On behalf of the Malaysian authorities, we would like to express our appreciation to the IMF team for the comprehensive and constructive dialogue during the 2019 Article IV consultation. We are encouraged by staff’s positive assessment on Malaysia’s economic and financial outlook as well as the appropriateness of the current macroeconomic policy setting.
In an environment of heightened uncertainty and downside risks in the global economy, resilience of the Malaysian economy is underpinned by strong macroeconomic fundamentals and a robust financial system. Appropriate policy frameworks, timely policy responses and ample buffers are in place to further reinforce the economy’s resilience. Our authorities continue to be vigilant over the near-term risks while remaining committed towards medium-term structural reforms to ensure inclusive and sustainable growth.
As a highly open economy with a financial system that is integrated with the international financial system, Malaysia is susceptible to external influences and spillovers from abroad. Given this environment, our authorities remain committed to exchange rate flexibility as a first line of defense against shocks. A broad suite of policies remain available to ensure the instruments deployed are the most effective for the specific risks being managed. As conditions evolve and new challenges emerge, the effectiveness of our policies are continuously assessed to ensure overall macroeconomic conditions are conducive to growth with price stability.
Our authorities welcome staff’s efforts to understand the domestic economy and country specific challenges. We are encouraged by staff’s recognition of the positive outcomes from the foreign exchange measures implemented by the authorities. Greater understanding of authorities’ policies and their intended outcomes are imperative for effective and balanced policy advice by the Fund. In this regard, we encourage staff to offer more constructive policy advice, such as alternative measures to better address the key challenges faced by the authorities, and to move away from rigid adherence to the Fund’s prescriptive set of policy advice. Policies have to be designed in the context of the situation.
Latest economic developments and outlook
Authorities agree with IMF’s assessment that the Malaysian economy continued to show resilience. In the first three quarters of 2018, the economy recorded growth of 4.7%. While a moderation from the 5.9% growth in 2017 had been expected, growth in 2018 was also marked by commodity-specific production disruptions. While there was a smooth political transition to a new Government, transitory policy uncertainty weighed down on growth in the few months after the May General Election. In 4Q 2018, growth is expected to rebound (3Q: 4.4%), supported partly by the on-going recovery in commodity output. Based on this development, for 2018 as a whole, the Malaysian economy is on track to expand at around the official forecast of 4.8%. At close to 5%, and amid global trade tensions and tighter financial conditions during the year, growth remains highly respectable. Headline inflation averaged at 1.0% in 2018, mainly reflecting the impact of the zerorisation of the Goods and Services Tax (GST) and the fixing of retail fuel prices. Labour market conditions were favourable, underpinned by firm employment and steady income growth. Importantly, the higher net employment gains were mainly driven by high- and mid-skilled workers. Malaysia’s external sector remained resilient, amid a challenging external environment during the year. Malaysia’s current account is expected to continue to register a surplus in 2018 (1Q-3Q 2018: 2.1% of GDP; 2017: 3.0% of GDP), with positive exports growth. As highlighted by staff, highly volatile short-term capital flows, which were driven mainly by global uncertainties, were ably intermediated by deep capital markets and broad base of domestic institutional investors.
For 2019, growth is projected to remain on a steady growth path and driven by the gradual recovery in commodities output, which would also support growth in the manufacturing sector and trade performance. In addition, the new production facilities particularly in the petrochemicals industry will lend further support to growth. On the demand side, private sector spending will remain the anchor of growth amid continued rationalisation of public sector expenditure. Private consumption is expected to normalise following the lapse of one-off factors in 2018, but remain firm underpinned by continued income and employment growth. Government measures such as the minimum wage increment, cash transfers and targeted fuel subsidy will support household spending among the lower-income household. Investment activities will remain supported by the on-going multi-year infrastructure projects and sustained capital spending by both domestic- and export-oriented firms. Inflation in 2019 is expected to average moderately higher, with the impact of the consumption tax policy on headline inflation lapsing towards the end of the year. However, the trajectory of headline inflation will be dependent on global oil prices given the resumption of the managed float fuel pricing mechanism. Nevertheless, underlying inflation is expected to remain contained in the absence of strong demand pressures. On the external front, exports is expected to record a more moderate but positive growth, in line with the expectations of slower global growth and trade momentum.
Going forward, Malaysia’s economic fundamentals are expected to remain strong. The diversified export base in terms of products and markets would partially mitigate the impact from slower global growth and trade. The current account is expected to remain in surplus, driven by a sizeable goods surplus, which will be more than sufficient to offset the services and income deficits. Malaysia’s deep and diversified financial markets and strong economic fundamentals will continue to intermediate capital flows. In addition, the broad base of domestic institutional investors, including banks, insurance companies, and provident and pension funds will mitigate excessive volatility in the domestic financial markets. Exchange rate flexibility with adequate levels of international reserves remain an important tool against external shocks.
Our authorities concur that risks to the growth outlook are tilted to the downside and stem mainly from external sources. As a small open economy, Malaysia will be affected particularly by the intensification of the trade conflict and slower-than-expected growth in trading partners. Notwithstanding this, the strong fundamentals and the diversified nature of the economy will enable Malaysia to continue to weather these downside risks. Macro- and micro- level stress tests conducted by the authorities and individual banking institutions affirm Malaysian banks’ strong capacity to withstand extreme macroeconomic and financial shocks, hence, presenting low downside risks to growth. Vulnerabilities associated with banks’ and corporates’ external debt are largely contained considering the risk profile and activities underpinning such exposures. While staff assessed the household debt as elevated, authorities view that risks to financial stability emanating from household indebtedness have receded amid sound underwriting standards, risk management practices and loan affordability assessments. Household debt growth has moderated towards a more sustainable rate, lower than that of income. Consequently, the household debt-to-GDP ratio has also been declining, a trend sustained since 2015, and the increase in house prices have moderated in recent years to be in line with domestic fundamentals.
The conduct of fiscal policy centers on strengthening the public finance position while supportive for a sustainable and inclusive economic growth. In this regard, the Malaysian authorities adopted prudent fiscal management approach that aims to build healthy fiscal buffer and to ensure debt remain at sustainable level. The authorities is also committed to instill efficient and good governance in the fiscal policy management. Towards this end, several measures have been initiated to strengthen transparency and governance aspects of the fiscal management, as well as efforts to achieve greater expenditure optimization and revenue enhancement.
The inaugural publication of the Fiscal Outlook and Federal Government Revenue Estimates in November 2018, signified the ongoing effort to promote better transparency and accountability in Malaysia’s public finance management. This is complemented with the introduction of the Medium-Term Fiscal Framework (MTFF) which outlines the 3-year fiscal consolidation plan and the indicative expenditure ceiling for the 2019–2021. Work is currently underway to introduce the Fiscal Responsibility Act (FRA), by 2021 to strengthen the current fiscal governance framework. Among others, the FRA will strengthen the conduct of fiscal policy by enhancing fiscal rules and principles, transparency and accountability while ensuring macro stability in the medium and long term. In addition, the Government Procurement Act will also be introduced to enhance fiscal governance and improve efficiency of public spending. The authority also took initiative to establish Debt Management Office to enhance debt management operation as well as intensify fiscal risk assessment.
The authorities is currently undertaking a rigorous expenditure optimization exercise with the emphasis to minimize fiscal leakages while at the same time ensure public programs and projects continue to support growth. Among the key priority measures to improve spending efficiencies are streamlining the structure and functions of ministries and agencies; ceasing of low priority programs and projects with low multiplier effect to the economy; and improving Government procurement policy through strengthening the procurement processes and implementing wider use of open tender. The Public Finance Committee has been established to monitor the progress and ensure effective implementation of these measures.
On the revenue enhancement, the Tax Reform Committee has been set up to carry out a comprehensive review of the Malaysian tax system including reviewing tax incentives and exploring new sources of sustainable revenue. The main task of the Committee is to narrow the tax gap and improve tax efficiency to increase tax buoyancy. The Committee is expected to provide its recommendations to the Government for its further consideration and onwards implementation.
Our authorities welcome the staff’s view that monetary policy should continue to be geared towards domestic stability and that the monetary policy framework has performed well. The Monetary Policy Committee (MPC) normalised the degree of monetary accommodation by raising the Overnight Policy Rate (OPR) by 25 basis point to 3.25% in January 2018. The OPR was maintained for the remainder of the year, as the MPC assessed that at the prevailing level of the OPR, the degree of monetary accommodativeness is consistent with the intended policy stance. The MPC will continue to monitor and assess the balance of risks surrounding the outlook for domestic growth and inflation.
Adjusting to external shocks
In 2018, similar to other emerging market economies, Malaysia experienced large non¬resident portfolio outflows and exchange rate depreciation pressure, driven primarily by external developments. Ongoing external uncertainties suggest that this could potentially continue going into 2019. For a small and open economy with liberalised financial markets, external developments will continue to affect non-resident investment behaviour, and periods of heightened capital flows and exchange rate volatility are inevitable. If not appropriately managed, prolonged periods of exchange rate volatility could disrupt orderly financial market activity and eventually spill over to the real economy. A key consideration therefore is to ensure that levels of volatility are not excessive to preserve orderly market conditions, public confidence and overall financial stability.
Our authorities concur with staff on the importance of exchange rate flexibility and wish to reiterate that exchange rate flexibility remains a key policy in enhancing Malaysia’s resilience to capital outflows and helping the economy adjust to external shocks. Foreign exchange market operations are limited to ensuring orderly market conditions particularly during periods of large and volatile capital flows. This is complemented by a sustained focus to enhance the depth and liquidity of the onshore market, and wider efforts to strengthen the underlying fundamentals of the Malaysian economy and financial system. Better hedging flexibilities ensure that domestic financial markets players are better equipped to manage currency risks.
International reserves of USD101.7 billion remain adequate, sufficient to finance 7.3 months of retained imports and 1.0 times short term external debt as at 15 January 2019. Beyond these headline numbers, the assessment of reserve level as a measure of external resilience should however, take into account the context within which reserves are held, in this case the high degree of reserves decentralisation, including liquid external assets held by the private sector. Domestic corporates and banks account for about three-quarters of Malaysia’s external assets. Our authorities welcome staff’s acknowledgment that sizable external assets held by private sector entities would allow banks and corporates to manage their own external liabilities. Potential claims on reserves to meet the external obligations are therefore assessed to remain limited as the large holdings of foreign currency external assets by resident entities can be drawn upon to meet their foreign currency external debt obligations.
Authorities concur that, Malaysia’s external debt remains manageable. The external debt-to-GDP ratio has declined considerably from 70.3% in 1Q 2018 to 65.4% in 3Q 2018. Despite higher external debt-to-GDP ratio than peer median countries, a set of mitigating factors accord Malaysia with resilience against external shocks. First, about one third of external debt is denominated in ringgit, lowering the exposure to currency fluctuations. Second, three-quarters of the foreign-currency external debt are subject to Bank Negara Malaysia’s prudential requirements and approval framework, ensuring credible repayment capacity of Malaysian borrowers. These include requirements on liquidity and funding risk management for banks’ external debt (i.e. interbank borrowings, non-resident deposits and bonds and notes), while corporate external borrowings in the form of loans and bonds and notes are subject to an approval framework to ensure that they are supported by foreign currency earnings or sufficiently hedged. Third, intercompany loans which are mostly accounted by FDI companies are generally on flexible and concessionary terms, including no fixed repayment schedules and zero or much lower interest rates charged compared to the prevailing market interest rates.
Our authorities welcome the Fund’s acknowledgement of the effectiveness of the December 2016 measures in reducing volatility in the onshore market. Prior to December 2016, the negative spillover impact from the offshore NDF market resulted in heightened USDMYR 1-month implied volatility of 12.0%, raising the risks of market dysfunction and financial instability. The volatility has since then moderated to an average of 4.6% along with other regional currencies (SGD, THB, IDR, PHP, CNY) at 5.5%. The spillover impact of the MYR NDF market has also remained contained as observed in the subdued daily volume of USD0.6 – 0.7 billion per day, from an average of USD2.9 billion in 2016 (High: USD6.9 billion). Ringgit has also traded in line with the performance and expectations of other regional currencies. Onshore foreign exchange trading volume has risen with better balance of demand and supply. The market recorded a healthy daily average foreign exchange transaction volume of USD10.6 billion since December 2016. Domestic liquidity also improved, as reflected in the narrowed USDMYR bid-ask spread while net inflows from resident trade contributed to a more balanced foreign currency supply and demand. The measures thus succeeded in providing stability to the onshore market.
Our authorities concur with staff’s view that the December 2016 measures should be gradually reviewed in line with evolving market conditions. Our authorities have indeed been proactive, as evident in the recent enhancement to the export conversion measure in August 2018. Exporters are now allowed to automatically retain export proceeds with onshore banks to meet up to 6 months’ foreign currency obligations without the need to first convert proceeds into ringgit. Our authorities wish to emphasise that the streamlining of investment abroad rules is prudential in nature and not distortive, as assessed by staff. The authorities continue to support productive investment abroad, as reflected in the high-level of approvals, while being mindful of the need to ensure safeguards are in place to prevent excessive build- up of corporate debt.
While our authorities remain committed to an open environment, the review of the December 2016 measures needs to be balanced with the risks that are being addressed. Subject to on-going assessment, these measures, which are prudential in nature, may be retained for an extended period of time as long as they are effective in managing the risks to the financial system and overall macroeconomic stability. When the intermediation capacity of the domestic market reaches a mature stage in terms of its ability to absorb and counter the effect of large and volatile capital flows, further relaxation or gradual phasing out of current rules can be considered. Therefore, staff needs to view the policies in place as part of a broader toolkit, alongside foreign exchange operations to ensure orderly market conditions. In this context, it would be helpful if staff could suggest policy alternatives to meet our objectives, rather than just advising the authorities to remove these measures.
Our authorities welcome the staff’s assessment that the Malaysian financial sector is resilient and that risks to financial stability remain broadly contained.
We are also encouraged by the staff’s recognition of the efforts undertaken to enhance operational resilience and crisis preparedness of the domestic financial system. We wish to highlight that efforts are already ongoing to strengthen the resolution framework and related facilities, including contingent resolution funding facilities, to ensure alignment with the principles set out in the Financial Stability Board’s Key Attributes for Effective Resolution Regimes.
While non-bank financial institutions (NBFIs) intermediate about 50% of financial system assets, contagion risks, as staff noted, from the activities of NBFIs remain contained. Most of the NBFIs are regulated by BNM, Securities Commission Malaysia, Malaysia Co-operative Societies Commission, or subjected to some form of oversight by government ministries. Institutional arrangements to support inter-agency cooperation are in place to facilitate information sharing across regulators and to enhance inter-agency responses and coordination. The surveillance of more systemic NBFIs by BNM is additionally supported by strengthened reporting frameworks applied to these NBFIs. The commitment by the new Malaysian Government to institutionalise greater transparency, governance and integrity across all NBFIs will also help promote the sustainability and long-term viability of these entities.
Businesses continue to maintain healthy debt servicing capacity and liquidity positions. This has supported the expansion in overall corporate debt, which grew in line with domestic economic expansion. The overall quality of business borrowings also remains high. While some sectors, such as the oil and gas and real estate sectors continue to face persistent headwinds, risks to domestic financial stability remain limited, with losses sufficiently provisioned by banks and the quality of borrowings remaining broadly stable. Bank exposures in these sectors (excluding end-financing for property) also remain small.
The authorities affirm that credit exposures to the household sector remained manageable. Debt servicing capacity of households continued to remain intact supported by healthy financial buffers with financial assets and liquid financial assets of 2.1 times and 1.4 times of debt, respectively. Asset quality remained sound with the ratio of aggregate impaired loans to total outstanding household debt for both banks and non-banks remaining low and stable.
While we note staff’s assessment on the vulnerability of the vulnerable household group (individual borrowers with monthly earnings of below RM3,000), authorities view that potential risks to financial stability emanating from credit exposures to this group are mitigated given a declining proportion of exposures to this segment to 18.3% of total exposures of the banking system as at end-June 2018 (2013: 25.1%). Underwriting practices remain sound, with the bulk of new loans approved to the vulnerable segment with prudent debt service ratios of below 60%. The authorities agree that significant income, interest rate or cost of living shocks could affect the ability of some households to service their debt. However, internal simulations as published in the Financial Stability and Payment Systems Report 20171, suggest that under stressed scenarios, potential losses to the banking system from exposures to the household sector of between RM66 billion and RM104 billion will be manageable given the high excess capital buffers of banks (RM124.5 billion).
Our authorities continue to be vigilant against risks emanating from the property market. While mortgages account for a significant portion of household debt as highlighted by staff, risks to the banking system from a sharp deterioration in house prices are mitigated by prudent loan-to-value (LTV) measures observed by banks (generally below 80%), and low and reducing share of investment borrowers. Sensitivity analysis further indicate that banks have sufficient capital buffers to absorb potential losses arising from up to a 50% decline in property prices and its spillover to business sectors that are highly dependent on the performance of the property sector.
A comprehensive set of macroprudential and fiscal measures put in place since 2010 have effectively contained risks from household indebtedness and rising property prices. These demand management measures were also complemented by the authorities’ efforts to increase the supply of affordable houses, which has also helped ease upward pressure on house prices. With these measures in place, credit risks from a more generalised downward correction in house prices are assessed to be low. As such, while the authorities take note of staff’s recommendation to impose sector-wide standardised LTV limits on first and second properties in the medium term, they remain of the view that current macro-prudential measures continue to be sufficient. This is supported by existing regulatory and supervisory measures such as the differentiated capital charges for loans with higher LTV, and the review of provisioning practices of banks which also consider LTV levels as a risk driver for setting provisions. Banks’ mortgage underwriting standards have also continued to strengthen as evidenced by vintage analysis for housing loans over recent years. While the authorities have not imposed a higher risk weight on the construction sector, BNM has introduced strengthened requirements on credit risk management in January 2018, which set out expectations of banks to conduct more robust assessments of financing proposals for new property development on construction prospects. Compliance with these expectations is reviewed through BNM’s supervisory activities.
Finally, the authorities disagreed with staff’s recommendation to phase out the differentiated RPGT and floor price for non-residents’ purchase of properties, and view that the measures remain relevant to ensure that growth in house prices are reflective of domestic fundamentals. Recent data from 2017 and the first half of 2018 has indicated some resurgence in the growth of investment property purchases by non-residents. In this regard, these measures are still considered appropriate to manage risks arising from the build-up of financial imbalances in the property market, which could spill over to the domestic financial system.
Efforts to strengthen safeguards against threats of money laundering and terrorism financing (ML/TF) continue to be a key priority for our authorities. In regard to efforts to support anti-corruption, our authorities have reduced the reporting threshold amount for Cash Threshold Reporting (CTR) from transactions amounting to RM50,000 (approximately USD12,000) and above, to RM25,000 and above in a day. These new measures were made based on the 2017 National Risk Assessment (NRA) and recent enforcement cases that found cash is still widely used by criminals to launder illegal proceeds. In addition, Malaysia continue to remain committed towards meeting its five-year National AML/CFT Strategic Plan objectives. As at 2018, 82% of the 74 action and sub-action plans have been reported as either completed or currently in progress within the stipulated timeline.
Reforms for sustainable and inclusive growth
The report of Mid-Term Review of the 11th Malaysia Plan (MTR 11MP), tabled and approved by the Parliament in October 2018, outlines the medium-term strategies and reform measures of the new government, with greater emphasis on strengthening the economy, public institutions and governance.
The MTR 11MP focuses on strengthening Malaysia’s economic fundamentals, premised on innovation, creativity and improving productivity, in line with the aspiration to become a developed and inclusive nation. Focus will be on strengthening sectoral growth – particularly services and manufacturing sectors – and promoting private investment, while efforts to accelerate improvement in education and human capital development will continue to be prioritised to increase productivity. The transformation of the education system will emphasise quality, equity, access, unity, efficiency and inclusivity of education. Enhancing science, technology, engineering and mathematics education, and higher order thinking skills will be the focus for basic education. Meanwhile, governance of Institutions of Higher Education and stronger industry-academia linkages will be further enhanced to improve the quality of graduates. In addition, existing programmes of Technical and Vocational Education will be continuously reviewed in collaboration with industry players to meet industry demand. Further efforts will also be taken to improve the business climate through enhancing the delivery of public services, reducing bureaucratic red tape and provision of quality infrastructure. In particular, the adoption of Good Regulatory Practices will be intensified to improve the processes and procedures in increasing productivity and competitiveness, and will be expanded to the sub-national or state level.
To ensure sustained and better enforcement of prudent public finance management, a comprehensive reform on fiscal and public finance management framework will also be implemented. Strategies to be implemented include improving the budgeting system, enhancing procurement management as well as strengthening performance management, monitoring and evaluation framework. The implementation of the accrual accounting system will also be expedited to further enhance transparency and full disclosure of government’s assets and liabilities. In addition, the Fiscal Responsibility Act (FRA) and Government Procurement Act will be introduced to enhance fiscal governance and improve efficiency of public spending. The authority also took initiative to establish the Debt Management Office to enhance debt management operations as well as intensify fiscal risk assessment.
Reform initiatives are also being undertaken to improve governance and strengthen public institutions. Among the key priorities is to strengthen the check and balance mechanism at all levels. For instance, the MTR 11MP outlines the commitment to establish a select committee in Parliament. To ensure operational independence of the institutions, the select committee will endorse the appointment of key positions, among others including in the Malaysia Anti-Corruption Commission (MACC), Election Commission (EC), National Audit Department and Judicial Appointments Commission. In addition, the MACC and EC will also be made answerable directly to Parliament. The Government is also committed to execute efforts in fighting corruption effectively and efficiently at all levels. In this regard, the MACC will be transformed into a fully independent body. Furthermore, the anti- corruption legislation such as the MACC Act, Witness Protection Act and the Whistleblower Protection Act will be continuously reviewed and strengthened to ensure its relevance with current development. The Government has also launched the National Anti-Corruption Plan (NACP) 2019–2023 that covers 6 strategies, including increasing the efficiency and transparency in public procurement, institutionalise the credibility of law enforcement agencies and inculcate good governance in corporate entities.
Malaysia’s diversified economy, sound fundamentals and strong financial system have considerably strengthened the economy’s resilience to withstand shocks. A robust policy framework, underpinned by a pre-emptive and pragmatic policy approach have also minimised risks and vulnerabilities. As the external economic and financial conditions evolve, our authorities remain vigilant to adverse developments and potential risks to the Malaysian economy and financial system. In the event of adverse shocks, our authorities have adequate policy buffers to respond in a timely and effective manner to preserve macroeconomic and financial stability, and achieve sustainable and inclusive growth.
Looking ahead, the challenging global environment also necessitates the Fund, as the multilateral institution responsible to safeguard the global financial system, to play greater role in reducing the risks from disruptive cross-border spillovers that can be detrimental to member economies, including Malaysia.
As per the Box Article on page 39 entitled ‘Indebted to Debt: An Assessment of Debt Levels and Financial Buffers of Households’