Lee Heng Guie SERC
WITH the reopening of the economy and international borders amid transitioning into an endemic phase, robust domestic demand, especially private consumption and continued exports, have delivered an exceptional 8.9% year-on-year (y-o-y) real gross domestic product (GDP) in the second quarter of 2022 (2Q22) (5% in 1Q22).
On a monthly compilation, real GDP grew by 5.6% y-o-y in April, 5% y-o-y in May before expanding robustly by 16.5% y-o-y in June, largely boosted by a low base effect in June 2021 as a result of the implications of the movement control orders.
The extraordinary 2Q22 GDP growth marks the strongest pace of growth since 2Q10 (9%), taking the average GDP growth to 6.9% in the first half of 2022 (1H22).
This 2Q22 GDP number is a huge surprise considering the markets expected 7% growth. Following a much higher 2Q22 GDP, we have revised this year’s GDP estimate to 6.5% in 2022 from 5.2% previously. We maintain our real GDP growth forecast of 4.2% for 2023.
Looking behind the numbers, the recovery pace remains uneven among major economic sectors. Both services and manufacturing sectors have shown stronger-than-expected growth in 2Q22; the construction sector has rebounded but is still weak, while the mining and agriculture sectors declined.
The services sector has surpassed expectations to grow by 12.0% y-o-y in 2Q22 (6.5% in 1Q22), thanks to a revival in domestic demand and tourism-related activities. We expect the services sector will continue to underpin GDP but increasing prices and higher cost of living will dampen services demand in 2H22.
The manufacturing sector expanded by 9.2% in 2Q22 (6.6% in 1Q22), boosted by an unexpectedly strong surge of 14.5% y-o-y and 12.9% month-on-month in June. There was a substantial jump in the production of electronics and electrical products as well as transport equipment.
With the expected softening of global demand, the production and exports of electronics and electrical products are expected to grow at a moderate pace in 2H22.
It is a relief that the construction sector has finally turned around to grow by 2.4% in 2Q22 (6.2% fall in 1Q22) after being trapped in negative territory in 2021.
Nevertheless, the sector’s growth momentum will continue to be challenged by the shortage of workers and increased cost of building materials.
Consumers would be the deciding force in determining whether the turbocharged 2Q22 GDP growth can be sustained in the quarters ahead.
The drivers for robust private consumption growth in 2Q22 (18.3% y-o-y vs 5.5% in 1Q22) are the release of pent-up consumer spending, supported by continued cash handouts; the fourth withdrawal of Employees Provident Fund or EPF money estimated at RM45bil; and also higher demand during the Hari Raya Aidilfitri festive celebration. Additionally, there has also been a revival in domestic tourism.
As consumer spending accounts for 58.8% of the economy, we have been closely watching for signs of a cooldown. Will robust consumer spending growth continue unabated in 2H22 and in 2023?
Going into 2H22 and in 2023, we remain wary about the strength of consumer spending on rising inflation, higher cost of living and the tapering effect of consumption and cash flow assistance measures such as the ending of targeted loan repayment assistance and resumption of the EPF employees’ contribution rate starting July 2022.
While consumers keep spending, the price increases and higher cost of living are weighing on them and could soon lead to a change in behaviour.
Some consumers have locked-in purchase of cars in June 2022 due to the expiry of the sales and service tax exemption; and have front-loaded purchases of items in anticipation of higher price increases ahead.
The mood of shoppers is expected to remain cautious due to rising prices as consumers tighten purse strings on consumer durables and big-ticket items.
The Consumer Sentiment Index dipped far below the 100-point optimism threshold to a four-quarter low of 86 in 2Q22 on tight present and expected household finances amid a less inspiring employment outlook.
Essentially, Malaysians are having to spend more to buy the same amount of goods and services. Real consumer spending devalues as inflation increases.
Despite an increase in nominal wage growth in 2Q22 (private sector: 7.8%; manufacturing: 5.2% and services: 9.3%), the increase in prices have taken off the increase in wages; and higher expenditure incurred is also running well below the increase in income. As a result, many households are having to dip into savings or take on debt to fund their spending.
Bank Negara has been raising interest rates since May to 2.25% currently and will continue to increase further to keep a check on both headline and core inflation.
June’s inflation of 3.4% is expected to average higher in the months ahead. Higher interest rates will hit high leveraged borrowers amid improved interest income for net savers.
Private investment has gained higher growth traction in 2Q22 (6.3% y-o-y vs 0.4% in 1Q22), due to improvement in structures and continued expansion in machinery and equipment investment.
But, the headwinds remain: shortage of workers, increased costs, weakening ringgit and concerns about slowing global growth and recession risk in the US economy.
Businesses are expecting a cautious business and demand outlook in the months ahead. So far, many have experienced somewhat much slower sales but have not seen a sharp plunge in consumer spending.
In the external sector, exports are expected to grow at a more moderate pace of averaging 15.3% per annum in 2H22 from an average growth of 26.1% in 1H22. This reflected the impact of a weakening global economy as well as easing commodity and energy prices.
We concur with Bank Negara’s assessment of downside risks to the growth outlook. These include the deceleration in global growth’ and we are concerned about recession risks in the US economy and Europe, supply disruptions and further increases in energy and commodity prices and acute labour shortages.
We believe that policymakers need to watch consumption and business investment for signs of cyclical strength or weakness over the next six-to-12 months.
Lingering concerns about global and US economic prospects, softening demand, inflation and cost pressures would weigh on household consumption and business activity.
We believe that Bank Negara will take into consideration the impact of its gradual and measured pace of interest rate hiking trajectory due to growth risks, while keeping inflation under its radar.
Lee Heng Guie is executive director of the Socio Economic Research Centre. The views expressed here are the writer’s own.
