As expected, Malaysia's economy posted a sharp turnaround in 2Q2021 after four consecutive quarters of contraction. While it was the highest quarterly growth ever recorded, the performance did not offset the deep contraction in last year's corresponding period. The economy shrank 3.9% compared to 2Q2019, so it still fell short of returning to pre-pandemic output levels.
Bank Negara Malaysia's (BNM) significant downward revision of its GDP growth forecast for 2021 from 6.0%–7.5% to 3.0%–4.0% is a testament to Malaysia's long and winding recovery path. We agree with BNM's revised forecast as our latest FY2021 projection falls within the range of 3.9%.
Malaysia's economy recorded a sharp turnaround of 16.1% year-on-year (y-o-y) in 2Q2021 compared to a contraction of 17.2% in 2Q2020. Strong growth in early 2Q2021 lost steam due to the stricter national lockdown imposed since late May, resulting in contractions in most industries and expenditure components. Overall, the economy grew at 7.1% in the first half of 2021 from a decline of 8.4% during 1H2020.
Given the economy is still reeling from intermittent lockdowns and the dissipating base effect, we foresee a slight contraction in 3Q2021. Firms' operating capacity constraints saw the manufacturing PMI remaining in the contraction zone (July 2021: 40.1). Challenging operating conditions such as supply chain disruptions would continue to weigh on business investment. Consumer sentiment hovered below the optimism threshold, mainly attributable to the elevated unemployment rate (2Q2021: 4.8%). Even so, an early resumption of economic activities would be the saving grace in avoiding a double-dip recession in 3Q2021.
We expect headline inflation to ease to below 3.0% in 3Q2021 as the base effect dissipates. We opine that BNM will hold the key overnight policy rate (OPR) at a historical low of 1.75%, at least for the rest of the year. The current monetary settings are sufficiently accommodative. Lowering the OPR will likely result in banks becoming more cautious in lending, more so following the announcement of a repayment moratorium.
The marked revenue shortfalls and increased expenditure will cause fiscal deficit to breach the government's target of 6.0% of GDP in 2021. Instead, we think that the fiscal deficit could come in at least 6.5% of GDP. The narrowing policy space and limited fiscal resources could push the government to temporarily raise the self-imposed statutory debt ceiling again, this time to 65%.
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