Foreseeable Softpatch


Text : RAM Economic Research

Global economy going through soft patch

The downside risks to global economic growth have increased substantially over the past few months. The disruption to Asia’s supply chain – particularly for electrical and electronic (E&E) and automotive goods – has become more evident following the Great Japan Earthquake in mid-March. This has been exacerbated by rising energy prices towards the end of April and continued political indecisiveness in resolving the deteriorating sovereign debt situations in Europe and the United States (US). All these have hampered global manufacturing activities (as measured by various Purchasing Managers Indices or PMIs) in recent months.

Nonetheless, some of the adverse shocks are transitory and may be resolved in the coming months. For instance, massive rebuilding efforts in Japan are currently underway while industrial capacity is expected to be restored over time. Furthermore, energy prices moderated substantially in May and are anticipated to ease further following the resolution of the geopolitical crises in the Middle East and North Africa.

All said the momentum of global recovery has hit an unexpected rough patch in recent months. While most structural issues had been resolved in the months following the worldwide recession, continued growth still depends very much on economic sentiment, which has suffered a significant blow after these events. Further unexpected shocks to the global economy may lengthen the recovery process.

The current economic slowdown has put most central banks in a bind – whether to focus on growth in the face of a possible downturn or to emphasize inflation-fighting as commodity prices remain elevated. Some monetary authorities have expressed caution with regard to inflation, such as the European Central Bank, despite the worsening fiscal conditions of some of its member nations. Other central banks – such as the US Federal Reserve – have committed to the restoration of domestic economic growth and kept interest rates low.

Weighing production and inflation risks of domestic economy

As worries over the adverse effects of the Japanese natural disasters in March cast doubt and uncertainty on the relative impact on the world’s supply chains, the global industrial production numbers for April highlight Japan’s integral role in the worldwide supply of components and parts. Malaysia has been no exception amid the contraction of industrial production indices (IPIs) for most regional economies. We experienced a 2.2% contraction in the overall IPI for April, attributable to declines in all the component indices; mining showed the most significant decrease. Notably, mining output has been falling continuously in the past few months, owing to complications at the Kikeh fields with regard to sand content in the oil.

After a moderately strong showing in March (+6.9%), the manufacturing sector also suffered a setback in April, with a 0.4% contraction. Manufactured goods, meanwhile, posted the steepest drop in the sub-groups of E&E and transport equipment (such as automobiles), which recorded double-digit declines of 15.3% and 17.3%, respectively. 

While we opine that the unfavorable performance is somewhat transitory, we expect some downside risk for economic performance in 2Q 2011.  

Price pressures built up steadily in May, with an eventual 3.3% increase in inflation that was in line with our expectations. Moving forward, we anticipate further price pressure ahead when the effects of the electricity tariff hike are manifested from June onwards. 

Our preliminary analysis indicates that upward pressure on the Consumer Price Index (CPI) in the coming months will not be solely driven by the direct impact of more expensive electricity (which accounts for 3.3% of the CPI basket). Another culprit will be industries’ attempts to pass on their costs, which will vary. As a rule of thumb, industries that are more likely to pass on cost increases are those that have no close substitutes.

We expect the immediate impact of the electricity tariff hike to contribute around 0.2 to 0.3 percentage points to inflation in June. This may accelerate in the next few months, fuelled by the persistence of these price effects and the supplementary impact from cost pass-through, particularly by the services sector.

The coming months will be of utmost importance on both the domestic and international scales, with the prevailing risks remaining threats against economic growth and momentum.