Malaysia: 2024 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Malaysia
Author:
International Monetary Fund. Asia and Pacific Dept
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Publication Date:
10 Mar 2024
eISBN:
9798400269837
Language:
English
Keywords:
short-term debt; growth momentum; headline inflation; ta performance; price discovery; Wages; Labor markets; Global
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1. Malaysia’s growth momentum is slowing, albeit from a high base in 2022. Against external headwinds, robust domestic demand continues to drive growth. Malaysia’s strong macroeconomic policy frameworks, including a track record of fiscal prudence and a credible monetary policy framework have become more important as the country undergoes important structural reforms. A history of costly and untargeted spending on subsidies is coming to an end. The passing of the Fiscal Responsibility Act marks a crucial fiscal and governance milestone. A long list of fiscal and structural reforms remains in the pipeline.

Abstract

1. Malaysia’s growth momentum is slowing, albeit from a high base in 2022. Against external headwinds, robust domestic demand continues to drive growth. Malaysia’s strong macroeconomic policy frameworks, including a track record of fiscal prudence and a credible monetary policy framework have become more important as the country undergoes important structural reforms. A history of costly and untargeted spending on subsidies is coming to an end. The passing of the Fiscal Responsibility Act marks a crucial fiscal and governance milestone. A long list of fiscal and structural reforms remains in the pipeline.

Context: Time for Reforms Amid Domestic and Global Fragilities

1. Malaysia’s growth momentum is slowing, albeit from a high base in 2022. Against external headwinds, robust domestic demand continues to drive growth. Malaysia’s strong macroeconomic policy frameworks, including a track record of fiscal prudence and a credible monetary policy framework have become more important as the country undergoes important structural reforms. A history of costly and untargeted spending on subsidies is coming to an end. The passing of the Fiscal Responsibility Act marks a crucial fiscal and governance milestone. A long list of fiscal and structural reforms remains in the pipeline.

2. Going forward, amid the need for an overall tight macro policy stance and narrow policy space, growth will have to be supported by key productivity-enhancing structural reforms. Positive projected output gaps, and upside inflation risks from planned subsidy reform, as well as elevated debt burdens and limited fiscal buffers, call for macro policies to maintain an overall tight stance. Malaysia’s path to high-income status will critically depend on the government’s ability to appropriately sequence and implement growth-enhancing structural reforms set out in its ambitious policy frameworks. This challenging task is more needed, given risks from geoeconomic fragmentation and from the growth slowdown in China, Malaysia’s largest trading partner.

3. The need for implementing structural reforms comes at a time of heightened global risks, internal political fragilities and rising calls for addressing pressing social issues. Chief among them is increasing perennially low wages and ensuring a sustainable pension system for an ageing population after a few years of allowed pandemic-era withdrawals that have depleted retirement savings for many. Achieving tangible progress on the government’s MADANI Economy Framework (MEF) and on the national strategic plans that followed (Appendix I), will both require and help domestic consensus.

Recent Developments: A Slowing, Yet Still Resilient, Recovery

4. Malaysia’s economy is slowing. Advance estimates suggest that growth in 2023Q4 moderated to 3.4 percent (2022: 8.7 percent), driven mainly by the services sector which was supported by the post-pandemic recovery in tourism. On the demand side, private consumption remained the main driver of growth, supported by a healthy labor market. Exports weakened markedly due to the economic slowdown in major trading partners, including China, and weak external demand (most notably for electrical and electronic (E&E) products). Credit growth has been strong at 4.7 percent in November 2023, driven by household demand and supported by the labor market recovery. The unemployment rate dropped to its pre-pandemic level of 3.3 percent in November 2023.

5. Disinflation is taking hold. After peaking at 4.7 percent in August 2022, headline inflation significantly moderated to 1.5 percent in December 2023, generally reflecting easing of energy and food prices, and core inflation moderated to 1.9 percent, falling from its 4.2 percent peak last November. For the whole year, average headline and core inflation stood at 2.5 (2022: 3.4 percent) and 3 percent (2022: 3 percent), respectively. The inflation broadness index, which measures the percentage of items in the consumer price index (CPI) basket rising more than a certain threshold, has declined continuously in the past year, and inflation expectations remain well anchored.

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Malaysia: Contribution to Growth of Goods Exports

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

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Malaysia: Macroeconomic Developments in ASEAN-5

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

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Malaysia: Inflation Developments in ASEAN-5

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

6. Malaysia faced external pressures through most of 2023. The weakening of the ringgit was broad-based during most of 2023. Negative interest rate differential between the overnight policy rate (OPR) and the US federal funds rate reached a historical low in recent months (of about -240 bps) and was one of the main drivers of the ringgit depreciation. Meanwhile, ringgit weakness was also highly correlated with renminbi moves over the period. External pressures have also manifested through capital outflows, primarily in the form of portfolio flows due to redemption of matured foreign currency debt and portfolio investment abroad by residents. Gross international reserves (GIR) declined from US$114.7 billion at end-2022 to US$113.5 billion at end-2023, causing the reserve coverage to decline from 113 to 110 percent of the ARA metric. As of mid-January 2024, however, reserves have increased to US$115.1 billion, surpassing their level at end-2022. Net international reserves (NIR), which had declined significantly in 2022 (US$71 billion at end-2022 relative to US$105 billion at end-2021), remained broadly stable in 2023 (US$70 billion at end-November 2023). The gap between GIR and NIR is primarily due to the use of FX swaps by BNM (about 21 percent of GIR at end-November 2023) to manage ringgit liquidity needs in the money market.

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Malaysia: Recent Exchange Rate Market Developments

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

7. The 2024 Budget charts a continued near-term consolidation path. The 2023 Budget deficit target of 5 percent of GDP is expected to be met, down from 5.5 percent in 2022. Stronger than expected revenue collection throughout 2023, notably from tax revenues, was counterbalanced by equally higher than budgeted expenditures to finance spending on subsidies and on initiatives under the MADANI economic framework. Amid a projected positive output gap, the 2024 Budget envisages continued consolidation toward a 4.3 percent deficit in 2024, driven by lower spending on subsidies given the subsidy reform in motion and on development expenditure as well as limited new tax measures.1 Revenues are instead projected to decline in percent of GDP driven by a fall in petroleum-related non-tax revenues and limited revenue-generation power from the new tax measures of about 0.3 percentage points of GDP (text table).2 The significant expected decline in subsidies and in petroleum revenues despite a higher oil price assumption of $85 per barrel (vs. $80 in 2023) reflects a combination of conservative revenue assumptions, and of a subsidy reform in motion. While plans to re-introduce the goods and services tax (GST) were absent from the 2024 Budget, the path to the medium-term deficit target incorporates additional revenue mobilization efforts and savings from subsidy re-targeting (1.1 and 0.5 percentage points of GDP, respectively).

Malaysia: Components of Consolidation

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Malaysia: Tax Measures in the 2024 Budget

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8. Monetary policy has remained on pause since May 2023 after a gradual normalization. The BNM increased the overnight policy rate (OPR) five times since May 2022 by a total of 125 bps to 3.0 percent (the prevailing OPR level pre-pandemic). BNM’s January 2024 statement highlighted that the decision to maintain the OPR at 3.0 percent was consistent with the continued easing of headline and core inflation amid moderating cost pressures and stabilizing demand conditions.

9. Financial conditions remain broadly accommodative. Financial conditions eased for most of 2023, as domestic inflation moderated, and investors curbed expectations of further BNM hikes in the second half of the year. The spread between OPR and 3-month Kuala Lumpur Interbank Offered Rate (Klibor) rose to just below 100 basis points in January 2023 as banks adjusted to no longer being allowed to recognize government securities as part of Statutory Reserve Requirement (SRR) amid monetary policy tightening and increased demand for ringgit loans.3 While signs of deposit competition have diminished, the spreads remained above levels observed in previous hiking cycles.

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Malaysia: Policy an Money Mar et Rates

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Sources loomberg NM and IM staff calculations
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Malaysia: Baning System Liquidity Place with BNM

(MYR bn)

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Sources BNM CEIC and IM staff calculationsNotes Excess Liquidity is calculated by banks net claims on NM less the required reserves Required Reserves are statutory reserves banks need to hold in their Statutory Reserve Accounts equivalent to a certain proportion of their eligible liabilities, based on the Statutory Reserve Requirement rate
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Malaysia: Bank Credit to Private Sector

(in y-o-y percent change)

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Note; The growth rates have been adjusted by staff to account for the re-classification of a non-bank to bank in April 2018.Sources: IMF, Integrated Monetary Database, and IMF staff calculations.
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Malaysia: Daily Financial Conditions Index

(Standard deviations)

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Sources: Bloomberg LP and IMF staff calculations.

10. The financial system continues to record healthy capital and liquidity positions. The banking sector total capital ratio stood at 18.1 percent, with common equity Tier 1 capital ratio at 14.5 percent, well above minimum requirements in November 2023. Banks rely on well-diversified deposit base, and the liquidity coverage ratio and net stable funding ratio stood healthy at 149.7 percent in November 2023 and 116.1 percent respectively as of September 2023, supported by high-quality liquid assets. Asset quality continued to hold up, with nonperforming loans (NPL) at 1.7 percent of total loans as of September 2023. The recovery of the banking system profitability continued albeit at a more moderate pace amid higher funding costs, supported by lending activities. The housing market continued to improve, supported by the home ownership initiative and better income and labor market conditions.

11. Malaysia’s external position in 2023 is preliminarily assessed to be stronger than warranted by fundamentals and desired policies (Appendix IV). The current account surplus is estimated to decline to 2.4 percent of GDP in 2023 from 3.1 percent of GDP in 2022, driven by muted demand for E&E products amid a global technology downcycle, and lower oil and gas exports. Adjusting for cyclical factors, Malaysia’s current account gap is assessed in the range of 2.7– 3.7 percent of GDP, which implies a REER undervaluation in the range of 5.4–7.4 percent.4 Weak social safety nets, proxied by low public healthcare expenditure, and relatively looser fiscal policy adopted by the rest of the world, contributed to Malaysia’s excess current account surplus.

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Malaysia: Current Account Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

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

12. Economic policies have been broadly consistent with past Fund advice. The authorities are anchoring fiscal policy on their medium-term consolidation objective. Monetary policy has been data dependent and in line with past advice. The authorities continue to indicate their commitment to exchange rate flexibility as the first line of defense against external shocks.

Outlook: Resilient Growth AMID Upside Risks to Inflation

13. Resilient domestically driven growth and upside risks to inflation define the near-term outlook. Growth is estimated at about 4 percent in 2023, significantly lower than in 2022 (8.7 percent), and is projected to slightly accelerate to 4.3 percent in 2024, supported by resilient private consumption and investment, a recovery in the external demand for E&E products, and a rebound in public spending. The output gap is projected to remain positive in 2023 and 2024. Inflation is projected to pick up to 2.9 percent in 2024, up from 2.5 percent in 2023, pending uncertainty around subsidy reform.

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Malaysia: Contributions to Real GDP Growth

(in percent)

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Source: Haver Analytics, IMF staff calculations.

14. The balance of risks is tilted to the downside. (Appendix V):

  • External risks: include the possibility of an abrupt global slowdown or recession, including in China Malaysia’s largest trading partner), with an associated spike in global risk premia, capital outflows and sudden stop risks. Monetary policy miscalibration could lead to a new cycle of aggressive tightening of monetary policy by major central banks leading to rapidly tightening financial conditions with implications for domestic balance sheets. As a commodity exporter, Malaysia is also vulnerable to commodity price shocks and associated volatility. China’s weaker medium-term growth poses a major risk for Malaysia.

  • Domestic risks. Domestically, fiscal risks from contingent liabilities could materialize and could necessitate additional measures to ensure medium-term fiscal sustainability. Any potential renewed political uncertainty could disrupt the government’s reform momentum.

Authorities’ Views

15. The authorities broadly agreed with staff assessment of the outlook. Resilient domestic demand in 2023 was underpinned by a supportive labor market with labor shortages easing across sectors and the labor force participation rate at all-time highs. The authorities expect the economy to grow at about 4 percent in 2023 and, between 4 and 5 percent in 2024, supported by sustained private consumption and a rise in private investment due to policy initiatives, accompanied by a recovery in electrical and electronic product exports and tourism. The authorities expect inflation to be in the range 2.1–3.6 percent in 2024 with upside risks associated with the ongoing retargeting of subsidies. They envisage the current account surplus to moderate in 2023 and reiterated their concerns over the large unexplained residual (about three-fourth of the CA gap) in the EBA. Nonetheless, they concurred with the need for structural reforms to enhance external rebalancing. While they recognize risks from geoeconomic fragmentation and China’s medium-term growth slowdown, they see trade diversification across product markets and countries as well as tourism diversification as mitigating factors.

Policies to Rebuild Buffers and Manage Risks While Supporting Medium-Term Growth

A. Fiscal Policy: Time to Mobilize Revenues and Rebuild Buffers

16. A gradual and credible medium-term fiscal consolidation is warranted to put debt on a firm downward path. Limited fiscal buffers, positive output gaps projected in the next few years, large contingent liabilities, amid moderate risk of debt distress (Appendix II), support the need for Malaysia to leverage the recovery to rebuild a significant buffer against the debt limit.5 The 2024 Budget consolidation trajectory until 2026 is consistent with the staff recommended deficit path. Achieving the latter however requires identifying high-quality and durable revenue measures to generate the needed revenue streams and buttress market confidence on Malaysia’s fiscal policy credibility.

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Malaysia: Fiscal Policy: Baseline and Proposed Staff Advice1

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

1 See appendix VII in the 2022 Article IV CR 22/126 on the optimal fiscal stance model.

17. Malaysia can potentially collect 15 percent of GDP in tax revenues based on its economic and institutional characteristics (Appendix VI). Notwithstanding progress on decreasing reliance on petroleum-related revenues over the last decade, tax revenue collection weakened to less than 12 percent of GDP in 2022, down from over 15 percent a decade ago. This has made Malaysia’s ta performance more comparable to low-income than emerging market peers. Based on a tax frontier analysis, staff estimate that Malaysia can collect an additional 3 percent of GDP over current levels in the short to medium term. While this estimated tax potential is not necessarily the optimal level of taxation, it provides a credible medium-term target that the authorities can work toward, within a medium-term revenue strategy (MTRS).

18. Malaysia can achieve its tax potential by reintroducing the GST while ensuring that any regressivity is addressed through spending. Malaysia ranked well on the C-efficiency score of the GST when the latter was in place during 2015–17.6 The score is an indicator of the departure of GST from a perfectly enforced tax levied at a uniform rate on all consumption. Malaysia’s policy and compliance gap towards a perfect score could be potentially addressed through continued focus on improving revenue administration as well as on reducing leakages and tax expenditures. While regressivity of the GST may be a concern, it is not conclusively so. Fundamentally, rather than any one tax, it is the tax and public spending system that affects and matters for equity. Furthermore, revenues collected from the GST can help finance pro-poor spending, which more than offsets any regressive effect of the tax itself.

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Malaysia: Revenues From Petroleum-related and Taxes

(in percent of GDP)

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Sources: Country authorities and IMF staff calculations.
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Malaysia: Tax Revenues: VAT vs. Non-VAT

(in percent of GDP)

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Sources: IMF World Revenue Longitudinal Data (WoRLD and IMF staff calculations.

19. The discussion of the long-awaited subsidy reform in the 2024 budget should be accompanied by necessary further details on timing and magnitudes, including over the multi-year horizon. Staff welcome the focus on gradualism and channeling of savings from subsidy reform towards higher cash assistance and development spending. The ongoing re-targeting of electricity subsidies by consumption, which started in 2023, is shifting them away from the top 10 percent of electricity consumers. A phased retargeting of industrial diesel subsidies towards public transportation and goods transportation/logistics sectors will start in Q1 2024, building on an existing system of fleet cards allowing targeted sectors to access diesel at subsidized prices. No details on RON95 pumping gas subsidies, the largest component of the subsidy bill, were announced, but the wide inflation forecast range in 2024 of 2.1–3.6 percent suggests that RON95 price liberalization may still be in the pipeline. The mechanism, as well as coverage, for compensating lower-income households have not been finalized. A key first step was the launching on January 1, 2024, of Padu, a socioeconomic central database, that will be used for appropriately targeting transfers.7

20. The historic passing of the Public Finance and Fiscal Responsibility Act (FRA) in October 2023 is a welcome step. The new law will enhance governance and accountability, requiring more transparency in financial reporting including the publishing of a mid-year expenditure performance report, a comprehensive fiscal risk statement, and a tax expenditure statement. The Act requires the minister of finance to formulate a Medium-Term Fiscal Framework, supported by a medium-term revenue strategy and a public expenditure policy, to guide fiscal planning and priorities over a three-to-five-year period, and sets several numerical targets to be achieved within that period. In the event of sudden shocks, the bill allows temporary deviation from the fiscal objectives, provided the Cabinet approves the minister’s assessment of the impact of the shock on economic and fiscal positions, and in turn the proposed fiscal adjustment plan prepared in response to the shock (to be then presented to parliament). In addition to the numerical limit on guarantees, it also appropriately includes provisions to ensure a rigorous process for granting and monitoring of guarantees, with the aim of decreasing the government’s exposure and provide mitigation plans if such guarantees are called.

Malaysia: Fiscal Objectives Under the FRA

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Authorities’ Views

21. The authorities are undergoing important fiscal reforms that are expected to underpin their fiscal consolidation path. They see the recently passed Fiscal Responsibility Act as an anchor for other fiscal reforms. They are proceeding with gradual subsidy retargeting, across both energy products and time, which they see as complementary to their planned reduction of dependence on petroleum-related revenues. Operational modalities and coverage for compensating lower-income households for fuel price liberalization will be rolled out in 2024. They agreed that the revenue measures of the 2024 Budget are expected to generate modest yields, and that achieving the medium-term fiscal deficit target would necessitate major steps such as revamping the current sales and services tax or reintroducing a carefully designed and improved consumption tax. The work on a medium-term revenue strategy (MTRS) continues; the strategy paper is planned for approval by the Fiscal Policy Committee by August 2024 with some elements to feature in the 2025 Budget. They are thankful to past Fund capacity development (CD) support and expressed interest in further CD on their MTRS, and on developing a tax expenditure assessment, one of the requirements under the FRA.

B. Monetary and Exchange Rate Policies: Tightening Bias Amid Upside Risks to Inflation

22. The broadly neutral monetary policy stance is appropriate; the BNM should keep a tightening bias in the near term in a data dependent manner. Staff estimates of the neutral real rate suggest that the monetary policy stance is currently broadly neutral. Upside risks to inflation include ongoing yet uncertain subsidy reform, more protracted US dollar strengthening, and potential commodity price spikes amid geopolitical tensions. These risks argue for the BNM to maintain a tightening bias and avoid premature easing of the monetary policy stance. The tightening bias is also warranted by estimated low sacrifice ratio and would ensure that (long-term) expectations remain anchored.8 More broadly, the BNM should continue to clearly communicate the rationale for its policy decisions, given high uncertainty.

23. Exchange rate flexibility and reserve adequacy should be preserved. In the context of Malaysia’s shallow X market, the Integrated Policy Framework (IPF) may warrant the use of FX interventions (FXI) to smooth large changes in hedging and financing premia if they generate risks to macroeconomic and financial stability. FXI is not however a substitute for needed policy adjustment and should not be used to lean against exchange rate pressures that are driven by fundamentals. Opportunistic reserve accumulation would be appropriate during risk-on episodes, given the decline in the GIR coverage and significantly lower NIR. The latter implies an eventual drain on reserves once BNM’s short FX forward positions are settled. However, as external pressures ease, GIR is expected to be bolstered by the conversion of FX proceeds by exporters. Reserve accumulation, however, should not interfere with the needed real exchange rate appreciation over the medium term, given that Malaysia’s 2023 external position is preliminarily assessed to be stronger than implied by fundamentals and desirable policies. A steady increase in daily FX turnover, averaging about US$15.5 billion in 2023, relative to US$12.1 billion over the preceding 5 years, is encouraging and indicative of the ongoing and welcome steps taken by the BNM to liberalize and deepen the FX market and, among other things, to enhance price discovery. In this context, existing CFMs should be gradually phased out with due regard to market conditions. Publication of FXI data (with an appropriate lag to guard against market sensitivities) could enhance communication and strengthen the commitment to the monetary policy framework.

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Malaysia: UIP Deviations

(LHS: in basis points; RHS: MYR/USD)

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Authorities’ Views

24. BNM stressed its commitment to maintaining price stability. They concurred with staff assessment that the current monetary policy stance is broadly neutral and appropriate, and noted that going forward monetary policy calibration will continue to be data dependent and deliberative. They are cognizant of the potential upside risks related to the subsidy reform, but at the same time, they are confident in their ability to respond to any associated second-round effects building on their track record. Such risks would be largely dependent on the coverage and impact of cash transfers on domestic demand as well as changes in firms’ price setting behavior

25. The authorities noted that a flexible exchange rate continues to play the role of a shock absorber an Malaysia’s strong economic fundamentals would help mitigate external risks. They highlighted that the external environment, particularly the high interest rates in most major economies, particularly the US, was the main driver of the ringgit’s performance this year as also experienced by many other regional currencies. Meanwhile, they noted that the often-cited high correlation of the ringgit with the renminbi could be explained not just by trade and tourism linkages, but also by market sentiment during risk-off episodes. They mentioned that FX interventions by BNM, which are done in a two-sided manner, were aimed towards smoothing excessive volatility of the ringgit and to facilitate price discovery. The authorities also noted that the depreciation of the ringgit was not reflective of Malaysia’s economic fundamentals, as growth remained robust in 2023 and, going forward, a diversified external sector, both in terms of products and trading partners, should moderate the co-movement of the ringgit with the renminbi. They highlighted that some of the measures that staff classify as capital flow management (CFMs) measures are not meant to restrict capital flows but are used as part of the financial stability toolkit as well as prudential measures. These measures have helped to strengthen onshore intermediation and remain critical for the development and resilience of the domestic FX market, consistent with the BNM mandate.

26. The authorities view further increasing their FX reserve coverage as a priority and risks stemming from future short-term drains on reserves to be manageable. They noted that while NM’s X reserves had declined in the face of external pressures throughout most of 2023, there was a sizeable increase in the last two months of the year, which improved the overall reserve coverage NM’s net short forward positions, which increased in , are a result of X swaps that BNM used largely to manage the level of domestic ringgit liquidity through sterilization of intervention. The need for intervention, in part, stems from reduced liquidity from exporters who, following the relaxation of export conversion requirements in 2021, decided to temporarily defer the conversion of their FX proceeds in the face of depreciation pressures. Relatedly, the increase in short-term FX deposits at BNM is also partly linked to increased FX holdings by corporates and exporters. Once external pressures subside, BNM is confident that the short forward positions can be unwound without significantly impacting gross international reserves, supported by the fact that the counterparties in these swap contracts are domestic entities.

C. Financial Sector Policies: Enhancing Resilience Amid Rapidly Evolving New Risks and Changing Landscape

27. The financial system appears resilient, with systemic financial risks contained, but close monitoring of banking profitability amid rising funding costs is warranted. Banks continue to hold strong capital and liquidity buffers, against increased exposure to higher interest rate risks owing to large government bond holdings. This is coupled with some compression in net interest margin as funding cost increased due to intensification of deposit competition, arguing for a careful monitoring of related financial stability risks. Undertaking integrated solvency-liquidity stress test would be desirable given the exposure of banks to higher interest rate risks. The BNM should maintain strong supervision of lending standards and continue to enhance monitoring of risks buildup, including due to higher interest rates amid weakening of growth momentum. The BNM should also continue to maintain strong surveillance of non-bank financial institutions--NBFIs (insurance and takaful operators).

28. Pre-emptive development of additional macroprudential tools as well as close monitoring of household balance sheets is warranted given existing pockets of vulnerabilities amid higher interest rates. Household debt is now slightly below pre-pandemic levels at 81.9 percent of GDP as of 2023Q2. While overall household balance sheets remain resilient with financial assets about 2 times larger than household debt in June 2023, as retirement savings bounced back strongly, pockets of vulnerabilities remain in some segments of vulnerable household borrowers. Staff recommend further pre-emptive broadening of macroprudential policy toolkit, to ensure that the variety of tools9 (including the introduction of sector-wide loan-to-value (LTVs) on first and second properties) are ready to be deployed to address any risk build-up, including potential risks arising from the sizeable share of floating rate loans, and increased interest rates.

29. Monitoring of emerging weaknesses and pockets of financial vulnerabilities among firms should continue. Interest coverage and liquidity ratios for the corporate sector were healthy as of 2023Q3. The share of firms-at-risk—the proportion of non-financial corporates with an interest coverage ratio below 2—moderated to 26 percent in 2023Q3 but remains above pre-pandemic levels. Elevated input cost and weak external demand continued to weigh on business profitability for SMEs in construction, agriculture, and manufacturing. Loans-in-arrears have consequently risen across these sectors, but financial vulnerabilities remain confined to a small portion of SMEs. BNM stress test shows however that banks have sufficient capital buffers to absorb large credit losses from the corporate sector. Staff recommend that the BNM continue to enhance its existing corporate surveillance monitoring as global growth weakens, geoeconomic fragmentation intensifies and post-pandemic pent-up demand tapers off. The BNM should also continue to enforce robust monitoring, including timely information gathering to assess credit risk, particularly for SMEs, and full provisioning of expected losses.

30. The authorities have taken important steps to enhance the AML/CFT framework, but additional steps are required to ensure effective implementation. The authorities are encouraged to ensure effective beneficial ownership (BO) transparency implementation by issuing updated guidance for reporting institutions in line with the updated international standards and through strengthening supervisory and monitoring activities. In October 2023, authorities tabled the Companies (Amendment) 2023 Bill for first reading. This amendment, if passed and implemented effectively, can bring greater clarity and transparency to Malaysia’s corporate environment, and support ongoing efforts to enhance tax compliance. The amendment is designed to bring the country in line with the revised international AML/CFT standards on beneficial ownership transparency (FATF Recommendation 24) issued in March 2022. In particular, the amendment codifies the need to maintain BO information in the Register of Beneficial Owners (RBO); expands the definition of a beneficial owner; and requires companies to obtain information on its beneficial owners.

Authorities’ Views

31. The authorities broadly shared staff assessment that systemic financial risks remain contained. They stressed that the financial system remains resilient, with banks continuing to hold strong capital and liquidity buffers Weaker asset quality in banks’ overseas operations was driven mainly by higher interest rates and continued repayment assistance in some of the markets and does not pose any risk to domestic financial stability. BNM continues to monitor small pockets of vulnerabilities including for SM s in a few industries, as well as banks’ funding costs, which tend to rise at the end of the year. Meanwhile, coming from the pandemic, BNM took steps to strengthen operational frameworks for crisis management and preparedness among financial institutions. NM’s analysis shows that although NBFIs hold substantial equity positions in banks, risks to the financial system are limited given large liquid assets. They see cyber security, climate-related, and market risks (higher for longer interest rates) as key risks that warrant close monitoring going forward. BNM also views the current macroprudential measures to be broadly appropriate given sizeable financial buffers, and minimal speculative activity in the real estate sector. Nevertheless, they see the need for pre-emptive broadening of the macroprudential toolkit as warranted.

D. Structural Reforms: Identifying and Closing the Gaps, and Reaping the Payoffs

32. There is room for structural reforms to boost potential growth and wages in Malaysia (Appendix VII). Empirical evidence shows that major governance, external sector, business regulation and domestic credit market reforms can accelerate growth in emerging and developing countries. Further, addressing the initial structural gaps in Malaysia as measured by the degree of informality and the high private debt are likely to amplify gains from structural reforms. While each of these reforms individually can promote growth, gains and synergies could be maximized through proper prioritization, packaging, and sequencing of reforms. Implementing first a package of reforms that includes governance and anti-corruption, external sector reforms to enhance export product space and more economic complexity, labor market and business regulation has the potential to significantly accelerate output growth. This sequencing can also help alleviate short-term tradeoff between promoting growth and reducing emission as the growth acceleration could offset some of the short-term costs associated with climate policies and create fiscal space to engage in the green transition.10

33. Wage levels and growth rates in Malaysia have been structurally low, with changes incommensurate with productivity and a narrowing education premium (Appendix VIII). Malaysia’s labor force has not sufficiently reaped the benefits of industrialization. Low pay incidence (percentage of the workforce earning less than two thirds of the median wage) is estimated at over percent, significantly higher than the C ‘s percent As a result, Malaysia’s labor share of income has remained low. While there is almost no gender pay gap (below that of many advanced economies), the link between wages and productivity has been weak and a large gap exists between the highest and lowest or mid-qualified. This is despite wage growth for the lowest qualified over the last decade (driven by introduction of minimum wage) and amid stagnant wage growth for the high and semi-skilled. Decreasing skilled job creation combined with increasing share of the labor force with tertiary education has resulted in increasing skill-related underemployment, outward skilled migration, and more skilled workers choosing to be self-employed. If left unaddressed, this could lead to lower incentives to pursue higher education. Furthermore, extending tax incentives for women to return to work and expanding childcare services through building new facilities, will help to improve female participation rates.

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Malaysia: Structural Gaps in Malaysia Compared to Global Frontier

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Note: Structural gaps are obtained as deviations from the frontier(the top performer in each macro-structural area In each year), in percent. Note that from IMF climate change indicators dashboard, MYS does not have energy tax revenues until 2018, hence a gap of 100 percent In 2010. Source: Budina et al. (2023).

34. Achieving the MADANI Economy Framework’s medium-term target of 45 percent labor income share will require the right set of policies. Sustained wage growth at all skill levels is needed. While the minimum wage introduction since 2013 has somewhat lifted low-skilled wages, the link between wages and productivity can be strengthened across all skill levels, through a flexible and competitive wage system that establishes a closer link between wages and productivity. In that respect, the planned implementation next year of a voluntary- and incentives-based productivity-linked Progressive Wage Policy is meant to establish that link. Malaysia’s industrial policies, including its New Industrial Master Plan,11 should remain narrowly targeted to specific objectives where market solutions cannot deliver due to the presence of externalities or other market imperfections, consistent with WTO obligations, and should avoid discriminatory measures that distort trade and investment flows.

uA001fig16

Malaysia: Wage Developments

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

35. The pandemic has put the spotlight on the exacerbated retirement income insecurity for a large proportion of Malaysians and while addressing low wages can help improve retirement income security, complementary policies are urgently needed. Notwithstanding good contribution rates, low wages entail low contributions, only 70 percent of which are earmarked for retirement. As of October 2023, only about 19 percent of total Employee Provident Fund (EPF) members aged 18 to 55 years old and 39 percent of active formal sector members in the same age group met the basic savings threshold. Basic savings by age is, a benchmark used by EPF to gauge the adequacy of retirement income, set at RM240,000, which is equivalent to a monthly retirement income of RM1,000 over a 20-year retirement period (which is below minimum wages). EPF initiatives, with government budget support, have successfully focused on incentivizing voluntary contributions, and on encouraging members to voluntarily shift to regular monthly payout rather than lump-sum withdrawals. Additional measures are needed. These include lengthening the savings’ accumulation period by allowing retirement withdrawals only at retirement age (rather than at 55 currently), and by eventually gradually increasing the retirement age. They also include increasing the share of contributions dedicated to retirement/Account I, and in that respect the planned restructuring of EPF accounts announced in the 2024 Budget is welcome. Ensuring universal registration to address low coverage, while improving old-age safety net and providing employment opportunities for the older cohort, would also help ensure retirement and old age security (Appendix VIII).

36. It remains critical to see through governance and anti-corruption reforms and anchor them in legislation. The progress achieved on the implementation of the initiatives under the 2019–2023 National Anti-Corruption Plan (NACP) is welcome, but more needs to be done. Priority should be given to amending the 2010 Whistleblower Protection Act and beefing up the anticorruption legal framework with a view to expanding protection and disclosure avenues, ensuring the operational independence of anti-corruption institutions, and to reforming public procurement. In that respect, the announcement in the 2024 Budget speech of the planned tabling of the Procurement Bill in Parliament this year is welcome.

37. With a sizeable share of Malaysia’s workers exposed to modern AI technologies, proactive labor policies are needed to leverage AI benefits while mitigating its risks (Appendix IX). The rapid progress in AI technologies is poised to transform economies, influencing the nature of work and the labor market. These technologies can enhance labor productivity but also pose risks of job displacement. To navigate this change, it is essential to identify which occupations are most exposed to AI. Following an approach developed in Felten et al. (2021), staff analysis finds that in Malaysia, around 39 percent of occupations are highly exposed to AI, with professionals facing the highest exposure while elementary occupations facing the least, although there is considerable variation within each occupational category. Proactive policy measures, including training, upskilling, and public awareness programs, particularly in sectors most exposed to AI, are required to leverage AI’s benefits while mitigating its risks.

Authorities’ Views

38. The authorities view their multifaceted structural policy agenda as pivotal to raising wages and ensuring retirement income security, and in turn achieving their aspiration of high-income status. They have finalized a strategy paper for the implementation of a voluntary and incentives-based productivity-linked Progressive Wage Policy (PWP), aimed at lifting median wages and targeting SMEs. With budget support providing incentives for employers to join in inception years, those participating in the PWP are expected to provide training that would increase employees’ productivity and in turn their wages A pilot project is planned for Q , and its performance will be reviewed before a comprehensive implementation plan for the PWP is finalized. The government has taken a firm stance on not allowing further pandemic-era withdrawals from EPF accounts, and the EPF is very cognizant of the long-stranding retirement insecurity which such withdrawals exacerbated. It is working on several complementary policy reform initiatives aimed at improving coverage, raising retirement savings, and ensuring their adequacy. The authorities are hopeful that their renewed focus on industrial policies through their New Industrial Master Plan (NIMP) 2030, amid a challenging geopolitical environment, will give Malaysia a second take-off, leveraging on its strategic location and strong human capital. They noted that a major objective of NIMP 2030 is to increase economic complexity, and position Malaysia as a market leader in generative AI.

39. The authorities highlighted their progress on governance reforms. A new national strategy known as National Anti-Corruption Strategies (NACS) is in the making and is expected to be released in June 2024, as a continuation of the existing National Anti-Corruption Plan (NACP). Notwithstanding slow progress due to frequent government changes in recent years, work is ongoing on amending the Whistle Blower Protection Act. The authorities also noted that the insertion of corporate liability provision under the Malaysia Anti-Corruption Commission (MACC) Act which came into effect in June 2020 serves as a safeguard against transnational aspects of corruption and vulnerabilities related to bribery of public officials by multinational companies. They see the planned enactment of the Government Procurement Act in 2024 as timely to ensure efficiency and transparency, and thus maximize the return on public investment.

Staff Appraisal

40. Malaysia’s growth has slowed. And disinflation is taking hold. Malaysia’s 023 external position is preliminarily assessed to be stronger than warranted by fundamentals and desired policies.

41. Downside risks, mostly external, cloud the near-term outlook. External risks include the possibility of an abrupt global slowdown with an associated spike in global risk premia, capital outflows and sudden stops. Geoeconomic fragmentation, specifically fragmentation of commodity markets, could amplify commodity price volatility and negatively affect Malaysia’s growth prospects

42. The fiscal consolidation strategy set out in the 2024 Budget is appropriate, but it should be credibly underpinned by high-quality and durable measures. Staff welcome the historic passing of the Fiscal Responsibility Act, a major reform expected to enhance governance and transparency and improve accountability and fiscal responsibility. More clarity on the timeline of fuel price liberalization as well as on the details of the mechanism for targeted transfers to lower-income households are still needed. Domestic revenue mobilization remains an urgent priority to create space for the ambitious development spending needs under the multiple national strategy plans, and reinstating the GST can help Malaysia reach its tax potential.

43. Monetary policy should maintain a tightening bias to manage upside risks to inflation. This will ensure inflation expectations remain well anchored while also preserving space for monetary policy to respond to downside risks. Premature interest rate cuts should be avoided. Exchange rate flexibility and reserve adequacy should be preserved.

44. The authorities’ commitment to safeguarding financial stability is welcome. Policies should seek to enhance monitoring of risks build-up due to high interest rates, and weakening of growth momentum, with particular attention to highly leveraged entities and smaller firms. The BNM should continue to update its stress test design to better capture emerging and rapidly evolving global risks.

45. Forging ahead with the implementation of the ambitious structural reform agenda is needed to support growth. The government faces the challenging task of implementing its well-crafted and concerted policy frameworks, which are appropriately focused on improving labor market outcomes and increasing incomes, addressing climate change, promoting digitalization, enhancing governance and reducing corruption vulnerabilities. Missing from the policy agenda is a clear action plan to ensure a sustainable pension system for an ageing population.

46. It is recommended that the Article IV consultation with Malaysia be held on the standard 12-months cycle.

Figure 1.
Figure 1.

Malaysia: Growth and Exports

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 2.
Figure 2.

Malaysia: Inflation and Domestic Resource Constraints

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 3.
Figure 3.

Malaysia: Monetary Developments

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 4.
Figure 4.

Malaysia: Capital Flows

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 5.
Figure 5.

Malaysia: Fiscal Policy Developments

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 6.
Figure 6.

Malaysia: Public Sector Fiscal Stance and Prospects

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 7.
Figure 7.

Malaysia: Financial Sector Developments

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 8.
Figure 8.

Malaysia: Financial Soundness Indicators

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 9.
Figure 9.

Malaysia: Household Debt

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Figure 10.
Figure 10.

Malaysia: House Prices

Citation: IMF Staff Country Reports 2024, 073; 10.5089/9798400269837.002.A001

Table 1.

Malaysia: Selected Economic and Financial Indicators, 2019–29

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Sources: Data provided by the authorities; CEIC Data, World Bank; UNESCO, and IMF, integrated Monetary Database, and staff estimates 1/ Data used in this report for staff analyses are as of January 30, 2024, unless otherwise noted. Official full year preliminary actual GDP is scheduled to be released on February 16th, 2024. 2/ Cash basis. 3/ Consolidated public sector includes general government and nonfinancial public enterprises [NFPEs) General government includes federal government, state and local governments, and statutory bodies. 4/ Based on data provided by the authorities, but follows compilation methodology used in IMF’s Integrated Monetary Database. Credit to private sector in 2018 onwards includes data for a newly licensed commercial bank from April 2018. The impact of this bank is excluded in the calculation of credit gap. 5/ IMF staff estimates, U.S. dollar values are estimated using official data published in national currency. 6/ Based on a broader measure of liquidity. Credit gap is estimated on quarterly data from 2000, using one-sided Hodrick-Prescott filter with a large parameter. 7/ Revisions in historical data reflect the change in base year for nominal GDP [from 2010–100 to 2015–100) 8/ The decrease in short-term debt by remaining maturity in 2017 was partly due to the implementation of an improved data compilation system that corrected previous overestimation, 9/ Includes receipts under the primary income account.
Table 2.

Malaysia: Indicators of External Vulnerability, 2019–23

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Sources: Haver Analytics; CEIC Data Co. Ltd.; data provided by the authorities; and IMF, Integrated Monetary Database and staff estimates.

Latest available data or IMF staff estimates.

Gross debt. General government includes the federal government, state and local governments, and the statutory bodies.

Based on data provided by the authorities, but follows compilation methodology used in IMF’s Integrated Monetary Database,

Kuala Lumpur interbank offer rate.

Based on balance of payments.

IMF staff estimates. U.S. dollar values are estimated using official data published in national currency.

Includes offshore borrowing, nonresident holdings of ringgit-denominated securities, nonresident deposits, and other short-term debt.

Includes receipts under the primary income account.

Table 3.

Malaysia: Balance of Payments, 2019–29 1/

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

Information presented in this table is based on staff estimates using official data published in national currency.

Based on IMF staff estimates of short-term external debt by remaining maturity.

Export and import volume growth in 2015–2018 is calculated using official export and import volume indices (2010=100).

Table 4.

Malaysia: Medium-Term Macroeconomic Framework, 2019–29 1/

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

Period ending December 31.

Data used in this report for staff analyses are as of January 30, 2024, unless otherwise noted. Official full year preliminary actual GDP is scheduled to be released on February 16th, 2024.”

IMF staff estimates. U.S. dollar values are estimated using the official data published in national currency.

The decrease in short-term debt by remaining maturity in 2017 was partly due to the implementation of an improved data compilation system that corrected previous overestimation.

Table 5.

Malaysia: Summary of Federal Government Operations and Stock Positions, 2019–29

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Sources: Data provided by the Malaysian authorities; and IMF staff estimates 1/ Cash basis. 2/ The authorities established a dedicated COVlD-19 trust fund where they channeled proceeds from borrowing needed to f nance the additional spending on COVID-19 relief measures All such expenditures are appropriated through the fund 3/ Net acquisition of nonfinandal assets include lending and loan repayment to and from other government related entities. In 2020–2022, it includes COVID-related capital projects. 4/ General government includes federal government, state and local governments, and statutory bodies. Public sector includes general government and nonfinancial public enterprises.
Table 6.

Malaysia: Depository Corporations, 2019–23 1/

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Sources: Data provided by the Malaysian authorities; and IMF, Integrated Monetary Database and staff calculations.

Based on data provided by the authorities, but follows compilation methodology used in IMF’s Integrated Monetary Database.

Actual data as provided by the Malaysian monetary authorities in the Integrated Monetary Database.

Broad money does not equal the sum of net foreign assets and net domestic assets due to non-liquid liabilities, primarily at the other depository corporations.

Table 7.

Malaysia: Banks’ Financial Soundness Indicators, 2018–2023Q3

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Sources: Bank Negara Malaysia; and IMF, Financial Soundness Indicators database.

Loans are classified as nonperforming if payments are overdue for three months or more. Total loans include housing loans sold to Cagamas Berhad. Net nonperforming loans exclude interest-in-suspense and specific provisions. There is a methodology change since 2018 following the implementation of Malaysian Financial Reporting Standards (MFRS) 9.