Malaysia
Recent Economic Developments
Author: International Monetary Fund
Publication Date:
15 Jan 1994
eISBN:
9781451828214
Language:
English
Keywords:
ISCR; CR; public enterprise; firm; export; FTZ; Malaysia
Download PDF (4.2 MB)

This paper describes economic developments in Malaysia during the 1990s. Real output growth strengthened to 8½ percent in 1993 from 7¾ percent in the previous year. In contrast to 1992, however, growth in output was driven exclusively by domestic demand, with all components recording stronger growth in 1993 than in the previous year. Consumption spending grew by 7¾ percent in 1993, up from 2¾ percent in 1992. Fuelled by higher real wages and the positive wealth effect of higher equity prices, real private consumption rose by 7½ percent in 1993, compared with 2½ percent in 1992.

Abstract

This paper describes economic developments in Malaysia during the 1990s. Real output growth strengthened to 8½ percent in 1993 from 7¾ percent in the previous year. In contrast to 1992, however, growth in output was driven exclusively by domestic demand, with all components recording stronger growth in 1993 than in the previous year. Consumption spending grew by 7¾ percent in 1993, up from 2¾ percent in 1992. Fuelled by higher real wages and the positive wealth effect of higher equity prices, real private consumption rose by 7½ percent in 1993, compared with 2½ percent in 1992.

I. Historical Perspective

Over the past three decades, the Malaysian economy has grown on average by 6 3/4 percent a year, with an annual per capita GDP growth of 4 percent. This performance places Malaysia squarely in the group of fast-growing Southeast Asian economies and, therefore, among the top performing economies in the world. Rapid growth has coincided with a major shift in the structure of the economy from one highly dependent on a small group of primary commodities to one where manufacturing is the largest sector. In addition, considerable diversification in both the range of primary commodities and manufactured products has occurred over this period. Growth has been supported by a rise in the investment rate from an average of 14 percent of GDP in the 1960s to 33 percent in 1990. This rise was facilitated by the growing openness of Malaysia’s economy, since much of the investment came from abroad and was concentrated in export-oriented activities.

At independence in 1957, 1/ Malaysia’s economy was heavily resource-dependent, with agriculture and mining accounting for about 38 percent and 6 percent of GDP, respectively, while manufacturing contributed less than 10 percent to total output. Furthermore, two commodities-rubber and tin--together accounted for over 70 percent of exports. Within agriculture, two distinct activities coexisted: export-oriented, foreign-owned plantation farming; and low-productivity, subsistence or smallholder farming which was largely associated with the ethnic Malay population.

In order to broaden the economic base, an import-substitution policy was adopted, supported by the introduction in 1958 of the Pioneer Industries Ordinance, which granted exemptions from corporate income tax for periods up to eight years to firms in approved industries. This legislation fostered the development and expansion of the food, rubber products, textiles, and car assembly industries, and contributed to an increase in manufacturing’s share in GDP to 14 percent by 1970. A decline in rubber prices and the emergence of synthetic alternatives provided the impetus for a diversification of the agricultural base. Attesting to this diversification, palm oil emerged as a major agricultural crop and a significant source of export revenue.

Reflecting the success of the industrialization strategy, real output grew by 6 1/2 percent a year during the 1960s. The emergence of new agricultural commodities was, however, insufficient to offset the reduction in rubber production. As a result, agriculture’s role in the economy declined over the decade. 2/ In addition, reflecting the bias toward import substitution policies during the 1960s, the share of imports in GDP declined from about 45 percent in the early 1960s to 37 percent by 1969.

In 1970, Malaysia embarked on a second stage in its development strategy with the introduction of the 20-year New Economic Policy (NEP). The main objectives of the NEP were poverty eradication and wealth redistribution. Economic growth through industrialization was viewed as essential to the success of the Plan since, given the distributional objectives of the NEP, only rapid growth could ensure that no group would be left worse off. In pursuit of the NEP objectives, the Government greatly increased its involvement in the industrial sector through direct participation in industrial projects and the regulation of private sector activity. During the 1970s, the number of public enterprises increased by 50 percent, financed by a large buildup in government-guaranteed foreign debt. The 1975 Industrial Coordination Act (ICA) established a system of licensing that enabled the Government to control what goods were produced, as well as the share of employment and equity ownership reserved for Malays. The regulatory environment associated with the ICA was met by a sharp drop in private investment, from 19 percent of GNP in 1974 to 13 3/4 percent in 1976.

In addition, under this second phase of Malaysia’s development, manufacturing became increasingly export oriented. This reflected, in part, the degree to which the size of the domestic market had constrained manufacturing production under the import-substitution policies of the 1960s. Under the Investment Incentives Act introduced in 1968, tax relief was offered to firms that exported more than 20 percent of their production, and export promotion expenses were eligible for a double tax deduction. In addition, free trade zones (FTZs) were established, which permitted firms to import their components free of duty and export their products exclusive of sales and excise taxes. As a result, foreign direct investment (FDI) expanded rapidly, reaching 19 percent of GDP in 1975, most of which was directed to the textile and apparel, and electrical and electronics industries established in the FTZs. During this period, nearly 15 percent of new manufacturing jobs were created in FTZs and, by 1980, 70 percent of manufactured exports were produced in these zones. However, tariff concessions granted to firms in the FTZs tended to increase the import content of the goods produced. In some industries, the propensity to import intermediate and capital goods exceeded 90 percent.

Reflecting the goal of export-led industrialization, manufacturing increased its share in GDP from 14 percent in 1970 to 20 percent in 1980 and exports grew from 46 percent of GDP to 58 percent over the same period. As a result, the share of agriculture declined from 32 percent of GDP to 23 percent of GDP during the 1970s. Growth in manufacturing, which averaged 12 percent a year during the 1970s induced a shift in employment from the rural sector and helped to reduce the rate of unemployment from 7 1/2 percent in 1970 to 5 1/4 percent in 1980. The discovery in the early 1970s of extensive petroleum deposits more than offset the effects on mining activity of the depletion of tin reserves. As a consequence, mining increased its share in GDP from 7 percent in 1970 to 10 percent in 1980. Petroleum developed into a major export commodity during the decade, rising from less than 5 percent of total export earnings in 1970 to nearly 20 percent of exports in 1980. Overall, output grew by 8 percent per annum during the 1970s.

The objective of rapid growth through export-driven industrialization was set back by the world recession of the early 1980s. Indeed, the global recession of 1981-82 had a severe, albeit delayed, effect on the Malaysian economy. Manufacturing, which was heavily concentrated into two export-oriented industries–electronics and textiles–was hard-hit by the decline in external demand. Relative to exports, debt service obligations–to which the surge in public enterprise spending and government-guaranteed debt under the NEP had contributed–increased significantly. Exacerbating the effects of weak external demand was a sharp deterioration in the terms of trade in 1985-86 (of about 24 percent)–owing largely to the drop in oil prices-and a collapse in private investment. As a result, output contracted by 1 percent in 1985–the only year since independence in which GDP declined-after rising by 6 3/4 percent per year during 1980-84.

In order to restore economic growth, the Government reoriented its policies and introduced a set of measures designed to promote private sector activity. The package, introduced between 1983 and 1986, included: (i) improvements in the investment climate by liberalizing equity and employment requirements and by introducing more generous corporate tax relief, particularly for export-oriented firms, and (ii) a reduction in the public sector’s role in industry through a cut in the share of development expenditure equivalent to 10 percent of GNP between 1983 and 1990, and the initiation of a privatization program.

Reflecting these measures, as well as an improvement in the external environment, the economy began a remarkable private investment-led recovery in 1987. Over the next few years, FDI inflows turned up sharply and the value of approved projects more than doubled between 1987 and 1988, accelerating further to reach a record level in 1991. Investment was particularly strong from Japan and the Asian newly industrialized economies (NIEs), which reflected, in part, the relocation of their production bases to lower cost countries. The net result was manufacturing growth that averaged IS percent per annum over the period 1986–90 and annual GDP growth of about 8.3 percent during the same period.

Encouraged by the economy’s performance under the liberal policies set in place during the second half of the 1980s, the Government introduced its ten-year National Development Policy (NDP) in 1991. The NDP emphasized growth through the promotion of private sector activity and human resource development. While the social objectives of poverty elimination and wealth redistribution were maintained, these were to be achieved through greater emphasis on education and equality of opportunity.

Rapid growth since 1987, which was concentrated largely in the export-oriented manufacturing sector, contributed to a sharp decline in the unemployment rate, from 8.2 percent in 1987 to 3.7 percent in 1992. As a result, shortages of both skilled and unskilled labor emerged. Increasingly tight labor market conditions contributed to rising labor costs, which threaten to erode Malaysia’s external competitiveness and to reduce the flow of foreign investment. While the economy has begun to shift away from (labor-intensive) assembly-type production and to implement labor-saving technologies in a number of sectors, thereby adding to potential output, demand pressures have intensified in recent years owing, in part, to a surge in short-term capital inflows.

II. Real Sector Developments

1. Aggregate demand, production, and prices

Real output growth strengthened to 8 1/2 percent in 1993 from 7 3/4 percent in the previous year. In contrast to 1992, however, growth in output was driven exclusively by domestic demand, with all components recording stronger growth in 1993 than in the previous year (Chart 1, Table 1, and Appendix Tables 7 and 8). Consumption spending grew by 7 3/4 percent in 1993, up from 2 3/4 percent in 1992. Fuelled by higher real wages and the positive wealth effect of higher equity prices, real private consumption rose by 7 1/2 percent in 1993, compared to 2 1/2 percent in 1992. Public consumption increased by 8 percent, reflecting higher spending for defense and essential services and supplies, and the payment of salary bonuses to public sector employees.

CHART 1
CHART 1

MALAYSIA SELECTED MACROECONOMIC INDICATORS, 1986–93

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: Data provided by the Malaysian authorities.
Table 1.

Malaysia: Economic Trends, 1977-93

article image
Sources: Data provided by the Malaysian authorities; and staff estimates.

Period average.

1979-80.

In percent of exports of goods and services.

In months of imports of goods and services.

Total investment expanded by 16 percent in 1993, up sharply from 2 percent in 1992. Private fixed investment increased by 10 percent in real terms, compared to 6 1/2 percent in 1992, reflecting a decline in real interest rates, the implementation of investment projects approved during the peak period 1990-91, and the announcement of a two-step reduction in the corporate tax rate beginning in 1994. Manufacturing continued to receive the largest share of private investment spending (26 percent), followed by the service and construction sectors, with 21 and 16 percent, respectively. Reflecting a greater emphasis on infrastructure upgrading, public investment increased by 12 1/4 percent in 1993, compared to 11 percent in 1992. Also contributing to the growth in investment was a buildup in inventories, following a decumulation in the previous year.

In line with the acceleration in private spending, real import demand grew by 14 percent in 1993, following a decline of 1 percent in 1992. Reflecting the strength of investment and output growth, imports of intermediate and capital goods increased more rapidly than imports of consumption goods. Real exports grew by 11 1/4 percent in 1993 (up from 5 percent in 1992), owing largely to the penetration of new markets for manufacturing goods in the Asia-Pacific region. Overall, therefore, while net exports were the primary source of growth in 1992, their contribution to growth in 1993 was negative.

On the supply side, the diversification of output continued in 1993, with the manufacturing, construction, and service sectors growing more rapidly than the economy as a whole (Appendix Table 9). Despite the rapid increase in manufacturing investment, capacity utilization (in manufacturing) rose to nearly 85 percent by end-1993, a historically high level. In addition, the manufacturing sector absorbed 24 percent of the labor force in 1993, up from 15 percent in 1986. Agriculture continued to expand in 1993, albeit at a moderate pace, while activity in the mining sector turned around to register a small decline (Appendix Table 10).

Manufacturing, which accounted for 29 percent of GDP in 1992, was the leading growth sector in 1993, expanding by 12 3/4 percent compared to 10 3/4 percent in the previous year (Appendix Table 11). Despite the sluggish economic performance of industrial countries, growth in export-oriented industries-electronics, wood products, textiles, and processed edible oils-rose to 14 1/4 percent from 11 1/4 percent in 1992. This development reflected, in part, the strengthening of demand in the United States’ computer market and the relocation of production facilities from Japan and Taiwan Province of China to Malaysia. Fuelled by the acceleration in domestic demand, domestic market-oriented manufacturing grew by 11 percent in 1993, compared to 9 1/4 percent in 1992. Within domestic-oriented manufacturing, the 58 percent growth rate recorded by the fabricated metals sector was particularly noteworthy.

The growth performance of the construction and service sectors, at 11 1/2 percent and 9 percent, respectively, in 1993, was largely unchanged from the previous year. Residential construction was boosted by the rise in real incomes and the wealth effect of higher equity prices. Additional impetus to construction activity was provided by several major ongoing infrastructure projects, including a new international airport and a light rail transit system. Service sector growth was dominated by the performance of the financial and business subsector, which expanded by 12 percent during 1993. A major factor was the surge in activity on the Kuala Lumpur Stock Exchange (KLSE).

Despite the acceleration in domestic demand, consumer price inflation moderated to 3 1/2 percent in 1993 from 4 3/4 percent in 1992 (Appendix Table 12), although it picked up at the end of the year. The moderation reflected a number of factors, including low world inflation and the steady value of the ringgit. In addition, the introduction in January 1993 of administrative measures–including the reduction or removal of import duties on more than 600 intermediate and final goods—also helped to limit increases in domestic prices, especially for food. 1/

Producer prices continued to increase more slowly than consumer prices in 1993. Reflecting growing wage pressure, local production costs were the main factor behind the 1 1/2 percent increase in the PPI (Appendix Table 13). However, in the first quarter of 1994, supply constraints and seasonal factors led to a sharp rise in the price of food at the producer level, which contributed to an acceleration in the 12-month PPI to 2 percent.

2. Investment and saving

The current account deficit widened to 4 percent of GNP in 1993, a one percentage point increase relative to the previous year. The deterioration in the external balance reflected an increase in investment equivalent to 1 1/2 percent of GNP, which more than offset the increase in national saving of about 1/2 percent of GNP (Appendix Table 14). The increase in the national saving was attributed to the rise in private saving to 20 percent of GNP, 1/2 percentage point higher than in 1992 (Chart 2).

CHART 2
CHART 2

MALAYSIA INVESTMENT AND SAVING, 1986–93

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: Data provided by the Malaysian authorities.

Gross fixed capital formation stabilized at just above 36 percent of GNP in 1993, with the private and public components remaining relatively constant at 24 and 12 percent, respectively. The relative stability of the private fixed investment ratio reflected three distinct forces. First, a diversion of foreign investment to lower cost countries in the region contributed to a reduction in FDI of 1 3/4 percent in nominal terms in 1993. Second, locally sourced investment rebounded strongly in 1993, following the introduction of the Domestic Investment Initiative which promotes investments by local businesses. This resurgence in locally sourced investment more than offset the decline in FDI. 2/ Third and finally, however, the deflator for fixed investment rose less rapidly than the GNP deflator in 1993. Other things equal, this relative price effect tended to reduce the share of private fixed capital formation in nominal GNP. 3/

3. Labor market

The continued expansion in economic activity led to a further tightening of labor market conditions in 1993. Employment growth of 3 1/2 percent contributed to a reduction in the unemployment rate, from 3 3/4 percent in 1992 to 3 percent, despite a 2 3/4 percent increase in the size of the labor force (Appendix Table 16). Employment growth was strongest in the manufacturing and construction sectors (8 1/2 percent), whereas the primary sector continued to shed its workforce. Manufacturing alone accounted for more than half of total new employment and, in 1992, surpassed agriculture as the leading employer.

Labor shortages were evident throughout the economy in 1993 but were most pronounced in the manufacturing and service sectors, where skilled labor was scarce, and in the plantation and construction sectors, where unskilled workers were in short supply. To increase the availability of skilled labor, the Government set up in January 1993 the Human Resource Development Fund (HRDF) to encourage greater private sector participation in skills training. The HRDF received a start-up capital of RM 49.8 million from the Government (payable in three equal annual installments beginning in 1993) and is financed by a 1 percent levy on wages, payable by companies with 50 or more employees. The importation of foreign workers to alleviate the shortage of unskilled labor, however, has been temporarily frozen since January 1994, pending resolution of the problem of illegal immigrants.

For the economy as a whole, average labor productivity, measured as real GDP per worker, increased by 5 percent during 1993, following a similar increase in the previous year. Agriculture continued to achieve the most rapid gains in productivity during the year (9 1/2 percent), followed by the service sector (5 percent). Labor productivity in manufacturing rose by 3 3/4 percent in 1993, following a small decline in the previous year. 2/

Reflecting the tightness in labor market conditions, real wage costs accelerated during 1993 (Chart 3). Although economy-wide wage data are not available, an indication of the rising cost of private-sector employment can be obtained from data on new collective agreements among unionized workers. 1/ Under private sector collective agreements concluded in 1993, nominal wages rose by 12 percent, 2/ up from 9 percent in the previous year. These increases, which exceeded improvements in (nominal) labor productivity, contributed to a sharp rise in unit labor costs and to an erosion of international competitiveness. As in 1992, wage increases were highest in manufacturing, followed by the service sector. Manufacturing wages increased by 15 percent on average, compared to 10 percent in 1992. In contrast, wage increases in other sectors were generally smaller than in the previous year. Within the manufacturing sector, wage increases displayed considerable variability, ranging from 0–34 percent depending on the subsector. Attesting to the acute shortage of skilled labor, more experienced and better trained workers tended to receive larger percentage wage increases.

CHART 3
CHART 3

MALAYSIA LABOR MARKET DEVELOPMENTS, 1986–93

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: Data provided by the Malaysian authorities.1/ Wage increases are based on collective agreements concluded during the year.

III. Recent Fiscal Developments

1. Overview of budgetary trends

After expanding considerably during the recessions of 1980-82 and 1985-86, the public sector was scaled back during the period of the Fifth Malaysia Plan (1986-90). Government spending was reduced sharply with a reprioritization of development expenditure and cutbacks in spending on goods and services, subsidies, and personnel recruitment. In addition, tax reforms were introduced to promote the development of the private sector. As a result, the federal government’s overall deficit declined from over 10 percent of GNP in 1986 to 3 percent of GNP by 1990 (Chart 4, Table 2, and Appendix Table 17).

CHART 4
CHART 4

MALAYSIA BUDGETARY TRENDS, 1985–93

(In percent of GNP)

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: Data provided by the Malaysian authorities, and staff estimates.
Table 2.

Malaysia: Summary of Federal Government Budgetary Developments, 1985-94

(In percent of GNP)

article image
Sources: Data provided by the Malaysian authorities; and staff estimates and projections.

The process of fiscal consolidation and restructuring has continued in the early 1990s and, in 1993, the overall balance of the federal government recorded a surplus, resulting in the federal government’s best financial performance in more than 30 years. The main fiscal developments in 1993 included a continuation of restraint in operating expenditure, further reprioritizing of development spending, and ongoing tax reforms aimed at increasing the efficiency of the tax system.

2. Expenditure trends: Reallocating to priority sectors

The reduction in total government spending, from 28 percent of GNP in 1992 to 26 percent of GNP in 1993, was accompanied by a reallocation of expenditure. Most of the spending cuts focused on current expenditure, while development expenditure was broadly maintained relative to GNP. However, within development spending, there was a reallocation toward more expenditure on infrastructure (particularly transportation) and social services (Chart 5). The shift in spending priorities was also evident on the functional side (Table 3 and Appendix Table 18). Expenditure on economic services and interest payments declined, while spending on education and health remained stable relative to GNP.

CHART 5
CHART 5

MALAYSIA EXPENDITURE DEVELOPMENTS, 1988–93

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: Data provided by the Malaysian authorities; and staff estimates.1/ Based on national classification excluding security expenditures.
Table 3.

Malaysia: Federal Government Functional Expenditure Shares, 1985-94

(In percent of GNP)

article image
Sources: Data provided by the Malaysian authorities; and staff estimates and projections.

The decline in current expenditure, from 24 percent of GNP in 1992 to 21 percent in 1993, was reflected in all of the major categories (Appendix Table 19). Wages and salaries fell by 1 percentage point of GNP, although this owed a one-time payment arising from the introduction of the New Remuneration System in 1992, which involved an 8-10 percent increase in salary levels with a backdating of the wage increase to January 1989. Adjusting for this one-time payment, the underlying wage bill grew by 14 percent in 1993, owing to wage increases in line with the normal annual increment, the payment of a half-month cash bonus, and new recruitment to fill essential vacancies in health and education. 1/

As regards the other principal components of operating expenditure, subsidies and current transfers declined, owing to a reduction in federal government transfers to statutory bodies, in line with the policy to encourage these agencies to rely more on self-financing. Expenditure on goods and services declined relative to GNP, reflecting government policy to exert strict control on the overall growth of these expenditures. Interest payments also fell, reflecting the reduced level of government debt.

While overall development expenditure, which includes net lending, increased slightly to about 5 1/2 percent of GNP in 1993, direct development spending remained broadly stable relative to GNP. However, there was a significant shift in the allocation of direct spending across the main sectors. Expenditure on transportation was increased, reflecting higher allocations for the rehabilitation of the highway network, the development of the rail system, and the upgrading of airports. Spending on the education sector also increased. Expenditure on commerce and industry, in contrast, continued to decline, in line with the reduced presence of the Government in the economy and the privatization of public enterprises. Lending to state governments and public agencies stabilized in nominal terms in 1993 but, as repayments declined slightly, there was a small increase in net lending.

3. Revenue developments and budgetary financing

a. Revenue trends: Tax reform and improvements in administration

In line with the objectives of the Sixth Malaysia Plan (1991-95), a series of reforms have been implemented in recent years with a view to increasing the efficiency of the revenue system. Tax rates and tariffs have been lowered in order to improve the climate for private sector activity and lower cost pressures in the economy. The corporate tax rate was reduced from 40 percent in 1988 to 35 percent in 1989, 34 percent in 1993, and 32 percent in 1994, with a further reduction to 30 percent already announced to take effect from January 1, 1995. Personal income tax rates have been cut from a range of 4-35 percent in 1991 to 2-34 percent in 1993. The development tax, which was 5 percent in 1989, has been gradually reduced and was eliminated in 1993. In addition, export duties have been either reduced or eliminated, stamp duties have been reduced, the estate duty has been eliminated, and import duties were reduced or eliminated on about 600 items in the 1993 budget and a further 500 items in the 1994 budget.

While direct tax rates have been lowered, revenue collections have been maintained by the extension of the coverage of the services tax, improvements in tax administration, and an increase in tariffs on alcohol and tobacco products. With respect to tax administration, in addition to the measures introduced in 1991 and 1992, 1/ several additional measures were implemented in 1993 and 1994 that have improved performance and increased collections from corporate and personal income taxes despite the reductions in tax rates: (i) a series of lectures, exhibitions, and dialogue sessions were held as part of a taxpayer education program and resulted in an increase in voluntary compliance; (ii) collection regulations were tightened to reduce payment of tax obligations by extended installment; (iii) direct banking of daily tax collections was initiated; and (iv) the functions of the Inland Revenue Department were decentralized and regional offices were opened.

In 1993, revenue collections declined relative to GNP, owing mainly to a drop in petroleum-related revenue, a reduction in nontax revenue, and tax concessions granted in the budget (Table 4 and Appendix Table 20). The impact of these factors, however, was partly offset by the continued strong performance of corporate and individual tax collections. 1/ At the same time, administrative measures introduced by the Inland Revenue Department raised tax collections, and service taxes increased considerably, owing to a further broadening of the tax base to include telecommunications and other services.

Table 4.

Malaysia: Components of Revenue, 1985–94

(In percent of GNP)

article image
Sources: Data provided by the Malaysian authorities; and staff estimates and projections.

b. Budgetary financing

Public sector deficits in Malaysia have typically been financed by external borrowing and from domestic nonbank sources like the Employees Provident Fund (EPF) (Appendix Table 21); relatively little recourse has been made to bank financing. The consolidation of the fiscal position in recent years has enabled the Government to make significant reductions in total outstanding government debt relative to GNP (Appendix Table 22). Moreover, since 1988, domestic sources of financing have been sufficient for the Government to make substantial prepayments on its external debt.

In 1993, the Government continued to make substantial net repayments and prepayments of external debt financed primarily by a drawdown of government cash balances in the central bank and other cash assets. Because of the low borrowing need of the Government, the issuance of government securities was limited during the year and, in contrast with previous years, Government Investment Certificates (GIC) were the major instrument of domestic borrowing. In addition, there was one issue of Malaysian Government Securities (MGS).

4. Consolidated public sector

The public sector is made up of the public enterprises and the general government which, in turn, consists of the federal government, statutory bodies, and 13 state and 80 local governments. In recent years, the evolution of the consolidated public sector position has largely reflected changes in the federal government’s overall balance (Chart 6 and Appendix Table 23). However, during 1992–93, improvements in the federal government’s financial position were offset by a deterioration in the position of the public enterprises, owing to a substantial increase in development expenditure.

CHART 6
CHART 6

MALAYSIA CONSOLIDATED PUBLIC SECTOR DEFICIT, 1985–93 1/

(In percent of GNP)

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: Data provided by the Malaysian authorities; and staff estimates.1/ After adjusting for inter-fovernmental transfers.2/ Consists of statutory bodies, and state and local governments.

a. General government

The overall balance of the general government, after adjusting for intergovernmental transfers, improved from a deficit of 3 percent of GNP in 1989 to a small surplus in 1993, closely reflecting the position of the federal government. The position of the rest of the general government, not including the federal government, has been roughly unchanged–local governments have remained broadly in balance, while state governments and statutory bodies have had small deficits (Appendix Tables 24–28).

b. Public enterprises

The public enterprise sector has undergone considerable reform in recent years, focusing on operational improvements in those enterprises remaining in the public sector and a moratorium on the creation of new public enterprises. 1/ This has led to a reduction in the number of loss-making enterprises and an increase in the overall operating surplus of the public enterprises, the bulk of which has been accounted for by several of the major enterprises, including the petroleum company (PETRONAS), Telekom Malaysia Berhad (TMB), Tenaga Nasional Berhad (TNB), and Malaysian Airlines (MAS). However, the increase in the operating surplus of the public enterprise sector has been more than matched by increases in development expenditure.

In 1993, development expenditure of nonfinancial public enterprises (NFPEs) increased sharply, particularly for infrastructure and public utilities, with the bulk of investment accounted for by several partially privatized public enterprises (MAS, PETRONAS, TMB, and TNB). As a result, the public enterprise sector recorded a small overall deficit for the first time since 1986 (Appendix Table 29).

c. Privatization

The Government’s privatization policy was initiated in 1983 and, to facilitate and accelerate its implementation, the Privatization Master Plan (PMP) was introduced in 1991. Within the PMP is a Privatization Action Plan, a two-year rolling plan under which individual projects and enterprises are identified for privatization. Several methods of privatization have been used: (i) the sale of equity or assets in government companies; (ii) a lease of the use of the assets for a specified period; (iii) management contracts; and (iv) build-operate and build-operate-transfer arrangements for new investment (primarily infrastructure) projects.

As of April 1994, 107 projects had been “privatized.” Of these projects, 56 involved the sale of equity or assets in government enterprises and 22 projects involved the transfer of new investment projects to the private sector through build-operate or build-operate-transfer arrangements. The remaining projects primarily involved leases or management contracts. Major public enterprises that have either been completely privatized or have had the Government’s equity stake reduced to a minority share are the Cement Industries of Malaysia, Edaran Otomobil Nasional, and Sports Toto Malaysia. Equity sales have also taken place in MAS, TMB, and TNB, although the Government still maintains a majority shareholding in these companies. In 1993, the Government divested its shares in two companies. In addition, 22 existing and new projects were privatized. During the first four months of 1994, three more new projects were privatized and equity sales in two enterprises were held.

IV. Monetary and Financial Sector Developments

1. Overview

While significant fiscal restructuring and consolidation have contributed to moderating demand pressure in recent years, monetary policy has also played an important role. The primary monetary policy tools used by Bank Negara have been direct borrowing from the banking system, changes in the Statutory Reserve Requirement (SRR), and the transfer of government and EPF deposits to the central bank. These instruments have been supplemented by sales of MGS and, since early 1993, Bank Negara bills.

During 1992-93, surging capital inflows complicated the conduct of monetary policy. Despite a sharp increase in Bank Negara’s liquidity operations in an effort to offset the expansionary impact of the inflows on the monetary base, monetary conditions eased and reserve money grew rapidly (Chart 7, Table 5, and Appendix Table 30). Moreover, the increased absorption of liquidity imposed a heavy cost on Bank Negara, contributing to the large reserve losses suffered in 1992-93.

CHART 7
CHART 7

MALAYSIA MONETARY DEVELOPMENTS, 1989–94

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: Data provided by the Malaysian authorities.1/ Includes net claims on financial institutions, issues of Bank Negura bills, and the recycling of the deposits of the Employees Provident Fund.
Table 5.

Malaysia: Banking Survey, 1990-94 1/

article image
Source: Data provided by the Malaysian authorities.

Consolidation of the accounts of the monetary authorities, commercial banks, finance companies, merchant banks, and discount houses.

2. Monetary policy and developments

Despite large-scale liquidity operations undertaken by Bank Negara throughout 1993, liquidity conditions eased gradually during the course of the year (Appendix Table 32). The operations, which included direct short-term borrowing from the money market, the sale of Bank Negara bills, the issuance of long-term saving bonds, and the transfer of government and EPF deposits to the central bank, absorbed RM 38 billion of liquidity (Appendix Tables 33 and 34). However, these operations were insufficient to fully offset the impact of a continuation of the surge in capital inflows. The inflows, which included a sharp increase in short-term external borrowing by commercial banks and other financial institutions (Appendix Tables 35 and 36), were related to the significant interest rate differential in favor of Malaysia, a pickup in international interest in Malaysia’s stock market, and market expectations of an appreciation of the ringgit. As a consequence, interest rates eased over the course of the year, with the three-month interbank rate declining from 8 percent at end-1992 to 6 1/2 percent at end-1993.

Liquidity conditions continued to ease in the first half of 1994, although the instruments employed by Bank Negara to counter the effects of the capital inflows varied considerably over the period. In response to a pickup in inflows at end-1993 and early 1994, Bank Negara imposed a set of measures to stem the inflow of short-term capital. These measures, implemented in stages during the period mid-January to mid-February, included: subjecting banking institutions to a ceiling on their nontrade- or noninvestment-related external liabilities; prohibiting residents from selling short-term monetary instruments to nonresidents; and requiring commercial banks to place with Bank Negara the ringgit funds of foreign banking institutions held in noninterest-bearing accounts. 1/ In addition, the eligible liabilities base was broadened to include inflows from abroad and the SRR was raised three times by a cumulative 3 percentage points to 11 1/2 percent in order to siphon off liquidity. Although the measures appeared to have succeeded in halting the short-term inflows, the substantial buildup of liquidity on account of the intervention operation at the start of the year gradually wound its way through the banking system. 2/ As a result, interest rates continued to decline during the first five months of 1994, and the three-month interbank rate fell to 4.5 percent by May before stabilizing at that level. Beginning in mid-February, the ringgit appreciated and, by mid-May, was broadly at the same level against the dollar as prevailed prior to the depreciation.

The rates of growth of the monetary aggregates reflected the strength of the capital inflows. However, the inflows, which initially were in the form of bank deposits, did not have a significant impact on lending. Instead, there was a substantial buildup of excess reserves of the banking system with the central bank and, as a result, velocity declined sharply. For 1993 as a whole, the growth rates for Ml and M3 were 35 1/2 percent and 23 percent, respectively, compared with 15 1/2 percent and 18 percent, respectively, in 1992. By March 1994, the 12-month growth rate of M3 had risen to 29 percent, while the growth of Ml remained above 35 percent. As regards the credit aggregates, domestic credit expansion to the private sector, which had moderated to 12 percent at the end of 1992, slowed further to 8 percent in the first quarter of 1993, before picking up as economic activity accelerated. By end-1993, credit growth was just under 12 percent but declined slightly to about 11 1/2 percent by March 1994.

3. Financial intermediation and the capital market

The banking system in Malaysia consists of commercial banks, merchant banks, finance companies, and other financial institutions, including the National Savings Bank, pension and provident funds, insurance companies, and specialized credit agencies. There are presently 37 commercial banks, 21 of which are domestically owned and 16 are foreign. The commercial banks account for about 85 percent of the total assets of the banking system. The main developments in the financial system in 1993 and early 1994 included an easing of lending and deposit interest rates, a surge in equity prices on the KLSE in 1993 followed by a market correction in early 1994, and continued development of the capital market.

a. Interest rates and lending

Since the late 1970s, the authorities have gradually liberalized the process by which commercial banks are allowed to set lending rates. At present, each bank or finance company may set its own base lending rate (BLR) based on its cost of funds, including the cost of holding statutory reserves and of meeting the liquid asset requirement. Subject to the margins surrounding the BLR, and excluding interest rates on certain priority sector lending which are subject to guidelines, financial institutions are free to determine their own lending rates.

Reflecting the easing of liquidity conditions during 1993 and early 1994, the BLRs of financial institutions declined gradually (Appendix Table 37). The average BLR among the commercial banks fell from 9 1/2 percent at the end of 1992 to 8 1/2 percent at end-1993 and 7 1/2 percent by March 1994. At the same time, commercial banks’ average lending rate declined from 10 1/4 percent at end-1992 to 9 3/4 percent by end-1993 and 9 1/4 percent in March 1994. Interest rates on fixed deposits have closely followed the trend in lending rates, declining from almost 8 percent for most maturities at end-1992, to 6 1/4 percent by end-1993 and 5 3/4 percent by March 1994.

The pattern of lending by the commercial banks was broadly unchanged in 1993 (Appendix Table 38). As in recent years, the manufacturing sector was the largest recipient of loans, accounting for almost one fourth of total lending. Lending to the financing, insurance, and business services sector rose by 25 percent, and the share of this sector in total lending increased to almost 15 percent. Individual housing loans and lending to the transport and communications sector also rose sharply. The share of the agricultural and mining sectors in total lending, however, continued to moderate in 1993, in line with the declining importance of these sectors in the economy.

b. Stock market developments

Malaysia’s stock market has grown rapidly in recent years and, in terms of market capitalization, it ranks among the 15 largest markets in the world (Charts 8 and 9, and Appendix Table 39). 1/ In 1993, the market experienced sustained increases in equity prices and the KLSE composite index doubled during the course of the year. Optimism in the stock market was broad based, supported by strengthening activity and the easing of inflation and interest rates during the course of the year. In addition, a sharp increase in participation by international investors served to boost equity prices to unprecedented highs, with net inflows for the purchase of stocks and shares estimated to have tripled to RM 23 billion in 1993.

CHART 8
CHART 8

MALAYSIA STOCK MARKET DEVELOPMENTS, 1990–94

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: IFC, Emerging Markets Database.
CHART 9
CHART 9

MALAYSIA COMPARATIVE STOCK MARKET INDICATORS, 1990–93

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: IFC, Emerging Markets Database.

In January 1994, after price/earnings ratios had risen to an historically high level, the KLSE experienced a sharp correction. Share prices, turnover volumes, and market capitalization fell from their peak levels on January 5. Share prices were further weakened as interest rates abroad rose and investors adjusted their portfolios in favor of nonringgit assets. After continuing to decline in the first quarter of 1994, the composite index stabilized and recovered slightly during the second quarter. By end-July, the composite index was about 20 percent below its level at end-1993.

The stock market has become an important source for raising funds to finance private investment in recent years (Appendix Table 40). In 1993, issues of shares and debt securities by the private sector amounted to RM 3.2 billion (8 1/2 percent of private fixed investment). While this represented a significant decline from 1992, the decrease was due mainly to the absence of new issues by privatized companies, which contributed heavily to the new issues in 1992. and the general easing of liquidity conditions in the financial system.

c. Development of the financial system

As the financial market has grown in sophistication and complexity, measures in recent years have been directed toward enhancing the market’s efficiency in allocating scarce resources and ensuring the introduction of and compliance with appropriate prudential regulations. In 1993. several measures were implemented to promote the development of the capital market. These included the launching of operations of the Securities Commission, a single regulatory agency to oversee the entire capital market; the implementation of the Futures Industry Act. providing a legal framework for trading in financial futures and options; the introduction of new guidelines and minimum standards governing the disclosure of information by stockbroking and securities firms; the liberalization of the activities of unit trust funds, according greater flexibility in the management of these funds; and the launching of the Interest-Free Banking Scheme, increasing access to Islamic banking facilities. In addition, reforms to strengthen the KLSE were implemented, including the issuance of guidelines on independent audits for all listed companies and the implementation of a central depository of information.

V. External Developments

1. Overview

Over the last two decades, the Malaysian economy has become increasingly open, with the ratio of exports and imports to GNP having risen from 44 percent and 37 percent in 1970, respectively, to 75 percent ami 70 percent in 1993, respectively (Chart 10). As the economy has industrialized, the share of manufactured products in total exports has increased steadily from 12 percent in 1970 to 74 percent in 1993. Within the manufacturing sector, exports of electrical machinery and components have grown most rapidly, accounting for well over one half of manufacturing exports in recent years. Textiles and clothing have also been an important source of export earnings, although their share in manufacturing exports has declined from 10 percent in 1987 to 6 percent in 1993.

CHART 10
CHART 10

MALAYSIA EXTERNAL DEVELOPMENTS, 1985–93

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Sources: Data provided by the Malaysian authorities.

The growth of the manufacturing sector, especially in recent years, has been financed to a large extent by inflows of FDI. Over the period 1988-93, investment inflows amounted to $17.5 billion, averaging 6 percent of GNP and accounting for almost one tenth of FDI flows to developing countries (Chart 11). These inflows have financed the import of investment goods and have more than offset the deficit in Malaysia’s external current account that emerged during the investment boom of the late 1980s and early 1990s. During 1992-93, however, short-term capital inflows have gained in prominence.

CHART 11
CHART 11

MALAYSIA NET PRIVATE CAPITAL FLOWS, 1989–93

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Sources: Data provided by the Malaysian authorities.

In 1993, the pickup in domestic demand pressures was reflected in a strong recovery in imports which, despite continued strong performance of manufacturing exports, resulted in a slight deterioration of the external current account position (Table 6). As regards the capital account, a decline in FDI inflows was more than offset by the continuation of the surge in short-term flows. As a result, the overall balance of payments surplus rose sharply and external reserves increased further.

Table 6.

Malaysia: Balance of Payments, 1989-93

(In billions of U.S. dollars)

article image
Source: Data provided by the Malaysian authorities.

Excludes operations of the central bank.

Includes valuation adjustments.

2. Currnet Account

After narrowing sharply to 3 percent of GNP in 1992, mainly on account of a moderation in import growth emanating from weak domestic demand conditions, the external current account deficit widened to 4 percent of GNP in 1993, as imports accelerated in line with the recovery in domestic demand. Export volumes, which had slowed considerably in 1992 owing to weak economic conditions in major trading partners, picked up in 1993 (Appendix Table 41). The strong export performance reflected mainly the relocation to and expansion of multinational corporations’ production facilities in Malaysia; an increase in market shares of Malaysian products in the rapidly growing regional economies; and the pickup in growth in the United States toward the end of the year.

Exports of manufactured goods rose by 24 percent in 1993, in line with the trend in recent years, and the share of manufactured goods in total exports expanded further to 74 percent (Appendix Table 42). Within the manufacturing categories, exports of electronics and electrical products, and wood, metal, and petroleum products recorded the most rapid increases. However, exports of food, beverages and tobacco, and textiles and footwear moderated, reflecting a shift toward higher value-added production and away from labor-intensive activities. The electronics and electrical products sector, which accounted for 61 percent of manufacturing exports in 1993, has undergone a significant structural transformation over the past decade. In 1984, electronic components contributed 73 percent of the sector’s exports, while consumer and industrial electronics comprised only 6 percent and 5 percent, respectively. By 1993, however, the share of electronic components had declined to 34 percent, while the shares of consumer and industrial electronics had risen to 23 percent and 25 percent, respectively.

In contrast with the performance of manufacturing exports, exports of commodities declined by 3 percent in 1993, with the shares of agricultural goods and minerals in total exports declining to 15 percent and 9 percent, respectively (Appendix Table 43). This owed not only to a reduction in export volumes for many commodities, but also to a decline in export unit values of tin, petroleum, and liquified natural gas. Export receipts from rubber and tin fell by 10 percent and 33 percent, respectively, while exports of palm oil rose by 6 percent. Timber exports were virtually unchanged from their 1992 level, with a significant decline in sawn logs exports offset by an increase in exports of sawn timber.

The acceleration of domestic demand in 1993 was reflected in the recovery of import growth to 15 percent (Appendix Table 44). The strongest growth occurred in imports of intermediate goods, which rose by 18 percent in volume terms, compared with a decline of 8 percent in 1992. The volume of consumption goods imports also accelerated to 13 percent, from 7 percent in 1992, reflecting the pickup in consumer spending. Despite a recovery in investment spending, however, the volume of investment goods imports continued to decelerate to 10 percent, mainly on account of the behavior of lumpy imports and because of lower imports of ships, boats, and railway locomotives.

The direction of Malaysia’s trade continued to change somewhat in 1993 (Appendix Table 45). The share of exports destined for ASEAN countries fell by almost 2 percentage points, while the share of exports to the United States rose by almost 2 percentage points. The importance of export markets in Hong Kong and Taiwan Province of China increased and exports to China rose by 58 percent. In contrast, the share of Malaysia’s exports accounted for by Japan and the European Union declined slightly. On the import side, the importance of Japan and the United States as trading partners rose, while imports from the ASEAN economies and the European Union declined.

The services account deficit, after improving to 9 percent of GNP in 1992, widened to 9 1/2 percent of GNP in 1993 (Appendix Table 46). Freight and insurance payments rose by 12 percent, reflecting the stronger import activity, and accounted for one third of the deterioration in the services account. In addition, investment income payments, particularly the repatriation of profits and dividends to foreign direct investors, rose significantly, while net interest receipts declined, reflecting the interest differential in favor of Malaysia.

3. Capital flows and international reserves

The balance of payments in 1993 were dominated by developments in capital flows, particularly short-term inflows. Buoyed by continued inflows of short-term capital and a sharp rise in errors and omissions, which the authorities view as partly reflecting unrecorded inflows of funds destined for the stock market, the overall balance of payments surplus surged to $10 billion (17 percent of GNP), compared with $7 billion (13 percent of GNP) in 1992. As a result, official reserves rose to the equivalent of 7 1/2 months of imports of goods and services (Appendix Table 47).

Net short-term inflows, after rising to $4.7 billion in 1992, increased further to $4.9 billion in 1993. Moreover, net errors and omissions rose to $3 billion. Key factors underlying the surge included the wide interest rate differential in favor of Malaysia; increased interest by international investors in Malaysia’s stock market; and expectations in the market that the ringgit would appreciate.

Inflows of FDI, though continuing at a high level of $4.3 billion, declined relative to GNP to 7 percent from 8 percent of GNP in 1992 and 9 percent of GNP in 1991. This decline may be attributed to both external and domestic factors. On the external side, outward investment from Japan and the Asian NIEs fell, owing to the economic slowdown in Japan and because the relocation of labor-intensive industries of investor countries was either nearing completion or was increasingly directed to lower-wage countries in the region. On the domestic front, growing labor shortages and rising wages acted to erode the competitiveness of the more labor-intensive industries.

4. External debt and debt service

The Government has pursued a cautious external borrowing policy and, in recent years, has engaged in early repayments of external debt. Consequently, the ratio of external debt to GNP, which was already low in comparison with other developing countries, has declined, with the decrease in public external debt more than offsetting a moderate rise in private long- and short-term borrowing (Appendix Table 48).

In 1993, external debt rose somewhat relative to GNP as a result of increased private sector borrowing, both long- and short-term, to exploit the wide interest rate differential in favor of Malaysia. Although the Government’s policy to prepay external obligations was maintained, increased external borrowing by public enterprises kept the public external debt ratio unchanged.

5. Exchange rate developments

The exchange value of the ringgit is determined by a managed float. Bank Negara monitors exchange rate developments against several baskets of currencies and intervenes in the interbank foreign exchange market to influence the value of the ringgit. Commercial banks are the only financial institutions licensed to deal in foreign exchange and are free to set their own rates and margins between buying and selling rates.

After appreciating by 9 percent against the dollar and 10 percent in nominal effective terms during the first half of 1992, the ringgit was broadly stable until mid-December 1993 (Chart 12). Between mid-December 1993 and mid-February 1994, the ringgit depreciated by 8 percent against the dollar and 9 percent in nominal effective terms, initially as a result of intervention by Bank Negara to deter currency speculators and later in response to the imposition of controls on short-term capital inflows. Since mid-February, however, the ringgit has appreciated steadily, stabilizing at broadly the same level against the dollar that had prevailed prior to the depreciation episode.

CHART 12
CHART 12

MALAYSIA EXCHANGE RATE INDICES, 1986–94

(1980 = 100)

Citation: IMF Staff Country Reports 1994, 004; 10.5089/9781451828214.002.A001

Source: IMF, International Financial Statistics, and Information Notice System.

6. Trade policies

Malaysia has traditionally maintained an open trade and exchange system. While there have been no major changes in the exchange system in recent years, efforts to further liberalize the trade system are continuing. 1/ Following a reduction in import duties on 600 items in the 1993 budget, duties on a further 500 items were reduced or abolished altogether in the 1994 budget. As a result, the ratio of import duty receipts to the value of imports declined from 4 3/4 percent in 1989 to 4 1/4 percent in 1992 and 4 percent in 1993.

Under the ASEAN Free Trade Agreement (AFTA), which aims to encourage the complementary use of resources in the region by lowering tariff barriers, Malaysia has offered 3,266 tariff lines for duty reductions in the 1994 package. Some of these reductions took place in 1993 and the remainder will be undertaken in 1994. In addition, more than 4,000 tariff lines already carry tariff rates of less than 1/2 percent, thereby conforming to Malaysia’s commitment under the AFTA tariff reduction schedule. 2/

Under the recent Uruguay Round agreement, Malaysia has offered to reduce and bind tariffs on 5,900 tariff lines in the industrial sector and 1,297 tariff lines in the agricultural sector. The bindings, covering 79 percent of imports, will increase the proportion of bound tariff lines to 65 percent, compared with 1 percent presently. As a result of the tariff reductions, the trade-weighted average tariff rate for industrial items will decline from 10 1/4 percent to 9 percent. For the agricultural sector, tariffs on all items will be lowered by an average of 28 percent and all nontariff barriers will be converted to tariffs. In order to conform with the Uruguay Round agreement on trade-related investment measures, local content requirements for investment approval and the provisioning of investment incentives will be phased out.

APPENDIX

Table 7.

Malaysia: Expenditure on Gross Domestic Product in 1978 Prices, 1989-93

article image
Source: Data provided by the Malaysian authorities.

Contribution to GDP growth.

Table 8.

Malaysia: Expenditure on Gross Domestic Product in Current Prices, 1989-93

article image
Source: Data provided by the Malaysian authorities.

Contribution to GDP growth.

Table 9.

Malaysia: Gross Domestic Product by Sector of Origin in 1978 Prices, 1989-93

article image
Source: Data provided by the Malaysian authorities.

Includes ownership of dwellings.

Includes utilities, domestic services to households, and import duties less imputed bank charges.

Table 10.

Malaysia: Production of Major Primary Products, 1989-93

article image
Source: Data provided by the Malaysian authorities.
Table 11.

Malaysia: Industrial Production Index, 1989-93

(1988 = 100)

article image
Source: Data provided by the Malaysian authorities.
Table 12.

Malaysia: Consumer Price Index, 1989-94 1/

(1990= 100)

article image
Source: Data provided by the Malaysian authorities.

New weights apply since December 1990.