2012 Article IV Consultation

This report discusses Malaysia’s economic accomplishment and other economic reforms. Malaysia has attained a strong growth in 2012, and a robust growth is expected in the next term. The financial position of Malaysia is sound and supported by a strong regulatory framework with high bank capitals, international reserves, and refined monetary and financial policies. Fiscal policies need to be restructured, and public financial management needs to be strengthened to deal with risks. The authorities expected Malaysia to be a high-income nation by 2020.


This report discusses Malaysia’s economic accomplishment and other economic reforms. Malaysia has attained a strong growth in 2012, and a robust growth is expected in the next term. The financial position of Malaysia is sound and supported by a strong regulatory framework with high bank capitals, international reserves, and refined monetary and financial policies. Fiscal policies need to be restructured, and public financial management needs to be strengthened to deal with risks. The authorities expected Malaysia to be a high-income nation by 2020.

Recent Developments, Outlook, and Risks

1. Political context. Malaysia has a parliamentary political system. General elections must be held at least once every five years, but can be called at any time by the Prime Minister before the five-year period has expired. The next general election must be held by June 2013, but has been expected since 2011, leading to a pre-election political climate for the past two years or so.

2. Developments. Malaysia’s economic performance in 2012 surpassed expectations. Robust domestic demand is offsetting external weakness and is fueling growth, now estimated by staff at 5.1 percent in 2012 (Figure 1). Private and public investment has been a key driver of the expansion, supported by low interest rates and the catalytic effects of large projects under the Economic Transformation Program (ETP), particularly in oil, gas, and infrastructure. Consumption growth has also been vigorous, supported by a strong labor market, credit to households, and government transfers. Net exports, on the other hand, have declined. This has led to a significant external rebalancing, with the current account surplus moderating by about 5 percentage points of GDP relative to 2011 (paragraph 31). Inflation eased in 2012, on lower global commodity prices and base effects. Average CPI inflation was 1.7 percent in 2012. Indicators of underlying inflation have also remained relatively subdued. With growth above potential in 2011-12, the output gap has closed (Figure 2).

Figure 1.
Figure 1.

Malaysia: Growth and Exports

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Figure 2.
Figure 2.

Malaysia: Inflation and Domestic Resource Constraints

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001


GDP Growth

(In percent)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: CEIC Data Co. Ltd; and IMF staff calculations.

Trade Volume Index and Current Account Balance

(2005 = 100)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Source: CEIC Data Co. Ltd.

3. Growth outlook. The robust pace of economic activity is expected to continue in 2013 and over the medium term. Consumption in 2013 will remain supported by low unemployment and by fiscal transfers. Investment should also remain strong, reflecting in part a large pipeline of ETP-related projects.1 Exports are expected to pick up slightly next year, in line with the WEO baseline. The federal government (FG), on the other hand, will provide a modest drag, with a fiscal impulse of -0.6 percent in 2013. Overall, staff projects growth in 2013 at 5.1 percent. Over the medium term, growth is projected at about 5 to 5.5 percent, as ETP-related investments boost productivity and female labor force participation rates increase (paragraph 27).

4. Inflation outlook. With output at about potential and dissipating base effects, inflation is projected to rise slightly to 2.2 percent in 2013. In addition, the introduction of a minimum wage in 2013 (Box 1), the gradual removal of fuel price subsidies, and the planned adoption of a goods and services tax (GST) are expected to have small one-off effects on inflation in the period 2013–15, tapering off subsequently.

5. Risks. The principal risks to Malaysia’s outlook are external and tilted to the downside (Appendix I). An intensification of the euro area crisis, a sharp slowdown in China (Malaysia’s main trading partner) or other shocks to global growth or risk aversion (for instance from a sharp fiscal contraction in the United States) would impact Malaysia through trade, commodity prices, and financial channels and could trigger capital flow volatility.2 The continued strength of intra-ASEAN trade, supported by robust domestic demand in several ASEAN economies, is however providing some resilience against these risks (Box 2). Domestically, elevated housing prices and growing household debt may pose risks for the financial sector. Also, a slower-than-expected pace of implementation of fiscal and structural reforms could pose risks. For instance, a protracted increase in unit labor costs resulting from slower-than-envisaged medium-term productivity increases or a higher-than-anticipated impact from the minimum wage could harm potential growth. Finally, the upcoming general elections could lead to some market volatility.

6. Authorities’ views. The authorities agreed that growth would remain robust in 2013 and beyond.

  • They argued that the existing pipeline of ETP projects would continue to support investment in 2013–14 while private consumption would hold up, partly due to fiscal transfers in early-2013 and continued growth in disposable incomes. They project growth at 4.5 percent to 5.5 percent in 2013, with potential growth boosted over the medium term to 5 percent to 5.5 percent by higher private investment.

  • The authorities agreed that the inflation outlook was fairly benign. While it may increase slightly, they expect inflation to remain modest in 2013 given subdued global commodity prices. They also argued that the impact of the minimum wage or any further gradual fuel subsidy cuts on inflation would likely be minor.

  • The authorities concurred that the principal risks to the outlook were external and skewed to the downside. They remained concerned about developments in the euro zone, uncertainty about the direction of U.S. fiscal policy, and the risk of a sharper slowdown in China. They did, however, point to the upside potential of the growth outlook associated with continued implementation of ETP-related investment projects and reforms.

The Near-Term: Keeping the Economy on an Even Keel

A. Near-Term Macroeconomic Policy Stance

7. Monetary policy. Monetary conditions remained accommodative in 2012. Having been one of the first central banks in the region to start a tightening cycle after the 2008–09 global crisis, Bank Negara Malaysia (BNM) has now kept its policy rate at 3 percent since May 2011, resisting a renewed trend among regional peers toward lowering rates (Figure 3). BNM characterizes its stance as supportive of growth in an environment that combines robust domestic demand and narrowing spare capacity with subdued inflation and well-anchored inflationary expectations.

Figure 3.
Figure 3.

Malaysia: Monetary Developments

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

8. Fiscal policy. The FG’s fiscal turnout in 2012 has been better than expected. Additional spending on fuel subsidies, wages, pensions, and transfers to target groups has been more than offset by buoyant revenue and one-off factors (including an extraordinary dividend payment). As a result, the FG deficit is estimated to decline to 4.5 percent of GDP this year, compared with 4.8 percent in 2011 (Figure 4). The 2013 FG budget envisages a further decline in the FG deficit to 4 percent of GDP, consistent with the government’s plan to reduce its deficit to 3 percent of GDP by 2015 (although the budget does not include measures to rationalize fuel subsidies). The 2013 fiscal effort is actually stronger if measured in terms of the non-oil primary balance, as oil-related revenues are projected to fall. The FG debt is projected to rise to about 53 percent of GDP in 2012–13, close to the authorities’ self-imposed ceiling of 55 percent of GDP. On the other hand, the overall public sector deficit is projected to have risen to 5.1 percent of GDP in 2012 (from 3.3 percent in 2011), partly reflecting higher investments by nonfinancial public enterprises (NFPEs), and is expected to widen to 6.3 percent of GDP in 2013 (Figure 5).3

Figure 4.
Figure 4.

Malaysia: Federal Government Balance

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Figure 5.
Figure 5.

Malaysia: Public Sector Balance

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

article image
Sources: Annual Reports; and webpages of various NFPEs.

Fiscal Impulse

(Change in cyclically-adjusted federal government balances, in percent of GDP)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: Malaysian authorities; and IMF staff estimates.

Federal Government Expenditure Growth

(In percent)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: Malaysian Authorities; and IMF staff estimates.1/ Wage growth calculations in 2012 and 2013 adjust for the one-month bonus awarded in 2012, to not distort the natural growth rate for 2013.

9. Staff position. In staff’s view, the macroeconomic policy mix in 2012–13 is well calibrated for the current conjuncture.

  • Bank Negara Malaysia’s slightly accommodative monetary policy stance strikes the right balance between supporting growth and keeping inflation in check, a view also supported by a simple Taylor rule (Figure 3). While domestic demand is robust and spare capacity is narrowing, inflation is subdued and inflationary expectations are well anchored—a testimony to BNM’s deft monetary management. The 2013 fiscal stance is also appropriate, balancing concerns about growing public debt with the need to avoid excessive or premature fiscal adjustment. While the 2013 budget likely understates spending, it is also conservative in its revenue projections. The deficit target seems feasible if, as assumed in the staff’s baseline, there are only minor slippages in current spending and a modest fuel subsidy reform is adopted in the second half of 2013.

  • Should downside risks to the growth outlook materialize, BNM has ample room to cut rates and allow the exchange rate to act as a shock absorber. However, the FG’s relatively high debt level affords limited space for a fiscal response in a downside scenario. Any fiscal stimulus should be well targeted, temporary, and anchored in an ambitious medium term consolidation plan.

  • In response to commodity price shocks, the exchange rate should be allowed to adjust. If the shock pushes prices up, monetary policy tightening ought to be considered only if second round price effects risk unhinging inflation expectations. Any fiscal revenue windfalls from higher commodity prices should be saved.

10. Authorities’ views. The authorities agreed with staff’s assessment on near-term macroeconomic policies. If downside risks were to materialize, the authorities agreed that they had ample room to cut interest rates and that two-way exchange rate flexibility would help respond to weak external demand. The authorities also argued that the 2013 budget reflected their commitment to fiscal consolidation while providing for policies (including cash transfers to low-income households) that would support domestic demand in a weak external environment.

B. Dealing with Capital Flow Volatility

11. Background. Capital flow volatility continues to be a fact of life for emerging markets like Malaysia. Flows have been influenced by both push and pull factors, including global risk appetite, expansionary monetary policies in systemically large economies, as well as macroeconomic fundamentals in recipient countries (Figure 6). Further inflows could fuel credit growth and lead to asset price exuberance. But global shocks, against the backdrop of a high share of foreign holdings in Malaysian bond and equity markets, could also trigger sudden outflows (Appendix I).

Figure 6.
Figure 6.

Malaysia: Capital Inflows

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001


Foreign Holdings of Government and BNM Debt

(In percent of total)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: Data provided by the authorities.

12. Policy response so far. Malaysia has successfully dealt with volatile capital flows in recent years. Its sound banking system and liquid capital markets facilitate the absorption of flows, while a stable core of domestic institutional investors and comfortable levels of official international reserves provide additional buffers against any volatility in external demand for domestic securities. But the policy response has also been appropriate: the authorities have coped with capital flows by allowing two-way exchange rate adjustment while smoothing out excessive exchange rate volatility. Macroprudential policies (MPPs) have been used selectively to tackle specific markets or risks, such as credit to households, but not as a direct response to capital flows.

13. Staff position. In case of large and sustained inflows, the exchange rate should be allowed to appreciate gradually and fiscal policy could be tightened at a faster pace. MPPs could also be adopted or tightened as needed to mitigate potential risks (paragraph 15), and could be complemented by liquidity management measures, including higher reserve requirements. Staff welcomes measures to liberalize outflows adopted by the authorities in recent years, such as the elimination of the requirement on residents to convert export earnings into ringgit. Regional initiatives under way, including regional crisis management and resolution frameworks, will bolster regional communication and cooperation in case of an emerging crisis.

14. Authorities’ views. The authorities agreed that capital flows would likely be volatile in the near term but felt the impact on the broader economy was manageable. While the share of foreigners in the sovereign bond market had risen since the global financial crisis, risk-off cycles over the last two years had not affected domestic credit provision. Moreover, domestic investors stood ready to step in if foreign demand for sovereign bonds slackened. The authorities expressed concern about the extended easy monetary policy in advanced economies and the challenges this was creating for emerging economies. The authorities took note of the Fund’s view that capital flow management measures should be part of the policy toolkit.

Safeguarding Financial Sector Stability

15. Background. The 2012 IMF-World Bank Financial Sector Assessment Program (FSAP), and the accompanying Financial System Stability Assessment (FSSA), found that Malaysia’s financial system is sound, well capitalized, and backed by a strong regulatory and supervisory framework.4 Malaysian banks have high capital adequacy ratios and are expected to comfortably meet Basel III capital requirements by 2019. FSAP stress tests indicate that the banking system has sufficient capital buffers to absorb credit losses under tail-risk scenarios. However, the capital of some small banks could fall below the regulatory minimum if a prolonged recession in Malaysia led to higher unemployment and lower housing prices. The quality of bank assets has improved. Liquidity is adequate, and while the share of corporate “at call” deposits is high, these appear to be stable. Banks’ exposure to currency risk is limited, as is their reliance on interbank and cross-border funding (Figure 7). Malaysia is a global leader in Islamic finance. This sector is playing a central role in promoting financial development through product diversification and financial inclusion. And the Financial Sector Blueprint, launched in 2011, strikes the right balance between tighter regulations in line with global trends and measures to foster further financial development.

Figure 7.
Figure 7.

Malaysia: Financial Sector Developments

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

16. Staff position.5 In line with the FSSA, the following areas warrant attention:

  • Strong growth of credit to households and house price appreciation (Figure 8). Housing prices are running ahead of household incomes and housing rents. Household debt is high, as is bank exposure to households (55 percent of bank credit) (Figure 8).6 In response, the authorities have introduced a number of MPPs and fiscal measures since 2010.7 These measures have succeeded in slowing down household credit growth, particularly for unsecured loans, while preliminary data suggest housing price appreciation may have decelerated. Some pressure points do remain, however: growth in credit to households remains in double digits, the supply of low-cost housing is tight, and prices are still rising strongly in some housing segments. The government is putting in place measures to increase the supply of more affordable housing, and the real property gains tax rate was further raised on January 1, 2013. However, if household credit growth and housing prices remain high, additional measures could be taken, including lower loan-to-value (LTV) caps, further increases in capital gains taxes on properties, higher stamp duties on real estate transactions, and a further tightening of regulations on unsecured personal loans. As noted by the FSSA, continued efforts to capture granular data on household assets and liabilities by income segment would strengthen monitoring of risks in this sector.

  • Malaysia’s extensive cross-border banking activities. Risks include foreign bank deleveraging and exposure of the domestic financial system to developments abroad. On balance, these risks appear manageable (Box 3). However, regional exposures should continue to be monitored closely. Deepening cooperation between home and host country supervisors is also important.

  • Consolidated supervision of financial holding companies. There is scope to enhance the framework for consolidated supervision of financial groups, including on capital and liquidity standards. Passage in December 2012 of the Financial Services Act, the Islamic Financial Services Act, and Amendments to the Central Banking Act 2009 is a welcome step in this direction.

Figure 8.
Figure 8.

Malaysia: Banks’ Exposure to the Household Sector

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

17. Authorities’ views. The authorities concurred with the FSAP assessment that the financial system is sound and that the regulatory and supervisory framework is strong. They also agreed with the findings from stress tests suggesting that the banking system has sufficient capital buffers even under tail-risk scenarios, except for some small banks. They have been closely monitoring household leverage and the housing market as well as lending practices of banking institutions. The increased vigilance has resulted in the issuance of a number of macroprudential policies and supervisory responses as well as fiscal measures. They said some of the measures already taken were working, as demonstrated by the recent moderation in the growth of household credit, a substantial decline in multiple housing loan accounts, and improvements in the repayment behavior of credit card holders. The ramping up of the supply of low-cost housing, improvements in public transportation, and the increase in the real property gains tax would help to further ease house price pressures. The recently passed financial services legislations and amendments to the Central Banking Act 2009 strengthen BNM’s powers to extend regulations to nonbank lenders as well as bringing them under the direct oversight of BNM where necessary. The authorities stand ready to take additional measures as and when needed.

Strengthening Fiscal Sustainability and Efficiency

A. Fiscal Sustainability and Resilience

18. Background. Malaysia’s fiscal space has shrunk considerably following the global financial crisis. The FG debt-to-GDP ratio has increased by 12 percentage points since 2008, reflecting both substantial discretionary fiscal stimulus and declining growth and oil prices in the aftermath of the crisis. This debt ratio is elevated compared to countries with similar credit ratings. The structural fiscal position has also deteriorated, as evidenced by the persistent decline in the non-oil primary balance and the current balance. The significant increase in operating expenditures in recent years may put at risk the FG’s golden rule of maintaining a positive current fiscal balance. A weak structural fiscal position and a relatively high debt ratio reduce the ability to mount countercyclical fiscal responses in the future.


Debt to GDP Ratio in 2012: Selected Countries in Asia

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: IMF, World Economic Outlook database; and IMF staff projections.

Debt to GDP Ratio in 2012: Countries With Upper Medium Grade Credit Rating

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: IMF, World Economic Outlook database; and IMF staff projections.

19. Outlook. In the absence of policy changes, Malaysia’s debt-to-GDP ratio would remain above current levels into the longer term (Annex I, Debt Sustainability Analysis). The staff’s fiscal baseline8 assumes some adjustment, consistent with the authorities’ target of reducing the FG deficit to 3 percent of GDP by 2015. However, the FG deficit would start rising again thereafter, reflecting declining oil revenue and rising pension and healthcare costs. These pressures are expected to intensify in the long term. Moreover, while the debt ratio is projected to decline slowly under the baseline, shocks to growth and interest rates could push it over the authorities’ 55 percent of GDP debt ceiling (Box 4). Lower-than-expected growth, because of slower reforms or a protracted global growth slowdown, could also push up the debt ratio.

20. Staff position. Staff welcomes the authorities’ commitment to fiscal consolidation and encourages them to underpin it with a comprehensive medium-term plan based on concrete measures, targets and timelines to be announced and put in place as early as feasible. This fiscal consolidation strategy should:

  • Take into account the potential decline in oil-and gas-related receipts and the increase in age-related government spending associated with demographic change in coming decades.

  • Be anchored, as suggested by staff analysis (Box 4), on the objective of gradually lowering FG debt to around 40 percent of GDP by 2020—the debt ratio prevailing before the global financial crisis. This target is also consistent with the authorities’ New Economic Model. Adhering to it would require strengthening the FG’s non-oil primary fiscal balance by 1.5 percentage points of GDP on average relative to the baseline.

  • Include increases in non-oil and gas-related tax revenues, as well as a rationalization of subsidies (see paragraphs 22–23).

21. Refocusing budget targets. Anchoring budget targets on the non-oil primary balance instead of the overall balance would help insulate government spending from volatile oil prices. This, in turn, would render fiscal policy more counter-cyclical.

B. Structural Fiscal Reforms

22. Broadening the revenue base. The FG’s revenue base is narrow and overly reliant on volatile oil and gas receipts, which account for about a third of the total. The planned introduction of the GST would help broaden the revenue base. In addition, the authorities should streamline fiscal incentives for investment, with their budgetary costs made more transparent.

23. Making government spending more cost-effective and equitable. Some components of spending, especially fuel and food subsidies, are not well targeted. Staff welcomes the authorities’ plans to gradually rationalize fuel subsidies, which will help reduce spending pressures while staggering the impact on inflation and real incomes. Subsidy reform should be accompanied by targeted support measures for vulnerable groups. Spending on emoluments, which increased by 0.6 percent of GDP in 2012 (in part reflecting a public sector salary review), must also be contained. Recent measures to reduce civil service growth and improve payroll management should help. Parametric reforms to the civil service pension system (a defined benefit scheme with no employee contributions) would also help contain long-term spending pressures.

C. Public Financial Management and Fiscal Risks

24. Growing fiscal risks. The public sector deficit is rising, reflecting a large increase in NFPE spending (Figure 5). Due to long reporting lags, the latter is difficult to monitor and control. Contingent liabilities for the FG are also growing from the rise in government’s statutory guarantees (which increased to 15 percent of GDP, partly reflecting borrowing by special purpose vehicles set up to finance large public infrastructure projects), and from public-private partnerships (PPPs) more generally. An IMF technical assistance mission will assess these risks and recommend mechanisms to monitor and manage them.

25. Strengthening public financial management. Staff welcomes the authorities’ planned shift to accrual-based fiscal accounting and outcomes-based budgeting by 2015, and work underway to formulate a medium-term fiscal framework. Fiscal transparency should also be improved by expanding the coverage of the budget to include pension funds and all autonomous entities, and by reporting on PPPs, new revenue and expenditure measures, and fiscal risks more generally.

D. Authorities’ Views

26. The authorities stressed their commitment to fiscal consolidation, tax reform and expenditure rationalization. They reiterated the government’s commitment to implement the GST, rationalize energy subsidies, and strengthen public financial management, including through a medium-term budget framework. They also highlighted their intention to address long-term spending pressures, including through reforms to the public pension scheme, to housing and student loan programs, and to the civil service.

Reforms to Boost Growth and Enhance Inclusiveness

27. Boosting growth. Malaysia’s record of economic development since independence has been remarkable, but growth slowed after the Asian financial crisis. Efforts are now underway to turn Malaysia into a high-income country by 2020. Thus, private investment has been propelled in recent months by the catalytic effect of large scale projects under the ETP. And significant progress has been made in improving the business climate: Malaysia’s ranking in the World Bank’s 2013 Doing Business survey has improved to 12th, from 14th in 2012. But important challenges remain that still hinder investment and growth:


Ease of Doing Business Rankings, 2013

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Source: World Bank, Doing Business Indicators.
  • A key bottleneck is the scarcity of skilled workers. Planned reforms to improve the education system and enhance equality of educational opportunities are therefore welcome.

  • Also, redundancy costs are high (Malaysia is ranked 108th out of 144 countries in this area in the World Economic Forum’s Global Competitiveness Report).

  • At 46 percent, female labor force participation is low by regional standards. Staff thus welcomes the authorities’ plans to boost this rate to 55 percent by 2015, including through incentives for the establishment of childcare facilities and the employment and training of women after a career break, and legal reforms to promote flexible work arrangements.9

  • Fostering technological readiness (including better access to broadband internet) and greater competition in product markets is also important.

28. Minimum wage. A minimum wage has been introduced with effect from January 2013, aimed at boosting wages of low-skilled workers and enhancing productivity. Preliminary analyses suggest that it is likely to have a limited impact on inflation and unemployment (Box 1), and should therefore help improve the incomes of the poor. The authorities could however consider whether highly affected firms should be granted more time to adjust, and whether further allowance should be made for regional wage dispersion. While the minimum wage should provide incentives for affected firms to shift to more capital-intensive production technologies, a sustained increase in productivity would require implementing the complementary reforms discussed in the previous paragraph.

29. Enhancing social protection mechanisms. The authorities could consider other measures to strengthen inclusiveness, such as introducing an unemployment insurance scheme funded by employers and employees; improving the targeting of cash transfer programs; and making them conditional on access to education and health care. Such conditional cash transfer schemes have proven effective in a number of countries. Stronger social safety nets should also help reduce precautionary savings and narrow the current account.

30. Pension reforms. Staff welcomes the recently introduced Private Retirement Scheme (PRS), which will help supplement the Employees Provident Fund (EPF). Consideration could be given to increasing the risk-sharing characteristics of Malaysia’s existing pension system by: (i) introducing a publicly funded, pillar-one pension scheme for low or noncontributors; and (ii) providing an option for workers to receive their pensions in the form of annuities, to help reduce longevity risk. The minimum age for pension withdrawals for existing EPF contributors should be gradually raised from 55 to 60 to match the increase in the retirement age in the private sector.

31. Authorities’ views. The authorities stressed that they remained committed to increasing potential growth and enhancing inclusiveness. The ETP was gaining traction in terms of boosting investment. However, they view it as a marathon and not a sprint, with progress on structural reform initiatives remaining essential. The authorities noted that there was broad support in the private sector for the adoption of a minimum wage. While they expect limited impact on employment, they would monitor implementation closely, and would consider modifications as and when needed. The authorities said they would study the case for greater use of conditional cash transfers and had tasked the International Labor Office with producing a report on how to design an appropriate unemployment insurance scheme.

External Sector Assessment

32. Staff position. The Malaysian economy is undergoing a significant external rebalancing, reflecting surging domestic demand and weak external demand. As a result, the current account is projected to decline to 6 percent of GDP in 2012–13, from 11 percent in 2011 and 17 percent in 2008, while the non-oil current account has swung into deficit. Notwithstanding the significant narrowing of the current account, staff assesses the external position to be stronger than is consistent with medium-term fundamentals and desirable policies (Box 5). As explained in Box 5, Malaysia’s strong external position mainly reflects structural factors, including insufficient social safety nets, investment bottlenecks, and large exports of nonrenewable resources.10


Current Account Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: CEIC Data Co. Ltd.; and IMF staff calculations.

Effective Exchange Rates

(Index, 2005=100; an increase means an appreciation)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: IMF, Information Notice System.

33. Outlook and policy implications. Over the medium term, the current account is expected to continue moderating. This reflects the impact on national saving of population aging and of reforms to strengthen social protection, which are expected to more than offset the effect of the envisaged fiscal consolidation. The structural reforms discussed earlier in this report to boost investment would further help narrow the current account. Reserve levels are adequate and no further accumulation is therefore needed for precautionary purposes. In that regard, continued exchange rate flexibility, with two-way intervention limited to dampening excessive volatility, should allow for a gradual appreciation of the trend real exchange rate. This, in turn, will underpin the continued external rebalancing and facilitate a gradual shift of resources from tradable to nontradable sectors.

34. Authorities’ views. The authorities concurred that the current account gap likely reflects structural characteristics, and stressed that it is not rooted in currency undervaluation. They noted that tackling it therefore calls for structural reforms rather than a shift in exchange rate policies. They also agreed on the need to consider the role of gas and oil trade when assessing the current account. The authorities questioned the capacity of EBA-based regressions to capture country-specific factors, and strongly disagreed with the conclusion from those regressions that the real exchange rate is undervalued. They also noted that typical symptoms of currency undervaluation are notably absent. In particular, there is no evidence of overheating and inflation has remained low (averaging just over 2 percent over the past decade); there are no financial imbalances (such as excessive credit growth); and the trade balance has shrunk considerably in the past three years.

Staff Appraisal

35. Outlook and risks. The Malaysian economy performed strongly in 2012, and is undergoing a significant external rebalancing. The near-term outlook is positive, with domestic demand expected to continue propelling activity and inflation remaining benign. Downside risks, however, remain substantial, and are predominantly external. A sharp intensification of the euro area crisis or a further growth shock in China could impact Malaysia through lower export volumes, lower commodity prices, and increased financial market volatility.

36. Near-term policies. Malaysia’s strong economic record in recent years reflects skillful and pragmatic economic management in the face of large external shocks. The current policy stance is no exception, with macroeconomic policies appropriately calibrated to the outlook and risks. Monetary policy is slightly accommodative, providing support for an economy with very low inflation and still subject to substantial external headwinds. The moderately contractionary fiscal stance provides a welcome step towards fiscal consolidation. In case downside risks materialize, monetary policy has ample room for easing. There is, on the other hand, less room for a countercyclical fiscal response given the relatively high level of FG public debt.

37. Dealing with capital flows. Malaysia has been exposed to volatile capital flows, and this is likely to continue in the near term. The policy response so far, characterized by two-way exchange rate flexibility while smoothing excessive exchange rate fluctuations, has been successful. This policy should continue going forward, and could be complemented with MPPs if needed to mitigate potential risks.

38. Safeguarding financial sector stability. The 2012 FSAP found that Malaysia’s financial system is sound, and backed by a strong regulatory and supervisory framework. Relatively high levels of household indebtedness and rising house prices could, however, pose some risks. Their impact would likely be low unless accompanied by a protracted growth slowdown in Malaysia, and policies so far seem to have helped cool off household credit growth and housing prices. Continued close monitoring is nonetheless warranted, and additional MPPs and other measures should be considered if needed.

39. Strengthening fiscal sustainability. Bringing down FG public debt over the medium term is a key policy priority of the authorities. Fiscal consolidation must be underpinned by a concrete plan, anchored on a debt target. This plan should account for the potential long-term decline in oil-related revenue and increases in age-related government spending, and be complemented by reforms to: (i) broaden the revenue base away from volatile oil-and gas-related receipts, including through expeditious passage of the GST; and (ii) boost the efficiency and inclusiveness of government spending, including through continued gradual reform of universal fuel subsidies, accompanied by targeted support measures for vulnerable groups.

40. Addressing fiscal risks. Fiscal risks, arising from the rising public sector deficit and government guarantees, have increased substantially in recent years. Staff supports the authorities’ efforts to monitor these risks more closely through sustained efforts to improve public financial management and statistical reporting, supported by Fund technical assistance.

41. Boosting growth. Realizing the authorities’ goal to turn Malaysia into a high-income nation by 2020 will require the sustained implementation of the broad structural reforms already identified by the authorities in their many initiatives. Particular priorities should be to improve education and develop the skills needed for a high-tech, high value-added economy; to increase labor market flexibility, including by reducing redundancy costs; and to raise female labor force participation.

42. Enhancing social protection. The introduction of a minimum wage policy from January 2013 should support the incomes of poorer workers, provided any negative impact on employment is small. The authorities should remain flexible to adjust the policy as experience is gained from its implementation. Introducing an unemployment insurance system, currently under consideration, and a pillar-one (noncontributory) pension scheme, would further strengthen social protection.

43. External assessment. Malaysia’s external position is stronger than warranted by medium-term fundamentals and desirable policies. In particular, despite having narrowed significantly in recent years, the current account is still above the norm. This current account gap likely reflects structural factors, such as inadequate social protection and investment bottlenecks, as well as the role of hydrocarbon exports. Population aging, as well as policies to boost investment and social protection, supported by continued two-way exchange rate flexibility, should help moderate the current account over the medium term.

44. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Malaysia: Minimum Wage

In May 2012, Malaysia announced the adoption of a minimum wage (MW) policy, with effect from January 2013. It follows significant recent increases in MWs across the region—in China, India, the Philippines, Thailand, and Vietnam—and the introduction by Hong Kong SAR of a MW policy in May 2011.

Justification. The Malaysian authorities gave three main reasons for adopting a MW: (i) ensuring basic needs of employees are met; (ii) encouraging firms to move up the value chain by investing in better technology and increasing labor productivity; and (iii) reducing dependence on unskilled foreign labor.

Key facets. The rate was set at RM 900 per month for Peninsular Malaysia; and RM 800 for Sabah, Sarawak, and the Federal Territory of Labuan. It will cover all sectors and employees except domestic servants. The main criteria used for calculating rates were poverty-line income and the median wage. While the median wage is much lower in Sabah and Sarawak than Peninsular Malaysia, poverty-line income is much higher (given higher costs of living). This is why the chosen rates do not differ much. The rate applies to the basic wage, which can include some regular, fixed allowances but not variable allowances. Small firms (no more than five workers), except those in professional services, will be allowed to defer it for up to 6 months.

Likely impact. The theoretical and empirical literature suggests that the impact of a MW depends on multiple factors. A key factor is the ratio of the MW to the average wage: if the rate is set too low, the MW does not bind; if too high, it will lead to significant employment losses. But other factors matter too, such as the degree of competition in the labor market and the degree of enforcement. For Malaysia, the impact on employment and inflation will likely be conditioned by the following:

  • Employment. The ratio of the chosen MW rates to mean wages is high, at around 50 percent for Peninsular Malaysia and above 60 percent for Sabah (levels in most OECD countries cluster around 40 per cent), suggesting there may be a negative impact. An estimated ¼ of the formal workforce currently have incomes below the set MW, and employers say that the MW will have an impact on the whole pay structure, even for wages above the MW. Employers have also complained that the adjustment period is too short, particularly for poorer states in Peninsular Malaysia and in Sabah and Sarawak, where the MW will likely be more binding. Over the medium term, many firms are likely to increase capital-labor ratios given the change in relative prices, potentially reducing employment growth (including of foreign workers). But several factors will provide important offsets: (i) the authorities and many analysts think that labor costs make up a small share of total business costs in many sectors, with profit margins able to absorb the hit; (ii) employers were given some flexibility in terms of allowances to be included in the MW rate; (iii) there is a sizable informal sector (the MW itself may lead to an increase in informality); and (iv) the current environment of robust growth and low unemployment is favorable.

  • Inflation. The inflationary impact will likely be mitigated by the low share of labor costs in total production costs. Moreover, wage growth has been slower than productivity growth in recent years, suggesting there is some room for additional wage increases before unit labor costs rise materially. The muted impact on inflation of substantial MW hikes in Thailand in 2012 provides some reassurance in this regard.

Malaysia: ASEAN Trade Integration: A Source of Resilience? 1/

Intraregional trade among ASEAN-5 economies (Indonesia, Malaysia, Philippines, Singapore, and Thailand) grew much faster than total trade between 1990–2003, and currently accounts for over 20 percent of the region’s total trade with the world, a larger share than trade with any country or trading bloc outside the region. While ASEAN-5’s trade with China has risen substantially over the last decade, this largely reflects increasing trade in intermediate goods as ASEAN-5 and China integrate to form a new supply chain network.2/ By contrast, trade within ASEAN-5 has become increasingly oriented to final consumer goods (Figure 1), pointing to growing significance of domestic consumption as a source of growth for the region. These patterns also hold for Malaysia, which has seen a growing share of exports going to ASEAN-5 countries (except Singapore).

How important is intraregional trade for Malaysia’s near-term growth? A Bayesian-VAR analysis suggests that intraregional demand is an important driver of Malaysian growth, alongside global demand, global financial shocks, and commodity price movements (Figure 2). Meanwhile, shocks to China’s growth do not have a statistically significant impact on Malaysia’s or ASEAN’s GDP growth, once global demand is controlled for. This suggests that, despite its increasing share in Malaysia’s and the region’s trade, China serves mainly as a conduit in transmitting global shocks through the supply chain network.

Moreover, results from a threshold model indicate that in Malaysia (as in Thailand), domestic demand is able to withstand external shocks up to a certain magnitude. Thus, Malaysian domestic demand is almost immune to a one standard deviation shock to external demand, but is substantially affected once the shock size is doubled (Figure 3). ASEAN as a bloc also exhibits similar nonlinear responses, but it takes a much larger external shock to materially affect aggregate domestic demand (Figure 3): even a two standard deviations shock does not exceed the estimated threshold. Domestic demand for ASEAN as a whole is therefore more resilient, reflecting the role of Indonesia, the region’s largest country and the most resilient to external shocks, as well as the synergy afforded by greater intraregional integration.


Intraregional Exports by Category

(In percent of total exports in each category)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: UN, Comtrade; and staff calculations

Accumulated Response of Malaysia GDP Growth to Cholesky One S.D. Innovations

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Source: IMF staff estimates.

Impulse Response of Domestic Demand to Export Shocks Under Threshold Effects

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Source: IMF staff calculations.
1/ Cubero, Peiris, Rungcharoenkitkul and Seneviratne, IMF Working Paper (forthcoming).2/ See Unteroberdoerster and others (2010).

Malaysia: Cross-Border Banking Spillovers 1/

The problems at the heart of advanced economy banking systems and the expansion of Malaysia’s banks abroad raise two important issues: (i) the implications for Malaysia of foreign banks deleveraging from Malaysia; and (ii) the exposure of the Malaysian financial system to developments abroad.

Foreign bank claims on Malaysia are relatively large but are mainly held by long-established U.K. and Singaporean banks. BIS-reported foreign bank claims are over 50 percent of GDP, significantly higher than for other countries in the region excluding the financial centers (see chart). These claims comprise mainly the local operations of the foreign banks in Malaysia (approximately 40 percent of GDP) which are predominantly funded in the form of local currency deposits. The longest established banks are the U.K. and Singapore ones, with total claims of around 35 percent of GDP, and which have extensive local branch networks.

The euro zone crisis may lead to some deleveraging but the impact appears manageable. The pullout of U.S. banks from emerging markets following the Latin American debt crisis and the deleveraging by Japanese banks in South East Asia after Japan’s financial crisis in the 1990s are cautionary tales. However, the U.K. banks with a systemic presence in Malaysia—HSBC and Standard Chartered—are not strongly interconnected with the euro zone: the bulk of their assets is outside of Europe, the U.K., and the United States. Singaporean banks are also well capitalized and appear able to withstand major shocks. Moreover, a high share of foreign bank claims resides in local affiliates and is in local currency. As a result, deleveraging by foreign banks has been small over the past few years (see chart). And overall credit provision has remained robust, as it did even during the global financial crisis when foreign bank deleveraging was marked (see chart). However, BNM should continue to monitor developments closely, especially any rating downgrades of relevant U.K. banks.

Over the last decade, Malaysian banks have expanded abroad significantly. The six biggest banking groups in Malaysia all have an overseas presence (Maybank, CIMB, Public Bank, Hong Leong, RHB Capital, and AmBank). Branches, subsidiaries, representative offices, and associate companies have been established in 20 countries. The largest affiliates are in ASEAN (Indonesia, Philippines, Singapore, and Thailand) and Hong Kong SAR, where exposures of the biggest three Malaysian banks are just below 30 percent of GDP. Over 30 percent of assets of the two largest Malaysian banks are in overseas operations.

Relative to other jurisdictions, Malaysian banks’ expansion overseas so far looks moderate but will require continued careful monitoring. Austrian, U.K., and Spanish banks also have significantly expanded overseas operations in recent times, but have much higher exposures (ranging from 60–400 percent of GDP). Looking ahead, Malaysian banks are likely to continue expanding abroad in light of increasing ASEAN economic integration and the opportunity provided by European bank deleveraging. International experience suggests that rapid bank expansion in new markets can pose challenges as bank risk management and supervisory monitoring may fail to keep pace. Uneven supervisory quality in host markets can also contribute to the masking of vulnerabilities. Thus, further deepening of home-host cooperation in supervision and crisis prevention—as outlined in the Malaysia’s Financial Sector Blueprint—will be important going forward.


Total Foreign Bank Claims by Country 1/

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: Bank for International Settlements; CEIC Data Company Ltd.; Haver Analytics; and IMF staff calculations.1/ Claims are on an ultimate risk basis. The sum of quarterly GDP in U.S. dollars between 2011:Q3 and 2012:Q2 is used in the denominator.

Malaysia: Foreign Banks’ Claims

(In percent of GDP)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Sources: Bank for International Settlements; IMF, World Economic Outlook.

Malaysia: Relationship between Domestic Credit and Foreign Bank Claims

(Year-on-year growth rate)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

1/ (D) refers to banking system loans made by Malaysian banks.2/ (F) refers to banking system loans made by foreign banks in Malaysia.3/ Total foreign claims refers to foreign bank claims on Malaysia as reported to BIS, including by banks outside Malaysia.
1/ This Box is a summary of a similarly titled technical note produced for the 2012 Malaysia FSAP.

Malaysia: Anchoring Fiscal Consolidation—A Stochastic Debt Sustainability Analysis (SDSA)

Background. Malaysia’s debt-to-GDP ratio has increased by 12 percentage points since the global financial crisis, reflecting both substantial discretionary fiscal stimulus and declining growth and oil prices. The debt ratio is projected to reach 53 percent of GDP in 2012, just below the government’s self-imposed ceiling of 55 percent. The authorities are committed to bringing debt down to ensure sustainability and create sufficient space to conduct counter-cyclical fiscal policy. The consolidation path should be anchored on a reasonable medium-term debt target and use the non-oil primary balance as an intermediate target. However, any consolidation plan is subject to potential shocks and therefore to uncertainty. A possible approach to estimating the debt target is thus to consider a path that ensures that debt remains below a certain debt ceiling with sufficiently high probability. This is the essence of the SDSA exercise presented in this box.

Methodology and assumptions. In this approach, two parameters must be chosen. The first is a debt ceiling. This exercise uses the government’s debt ceiling of 55 percent, which is also close to those adopted in other countries and recent estimates of debt thresholds for emerging markets.1/ The second parameter is the probability of remaining below the ceiling, given historical uncertainty in key macroeconomic variables such as real interest rates, economic growth, the real exchange rate and oil prices. In line with standard statistical analysis, a probability of 90 percent is chosen. The distribution of debt profiles reflects shocks to macroeconomic and fiscal variables around the baseline based on a small quarterly VAR. The SDSA also reflects: (i) a gradual decline in oil-and gas-related revenue in the medium term; and (ii) an increase in pension and healthcare related spending.

Results. A consolidation path consistent with remaining below the given debt ceiling with about 90 percent probability would reduce debt to around 40 percent of GDP by 2020. This medium-term debt target has two additional strengths. First, it is similar to the average debt ratio for emerging and developing countries and for countries with similar sovereign credit ratings. Secondly, it would allow for absorption in its entirety of liabilities arising from loan guarantees (15 percent of GDP as of mid-2012) should they be called upon.2/ By contrast, the authorities’ fiscal consolidation plan (the baseline) is projected to lower debt to about 48 percent of GDP by 2017. However, under this scenario macroeconomic and commodity price shocks could lead to breaching the ceiling with a relatively high probability. The figures also show, as benchmark, a no-reform (passive) scenario, which would most likely keep debt on an upward path and breach the ceiling.


Debt Simulations, 2010- 2020

(In percent of GDP)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Source: IMF Staff estimates.

Implied medium-term fiscal consolidation and possible measures. Achieving the proposed debt target involves reducing the non-oil primary deficit to 3 percent of GDP by 2020. Relative to the baseline scenario, the non-oil primary balance needs to be higher on average by about 1.5 percentage points of GDP in the medium term (about 2.5 percentage points relative to a no-reform scenario). Possible measures could include: a reform that eliminates fuel subsidies by end-2015 and replaces them with transfers targeted to low-income households of about ½ percent of GDP (net savings of ½ percent of GDP); introducing the GST at a higher rate of 8 percent (net savings of 1 percent of GDP);3/ restraining public sector wage growth by limiting new hiring (½ percent of GDP); improving the efficiency of government spending; adopting measures to improve tax administration; and closing tax loopholes and exemptions.


Non-Oil Primary Deficit, 2010- 2020

(In percent of GDP)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Source: IMF Staff estimates.

Oil price volatility and fiscal risks: Oil price volatility contributes importantly to debt dynamics through its effect on revenues and subsidies. The resulting volatility of oil-related revenue adds to the uncertainty about debt. Eliminating shocks to the deviation of real oil price from its long-run trend (based on WEO) shrinks the uncertainty around debt simulations significantly: the 90th percentile of possible debt outturns shifts down by 2 percent of GDP by 2017. This highlights the importance of employing mechanisms to hedge against the volatility in oil-related revenue.


Debt Simulations—Effect of Oil Price Volatility, 2010- 2020

(In percent of GDP)

Citation: IMF Staff Country Reports 2013, 051; 10.5089/9781475546590.002.A001

Source: IMF Staff estimates.

Longer-term challenges. In the long term, oil revenues are expected to continue to decline and aging-related costs to rise further. These pressures will require sizable additional measures beyond 2020.

1/ Although the empirical estimates of debt thresholds for debt distress have a wide range, Fund staff estimates it to be about 63 percent for emerging markets based on recent data2/ Unfortunately, there is no data on other types of government contingent liabilities.3/ The average VAT rate in the Asia and Pacific region is about 10 percent.

Malaysia: External Sector Assessment

Current account (CA). Although there is a significant ongoing moderation in the CA, econometric analysis based on the IMF’s Consultative Group on Exchange Rate Assessments (CGER) and the pilot External Balance Assessment (EBA) methodologies suggests that the cyclically-adjusted CA is still stronger (by between 4½ to 6½ percentage points of GDP) than the level consistent with medium-term fundamentals and desirable policies (the CA “norm”). However, Malaysia’s CA has been erratic and the models contain large residuals, which account for most of the difference between the actual CA and the fitted CA norm (the CA “gap”). In the staff’s view, Malaysia’s CA surplus predominantly reflects structural factors that are not fully captured in the econometric models; in particular:

  • Insufficient social safety nets (which are not fully captured by health spending) as well as large exports of nonrenewable resources (net oil and gas exports are 7 percent of GDP), both of which drive up the actual and optimal rates of saving.

  • Bottlenecks to investment, resulting in relatively low private investment rates (despite the recent increase).

Taking these factors and the uncertainty surrounding model estimates into consideration, staff assesses the CA gap to be of the order of 2–5 percentage points of GDP.

Real effective exchange rate (REER). After a strong appreciation between September 2009 and April 2010, the REER has fluctuated around a fairly horizontal trend. CGER and EBA-based estimates suggest that the REER is undervalued relative to the level consistent with fundamentals and desirable policies. However, as noted above, these methodologies do not fully capture Malaysia’s structural characteristics.

Capital account. Malaysia, like other emerging markets, has experienced volatile portfolio flows over the past few years. Overall net capital flows, however, have typically been negative in Malaysia, driven by net foreign direct investment (FDI) and nonportfolio investment outflows. In 2012, the capital account is projected to have returned to a net negative balance. The authorities have continued to liberalize restrictions on foreign exchange administration, including via greater flexibility for companies to undertake FDI abroad and obtain loans from related resident and nonresident companies.

Reserves. Foreign exchange intervention by BNM seeks to limit excess exchange rate volatility and is two sided. In line with this, official reserves have fluctuated around a relatively flat trend over the past two years. They stand at about 131 percent of the IMF’s composite reserve adequacy metric (the benchmark range is 100–150 percent), and cover about 247 percent of short-term external debt and 31 percent of broad money. Thus, current reserve levels are adequate.

Net foreign assets. The net international investment position remains small and positive, at about 4 percent of GDP. Gross liabilities (118 percent of GDP) consist primarily of FDI and portfolio equity. External debt is relatively low at less than 30 percent of GDP, and only about 40 percent of this is short term, by original maturity. The overall net foreign asset position is thus not a source of risk.

Overall assessment. In sum, the external sector position appears stronger than that consistent with estimates of medium-term fundamentals and desirable policies.

Table 1.

Malaysia: Selected Economic and Financial Indicators, 2008–13

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Sources: CEIC; Data provided by the authorities; and Fund staff estimates.

Capital expenditure in the budget includes foreign fixed assets and other items, such as purchase of shares and land, which are excluded from public investment in the national accounts.

By remaining maturity.

Table 2.

Malaysia: Indicators of External Vulnerability, 2008–12

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Sources: Haver Analytics; data provided by the authorities; and Fund staff estimates.

Gross debt.

Discount rate on 3-month treasury bills.

Table 3.

Malaysia: Balance of Payments, 2008–13

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Sources: Data provided by the authorities; and Fund staff estimates.

By remaining maturity.

Table 4.

Malaysia: Illustrative Medium-Term Macroeconomic Framework, 2008–17 1/

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Sources: Data provided by the authorities; and Fund staff estimates.

Period ending December 31.

Capital expenditure in the budget includes foreign fixed assets and other items, such as purchases of shares and land, which are excluded from public investment in the national accounts.

By remaining maturity.

Table 5.

Malaysia: Summary of Federal Government Operations and Stock Positions, 2008–13

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

Overall fiscal balance includes net lending (net acquisition of loans) as part of total expenditures, whereas net lending/borrowing excludes it.