Introduction

On behalf of our Malaysian authorities, we would like to convey our appreciation to the mission team, led by Mission Chief Mr. Lamin Leigh, for the constructive 2022 Article IV consultation and the comprehensive report.

Our authorities broadly agree with the thrust of staff’s appraisal and will carefully consider the key policy recommendations. There is common understanding that macroeconomic policies going forward will need to be calibrated to the pace of the recovery while preserving policy space, given the uneven recovery and ongoing uncertainties surrounding the pandemic trajectory. The stronger-than-expected recovery provides an opportunity to shift the overall focus of policy towards longer-term structural reforms, balanced with the need to ensure that immediate policy support remains for the more vulnerable segments of the economy.

Latest economic developments and outlook

Economic activity improved moderately in 2021 with GDP growth at 3.1 percent (2020: -5.6 percent). The recovery was supported by the rapid progress in domestic vaccinations¹, and phased lifting of restrictions under the National Recovery Plan (NRP) that contributed to a gradual normalization in economic activity towards the end of the year. While headline inflation saw an increase to 2.5 percent, this was driven mainly by the base effects from the low retail fuel prices in 2020. Core inflation remained subdued, averaging at 0.7 percent (2020: 1.1 percent), reflecting spare capacity in the economy, although it increased slightly towards the end of the year, in line with the improved demand conditions.

The Malaysian economy is expected to improve further in 2022, with growth projected to expand by between 5.3 to 6.3 percent, supported by the continued expansion in global demand, the lifting of domestic containment measures, reopening of international borders and further improvement in labor market conditions. Policy support for households and businesses will remain in place and, while scaled down and more targeted, will also help facilitate the recovery momentum and enable a more entrenched recovery in domestic demand. Authorities project headline inflation in 2022 to remain manageable, averaging between 2.2 to 3.2 percent, with core inflation expected to average higher, driven by the improvement in demand conditions amid lingering cost pressures.

Our authorities agree with staff’s assessment that the balance of risks to the growth outlook remains tilted to the downside, stemming mainly from COVID-19 related factors on both the domestic and external fronts. Factors which pose upside risks to the growth outlook include higher-than-expected global growth and stronger-than-expected improvement in tourism-related sectors amid the reopening of international borders. Importantly, our authorities recognize that the recovery remains uneven. Globally, the pandemic has had a disproportionate impact across economic sectors, labor markets segments and income groups. In Malaysia’s case, the authorities are paying close attention to developments within adversely affected economic sectors (e.g., tourism), low-income households, SMEs as well as the different labor market dimensions (e.g., age groups, gender, skills). In line with this, policy support measures have been, and will continue to be, tailored and targeted to these affected groups. To mitigate the impact of long-term economic scarring, our authorities recognize the urgency, and is fully committed to implementing wide-ranging structural reforms, as reflected in the various key reform initiatives announced over the past year.

Our authorities’ macroeconomic management framework utilizes a broad range of policy tools including monetary, fiscal, financial, prudential, and structural policies. This avoids the overburdening of any single policy tool, increases policy complementarities while minimizing the trade-offs, and allows the authorities to employ the right tools to address different risks. In our view, being able to maintain policy flexibility has been critical to our authorities’ effective policy responses in mitigating the lasting impact of the pandemic.

Fiscal policy

Our authorities agree with staff that additional and targeted fiscal support is warranted in the near-term and are committed to providing adequate fiscal support until the economic recovery has firmly taken hold. This is reflected in the expansionary Budget 2022, which is the largest budget to date with an allocation of RM332.1 billion or 20.3 percent of GDP, geared towards near-term economic revitalization efforts, as well as catalyzing structural reform strategies as envisioned in the Twelfth Malaysia Plan, 2021–2025 (12MP). An additional RM23 billion or 1.4 percent of GDP was dedicated to the COVID-19 Fund for stimulus and economic recovery measures allocated through targeted cash assistance, wage subsidies, grants for SMEs, re-skilling and upskilling programs and other measures. The Federal Government’s statutory debt limit was also raised from 60 to 65 percent of GDP in October 2021 to provide the fiscal space to facilitate the implementation of existing stimulus measures and the financing requirement for the 12MP.

Despite the expansionary fiscal policy to finance recovery measures, our authorities remain fully committed to medium-term fiscal consolidation. Fiscal strategy will be guided by the Medium-Term Fiscal Framework (MTFF), which serves as guidance for budgetary planning by setting a three-year macro-fiscal projection, including for revenue and expenditure. Our authorities view that a gradual and careful fiscal consolidation could commence in 2022 instead of 2023 as proposed by staff, to begin the process of rebuilding policy space for future shocks. Nevertheless, to maintain agility and flexibility in providing the necessary fiscal support during these uncertain times, the 2022 – 2024 MTFF has been revised with a more gradual fiscal consolidation than initially projected, with the overall fiscal deficit averaging at 5 percent of GDP for the three-year period (2021 – 2023 MTFF: 4.5 percent). In line with this, the fiscal deficit is projected to decline to 6 percent of GDP in 2022 (2021: 6.5 percent) and 3.5 percent in the medium- term. Our authorities also aim to reduce the overall debt-to-GDP ratio to below 60 percent in the medium-term.

Fiscal sustainability remains a key priority and the Budget 2022 reflects the authorities’ strong resolve for bold and effective reforms to strengthen public finances and enhance public financial management. To further enhance governance, accountability and transparency in fiscal management, the Fiscal Responsibility Act (FRA), which also includes some of staff’s recommendations via technical assistance, is expected to be tabled to the Parliament this year. Enhancing the revenue base will be guided by the Medium-Term Revenue Strategy (MTRS). While some revenue enhancement measures in line with the MTRS were already announced in Budget 2022, others are in the pipeline, including feasibility studies on capital gains, value added and carbon taxes. On the expenditure side, a Tax Expenditure Statement will be published to determine the costs incurred by the Government in providing tax incentives, one-off exemptions and other tax policies. The Government is also collaborating with the World Bank in conducting a Public Expenditure Review to ensure efficiency and effectiveness of public spending.

The authorities remain steadfast in undertaking other ongoing reforms to support sound public financial management, including through strengthening the ecosystem and governance structure of government-linked companies (GLCs) and government-linked investment companies (GLICs), and continuing their progress with implementing initiatives under the National Anti-Corruption Plan (NACP).

Monetary, exchange rate and financial market policies

Authorities welcome staff’s assessment that Malaysia’s monetary policy stance is appropriate. Monetary policy remained accommodative in 2021, with Bank Negara Malaysia (BNM) keeping the Overnight Policy Rate (OPR) unchanged at the historical low of 1.75 percent throughout the year, amid the relatively modest outlook on inflation and limited risks to financial imbalances. Monetary policy was also complemented with other targeted financial policies that were better tailored to provide support to segments of the economy that were experiencing an uneven recovery.²

In line with the accommodative monetary policy, BNM’s monetary operations continued to ensure conducive domestic liquidity conditions, the orderly functioning of domestic financial markets and continued intermediation activity to the real economy. Domestic banking system liquidity remained ample. The extension of the Statutory Reserve Requirement (SRR) microenterprises and affected SMEs, additional allocation to existing facilities under BNM’s Fund for SMEs to provide relief for and support the recovery of SMEs in the services sector and allowing SMEs to utilize part of these financing proceeds to repay existing business loans. flexibility provided sustained liquidity support.³ BNM also conducted liquidity injection operations through various instruments including reverse repos, outright purchase of Government securities and foreign exchange swaps to ensure orderly market conditions during intermittent periods of heightened volatility.

Monetary policy decisions will continue to be data-driven and guided by the evolving balance of risks surrounding the outlook for domestic growth and inflation. On March 3, 2022, the Monetary Policy Committee (MPC) of BNM decided to maintain the OPR at 1.75 percent, which they deem as accommodative and appropriate. Considerations for continued monetary policy support would also be balanced against risks of a potential buildup in financial imbalances. Any potential adjustments to the degree of monetary accommodation would be made in a measured and gradual manner, while being mindful of avoiding a premature withdrawal of policy support that could risk jeopardizing the economic recovery.

The flexibility of the exchange rate continues to be the first line of defense, serving as a shock absorber for the economy. BNM’s foreign exchange intervention (FXI) activities remain solely targeted at managing excessive exchange rate volatility and maintaining orderly domestic foreign exchange (FX) market conditions. This is in line with staff’s assessment that Malaysia’s de-facto exchange rate arrangement remains classified as floating.

In addition, initiatives to liberalize Malaysia’s foreign exchange policy (FEP) and deepen the domestic FX market have been ongoing. Despite differences in views over the Fund’s CFM taxonomy, staff noted that many FEP liberalization measures undertaken by the authorities within the past year were considered an easing in CFMs. The authorities view that remaining FX market and prudential measures continue to be crucial for financial stability as well as the development of the domestic FX market, and therefore disagree with staff’s recommendation to gradually phase out these measures at this stage. They also caution that any exit strategy would need to be undertaken carefully, giving due regard to the prevailing risks and potential impact on the domestic FX market. On the publication of FXI data, our authorities continue to consider the various trade-offs including concerns over the confidential and market sensitive nature of the data, which could lead to speculative activities and hinder the effectiveness of FXI operations.

Malaysia’s current account (CA) surplus is generally seen as a sign of strength for the economy, especially in a highly uncertain environment. Therefore, it is important that the EBA findings are interpreted with the domestic context in mind and to remain focused on the explanations and nuances behind the drivers of the CA balance rather than just rely on the results of the model. We, and our authorities, continue to see limitations in the EBA model, given the weak explanatory power of the model in the context of Malaysia, even with the inclusion of adjustors. On external debt sustainability, our authorities view that the current level of external debt remains manageable in the presence of mitigating factors, as highlighted in the staff report.

Financial sector

Domestic financial stability remains firmly supported by a resilient financial sector, which continues to maintain sufficient financial buffers. Banks continued to prudently set aside buffers for potential credit losses in anticipation of a deterioration in asset quality as repayment assistance programs are gradually unwound. While the credit risk outlook remains challenging due to ongoing pandemic-related uncertainties, any risks of a material increase in impairments remain manageable. In addition, results from BNM’s latest macro stress test affirm that banks can continue to withstand potential losses from severe macroeconomic and financial shocks, while sustaining support for economic recovery.

Risks from the household sector are assessed to be contained. Household debt-to-GDP ratio, while elevated, has declined slightly to 89.0 percent as at end-2021. Our authorities disagree with staff’s use of the term ‘household debt overhang’ to characterize household debt, which implies that high indebtedness has resulted in the household sector being unable to take on more debt. There is limited evidence that households are currently experiencing a debt overhang. Households across all income groups continue to experience steady flow of credit, with household debt growing at 4.1 percent in 2021. Bank lending continues to be underpinned by sound and prudent underwriting standards and loan affordability assessments. Household borrowers, on aggregate, have also maintained ample financial buffers at least twice the size of their debt. The improving economic outlook and employment prospects are expected to support overall household resilience. Nevertheless, borrowers who are highly leveraged and have low financial buffers, particularly from the lower-income group, warrant closer attention. Importantly for these groups, assistance remains available for individuals still experiencing financial distress. These include efforts by banks and the Credit Counselling and Debt Management Agency (AKPK) to offer personalized and holistic support such as the Financial Management and Resilience Programme (URUS) for the bottom 50 percent of the household income distribution. Banks also stand ready and are committed to offer tailored repayment assistance packages to distressed borrowers.

Our authorities agree with staff for continued targeted support to businesses, especially for the more vulnerable SMEs. While non-financial corporates have generally experienced improved financial performance and the share of firms-at-risk has declined, SMEs are more vulnerable given their smaller cash buffers and thinner profit margins. It should be noted, however, that new rescheduling and restructuring (R&R) applications by SMEs have decelerated from its peak in July 2021, indicating greater confidence among SMEs of their ability to service debt. Leading indicators by banks also reflect a recovery, as loans with increased credit risk grew at a slower pace. BNM has recently announced additional funds for SMEs, comprising additional allocations to the existing Fund for SMEs (e.g., Targeted Relief and Recovery Facility, TRRF) and the creation of two new funds to support SME business recapitalization and transition of SMEs towards more sustainable and low carbon practices. The TRRF was further enhanced to allow SMEs to utilize up to 30 percent of the financing approved to repay existing business financing. Existing credit guarantee schemes and on-going R&R by banks will also support business recovery and mitigate risks of a significant rise in impairments.

Structural and governance reforms

Our authorities are firmly committed to structural and institutional reforms as being the key focus of policies to enhance economic dynamism, mitigate the impact of scarring from the pandemic, and secure sustainable and inclusive growth in the medium- to long-term. Several transformational agendas would anchor Malaysia’s initiatives to, among others, reinvigorate economic growth, narrow existing socioeconomic disparities, strengthen social safety nets, accelerate the adoption of technology and innovation and transition towards a greener, more climate-resilient economy.

Progress continues to be made on 12MP priorities. The Government’s Budget 2022 is aligned to the 12MP framework, with significant allocations contributing towards, for example, raising the quality of education, strengthening the labor market support system, expanding social protection, and moving towards a more sustainable economy. The adoption of National Investment Aspirations (NIA) into national strategies and the ongoing policy reforms under the New Investment Policy would accelerate the realization of quality investments in the future. The Malaysia Digital Economic Blueprint (MyDIGITAL) was launched last year to catalyze the new growth areas under Malaysia’s digital economy and enable greater digital inclusiveness across the nation. BNM had also recently published the Financial Sector Blueprint 2022–2026 (FSB), charting the agenda for the financial sector, of which key thrusts include elevating the well-being of households and businesses, advancing digitalization of the financial sector, and positioning the financial system to facilitate an orderly transition to a greener economy.

On advancing green and climate initiatives, the 12MP has reaffirmed Malaysia’s aspiration to achieve net zero carbon emissions by 2050, supported by strong public- private sector collaboration. The Ministry of Environment and Water Malaysia is currently developing the Long-Term Low Emission Development Strategy which is targeted to be finalized by end-2022. Currently, Malaysia has updated the Nationally Determined Contribution (NDC) to reduce carbon emissions by 45 percent compared to 35 percent, by driving the NDC roadmap implementation until 2030, in alignment with the commitments made under the Paris Agreement. The Government is also undertaking a feasibility study of introducing a carbon tax. Regarding the financial sector, BNM plans to integrate climate-related and environmental risks in prudential regulation and supervision, including stress-testing requirements. BNM also issued the Climate Change and Principles-based Taxonomy in April 2021, which aims to facilitate consistent assessments of economic activities and their associated impacts on the climate and broader environment. Climate-related risk disclosures will also be made mandatory for all banks.

Efforts to strengthen governance and the AML/CFT framework remain a key priority for our authorities and will be accelerated. Eight out of the 82 initiatives outlined in the mid- term review of the NACP 2019–2023 have been successfully implemented. Another 14 initiatives are expected to be implemented by mid-2022, with the commitment to implement more NACP initiatives throughout the year. Our authorities remain committed to drive a robust national AML/CFT regime and have set out medium-term priorities for preserving the integrity of the financial system in the FSB, which will continue to build on the established collaboration mechanisms, while targeting mitigation of the ML/TF risks identified in the recently concluded National Risk Assessment 2020.

Final Remarks

The Malaysian authorities remain committed to sound macroeconomic management and continued structural reforms, which has served the economy well and is reflected by the good performance track record of the Malaysian economy, and its continued resilience towards adverse shocks. Going forward, our authorities look forward to continued engagement and strong collaboration with the Fund, including through ongoing and future technical assistance programs.