The Economic Transformation Program

My verdict: Good to Pretty Good. Liked the fact that PEMANDU is there, supposedly to ensure proper execution of the projects.

Hwang DBS: The Government held an Open Day to present ideas for the Economic Transformation Program (ETP) on various key economic sectors for the country – including oil, gas & energy, financial services, palm oil and wholesale & trade. In our view, the program, approach and selected ideas/initiatives highlighted inspire optimism. If implemented successfully, we believe the projects will be able to generate greater economic activity.

Among the key projects, we understand that the RM36bn KL MRT, which features in the Greater Kuala Lumpur plan, has received high level of commitment – increasing the likelihood of the project’s approval. Potential beneficiaries: Gamuda (High Conviction Pick; TP: RM4.35), MMC (Buy; TP: RM3.20).

The Rubber Research Institute (RRI) project was also included. Potential beneficiaries: MRCB (High Conviction Pick; TP: RM2.25), WCT (Buy; TP: RM3.60).

Other mega projects include the previously shelved RM8bn high speed train to Singapore (potential beneficiary: YTL Corp; Not Rated) and the Klang river project (potential beneficiaries: SP Setia (Buy; TP RM4.80), YTL Power (Hold; TP: RM2.50), MRCB).

The drive to improve Kuala Lumpur’s attractiveness would also benefit large landowners in the greater KL area such as SP Setia, Bolton (Buy; TP: RM1.50) and DNP (Buy; TP: RM2.25).

Implementation is key. There will definitely be major challenges to some of the initiatives. Implementation is a key test for the ETP. In our opinion, Senator Dato Sri Idris Jala and PEMANDU’s (Performance Management and Delivery Unit) role in facilitating implementation would help enhance the likelihood of success. Successful execution of the ETP would help transform the country and attract investments.

Highlights of Economic Transformation Program
Sector Initiative Potential beneficiaries
Greater KL KL MRT - received high level of commitment Gamuda, MMC
Rubber Research Institute project MRCB, WCT
High speed train to Singapore YTL Corp
Klang river project SP Setia, YTL Power, MRCB
Initiatives to make KL more attractive SP Setia, Bolton, DNP
Oil, gas & energy LNG regasification plant KNM, Dialog, Kencana
Financial services Create regional champion Maybank
Improve capital markets Bursa Msia
Promote bond market Maybank
Business Services Increase level of skilled workforce Jobstreet
Health services Promote generic drug manufacturing and export Pharmaniaga
Education Push for health services education Masterskill
Source: PEMANDU, HwangDBS Vickers Research

ETP: Macro takeaways
NKEA projects will achieve economic growth of 6%
A high income nation with GNI per capita of USD15,000 by 2020
The NKEAs will contribute over 73% of Malaysia’s GNI (USD523 billion in 2020)
92% of funding for the projects will come from private investment and only 8% from public funding
Will generate an additional 3.3 m jobs, over 60% will be in medium-income or high-income salary brackets
NKEA Labs feature 131 EPPs and 60 Business Opportunities
Source: PEMANDU, HwangDBS Vickers Research



Construction sector

From the EPPs (Entry Point Projects) for Greater KL, there were several projects that will provide opportunities for contractors.

MRT – Gamuda and MMC are potential beneficiaries of the project. Gamuda’s orderbook could double and MMC’s triple, but we believe the sector will benefit given the sheer size of the RM36bn project. Among the key projects, we understand that this project has received high level of commitment – increasing likelihood of the project’s approval.

High Speed Rail (HSR) – This RM8bn project was initially proposed in 2008 but put on hold. The lab recommended a study by Land Public Transport Commission (SPAD) and Economic Planning Unit (EPU) to determine the feasibility of the project with results to be tabled to the Cabinet by
January 2011. Potential beneficiary: YTL Corp (Not rated).

Klang river project – In March 2010, the Selangor government appointed three companies to carry out the project that was expected to attract RM50bn worth of investments. Potential beneficiary: YTL Power (Hold; TP: RM2.50), MRCB.

In addition, the Rubber Research Institute (RRI) project was among projects included in the Greater KL National Key Economic Area (NKEA). Potential beneficiaries: MRCB (High
Conviction Pick; TP: RM2.25), WCT (Buy; TP: RM3.60).

Property sector

The “Greater KL” NKEA aims to improve KL’s ranking to one of the Top 20 most liveable cities and economic cities in the world by 2020 (currently ranked 79/130 in recent quality of life survey). Initiatives proposed include:
a) Foreign magnet: Attracting 100 of the world’s top MNCs & high-skilled immigration;
b) Improved connectivity: High-speed rail to Singapore, MRT (integrated urban rail system);
c) New attractions: Rejuvenation of rivers, greener KL, iconic places; and
d) Enhanced services: Pedestrian network, solid waste management.

PEMANDU expects KL population to balloon to 10m by 2010 from 6.5m currently, creating demand for 1m new homes. Areas identified to benefit the most from transformation of KL:
a) High-impact: RMAF base @ Sungai Besi, Dataran Perdana, MATRADE @ Hartamas, RRIM @ Sungai Buloh, Kampung Baru
b) Ripe for redevelopment: Bukit Bintang, Pusat Bandar Damansara, Dataran Sunway, 1 Utama, Subang Bestari, Balakong, Serdang

Aside from GLC/Bumi developers tipped to benefit from government land redevelopment (eg MRCB, Boustead, Bolton, SP Setia, Mah Sing), owners of large landbank and investment assets in KL should also stand to benefit.



Oil and gas

PEMANDU has identified 12 EPPs and 7 BOs (Business Opportunities) for the oil, gas and energy sector under the NKEA. A 3 pronged area of focus – sustain, grow and diversify. The EPPs and BOs are expected to bring about RM76.8bn in GNI (Gross National Income) and create 52,000 jobs by 2020.

Several of the broader initiatives presented included PETRONAS strategies such as enhancing oil recovery in existing fields, developing smaller fields, and the construction of a LNG regasification terminal to meet the nation’s gas demand. However, what we understand that is making the difference is the role that PEMANDU will be playing to ensure smooth and effective implementation of the said EPPs. This, we believe, would be the critical factor leading to the success of the program.

Based on the roadmap shown by PEMANDU, we understand that the government is looking to receive its first LNG imports into the country by 2013. This would mean that the tender for the LNG regasification plant could be out as early as the beginning of 2011, assuming 2 years of construction.

We see KNM Group (Hold; TP: RM0.55), Kencana Petroleum (Not Rated), and Dialog (Not Rated), as potential beneficiaries to the project. The initiatives highlighted include the 10m cubic metres oil storage terminal in the works spearheaded by Dialog and Vopak in Pengarang, Johor. The development of small fields and enhancement of oil recovery should benefit a handful of local oil & gas players.

Tanjung Offshore (Hold; TP: RM1.60) could stand to gain under its engineering and marine divisions while both Alam Maritim (Buy; TP: RM1.40) and Petra Perdana (Fully Valued; TP: RM1.00) could benefit under their OSV operations.

Outlook For Ringgit For The Rest Of 2009

• Malaysia Ringgit (MYR) has appreciated 6% after hitting a low in early March taking the ytd losses to 1% as of May-end 2009
• March 3, 2009: MYR fell to the lowest level (3.725-3.735/USD) in 3 years due to weakening exports and foreign investment
• February 2009: To promote bilateral trade and investment for economic development, Malaysia's central bank and Chinese central bank established RMB40billion currency swap arrangement for 3 years
  
  Risks for ringgit in 2009:
• External balances: electronic and commodity exports are contracting at a sharp pace and the trend is likely to continue through 2010 with a sluggish recovery in 2010. Presently greater contraction in imports relative to exports is sustaining the trade and current account surpluses and forex reserves
• Easing capital flows: keeping interest rate on hold in April and May 2009 has helped reverse some of the past capital outflows. Rising bond issues at higher yields and sharia bond issues are a plus. But ratings downgrade due to increasing fiscal deficit can weigh on debt inflows. Impact on lower corporate earnings ad revival of risk aversion can weigh on stock market. A recession in 2009 and rising bond issues in U.S. (safer-haven) can be a negative. FDI is expected to fall over 50% y/y in 2009 due to decline in export manufacturing related capex
  
• Central Bank policy: In 2008, central bank was intervening in the FX market selling USD reserves to contain currency depreciation but in 2009 the central bank has been defending the exchange rate to support exports especially as reserves have also been declining. foreign exchange reserve stood at US$88bn as on 15 May, 2009 which is sufficient to finance 8.3 months and 3.8 times the short-term debt. Large forex reserves and external surpluses are a plus to deal with export contraction and any revival of capital outflows. Trend in USD and SGD will also be improtant determinants of movement in ringgit
  
• Since the central bank decided to keep key rate at 2%, USD/MYR is expected to be higher by the end of Q2 2009. But USD/MYR will be lower in H2 2009 as the economic situation is improving. But further stabilization in domestic and global economy is still necessary to guide USD/MYR around 3.45 by the end of 2009
• MYR continues to track the SGD and is expected to weaken against USD in mid-2009 due to anticipated resurgence in USD strength
  
• Declining forex reserves and depreciating SGD would put further pressure on ringgit
  
• Confidence of ringgit would be dampened due to increasing deficit on overall balance of payments, declining exports, outflow foreign capital, and expectation of further rate cut by central bank
• In 2009, ringgit would be weak against USD as the process of de-leveraging by international investors will continue to boost demand for USD
  

p/s photos: Hanako Takigawa

Roubini's 10 Risks To Global Economy Growth Prospects (Part 1)

Nouriel Roubini: This week, I will discuss why the recovery will be sub-par and below trends for a few years once it does occur, and why there is even the risk of a double-dip W-shaped recession.

The crucial issue facing us is not whether the global economy will bottom out in the third or fourth quarter of this year, or in the first quarter of next year. It's whether the global growth recovery, once the bottom is reached, will be robust or weak over the medium term--say 2010-11. As I argued last week, one cannot rule out a sharp snapback of GDP for a couple of quarters, as the inventory cycle and the massive policy boost lead to a short-term growth revival. My analysis, however, suggests that there are many yellow weeds that may lead to a weak global growth recovery over 2010-11.

The current consensus among "green shoot" optimists sees U.S. economic growth going back in 2010 to a rate that is close to the 2.75% potential growth rate, and returning to potential by 2011. Many optimists go even further, arguing that the snapback of demand and production after the depressed levels of the current recession will lead growth to be well above trend (3.5% to 4%) for a couple of years, as most previous U.S. recessions have been followed by a period of above-trend growth once the recovery gets going. Yet a detailed analysis suggests that growth will remain well below potential for at least two years--if not longer--as the severe vulnerabilities and excesses of the last decade will take years to resolve. Let us examine 10 factors that will cause below-potential economic growth over the medium term even after this recession is over.

First, an incorrect interpretation of the causes of this crisis has led to a policy response that doesn't resolve the fundamental causes. The right way to think of this crisis is of its being caused by: excessive over-borrowing and overspending by households; excessive and risky borrowing and lending by financial institutions; and excessive leverage of the corporate sector in a global economy where housing, asset and credit bubbles got out of hand and eventually went bust. So this is a crisis of debt, credit and solvency, not just illiquidity. The alternative interpretation is that this is a crisis of confidence--an animal-spirit-driven, self-fulfilling recession--that has led to a collapse of liquidity (as counterparties don't trust one another) and of aggregate demand (as concerned households and firms cut consumption and investment in ways that can turn a regular business-cycle recession into a near-depression).

Note that even those who believe that this is a crisis of over-leverage and overspending agree that aggressive monetary and fiscal easing is necessary to prevent a severe recession triggered by such excesses from turning into a near-depression. But while such easing is necessary to prevent the global economy from falling off a cliff into the depression abyss, the ability of these over-leveraged economies to resume lending, borrowing, spending, investment and growth depends on the resolution of the excesses that caused the crisis in the first place.

Yet true de-leveraging by households, corporate firms and financial institutions has not even started, as private losses and debts are being socialized and put on the balance sheet of governments. The lack of true de-leveraging--or appropriate debt restructuring--will lead to a corrosive debt deflation and limit the ability of households to spend, of firms to invest, and of banks and other financial institutions to lend. In other words, if this is a crisis of credit and solvency rather than just illiquidity and confidence, much more is needed than easy money and massive fiscal stimulus to resume high economic growth. Worse, the socialization of private losses creates--down the line--another dangerous debt and solvency problem, this time for the sovereign, with risks of a more severe financial crisis once a refinancing crisis occurs and/or the ability of the sovereign to borrow more is curtailed.

The right way to resolve a problem of excessive debt relative to equity capital is to reduce such debt and convert it into equity. Corporate debt and the financial sector's unsecured liabilities should be converted into equity. Even household debt can be converted into equity by reducing the principal value of mortgages and providing an equity upside to the mortgage creditor in the form of a warrant.

Second, in current-account deficit countries (i.e., where the country spent more than its income), consumers need to cut spending and save more: shopped-out, savings-less and debt-burdened consumers have been hit by a wealth shock (falling home prices and stock markets), rising debt-servicing ratios and falling incomes and employment. These deficit countries include not only the U.S., but also the U.K., Ireland, Iceland, Spain, many emerging European economies, Australia and New Zealand.

In these economies, the retrenchment of consumption and buildup in savings to reduce debt, restore net worth and resume robust spending will take several years. In the U.S., consumption averaged 65% of GDP (and household savings averaged 11% of disposable income) for a long time before the latest decade-long housing bubble and consumption binge.

At the peak of the bubble, consumption had risen from 65% to 72% of GDP, and the savings rate plunged to zero and even negative for a few quarters. Currently, consumption has fallen from 72% to 70% of GDP and saving has increased from near zero to about 5% of disposable income. Even if one were--heroically--to assume that consumption will not revert to the long-term average, a fall from 70% to, say, 67% is likely and necessary, while the savings rate goes toward double digits.

But how can households reduce debt ratios that have increased from 65% of disposable income in the early 1990s to 100% in 2000 and 135% today? And the debt ratio risks rising even further as price deflation leads to debt deflation (a rise in the real value of nominal debts). One solution might be to save a lot to reduce debt and rebuild net worth, but the "paradox of thrift" scuttles this. If households sharply cut spending and save more, the recession becomes a near-depression and the ensuing fall in income further increases the debt-to-income ratio. The only remaining solution is debt default and debt reduction.

Third, the financial system (specifically, traditional commercial banks) is severely damaged, and the credit crunch will thus not ease very fast. Most of the shadow banking system is either gone or in severe difficulty. The equivalent of a bank run has hit most of the highly leveraged institutions of this system: 300 non-bank mortgage lenders are bust; the system of conduits and structured investment vehicles is gone; two major broker-dealers are gone, one merged with another bank and the last two converted into bank holding companies; money-market funds cannot even cover their costs, as interest rates are zero and now under the umbrella of a government guarantee; half of all hedge funds may close shop in the next couple of years; even private equity will experience a serious refinancing crisis once "covenant lite" clauses and payment-in-kind toggles run their course; finance companies and insurance companies are also in trouble and need government support and recapitalization. Securitization is a shadow of its recent peaks and the attempt to revive it--TALF--has been a mixed bag.

After $12 trillion of liquidity support, guarantees, insurance and recapitalization, most of the U.S. financial system is under effective government control. And the financial sector damage is not limited to the U.S.: Most major U.K. banks--with the exceptions of HSBC and Barclays -are under effective government control. The IMF estimates massive losses on loans and securities of other European banks, given their exposure to both domestic borrowers and emerging Europe, a region on the verge of a broader financial crisis. According to the IMF, even Japanese and other Asian banks are not immune to significant losses on loans and securities.

Over time, financial institutions in the U.S. and around the world will clean up their balance sheet. But systemic banking crises are not resolved in a few months: They usually last several years and are associated with a persistent credit crunch. Given that a lot of economic activity is financed with debt/credit, this crunch will inflict persistent damage and restrict the ability of households and corporate firms to borrow, consume, spend and invest.

Fourth, a large part of the corporate sector is also under severe financial stress, and its ability to increase production, employment and capital spending will be restricted by poor profitability driven by slow revenue growth, deflationary pressures and rising corporate defaults. While most U.S. corporations are less leveraged than they were in 2000-01, the corporate sector has a large fat tail--similar to that of the household sector--that is severely indebted.

Firms that in the past would have been able to roll over their loans, bonds and debts coming to maturity now face a liquidity crisis that may lead them into costly debt restructuring. Some firms that would have gone into Chapter 11 debt restructuring will end up in socially costly liquidation (Chapter 7) because of the lack of financing. This process of corporate debt restructuring or outright liquidation may take years.

But the main constraint to a recovery in the corporate sector will be a weak recovery of corporate profitability. If the global economy grows at sub-par rates in 2010-11, corporate revenues will grow slower than otherwise; and if deflationary pressures remain across the world--given the glut of supply relative to aggregate demand--pricing power of firms will be limited and profit margins will be further squeezed. The ability to control costs and restore earnings by slashing employment will reach a limit, and excessive employment contraction has negative macro effects: Fewer jobs means less income, less consumption, less corporate revenue and lower profits and earnings.

p/s photos: Hanako Takigawa