VZCZCXRO3285
RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHKL #1108/01 1860507
ZNR UUUUU ZZH
R 050507Z JUL 07
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 9596
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1491
RUCNASE/ASEAN MEMBER COLLECTIVE
RUEHBY/AMEMBASSY CANBERRA 2358

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001108 
 
SIPDIS 
 
STATE PASS USTR - WEISEL AND JENSEN 
STATE PASS FEDERAL RESERVE AND EXIMBANK 
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN 
USDOC FOR 4430/MAC/EAP/J.BAKER 
TREASURY FOR OASIA AND IRS 
GENEVA FOR USTR 
CANBERRA FOR ECON - MATTHEWS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV MY
SUBJECT:  Malaysia's Economy Slows in Q1 
 
REF:  KUALA LUMPUR 
 
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Summary 
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¶1. (U) Malaysia's economic growth slowed to 5.3% in the first 
quarter of 2007, down from an average of 5.9% in 2006.  Services led 
the way with 9.6% growth and construction continued to recover as 
development funds from the Ninth Malaysia Plan (9MP) finally started 
flowing in significant amounts.  The agriculture and mining sectors 
recorded puzzlingly weak results, in view of the strong world demand 
for commodities.  Government fiscal stimulus should generate 
stronger growth as the year progresses, with continued 
implementation of 9MP programs, and spending associated with 
expected elections and Malaysia's 50th anniversary of independence. 
Nevertheless, Finance Minister (II) Nor Yakcop expects the 
government's deficit target of 3.4% of GDP.  End summary. 
 
--------------------- 
Services Lead the Way 
--------------------- 
 
¶2.  (U) Malaysia's GDP growth slowed in first quarter 2007 to 5.3% 
from an average rate of 5.9% during 2006.  Nevertheless, the first 
quarter exceeded the expectations of many analysts who had forecast 
4.7% growth. 
 
¶3.  (U) On the supply side, services led the way, expanding 9.6% 
year-on-year in Q1, partly due to increased tourism under the 
GOM-sponsored promotion campaign "Visit Malaysia Year 2007."  Growth 
in the finance, insurance, real estate and business services 
sub-sector expanded a strong 17.6%.  Manufacturing, the traditional 
backbone of Malaysia's economy, grew a scant 1.7% year-on-year on 
weak global demand for electrical and electronic products. 
Agriculture also disappointed, growing 2% year-on-year on lower 
output of crude palm oil and rubber.  Mining shrank 1.1% 
year-on-year because of lower crude oil production, which slipped 
3.8% to 680,153 bpd in Q1 2007 from 707,294 bpd in Q1 2006.  The 
construction sector rose 4% as government projects commenced under 
the Ninth Malaysia Plan.  (Comment:  The fact that both agriculture 
and mining recorded such slow growth, despite high world prices for 
palm oil, rubber and petroleum, is somewhat surprising.) 
 
 
------------------------------- 
Domestic Demand Pulls the Train 
------------------------------- 
 
¶4. (U) Domestic demand grew a steady 7.6% year-on-year in Q1 2007. 
Private consumption rose a stronger 8.6% year-on-year.  A stable 
labor market and high commodity prices of palm oil and natural 
rubber helped buoy consumer spending.  The Malaysian Institute of 
Economic Research's (MIER) Consumer Sentiments Index (CSI) rose 13.2 
points to 124.1 points in the first quarter, its highest level since 
Q3 2000.  MIER's data indicates consumers have increased confidence 
regarding employment and income prospects.  Public consumption 
increased 7.3%, primarily due to higher government spending for 
salaries, supplies, and services.  This is expected to increase 
further with the implementation of recently announced civil service 
pay raises ranging from 7.5% to 35.0%, and a doubling of the cost of 
living allowance (COLA) for more than one million government 
employees which takes effect July 1.  The pay increase will cost the 
government an additional RM 8 billion (US$ 2.35 billion) annually. 
 
 
¶5. (U) Total investment expanded by 5.4% during the first quarter of 
2007, down from 9.8% in the fourth quarter of 2006.  The government 
disbursed an estimated RM 5.3 billion (US$ 1.53 billion) of 
development spending in Q1.  Although the development expenditure 
was 2.5 times that of the last corresponding quarter, the rate of 
disbursement is expected to speed up in the second-half of the year 
as 9MP projects heat up.  MIER's Business Conditions Index (BCI) 
eased by 1.7 points to 105.5 in the first quarter, but still stayed 
above the 100-point (business neutral) benchmark.  According to the 
MIER survey, manufacturers were slowing production in reaction to 
disappointing domestic and external orders.  However, manufacturers' 
outlook for the near-term remains positive and increased output is 
planned for next quarter. 
 
¶6. (U) Exports slowed significantly, growing only 1.9% year-on-year 
 
KUALA LUMP 00001108  002 OF 003 
 
 
in Q1, due to weak demand for electronic and electrical products. 
Imports remained moderate, expanding 3.5% over the first quarter 
supported by higher imports of intermediate and consumer goods. 
 
 
----------------------------- 
Lower Fiscal Deficit, For Now 
----------------------------- 
 
¶7. (U) The federal government recorded a fiscal deficit of RM 2.6 
billion (US$ 754 million), or 1.8% of GDP in Q1 2007, compared to a 
fiscal surplus of RM 4.9 billion (US$ 1.3 billion), or 3.6% of GDP 
in Q1 2006.  In 2006, the overall fiscal deficit was 3.5% of GDP. 
Total government spending rose 38.7% year-on-year in the first 
quarter of 2007.  Development spending rose 148% year-on-year with 
the starting of the 9MP projects.  Revenue collections remained flat 
at RM 24.2 billion (US$ 7.2 billion) in the quarter. According to 
press reports, Finance Minister (II) Nor Mohamed Yakcop expressed 
confidence that the government would meet its fiscal deficit target 
of 3.4% of GDP in 2007. 
 
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Reserves Escalate as External Debt Declines 
------------------------------------------- 
 
¶8. (U) Malaysia's foreign exchange reserves rose to US$ 88.6 billion 
as of the end of March 2007, from US$ 82.5 billion at the end of 
December 2006.  Reserves rose further to US$ 98.4 billion by 
end-May, sufficient to finance 9 months of retained imports.  In May 
alone, reserves rose by US$ 6.8 billion, accounting for 43% of the 
net increase year to date.  Large foreign inflows prompted by the 
inclusion of Malaysia in a widely followed global investment index 
contributed significantly to the surge.  Net inflows of portfolio 
investment rose from RM 5.4 billion (US$ 1.6 billion) in Q4 2006 to 
RM 26.9 billion (US$ 7.8 billion) in Q1 2007.  Two-thirds of the 
inflows were invested in shares and corporate securities, 21.3% in 
monetary instruments and 7% in Malaysian government securities. 
 
 
¶9.  (U) Malaysia's external debt declined (in ringgit terms) to RM 
178 billion (US$ 51.0 billion) at the end of March from RM 183.1 
billion (US$ 51.4 billion) at the end of 2006 as the ringgit 
appreciated against major currencies, particularly the dollar.  The 
volume of medium- and long-term external loans fell.  Public sector 
debt declined as the federal government borrowed less and repaid 
external debt.  Private sector debt remained unchanged.  Both public 
and private short-term debt declined 6.9% to US$ 38.9 billion (US$ 
11.3 billion). 
 
--------------------------- 
Key Interest Rate Unchanged 
--------------------------- 
 
¶10. (U) Malaysia has kept its key benchmark interest rate unchanged 
at 3.50% since April 27, 2006.  Slower GDP growth in Q1 had raised 
expectations that Bank Negara might consider cutting rates to 
stimulate the economy.  However, the central bank signaled it was 
unlikely to reduce rates, stating that they are at the appropriate 
level to support domestic demand. 
 
¶11. (U) The ringgit appreciated against the major currencies during 
the first quarter.  The ringgit reached its 10-year high of RM 3.388 
to the dollar on May 28, but weakened to RM 3.4835 on June 27 as the 
dollar regained its strength. 
 
--------------------------- 
Inflationary Pressures Ease 
--------------------------- 
 
¶12. (U) As measured by the Consumer Price Index (CPI), inflation was 
moderate at 2.6% year-on-year in Q1.  In March, Malaysia's inflation 
eased to its lowest level (1.5% year-on-year) since August 2004. 
For January through May, the CPI rose 2.2% year-on-year as compared 
to 3.6% during the same period in 2006.  Bank Negara forecasts that 
inflation will average around 2.0% to 2.5% in 2007. (Comment: 
Malaysia's CPI statistics are misleading because they are based 
largely on fixed-price items, including highly-regulated food 
products.) 
 
--------------------------------------------- -- 
Signs Point to Faster Growth in the Second Half 
 
KUALA LUMP 00001108  003 OF 003 
 
 
--------------------------------------------- -- 
 
¶13. (U) Comment:  With the government opening the spending taps, 
economic activity undoubtedly will strengthen over the 5.3% recorded 
in the first quarter.  Such stimulus is not, however, a good 
foundation for diversified long-term term growth.  Prime Minister 
Abdullah has said he wants the private sector to drive the economy, 
but Malaysia remains highly dependent on government spending to 
sustain its development.  The poor results in the agriculture and 
mining sectors are puzzling given the strong worldwide demand for 
these commodities.  They bear watching to see if this is a one time 
event, or if capacity constraints may be preventing Malaysia from 
taking full advantage of the favorable conditions for its basic 
commodity exports. 
 
 
 
LAFLEUR