Malaysia. Real Sector. Economic recovery is gaining momentum.

Malaysia Real Sector Economic recovery is gaining momentum. Malaysia s economy grew 4.7% in the first three quarters of 23, well above the year-earlier pace of 3.7%. GDP rose 5.1% in the third quarter, indicating that the economy gained momentum. The official forecast for full-year growth is 4.5%, up from 22 s actual growth of 4.1% (Table 1). Table 1: GDP Growth and Projections (%) 1 Ministry of Finance, September 22. 2 ADB, Asian Development Outlook 23 Update, October 23. 3 IMF, World Economic Outlook, October 23. 4 World Bank, East Asia Update Regional Overview, October 23. 5 Consensus Economics Inc., Asia Pacific Consensus Forecasts, November 23. 1997 1998 1999 2 21 22 23 24 Official 1 7.3-7.4 6.1 8.5.3 4.1 4.5 ADB 2 4.1 4.9 IMF 3 4.2 5.3 World Bank 4 4.6 5.4 Consensus Economics 5 4.6 5.4 6 4 2-2 -4 Figure 1: Growth of GDP Expenditure Components (y-o-y, %) -6 98Q1 99Q1 Q1 1Q1 2Q1 3Q1 Public Consumption Private Consumption Gross Domestic Investment Private consumption spending is sustained. The unfavorable global economic climate in the first half slowed Malaysia s export growth. Shipments of electronic goods fell 5.9% in the 1 months to October. However, soft external demand was offset by solid domestic demand, stimulated by robust growth in public sector spending in the first half. The public sector has made a substantial contribution to GDP growth in recent years, with much of the spending allocated to development programs. Fiscal stimulus in 22 helped sustain private consumption expenditure into 23 (Figure 1). But private investment continued to falter, leaving total gross fixed capital formation growth at just 2.4% for the first three quarters. This was a slight improvement over 22, when total gross fixed capital formation was virtually flat. In 21, it contracted 2.8%. Manufacturing and agriculture turned in solid performances. Manufacturing expanded about 6% in the first half, accelerating to a robust 8.5% in the third quarter, despite the weakness in electronics. The industrial production index for October showed strong 14.6%

4 2-2 Figure 2: Sectoral GDP Growth (y-o-y, %) expansion in manufacturing for that month from a year earlier. Agriculture had a particularly strong second quarter, recording 1.4% growth, followed by 6.3% in the third quarter. But services and construction were in sharp contrast. Services, hurt by a SARS-affected contraction in the hotel and restaurant industry during the first half, grew 3.9% over the first three quarters. Construction recorded just 1.7% growth (Figure 2). -4 98Q1 99Q1 Q1 1Q1 2Q1 3Q1 Agriculture Construction Manufacturing Services Fiscal and Monetary Developments The budget deficit is expected to be 5.4% of GDP. 12 8 4-4 Figure 3: Short-Term Interest Rate, Real Bank Credit Growth, and Inflation Rate (%) 98Q1 99Q1 Q1 1Q1 2Q1 3Q1 Three-Month Interbank Lending Rate, End of Period Growth in Real Bank Credit to Private Sector, End of Period (y-o-y) Inflation Rate (y-o-y) Fiscal policy is the main countercyclical tool under the present exchangerate system. The Government introduced a $1.9 billion economic stimulus package in late May, equivalent to 2% of GDP. Measures were aimed at helping SARS-affected industries, and included tax exemptions and extra government spending. This is expected to widen the Government deficit to around 5.4% of GDP from an earlier target for this year of 3.9%. Last year the deficit was 5.6% of GDP. The deficit did not lead to a rise in interest rates because of sluggish private investment and ample liquidity in the banking system. Interest rates were cut to a 1-year low in May. Monetary policy has remained accommodative. Bank Negara Malaysia lowered its three-month intervention rate 5 basis points to 4.5% in May, a 1-year low. The result was a significant rise in broad money growth in June. Outstanding bank credit increased 5.2% in the 12 months to September. Inflation has been fairly stable, even as domestic demand strengthened. CPI-based inflation slowed from 1.7% in January to 1.1% in September (Figure 3). The rise in the producerprice index decelerated to 1.4% in September from 12.9% in January, in response to more moderate increases in prices of raw materials such as crude oil, mineral fuels, and palm oil. Balance of Payments The current account surplus rose sharply in the first half. The decline in electronics exports the largest export component was offset in part in the first half by chemical products and manufactured 66

4 2 Figure 4: Growth of Merchandise Exports and Imports, Dollar Value (y-o-y, %) metal exports. Total exports grew 5.2% in the first three quarters. Imports declined 2.9%, reflecting soft investment spending (Figure 4). As a result, the trade surplus increased sufficiently to overcome the deficit in the services account, and that produced a substantial rise in the current account surplus in the first half. -2-4 98Q1 99Q1 Q1 1Q1 2Q1 3Q1 Exports Imports The overall BOP position remains healthy. The capital and financial account registered a first-half deficit of RM1.1 billion, widening from a deficit of RM1.8 billion a year earlier. Inflows of FDI decreased, overseas direct investments by Malaysians increased, and other investment outflows also rose. Covering loans, trade credits, and bank deposits, these other investments recorded a net outflow of RM7.6 billion in the first half, double the outflow of a year earlier, partly as a result of higher net loan repayments. Portfolio investments, however, recorded a lower net outflow of RM1.3 billion in the first half compared with a net outflow of RM2.1 billion a year earlier. The overall BOP surplus in the first half was RM9.5 billion, slightly below the RM1.5 billion a year earlier. Figure 5: International Reserves and External Debt ($ billion) 98Q1 98Q3 99Q1 99Q3 Q1 Q3 1Q1 1Q3 2Q1 2Q3 3Q1 3Q3 1 2 3 4 5 Gross International Reserves Total External Debt Short-Term External Debt 6 International reserves rose to $43.6 billion. Gross international reserves rose to $43.6 billion by October from $34.6 billion at the start of 23 (Figure 5). This is equivalent to about 6.7 months of imports. Bank Negara Malaysia s intervention rate was kept above international interest rates to deter capital outflows and assist in accumulating foreign reserves. Total external debt was equivalent to 51% of GDP at midyear, down slightly from 51.4% at end-22. Short-term debt as a ratio of gross international reserves rose to 26%, still well below the 79% level at the time of the 1997 financial crisis. The ringgit has depreciated in nominal and real terms. With the continued weakness of the US dollar, the pegged ringgit depreciated against other major currencies. The ringgit dropped 8.6% against the yen and 9.8% against the euro by mid-november. It has also depreciated against most regional currencies, from.6% against the Indonesian rupiah to 7.9% against the Thai baht. The Malaysian currency has edged up against the Philippine peso and Singapore dollar, though. Since appreciating through the first quarter of 22, the real effective exchange rate has declined nearly 1%. 67

Financial and Corporate Restructuring Bank capitalization remains high and the NPL ratio has improved. The risk-weighted capital ratio of Malaysian banks was 13.1% in June, little changed from 13.2% at end-22, but well above the BISrecommended ratio of 8%. Progress has been largely a consequence of consolidation, with the number of banks reduced from 6 before the 1997 financial crisis to 3. Banking authorities insisted on better capitalized, larger, and more diversified domestic banks. Reforms also were initiated to consolidate the insurance and stock-brokerage industries to create stronger and more diversified firms. The NPL ratio (three-month basis) of commercial banks has continued to improve, falling to 8.3% by October from 9.3% at end-22. Much of this decline reflected new lending. The NPL ratio of merchant banks remained high at 32% at the start of 23. Danaharta s asset disposal is nearly complete. Danaharta, the national asset management company, has recovery plans and restructuring solutions for all loans in its portfolio. A 58% recovery rate was targeted for the RM52.3 billion of loans it acquired, and it will focus on these until its mandate ends in 25. Prospects and Policy Issues Growth in 24 is forecast at 5.4%. Malaysia s economy will expand around 4.6% this year, according to the Consensus Economics survey. With fiscal policy expected to remain expansionary into 24 in the run-up to national elections, and the more favorable global economy, growth should rise to 5.4% next year, according to the survey. The transition to a new Prime Minister in late 23 was announced well in advance and there has been continuity of major economic policies. Fiscal consolidation should be a priority. Additional fiscal stimulus this year moved the Government target for a balanced budget out by one year to 26. The 24 budget gap was planned to be limited to 3.3% of GDP, but some economists anticipate election-related spending will stretch this to about 4%. Thus, there 68

will need to be a clear trend in 25 toward a balanced budget. In the past, deficit spending supported the private sector by improving competitiveness and encouraging diversification. However, continued fiscal slippage may crowd out private investment and make it less likely the Government can act on a request from the business sector to lower the corporate tax rate. A tax rate reduction could stimulate private investment. Private investment needs to be strengthened. Malaysia s investment rate, or the ratio of gross domestic investment to GDP, has not returned to its pre-crisis level. Constraints on private investment include a shortage of skilled labor, technological capabilities and, according to a World Bank study, a significant regulatory burden. The Government is aware of these concerns and is trying to transform Malaysia into a knowledge-based economy. In particular, its Multimedia Super Corridor provides infrastructure to support this strategy. An impact survey of the facility indicates progress in jobs created, export sales, and technology. By May, 55 companies had established businesses there. But more needs to be done to rekindle investment. Plans include reducing the regulatory burden to stem the decline of FDI. Rules governing company and property ownership by foreigners will be relaxed. In addition, the central bank lifted capital controls directly limiting operations of foreign banks and foreign multinationals. Since the early 198s, the central bank required multinationals operating in Malaysia to raise a minimum of 5% of their banking credit from local sources. 69

Malaysia: Selected ARIC Indicators 1996 1997 1998 1999 2 21 22 Q1 Q2 Q3 Q4 1Q1 1Q2 1Q3 1Q4 2Q1 2Q2 2Q3 2Q4 3Q1 3Q2 3Q3 Output and Prices GDP Growth (%) 1. 7.3-7.4 6.1 8.6.3 4.1 11.4 8.3 8.1 6.7 2.9.4-1. -.8 1.2 4. 5.8 5.4 4.6 4.5 5.1 Private Consumption Expenditure Growth (%)... 4.3-1.2 2.9 13. 2.4 4.4 15.3 13.6 12.3 11. 3.4 1.3 1.8 2.9 3.3 5.6 4.2 4.6 4.3 3.4 5.4 Public Consumption Expenditure Growth (%)... 5.7-8.9 17.1 1.6 17. 12.2 3.6 9.9-7.2 2.7 14.2 12.7 17.8 21.3 11.4 12.8 19.2 6.5 18.9 7.2-1.6 Gross Domestic Investment Growth (%)... 12.2-43.5-3.9 28. -9.4 8.9 15.8 29.1 49.5 18.2.9-9.5-19.1-7.4 4.1 9.4 13.5 8.3.1-3.3 1.8 Gross Fixed Investment Growth (%)... 9.2-43. -6.5 25.7-2.8.3 23.1 33.8 34.7 12.5 8.3.2-1.2-8.1-8.5-2. 2.8 1. 3.8.4 3.2 Agricultural Sector Growth (%) 4.5.7-2.8.5 2.6 -.9 3. 2.8-2.9 4.9 5.7 1.7.1-6.2-5.8-3.6 1.4 8.3 5.6 3.4 1.4 6.3 Manufacturing Sector Growth (%) 18.2 1.1-13.4 11.7 18.3-5.8 4. 24.2 19.2 18.1 12.7 1.3-7.2-8.7-8.1-2.3 5.5 7.3 5.7 5.8 6.5 8.5 Construction Sector Growth (%) 16.2 1.6-24. -4.4.6 2.1 2.3.7 1. -.2.7.6 2.9 2.4 2.2 2.9 3.4 2.6.5 1.2 1.4 2.4 Services Sector Growth (%) 8.9 9.9 -.4 4.5 6.7 5.8 4.1 7.6 6.3 5.9 7. 5.2 6.7 6. 5.2 4.5 4. 3.4 4.6 4.5 2.9 4.2 Exports of Goods and Services Growth (%)... 5..9 13.2 16.1-7.5 3.6 21.4 16.8 19.2 8.3 6.4-6. -16.3-12. -6.5 3.1 11.2 7.2 1.9.2-5. Imports of Goods and Services Growth (%)... 5.8-18.8 1.6 24.4-8.6 6.2 25.8 27.9 32.3 12.8 7.5-8.1-2.1-1.5-4.8 6.6 15.6 8.1 1.6-2.9-5.1 Inflation Rate (%) 3.5 2.7 5.3 2.8 1.4 1.4 1.8 1.5 1.3 1.4 1.6 1.5 1.6 1.4 1.2 1.5 2. 2.1 1.8 1.3.9 1. Unemployment Rate (%) 2.5 2.6 3.2 3.4 3.1 3.7 3.5 3. 3.3 3.1 3. 4. 3.7 3.3 3.7 3.7 3.8 3.2 3.2 3.8 4.... Monetary and Fiscal Accounts Growth of Broad Money, M2 (%) 1... 22.7 1.5 13.7 5.2 2.2 5.8 1.1 6.8 4.9 5.2 3.6 3. 5. 2.2 6.1 6.1 4.4 5.8 5.6 8.6 1.3 Three-Month Interbank Lending Rate (%) 1...... 6.5 4. 3.2 3.2 3. 3.2 3.2 3.3 3.3 3. 3. 3.3 3.3 3.2 2.8 2.8 3.1 2.9 2.9 2.9 Growth in Real Bank Credit to Private Sector (%) 1 22.3 2.2-2.3 -.6 4.9 3.3 5. 3.4 5.4 1.4 4.9 3.7 3.7 4.7 3.3 4. 3.2 2.9 5. 6.1 6.4 NPL Ratio of the Financial System 1...... 13.6 11. 9.7 11.5 1.2 1.7 1.4 1.1 9.7 1.6 11.4 11.7 11.5 11.5 11. 1.5 1.2 9.9 9.5 9. NPL Ratio of the Commercial Banking System 1...... 1.3 8.8 8.3 1.5 9.3 8.9 8.6 8.5 8.3 9.3 1.3 1.7 1.5 1.6 1. 9.6 9.3 9.1 8.8 8.3 Average Stock Price Index 1,134.8 972.6 515.9 696.3 841.4 636.7 71.7 95.1 892.8 792. 734.8 694.7 579.2 646.7 632.7 72.2 767.5 712. 642.5 647.9 652.3 73.7 Central Government Fiscal Balance as % of GDP.7 2.4-1.8-3.2-5.8-5.5-5.6 1.2-1.9-5.2-16.4-2. 2.2-3.6-18.6-1.6-4.5-5.5-1.3-7.3-8.4... Central Government Debt as % of GDP 1 35.3 31.9 36.4 37.3 36.7 43.6 45.7 36.4 37. 36.9 36.7 37.5 37.8 4.8 43.6 43.6 44. 44.9 45.7 47.2 48.2... Government Expenditure on Education (% of Total) 21.4 21.3 21.4 22.1 23.7 25................................................. Government Expenditure on Health (% of Total) 19. 17.9 17.9 17.7 16.8 16.2................................................ External Account, Debt, and Exchange Rates Growth of Merchandise Exports ($ fob, %) 5.9.4-6.8 15.3 16.1-1.4 5.9 22.1 16.8 21.6 5.8 1.7-8.9-19.4-13.1-4.9 5.1 14.3 9.7 8. 6.1 1.8 Growth of Merchandise Imports ($ cif, %).1.7-26.1 12.1 25.4-1. 8. 26.7 31.8 33.4 11.5 7. -1.5-22.5-1.5-5. 9.8 19.6 8.6 2.6-5. -5.7 Current Account Balance as % of GDP -4.8-5.2 13.5 15.9 9.1 8.3 7.8 12.9 7.8 7.2 8.6 8.5 8. 9.8 6.7 8.8 6.7 7.4 8.4 12.6 12.... Net Foreign Direct Investment ($ Billion) 2 2. 5.6 2.2 2.3 1.8.3 1.3.5.2.4.6.3.3.6 -.9.6..6.1 -.6.3... Net Portfolio Investment ($ Billion) 2 1.6-4.4-6.9-3.9-2.5 -.6-1.7 1.4-1.7-1.2 -.9 -.6 -.2.6 -.4.8-1.3 -.4 -.8 -.2.2... Gross International Reserves ($ Billion) 1 27.8 15.7 26.2 3.9 29.9 3.8 34.6 34. 34. 32.3 29.9 27.2 26. 29.7 3.8 32.7 33.6 34. 34.6 34.9 37.1 4.7 Total External Debt as % of GDP 1 38.5 48.5 61.9 53.9 47. 51.9 51.4 5.7 49. 47.6 47.1 46.3 46.9 49.5 51.9 53.4 51.8 5.8 51.4 5.4 51.... Short-Term Debt as % of Gross International Reserves 1 37. 59.8 36.9 19.3 15.7 2.7 24.6 16. 15.5 16. 15.7 17.6 18.2 18.1 2.7 22. 18.8 2.3 24.6 23.4 25.5... Short-Term Debt as % of Total Debt 1 25.7 25.3 21.1 13.8 1.9 13.8 17.3 12.8 12.5 12.2 1.9 11.2 11.1 12. 13.8 15.2 13.5 14.6 17.2 16.3 18.4... Real Effective Exchange Rate (1995=1) 3 16.5 15.5 86.8 87.6 86.2 92.9 95.3 85.8 85.7 85.8 87.4 91. 92.8 92.7 95.1 99. 95.8 93.1 93.2 9.9 9.9 9.9 Average Exchange Rate (Local Currency to $) 2.5 2.8 3.9 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 3.8 Note: All growth rates are on a year-on-year basis.... = not available. 1 End of period. 2 Quarterly figures were converted to dollars from ringgit using the quarterly average exchange rate. 3 Trade weighted using wholesale price index for trading partners and consumer price index for the home country. Sources: Data on output and prices, nonperforming loan ratios of the financial and commercial banking system, central government fiscal balance, central government debt, government expenditure on education and health, merchandise exports and imports, current account balance, net foreign direct and portfolio investments, gross international reserves, and total and short-term external debts are from national sources. Data on M2, and real bank credit to private sector are from the International Monetary Fund, International Financial Statistics. Data on interbank lending rate, average stock price index, and average exchange rate are from Bloomberg, LP. Real effective exchange rates are based on REMU staff calculations.