Malaysia: Staff Report for the 2016 Article IV Consultation

Adjusting to shocks. The Malaysian economy has faced a sequence of shocks since mid-2014, including declines in commodity prices, spillovers from China, volatility of capital flows, and domestic political controversy. The economy's adjustment is aided by its diversified production and export bases, deep financial markets, strong regulatory framework, strong external position, flexible exchange rates, and responsive fiscal policy and reforms. Outlook. The outlook for 2016 is shrouded in uncertainties, owing to a confluence of factors that include the global and regional trade slowdowns; China spillovers; the normalization path of U.S. interest rates; and the uneven strength of activity in Malaysia's other major trading partners. Nevertheless, growth should remain healthy at 4.4 percent.


Adjusting to shocks. The Malaysian economy has faced a sequence of shocks since mid-2014, including declines in commodity prices, spillovers from China, volatility of capital flows, and domestic political controversy. The economy's adjustment is aided by its diversified production and export bases, deep financial markets, strong regulatory framework, strong external position, flexible exchange rates, and responsive fiscal policy and reforms. Outlook. The outlook for 2016 is shrouded in uncertainties, owing to a confluence of factors that include the global and regional trade slowdowns; China spillovers; the normalization path of U.S. interest rates; and the uneven strength of activity in Malaysia's other major trading partners. Nevertheless, growth should remain healthy at 4.4 percent.

Recent Developments, Outlook, and Risks

1. Recent developments. Malaysia’s highly open and diversified economy was in a favorable position in mid-2014, with strong economic growth, a large current account surplus and substantial reserves. But the effects of multiple external shocks from lower commodity prices, capital outflows, slowdown in external demand, and China-related financial volatility, have been large and growth is slowing down. The ringgit depreciated by 25.5 percent against the U.S. dollar between July 2014 and December 2015, while US$36.5 billion of reserves were deployed to cushion the capital outflows and maintain orderly market conditions (Figures 12).

Figure 1.
Figure 1.

Malaysia: Growth and Exports

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Figure 2.
Figure 2.

Malaysia: Inflation and Domestic Resource Constraints

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Figure 3.
Figure 3.

Malaysia: Monetary Developments

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

2. Economic performance. Real GDP grew by 5 percent in 2015, down from 6 percent in 2014; and the positive output gap has narrowed. Private sector domestic demand was the main driver of growth. Exports picked up in the second half of the year on stronger external demand and a depreciated currency, and the current account remained in surplus. Investment has been resilient owing to the continued implementation of long-gestation projects in infrastructure and industry. The manufacturing and services sectors have also been resilient. Inflation has remained subdued as weaker demand and lower oil prices offset the impact of GST and currency depreciation. Credit growth is slowing to a more moderate pace.

3. Policy adjustments. The authorities’ responses to shocks have been timely and their policy agenda remains on track and is in line with Fund policy advice (Appendix I). Fiscal consolidation is aimed at offsetting lower oil and gas related revenues and delivering medium-term sustainability. The introduction of GST and elimination of fuel subsidies in 2015 helped to diversify government revenues and protect the fiscal position from lower oil prices. Monetary policy was calibrated to support growth and contain inflationary pressure from the GST introduction and currency depreciation. A series of targeted macroprudential policies have helped build financial sector resilience as the financial cycle is turning.

4. Outlook. Staff expects economic growth to ease to 4.4 percent in 2016 and the economic environment has become more challenging. Activity should continue to be underpinned by healthy, albeit moderating, domestic demand but constrained by weak external demand. Credit growth is expected to slow down, dampening the accumulation of debt. Nevertheless, financial conditions are expected to remain accommodative of growth. Consumption growth will be supported by a temporary reduction in mandatory Employee Provident Fund (EPF) contribution rates, tax relief for middle and lower income taxpayers and expanded federal transfers to lower-income groups, lower fuel prices, and by high rates of household formation and strong employment. Private investment growth is projected to decelerate to about 5 percent. Inflation will rise temporarily in early 2016 as the impact of lower oil prices wanes and a more depreciated exchange rate passes through to prices.1 Over the medium term, potential growth will remain close to 5 percent but is likely to be slightly lower than previously projected owing to lower commodity prices, slower potential growth in China and other emerging markets, and lower potential growth in advanced economies. Despite the large negative terms of trade shock, the current account is projected to stay in surplus.


Tapis Oil and Ron 95 Gasoline Prices

(in MYR) 4.00

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Sources: IMF Staff calculations1/ Tapis Index, end-December 2014 = 2.26

5. Risks. The outlook for 2016 is uncertain owing, inter alia, to the global and regional trade slowdowns, China-related volatility and spillovers and the normalization path of U.S. interest rates; (Appendix II).

  • External risks. Despite significant capital outflows during 2015, foreign investors still hold sizeable positions in Malaysian Government Securities (MGS) and Malaysia remains vulnerable to further outflows, especially during periods of heightened global financial stress. Other risks include a sharper-than-expected slowdown in China in 2016–17; structurally weak growth in advanced and emerging market economies; and a further decline in energy and commodity prices.

  • Domestic risks. These are related to a sharp rise in domestic debt in the post-GFC period: federal debt and contingent liabilities are relatively high, as is external and household debt. Realization of contingent liabilities would likely contribute to financial market volatility and potential spikes in sovereign bond yields. Risks of a severe downturn in the financial cycle appear to be relatively low: continuing growth and a resilient banking system, bolstered by BNM’s macroprudential policies, should limit any increase in non-performing loans (NPLs). Pass-through from the exchange rate to domestic prices needs to be monitored.

Malaysia: Outstanding Debt

(In percent of GDP)

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

6. Authorities’ views. The authorities were in broad agreement with staff’s assessment. Malaysia’s diversified economy and strong macroeconomic fundamentals have blunted the impact of lower commodity prices. Nevertheless, growth has moderated and is expected to be between 4.0–4.5 percent for 2016, led by domestic demand. Consumption growth will remain healthy but at a slower pace. Private investment growth is also expected to moderate but will be sustained by the pipeline of strategic infrastructure projects. Manufacturing exports are expected to benefit from the depreciation of the ringgit. The authorities agree that externally driven volatility is likely to persist. They emphasized the low probability of fiscal contingent liabilities materializing. BNM assesses the probability of a sharp turn in the financial cycle as low and views the risks as manageable.

Adjusting to External Shocks

7. Lower commodities prices. Malaysia’s exports are diversified but oil and gas related commodities are important, accounting for about 10 percent of exports. The large fall in commodity prices has led to a significant narrowing of the current account surplus, to 2.9 percent of GDP in 2015, as weak commodity exports are only partially offset by a pickup in manufacturing exports (Appendix III). The decline in the current account surplus was reflected in lower corporate saving in the first instance. The deficit of the nonfinancial public sector (NFPS), which includes important government-linked companies (GLCs) such as PETRONAS, the national oil company, widened, reflecting, inter alia, the lagged adjustment of dividends to the budget by PETRONAS and continued implementation of domestic investment programs.2 (Appendix IV) At the same time, offsetting measures have left the federal budget deficit little changed.3 Looking ahead, the NFPS deficit will gradually decline as public savings recovers over time. While the investment ratio is still projected to rise over time, its trajectory will be more modest. The current account is expected to narrow further, to about 1.6 percent of GDP over the medium term. Expenditure switching associated with a more competitive exchange rate should help boost exports but this will be offset by large import needs. Malaysia’s prior experience with adjusting to lower commodities prices highlights the positive impact of fiscal reforms on growth (Appendix V).


Emerging Markets (excl. China): Exchange Market Pressure (EMP) 1/

(In percent) 40

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Source: IMF staff calculations.1/ EMP is defined as the sum of percentage changes in US$ exchange rate and FX reserves. Bubble size represents average share of goods exports going to China over 2012–14.

Malaysia: Contributions to Export Growth by Destinations and Types of Goods in 2015

(In year-on-year percentage points; in U.S. dollar terms)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Sources: CEIC Data Co. Ltd; and IMF staff calculations.1/ Commodities were 29.4 percent of total exports in 2015 (2014: 34.7 percent).2/ Selected European countries include France, Germany, the Netherlands, and the United Kingdom (66 percent of Malaysia’s goods exports to Europe in 2015).

8. Spillovers from China. China is Malaysia’s largest trading partner and spillovers through the trade and commodity channels are relatively important. Malaysia’s exports to China comprise manufactures which are part of the regional supply chain as well as palm oil and other non-oil commodities. However, the direct spillover effects of developments in China on Malaysia’s exports have been small thus far as confirmed from detailed goods exports data, decomposed by commodities and non-commodities and by country of destination. Much of the negative effect on the trade balance is from the impact of lower international prices of products Malaysia exports outside of China, for example, LNG exports to Japan and Korea. In addition, there may be second round effects on exports, as other countries are negatively impacted, decreasing overall external demand for Malaysia.

9. Exchange Market Pressure (EMP). The extent to which Malaysia’s FX market was affected by global shocks during 2015 in relation to its peer Emerging Market Economies (EMEs) can be gauged by a simple EMP index (Appendix VI).4 Malaysia’s EMP showed a sizeable depreciation pressure and was higher than, for example, some Latin American EMEs. Malaysia’s EMP was broadly in line with that predicted by cross-country regression analysis, with export exposure to China and to mineral fuels largely explaining it. In terms of composition of EMP, data analsysis shows that changes in reserves contributed more in Malaysia than in most EMEs. This largely reflects a reduction in foreign holdings of the short-term BNM bills, which were used to sterilize and smoothen the impact of the global capital flow cycles on the domestic financial markets (see paragraph 12).


Emerging Markets: EMP by Monetary Framework 1/

(In percent)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Source: IMF staff estimates.1/ Countries with shares of commodity exports and China-bound exports in total exports at or above their in-sample median are shown in dark markers. Sample does not include China.

10. Authorities’ views. The adjustment to lower commodity prices is ongoing, supported by Malaysia’s diversified economy and government revenue sources. Furthermore, exchange rate depreciation is supporting manufacturing exports and is helping to partially offset the commodities price shock. The authorities remain committed to balancing the budget by 2020. Medium-term fiscal consolidation will be achieved primarily through expenditure rationalization and restraint. The authorities concur that spillovers from rebalancing of the Chinese economy could reduce growth and increase volatility; however, the Malaysian economy’s enhanced trade linkages with other economies creates additional growth opportunities.

Capital Outflows: Stress Testing Resilience

11. Capital inflows and reversals. Malaysia has relied both on foreign reserves and the exchange rate to cushion the impact on the economy of shocks to capital flows and its terms of trade. Capital inflows in the post-GFC era were sizable, with cumulative portfolio inflows amounting to US$81billion (26 percent of GDP) between early 2009 and their peak in mid-2013. During this period, Malaysian institutional investors, including the Employees Provident Fund (EPF), were also diversifying their portfolio by investing abroad, easing demand for domestic assets and reducing net inflows. BNM sterilized inflows by issuing bills, and changes in foreign holdings of BNM bills were matched by similarly sized changes in reserves. Reserves accumulated during inflow surges were used to cushion the impact of capital outflows during 2013–2015.


Portfolio Flows

(Accumulation since Q2 2009, percent of GDP)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

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

Change in Reserves and Estimates of Intervention and Valuation Changes

(Billions of USD)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Sources: Haver Analytics; and IMF staff estimates.

12. Recent volatility. Capital outflows were particularly high during 2015. In late 2014–early 2015 outflows were primarily from the equity market and were primarily in response to declining commodity prices and weak external demand. For the rest of the year, outflows were primarily from BNM bills largely reflecting the unwinding of the carry trades, and by June 2015, foreign holdings of BNM bills had shrunk to near zero. In contrast, foreign holdings of MGS have been relatively stable. These episodes were similar to earlier bouts of capital flow volatility and BNM used its reserves and the exchange rate to smooth the adjustment and maintain orderly market conditions. Reflecting the depth of Malaysia’s financial markets, the effects on domestic interest rates and the real economy were small.

13. Assessing vulnerabilities. Malaysia’s vulnerabilities arise mainly from high foreign holdings of MGS and equities, high short-term debt of the banking system, and high household and corporate sector debt. However, deep-pocketed domestic institutional investors and sizeable bank liquidity with BNM contribute to continued resilience (Appendix VII).


Banking System: External Assets and Liabilities. 2009Q1-2015Q4

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Sources: CEIC Data Co. Ltd; IMF staff calculations
  • The MGS market is deep and liquid and MGS yields are less volatile than government bond yields in other EMEs. Domestic institutional investors, with ample liquidity, tend to buy opportunistically when foreign investors exit and there is upward pressure on yields. Staff analysis suggests that these investors have balance sheet capacity to absorb additional MGS holdings of at least 5 percent of GDP, which would help stabilize the market.

  • Short-term external debt of the banking system has increased to almost 23 percent of GDP by end-September 2015. This debt comprises short-term offshore borrowing and non-resident deposits. The rise in short-term offshore debt appears to be primarily related to centralization of overseas treasury operations of foreign branches of Malaysian banks and has been accompanied by an increase in short-term banking sector assets. Non-resident deposits amounting to 7.2 percent of GDP, of which two thirds comprise business deposits, have been stable so far. However, in a stress scenario, withdrawal of non-resident deposits could pose a vulnerability.

  • Outstanding liquidity placed with BNM amounted was approximately RM 220 billion at end December 2015, of which approximately RM 50 billion represents statutory reserves, down from RM 320 billion in August 2014. BNM can release part of this liquidity to the banks in a stress scenario and offset the impact of outflows on their balance sheets.

14. Stress tests. Malaysia’s external debt has increased from about 54 percent of GDP in 2009 to 65.6 percent at end-2015, of which one quarter comprises foreign holdings of local currency debt. A severe stress test that simulates a further outflow of foreign capital (similar in magnitude to that observed during the GFC) reaffirms that risks to Malaysia from capital outflows remain contained (Appendix VII). A substantial part of Malaysia’s external debt, about 36 percent, is in its own currency and its exchange rate is flexible, allowing for more risk sharing with foreign investors: when shocks lead to outflows and currency depreciation, foreign holders experience valuation losses, reducing the drain on reserves and incentives to exit.

15. Authorities’ views. The authorities agree that Malaysia’s open economy and large financial sector expose the economy to capital flow volatility. Accumulation of reserves during post-GFC inflow surges helped limit the appreciation of the exchange rate and reduce excess liquidity in the banking system, thereby maintaining stable monetary conditions. Subsequently when flows reversed, the use of reserves and release of liquidity into the banking system insulated the impact on monetary conditions and the economy. In addition, exchange rate flexibility played a key role in the adjustment to lower commodity prices. The authorities noted that Malaysia’s resilience to capital flow volatility is strong as demonstrated by the modest impact on the real economy during capital outflow episodes. They agreed with staff’s assessment that the Malaysian economy can be resilient to a stress scenario due to its solid fundamentals and macroeconomic policies, including diversified sources of growth, current account surpluses and FDI inflows, manageable level of external debt, liberal capital accounts as well as a deep and diversified financial system.

Policies for Resilience

16. Response to shocks. Uncertainty about external conditions requires continued fiscal prudence and flexibility in setting fiscal, monetary and exchange rate policies. With receding risks to price stability, monetary policy has more room to focus on domestic growth. Fiscal policy should persevere with growth-friendly consolidation over the medium term. While fiscal space is limited, temporary and targeted measures anchored in a medium-term consolidation plan can support aggregate demand. Exchange rate flexibility should continue to be the first line of defense to external shocks and reserves deployed to ensure smooth functioning of markets. Over the medium term, reserves can be gradually and opportunistically rebuilt. Staff supports the authorities’ declaration to abstain from using capital controls on outflows.

A. Monetary Policy

17. Appropriate stance. The current environment of moderating growth, low inflation and tightening credit conditions calls for accommodative monetary policies. BNM has kept its policy rate unchanged since July 2014, resulting in low real interest rates that are supportive of domestic demand. Capital outflows and implementation of liquidity coverage ratio (LCR) requirements led to a tightening of domestic liquidity conditions. Meanwhile, the recent 50 basis point reduction in the statutory reserve requirement ratio should help prevent an over-tightening of credit conditions. Inflation will peak in the first quarter due to the waning impact of earlier declines in oil prices but is expected to remain moderate during 2016 on modest exchange rate pass through.

18. Outlook and managing risks. No change in the policy rate is anticipated during 2016, in line with projections from an estimated Taylor rule (Appendix VIII). A reduction in the policy rate to aid growth in the near term would risk re-igniting strong credit growth. A tightening of interest rates should be considered if signs emerge of second round inflation pressures from the large exchange rate depreciation. In a risk scenario where prolonged capital outflows result in a significant tightening of domestic liquidity conditions, BNM could provide liquidity through open market operations and/or further lower the statutory reserve requirement. Going forward, given the lower level of reserves, greater reliance on exchange rate flexibility is recommended.

19. Authorities’ views. The current stance of monetary policy is supportive of activity. Growth is expected to moderate while inflationary pressures are expected to remain subdued. Recent external and domestic developments have weakened the exchange rate, with capital outflows contributing to lower domestic liquidity. BNM will continue to ensure sufficient liquidity to maintain orderly markets and support growth. The authorities agreed with staff on the importance of exchange rate flexibility and on the need to rebuild reserves over the medium term. However, they would not rule out using reserves to buffer short-term capital flows as in the past.

B. Fiscal Policy

20. Background. Fiscal policies in recent years have strived to balance near-term support for growth with medium-term fiscal sustainability. The 2015 deficit target of 3.2 percent of GDP was achieved through introduction of the GST, subsidy reform, restraint in recurrent spending, and lagged adjustment in the PETRONAS dividend. These reforms will also help sustain the fiscal consolidation effort going forward although, in staff’s view, balancing the budget by 2020 could require additional measures up to 1.2 percent of GDP.


Federal Government Overall and Non-Oil Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Sources: Malaysian authorities; and IMF staff estimates.

21. 2016 Budget. The 2016 Budget, including the January recalibration, targets a deficit of 3.1 percent of GDP. Faced with further declines in oil and gas related revenues, the authorities cut spending on supplies and services and grants and refocused development expenditure on high impact projects with low import content. The measures adopted strove to mitigate the impact on the domestic economy and the fiscal impulse is -0.8 percent of GDP in 2015 and −0.1 percent of GDP in 2016. (Figures 4 and 5). In addition, measures were taken to support consumption by low and middle income earners: Employers Provident Fund (EPF) contributions were reduced temporarily by 3 percentage points (until end-2017); and additional tax relief was provided to those earning RM 8,000 or below per month.

Figure 4.
Figure 4.

Malaysia: Federal Budget Developments

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Figure 5.
Figure 5.

Malaysia: Public Sector Fiscal Stance and Prospects

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Figure 6.
Figure 6.

Malaysia: Capital Flows

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Malaysia: Fiscal Developments 2014-16

article image
Sources: IMF staff calculations.

22. Policy response to shocks. If the economy is weaker than envisaged under the baseline, staff advises that the automatic stabilizers should be allowed to operate and the federal deficit could be allowed to rise slightly while maintaining commitment to the medium-term fiscal consolidation plan. Should the growth outlook deteriorate significantly, relatively high fiscal deficit and public debt afford limited space for a sustained countercyclical fiscal response. Any fiscal stimulus should be temporary, targeted and anchored in a medium-term fiscal consolidation program.

23. GST. The GST has played a critical role in the adjustment to lower oil prices. Its effectiveness could be enhanced by narrowing the list of exempt and zero-rated items. At 6 percent, the GST rate is low relative to other countries and could be increased to help achieve medium-term fiscal objectives.


OECD and Selected Asian Countries: Rate at Introduction

(In percent)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Sources: International Bureau of Fiscal Documentation website; and Deloitte, Global Indirect Taxes, 2013.

24. Federal debt and contingent liabilities. Federal debt is expected to remain below the 55 percent of GDP ceiling in the short-and medium-term (Appendix IX). Contingent liabilities (in excess of 15 percent of GDP) require continuous monitoring. Staff recommends that a statement on fiscal risks be published annually to inform policy. Staff notes that a new statutory body, Public Sector Housing Financing Board, has been created which will manage housing loans to civil servants starting in January 2016. Associated assets and a portion of associated liabilities have been transferred to the new body, reducing federal debt by 2 percent of GDP but leaving general government debt unchanged. Although the default risk is low given at-source deductions from payroll, this requires transparent treatment in a fiscal risks statement.

25. Fiscal institutions and framework. Staff welcomes the adoption of a medium-term fiscal framework and the inclusion of three-year projections in the 2016 budget. Looking ahead, staff encourages additional information in future budgets, including annual projections of revenue and expenditure and an explicit link with 11th Malaysia Plan. Staff welcomes implementation of accrual accounting and outcome-based budgeting. Malaysia has made important strides in the provision of public infrastructure (Appendix X). Under the 10th Malaysia plan, the ratio of public capital stock to GDP has increased. Malaysia also fares well in surveys of infrastructure quality and access. Malaysia, as other countries, would benefit from a Public Investment Management Assessment (PIMA).

26. Nonfinancial public enterprises. The NFPS deficit is estimated to have increased from 5.9 percent of GDP in 2014 to 8.9 percent in 2015. This stemmed mostly from the fall in global oil prices, which lowered GLCs’ operating surpluses, and continued implementation of GLC investment, which provided support to the economy. GLCs finance capital expenditure from retained earnings and the issuance of debt and equity. Clear communication of GLC investment and financing plans will be important to ensure markets are appropriately informed.

27. Authorities’ views. The authorities reiterated their commitment to fiscal sustainability and achieving a budget that is broadly balanced in the medium term. For the 2016 Budget, the authorities noted the significant contribution from GST revenues and emphasized that expenditure restraint measures will focus on areas with low impact on aggregate demand. Although contingent liabilities are sizable, government loan guarantees have a low probability of being called as they are granted strategically to nonfinancial entities with healthy balance sheets.

The Financial Cycle and Leverage

28. Background. The financial cycle is turning and loan growth continues to ease, reflecting macroprudential policies and macroeconomic factors. The turn in the credit cycle is lagging the turn in the economic cycle and, as a result, the ratio of credit to GDP has increased, widening the credit gap. However this is expected to reverse as nominal GDP growth picks up and outpaces more moderate credit growth. While credit markets are expected to remain supportive of growth, tighter credit conditions and high debt levels will weigh on domestic demand (Figure 7).

Figure 7.
Figure 7.

Malaysia: Financial Sector Developments

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001


Output Gap and Credit-to-GDP Gap

(Percent of GDP, deviation from one-sided HP filter, estimation period 2000:Q1 to 2015: Q4)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

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

29. Banks. Banks’ strong liquidity position with BNM has helped to cushion the impact of capital outflows. Real interest rates on deposits remain low contributing to sluggish deposit growth which, along with banks’ adjustment to LCR requirements, has resulted in intensified competition for deposits. Banks’ capital position strengthened in 2015, but profitability weakened slightly. Loan quality remains good although the NPL ratio was unchanged, consistent with slower economic growth (Figure 10). Banks’ short-term FX debt has increased and although matched by an increase in FX assets, warrants careful monitoring. Malaysian banks are well placed to meet the Basel III capital and phased-in liquidity requirements. Significant progress has also been made in implementing key FSAP recommendations (Appendix XI).

Figure 8.
Figure 8.

Malaysia: Household Debt

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Figure 9.
Figure 9.

Malaysia: House Prices

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Figure 10.
Figure 10.

Malaysia: Financial Soundness Indicators, 2015:Q4

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001


Overnight Policy Rate and 3 month KLIBOR


Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Source: CEIC Data Co. Ltd.

30. Non-banks. Non-bank credit intermediaries contributed significantly to the build-up of household debt but growth in nonbank lending and the stock of debt to households have declined following implementation of macroprudential measures in 2013. Direct linkages between banks and non-banks are limited and covered by BNM’s regulation on single counterparty exposures (Appendix 8, 2014 Malaysia Article IV Consultation).


Commercial Banks’ Impaired Loans, December 2015

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Source: CEIC Data Co. Ltd.

31. Household debt and macroprudential policies. Household debt has increased by 15 percentage points of GDP since end-2009 but growth has begun to moderate as of late (Figure 8). Close to 50 percent of the debt is owed on residential property and about 60 percent are variable rate loans. Macroprudential measures have helped to curb household borrowing (Table 8). The impact of measures continues to be felt and the reduced loan applications and approvals reflect in part an enhanced framework for risk-based pricing of loans. Risks from high household debt are mitigated by strong household financial assets (including EPF savings and banking system deposits) and low unemployment. NPLs are likely to increase as the financial cycle turns but any increase is likely to be small. House prices are still growing but prices of high-end properties in Kuala Lumpur have declined slightly. Given the slowdown in loan growth and in housing, no further measures are recommended. LTV caps on second and first mortgages should be considered if rapid house price and credit growth were to reignite.

32. Corporate sector debt. Corporate sector debt, at 96 percent of GDP, is relatively high but its growth has moderated since the GFC (Appendix XII). Corporate debt risks in terms of maturity, currency, and exposure to commodities appear contained. Bank loans, representing about half of total corporate debt, are well diversified and predominantly medium term. Less than 26 percent of total debt is foreign-currency denominated and well below the emerging market average of close to 35 percent. BNM’s approval regime for external borrowing ensures that corporates’ foreign currency debt is either naturally hedged or is hedged using derivatives. Commodities account for less than 20 percent of listed corporate sector debt. Stress testing results imply that Malaysian corporates are resilient to declines in income, depreciation of the exchange rate, and increases in interest rates.

33. Authorities’ views. The authorities concurred that the financial cycle is turning. Nevertheless, due to macroprudential policies and risk-based supervision, banks are expected to remain resilient. High underwriting standards imply that only a modest and manageable increase in NPLs is anticipated. Additional macroprudential measures are not needed at this time and there are no plans to wind down existing measures, given their prudential nature. Risks from non-financial corporate sector debt remain manageable, supported by generally healthy balance sheets and financial positions. Close to 73 percent of external borrowings were of longer maturities, exceeding one year, further reducing short-term risks. Outstanding non-financial corporate external debt is borne by domestic conglomerates and local outfits of multinational corporations (mainly in the form of inter-company loans). As part of BNM’s approval consideration for external borrowings equivalent to RM 100 million and above, the borrowings should be adequately hedged or supported by foreign currency receivables.

External Sector Assessment

34. External sector assessment. Malaysia’s 2015 external position was stronger than warranted by fundamentals and desirable policies (Appendices XIII–XIV). The 2015 External Balance Assessment (EBA) estimates the cyclically-adjusted current account (CA) surplus to be 4.6 percent of GDP, with the CA norm at 0.5 percent of GDP. However, staff’s estimate of the current account norm is 1.8 percent of GDP, which implies a CA gap of 2.8 percent of GDP, with the policy gap contributing −0.1 percent of GDP. The CA gap reflects structural factors, viz. low investment since the Asian financial crisis on the back of high saving. While the gap has narrowed significantly in recent years—saving has declined and investment has increased, though at a slower pace—policy measures should help to further reduce this gap through, for example, improving social insurance institutions and addressing labor force skill mismatches. Malaysia’s real effective exchange rate (REER) is assessed to also be moderately undervalued, by 9.7 percent, consistent with the identified CA gap. Reserves were above 100 percent of the IMF’s reserve adequacy metric prior to the onset of the large shocks in 2014–15. The use of reserves to cushion capital outflows has resulted in a decline to 80 percent of the metric for 2015, which is below the suggest adequacy range of 100–150 percent. Going forward, staff recommends greater reliance on the exchange rate flexibility and that reserves be increased as opportunities present themselves. Malaysia’s net international investment position is 8.4 percent of GDP at end-2015, a significant improvement over 2014 that is attributed to capital outflows and valuation effects.


Malaysia: Assessing Reserve Adequacy (ARA) Metric 1/

(In percent of the metric)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Source: IMF staff estimates.1/ Please see IMF (2015): Assessing Reserve Adequacy – Specific Proposals.

Malaysia: Quantitative External Sector Assessment

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Staff’s estimate of the multilaterally consistent cyclically-adjusted norm and actual for 2015, based on EBA February 2016.

Policy gaps refer to policy distortions that can arise from domestic policies and/or as a result of the policies of other countries. See 2015 Pilot External Sector Report.

From EBA January 2016. Based on 2013 NFA/GDP ratio of -5.0 percent of GDP and an adjusted medium-term CAB of 2.0 percent.

Misalignment based on EBA January 2016.

The semielasticity of the current account balance with respect to the REER is η_CA= -0.29, computed according to η_CA=η_Xnc s_Xnc-(η_M-1) s_M-s_Xc, where η_Xnc is the elasticity of the volume of non-commodity exports with respect to the REER, η_M is the elasticity of the volume of imports with respect to the REER, estimated at η_Xnc= - 0.82, η_M= 0.26, s_Xnc= 58.2 percent is the share of non-commodity exports in GDP, s_Xc= 16.8 percent is the share of commodity exports in GDP, and s_M= 61 percent is the share of imports in GDP.

35. Authorities’ views. The authorities broadly agree with staff’s assessment. Exchange rate adjustments continued to perform a critical role in absorbing external shocks. Exchange rate flexibility was complemented by foreign exchange intervention, utilizing reserve buffers in times of heightened volatility when market participants were prone to herd-like behavior. Despite the decline, Malaysia’s international reserves remain ample. Reserves constitute only one-fourth of Malaysia’s total external assets and other external assets also provide a cushion, if needed, against short-term claims. The authorities also note that the Fund’s reserve adequacy metric uses an unfavorable binary classification under which Malaysia’s exchange rate regime is classified as “other fixed” instead of “free floating.” They emphasize the importance of judgment in making assessments and the need to avoid a rigid interpretation of any metric. The authorities expect the current account to remain in surplus over the medium term.

Structural Reforms for Real Convergence and Inclusion

36. The challenge. Malaysia has made substantial progress in real convergence under the 10th Malaysia Plan.5 The challenge now is to make the leap to advanced country status by boosting productivity. The 11th Malaysia Plan, unveiled in May 2015, envisages investments in hard and soft infrastructure, including a high speed rail linking Kuala Lumpur to Singapore, expansion of the Kuala Lumpur metro system, and the Pan Borneo highway. These investments should help connectivity with neighbors, alleviate congestion in Malaysia’s cities and make them more attractive to foreign investment and skilled labor.


GDP per Capita

(In logs of current U.S. dollars)

Citation: IMF Staff Country Reports 2016, 110; 10.5089/9781484343067.002.A001

Sources: IMF, World Economic Outlook; and IMF staff calculations and projections.Note: Advanced economies includes France, Germany, Italy, Japan, and the UK; ASEAN-4 includes Indonesia, Malaysia, Philippines and Thailand; CLMV includes Cambodia, Lao PDR Myanmar, and Vietnam.

37. Championing trade integration. Malaysia remains a champion of free trade and investment in ASEAN. The launch of the ASEAN Economic Community (AEC) in January 2016 following Malaysia’s chairmanship should help reduce extensive intra-ASEAN non-tariff trade barriers and strengthen trade and investment, especially in services. Malaysia is also signatory to the Trans-Pacific Partnership (TPP), whose implementation starting in 2018 should help improve productivity through greater competition and better governance. Staff welcomes the authorities’ staunch support of free trade, despite domestic opposition.6 Viewed in their totality, better infrastructure and adherence to free trade should help make Malaysia more competitive.

38. Boosting human capital and home grown innovation. Improvements in workforce skills, more home-grown innovation and more intensive technology adoption will also be necessary if Malaysia is to avoid the middle income trap and become more inclusive. Staff encourages steadfast implementation of the Malaysia Education Blueprint 2013–25, which aims to boost student educational attainment and raise scores to the upper third of international comparisons. Malaysia’s education system needs continued transformation, with industry-led cooperative arrangements with universities and technical vocational institutes, as well as a sharpening of incentives in the allocation of research budgets and greater focus on commercialization of knowledge obtained from research and development.

39. Strengthening institutions. Recent events surrounding a government-owned strategic investment fund that is embroiled in scandal underscore the need to uphold high standards of governance and communication in public financial management. Transparency International’s Corruption Perceptions Index for Malaysia declined from 52 to 50 in 2015 and the ranking fell from 50th to 54th. Malaysia continues to score well on the World Bank’s Ease of Doing Business Index, ranking 18th in 2016. Staff welcomes steps currently under consideration to strengthen the Malaysia Anti-Corruption Commission and Malaysia’s engagement with its Financial Action Task Force peers to strengthen the domestic framework and implementation of laws relating to Anti-Money Laundering and Countering the Financing of Terrorism (AML-CFT). Staff also encourages the authorities to enhance the asset declaration system and strengthen law enforcement agencies’ capacity to conduct financial investigations.

40. Authorities’ views. The authorities agreed with the broad thrust of staff’s assessment. They reiterated their commitment to fiscal prudence and to fiscal and structural reforms to raise the efficiency and fairness of fiscal policy and to improve the quality of education and strengthen their investments in research and development. They also reiterated their commitment to trade integration and economic openness which will provide an anchor for reforms and help improve living standards for all Malaysians. They are confident that implementation of their wide ranging reform agenda will help Malaysia achieve high income status by 2020.

Staff Appraisal

41. Outlook. Malaysia’s highly open economy remains resilient despite being buffeted by multiple shocks since late 2014. However, growth is slowing down, the economic environment has become more challenging, and downside risks have risen. On-going re-balancing in China could imply additional spillovers in the near term. Uncertainty about the external environment, including the likelihood of persistently low commodity prices and more capital outflows, require continued prudence in selecting policy settings.

42. Fiscal policy. The authorities have broadened revenue bases and diversified them away from oil and gas related revenues in a timely manner. The NFPS deficit has risen as commodity prices declined, but this is expected to reverse in the medium term. Protecting and strengthening the fiscal position should continue to be the authorities’ top priority, by adhering to the federal budget deficit target for 2016 and by balancing the budget by 2020. While automatic fiscal stabilizers should be allowed to operate if the economy is much weaker than envisaged, there is relatively little room for countercyclical fiscal policies. Given the relatively high federal debt and contingent liabilities, any fiscal stimulus should be targeted, temporary and consistent with the medium-term fiscal consolidation plan.

43. Monetary policy. In response to external shocks and capital outflows, BNM has allowed the ringgit to depreciate and deployed reserves to smooth the capital flow cycle and ensure orderly conditions in foreign exchange and financial markets. Going forward, BNM should rely more on exchange rate flexibility and intervene judiciously and gradually rebuild its stock of international reserves. While headline inflation is expected to rise temporarily in 2016, core inflation is well anchored, and BNM’s current monetary policy setting is appropriate. However, the authorities should continue to monitor risks to inflation from stronger than expected exchange rate pass-through and a tightening of interest rates could be considered if signs of second-round effects emerge.

44. Financial sector. Macroprudential policies and tighter financial conditions have resulted in lower credit growth, a welcome development following years of strong growth. Nevertheless, household and corporate sector debt remains elevated. Additional macroprudential policies are not currently recommended. Liquidity remains adequate and supportive of growth. Malaysian banks are well capitalized and are expected to remain strong as the financial cycle turns but the authorities should monitor risks from rising NPLs.

45. Structural policies. Implementation of reforms envisaged in the 11th Malaysia Plan and commitment to freer trade policies should all help anchor structural reforms and raise Malaysia’s potential growth over the medium term. Further raising the skills of Malaysia’s labor force, through steadfast implementation of education policies, will be critical in the nation’s drive to become a high income nation. Recent events underscore the need to uphold high standards of governance and communication in public financial management.

46. It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

Table 1.

Malaysia: Selected Economic and Financial Indicators, 2011–17

Nominal GDP (2015): US$296 billion

Main export (percent of total): electrical & electronic products (39%), commodities (23%)

GDP per capita (2015): US$9,556

Population (2015): 31.0 million

Unemployment rate (2015): 3.2 percent

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

Based on staff’s estimate of the federal government fiscal balance using GFSM 2001, which differs from the authorities’ cash-based measure of the fiscal deficit.

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.

Staff estimates.

Includes receipts under the primary income account.

Table 2.

Malaysia: Indicators of External Vulnerability, 2011–15

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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.

Staff estimates.

Includes offshore borrowing and nonresident holdings of ringgit-denominated Malaysian government securities.

Includes receipts under the primary income account.

Table 3.

Malaysia: Balance of Payments, 2011–17

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

Based on staff’s estimate by remaining maturity.

Table 4.

Malaysia: Illustrative Medium-Term Macroeconomic Framework, 2011–21 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.

Staff estimates.

Table 5.

Malaysia: Summary of Federal Government Operations and Stock Positions, 2011–17

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

Authorities’ measure of the overall fiscal balance and the IMF’s measure of fiscal balance (net lending/borrowing) are different due to differences in methodology/basis of recording (GFSM2001 versus authorities’ modified-cash based accounting) and differences in the treatment of certain items.

General government includes federal government, state and local governments and statutory bodies. Public sector includes general government and NFPEs.