Savage Inventory Cuts in Malaysia Lead to Q1 GDP Contraction

The Domestic Economy Gives Way

The first quarter GDP breakdown has confirmed IHS Global Insight's predictions in terms of influential shifts in growth patterns compared to the prior three months. Much of the slowdown in late-2008—when GDP barely scraped into positive territory with 0.1% year-on-year (y/y) growth during the fourth quarter—was related to the collapse in export demand. By contrast, the first-quarter data shows a favourable contribution to growth from net exports, but reveals a much-weakened domestic economy. In particular, private consumption growth turned negative in annual terms, albeit marginally at -0.7% y/y, marking a sharp contrast with the 5.3% y/y growth rate recorded in the fourth quarter of 2008, and the 11.3% y/y peak reached in the first quarter of 2008. This outturn came in a shade weaker than our forecast of a 0.6% expansion and is a notable development indeed: although the broad economy had temporarily registered negative growth during the high-tech bubble collapse in 2001, real private consumption has not seen outright contraction since the 1997 Asia crisis.

The current weakness reflects the full force of "second round" effects from the earlier collapse in export demand now feeding through the domestic economy. In late 2008, companies began shedding workers in an attempt to maintain profitability amid sliding export orders, but the adjustment has been lagging developments on the export front. This was partly due to regulatory restrictions (firms are required to give the government a one-month advance notification before any lay-offs can take place), and partly because the speed of the export collapse following the onset of the financial crisis last autumn simply took everyone by surprise. As a result, job losses accelerated greatly in the first quarter of 2009: total layoffs for the quarter, for instance, were almost as high as during the whole of 2008. In specific sectors, such as manufacturing, jobs lost in the first three months of 2009 exceeded those for the entire 2008. With the labour market adjustment process likely to continue for another couple of quarters, we forecast the first annual contraction in private consumption spending since the 1997 Asia crisis (-1.6%). The recovery in 2010 will probably be quite subdued, as there is less pent-up demand in the system after several years of very strong growth, even if the job market returns to normalcy. In addition, Malaysian households already have a higher indebtedness level than most others in Asia, so a strong debt-financed consumption boom over the medium term is less likely.

Inventory Cycle is Front and Centre

The big surprise in the first-quarter data was, without a doubt, the savage reduction in inventories. The extent to which this process intensified during the quarter was quite remarkable, especially since Malaysia had experienced inventory declines in each of the previous six quarters and was, arguably, "ahead of the game" on this front. Yet, during the first quarter, inventories declined at an astounding rate—three times more than in any other quarter since 2000, and by almost as much as during the prior six quarters combined. In short, the importance of the inventory cycle in the first-quarter data cannot be overstated. For illustration purposes only, consider this: had inventories declined by only half as much as they did, ceteris paribus, first-quarter GDP growth would have come in at -0.5% y/y instead of -6.2%. Had inventories declined by the same amount they did in the fourth quarter of 2008, first-quarter growth would have been a positive 4.4% y/y! But inventories did indeed fall by an incredible amount, detracting substantially from the first-quarter performance. Yet, consequently, inventories also hold the key to how the recovery phase will play out, at least in the next 12 months. Since almost everything that comes down must go back up at some point, the big question to consider going forward is how rapidly and how substantial the inventory-rebuilding process will turn out to be once the global economy and export demand begins to recover. Indeed, solely due to the impact of the inventory cycle, we may very well see a quarter or two of very high (high single-digit) growth in Malaysia in late 2009-early 2010.

Imports Plunge Along With Domestic Demand

Net trade actually helped matters during the first quarter, having detracted from growth in the fourth quarter. This positive contribution came entirely from the import side, as imports fell by 23.5% y/y in response to weak demand for consumption and intermediate goods. This was more than twice the contraction seen in the fourth quarter of 2008 (-10.2%). Exports continued to slump as well, contracting by 15.2% y/y, but this performance was not much different from the 13.3% y/y decline seen in the previous quarter. In fact, exports and investment were the two sub-sectors which turned in a better-than-expected performance in the quarter, relative to IHS Global Insight's earlier forecast (which had been for a 16% y/y contraction).

Fiscal Stimulus Yet to Kick In, Investment Still Down

Although the government had announced substantial fiscal stimulus measures to help the ailing economy, these have not been evident in the first-quarter data. In fact, real government-consumption growth stood at just 2.1% y/y during the first quarter, slowing abruptly from the 12.7% y/y rate recorded in the previous quarter, and 14.1% y/y seen a year earlier. This reflects the government's initially modest fiscal package, which was then sharply augmented. The stronger fiscal stimulus should become apparent in data for the second quarter, with momentum maintained through the rest of the year. On the investment front, activity remained weak, though the additional retrenchment that we had expected to occur during the quarter did not materialise. Fixed investment fell 10.8% y/y, marginally worse than that 10.2% rate in the fourth quarter of 2008, but, given the environment, a better than expected outturn.

Manufacturing Most Hurt on Production Side, But Weakness is Broadening

On the production side of GDP, manufacturing continued to bear the brunt of the recession, contracting by 17.6% y/y (compared to 8.8% contraction in the previous quarter). The weakness in private consumption which became apparent during the quarter was closely matched by a broadening of the slowdown into previously resilient sectors, such as services. Indeed, having expanded by 5.7% y/y as recently as the fourth quarter of 2008, services contracted marginally, by 0.1% y/y during the current quarter. Agricultural output also contracted sharply, by 4.3% y/y, erasing a modest gain in the previous three months. Mining and construction were the two sectors where activity held up better: mining activity contracted by 5.2% y/y and construction by -0.6% y/y (compared to contraction of 5.7% and 1.6% y/y respectively in the fourth quarter).

Outlook and Implications

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