by RAM Holdings Bhd

The sustained uptrend of the Purchasing Managers Index in most industrialised countries (ex-Japan) in 1Q 2011 signals that global recovery is clearly underway.

The Japanese government has announced a ¥4 trillion (RM149 billion) stimulus package to resuscitate its economy following the devastating March earthquake in Japan that derailed the country's growth aspirations for 2011. The Bank of Japan has also announced further measures to help businesses financially debilitated by the disaster. Despite tentative steps towards global economic rejuvenation, structural issues have come to a stalemate (the American deficit situation) and, in some cases, even worsened (the Euro debt crisis). Although efforts are being made to resolve these issues, they pose a significant risk to global economic stability. However, we do not expect these developments to have a significant impact on the Malaysian economy because of the region's robust growth.

Inflation more evident on global scale
With the global economic recovery picking up momentum and more prospects of sustainable growth, the main concern now is that the recovery momentum could be halted or, at worst reversed by de-stabilizing inflationary pressures.

Upward price pressures have been prevalent in both the industrialised and emerging economies, as commodity prices have been elevated by supply concerns and geopolitical tensions. This is not to mention the start of fiscal consolidation that has led to heftier tax burdens on consumers, especially in the European Union.

In April, the European Central Bank acted on persistent inflation readings, lifting its key policy rate by 25 basis points (bps) to 1.25%. On the other hand, the American Federal Reserve signalled that it would leave rates unchanged and continue with the last stage of the second round of quantitative easing (QEII), launched towards the end of 2010.

Ringgit appreciation spurred by capital inflows and strong macroeconomic fundamentals
Notably, the Ringgit seems responsive to these announcements. Capital inflows had caused it to appreciate from RM2.99 to RM2.93 per US$, a new 13-year high in a matter of days. It has since settled at 3.03 (at the time of publication). However, we expect the Ringgit to appreciate further through the year, supported by Malaysia's macroeconomic fundamentals, a strong current account surplus and the favourable interest rate differential vis-à-vis the industrialised economies.

Output growth still moderately strong
On the domestic front, both employment and output trends have remained strong, with the unemployment rate registering 2.9% in March and a 5.0% expansion of the Industrial Production Index (IP"). Inflation is still rising at a moderate pace, with the headline rate reaching 3.0% in March and core inflation staying stable at 1.3% (unchanged from the previous month). In fact, producer prices appear to be increasing significantly, advancing at a more rapid rate and with much of this momentum stemming from domestic-sourced inputs. Looking ahead, we expect some feed-through effects on consumer prices in the months to come.

Resilient domestic consumption
Strong consumption trends have been observed, with an increase in purchases of consumer durables (passenger car sales surged 48.3% month-on-month in March). This was driven by the continued growth in household loans, which accelerated 18.9% in March – the fastest rate in the past two years. Based on all the factors cited, we believe that the recent OPR hike of 25 bps by Bank Negara Malaysia is a clear signal that it intends to nip inflation in the bud and is still concerned about rising indebtedness, as well as the level of excess liquidity in the economy. Yet, the banking system is still stable, with financial institutions' integral capital-adequacy ratios relatively unchanged from historical levels.

Export performance buoyed by robust commodity prices
Notably, trade performance came in better than anticipated with reference to the preliminary March figures. The value of both imports and exports grew a respective 12.1% and 7.8%. Notably, Exports to China jumped 19.4% year-on-year to RM7.98 billion, mainly comprising electrical and electronic components and crude rubber. Another noteworthy development is that exports to Japan rose to 13.9% year-on-year to RM6.6 billion in March, attributable to sustained demand for crude petroleum, LNG and palm oil.

Overall, Malaysia's economic growth seems well underway. The downside now would be shocks from adverse external factors.

Under the current scenario, we maintain our 5.2% GDP growth forecast for 1Q 2011.