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Multi-asset Malaysia – Economics, FX, Rates Malaysia’s budget Budget 2016 projects very conservative revenue and expenditure growth Nothing to rock the boat Fiscal deficit to narrow marginally to 3.1%, although we see risks of slippage We look at the implications for Economics, Rates, and FX Prime Minister Najib Razak has unveiled his government’s 2016 budget proposal; the first budget in a series of five under the 11th Malaysia Plan intended to transform Malaysia into a high-income advanced economy. Describing it as a budget for “Prospering the Rakyat” (or “Prospering the People”), PM Najib said this and future budgets aimed to strike a balance between the Capital Economy and People Economy. 24 October 2015 Su Sian Lim Economist The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch +65 6658 8783 [email protected] André de Silva Head of Global EM Rates Research The Hongkong and Shanghai Banking Corporation Limited +852 2822 2217 [email protected] Major initiatives include MYR5.9bn of cash handouts for low-income households, a hike in minimum wages, higher income tax rates for high-income earners and various investments across a number of industries. GDP is expected to slow to 4%-5% in 2016 from an estimated 4.5%-5.5% this year; the fiscal deficit is expected to narrow to 3.1% of GDP next year from 3.2% in 2015, just shy of the long-held 3% target. This multi-asset report looks at the budget from the perspective of economics, FX, and rates strategy. Joey Chew Asian FX Strategist The Hongkong and Shanghai Banking Corporation Limited +852 2996 6568 [email protected] Economics: We remain cautious on the fiscal outlook, and see risks of slippage from current official projections Prerana Seth Associate Bangalore Rates: We remain bearish on Malaysian government bonds View HSBC Global Research at: http://www.research.hsbc.com Issuer of report: The Hongkong and Shanghai Banking Corporation Limited Singapore Branch MICA (P) 073/06/2015 MICA (P) 136/02/2015 MICA (P) 041/01/2015 Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it FX: The budget is likely neutral for the MYR. But we believe it remains too early to position for a sustainable recovery in the currency. We expect USD-MYR to head higher, reaching 4.30 by end-2015 and 4.40 by end-2016 abc Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 Economics: Beware of slippage PM Najib has unveiled a 2016 budget deficit of 3.1% of GDP, just shy of the long-held government target of 3.0% We continue to see risks of fiscal slippage, forecasting a 3.2% gap on more conservative growth expectations Slower development expenditure in 2016 means less boost to growth; in terms of revenues, there is now a significant, but precarious, reliance on the Goods and Services Tax (GST) No 3% deficit in 2016 after all Unveiling his “Prospering the Rakyat” budget (translated as “Prospering the People”), PM Najib proposed a deficit of 3.1% of GDP for 2016 (MYR38.8bn), versus a projected 3.2% this year (MYR37.2bn). While this is not far off the government’s longheld deficit target of 3% of GDP, we were somewhat disappointed, considering that the target was supposed to have been met this year, but was postponed in January owing to the slump in global oil prices. Highly conservative revenue and expenditure projections… To be sure, both revenue and expenditure projections remained extremely conservative, as has been the case in the last few budgets. Revenues are projected to rise just 1.4% to MYR225.7bn, from a mere 0.8% rise this year. Meanwhile total expenditure is forecast to rise 2 1.7% to MYR265.2bn, following a 0.6% gain in 2015. In our view, it is likely that both revenues and expenditures will overshoot government projections, in both 2015 and 2016. Although the (real) economy is currently losing momentum, the last time revenue growth fell below 2% (to just 0.6%) was in 2010 – when the economy was just emerging from the aftermath of the Global Financial Crisis. Meanwhile, on the expenditure side spending last saw significant compression in 2013 (rising just 0.8%), when Malaysia’s sovereign credit ratings first began to come under pressure from rating agencies as the public debt-to-GDP ratio looked in danger of breaching the 55% statutory limit. By 2014, spending had risen 2.4%. Based on our expectations for nominal GDP growth to pick up in 2016, and the view that public spending – particularly on the operational side – will be challenging to curb, we think abc Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 revenue growth could rise to 4.9% this year and 6.6% in 2016 (from 3.4% in 2014), while expenditure could rise to 5.0% and 5.7%, respectively (from 2.4% in 2014). In net terms, however, our estimates still leave the overall budget deficit larger than what the government expects, at MYR39.5bn for 2015 and MYR39.6bn for 2016, or 3.4% and 3.2% of GDP, respectively. … but very optimistic macro assumptions Oddly enough, despite the government’s highly conservative revenue and expenditure projections, the underlying macroeconomic assumptions for 2016 appeared rather sanguine. Real GDP growth is projected to decelerate only a touch, from 4.55.5% this year to 4%-5% next year. While our growth projection of 4.6% for this year sits within the official forecast range, for 2016 we think real activity could slow to 3.6%. By industry, agricultural output is expected to remain unchanged at 1.3%, while mining/quarrying activity is forecast to accelerate to 4.0%, from a projected 3.5% this year. Manufacturing is expected to slow only a touch, to 4.3% for 4.5%. Construction is forecast to slow to 8.4% from 8.8%, while services growth is expected to moderate to 5.4% from 5.7%. On the expenditure side, the expectations are similarly moderate. Private consumption growth is pencilled in at 6.4% for 2016, versus 6.8% this year. The slowdown in private investment is expected to be a bit more material, at 6.7% versus 7.3% this year. Meanwhile, exports are predicted to bounce 0.9%, versus -0.8% in 2015, while imports are expected to accelerate to 1.5% from 0.8% this year. Little bang for the buck Risks are that Malaysia’s slowdown next year turns out to be more significant than what the government currently assumes. Amid the weakness and volatility in the Malaysia ringgit, rate cuts to prop up the economy are unlikely to be forthcoming from Bank Negara Malaysia (BNM). But today’s budget – quite predictably – also underscored the fact the government, too, is limited in what it can do to boost the economy via fiscal policy, as it remains constrained by fiscal and debt ratios. Following a 20% increase this year (the first increment in five years), development expenditure – the part of the budget where the boost to economic growth really comes from – is set to slow to a mere 5.4% in 2016, as the government slows the tap on economic and social services across the board. In fact, transport as well as education services will see cuts in spending, of 3.4% and 16.7%, respectively. This casts a bit of a shadow over infrastructure plans laid out by PM Najib, such as a MYR900m effort to reduce congestion in the capital city of Kuala Lumpur through a public-private partnership, MYR1.4bn to build and upgrade 700km of rural roads nationwide, and a continuation of negotiations with Singapore regarding a high-speed rail between the two countries. To be sure, a number of other LRT and MRT projects also appear to be on track and will start operating in various phases next year. However, the outlays for these projects would already have been made in prior years. Meanwhile, it remains to be seen if on the operational side the government can indeed stick to its projection for a modest 0.9% rise, following a 2.9% reduction this year. Although subsidy spending will remain fairly flat following reforms this year (-0.5% versus -34% in 2015), civil service salaries and pensions will rise a further 3 abc Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 2% (from 3.2% this year), while debt service charges will pick up to 9.3% from 7.9%. Revenues relying heavily on the GST With real activity set to slow in the absence of monetary easing, not much additional new fiscal stimulus, and oil likely remaining in a slump (the official assumption is that crude will average USD50/bbl over 2016, versus USD55 this year), where revenues are concerned the government now appears significantly more reliant on the GST. For 2016, GST collections are projected to surge to MYR39bn, from MYR27bn this year (the tax was introduced only in April). Interestingly, this MYR12bn jump – a sizeable 1% of GDP – almost offsets the projected decline in oil-related revenues. According to PM Najib, the contribution from state oil agency Petronas (including its dividend) and other oil-related activities will come to MYR31.7bn in 2016, from MYR44bn this year – a MYR12.3bn drop. Clearly, the GST has been a success in the context of fiscal reform, with collections this year having exceeded expectations (the original projection was MYR21.7bn). However, the downward pressure faced by oil-related revenues this year and the next means that the government has to lean all the more on the GST to pick up the slack. This is a potentially precarious dependency, considering that GST collections are also subject to the economic cycle. Furthermore, as part of its plans to ease the cost of living for Malaysians, in 2016 the government will increase the range of zerorated goods. The brands of medicine that will be zero-rated will be doubled to 8,630 from 4,215; various food items such as soybean-based milk and organic-based milk for infants and children, dhal, and mustard seeds will also be zero-rated. Others who will be able to receive GST relief include oil and gas companies or those in the 4 promotion, research, or exhibition industry that are re-importing certain types of equipment, as well as consumers purchasing prepaid mobile services. Other key takeaways As expected, an area that the budget attempted to address was the rising cost of living, which has been cited as the foremost concern among Malaysians. To that end, the government increased its cash handouts for low-income households (known as the 1Malaysia People’s Aid, or BR1M) to MYR1,000 from MYR900. Families with incomes between MYR3,001 and MYR4,000 will also receive higher handouts, with the BR1M assistance in total benefiting 4.7m households to the tune of MYR5.9bn. Minimum wages will also be raised from 1 July 2016, to MYR1,000 a month from MYR900 currently in Peninsula Malaysia, and to MYR920 in Sabah and Sarawak. For civil servants, the minimum starting salary will be raised to MYR1,200. Conversely, high-income earners will be taxed more. The taxable income band for the highest tax rate was increased to 26% from 25%, for those earning an income of between MYR600,000 and MYR1m. For those earning above MYR1m, the tax rate will increase to 28% from 25%. Some serious money will also be poured into various projects to boost investment, although we expect multiplier effects from these to be apparent only over the medium to long term. These include an MYR18bn allocation next year for the Refinery and Petrochemical Integrated Development Project (RAPID) Complex in Pengerang, Johor; the development of an airport township or KLIA Aeropolis over 1,300 acres, which is expected to attract an investment of MYR7bn; development of the Malaysian Vision Valley over 108,000 hectares between Nilai and Port Dickson as announced in the 11th Malaysia Plan, with an initial investment of MYR5bn next year; and abc Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 implementation of Cyber City Centre in Cyberjaya with a development cost of almost MYR11bn over a period of five years. hikes and the list of sizeable investment projects potentially seen as providing weakening domestic demand a much-needed boost. Meanwhile, sovereign wealth fund, Khazanah, will also be investing MYR6.7bn in nine “highimpact” domestic projects, in sectors such as healthcare, education, tourism, communication software, and infrastructure. But we have our doubts over how long any upturn in sentiment can last. Admittedly, cash hand-outs and wage hikes might provide some relief to households in the short term. But there currently exists a high level of precaution among consumers, particularly with regards to the labour market outlook – an area that the budget did not address. Consequently, it is difficult to see the hand-outs and wage hikes suddenly translating into sustainably stronger private consumption. Higher minimum wages will also be an additional burden on firms, many of whom are already grappling with excess capacity amid a fall-away in both external and domestic demand, as well as rising import costs (due to the ringgit’s weakness). Tourism clearly remained a key pillar of the economy, with PM Najib describing the sector as having “the highest potential to generate economic activities in the currency situation.” For 2016, the government targets 30.5m tourists, which is expected to contribute MYR103bn to the economy. For this, a sum of MYR1.2bn will be allocated to the Ministry of Tourism and Culture. Online visa applications will also be implemented beginning with China, India, Myanmar, Nepal, Sri Lanka, the US and Canada; by mid-2016, and EVisa will be implemented. To take advantage of the current level of the ringgit and in efforts to attract more tourists, the 100% income tax exemption on statutory income for tour operators will be extended from year of assessment 2016 until 2018. Agriculture – and in particular food production – also received a leg-up, with the Ministry of Agriculture and Agro-based industry receiving a MYR5.3bn allocation for 2016. This will go towards programmes on cultivation, research, agricultural infrastructure and food subsidies. Furthermore, more companies in the food production business will receive various tax deductions and exemptions for investing in subsidiaries, undertaking new food production, or undertaking project expansion. Meanwhile, from the fiscal angle this budget does not “rock the boat” in any sense, and does just enough to keep the ratings agencies at bay for now. A 3.1% budget deficit to GDP ratio is not great, but not terrible either – assuming the government does indeed manage to achieve a narrower gap of 3.2% this year as well. Nevertheless, as we have highlighted, there continues to be risk of fiscal slippage both for 2015 and 2016, given ongoing pressures on both revenues and expenditure. Potentially overly optimistic projections on items such as GST collections and low operating expenditure leave the government little room for error. In conclusion In the very near term, the budget may well provide a fillip to Malaysian markets, with factors such as the BR1M hand-outs, minimum wage 5 abc Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 Rates: Still bearish HSBC Rates Research stays bearish on government bonds as risks of overshooting the fiscal deficit target still remain Net bond supply is projected to rise; government bond curve is likely to steepen Stay paid 5yr MYR ND IRS due to the political uncertainty and prospect of further ringgit weakness HSBC Rates Research retains a bearish stance on Malaysia bonds as risks of overshooting the fiscal deficit target still remain given the reliance on tax revenues. Further, we note that there is a possibility that the Budget may not be passed in parliament due to domestic political developments (Malaysia Chronicle, 19 October). Continued political uncertainty and concerns over reserves adequacy are likely to linger, impacting the outlook for government bonds. Net bond supply to rise in 2016; curve likely to steepen Based on 2016 budget estimates, gross issuance is expected to slightly shrink to MYR87bn, down from the targeted issuance of MYR90.5bn in 2015. This is mainly due to lower bond redemptions in 2016. However, net bond supply is projected to rise from an estimated MYR37bn in 2015 to MYR39bn in 2016. The complete auction calendar for 2016 is not due until December 2015. Based on the maturity profile of the government bonds and the issuance trend seen over the past three years, the proportion of long-dated issuance (7yr and above maturity) is expected to rise 6 further in 2016, adding to a steepening bias of the MGS curve. There are five more auctions for the rest of 2015. The Ministry of Finance has raised MYR77bn via government bonds year to date. Fiscal revenues have improved this year and as such, the size of upcoming auctions could be smaller than average, resulting in a slightly lower-than-expected gross issuance of MYR90.5bn (versus our original estimate of MYR94bn) in 2015. The bias for short-dated bonds is likely to remain as three out of the five remaining bond auctions are for longer-dated tenor bonds. Foreign liquidation could continue due to currency weakness but it is unlikely to be as large as before as there are no bond redemptions scheduled in the last quarter of the year. The next MGS redemption is not due until July 2016. Onshore investors have also been providing decent support at the government bond auctions. This is evident from the average bid-to-cover ratios this year that are almost the same as last year and higher than in 2013. Based on the quarterly disclosure, the Employee Provident Fund's holdings of Malaysian government bonds Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 abc (Malaysian Government Securities and Government Investment Issue) jumped by MYR12.5bn in the first half of the 2015, taking their share of total government bond holdings from 22.3% in 2014 to 23.2% in June 2015. Stay paid MYR 5yr ND IRS Post FOMC, there has been a downward retracement in MYR swap rates, tracking the decline in EM rates. Given the potential for further ringgit weakness, this relief rally in MYR swap rates is unsustainable unless the central bank eases monetary policy. However, judging from the central bank’ activity in the money market, a rate cut does not seem likely at this juncture. After reducing the supply of short-dated instruments in the first seven months of the year, the BNM restarted issuing central bank bills from August. As a result, the overall outstanding of central bank bills (BNMNs) rose in September, for the first time since November 2014, by MYR7.5bn. This is likely done to sterilize the ringgit liquidity added via the central bank's foreign exchange intervention. Nonetheless, the decision to sterilise underscores a preference to keep domestic interest rates stable. Furthermore, the 3-month interbank rate has edged slightly higher from 3.69% on 21 August 2015 to 3.74% currently. Surprisingly, the central bank has not been issuing more longerdated reverse repos to reverse this upward movement. This is in contrast to their behaviour in the beginning of the year. We therefore believe that the BNM is comfortable with current ringgit liquidity conditions and is unlikely to pursue a more accommodative stance for the time being. As such, we maintain our preference to pay 5yr MYR NDIRS with a target of 5% due to the political uncertainty and prospect of further ringgit weakness. 7 abc Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 MYR: Still on probation The 2016 Budget is probably neutral for the MYR But it remains premature to position for a sustainable recovery in the currency The requisites for such a recovery have not yet been fulfilled The 2016 Budget is probably neutral for the MYR, in our view. Policymakers may have mitigated the fiscal impact of lower oil prices with timely subsidy cuts and rollout of GST earlier in the year, but these do not address the longer-term growth prospects in the resource-rich economy. There are also implementation risks in the budget and 11MP investment plans given rising political uncertainty, as reflected in the sharp widening of Malaysia's CDS spreads since July (Chart 1). The MYR has rebounded by 4% since 2 October, among the outperformers in EM FX. Equity inflows have resumed for the first time in many months amid a pick-up in global risk sentiment (Chart 2). Some investors are also now taking note of the regional outperformance by Malaysia's non-commodity exports, helped by MYR undervaluation (Chart 3). 8 But we believe it may be pre-mature to position for a sustainable recovery in this currency just yet. Three conditions are necessary for that: 1) an improvement in the commodity price outlook and global growth conditions; 2) a decline in political uncertainty; and 3) more normal liquidity and trading conditions in the onshore and offshore NDF markets (Chart 4; see MYR: Tough questions, 9 September 2015). Political concerns could also rise in the coming weeks – there are media reports of a potential no-confidence vote on the Prime Minister and/or this budget in Parliament (The Star, 22 October). 1. Political uncertainty has weighed on the MYR 2. The external backdrop has turned more positive Source: Bloomberg, HSBC Source: Bloomberg, HSBC abc Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 3. Malaysia's non-commodity exports are doing fine 4. MYR rebounds amid low trading volumes Source: CEIC, HSBC Source: Bloomberg, HSBC The turnaround in the MYR is unlikely to be decisive and significant at the initial stages, in any case. BNM is intent on rebuilding FX reserves when the opportunity arises again, which would be prudent, in our view. Our year-end forecasts for USD-MYR are 4.30 for 2015 and 4.40 for 2016. 9 Multi-asset Malaysia – Economics, FX, Rates 24 October 2015 abc Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Su Sian Lim, Andre de Silva and Joey Chew Important Disclosures This document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for the clients of HSBC and is not for publication to other persons, whether through the press or by other means. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other investment products mentioned in it and/or to participate in any trading strategy. Advice in this document is general and should not be construed as personal advice, given it has been prepared without taking account of the objectives, financial situation or needs of any particular investor. Accordingly, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to their objectives, financial situation and needs. If necessary, seek professional investment and tax advice. Certain investment products mentioned in this document may not be eligible for sale in some states or countries, and they may not be suitable for all types of investors. 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