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DEVELOPMENTS IN THE MALAYSIAN ECONOMY
Sustained growth momentum
supported by stronger exports
The Malaysian economy registered a growth of 6.3% (1Q 08: 7.1%) in the second quarter of 2008. Growth was supported by stronger export
performance, while domestic demand expanded at a more moderate pace in an environment of higher prices and costs. On the supply side, growth was driven by the key sectors of the economy.
Domestic demand moderated
Domestic demand moderated to 7.8% in the second quarter (1Q 08: 10%) refl ecting mainly the effects of higher prices and more cautious outlook by consumers and businesses. 
Private consumption expenditure grew by 9%. Although major consumption indicators such as credit card spending, imports of consumption goods as well as loans disbursed to households pointed to higher nominal consumer spending activities during the quarter, growth of private consumption in real terms moderated due to higher prices of consumer goods, particularly
in May and June. Concerns over rising prices following the subsidy restructuring also had affected consumer sentiments as refl ected by the drop in the MIER Consumer Sentiment Index to 70.5 points during the quarter (1Q 08: 115.5 points).
Public consumption continued to record a growth of 7.1% due to higher expenditure on emoluments, defence, supplies and services.
Gross fixed capital formation was sustained at 5.6% in the second quarter (1Q 08: 6%). Investment activity was supported by the continued infl ow of foreign direct investment, mainly into the services and manufacturing sectors. While indicators such as imports of capital goods pointed to continuing investment
activities, the higher cost of capital goods has moderated investment spending in real terms. In addition, business sentiments as indicated by the MIER Business Conditions Index moderated slightly to 114.1 points (1Q 08: 119.9 points). Meanwhile, the development expenditure of the government was higher, channelled mainly into education, improvement of public utilities, social
welfare services and transport infrastructure.
Business confidence moderated slightly while consumer sentiment declined significantly Points
Growth supported by the key sectors of the economy
On the sectoral front, the key sectors of the economy contributed positively to
growth, except for mining. The services sector benefi ted from trade, finance and consumption-related activities. Strong performance in domestic-oriented industries led the growth in the manufacturing sector, while growth in the agriculture sector was underpinned by double-digit expansion in crude palm oil output. The construction sector grew at a moderate pace amidst an environment of rising cost of building materials. Meanwhile, the mining sector contracted slightly due to lower output of natural gas.
Strong performance in services sector
The services sector expanded by 7.6% led by strong growth in the wholesale and retail trade as well as favourable performance in the communication; transport and storage; and finance and insurance sub-sectors.
The wholesale and retail trade sub-sector recorded a higher growth of 12.6% (1Q 08: 11.9%), supported by continued consumption activities, especially in the motor vehicle segment as well as higher tourism activities. Similarly, growth in the communication subsector was higher, driven by strong demand for voice and data services, particularly from the broadband segment.
Meanwhile, growth in the transport and storage sub-sector was sustained due to strong trade-related activities. Growth in the finance and insurance sub-sector remained favourable (7.5%; 1Q 08: 9.9%), supported by lending activities as well growth in the fee-based and insurance segments. 
Domestic-oriented industries supported the manufacturing sector
Value-added growth in the manufacturing sector expanded by 5.6% (1Q 08: 7%), supported by strong performance of the domestic-oriented industries as well as selected resource-based industries which are export- oriented.
Growth of domestic-oriented industries remained strong, expanding by 12.9% (1Q 08: 14.8%), driven by higher production in transport equipment, food and construction-related materials industries. The transport equipment industry benefited from the strong sales of new motor vehicles, while the construction-related materials industry was supported by strong regional demand and continued growth in the domestic construction sector.
Production of export-oriented industries moderated to grow by 2.1% during the quarter (1Q 08: 4.6%) on the lower output of computers and parts as demand from US slowed and production of petroleum and basic chemical products declined due to lower output of natural gas during the quarter. Nevertheless, output in electronics and electrical products (E&E) industry was sustained, driven predominantly by higher external demand for electrical products, particularly audio visual products, and semiconductors.
Output of semiconductors was in line with the rising trend of global semiconductor sales following continued demand for electronic products. Meanwhile, selected resource-based industries such as off-estate processing and rubber products continued to lend some support to the export-oriented industries. The strong growth in the off-estate processing industry was in tandem with the production of crude palm oil, while the rubber products industry was underpinned by higher external demand for rubber gloves. 
The overall capacity utilisation in the manufacturing sector remained unchanged at 78% in the second quarter, with the export oriented and domestic-oriented industries operating at 79% and 75% respectively (1Q 08: 79% and 74% respectively).
Strong growth in the agriculture sector
The agriculture sector continued to record a strong growth of 5.9% in the second quarter, driven by double-digit growth in crude palm oil production (21.8%), and further supported by better performance in paddy, livestock and fisheries sub-sectors. The mining sector, however, recorded a marginal decline due to lower output of natural gas. However, crude oil production (including condensates) increased by 0.7% during the quarter to 681,104 barrels per day. 
Moderate growth in the construction sector
The construction sector expanded by 3.9% during the quarter (1Q 08: 5.3%) as the uncertainty on prices of building materials led to moderation in growth in the civil engineering sub-sector. However, the overall growth was supported by the residential sub-sector, particularly in the high-end segment. The non-residential segment continued to be supported by demand for office space, especially in Kuala Lumpur. 
Inflation was higher in the second quarter
Headline inflation rose to 4.8% in the second quarter (1Q 08: 2.6%) mainly reflecting higher prices in the transport and food categories. Prices in the transport category increased by an average of 7.1% (1Q 08: 0.9%), primarily as a result of the new retail prices for petrol and diesel announced by the Government on 4 June 2008.
Prices in the food and non-alcoholic beverages category rose by 8% during the period, accounting for 52% of the overall inflation rate. High domestic rice prices, following soaring global rice prices contributed to the increase. Nevertheless, since May 2008 international rice prices have softened and are expected to limit further upward pressures on domestic rice prices. Meanwhile, price increases were also recorded in the alcoholic beverages and tobacco; restaurants and hotels; and miscellaneous goods and services categories.
In contrast, prices were lower in the communication; and clothing and footwear categories, reflecting the strong competition among producers in both markets. The price declines in these categories moderated the rise in headline inflation.
Headline inflation is expected to remain at elevated levels from June 2008, before beginning to moderate towards the middle of 2009.
Producer price index (PPI) inflation increased to 12.3% (1Q 08: 9.7%) due to higher prices in both the commodity and non-commodity based components of the PPI. Price increases in the commodity-based PPI components remained high due to elevated global prices for raw materials such as crude oil, rubber and crude palm oil. Meanwhile, prices in the non commodity-based PPI components increased at a faster pace, reflecting increased cost pressures facing domestic producers. 
In terms of composition, prices in the local component of the PPI increased to 15.4% (1Q 08: 11.2%). This reflected higher prices in the food and live animals; mineral fuels, lubricants and related materials; and chemical and related product categories. However, the imported component of the PPI rose at a slower rate of 6.1% (1Q 08: 6.6%) due to slower price increases mainly in the machinery and transport equipment; and manufactured goods classified chiefly by material categories.
Labour market conditions remained stable
While there was a marginal increase in retrenchments, overall labour market conditions remained stable in the second quarter, supported by firm labour demand and higher productivity growth in the manufacturing sector as a result of higher sales recorded during the quarter. Labour demand for all levels of skills continued to be strong, as reflected by the higher number of vacancies in the Electronic Labour Exchange (292,934 positions; 1Q 08: 219,366 positions). Broadly, there were more job openings in the services (33% share), manufacturing (32%) and agriculture (26%) sectors. Meanwhile, vacancies for graduates were concentrated in the financial sector. 
Total retrenchments increased slightly to 2,821 persons during the quarter (1Q 08: 2,397 persons), due mainly to lay-offs in the manufacturing sector (74% of retrenchments), and in the distributive trade, restaurants and hotels sub-sector (14% share). One-third of the retrenched workers were plant and machine operators and assemblers, while general workers constituted 28%.
Strong export growth, largely contributed by high commodity prices
Exports grew strongly by 20.8% in the second quarter, led by continued strong growth in commodity and resource-based manufactured exports and reinforced by recovery in exports of E&E. Import growth was also higher at 9.8%. As exports outpaced imports, the trade surplus increased further to RM40.8 billion. The robust agriculture exports were driven mainly by higher export prices. Export earnings from palm oil rose by 84.5% due mainly to higher prices (RM3,524 per tonne) and to some extent from higher export volume. Rubber exports, benefiting from significantly higher export prices, also contributed positively to the export growth. The sharp increase in agriculture prices was spurred by strong export demand from the regional countries, the US and Japan, and as well as the surge in oil prices. Higher crude oil prices and liquefied natural gas also partially explained the strong growth in mineral exports. Export price of crude oil increased by 58.1% to record an average of USD116 per barrel.
Higher manufactured exports were due mainly to higher prices in resource-based products and semiconductors. Exports of resource-based products such as chemicals and chemical products, rubber products and petroleum products increased further, benefiting from strong commodity prices and sustained demand. E&E exports recorded a positive growth after registering five quarters of negative growth. The improved performance in semiconductor exports was due to better global semiconductor prices and higher demand from PR China. Meanwhile, stronger exports of electrical products were attributed to higher demand from the PR China, Hong Kong SAR, Korea, Japan and US.
All categories of imports registered stronger growth in the second quarter. Growth in intermediate imports was in tandem with higher manufactured exports. Capital imports were supported by continued investment activities in the domestic economy, while strong growth in consumption imports reflected mainly continued consumption activities and high prices for imported consumer products such as processed food and beverages. 
Larger FDI amidst reversal in portfolio investment
On a cash basis, gross inflows of foreign direct investment (FDI)2 increased to RM12.2 billion (1Q 08: RM7.1 billion), due mainly to larger drawdown of inter-company loans from parent companies abroad and inflows of equity capital. The FDI inflows were channeled mainly into the services (74%), manufacturing (11%) and oil and gas (10%) sectors. FDI in the services sector reflected partly foreign acquistion of interests in two domestic banks and the commencement of operations by a new foreign takaful company, as well as continued investments in the wholesale and retail trade sub-sector. Meanwhile, FDI inflows in the manufacturing sector were channelled mainly into the E&E, solar panels, and downstream petroleum related industries. After adjustments for gross outflows due mainly to repayments of the short-term loans, net FDI was higher at RM8.3 billion (1Q 08: RM2 billion).
Overseas investment by Malaysian companies recorded a net outflow of RM3.5 billion (1Q 08: - RM6.6 billion), mainly in the services and manufacturing sectors. In the services sector, overseas investments reflected mainly the acquisition of a strategic stake in the finance and insurance sub-sector, as well as investments in the real estate and business services sub-sector. Meanwhile, overseas investments in the manufacturing sector were mainly for the acquisition of a process equipment manufacturer, followed by investments in the E&E, automotive and chemical-related industries.
Portfolio investment registered a net outflow reflecting mainly the liquidation of both bonds and equities by foreign investors. During the quarter, investor sentiment was affected by continued volatility in the global financial markets amid concerns of slower growth in the US and the lingering effects of the credit crisis, as well as concerns over the impact of high energy prices and rising cost of production on domestic growth prospects. These developments were also broadly experienced in other regional markets.
External debt remained manageable
As at end-June 2008, Malaysia’s total external debt amounted to RM234.8 billion or USD71.2 billion (end-March 08: RM216.7 billion or USD67.1 billion), equivalent to 34.4% of GNI. The medium- and long-term external debt was higher at RM142.3 billion (end-March 08: RM135.1 billion), due mainly to a net drawdown by the private sector (+RM5.3 billion), largely by a non-resident controlled company to finance its investment as well as borrowings by companies in the manufacturing sector. Meanwhile, the public sector continued to record a net repayment (-RM0.4 billion) as repayment by the NFPEs more than offset a net drawdown by the Federal Government.
The total short-term external debt increased to RM92.5 billion or USD28.1 billion (end-March 08: RM81.6 billion or USD25.3 billion) due mainly to inter-bank borrowings arising from treasury operations. As at end-June 2008, the short-term debt remained low and accounted for 22.5% of the net international reserves.  International reserves
The international reserves of Bank Negara Malaysia amounted to RM410.9 billion (equivalent to USD125.8 billion) as at 30 June 2008. The reserves level as at 30 June 2008 has taken into account the quarterly adjustment of the foreign exchange revaluation gain, following the strengthening of the major currencies against ringgit during the quarter. The reserves amounted to RM403.9 billion (equivalent to USD123.7 billion) as at 15 August 2008. The reserves position is sufficient to finance 9.7 months of retained imports and is 5 times the short-term external debt. 
Improved fiscal position
The Federal Government’s fiscal deficit in the second quarter was lower at 1% of GDP (RM1.9 billion) as the rise in total revenue was larger than the increase in operating expenditure (1Q 08: fiscal deficit of 4.4% of GDP or RM7.7 billion). There was greater revenue collection from petroleum-based turnover and corporate income taxes. Total expenditure rose at an annual rate of 34.8% due to increases in both operating and development expenditures. The deficit was financed mainly from domestic sources. As at end-June 2008, total outstanding debt of the Federal Government amounted to RM285.1 billion or 39.8% of GDP. 
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