Construction Growth Slowdown Still Expected

BMI View: Despite a strong performance by the residential and non-residential buildings sector in Q313, we continue to expect construction activity in Malaysia to slow its pace of expansion in 2014. This is because we expect the demand for residential and non-residential buildings to fall in 2014, while fiscal concerns will continue to present financing risks for public-funded projects, particularly within the infrastructure sector. Having said that, the government has been very successful in attracting foreign and private sector parties to implement and finance its investment plans, and we believe this success is a positive tailwind for construction activity.

The slowdown in Malaysia's construction growth has taken a respite in Q313. Latest figures from the Malaysian Department of Statistics show that real construction growth came in at 10.2% year-on-year (y-o-y) in Q113. This is a marginal increase from the 9.9% y-o-y seen in Q213, but much lower than the growth of 17.9% in Q312.

This respite was primarily due to a pick-up in work done for the non-residential building sector, with growth in non-residential work reaching 9.9% y-o-y in Q213. This was much higher than the 0.5% y-o-y in Q213, but still lower than the growth of 16.1% y-o-y in Q312.

Decline Checked
Malaysia Quarterly Construction Industry Data

BMI View: Despite a strong performance by the residential and non-residential buildings sector in Q313, we continue to expect construction activity in Malaysia to slow its pace of expansion in 2014. This is because we expect the demand for residential and non-residential buildings to fall in 2014, while fiscal concerns will continue to present financing risks for public-funded projects, particularly within the infrastructure sector. Having said that, the government has been very successful in attracting foreign and private sector parties to implement and finance its investment plans, and we believe this success is a positive tailwind for construction activity.

The slowdown in Malaysia's construction growth has taken a respite in Q313. Latest figures from the Malaysian Department of Statistics show that real construction growth came in at 10.2% year-on-year (y-o-y) in Q113. This is a marginal increase from the 9.9% y-o-y seen in Q213, but much lower than the growth of 17.9% in Q312.

Decline Checked
Malaysia Quarterly Construction Industry Data

This respite was primarily due to a pick-up in work done for the non-residential building sector, with growth in non-residential work reaching 9.9% y-o-y in Q213. This was much higher than the 0.5% y-o-y in Q213, but still lower than the growth of 16.1% y-o-y in Q312.

Non-Residential Building Recovering
Malaysia - Construction Work Done, By Quarter, By Sector, % (LHS); Growth, % chg y-o-y (RHS)

On the other hand, work done for the civil engineering sector (rather than the residential building and non-residential building sectors (in BMI terms, the civil engineering sector includes construction works in the transport and utilities infrastructure sectors as well as the commodities sectors) continues to ease. After a temporary hiatus in Q113, growth in civil engineering work continued its steady decline to reach 6.5% y-o-y in Q313, the lowest growth rate since Q211. Work done for the residential building sector also experienced a growth slowdown in Q313, though to a much lesser extent. Growth in residential work reached 23.6% y-o-y in Q313, compared to 25.6% y-o-y in Q213 and 21.1% y-o-y in Q312.

Residential/Non-Residential Weakness

We continue to hold the view that this level of growth for the residential and non-residential buildings sectors is unsustainable, with both sectors to experience a slowdown in growth rates in 2014. This is reflected in our forecasts, with real growth for the buildings sector to reach 8.7% and 5.3% in 2013 and 2014 respectively, lower than the 10.2% seen in 2012. This outlook negatively affects our short-term forecasts for Malaysia's construction sector, with real growth for Malaysia's construction sector projected to continue to slow to10.1% in 2013 and 6.7% in 201, lower than the 18.1% seen in 2012.

On Track To Slow
Malaysia - Construction Industry (and its Components) Value Forecasts

Residential Construction: We expect housing demand in Malaysia to weaken in 2014 and this will negatively affect residential building activity. This is due to the current oversupply situation at the high-end housing market, the introduction of new government measures to curb speculation in the property market such as a major hike in real property gains tax and the ongoing slowdown in the Chinese economy.

The planned supply for residential properties in Q213 was near record-low, while housing prices in Malaysia appear to have topped out ( see chart). We believe the fall in housing prices suggests that the demand for housing in Malaysia is weakening, which in turn is deterring developers from constructing new residential projects, hence the decline in planned housing supply. In addition, we believe that we have yet to witness the worst of China's economic slowdown and we could see demand for real estate stall over the coming quarters, particularly from overseas buyers. We do however highlight that the government's recent initiatives to incentivise developers to build affordable housing could soften the blow from a decline in building activity from the high-end segment.

Residential Slowing
Malaysia - Residential Property Under Construction And Planned Supply, '000 unit (LHS); And Housing Price Index, 2000=100 (RHS)

Non-Residential Construction: Weakness in the Chinese economy is also expected to dampen demand for non-residential buildings in Malaysia over the short-term and reverse the recent growth in non-residential building activity ( see 'Industrial Production Data Supports Subdued Outlook On Growth', November 29 2013). This is because Malaysian exporters (a major component of the economy) are likely to face a challenging economic environment in 2014, due primarily to the country's close trading ties with China - Malaysia's trade exports to China as a share of GDP have surged from 14.4% in 2008 to 23.1% in 2011, the highest among our group of ASEAN countries. We expect this slowdown in exports to dampen the demand for industrial and office buildings in 2014.

Non-Residential Too
Malaysia - Non-Residential Buildings By Sector, Planned Supply

Having said that, we have seen the planned supply for non-residential buildings bottom out and experience a minor increase from their five-year lows (see chart). This suggests that there could be renewed optimism towards the economic outlook for Malaysia from foreign and private investors. This optimism could soften the impact of a Chinese economic slowdown. To be sure, foreign direct investment (FDI) into Malaysia rose by a staggering 71% to MYR30.7bn in H113, and is likely to exceed the government's full-year growth target of above 20%, according to the Malaysian Investment Development Association. Meanwhile, investment channelled towards the government's 10-year economic plan, the Economic Transformation Programme (ETP), remains substantial. According to a recent report published by the Performance Management & Delivery Unit in August 2013, 86% or MYR25.4bn in committed investments for projects in 2011 and 2012 have already been realised, and the ETP is right on track to meet its 2013 targets.

Weakness Reinforced By Fiscal Threats

Our call for a slowdown in residential and non-residential building activity is reinforced by concerns about Malaysia's fiscal position. On July 31 2013, Fitch Ratings downgraded its 'A-' credit outlook for Malaysia from stable to negative, citing the lack of progress on budgetary reforms to address the country's deteriorating fiscal position.

This downgrade prompted the Malaysian government to announce decisive steps to bring the country's fiscal accounts back in order during its 2014 budget announcement ( see '2014 Budget: A Step In The Right Direction', October 29 2013). While we believe that the measures announced by the government are positive for Malaysia's construction sector, the effects of these measures will only take place over the medium-to-long term. Meanwhile, the effects of welfare spending (which are still excessive) will continue to have a negative impact on government investment over the near-term ( see '2014 Budget: Implications On Infrastructure Capex', October 31 2013).

Not An Easy Balancing Act
Malaysia - Fiscal Balance, MYRmn (LHS) & % of GDP (RHS)

In our opinion, this means that some of the government's large-scale construction projects could still be postponed, even though no project postponements were stated during the 2014 budget announcement. One such project is the MYR26bn Tun Razak Exchange (TRX). Anecdotal evidence indicates that there is an excess supply of office space in certain areas of the Klang Valley and the TRX was expected to significantly increase office space in the valley over the coming years.

Infrastructure Affected Too

We expect a decline in government investment to have a significant impact on infrastructure activity over the coming years as the public sector accounted for 58% of civil engineering works in Q313. This is reflected in our forecasts, with real growth for the infrastructure sector forecast to reach 12.8% and 9.1% in 2013 and 2014 respectively, lower than the 48.0% seen in 2012.

While no infrastructure projects were postponed during the 2014 budget announcement, we still believe that hydropower plant projects in Sarawak could be deferred. The state already enjoys excess electricity supply, but is still planning to develop more of its hydropower resources under the Sarawak Corridor of Renewable Energy programme ( see 'Sarawak-West Kalimantan Line Heralds Greater Regional Interconnection', August 30 2013).

Peaking Differently
Malaysia - Construction Industry Value Real Growth Forecasts, By sub-sector, % chg y-o-y

This decline in government investment could also increase the government's reliance on foreign and private sector parties to implement its investment plans. So far, Malaysia has been very successful in this regard, be it through direct investment or with securing financing through the use of Islamic bonds.

This success looks set to continue over the coming years, even for projects with questionable viability. We had previously highlighted that the proposed high-speed railway line between the Singapore and Kuala Lumpur could be deferred due to its high cost and its perceived potential benefits to foreign companies and foreign economies residing in Singapore ( see 'Construction Outlook: Fiscal Risks To The Fore', September 11 2013). However, it appears that government-level negotiations between Singapore and Malaysia over the project are still on track, with several Malaysian and foreign companies already in the process of forming consortiums to bid for the project, according to The Star in November 2013.

Infrastructure Pipeline Shrinking
Malaysia - Value of Construction Work Done By Stage Of Project Completion, By Sector, Q3 2013, MYRmn

At present, the project pipeline for Malaysia's infrastructure sector is shrinking, with a growing number of projects moving closer to completion ( see chart above). We expect this trend to reverse soon as several large-scale infrastructure projects are scheduled to be implemented over the near-term. Key examples of these infrastructure projects are:

Urban Railways: A notable example is the Greater KL MRT development, the largest infrastructure project currently being developed in Malaysia. The Malaysian government has started construction works on the first line of the 156km MRT project and is set to finalise details of the second and third lines by the end of 2013. The urban railway project has already been highlighted by the government as a project that would be implemented as planned due to its potential to be a high economic multiplier (increased ease of travel).

Power Plants: Another notable example is the power sector, where fears of a power shortage in Peninsular Malaysia have prompted the government to award contracts for the construction of several large-scale thermal power plants. In August 2013, Malaysian state-owned utility Tenaga Nasional (TNB) was awarded a 1000MW coal-fired power plant project in Perak. The utility has since awarded the EPC contract for the project to a Japanese-South Korea consortium, making it highly likely for the project to start construction works at the start of 2014 ( see 'Daelim's Win A Change In Competitive Landscape', August 27 2013).

Roads: We expect expressway projects planned by the government to continue to be implemented given their importance in unlocking new growth areas and supporting Malaysia's export-oriented economy. Several large-scale road projects have already been awarded (such as the West Coast Expressway and the integrated road project In Penang) or are in an advanced stage of planning (such as the Damansara-Shah Alam Highway and the Sungai Besi-Ulu Kelang Elevated Expressway).

Increased Political Stability

We highlight that a pertinent upside risk to our forecasts over the long-term is the recent increase in political stability within Malaysia. In September 2013, Prime Minister Najib Razak secured an uncontested victory for his presidency of the ruling United Malays National Organisation (UMNO), while in October 2013, Prime Minister Najib Razak's political allies won a sweeping victory during the latest party elections in UMNO ( see 'Uncontested Victory For Najib Positive For The Economy', September 24 2013, and 'Sweeping Victory For Incumbents To Pave The Way For Reforms', October 22 2013). These victories ensure that the economic reforms and investment plans introduced by Najib - such as the ETP and the fiscal consolidation measures - will have a strong likelihood of being implemented over the coming years.

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