Economy Strong FDI growth a bright spark

by **Cals** Fri 28 Mar 2014, 19:14

Economy Strong FDI growth a bright spark

Business & Markets 2014

Written by theedgemalaysia.com

Friday, 28 March 2014 16:00

IN last week’s issue, we indicated that it was a bit too early to be bullish on exports to boost Malaysia’s economic growth. Slowing growth in China, the “disconnect” of the US economy from Malaysian export performance and ominous signs from the hard commodities sector about the state of the global economy point towards sluggish export growth.

This week, the spotlight is on private sector investments. It also comes in the wake of Bank Negara Malaysia (BNM) forecasting 2014 real GDP growth of 4.5% to 5.5% versus the market consensus of 5%. Can the private sector deliver enough investment growth to power the economy?

Historically speaking, yes.

Past performance of private sector investment expenditure

Since 2010, the private sector has registered strong double-digit growth in investments (Chart 1). By growing at an average annual rate of 16.1%, it outpaced average private consumption growth of 7.2% and helped cushion the substantial contraction in Malaysia’s net exports.

The strong growth also drove private sector investment expenditure to become the second largest contributor to Malaysia’s GDP at 16.9% in 2013, behind private consumption at 52% (Chart 2). So, what caused the recent emergence of the private sector as a growth driver?

The answer lies in the government’s Economic Transformation Programme (ETP), which was launched in October 2010 and implemented by the Performance Management and Delivery Unit. Its goal is to elevate Malaysia to developed nation status. One of the ways is by attracting US$444 billion (RM1.457 trillion) in investments. Of this amount, 92% is targeted to be driven by the private sector.

With such robust growth coming from private sector investments, it appears that the economy has a steady growth driver to depend on. The 10th Malaysia Plan states that for Malaysia to become a high-income nation, private sector investment growth has to average 10.9% annually. Historical growth since 2010 has already breached this benchmark.

However, investors always need to be vigilant about the downside risks in future. There could already be signs that private sector investments may grow at a slower pace, which will be discussed below.

Rising borrowing costs and tightening credit conditions

To begin with, the tapering of the US Federal Reserve’s quantitative easing programme (QE) will see borrowing costs rise in the near term. QE has flooded the market with money, lowering borrowing costs and driving the economy as consumers spend more. The tapering of QE could potentially put the brakes on economic growth. Since December 2013, QE has been tapered by US$30 billion a month, with the latest tapering last Wednesday, announced at the Federal Open Market Committee meeting. Fed chairman Janet Yellen is also forecasting interest rates to rise earlier than expected in April 2015.

Based on Chart 3, one can see that the yields of AAA-rated private debt securities (PDS), which are the safest investment grade, have already begun to trend upwards since May 2013. PDS are bonds that are issued by the private sector to fulfil their funding needs. Increasing yields imply higher borrowing costs going forward, giving companies less incentive to tap the debt market for funding. In view of this, companies may not be as aggressive in seeking new investments, which could hurt growth in the process unless they can seek alternative funding from the banking sector.

One indicator of whether this has been taking place is through the approvals of banking loans to non-household sectors like mining, manufacturing and construction. Based on BNM’s latest statistics, RM9.3 billion worth of loans were approved in January 2014, a 27.8% drop from the month before and the lowest in nearly a year (Chart 4). This was also 28% below the 2013 monthly average of RM12.9 billion. Approvals in major sectors like construction, real estate and manufacturing were 33%, 25.9% and 16.3% respectively, below their 2013 averages.

What could this be telling us?

It could be that banks are now becoming more stringent with credit controls and cutting back on loan approvals. This is normally the case in times of economic uncertainty. However, it could come at the private sector’s expense. Sourcing new bank loans will gradually become more difficult, placing pressure on growth in investments.

Potential shift in government policies to affect private sector investments?

Recent shifts in government policy could also impact private investment growth. One example is the property cooling measures announced in Budget 2014, which was done to curb speculation in the property market. This change in policy could directly impact real estate investments in Malaysia.

According to the Malaysian Investment Development Authority’s (Mida) latest annual report, the amount of approved investments in the real estate sector surged 41.7% to RM83.3 billion in 2013. As a percentage of total approved investments in 2013, the sector accounted for a staggering 38.5%, up from a mere 11.4% in 2011. A total of 97.4% of real estate investments in 2013 came from domestic sources.

It is still too early to ascertain the impact of the abovementioned policy, but potential investors may think twice before investing in future.

Another potential change in government policy that we need to keep an eye on is the switch from private finance initiative (PFI) to public-private partnerships (PPP). The government is looking to do this to address the rising debt of non-financial public enterprises, most of which have been incurred under the PFI for infrastructure projects. This has grown from RM7 billion in 2009 to RM93 billion in 2013.

Under the PFI, the government guarantees the private sector’s returns on investment (ROI) of projects. In doing so, the risk to the private sector is almost zero. However, the PPP model takes away this safety net and makes the private sector bear the risk of ensuring that the ROIs are met. As a result, the private sector could be less inclined to partake in large investments under the ETP.

Investment growth still strong

On the bright side, according to Mida, Malaysia attracted a record RM216.5 billion in approved direct investments in 2013, which was 29% more than the RM167.9 billion registered the year before. Of the total investments approved, RM157 billion or 72.5% came from domestic sources, with RM59.5 billion (27.5%) coming from foreign investors.

Despite an uncertain global economy, foreign investors remained bullish about the prospects of Malaysia. Foreign direct investments (FDI) surged 24% to a record RM38.8 billion in 2013 from RM31.1 billion in 2012. This surpassed the previous high of RM37.3 billion set in 2011.

In terms of implementation of approved investments, Mida only publishes figures for the manufacturing sector (Chart 5). A project is deemed implemented when it has reached either the production or machinery installation and factory construction stage.

The numbers show that the strong growth in approved direct investments has not affected the implementation rates, which is a sign that quality projects are being brought in. This bodes well for the growth in Malaysian private sector investments.

Moving forward, private sector investments in Malaysia should remain supported by the ETP and strong FDI growth. But investors still need to be mindful of the potential risks as mentioned earlier.

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This article first appeared in The Edge Malaysia Weekly, on March 24, 2014.