Tuesday, 7 December 2010

The Economist Intelligence Report on Malaysia December 2010


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Written by Administrator
Sunday, 05 December 2010 20:15

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Outlook for 2011-15

  • The ruling Barisan Nasional (BN) coalition is expected to maintain its hold on power in the coming five years, securing a victory at the next election.
  • The Economist Intelligence Unit expects the BN, which is controlled by its largest component party, the United Malays National Organisation (UMNO), to call an election in 2012, a year before its term ends, as is the tradition.
  • Fiscal policy will be tightened gradually during the forecast period (2011-15) as the government strives to balance its budget by 2020. Tighter monetary policy will also be applied as domestic demand strengthens.
  • The economy is expected to resume a sustainable growth path in 2011-15, following a mild recession in 2009 and a strong rebound in 2010. Real GDP growth will average 5% a year in 2011-15.
  • The annual rate of inflation is expected to average a subdued 3% in 2011-15. Government efforts to rationalise the country's extensive subsidy schemes will exert an upward influence on prices in the forecast period.
  • Despite the relatively fast pace of growth in merchandise imports compared with that in exports, Malaysia will continue to run substantial trade and current-account surpluses in 2011-15.

Outlook for 2011-15: Political stability

Political stability in Malaysia will come under moderate threat during the next five years as the Barisan Nasional (BN) coalition, which is controlled tightly by its largest component party, the United Malays National Organisation (UMNO), faces greater challenges to its grip on power. The March 2008 general election revealed that UMNO could no longer count on the strong support of the majority of Malays. However, the main opposition Pakatan Rakyat (PR) alliance will not be able to offer a sufficiently credible, stable alternative to the BN. Political intrigues within UMNO itself therefore constitute the biggest threat to political stability in Malaysia.

Since March 2008 the ability to make or break the BN has been in the hands of political parties from Sabah and Sarawak. BN legislators from the two states, which are located on the island of Borneo, number 52, thus making up over one-third of the BN's total of 137 members of parliament (MPs). The BN's Borneo power base is likely to be severely tested at the Sarawak state elections, which must be held by July 2011. Unresolved issues, such as illegal foreign immigration to Sabah, may cause the BN parties based in Borneo, or individual MPs, to defect to the opposition or to use the threat to do so to secure greater influence within the coalition in the run-up to the next general election. Moreover, the Borneo-based parties will become even more influential if MPs from the island retain their seats at the next election and a substantial number of BN legislators based in peninsular Malaysia lose theirs.

Although voters in the rural heartland of peninsular Malaysia continue to support UMNO, a significant number of better-educated, liberal middle-class Malays have deserted the ruling party in favour of the opposition. This shift in support away from UMNO could be further encouraged by the greater availability of uncensored information on Internet news sites and blogs. Given the Malaysian government's heavy censorship of the print media and broadcast services, the Internet will continue to be the main arena for the exposure of alleged government corruption and the political intrigues of individual MPs. Some conservative Malays have also voiced concerns over the government's plan to reform positive-discrimination policies that favour bumiputera (ethnic Malays and other indigenous peoples), believing that the special rights accorded to them in the constitution may be taken away. UMNO's forthcoming internal election for the party presidency, expected in late 2011 or early 2012, could be a source of instability, particularly if the party fails to secure a resounding victory in the state election in Sarawak. Under these circumstances there will be even greater resistance to economic reforms, undermining the credibility of the prime minister, Najib Razak, and even placing his position as the current president of UMNO—and hence his role as head of the government—at risk. The most likely contender to become UMNO's next leader is the deputy prime minister, Muhyiddin Yassin. UMNO tends to turn inward during leadership battles, ignoring the interests of other BN parties.

The leader of the PR, Anwar Ibrahim, a former deputy prime minister, is likely to be convicted on a charge of sodomy in the coming months. Mr Anwar claims that the case against him is politically motivated. Without him, the ties that hold together the disparate parties making up the PR—the reformist, multicultural Parti Keadilan Rakyat (PKR), the conservative, Islamist Parti Islam se-Malaysia (PAS) and the predominantly ethnic-Chinese, left-of-centre Democratic Action Party (DAP)—are likely to fray, while the process of choosing a new PR spokesman could deepen divisions within Mr Anwar's party, the PKR, and also between the coalition's members. Yet the likely sentencing of Mr Anwar to a prison term could also facilitate a realignment of the opposition and elements within the BN, thus offering an alternative to the current political groupings.

Outlook for 2011-15: Election watch

A general election has to be held every five years, and the next one must take place before April 2013. However, the Economist Intelligence Unit believes that a poll will be held sooner. Traditionally, the BN has preferred to call elections about a year before the end of its term of office, and this would appear to make early 2012 a likely date for the next election. Speculation about a snap poll in early 2011 has intensified following the BN's wins in two by-elections held in November 2010, and an election then could possibly give Mr Najib a stronger mandate to push ahead with difficult economic reforms. However, we still believe that Mr Najib will set a general election date after the Sarawak state election, which must be held by July 2011 and is the largest event on the political calendar before the next national poll. The results of the Sarawak election will provide a good indication of the level of public support for the government and its reform plans. Recent by-elections suggest that the electorate—and especially non-Malay voters—have become much more volatile. The results of the two by-elections in November point to a slight shift in non-Malay sentiment in favour of the BN, suggesting that the government's plans to reform policies that currently favour bumiputera has increased its appeal among ethnic minorities.

However, the most likely outcome of the next general election is that the BN will suffer a further loss of seats as younger, moderate Malay voters, disillusioned by political scandals and UMNO's strong promotion of Islamic values, decline to give their support to the ruling coalition. The PR will make gains, notwithstanding internal difficulties in the aftermath of Mr Anwar's likely removal from the political scene, but the opposition alliance is unlikely to garner enough parliamentary seats to be able to form a government.

Outlook for 2011-15: International relations

Under the leadership of the previous prime minister, Abdullah Badawi, and now that of Mr Najib, economic links with Singapore have become closer, and we expect economic ties to strengthen further in the next five years. There is no longer constant bickering over minor issues, although a degree of racially tinged wariness persists. Solutions to outstanding disagreements—especially over water supplied to Singapore by Malaysia—are likely to be reached in the forecast period (2011-15). China will become an increasingly important trading partner in the next five years. The Malaysian government's apprehensiveness about China's rise and growing economic influence is mixed with ambivalence towards ethnic Chinese among its own population and a need to attract investment. As Malaysia's economic dependence on China grows, uneasiness in Malaysia about Chinese power in South-east Asia is expected to increase.

Outlook for 2011-15: Policy trends

The policy agenda during the forecast period will be guided by a host of initiatives aimed at raising income levels and achieving the government's goal of turning Malaysia into a high-income nation by 2020. Under the Government Transformation Programme, the BN has outlined six "national key result areas", which include tackling corruption, improving education and upgrading basic rural infrastructure. In addition, a recently unveiled Economic Transformation Programme identifies eight strategic reform initiatives, including reinvigorating private investment, and 12 national key economic areas (NKEAs) that are to be prioritised. The government considers the NKEAs, which include tourism and palm oil cultivation, to be the sectors with the greatest potential to boost overall economic growth. The Tenth Malaysia Plan (10MP), a medium-term spending plan for 2011-15, will support the implementation of these programmes. Specific issues on the reform agenda for the next few years include the phasing out of price controls and subsidies, in a process that is widely considered to be necessary to create a competitive domestic economy. The government will also push ahead with changes to the bumiputera positive-discrimination policies. It has already relaxed a requirement that obliged companies to offer minority equity stakes to bumiputera. It hopes that further reforms will attract greater inflows of foreign direct investment, which it believes has the potential to be a major engine of growth in the next five years. However, the government is unlikely to dismantle affirmative-action policies altogether, for fear of alienating its Malay support base.

Outlook for 2011-15: Fiscal policy

The government will make only slow progress in bringing its budget close to balance during the next five years. In its budget plans for 2011 the government is targeting a deficit equivalent to 5.4% of GDP, which would represent only a small reduction compared with its estimate of a shortfall of 5.6% of GDP in 2010. We expect the government to be fairly successful in adhering to its budget plans for 2011, which feature an increase in spending of 2.8% compared with estimated total expenditure in 2010. Although it will rein in subsidies, the government will continue to spend heavily on supplies and services in 2011. Debt-servicing costs will also rise, and are expected to account for around 10% of total operating expenditure in 2011. The budget is forecast to remain in deficit in 2012-15. However, assuming that the government reduces operating expenditure and has some success in increasing revenue by expanding the tax base, the deficit will shrink to an average of 4.3% of GDP during that period. A widening of the tax base is expected to be achieved through the introduction of a goods and services tax (GST), although implementation of the tax is likely to be hampered by opposition from households and businesses. Further moves to alter the subsidy structure could also prove unpopular.

Outlook for 2011-15: Monetary policy

Bank Negara Malaysia (BNM, the central bank) is expected to continue to make incremental changes to its main interest rate, the overnight policy rate (OPR), during the early part of the forecast period as it proceeds with the normalisation of monetary policy. BNM has raised the OPR three times since March 2010, by a total of 75 basis points, bringing the rate up to 2.75%, after having cut it to a record low in response to the dramatic downturn in the Malaysian economy that occurred in 2009. However, the recent sharp appreciation of the local currency, the ringgit, and signs of slower economic growth suggest that further rises in official interest rates in the next few months are unlikely. BMN does not expect inflation to rise to problematic levels, believing that it will remain moderate in 2011 as strengthening domestic demand is accompanied by only a gradual acceleration in the rate of price increases. In 2011 we do not expect the OPR to exceed the high of 3.5% at which it stood in 2007 and much of 2008. But a quickening in the pace of domestic demand growth from 2012 will prompt BNM to raise the OPR above this level during the remainder of the forecast period to contain inflationary pressures.

The Malaysian economy is expected to move on to a more stable growth path in 2011-15, when we expect real GDP growth to average 5% a year. This will follow a period of instability, during which the economy contracted by 1.7% in 2009 amid the global economic downturn before rebounding to estimated growth of 6.8% in 2010. Data for the first half of 2010 show that the economy expanded by an average of 9.5% year on year during that period, but data for the third quarter point to a marked slowdown in the rate of GDP growth, and this trend is expected to continue in the fourth quarter. The strong economic recovery this year has largely reflected a new phase in the inventory cycle, as a dramatic drawdown of stocks in 2009 amid the global recession has been followed in 2010 by restocking. It has also been partly owing to the low year-earlier base of comparison. In 2011-15 private consumption and investment will remain the primary drivers of growth. The positive effect of restocking on real GDP growth in 2010 is expected to wane from 2011 as the process of stock accumulation moderates. Despite the government's efforts to consolidate its finances, public spending will continue to account for around 14% of GDP. Spending will be guided by the 10MP. Exports of goods and services are expected to grow by an average of 8.2% a year in 2011-15. However, the contribution of net exports to GDP growth will be marginal, owing to the fact that imports of goods and services will record similar growth.

In supply-side terms, the services sector will be the largest and most dynamic part of the economy, as the government channels more resources into the sector in its bid to ensure that Malaysia becomes a high-income nation by 2020. The industrial sector will continue to constitute a sizeable part of the economy, but we expect it to remain smaller than the services sector during the forecast period. Growth in the industrial sector will generally track the rate of expansion in the economy as a whole in 2011-15. The most dynamic services subsectors will be financial services, wholesale trade, and hotels and restaurants. Growth in financial services will be encouraged by gradual liberalisation. This will help to improve the international competitiveness of Malaysia's financial system, especially in Islamic-finance products, and will make it more responsive to the financing needs of both the private and public sectors. The contribution of agriculture, and especially palm oil production, to the overall economy will be important and will help to raise rural incomes and consumption during the forecast period.

Annual inflation will average 3.4% in 2011-15. Government efforts to rationalise the country's extensive subsidy scheme will exert an upward influence on prices in the forecast period. An inflationary risk will also be posed by the new GST, which the government will attempt to introduce in the early part of the period. But disinflationary influences will be strong. The removal of trade barriers and greater regional economic integration will help to maintain a low-inflation environment. As a nation that is heavily dependent on international trade, Malaysia will not be able to escape the effects of growing competition and import penetration, especially in the form of a wide range of consumer and producer goods from China. Another factor tending to slow inflation will be the forecast appreciation of the ringgit against the US dollar during the forecast period: as most imports and exports are denominated in US dollars, imports will consequently become cheaper.

Outlook for 2011-15: Exchange rates

The ringgit has strengthened markedly against the US dollar in recent weeks, rising to M$3.12:US$1 in mid-November, and we estimate that the currency will appreciate by nearly 10% on an annual average basis in 2010. The ringgit, like several other Asian currencies, has seen its value driven up in recent months, mainly by a surge in inflows of capital, although it is also being supported by large surpluses on the trade and current accounts. A positive interest-rate differential with the US will persist in the early part of the forecast period, continuing to provide support to the ringgit. We therefore expect the exchange rate to remain strong, reaching an annual average of M$2.95:US$1 in 2015. BNM has not come under heavy pressure to impose capital controls in order to contain the ringgit's appreciation, and the central bank will maintain its current exchange-rate regime, under which the ringgit is subject to a managed float against a trade-weighted basket of currencies. BNM will continue to stress that it does not actively maintain the ringgit at a particular level and intervenes only to minimise volatility and prevent misalignments. Offshore trading of the ringgit is prohibited under a rule that was imposed in the wake of the 1997-98 Asian financial crisis. However, further progress towards regional economic integration makes it likely that BNM will alter this policy in the latter part of the forecast period to allow the ringgit to be traded offshore.

Outlook for 2011-15: External sector

In the next five years Malaysia will continue to post large current-account surpluses, which will be equivalent to 12.4% of GDP on average. Growth in exports will be underpinned by recoveries in external demand and regional trade, as well as by higher global energy prices than in 2009. An improvement in external conditions is expected to boost demand for imports of the intermediate goods used in the manufacture of Malaysia's exports. Import growth will also be supported by firm domestic demand. However, as exports far exceed imports in absolute terms, the expected faster rate of growth in imports will not make a significant dent in the trade surplus. Malaysia will broaden its export range, but the economy will remain highly sensitive to the global electronic-goods cycle. Levels of non-manufactured exports, consisting largely of agricultural commodities (notably palm oil) and minerals (particularly crude petroleum and liquefied natural gas, or LNG), will also continue to be determined by global economic conditions. In addition, there will be a shift in the balance of export destinations and import suppliers in 2011-15. China will remain the fastest-growing economy in the Asia region, creating many opportunities for entrepreneurs in the Association of South-East Asian Nations (ASEAN) and especially for Malaysia's ethnic-Chinese minority. As a result, China is likely to overtake Singapore to become Malaysia's largest export market during the forecast period, while trade with the US, the EU and Japan will decline in relative importance.

The political scene: BN by-election wins increase speculation about a snap poll

Two by-election victories on November 4th marked a clear turning point for the ruling Barisan Nasional (BN) coalition and the prime minister, Najib Razak. For the first time since the March 2008 general election the government scored a convincing (and unexpectedly large) victory and regained a seat from the opposition Pakatan Rakyat (PR) alliance. The results ended a string of by-election defeats that had marred Mr Najib's premiership since he came to power in April 2009. Speculation has intensified that the prime minister could call a snap general election in the spring of 2011, two years ahead of the 2013 deadline.

The differences between the state assembly seat of Galas and the national parliamentary seat of Batu Sapi—the two seats for which the recent by-elections were held—made the BN's gains more significant. The Galas seat, in the state of Kelantan, fell vacant on the death of Che Hashim Sulaiman of Parti Islam se-Malaysia (PAS, which is part of the PR). Mr Che won the seat at the 2008 general election with a margin of 646 votes over his rival from the United Malays National Organisation (UMNO, the main constituent party of the BN). It is a largely rural seat that is in the throes of development, whose young population is mainly Malay (61.5%), with a sizeable Chinese minority (19.7%) and an unusually large share of native orang asli (17%). The PAS had hoped to hang on to the seat, relying on a small swing in the Chinese and orang asli votes. Kelantan state is regarded as a conservative Malay heartland; the state legislature has been governed by the PAS for nearly two decades. The BN chose a respected local politician, 73-year-old Razaleigh Hamzah, a former finance minister, to lead the by-election campaign. This appeared an odd choice, given that he has been openly critical of his own party, UMNO, on a number of occasions. However, Galas voters appear to have warmed to Mr Razaleigh's vocal defence of the state's oil royalty rights, and this helped the UMNO candidate, Abdul Aziz Yusoff, to secure a winning margin of 1,190 votes over the PAS candidate. The outcome of the by-election was particularly perturbing for the PAS, and for the PR more generally, as it showed a modest shift in the ethnic-Chinese and orang asli vote towards UMNO and a degree of apathy among young voters, a group who generally sympathise with the opposition. Chinese voters were said to have been attracted by Mr Najib's racially inclusive 1Malaysia programme, which emphasises national unity.

The contest for the parliamentary seat of Batu Sapi in the state of Sabah presented the PR with an even greater challenge, given that it was a three-way fight between the opposition alliance, the BN and the Sabah Progressive Party (SAPP), which was a junior member of the ruling coalition until 2008. Batu Sapi is a semi-rural constituency whose population includes a large number of immigrants from the Philippines and where many people vote by post. The BN chose to field Linda Tsen Thau Lin, the widow of the late Edmund Chong Ket Wah, the seat's previous holder. The PR, meanwhile, decided to select a candidate from the Parti Keadilan Rakyat (PKR), but PR members were divided between Ansari Abdullah, a member of the PKR's supreme council, and Ahmad Thamrin Jaini, the chief of the party's Sabah branch. The eventual choice of Mr Ansari proved ineffective. So too did the high-profile campaign run by SAPP based on the slogan "Sabah for the Sabahans". The combined votes for the PKR and SAPP fell well short of those polled by Ms Tsen, who won the seat by the wide margin of 6,359 votes, ahead of Mr Ansari.

The seats of Galas and Batu Sapi are the kinds of constituencies that the PR needs to win if it is to attain a parliamentary majority. The opposition alliance has its main support base in urban areas. It needs to make inroads in rural constituencies, but the results of the November by-elections make it clear that it is losing ground—a view that is confirmed by recent opinion polls and political blogs.

The political scene: The PKR's leadership elections reveal major divisions

Internal elections in the PKR, the party of the former deputy prime minister and current opposition leader, Anwar Ibrahim, have turned into an ordeal for the opposition. After the March 2008 general election the PKR was the largest of the three parties in the PR, but owing to defections it now has fewer members of parliament than its ally, the ethnic-Chinese-dominated Democratic Action Party (DAP), and just one more than the PAS. The PKR forms the core of PR; it has ambitions to replace UMNO in power, but as a multiracial party. The direct election of the PKR leadership by all the party's members was intended to be a demonstration to UMNO of democracy at work. Instead, the choice of a deputy president has sparked accusations of voter manipulation and has led to open quarrels between the candidates, as well as to questions about Mr Anwar's leadership.

In recent weeks Mr Anwar's preferred candidate for deputy president, his former private secretary, Azmin Ali, has clashed with Zaid Ibrahim, a regional PKR leader who was a minister in the administration led by the previous prime minister, Abdullah Badawi. Mr Zaid had played an important role in drafting and reconciling the PR's policy programme. However, he has recently complained about the intrigues and underhand tactics that he believes to have been used to prevent him from contesting the role of deputy president of the PKR, and has publicly expressed doubts about the way that Mr Anwar is running the party. He pulled out of leadership contest in early November and has since resigned from the PKR, hinting that he might set up his own party.

The opposition's troubles and Mr Najib's growing popular support present the prime minister with an opportunity to call an early general election. Mr Najib may also be encouraged by signs that ethnic-Indian and Chinese parties in the BN are slowly regaining some of their strength, and that ethnic minorities in the country are beginning to warm to his racially inclusive 1Malaysia programme. However, he may choose to wait until after the state election in Sarawak, which must be held by July 2011, to make up his mind about the timing of an early national poll.

Economic policy: The central bank leaves interest rates unchanged The monetary policy committee of Bank Negara Malaysia (BNM, the central bank) decided to leave its main interest rate, the overnight policy rate (OPR), unchanged at 2.75% when it met on November 12th. In its statement, the committee explained that it considered the OPR's current level consistent with prospects for economic growth and inflation, and said that monetary policy remained accommodative. It argued that although economic growth had moderated in the third quarter of 2010 it would continue to be supported by strong domestic demand, firm consumption and increased private capital spending. BNM expects inflation to be moderate going into 2011, despite rising global commodity and food prices. What stood out in the committee's statement was an emphasis on caution, vigilance and potential risks. It pointed out that international financial market conditions had become more volatile, and noted that increased capital flows to emerging markets had caused a shift in global liquidity that could threaten the macroeconomic and financial stability of emerging-market economies. The committee stated that domestic financial conditions remained orderly, but said that the potential risks from large, volatile capital flows would be watched with greater vigilance.

BNM has taken a fairly relaxed attitude to speculative capital flows compared with the authorities in Brazil and Taiwan, which have recently imposed capital controls. Other Asian economies, such as India, China and South Korea, already have effective controls in place. Little is left of Malaysia's capital restrictions, which were introduced during the 1997-98 Asian financial crisis, other than a ban on offshore trading of the ringgit. One reason for the more easygoing attitude in Malaysia is that the country has experienced lower inflows. This is shown by the underperformance of the Malaysian equity market compared with some of its regional competitors. The main stockmarket index in Malaysia, FTSE Bursa KLCI, has risen by 19.6% since January 2010, compared with a gain of 41.3% in the main Thai index, the Bangkok SET. At the same time, the upward trend of the ringgit has not been particularly worrying. The central bank governor, Zeti Akhtar Aziz, commented that Malaysia's foreign-exchange market conditions had been orderly, and added that BNM would intervene only if conditions became disorderly. She also pointed out that BNM measured the external value of the ringgit against a trade-weighted basket of currencies, rather than against the US dollar alone. In 2009 Asian economies were the destination of around 60% of Malaysian exports. Since the start of 2010 the ringgit has remained on a gradual upward trend against the Singapore dollar and the Japanese yen, but has appreciated by more than 10% against the US dollar.

The authorities may be reluctant to impose capital controls, given the very open nature of the Malaysian economy and the damage done to Malaysia's financial reputation under a former prime minister, Mahathir Mohamad, when his decision to introduce capital controls in the wake of the Asian crisis hit foreign investor sentiment hard. At that time the monetary authorities gave a notice period of just one month to firms and individuals to repatriate their ringgit from offshore accounts. Since the Asian crisis the importance of the financial industry to the Malaysian economy has grown considerably, and the sector accounted for 9% of GDP at factor cost in 2009. The government's long-term plans to transform the economy from middle-income to high-income status also rely heavily on rising inflows of foreign capital. Moreover, the imposition of capital controls could derail the prime minister's programme of financial deregulation and the sale of assets by the government and government-linked companies. International demand for these types of asset is very strong at present, as demonstrated by the success of an initial public offering (IPO) on November 12th of one-third of the shares in Petronas Chemicals, a subsidiary of the Malaysian state-owned oil company, Petronas. The heavily oversubscribed IPO raised US$4.1bn, almost double the amount that the local financial market had expected.

Economic policy: Mr Najib unveils details of ETP projects

On October 26th Mr Najib unveiled more details of nine "entry-point projects", which form part of a M$1.4trn (US$450bn) investment programme to be undertaken under the Economic Transformation Programme (ETP) in the next ten years. The programme has attracted a great deal of attention, including criticism, and not just from the opposition. Many of the infrastructure and property projects are not new, but they were all announced at the same time. It is in the government's interest to make the projects as attractive to the private sector as possible, in order to achieve the highly ambitious target of doubling private investment as a proportion of GDP in the next ten years; in 2009 such investment stood at under 10% of GDP. The opposition claims that some of the projects have already been announced without an open tender having taken place, while more than 200,000 members of the public have signed a petition against a proposal to build a 100-storey tower in the capital, Kuala Lumpur. There are also fears that the concentrated infrastructure spending that the programme will entail could lead to bottlenecks and long-term overcapacity in the property sector. Domestic critics have not been the only ones to complain about the lack of a reform agenda and absence of transparency and public scrutiny. Ominously, Malaysia's ranking in the 2010 Corruption Perceptions Index, compiled by a German-based graft watchdog, Transparency International, is unchanged at 56th, while the country's score has deteriorated to an all-time low of 4.4.

Economic performance: The pace of economic growth slows in the third quarter

The pace of economic growth has slowed. According to the Department of Statistics, real GDP grew by 5.3% year on year in the third quarter of 2010, compared with 8.9% in the second quarter. A sharp contraction in government expenditure, which fell by 10.2% year on year in July-September, together with a marked slowdown in exports of goods and services, exerted the largest drag on growth. The dramatic decline in public expenditure is partly attributable to unfavourable base effects. Government spending was high in the year-earlier period, as the authorities implemented a package of fiscal stimulus measures and continued to subsidise fuel and basic food items. The government announced a less expansionary budget for 2010, and is gradually withdrawing subsidies on fuel and sugar. As in previous quarters, economic growth in July-September was driven largely by solid gains in private consumption, which increased by 7.1% year on year against the backdrop of favourable labour market conditions and firm consumer confidence. Fixed investment, which accounts for around 20% of GDP, increased by 9.8% year on year in the third quarter, driven mostly by private-sector investment spending. The ongoing efforts of firms to build up stocks also made a large contribution to the overall growth rate.

On the supply side, all the main sectors of the economy except mining made positive contributions to GDP growth in the third quarter. Bolstered by an increase in production of rubber and crude palm oil, total agricultural output increased by 2.7% year on year in the period. Growth in the construction sector was supported by firm activity in the non-residential and civil engineering subsectors. Activity in the construction sector is expected to be underpinned by the nine entry-point projects under the ETP, which include a new hotel in Kuala Lumpur and five new biofuel plants. Output from the mining sector declined by 1.1% year on year in the third quarter, reflecting lower crude oil production. According to the Department of Statistics, output of crude oil and condensates has fallen in both of the past two quarters. Ageing oilfields are one factor behind the decline—a trend that is likely to persist in the short term.

Economic performance: Manufacturing companies are less optimistic

Business sentiment also deteriorated in the third quarter of 2010 compared with the second quarter, according to a local organisation, the Malaysian Institute for Economic Research (MIER). The MIER business conditions index fell by 14.7 points to 104.9 in July-September, but the fact that it remained above 100 indicated fairly optimistic sentiment. Manufacturing companies warned that production and new orders were significantly lower than in the previous quarter, and that they expected further falls in production and export sales. By contrast, the consumer sentiment index rose to a two-and-a-half year high of 115.8 in the third quarter as consumers expressed satisfaction with their incomes and optimism about their prospects for jobs and future earnings, and as they remained positive about spending and were less concerned than before about inflation.

Economic performance: Exports and imports continue to slow

The difference between the current health of the corporate sector and that of the household sector is also evident from the latest trade data. Growth in both exports and imports slowed further during September, although imports were less badly affected than exports, possibly because of relatively firm domestic demand. The value of merchandise exports increased by 6.9% year on year in September, compared with a gain of 10.6% in August. Imports were up by 14.7% on in September—a slightly slower pace of growth than the gain of 16.5% in August. The increase in September was attributable to a rise in imports of raw materials and industrial goods.

Economic performance: Inflationary pressures remain tame

There was a break in the trend of steadily rising inflation in September as the rate of increase in the consumer price index (CPI) slowed to 1.5% year on year, from 2.1% in August. Prices were unchanged month on month, following an earlier increase of 0.4% in August and rises in most of the preceding months in 2010 as the economic recovery became firmly established. The impact of high international commodity prices is being tempered by a strengthening of the ringgit against the US dollar. Prices for food and non-alcoholic beverages, the largest component of the CPI (accounting for 31.4% of the total index), were unchanged on a month-on-month basis in September but were up by 2.7% year on year. Non-food prices, meanwhile, were 1.3% higher than in the year-earlier period.