Response to Recession

Recent Economic Data Pointing to Deepening Recession
- Industrial production fell sharply in December, reflecting weakness not only from falling external demand but also domestic demand. Monthly indicators of services activity suggest that 4Q08 GDP growth will likely fall below our current forecast of 2%yoy, and -4% QoQ SAAR. While we maintain our 2009 forecast of 0.5% pending 4Q08 GDP, we would not be surprised to see 2009 GDP growth fall by -1 to -2% instead.

§ Pause, But Not End of Monetary Easing - Governor Zeti's comments that "it is not constructive to have too low rates" implies that further OPR cuts are unlikely in Feb. But the worsening outlook could prompt further cuts in 2Q09. A widening fiscal deficit, cuts in EPF contribution rates, are raising supply risk in the bond market, potentially sparking sell off in foreign holdings of Malaysian bills/bonds, further MYR weakness and cause back-end yields to spike. Monetary easing may be needed to anchor back-end yields and accommodate looser fiscal stance.

§ RM10-15bn "Mini-Budget" To Be Announced on March 10th - Possible targeted tax incentives for SMEs, and incentives for the tourism and manufacturing are likely. Possible cuts in EPF contribution rates to boost disposable income and/or lower wage costs, but concerns over sufficient EPF demand to absorb MGS supply could be constraints. Further liberalization in services will have limited immediate effects, but could position Malaysia favourably for the eventual recovery.

§ Political uncertainties rear their ugly head again - Political noise could divert the government's energy away from addressing the impending economic woes, and deter foreign investors further. Coming soon after DPM Najib's inauguration as PM in March, the two by elections in Kedah and Perak in April are widely viewed as referendum on his premiership.
§ Markets
§ Fixed Income Markets - It was a cautious start to the week for the local bond market ahead of the 10-year GII Tender on Thursday. A steeper yield curve was the play of the week, as yields rose across the curve, on supply concerns ahead of the 2nd economic stimulus package, which is to be announced in parliament on March 10th.

§ Interest Rate and Related Derivatives - Global positive sentiment towards risky assets (emerging markets) were short-lived as the release of the US bank rescue plan was deemed to lack detail. MYR closed the week at 3.6010/30. $MYR forwards move right as BNM Governor Zeti seemed to rule out a rate cut in Feb, 6s 60/80 (previous week's close -30/par).


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