UPDATE 2-Malaysia's current account slumps in Q2, GDP growth picks up slightly
(Recasts to focus on economic, fiscal risks, add quotes)
* Economy expands 4.3 pct in Q2 y/y, vs poll 4.9 pct
* Full-year growth target trimmed to 4.5-5.0 pct
* Cbank says Malaysia can cope with capital outflows
* Current account shrinks, seen in surplus for year
By Anuradha Raghu and Siva Sithraputhran
KUALA LUMPUR, Aug 21 (Reuters) - Malaysia's current account surplus plunged in the second quarter on weakening exports, overshadowing a slight acceleration in economic growth and highlighting the country's vulnerabilty to market selloffs that have rocked several other Asian economies.
The Indian rupee hit record lows this week and Indonesia's stock market and currency plunged on concerns that their worsening current account deficits left them exposed to an expected withdrawal of U.S. super-loose monetary policy.
Fears that Malaysia and Thailand could join that club have pushed their currencies to multi-month lows in recent days, raising concern that the market contagion could spread to economically healthier countries in Southeast Asia.
Data on Wednesday confirmed that Malaysia's current account surplus is evaporating fast, falling to 2.6 billion ringgit ($790 million) in the second quarter from 8.7 billion ringgit in the first three months and 22.9 billion ringgit before that, reflecting plunging exports and solid imports.
Still, the decline was not as much as some economists had fears.
Economic growth accelerated slightly to 4.3 percent in the April-June period from a year earlier, helped by pre-election government spending and a pick-up in activity after the May polls, but fell well short of economists' expectations of 4.9 percent.
In a nod to the deteriorating growth prospects, the central bank cut its forecast for full-year growth to 4.5-5.0 percent from 5-6 percent.
Malaysia, which is heavily dependent on its exports of commodities such as palm oil, could soon be recording its first current account deficits since the 1997 Asian financial crisis.
"I think the era of strong double-digit current account surpluses is over," said Lee Heng Guie, an economist at CIMB Investment Bank in Kuala Lumpur.
"Unless an export recovery materialises and is supported by a revival in commodity prices, the surplus will still be narrowing for the next two years."
Central bank Governor Zeti Akhtar Aziz said that Malaysia was expected to maintain a current account surplus this year, and could cope with the current "highly destabilising" capital flows.
"This is not a new phenomenon. We coped with it before," she said, adding that the economy was expected to remain supported by strong domestic growth.
Sales of Malaysian bonds by foreigners, who hold almost half of the country's government debt, could be absorbed by Malaysian institutions including the insurance industry, she said.
Other data on Wednesday showed that inflation ticked up to 2.0 percent in July from 1.8 percent in June, in line with market expectations.
Manufacturing output rose 3.3 percent in the second quarter after subdued growth of 0.3 percent in the first, while mining activity picked up 4.1 percent after shrinking in the first three months of the year.
Many businesses put investment plans on hold in the first quarter ahead of the tense national election in May that was narrowly won by the long-ruling National Front coalition.
Investment has been rising strongly as Prime Minister Najib Razak pushes through his $444 billion Economic Transformation Programme aimed at doubling per capita incomes by 2020, but that has also pushed up imports, undermining the current account.
While economists note that Malaysia has a much stronger external position than Indonesia, its weaknesses include a stubborn fiscal deficit, a relatively high government debt of 53 percent of GDP and one of Asia's highest household debt levels.
Najib faces a possible leadership challenge from within his ruling party in October, raising uncertainty over his pledge to cut the budget deficit of 4.5 percent of GDP. He has pledged to announce steps to improve the fiscal position in his budget address in October.
Malaysia's ringgit has tumbled more than 7 percent this year to three-year lows around 3.3 to the dollar and is among Asia's worst performers this year. On Wednesday, it weakened further ahead of the data, falling 0.2 percent to 3.2940.
"It is just a liquidity event that hurt everyone," Abdul Farid Alias, the chief executive of Malayan Banking Bhd (Maybank), Malaysia's biggest bank by assets, told reporters on Wednesday.
"The fundamentals of the economy in Malaysia, of our organisation, remain strong."
The Malaysian data follows Thai gross domestic product figures released on Monday that showed a surprise contraction in second-quarter growth, partly due to weakening exports.
Regional economies have built up hefty foreign reserves and sharply reduced foreign currency debt since they were devastated by the Asian financial crisis in 1997, making them less vulnerable to flighty foreign capital.
Data from the Bank for International Settlements shows Malaysia has enough reserves to cover four times its short-term external debt, while Thailand has 6.8 times. Indonesia has only 1.7 times.
Kelvin Tay, regional chief investment officer Wealth Management Southern Asia-Pacific, said that while Asian debt levels had risen since the 2008 financial crisis, they were mostly sustainable because of higher growth rates.
"We have actually gone up (in debt) but don't forget the economies here are at growing at 6.5-7 percent as a whole," he said. "If you have growth of that kind of level you can certainly sustain the debt levels. If your growth falls to 4-4.5 percent then, yeah, you are in trouble."
Malaysia's central bank left its key policy rate unchanged at 3.0 percent at its last meeting in July, but warned that the weak global environment may hurt growth prospects. However, a pick-up in inflation and further weakness in the currency could prompt it towards a tightening bias. (Additional reporting by Niluksi Koswanage in Kuala Lumpur, Saeed Azhar in Singapore and Wayne Arnold in Hong Kong; Writing by Stuart Grudgings; Editing by Kim Coghill)
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