CHART 1

CHART 2

CHART 3

Keynotes

• OPR was raised by 25 basis points in BNM's latest monetary statement, a surprise to many investors.
• The rate hike was underpinned by a stronger than expected economic recovery.
• Rate hike is expected to damper loan growth albeit in a mild manner.
• RM is expected to appreciate against USD which bodes well for the equity market, but might hurt exports temporarily.
• BNM demonstrates its commitment to ensure a sustainable economic recovery by controlling inflation expectations while interest rates remain accomodative. Equity market outlook remains optimistic.

Overnight Policy Rate’s (OPR) rate hike by 25 basis points to 2.25% in its latest monetary statement surprised many investors as market consensus only expected rate hikes in the second half of 2010. BNM’s decision to raise OPR was to ‘adjust the OPR towards normalising monetary conditions and preventing the risk of financial imbalances that could undermine the economic recovery process’. This will be the central bank’s first rate hike after 4 years, reversing the expansionary monetary policy where OPR was reduced from 3.5% to 2.00% from Nov 2008 to Feb 2009 to avert the economic downturn. It is interesting to note that KLCI outperformed other regional markets since the announcement of interest rate hike on 4th Mar 2010. KLCI was up 1.22% versus MSCI AxJ’s (MSCI Asia ex Japan Index) +1.12% on 5th Mar 2010 whereas on 8th Mar 2010, KLCI rose another 2.5% as opposed to MSCI AxJ’s +1.9% (in USD terms). It seemed the market interpreted the recent rate hike as an indication of more optimistic economic recovery ahead. This was not surprising given Malaysia’s strong turnaround in its economy in 4Q 09.

Stronger than expected turnaround in the economy

Malaysia economy moved out of recession in 4Q 09 by posting a better than expected y-o-y growth of 4.5%, bringing GDP growth of -1.7% y-o-y in 2009. This was much higher than market consensus of -2.4% y-o-y. The improvement was broad-based with most economic sectors showing positive growth except for mining sector. The better performance was mainly bolstered by manufacturing and services sectors which rose 5.3% y-o-y and 5.1% y-o-y respectively as manufacturing sector benefitted from improving external and domestic demand while services sector was alleviated by strong expansion in Finance & Insurance (+9.8%) and Wholesale & Retail Trade (+3.3%). Effects of stimulus measures also trickled down to construction activities which improved significantly by 9.2% y-o-y. On the demand side, we saw continuous improvement in public and private expenditure which increased 1.3% and 1.7% respectively while gross fixed capital formation turnaround to a positive 8.2% y-o-y after 4 consecutive quarters of decline backed by fiscal stimulus measures.

Going forward, we believe the recovery momentum is expected to maintain over the next few months, backed by strong rebound in exports and industrial production, followed by anticipated uptick in private expenditure and roll out of major construction projects. Based on MIER’s (Malaysia Institute of Economic Research) survey, BCI (Business Conditions Index) and CSI (Consumer Sentiments Index) continued to show improvement which was above the 100-point threshold for the third consecutive quarter, indicating recovery in private expenditure ahead which is expected to drive the economic growth in 2010.

Rate hike to damper loan growth, but mildly

There are concerns that interest rate hike will hamper loan growth as higher borrowing costs could render business activities or investments less attractive and drag down consumer credit. To recap, during the previous rate hike by 80 basis points from 2.7% to 3.5% during the period between Nov 05 and May 06, loan growth actually moderated from 9% in Nov 05 to 6% in Oct 06 (Refer to Chart 2). Nonetheless, we opine that the rate hike impact on loan growth will not be pronounced should there be a total of 50-75 basis point increase in OPR for the entire 2010, as OPR remains considerably low at 2.75% (if OPR rises another 50 basis points) as compared to the height of 3.5% in 2006-08. Furthermore, strong recovery in loans as evidenced by loan approvals which rose by 41.5% y-o-y in Jan 10 will also help cushion any drag to loan growth. Thus, loan growth for 2010 is expected to remain healthy at historical average of 7-8% y-o-y.

Appreciation of RM vs US

With BNM expected to hike rates in the months to come coupled with US Fed possibly retaining interest rates at low levels for an extended period of time, RM is expected to appreciate against USD owing to the increasing interest rate differential between Malaysia and US. This is further backed by Malaysian Government’s efforts to consolidate its fiscal position via cuts in operating expenditures, easing of subsidies and sale of government assets coupled with implementation of reform policies aimed at boosting FDIs (Foreign Direct Investments) and alleviating Malaysia’s economy. The appreciation of RM will also bode well for the local capital markets in anticipation of higher foreign funds inflow.

….but possible risk to exports

Having said that, the appreciation of RM against other Asian currencies might hurt exports as Malaysia is the first country to raise interest rates in Asia. Nonetheless, this would be temporary as Asian economies are expected to catch up with Malaysia in raising interest rates later this year.

Optimistic on Malaysia equity market

We view the recent rate hike as a sign of firmer economic recovery ahead which bode well for the equity market. The central bank’s decision to hike rates also demonstrated its commitment to ensure a sustainable economic recovery by controlling inflation expectations in the midst of firmer commodity prices, easing subsidies on price-controlled items and firmer domestic demand. Risks of asset bubble will remain a distant possibility as inflation remains benign. In addition, the local capital market could benefit from potential higher foreign funds inflow with the appreciation of RM. With more rate hikes in the pipeline, we are not too concerned over the negative impacts to the economy and equity market. The reason being the rate hikes are expected to be gradual while OPR which could reach 2.75% by 2010 remains accommodative as it is still considerably lower than the peak of 3.5% in 2006-2008.

Our recommended funds invested into Malaysia equity are as follow:
OSK-UOB Smart Treasure Fund
Prudential Equity Income
OSK-UOB Emerging Opportunity Unit Trust