After a blistering pace in 1Q10, the global economy softened in 2Q10. This cyclical slowdown is expected to persist in 2H10, given weaker global trade conditions and the ongoing sovereign debt problem in the Eurozone. Nevertheless, developing Asia continued to lead global growth through their resilient domestic demand.

Similarly in Malaysia, economic growth decelerated to 8.9% yoy in 2Q10 on slower growth in net exports. Domestic demand was strong with private investment gradually recovering. All key sectors moderated, but were dominated by manufacturing and services. The industrial production index (IPI) up 4.0% yoy in Aug-10, despite a slower rate of growth in gross exports. The shipment of electrical and electronic products eased to 3.8% yoy in Aug-10 due to weaker global demand for chips. Meanwhile, non-electrical and electronic products were also down to 15.8% yoy, due to falling global commodity prices.

Headline CPI increased 2.1% yoy in Aug-10, due to the effects from lower subsidies on part of fuel and sugar. Meanwhile, core CPI was also firmer at 1.5% yoy in Aug-10. The banking system’s outstanding loan growth eased to 11.8% yoy in Aug-10, due to weaker demand from the business sector of 9.9%. Household loans growth continued to improve at a healthy rate of 13.4%. Total deposits in the banking system were unchanged at 8.7% yoy in Aug-10. Liquidity remained ample as indicated by the loan-deposit ratio of 77.4%, arising from a weaker mom growth in total loans compared to total deposits.

The 3-month net NPL ratio was steady at 2.1% in Aug-10, while the risk-weighted capital ratio (RWCR) was at 15.1%. These measures indicated that asset quality remained healthy and the capital base of the banking system was strong. The growth rate of broad money (M3) increased 8.2% yoy in Aug-10, due to higher credit demand, public spending, and foreign inflows. Narrow money (M1) accelerated by 13.9% on larger transactional demand ahead of the Eid celebration.

Using this data, MIER maintains its 2010 and 2011 economic growth forecasts at 6.5% and 5.2% respectively. Importantly, these forecasts are also supported by recent in-house surveys. The Business Conditions Index (BCI) fell sharply to 104.9 pts in 3Q10, which more than offsets the surge in the Consumer Sentiment Index (CSI) to 115.8 pts. Other indices also painted a similar gloomy environment ahead.

In terms of interest rates, MIER anticipates the OPR to be kept at 2.75% until end-2010. This is useful in order to assess the effects of previous rate hikes and the possible impact from the economic fallout in the Eurozone. The OPR will trend higher to 3.25% in 2011, in tandem with a higher overall CPI forecast of 2.5% yoy (2.2% in 2010).

Recent foreign exchange liberalisation measures have lifted RM sentiment and should be conducive for further development of the financial market. However, these measures also generated more volatility to exporters. MIER forecasts an average RM/USD of 3.20 in 2010 before strengthening further to 3.10 in 2011.