This article first appeared in The Edge Financial Daily on August 2, 2017

KUALA LUMPUR: The headline Nikkei Malaysia Manufacturing Purchasing Managers’ Index (PMI) rebounded to 48.3 in July from its all-time low of 46.9 in June. However, the persistent weakness in several key indices has kept the index below the 50-threshold level — an indication of contraction, instead of expansion.

Furthermore, the index was also below the average of 48.9 in the first half of this year, meaning that manufacturers are now less positive about prospects compared with earlier of the year.

The cautious tone seems to have spilled over elsewhere in Asean. The Nikkei Asean PMI has fallen below the 50-level threshold for the first time this year, indicating that the region started the second half of the year with a decline in the manufacturing operating condition, according to the latest Nikkei PMI released yesterday.

“The Malaysian manufacturing sector continued to struggle in the face of tepid demand, particularly from within the domestic economy, during July. Output, purchasing activity and inventories were all cut as near-term prospects remained bleak,” Paul Smith, director at IHS Markit, which compiles the survey, said.

Recall that Malaysia’s PMI only climbed above the 50-level in April this year.

Markit said that the degree to which output fell was weaker than in June, but nonetheless still marked.

“Falling levels of new orders, linked to underwhelming market demand, were the primary factor behind the deterioration in sales. Weakness in the domestic market was [the] key reason for reduced overall new sales; foreign sales were broadly unchanged in July,” it said.

According to RHB Research’s chief Asean economist, Peck Boon Soon, there is a disconnect between the country’s PMI number and the Index of Industrial Production, which showed an increase of 4.6% in May this year, supported by a strong growth of 7.3% in the manufacturing index.

“We should not read too much into the PMI’s number as it’s a sentiment survey index,” Peck said in a telephone interview with The Edge Financial Daily.

He explained that the sentiment among manufacturers, especially those that focus on the domestic market, was not that good.

“The readings are slightly more pessimistic because for domestic players, they are just on the recovery side. If you recall, demand weakened significantly towards the second and third quarters of last year before a recovery was seen in the fourth quarter. Domestic demand only started to pick up in the first quarter … generally, sentiment remains cautious as manufacturers are only starting to recover,” Peck added.

He commented that in comparison, exports are doing well, as reflected in the export numbers in May that grew by 32.5%, marking a sixth consecutive month of double-digit growth.

Peck’s view is also reflective of Markit’s report that highlighted a positive view on the longer-term expectations.

“That said, longer-term expectations were seen as more positive, with respondents on average anticipating a rise in production over the coming 12 months. Expected growth underpinned a slight increase in employment, the second time in the past three surveys that a rise in workforce numbers has been recorded,” it said.

The survey also showed that backlogs of work continued to decline for the third time in the past four months, with the rate of contraction the greatest recorded by the survey since data were first collected over five years ago.

The weak trend in new orders was widely reported to have enabled firms to reduce their unfinished work, with poor near-term prospects leading to reductions in stocks of both purchases and finished goods.

The July data also saw more countries across the Asean region report a decline in operating conditions, with five nations (including Malaysia) indicating a deterioration, while only the Philippines and Vietnam saw manufacturing sector conditions improve. Even then, both the countries have seen the rate of improvement moderating since June.

“Total new business inflows fell for the first time this year in July. Weaker demand was not only limited to the domestic market, but foreign orders as well, which was shown by new export sales decreasing after expanding through the second quarter,” the report said of Asean’s manufacturing operating condition.

Bernard Aw, an economist with IHS Markit, said that the weaker demand had an impact on production volumes and backlogs, which in turn harmed employment prospects.

“Moreover, business optimism remained below the historical average, reflecting uncertainties over manufacturing growth across the region,” he said.