MALAYSIA: ECONOMIC & POLITICAL OULOOK 2013

AZRUL AZWAR AHMAD TAJUDIN CHIEF ECONOMIST

Strictly Private & Confidential

STILL LANGUISHING GLOBAL ACTIVITIES

65 60 55 50 45 40 35 30

GLOBAL PURCHASING MANAGERS' INDICES (PMI)

Composite PMI

Manufacturing PMI

Services PMI

Spots of deterioration in the global economy since 3Q2012 with heightened downside risks part of sluggish and bumpy recovery OR beginning of a more prolonged downturn? Global economic challenges:
o Short-term : Proactive response to shortrun slowdown o Medium-term: The global economy is operating in a world of high public debt and/or budget deficits in particular rising doubts over:
the viability of the Euro zone as weaknesses in the periphery appears to have spread to core economies capability of peripheral Euro countries to deliver the required fiscal and structural adjustments
3

Sources: JP Morgan & Markit, Bank Islam

30

Dec-12 Sep-12 Jun-12 Mar-12 Dec-11 Sep-11 Jun-11 Mar-11 Dec-10 Sep-10 Jun-10 Mar-10 Dec-09 Sep-09 Jun-09 Mar-09 Dec-08 Sep-08 Jun-08 Mar-08 Dec-07 Sep-07 Jun-07 Mar-07 Dec-06 Sep-06 Jun-06 Mar-06 Dec-05 Sep-05 Jun-05 Mar-05 Dec-04 Sep-04 Jun-04 Mar-04
OECD LEADING INDICATORS (12-MONTH ANNUALISED GROWTH)
25 20
15

10

Sep-12 May-12 Jan-12 Sep-11 May-11 Jan-11 Sep-10 May-10 Jan-10 Sep-09 May-09 Jan-09 Sep-08 May-08 Jan-08 Sep-07 May-07 Jan-07 Sep-06 May-06 Jan-06 Sep-05 May-05 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00 Sep-99 May-99 Jan-99 Sep-98 May-98 Jan-98 Sep-97 May-97 Jan-97 Sep-96 May-96 Jan-96
China India Brazil Russia Japan Euro US UK Total

-5

-10

-15

Sources: OECD, Bank Islam

LIMITED IMPROVEMENT TO GLOBAL TRADE

14 12
10

ANNUAL WORLD MERCHANDISE TRADE GROWTH

8 6 4 2 0

The World Trade Organisation (WTO) cut its global trade growth forecasts to 2.5% for 2012 from 3.7% and to 4.5% for 2013 from 5.6%:
o given heightened risks on the downside due largely to the prolonged Euro zone crisis, sub-trend US growth, Chinas slowdown (after expanding by 7.7% during the first 3Qs of 2012, official GDP growth targets of 7.5% in 2012 and 7.0%-7.5% in 2013) and Japans subdued growth o Improving trade growth outlook in developing economies given tentative signs of a pick-up in recent export performance could be limited mainly to Asian economies whose supply chain networks closely integrated with China and could only partially fill up the global slack

2017 F 2016 F 2015 F 2014 F 2013F 2012 F 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 1974 1973 1972 1971

-2
-4

-6 -8 -10 -12

Sources: IMF, Bank Islam

30.0

GLOBAL CHIP INDUSTRY

1.4

25.0

1.2

20.0

1.0

15.0

0.8

0.6 10.0 0.4 5.0

0.2

0.0

0.0

Sources: SIA, SEMI, Bank Islam

Sep-12 May-12 Jan-12 Sep-11 May-11 Jan-11 Sep-10 May-10 Jan-10 Sep-09 May-09 Jan-09 Sep-08 May-08 Jan-08 Sep-07 May-07 Jan-07 Sep-06 May-06 Jan-06 Sep-05 May-05 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00 Sep-99 May-99 Jan-99 Sep-98 May-98 Jan-98 Sep-97 May-97 Jan-97 Sep-96 May-96 Jan-96 Sep-95 May-95 Jan-95
Global Semiconductor Sales (US billion, LHS) US Book-to-Bill Ratio (RHS)

SLOW AND UNEVEN RECOVERY IN SIGHT

65 60 55 50 45 40 35 30

EU MANUFACTURING PURCHASING MANAGERS' INDICES (PMI)

Potential major causes disappointing global growth 2H2012 and 1H2013:

of in

Eurozone

Germany

France

Italy

UK

Sources: JP Morgan & Markit, Bank Islam

30

OECD LEADING INDICATORS (12-MONTH ANNUALISED GROWTH)

25

20

15

10

-5

-10

-15

China

India

Brazil

Russia

Japan

Euro

US

UK

Total

o No let-up in the intensity of the Euro zone sovereign debt crisis o Short-term contractionary effects on growth due to austerity measures and fiscal cutbacks worldwide especially in Europe in particular peripheral Euro zone, the US and UK and spillovers on developing countries o Weak financial institutions and inadequate policy responses in key advanced economies o Tail-off in Japans disaster reconstruction spending o Downshift in prospects for China, India and Brazil
5

Sources: OECD, Bank Islam

Nov-12 Sep-12 Jul-12 May-12 Mar-12 Jan-12 Nov-11 Sep-11 Jul-11 May-11 Mar-11 Jan-11 Nov-10 Sep-10 Jul-10 May-10 Mar-10 Jan-10 Nov-09 Sep-09 Jul-09 May-09 Mar-09 Jan-09 Nov-08 Sep-08 Jul-08 May-08 Mar-08 Jan-08 Nov-07 Sep-07 Jul-07 May-07 Mar-07 Jan-07 Nov-06 Sep-06 Jul-06 May-06 Mar-06
Sep-12 May-12 Jan-12 Sep-11 May-11 Jan-11 Sep-10 May-10 Jan-10 Sep-09 May-09 Jan-09 Sep-08 May-08 Jan-08 Sep-07 May-07 Jan-07 Sep-06 May-06 Jan-06 Sep-05 May-05 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00 Sep-99 May-99 Jan-99 Sep-98 May-98 Jan-98 Sep-97 May-97 Jan-97 Sep-96 May-96 Jan-96

SLOW AND UNEVEN RECOVERY IN SIGHT (continued)

o The 11th hour compromised deal only averted the immediate pain of the fiscal cliff, a harsh combination worth US$609 billion of harsh spending cuts (US$109 billion in defence and non-defence programmes) and sharp tax increases (US$500 billion) due to take effect 1 Jan 2013 BUT not all possible negative impact:
another potential political bickering and gridlock in the Congress as early as mid-Feb 2013 over the need to raise the US$16.4 trillion US Federal Govt debt ceiling as the Treasury Dept exhausts extraordinary measures taken since 31 Dec 2012 to finance about US$200 billion in deficits possible damage to fragile consumer and business confidence 2-month delay to automatic spending cuts or sequestration (US Govts belt-tightening to pare down deficits) but to finally take effect on 1 March 2013 US growth to slow especially in the 1H2013 but not grind to a halt

o Possibility of waning momentum in domestic demand in developing economies due to fiscal constraints (Malaysia), overheating concerns (Indonesia) and a host of other factors o Stalled E&E turnaround?
US SEMI book-to-bill ratio, a forward-looking indicator for the global chip industry remained below parity for the 6th month in a row in November 2012 to 0.79x after tentative signs of recovery with above the 1x-threshold for a short period of 4 consecutive months between Feb 2012 and May 2012. The World Semiconductor Trade Statistics (WSTS) forecast modest growth in global semiconductor sales in 2013 and 2014, by 4.5% and 5.2% to US$303 billion and US$319 6 billion respectively vs. a 3.2% decline in 2012 to US$290 billion .

SLOW AND UNEVEN RECOVERY IN SIGHT (continued)

QUARTERLY REAL OR CHAINED GDP GROWTH OF SELECTED BRIC & OECD COUNTRIES (YoY %)
15

10

1Q95 3Q95 1Q96 3Q96 1Q97 3Q97 1Q98 3Q98 1Q99 3Q99 1Q00 3Q00 1Q01 3Q01 1Q02 3Q02 1Q03 3Q03 1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12

On 9 October 2012, the IMF downgraded its global growth forecasts to 3.3% (from 3.5%) for 2012 and 3.6% (from 3.9%) for 2013 global slowdown to persist especially in the earlier part of 2013 on:
o Lacklustre US recovery o Flimsy turnaround from recession in the Euro zone and the UK o Stalled recovery in Japan o Sub-par growth in China, India and Brazil

-5

-10

US

UK

EU

Japan

China

India

Brazil

Sources: IMF, national authorities, Bank Islam

International Monetary Fund's Forecasts

Selected Economies World Output Advanced Economies * United States * Euro Zone * Japan * United Kingdom * Canada * Newly Industrialized Asia * Malaysia * China * India 2008 2.8 0.0 -0.3 0.4 -1.0 -1.1 0.7 1.8 4.8 9.6 6.2 2009 -0.6 -3.6 -3.5 -4.3 -5.5 -4.4 -2.8 -0.7 -1.6 9.2 6.6 2010 5.3 3.2 3.0 1.9 4.4 2.1 3.2 8.5 7.2 10.4 10.6 2011 3.9 1.6 1.7 1.5 -0.7 0.7 2.4 4.0 5.1 9.2 7.1 17-Apr-12 2012 F 2013 F 3.5 4.1 1.4 2.0 2.1 2.4 -0.3 0.9 2.0 1.7 0.8 2.0 2.1 2.2 3.4 4.2 4.4 4.7 8.2 8.8 6.9 7.3 16-Jul-12 2012 F 2013 F 3.5 3.9 1.4 1.9 2.0 2.3 -0.3 0.7 2.4 1.5 0.2 1.4 2.1 2.2 2.7 4.2 4.0 4.7 8.0 8.5 6.1 6.5 9-Oct-12 2012 F 2013 F 3.3 3.6 1.3 1.5 2.2 2.1 -0.4 0.2 2.2 1.2 -0.4 1.1 1.9 2.0 2.1 3.6 4.4 4.7 7.8 8.2 4.9 6.0

Asia will continue to power the global growth at a faster clip than the global economy despite risks of the Asian growth slowing to levels last seen during the 2009 global financial crisis.

Sources: IMF, Bank Islam

GRAVITY-DEFYING FIRST 3QS OF 2012

40.0

QUARTERLY DEMAND SIDE PERFORMANCE (% YoY)

30.0

20.0

10.0

0.0

-10.0

-20.0

Stronger-than-expected GDP showing in the first 3Qs of 2012 in particular the surprise 5.2% YoY pace in 3Q2012 and the upgrade in 2Q2012 reading to 5.6% YoY from 5.4% YoY. Key takeaways in 3Q2012:
o 3.0% YoY contraction in exports, the first decline on a quarterly basis since 3Q2009 after decelerating for 2 consecutive Qs (2Q2012:+2.1% YoY, 1Q2012:+2.8% YoY) external demand to remain a major drag on the Malaysian economy at least until 1H2013 o Very robust domestic demand, sustaining double-digit growth of 11.4% YoY (2Q2012:+14.0% YoY, 1Q2012:+10.0% YoY), led by both public and private sectors in particular:

1Q2006

2Q2006

3Q2006

4Q2006

1Q2007

2Q2007

3Q2007

4Q2007

1Q2008

2Q2008

3Q2008

4Q2008

1Q2009

2Q2009

3Q2009

4Q2009

1Q2010

2Q2010

3Q2010

4Q2010

1Q2011

2Q2011

3Q2011

4Q2011

1Q2012

2Q2012

3Q2012

-30.0 Overall GDP

Public Investment

Private Consumption
Exports

Public Consumption
Imports

Private Investment

Sources: BNM, Bank Islam

25.0

QUARTERLY SECTORAL PERFORMANCE (% YoY)

20.0 15.0 10.0

5.0

0.0

1Q2006

2Q2006

3Q2006

4Q2006

1Q2007

2Q2007

3Q2007

4Q2007

1Q2008

2Q2008

3Q2008

4Q2008

1Q2009

2Q2009

3Q2009

4Q2009

1Q2010

2Q2010

3Q2010

4Q2010

1Q2011

2Q2011

3Q2011

4Q2011

1Q2012

2Q2012

3Q2012

-5.0 -10.0 -15.0 -20.0

Overall GDP

Agriculture

Mining & Quarrying

Manufacturing

Construction

Services

Sources: BNM, Bank Islam

GRAVITY-DEFYING FIRST 3QS OF 2012 (continued)

YoY GROWTH (3-MONTH MOVING AVERAGE BASIS)
30.00

20.00

10.00

0.00

-10.00

-20.00

-30.00

IPI

Gross Exports

Sources: Department of Statistics, MATRADE, Bank Islam

130 120 110 100 90 80 70 60 50

MIER INDICATORS

22.7% YoY spike in GFCF (2Q2012:+26.1% YoY, 1Q2012:+16.1% YoY), supported by both domestic and foreign investments of which public investment was up by +22.4% YoY (2Q2012:+28.9% YoY, 1Q2012:+10.3% YoY) and private investment by +22.9% YoY (2Q2012:+24.6% YoY, 1Q2012:+19.8% YoY) 8.5% YoY jump in household spending (2Q2012:+8.8% YoY, 1Q2012: +7.4% YoY), lifted by Govt cash transfers and assistance benefits while public consumption was up by 2.3% YoY(2Q2012:+10.9% YoY, 1Q2012: +9.1% YoY)

Sources: MIER, Bank Islam

Oct-12 Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 Nov-11 Oct-11 Sep-11 Aug-11 Jul-11 Jun-11 May-11 Apr-11 Mar-11 Feb-11 Jan-11 Dec-10 Nov-10 Oct-10 Sep-10 Aug-10 Jul-10 Jun-10 May-10 Apr-10 Mar-10 Feb-10 Jan-10 Dec-09 Nov-09 Oct-09 Sep-09 Aug-09 Jul-09 Jun-09 May-09 Apr-09 Mar-09 Feb-09 Jan-09 Dec-08 Nov-08 Oct-08 Sep-08 Aug-08 Jul-08 Jun-08 May-08 Apr-08 Mar-08 Feb-08 Jan-08

1Q12 3Q11 1Q11 3Q10 1Q10 3Q09 1Q09 3Q08 1Q08 3Q07 1Q07 3Q06 1Q06 3Q05 1Q05 3Q04 1Q04 3Q03 1Q03 3Q02 1Q02 3Q01 1Q01 3Q00 1Q00 3Q99 1Q99 3Q98 1Q98
Consumer Sentiment Index Business Conditions Index

GRAVITY-DEFYING FIRST 3QS OF 2012 (continued)

o Growth moderation across almost all sectors:
Construction sector remained the major growth leader: +18.3% YoY (2Q2012:+22.2% YoY, 1Q2012: +15.5% YoY), led by the civil engineering sub-sector spanning across various industries/sub-sectors in particular roads/highways/bridges, transportation, utilities, oil & gas and services related as well as residential sub-sector Pick-up in services output growth to 7.0% YoY (2Q2012:+6.6% YoY, 1Q2012:+5.7% YoY), underpinned domestic-oriented activities Apparent slowdown in manufacturing activities, increasing by just 3.3% YoY (2Q2012:+5.6% YoY, 1Q2012:+4.4% YoY) on moderation in export-oriented and domestic-oriented industries Return to the positive territory for the agriculture sector despite a marginal 0.5% YoY growth (2Q2012:-4.7% YoY, 1Q2012:+2.1% YoY) thanks to a turnaround in CPO output Unexpected slump in mining activities with a 1.2% YoY drop (2Q2012:+2.3% YoY, 1Q2012:+0.3% YoY) as a result of lower natural gas production due to planned facility shutdowns

MALAYSIA: 2013, YEAR OF 2 HALVES?

YoY GROWTH RATES OF LEADING, COINCIDENT & LAGGING INDICATORS
12.00

7.00

2.00

-3.00

The progress of economic rebalancing and transformation, on a journey to become a developed, high-income nation by 2020 to gain traction. Pockets of weakness in the 1H2013 with
o erratic export performance given the still tentative global recovery o uncertainties related to GE13

Oct-12 Jul-12 Apr-12 Jan-12 Oct-11 Jul-11 Apr-11 Jan-11 Oct-10 Jul-10 Apr-10 Jan-10 Oct-09 Jul-09 Apr-09 Jan-09 Oct-08 Jul-08 Apr-08 Jan-08 Oct-07 Jul-07 Apr-07 Jan-07 Oct-06 Jul-06 Apr-06 Jan-06 Oct-05 Jul-05 Apr-05 Jan-05 Oct-04 Jul-04 Apr-04 Jan-04 Oct-03 Jul-03 Apr-03 Jan-03 Oct-02 Jul-02 Apr-02 Jan-02 Oct-01 Jul-01 Apr-01 Jan-01 Oct-00 Jul-00 Apr-00 Jan-00 Oct-99 Jul-99 Apr-99 Jan-99 Oct-98 Jul-98 Apr-98 Jan-98 Oct-97 Jul-97 Apr-97 Jan-97
Leading Index Coincident Index Lagging Index

-8.00

-13.00

Sources: Department of Statistics, MATRADE, Bank Islam

130 120 110 100 90 80 70 60 50

MIER INDICATORS

A pick-up in Malaysias growth momentum in 2H2013 with significant export recovery on the widely expected global turnaround thanks to:
o Clarity about resolution to the Euro zone crisis - resumption of recovery by mid2013 particularly for core countries and return to growth for all nations by 2014 o More conclusive signs of sustainable bottoming out in the US and China

Sources: MIER, Bank Islam

1Q12 3Q11 1Q11 3Q10 1Q10 3Q09 1Q09 3Q08 1Q08 3Q07 1Q07 3Q06 1Q06 3Q05 1Q05 3Q04 1Q04 3Q03 1Q03 3Q02 1Q02 3Q01 1Q01 3Q00 1Q00 3Q99 1Q99 3Q98 1Q98
Consumer Sentiment Index Business Conditions Index

PROSPECTS IN 2013
GROWTH (%) GDP (constant prices, 2000=100) Demand Side Final Consumption Expenditure * Private Consumption * Public Consumption Gross Fixed Capital Formation (GFCF) * Private Investment * Public Investment Domestic Demand Exports Imports Supply Side Agriculture, Fishing & Forestry Mining & Quarrying Manufacturing Construction Services 2008 2009 2010 2011 1H2012 2012 BI 2012 MoF 2013 BI 2013 MoF
4.8 8.4 8.7 6.9 2.4 0.1 5.2 6.6 1.6 2.3 3.8 -2.4 0.8 4.4 8.6 -1.5 1.4 0.6 4.9 -2.7 -7.4 2.9 0.3 -10.9 -12.7 0.05 -6.5 -9.0 6.2 2.9 7.2 5.8 6.6 2.9 10.4 15.5 5.0 7.0 11.3 15.6 2.4 -0.4 11.9 6.0 7.2 5.1 8.9 7.1 16.1 6.5 12.2 -0.3 8.2 4.2 6.2 5.9 -5.7 4.7 4.6 7.0 5.1 8.1 8.1 8.4 21.3 22.4 19.5 11.8 2.5 7.5 -1.5 1.3 5.0 18.9 5.8 5.1 7.8 8.0 7.2 19.9 19.7 20.1 11.1 1.4 6.5 -0.6 1.0 4.3 18.1 6.0 4.5-5.0 7.9 7.0 11.3 13.5 11.7 15.9 9.4 1.6 5.1 0.6 1.5 4.2 15.5 5.5 5.3 5.2 6.2 1.2 10.2 11.7 8.3 6.6 4.2 5.7 1.8 2.5 5.1 11.0 5.9 4.5-5.5 4.2 5.7 -1.2 9.3 13.3 4.2 5.6 2.8 3.6 2.4 2.7 4.9 11.2 5.6

Notwithstanding a multitude of uncertainties in the global economy and financial environment, the latest official GDP growth guidance of between 4.5%5.0% for 2012 and 4.5%-5.5% for 2013 seems reasonably realistic - In-house GDP growth forecasts of 5.1% for 2012 and 5.3% for 2013 respectively exceed or at the upper-end of official targeted ranges:
o Domestic demand (+11.8% YoY during the first 3Qs of 2012), proven so far to be more than adequate to withstand external headwinds and absorb external shocks, will continue to anchor growth on disposable income enhancement measures and other domestic demand supportive incentives under Budget 2013, particularly led by:
13

Sources: BNM, Economic Report 2012/2013, Bank Islam

PROSPECTS IN 2013 (continued)

investment revival, both private and public consumer spending notwithstanding expectations of public consumption slowdown given limited room for further fiscal stimulus

o Across-the-board expansion in all sectors in 2013 with construction, services and manufacturing sectors as growth leaders:
double-digit growth rates for construction activities, anticipated to persist in 2012 and 2013 with huge multiplier effects on the overall economy increase in services activities to sustain above 5.5% underpinned particularly by robust activities in financial, real estate, communications segments respectable manufacturing output growth, driven by both export-oriented and domesticoriented industries

14

PROSPECTS IN 2013 (continued)

Direct measures to further boost foreign and domestic direct investments (FDIs and DDIs), private or public sector led:
o RM3 billion allocation to accelerate the implementation of the Entry Point Projects (EPPs) under the 12 National Key Economic Areas (NKEAs) including the RM1 billion Domestic Investment Strategic Fund under the Malaysian Investment Development Authority (MIDA) announced in July 2012 to promote DDIs and accelerate the participation of Malaysian companies in the global supply chain while leveraging on outsourcing activities and acquisition of technology by Malaysian companies o RM6 billion allocation under the Private Finance Initiatives (PFI 2) to implement various projects such as refurbishment and maintenance of schools & health clinics, housing development, water tanks, flood mitigation plans and sport facility building to ensure the peoples well-being while spurring investment activities

15

PROSPECTS IN 2013 (continued)

Notwithstanding the marginal 0.6% YoY increase in exports during the first 3Qs of 2012 of which the 3Q2012 suffered a 3% contraction as evidence of the impact of global slowdown, the baseline scenario points to improving prospects towards 1H2013, paving the way for a commendable acceleration especially towards 2H2013 and in 2014 due to:
o Optimism from stimulus measures such as aggressive monetary easing and/or reflationary fiscal policy or other pro-growth macroeconomic policies already or will be undertaken by the worlds major economies, coordinated or otherwise
After spending US$2.3 trillion in QE1 and QE2, the US QE3 was announced in mid-Sep 2012, comprising a monthly programme to purchase mortgage-backed bonds worth US$40 billion until a sustained turnaround in the job market, most probably after the unemployment rate dips to way below 7% (although still above the desired 5%-6% range) while helping to nurse the housing market to recovery Chinas CNY1 trillion infrastructure stimulus package over 3 to 8 years to build subway lines, railways, roads, highways, ports, etc announced in early Sep 2012 Launch of the Outright Monetary Transactions (OMT) in September 2012 (but ready to activate from Day 1), the European Central Banks (ECB) new bond buying programme to calm financial markets and bring down sovereign bond spreads of troubled countries (with high borrowing costs) sterilised purchase of unlimited amounts of sovereign bonds of Euro zone countries that seek assistance and agree to fiscal adjustment programmes and sound economic policies

16

PROSPECTS IN 2013 (continued)

A 10-trillion yen extension, announced in Sep 2012 to Bank of Japans asset-buying programme amounting to 80 trillion yen in total 5 trillion yen on short-term bills by June 2013 and another 5 trillion yen on long-term bonds by end-Dec 2013

o Tentative signs of a shift in US household borrowing patterns in 2Q2012 and 3Q2012, indication of the beginning of an end to the long private sectors deleveraging process in particular households who may demonstrate greater willingness to loosen their purse strings despite muted income growth as debt has increasingly become less of a burden if corporate deleveraging subsides at the same time, then deleveraging will no longer be a big drag on the economy o Rather stable commodity prices in particular related to energy and food could to a certain extent cushion the downside risks to global growth although it may not be able to spur a meaningful economic recovery. Lower commodity prices:
help boost domestic demand to partially make up for sluggish exports thanks to improved capacity to spend with better consumers purchasing power and businesses balance sheets provide the scope for monetary policy support as central banks should be able to maintain or even lower interest rates if necessary come as a relief for Governments struggling to pay national subsidy bills
17

DOMESTIC AREAS OF VULNERABILITY?

Some domestic-driven risk factors that could potentially constrain growth potential in 2013:
o Delay in holding the 13th General Election (GE13) - negative for the economy given the inclination among both businesses and consumers to adopt a wait-and-see attitude, deferring their spending decisions as well as a potential burden on the Federal Govts finances if the ruling party continues dishing out more generous handouts o Delay in the full start-up of Malaysias Gumusut-Kakap deep-sea oilfield (2nd deepwater development after Kikeh field offshore Sabah) with a full production capacity of up to 135,000 bpd to the 2H2013 (instead of the 2H2012) due the longer-than-expected time needed to construct the floating production facility - protracted modest growth for the mining sector. However, its maiden production was made possible since Nov 2012 via an interim crude evacuation system (ICES) by tying back or linking its 2 wells to the existing Kikeh field and is expected to hit the maximum of 25,000 bpd. o Limitations of domestic demand after 4 straight quarters of beyond expectations concerns whether it has further leg to hold up and provide support to Malaysias economic growth if the global slowdown prolongs; sudden upturn in inflationary pressures especially from food and fuel prices; escalating household and Govt indebtedness which may require some macroeconomic policy tightening and pending potential policy shift in general in particular post-GE13
18

TAME INFLATION OUTLOOK

18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0

ANNUAL HEADLINE CPI GROWTH

Very subdued inflationary pressures as headline CPI growth in Nov 2012 remained stuck at 1.3% for 3 months in a row, the slowest pace since March 2010, reflecting:
o high base effects o price declines for communications; recreation services & culture and clothing & footwear o slowdown in price gains for food & nonalcoholic beverages; transport; alcoholic beverages & tobacco and housing, utilities & fuels

Sources: Department of Statistics, Bank Islam

20.0

2013 BI 2012 BI 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 1974 1973 1972

CPI vs. PPI (YoY Growth)

15.0

10.0

5.0

0.0

-5.0

-10.0

-15.0

Headline CPI

Headline PPI

Sources: Department of Statistics, Bank Islam

Continued easing in core inflation to below 1.0% YoY since July 2012 and negative PPI growth since June 2012, an indication of cooling price pressures or limited pass-through effects on the ground.
19

Nov-12 Sep-12 Jul-12 May-12 Mar-12 Jan-12 Nov-11 Sep-11 Jul-11 May-11 Mar-11 Jan-11 Nov-10 Sep-10 Jul-10 May-10 Mar-10 Jan-10 Nov-09 Sep-09 Jul-09 May-09 Mar-09 Jan-09 Nov-08 Sep-08 Jul-08 May-08 Mar-08 Jan-08 Nov-07 Sep-07 Jul-07 May-07 Mar-07 Jan-07 Nov-06 Sep-06 Jul-06 May-06 Mar-06 Jan-06

TAME INFLATION OUTLOOK (continued)

However, remain cautious of the upside risks to inflation emanating from both external and domestic factors such as:
o Sudden reversal in global commodity prices particularly related to energy, food and building materials surge in global surplus liquidity; rising risk premium of global oil prices due to heightened geopolitical concerns; supply chain disruptions due to natural catastrophes and adverse weather conditions due to climate change o Strict implementation of the PEMANDUs Subsidy Rationalisation Programme (SRP) removal or significant reduction to subsidies (price hikes and upward tariff reviews) that have shielded somewhat the impact of higher global commodity prices on selling prices of goods & services in Malaysia and their impact on the Malaysian economy o Sticky food inflation could bump up the overall CPI as the Food & Non-Alcoholic Beverages is the largest CPI component (30.3%) o Income effects from the implementation of minimum wage policy for some 3.2 million private sector workers and 7%-13% increments for some 1.4 million civil servants

20

TAME INFLATION OUTLOOK (continued)

Notwithstanding these upside risks to inflation and the relative strength in domestic demand, the current easing cycle in inflation should be able to sustain thanks to:
o Significant excess capacity in the economy that should help contain inflationary pressures despite robust domestic demand o Cost-push and demand-pull inflation dynamics have yet to show signs of a breakout in the absence of significant price pressures from labour market, credit expansion or supply bottlenecks o Moderate pressures from food and energy inflation as global commodity prices in particular agricultural commodities and oil & gas are expected to stay within acceptable/manageable ranges despite expectations of much improved global economic conditions in 2H2013 o Relatively well-anchored inflation expectations

Assuming no upward revision to retail prices of subsidised items in particular petrol and diesel and barring other unforeseen circumstances, CPI growth:
o may have hit bottom at 1.3% YoY in November 2012 o may gain some ground in December 2012 but still to average around 1.7% in 2012 (way below the BNMs targeted range of 2.0%-3.0%) vs. 3.2% in 2011 o should average below 2.5% in 2013 with a spike nearing the implicit tolerance levels of 3% in the 2H2013 on base-effect lapses, changes to administrative prices 21 by mid-2013 and an uptick in demand-pull inflation

OPR PAUSE TO CONTINUE WITH A SLIGHT UPSIDE RISK

ACTUAL AND FORECAST REAL SHORT-TERM INTEREST RATES
8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0
Apr-04 Jun-04 Aug-04 Oct-04 Dec-04 Feb-05 Apr-05 Jun-05 Aug-05 Oct-05 Dec-05 Feb-06 Apr-06 Jun-06 Aug-06 Oct-06 Dec-06 Feb-07 Apr-07 Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13

CPI

OPR

Real OPR

Sources: Department of Statistics, Bank Islam

25 20 15 10 5 0 -5 -10 -15
-20

YoY GROWTH OF SELECTED CPI COMPONENTS

-25 Headline CPI Food CPI Transport CPI Adjusted or Non-Food CPI Housing, Utilities & Fuel CPI

Sources: Bank Negara Malaysia, Bank Islam

The outlook for both growth and inflation should be carefully assessed to avoid over or under adjustment of monetary policy. While rather benign inflation outlook in 2013 provides the scope for OPR cuts or at least extended rate-pause, there is a minor tightening risk to OPR towards the later part of 2013 especially if growth turns out much stronger than expected, exerting a strain on inflation. Deemed accommodative and adequate to support domestic demand while preventing a build-up of financial imbalances, OPR should remain at normalised levels of 3% throughout 2013. Stable OPR outlook in 2013 while the earliest rate-hike delayed to 1H2014? 22

Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12

RATHER BULLISH MYR OUTLOOK

Although we can expect some volatility in the 1H2013, the general uptrend that MYR has experienced since August 2012 should persist for much of 2013 without being out-of-synch vis--vis its regional peers. Asian currencies should draw strength from:
o Capital inflows particularly portfolio funds in search of high-yielding assets. The Institute of International Finance (IIF) estimates that private flows into emerging markets to hit US$1.1 trillion in 2013 trillion (vs. US$1 trillion in 2012) of which 46.3% or US$0.51 to reach Asia. By default, Asian currencies should benefit since Asia vis--vis other regions:
is projected to be the worlds fastestgrowing region with the most reliable and exciting growth story has solid underlying fundamentals 23

MYR PERFORMANCE VS. USD & EUR

Sources: Bloomberg, Bank Islam

COMPARATIVE NORMALISED PERFORMANCE : MYR, SGD, KRW, TWD

Sources: Bloomberg, Bank Islam

RATHER BULLISH MYR OUTLOOK (continued)

o Boost to risk appetite for emerging currencies due to rosier economic prospects especially for Asian economies thanks to some form of stimulus measures to be or already undertaken by the worlds largest economies to stem the slowdown improving export outlook for tradedependent economies hence widening current account surpluses o Reduced safe-heaven appeal of USD due to QE3 in favour of other currencies with better economic growth potential and more favourable yield prospects such as Asian currencies
JPY

COMPARATIVE NORMALISED PERFORMANCE : MYR, CNY, THB, IDR

Sources: Bloomberg, Bank Islam

8.88 7.00

SPOT PERFORMANCE OF SELECTED ASIAN CURRENCIES VS. USD (%) -1 JAN 2012 TO DATE
7.64 5.68 4.50 4.33 3.82 1.20 0.20

2.00

KRW -3.00

PHP

SGD

TWD

MYR

THB

CNY

HKD

INR -2.76

IDR

-6.03 -8.00

-13.00

-12.17

Asian currencies may gain significant grounds towards year-end and hence, MYR may end at a RM2.97-3.02 range from RM3.052 as at end-2012.
24

Sources: Bloomberg, Bank Islam

25

GE13: D-DAY IS A GUESSING GAME

The Gap Period Between Two Consecutive Election Dates Polling Date Interval Period GE1: Wednesday, 19 August 1959 GE2: Saturday, 25 April 1964 4 years 8 months GE3: Saturday, 10 May 1969 5 years GE4: Saturday, 24 August 1974 5 years 3 months GE5: Saturday, 8 July 1978 3 years 10 months GE6: Thursday, 22 April 1982 3 years 9 months GE7: Sunday, 3 August 1986 4 years 3 months GE8: Sunday, 21 October 1990 4 years 3 months GE9: Tuesday, 25 April 1995 4 years 6 months GE10: Monday, 29 November 1999 4 years 7 months GE11: Sunday, 21 March 2004 4 years 4 months GE12: Saturday, 8 March 2008 3 years 11 months GE13: March 2013? 5 years?

Sources: Election Commission, Bank Islam

The constitutional Parliamentary term is valid from 29 April 2008, the date of the Parliaments first sitting after the 12th General Election (GE12). As such, the Parliament must be dissolved by 28 April 2013. From the dissolution date, the GE13 must be held within 60 days. Historically, Malaysia has never come close to the full term of 5 years except for the GE3 in 1969 and GE4 in 1974. Given deep changes in Malaysias political landscape since 8 March 2008, its difficult for the PM to arrive at a perfect time to dissolve the Parliament and to hold the GE13.

Sources: Election Commission, Bank Islam

26

GE13: FREE & FAIR ELECTION?

SEAT DISTRIBUTION AT HOUSE OF REPRESENTATIVES AND STATE LEGISLATIVE ASSEMBLIES Dewan Rakyat Dewan Undangan Negeri Perlis 3 15 Kedah 15 36 Penang 13 40 Perak 24 59 Selangor 22 56 Negeri Sembilan 8 36 Melaka 6 28 Johor 26 56 Pahang 14 42 Terengganu 8 32 Kelantan 14 45 Sarawak 31 71 Sabah 25 60 FT Kuala Lumpur 11 N/A FT Putrajaya 1 N/A FT Labuan 1 N/A TOTAL 222 576

As at 16 August 2012, explosion in the number of registered voters, crossing the 13 million mark to 13.05 million people and surging by 19.5%:
o compared to a very mild growth of ONLY between 6%-7% as at GE10, GE11 and GE12 o from just 10.92 million at GE12, equivalent to 2.13 million increase, the biggest in Malaysias history o out of whom 274,247 people or 2.1% are absent voters comprising armed forces, police and overseas voters Top 3 states with most absent voters are Federal Territory of KL (40,543 people), Perak (38,367) and Johor (25,058) while Selangor has the highest number of overseas voters with 579 people
27

Sources: Election Commission, Bank Islam

Year 1959 1964 1969 1974 1978 1982 1986 1990 1995 1999 2004 2008 2012* VOTER BASE No of Registered Voters Growth (in number) Growth (%) 2,171,097 2,763,077 591,980 27.27 3,843,782 1,080,705 39.11 4,132,032 288,250 7.50 5,059,689 927,657 22.45 6,081,628 1,021,939 20.20 6,964,960 883,332 14.52 7,968,640 1,003,680 14.41 9,012,173 1,043,533 13.10 9,564,071 551,898 6.12 10,284,591 720,520 7.53 10,922,139 637,548 6.20 13,052,374 2,130,235 19.50

Sources: Election Commission, Bank Islam

GE13: FREE & FAIR ELECTION? (continued)

Although there are still about 3.2 million unregistered eligible voters (out of 16.3 million eligible voters), concerns whether this phenomenon of sharp increases in voter registry really reflects increased voter awareness, growing political interest and voter registration efforts by political parties rising pressures on the Election Commission (EC) to:
o o speed up the clean-up of the electoral roll from dubious entries address the 8 demands by BERSIH especially related to free and fair electoral system and election process

28

GE13: CHALLENGES OF PREDICTING

The unprecedented Oppositions victory on 8 March 2008 at the GE12 and continued close cooperation of Opposition parties even post-GE 12 until the establishment of Pakatan Rakyat (PR), the first cohesive, credible and viable alternative coalition in Malaysia since Independence to challenge BN has fundamentally transformed expectations of what could be the outcome of future elections. As no two GEs can provide almost exactly the same reading and in view of the surprise GE12 results, predicting the outcome of the GE13 could prove very challenging and a highly speculative attempt. However, we will focus only on the outcome for Parliamentary seats since that will determine the composition of the Federal Government. While acknowledging that economists are in no way political analysts, we will try to predict the outcome of GE13 and look for clues by:
o Analysing:
current voter profile (age groups, gender, ethnic groups, urban-rural, income brackets, etc), etc past voting trends in all GEs in particular GE12

29

GE13: CHALLENGES OF PREDICTING (continued)

results of all 16 by-elections where both BN and PR secured an equal share of 8 seats of which the final 5 by-elections were captured by BN with bigger majorities compared to GE12 (Kerdau in Pahang, Merlimau in Melaka, Tenang in Johor, Galas in Kelantan and Batu Sapi in Sabah) results of Sarawak state elections in April 2011 where PR made major inroads (securing 16 state seats from 9 previously with 44.6% of popular votes vs. 38.2% previously) could provide indications of how fierce battles of GE13 will be and voting trends of Sarawakians and Sabahans

o Taking stock of the feedback from our ground visits to selected areas nationwide to gauge the underlying voter sentiment o Identifying election issues, local or national that could affect voters decisions o Assessing possible voting patterns among wild card groups that could swing either way, namely:
newly registered voters young voters urban voters voters in Sabah and Sarawak (with 56 Parliamentary seats) voters in Felda constituencies (54 Parliamentary seats) 17 marginal seats where the winning majority was less than 1,000 votes at GE12 (a swing of 500 votes in these constituencies may sway the election results either way)
30

GE13: GREATER POLITICAL TSUNAMI

Based on the analysis of selected factors that we think could affect the election outcome, we have outlined 3 possible scenarios:
o Scenario with moderate probability or best-case scenario: Narrow win for BN, securing 112-122 Parliamentary seats (narrow loss for PR: 100-110)
Failure to retake Kedah, Penang, Selangor and Kelantan Lose control of Perak and Negri Sembilan

o Scenario with high probability or base-case scenario: Narrow loss for BN, securing only 97-107 Parliamentary seats (narrow victory for PR: 115-125)
Failure to retake Kedah, Penang, Selangor and Kelantan Lose control of Perak, Negri Sembilan, Terengganu and Perlis Narrowly retain Pahang and Johor Lose significant grounds in Melaka, Sabah and Sarawak

o Scenario with low probability or worst-case scenario: Big loss for BN, securing only 82-92 Parliamentary seats (big victory for PR: 130-140)
Failure to retake Kedah, Penang, Selangor and Kelantan Lose control of Perak, Negri Sembilan, Terengganu, Perlis and Pahang Narrowly retain Johor and Melaka Lose significant grounds in Sabah and Sarawak
31

GE13: GREATER POLITICAL TSUNAMI? (continued)

GE RESULTS FOR PARLIAMENTARY SEATS ALLIANCE/BN OPPOSITION TOTAL Year No. of Seats Won Change from % of Total Seats % of Popular Votes No of Seats Won Change from % of Total Seats % of Popular Votes No of Seats Registered Voters Voter Turnout Previous GE Previous GE (million) (%) 1959 74 71.2 51.7 30 28.9 48.3 104 2.17 73.3 1964 89 15 85.6 58.5 15 -15 14.4 41.5 104 2.76 78.9 1969 95 6 66 49.3 49 34 34.0 50.7 144 3.84 73.6 1974 135 40 87.7 60.7 19 -30 12.3 39.3 154 4.13 75.1 1978 130 -5 84.4 57.2 24 5 15.6 42.8 154 5.06 75.3 1982 132 2 85.7 60.5 22 -2 14.3 39.5 154 6.08 74.4 1986 148 16 83.6 57.3 29 7 16.4 42.7 177 6.96 70.0 1990 127 -21 70.6 53.4 53 24 29.5 46.6 180 7.97 72.6 1995 162 35 84.4 65.2 30 -23 15.6 34.8 192 9.01 71.4 1999 148 -14 76.6 56.3 45 15 23.3 43.5 193 9.60 71.1 2004 199 51 90.8 63.9 20 -25 9.2 36.1 219 10.28 73.5 2008 140 -59 63.1 50.4 82 62 36.9 49.6 222 10.92 76.0 2012? 97 to 107? (33) to (43)? 43.7 to 48.2 ? 115 to 125? 33 to 43? 51.8 to 56.3? ? 222 13,052,374* 75 to 80? * as last gazetted on 16 August 2012 out of whom 12,778,127 ordinary voters and 274,247 absent voters

Assumptions for the base-case scenario (no 2/3 majority but enough for PR to form the Federal Govt): o 2-cornered fights o 75%-80% in overall national voter turnout o Conservative but realistic voting tendency/share of votes for BN by ethnic breakdown: 55%-60% among Malays, 20%-25% among Chinese, 45%-50% among Indians and 60%-65% among Others o Electoral fraud cases such as phantom voters, vote rigging, ballot stuffing, etc 32 make up less than 5% of total voter turnout

GE13: GREATER POLITICAL TSUNAMI? (continued)

FBMKLCI PERFORMANCE PRE-AND-POST GENERAL ELECTIONS Number of days before or after GE -180 -90 -30 -7 -1 1 7 GE8 -9.1% -23.8% -6.0% 1.6% 1.6% 4.0% 4.9% GE9 -11.5% 12.0% 1.8% 1.3% -0.3% -1.7% -2.5% GE10 -0.5% -2.8% 0.4% 1.7% 1.0% -1.5% -2.6% GE11 22.7% 16.7% 5.0% 2.3% 0.3% 0.5% -1.0% GE12 0.4% -9.6% -8.4% -4.5% -0.3% -9.5% -7.8%
Sources: Bloomberg, Bank Islam

30 0.2% 6.6% 7.9% -4.8% -5.8%

90 2.2% 7.2% 34.4% -9.1% -3.7%

180 24.9% -1.6% 18.6% -5.0% -16.3%

We can expect negative, knee-jerk (over)reaction on the first day of trading of financial markets post-GE13 on fears over political instability, administrative uncertainties and policy inconsistency; short-term nervousness over power handover and transition; perceived up-tick in Malaysias political risk, among others:
o Sell-down in equity, bond and foreign exchange markets the circuit breaker could be triggered in Bursa Malaysia i.e. the KLCI is down by more than 10% in a trading session; sudden spike in bond yields and slide in MYR o Other factors mostly external such as emergence of more conclusive signs of resumption of a global recovery; improving global risk appetite, etc to significantly limit the downside 33

GE13: MID-AND-LONG TERM POSITIVE FOR MSIA

In the medium-to-long term, after this mild political revolution or the socalled Malaysian spring, the stiff competition for the hearts and minds of voters will make the PR-led Federal Government always disposed to prove that it can strike the balancing act between meeting the aspirations of the people and the needs of the business/investing community i.e. conducive environment for both the people and businesses not at the expense of the other within a short period of time by implementing recommended measures in Buku Jingga. Success stories of PR states in particular Selangor and Penang and thumbs-up from the Auditor-General in his annual report should be a clear indication whats in store with a PR Federal Government. Malaysia may even emerge as an even more attractive and viable investment destination as proven by the capability of Penang and Selangor, 2 PR-held states in luring the most approved manufacturing investments in 2010 and 2011. Faster reduction in budget deficits and public debt levels as proposed in the PR Alternative Budget 2013 compared to the BN Govt?
34

GE13: MID-AND-LONG TERM POSITIVE FOR MSIA (continued)

Given the anticipated narrow PR win, the presence of relatively strong opposition in the Parliament should keep the PR government on its toes at all times and help push through:
o a well functioning and genuine check-and-balance system to protect the rights of all citizens, consistent with the Federal Constitution o the reformist agenda acceleration - economic, structural, institutional, political, social and law reforms, required to raise Malaysias long-term competitiveness o greater transparency, accountability, governance and integrity in all aspects in particular award of Govt contracts (through open tender), procurement process and other business practices & dealings, necessary to regain and retain investor confidence o promotion of business-friendly and free-market policies without imposing hardship on the rakyat o zero-tolerance for corruption and rent-seeking culture as well as dismantling of monopolies/oligopolies and cumbersome regulations should in turn reduce the overall costs of doing business in Malaysia and create a more conducive business environment o lower long-term risk premium assigned to Malaysia
35

GE13: MID-AND-LONG TERM POSITIVE FOR MSIA (continued)

Increased well-being of the rakyat and strengthening of the democratic process:
o No amendment to the Constitution at whims and fancies since constitutional amendments under Articles 159 (3), 159 (5) and 161 E require a supermajority of 2/3 o The emergence of a genuine two-coalition system, mirroring the two-party system that exists in the UK, the US, etc as well as other changes to the Governmental system such as limiting to 2 terms a person can hold the position as PM, limiting to only 1 key cabinet portfolio a minister can hold. For example, the PM cannot become the Finance Minister to avoid conflict of interest o Adjustments to the affirmative action such as NEP and other welfare policies that have deviated from the original objectives; transformation to a needs-based, meritbased and market-oriented affirmative action for all instead of a race-based programme to flush out NEP-related shortcomings and abuses in particular cronyism, corruption and systemic inefficiency while assisting the poor and marginalized o Positive changes in policy-making process with policies that serve the interest of the masses especially the small people rather than enriching the politically 36 connected elite group (within the inner circle of people in power)

GE13: MID-AND-LONG TERM POSITIVE FOR MSIA (continued)

o Higher quality debates in the Parliament and State Assemblies

o Perhaps, more freedom for MPs to vote in the Parliament based on their wisdom or the feedback from the people they represent?

Among major concerns if PR unseats BN:

o Economic sabotage, resistance and non-cooperation by those in the business community and civil service who are aligned to the losing coalition o Perceptions of political instability especially during the period of power transition with threats of chaos by some political leaders, simmering ethnic and religious tensions (delicate race-religion relations), protests against the PRs reform policies especially the needs-based affirmative action to correct socio-economic imbalances o No assurance of continuity of Govt policies and guarantee of the sanctity of contracts in particular related to lopsided concession agreements o No introduction of GST, much needed to diversify the Govts revenue base
37

THANK YOU

Email: azrulazwar@bankislam.com.my Phone: +603-20888075

Originating Department

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