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Malaysia: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Malaysia

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
March 2019
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Economic Developments and Outlook: Continued Favorable Performance with Downside Risks

1. Malaysia’s economy continued to show resilience as a smooth political transition took place in May 2018. The opposition coalition led by former PM Mahathir secured a surprise victory in Malaysia’s 14th General Election, resulting in the first ruling party change since independence in 1957. The peaceful political transition was a demonstration of the strength of Malaysia’s institutions, and robust economic activity also endured.

2. Growth is moderating (Figure 1). Growth is estimated at 4.7 percent in 2018 (5.9 percent in 2017), narrowing the output gap. While improved labor market conditions and the zero-rating of the GST boosted private consumption, public investment declined due to the winding down of large projects. Tightening global financial conditions, trade tensions, and a temporary spike in uncertainty regarding the new government’s policy agenda have affected confidence and private investment. That said, exports have risen, driven by electronics, and investment strengthened in the third quarter. On the supply side, disruptions in the oil and gas sector and adverse weather conditions contributed to lower growth.

Figure 1.Malaysia: Growth and Exports

Chart 1.Malaysia: Contributions to Real GDP Growth

(In percentage points; year-on-year)

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

3. Inflation has come down (Figure 2). Headline inflation dropped from an average of 3.7 percent in 2017 to 1.0 percent in 2018 as domestic fuel price adjustment was suspended in March, the GST was zero-rated in June, and food price inflation declined. The pass-through to prices from the re-introduction of the Sales and Services Tax (SST) in September, with a smaller tax base than the GST, was moderate. In addition, the price-cutting pressures faced by government contractors partly offset the effect of the SST. While credit growth has rebounded recently, driven by lending to corporations, the credit-to-GDP ratio is declining, and the credit gap has almost closed (Figure 3).

Figure 2.Malaysia: Inflation and Domestic Resource Constraints

Figure 3.Malaysia: Monetary Developments

Chart 2.Malaysia: Contributions to CPI Inflation

(Year-on-year, in percentage points)

Sources: Haver Analytics; and IMF staff calculations.

4. The 2018 fiscal deficit exceeded the budgeted level (Figures 4 and 5). The new government took immediate steps to increase transparency over the fiscal accounts, recognizing additional tax refund obligations (about 0.3 percent of GDP in 2018) and bringing on budget identified off-budget spending. The latter, together with additional spending needs (partly on social assistance), has raised net government spending by 0.5 percent of GDP, despite the review of existing infrastructure projects. Moreover, the re-introduction of subsidies for lower-grade petroleum added 0.2 percent of GDP in spending. On the revenue side, replacing the GST by the SST has narrowed the tax base and has created an estimated revenue shortfall of 1.2 percent of GDP in 2018. Higher oil revenues and transfers from Petronas and other government-linked companies (GLCs) raised 1.2 percent of GDP. Consequently, the 2018 deficit is estimated at 3.7 percent of GDP, 0.9 percent of GDP higher than budgeted.

Figure 4.Malaysia: Capital Flows

Figure 5.Malaysia: Fiscal Policy Developments

Chart 3.Malaysia: Official Foreign Reserves

(In billions of US dollars and percent of ARA metric)

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

5. Although vulnerabilities exist, capital outflows have been manageable. During the second quarter of 2018, Malaysia experienced large capital outflows in face of the general EM risk-off sentiment and post-election policy uncertainty. Nonetheless, the impact on the exchange rate, stock market prices, and government bond yields was contained due to increased domestic investor participation and central bank foreign exchange market intervention to counter disorderly market conditions (Figure 6). The share of resident holding in government paper (MGS, MGII, Treasury Bills, and Islamic Treasury Bills) increased from an average of 71 percent post-GFC to 75 percent in October, amid robust demand for government bonds from domestic institutional investors.

Figure 6.Malaysia: Public Sector Fiscal Stance and Prospects

Chart 4.Capital Flows and Exchange Market Pressure Index 1/

(EMPI = percent change in U.S. dollar/local currency exchange rate plus percent change in reserves; since end 2017)

Source: Institute of International Finance; Haver Analytics; and IMF staff calculations.

1/ As of Oct 2018

Chart 5.Exchange Rate, Equity Price, and Bond Yield 1/

(Percent change; since end 2017)

Sources: Haver Analytics; Bloomberg LP.; and IMF staff calculations.

1/ As of Oct 2018

6. While moving towards equilibrium, the external position remains stronger than warranted by fundamentals and desired policies (Appendix I). In recent years, Malaysia’s growth drivers have shifted towards domestic demand and its current account surplus has narrowed. In 2018, the real effective exchange rate (REER) appreciated by 4.1 percent and the current account surplus declined to an estimated 2.2 percent of GDP. Although this surplus has helped reassure foreign investors during the recent EM sell-off, it represents a current account gap that cannot be explained by fundamentals nor by desired policies identified by the Fund’s external balance modeling. While identified domestic policy gaps have offsetting effects, low public healthcare spending contributes to the excess surplus, and so does saving by private nonfinancial corporations, as suggested by national accounts data (Appendix II). Going forward, creating fiscal space to expand social safety nets and increase health spending would help reduce precautionary household savings. This, together with structural reforms aimed at enhancing investment and productivity, would facilitate external rebalancing.

7. Policies have been largely in line with past Fund advice, with some exceptions (Appendix III). In line with IMF recommendations, the authorities are anchoring fiscal policy to their medium-term consolidation objective, improving efficiency of spending via zero-based budgeting, and are working on a Fiscal Responsibility Act. However, the GST was zero-rated against IMF staff advice, creating a revenue shortfall. The current monetary policy stance is consistent with advice to carefully calibrate monetary policy in response to economic conditions. The authorities continue to indicate a firm commitment to exchange rate flexibility as the main defense against external shocks. Structural reforms are largely in line with IMF advice.

8. Growth is expected to stabilize in 2019 and over the medium term, with inflation picking up and the current account surplus continuing to narrow. Domestic demand will remain the main driver of growth. Given Malaysia’s position in global value chains, the U.S. tariffs on imports from China could reduce Malaysia’s growth rate by 0.2 percentage points in 2019 via traditional trade channels and through financial and confidence effects, despite some trade diversion.1 While public investment will contribute negatively to growth in the near term due to the ongoing review of infrastructure projects, private consumption and investment are expected to be robust, underpinned by an improved business environment and greater confidence. The latter factors are expected to counterbalance the negative drag from the external environment and fiscal consolidation, leaving growth flat at 4.7 percent in 2019. Inflation should rise above 2 percent in 2019, as the effect of the GST removal dissipates, and oil subsidies become targeted. Over the medium term, growth is expected to converge to potential (4.8 percent) and inflation will remain subdued.

9. Risks to the growth outlook are to the downside (Appendix IV). With a highly open economy, Malaysia is vulnerable to rising protectionism and weaker-than-expected growth in trading partners. Output shocks could undermine households’ ability to service their debts. A sharp tightening of global financial conditions could cause financial stress for banks and corporations. Lower-than-projected oil prices could reduce exports and growth, complicating the authorities’ fiscal consolidation efforts. Domestically, contingent liabilities could necessitate additional measures to ensure medium-term fiscal sustainability, while delays or resistance to the governance reform agenda could undermine confidence, leading to lower investment and growth. Sharp adjustment in real estate prices or a deterioration in households’ debt service ability could affect financial stability and growth.

Authorities’ Views

10. The authorities broadly agreed with staff’s assessment of the economic outlook and risks. They expected growth to be 4.9 percent in 2019, driven by domestic demand and underpinned by strong fundamentals, particularly favorable labor market conditions, in addition to an improved business environment and greater confidence. They expected inflation to rebound to between 2.5–3.5 percent in 2019, contingent on the timing of fuel subsidy reform and oil prices. Over the medium term, the authorities saw growth at 4.5–5.5 percent, with risks stemming from external sources and tilted to the downside. The authorities took positive note of the 2018 methodological refinements to staff’s external balance assessment but continued to see limitations in the IMF’s analytical framework given the relatively weak explanatory power of the current account regression model in the Malaysian context. They agreed with the structural reforms advised to address policy gaps, noting that their reform plans aim to boost investment and productivity and improve infrastructure.

Macroeconomic and Financial Policies: Achieving Fiscal Consolidation while Safeguarding Growth and Financial Stability

11. Policies should aim at achieving fiscal consolidation while protecting growth and financial stability. A credible fiscal consolidation plan is needed to rebuild fiscal buffers, put public debt on a clear downward path, and boost market confidence. Monetary policy should continue to be geared towards domestic stability, and macroprudential policies should help maintain financial stability. External imbalances should be addressed over the medium term by creating fiscal space to expand social safety nets and reduce precautionary household saving and structural reforms aimed at enhancing investment and productivity.

A. Fiscal Policy

12. The 2019 budget entails a welcome consolidation and transparency over fiscal accounts (Chart 6). The new government continued its efforts to increase fiscal transparency by budgeting for full clearance of tax refund arrears in 2019 and enhancing the analysis of fiscal risks and liabilities. Expenditure rationalization and improvements in targeting social assistance and subsidies are expected to save 2.1 percent of GDP. Higher non-tax revenue (1.3 percent of GDP), mainly due to additional one-off transfers from Petronas (2 percent of GDP) will partly finance one-off tax refunds (2.4 percent of GDP). The full year impact of replacing the GST with the SST and additional provision for 2019 tax refunds will raise the deficit by 0.7 percentage point of GDP. Consequently, the deficit is budgeted at 3.4 percent of GDP in 2019. Additional, albeit small, revenue measures2 could potentially deliver higher revenue relative to the 2019 budget and IMF staff baseline. While expenditure compression could weigh on growth, particularly through a slowdown in public investment, the adverse impact should be mitigated by the improvement in the targeting of transfers and the tax refunds. More importantly, the anticipated fiscal consolidation should help shore up market confidence. Nevertheless, the one-off dividends from Petronas, together with the revenue shortfall from replacing the GST with the SST, has increased the dependence on oil-related revenue, calling for further adjustment over the medium term.

Chart 6.Malaysia: 2019 Projected Fiscal Deficit

(Percent of GDP)

Sources: IMF staff estimates.

13. The authorities plan to further reduce the deficit over the medium term. Malaysia’s fiscal policy is anchored by a commitment to keep the federal government debt below 55 percent of GDP. However, the federal government debt is estimated at 51.9 percent of GDP at end-2018, implying that the limit could be breached if downside risks materialize. Besides, federal government guarantees (18 percent of GDP, as of June 2018) and possible future payment obligations related to Public-Private-Partnerships (PPPs) projects (13 percent of GDP, on an undiscounted cash basis over next 30 years, also as of June 2018) could pose an upside risk to public debt. These factors imply that Malaysia’s fiscal space is at risk3 absent fiscal consolidation. Against this backdrop, the 2019 budget announced a medium-term consolidation path—with the deficit reduced to 3 percent of GDP in 2020, 2.8 percent of GDP in 2021, and 2 percent of GDP over the medium term. This gradual consolidation path would put debt on a downward trajectory, allowing it to reach 47 percent of GDP by 2024 (Appendix V). This would provide welcome buffers vis-a-vis the federal government debt limit, thereby enhancing fiscal space.

14. Revenue mobilization is a priority given Malaysia’s low tax revenue (13.1 percent of GDP in 2017, Chart 7). Based on theory and international best practice, the value-added tax (GST) is a preferable form of taxation. At the current juncture, other measures will be needed, such as strengthening the SST, revisiting existing tax incentives for corporate investment, increasing excise taxes, broadening the PIT base, and introducing a capital gains tax (text table). With this objective in mind, the authorities have established a high-level Tax Reform Committee, tasked to carry out a comprehensive review of the Malaysian tax system including tax incentives and possible new sources of sustainable revenues.

Chart 7:Tax Revenue: OECD and ASEAN-5, 2014

(In percent of GDP)

Sources: IMF FAD Tax Revenue Indicators database; and IMF staff calculations.

Options for Fiscal Policy Adjustment, 2020–2024(In percent of GDP)
Adjustment needs2–2.5
Bringing fiscal deficit to 2 percent of GDP1
Additional social and development spending1 – 1.5
Social protection and healthcare spending
Investment in human capital
Infrastructure and R&D
Options for adjustment Upto 2.5
Additional sources of revenue1.7
Expanding SST coverage0.5
Reducing investment incentives in CIT0.5
Broadning PIT base0.5
Increase excise taxes (e.g., tobacco)0.1
Capital gains tax0.1
Expenditure savings measures0.8
Rationalizing subsidies and transfers0.3
Wage bill savings0.2
Enhancing procurement policy0.3

15. Revenue measures should be coupled with expenditure rationalization. The authorities’ zero-budgeting process has rightly increased focus on existing spending but could be further strengthened by a targeted and strategic spending review mechanism, on a rolling basis, which would also help to realize expenditure savings (possible measures are illustrated in the text table). Revenue mobilization and expenditure rationalization should create space for additional social and development spending. Such spending should be prioritized in accordance with the main pillars in the Mid-Term Review of the Eleventh Malaysia Plan and include further improvements in social protection and healthcare spending. This would help put the economy on a path of sustainable, inclusive growth towards high-income status.

16. Fiscal adjustment should be embedded in a strengthened fiscal framework. The government plans to table a Fiscal Responsibility Act (FRA) and adopt accrual accounting by 2021. The FRA should clearly stipulate fiscal objectives, the fiscal anchor, and the key components of the medium-term fiscal framework including operational targets and the institutional setup. Over the medium-term, to further strengthen the fiscal framework, introducing an expenditure rule (capping the growth rate of expenditure at an appropriately calibrated level that meets the government’s strategic objectives while ensuring fiscal sustainability) could be considered to help prevent procyclical fiscal policy and meet the government’s strategic spending objectives without undermining fiscal space (Appendix VI).

Authorities’ Views

17. The authorities reaffirmed their commitment to medium-term fiscal consolidation. They stressed that the higher deficit in 2018–2019 is temporary and reflects efforts to improve fiscal transparency and governance. They noted that the revenue shortfall from replacing the GST with the SST will be addressed through revenue mobilization measures to be identified by the Tax Reform Committee and further expenditure rationalization. The authorities noted their commitment to reducing the deficit to 2 percent of GDP over the medium term. While the authorities agreed on the importance of revenue mobilization, they indicated that additional spending needs can also be accommodated by improving expenditure efficiency. They agreed with the need for a strengthened medium-term fiscal framework, including better fiscal risk management, and highlighted their plan to propose a Fiscal Responsibility Act and adopt accrual accounting by 2021.

B. Monetary, Exchange Rate, and Financial Markets Policies

18. The monetary policy stance should remain broadly neutral. Domestic economic and financial considerations continue to guide monetary policy decisions, within a policy framework that has been delivering broad price and output stability despite economic shocks. After raising the policy rate by 25 bps to 3.25 percent in January 2018, the Monetary Policy Committee has kept the rate unchanged in its five subsequent meetings, thus maintaining the real policy rate within the natural rate band (Chart 8). Looking forward, at unchanged policy rates, the monetary policy stance will remain broadly neutral. Given gradual growth deceleration toward sustainable levels, no evident underlying inflation pressures, and gradually tightening financial conditions (Chart 9 and Appendix VII), monetary policy should remain on hold.

Chart 8Real Policy Rate versus Natural Rate, 2013:Q2–2019:Q4

(Percent)

Sources: IMF staff calculations.

Note: Natural rate band derived using TV VAR with inflation expectations proxies by backward looking inflation moving average and forward looking Consensus Forecasts. Projected real policy rate assuming no change in the nominal monetary policy rate through end 2019.

Chart 9Financial Conditions Index For Malaysia

(1991:Q1–2018:Q2)

Note: Based on the model outlined in 2017 April GFSR, estimated using 10 financial indicators covering credit, foreign exchange, debt, and equity markets for 43 advanced and emerging market economies for 1990–2016. An increase in the index means tightening financial conditions.

19. Exchange rate flexibility is essential. BNM intervention in the foreign exchange market following the surprise election results helped ensure orderly market conditions. Looking forward, and in the context of protracted uncertainty in global financial conditions, foreign exchange market intervention should continue to be limited to preventing disorderly market conditions and the exchange rate should continue to play the role of shock absorber. This would safeguard reserves and help to further develop and deepen financial markets. Gross foreign reserves are adequate (US$101.4 billion as of end 2018—about 108 percent of the Assessing Reserve Adequacy (ARA) metric for a floating exchange rate regime). When adjusted for net forward positions, which is also relevant given the forward-looking nature of the ARA metric, reserves are below 100 percent of the metric. In case of an inflow surge, some reserve accumulation would be appropriate to increase the reserve coverage. Although banks and corporates could resort to their own external liquid assets to service their maturing external debt, foreign currency debt still represents a potential claim on BNM’s foreign exchange reserves.

20. Malaysia’s external debt remains manageable, although external financing vulnerabilities are higher than in the median peer country (Appendix VIII). Malaysia’s external debt-to-GDP ratio has risen by about 11 percentage points of GDP between 2009 and 2018Q3, to 65.4 percent of GDP, measured in U.S. dollars (2009: 54¼ percent of GDP). About one-half of this increase in the debt ratio was due to the rise in other investment liabilities, including intercompany loans and interbank borrowing. Portfolio debt inflows accounted for about 3 percentage points of GDP of the increase, despite large portfolio outflows in 2018Q2. Standard stress tests under the IMF’s External Debt Sustainability Analysis indicate that the external debt-to-GDP ratio would remain close to the baseline level under a variety of shocks over the medium term, except under an exchange rate depreciation shock. However, close to one-third of external debt is denominated in ringgit, which provides some cushion against exchange rate risks.

21. The measures introduced by the authorities in December 20164have reduced volatility in the onshore FX market, but at the likely cost of creating distortions. The attestation requirement for banks’ noninvolvement in offshore ringgit derivatives trading is motivated by the authorities’ goal of closely monitoring activity in the FX market and dissuading speculative activities. A removal of this ban would have to proceed with caution as conditions for further liberalization allow. While domestic FX markets appear to be functioning well (Appendix IX), the export proceed conversion requirement and limit on foreign currency investments by residents with domestic ringgit borrowing (including the limit by resident non-exporters) can be distortive, potentially leading to resource misallocation, and therefore may not support market development. In August 2018, the BNM eased the conversion requirement by allowing exporters to keep FX earnings in excess of 25 percent of export proceeds when these are needed to meet import or debt service obligations in the next six months without going through a process of conversion/reconversion as previously required. These measures should be gradually phased out with due regard to market conditions.

Authorities’ Views

22. The authorities agreed with staff’s assessment, albeit with caveats. They viewed monetary policy as still accommodative and noted that growth and inflation remain the key determinants of monetary policy. The authorities stressed that, in the post-election months, FX interventions were needed to prevent disorderly market conditions. However, they also noted that exchange rate flexibility will continue to be the first line of defense against external shocks. They viewed BNM reserves to be adequate and external debt to be manageable, highlighting several buffers against external shocks: (i) BNM’s reserves account for a quarter of total foreign assets, with the remainder held by resident banks and corporates, which can be drawn upon to meet external obligations without creating a claim on international reserves; (ii) about one-third of external debt is ringgit-denominated; (iii) three-quarters of FX-denominated external debt is subject to prudential requirements; (iv) over half of external debt has medium/long-term maturity; and (v) three-quarters of short-term interbank borrowing is intragroup, which must comply with local liquidity regulations and is deemed more stable. Regarding the 2016 FX market measures, the authorities disagreed that these created distortions, noting that they helped reinforce Malaysia’s long-standing policy on the non-internationalization of the ringgit, limit speculation that causes excessive exchange rate volatility, and deepen onshore markets.

C. Financial Sector

23. The financial system seems well positioned to cope with most shocks (Figures 7, 8). Banks are well-capitalized and liquid, with capital and liquidity buffers exceeding regulatory levels. Loan quality is strong, with aggregate NPLs at 1.5 percent of gross loans as of 2018 Q3, and provisions are sizable. The impaired loans in the oil and gas sector are adequately provisioned for, have been written off, or restructured. The real estate sector (especially its commercial segment) represents a vulnerability, but risks are mitigated by large developers’ sizable cash buffers. While some small property developers have faced cash flow problems recently, the risks appear to be contained.

Figure 7.Malaysia: Financial Sector Developments

Figure 8.Financial Soundness Indicators 1/

1/ Financial Soundness Indicators for Malaysia are as indicated, while for the other countries those indicators range between 2017Q2 and 2018Q3 depending on availability.

24. The potential for spillovers from the non-bank financial institutions (NBFIs) to the banking sector appears limited. NBFIs include retirement funds, investment funds, credit cooperatives, Development Financial Institutions (DFIs), and the National Higher Education Fund, among others. NBFIs’ investments in equities and bonds continue to be the main transmission channel of contagion risk to the financial sector. Also, some segments of the sector are government-owned, posing potential fiscal risk in case a large adverse shock materializes. To help manage these risks, the BNM has taken steps to improve the flow of NBFIs’ financial reporting.

25. Household debt is elevated compared to regional peers, but declining (Figure 9). Total household debt stood at 83.2 percent of GDP as of 2018Q3. High household financial assets (twice the size of total household debt) help mitigate the vulnerability for all but the lowest income group (with income below RM 3,000 per month). Households in the second income group (earning between RM3,000 and RM5,000 per month) would face the largest cash flow shortages under income, interest rate, or cost-of-living shocks, according to BNM stress tests. Macroprudential norms and credit underwriting standards have been effective in containing household NPLs at 1.4 percent. Mortgages, which represent 60 percent of total household debt, have mostly a variable rate structure and are subject to interest rate risk. Despite high loan quality and the positive outcome of the BNM’s latest stress testing, household debt continues to require close monitoring.

Figure 9.Malaysia: Household Debt

26. The authorities continue to closely monitor risks emanating from the housing market, although the risks are deemed manageable (Figure 10). House price growth has declined from 6.5 percent in 2017 to 3 percent in 2018H1, and the volume of transactions has also declined. The number of unsold housing units that have been completed or are currently under construction is increasing and is mostly concentrated in high-rise buildings. Banks’ direct exposure to developers remain small and is closely monitored by the BNM.5 According to BNM stress tests, potential bank losses originating from a possible sharp real estate price adjustment and shocks to income and interest rates are small relative to the banks’ capital buffers. The BNM, MOF, and Ministry of Housing and Local Government have introduced new measures that help reduce the cost of property or of contracting a mortgage loan, with the objective to strengthen the demand for housing and facilitate leasing, and therefore gradually reduce the supply overhang. The impact of these measures should be evaluated on an ongoing basis to ensure effectiveness and correct potential distortions.

Figure 10.Malaysia: House Prices

27. As systemic risks from the housing market dissipate, the residency-based differentiation in the real estate measures introduced in 20146should be gradually phased out. Given banks’ sizable exposure to mortgage lending and to the construction industry, a real estate market price correction, through a reduction in household and corporate wealth, and these agents’ debt servicing capacity, could have a significant impact on growth and financial stability as NPLs rise. During 2012–13, the Malaysian House Price Index (MHPI) grew by a cumulative 24 percent, well-above its long-run annual average of 6 percent and, in 2014, amid further significant price increases, the number of transactions by non-citizens surged by 30 percent (Appendix X). The measures introduced in 2014 helped cool down the market (cutting growth in property purchases by non-citizens by over 50 percent in 2015 and by another 38.9 percent in 2016, and slowing the growth rate of MHPI to 9.4 and 7.4 percent in 2014 and 2015, respectively), avoid significant price adjustments, and reduce the rate of future debt build-up, thus reducing the probability of systemic distress. In the absence of a capital inflow surge for the time-being, but still high household leverage, gradually removing the residency-based differentiation in both measures is recommended as systemic risk dissipates. Carefully calibrated changes to the measures could have the additional benefits of helping to reduce the excess supply of high-end housing where nonresident buyers are concentrated and thereby the probability of a sharp downward price correction.7 Should the activity in certain segments again threaten financial stability, the authorities may consider macroprudential measures that target the specific segments, without a differentiated treatment of non-residents.

28. The corporate sector is moderately leveraged. Intercompany loans in 2018 have increased as a share of GDP, driven largely by multinational companies’ lending to local subsidiaries, which is considered relatively stable (compared to other market-based funding). Corporations remain resilient to interest rate shocks: the interest cover ratio is above 8 sector-wide, against a prudent threshold of 2. The overall corporate sector NPLs are at 2.5 percent, suggesting strong debt service capacity. However, some corporations are presently experiencing declining margins due to ongoing renegotiations of public sector projects and delays in infrastructure projects, which represents a risk to their profitability.

29. Although the financial sector is deemed resilient at present, the authorities continue to closely monitor risks and consider measures to mitigate them. The authorities are making ongoing efforts to enhance operational resilience and crisis preparedness. These actions could be further strengthened by a comprehensive internal review of crisis preparedness, resolution framework, and related facilities (ELA or Deposit Insurance payout framework) and legislation. This would help ensure, inter alia, seamless inter- and intra-agency functioning at a time of distress. Over the medium term, to strengthen the macroprudential framework, consideration could be given to introducing sector-wide LTVs (on the second and first properties) and debt-service-to-income limits for all income groups to replace the ones that are presently self-imposed by the banks.

30. The framework governing BNM’s financial oversight functions appears robust. The 2012 FSAP found that the BNM’s role is clearly defined in the law; it is well funded; and its staff has credibility based on their professionalism and integrity. It also found that the overall supervision of the banking sector and some non-bank financial institutions, as mandated, is sound and delivers effective oversight. The main gaps identified by the 2012 FSAP—specifically, improving the administration of licensing standards, extending information-sharing arrangements with foreign supervisors, and strengthening the supervisory powers in the insurance sector—have been addressed.

31. The authorities should continue strengthening the implementation of AML/CFT measures, which would also assist in mitigating risks from corruption. Ensuring that financial institutions effectively apply enhanced customer due diligence measures on high risk politically exposed persons can help detect and deter the laundering of corruption proceeds. In this regard, efforts to strengthen the asset declaration system should be stepped up, in particular expanding the coverage of high-level public officials and improving mechanisms for verification, sanctions and public access. The proposed study by the Companies Commission of Malaysia on the implementation of beneficial ownership requirements should identify measures to enable competent authorities to have access to accurate and up-to-date ownership information of legal persons and legal arrangements established in Malaysia.

Authorities’ Views

32. The authorities viewed financial sector risks as appropriately monitored and contained. They noted that the financial sector has the necessary buffers to cope with sizable shocks. While agreeing that household balance sheet risks require close monitoring, the authorities noted that the associated problems do not pose systemic financial stability risks at this juncture. They were of the view that, with real estate price increases moderating, and given the strength of the macroprudential framework, the likelihood of a sizable adjustment with systemic implications is low. The authorities viewed sector-wide LTVs on first and second mortgages as unwarranted given existing supervisory measures and prudent risk management practices at banks. They noted staff’s recommendation to phase out the residency-based differentiation in the RPGT and property floor price but consider these measures necessary to limit speculative demand and minimize financial sector risks, given the rebound in growth of property purchases by non-citizens in 2017–2018H1. Regarding crisis preparedness, they indicated that, in addition to periodic reviews of such preparedness, resolution frameworks, and related liquidity facilities, they were increasingly focused on testing the banking system’s operational resilience, including to cyber risks.

Medium–Term Challenges: Improving Governance and Achieving Sustainable Growth

33. Weaknesses have been identified in fiscal governance and anti-corruption frameworks. Vulnerabilities on the fiscal side include off budget spending, weaknesses in managing large infrastructure projects and in procurement systems, and a budget process that could be more transparent. Significant reliance on off budget initiatives, including government guarantees and PPPs, have made it difficult to form a comprehensive assessment of the government fiscal position. The governance of large infrastructure projects in terms of project appraisal, approval, costing, and extension of government guarantees presents further challenges and exposes the country to corruption vulnerabilities. Malaysia ranks low compared to the OECD average on the strength of procurement systems and on a range of indicators of corruption and anti-corruption institutions (Appendix XI).

34. The new government has launched multiple initiatives to address governance weaknesses and corruption. The Mid-Term Review of the Eleventh Malaysia Plan reoriented government priorities towards improving transparency and public services efficiency. The National Centre for Governance, Integrity and Anti-Corruption (GIACC) was established to develop a national anti-corruption plan8 and to coordinate governance and anti-corruption reforms. The intention is to move forward with important legislation to secure these reforms, as well as take firm steps towards ensuring public participation and key institutional reforms. Special committees were established to tackle specific governance weaknesses, such as procurement, and existing institutions are being strengthened, including the Malaysian Anti-Corruption Commission (MACC), the Economic Planning Unit, the PPP framework, and the SOE legal framework.

35. The governance reform agenda will take time to implement and will require legislative changes. Several important reforms require constitutional changes (Annex XI). Legislative reforms will be needed covering freedom of information, political financing, and declaration of assets. Improvements in the public investment management framework will require a number of additional legislative and procedural changes. Measures will also be needed to avoid future tax refund arrears, improve financial oversight of SOEs, and publish a more detailed set of accounts and a fiscal risks statement. Tax administration could be improved by merging the multiple tax collection roles under the umbrella of the Inland Revenue Authority.

36. The authorities’ structural reform agenda, laid out in the Mid-Term Review of the Eleventh Malaysia Plan, aims to help Malaysia reach high-income status and inclusive economic development. In addition to governance reforms, the government is prioritizing inclusive and balanced regional development, investing in human capital, enhancing environmental sustainability, and strengthening economic growth. In this vein, accelerating the ratification of the CPTPP9 (currently under review) and increasing female labor force participation and productivity would be essential. Despite robust growth and substantial improvement in export sophistication, Malaysia’s total factor productivity growth slowed recently. Policies to help lift productivity growth should focus on improving education and encouraging innovation, technology adoption, and a move up the value chain.

37. Improvements in education would help raise productivity. Priority should be given to policies that raise the quality of human capital, by improving the quality of teachers and design of curricula and by expanding vocational and technical training to address skills mismatches. This would also help ease labor shortages and prepare Malaysia to better face automation challenges.

38. Productivity gains can also be achieved by accelerating innovation and technology adoption, another objective of the Mid-Term Review of the Eleventh Malaysia Plan. In this respect, aligning research and innovation to business needs and fostering firm dynamism would help. Given the positive but limited technology spillovers from FDI, the authorities place an equal emphasis on the creation of own technologies. In this respect, the authorities are rightly preparing measures to address the lack of coordination in research, development, commercialization and innovation activities and the low commercialization of R&D output.

39. Encouraging a move up the value chain through market-based measures would also help. Digital technology and automation provide an opportunity for Malaysia to upgrade its industries. While the government intends to provide targeted incentives and funding under its Industry 4.0 initiative, concerted efforts by the private sector to invest in digitalization are needed. The authorities view the easy access to low-skilled foreign workers as a drag to the upgrade effort and are working on an updated foreign worker policy to increase the cost of hiring foreign labor and clamp down on illegal foreign workers employment. Any reform to foreign labor policies should be market-based, clearly communicated, and gradually phased-in to allow sectors that rely on foreign workers to adjust.

Authorities’ Views

40. On governance, the authorities agreed with the identified weaknesses and the steps needed to close the gaps. They are firmly committed to enhancing governance and combatting corruption at all levels. In this regard, the implementation of principles of good governance, strong institutions, and integrity and accountability in the public sector will be the pillars of the strategy. The authorities emphasized that they are looking at numerous reforms in the areas of administration, legislation, and judicial system, as well as public financial management and relevant institutions.

41. The authorities reaffirmed their goals of achieving high-income status and inclusive development. Guided by the Mid-Term Review of the Eleventh Malaysia Plan, the authorities are prioritizing reforms to improve governance, accelerate innovation, boost productivity, move up the value chain, enhance the wellbeing of the people, and achieve inclusive growth. The new government is reviewing the CPTPP to ensure it will be beneficial to Malaysia, a necessary condition for ratification in the authorities’ view. They are focusing on improving the quality of teachers and design of the curricula and are prioritizing quality over quantity of vocational and technical training. The authorities intend to provide targeted incentives to promote adoption of improved standards under their Industry 4.0 initiative and better integration of R&D. They stressed that, while foreign workers contribute to economic growth, there is also a need to reassess the costs of the high presence of low-skilled foreign workers and the overreliance of certain economic sectors on these workers.

Staff Appraisal

42. The Malaysian economy has shown resilience in recent years. Real GDP growth is moderating towards potential, and there are no evident signs of inflationary pressures presently. The risks to the growth outlook are to the downside. Developments in 2018 suggest that Malaysia’s external position remains stronger than warranted by fundamentals and desired policies. Policy priorities are anchoring governance reforms in appropriate legislation and achieving fiscal consolidation while safeguarding growth and financial stability.

43. Fiscal policy should follow a gradual consolidation path, prioritizing revenue mobilization to create space for social and development spending. The announced medium- term consolidation path is appropriate and should help build fiscal buffers and bolster market confidence without disrupting growth. The adjustment should be embedded in a strengthened fiscal framework and rely on credible revenue and expenditure measures. Given Malaysia’s low tax revenues, revenue mobilization is a priority. It will help finance needed expenditure to achieve government priorities identified under the Mid-Term review of the Eleventh Malaysia Plan and help with external rebalancing.

44. The broadly neutral monetary policy stance is appropriate. Malaysia’s monetary policy framework has performed well, delivering price stability and robust growth in recent years. The broadly neutral stance is appropriate given close-to-potential growth, no underlying inflationary pressures, and still-supportive albeit gradually tightening financial conditions. Domestic economic and financial considerations should continue to guide monetary policy decisions. Given constraints on fiscal policy and limited reserve buffers, exchange rate flexibility remains the recommended first line of defense against shocks and should help further financial market deepening. The December 2016 FX market measures should be gradually phased out with due regard to market conditions.

45. The financial sector appears resilient, but household debt and the real estate market require close monitoring. Bank profitability and liquidity are sound, and NPLs low. The corporate sector is moderately leveraged and appears resilient. While potential spillovers from NBFIs appear limited, BNM’s steps to improve NBFI financial reporting are welcome. Household debt is high compared to peers, with a high share of mortgages and with pockets of vulnerability in lower-income groups. The real estate sector (especially its commercial segment) represents a vulnerability, which requires close monitoring. The residency-based differentiation in the property market measures should be gradually phased out as systemic risks dissipate. The authorities’ ongoing efforts to enhance operational resilience and crisis preparedness are welcome and could be strengthened by a comprehensive review of the overall framework, covering associated facilities and legislation.

46. Fiscal governance reforms and strengthening of anti-corruption institutions are fundamental. It will be important to see through the intended governance reforms and anchor them in legislation. This is particularly needed to secure the independence of anti-corruption institutions and appropriate separation of powers. Legislative reforms are needed on freedom of information, political financing law, and declaration of assets. The authorities should avoid future tax refund arrears, improve financial oversight of SOEs, enhance the effectiveness of the AML/CFT framework, and consider adopting all staff’s past recommendations regarding public investment management.

47. The emphasis on raising productivity and inclusive development is welcome. The government is rightly prioritizing inclusive and balanced regional development, improving human capital, boosting environmental sustainability, and putting economic growth on a strong, sustainable footing. Priority should be given to increasing female labor force participation and productivity by, among others: (i) improving education; (ii) accelerating innovation and technology adoption; and (iii) encouraging a move up the value chain.

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

Table 1.Malaysia: Selected Economic and Financial Indicators, 2014–20
Nominal GDP (2018, est.): US$353.6 billionPopulation (2018, mid-year): 32.4 million
GDP per capita (2018, current prices, est.): US$10,919Poverty rate (2016, national poverty line): 0.4 percent
Unemployment rate (August 2018): 3.4 percentAdult literacy rate (2017): 95.9 percent
Main goods exports (share in total, 2017): electrical & electronics (36.7 percent), commodities (13.6 percent), and petroleum products (7.7 percent).
EstProj.
2014201520162017201820192020
Real GDP (percent change)6.05.14.25.94.74.74.8
Total domestic demand5.36.04.56.64.65.14.8
Private consumption7.06.06.07.07.36.85.8
Public consumption4.44.50.95.40.80.20.6
Private investment11.16.34.39.34.45.56.0
Public gross fixed capital formation-4.7-1.1-0.50.1-1.6-2.51.1
Net exports (contribution to growth, percentage points)1.2-0.30.1-0.20.50.00.3
Saving and investment (in percent of GDP)
Gross domestic investment25.025.125.825.624.524.224.2
Gross national saving29.428.228.328.526.726.025.8
Fiscal sector (in percent of GDP) 1/
Federal government overall balance-3.4-3.2-3.1-3.0-3.7-3.4-3.0
Revenue19.918.917.316.316.617.215.0
Expenditure and net lending23.322.120.419.320.318.218.0
Tax refunds (Arrears) 2/2.4
Federal government non-oil primary balance-7.3-5.2-3.5-3.5-5.2-6.6-4.1
Consolidated public sector overall balance 3/-7.4-7.7-5.1-3.2-5.5-5.8-5.1
General government debt 3/56.257.956.655.256.356.556.0
Of which: federal government debt52.754.452.750.751.952.151.5
Inflation and unemployment (annual average, in percent)
CPI inflation3.22.12.13.71.02.22.6
CPI inflation (excluding food and energy) 4/2.13.22.61.60.41.22.4
Unemployment rate2.93.23.53.43.43.43.4
Macrofinancial variables (end of period)
Broad money (percentage change) 5/6.33.02.74.85.5
Credit to private sector (percentage change) 5/9.28.65.35.46.0
Credit-to-GDP ratio (in percent) 4/6/130.1134.6133.9128.3129.1
Credit-to-GDP gap (in percent) 4/6/12.713.59.42.52.6
Overnight policy rate (in percent)3.253.253.003.003.25
Three-month interbank rate (in percent)3.93.83.43.53.7
Nonfinancial corporate sector debt (in percent of GDP)98.6106.7109.5102.8104.3
Nonfinancial corporate sector debt issuance (in percent of GDP)3.22.63.23.43.7
Household debt (in percent of GDP)86.188.487.883.883.0
Household financial assets (in percent of GDP)182.1183.1181.5177.6
House prices (percentage change)9.47.47.16.5
Exchange rates (period average)
Malaysian ringgit/U.S. dollar3.273.914.154.304.04
Real effective exchange rate (percentage change)-0.7-7.9-4.3-1.74.1
Balance of payments (in billions of U.S. dollars) 4/
Current account balance14.89.07.29.47.76.56.4
(In percent of GDP)4.43.02.43.02.21.81.6
Goods balance34.628.024.627.230.729.831.3
Services balance-3.3-5.3-4.6-5.3-6.6-6.5-6.9
Income balance-16.5-13.7-12.8-12.5-16.5-16.9-18.0
Capital and financial account balance-24.3-14.50.00.92.35.57.0
Of which: Direct investment-5.5-0.53.33.84.14.34.6
Errors and omissions-1.76.4-5.8-6.4-11.00.00.0
Overall balance-11.21.01.43.8-1.012.013.4
Gross official reserves (US$ billions) 4/115.995.394.5102.4101.4113.4126.8
(In months of following year’s imports of goods and nonfactor services)7.56.35.65.85.55.96.2
(In percent of short-term debt by original maturity)111.6116.2112.5109.9105.8112.1121.1
(In percent of short-term debt by remaining maturity)78.374.472.672.570.476.182.3
Total external debt (in billions of U.S. dollars) 4/213.4195.0204.2218.3221.1225.9233.2
(In percent of GDP)63.165.768.869.462.561.058.7
Of which: short-term (in percent of total, original maturity)48.742.041.242.743.444.844.9
short-term (in percent of total, remaining maturity)69.465.763.764.765.166.066.0
Debt service ratio 4/
(In percent of exports of goods and services) 7/17.921.523.421.021.321.120.5
(In percent of exports of goods and nonfactor services)19.122.724.822.222.522.321.7
Memorandum items:
Nominal GDP (in billions of ringgit)1,1061,1591,2311,3531,4271,5221,633
Sources: Data provided by the authorities; CEIC Data Co. Ltd.; World Bank; UNESCO; and IMF, Integrated Monetary Database and staff estimates.

Cash basis. The authorities plan to adopt accrual basis by 2021. For 2019, overall and primary balance includes the payment of outstanding tax refund (arrears) amounting to RM37 billion.

Tax refunds in 2019 are allocated for payment of outstanding tax refunds.

Consolidated public sector includes general government and nonfinancial public enterprises (NFPEs). General government includes federal government, state and local governments, and statutory bodies.

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

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

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.

Includes receipts under the primary income account.

Sources: Data provided by the authorities; CEIC Data Co. Ltd.; World Bank; UNESCO; and IMF, Integrated Monetary Database and staff estimates.

Cash basis. The authorities plan to adopt accrual basis by 2021. For 2019, overall and primary balance includes the payment of outstanding tax refund (arrears) amounting to RM37 billion.

Tax refunds in 2019 are allocated for payment of outstanding tax refunds.

Consolidated public sector includes general government and nonfinancial public enterprises (NFPEs). General government includes federal government, state and local governments, and statutory bodies.

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

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

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.

Includes receipts under the primary income account.

Table 2.Malaysia: Indicators of External Vulnerability, 2014–18
20142015201620172018 2/
Financial indicators
General government debt (in percent of GDP) 1/56.257.956.655.256.2
Broad money (end of period, year-on-year percent change) 3/6.33.02.74.85.7
Private sector credit (end of period, year-on-year percent change) 3/9.28.65.35.46.3
3-month interest rate (percent, 12-month average) 4/3.53.73.63.43.7
External indicators 5/
Goods exports, f.o.b. (percent change, 12-month basis, in U.S. dollars terms) 6/2.5-15.9-5.113.310.5
Goods imports, f.o.b. (percent change, 12-month basis, in U.S. dollars terms) 6/0.6-15.2-3.713.810.4
Current account balance (12-month basis, in billions of U.S. dollars) 6/14.89.07.29.48.3
Current account balance (12-month basis, in percent of GDP)4.43.02.43.02.3
Capital and financial account balance (12-month basis, in billions of U.S. dollars) 6/-24.3-14.50.0-1.14.6
Gross official reserves (in billions of U.S. dollars)115.995.394.5102.4101.4
In months of following year’s imports of goods and nonfactor services 6/7.56.35.65.55.3
As percent of broad money 3/6/26.826.226.424.723.6
As percent of monetary base 3/6/325.7297.9300.1281.2268.1
Total short-term external debt by: 6/7/
Original maturity (in billions of U.S. dollars)103.982.084.093.295.5
Remaining maturity (in billions of U.S. dollars)148.0128.1130.2141.2142.8
Original maturity to reserves (in percent)89.686.088.991.094.2
Original maturity to total external debt (in percent)48.742.041.242.743.7
Remaining maturity to reserves (in percent)127.7134.4137.7137.9140.8
Remaining maturity to total external debt (in percent)69.465.763.764.765.3
Total external debt (in billions of U.S. dollars) 6/7/213.4195.0204.2218.3218.6
Of which: public sector (medium- and long-term (MLT))69.770.172.274.870.3
Total external debt to exports of goods and services (in percent) 6/8/80.487.996.192.184.0
External amortization of MLT debt to exports of goods and services (in percent) 6/8/16.519.921.719.518.5
Financial market indicators
Kuala Lumpur Composite Index (KLCI), end of period1,7611,6931,6421,7971,691
10-year government securities yield (percent per annum, average)4.04.03.84.04.1
Sources: Haver Analytics; CEIC Data Co. Ltd.; data provided by the authorities; and IMF, Integrated Monetary Database and staff estimates.

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

Latest available data or IMF staff estimates.

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.

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

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

Latest available data or IMF staff estimates.

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, 2014–23 1/
Est.Proj.
2014201520162017201820192020202120222023
(In billions of U.S. dollars)
Current account balance14.89.07.29.47.76.56.45.44.03.0
Goods balance34.628.024.627.230.729.831.332.332.432.6
Exports, f.o.b.207.4174.4165.6187.7197.9204.3215.1226.5237.3248.0
Imports, f.o.b.172.8146.5141.0160.5167.2174.5183.8194.2204.9215.3
Services balance-3.3-5.3-4.6-5.3-6.6-6.5-6.9-7.7-8.5-9.3
Receipts42.034.835.637.038.439.841.342.944.646.4
Payments45.340.140.142.344.946.248.250.653.155.7
Primary income-11.2-8.2-8.3-8.5-12.0-12.1-13.0-13.7-14.0-14.0
Secondary income-5.3-5.5-4.5-4.0-4.5-4.7-5.1-5.5-5.9-6.3
Capital and financial account balance-24.3-14.50.00.92.35.57.08.910.912.7
Capital account0.1-0.30.00.00.00.00.00.00.00.0
Financial account-24.4-14.2-0.10.92.35.57.08.910.912.7
Direct investment-5.5-0.53.33.84.14.34.65.05.45.7
Portfolio investment-12.0-6.7-3.4-2.9-7.50.81.72.43.63.9
Other investment-6.9-7.00.00.05.70.40.61.51.93.1
Errors and omissions-1.76.4-5.8-6.4-11.00.00.00.00.00.0
Overall balance-11.21.01.43.8-1.012.013.414.314.915.7
Gross official reserves115.995.394.5102.4101.4113.4126.8141.1156.0171.7
In months of following year’s imports of goods and nonfactor services7.56.35.65.85.55.96.26.66.97.2
In percent of short-term debt 2/78.374.472.672.570.476.182.387.992.496.2
(In percent of GDP)
Current account balance4.43.02.43.02.21.81.61.30.90.6
(Excluding crude oil and liquefied natural gas)-1.7-1.7-1.0-0.7-1.2-1.6-1.9-2.1-2.4-2.5
Goods balance10.29.48.38.68.78.17.97.67.16.6
Exports, f.o.b.61.458.855.859.656.055.254.253.151.750.3
Imports, f.o.b.51.149.447.551.047.347.246.345.544.743.7
Services balance-1.0-1.8-1.5-1.7-1.9-1.8-1.7-1.8-1.9-1.9
Primary income-3.3-2.8-2.8-2.7-3.4-3.3-3.3-3.2-3.0-2.8
Secondary income-1.6-1.8-1.5-1.3-1.3-1.3-1.3-1.3-1.3-1.3
Capital and financial account balance-7.2-4.90.00.30.61.51.82.12.42.6
Direct investment-1.6-0.21.11.21.11.21.21.21.21.2
(Annual percentage change)
Memorandum items:
Goods trade
Exports, f.o.b., value growth (in U.S. dollars) 1/2.5-15.9-5.113.35.53.35.35.34.84.5
Export volume growth6.66.03.310.82.13.94.84.54.13.9
Imports, f.o.b., value growth (in U.S. dollars) 1/0.6-15.2-3.713.84.24.45.35.75.55.1
Import volume growth4.11.30.512.80.64.94.84.94.84.5
Terms of trade-1.4-3.4-3.31.1-0.2-0.20.0-0.1-0.1-0.1
Net international investment position 1/
(In billions of U.S. dollars)-5.025.415.6-6.2
(In percent of GDP)-1.58.65.3-2.0
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.

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.

Table 4.Malaysia: Illustrative Medium-Term Macroeconomic Framework, 2014–23 1/
EstProj.
2014201520162017201820192020202120222023
Real sector (percent change)
Real GDP growth6.05.14.25.94.74.74.84.84.84.8
Total domestic demand5.36.04.56.64.65.14.85.25.45.3
Output gap (in percent) 2/0.10.3-0.20.60.40.20.10.10.10.0
Consumer prices (period average)3.12.12.13.81.02.22.62.52.42.3
Consumer prices, excluding food and energy (period average) 2/2.13.22.61.60.41.22.42.32.11.9
GDP deflator2.5-0.42.03.80.71.92.42.42.32.3
Saving and investment (in percent of GDP)
Gross domestic investment25.025.125.825.624.524.224.224.224.324.3
Private, including stocks15.616.217.317.617.017.317.417.717.918.1
Of which: gross fixed capital formation16.617.117.217.417.417.517.818.018.218.4
Public9.49.08.67.97.57.06.76.66.46.2
Gross national saving29.428.228.328.526.726.025.825.525.124.9
Private 3/24.923.621.921.321.820.122.121.921.521.3
Public 3/4.54.66.37.24.95.93.63.63.73.6
Fiscal sector (in percent of GDP)
Federal government
Revenue19.918.917.316.316.617.215.014.914.814.7
Tax14.814.313.813.112.211.611.611.511.511.4
Nontax5.14.63.53.24.35.63.43.43.33.3
Expenditure and net lending23.322.120.419.320.318.218.017.817.717.6
Current19.718.617.016.016.514.614.614.514.414.3
Development3.63.53.43.23.83.63.43.43.43.4
Overall balance-3.4-3.2-3.1-3.0-3.7-3.4-3.0-3.0-2.9-2.9
Cyclically-adjusted balance (in percent of potential GDP) 2/-3.7-2.7-2.6-3.0-4.9-2.9-2.9-3.0-2.9-3.0
Nonoil and gas primary balance-7.3-5.2-3.5-3.5-5.2-6.6-4.1-4.0-3.8-3.7
Federal government debt52.754.452.750.751.952.151.551.050.450.0
General government and consolidated public sector
Consolidated public sector overall balance 4/-7.4-7.7-5.1-3.2-5.5-5.8-5.1-5.1-5.1-5.1
General government debt 5/56.257.956.655.256.356.556.055.454.854.4
Balance of payments (in billions of U.S. dollars) 2/
Goods balance34.628.024.627.230.729.831.332.332.432.6
Services balance-3.3-5.3-4.6-5.3-6.6-6.5-6.9-7.7-8.5-9.3
Income balance-16.5-13.7-12.8-12.5-16.5-16.9-18.0-19.1-19.8-20.3
Current account balance14.89.07.29.47.76.56.45.44.03.0
(In percent of GDP)4.43.02.43.02.21.81.61.30.90.6
Capital and financial account balance-24.3-14.50.00.92.35.57.08.910.912.7
Of which : Direct investment-5.5-0.53.33.84.14.34.65.05.45.7
Errors and omissions-1.76.4-5.8-6.4-11.00.00.00.00.00.0
Overall balance-11.21.01.43.8-1.012.013.414.314.915.7
International trade in goods (annual percent change) 2/
Goods exports, f.o.b. (in U.S. dollars terms)2.5-15.9-5.113.35.53.35.35.34.84.5
Goods imports, f.o.b. (in U.S. dollars terms)0.6-15.2-3.713.84.24.45.35.75.55.1
Terms of trade-1.4-3.4-3.31.1-0.2-0.20.0-0.1-0.1-0.1
Gross official reserves (in billions of U.S. dollars)115.995.394.5102.4101.4113.4126.8141.1156.0171.7
(In months of following year’s imports of goods and nonfactor services)7.56.35.65.85.55.96.26.66.97.2
(In percent of short-term debt by original maturity) 2/111.6116.2112.5109.9105.8112.1121.1128.9135.1139.5
(In percent of short-term debt by remaining maturity) 2/78.374.472.672.570.476.182.387.992.496.2
Total external debt (in billions of U.S. dollars) 2/213.4195.0204.2218.3221.1225.9233.2242.4254.6267.3
(In percent of GDP) 2/63.165.768.869.462.561.058.756.855.554.2
Short-term external debt (percent of total, original maturity) 2/48.742.041.242.743.444.844.945.145.346.0
Short-term external debt (percent of total, remaining maturity) 2/69.465.763.764.765.166.066.066.266.366.8
Debt-service ratio 2/
(In percent of exports of goods and nonfactor services)19.122.724.822.222.522.321.721.721.421.3
Net international investment position (in billions of U.S. dollars) 2/-5.025.415.6-6.2
Memorandum items:
Nominal GDP (in billions of ringgit)1,1061,1591,2311,3531,4271,5221,6331,7531,8812,016
Sources: Data provided by the authorities; and IMF staff estimates.

Period ending December 31.

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

For 2013 and 2014, based on data published by Department of Statistics, Malaysia. IMF staff estimates are used 2015 onward.

Capital expenditure in the budget includes foreign fixed assets and other items, such as purchases of shares and land, which are excluded from public investment in the national accounts.

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

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

Period ending December 31.

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

For 2013 and 2014, based on data published by Department of Statistics, Malaysia. IMF staff estimates are used 2015 onward.

Capital expenditure in the budget includes foreign fixed assets and other items, such as purchases of shares and land, which are excluded from public investment in the national accounts.

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

Table 5.Malaysia: Summary of Federal Government Operations and Stock Positions, 2014–23
Est.Proj.
20142015201620172018bdgt201820192020202120222023
I. Statement of Government Operations 1/(In billions of ringgit)
Revenue220.6219.1212.4220.4239.9236.5261.8244.4260.6278.4296.0
Taxes164.2165.4169.3177.7191.6174.7176.2188.9201.5215.6229.3
Direct taxes126.7111.8109.6116.0127.7133.5135.1144.8154.1164.6174.4
Indirect taxes37.553.759.761.663.941.241.144.147.451.054.9
Non-tax revenue56.453.643.142.748.361.885.755.559.162.866.7
Investment income33.832.821.421.624.636.959.530.732.734.937.2
Other revenue22.720.821.721.123.724.826.124.826.427.929.5
Expenditure and net lending258.0256.3250.8260.7279.7289.8276.9293.2312.7333.3355.4
Expense217.8215.3209.5217.2233.7234.9222.2238.2253.6269.9287.4
Compensation of employees66.970.173.177.079.181.382.086.791.295.8100.7
Use of goods and services34.336.430.134.733.636.529.131.233.535.938.5
Interest22.624.326.527.930.930.933.033.736.940.344.2
Subsidies39.727.324.722.426.528.122.323.625.126.628.2
Grants and transfers34.637.333.231.337.831.227.531.833.836.338.3
Social benefits and other expense19.720.021.923.825.626.928.331.033.135.037.5
Net acquisition of nonfinancial assets 2/40.341.041.343.546.054.954.755.159.163.468.0
Gross operating balance2.83.82.93.26.21.639.66.27.08.58.6
Net lending/borrowing-37.4-37.2-38.4-40.3-39.8-53.3-15.1-48.8-52.2-54.9-59.4
Tax refunds (Arrears) 3/-37.0
Overall fiscal balance (authorities’ definition) 1/-37.4-37.2-38.4-40.3-39.8-53.3-52.1-48.8-52.2-54.9-59.4
(In percent of GDP)
Revenue19.918.917.316.316.616.617.215.014.914.814.7
Taxes14.814.313.813.113.212.211.611.611.511.511.4
Direct taxes11.59.68.98.68.89.48.98.98.88.88.7
Indirect taxes3.44.64.94.64.42.92.72.72.72.72.7
Non-tax revenue5.14.63.53.23.34.35.63.43.43.33.3
Investment income3.12.81.71.61.72.63.91.91.91.91.8
Other revenue2.01.81.81.61.61.71.71.51.51.51.5
Expenditure and net lending23.322.120.419.319.320.318.218.017.817.717.6
Expense19.718.617.016.016.216.514.614.614.514.414.3
Compensation of employees6.16.05.95.75.55.75.45.35.25.15.0
Use of goods and services3.13.12.42.62.32.61.91.91.91.91.9
Interest2.02.12.22.12.12.22.22.12.12.12.2
Subsidies3.62.42.01.71.82.01.51.41.41.41.4
Grants and transfers3.13.22.72.32.62.21.81.91.91.91.9
Social benefits and other expense1.81.71.81.81.81.91.91.91.91.91.9
Net acquisition of nonfinancial assets 2/3.63.53.43.23.23.83.63.43.43.43.4
Gross operating balance0.30.30.20.20.40.12.60.40.40.50.4
Net lending/borrowing-3.4-3.2-3.1-3.0-2.8-3.7-1.0-3.0-3.0-2.9-2.9
Tax refunds (Arrears) 3/-2.4
Overall fiscal balance (authorities’ definition) 1/-3.4-3.2-3.1-3.0-2.8-3.7-3.4-3.0-3.0-2.9-2.9
II. Stock Positions(In billions of ringgit)
Federal government debt582.8630.5648.5686.8741.1793.0841.7893.8948.61,008.0
(In percent of GDP)52.754.452.750.751.952.151.551.050.450.0
By instrument
Domestic debt566.1609.1624.8665.6719.5
Offshore borrowing16.821.523.721.321.6
By holder residence
Domestic415.3436.9438.2484.0535.9
Foreign167.5193.6210.2202.8205.2
Memorandum items:
Structural balance (percent of potential GDP) 4/-3.7-2.7-2.6-3.0-4.9-2.9-2.9-3.0-2.9-3.0
Structural primary balance (percent of potential GDP) 4/-1.6-0.6-0.5-1.0-2.7-0.7-0.9-0.9-0.8-0.8
Primary balance (percent of GDP)-1.3-1.1-1.0-0.9-1.6-1.3-0.9-0.9-0.8-0.8
Nonoil and gas primary balance (percent of GDP) 4/-7.3-5.2-3.5-3.5-5.2-6.6-4.1-4.0-3.8-3.7
Oil and gas revenues (percent of GDP)6.04.12.52.63.65.33.23.13.02.9
General government revenue (percent of GDP) 5/23.722.520.419.419.420.017.817.717.617.5
General government expenditure (percent of GDP) 5/26.325.123.021.923.020.620.320.220.120.1
General government balance (percent of GDP) 5/-2.7-2.6-2.6-2.4-3.6-3.0-2.6-2.6-2.5-2.6
Public sector balance (percent of GDP)-7.4-7.7-5.1-3.2-5.5-5.8-5.1-5.1-5.1-5.1
Nominal GDP (in billions of ringgit)1,1061,1591,2311,3531,4471,4271,5221,6331,7531,8812,016
Sources: Data provided by the Malaysian authorities; and IMF staff estimates.

Cash basis. The authorities plan to adopt accrual basis by 2021.

Net acquisition of nonfinancial assets include lending and loan repayment to and from other government related entities.

Tax refunds in 2019 are allocated for payment of outstanding tax refunds.

Structural (primary) balance removes one-off revenues and tax refunds in 2019, while nonoil and gas primary balance does not exclude tax refunds in 2019.

General government includes federal government, state and local governments, and statutory bodies. Public sector includes general government and nonfinancial public enterprises (NFPEs).

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

Cash basis. The authorities plan to adopt accrual basis by 2021.

Net acquisition of nonfinancial assets include lending and loan repayment to and from other government related entities.

Tax refunds in 2019 are allocated for payment of outstanding tax refunds.

Structural (primary) balance removes one-off revenues and tax refunds in 2019, while nonoil and gas primary balance does not exclude tax refunds in 2019.

General government includes federal government, state and local governments, and statutory bodies. Public sector includes general government and nonfinancial public enterprises (NFPEs).

Table 6.Malaysia: Monetary Survey, 2014–20 1/
Est.Proj.
2014201520162017201820192020
(In billions of ringgit; end of period)
Net foreign assets326.0359.7361.2347.3348.3395.1442.3
Foreign assets579.3592.8584.6583.3595.9645.3699.3
Foreign liabilities253.3233.1223.4236.0247.6250.2257.0
Net domestic assets1,200.21,213.71,254.21,380.01,470.71,542.31,632.8
Net domestic credit1,521.81,640.91,749.91,857.21,973.32,102.72,250.1
Net credit to nonfinancial public sector121.1121.8142.2161.7176.1190.3203.7
Net credit to central government101.0105.0125.3144.4158.8172.8186.0
Net credit to state & local government1.41.21.01.92.02.22.3
Net credit to nonfinancial corporations18.815.615.915.415.315.315.3
Credit to private sector1,334.11,448.91,525.21,607.41,704.41,813.31,940.1
Net credit to other financial corporations66.570.282.588.192.999.1106.3
Capital accounts293.0375.2413.7423.2443.2463.2483.2
Other items (net)-28.7-52.0-81.9-53.9-59.4-97.2-134.0
Broad money 2/1,517.01,563.11,605.11,681.51,773.21,891.62,029.3
Narrow money374.5399.0419.5449.9474.4506.1543.0
Currency in circulation68.076.685.592.398.7105.3112.9
Transferable deposits306.4322.4334.0357.5375.7400.8430.0
Other deposits1,111.61,142.01,160.91,199.41,281.91,367.51,467.0
Securities other than shares30.922.124.632.216.918.019.3
(Contributions to 12-month growth in broad money, in percentage points)
Net foreign assets-0.82.20.1-0.90.12.62.5
Net domestic assets7.00.92.67.85.44.04.8
Memorandum items:
Broad money (12-month percent change)6.33.02.74.85.56.77.3
Currency in circulation (12-month percent change)8.512.711.58.16.96.77.3
Credit to private sector (12-month percent change)9.28.65.35.46.06.47.0
Money multiplier (broad money/narrow money)4.13.93.83.73.73.73.7
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.

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.

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.

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, 2014–18
20142015201620172018 Q2
(In percent; end of period)
Capital adequacy
Regulatory capital to risk-weighted assets15.416.316.517.117.0
Regulatory Tier 1 capital to risk-weighted assets13.413.914.014.313.5
Asset quality
Nonperforming loans net of provisions to capital 1/7.06.86.76.25.7
Nonperforming loans to total gross loans1.61.61.61.51.6
Total provisions to nonperforming loans95.588.884.684.684.6
Earnings and profitability
Return on assets1.51.21.31.41.5
Return on equity15.012.312.313.113.4
Interest margin to gross income61.061.861.061.158.6
Non-interest expenses to gross income43.046.744.043.141.3
Liquidity
Liquid assets to total assets (liquid asset ratio)13.322.121.222.523.9
Liquid assets to short-term liabilities43.2141.8134.5142.0151.7
Loan-deposit ratio 2/86.788.689.889.689.2
Liquidity Coverage Ratio 3/125.1124.3134.9139.3
Sensitivity to market risk
Net open position in foreign exchange to capital13.212.513.110.310.2
Sectoral distribution of total loans to nonbanking sector
Residents96.996.997.397.097.0
Other financial corporations2.83.13.43.33.0
General government1.71.41.61.92.0
Nonfinancial corporations36.836.936.735.936.0
Other domestic sectors55.655.555.556.055.9
Nonresidents3.13.12.73.03.0
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.

Deposits exclude those accepted from banking institutions and Bank Negara Malaysia. Loans exclude loans sold to Cagamas Berhad and loans extended to banking institutions. Beginning July 2015, loans exclude financing funded by Islamic Investment Accounts.

Introduced in July 2015.

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.

Deposits exclude those accepted from banking institutions and Bank Negara Malaysia. Loans exclude loans sold to Cagamas Berhad and loans extended to banking institutions. Beginning July 2015, loans exclude financing funded by Islamic Investment Accounts.

Introduced in July 2015.

Appendix I. External Sector Assessment
MalaysiaOverall Assessment
Foreign asset and liability position and trajectoryBackground. Malaysia’s net international investment position (NIIP), as a percent of GDP, averaged 1.2 percent of GDP since 2010, with changes in recent years reflecting both capital flows and valuation effects. In 2018Q3, the NIIP was at about -7.9 percent of GDP (end-2017: about -2.0 percent of GDP), with higher net direct investment and other investment liabilities more than offsetting the reduction of net portfolio capital liabilities.1/ Official reserves contribute most to net assets, while net portfolio liabilities contribute most to net liabilities. Total external debt, measured in U.S. dollars, was at about 65.4 percent of GDP in 2018: Q3 (end-2017: about 70 percent of GDP), of which about two-thirds was in foreign currency and 46 percent in short-term debt.

Assessment. The NIIP should rise gradually over the medium term reflecting projected moderate current account (CA) surpluses. Malaysia’s balance sheet strength, along with exchange rate flexibility and increased domestic investor participation, would help support resilience to a variety of shocks, including outflows associated with external liabilities. 2/
Overall Assessment

The external position in 2018 is assessed to remain stronger than the level consistent with fundamentals and medium-term desirable policies. The current account surplus, as a ratio to GDP, is projected to be lower than its 2017 level, following an increase in income account deficit and strong domestic private demand.

Potential Policy Responses

Over the past few years Malaysia’s growth model has become increasingly driven by domestic demand, and its current account surplus has narrowed significantly. Going forward, continued exchange rate flexibility, improved government spending, and structural policies should address the existing policy gaps.

Spending needs should accommodate further improvements in social protection and public healthcare. At the same time, addressing structural bottlenecks (for example, labor market frictions in terms of skills mismatch; low female labor participation; and weak education quality) and improving the quality of infrastructure, supported by enhanced public finance management, would help support higher private investment and productivity growth.
Current accountBackground. Malaysia’s CA surplus has declined by about 7 percentage points of GDP between 2010 and 2017, driven mainly by a decline in national saving, while investment also rose. In the first three quarters of 2018 the CA surplus narrowed to 2.2 percent of GDP, down from 3 percent of GDP in 2017. Trade balance remains the main contributor to Malaysia’s overall CA surplus, with export growth supported by continued demands from Malaysia’s major trade partners in the region and import growth by re-export activities. Services and income accounts register larger deficits. In 2018, the CA surplus is estimated at 2.1 percent of GDP.

Assessment. The EBA CA regression (November 2018 vintage) estimates the 2018 CA norm at 0.0 percent of GDP after cyclical and multilateral consistency adjustments. The 2018 cyclically adjusted CA is estimated at about 2.2 percent of GDP. This leads to an estimated 2018 CA gap of 2.2 percent of GDP (±about 1 percent of GDP). Unidentified residuals explain the entire CA gap, potentially reflecting structural distortions and country-specific factors not included in the model. Identified domestic policy gaps have offsetting effect. While low public healthcare spending contributes to the excess surplus, FX intervention that helped to prevent further currency depreciation reduces the surplus. The CA balance is expected to remain in surplus, albeit a lower one, over the medium term, driven by smaller private sector net saving.3/
Actual CA2.2Cycl. Adj. CA2.2EBA CA Norm0.0EBA CA Gap2.2Staff Adj.0.0Staff CA Gap2.2
Real exchange rateBackground. In 2018, average real effective exchange rate (REER) was appreciated by 4.1 percent. However, it had depreciated nearly 3.5 percent since April 2018. The REER is about 10 percent lower than its 2013 level, reflecting impact on the NEER from capital outflows and terms of trade shocks, with the latter contributing to a decline in the CA surplus. 4/Assessment. The EBA REER models estimate Malaysia’s REER to be about 26–29 percent below what is warranted by fundamentals and desirable policies. However, the usual macroeconomic stresses associated with such undervaluation are absent, for example, high core inflation, sustained wage pressure, or significant FX reserve build up. Consistent with the assessed CA gap, staff assesses the REER gap in 2018 was close to -4.8 percent (± about 2 percent).5/
Capital and financial accounts: flows and policy measuresBackground. Since the Global Financial Crisis, Malaysia experienced significant capital flow volatility, largely driven by portfolio flows in and out of the local-currency debt market. In 2017, the annual financial account balance was in a small surplus for the first time since 2011. Following the tightening of global financial conditions and general elections in spring 2018, Malaysia experienced intensified portfolio outflows from the Malaysian government debt market and equity market in the second quarter of 2018. Since late 2016, the Financial Markets Committee has implemented measures to develop the onshore FX market.6/

Assessment. Exchange rate flexibility and macroeconomic policy adjustments should continue to play the central role in response to capital flow volatility. The capital flow management measures should be gradually phased out, with due regard to market conditions.
FX intervention and reserves levelBackground. During the first four months of 2018, gross official reserves increased by US$7.1 billion to US$109.5 billion as of end-April 2018. However, reserves have dropped by US$8.1 billion since then and stood at US$101.4 billion as of end-2018. In the past years, Malaysia faced significant reserve losses in 2014 and 2015 and a slight decrease in 2016 and witnessed an increase of nearly US$8 billion in 2017.

Assessment. Under the IMF’s composite reserve adequacy metric (ARA) 7/, reserves remain broadly adequate. Gross official reserves are about 108 percent of the ARA metric as of end 2018, but reserves adjusted for net forwards positions are below 100 percent of the ARA metric. Given limited reserves and the increased hedging opportunities since 2017, FX interventions should be limited to preventing disorderly market conditions.
Technical Background Notes1/ The ratios to GDP are based on staff estimates using U.S. dollar values and may vary with the authorities’ data mainly due to different exchange rate assumptions for converting the nominal GDP in U.S. dollar terms.

2/ Close to one-third of external debt is denominated in local currency and largely of medium-term maturity, helping to reduce FX and rollover risks. Malaysia’s local currency external debt reflects holdings of domestically-issued debt (mainly Malaysian Government Securities-MGS) by nonresident investors (about 13 percent of GDP as of 2018Q3). Short-term FX-denominated debt largely belongs to the banking system and a good portion is matched by short-term foreign currency assets, which is being closely supervised by Bank Negara Malaysia, including through frequent liquidity stress tests. Stress test analysis by staff suggests that the Malaysian economy could be resilient to a large reversal due to the depth of the domestic financial markets and the role of institutional investors.

3/ Preliminary assessment, given the reliance on staff estimates of the 2018 CA balance and explanatory variables. The estimated 2018 EBA norm is 0.6 percentage point lower than the 2017 norm, largely reflecting a decrease in the net foreign assets (NFA) and a larger debt stabilizing fiscal deficit.

4/ Since 2000, movements in the REER have been driven largely by the nominal exchange rate rather than inflation differentials. In 2018, the average NEER was about 5.2 percent appreciated.

5/ The REER gap is based on the estimated semi-elasticity of CA to REER at -0.46. The elasticity estimate has been updated from the last assessment. It is based on cross-country estimates of exports and imports elasticities obtained from the IMF’s Consultative Group on Exchange Rates (CGER), adjusting for updates to Malaysia’s trade openness and share of commodity exports.

6/ On December 2, 2016, the Financial Markets Committee (FMC) announced a package of measures aimed at facilitating onshore FX risk management and enhancing the depth and liquidity of onshore financial markets. Two of these measures were classified as capital flow management measures under the IMF’s Institutional View on capital flows. In addition, the authorities’ strengthened enforcement of regulations on resident banks’ non-involvement in offshore ringgit transactions was considered as enhanced enforcement of an existing capital flow management measure. In April, September, and November 2017, additional measures were announced to help deepen the onshore financial market and facilitate currency risk management.

7/ The IMF’s composite reserve adequacy metric uses a binary classification of the exchange rate regime and classifies Malaysia’s regime as “floating” since 2016.
Appendix II. Corporate Savings in Malaysia1

A. Introduction

1. IMF analysis suggests that Malaysia’s current account (CA) surplus is higher than warranted by medium-term fundamentals and desired policies. National income account data up to 2015 suggest that private nonfinancial corporations could be a significant contributor to the CA surplus, followed by private financial firms. Given the importance of private nonfinancial corporations in Malaysia’s national savings, staff undertook an analysis of these savings to understand their history and identify their drivers.

2. Leveraging firm-level data for listed firms, we focus on the contribution to the CA surplus of private nonfinancial corporations. Specifically, we aim to understand:

  • Which categories of corporations are contributing most to national savings? How do corporate savings evolve over time?

  • From an accounting perspective, what factors explain saving behavior? What are the economic drivers of corporate savings?

  • Are those savings excessive in light of the underlying determinants?

B. Stylized Facts Based on National Income Account Data

3. From a global perspective, the corporate sector has shifted from a net borrower to a net saver (Chen et al., 2017 JME). This rise in gross savings does not seem to have led to an increase in capital investment, but a larger holding of liquid financial assets (cash).

4. In Malaysia, aggregate net savings have been on a declining trend since 2006, with non-financial corporates being the largest contributor. The contributions of the corporate sector to the CA surplus are partially offset by dissaving by the public sector and households2 & non-profit institutions. Listed firms tend to invest more than non-listed firms, possibly reflecting their easier access to external finance.

Decomposition of Aggregate Net Saving

(In percent of GDP)

Aggregate Saving by Non-listed Firms

(In percent of GDP)

C. Firm Level Analysis

5. We employ balance sheet and income statement data for 1400 publicly listed firms in Malaysia over the period of 2000–2017 (currently about 940 active, total assets about 170 percent of GDP), drawing from the Thompson WorldScope Database. As the interpretation of saving and investment flows for financial firms is different from that for non-financial corporations, this study focuses only on the financing decisions of non-financial corporations (see Fama and French, 2001; and DeAngelo et al., 2004). An important drawback is that the WorldScope database does not include information on non-listed firms, which might have different motivations for saving than listed-firms. Key variables of interest are defined as follows:

  • Profit = Gross Operating Surplus – Taxes on Profits – Interest;

  • Gross Saving = Profit — Net Dividends;

  • Net Saving = Gross Saving — Investment.

6. In the study period of 2000–2017, the following overall patterns are worth noting:

  • Most sectors were dissaving3over the period of 2000–2017. Among all non financial corporations, industrials, utilities, and consumer cyclicals are the largest net savers and they share similar saving/investment behaviors. Energy sector, Telecommunications, and other non-categorized firms show significant negative net savings rates as gross savings are more than offset by large scale investments.

  • Gross savings exhibit cyclical fluctuations and investment was positively correlated with gross savings up to 2012. Capital expenditure surged during 2013 and 2014, becoming a main engine of GDP growth, and began to decline thereafter. As a result, net corporate savings rate remained largely stable around zero up to 2012 and entered the negative domain since 2013. It began to pick up since 2015 due to a cyclical upswing of gross savings and the continued decline of investment.

Sectoral Composition of Listed Firms, 2000–2017

(In percent, excluding financial sector)

Sources: WorldScope and IMF staff calculation.

Corporate Net Saving, 2000–2017

(in percent of total asset, excluding financial sector)

Sources: WorldScope and IMF staff calculation.

7. Individual firm-level data confirm that in case of large profits (or, equivalently, cash flows), Malaysian non-financial firms tend to increase their net savings (in the form of cash), as opposed to paying more dividends or increasing investment. The four panels below plot the 10-year trend in percentage point in firm profit against the trends in the main components of it. The area of each circle corresponds to a firm’s average size over the sample period. The top panels show a strong cross-sectional relationship between trends in gross savings rate and trends in profit relative to total asset, partly because of a weak correlation between profit and dividends. The bottom panels show that trends in investment are uncorrelated with trends in profit, leading to a meaningful positive relationship between profit and net savings rate. These conclusions are robust if the 10-year trend is replaced with a 5-year trend.

Firm’s Profit and Saving Trends

Sources: WorldScope and IMF staff calculation.

D. External Financing Dependence—A Proxy for Excess Savings by Corporates

8. Various industries have different dependence on external funds, depending on the technological characteristics of the industry. We define the external financing dependence (EFD) at the industrial level following a two-step process developed by Rajan and Zingales (1998). First, we derive a firm’s EFD by summing the firm’s use of external finance (borrowings and equity issues) over a 10-year period and then divide it by the sum of capital expenditure over the same period, i.e., (CapEx – Opt. CashFlow)/CapEx.4 Then, to summarize the EFDs across all firms in an industry, we use the industry median.5

9. While an industry’s actual dependence on external financing may differ significantly across countries, its desired dependence on external funds is identified using the data on U.S. firms and applied to other countries. This approach is reasonable because: (i) the production functions6 of the same industry are similar across different countries—particularly, an industry in the manufacturing sector is more likely to use similar technologies across different countries than the services sector does; and (ii) capital markets in the United States are relatively frictionless—as a result, the actual amount of external funds raised by a U.S. firm reflects the technological demand for financing, as opposed to supply constraints.

10. The trend analysis above indicates a high dependence of listed firms in Malaysia on internal funds (savings) to finance their investments or, equivalently, a lower dependence on external funds. This is particularly true when we compare the external financing dependence of firms in Malaysia with those firms of the same industries in the U.S. The top panels in figure below show that across a variety of industries, there are significant gaps, in terms of use of external funds, between Malaysia and U.S., 7 particularly among young firms (i.e., less than ten years from listing).8 This is perhaps because firms tend to depend more on external funds at early stage. In addition, as is shown in the bottom panels below, the EFD gaps are largely attributable to the industries with high desired EFDs.9

External Financial Dependence by Industry

(Comparison between Malaysia and United States)

External Financial Dependence by Maturity

(Number of years since IPO)

Sources: WorldScope and IMF staff calculations.

11. Capital expenditure (CapEx) shortfall could be used as a proxy for excess savings by corporates. Taking the cash flow of a firm as given, the firm can generate excess net savings through underinvestment. While paying less dividends could lead to over-saving (gross), it is more reasonable to assume that the investment channel plays a more significant role in understanding corporate’s excess savings. Specifically, the CapEx gap of a firm j in industry i, CapEx Gapij is defined as the amount of investment required to restore its actual capital expenditure, over a 10-year period, to the desired dependence of external financing of industry i, EFDidesired. That is,

Capital Expenditure Gap (excl. Service Sectors, 2000–2017

(In billions of Ringgit, in percent of GDP)

Sources: IMF and WorldScope.

where CapExijdesired=Opt.CashFlowij/(1EFDidesired).10 To make this approach more plausible, we also make a distinction between the EFDidesired for young and old firms in industry i, respectively. Preliminarily calculation shows that the total CapEx gap of all listed firms (excluding the services sector) accounts for 2.8 percent of GDP on average in the period between 2000–2017.

12. Many drivers could help explain why firms raise less funds externally than the desired level. It could reflect either the external financing constraints faced by firms (particularly SMEs) in countries with less developed financial markets, the lack of profitable investment opportunities due to slow productivity growth, weak governance, or policy distortions. A companion selected issues paper explores these possible economic drivers.11

E. Conclusions

13. In the past two decades, Malaysian companies have maintained high net savings rates, contributing to national savings. Micro firm level data suggest that corporate gross savings are procyclical due to procyclical profits and acyclical dividend payments. Increases in gross savings do not lead to higher investment, but rather to a larger holding of liquid financial assets (net savings). In external-financing dependent industries, there is evidence of gaps between the actual and desired level of external financing, particularly among young firms. Using CapEx gap as a proxy, our calculation suggests that industrial firms contribute positively to the current account surplus. A selected issues paper explores possible economic drivers of corporate net savings and CapEx gap.

Appendix III. Staff Policy Advice from the 2017 and 2018 Article IV Consultations
Staff AdvicePolicy Actions
Fiscal Policy
Anchor fiscal policy to the medium-term consolidation objective, with the annual pace of consolidation reflecting evolving economic conditions (2017). Follow a gradual consolidation path and improve the composition of fiscal adjustment by prioritizing revenue measures (2018).The authorities have reset their fiscal consolidation path in the 2019 budget, given a higher deficit outcome in 2018. The path implies gradual consolidation, in line with staff’s advice, and the authorities continue to express commitment to medium-term fiscal consolidation to respect the self-imposed limit of 55 percent of GDP for federal government debt.
Increase tax compliance through increased information sharing between agencies. Improve the international taxation framework to strengthen anti-avoidance rules (2017). Broaden the tax base, including by eliminating GST exemptions. Raise the GST rate (2017, 2018). Reduce investment incentives (which are tax expenditures) (2018).The authorities replaced the GST by the SST, which has narrowed the tax base and created a revenue shortfall. However, they have announced other, albeit small, revenue measures (e.g. increases in excise and property taxes). Also, a Tax Reform Committee was established in September 2018, tasked to carry out a comprehensive review of the Malaysian tax system including tax incentives and will explore new sources of sustainable revenues.
Implement spending reviews. Improve efficiency of public spending through better targeting of social spending, cost recovery in higher education, user fees for health care services, and limiting duplications in transport and tourism programs (2017, 2018). Improve the quality of fiscal adjustment to facilitate external rebalancing (2018)While the authorities have brought back subsidies for lower-grade petroleum in 2018 against staff advice, they have announced the reintroduction of a managed-float fuel price mechanism with targeted subsidies for the low-income group effective 2019. In the 2019 budget, the authorities have also announced a plan to restructure cash assistance (Living Aid Assistance) through better targeting.
Enrich the recently introduced Medium Term Fiscal Framework with more detail (2017, 2018). Fully integrate in the budget preparation process annual fiscal risks statements. Complete the implementation of accrual fiscal accounting (2018)The authorities have announced plans to draft a Fiscal Responsibility Act and move to accrual accounting by 2021 and recognize the need to further improve risk monitoring and enhance fiscal transparency. In the 2019 budget, the authorities enhanced their reporting on federal government guarantees and possible future payment obligations related to PPPs.
Monetary, Exchange Rate, and Financial Policies
The current bias towards reduced monetary policy accommodation is appropriate (2018). Domestic economic and financial considerations should continue to guide monetary policy decisions (2017/18).The BNM has maintained its policy rate at 3.0 percent since July 2016 but appropriately signaled a bias towards reduced monetary policy accommodation in November 2017. After a 25 bps in January 2018, the rate has been maintained at 3.25 percent (through November 2018).
Use exchange rate flexibility as a key absorber of external shocks. Deploy reserves in the event of disorderly market conditions. (2017). A more holistic approach towards onshore market development—which would address existing gaps and phase out recent FX market measures—would have potential benefits (2018).The Ringgit has depreciated following the capital outflow pressures in late 2016 and early 2017, but regained value through April 2018 beyond which it started to depreciate again. In the 12 months since November 2016, the Financial Markets Committee introduced measures to deepen domestic FX markets and bolster resilience to external shocks. However, while limiting FX volatility, some of the measures also limited capital flows. The authorities notified the Fund of the change in their de jure exchange rate regime, effective September 2016, following which the de facto regime is currently classified as floating.
To contain risks from a possible real estate price correction, consider measures that would further strengthen the prudential framework and encourage the development of a rental market (2018).The authorities maintain macroprudential measures to curb household indebtedness (amid declining aggregate debt-to-GDP ratio) and an enhanced framework for monitoring (still high) household indebtedness. The BNM, MOF, and Ministry of Housing and Local Government have introduced new measures with the objective to strengthen the demand for housing and facilitate leasing.
Structural Policies
Steadfast implementation of the domestic reform agenda will be necessary in realizing the long-term development objectives (2017). Raise productivity growth within the framework outlined in the Eleventh Malaysia Plan (2016–20) and Malaysia Productivity Blueprint to support longer-term economic potential (2018).As the first policy document of Malaysia’s new government, the Mid-Term Review of the Eleventh Malaysia Plan (October 2018) reoriented government priorities. Reforms will aim at improving governance, accelerating innovation, boosting productivity, moving industries up the value chain, enhancing the wellbeing of the people, particularly the bottom 40% of the household income group (B40), and achieving inclusive growth.
To significantly boost long-term growth the authorities should: further raise female labor participation; improve the quality of education; lower skill mismatches, boost productivity growth by encouraging R&D; and uphold high standards of governance (2017/18). Expand vocational and technical training to reduce skill mismatches; raise enrollment in higher education (2018).In May 2017, the authorities launched the Malaysia Productivity Blueprint which describes the strategy to reach productivity targets under the Eleventh Malaysia Plan. In October 2018, the Mid-Term Review of the Eleventh Malaysia Plan continued to prioritize human capital development. Intended reforms will focus on improving labor efficiency and productivity, enhancing access to quality education and training as well as fostering stronger industry-academia linkages.
Facilitate trade integration and encourage foreign investment (2017).Malaysia is participating in multilateral trade agreement discussions such as the RCEP. Ratification of the CPTPP is still under consideration. The authorities plan to rationalize existing tax incentives to better steer investment towards high value-added, high productivity industries and less developed regions.
Any reform to foreign labor policies, to induce firms to raise productivity, should be market-based, clearly communicated, and gradually phased-in to allow sectors that rely on foreign workers to adjust (2018).Per the Mid-Term Review of the Eleventh Malaysia Plan, efforts will also be undertaken to reduce dependency on foreign workers by promoting greater automation and strictly regulate the number of foreign workers by introducing progressive multi-tiered charges on foreign labor employment.
Updating public infrastructure and the regulatory framework would help further improve the business environment and support higher private investment, which would help with rebalancing (2018).The authorities have initiated a review of all major infrastructure projects and are taking steps to improve public investment management. They are committed to providing quality infrastructure and efficient utilities to boost economic development.
Appendix IV. Risk Assessment Matrix1
RisksLikelihood and TransmissionExpected Impact of RiskRecommended Policy Responses
External
Sharp tightening of global financial conditions. (Short-term).High

Tighter financial conditions could be triggered by a sharper-than-expected increase in U.S. interest rates or the materialization of other risks.
Medium

This could cause higher debt service and refinancing risks; stress on leveraged firms and households; capital account pressures; and a broad-based downturn.
Liquidity support (including in FX) could be provided, while the exchange rate is allowed to adjust to discourage capital outflows. If capital outflows threaten domestic activity, reserve requirements could be relaxed.
Rising protectionism and retreat from multilateralism (Short- to medium-term).High

Global imbalances and fraying consensus about the benefits of globalization could lead to sustained trade actions and spreading isolationism. This threatens the global trade system, labor mobility, as well as global and regional policy and regulatory collaboration.
Medium

With a highly open economy, Malaysia is vulnerable to measures aimed at curtailing global trade. The impact would be felt both directly and indirectly (via trading partner exposures).
Ongoing efforts to accelerate the ASEAN regional integration agenda, and pursue new, high-standard regional trade agreements, including through completing the approval and initiating implementation of the CPTPP, which are important in their own right, would also help mitigate the impact of this shock. In the absence of adequate automatic stabilizers, discretionary fiscal policy should only be deployed temporarily and if the shock is perceived as temporary. The exchange rate should continue to act as a key shock absorber.
Weaker-than-expected growth in advanced economies (Medium-term).Medium In the Euro Area, progress on fiscal adjustment, on addressing legacy banking-sector problems, and on other structural reforms slows or reverses, raising debt sustainability concerns. In the US, as the economy pushes further through full employment, the risks of a sharper-than-expected slowdown increase.Medium

Weaker than expected external demand would reduce exports and activity in the manufacturing sector, and therefore dampen domestic demand, increasing unemployment, dampening housing and asset prices, weakening bank, corporate, and sovereign balance sheets, in a negative feedback loop
The ability of macroeconomic policies to provide a cushion against a protracted slump is limited. Policymakers would need to adjust to slower medium-term growth although carefully selected infrastructure projects and structural reforms could increase productivity and growth.
Unsustainable macroeconomic policies (Short-to medium-term).Medium

Policies in systemically important countries to boost near-term activity beyond sustainable levels may exacerbate underlying vulnerabilities and, in some cases, backfire by hurting confidence and global growth.
Low/Medium

These developments could weigh on global growth and reduce the demand for Malaysian exports, with resulting slowdown of growth and emergence of vulnerabilities of financial and corporate sectors.
In the absence of adequate automatic stabilizers, discretionary fiscal policy should only be deployed temporarily and if the shock is perceived as temporary, and the exchange rate should be allowed to continue to act as a key shock absorber.
Sizable decline in energy prices from the baseline (Short-to medium-term).Medium

Prices could drop significantly if downside global growth risks materialize or supply exceeds expectations, possibly due to faster-than-expected U.S. shale production growth, or, over the medium term, higher OPEC/Russia production.
Low

Lower growth along with reduced oil revenues could cause a set-back in fiscal consolidation efforts. Substantial declines in commodity prices could also push Malaysia to a twin deficit and trigger an adverse feedback loop of higher interest costs and undermine investor confidence.
Fiscal reforms to reduce the reliance on oil revenues, such as broad-based taxes, are critical. Investment in infrastructure and other productivity-boosting structural reforms could continue to reduce reliance on the energy sector. Since fiscal and structural reforms will take time, the exchange rate can provide the first line of defense in the short term.
Weaker-than-expected growth in China (Short- to medium-term).Low/Medium

Disorderly deleveraging may adversely affect near-term growth. In the medium term, insufficient progress in deleveraging and rebalancing reduces growth, with additional credit stimulus postponing the slowdown, but making it sharper.
Medium

The resulting weaker domestic demand in China would roil global financial markets and reduce global growth, resulting in an external demand shock for Malaysia.
The exchange rate should be allowed to act as a key shock absorber, intervening only to prevent disorderly market conditions. A more accommodative monetary policy stance could be appropriate, if risks of fueling financial imbalances are low.
Domestic
Fiscal risks from public debt and contingent liabilities (Short-to medium-term).Medium

Realization of risks would have adverse consequences for fiscal policy, raising the sovereign’s financing cost and requiring even stronger fiscal adjustment to restore fiscal sustainability.
Medium/High

Higher financing costs for the sovereign; a relatively high public debt; and realization of contingent liabilities would exacerbate concerns about public debt sustainability and could lead to an adverse feedback loop of spikes in domestic interest rates and exit of foreign investors.
The authorities’ ability to mount countercyclical responses would be boosted by medium-term fiscal consolidation. Continued progress in reforming fiscal institutions can mitigate the impact, including adopting a fiscal risks management framework and publication of an annual fiscal risks statement, along with increased transparency of GLC operations.
Cyber-attacks (Short- to medium-term)Medium

Attacks on critical global financial, or communication infrastructure and broader private and public institutions trigger systemic financial instability or widespread disruptions in socio-economic activities.
Medium/High

Theft of personal information, SWIFT fraud, hacked crypto-asset exchanges, and business disruptions across the supply chain could materialize. Larger attacks could be highly disruptive to the global economy.
Existing IT security frameworks could be strengthened, and new lines of defense could be built to eliminate the risk of such attacks and minimize their impact.
Sharp adjustment in housing market prices or ability to service debt (Short- to medium-term).Low/Medium

A large stock of unsold (luxury) residential and commercial properties may result in a sharp drop in real estate prices. A deterioration of households’ ability to service debt may trigger defaults and increase bank NPLs.
Medium

Despite existing buffers, a large housing price adjustment could adversely affect real estate developers, with implications for downstream sectors and aggregate demand and may have implications for banks’ balance sheets.
Vigilant micro- and macro-prudential oversight would be required to mitigate the risks and ensure financial stability. Specific measures could include risk weights and credit limits targeting construction sector, and measures encouraging developers to lease the unsold housing stock to prevent sizable price adjustments.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

Appendix V. Public Debt Sustainability Analysis1

Under the baseline scenario, Malaysia’s federal government debt is projected to remain below the authorities’ debt anchor of 55 percent of GDP as well as the DSA’s debt burden benchmark of 70 percent. Nevertheless, the debt will remain high at around 50 percent of GDP over the medium-term, implying that the federal government debt limit of 55 percent of GDP could be breached if downside risks materialize and there is no fiscal consolidation. Sizable external financing needs and high contingent liabilities exacerbate debt sustainability risk. A gradual fiscal consolidation is needed to build fiscal buffers, improve market confidence, and lower debt sustainability risks.

1. Macro-fiscal assumptions. Macroeconomic projections and policy assumptions are consistent with the macro-framework:

  • Growth. Economic growth is moderating to 4.7 percent in 2018 and 2019 from 5.9 percent in 2017. Growth will remain stable over the medium-term.

  • Fiscal policy. The federal government fiscal deficit is estimated at 3.7 percent of GDP in 2018 relative to the 2018 budget target of 2.8 percent. The deficit is projected to decline to 3.4 percent in 2019, and then remain at around 3 percent over the medium-term if there is no additional fiscal consolidation.

  • Interest rate. Nominal interest rates are assumed to increase by 1 percentage points by 2024. This reflects that pressure from higher global interest rates will be largely mitigated by robust demand for government bonds from domestic institutional investors. In addition, the effective interest rate on government debt will increase only modestly by 0.3 percentage points, helped by an extended maturity of federal government bonds (above 7 years as of 2018).

2. Financing Needs. Malaysia’s gross financing needs (defined as the sum of the fiscal deficit and maturing debt) are expected to be stable at around 8 percent of GDP, showing a moderate decline trend over the medium-term.

3. Debt Profile. The debt profile is based on the federal government budget, consistent with the government debt data reported by the authorities. This definition of debt accounts for more than 90 percent of general government debt. However, it does not include local and state governments and statutory bodies which typically receive explicit government guarantees. Federal government guarantees (18 percent of GDP as of June 2018) and possible future payment obligations related to Public-Private-Partnerships (PPP) projects (13 percent of GDP on an undiscounted cash basis over next 30 years, also as of June 2018) could pose an upside risk to public debt and constrain fiscal space. The external financing requirement is high at 38 percent of GDP, while the share of foreign currency denominated debt is low at 3 percent of total debt.

4. Realism of Baseline Assumptions. Past assumptions on real growth and the primary balance are neither too optimistic nor pessimistic. On the other hand, the median forecast error for the GDP deflator is -1.8 percent, suggesting that staff forecasts for nominal GDP have been relatively optimistic. Nevertheless, the forecast bias has improved in the past few years

  • Under the baseline scenario, the projected 3-year adjustment in the cyclically adjusted primary balance (CAPB) is relatively small, with a percentile rank of 31 percent compared to the historical experience for high-debt market access countries. The CAPB level is in a percent rank of 70 percent.

5. Stress Tests, Reform Scenario and Risks. Under the baseline scenario, the federal government debt will remain below the authorities’ debt anchor of 55 percent of GDP as well as the DSA’s debt burden benchmark of 70 percent. However, stress tests illustrate that Malaysia’s public debt position is exposed to various risks:

  • Fan chart. The fan chart, which incorporates feedback effects between macroeconomic variables and relies on historical data to calibrate shocks, illustrates uncertainty around the baseline. For example, under the worst quartile case, the debt-to-GDP ratio could reach 60 percent of GDP by 2024—exceeding the authorities’ debt anchor.

  • Macro-fiscal stress tests. Under a primary balance shock (equivalent to half of the 10-year historical standard deviation), the debt-to-GDP ratio is not expected to breach the authorities’ debt anchor of 55 percent throughout the projection period. However, a real GDP shock (based on the 10-year historical standard deviation) or interest rate shock (based on the historical maximum real interest rate) would bring the debt-to-GDP ratio to 55 percent, hitting the debt anchor. In particular, the effect of an interest rate shock would become larger over a longer time horizon. This risk is particularly relevant amid the expected monetary policy normalization in major advanced economies and highlights the importance of maintaining market confidence. More importantly, the combined macro-fiscal shock will bring debt to above 60 percent of GDP, easily breaching the debt anchor.

  • Contingent liability shock. As mentioned earlier, the federal government is exposed to sizeable contingent liabilities. This shock assumes that the government is obliged to absorb all government guarantees that mature within 5 years, totaling 6 percent of GDP, over 5 years. This shock also assumes a negative feedback effect on the interest rate. The debt-to-GDP ratio could reach 55 percent of GDP under this scenario.

  • Authorities’ fiscal consolidation scenario. In order to make the authorities’ debt anchor of 55 percent of GDP resilient to various shocks, a gradual fiscal consolidation is essential to build fiscal buffers. In this respect, the authorities aim at bringing down fiscal deficit to about 2 percent of GDP over the medium-term. This gradual consolidation would lower debt-to-GDP ratio to 47 percent by 2024, which would provide comfortable buffers based on historical volatility in macroeconomic variables.

  • Heat map. Malaysia faces risks arising from its large external financing requirement, which is above the upper threshold of early warning benchmarks. The share of debt held by foreigners is also high at 26 percent, exceeding the lower threshold of early warning benchmarks. Nevertheless, the existence of a large domestic institutional investor base mitigates this risk.

Figure 1.Malaysia Published DSA Risk Assessment

Source: IMF staff.

1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.

4/ Long-term bond spread over U.S. bonds, an average over the last 3 months, 06-Oct-18 through 04-Jan-19.

5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Figure 2.Malaysia Public DSA – Realism of Baseline Assumptions

Source: IMF Staff.

1/ Plotted distribution includes all countries, percentile rank refers to all countries.

2/ Projections made in the spring WEO vintage of the preceding year.

3/ Not applicable for Malaysia, as it meets neither the positive output gap criterion nor the private credit growth criterion.

4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Figure 3.Malaysia Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP, unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as central government.

2/ Based on available data.

3/ Long-term bond spread over U.S. bonds.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).

8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 4.Malaysia Public DSA – Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Figure 5.Malaysia Public DSA – Stress Tests

Source: IMF staff.

Appendix VI. Medium-Term Fiscal Framework1

1. Malaysia’s fiscal policy is currently anchored by a commitment to keep the total federal government debt within 55 percent of GDP. However, staff simulations suggest that, under the status quo scenario without fiscal consolidation, there is a 15–20 percent probability that the debt trajectory will exceed the debt-to-GDP ceiling of 55 percent. To contain the probability breaching the anchor at a prudent level—within 10 percent, the debt level in normal time should be lowered to 46 percent of GDP (See text charts). In this respect, the authorities’ fiscal consolidation path is appropriate, reducing the debt-to-GDP ratio to 47 percent of GDP by 2024 (Appendix V).

Status Quo Scenario

Source: IMF staff calculations.

Debt-to-GDP Reduced to 46 Percent

Source: IMF staff calculations.

2. The authorities’ consolidation path should be embedded in a strengthened framework being mindful of the procyclical nature of a nominal fiscal deficit target. The authorities’ fiscal deficit target is simple, closely linked to debt dynamics, easy to communicate to the public, and therefore has played an important role in building market confidence. Nevertheless, the medium-term target is not fully operationalized in the annual budget process, which could undermine its enforceability. Clearer operational rules embedded in a medium-term fiscal framework are necessary. Moreover, the fiscal deficit target does not consider the cyclical position of the economy. Hence, in bad times, meeting the target could require undesirable expenditure cuts to offset the decline in tax revenue. In addition, the overall fiscal balance could be affected by debt service payments, which cannot be fully controlled by the government. The procyclical nature of a nominal fiscal balance is further exacerbated by the dependence of oil-related revenues on the economic cycle. The authorities could calibrate the fiscal stance by being mindful of the underlying economic conditions. However, under the current framework, there is no clear guidance regarding modalities and timing of such calibration.

3. Introducing an expenditure rule could be considered as an option to strengthen the fiscal framework. Expenditure rules can help avoid procyclicality and are generally easy to communicate and implement, and compliance can be relatively easily monitored.2 Specifically, an expenditure rule would include the following key features:

  • The expenditure rule would cap the growth rate of primary expenditure. This allows automatic stabilizers to operate by helping contain expenditure growth in an economic upturn while preventing large expenditure cuts in a downturn. Expenditure rules in percent of GDP should be avoided as they tend to be procyclical.

  • The growth rate of expenditure would need to be consistent with the authorities’ debt anchor. The expenditure rule should achieve the debt anchor under realistic assumptions on GDP growth and financing cost and be resilient to cyclical fluctuations. Nonetheless, since primary expenditure has only partial implications on debt dynamics, there is a risk that the implementation of an expenditure rule would not deliver intended debt dynamics due to, for example, a permanent shift of trend growth. To address this concern, a feedback mechanism is warranted to adjust the growth rate of expenditure when the projected debt trajectory deviates from the anchor.

  • The growth rate of expenditure would be calibrated to meet the government’s strategic objectives. Given Malaysia’s relatively low tax revenue and the need to raise spending to meet social and development objectives, revenue mobilization is a priority, as the expenditure rule also needs to be based on realistic and achievable revenue projections. Therefore, the growth rate of expenditure should not be constrained by current revenue mobilization capacity. Rather, specific revenue mobilization measures would need to be developed to meet the needs specified by the spending rule and ensure its consistency with planned revenues.3

  • Illustrative scenarios based on staff’s macro-fiscal projection (trend nominal GDP growth at 7 percent): The text table below shows that without additional revenue mobilization, the growth rate of expenditure would need to be 5 percent—below the trend nominal GDP growth—to achieve a fiscal deficit of 2 percent of GDP by 2024 (in line with the authorities’ consolidation plan). However, this would lower the non-interest expenditure in percent GDP from 15.9 percent in 2020 to 14.5 percent in 2024 and undermine the authorities’ ability to meet its social and development objectives. On the other hand, as shown in text chart (main text, paragraph 14), staff recommends that the primary expenditure should broadly remain at the same level in percent of GDP to accommodate additional spending needs. In this case, revenue mobilization measures need to be specified to allow the non-interest expenditure to grow at the trend nominal GDP growth rate while achieving fiscal deficit of 2 percent by 2024. To this end, revenue in percent of GDP should increase from 15.0 percent in 2020 to 16.1 percent in 2024.

Table 1.Illustrative Scenarios
Assumptions
Trend nominal GDP growth: 7 percent
Consolidation path: Achieving fiscal deficit of 2 percent of GDP by 2024 (in line with the authorities’ plan)
Scenarios
20202021202220232024
Status quo (without consolidation)Revenue15.0%14.9%14.8%14.7%14.7%
Non-interest expenditure15.9%15.7%15.6%15.4%15.4%
Fiscal balance-3.0%-3.0%-2.9%-2.9%-2.9%
Consolidation without revenue mobilizationRevenue15.0%14.9%14.8%14.7%14.7%
(Expenditure growth: 5 percent every year)Non-interest expenditure15.9%15.5%15.2%14.8%14.5%
Fiscal balance-3.0%-2.8%-2.5%-2.3%-2.0%
Consolidation with revenue mobilizationRevenue15.0%15.2%15.5%15.7%16.1%
(Expenditure growth in line with trend nominal GDP growth)Non-interest expenditure15.9%15.9%15.9%15.9%15.9%
Fiscal balance-3.0%-2.8%-2.5%-2.3%-2.0%
Sources: IMF staff calculations based on Public Debt Sustainability Analysis.
Sources: IMF staff calculations based on Public Debt Sustainability Analysis.

4. Well-defined escape clauses and a formal accountability mechanism will support the effectiveness of the rule-based framework. To make a fiscal framework credible and resilient, it should include well-defined escape clauses allowing flexibility to adjust to tail events. An escape clause should define: (i) a limited set of events triggering the operation of the clause, (ii) for how long fiscal policy can deviate from the targets, and (iii) a correction mechanism to the targets after the operation of the escape clause. Also, effectiveness of fiscal rules hinges on strong compliance. Greater fiscal transparency (e.g., obligations to publicly explain deviations from the fiscal rule) can increase political incentives for compliance by raising the reputational costs associated with noncompliance. An independent fiscal institution could be useful to analyze fiscal policy developments and alert to the risk of breaching fiscal rules.

Appendix VII. Financial Conditions Index1

Background

1. Early research on financial conditions was narrowly focused on the slope of the public yield curve, while more recently additional variables were included. The yield curve has been found to outperform other financial variables in terms of predicting recessions (Estrella and Mishkin, 1996). Stock market variables had been included in indexes of leading indicators since the 1950s (Zarnowitz, 1992). The Bank of Canada (BOC) pioneered work on broader financial condition measures in the mid-1990s, when it introduced its monetary conditions index (MCI, Freedman, 1994). For the BOC, the exchange rate was the most important additional variable. Its MCI, therefore, consisted of a weighted average of its refinancing rate and the exchange rate.2

2. In the late-1990s, MCIs along the lines constructed by BOC became a widely used tool to assess the stance of monetary policy in many countries. Moreover, the scope of variables augmenting the effects of policy rates was broadened to include long-term interest rates, equity prices, and house prices (since rising house prices increased the borrowing capacity of households). These broader measures became known as financial condition indexes (FCIs) to distinguish them from MCIs.

3. A variety of methodologies for constructing FCIs have been developed over time and tend to fall into two broad categories: a weighted-sum approach and a principal-components approach. In the weighted-sum approach, the weights on each financial variable are generally assigned based on estimates of the relative impacts of changes in the variables on real GDP. The principal components methodology extracts a common factor (from a group of several financial variables), which captures the greatest common variation in the variables and is either used as the FCI or is added to the central bank policy rate to make up the FCI.

4. In most cases, financial condition indexes are based on the current value of financial variables, but some take into account lagged financial variables as well. Some FCIs can be interpreted as summarizing the impact of financial conditions on growth, others can be interpreted as measuring whether financial conditions have tightened or loosened.

5. The FCIs offer a useful addition to the macro-financial surveillance toolkit by providing consolidated information from a broad array of widely observable financial variables. Absent significant structural improvements/deepening in the financial system during the observed period (e.g. which may suggest either shifts in relative importance of sub-components of the index or increased tolerance of the financial system toward a particular type of imbalance), the FCIs provide a good measure of changes in financial conditions over time (i.e., indicate whether overall financial conditions are tightening or loosening relative to a base period).3

Financial Conditions Index for Malaysia

6. The FCI used by staff4is based on MCM’s FCI published in 2017 GFSR, with subsequent updates for 2017–2018Q2. The approach is based on Koop and Korobilis (2014) with time-varying parameter vector autoregression (Primiceri, 2005) and dynamic factors (Doz, Giannone, and Reichlin, 2011). Essentially, it handles the following three issues: (i) selection of financial variables to enter into the FCI, (ii) the weights used to average these financial variables into an index and (iii) the relationship between the FCI and the macroeconomy.5 The model parameters are estimated based on 20 financial indicators covering credit, foreign exchange, debt, and equity markets for 43 advanced and emerging market economies for 1990–2016, where data are available, transformed to stationarity (Hatzius et al. 2010). Increase in the index means tightening financial conditions.

7. The model used for estimating the FCI for Malaysia can be presented as:

in which x is a vector of financial variables, Yt is a vector of macroeconomic variables of interest (including growth in industrial production and inflation), λyt are regression coefficients, λtf are the factor loadings, and ft is the latent factor, interpreted as the FCI.

8. Some subcomponents of Malaysian FCI, representing all four markets, are shown in Figure 1 below. Both the FCI and its components seem to reflect Malaysia’s financial histories well, showing periods of both tight and lose conditions consistent with anecdotal evidence and historic developments. From the early 2000s through the global financial crisis, financial conditions had been easing and, following a sharp tightening in the wake of the GFC, financial conditions eased again. While forecasting power (and therefore policy relevance) of FCIs may be limited (since financial systems evolve and variables most relevant for tracking financial conditions may change), looking at FCIs in conjunction with its key components (representing various markets) may prove useful for policy conduct. Significant easing in 2016–17, as portrayed by the estimated FCI, justified the tightening monetary policy bias in 2017, and the policy rate increase in January 2018; likewise, the recent tightening would justify monetary policy remaining on hold.

Figure 1.Components of Financial Conditions Index

References

    DozCatherineDomenicoGiannone andLucreziaReichlin2011. “A Two-Step Estimator for Large Approximate Dynamic Factor Models Based on Kalman Filtering.” Journal of Econometrics 164: 188205.

    EstrellaA. andFMishkin1998. “Predicting U.S. Recessions: Financial Variables as Leading IndicatorsReview of Economics and Statistics 80 4561.

    FreedmanCharles. 1994. “The Use of Indicators and of the Monetary Conditions Index in Canada.” In Tomas J. T. Balino and Carlo Cottarelli (eds.) “Frameworks for Monetary Stability: Policy Issues and Country Experiences” Washington DC: International Monetary Fund45876.

    HatziusJanPeterHooperFredericS.MishkinKermit L.Schoenholtz andMarkWatson2010. “Financial Conditions Indexes: A Fresh Look after the Financial CrisisNBER Working Paper No. 16150.

    KoopGary andDimitrisKorobilis2014. “A New Index of Financial ConditionsEuropean Economic Review71: 10116.

    PrimiceriGiorgio. 2005. “Time Varying Structural Vector Autoregressions and Monetary Policy.” Review of Economic Studies 72: 82152.

    ZarnowitzV.1992. “Composite Indexes of Leading Coincident and Lagging Indicators” in V. Zarnowitz (ed.) “Business Cycles: Theory History Indicators and Forecasting” University of Chicago Press316356.

Appendix VIII. External Debt Sustainability Analysis1

1. Malaysia’s external debt has trended upward post the Global Financial Crisis, driven by a surge in the inflows of portfolio debt and other debt liabilities. Malaysia’s external debt-to-GDP ratio has risen by more than 16 percentage points of GDP between 2009 and 2018Q1, to about 70 percent of GDP (2009: 54¼ percent of GDP). About one-half of this increase in the debt ratio was due to the rise in portfolio debt liabilities between 2009 and 2013, particularly nonresident investment in Malaysia’s local-currency debt securities. While portfolio debt liabilities as a share of GDP have declined since 2014, increases in other debt liabilities (interbank borrowings and intercompany loans) contributed to an increase in the overall debt ratio by about 7.2 ppts of GDP.2

Malaysia: External Debt

(In percent of GDP; based on U.S. dollar values)

Sources: Bank Negara Malaysia; and IMF staff calculations.

2. The composition of external debt changed in the face of a general EM risk-off sentiment and post-election policy uncertainty. As of 2018Q3, Malaysia’s external debt, valued in U.S. dollars, stood at 65.4 percent of GDP, down from 70.3 percent of GDP in 2018Q1. This is primarily driven by the reduction of nonresident holding of local currency-denominated government debt (portfolio debt liabilities: local-currency) since May 2018, which was partly offset by the increased interbank borrowings3 (other investment: debt liabilities) for liquidity management purposes and intercompany loans. These changes lead to two compositional effects: (i) foreign currency-denominated debt increased both in nominal value and as a share of total external debt; and (ii) the share of short-term debt reached 48 percent of total external debt in 2018Q2, approaching its peak level in 2014 (see Text Table below), and dropped slightly to 46 percent in 2018Q3. The reduction in nonresident holding of ringgit-denominated government debt was compensated by an increase in domestic investor holdings.

3. Over the medium term, the external debt-to-GDP ratio is projected to remain on a steady downward path, falling to about 53 percent by 2023. Under staff’s baseline, this path reflects the net effect of sustained current account (CA) surpluses (excluding interest payments), robust growth, continued non-debt generating capital inflows, and an expected increase in external financing rates. Share of short-term debt, by original maturity, is assumed to gradually decline to about 45 percent of total external debt by the end of the medium term.

4. Sizable external debt would keep Malaysia’s external vulnerabilities elevated. Standard stress tests under the external DSA indicate that external debt is most vulnerable to exchange rate depreciation. A 30 percent real exchange rate depreciation could push external debt above 71 percent of GDP over the medium-term. Moreover, a permanent drop in the CA balance (excluding interest payments) could raise the external debt level above 66 percent of GDP in the outer years. Other scenarios—such as a deceleration in real GDP growth and a rise in the interest rate—would lead to moderate increases in external debt. The impact of these shocks would be mitigated by the high share of ringgit-denominated external debt (more than 30 percent). The large net inflows of interbank borrowings, which experienced reversals following the GFC and AFC, are less likely to pose a risk in case of adverse external shock, as three-quarters of short-term interbank borrowings today are accounted for by stable intragroup placements among banks as of 2018Q3.

Interbank Borrowing: Malaysia

(millions of U.S. dollars)

Sources: BIS International Locational Banking Statistics.

5. Risks to Malaysia’s external debt sustainability arising from the above vulnerabilities would be managed via a variety of mitigation measures. As of December 2018, gross official reserves stood at $101.4 billion, or about 70 percent of short-term external debt by remaining maturity. Gross official reserves are adequate under the IMF reserve adequacy metric (ARA) (about 108 percent of the ARA metric).4 Exchange rate flexibility, a moderate CA surplus, and the relatively large share of ringgit-denominated external debt5, will continue to serve as important buffers against potential external shocks. Moreover, banks’ foreign currency debt is subject to robust internal controls and policies, and the authorities indicated that intercompany FX loans are usually available on concessional terms.

Malaysia: Profile of External Debt(In percent of GDP unless otherwise mentioned; original maturity)
20142015201620172018Q12018Q22018Q3
Total external debt (staff estimate) 1/63.165.768.769.170.367.965.4
Medium- and long-term32.438.140.339.339.035.335.3
Offshore borrowing17.822.724.322.922.321.322.2
Public sector7.910.19.89.49.010.19.6
Federal government1.41.71.41.31.31.21.1
Public enterprises6.48.48.48.17.78.98.5
Private sector9.912.614.413.413.311.212.6
Banks3.13.94.03.33.33.03.0
Nonbanks6.88.710.510.110.08.29.6
Nonresident holdings of ringgit-denominated debt instruments13.714.515.215.415.612.812.0
Government securities12.813.614.314.414.512.011.2
Other securities1.00.90.91.01.00.80.8
Other0.90.90.91.11.21.21.1
Short-term30.727.628.429.831.332.630.1
Offshore borrowing14.314.015.616.518.521.218.2
Public sector0.00.00.00.00.00.00.0
Private sector14.314.015.616.518.521.218.2
Banks12.612.712.813.613.216.114.6
Nonbanks1.71.32.82.95.25.13.6
Nonresident holdings of ringgit-denominated debt instruments5.12.10.80.91.00.60.7
Government securities0.00.30.10.30.40.20.3
Other securities5.11.90.70.60.60.40.4
Nonresident deposits6.66.46.57.26.96.26.6
Other4.75.15.55.34.94.64.7
Memorandum items:
(In percent of total external debt unless otherwise mentioned)
By original maturity:
Short-term48.742.041.243.144.548.046.0
Medium- and long-term51.358.058.856.955.552.054.0
By currency:
Local currency denominated41.036.034.034.434.831.230.6
Foreign currency denominated59.064.066.065.665.268.869.4
By instrument:
Nonresident holdings of ringgit-denominated debt instruments29.925.323.423.523.519.819.4
Interbank borrowing20.019.318.719.218.823.722.2
as share of GDP12.612.712.813.313.216.114.5
Bonds and notes15.719.118.517.415.915.615.8
Intercompany loans9.411.115.011.314.113.913.9
as share of GDP5.97.310.37.89.99.49.1
Nonresident deposits10.49.89.410.39.89.110.0
Loans5.86.35.95.89.19.59.7
Gross official foreign exchange reserves (US$ billion)115.995.394.5102.4107.8104.8103.0
Sources: Bank Negara Malaysia; and IMF staff calculations.

Based on staff’s estimate of external debt and nominal GDP in U.S. dollar. Authorities’ data are in ringgit terms. Differences with the authorities’ debt-to-GDP ratio may occur on account of the exchange rate assumptions.

Sources: Bank Negara Malaysia; and IMF staff calculations.

Based on staff’s estimate of external debt and nominal GDP in U.S. dollar. Authorities’ data are in ringgit terms. Differences with the authorities’ debt-to-GDP ratio may occur on account of the exchange rate assumptions.

Figure 1.Malaysia: External Debt Sustainability: Bound Tests 1/2/

(In percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2010.

Table 1.Malaysia: External Debt Sustainability Framework, 2013–2023

(In percent of GDP, unless otherwise indicated)

Table 1. Country: External Debt Sustainability Framework, 2013–2023

(In percent of GDP, unless otherwise indicated)

ActualEst.Proj.
20132014201520162017201820192020202120222023Debt-stabilizing non-interest current account 6/
Baseline: External debt65.763.165.768.869.462.759.657.155.153.752.5-2.4
Change in external debt3.1-2.62.63.10.6-6.7-3.1-2.5-1.9-1.5-1.20.0
Identified external debt-creating flows (4+8+9)-5.0-6.61.1-5.0-8.9-6.7-6.1-6.0-5.3-4.5-4.40.0
Current account deficit, excluding interest payments-4.6-5.5-4.2-3.7-4.1-4.1-4.2-4.3-4.0-3.3-3.22.4
Deficit in balance of goods and services-8.5-9.3-7.6-6.8-6.9-6.5-6.2-6.2-5.6-4.8-4.6
Exports75.673.870.667.871.466.865.263.962.159.857.7
Imports67.164.562.961.064.460.359.057.756.555.053.1
Net non-debt creating capital inflows (negative)0.61.60.2-1.1-1.2-1.1-1.0-0.9-0.8-0.7-0.7-0.7
Automatic debt dynamics 1/-1.1-2.75.1-0.2-3.6-1.5-1.0-0.7-0.5-0.5-0.6-1.8
Contribution from nominal interest rate1.11.11.21.31.21.41.71.92.12.01.81.8
Contribution from real GDP growth-2.9-3.8-3.7-2.8-3.8-2.9-2.7-2.7-2.6-2.5-2.4-2.4
Contribution from price and exchange rate changes 2/0.7-0.17.61.3-0.9. .... .-1.2
Residual, incl. change in gross foreign assets (2–3) 3/8.14.01.58.19.40.03.03.53.33.13.30.0
External debt-to-exports ratio (in percent)86.885.593.2101.597.293.991.489.388.889.790.9
Gross external financing need (in billions of US dollars) 4/122.9132.2139.0120.8120.8131.8134.2138.3144.4152.4159.7
in percent of GDP38.039.146.940.738.410-Year10-Year37.435.634.133.132.431.7
Scenario with key variables at their historical averages 5/62.758.454.851.147.443.80.1
Key Macroeconomic Assumptions Underlying BaselineHistorical AverageStandard DeviationFor debt stabilization
Real GDP growth (in percent)4.76.05.14.25.94.82.44.74.64.84.84.84.84.8
GDP deflator in US dollars (change in percent)-1.8-1.4-16.5-4.00.10.410.16.82.52.72.52.82.32.3
Nominal external interest rate (in percent)1.81.81.61.91.82.61.52.32.93.53.93.83.73.7
Growth of exports (US dollar terms, in percent)-2.02.0-16.1-3.911.71.713.04.64.75.44.43.83.5
Growth of imports (US dollar terms, in percent)0.60.6-14.4-2.912.02.813.34.64.95.35.24.93.6
Current account balance, excluding interest payments4.65.54.23.74.18.65.44.14.24.34.03.33.2
Net non-debt creating capital inflows-0.6-1.6-0.21.11.2-1.21.61.11.00.90.80.70.7
Sources: Data provided by the authorities; and IMF staff estimates.

Derived as [r – g – ρ(1 +g) + εα(1+r)]/(1 +g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

Derived as [r – g – ρ(1 +g) + εα(1+r)]/(1 +g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; α = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

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

Derived as [r – g – ρ(1 +g) + εα(1+r)]/(1 +g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

Derived as [r – g – ρ(1 +g) + εα(1+r)]/(1 +g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; α = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Appendix IX. Foreign Exchange Market Considerations1

A. Introduction

1. The authorities have taken several steps to develop the onshore financial markets over recent years while seeking to curtail ringgit activity in offshore markets. Underpinning this approach is a desire to closely monitor activity in foreign exchange markets, while seeking to dissuade activity which they consider to be of a short-term or speculative nature. Such activity is seen to increase risks to market stability, upon which the authorities place a greater weight than they do on the potential costs of limiting capital flows, including from the loss of market liquidity in the offshore market arising from limiting participation.

2. This appendix assesses developments in the foreign exchange market incorporating feedback received during a July 2018 staff visit to Malaysia. The focus is on Capital Flow Management Measures and activity in the foreign exchange market while broader issues of the monetary policy framework and prudential policy are not covered. A summary of the feedback from the meetings held during the mission is contained in Box 1.

B. BNM Market Development Initiatives

3. The BNM’s approach to financial markets development is guided by the Financial Sector Blueprint 2011–2020, which covers a broad range of financial sector issues. At the core is a belief that the financial markets should serve the participants in the real economy, which calls for ringgit-based activity to be closely monitored and regulated, thereby favoring onshore market activity over activity conducted offshore. With regard to the foreign exchange market, the Financial Sector Blueprint contained four specific recommendations; i) allow corporations to actively manage foreign currency exposures arising from overseas operations, ii) permit institutional funds and retail investors to trade in foreign currencies subject to suitable safeguards, iii) allow financial institutions to offer internet and electronic trading platforms for corporations and retail investors, and iv) permit participation by non-residents in the onshore foreign exchange derivatives market without underlying trades or investments, subject to safeguards.

Box 1:Summary of Financial Market Participants’ Views1

The mission held meetings with a cross-section of onshore and offshore banks, asset managers, importers/exporters to discuss the functioning of the foreign exchange market in the context of the BNM’s objective to improve foreign currency liquidity in onshore markets. Onshore participants were supportive of this objective while parties offshore were critical of some of the 2016 measures introduced by BNM, reflecting the relative impact on activity in the respective segments. Three themes were prominent throughout the discussions: 1) The changes made in late 2016 were implemented without giving market participants a chance to adequately prepare (not enough advance warning and clarity about modalities of implementation) but they have now adjusted, and compliance is not an issue; 2) the administrative burden and costs of complying with the regulations are not negligible but are manageable; and 3) the domestic markets are functioning reasonably well.

Offshore players tended to be more negative about the tightening of regulations in late-2016, some noting the impact on offshore activity. Large fixed income investors attributed the fall in the weighting of Malaysian bonds in the JPMorgan EMBI from over 10 percent to 5.6 percent partially to the December 2016 measures.

Local banks were generally happy with the functioning of the domestic foreign exchange markets noting a decline in ‘speculative’ trading, with good liquidity and tight bid/offer spreads. They noted a clear sign of improvement in the onshore market following the introduction of the measures in late 2016. Almost all interbank activity is reported to be undertaken through three voice-brokers with only moderate support expressed for moving to an electronic matching platform. BNM interventions were seen as building confidence as they provided liquidity when market conditions were thin or when a large transaction was being dealt. BNM was not seen as defending an exchange rate level or seeking to change the trend. Local banks noted the benefit of the extended onshore trading hours while trading could also happen outside of these hours through Appointed Overseas Offices (AOOs); it seems little business is conducted outside of Malaysia hours. The views about the functioning of the MGS market were positive with traders able to take short positions, facilitated by the broadening of short-selling eligibility to include non-bank resident entities and supported by the BNM securities-driven repo facility.

Corporates reported that liquidity and the cost of doing business (i.e. bid/offer spreads) in the foreign exchange market were generally acceptable. There was some support for regulatory measures to the extent that they lowered volatility. However, the strict interpretation of domestic borrowings (which captured corporate credit cards) activated limits on foreign currency investment and has resulted in regional treasury units being based outside of Malaysia. Noted also was the inability to manage foreign exchange risks across companies within a group, where one company may earn the bulk of the export proceeds while others may import.2 In such cases the mandatory conversion requirement may be more binding than intended.

1 These views were gathered in meetings held during the July 2018 staff visit.2 Regarding this concern, BNM indicated that it welcomes applications to seek approval for foreign currency intragroup payments especially for cases where the exporting arm and importing arm are two separate entities within the same group of companies.

4. Progress has been made on implementing measures to deepen the onshore foreign exchange market, including: i) improving credibility of the foreign exchange reference rate by using traded rates covering most of the day, ii) allowing residents to hedge foreign currency exposures up to net MYR position of RM6 million per bank against 5 major currencies (i.e. USD, CNH, GBP, EUR and JPY) without documentary evidence, subject to declaration of hedging intent to the licensed onshore bank,, iii), allowing dynamic hedging (where registered foreign institutional investors are able to actively manage their FX exposure to hedge up to 100 percent of their underlying MYR assets as well as manage an additional 25 percent of FX exposure, where settlements of forward transactions can be undertaken on gross or net basis), iv) extending official trading hours by one hour to 6pm, and v) allowing short-selling of MGS and MGII. Further, to enhance monitoring of the domestic securities market, the BNM implemented the “RENTAS Segregated Securities Account (SSA) Initiative” up to fund manager level, replacing the practice of having securities block reported in omnibus accounts. All custodians have complied except Euroclear, which has agreed to do so and has been given an extension to comply Complementing RENTAS SSA implementation is the adoption of Legal Entity Identifier (LEI) as a unique identifier, in line with global practices, to promote greater transparency. The adoption of LEI is similar to EU’s MIFID II requirements for the use of LEI to report financial market transactions.

C. The Regulatory Environment

4. The foreign exchange regulatory regime is quite complex. Changes in the regulatory regime are motivated by the authorities’ desire to curtail offshore ringgit activity, and other activity they see as ‘speculative’, which they assess as activity that is not based on real underlying economic transactions or investments with a medium-term horizon. The offshore ringgit non-deliverable forwards (NDF) market falls into this category. This market arose from impediments some participants (e.g. portfolio investors) faced when dealing onshore and from capital account restrictions. In late 2016, the authorities introduced three measures that were assessed as capital flow management measures under the Fund’s Institutional View (IV).2 The three measures are as follows3:

  • The BNM tightened the enforcement (November 2016) of an existing measure by requiring attestations about banks’ activities to the effect that they do not engage or facilitate transactions in the offshore ringgit NDF market. The long-standing measure which predates the IV, limits capital outflows by not allowing onshore banks to engage in or facilitate offshore activities.4

  • The BNM introduced a requirement for conversion of 75 percent of export proceeds (December 2016) which increases the cost of investment abroad in FX and thus limits capital flows.

  • A measure limiting investment in FX assets by residents with domestic ringgit borrowing (which predates the IV) was extended to exporters in December 2016; they were previously exempted.

5. In April 2017, steps were taken to ease the restrictions on capital movements, including:

  • Simplified and streamlined procedures for registered nonresident investors to hedge up to 100 percent of their ringgit exposures, up from 25 percent, and take additional 25 percent MYR exposure on top of their underlying asset.

  • Residents are allowed to hedge foreign currency exposures up to net MYR position of RM6 million per bank against 5 major currencies (i.e. USD, CNH, GBP, EUR and JPY) without documentary evidence, subject to declaration of hedging intent to the licensed onshore bank.

  • Since August 2018, exporters are allowed to retain their export proceeds in a Trade Foreign Currency Account (Trade FCA) to meet their 6 months foreign currency obligations (including import and foreign currency loan repayment). This improvement was welcomed by market participants as it allows them to avoid the practice of conversion-reconversion.

D. Market Developments

6. The measures taken during late 2016 markedly reduced the turnover in the NDF market with limited activity moving onshore (Figure 1). Total spot and hedging activity—defined as spot, forward and NDFs activity—fell from around US$150 billion per month to US$105 billion per month, and since then has been steadily increasing on account of an increase in onshore spot activity.5 Onshore forward activity has similarly been increasing, but only marginally, even though some requirements were relaxed and offshore participants were permitted to hedge up to 100 percent of their underlying MYR assets as well as manage an additional 25 percent of FX exposure from early-2017. Overall, activity in longer-dated risk markets (NDF and onshore forwards) has declined while spot activity has increased.

Figure 1:Foreign Exchange Market Turnover

(In billion U.S. dollar)

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

7. Ringgit volatility has remained near the middle of the pack of comparator countries (Figure 2). After spiking in mid-2015, volatility has returned close to the levels of neighboring countries while there is evidence that movements in both the price and volatility of the USD/MYR, are correlated with oil. For example, pre-December 2016 the correlation between USD/MYR and oil was -0.94, which since has fallen to -0.79. It is noted that the stated objective of BNM intervention is to limit what they see as excessive volatility.

Figure 2:Currency Volatilites

(Rolling 1-month standard deviation)

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

8. Market resilience is important from both price and financial stability viewpoints. Resilience can be proxied as volatility per unit of currency traded. That is, for a given volume, how much does the currency move – the lesser the movement, the greater the resilience. On this measure, resilience has generally improved from end-2015, with a notable dip after the introduction of the measures at end-2016 which has since been recovered (Figure 3). However, the caveat when assessing the resilience here is the extent of central bank intervention, given its impact of lowering volatility and increasing traded volumes, which would overstate market resilience. Further analysis is constrained by the lack of intervention data.

Figure 3:Foreign Exchange Market Resillience

(Volatility/FX Trunover Index (Jan 2016 =100))

Sources: CEIC Data Co. Ltd.; Bloomberg LP.; and IMF staff calculations

9. Financial market turbulence after the 2016 US election lead to capital outflows from Malaysia and the authorities responded initially by tightening some regulations. The outflows were most pronounced in MGS, while also noticeable in MGII (Figure 4). A rebound in non-resident holdings appears to coincide with a relaxation of some of the measures through the further liberalization of dynamic hedging, in April 2017, allowing non-resident investors to hedge up to 100 percent of their underlying MYR assets as well as manage an additional 25 percent of FX exposure.

Figure 4:Non-resident Holdings

(In percent of Total Holdings)

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

10. The onshore financial markets have grown recently and fare well against other like countries.

  • BNM’s annual report on the financial markets reveals a 20 percent increase in onshore foreign exchange activity to US$2.4 trillion, the majority of which is swaps (51 percent), and spot (41 percent).6 The share of the top ten banks has fallen from 81 percent in 2016 to 77 percent in 2017.

  • The markets generally fare well against comparable countries.7 In terms of foreign exchange spot turnover as a percentage of GDP, Malaysia is at the median (0.5 percent) of a group of emerging market countries. And for forward, swaps and options, is materially above the median (2.3 percent versus a median of 1.0 percent for the group).8

E. BNM Intervention and Reserve Coverage

11. BNM characterizes its objectives in the foreign exchange market as smoothing volatility and supporting market liquidity. Market participants agreed with this characterization, with none believing that the BNM sought to defend a level of the exchange rate. Without intervention data, it is however difficult to deduce the BNM’s reaction function, however the USD/MYR has moved in a wide range over recent years (Figure 5).

Figure 5:Exchange Rates

(Increase = appreciation)

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

12. The BNM holds reserves that are in the lower part of the range considered to be broadly adequate. Assessed against the Fund’s reserve adequacy framework (ARA), BNM reserves were about 108 percent of the relevant metric in December 2018 (Figure 6). The improvement in the ARA coverage (September 2016) stemmed from a substantial fall in the metric after the exchange rate regime was reclassified to ‘floating’.9 It is worth noting that the ARA is a gross metric and the unencumbered reserves level is lower given BNM’s net USD short forward position which stood at $21.7 billion in November 2018.10

Figure 6:Assessing Resserve Adequacy and Gross International Reserves

(In billions of U.S. dollars, in percent)

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

F. Concluding Observations

13. The BNM has made important progress in developing onshore financial markets, including the foreign exchange market. Good progress has been made with respect to establishing an appropriate market micro-structure, along with a code of conduct, and market infrastructure. Some further steps could be taken to improve market functioning with potential benefits of lower transaction costs, increased liquidity and greater resilience.

14. The authorities have decided to limit participation from entities with short-term trading horizons while opting for measures that allow for closer monitoring and stronger regulation. Excluding a segment of participants (i.e. those involved in the NDF segment) with heterogenous risks profiles reduces liquidity in good times, and resilience when shocks hit. Indeed, when shocks do hit, the presence of the NDF market ensures that while some but not all, short-term traders may exit, others enter seeking profit opportunities.

16. For a given institutional and financial setting, the impact of regulation may be viewed along a continuum (Figure 7). The authorities would seem to have assessed the trade-offs, and placed themselves at a point to the right, along this continuum; a point where they consider their actions to be of benefit to the ‘real’ users of the foreign exchange market – those being, importers, exporters, medium-term investors. This being the case, the markets do appear to be functioning reasonably well – with narrow bid/offer spreads – based on a preliminary assessment of resilience, general feedback from the domestic players that the mission met, and when compared with peer countries.

Figure 7:Tradeoffs in Regulating Foreign Exchange Markets

Appendix X. Malaysia Housing Market Measures1

1. The housing market is an important part of Malaysia’s economy with significant linkages to the financial sector. Sixty percent of Malaysian households’ high total debt (83 percent of GDP in 2Q 2018) is in mortgages held by banks and NBFIs. In addition to mortgages, financial institutions are also exposed to (residential and commercial) real estate developers—together constituting 12 percent of outstanding credit to the economy—making them vulnerable to large real estate price adjustments.

2. Prior to 2014, the housing market in Malaysia experienced significant price increases, largely believed to be triggered by speculative activity, including by non-resident investors.2 The Malaysian House Price Index (MHPI) grew by a cumulative 24 percent in 2012–13 (or above 11 percent per annum), well above its long-run average of 6 percent. In 2014, amid significant price increases, transactions by non-residents surged as well, reaching 2,406 (or 1 percent of total residential property transaction by volume, Table 1).3

Table 1.Residential Property Transactions by Non-residents
201220132014201520162017
No. of transaction (Annual growth, %)1,934

(+1.3)
1846

(-4.6)
2.406

(+30.3)
1,156

(-52.0)
706

(-38.9)
792

(+12.2)
As % of total residential property transactions0.7%0.7%1.0%0.5%0.3%0.4%
Source: NAPIC
Source: NAPIC

3. In response to the growing concerns about the aggregate household balance sheet and property market risks, the government has since 2010 introduced a series of policy measures to cool down the residential property market, preserve financial stability, and address deteriorating housing affordability. These measures included the introduction of 70 percent LTV for third property, reintroduction of the RPGT (both in 2010), an increase of capital risk-weights to 100 percent for mortgages with LTVs exceeding 90 percent, introduction of an LTV cap of 60 percent on housing loans for corporates (both in 2011), prohibition of the Developer Interest Bearing Schemes, and limiting mortgage loans to 35 years (both in 2013). Subsequently, in 2014, the real property gains tax (RPGT) was increased to 30 percent (with higher rates for non-residents for holding 4 years and beyond, bringing the rate structure essentially to the one that existed prior to April 1, 2007; Table 2), and a minimum price of property that can be purchased by foreigners was increased to RM1 million.4 Given that land matters are under the purview of each State government, several states have imposed their own buying restrictions and enforcement date, and four out of sixteen states have maintained a minimum price for property purchases by foreigners at 0.4 or 0.5 million ringgits.5 These measures are complemented by wider efforts by the government to increase the supply of affordable housing nationwide and promote the rental market as an alternative to home ownership.6

Table 2.Real Property Gain Tax Historical Rates
PeriodType of sellerDisposal in 1st yearDisposal in 2nd yearDisposal in 3rd yearDisposal in 4th yearDisposal in 5th yearDisposal in 6th year & above
Prior to 1 April 2007Individual30%30%20%15%5%0%
Non citizen & non PR30%30%30%30%30%5%
Company30%30%20%15%5%5%
1 Apr 2007 – 31 Dec 2009Individual0%0%0%0%0%0%
1 Jan 2010–31 Dec 2011Individual5%5%5%5%5%0%
Non citizen & non PR5%5%5%5%5%0%
1 Jan 2012–31 Dec 2012Individual10%10%5%5%5%0%
Non citizen & non PR10%10%5%5%5%0%
Company10%10%5%5%5%0%
1 Jan 2013–31 Dec 2013Individual15%15%10%10%10%0%
Non citizen & non PR15%15%10%10%10%0%
Company15%15%10%10%10%0%
Effective 1 Jan 2014Individual30%30%30%20%15%0%
Non citizen & non PR30%30%30%30%30%5%
Company30%30%30%20%15%5%
Effective 1 Jan 2019Individual30%30%30%20%15%5%
Non citizens non PR30%30%30%30%30%10%
Company30%30%30%20%15%10%

4. The macroprudential measures adopted by the authorities have contributed to a slowdown in activity in the housing market, including by non-residents. The number of nonresident transactions in the real estate market more than halved in 2015, and dropped by another 38.9 percent in 2016, before picking up again in 2017. Housing price growth decelerated— at 3 percent in 2018Q1, growth of the MHPI is now below its long-term average (6 percent during 2001–17). By 2017, nonresidents only accounted for 792 transactions in the property market. While this is a small share of the total, the authorities continue to view the role of nonresidents as destabilizing the market and are watching carefully the resurgence of nonresident activity in the property market (by 12.2 percent in 2017 and 8.5 percent in 2018H1). The authorities also view macroprudential measures aimed at nonresidents as a necessary signal to property developers to encourage a rebalancing of supply towards the more affordable range, thus reducing the probability of large price adjustment (and financial stability implications) in the future.

Table 3.Breakdown of Property Transactions by Nonresidents
2009201020112012201320142015201620171H 2018
As % of total non-residents’ residential property transactions
<RM250,0004.410.010.59.73.82.74.25.73.42.6
RM250,001-RM500,00056.339.222.816.16.45.45.36.25.76.8
RM500,001-RM1 million25.430.443.344.150.647.928.718.316.215.5
>RM1 million13.920.423.330.139.244.061.969.874.775.1
Source: NAPIC
Source: NAPIC
Appendix XI. Fiscal Governance and Anti-Corruption Measures1

1. Fiscal governance vulnerabilities include the reliance on off budget spending, weaknesses in managing large infrastructure projects and in procurement systems, and a budget process that could be more transparent. Significant reliance on off budget initiatives, including government guarantees and public-private partnerships (PPPs), make it difficult to form a comprehensive assessment of the government fiscal position. The governance of large infrastructure projects in terms of project appraisal and approval, costing, and extension of government guarantees presents further challenges. Malaysia ranks low compared to the OECD average in the 2017 World Bank Benchmarking PPP Procurement (text chart), especially on (i) needs assessment, call for tender, and bid preparation; (ii) bid opening, evaluation and award; and (iii) payments to suppliers. The Open Budget Survey 2017, which assesses the transparency of central government budget processes, suggested that Malaysia provides the public with limited budget information, there are few opportunities for the public to BPP provides expert assessment of PPP frameworks around the world in terms of PPP preparation, PPP procurement, treatment of unsolicited proposals, and PPP contract management. engage in the budget process, and the legislature and supreme audit institution provide weak oversight of the budget.

Strength of Procurement Systems, 2017

(Score between 0 and 1; higher is better)

Sources: World Bank Benchmarking PPP Procurement (BPP); and IMF Staff calculations.

2. Governance weaknesses have also led to corruption in Malaysia. Available indicators show that, as of end 2017 (text chart), Malaysia performed worse than the OECD average in terms of control of corruption (WB World Governance Indicators) and the strength of anti-corruption institutions (Maplecroft). Inefficient bureaucracy and corruption were among the six most problematic factors in doing business in Malaysia according to the 2017 executives survey by the World Economic Forum. According to Transparency International, in 2017 perception of corruption was high in Malaysia, and 60 percent of respondents perceived corruption to be on the rise and gave poor ratings on the previous government’s efforts to fight corruption.

Corruption Perception Indicators, 2017

(Normalized between 0 and 1; higher is better performance)

Sources: Worldwide Governance Indicators (WGI); Maplecroft; World Economic Forum (WEF); Transparency International (TI) Corruption Perceptions Index and Global Corruption Barometer; and IMF staff calculations.

3. The new government has launched initiatives on multiple fronts to address governance weaknesses and corruption:

  • In terms of the overall framework, the Mid-Term Review of the Eleventh Malaysia Plan reoriented government priorities towards improving transparency and public services efficiency. The National Centre for Governance, Integrity and Anti-Corruption (GIACC) was established to develop a national anti-corruption plan (expected launch in the first quarter of 2019) and to coordinate all government initiatives and activities related to governance. A Special Cabinet Committee against Corruption (JKKMAR) chaired by the Prime Minister was formed and meets monthly to mobilize government efforts to formulate appropriate governance policies. The intention is to move forward with important legislation to anchor governance reforms, as well as take firm steps towards ensuring public participation and key institutional reforms. Public participation seems to be working well; policy advocacy groups seem to be openly engaging with the general public, Parliament, and governance committees, which helps improve checks and balances.

  • Special committees were established to tackle specific governance weaknesses. A Special Investigation Committee on Governance, Procurement, and Finance was formed to audit existing procurement contracts in line ministries. Pre-qualified open tender has been enforced in procurement, and single-sourced tenders have been prohibited. A Special Task Force on 1MDB was formed to track asset recovery and criminal investigations.

  • Existing institutions are being strengthened: (i) the current Prime Minister no longer holds the Minister of Finance portfolio; (ii) consideration is being given to vesting with a parliamentary committee the responsibility for high level appointments (such as Attorney General and head of the MACC and judges), which had been resting with the PM – this would help minimize the risks of political influence; (iii) the Economic Planning Unit was moved from the PM office to a new Ministry of Economic Affairs (MEA), which constitutes a first step in strengthening its gatekeeper role for public investment; (iv) the PPP unit was moved under MOF control and the existing PPP framework is currently under review by MOF and MEA; (v) the government is working on strengthening the legal framework and SOEs’ structure to improve their fiscal management and governance.

4. Anchoring governance reforms in appropriate legislation is needed to make them sustainable. Several important reforms – such as ensuring the independence of the MACC (appointment of the Chief Commissioner, securing its own yearly operational budget, and wider reporting of findings) and separating prosecution powers from legal advisory powers (both currently embodied in the person of the Attorney General) – require constitutional changes and a 2/3 approval in Parliament. Legislative reforms will be needed on freedom of information, political financing, and declaration of assets.

5. Improving fiscal governance will also require significant institutional reforms. Improvements in public investment management would require: (i) establishing an independent appeals panel for procurement and publish an annual report from this panel; (ii) updating regulations to establish a rigorous process for appraisal, pre-approval and approval of projects to avoid premature funding decisions, (iii) establishing comprehensive reporting of PPPs and their associated risks; and (iv) developing a medium-term fiscal framework that helps reconcile the medium-term resource envelope with medium-term estimates of operational and development expenditure, including required funding to complete the projects. It is important to avoid future tax refund arrears, improve financial oversight of SOEs and publish a more detailed set of accounts, and of a fiscal risks statement.

See the 2018 October IMF Regional Economic Outlook for Asia and Pacific Background Paper No. 2 “The Evolving Role of Trade in Asia: Opening a New Chapter”.

These are increases in excise taxes, in the real property gains tax and in the stamp duty on properties, and an eight- month reduced penalty rate on unpaid taxes under the Special Voluntary Disclosure Program. While these measures were announced in the 2019 Budget Speech and are intended to be implemented over the course of 2019, the expected revenues have not been included in the 2019 budget targets nor in staff’s baseline.

This is not a substantive change from the fiscal space assessment for Malaysia in the 2018 IMF Country Report No. 18/61. The different terminology reflects the recent change in the IMF’s categorization of the bottom line assessment of fiscal space. The previous category of “limited fiscal space”— indicating that no (or at most only marginal) fiscal loosening compared to the baseline can be contemplated—was split into two new categories: (i) “no fiscal space” for countries where fiscal sustainability and market financing are patently in question, or market financing is already prohibitively expensive; and (ii) “fiscal space at risk” for countries where there are clear, but not imminent, risks to fiscal sustainability and at most marginal fiscal loosening is possible compared to the baseline. As a result, the new classification system stands as: (i) “substantial fiscal space”; (ii) “some fiscal space”; (iii) “fiscal space at risk”; and (iv) “no fiscal space.” The new classification helps clearly distinguish Malaysia from countries with no fiscal space.

Assessed to be capital flow management measures in IMF Country Report No. 18/61.

Risks to banks’ mortgage portfolio are mitigated by: (i) large household liquid assets; (ii) a large share of primary homeowners (85 percent); and (iii) a small share (3 percent of total) of investment property mortgages, which are also subject to conservative LTV ratios (70 percent for individual owners of 3+ properties and 60 percent for all legal entities).

Two measures that the authorities introduced in 2014 to cool down the property market – an increase in the real property gains tax (RPGT) on property disposals by non-citizens and floor price for property purchases by non- citizens – are classified as residency-based capital flow management measures (CFMs) and macroprudential measures (MPMs), or CFM/MPMs. These measures limit capital flows while differentiating between residents and nonresidents, but also aimed to address systemic financial risk from the overheating housing market and strong credit growth. The differentiation in the property market measures applies to non-Malaysian citizens residing in Malaysia or abroad, but not to Malaysian citizens regardless of where they reside.

The number of unsold residential properties stood at a decade-high of 167 thousand in June 2018, underscoring the risk of a sharp price correction.

Launched on January 29, 2019.

The CPTPP entered into effect December 30, 2018, for the 7 members that have ratified it to-date.

Prepared by Xin Li.

Nonetheless, it is important to note that households in Malaysia hold significant net financial assets (about 95 percent of GDP as of 2017), part of which may reflect precautionary motives.

Gross or and net savings rates are defined as shares of total asset, as opposed to profit, because profit can be either positive or negative.

The sum of cash flows over a period of 10 years could be a good approximation of cumulative cash stock, unless the firm had a large initial cash stock in the beginning of the period (i.e., mature firms).

Similar to Rajan and Zingales (1998), we treat large and small firms equally, which allows us to prevent large, mature firms from swamping the information of small firms (e.g., Apple’s large free cash flow should mask the possible constraint faced by smaller IT firms).

Production function is used to represent the investment cycle of an industry driven by the technological characteristics associated with the industry, such as size of initial investment, implementation period, cash harvest period, and follow-up investment.

The 45-degree line (red solid line) represents industries with identical EFD in Malaysia as in United States. The size of each bubble is proportional to the total asset size of the corresponding industry. The bubbles below the 45-degree line designate industries that depict lower external financial dependence in Malaysia compared to the US. In addition, the chart does not show indust with large EFD in the United

The interquartile range of Malaysian industries’ EFDs is 1.1 (75th percentile: 0.7; 25th percentile: -0.4); whereas it is 2.1 (75th percentile: 1.4; 25th percentile: -0.7) for American industries.

We define an industry is of high EFD if its desired EFD is above the median EFD across all industries.

Some caveats are worth mentioning. First, the identification of the desired EFDs for Malaysian firms hinges on the assumption that firms in the same industry share similar technologies and investment cycles across countries. This assumption would be challenged, for example, by the distinct roles that firms in different countries play in the global value chain. Second, this is only a partial equilibrium result, in the sense that it does not consider the counterfactual effect of increased capital expenditure on future cash flows (i.e., operational cash flows are taken as given).

See the companion Selected Issues Paper, Chapter 1—Corporate Savings in Malaysia.

Prepared by Kazuaki Miyachi.

Prepared by Kazuaki Miyachi. For details, see 2019 Malaysia Selected Issues Paper “Medium-Term Fiscal Framework in Malaysia.”

One potential alternative could be targeting the structural balance, taking into account the business cycle and one- off factors. However, the structural balance could be difficult to compute, monitor, and communicate.

For example, the European expenditure benchmark takes into account the revenue side by capping the growth rate of expenditure net of new revenue mobilization measures.

Prepared by David Grigorian.

The weights were determined via simulations with macroeconomic models designed to quantify the relative effect of a given percentage change in each variable on GDP or final demand.

Indeed, major investment banks (e.g., Citi, Deutsche Bank, Goldman Sachs, etc.) and Bloomberg have built their own FCIs. In addition, various Fund teams have created their own country FCIs, including those for the US, France, South Africa, Greece, Russia, and Poland. Finally, BNM has created own FCI for Malaysia, made public in the 2017 Financial Stability Report.

See paragraph 18 of the staff report’s main text.

It does so by implementing model selection or model averaging in a dynamic manner (i.e., choosing different financial variables to make up the FCI at different points in time) and constructing an FCI by averaging over many individual FCIs built using different financial variables and time-varying weights.

Prepared by Xin Li.

As a share of GDP, interbank borrowings increased from 12.6 to 16.2 percent, and intercompany loans increased from 5.9 to 9.5 percent since 2014.

That is, through higher placements of foreign currency and deposits with domestic financial institutions.

However, net reserves adjusted for net forwards positions are below 100 percent coverage of the ARA metric.

As of 2018Q2, local currency-denominated debt accounted for close to one-third of total external debt.

Prepared by Darryl King with contributions from Nada Choueiri, Kelly Eckhold, Tjoervi Olafsson, Asad Qureshi and Jochen Schmittmann.

IMF 2012: The Liberalization and Management of Capital Flows: An Institutional View.

See IMF Malaysia Staff Report January 2018 for further discussion of the measures taken in late-2016.

IMF 2018 Taxonomy of Capital Flow Management Measures.

The complete picture on NDFs activity is difficult to ascertain because much of the trading is OTC, some of which may be unreported. However, it is estimated that around 80 percent of trade is captured from reporting in the major trading centers of London, New York and Singapore.

BNM: 2017 League Table

See Appendix 3: Foreign Investors, Domestic Investor Base, and Market Liquidity Measures.

IMF Global Financial Stability Report October 2018. Note that this figure includes foreign exchange swaps while the earlier reference (paragraph 7) excludes swaps.

As result the weights on exports, broad money and other liabilities were reduced by five percent

BNM publishes data on its forward book monthly with a one-month lag.

Prepared by David Grigorian.

BOP data do not allow differentiation of inflows by purpose to help draw inferences regarding non-resident property purchases in Malaysia.

About 64 percent of purchases by non-residents in 2010–13 were for properties priced between RM250,000 to RM1 million and 70 percent for properties priced above RM500,000.

These measures are assessed as CFM/MPMs under the Fund’s Institutional View on capital flows. A minimum price for the acquisition of property by foreigners was first enforced on June 30, 2009, with a floor at RM250,000 per unit. Subsequently, the threshold was raised to RM500,000 per unit effective January 1, 2010, and thereafter to RM1 million effective January 1, 2014.

For example, since July 1, 2012, the Penang State Government had restricted foreign interests to property purchase above RM1 million in Penang and RM2 million for the landed property on the island. In 2015, to curb property speculative activity by foreigners, non-citizens were limited to properties above RM2 million for landed properties and RM1 million for strata-titled properties on the island. For the mainland of Penang, the floor price is maintained at RM1 million for landed properties and reduced to RM500,000 for strata-title properties. The Penang State government also introduced a 3 percent approval fee for all foreign purchase of properties in the state at that time. The share of residential property transactions in Penang was 7.4 percent of the national real estate transactions.

These measures include the establishment of a single entity for affordable housing (announced in July 2018) and the enactment of a Residential Tenancy Act (announced in the Federal Budget 2018).

Prepared by Katsiaryna Svirydzenka.

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