MALAYSIA Summary A broad-based economic recovery gained momentum in 2002, despite a more challenging external environment. Macroeconomic fundamentals have continued to strengthen. Financial and corporate sector reforms remain on track. Despite the geopolitical uncertainties, the strong economic fundamentals of the Malaysian economy, the significant restoration of macroeconomic stability, and the progress achieved in the restructuring of financial and corporate sectors provide the policy makers with greater policy flexibility to sustain economic recovery in 2003. Going forward, a modest world economic growth, some pick-up in the global electronics industry, firm commodity prices, and further expansion in the intra-regional trade will help sustain economic growth in Malaysia. Global recovery is expected to continue, but at a more moderate pace than projected earlier. Private investment appears to be turning around, although geopolitical uncertainty, excess capacity, and the complex transition from an investment-led to an innovation-led growth model has slowed down the pace of recovery. Malaysia is on its way to achieving Millennium Development Goals. A broad based recovery gained momentum in 2002. Real GDP grew by 4.2% in 2002, up from 0.4% in 2001. From the supply side, growth was supported by the rapid expansion in the services and mining sectors and the favorable expansion in the manufacturing sector. The services sector grew by 4.5% in 2002, supported by the recovery in domestic demand, the expansion in trade related activity and the growth in tourist arrivals. The manufacturing sector turned around with an expansion of 4.1% in 2002 compared to the 6.2% contraction in 2001. Mining sector grew by 4.5% thanks to increased production from new oil and gas fields, the increase in demand and favorable prices. From the demand side, growth was also broad-based helped by the continued expansionary fiscal policy, favorable export performance, and increased private consumption. Increase in public expenditures, largely channeled for development purposes, was supported by the timely expansion in fiscal policy, which remains the main counter-cyclical instrument under the current exchange rate regime. Private consumption was helped by the favorable labor market conditions (unemployment rate fell to 3.5% in 2002), the reduction in income taxes, low interest rates, rise in disposable incomes in the urban areas, rise in rural income as a result of the sharp increase in agricultural commodity prices, and increased access to credit as a result of the improved banking sector. Higher commodities prices brought benefit to about half a million small holder families in the rubber, palm, and cocoa sectors. Exports grew by 6% in 2002, compared to sharp contraction in 2001 (by 1 in 2001 in US$ terms). Export growth has been helped by the increased intraregional trade and the accession of China into WTO. Malaysian exports to ASEAN have steadily increased, from around 2 of its total exports in 1997 to 22.5% in 2001. China share in Malaysia s trade, while small (4.7% of total trade in 2001) has also been rising. Given that China s business cycle is unsynchronized with those of Malaysia s trading partners, closer links with China is likely to play an important stabilizing role for Malaysia s balance of payments. Although competition between Malaysian and Chinese exports in third country markets is likely to intensify, an analysis of US import data shows that since 1998 Malaysia has sustained increasing competitiveness in key segments of electronics exports such as office/data processing machines, relative to the reference economies China, Singapore, South Korea and Taiwan, all of which are Malaysia s close rivals in electronics exports. The terms of trade effect of China s accession into WTO is likely to be positive for Malaysia, given that China s demand for food and energy imports is expected to rise significantly and Malaysia is a new exporter of these products. While Malaysia seems to be coping well against increasing competition, China s entry into the WTO places a premium on the competitiveness of Malaysian firms and Malaysia s attractiveness as a destination for FDI.
Malaysia Brief 2 Food and Live Animals Revealed Comparative Advantage of South-East Asian Economies in China, 2000 1/ Beverage and Tobacc o Crude Materials, Excluding Fuels Animal and Vegetable Oils Basic Manufacture Machines, Transport Equipmen t Misc. Manufac. Goods Mineral Fuels Chemicals Indonesia 1.07 0.07 1.87 4.05 12.85 0.92 1.21 0.07 0.12 Korea 0.32 0.22 0.33 1.10 0.05 1.66 1.54 0.75 0.87 Malaysia 0.34 0.25 1.05 1.20 25.91 0.68 0.63 1.06 0.49 Philippines 3.65 0.00 0.45 1.19 4.99 0.24 0.80 1.37 0.24 Taiwan 0.02 0.01 0.66 0.07 0.03 2.42 0.79 1.05 0.57 Thailand 4.44 0.97 1.73 1.67 0.22 0.88 0.53 0.86 0.37 Source: IMF. 1/ The revealed comparative advantage is defined as the ratio of the market share for a given SITC category to the country s total market share. A value exceeding 1 reveals comparative advantage. External position remains healthy. The overall balance of payments improved thanks to the sustained large surplus in the current account, larger inflows of long term capital and a lower net outflow of short term capital. The surplus in the goods account was more than sufficient to offset the deficit in the services account. Net international reserves with Bank Negara Malaysia increased from $30.8 billion in 2001 to $34.6 billion in 2002, adequate to finance 5.3 months of imports, and equivalent to 4.3 times the short-term external debt. Total external debt increased modestly from US$ 45.7 billion in 2001 to US$ 48.8 billion, equivalent to 55% of GNP in 2002, but remains manageable. Macroeconomic policy continues to be supportive of recovery. Timely fiscal and monetary stimuli have been instrumental in weathering the adverse impact of the global slowdown. The Bank Negara Malaysia intervention rate has remained stable and above international interest rates, helping to stem capital outflows and build foreign reserves. Outstanding loans by the banking sector increased in the fourth quarter of 2002, with loans to small borrowers increasing more rapidly. Lending by financial institutions to purchase residential property has steadily increased over time, rising from 13.4% of total lending in 1998 to 18.5% in 2001, while lending for consumption credit increased from 11.5% to 14.8% during the same period. Another indicator of consumption spending, spending through credit cards, increased by 25.8%, continuing the high rate recorded in 2001 (22.3%). Growth was higher in both the number of credit cards in circulation as well as the value of transactions. This high growth notwithstanding, credit card balances have been settled thanks to higher disposable income. NPLs of credit card transactions, about 0.7% of total NPLs of the banking system, declined to 4.1% of total outstanding loans at end-2002 from a peak of 17.4% at end-1998. Fiscal policy has been the main counter-cyclical instrument of the Government. Fiscal policy played a central role in mitigating global uncertainties in 2002 with the Government s overall financial position registering a deficit of 5.6% in 2002 compared to 5.5% in 2001. The high savings rate (gross national savings was 34 % of GNP in 2002) and ample liquidity in the banking system made it possible for the fiscal deficit to be largely financed domestically. Fiscal policy measures included increased development expenditures for projects with high employment potential, low import content, and a short gestation period; a 2 percentage point reduction in pension contributions to the Employee s Provident Fund and higher individual tax rebates. Public debt has increased but is manageable. Given the cumulative fiscal stimulus, and Government s assumption of contingent liabilities on selected infrastructure projects, public sector debt increased to 7 of GDP in 2001, up from 55% in 1997. With the 2003 budget, Malaysia has announced its intention to balance the central government budget in 2005. Central government debt at 43% of GDP appears manageable. Debt of the non-financial public enterprises, at 26% of GDP, is owed by large enterprises (e.g., Petronas, Tenaga, Malaysia Telecom) with adequate capacity to repay. Fiscal consolidation remains a priority going forward, by scaling back noncore development expenditure and quasi-fiscal activities, and by improving the transparency of the public sector within a multi-year budgeting framework that includes all the assets and contingent liabilities of the government. Market sentiments, as reflected in sovereign ratings, remain favorable.
Malaysia Brief 3 Malaysia has made progress in reforming financial and corporate sectors. The banking system remains resilient with capital adequacy ratio above 12%. Asset quality improved as a result of stronger economic recovery, significant progress in corporate debt restructuring, and rehabilitation programs undertaken by the banking institutions, which enhanced the debt servicing capacity of borrowers. The banking system recorded a pre-tax profit in 2002 and the returns on assets and equity improved. Non-performing loans for the banking system, including the finance companies and Danaharta (the Assets Management Company) holdings, fell from 18.1% in December 2001 to 16.7% in December 2002. The financial restructuring institutions established following the 1997 crisis are on track towards achieving their objectives. The Corporate Debt Restructuring Committee (CDRC) closed in August 2002, after successfully resolving the debt of 32 companies amounting to RM 36 billion, from a total debt of RM 52.6 billion. Danaharta is implementing recovery strategies to maximize the value of NPLs acquired, and its operations are expected to close by 2005. The recapitalization exercise conducted by Danamodal has also been completed, and its operations are expected to cease by 2003. Malaysia has made a remarkable progress on improving corporate governance framework and practices since the Asian Crisis of 1997. The reform program has been comprehensive and in all fronts. For example, rights and equitable treatment of shareholders has been strengthened significantly. Measures include: fiduciary duties of directors, one-share one-vote rule, and related party transactions. Another area of reform has centered on improving disclosure and transparency. Recent improvements include, directors statement on internal control, mandatory disclosure on the extent of compliance with the corporate governance code, and adoption of improved accounting standards consistent with internals accounting standards. The roles and responsibilities of board of directors have been markedly enhanced. A vigorous mandatory training program for directors of PLC is in place. A best-practices guideline on internal audit function has recently been issued. Most notably, enforcement has been improved. The Securities Commission now has more supervisory and enforcement capabilities such as improved civil enforcement power, power to impose civil penalties. These efforts are supported by other initiatives such as acceleration of corporate restructuring, appointment of professional managers, on-going education and training program, and engagement with all stakeholders. Going forward, further effort will be required to ensure that Malaysia continue to improve corporate governance practices in line with OECD principles. The focus of banking sector reform has begun to shift from the restructuring process towards enhancing the quality and efficiency of services provided by financial institutions. The Financial Sector Master Plan provides the timetable for improving the capacity of the domestic financial institutions, promoting stability, developing an efficient and stable payments system infrastructure and putting in place an efficient and market driven consumer protection framework. A key tool in this upgrading process is a benchmarking exercise that measures Malaysian financial institutions performance against international best practices. The Islamic banking industry continued to expand during 2002. Corporate governance is also being strengthened in accordance with the Finance Committee Report on Corporate Governance, and the Capital Market Master Plan. The incorporation of the Malaysian Code on Corporate Governance in the revamped KLSE Listing Requirements elicited a positive response from the public. Malaysian measures to enhance standards of corporate governance and shareholder value recognition have increased public awareness and appreciation in these areas. The full implementation of the Financial Sector Master Plan, the liberalization of interest rates, strengthening of the supervisory framework and the introduction of a market-based deposit insurance scheme, and progress in corporate governance are important steps towards enhancing the competitiveness of the financial sector.
Malaysia Brief 4 Malaysia: Non-Performing Loans (%) 1998 1999 2000 2000 2000 2000 2001 2001 2001 2001 2002 2002 2002 2002 Dec Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Malaysia 21.1 23.4 23.5 23.2 23.0 22.5 23.2 23.9 24.6 24.4 24.6 24.1 23.4 22.2 exc. Danaharta 18.9 16.6 16.4 16.2 16.1 15.4 16.2 17.2 17.9 17.8 18.1 17.6 16.9 15.7 (includes provisions and interest in suspense) 1998 1999 2000 2000 2000 2000 2001 2001 2001 2001 2002 2002 2002 2002 Dec Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Malaysia 15.8 17.8 17.8 17.4 17.0 16.8 17.6 18.1 18.4 18.1 18.0 17.5 17.0 16.7 exc. Danaharta 13.6 11.0 10.7 10.4 10.1 9.7 10.6 11.4 11.7 11.5 11.5 11.0 10.5 10.2 (excludes provisions and interest in suspense) Source: BNM Despite the geopolitical uncertainties, the strong economic fundamentals of the Malaysian economy, the restoration of macroeconomic stability, and the progress achieved in the restructuring of financial and corporate sectors provide the policy makers with greater policy flexibility to sustain economic recovery. The structure of the Malaysian economy is diversified with a strong traditional sector petroleum, gas, palm oil, and other commodities that will act as a buffer against uncertainty in the other modern sectors of the economy. A modest world economic growth, some pick-up in the global electronics industry, firm commodity prices, and further expansion in intraregional trade will help sustain economic growth in Malaysia. When the recovery in US, Japan and Europe gains momentum, Malaysia is likely to benefit from it hugely, given its high level of integration into the global economy. Although private investment remains sluggish, it appears to be turning around. Following the crisis, private gross fixed capital formation fell sharply from 38% in 1997 to around 1 in 2001. Net foreign direct investment also fell during this period. Does the decline in private investment reflect loss of the competitiveness of the Malaysian economy? There are several reasons to suggest that the trend and composition of private investment are beginning to reflect underlying structural changes in the economy. First, outward investment by Malaysian companies has increased, led by some large companies in the oil and gas, manufacturing and utilities sectors. Overseas investments are now in larger projects in utilities and plantations, compared to previous years when they were concentrated in holding and trading companies. These overseas investments now generate substantial repatriation of profits and dividends for Malaysia. Second, the pattern of FDI inflows into Malaysia is changing. FDI inflows into services sector is increasing and are going into retail industry, financial services, telecommunications and software development. These new investments, while small in dollar value, enhance productivity and competitiveness. Third, private investment, earlier restrained by excess capacity, is rising in several industries in the manufacturing sector such as electronics, chemical products, which are now operating at high rates of capacity utilization in response to stronger external demand. Malaysia is also benefiting from some diversion of FDI as a result of outsourcing and relocation by several MNCs. The pause in private investment in Malaysia reflects the transition from an investment-led to an innovation-led economy. It also reflects the downturn in the global capital markets, excess capacity in selected sectors, and that the capital-goods sector is undergoing structural adjustments in the global search for lower cost of production. Malaysia--Net FDI, inflows, and outflows (%of GDP) 6. 5. 4. 3. 2. - 0. 1. - - 19 19 20 20 20 Net Inf Out Medium-term growth potential may be compromised by the remaining micro-level rigidities in the system. While macro-economic stability has been largely restored, micro-level
Malaysia Brief 5 rigidities in the product and factor markets may restrain the long-run growth potential of the country. During the 1990s, output growth was driven by physical capital growth (8-1) and labor force growth (3.4%), while total factor productivity growth was stagnant. It is unlikely that Malaysia will be able to enjoy such high historical GDP growth rates through factor accumulation. Historically, Malaysia s labor force growth has grown quickly on account of high birth rates, steady growth in participation rate that reflected the expansion of the formal economy, and the increase in women s participation in the labor force. None of these factors are likely to persist indefinitely. Thus the contribution to growth from an expansion of the labor force is likely to fall over the next decade. Malaysia has made considerable progress in raising the average years of education of the labor force from three years in the early 1970s to over seven years in the mid-1990s. Malaysia can double the average years of education as well as intensify knowledge accumulation by improving education quality. There is room for increasing private investment to 15-2 of GDP by improving the investment climate, but it is unlikely to reach the pre-crisis levels of 35%. Productivity growth will need to drive GDP growth over the medium-term. If Malaysia has to achieve 6-7 % GDP growth, it will need to enhance TFP growth to 3%. This would require improving education outcomes, improving technological capability of firms, better networking, acquiring knowledge through international trade and openness and structural reforms that lead to improved allocation of resources and better selection of projects. Progress on Millennium Development Goals is on track. Three features stand out about Malaysia. First, despite the 1997 financial crisis, Malaysia has maintained its progress on poverty reduction. The proportion of population living at less than $2 a day has fallen from 11.5% in 1996 to 4% in 2002. As Malaysia confronts the hard-core poor, progress on poverty reduction appears to have slowed down. Actually, poverty increased in 2001 to 5.5% of the population, but is projected to decline over time. Second, Malaysia is making steady progress towards achieving the Millennium Development Goals. The infant mortality rate at 8 per 1,000 live births in 1999 is close to the 2015 target at 5. The proportion of oneyear-old children immunized against measles at 88 % in 1999 is close to the millennium target of 100 by 2015. Third, despite rapid economic progress, Kelantan, Terengganu and Sabah continue to lag behind the other regions, with a higher incidence of structural poverty. Malaysia Recovery has gained momentum Figure 1. Substantial progress on poverty reduction and output surpassed pre-crisis levels. Headcount (%) ($2-a day) Real GDP per capita (1996=100) 25% 110 2 105 15% 1 100 95 90 5% 85 1990 1992 1995 1996 1997 1998 1999 2000 2001 2002 80 1996 1997 1998 1999 2000 2001 2002 Source: World Bank, EASPR Source: BNM.
Malaysia Brief 6 Figure 2. Foreign Exchange Reserves at comfortable level while NPLs decline. 40 12% 35 30 25 20 15 10 12% 11% 11% 1 1 5 9% 1997 1998 1999 2000 2001 2002 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02 Jul-02 Aug-02 Sep-02 Oct-02 Nov-02 Dec-02 Ratio of Gross Official Reserves to S-T Debt NPLs (3 mos/total Loans) Source: IMF Source: BNM Figure 3. but Challenges Remain 8 6 4 2 1997 1998 1999 2000 2001 2002 Public Debt/GDP 35% 3 25% 2 15% 1 5% 1997 1998 1999 2000 2001 2002p Private Investment/GDP 4% 3% 2% 1% 1997 1998 1999 2000 2001 FDI/GDP 2002p Source: IMF Source: IMF Source: IMF