% but“debt” is defined as outstanding MGS, MGII and MITB only; hence, such debttotalled 48.5% of GDP at end-June 2016, c.5ppts lower than headline 53.2%.

Fiscal sustainability/BR1M: the relentless increase in the share of operatingexpenditure, from a total 52% in 2015 to a forecast record 60% in 2017, goingto the 1.6m-strong civil service (via emoluments and pensions) and to debtservicing, appears unsustainable and is at the price of capping more utilitariandevelopment spending. Annual BR1M cash transfers seem an economic andpolitical bargain by comparison, paid quarterly and with the RM6.8bn spendallocated for 2017 to benefit 7mn recipients (25% of the population; figs 3-4).

China drag risk: noting downside risk from largest trading partner China (fig5) transitioning to a “new normal” of slower growth as it moves away from anexport / investment-driven model to domestic services and consumption, theMOF cited an IMF study estimating every 1ppt decline in China’s GDP growthwould impact Malaysia’s GDP growth by 0.3ppts. Positively mitigating wouldbe Chinese FDI and funding support e.g. RM55bn soft loans for the ECRL.

Housing: underscoring the fact that affordable housing shortage is not due tolack of housing programmes (fig 6 – already have 7) but combination of weakexecution and poor affordability (fig 7), possibility of private sector developers,especially GLCs, with large landbanks being roped in to “help” appears high.

Current account (CA) stress: whilst GST has cushioned the fiscal impact ofthe plunge in energy prices, the CA is flirting with its first deficit since 1997(figs 8-9). A “twin deficits” reality would have multiple negative flow-throughsi.e. potential debt ratings downgrade, Ringgit slide and project deferments.