Statement by Mr. Wimboh Santoso, Executive Director for Malaysia and Ms. Nooraihan Mohd Radzuan, Advisor to Executive Director, February 13, 2015

This 2014 Article IV Consultation highlights that Malaysia’s well-diversified economy continued to perform well in 2014. Growth accelerated to 5.9 percent, aided by robust domestic private demand and a recovery in exports. Lower energy costs helped contain inflation to 3.1 percent despite the removal of fuel subsidies and increase in electricity tariffs. Growth is expected to moderate to 4.8 percent in 2015. Strong investment momentum should help offset headwinds from continued fiscal consolidation. Lower energy prices will be a drag on oil and gas production but should provide a boost to the large non-oil sector.

Abstract

This 2014 Article IV Consultation highlights that Malaysia’s well-diversified economy continued to perform well in 2014. Growth accelerated to 5.9 percent, aided by robust domestic private demand and a recovery in exports. Lower energy costs helped contain inflation to 3.1 percent despite the removal of fuel subsidies and increase in electricity tariffs. Growth is expected to moderate to 4.8 percent in 2015. Strong investment momentum should help offset headwinds from continued fiscal consolidation. Lower energy prices will be a drag on oil and gas production but should provide a boost to the large non-oil sector.

1. On behalf of the Malaysian authorities, we would like to thank the IMF team for the constructive and open discussions on macroeconomic developments and policy issues in Malaysia. For the most part, there is broad agreement on almost all the major policy thrusts. We are further encouraged by the assessment that the current policy stance is appropriately calibrated to reflect the outlook and risks facing the economy. This statement will provide an update on the latest developments in Malaysia and elaborate on selected policy issues.

Economic Outlook

2. The outlook for the Malaysian economy remains favorable, despite the more challenging global environment. The authorities have projected the Malaysian economy to expand at a steady pace of between 4.5% and 5.5% in 2015, driven mainly by domestic demand. The staff estimates and recent forecasts by private sector economists are therefore, in line with the authorities’ projection. Private consumption will remain supported by the steady rise in incomes, stable employment conditions and the additional disposable income from the lower oil prices. Investment activity is projected to remain resilient, with broadbased capital spending by both the private and public sectors cushioning the lower oil and gas-related investment. On the external front, the expected improvement in manufactured exports will partly offset the impact of lower commodities exports. With lower energy and commodity prices, inflation for 2015 is expected to be lower than earlier anticipated. The projected lower energy prices will partially offset other domestic cost factors, including the impact of the introduction of the Goods and Services Tax (GST).

3. Malaysia has, over the last decade, embarked on various structural reforms and initiatives to achieve strong foundations and well-diversified economic structure. Thus, while the commodities sector has an important role in the economy, the existing structure of the economy will allow the country to weather the negative impact from the sharp decline in commodity prices. The mining sector accounts for only 8% of GDP, a relatively small share compared to the services (55% share of GDP) and manufacturing (25% share) sectors. In terms of exports, the commodities sector accounts for 23% of gross exports while the bulk of Malaysia’s exports is manufactured goods (76% of gross exports). In addition, the higher disposable income from the lower fuel prices will offset the fall in commodity-related income. Employment in the commodity sectors account for only 13% of total employment, compared to 60% and 17% shares in the services and manufacturing sectors, respectively. While the oil shock will affect investment in the oil and gas sector, capital spending in Malaysia remains broad-based, with 83% of the growth in total investment in 2013 coming from the services and manufacturing sectors.

External Sector Assessment

4. The current account balance will narrow but is expected to remain in surplus. While the sharp decline in energy prices will result in a narrowing of the commodities surplus, exports of manufactured goods will continue to expand, in line with the improvement in the global growth trajectory. Malaysia’s external sector will continue to reflect the changing global environment and the on-going structural transformation of the domestic economy.

5. Given the significant degree of integration with the global economy and financial markets, Malaysia has experienced increased volatility in recent months amid shifts in global liquidity and heightened uncertainty, particularly with regard to global growth prospects and the decline in commodity prices. This has led to capital flow reversals and a depreciation of the Malaysian ringgit, developments that have also affected other emerging economies. Notwithstanding the challenging external environment, Malaysia’s well-developed financial markets and well-capitalized banking institutions have ensured that these reversals of flows were effectively intermediated by the financial system, without adversely affecting real economic activity. Greater exchange rate flexibility, a healthy level of international reserves and the availability of a wide range of monetary instruments have also accorded authorities the policy flexibility to manage these external shocks. In this regard, the recent market overreaction that resulted in portfolio flow reversals provided clear evidence of the need for an open economy like Malaysia to have a sufficient reserves buffer. Going forward, authorities will remain focused on their mandate to maintain orderly financial market conditions and mitigate risks of abrupt adjustments to the exchange rate over a short period of time in order to minimize potential disruptions to the real economy.

Monetary Policy

6. The current monetary policy stance remains accommodative and is assessed to be appropriate given the balance of risks to the outlook for domestic growth and inflation, having taken into consideration the greater downside risks emanating from the external environment and the lower than anticipated inflation going forward. The Monetary Policy Committee (MPC) of BNM will continue to carefully assess the external developments and their implications for the Malaysian economy. The MPC will also continue to monitor the risks of destabilizing financial imbalances. This is to ensure that the monetary policy stance is consistent with the longer-term sustainability of the Malaysian economic growth.

Fiscal Policy

7. The Malaysian authorities have remained steadfast in their commitment towards fiscal consolidation. Since first announcing its target of achieving a balanced budget by 2020, the Government has consistently achieved its annual fiscal targets. The fiscal consolidation strategy was comprehensive, with reforms to broaden the Government’s revenue base and reduce reliance on oil-related revenue over the longer-term. As a result, the share of oil related revenue to total Federal Government revenue has fallen from around 40% in 2009 to 30% in 2013.

8. Going forward, the conduct of fiscal policy will continue to be centered on ensuring sound public finances while remaining supportive of policies for sustainable and balanced economic growth. In response to the significant decline in oil prices, the Government had proposed a mix of expenditure-optimization and revenue-enhancement measures to ensure that fiscal consolidation would remain on track. As a result of these measures, the fiscal deficit is expected to further decline from 3.5% of GDP in 2014 to 3.2% of GDP in 2015, the sixth consecutive decrease in the fiscal deficit to GDP. While this is a more gradual consolidation compared to the earlier announced fiscal deficit target of 3%, the course of fiscal consolidation remains intact and will be underpinned by reforms to broaden the Government’s revenue base, the removal of fuel subsidies and greater optimization of supplies and services expenditure. As a result of the measures announced, the Federal Government debt-to-GDP ratio will be contained within 55%.

9. The Malaysian authorities remain committed to ongoing reforms to strengthen public finances over the long-term. Fiscal reforms and a more strategic management of resources will continue to be judiciously pursued on several fronts without undermining economic growth and the well-being of the population, particularly, the low-income and vulnerable groups. In light of the lower oil prices, the Government had removed fuel subsidies and implemented a managed float system for fuel prices. Of significance, the broad-based and more efficient Goods and Services Tax (GST) is on target to be introduced in April 2015. The move is expected to streamline the present tax structure to make it more efficient, transparent and business friendly. Other initiatives to enhance fiscal sustainability include the implementation of accrual accounting and the adoption of outcome-based budgeting. Apart from embracing fiscal reforms to strengthen the Government’s financial position, fiscal resources will be geared towards invigorating high value-added investments, intensifying human capital development and enhancing public sector delivery.

Financial Sector

10. Financial stability continued to be preserved in 2014 supported by financial strength and capital buffers both at the system and institutional levels. Stress tests undertaken by the authorities and staff have demonstrated the resilience of the banking system to major economic and financial market shocks. Of significance, the recent volatility in financial markets has not disrupted financial intermediation, with lending activities continuing smoothly. Businesses, including small and medium enterprises, continue to have access to financing from banking institutions and the capital market. Banking system liquidity also remains ample.

11. Growth in household debt has moderated since its peak in 2010, underpinned by the moderation in personal financing. Risks to domestic financial stability arising from household indebtedness remain manageable, supported by strong overall household financial capacity as well as continued improvement in the quality of new household debt. At the aggregate level, household financial assets remained healthy at 2.2 times of household debt. The likelihood of a material impact on the stability of the financial system arising from exposures to the household sector remains low, given the strong capitalization and financial strength of financial institutions.

12. While banking system deposit growth has moderated, this has largely been driven by a confluence of factors. These include growing investment abroad by large domestic institutional investors such as pension and provident funds and asset and fund management companies for revenue diversification and increase investments in higher yielding assets such as unit trust funds for wealth management and retirement savings purposes by households via the institutional fund/asset managers.

13. The macroprudential alongside fiscal measures introduced by the authorities in 2010–2013 have yielded positive results. Growth in personal financing by the non-bank financial sector has slowed considerably and growth in house prices has moderated. These measures were wide-ranging and include enhancing responsible lending practices by key credit providers, increasing the property gains tax, prohibiting the development and financing of property projects with elements of interest capitalization schemes and requirements on greater transparency in property prices by developers. Furthermore, the measures announced were targeted, in order to minimize unintended cross-sectional spillovers. Instead of a broadbased LTV ratio limit, the limit was aimed to curb speculative purchases whilst ensuring that eligible first time home buyers and those investing in a second house for wealth diversification would continue to have access to financing. Whilst the authorities deem the current macroprudential measures to be sufficient at this juncture and risks are assessed to be contained, the authorities continue to maintain their surveillance and supervisory vigilance at a heightened level. The authorities stand ready to act preemptively to address any resurgent of build-up of risks and threats to domestic financial stability.

14. The legislative framework underpinning Malaysia’s financial sector was further strengthened with the enactment of the AMLATFA (Amendment) Bill addressing the risks and threats of money laundering and terrorist financing. In addition, the enactment of the Netting of Financial Agreements Act has now established Malaysia as a netting friendly jurisdiction.

Regional initiatives

15. Malaysia’s chairmanship of ASEAN in 2015 comes at a critical juncture, with the ASEAN Economic Community 2015 (AEC 2015) expected to be established by the end of the year. Through collective efforts, the establishment of AEC 2015 aims to create a single market and production base and will entail the reduction or elimination of tariffs, the progressive liberalization and removal of barriers to trade and services, much of which have already been accomplished. As ASEAN chair in 2015, Malaysia will also help to develop the region’s 10-year post-integration plan which will steer ASEAN’s continued growth strategies from 2016 to 2025.

Reforms to enhance growth potential

16. Reform initiatives to accelerate Malaysia’s transformation into a high-income economy by 2020 have also advanced. In recent years, the Government had implemented farreaching reforms to raise productivity, including raising the retirement age, implementing the minimum wage policy and enhancing the quality of education through the National Education Blueprint. Going forward, reform initiatives include tabling the Companies Bill 2014 which introduces provisions relating to Corporate Insolvency Law and the implementation of measures to improve logistics and enhance trade facilitation.

Final remarks

17. The authorities remain vigilant that the global economy is facing important economic shifts. The commodity price shock is sizable and there remains considerable uncertainty about global growth prospects. Investor sentiments have also been adversely affected. Nonetheless, the Malaysian economy is well-diversified, which will allow the economy to weather these shocks with greater resilience. Economic fundamentals remain sound following decades of policy efforts to strategically and pro-actively address areas of vulnerabilities, and to build buffers to absorb any shocks to the system. While growth may be affected in the short-term, the Malaysian economy will continue to perform well, driven by the private sector across a diversified range of economic activities. Of importance, employment remains strong and incomes are rising. Inflation will remain anchored and the current account balance will remain in surplus. The strength of Malaysia’s external position remains intact, with international reserves at healthy levels and external debt within prudent limits.

18. The authorities are pleased to inform the Executive Board that they agree to the publication of the full suite of reports, covering the 2014 Malaysia Article IV Staff Report and the Selected Issues Papers.