IMF Executive Board Concludes 2016 Article IV Consultation with Malaysia

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.

Abstract

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.

On April 22, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Malaysia.

Malaysia’s highly open and diversified economy was hit by a number of external and domestic shocks since late 2014, including sharply lower energy prices, spillovers from China, capital outflows and domestic political controversy. The economy has remained resilient, although growth moderated to 5 percent in 2015 from 6 percent in 2014, led by domestic demand in the face of weak external demand. Inflation remained subdued, close to 2 percent, despite the significant depreciation of the ringgit against the U.S. dollar and the implementation of the GST. The current account surplus narrowed to about 3 percent of GDP.

The authorities have responded to the multiple shocks in a timely and decisive fashion and their policy agenda remains on track. Fiscal consolidation, including the introduction of GST in April 2015 and removal of costly and untargeted fuel and other subsidies starting in late 2014, have been effective in shielding the fiscal position from the effects of lower oil-related revenues and in diversifying the revenue base, with appropriate compensatory measures put in place to help offset the impact of fiscal consolidation on lower and middle income households. The medium-term fiscal strategy calls for further consolidation, balancing the budget and materially lowering the federal debt by 2020 while taking into account the economy’s cyclical condition. Limited pass through of exchange rate changes to domestic prices and low prices of imports have helped to contain inflation closer to BNM’s comfort range. Monetary policy remains accomodative, with cuts in the reserve requirements supporting domestic liquidity and growth. The authorities allowed the exchange rate to depreciate substantially, by about 25 percent against the U.S. dollar between July 2014 and December 2015, and also deployed US$36.5 billion of reserves over the same period, including reserves accumulated during the post-GFC inflow period, to cushion the effect of capital outflows on the economy and maintain orderly market conditions. A series of well-targeted macroprudential policies remain in place and have helped build financial sector resilience as the financial cycle turns.

Staff expects economic growth to ease to a still robust 4.4 percent in 2016. Activity should continue to be underpinned by healthy, albeit moderating, domestic demand but constrained by weak external demand. Inflation will rise temporarily but remain close to 3 percent as the impact of lower oil prices wanes and a more depreciated exchange rate passes through to prices. The authorities’ structural agenda includes continued focus on improving Malaysia’s physical infrastructure and human capital endowment and pursuing economic reforms on a wide front in the context of their 11th Malaysia Plan, 2016–2020. Malaysia has ratified the Trans-Pacific Partnership and is an active participant in the ASEAN Economic Community which came into force in January 2016.

Executive Board Assessment2

Strong fundamentals, ample buffers, a robust financial system, and timely policy responses have enabled the Malaysian economy to weather external shocks, including from lower commodity prices and spillovers from trading partners. While the outlook for the economy is good, Directors agreed that the increasingly challenging environment requires continued implementation of sound macroeconomic policy. Pushing ahead with structural reforms will also be important to raise growth potential over the medium term.

Directors endorsed the current settings for fiscal policy, noting the authorities’ continued commitment to fiscal consolidation as evidenced by the 2016 budget. They commended the authorities for the timely elimination of fuel price subsidies, and the implementation of GST, which has significantly diversified the revenue base away from reliance on oil and contributed to fiscal sustainability. Directors underscored that protecting and strengthening the fiscal position should continue to be a top priority, including by adhering to the federal budget deficit target for 2016 and by balancing the budget by 2020. Directors noted that automatic fiscal stabilizers should be allowed to operate to support the economy, and if needed, any additional fiscal stimulus should be targeted, temporary and consistent with the medium-term consolidation plan.

Directors concurred that the current accommodative monetary policy stance is appropriate in an environment of moderating growth and low inflation. Noting that exchange rate flexibility, combined with the use of reserves, had helped insulate domestic financial conditions from global cycles, Directors called for continued exchange rate flexibility, while maintaining an adequate level of reserves. Some Directors noted that the use of reserve adequacy metrics should be supplemented with a broader assessment of the country’s economic and financial development. Directors noted that Malaysia’s banking sector is well capitalized and resilient and that tighter financial conditions and macroprudential policies have resulted in a slowdown in credit growth. They noted the risks from the relatively high household and corporate debt, but agreed that further macroprudential policies are not needed at this time. They encouraged the authorities to closely monitor risks from rising NPLs as the financial cycle turns.

Directors welcomed the authorities’ broad structural reform agenda, including the 11th Malaysia Plan, unveiled in May 2015. These reforms, along with recent international agreements, including the ASEAN Economic Community and the Trans-Pacific Partnership, should help boost productivity and enhance regional integration. In addition, Directors noted that improving the quality of education will be critical in achieving higher-income status. They also underscored the importance of high standards of governance of public enterprises and a clear communication of government-linked companies’ investment and financing plans. Malaysia could also benefit from a Public Investment Management Assessment.

Malaysia: Selected Economic and Financial Indicators, 2011–17

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Sources: CEIC Data Co. Ltd; Data provided by the authorities; Dealogic; and IMF 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.

1

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

2

At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

Malaysia: 2016 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Malaysia
Author: International Monetary Fund. Asia and Pacific Dept