On behalf of the Malaysian authorities, we thank the IMF team for the constructive and comprehensive discussions on macroeconomic developments and policy issues in Malaysia. We are encouraged by staff’s assessment that the Malaysian economy is resilient and that the current macroeconomic policy settings are appropriately attuned to the outlook and risks facing the economy and the financial system.
We continue to have strong concern on the Fund’s inflexibility to be receptive and open to new approaches and policy instruments needed to maintain stability and promote financial market development. Our authorities are also deeply concerned with staff’s lack of understanding of the domestic context which can diminish the Fund’s role as trusted adviser. The Fund should be more flexible and open to new approaches and policy instruments needed to maintain stability and promote financial market development. Contextualization of country specific circumstances must be taken into account adequately and “one size fits all” assessment must be avoided. In addition, measures that have yielded clear positive outcomes for a country to be more resilient and safeguard against shocks should be recognized. This would enable the Fund to be more effective in advancing reforms in the international monetary system.
Our authorities wish to record their disappointment on the fact that staff did not adequately reflect the Authorities’ Views in the Staff Report as conveyed during series of meetings and feedback. In particular, the authorities firm view that the Financial Markets Committee (FMC) measures introduced in December 2016 are not CFMs was not adequately recorded in the Authorities’ Views. This omission is highly regrettable and staff’s failure to reflect clearly Authorities’ Views can mislead the Board, investors and market. Our authorities further cautioned that any inappropriate assessment by the Fund, particularly on the onshore FX measures, could potentially lead to unintended market consequences and should be avoided altogether.
Our authorities felt that assessment by staff, as in the past, did not provide enough consideration on the negative spillover effects by a neighboring market that had caused instability and disorder to the Malaysian financial market. The authorities also felt that market failure and unfettered and opaque NDF were tolerated to the detriment of members’ financial market stability. These challenges are not self-correcting and will continue to prevail if no specific measures are taken. This is where the Fund as a multilateral institution responsible in advancing global financial stability, should play a role in reducing disruptive cross-border implications of NDF market.
Economic Developments and Outlook
The Malaysian economy registered robust growth of 5.9% in the first three quarters of 2017. Growth in Q4 2017 is expected to be sustained at a similar pace and based on this performance, growth for the whole 2017 is expected to exceed the upper end of the official range of 5.2 – 5.7% released earlier (2016: 4.2%). Continued expansion in domestic demand and improving external environment which benefitted the export sector, was the main driver to this better-than-expected growth performance during the year. Inflation remained low (January – November 2017: 3.4%; 2016: 2.1%) and labor market conditions remained favorable amid stable unemployment rate (November 2017: 3.3%; 2016: 3.5%). Malaysia’s external position strengthened amid a more favorable external environment, supported by broad-based improvement in the global economy and relatively lower volatility in the international financial markets. The current account balance recorded a healthy surplus (1Q-3Q 2017: 2.8% of GDP; 2016: 2.4% of GDP) while international reserves were at a comfortable level of USD103 billion (as at January 15, 2018), sufficient to finance 7.2 months of retained imports and 1.1 times short term external debt as at 29 December 2017. After depreciating by 5.9% in 2016, the Malaysian ringgit appreciated by around 10.4% against the US dollar in 2017. Similarly, backed by the resumption of capital inflows, the Kuala Lumpur Composite Index increased by 9.4% in 2017.
The prospects for the Malaysian economy over the medium term remain positive. For 2018, the Malaysian economy is projected to expand between 5.0 – 5.5% in line with staff’s estimates. Supported by strong economic fundamentals, domestic demand will remain the key driver of growth, particularly from continued expansion in the private sector expenditure. Private consumption will be the largest driver of growth, supported by improvements in income and labor market conditions. Investment activities are expected to be sustained by the implementation of infrastructure projects and continued capital investment by manufacturing and services firms. Favorable global outlook will provide additional support to the Malaysian economy through healthy exports sector. Manufactured and services exports will continue to record positive growth, benefiting from the further strengthening in US and euro area growth, and continued growth in the regional economies. The higher commodity prices are also expected to lend support to Malaysia’s current account surplus.
In the medium term, inflationary pressure is expected to moderate. The expected improvement in domestic demand condition will be accompanied by continued expansion in productive capacity, which will contain the potential upward pressures on core inflation. Nevertheless, movement of the headline inflation will be affected by the uncertain movements in the global energy and commodity prices.
Our authorities concur that risks to the growth outlook are balanced. Better-than expected global demand and stronger-than-expected spillovers from the external sector performance to the domestic economy are the two potential risks factors that could provide further impetus to the growth momentum. However, downside risks to domestic growth remain, emanating mainly from the external developments including the performance and policies of major trading partners which could affect trade performance and financial markets sentiments.
Our authorities welcome staff’s assessment that Malaysia’s external debt remains manageable under a variety of shocks. Malaysia’s external debt stood at RM873.8 billion or USD204.7 billion as at end-September 2017, equivalent to 65% of GDP (2016: RM916.9 billion or USD202.3 billion; 74.5% of GDP). Malaysia’s external debt is supported by a favorable debt structure with about 34% of external debt denominated in ringgit. The remaining external debt denominated in foreign currency are mostly held by banking institutions, which are subject to the central bank’s prudential management.
Staff’s assessment on Malaysia’s higher external financing vulnerabilities relative to peer median does not sufficiently take into account Malaysia’s degree of openness and financial market depth. For instance, Malaysia has the second-largest local-currency denominated bond market in Asia (relative to GDP, excl. Japan), with active non-resident participation. The banking sector’s external exposures is also in line with centralized liquidity management practices of domestic banks with large regional footprint and strong presence of locally-incorporated foreign banks. Importantly, any assessment should also consider Malaysia’s external assets. Malaysia’s external assets are predominantly denominated in foreign currency (95% share) while a significant share of Malaysia’s liabilities are in domestic currency (59.5%). Non-FDI foreign-currency assets exceed foreign-currency liabilities. Hence, the potential claim on international reserves from non-FDI liabilities would be limited. Taken collectively, these factors have enhanced Malaysia’s resilience against external shocks and exchange rate movements.
Adjusting to external shocks
As a highly open economy, with a financial system that is integrated with the international financial system, Malaysia remains exposed to developments in the global financial markets and volatile capital flows. In the current environment, policymakers need at their disposal a full array of effective policy tools to safeguard the stability of the economy and financial system. As the global environment evolves and new challenges emerge, policymakers need to be agile in its approach and to constantly recalibrate the most appropriate policy response.
Our authorities wish to reiterate that the FMC measures introduced in December 2016 are not to limit capital flows, and hence, should not be classified as capital flow management measures (CFMs). Rather, these measures are solely for the development of onshore market and for prudential reason. The authorities strongly disagree with staff’s recommendation to phase out the measures as the measures introduced have yielded positive benefits to Malaysia. The authorities call for the Fund to be more pragmatic in application of the Institutional View on Capital Flow and call staff to continue to deepen their understanding on country specific circumstances.
Our authorities disagree with staff’s assessment that suggest the authorities have no clear strategy in implementing the onshore FX measures, despite the clear and extensive explanation on the measures. Since December 2016, the Financial Markets Committee (FMC) has introduced a series of measures designed to foster the development of the onshore foreign exchange (FX) markets. The measures are indeed part of the comprehensive long-term strategy to develop a highly liquid and deep FX market in Malaysia that commensurate with the strong economic growth and increasingly sophisticated needs of businesses and investors. Therefore, our authorities are of the view that staff needs to have a holistic understanding of the measures implemented. In this regard, our authorities stand ready to further engage with staff for the Fund to develop a holistic understanding on this matter.
Our authorities view the recommendation by staff for the authorities to communicate to the public on the FX market strategy as inappropriate and misleading as it gives the impression that the authorities were not robust in implementing and communicating the policies to the public. The statement is not consistent with the press release issued on 11 December 2017 where the Fund has acknowledged continuous communication undertaken by the authorities. Market consultation and robust communication strategy have been anchoring the formulation of policies. In fact, the measures were carefully deliberated pre- and post-measures by the FMC which consists of representatives from the industry, including corporates. Our authorities have been conducting continuous wide-ranging engagement with over 3,600 corporations from government agencies, association of companies, commercial banks, local and foreign media, analysts, and fund managers and have addressed concerns raised. In addition, all FMC measures were made transparent to the public and communicated via press statements, speeches and periodic market updates published on the BNM’s website.
Our authorities are concerned with the suggestion that exporters with unhedged ringgit domestic borrowing as source of financial instability as it lacks rationale and basis. The exporters with domestic ringgit borrowing are freely allowed to manage their FX risk. The underlying issue is not FX exposure arising from the unhedged ringgit borrowing by exporters, rather, on the impact of debt servicing capacity of all residents with domestic borrowing (including exporters) arising from their large investments abroad and the use of scarce domestic resources for such investment.
Our authorities also clarified the FMC measures represented a balanced approach in terms of fostering the above objectives and addressing the impact from external spillovers. The cost indicated by market participants are mainly related to compliance to the existing regulation. The suggestion by staff that the measures have increased compliance cost lacks evidence. In addition, our authorities strongly disagree with the suggestion that the measures had a sustained negative impact on market sentiment. The decline in MGS weight in JP Morgan’s GBI EM Global Diversified Index is a reflection of broadening country coverage and relative market issuances. The reduced foreign investors’ interest was only temporary that reflects sell-off by speculative investors, an intended policy outcome by our authorities. In fact, interest of investors into the Malaysian market has resumed, particularly the long term investors, underscored that the measures have not led to a sustained erosion of market confidence.
Our authorities wish to re-emphasize the following:
- a. The conversion of export proceeds into ringgit is meant to address the structural imbalances of supply and demand for foreign currencies in the onshore foreign exchange market. The requirement does not in any way hinder exporters from holding more than 25 percent of export proceeds in foreign currency if they have genuine business need. The framework allows reconversion to foreign currency at the same rate with no additional cost incurred by exporters for building up their foreign currency balances to meet their imports and current international obligations.
- b. The prudential limit on foreign currency investments by residents with domestic ringgit borrowing is to streamline the rule relating to investment in foreign currency assets with the broad objective of mitigating potential systemic risk to the financial system. This is done through the management of large investments by residents with domestic ringgit borrowing. Residents, including exporters, without domestic ringgit borrowings can continue to freely invest in foreign currency assets onshore and offshore up to any amount.
The Fund’s rigidity towards policy subscription instituted under the Institutional View led to the apparent failure of staff to adequately recognize the effectiveness of the authorities’ measures. Since its implementation, the measures have yielded clear positive outcomes (see Figure 1). Market adjustments have gradually taken place. Liquidity in the onshore FX market, as reflected in the higher average daily turnover, has deepened significantly, enabling a better facilitation of FX needs of the market. Bid-ask spread has narrowed, which contributed to reduced transaction costs for market participant. Net FX conversion has increased significantly, contributing to the rebalancing of the foreign currency demand and supply.
Note: volatility refers to the difference between MYR/USD interbank intraday highest and lowest rate. Offshore rate refers to the NDF 1-month rate while onshore rate refers to the spot rate.
Source: Bloomberg; Bank Negara Malaysia
After maintaining the Overnight Policy Rate (OPR) since July 2016, the Monetary Policy Committee (MPC) decided to normalize the degree of monetary accommodation by raising the OPR by 25 basis points to 3.25% in January 2018. The MPC assessed that there would be faster expansion in global growth, with more balanced risks to the outlook. The domestic economy is firmly on a steady growth path, and headline is expected to average lower in 2018. The adjustment also pre-emptively ensures that the stance of monetary policy is appropriate to prevent the build-up of risks that could arise from interest rates being too low for a prolonged period. The normalization would contribute towards preserving the sustainability of growth, while ensuring ample policy space. At the current level of the OPR, the stance of monetary policy remains accommodative and supportive of growth. The MPC will continue to closely assess the risks surrounding the outlook for growth and inflation in deciding the stance of monetary policy moving forward.
Our authorities welcome staff’s assessment that the planned pace of consolidation for 2017–18 is appropriate. The fiscal deficit declined to 3% of GDP in 2017 and is projected to reach 2.8% in 2018. Similarly, prudent fiscal management has led to the consistent reduction in federal government debt over the years, projected to be 50.9% of GDP in 2017 (2016:52.7% of GDP).
Fiscal consolidation is ongoing while sound macroeconomic environment will continue to support private sector activity. To drive the fiscal consolidation efforts, the authorities are currently implementing the Medium-Term Fiscal Framework (MTFF) which acts as the principal planning mechanism to optimize fiscal revenues and expenditures. Under the framework, the fiscal deficit level is targeted to be gradually reduced during the period of 2018 – 2020 with target to achieve a balanced budget in the next 5 years. Based on this framework, our authorities have implemented several initiatives to improve both revenue enhancement and expenditure efficiency. Among the initiatives include enhancing tax administration and compliance; expenditure rationalization and optimization; strengthening budget management and control, as well as improving fiscal policy institution.
To strengthen the institutional capacity of fiscal management, the Fiscal Policy Committee established the Fiscal Risk and Contingent Liability Technical Committee in May 2016. The committee is mandated to evaluate and propose measures to manage fiscal risks and contingent liabilities. Our authorities also extended their appreciation to the Fund’s TA on Public Investment Management Assessment in April 2017.
Our authorities welcome staff’s assessment that the Malaysian financial sector is resilient and that the overall risks are contained. This assessment is consistent with the outcome of the regular stress tests conducted by the authorities and by the individual banking institutions separately. The stress test results demonstrated that Malaysia’s banking system is resilient to major macroeconomic shocks. The strength of the Malaysian financial system is also underpinned by strong balance sheet, asset quality and capital buffers both at the system and institutional levels. Nevertheless, our authorities acknowledge risks to financial stability remained, particularly risks emanating from the household, business and property sectors. In this regard, BNM continues to focus its surveillance and supervisory activities to contain emerging risks, both domestically and internationally. BNM’s assessments are as follow:
- a. Concerns on high household indebtedness are mitigated as measures put in place by BNM in the past few years are working well and remain relevant to contain financial stability risk. The level of household debt continues to record its moderating growth trend for the sixth consecutive year supported by macroprudential measures and prudent underwriting standards by banks to ensure borrowers are credit worthy.
- b. Corporate leverage, including external borrowings, continues to be supported by sound debt servicing capacity and hedging practices. The increase in the overall debt level of corporate sector in recent years is in tandem with economic expansion, thus the financing needs. The concern on corporate leverage is mitigated by the corporate sector’s healthy balance sheets, sustained financial strength and good debt servicing capacity that is based on the prudent cash flow projections from business operations.
- c. The imbalances in the property market remain, but are currently contained to the specific property segments, namely the high-end high-rise residential and commercial property. Banking system’s exposures to these higher-risk segments are limited. This reflects continuous improvements in bank’s credit risk management practices including refinements in their risk appetite and underwriting standards to account for increased risks associated with lending to property sector. BNM is developing a holistic solution to promote a sustainable property market, including a legislation for the residential rental market and the second National Housing Policy to drive a medium-term strategy for the housing market development. Given that risks to domestic financial stability are well- contained amid a favorable economic outlook, BNM is of the view that no further macroprudential or other policy measures are needed at this point.
Malaysia remains committed towards addressing the deficiencies in its AML/CFT regime and meeting its five-year National AML/CFT Strategic Plan objectives. As at 2017, 80 percent of the action plans have been completed or are in progress to be completed within the estimated timeline. This includes the enhancement in ML/TF risk understanding, legal and operational reform.
Reforms to enhance growth potential
Reform initiatives as outlined in the 11th Malaysia Plan (11 MP) (2016–2020) have also made further progress. Aims to accelerate Malaysia’s transformation into a high-income economy by 2020, the main thrust of the 11 MP is to promote a more inclusive growth and raise productivity and competitiveness. Reaching a half-way of its implementation term, the mid-term review to evaluate the progress of the 11 MP is currently on-going. Led by the Economic Planning Unit, the review started in July 2017 and is aimed to evaluate progress on the targets, initiatives, programs and development projects outlined in the 5-year plan. Most importantly, the review will identify gaps and the necessary steps that need to be taken to improve the implementation progress, so that the targets will be achieved. The report of the 11 MP mid-term review will be presented to the parliament by July 2018.
Among the key initiatives under 11 MP is the implementation of Malaysia Productivity Blueprint. Launched in May 2017, it defines five key strategic thrusts to raise labor productivity – building workforce of the future; driving digitalization and innovation; making industry accountable for productivity; forging a robust ecosystem; and securing a strong implementation mechanism. The blueprint aims to achieve the labor productivity growth target of 3.7% by 2020.
Our authorities are in the process of formulating the Transformasi Nasional 2050 (TN50) – a 30-year national development initiative which will provide continuity in the developmental goals for the nation beyond 2020. Engagement with various stakeholders to formulate TN50 is currently underway and the policy document will be published in early 2020. TN50 will outline the economic, social, cultural and environmental targets that Malaysia aims to achieve by 2050.
Strong and resilient macroeconomic fundamentals accord Malaysia the ability to manage current challenges and pursue structural reforms. The Malaysian economy’s strengths are derived from its highly diversified economic structure, resilient external position and policy flexibility. Looking ahead, the challenging global environment necessitates continued emphasis on enhancing the nation’s economic resilience and broadening growth sources. These structural reforms and pre-emptive policy measures are envisaged to provide greater support to Malaysia’s future growth prospects.