WITH commodity prices on the downtrend, strong manufacturing numbers are needed more than ever to maintain economic activity in order to hit the country’s growth targets for the second half of 2015. As one local manufacturer puts it, “The country cannot rely on oil and commodities forever. In the end, it will be up to the manufacturers to keep growth going.”

But, if early indicators of manufacturing activity are anything to go by, factories here are showing signs of fatigue.

According to a Sept 1 report issued by London-based research house Markit, Nikkei Malaysia’s purchasing managers’ index (PMI) — an economic indicator of manufacturing activity derived from indicators of new orders, output, employment, suppliers’ delivery times and stocks of purchases — for August is at its lowest since September 2012.

At 47.2 versus 47.7 in July, the August PMI reading represents a decline for the fifth straight month. Any figure greater than 50 indicates overall improvement of sector operating conditions. Put another way, Malaysia’s PMI readings for July and August suggest that the manufacturing sector has had a slow start to the second half of the year.

Markit senior economist, Rob Dobson, tells digitaledge Weekly, “The recent trend in the Malaysian PMI has signalled a definite softening in the manufacturing sector. This softening trend has also been exhibited in the official data, where the growth rate in manufacturing peaked around January and February of this year and then eased through to the middle of the year.”

“The main factors likely to restrict the Malaysia manufacturing sector are subdued demand and the exchange rate.”

Dobson adds that the trend of weakening manufacturing growth in Malaysia could worsen after August if there is a continued broader regional slowdown due to factors such as weakening growth in China and if the recent increase in financial market volatility starts to directly hit business confidence.

“With the higher currency volatility in Asia, external demand may weaken, which should weigh on Malaysian exports in the second half of 2015,” Barclays Bank economist Rahul Bajoria writes in a note after official data showed Malaysia’s trade surplus fell to a nine-month low of RM2.4 billion in July, despite exports rising 3.5% year on year in July on strong increases in electronics, metal products, machinery and appliances.

While he expects the drop in trade surplus to be reversed, Bajoria also expects the improvement in export momentum to be short-lived on sluggish external demand.

Alan Tan, an economist at AffinHwang Investment Bank, points out that Markit’s manufacturing PMI numbers are at odds with Malaysia’s own industrial production index (IPI).

Official data from the Department of Statistics (DOS) show that growth in the manufacturing sector rose from 3.2% y-o-y in May to 4.9% in June, while total IPI growth moderated from 4.5% y-o-y to 4.3% during the period. During the month, sales value for the sector increased by 6.8% to RM54.3 billion while productivity per employee in June 2015 increased by 7.1% month on month.

Also, DOS’ leading index, which is used to measure turning points of economic growth cycles, was at -0.2% or 117.2 points in May but has turned positive to 0.8% or 117.6 points in June 2015, suggesting that overall economic growth is expanding despite PMI readings being on the decline.

While Tan welcomes the addition of the manufacturing PMI to the indicators the market can use to gauge economic performance, he does not expect the manufacturing sector to perform as poorly as July and August PMI numbers suggest.

“Going forward, we expect manufacturing production to be softer in 2H2015 but we still believe that the slowdown will not be as significant as the PMI readings. The semiconductor industry will still grow in tandem with the growth of exports of electronic and electrical products and you can still expect some healthy demand from the United States and Europe. This will offset the slowdown in China,” he says.

As it stands, head of research at M&A Securities Rosnani Rasul also prefers the official IPI reading to the manufacturing PMI headline numbers.

“Markit’s PMI is still a relatively new index and only started a few months ago. While it has been used for a long time in other countries, it still may not capture the whole picture in Malaysia. I believe that the IPI data, which is audited and verified by external parties, paints a better picture of the economy and the manufacturing sector,” she says.

“I believe that Malaysia will see a ‘U-turn’ in the second half. The weaker ringgit has made Malaysia’s exports very competitive and we should see the impact on own numbers in 2H2015. That should be positive for the manufacturing sector but we will have to wait for IPI data to be sure,” she says.

The optimism is shared by some manufacturers in Malaysia.

Datuk James Wong, executive director of hard disk drive maker JCY International Bhd (fundamental: 2.50; valuation: 2.40), says he is “not surprised” that the domestic manufacturing industry is experiencing growth despite softer demand and a weaker ringgit.

“If you ask me if there is global demand growth, I would say no. It has declined because China is slowing and Europe’s recovery is not as robust. But, if you ask me if the government’s assessment that the industry has grown [is correct], I would agree. While there is no growth in demand, you can expect that manufacturers would relocate to Malaysia where the cost of production is low, thanks to the ringgit. There could be a shift towards Malaysia,” Wong says.

That, though, is not saying that the manufacturing PMI figures are not reflective of the current operating environment for Malaysia-based manufacturers. Other manufacturers are feeling the sluggishness of the industry and expect it to continue for the rest of the year.

The Malaysian Plastics Manufacturers Association (MPMA) says the plastics manufacturing industry registered a mild growth of 3% in 1H15, a slowdown compared with the 8% growth seen during the same period last year. Overall, it is already anticipating 4% growth for 2015.

“A depressed currency, implementation of the Goods and Services Tax and weaker consumer sentiment have affected domestic sales. Orders from overseas also slowed down as the recovery in the European and Japanese economies is not as strong as anticipated. Some exporters benefited from the currency gains in the US dollar and Singapore dollar in the short term, while some are obligated to review their contracts with overseas customers regularly, either on a monthly basis or as and when required by their customers,” says Datuk Lim Kok Boon, MPMA president.

Mak Siew Wei, executive director of industrial automation systems at machinery manufacturer AT Systemization Bhd (fundamental:1.15; valuation: 0.90), says Malaysia’s manufacturing PMI is reflecting challenges and downward pressures on the country’s domestic manufacturing sector.

“Things have definitely slowed down. Our orders from multi-national corporations based in Malaysia have definitely slowed. I hope things pick up but expect this to continue for at least another year,” Mak says.

Given the split responses, the conflicting findings of the PMI and Malaysia’s IPI surveys are perhaps yet another indication that not everything is going well.

The PMI also focuses on a specific sector while Malaysia’s IPI is broader. As Dobson explains, “The Malaysia manufacturing PMI covers the manufacturing sector only, as opposed to an IPI which covers additional production industries such as energy. It is also a different focus to a leading economic indicator, which uses a range of economic variables to calculate a forecast of what is likely to occur in the whole economy in the coming months.”

“The PMI is based on hard observed facts reported to us from our panel of companies, not based on sentiment or a forecast model procedure. On this basis, it provides a fast and reliable indication of the trend and turning points in the manufacturing sector.”

In that vein, whether or not the Malaysia’s manufacturing industry is on course for a slowdown will be clearer when the official IPI figures are released  on Sept 10. In the meantime, Malaysia will be keeping her fingers crossed that earlier official indicators are spot on.

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This article first appeared in digitaledge Weekly, on September 7 - 13, 2015.