Prudent Budget focusing on Budget Deficit

KUALA LUMPUR (Oct 1): We believe Budget's 2013 real gross domestic product (GDP) growth projection for 2012 is achievable. We are looking at a much stronger real GDP growth of 5.3% vis-à-vis Budget 2012 projection of 4.5%-5.0%.

Following the strong economic growth in the first half of 2012 (1H2012) by 5.2% year-on-year (y-o-y), the economy is poised to register a credible growth in 2H2012 boosted by domestic demand and complemented by exports which we expect will expand by 3.3% hurt from the on-going euro crisis, fiscal cliff in US and slower growth in China.

Looking at 2013, our view is that the economy would expand by 5.8%, which is much stronger than Budget 2013 projection of 4.5%-5.5%. Domestic demand will still be the main driver of the economic growth. Growth will continue to come from private consumption.

Lending support to private consumption in our view are: a healthy labour market, better income growth coming from domestic and export sectors as well as from commodities, strong real disposable income on the back of low inflation, improved consumer sentiment, financial assistance to the lower income households and a stronger spending power by pensioners as well as civil servants.

Gross fixed capital formation will remain strong driven by the on-going projects and the roll out of new projects. One particular area will be the capital expenditure from the federal government.

Focus will continue in the ongoing areas like public transportation system and infrastructure. Also, emphasis will continue in the social services area like education and training to improve human capital skills and knowledge. Upgrading of schools and also hospitals will also add positive impetus to public sector.

We expect capital spending by non-financial public enterprises (NFPEs) in the area of mining to support public expenditure. Emphasis will be on the upstream and downstream segments in new oil and gas fields. Other areas of growth drivers will come from the development in the on-going transportation sector like the Light Rail Transit (LRT) line extension project, fleet expansion and airport construction, utility and communication sector.

Private investment will be boosted by domestic-oriented industries
Ongoing Economic Transformation Programme (ETP) projects will augment private investment activity. Investment in mining sector will support private investment, especially in the area of exploration and development activities in deepwater and marginal oil fields. Services sector will boost private investment via capital expenditure in the consumer oriented industries, communications sector and also in the area of wholesale and retail trade.

Also, private investment in the export-oriented industries is poised to improve in 2013. Expenditure will continue from the resource-based industries and also in new growth areas encompassing renewable energy and advanced E&E products like light-emitting diodes (LEDs) and test equipment.

Complementing will be exports. We expect exports growth to be much stronger at 6.0%-8.0% in 2013 supported by firmer commodity prices (palm oil at RM3,000-RM3,100 per ton and crude oil at US$90-US$100 per barrel) supported by improving E&E sector and intra-regional trade. We project 2013 global growth at 4.1% and global trade at 7.0% from 3.3% and 3.5% respectively in 2012.

The estimated Budget deficit for 2012 of -4.5% of GDP turned out to be slightly better than our projection of -4.7% of GDP. We view the improvement positively and believe it is due to higher revenue which compensated for the increase in expenditure.

A key challenge for the government is to reduce the budget deficit in 2013 amidst the on-going multiple headwinds on the external front ranging from the on-going euro debt issues, US fiscal cliff and slower growth in China and India. The magnitude of the reduction of the budget will depend much on how the global and domestic economy crafts out. With our economic growth projection of 5.8%, we believe the deficit could ease to 4.0%-4.3% of GDP in 2013.

We are of the view that the reduction in budget deficit will have to be gradual given the on-going uncertainty on the global front, although it is expected to ease further. Should the global growth improve in 2013 surpassing our 4.1% growth target, we believe there are possibilities for the deficit to dip below the 4.0% threshold. If that happens, it will be the first time since 2007.

While we applaud the lower budget deficit in 2013, there could be some concern with respect to the decline in gross development expenditure, dragged by direct expenditure. We suspect the drop could be due to the increasing role of Private-Public-Partnership.

We believe the impact from the on-going implementation of the 12 NKREAs and EPPs have been well priced-in into the economic growth for 2013.

We view this move positively since it tends to blend with the roadmap of achieving high-income nation and step up gross national product/gross national income (GNP/GNI) by alleviating the mood of local firms to leverage on outsourcing, acquiring technology and foreign companies and also merge into bigger entities. We believe such incentives will allow the local firms to take advantage in the global market by alleviating their product integrity and also their overall market share.

We view this move positively. It will help ease the burden of small-medium enterprises (SMEs), especially with respect to financing which in turn would accelerate their growth, innovation and productivity. With SMEs playing a critical role, we believe such funding will improve the overall contribution of the SMEs to the economic growth.

Construction sector to see double-digit growth again next year
Despite no surprises in the form of new project announcements in Budget 2013, we are comfortable with the growth numbers that are guided by the government. The government expects the construction sector to grow by 15.5% and 11.2% in 2012 and 2013 respectively.

Going forward, we believe the government will continue to focus on awarding and executing big-ticket projects to meet its double-digit growth target. The projects, among others are West Coast Expressway, MRT2 or MRT3 line, Southern Double Tracking, Prai Power plant, and Langat 2 treatment plant.

In addition, we will also be seeing awards of sizeable mixed development projects such as Tun Razak Exchange (TRX) and Kwasa Damansara to materialise end-2012 or next year. These projects, collectively, could worth as much as RM90 billion.

Property sector may see demand shifted to the affordable segment
We are not surprised with the revision to the real property gains tax (RPGT) as it had been widely speculated. We believe the increase in RPGT is crucial for the long-term sustainability of the property sector, as uncontrolled property speculation activities will lead to a property bubble.

Additionally, we foresee higher demand for properties priced below RM400,000 due to (i) further extension to stamp duty exemption on the instrument of transfer agreements and loan agreements for the purchase of the first residential property, as well as (ii) higher income limit for My First Home Scheme.

Various goodies to the people will benefit the Consumer sector. We are seeing a positive impact to the Consumer sector from the measures announced today given the government's efforts to tackle the rising cost of living via the increase in the Rakyat's disposable incomes. However, the "hand-outs" are done in small pockets across the economy and it is unlikely that the increase will significantly improve the Rakyat's wealth or consumer confidence to the extent that it creates significant growth in the sector.

No extension to Auto 'green' incentives
There was no mention in the budget announcement of an extension to the full exemption of import and excise duties for hybrid and electric vehicles. However, we are still hopeful that the duties extension will be announced in the upcoming National Automotive Policy (NAP).

Cigarette tax stays
As we had expected, the government retained its stance of not increasing the excise duty for cigarette, and maintaining it at the current level of 22sen per stick. This is consistent with the government's intention of bringing further down the level of illicit cigarette in the market.

To recap, the illicit trade activities are costing the government RM1.8 billion annually in lost excise collection. Hence, we view the absence of an excise hike in Budget 2013 positively, as it will further suppress the illicit cigarette, boost the total industry volume, and enhance government's excise duty collection.

Overall, our positive view on the market remains. We find no material surprises from the budget that may spur additional trading interest in the equity market.

Having said that, we expect the market to retain its upward momentum, supported by the still rising tide of external liquidity as attested by the continued inflows of foreign funds.

In addition, despite its premium relative valuation vis-à-vis other regional bourses, the FBM KLCI is currently trading at a discount relative to its historical yardstick. If we were to peg its CY13 PER to the historical average of 14.78x, the local benchmark should be valued at circa 1,750 points level.

Hence we retain our FBM KLCI 2012 yearend target of 1,670 points which is equivalent to PER of 15.4x CY2012 earnings.