MARKET DATELINE

PP 7767/09/2011(028730)

15 October 2010
ï
Malaysia

Economic Update

Ministry Of Finance Economic Report 2010/2011

– Continuing Fiscal Consolidation, No Major
Surprises In Growth Forecasts

Executive Summary
‹ The MOF expects the country’s real GDP to ease to a range of 5.0-6.0% in 2011, from +7.0%
estimated for 2010. This is mainly on account of slowing export growth, but supported by resilient
consumer spending. The MOF’s outlook projection is broadly in line with our expectation, as we
expect the economy to moderate to +5.0% in 2011, from +7.3% estimated for 2010.

‹ The Federal Government expects its budget deficit to narrow slightly to 5.4% of GDP in 2011
(before imputing the proposed measures in the budget speech), from a deficit of 5.6% estimated
for 2010. This is higher than our expectation of a deficit of 4.2% of GDP for 2011, suggesting that
the Government intends to front load its expenditure during the initial period of the implementation
of various initiatives under the New Economic Model. This is prudent given tising risk of a sharper-
than-expected slowdown in the global economy, which will in turn hurt the country’s exports.

‹ The MOF expects real exports to slow down to +6.7% in 2011, after a rebound to +11.6% estimated
for 2010. The slowdown is consistent with a slowdown in the global economy projected by the
International Monetary Fund (IMF) and broadly in line with our expectation.

‹ In tandem with a slowdown in the growth of exports, the MOF forecasts real aggregate domestic
demand to ease to +5.8% in 2011, from an estimate of +6.9% in 2010, as consumers and
businesses turn more cautious on spending. This will likely be compounded by a cutback in the
Government’s development expenditure.

‹ On the supply side, the slowdown in economic growth will be reflected in slower growth in the
manufacturing and services sectors, in tandem with a slowdown in the growth of exports and
domestic demand. Similarly, construction activities are projected to moderate, as the Government
reduces its development spending. These, however, will likely be mitigated by a pick-up in
agriculture and mining output during the year.

‹ The MOF expects the current account surplus of the balance of payments to widen to RM114.2bn
or 14.1% of GNI in 2011. This is broadly in line with our expectation and the surplus will continue
to provide an underlying support to the ringgit. We expect the ringgit to trade at RM3.00-3.10/US$
in 2011.

‹ The MOF expects inflation to rise to an average rate of +1.5% in 2010 but it did not provide any
forecast on the inflation outlook for 2011. We expect inflation to trend up to an average of 2.8%
in 2011, from +2.0% estimated for 2010. Meanwhile, we believe the Central Bank will likely resume
its policy normalisation in 2011 but the timing will depend on how soon the global economy
stabilises.
Peck Boon Soon
Please read important disclosures at the end of this report. (603) 9280 2163
bspeck@rhb.com.my

A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
Ministry Of Finance Economic Report 2010/11

Fiscal Consolidation To Continue, No Major Surprises In Growth

Forecasts

The Malaysian economy is projected to grow at a more moderate pace in 2011, on The MOF expects real GDP
the back of a slowdown in exports growth, according to the Ministry Of Finance growth to soften to 5-6%
(MOF). The MOF expects the country’s real GDP growth to ease to a range of in 2011, broadly in line with
5.0-6.0% in 2011 (see Table 1), from +7.0% estimated for 2010. Based on the our expectation
data provided in the Economic Report, the growth works out to be 5.5%. This is
mainly on account of slowing export growth, but supported by resilient consumer
spending. The MOF’s outlook projection is broadly in line with our expectation,
as we expect the economy to moderate to +5.0% in 2011, from +7.3% estimated
for 2010.

Table 1
Key Economic Indicators

2010(e) 2011(f)

Real GDP growth (%) 7.0 5.0-6.0

Agg.domestic demand (real,%) 6.9 5.8
Exports of goods&services (real,%) 11.6 6.7
Fed.Govt budgetary position(RMbn) -43.3 -45.5
(% of GDP) -5.6 -5.4
Public sec. budgetary position(RMbn) -60.1 -63.5
(% of GDP) -7.8 -7.6
Inflation rate (%) 1.5 n.a
Unemployment rate (%labour force) 3.6 3.5
Current account balance (RMbn) +103.8 +114.2
(% of GNI) +13.8 +14.1
Gross national savings (% of GNP) 35.6 35.7
External debt service ratio 7.6 n.a
(% of total export earnings)

e : Estimates f : Forecasts
Source : MOF's Economic Report 2010/2011

In its slightly more optimistic real GDP forecast, the Government’s gross The Government intends to
development expenditure allocation for 2011 came in higher than the guidance front load its expenditure
provided under the Tenth Malaysia Plan (10MP), which was released in June. In this
during the initial period of
respect, the Government only cut the gross development expenditure allocation by
the implementation of
9.0% to RM49.2bn for 2011, compared to our expectation of a reduction of about
various initiatives under
19% in 2011. This suggests that the Government intends to front load its
the NEM
expenditure during the initial period of introducing the New Economic
Model (NEM) and the implementation of various initiatives under the model. Indeed,
a total of RM9.5bn will be allocated for the six National Key Result Areas (NKRAs),
mainly to cater for the need of rural basic infrastructure (RM6.4bn) and urban public
transport (RM1.4bn) spending. A total of RM6.0bn will be allocated for the 12
National Key Economic Areas (NKEAs), which include RM2.2bn for Greater KL (Klang
Valley), RM857m for electrical & electronics, RM821m for agriculture, RM447m for
palm oil, RM425m for tourism and RM234m for education sectors. The move also
suggests that the Government intends to gradually reduce its budget deficit to It intends to gradually
ensure that the economy will sustain its growth amidst a slowdown in the global reduce its budget deficit by
economy. This is a policy that was adopted by the Government in the early 2000s adopting a “growth-based”
under a “growth-based” fiscal consolidation. In a “growth-based” fiscal fiscal consolidation
consolidation”, the Government cuts back its expenditure gradually to ensure that
economic growth remains intact. The argument is that large fiscal consolidations will

ECONOMIC 2 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
lead to a revision in expectations about future tax burden. If consumers and
businesses anticipate long-run tax reductions, they may increase expenditure now,
so much so that it could potentially offset the demand-side effects of the fiscal
contraction. However, the “growth-based’ fiscal consolidation policy has to be
implemented in a credible and decisive manner; and followed through by systematic
reforms. In contrast, if the fiscal contraction does not lead to the expectation of
significantly lower permanent government consumption expenditure and hence
taxes, then the conventional negative aggregate demand effect may dominate. As
a result, the Federal Government expects its budget deficit to narrow slightly
to 5.4% of GDP in 2011 (before imputing the proposed measures in the budget The budget deficit is

speech), from a deficit of 5.6% estimated for 2010. This is higher than our projected to narrow
expectation of a deficit of 4.2% of GDP for 2011. Meanwhile, the Government also slightly to 5.4% of GDP in
revised up its budget deficit estimate for 2010 to 5.6% of GDP, from 5.3% of GDP 2011
projected in the 10MP.

Apart from front loading its expenditure under the ETP, prospects of a slowdown Prospects of a slowdown in
in the global economy, and hence the country’s exports, might have prompted the the global economy might
Government to cut its gross development expenditure less than the guidance have prompted the
provided under the 10MP, in our view. As it stands, the slowdown in the world’s Government to cut its gross
major economies, from the US to Japan and China, has become more widespread
development expenditure
since the 2Q, after a strong rebound from the worst recession since the world war
less than the amount
II. The latest economic data releases suggest that the growth in these countries will
guided under the 10MP
likely soften further in the 2H of the year and extend into 1H 2011. Also,
the effect of the dissipating global stimulus spending will likely be felt in the 2H of
the year. Meanwhile, the austerity drive in the highly indebted European countries
is beginning to affect economic activities in the region. Already, global
manufacturing and services activities slowed down for the fifth straight month in
September (see Chart 1). Furthermore, manufacturing new orders weakened to the
slowest pace of growth in 15 months, indicating that global manufacturing activities
are likely to moderate further in the months ahead. Similarly, the OECD composite
leading indicator’s 12-month rate of change moderated for the fifth consecutive
month to 3.8% in August, the slowest pace of increase in 10 months and from +5.3%
in July (see Chart 2), indicating that OECD countries’ economies are likely to expand
at a slower pace in the months ahead.

Chart 1 Chart 2
OECD Leading Indicator Points To Global Manufacturing And
A Slower Economic Growth Ahead Services Activities Slowing Down

% 12-mth annualised rate of change Index

30 65

25
60
20

15 55

10
50
5
45
0

-5 40
Total OECD Japan
-10
US Euro area 35
-15
China
-20 30
00 01 02 03 04 05 06 07 08 09 10 05 06 07 08 09 10

As a result, we believe the US Federal Reserve is moving closer to implement The US Federal Reserve is
a new round of quantitative easing as soon as on 2-3 November during the moving closer to
forthcoming FOMC meeting. Similarly, the Bank of Japan (BOJ) stepped up its implement a new round of
monetary easing on 5 October by lowering its benchmark interest rate to a range quantitative easing, while
of 0-0.1% and expanding its balance sheet to buy government bonds and other Japan has stepped up its
assets. Although the European Central Bank (ECB) said that policymakers are in efforts to ease its policy
the same mood a month ago, thus far they remained committed to phase out their
unlimited lending programme. With monetary policies leaning towards a loosening

ECONOMIC 3 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
bias, we believe developed countries are unlikely to fall back into a recession. In
Asia, we believe most central banks in the region are likely to slow down their policy
tightening or taking a pause in view of the risk of a sharper slowdown in the global
economy and a sharp appreciation in currencies due to inflow of foreign capital.

Still, the small reduction in the Government’s budget deficit in 2011 indicates that The small reduction in the
the Government has limited room to manoeuvre in the event the global Government’s budget
economy falls into a “double-dip” recession. This is especially the case given that deficit in 2011 indicates
the Government announced on 13 October that it will postpone the implementation that the Government has
of a goods and services tax (GST), without specifying the length of the delay to limited room to manoeuvre
enable the Government to engage inclusively with all segments of society pertaining
to the GST. We believe without an introduction of the GST to broaden the tax base,
it would remain difficult for the Government to lower its budget deficit to a more
manageable and flexible level in the near future. This is reflected in the Government
revenue, which is projected to increase only modestly by 2.3% in 2011, while total
expenditure is forecast to increase by 2.8%. Also, oil revenue still accounts for a
sizeable 35% of the government revenue in 2011 based on our estimate, a drop
from around 40% in 2009.

Meanwhile, the Government’s subsidies are projected to fall by 4.9% to RM23.7bn The Government will cut its
in 2011, indicating that the Government will cut its subsidies gradually as subsidies gradually as
indicated by the Performance Management and Delivery Unit (Pemandu). This is to indicated by Pemandu
ensure that consumers would not be significantly affected by the reduction in
subsidies that will lead to higher prices of food and energy. Furthermore, the
economy needs a resilient domestic demand to cushion the slowdown in exports
which may turn out to be sharper than expected.

As a whole, we are maintaining our real GDP forecast unchanged at 5.0% in We are maintaining our
2011, a more moderate growth than +7.3% estimated for 2009. For 2010, the MOF real GDP forecast
expects the economy to expand by 7.0%, an upward revision from 6.0% projected unchanged at 5.0% in 2011
previously.

A Slowdown In Exports In 2011

The MOF expects real exports to slow down to 6.7% in 2011, after a rebound The MOF expects real
to +11.6% estimated for 2010. The slowdown is consistent with a slowdown in the exports to slow down in
global economy projected by the International Monetary Fund (IMF). Indeed, the 2011, broadly in line
IMF cuts its projection for the global economy to 4.2% in 2011, from +4.3% with our expectation
forecast previously and compared with +4.8% estimated for 2010. This is broadly
in line with our expectations, as we expect real exports to weaken to 7.6% during
the year, from +11.7% estimated for 2010.

As it stands, the US personal consumption expenditure (PCE) slowed down to an The US economic growth is
annualised rate of 1.7% in August, from +1.9% in July and the peak of +2.6% in projected to moderate to
May. This was the third consecutive month of easing and the slowest pace of 2.5% in 2011, from +2.7%
increase in seven months, suggesting that consumer spending is slowing down. estimated for 2010
However, it will likely remain resilient given that non-farm private sector continued
to create jobs for the last nine consecutive months, albeit at a slow pace in recent
months. Similarly, manufacturing activities weakened to the slowest pace in 10
months in September, although services activities rebounded during the month. As
a whole, the US economic growth is projected to moderate to 2.5% in 2011, from
+2.7% estimated for 2010.

Similarly, Japan’s manufacturing activities contracted in September, the first in 15 The export-dependent
months, and exports eased for the sixth straight month in August, suggesting that Japanese economy will
the export-dependent Japanese economy will likely turn weaker in the months likely turn weaker and the
ahead. In the same vein, the Euroland’s economic growth is likely to have peaked Euroland economy will
in the 2Q, as its export engine, which powered the 2Q’s GDP growth, has started to likely slow down as well
moderate.

ECONOMIC 4 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
China’s Purchasing Managers Index (PMI) for the manufacturing sector, on the other Economic activities in China
hand, rose to 53.8 in September, from 51.7 in August and a 17-month low of 51.2 have stabilised somewhat
in July. This was the third straight month of picking up, suggesting that in the 3Q
manufacturing activities expanded at a faster pace during the month. China’s money
supply, however, moderated in September. As a whole, the readings suggest that
economic activities in China have stabilised somewhat in the 3Q, after easing to
+10.3% yoy in the 2Q.

In tandem with a more moderate growth in the global economy, the demand for Demand for E&E products
electrical & electronic (E&E) products, which accounted for about 45% of and other non-E&E
Malaysia’s total exports in 2009, and other non-E&E manufactured goods is likely to manufactured goods is
soften in 2011. Already, worldwide semiconductor sales eased to +32.6% yoy in likely to soften in 2011
August, from +37.0% in July and after reaching a high of +59.9% in March. Also,
the Semiconductor Industry Association expects chip sales to grow at a much slower
pace of 6.3% in 2011, compared with +28.4% in 2010.

Domestic Demand To Expand At A More Moderate Pace

In tandem with a slowdown in exports, the MOF forecasts real aggregate The MOF forecasts real
domestic demand to ease to +5.8% in 2011, from an estimate of +6.9% in 2010, aggregate domestic
as consumers and businesses turn less upbeat. This will likely be compounded by demand to ease in
a cutback in the Government’s development expenditure. As a result, the 2011, as consumers and
contribution from the private sector to GDP growth is projected to moderate to 4.5
businesses turn less
percentage points in 2011, from +5.1 percentage points estimated for 2010 (see
upbeat
Table 2). This is reflected in smaller contributions from both private consumption
and investment, which are projected to ease to 3.4 percentage points and 1.1
percentage points respectively in 2011, from +3.6 percentage points and +1.5
percentage points respectively estimated for 2010.

Table 2
GDP By Demand Aggregates
(In 2000 Prices)

2009 2010(e) 2011(f) 2009 2010(e) 2011(f)

(%, change) (Contribution to GDP

growth in percentage pt.)

Private Expenditure -2.7 8.1 7.0 -1.7 5.1 4.5

Consumption 0.7 6.7 6.3 0.4 3.6 3.4
Investment -17.2 15.2 10.2 -2.1 1.5 1.1
Public Expenditure 5.2 3.8 2.8 1.2 1.0 0.7
Consumption 3.1 0.2 4.6 0.4 0.0 0.6
Investment 8.0 8.3 0.6 0.8 0.9 0.1

e : Estimates f : Forecasts
Source : Ministry of Finance Economic Report 2010/2011

In this regard, the MOF projects total private expenditure to moderate to +7.0% in Consumer spending is
2011, from +8.1% estimated for 2010. This is reflected in a slowdown in consumer projected to expand at
spending, which is projected to expand at a slower pace of 6.3% in 2011, compared a slower pace in 2011
with an estimate of 6.7% in 2010 (see Table 3). Already, the Malaysian Institute
of Economic Research’s (MIER) consumer sentiment index fell to 110.4 in the 2Q,
from a high of 114.2 in the 1Q. Similarly, manufacturers have turned cautious in
the recruitment for workers in recent months, in tandem with a slowdown in the
global economy and the country’s exports. In the same vein, private investment
is envisaged to ease to +10.2% in 2011, from +15.2% estimated for 2010. This is
in line with a drop in business confidence as indicated by the MIER’s business
Private investment is
conditions index, which fell to 119.6 in the 2Q, the first easing in more than a year
and from 124.0 in the 1Q. As a whole, the slowing growth trend in consumer envisaged to ease to

spending and private investment projected by the MOF is broadly in line with our +10.2% in 2011

expectations but the MOF’s projections are generally more optimistic.

ECONOMIC 5 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
 Table 3
GDP By Demand Aggregates

2009 2010(e) 2011(f) 2010(e) 2011(f)

MOF RHBRI
(% Growth in real terms)
Consumption
P u b lic 3.1 0.2 4.6 -0.4 4.5
Private 0.7 6.7 6.3 5.6 5.4

Gross fixed
capital formation -5.6 11.6 5.3 9.7 6.3
Public 8.0 8.3 0.6 10.8 4.9
Private -17.2 15.2 10.2 8.6 7.8
Agg.domestic demand* -0.5 6.9 5.8 5.6 5.5

Exports of goods
& non-factor services -10.4 11.6 6.7 11.7 7.6

Imports of goods
& non-factor services -12.3 16.6 7.2 16.5 8.4

GDP -1.7 7.0 5.0-6.0 7.3 5.0

* : Excluding stocks
f: Forecasts e: Estimates
Source : MOF's Economic Report 2010/2011

In the same vein, the public sector contribution to GDP growth will ease to 0.7 The MOF forecasts
percentage point in 2011, from 1.0 percentage point estimated for 2010. In public investment to
particular, the contribution from public investment is projected to slow down to a slow down significantly
mere 0.1 percentage point in 2011, from +0.9 percentage point estimated for 2010, in 2011 due to a
in tandem with a cutback in the Government’s development expenditure. This, cutback in development
however, is mitigated by a pick-up in public consumption contribution to GDP, which spending
is projected to contribute 0.6 percentage point in 2011, after recording a zero
contribution in 2010. The MOF forecasts public investment to slow down
significantly to 0.6% in 2011, after picking up to an estimate of +8.3% in 2010. This
is on account of a cutback in the Government’s gross development expenditure, in
line with the fiscal consolidation to contain the Federal Government’s budget deficit.
Similarly, non-financial public enterprises’ (NFPEs) development spending is
projected to slow down to 2.8% in 2011, from +9.2% estimated for 2010.
Nevertheless, the 2010’s development spending of the NFPEs has been revised up
from a decline of 19.8% projected previously, suggesting that its spending in 2011
could also surprise on the upside. Public consumption, however, is projected to Public consumption is

grow at a faster pace of 4.6% in 2011, compared with an estimate of +0.2% in 2010. projected to bounce
As a whole, the MOF forecasts public expenditure to moderate to 2.8% in 2011, from back during the year
+3.8% estimated for 2010.

The slowdown in domestic demand contribution to GDP growth, however, will likely Consumer spending will
be mitigated by a turnaround in contribution from net exports, which is projected to remain as a key driver
record a positive contribution of 0.2 percentage point, compared with the subtraction for the economy in 2011
of 3.1 percentage points estimated for 2010. As a whole, the above analysis
suggests that the private sector, particularly consumer spending, will remain as
a key driver for the economy in 2011.

ECONOMIC 6 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
Manufacturing, Services And Construction Sectors Will Grow At A
Slower Pace

On the supply side, the slowdown in economic growth is reflected in slower growth The manufacturing sector
projected for the manufacturing, services and construction sectors. These, however, is projected to weaken in
are mitigated by a pick-up in output projected for the agriculture and mining sectors. 2011, as exports and
The MOF forecasts value added in the manufacturing sector to weaken to domestic demand soften
6.7% in 2011, from +10.8% estimated for 2010 (see Table 4), on account of a
slowdown in exports and domestic demand. We are slightly more upbeat about the
manufacturing sector’s outlook, as we expect domestic demand to remain resilient
to cushion a slowdown in export growth. As a result, we expect the sector to grow
by 8.0% in 2011, albeit at a slower pace than +12.3% estimated for 2010.

Table 4
GDP By Industrial Origin

2009 2010(e) 2011(f) 2010(e) 2011(f)

MOF RHBRI
(% Growth in Real Terms)
GDP -1.7 7.0 5.0-6.0 7.3 5.0
Agriculture 0.4 3.4 4.5 3.3 3.5
Mining -3.8 1.0 2.9 2.1 2.3
Manufacturing -9.4 10.8 6.7 12.3 8.0
Construction 5.8 4.9 4.4 4.2 2.8
Services 2.6 6.5 5.3 6.3 4.6

f: Forecasts e: Estimates
Source : MOF's Economic Report 2010/2011

In the same vein, the MOF expects the services sector to grow at a slower The MOF expects the
pace of 5.3% in 2011, compared with +6.5% estimated for 2010, on the back services sector to grow at
of a slowdown in consumer spending, business and trade activities . The slower a slower pace in 2011, in
growth projection is reflected in slower increases in activities in the transport & line with a slowdown in
storage, finance & insurance, real estate & business, utilities and wholesale & retail consumer spending and
trade sub-sectors. These will likely be made worse by a slowdown in government trade activities
services. A pick-up in activities in accommodation & restaurants and
communications sub-sectors, however, will help to mitigate the slowdown. This is
broadly in line with our expectation, as we expect the sector to slow down to 4.6%
in 2011, from an estimate of +6.3% in 2010.

Similarly, the growth in the construction sector is envisaged to moderate to Construction sector is
4.4% in 2011, from +4.9% estimated for 2010. This is in line with a cutback in envisaged to moderate, in
the Government’s development expenditure during the year. Growth, however, will line with a reduction in
likely be driven by the ongoing projects such as KLIA2, the Second Penang Bridge, government spending
SKVE (package 3), Sabah-Sarawak Gas Pipeline and the LRT extensions.
Development projects in the five corridors as well as the implementation of new
projects under the 10MP will also help. These projects include Electrified Double
Track from Gemas-Johor Bahru, West Coast Banting-Taiping Expressway, Guthrie-
Damansara Expressway, Elevated Ampang-Pandan-Cheras Expressway, ITT in
Gombak and the 300MW Gas-Fired Power Plant in Sabah. Indeed, the Government
has allocated RM12.4bn under the 10MP and another RM22bn for completion of
projects under the Ninth Malaysia Plan (9MP). Meanwhile, the MOF expects the
residential sub-sector to recover in 2011. This is broadly in line with our
expectation.

The mining sector, however, is projected to rebound to +2.9% in 2011, after The mining sector is
recovering to a growth of +1.0% estimated for 2010. This is mainly on account of projected to rebound
a pick-up in the production of liquefied natural gas (LNG), on account of a robust during the year, on account
performance of domestic chemical industries as well as higher global demand, of a pick-up in LNG output
particularly from China and India. This, however, will likely be offset partially by
ECONOMIC 7 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
a decline in crude oil production during the year due to scheduled plant maintenance
activities and the implementation of the Reservoir Management Plan by Petronas to
sustain its long-term crude oil production.

The MOF also expects agriculture output to record a stronger growth of 4.5% Agriculture output will
in 2011, compared with an estimate of +3.4% in 2010. This is due to a pick-up record a stronger growth in
in palm oil production on the back of increased matured areas, particularly in Sabah 2011, due mainly to a pick-
and Sarawak. The production of rubber, however, is projected to moderate although up in palm oil production
firm rubber prices will encourage tapping among smallholders. The non-commodity
sub-sector, mainly livestock and other agriculture, is projected to expand further
arising from the ongoing implementation of various high-impact projects.

A Gradual Reduction In Budget Deficit

The Federal Government’s revenue is projected to inch up by 2.3% to RM165.8bn The Federal Government’s
in 2011, after a gain of +2.2% estimated for 2010 (see Table 5). This is on account revenue is projected to
of a pick-up in direct tax revenue, underpinned by a rebound in petroleum income inch up modestly in 2011,
tax, which is projected to increase by 19.1% in 2011 (-32.9% in 2010), due to higher on account of a pick-up in
crude oil prices. This, however, will likely be offset partially by a slowdown in petroleum income tax
corporate and individual income tax revenues, which are projected to moderate to
8.9% and 5.8% respectively in 2011, from the corresponding rates of +10.1% and
+20.4% estimated for 2010, in line with a slowdown in the economy. Similarly,
indirect tax revenue is projected to ease, mainly on account of a slowdown in
revenue from excise duties. A decline in non-tax revenue, particularly investment
income, however, will offset a pick-up in direct tax revenue. Investment income is
projected to fall by 15.9% in 2011, after slowing down to 5.5% in 2010. We suspect
it could be due to a drop in other investment income, as Petronas is expected to
maintain its dividend at RM30bn.

Table 5
Federal Government Financial Position

2009 2010(e) 20111(f) 2010(e) 2011(f)

(RM bil) (%, change)

Revenue 158.6 162.1 165.8 2.2 2.3

Operating Expenditure 157.1 152.2 162.8 -3.1 7.0
Current balance 1.6 10.0 3.0
Gross development expenditure 49.5 54.0 49.2 9.1 -9.0
Less : Loan recoveries 0.5 0.7 0.7 41.0 -6.8
Net development expenditure 49.0 53.3 48.5 8.8 -9.0
Overall balance -47.4 -43.3 -45.5
% to GDP -7.0 -5.6 -5.4

1
Budget estimate, excluding 2011 tax measures
e : Estimates f : Forecasts
Source : MOF's Economic Report 2010/2011

Similarly, the Federal Government’s total expenditure is projected to increase by The Federal Government
2.8% to RM212.0bn in 2011, after falling by 0.2% in 2010. The Federal Government expects its operating ex-
expects its operating expenditure (OE) to increase by 7.0% in 2011, after falling penditure to increase by
by 3.1% estimated for 2010. A total of RM1.2bn and RM525m will be provided for
7.0% in 2011
‘shovel-ready’ projects under the NKRAs and NKEAs, respectively. This is in line with
the Government’s move to front load its expenditure for the implementation of
various initiatives under the NKRAs and NKEAs. The rise in pension & gratuities, debt
servicing, grants to state governments and supplies & services will also contribute
to the increase in OE. The double-digit increases in these expenditures suggest that
the Government’s OE will likely remain sticky downward. In particular, the
Federal Government’s debt servicing burden is projected to increase by 16.6% in

ECONOMIC 8 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
2011, after rising by 11.7% in 2010 and +11.1% in 2009. This will increase the The subsidy bills are
share of debt servicing to 11.4% of total OE. The subsidy bills, on the other hand, projected to fall by 4.9%
are projected to fall by 4.9% to RM23.7bn in 2011, after picking up by 22.5% in to RM23.7bn in 2011
2010. The bulk of the subsidies in 2010 would be spent on fuel (40%), assistance
for education (28.5%) and food (paddy, rice, sugar & flour) (8.1%).

The Federal Government’s gross development expenditure, however, is The gross development ex-
projected to fall by 9.0% to RM49.2bn in 2011, after easing to 9.1% in 2010 due to penditure is projected to
the absent of stimulus spending. If we strip out the RM5.0bn economic stimulus fall during the year due to
spending for 2010, the gross development would have inched up by 0.3% in 2011. the absent of stimulus
The drop in 2011 gross development expenditure is reflected in declines in
spending
allocations for education and healthcare, while allocations for rural development and
housing sectors are projected to fall for another year in 2011. These, however, will
likely be mitigated by a pick-up in allocation for defence & internal securities, public
utilities, trade & industry and transport sectors. In particular, the allocations for the
latter three sectors are meant to facilitate the implementation of the NKRAs and
NKEAs.

Consequently, the Federal Government’s budget deficit is projected to narrow slightly The budget deficit is
to 5.4% of GDP or RM45.5bn in 2011, from a deficit of 5.6% of GDP or RM43.3bn projected to narrow
estimated for 2010. We believe financing of the budget deficit in 2011 should not slightly to 5.4% of GDP in
be a problem given ample liquidity in the banking system. The excess liquidity 2011
mopped up the Central Bank stood at RM225.3bn at end-September. In 2010, the
Government funded its budget deficit mainly through domestic borrowings.
Assuming that the Government finances all the 2011’s budget deficit through
borrowings, the Federal Government’s debt level is likely to rise to 54.1% of GDP
or RM453.7bn in 2011, from 52.7% estimated for 2010. About 96% of the total debt
in 2010 was financed from domestic borrowings.

Similarly, at the consolidated public sector, which includes the state Fiscal spending at the
governments, statutory authorities, local governments and non-financial public consolidated public sector
enterprises (NFPEs), fiscal spending will be less expansionary in 2011. As a result, will be less expansionary
the consolidated public sector is projected to record a smaller deficit of 7.6%
of GDP or RM63.5bn in 2011, compared with a deficit of 7.8% of GDP or RM60.1bn
estimated for 2010 (see Table 6).

Table 6
Consolidated Public Sector Financial Position

2009 2010(e) 20111(f) 2009 2010(e) 2011(f)

(RM bil) (%, change)

Revenue 134.0 132.8 138.6 4.4 -0.9 4.4

Operating expenditure 170.3 168.0 176.8 3.2 -1.3 5.2
NFPEs current surplus 101.2 94.2 93.2 -15.2 -6.9 -1.1
Public sector current balance 64.9 59.0 55.0
% of GDP +9.6 +7.6 +6.6
Development expenditure 111.3 119.1 118.5 -10.5 7.0 -0.5
General government 54.5 57.1 54.8 7.9 4.8 -4.1
NFPEs 56.8 62.0 63.7 -23.1 9.2 2.8
Overall balance -46.4 -60.1 -63.5
% of GDP -6.8 -7.8 -7.6

1 Budget estimate, excluding 2011 tax measures

Source : Ministry Of Finance Economic Report 2010/2011

ECONOMIC 9 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
Widening Current Account Surplus Supportive Of A Stronger
Ringgit

The MOF expects the current account of the balance of payments to record The MOF expects the
a larger surplus of RM114.2bn or 14.1% of GNI in 2011, compared with the current account surplus
surplus of RM103.8bn or 13.8% of GNI estimated for 2010 (see Table 7). This is of the balance of
on account of a larger surplus in the merchandise trade during the year, as imports payments to widen in
are likely to slow down at a faster pace than exports, in tandem with a slowdown 2011
in the economy. This, however, will likely be offset partially by a widening deficit
in the income account during the year, as repatriation of profits by non-resident
controlled companies is likely to remain large. Similarly, repatriation of salaries and
wages by foreign workers is likely to widen slightly during the year. Meanwhile, the
services account surplus is projected to remain relatively stable in 2011. This is
broadly in line with our expectation, as we expect the current account surplus of the
balance of payments to widen marginally to around RM98.6bn or 12.4% of GNI in
2011, from a surplus of RM97.1bn or 13.0% of GNI estimated for 2010.

Table 7
Balance Of Payments

2009 2010(e) 2011(f) 2010(e) 2011(f)

MOF RHBRI
RM(bil)
Current account 112.1 103.8 114.2 97.1 98.6
(% of GNI) (16.9) (13.8) (14.1) (13.0) (12.4)
Goods 141.7 145.9 159.6 143.1 145.2
Services 4.7 0.5 0.5 -1.4 -0.9
Income -14.6 -25.1 -27.2 -26.1 -27.2
Current transfers -19.6 -17.4 -18.8 -18.5 -18.5
Capital account -0.2 n.a n.a 0.0 0.0
Financial account -80.2 n.a n.a -53.0 -45.5
Errors & omissions* -17.9 n.a n.a -50.0 -25.0
Overall balance 13.8 n.a n.a -5.9 28.1
Outstanding reserves^ 331.4 n.a n.a 325.4 353.5
(US$)^ 96.7 n.a n.a 94.9 103.7

* Includes errors & omissions and foreign exchange revaluation gains or losses
^ as at end of period
f: Forecasts e: Estimates
Source : MOF's Economic Report 2010/2011

The widening current account surplus will lead to a build-up of foreign exchange We expect the ringgit to
reserves and provide an underlying support to the ringgit. Indeed, the ringgit trade at RM3.00-3.10/
strengthened against the US dollar in recent months. The ringgit appreciated by US$ in 2011
5.4% against the US dollar between 18 June and 30 September, after depreciating
by 2.0% between 1 May and 18 June. Year-to-date, the ringgit has appreciated by
11.1% against the US dollar, the third strongest gain after the Japanese yen and Thai
baht. This was partly on account of a weakness in the US dollar as investors expect
the US Federal Reserve to announce its own big plan to buy government debt after
its 2-3 November FOMC meeting. The improving sentiment over regional currencies,
after China said that it would adopt a more flexible exchange rate on 18 June and
the liberalisation of administrative rules on foreign exchange transactions by the
Central Bank on 18 August further boosted the ringgit. A widening interest rate
differential in favour of Malaysia versus the US, after Bank Negara Malaysia raised
its key policy rate three times and by a total of 75 basis points this year, also helped.
This has attracted a sizeable amount of inflow of “hot money”, which has risen to
a more than 2-year high in August. As the “hot money” could come and go at
anytime, we expect the ringgit to remain volatile and will likely fluctuate at around
RM3.10-3.20/US$ for the rest of 2010. Already, the gain in the ringgit against the

ECONOMIC 10 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
US dollar has slowed down lately and it appreciated by 0.05% against the US dollar
between 30 September and 14 October. Further out, we expect the ringgit to
trade at RM3.00-3.10/US$ in 2011.

Bank Negara Will Likely Resume Its Policy Normalisation In 2011

The MOF expects inflation to rise to an average rate of +1.5% in 2010, from +0.6% The monetary policy
in 2009. It, however, did not provide any forecast on the inflation outlook for 2011. stance is expected to
Nonetheless, the MOF expects the accommodative monetary policy stance to remain accommodative
be maintained to support economic growth.

We expect inflation to trend up in 2011 due to the Government’s move to We expect the headline
gradually reduce its subsidies once every six months that will lead to higher retail inflation rate to pick up to
fuel and food prices. Already, the Government raised fuel prices by around 3% and an average of 2.8% in 2011
sugar price by 16.7% on 16 July. As a result, inflation rate accelerated to 2.0% yoy
in July-August, from +1.6% in the 2Q. This, however, will likely be offset partially
by a slowdown in demand. As a whole, we expect inflation to pick up to an
average of 2.8% in 2011, from +2.0% estimated for 2010.

Although the change in administrative pricing will lead to higher inflationary pressure, BNM is likely to resume its
we believe Bank Negara Malaysia (BNM) will unlikely act on it. As it stands, its policy normalisation in
interest rate hikes thus far were geared towards normalising monetary conditions in 2011 but the timing will
the economy rather than controlling inflation. Indeed, we believe the Central Bank depend on how soon the
is likely to have done with its interest rate hikes this year, after raising it by a total global economy stabilises
of 75 basis points in three meetings and the overnight policy rate (OPR) will likely
stay at 2.75% until end-2010. Further out, we believe the Central Bank will likely
resume with its policy normalisation and the OPR will likely be raised by 50-75
basis points to bring it to a more neutral level of 3.25-3.50% in 2011. The timing,
however, will depend on how soon the global economy stabilises.

ECONOMIC 11 UPDATE
A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com
 RHB DEALING AND RESEARCH OFFICES
MALAYSIA
RHB Investment Bank Bhd
Level 10, Tower One, RHB Centre,
Jalan Tun Razak
50400 Kuala Lumpur
P.O. Box 12699
50786 Kuala Lumpur, Malaysia
Tel (General) : (603) 9285 2233

Dealing Office
Tel (Dealing) : (603) 9285 2288
Fax (Dealing) : (603) 9284 7467

RHB Research Institute Sdn Bhd

Level 10, Tower One, RHB Centre,
Jalan Tun Razak
50400 Kuala Lumpur
P.O. Box 12699
50786 Kuala Lumpur, Malaysia
Tel (Research) : (603) 9280 2160
Fax (Research) : (603) 9284 8693

IMPORTANT DISCLOSURES

This report has been prepared by RHB Research Institute Sdn Bhd (RHBRI) and is for private circulation only to clients of RHBRI and
RHB Investment Bank Berhad (previously known as RHB Sakura Merchant Bankers Berhad). It is for distribution only under such
circumstances as may be permitted by applicable law. The opinions and information contained herein are based on generally available
data believed to be reliable and are subject to change without notice, and may differ or be contrary to opinions expressed by other
business units within the RHB Group as a result of using different assumptions and criteria. This report is not to be construed as an
offer, invitation or solicitation to buy or sell the securities covered herein. RHBRI does not warrant the accuracy of anything stated
herein in any manner whatsoever and no reliance upon such statement by anyone shall give rise to any claim whatsoever against
RHBRI. RHBRI and/or its associated persons may from time to time have an interest in the securities mentioned by this report.

This report does not provide individually tailored investment advice. It has been prepared without regard to the individual financial
circumstances and objectives of persons who receive it. The securities discussed in this report may not be suitable for all investors.
RHBRI recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek
the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor’s individual
circumstances and objectives. Neither RHBRI, RHB Group nor any of its affiliates, employees or agents accepts any liability for any
loss or damage arising out of the use of all or any part of this report.

RHBRI and the Connected Persons (the “RHB Group”) are engaged in securities trading, securities brokerage, banking and financing
activities as well as providing investment banking and financial advisory services. In the ordinary course of its trading, brokerage,
banking and financing activities, any member of the RHB Group may at any time hold positions, and may trade or otherwise effect
transactions, for its own account or the accounts of customers, in debt or equity securities or loans of any company that may be
involved in this transaction.

“Connected Persons” means any holding company of RHBRI, the subsidiaries and subsidiary undertaking of such a holding company
and the respective directors, officers, employees and agents of each of them. Investors should assume that the “Connected Persons”
are seeking or will seek investment banking or other services from the companies in which the securities have been discussed/covered
by RHBRI in this report or in RHBRI’s previous reports.
This report has been prepared by the research personnel of RHBRI. Facts and views presented in this report have not been reviewed
by, and may not reflect information known to, professionals in other business areas of the “Connected Persons,” including investment
banking personnel.

The research analysts, economists or research associates principally responsible for the preparation of this research report have
received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive
factors and firm revenues.

◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆ ◆

Lim Chee Sing

Director

RHBRI is a participant of the CMDF-Bursa Research Scheme and will receive compensation for the participation.
Additional information on recommended securities, subject to the duties of confidentiality, will be made available
upon request.

This report may not be reproduced or redistributed, in whole or in part, without the written permission of RHBRI and
RHBRI accepts no liability whatsoever for the actions of third parties in this respect.