Information about Asia and the Pacific Asia y el Pacífico

7 Export Volatility and Stabilization in Malaysia

Ungku Abdul Aziz
Published Date:
March 1990
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This paper presents Malaysia's experience in responding to volatile and unstable export earnings, more generally, to the adverse external shocks arising from volatile trade and capital flows.

The problems of export instability of primary commodities have been the focus of attention at both the national and international levels since the 1970s. Studies have been extensive, spanning several decades, but satisfactory solutions have not been found. Since the early 1980s, the problems of export instability have been further aggravated in Malaysia and the countries of the Association of Southeast Asian Nations (ASEAN) by higher degrees of capital flows and exchange rate volatility.

On the international level, weak markets and rapid price declines for many commodities in the early 1980s have again called into question the effectiveness of negotiated international commodity agreements in promoting stability in primary commodity prices and export earnings of developing countries. Of the five international commodity agreements, today only one, the International Natural Rubber Agreement is still operational, the rest, covering tin, sugar, cocoa, and coffee, are either inactive or in complete disarray. Prices of primary commodities over the last decades, for various reasons stemming both from the supply side and the demand side, were subjected to extreme swings and in many cases were volatile. For the relevant commodities under the international commodity agreements, the sharp swings in export earnings reflected directly on the effectiveness of negotiated export quotas and buffer stock schemes, which are the primary mechanisms of such agreements. In the past, negotiated export quotas have proven to be more rigid in practice than envisaged in response to changing market forces. With such a dissappointing track record, it is doubtful if the international commodity agreements in their present form can continue to play a useful role in promoting price stability.

The other international response to this problem was the compensatory financing facility of the International Monetary Fund. Initially, when the facility was established in 1963, it was intended to assist member countries by offering financial assistance to those suffering from shortfalls in export earnings. In its earlier version, where access to the facility was more liberal, it proved to be extremely popular among the primary producing countries as a source of quick disbursing, short-term financing to cover a temporary decline in export earnings. In its later version, however, with harsher conditions attached to each drawing, the use of the facility fell dramatically. This had accounted partly for the fall in drawings to only $2.3 billion during 1986–87, compared with $5.4 billion during 1982–83. Further changes that were introduced in 1988 have again transformed almost completely the original character of the facility, limiting its usefulness in stabilizing export earnings.

Another response, which is also global in character, is the producers' cartel. An outstanding example is the petroleum cartel of the Organization of Petroleum Exporting Countries (OPEC). Its extension to other commodities is, however, extremely limited. To be effective, it requires control over the major portion of the market and the ability to impose discipline among the membership. Not many, if any, of the 18 commodities1 identified by the United Nations Conference on Trade and Development (UNCTAD) as being of particular concern to developing countries qualify for such an arrangement.

But there is little doubt that achieving a stable stream of income from trade can be beneficial, at least for the following reasons. First, stability in export earnings can promote better planning by the government in its annual budgetary process, as well as economic development plans. For Malaysia, two of its development plans were significantly affected by substantial changes in the prices of primary commodities. The Third Malaysia Plan (TMP) 1976–80, was set in a framework of substantial economic growth targeted at 8.4 percent a year in real gross domestic product (GDP), but its sectoral expenditure targets were grossly affected by an unanticipated commodity price boom, raising the average real GDP growth to 8.6 percent annually. Two factors were mainly responsible for the underestimation. First, the strong rise in the price of the country's traditional commodities (rubber and tin) during 1976–78 and second, the oil shock which nearly tripled crude oil prices during 1979–80. These developments raised export proceeds above the Plan's projection by about $23 billion and revenues by about $10 billion, or by over 1 percent of gross national product (GNP) a year. Compared with the TMP projection of a current account deficit in the balance of payments of 5 percent of GNP by 1980, the higher exports had instead resulted in four years of surpluses during 1976–79, and a deficit of only 1.2 percent of GNP in 1980. Thus, it is possible that the Plan could have been framed differently had the sizable changes in resources been anticipated. In the Fifth Malaysia Plan (FMP) 1986–90, the position was reversed. An unexpected collapse in the prices of primary commodities altered significantly the underlying price assumptions of the Plan. This development in turn imposed a severe resource constraint on the development budget, which forced a substantial $16.5 billion (a cut of 22 percent) revision to development expenditure (a cut equivalent to nearly 1 percent a year of GNP) over the five-year period of the Plan.

Second, there is strong reason to believe that reduced variability of export proceeds would remove much of the uncertainty surrounding investment decisions in the agricultural sector. Perennial tree crops, where gestation lags between tree planting and maturity can range from four to seven years, are particularly vulnerable to price fluctuations.

As a major exporter of primary commodities, Malaysia experienced one of the worst cases of export instability in the world. But this fact is hardly surprising given the wide open nature of the economy, with total external trade that is greater than GNP (an export to GNP ratio of 60 percent and imports of 42 percent in 1987) and a traditionally high concentration of exports in a few primary commodities. What is remarkable is that the high incidence of export instability appears not to have had adverse consequences on growth performances, at least over the longer term. High rate of growth was in fact achieved with relative ease and consistency during the periods of the sixties, seventies, and the latter part of the eighties.

The problem of export earnings instability in a wider context, raises a number of difficult issues. In developing countries, a price collapse would restrict their ability to fund development and meet external financial obligations. The experience with international commodity agreements calls for a reconsideration of strategies for dealing with this problem on an international scale. In the context of existing arrangements, a stronger mechanism than the compensatory financing facility is needed to provide primary commodity exporting countries with temporary financing for export shortfalls. And needless to say, enhanced cooperation is required between the producer and consumer countries to realize the objectives of the Integrated Programme for Commodities adopted at the fourth session of UNCTAD in 1976. Among the objectives was the welcomed establishment of a new international financial institution, the Common Fund for Commodities to assist producer countries. On the national level, the developing countries are faced with an equally difficult choice.

This paper presents a response to export earnings instability in Malaysia. The paper first reviews briefly major economic developments in the country over the last two decades and then examines the policies to moderate the impact of export instability. Finally, the concluding section poses a number of policy issues for consideration in the context of stability.


Malaysian economic performance for most of the 1970s was exceptional: the average annual growth rate was sustained at about 8 percent and gave rise to a per capita income of $1,563 by 1980. The economy was broadly open with imports and exports each exceeding 50 percent of GNP. The effects of the terms of trade were quickly transmitted to the domestic economy. This phenomenon is mostly true for the rest of the ASEAN countries. For Malaysia, a collapse of the primary commodity market in 1986 led to a large terms of trade loss of 15.5 percent, which induced an unprecedented fall in the aggregate consumption in the country by nearly $3 billion, or by 10 percent in nominal terms. GNP growth collapsed by nearly 8 percent for the year. The current account of the balance of payments was in deficit for most of the first half and in surplus for most of the second half of the 1970s, with the peak in 1979 equivalent to about 5 percent of GNP, and record deficit in 1974 at 6 percent of GNP. Although federal deficits as a percentage of GNP have been traditionally large, about 8 percent in the 1970s, they have been largely financed from domestic noninflationary sources, namely, from the savings of the pension funds. The residual, only about 2 percent a year of GNP, was raised from domestic banking sources. External sources of financing during the period remained modest.

The sources of growth were several. The most impressive was the contribution of oil palm, which rivaled rubber as the premier crop when much of the acreage used to grow rubber trees was switched to oil palms. The rate of substitution was gradual, spanning about twenty years. When the oil palm crop began to be cultivated extensively in 1965, the share of agricultural land devoted to rubber cultivation exceeded 68 percent. Padi cultivation and other products, such as tea and coffee, were minor. By 1988, the acreage under rubber cultivation shrank to 35.5 percent of cultivatable land with oil palm making up much of the balance with 34 percent. A second source was the rise in oil exports. Production rose from about 69,000 barrels a day in 1971 to about 276,000 barrels a day in 1980. The third major contributor was the rapid growth of the manufacturing sector, which easily surpassed agriculture in the 1980s.

The rapid but different rates of sectoral growth have transformed the structure of the economy in several areas. Agriculture in 1970 accounted for 31 percent of GDP and 61 percent of gross exports. By 1980, the share had fallen to 27 percent of GDP and 44 percent of gross exports. Manufacturing, which has been the most dynamic, with growth averaging around 11.6 percent a year during 1971–75 and 11.3 percent during 1976–80, increased its share from under 15.5 percent to 18.2 percent of GDP and accounted for 22.4 percent of exports in 1980 as compared with 12 percent in 1971.

The major structural shift in the pattern of production became much more pronounced in the 1980s, as the commodity boom spilled over in the first half of the decade into nontradable activities, particularly in the construction sector until its collapse in 1985 along with an unprecedented fall in commodity prices. A similar pattern to that of the 1975 recovery can be observed in the strong recovery during the second half of the eighties owing primarily to a strong resurgence in commodity trade and exports of manufactures.

What is apparent from these developments over the last two decades is that the cycle of growth in the economy is closely linked to the external sector. The recession in 1974–75 was associated with a decline in prices of commodities of about 16 percent and the subsequent fall in the terms of trade of about 14 percent, followed later by a commodity-induced boom throughout the second half of the 1970s. The same is also true for the recession of 1985–86 when export prices fell by nearly 16 percent and the terms of trade loss over the two years was more than 15 percent (Chart 1).

Chart 1.Terms of Trade, 1981–88

(Percent change)

Source: International Monetary Fund. World Economic Outlook: A Survey by the Staff of the International Monetary Fund, World Economic and Financial Surveys (Washington, April 1988).

1 Gross national product.

2 Terms of trade.

In trade, the issue is whether or not Malaysia as the leading exporter of natural rubber, palm oil, tin, cocoa, and timber can insulate itself from the sharp swings in activity in the domestic economy due to fluctuations of primary commodity prices.


In spite of their inherent instability, primary commodities had been the mainstay of the economy until the second half of the 1980s when manufactured exports began to dominate. In 1980, close to 80 percent of exports was accounted for by primary commodities; nearly 46 percent was agricultural products and 34 percent minerals. A significant shift in the trade pattern was observed in 1985 when the total export share of primary commodities declined to 67 percent and that of agricultrual products to just below 33 percent. The slack was taken up by manufactured products, which rose to 33 percent of exports. Natural rubber exports lost the lead of almost 16 percent in 1980 to just less than 8 percent in 1985; palm oil maintained its share at about 10 percent. In the mineral category, tin exports, once a major foreign exchange earner in the 1950s and 1960s, accounted for only 4 percent of exports in 1985, down from 9 percent in 1980. Crude petroleum gained in importance, accounting for 23 percent of export proceeds in 1985, up from 17 percent in 1979. Agriculture's contribution to growth over the last twenty years has been impressive (Table 1). Gains were made despite extremely unstable export earnings.

Table 1.Annual GDP Growth and Distribution, 1971–87
(In percent)(In percent of GDP)

In terms of the index of instability, Malaysia belongs to the group with the highest index in the world. A study in 1969 estimated the index for the period 1946–58 was close to 392 for West Malaysia, compared with 17.6 for 18 developed countries and 23 for 45 developing countries (Erb and Shiavo-Campo (1969)).

In another study of export patterns (Leith (1970)) using a sample of 25 developed and 70 developing countries covering the period 1948–58 and measuring the index of instability as deviations from the trend values of exports, the result was 19.6 for West Malaysia, and 7.9 for developed and 12.0 for developing countries. Using similar techniques, Naya (1973) tested 18 developed and 48 developing countries for export earnings instability, using the sample period 1950–69. He found that among developing countries, Asia on average faced sharper swings in exports with an index of 12.1 against 9.4 for all developing countries. The index for Malaysia was surprisingly lower at 8.9.

This pattern of instability can be observed in Table 2, on the basis of monthly samples taken.3 The index of variations for exports as a rule exhibited greater instability for commodities whose unit price was highly volatile. The surprising exceptions were palm oil and rubber, which possessed an instability price index respectively of 3.82 and 2.24 but ranked only third (palm oil) and fifth (rubber) in terms of export value. Probably, part of this volatility was partially canceled by the stability in supply, as given in Column (2).

Table 2.Export Instability Index, January 1982–September 1988





(In ringgit)(In ringgit)(In U.S. dollars)
Palm Oil4.361.133.824.34
Total Agriculture1.81
Total Exports0.82
Note: Export values based on quarterly data: 1960s = 0.90; 1970s = 0.50; and 1980–September 1988 = 049.
Note: Export values based on quarterly data: 1960s = 0.90; 1970s = 0.50; and 1980–September 1988 = 049.

In terms of total agriculture, the result, as expected, indicated a sharply lower variation with an index of 1.8, although the index of the smallest individual item (rubber) was close to twice the total, and the largest (tin) by 4.5 times. But the broader index was four times more than the variation achieved by manufactured exports. Part of the explanation apparently was due to the absolute size of the export proceeds, which was itself a significant stabilizing factor.4


It is now becoming increasingly obvious that Malaysia like other open economies cannot insulate itself completely from external disturbances, in either the commodity or the financial market. This is becoming more so since most obstacles to capital flows were removed in efforts to promote foreign investment.

For Malaysia, the solution to the problems posed by export instability lies in a number of areas. The first is to influence prices through direct intervention in the market. This approach embraces the international buffer stock agreements for rubber and tin, which are subscribed by a number of countries in ASEAN, as well as production control as practiced by OPEC. In the buffer stock scheme, the mechanism involves direct access to a commodity stockpile that can be disposed of if needed to defend the ceiling price and to cash resources in order to preserve the floor price. The agreements for rubber and tin are supported by Malaysia as a means to moderate price volatility in the international market. But the results have been disappointing: success has been limited in stabilizing earnings, and technology has caused a secular decline in demand.

The other strategies that are less obvious but more difficult to achieve over the short term relate to the promotion of product diversification, a broadening of the export base and market destinations, and improving production efficiency. Second, solutions lie in the areas of fiscal and monetary management. In the latter case, a notable feature of the Malaysian financial system—but not confined only to the Malaysian experience—is the apparent presence of built-in automatic stabilizers.

Commodity Diversification and Broadening the Export Base

In terms of product diversification, a significant broadening of the product base away from a narrow specialization in only tin and natural rubber can be observed in the last two decades. A most remarkable performance has been the successful introduction of oil palm (Table 3). Oil palm, which was introduced into the country as a cash crop in the early 1960s, quickly expanded in terms of both area planted and output so that by 1980, total area under oil palm cultivation occupied nearly 1,023 million hectares, with a production of 2,576 million tonnes, as against rubber acreage of 2,004 million hectares, and an output of 1,530 million tonnes. In terms of export share in 1980, 9.2 percent was taken up by palm oil and 16.4 percent by rubber. Since 1980, total planted area under oil palm rose by 7.4 percent annually to account for 30.2 percent in 1988 (or equivalent to 1,786 million hectares) of total agricultural land. Total acreage under rubber was about 1,875 million hectares in 1988, representing an annual decline of 0.5 percent since 1980.

Table 3.Selected Agricultural Commodities, 1975–88
Planted hectarage2,019.51,991.82,003.91,948.71,874.7
(In thousands of hectares)
(In thousands of tonnes)
(Kilogram per hectare)
Export Value1,723.72,025.54,618.02,872.25,255.9
(In millions of U.S. dollars)
Palm oil
Planted hectarage291.0641.81,023.31,482.41,785.7
(In thousands of hectares)
(In thousands of tonnes)
(Ton per hectare)
Export value263.11,319.62,603.13,963.34,540.2
(In millions of U.S. dollars)
Planted hectarage5.930.3123.9303.9353.9
(In thousands of hectares)
(In thousands of tonnes)
Yield/hectare— na —
Export valuen.a.35.5161.9409.5708.3
(In millions of U.S. dollars)
Source: Department of Statistics, Malaysia.Note: na = nonapplicable.

Data for 1970 and 1975 are for Peninsular Malaysia only.

Source: Department of Statistics, Malaysia.Note: na = nonapplicable.

Data for 1970 and 1975 are for Peninsular Malaysia only.

The effects of these efforts to diversify over the last two decades can again be observed in Table 2. On their own, individual commodities tended to exhibit extreme volatility, both in volume and price but when taken together were sharply more subdued. This was first due to the size of the export proceeds, which, as a proportion of GNP, reached as much as 60 percent in 1987. And second, some of the variations were either offset or made up for by the earnings, as well as volume, of the other commodities. The results were even more striking when total manufactured exports were included. The total instability index showed a significant decline by nearly 55 percent to 0.82 while the index for manufacturing was only 0.47. The extent over time of the results of diversification and the rise in total export value are re-emphasized by the fall in the gross exports index—from 0.90 in the 1960s, to 0.50 in the 1970s and 0.49 in the 1980s.

As an approximate measure of concentration5 (see Naya (1973)), the degree of export diversification achieved is derived in Table 4 below taken for the years 1970, 1975, 1980, and 1987.

Table 4.Measure of Export Concentration
Primary Product0–40.5490.4050.4220.325
Raw Material2,30.5430.3650.4050.307
Note: SITC = Standard International Trade Classification.
Note: SITC = Standard International Trade Classification.

In terms of primary products classified under SITC 0–4, food under SITC 0,1 and 4, and raw materials under SITC 2 and 3, the trend has been quite distinct over the last two decades, indicating a lower degree of concentration or greater product diversification. The rise in prominence of manufacturing products (SITC 5–8) since 1970 is significant, but the transformation over the two decades was quite gradual. It was not until 1987 that a larger degree of concentration could be observed in this sector, but it has yet to surpass those of the five big primary products and raw materials.

Using the same index, the comparative results for the five big ASEAN countries combined are tabulated below in Table 5. Among the ASEAN, the trend since 1970 in favor of diversification is obvious in all categories of primary commodities. The trend favoring concentration in manufacturing can also be observed. A surprising result arising from Table 5 is that Malaysia in the 1980s was higher than average in its concentration in primary products and raw materials and significantly less than average in terms of its dependence on manufacturing output, although the trend pointed positively in favor of diversification.

Table 5.Measure of Export Concentration in the ASEAN as a Group
Primary Product0–40.7470.7170.6470.459
Raw Material2,30.4000.2950.3140.166
Source: International Monetary Fund, International Financial Statistics (IFS).Note: Data for 1970 do not include Indonesia; data for 1980 do not include the Philippines; and the Philippines data for 1984 is included under 1987. The data set used covers only the five big ASEAN countries: Indonesia, Malaysia, the Philippines, Singapore, and Thailand.
Source: International Monetary Fund, International Financial Statistics (IFS).Note: Data for 1970 do not include Indonesia; data for 1980 do not include the Philippines; and the Philippines data for 1984 is included under 1987. The data set used covers only the five big ASEAN countries: Indonesia, Malaysia, the Philippines, Singapore, and Thailand.

Among the factors that have contributed positively to the policy of diversification, the following five deserve special mention.

First, the emphasis placed on export-led expansion is noteworthy. This strategy among all others may have been the most decisive factor in having a direct and systematic impact on growth notwithstanding the presence of export instability. At least in the Malaysian experience, there is some evidence to suggest that the exposure of the foreign sector to international competition has promoted the development of industries that are resilient and enjoy a comparative advantage in world markets. It follows also that products that are sheltered or heavily subsidized do not stand the test of time. A good example is rice cultivation, where a 100 percent sufficiency target has been abandoned because it is more cost effective to import. It does not seem also to matter which commodities are selected for promotion. Apparently, choosing those that tend to offset each other's variation in prices or output is not a criterion that is vigorously pursued. For example, cocoa was promoted initially more on account of its suitability as a crop that can be sandwiched under the shade of rubber trees and oil palms rather than for its price and output characteristics. In other instances, pineapple and sugarcane crops were also tried in Malaysia but failed to flourish owing to stiff competition from abroad and the presence of more lucrative crops (rubber and oil palm) in the country. The same applies to the livestock industry, which was tried as a substitute for the Australian and Indian imports of beef and cattle. The same fate applies to the fall in acreage and output of coffee, which was an important cash crop until natural rubber was introduced on a commercial basis. This trend could apply as well over the long term to the observed substitution taking place between oil palm and rubber.

Second, a corollary to the export-led strategy is the maintenance of sound fiscal and financial policies. Policies that preserve financial stability relate to minimal inflation and relatively low rates of interests. The record for Malaysia has been good on both counts. During the 1970s, domestic price inflation as measured by the changes in the consumer price index (CPI) was on average 5.5 percent a year. The interest rate during the period was only 9.7 percent a year for loans. The record for the 1980s is equally good. The CPI rose by 5.9 percent a year in the first half and fell to only 1.1 percent on average in the current period with expectations for it to remain at about the 3.6 percent level in 1989. The average lending rate was 9 percent a year as at October 1988.

Third, in support of an export-led orientation, the maintenance of a flexible exchange rate regime is crucial in order to maintain external competitiveness. An external policy that encourages capital investment (both domestic and foreign) and is supported by a realistic exchange rate regime helps broadly to support the diversification objective.

The strong revival of the industrial sector in Malaysia since 1985 was reflected by the external competitive edge gained since the Plaza Accord of September 1985 (Chart 2). These gains were observed through the gradual depreciation in the exchange value of the ringgit to reflect economic fundamentals. In comparison with the major ASEAN countries, the real effective exchange rate index for Malaysia was 73.6 in April 1989, compared with Thailand at 79.9, Indonesia 45.5, Singapore 104.6, and Korea at 103.9. In Indonesia, the index reflected the two mega-devaluations of the rupiah taken in March 1983 by 28 percent and in September 1986 by another 31 percent. The largest devaluation of the baht in Thailand took place in November 1984; it was devalued by almost 15 percent. As for the future, the edge that Malaysia could perhaps enjoy is its track record of low inflation and higher productivity. The stability gained from the ringgit and U.S. dollar alignment can also be observed in Table 2. The instability associated with the price of commodities expressed in U.S. dollars in this table is shown to be greater than in ringgit terms. This observation could mean that variations in the exchange rate have managed to stabilize movements in export unit value denominated in ringgit and therefore are consistent with the insulation property of a flexible exchange rate regime.

Chart 2.Real Effective Exchange Rates for Competitor, Based on Trade Weights, January 1988–April 1989

(1980 = 100)

Fourth, the promotion of both agriculture and manufacturing in the various five-year Malaysia Plans have ensured that the push for rapid growth and development was not at the expense of agriculture. The importance placed on the agricultural sector is reflected in the Government's National Agricultural Policy, which stresses the importance of both new land and in situ developments, as well as agricultural support services. For the latter category, agricultural research programs have been among the most successful. These are exemplified by the results produced by the Rubber Research Institute (RRI), the Palm Oil Research Institute of Malaysia (PORIM), and the Malaysian Agricultural Research and Development Institute (MARDI). It is difficult to measure precisely the effects of agricultural support service, but the fruits of research, farming, training, and credit promotion are important in raising yields and productivity. In the rubber sector, yield estimate per hectare for the high-yielding material reached as high as 1,500 kilograms (an estimated 750 kilograms per hectare in Thailand) in 1988, and 5 tonnes per hectare in the oil palm sector (3.3 tonnes in Indonesia). These yields were among the highest compared with the other producing countries in the region.

Fifth, the success in drastically lowering export instability lies much more with the policy to increase the manufacturing sector's share of exports (instability index of 0.47 compared with 1.81 for agriculture). This was first achieved in terms of GDP when the share of the manufacturing sector rose from just below 14 percent in 1970 to 20 percent by 1980, and thereafter rose to 24 percent to surpass the agricultural sector by 1988, which has a share of 21 percent. The rise in the export share of manufacturing over the last two decades is equally remarkable, beginning with 12 percent in 1970 to 49 percent in 1988. But the success story of the meteoric rise of manufacturing has its weaknesses. Basically, this refers to the overconcentration of industries in electronic related products (54 percent export share in manufacturing in 1987) and textiles (11 percent share) as a source of growth in the sector.

Diversification of Markets

Although a desirable objective policy to promote export stability, market diversification has not had an impressive record. It has proved more difficult to diversify into new geographical areas than to maintain or even expand on Malaysia's existing market share (Table 6). Singapore, Japan, the United States, and the European Community (EC) have been the traditional markets for Malaysian exports, in that order.

Table 6.Direction of Trade(Market Share)



Source: International Monetary Fund, International Financial Statistics (IFS).
Source: International Monetary Fund, International Financial Statistics (IFS).

Although the share of these markets has been generally stable, accounting for about 70 percent of total exports, the trend has been declining, particularly since 1985. This is reflected to a certain extent by the expansion of new markets in Asia and the Middle East, which have expanded from just below 9 percent in 1980 to above 12.5 percent in 1985 and 15 percent by 1987. In the case of Singapore, the declining trend was a reflection of the move by Malaysia toward direct marketing of its exports to the importing countries.

Built-in Automatic Stabilizers

The external components of the country's monetary base have been subjected to wide fluctuations measured either quarterly or annually. These had been primarily the results of volatile export proceeds and capital movements. Capital flows were observed to be exceptionally volatile in the 1980s, arising from the more liberal exchange control regime and closer integration between domestic and international financial markets. Much of the impact of these fluctuations has, however, been effectively neutralized by compensating movements of the domestic components of the reserve base (Chart 3), thereby keeping reserve money growth quite stable. This is an important and desirable objective of policy, as it shields the economy from sharp external payments shocks and financial instability. The Central Bank's intervention is also influenced to a large extent by its policy to keep the level of liquidity consistent with its GNP growth forecast. The degree of prudence by which this policy is exercised is borne out by the extraordinary degree of price stability enjoyed over the last three decades.6

Chart 3.Malaysia: Factors Affecting Reserve Money, 1978–88

(Change in billions of ringgit)

Source: International Monetary Fund, International Financial Statistics (IFS).

The domestic automatic stabilizers arose as export receipts were highly correlated with government revenue (estimated elasticity was about 0.85 during 1970–87). For example, the rise in export receipts was offset partly by the consequent rise in corporate profits and government revenue. These resulted in reduced credit requirement by the Government and corporations of the banking system. Most interesting by way of comparison was that the same phenomenon in terms of built-in automatic stabilizers is observed in the other ASEAN member countries (see Charts 4, 5, and 6).

Chart 4.Indonesia: Factors Affecting Reserve Money, 1979–88

(Change in billions of rupiah)

Source: International Monetary Fund, International Financial Statistics (IFS).

Chart 5.Philippines: Factors Affecting Reserve Money, 1979–88

(Change in billions of pesos)

Source: International Monetary Fund, International Financial Statistics (IFS).

Chart 6.Thailand: Factors Affecting Reserve Money, 1981–88

(Change in billions of baht)

Source: International Monetary Fund, International Financial Statistics (IFS).

Higher Reserves Cushion

The final point is on the level of reserves. The level of external reserves is usually a reflection of a country's earnings instability in international trade. In part, it is a reflection of the need to keep enough reserves to cushion against a collapse in exports and thereby insulate the economy temporarily against disruptions in imports and payments flows. The optimum level of reserves is of course debatable. In the last five years, Malaysia's gross international reserves varied from as low as $4 billion, or equivalent to about 4 months of imports in 1983, to as high as $7.8 billion, or 7.4 months of imports in 1987. The argument in favor of a large reserve level is that Malaysia is an open economy with relatively free capital flows. Reserve levels therefore ought to be high enough to deal with the fluctuations without any need to resort to such inefficient devices as multiple currency practices, quantitative restriction on imports, or other forms of foreign exchange rationing that can ultimately hurt the chances for exports to thrive in the international market.


In the final analysis, Malaysia's success with export-led expansion lies less with a strategy to insulate the economy against external shocks than with its readiness to let the shocks pass through to the rest of the economy. This is reflected by the changes in the terms of trade and the growth rate of the country's GNP. Such a phenomenon can be observed during both the boom and recession years. The willingness to accept this fact is important, as the economy is allowed to react accordingly. Any degree of protection or stimulation can be costly, especially in a wide open economy.

A pertinent lesson can be learned from Malaysia's policy actions during a global recession. In 1981–82, the authorities decided to embark on a costly countercyclical stance, against a terms of trade loss during 1980–82 of almost 8 percent. The resulting deficits incurred in the federal government budget peaked at 18 percent of GNP by 1982, and in the current account of the balance of payments of 14 percent. These were well above Malaysia's sustainable financial capacity without resorting to massive external and domestic borrowings. The period of economic adjustment to the policy spanned six years resulting in a rise in unemployment and comparatively lower economic growth.

A second issue is the role of the government. In the early stages of development in Malaysia, certainly in terms of the plan to develop both agriculture and manufacturing, the presence of the government was indeed dominant. In agriculture, the promotion and servicing of the small-holding sector in both oil palm and rubber croppings were achieved with government assistance through the opening of new land, as well as the distribution of new improved seeds, through such organizations as the Rubber Industry Small Holders Development Authority (RISDA) and Federal Land Development Authority (FELDA). The mood today is the reverse, especially in the Government's efforts to industrialize. In this respect, the right environment has been achieved in creating a viable and competitive atmosphere. Admittedly, more revision needs to be done in terms of privatizing state enterprises and the so-called nonfinancial public enterprises, but more important, the competitive edge has now been gained through maintaining a relatively flexible exchange rate regime. The latter especially has been instrumental in reviving an export-oriented manufacturing industry.

The issue above is not so much over the narrow concentration of industries, which (like the experience in agriculture) can be broadened to take up the expanding opportunities of the rich domestic agricultural sector, but over investment, namely, direct foreign investment. The country's experience with direct foreign investment in electronics and textiles in the last two decades has been somewhat disappointing. Despite its strong presence, there has hardly been any linkages to the rest of the economy, especially to electronics and electrical goods. The spin-off in terms of research and development and of promotion of higher value-added goods has been minimal. Whether or not multinational companies on foreign soil, more so in the developing countries, will devote more investment to research and development and encourage linkages is difficult to establish. Evidence points increasingly to their single-minded pursuit of the low-wage objective. This fact makes it worthwhile to examine if, with high domestic savings, Malaysia ought not to concentrate more on local counterparts.


Much has been achieved over the last two decades. The evidence shows that Malaysia is quite successful in living with instability in both trade and product diversification. The record is impressive in terms of the level of growth that has been sustained over three decades. The key lies in the promotion of an open economy with flexible prices and prudent management of the economy.



Mr. Ahmad's paper contains many useful insights. First, and most important, it tells us that difficult as the problem of commodity price instability may be, it can be managed. The record of Malaysia speaks for itself here. This record also throws into relief the author's introductory remarks bemoaning the disarray in international commodity agreements, the diminished use of the compensatory financing facility, and the lack of institutional palliatives.

Second, while the precise approach to dealing with price volatility will of course differ from country to country, the paper identifies a number of elements and ingredients that are likely to be both crucial and generally applicable. His last sentence, in many ways, says it all: “The key lies in the promotion of an open economy with flexible prices and prudent management of the economy” (p. 150).

The commitment to an open economy does not serve simply to “let the shocks pass through to the rest of the economy” (pp. 148–49). Greater exposure to the rigors and discipline of the international market breeds efficiency, facilitates effective diversification, and improves the flexibility of an economy in the face of adverse external developments. We have seen this documented elsewhere. Compared with the alternative, it helps cushion part of the shock and perhaps even offset it.

To the remaining shock, the country must adapt; hence, prudent management. It is unfortunate, in this connection, that in some countries, “adjustment” has become an emotionally charged word. When circumstances change, adjustment is inevitable. And the longer the corrective action is postponed, the more drastic it is likely to be. Ahmad tellingly cites Malaysia's miscalculation here in 1981–82.

The adjustment process can be “smoothed” by “institutional” arrangements. Indeed, Malaysia has participated in various international commodity agreements and availed itself of credits under the Fund's buffer stock financing and compensatory financing facilities, which brings me to Ahmad's implied criticism of the evolution of Fund practices here. He laments two developments: the reduced use of the compensatory financing facility after the early 1980s and, what he sees as the complete transformation of the original character of the facility in 1988.

The reduced use of the facility he attributes to “harsher conditions attached to each drawing” (p. 131). True, conditionality was effectively tightened in 1983. This was a prudential move designed to protect the revolving character of the Fund's resources. But there are other reasons for the lower level of use of the facility since then. During the immediately ensuing period, the value of exports of most primary producers strengthened along with world economic activity. Many countries had used up most of their access to the facility effectively for five years, as they had made substantial use of it during 1982–83. Also, for the low-income countries, the structural adjustment facility and the enhanced structural adjustment facility are a cheaper form of financing.

As to the transformation of the facility's original character, there has been no fundamental change in its compensatory component. The requirement of “cooperation with the Fund” was clarified and tightened in 1983, as noted. In 1988, the maximum compensation available for temporary shortfalls in exports was reduced in most cases (from 83 percent of quota to 65 percent of quota). But the character of such assistance was not altered; indeed, compensating members for temporary export shortfalls remains an essential activity of the Fund.

Access limits were lowered because the Fund, in an effort to sustain adjustment efforts in the face of external shocks broadened the contingencies against which it would offer assistance—such that in addition to, say, drawing 65 percent of quota to compensate for export shortfalls, a country might also be able to draw 40 percent of quota to help defray the costs of, for example, an increase in interest rates on debt or a surge in import prices beyond original expectations. And where a member encounters payments difficulties arising solely from a classical shortfall in exports, it will continue to be eligible to draw 83 percent of quota.

The Fund's business is to support adjustment. As Ahmad notes, countries cannot insulate themselves from the outside world. They must adapt—and adapt on a continuous basis. The author has provided a lucid exposition of how one country has grasped this nettle.


Note on the Econometric Analysis Used

The econometrics employed in the paper revolve around the computation of instability indices for various export commodities of Malaysia. For each commodity, instability indices are computed for export value, unit value, and quantity. Two instability indices are calculated for each unit value: one in terms of ringgit, and the other in terms of U.S. dollars. The computations are based on monthly data from Bank Negara Malaysia for the period December 1982–September 1988.

Instability indices for various exports of Malaysia were computed using the same measure as Cuddy and Dellavalle (1978) and Charette (1985):

where CV is the coefficient of variation for the series, and R¯2

is adjusted R2 obtained from a log-linear time trend regression of the series:

where X is the relevant export variable and T is the time trend variable.

The results of the regression are summarized below. In the first column, .V represents export value, .UM represents unit value in Malaysian ringgit, .US is unit value in U.S. dollars, and .Q for export quantity.

Regression Results


Palm Oil

In addition, a simple regression analysis to establish the relationship between variabilities in export, on one hand, and variabilities in gross capital formation and GNP, on the other, has also been done as described below.

The issue involved in empirical testing of the effect of export variability would ideally seek a measure of the uncertainty introduced by the variability in export in any period. The approach taken here is to adopt the observed variability from the trend rate as a measure of uncertainty. In the regression that follows, the trend values were derived by assuming exponential growth rates for capital formation, exports, and GNP. The regression results, with variables measured in terms of their deviations from trends, are

For this regression, annual data on gross capital formation, gross exports, and nominal GNP for the period 1965–87 were used.


    AriffK.A.MohamedExport Trade and the West Malaysian Economy: An Enquiry into the Economic Implications of Export Instability Monograph Series Malaysian Economic Affairs (Kuala Lumpur: University of Malaya1972).

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    CoppoachJ.D.International Economic Instability (New York: McGraw Hill1962).

    CuddyJohnD. andP.A.Dellavalle“Measuring Instability of Time Series Data,”Oxford Bulletin of Economics and Statistics (Oxford, England) Vol. 40 (1978) pp. 7985.

    ErbG.F. andS.Schiavo-Campo“Export Instability, Level of Development and Economic Size of Less Developed Countries,”Bulletin of the Oxford University Institute of Economics and Statistics (Oxford, England) Vol. 31 (1969) pp. 26384

    LeithJ.C.“The Decline in World Export Instability: A Comment,”Oxford Bulletin of Economics and Statistics (Oxford, England) Vol. 32 (1970) pp. 26772.

    Malaysia Government ofFifth Malaysia Plan 1986-90.

    Malaysia Government ofThird Malaysia Plan 1976-80.

    MassellB.F.“Export Instability and Economic Structure,”American Economic Review (Nashville) Vol. 60 (September 1970) pp. 61830.

    NayaS.“Fluctuations in Export Earnings and Economic Patterns of Asian Countries,”Economic Development and Cultural Change (Chicago) Vol. 21 (July 1973) pp. 62941.

    World BankWorld Tables 1987 (Baltimore: Johns Hopkins University Press1987).

I wish to acknowlege the assistance of Sukdave Singh and others in the Economics Department of the Central Bank of Malaysia in the preparation of this paper. All remaining errors are mine. The opinions expressed do not necessarily reflect those of the Central Bank of Malaysia.

Among them are bananas, cotton, jute, tea, tropical timber, bauxite, copper, iron ore, and phosphates.

The index used was the root of the antilog of

xt = export unit value; and

n = the number of years.

The index used is adapted from Cuddy and Dellavalle (1978) using the formula

where CV is the coefficient of variation, that is, the ratio of the root mean square error over the mean of the dependent variable. CV was derived from a log linear trend regression and the coefficient R̄2 is the adjusted coefficient of determination.

An earlier study by Massell (1970) made similar observations when the size of total exports, introduced as an approximation of export share, explained instability better than the export share itself.

Defined as the root of the sum of squares of export ratios as follows:

where the ratio χ/χ is the export ratio of the ith product in terms of total export χ. The interpretation taken is that the greater or more evenly exports are diversified, the lower is the ratio.

Annual percentage change in the CPI during 1961–70 was 0.9 percent; 5.9 percent during 1971–80; 5.8 percent during 1981–84; and 0.5 percent during 1985–87.

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