IMF Country Report No. 14/80; Malaysia: 2013 Article IV Consultation-Staff Report; Press Release; and Statement by the Executive Director for Malaysia; February 14, 2014

IMF Country Report No. 14/80

MALAYSIA

2013 ARTICLE IV CONSULTATION—STAFF REPORT;

PRESS RELEASE; AND STATEMENT BY THE EXECUTIVE

DIRECTOR FOR MALAYSIA

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with

members, usually every year. In the context of the 2013 Article IV consultation with Malaysia,

the following documents have been released and are included in this package:

 The Staff Report prepared by a staff team of the IMF for the Executive Board’s

consideration on March 7, 2014, following discussions that ended on December 16, 2013,

with the officials of Malaysia on economic developments and policies. Based on

information available at the time of these discussions, the staff report was completed on

February 14, 2014.

 An Informational Annex prepared by the IMF.

 A Press Release summarizing the views of the Executive Board as expressed during its

March 7, 2014 consideration of the staff report that concluded the Article IV consultation

with Malaysia.

 A Statement by the Executive Director for Malaysia.

The following document will be separately released.

Selected Issues Paper

The publication policy for staff reports and other documents allows for the deletion of market-

sensitive information.

Copies of this report are available to the public from

International Monetary Fund  Publication Services

PO Box 92780  Washington, D.C. 20090

Telephone: (202) 623-7430  Fax: (202) 623-7201

E-mail: [email protected]

Web: http://www.imf.org

Price: $18.00 per printed copy

International Monetary Fund

Washington, D.C.

March 2014

MALAYSIA

STAFF REPORT FOR THE 2013 ARTICLE IV CONSULTATION

KEY ISSUES

Near-term outlook. Malaysia’s healthy, noninflationary growth continued in 2013, albeit

at a somewhat slower clip than earlier years. While domestic demand remained robust,

the economy was buffeted by external headwinds, including from volatile capital flows in

spring-summer and weak export growth. The current account surplus continued to

narrow, although it remains comfortably in surplus. Continued strength in domestic

demand, especially investment, and a pickup in external demand should help maintain

robust growth going forward despite the welcome fiscal tightening.

Macroeconomic policy mix. Staff welcomes the timely, credible, and gradual

recalibration of macroeconomic policies, which should help achieve a smooth transition

to the post-UMP environment. The budget is being tightened and fiscal institutions

strengthened. Bank Negara Malaysia (BNM), which maintains an accommodative

monetary stance for now, possesses ample policy credibility and should be able to

contain any second round price effects associated with fuel subsidy reductions.

Fiscal policy breakthrough. Amidst concerns about Malaysia’s public finances and a

sharp narrowing of the external surplus in spring-summer, the authorities took timely

action to secure fiscal sustainability and assure markets. Staff welcomes the

comprehensive and gradual approach to fiscal adjustment, which includes subsidy

rationalization, broadening of revenue bases, and the strengthening of the social safety

net. It urges the authorities to persevere in their efforts to rebuild fiscal buffers, improve

the management of contingent liabilities, and address ageing-related fiscal challenges.

Financial stability. Malaysia’s financial system is sound, supported by strong supervision

and regulation. Targeted, yet escalating macroprudential policies (MAPs) are being

employed to deal with the risks from high rates of credit growth and rising household

debt. These risks, as well as the effectiveness of MAPs, should continue to be closely

monitored. The exchange rate remains flexible and, together with Malaysia’s ample

financial buffers and sound monetary and fiscal policies; should safeguard the economy

from potentially volatile capital flows.

Inclusive growth: the role of human capital. The authorities have designed and are

implementing several ambitious transformation programs and blueprints to turn

Malaysia into a high-income, knowledge and innovation based nation by 2020. Their

efforts are on track, although skills mismatches need to be addressed through intensified

human capital development efforts. Progress in education, as outlined in the Malaysia

Education Blueprint, 2013−2025, is a high priority. This will call for achieving stronger

performance in education in a tighter budgetary environment.

February 14, 2014

MALAYSIA

2 INTERNATIONAL MONETARY FUND

Approved By

Hoe Ee Khor and

Ranil Salgado

Mission dates: December 5−16, 2013

The mission comprised Alexandros Mourmouras (Head), Niamh

Sheridan, Elif Arbatli, Jade Vichyanond (all APD), Mustafa Saiyid

(MCM), and Geoffrey Heenan (Singapore Resident Representative) and

Seen Meng Chew (Resident Representative’s Office). Hoe Ee Khor

(APD Reviewer) participated in the policy discussions.

CONTENTS

RECENT DEVELOPMENTS, OUTLOOK, AND RISKS ______________________________________________ 4

NEAR-TERM ECONOMIC POLICIES: ACHIEVING A SMOOTH TRANSITION ___________________ 7

FISCAL POLICY: BREAKTHROUGH _____________________________________________________________ 10

FINANCIAL STABILITY __________________________________________________________________________ 14

CAPITAL OUTFLOWS: VULNERABILITIES AND RESILIENCE __________________________________ 20

EXTERNAL SECTOR DEVELOPMENTS __________________________________________________________ 22

BOOSTING GROWTH AND INCLUSION: THE ROLE OF HUMAN CAPITAL DEVELOPMENT _ 23

STAFF APPRAISAL ______________________________________________________________________________ 24

BOXES

1. Fiscal Policy Committee ______________________________________________________________________ 27

2. Goods and Services Tax (GST) _______________________________________________________________ 28

3. Medium-Term Fiscal Consolidation __________________________________________________________ 29

4. Household Debt _____________________________________________________________________________ 31

FIGURES

1. Growth and Exports __________________________________________________________________________ 32

2. Inflation and Domestic Resource Constraints ________________________________________________ 33

3. Monetary Developments _____________________________________________________________________ 34

4. Fiscal Policy Developments __________________________________________________________________ 35

5. Capital Inflows _______________________________________________________________________________ 36

6. Financial Sector Developments ______________________________________________________________ 37

7. Household Debt _____________________________________________________________________________ 38

8. House Prices _________________________________________________________________________________ 39

9. Financial Soundness Indicators, 2013:Q3 ____________________________________________________ 40

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INTERNATIONAL MONETARY FUND 3

TABLES

1. Selected Economic and Financial Indicators, 2009–14 _______________________________________ 41

2. Indicators of External Vulnerability, 2008–12 ________________________________________________ 42

3. Balance of Payments, 2009–14 _______________________________________________________________ 43

4. Illustrative Medium-Term Economic Framework, 2009–18 ___________________________________ 44

5. Summary of Federal Government Operations and Stock Positions, 2009–14 ________________ 45

6. Monetary Survey, 2009–13 ___________________________________________________________________ 46

7. Banks’ Financial Soundness Indicators, 2009–13 _____________________________________________ 47

8. Macroprudential Measures Since 2010 ______________________________________________________ 48

APPENDICES

1. Staff Policy Advice from the 2011 and 2012 Article IV Consultations ________________________ 49

2. Risk Assessment Matrix ______________________________________________________________________ 50

3. External Sector Assessment __________________________________________________________________ 51

4. Public Debt Sustainability Analysis ___________________________________________________________ 56

5. External Debt Sustainability Analysis _________________________________________________________ 63

6. 2013 FSAP—High Priority Recommendations _______________________________________________ 66

7. Stress Tests of Banking, Household and Corporate Balance Sheets _________________________ 67

8. What Explains Malaysia’s Resilience to Capital Outflows? ___________________________________ 70

9. Transformation Plans to Boost Growth and Inclusion ________________________________________ 74

MALAYSIA

4 INTERNATIONAL MONETARY FUND

RECENT DEVELOPMENTS, OUTLOOK, AND RISKS

1. Context. General elections were held on May 5, 2013. Prime Minister Najib’s incumbent

coalition won narrow election, thus ensuring smooth policy transition. Amidst a difficult external

environment for Emerging Market Economies (EMEs) last spring-summer, the administration has

taken actions that signal its resolve to respond decisively to domestic and external challenges. A

High-Level Fiscal Policy Committee (FPC) was created to improve management of the public

finances, food and fuel subsidies and electricity tariffs are being rationalized, and a Goods and

Services Tax (GST) will be introduced in 2015. These measures are key steps towards rebuilding fiscal

buffers lost on account of expansionary policies during the global financial crisis.

2. Economic developments. Growth

slowed to 4.7 percent in 2013, compared

with 5.6 percent in 2012, but remained

healthy. Weak external demand, especially

in the first half of the year, weighed on

activity, and a small negative output gap

opened up. Domestic demand remained

robust, supported by healthy labor markets,

accommodative financial conditions and,

during the first half, expansionary fiscal

policies (Figure 1). Inflation remained

subdued through the spring and summer

despite the introduction of a minimum

wage in 2013 but picked up recently. Headline inflation rose to 3.2 percent year‐on‐year in

December, reflecting subsidy cuts. Core inflation has also increased but is still very low, less than

2 percent in December (Figure 2).

3. Financial Market Developments.

Like many other EMEs, Malaysia has been

experiencing capital outflows during

periods of market turbulence, including

spring-summer and early this year. Between

end¬May and end¬2013, the yield curve for

Malaysian Government Securities (MGS) has

steepened: 10‐year yields have increased by

70 bps, and the spread against the

U.S. dollar has widened by about 20 bps.

During summer turbulence, the ringgit

weakened by about 11 percent against the

dollar (peak-to-trough) and after a brief

period of strengthening is now back below the September

MALAYSIA

INTERNATIONAL MONETARY FUND 5

trough. Deep financial markets and a flexible exchange rate have helped facilitate financial

adjustment, and the economy has been able to absorb the shocks without appreciable harm to date.

4. Outlook. Growth is projected to accelerate to 5.0 percent in 2014. Consumption and

investment growth are expected to moderate somewhat but should generally hold up amidst

conditions of full employment and the long pipeline of large, multiyear investment projects. In

addition, the pickup of export growth since the second half of 2013 should be sustained as the

global economy continues to improve, and offset headwinds from fiscal consolidation (a fiscal

impulse of about minus 1 percent of GDP in 2014, although staff views the fiscal multipliers as low).

Over the medium term, growth is expected to average 5 percent, reflecting higher investment,

including infrastructure upgrades, which should help boost productivity. The gradual removal of

subsidies is expected to result in a modest increase in inflation during 2014. Second round price

effects are, however, expected to be limited in light of the low initial level of inflation, and BNM’s

considerable monetary policy credibility. Inflation will likely reach about 4.0 percent in 2015

following the introduction of GST, but in staff’s baseline scenario, is expected to gradually moderate

to below 3.0 percent in the medium term.

5. Risks. The risks to the staff’s baseline scenario are primarily on the downside and stem from

both external and domestic sources (Appendix 2).

 External risks. A key risk is a potentially bumpy exit from unconventional monetary policies

(UMP) in advanced economies (AEs), which could trigger bouts of financial market turbulence

and dampen external demand. With foreign investors still holding sizeable positions in the

domestic bond and equity markets, Malaysia is vulnerable to capital outflows during periods of

heightened global financial stress, as evidenced during spring-summer 2013. Other risks include

a further slowdown in China, a protracted period of slow growth in Europe, and commodity

price shocks.

 Domestic risks. The relatively high level of federal debt (close to the government’s self-imposed

ceiling of 55 percent of GDP) and large contingent federal liabilities limit the room for

countercyclical fiscal policy. And while recent fiscal actions are welcomed, there remain

implementation risks associated with these comprehensive reforms. In particular, setbacks in the

implementation of fiscal reforms could undermine investor sentiments and trigger outflows from

the bond market and a jump in yields which, in the context of the government’s high financing

needs, could have a significant macro-fiscal impact. In staff’s view, however, implementation

risks are low—the authorities have demonstrated the political will and possess the technical

expertise to carry reforms out. In addition, high house prices, rising household debt, and banks’

large exposure to real estate remain a concern, particularly in light of UMP unwinding and a

likely tightening in domestic financial conditions and higher interest rates. Other domestic risks

include a higher and more persistent increase in inflation and inflation expectations, triggered

by higher fuel and electricity prices as subsidies are being rationalized. Adjustments in fuel

prices are expected to add about 0.5 percentage point to annual inflation in 2014−15, while the

GST could add about 0.9 percentage point in 2015. The low starting level of inflation and the

MALAYSIA

6 INTERNATIONAL MONETARY FUND

substantial policy credibility of the monetary authorities, circumscribe, in staff’s view, the risk of

second round effects.

6. Policy advice. The authorities are taking decisive and proactive steps to reinforce Malaysia’s

macroeconomic and structural policies (Appendix 1). While specific measures are consistent with

Fund policy advice, they are home grown and driven by the authorities’ own multiyear adjustment

and reform programs. Specifically, the authorities took action to strengthen Malaysia’s public

finances during the second half of 2013. These measures are framed in the context of a medium

term fiscal adjustment program and are consistent with past Fund technical assistance and staff

policy advice. The authorities are carefully monitoring financial sector risks and are implementing

additional macro prudential measures; they are also in the process of strengthening their

information base through the collection of granular data on household assets and liabilities. The

authorities are allowing two-way exchange rate flexibility. They are also implementing wide ranging

structural reforms, and their specific programs benefit from extensive technical and policy support

from the IMF and other international organizations.

7. Authorities’ views. The authorities were in broad agreement with staff’s assessment of the

economic outlook and balance of risks.

 They anticipate growth to increase in 2014 with the improvement in the external environment,

although the fiscal consolidation can be expected to be a drag on growth. Private investment

growth should remain robust at about 13 percent but some moderation in private consumption

growth is likely.

 The authorities also see the main risks to the outlook are being primarily on the downside and

they highlighted risks from external sources, with a slowdown in global growth a key concern. In

addition, uncertainty surrounding the unwinding of UMPs and the potential for policy missteps

along the way and heightened volatility are also key risks for Malaysia.

 On the domestic front, the authorities reiterated their commitment to steadfast implementation

of fiscal reforms. The authorities acknowledged the risk of spillover to prices of other nonfuel

goods and services from subsidy rationalization, which will raise headline inflation (albeit from

low starting levels). They assess the risk of second-round effect at this point to be limited.

 The authorities are less concerned with risks to financial stability from high household debt and

house prices. They pointed to the large cushions provided by high levels of household financial

assets, healthy labor markets and low risk of unemployment. In addition, mortgage interest rates

are largely tied to the policy rate (indirectly through the base lending rate), which has been

relatively stable and makes sudden increases unlikely. Lastly, the authorities’ targeted and

phased approach to macroprudential policies, along with efforts to increase financial literacy,

has curtailed risks.

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INTERNATIONAL MONETARY FUND 7

NEAR-TERM ECONOMIC POLICIES: ACHIEVING A

SMOOTH TRANSITION

8. Policy mix. The authorities’ policy mix is appropriate in the present conjuncture, in which

Malaysia’s priority is to address fiscal vulnerabilities against a backdrop of low inflation, and an

improving external environment that is nevertheless still subject to large uncertainties and potential

capital flow volatility. The decisive, yet gradual tightening of fiscal policy should help Malaysia maintain

market access at low funding costs while avoiding undue damage to economic growth or igniting higher

inflation. The slightly accommodative monetary policy stance has been appropriately supportive of

growth in the context of low inflation, a small negative output gap and, until mid‐May 2013, strong

capital inflows. Going forward, however, monetary policy may need to be recalibrated as UMPs unwind

and if inflation risks rise. The tightening of macroprudential policies to date appears to have helped to

address potential financial stability risks, but continued monitoring is appropriate and additional

measures may be needed.

9. Fiscal policy. Following the market turmoil in spring-summer, the federal government

recalibrated fiscal policy in September-October and is on track to reach its fiscal deficit target of

4.0 percent of GDP in 2013.

According to staff projections, fiscal adjustment in 2013 was significant

(about 1 percent of GDP), driven by higher income taxes and lower development spending. Current

spending, which has increased considerably in recent years, driven by wages and subsidies, was higher

than budgeted in 2013 but is expected to remain stable relative to GDP. In particular, spending on

subsidies, which increased by 0.6 percentage points of GDP in 2012, is expected to remain elevated

in 2013 and would have been higher in the absence of the fuel price adjustments implemented in

September. The 2014 federal deficit target of 3.5 percent of GDP seems feasible if, as assumed in the

staff’s baseline projection, growth in current spending is contained within a tight envelope and fuel

prices are increased further during the year (Figure 4). Oil revenues are projected to decline by

0.5 percent of GDP, in line with a projected decline in international oil prices. Under the staff’s baseline

projection, fiscal adjustment in 2014 will be driven by subsidies (about 1 percent of GDP), the wage bill,

while development spending as percent of GDP will also slow down.

The fiscal impulse (based on staff’s

The authorities' measure of the overall fiscal balance differs from staff’s (net lending/borrowing) due to differences in

methodology/basis of recording (Government Finance Statistics Manual 2001 versus the authorities’ modified-cash based

accounting), and differences in the treatment of certain items. These reasons account for a 0.4−0.7 percentage point

difference in the measured fiscal deficits for 2012−13.

The decline in fuel subsidies is driven by the carry-over effect of the September fuel price adjustments (0.4−0.5 percent

of GDP). Staff assumes in its baseline projection an additional 20 sen hike to take place in mid-2014 with a half-year yield

of 0.2-0.3 percent of GDP, which will be partially offset by higher direct cash transfers.

Malaysia’s development budget is determined for five year intervals and the current budget allocation covers the five

year period ending in 2015. The 11

Malaysia plan, to be announced in 2015 will cover development spending during

2016-2020.

MALAYSIA

8 INTERNATIONAL MONETARY FUND

definition of fiscal balance) is about minus 1 percentage point of GDP.

Its impact on growth is

expected to be relatively small, given that a significant share of the adjustment comes from subsidy

rationalization, whose fiscal multipliers are low. The public sector deficit has widened in recent years,

reaching 5 percent of GDP in 2012, and is expected to be about 6½ percent of GDP

during 2013−2014. The increase in the public sector deficit was driven in part by higher development

spending by Nonfinancial Public Enterprises (NFPEs), which has offset the decline in development

spending at the federal government level. Fiscal impulse at the broader public sector level was

positive in 2013 but is expected to turn negative in 2014.

10. Monetary policy. Bank Negara Malaysia (BNM) has kept its policy rate unchanged at

3 percent since May 2011 (Figure 3). This policy stance, reflecting BNM’s dual mandate of ensuring

medium-term price stability and sustainable

growth, kept real interest rates low and

supported growth, against a backdrop of

uncertain global growth prospects and low

domestic inflation rates. Looking ahead, staff

expects BNM to begin a gradual tightening

cycle. The gradualist approach is warranted by

the unusual degree of uncertainty around the

external environment and is also consistent

with the need to safeguard domestic financial

stability in an environment of high household

debt. Furthermore, while inflationary

expectations are well anchored at present, the succession of price increases stemming from subsidy

rationalization and the introduction of the GST

Fiscal impulse is defined as the change in cyclically-adjusted Federal Government overall balance as percent of

potential GDP.

MALAYSIA

INTERNATIONAL MONETARY FUND 9

could lead to a pickup in inflation expectations. BNM’s task in the near term is to allow pass-through

of cost-related increases in prices (cost‐push inflation) while detecting and preempting, in a timely

and decisive fashion, any second round effects from becoming embedded in the wage-price

structure.

11. Macroprudential policies (MAPs). BNM’s current monetary policy stance is supported by

macroprudential policies to curtail financial stability risks from rapid increases in household debt

and house prices (see Box 3). Household debt reached 83 percent of GDP at end-September 2013,

up from 55 percent five years earlier. Over half of the debt is on residential property, of which nearly

70 percent is contracted at variable rates tied to the Base Lending Rate (BLR), although lending rates

have fallen recently even as the BLR has remained unchanged. Starting in November 2010 and

continuing, most recently, with the 2014 budget in October 2013, the authorities have imposed a

series of targeted, gradual, and escalating MAPs, which have been mainly directed at speculative

purchases of homes and unsecured credit (see Table 8). The 2014 budget also addressed

affordability issues through special financing schemes and measures to raise the supply of

affordable housing.

There are early signs that the more recent measures have slowed down the

approval of new loans and begun to cool the housing market; however, some inertia in loan growth

due to drawdowns of loans already committed can be expected. Should credit growth remain

strong, additional MAPs should be introduced, and their scope and stringency should depend on

the evolving stance of monetary policy, and they should be carefully designed to ensure

effectiveness and avoid circumvention. Options for additional macroprudential measures include

capping loan-to-value ratios (LTV) on second and first mortgages, explicit limits on debt

service-to-income ratios, or additional capital charges on high LTV loans.

12. Risks to the baseline and policy responses. In the present “inflection point” for growth in

EMEs, staff’s baseline scenario is subject to a wider-than-usual range of uncertainty. Should the

growth outlook deteriorate significantly, the flexible exchange rate can act as a shock absorber and

there is ample room for BNM to cut its policy rate to support growth. However, relatively high fiscal

deficit and public debt levels afford limited space for a sustained countercyclical fiscal response. Any

fiscal stimulus should be temporary, targeted and anchored in a credible medium term fiscal

consolidation program. Importantly, structural reforms and the all important subsidy rationalization

and GST implementation should not be delayed or compromised as sound public finances are

paramount to macrofinancial stability. Exchange rate flexibility, complemented by foreign exchange

intervention to smooth excessive volatility, should be the main response to unpredictable capital

flows.

13. Authorities’ views. The authorities reiterated their commitment to meeting their fiscal

targets, and to press ahead with subsidy rationalization and the implementation of the GST. The

The Private Affordable Ownership (MyHome) Scheme was introduced to incentivize private developers to build

more low- and medium-cost houses, with the subsidy provision of up to RM 30,000 per unit built. A total of

RM 300 million has been allocated in 2014 for the construction of 10,000 housing units. For Perumahan Rakyat

1Malaysia (PR1MA), the government has allocated RM 1 billion to provide 80,000 units of affordable housing to

middle income households (combined income of RM 2,500−7,500 per month) for homes in the RM 100,000−400,000

price range.

MALAYSIA

10 INTERNATIONAL MONETARY FUND

creation of the high-level FPC provides additional assurance that Malaysia will push through with

sound fiscal policies to ensure fiscal sustainability while safeguarding growth. The authorities view

the current monetary policy stance as supportive of growth but acknowledged the risk to inflation

from subsidy rationalization. Inflation developments are closely monitored, both in terms of the

pervasiveness and persistence of price increases across all items of the CPI basket, using various

qualitative and quantitative indicators including the newly developed survey of price expectations. In

terms of the impact of unwinding of UMPs in AEs, the authorities welcomed the prospect of

recovery in AEs and normalization of global interest rates as beneficial for Malaysia but were

concerned about potential volatility and capital outflows. A monetary policy response to the

unwinding of UMPs would depend on the implications to the overall outlook for growth and

inflation for the Malaysian economy.

FISCAL POLICY: A BREAKTHROUGH

14. Background. The authorities took vital steps to shore up fiscal management and policy in

the second half of 2013, and signaled their commitment to secure medium-term fiscal targets in

the 2014 Budget. Fiscal management and institutions were strengthened substantially by the

establishment of a high-level FPC (Box 1). In addition, subsidies on fuel, electricity, and sugar are

being rationalized, and a GST will be introduced in April 2015 (Box 2). To mitigate the impact of

fiscal consolidation on the poor, the authorities are taking steps to strengthen the social safety net

by enhancing the existing cash transfer program to lower income groups. The authorities are

committed to their large and complex fiscal reform agenda and are striving to carefully design and

execute it in order to mitigate implementation risk.

15. Fiscal sustainability and medium-term fiscal adjustment. The authorities’ decisions

in 2013 are tantamount to a fiscal policy breakthrough aiming to contain federal debt and related

fiscal risks. Federal debt has risen significantly in recent years, to an estimated 54.8 percent of GDP

at end-2013, from about 40 percent of GDP at the start of the global financial crisis. Based on staff’s

debt sustainability analysis (see Appendix 4

), under a no adjustment scenario (the constant primary

balance scenario), the federal debt-to-GDP ratio would exceed the authorities’ self-imposed debt

ceiling of 55 percent in the medium-term and would continue to increase thereafter.

16. Staff position. Staff welcomes the authorities’ comprehensive fiscal reform package, which

is well timed, appropriately paced, and allows sufficient preparation time for the introduction of the

GST, including an all important public education campaign. The authorities’ plans to strengthen the

social safety nets by better targeting them are also welcome. Finally, the management of fiscal

policy has been strengthened by the establishment of the high-level FPC. Implementation and

political risks from fiscal reforms are, in staff’s view, circumscribed by the authorities’ commitment to

the reforms and by their sound preparation and technical plans to carry them out. Fiscal reforms are

a marathon, not a sprint, and the large unfinished agenda in this area requires careful design and

execution in order to mitigate implementation risk.

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INTERNATIONAL MONETARY FUND 11

17. Staff supports the authorities’ plans to reduce the federal deficit to 3 percent by 2015, and to

about zero by 2020. The proposed fiscal adjustment signals the authorities’ commitment to fiscal

consolidation and is

appropriately paced, with

significant frontloading that

is commensurate with the

need to rebuild fiscal buffers.

Under the mission’s baseline

assumptions, a cumulative

improvement of about

4 percent of GDP in the

cyclically-adjusted primary

balance is required in order

to lower the federal debt-to-

GDP ratio to its pre-crisis

level of about 40 percent.

This medium-term debt

target is needed to rebuild

buffers to allow for

countercyclical fiscal policy,

absorb contingent liabilities, and ensure that the debt to GDP ratio remains below 55 percent.

 The authorities’ target of reducing the deficit to 3 percent of GDP by 2015 is feasible if, as assumed

in staff’s baseline, the GST is implemented and fuel price subsidies are rationalized. However, further

measures will be needed beyond 2015 to balance the federal budget by 2020 as oil revenues are

projected to decline and nondiscretionary expenditures are expected to rise. Spending pressures will,

inter alia, arise from civil service pensions and other aging-related costs; the need to repay previous

off-budget stimulus spending; and other federal obligations, such as spending on the Mass Rapid

Transit (MRT) project.

In this context, staff supports the authorities’ plan to further elaborate,

quantify and communicate their medium term fiscal consolidation strategy.

 To achieve the authorities’ fiscal targets for 2020 and generate sustained fiscal savings, staff

elaborated a medium-term fiscal strategy that relies on revenue and expenditure instruments with a

desirable mix of stabilization, efficiency, growth, and distributional characteristics (see Box 3 and

Selected Issues Paper on Malaysia’s medium-term fiscal strategy). These characteristics include low

fiscal multipliers; reduced reliance on corporate and oil revenues; and a progressive (or at least less

regressive) distributional impact. This fiscal strategy should also be underpinned by concrete

structural reforms to promote efficiency, growth and equity.

The 2012 Malaysia Article IV report (Box 4) details the medium-term debt target and staff’s stochastic Debt Sustainability

Analysis (DSA).

MRT is a public infrastructure project that is funded off-budget through a special vehicle that enjoys a federal guarantee;

given the non-commercial nature of the project, it may be assumed that a fraction of the debt repayments associated with

the MRT will be eventually funded through the budget.

Potential Yield

Description (Percent of GDP)

Revenue measures

GST

Broaden the tax base through revising the list

of zero-rated and exempt goods. Increase GST

rate from 6

percent to 8

percent.

1.5

Property taxes Broaden recurrent property taxes 0.3

0.5

Expenditure measures

Rationalize non-fuel subsidies

Rationalize subsidies on rice, flour and cooking

oil and partially replace them with targeted

transfers.

0.2

0.3

Restrict wage growth

Continue to limit the establishment of new

posts, restrict bonus payments and achieve

savings in emoluments in the education sector.

0.2

0.5

Reduce inefficiencies in spending

Continue efforts to improve procurement,

improve efficiency of education spending and

spending on social safety nets.

0.5

-1

Malaysia: Potential Revenue and Expenditure Measures Beyond 2015

MALAYSIA

12 INTERNATIONAL MONETARY FUND

 Viewed from this perspective, the authorities’ plans to date to rationalize subsidies, introduce a

GST, increase transfers and improve their targeting, and protect public investment spending are

a step in the right direction. Staff also argued that there was a need to restrict wage growth and

improve the efficiency of public spending in general, and education spending in particular.

Finally, staff recommended raising contributions to the Civil Service Pension Fund (KWAP) to

reduce the unfunded portion of federal pension liabilities and consider other measures to

address its long-term sustainability.

18. Tax policy. Staff strongly welcomed the authorities’ efforts to implement the GST, which

should help to broaden the tax base and reduce reliance on oil and gas revenues over time (Box 3).

The GST should also help reduce informality and improve tax buoyancy.

The net revenue yield from

GST, estimated at about 0.3 percent of GDP, is however expected to be relatively small initially. This

is due to the relatively low standard rate, the reduction of income taxes and other offsetting

measures adopted in the 2014 budget.

 Staff argued that, small initial revenue gains notwithstanding, the GST provides a powerful and

flexible revenue-generating mechanism to respond to future economic shocks. If needed, GST

base broadening, including the reduction of GST exemptions and zero-rated goods, should take

precedence over increasing the standard rate.

Staff strongly urged the authorities to resist

pressures to expand the list of exempt and zero-rated goods to ensure that the efficiency of GST

is not compromised.

 Staff argued that recurrent property taxes, a growth-friendly and progressive revenue source,

are currently underutilized in Malaysia relative to its peers and could also be used to broaden

the revenue base going forward.

 The authorities are also conducting an assessment of the effectiveness and costs of tax

incentives. Staff recommended better targeting of incentives based on this cost-benefit analysis.

The pension scheme for civil servants, Kumpulan Wang Persaraan (KWAP) is a defined benefit scheme that is

partially funded by the budget, unlike the Employees Provident Fund (EPF), the scheme for private sector workers

which is a fully funded defined contribution scheme. KWAP was incorporated in 2007, taking over the assets and

liabilities of the Pension Trust Fund, which the government had established in 1991 to help fund its future pension

liabilities. KWAP covers employees who joined civil service after 1991 (pension liabilities of civil servants who joined

before 1992 are funded on a pay-as-you-go basis from the budget). KWAP was intended to be fully funded, by

contributions from federal, state and local governments; however, federal contributions are currently below levels

consistent with full funding.

Being a value-added tax, the GST generates relevant information on different tax payers along the production

chain.

As a general principle, minimizing the number of GST exemptions, including at the implementation stage, is crucial

to improve efficiency (already at the implementation stage).

Taxes on financial and property transactions and other property-related taxes are about 1.1 percent of GDP in

Malaysia, which is lower than the median of 1.6 percent of GDP in OECD countries.

MALAYSIA

INTERNATIONAL MONETARY FUND 13

19. Subsidy reform. At over 10 percent of

federal spending, fuel subsidies are regressive and

costly to the budget. Staff welcomed the price

adjustments announced in September as a first step

in replacing them with more targeted transfers to

low-income Malaysians.

Staff made the following

recommendations:

 Gradual but credible rationalization of fuel

subsidies and a switch, eventually, to an

automatic price adjustment mechanism for fuel

prices would ensure that fiscal savings are

preserved and the issue is depoliticized.

The authorities’ plans to gradually reduce off budget

subsidies on natural gas and electricity are also critical in this regard. Bringing on budget these

implicit subsidies would improve the transparency of fiscal policy, and could bolster support for

subsidy reform.

 Cash transfers (Bantuan Rakyat 1Malaysia (BR1M)), first introduced in 2012, were increased

subsequently, their eligibility criteria were broadened, and these transfers now benefit over

55 percent of households. Staff noted that it would be desirable to improve the targeting of

welfare transfers under different programs and welcome steps to create a comprehensive

database on welfare recipients and programs, as announced in the 2014 budget.

20. Fiscal risks. Despite important recent progress, Malaysia still faces significant fiscal risks.

Continued reliance on oil and gas revenues is a medium term risk to debt sustainability in view of

the depletion of the oil and gas resources over time. Oil price shocks or exchange rate shocks can

lead to unanticipated increases in the subsidy bill, offsetting the savings from domestic price

adjustments. Federal contingent liabilities are sizeable, with loan guarantees alone amounting to

15 percent of GDP.

In staff’s view, the FPC, which will be in charge of endorsing medium-term fiscal

targets and strategy, should also play a critical role in monitoring, assessing, and managing fiscal

risks going forward. In this context, staff

Prices of gasoline and diesel were raised by 20 sen per liter in September, reducing the price gap (the difference

between market price and subsidized price) from 30 to 23 percent for gasoline and from 36 to 29 percent for diesel.

After the adjustment in September, there is still a subsidy of 63 sen per liter for gasoline (RON 95) and 80 sen per

liter for diesel.

Staff assumes in its baseline scenario that fuel prices are gradually increased to reach parity with international

prices by end-2016.

Federal contingent liabilities include loan guarantees (15 percent of GDP), potential obligations under user-funded

PPPs, liabilities of NFPEs, insured deposits under the deposit insurance, the deposits of some development finance

institutions and government linked investment funds, and credit guarantee schemes. About 20 percent of loan

guarantees are to statutory bodies and the rest are to public companies.

MALAYSIA

14 INTERNATIONAL MONETARY FUND

 Argued for anchoring budget targets on the nonoil primary balance, which would help insulate

the budget from these risks and also reduce the procyclicality of spending.

 Supported efforts to improve the monitoring and management of loan guarantees and other

contingent liabilities, and recommended preparing a fiscal risks statement to be published with

the budget documents.

 Highlighted the risk that as federal gross debt approaches the government’s self-imposed

ceiling, there could be pressure to push spending off-budget, which would undermine the

credibility of the formal budget process and the medium term fiscal consolidation.

 Supported reforms to strengthen public financial management, including adopting accrual

accounting, introducing a medium-term fiscal framework, and reducing the use of

supplementary budgets, some of which are already underway.

 Welcomed the authorities’ efforts to improve public procurement and move towards

performance-based budgeting.

21. Authorities’ views. The authorities stated their commitment to a medium-term fiscal

consolidation, including subsidy rationalization and the introduction of the GST in 2015,

underpinned by efforts to strengthen fiscal management and institutions and other structural

reforms. The authorities emphasized the importance of adopting a gradual approach in

implementing fiscal adjustment and subsidy rationalization, and the need to protect vulnerable

households. In their view, implementation risks are small, as evidenced by the political commitment

at the highest level to these reforms and the high level of their technical preparedness. They agreed

with staff on the need to outline a medium-term fiscal plan, to be endorsed by the FPC, and

indicated that work was underway to formulate a medium-term fiscal plan. The authorities stated

that although federal loan guarantees have increased recently, government’s loan guarantees are

primarily to commercial nonfinancial public enterprises with evident capacity to service debt, and

that contingent liabilities should be analyzed taking into account their (low) probability of default.

FINANCIAL STABILITY

22. Background. The 2012 IMF-World Bank Financial Assessment Program (FSAP) found that

Malaysia’s financial system is sound and backed by a strong supervisory and regulatory system.

Malaysia’s financial system is well diversified although banks continue to provide over 85 percent of

credit domestically. Nonbanks, including development financial institutions, provide the remaining

15 percent of credit but constitute only 9 percent of financial system assets. Consistent with the

FSAP, staff found that Malaysian banks are well-capitalized, profitable, and have adequate liquidity

buffers. With a Tier 1 capital ratio of 13.9 percent at end-2012, banks are well-positioned to meet the

MALAYSIA

INTERNATIONAL MONETARY FUND 15

Basel III target of 8.5 percent by 2019.

Banks’ liquidity coverage ratio (LCR) of 60 percent is consistent

with the 2015 Basel III target but meeting the 2019 target of 100 percent, while attainable, is more

challenging under current definition.

Banks’ funding structure is dominated by deposits, which make

up 80 percent of the total; 17 percent of these deposits are classified as strictly callable. Banks are

moderately profitable, with return on equity averaging about 14 percent in recent years, although

recent heightened competition for retail deposits has compressed net interest margins.

Looking

ahead, banks’ funding costs are likely to increase as deposit rates rise with the unwinding of UMPs but,

with variable rate loans largely tied to the BLR (which has tended to only change when the OPR

changes), banks could face further compression of their net interest rate margins.

23. FSAP update. Staff noted that the authorities have made significant progress with

implementation of the recommendations of the FSAP (see Appendix 6). Notably, the Financial Services

Act (FSA) and the Islamic Financial Services Act (IFSA) came into force on June 30, 2013, strengthening

BNM’s powers, including the ability to take prompt corrective action for financial institutions and to

carry out consolidated supervision of financial holding companies. In addition, the regulatory

perimeter is widened to include onshore nonbank financial entities and nonbank financial entities

operating in the offshore

The decline in banks’ CAR from 17.6 percent at end-2012 to 14.7 percent at Q3:2013, is reflective of banks’ efforts to

reduce capital that no longer qualifies as loss-absorbing capital under Basel III. The Tier 1 capital ratio of the banking

system, the relevant Basel III metric, has remained stable over this period.

Liquidity as measured by one-year coverage of liabilities with assets has come down slightly since 2012 but remains

similar to the 2011 level. Under the LCR, the more stringent Basel III definition of liquidity, that measures one-month

coverage of liabilities, banks are consistent with the global phase-in schedule.

Banks’ spreads between lending and deposit rates have shrunk over the past 10 years (by about 100 bps) as lending

rates have come down faster than deposit rates, reflecting, in part, increasing competition in the banking sector and

improving borrower creditworthiness (as evidenced by falling amounts of impaired loans for the overall system).

However, BNM issued an industry consultation paper in January 2014 proposing a new reference rate to replace the

BLR. The proposed new reference rate is designed to reflect each financial institution’s funding costs, enhancing

transparency in setting the reference rate, and increasing the sensitivity of the reference rate to changes in an

institution’s funding costs, which will reduce their risk.

Sovereign CDS spread

(bps)

Private domestic credit

growth (percent y/y)

Regulatory Tier 1

Capital to Risk-

Weighted Assets

Non-performing loans

(NPL) ratio

Liquid assets to short-

term liabilities

Gross portfolio inflows

to GDP

2012Q3

2013Q3

Sources: IMF, International Financial Statistics and Financial Soundness

Indicators; Bloomberg LP.; Haver analytics; and IMF staff calculations.

1/ Away from center signifies higher risks, easier monetary and financial

conditions, or higher risk appetite.

Malaysia: Macrofinancial-Environtment Spidergram 1/

MALAYSIA

16 INTERNATIONAL MONETARY FUND

Labuan International Business and Financial Center (Labuan IBFC) other than those licensed by the

Labuan Financial Services Authority. The IFSA provides a legal framework that is consistent with

Shariah on regulation and supervision, from licensing to the winding up of institutions. Separately, a

high-level committee, the Financial Stability Executive Committee, comprising the BNM, Perbadanan

Insurans Deposit Malaysia (PIDM), and the fiscal authority, formed since 2010 to discuss systemic risk

issues and decide on measures to address such risks, including those emanating from entities outside

of the regulatory purview of BNM, has expanded its permanent membership to include the Securities

Commission. With regard to the FSAP recommendation for improvement in granular data on

household assets and liabilities, the authorities expect to complete collection of data by income group

by end-2014.

24. Staff position. In staff’s view, the following areas warrant attention:

 Household debt. Concerns have centered on rapidly growing household debt of 83 percent of

GDP, amid rising exposure of banks to the household sector (47 percent of banks’ assets), vigorous

house price appreciation, and strong growth in unsecured consumer credit (see Box 4).

Given the

rapid credit growth to households and growing credit intermediation by nonbanks to households,

staff suggested that additional macroprudential measures may be needed and emphasized the

importance of continuing to enhance monitoring. Options for additional macroprudential policies

include explicit limits on debt service-to-income ratios, which would have to be supported by

ongoing development of credit registries; capping LTVs on second and first mortgages, or

additional capital charges on loans with high LTVs.

Recent independent policy actions by state

governments to curb price increases also suggest there is scope for closer coordination between

local and federal authorities to ensure that combined measures are not overly restrictive. Staff

welcomed progress with the collection of

granular data to support surveillance and steps

recently taken by the authorities to issue

guidelines for responsible financing to nonbanks

that are similar to those applicable to banks.

 Banks’ exposure to real estate. Banks carry

significant exposure to the nonfinancial

corporate sector (43 percent of banks’ assets).

Exposure to the real estate sector makes up

about 30 percent of the total stock of corporate

loans, and nearly 40 percent of recent flow,

which suggests that a price correction in the real estate market could have a significant

In November 2013, S&P downgraded its rating outlook for one large bank and two mid-tier banks on concerns that

asset quality could deteriorate in the future due to rising household indebtedness and potential for a correction in

house prices. However, also during November 2013, Moodys’ affirmed its stable ratings for 9 Malaysian banks, including

the one large bank downgraded by S&P, while raising its future outlook to positive from stable.

In its guidelines on responsible financing for financial institutions, the BNM already requires banks to set a prudent

limit on the debt service ratio (DSR). Importantly, there is no set limit for all borrowers but rather banks are expected to

vary the DSR based on borrower creditworthiness.

MALAYSIA

INTERNATIONAL MONETARY FUND 17

impact on the value of banks’ collateral. The aggregate nonfinancial corporate sector has assets

estimated to be more than 4 times GDP.

 Corporate debt. Corporates rely mainly on bank loans for financing, which make up nearly

60 percent of total liabilities. Debt issuance is long term in nature and mainly denominated in

ringgit, averaging almost 80 percent of the total in recent years. Following the advent of the

global financial crisis in 2008, there was a surge in U.S. dollar-denominated debt issuance by

Malaysian corporates seeking to take advantage of low borrowing rates in global markets, but

this has reverted to the average pre-crisis level since 2010. The aggregate solvency situation

appears comfortable with earnings of nearly four times interest expense on debt liabilities, while

the liquidity situation with current assets of nearly 1.6 times current liabilities is adequate. In

aggregate, cash buffers estimated at 14 percent of assets are reasonable, and leverage is

moderate with a debt-equity ratio of about 45 percent. Nevertheless, the solvency situation

varies considerably across the corporate universe and the aggregate picture could change

rapidly as earnings are volatile.

Resident companies including large multinational companies

hedge their foreign currency exposure either with onshore banks or by relying on foreign

currency earnings from abroad to meet the foreign currency commitment.

There were no

reports of concerns in the corporate sector from the depreciation of the ringgit during the

summer of 2013.

 Asset quality. Overall asset quality has

improved significantly in recent years with

nonperforming loans at a relatively low level

of 2 percent of gross loans in 2013 compared

with 6 percent at end-2007. Against a

backdrop of strong credit growth, the long

term improvement in asset quality is

confirmed by a trend decline in the amounts

of impaired loans, although there has been a

slight reversal in this trend since March 2013.

Providing a cushion, banks’ provisions cover

nearly 100 percent of all impaired loans.

Banks’ holdings of government and corporate securities comprised about 16 percent of total

assets in August 2013, of which federal government securities are 4.5 percent, although

accounting for government-guaranteed securities increases the potential exposure.

Nevertheless, with many of these securities held to maturity, there was no significant impact on

banks’ capital from higher MGS yields in 2013.

Unlike the household sector, data on individually listed corporates is available on filings data and it is therefore

possible to assess potential vulnerabilities at a granular level.

Further detailed assessment of foreign currency assets and liabilities of domestic corporates is desirable. It would

require access to banks’ data on the size and nature of foreign currency hedging done by corporates as this is not

publicly available information.

MALAYSIA

18 INTERNATIONAL MONETARY FUND

 Foreign currency and cross-border exposures. For the banking system as a whole, foreign

currency exposure is 4 percent of loans and 5 percent of deposits. The authorities’ own stress

tests indicate a manageable level of FX liquidity risk in the banking system. Banks emphasize the

need to strengthen fee-based income and to continue with plans to expand overseas in ASEAN.

As cross-border banking activity continues to grow, the authorities are appropriately expanding

the list of countries with which they have Memoranda of Understanding for cross-border

supervision. At present, cross-border assets are mainly funded from host countries. Overseas

lending by the top five banks makes up nearly 24 percent of total lending while loans-to-local

deposit ratios are moderate at about 84 percent. Most of the exposure and international

earnings contributions come from Singapore, Indonesia, Hong Kong, Thailand and Cambodia.

Although Malaysian banking operations in Indonesia and Thailand remain profitable as of

Q3:2013, asset quality could weaken in response to recent developments. Malaysian banks are

likely to continue expanding abroad as ASEAN economic integration picks up steam in the years

ahead. International experience suggests that substantial financial integration spearheaded by

rapid bank expansion in new markets can pose challenges for bank risk management and

supervisory monitoring. Going forward, it will thus be important to deepen home-host

cooperation and supervision and strengthen crisis prevention and mitigation mechanisms, as

outlined in Malaysia’s Financial Sector Blueprint.

25. The impact of higher interest rates. In view of ongoing and prospective unwinding of

UMPs in AEs and the normalization of global interest rates, staff conducted a simple solvency

sensitivity analysis of the aggregate household, corporate and banking balance sheets to increases

in MGS yields, the OPR, banks’ deposits rates and nonperforming loans (NPLs) (see Appendix 7).

From a financial stability perspective, plausible increases in domestic interest rates resulting from

orderly tapering of UMP in advanced economies appear manageable at the aggregate level. For

example, an increase in MGS yields by 100 bps combined with an increase in the OPR of 50 bps over

the course of one year is estimated to have little impact on aggregate household balance sheets or

bank capital because of earnings and savings buffers. However, the corporate interest servicing ratio

rises by 2.6 percentage points to 27.6 percent, which could potentially lead to difficulties at some

individual corporates but is unlikely to have a systemic impact.

26. More stringent stress tests. While an increase in borrowing costs by 100 bps over

12 months is plausible, more stringent tightening of financial conditions cannot be ruled out going

forward. A 200 bps increase in the policy rate over a one-year period would:

 Increase the aggregate household debt servicing ratio (DSR) by 4 percentage points to nearly

48 percent ignoring the corresponding increase in income from savings; including the latter

would raise the aggregate household DSR by only half a percentage point. However, the asset

and liability positions may not match across all categories of households and some income

groups may experience larger increases in their DSR and may become stressed.

 Raise the corporate interest service ratio by nearly 8 percentage points to 33 percent, assuming

no change in corporate earnings and full rollover of debt coming due.

MALAYSIA

INTERNATIONAL MONETARY FUND 19

 Reduce the banking system’s Tier 1 capital ratio by 1.1 percentage points to 12.8 percent (same

as a doubling of NPLs).

The same rate shock over a 2 year period would have a much lower impact on bank capital as it

would allow use of additional earnings as a buffer. It is important to emphasize that these results are

obtained at the aggregate level; and the future availability of granular data on households together

with more detailed analysis at individual corporate and banking level would provide more

information on vulnerabilities of individual institutions.

27. Authorities’ views. The authorities agreed with staff’s assessment that the financial sector is

well-diversified; and the banking system is strongly capitalized, very liquid and reasonably profitable.

They noted recent enhancements in internal models used to stress-test banks’ solvency and

liquidity, addressing, for instance, the FSAP recommendation for multiyear bottom-up analysis. In

terms of asset quality, the authorities commented that while the household debt burden has risen as

a proportion of GDP in recent years, it remains well-supported by much larger financial asset buffers;

while on the corporate side, leverage remains moderate. They described their approach to

macroprudential policies as intentionally gradual in order to avoid unintended consequences and

over-adjustment. They noted that rapidly increasing house prices are a concern but argued the

increase is not solely driven by credit but primarily reflects mismatches between supply and

demand, motivating increases in the Real Property Gains Tax (RPGT) and other budgetary measures

to increase the supply of affordable housing. With regards to the impact of UMP withdrawal, the

authorities believe that households will remain largely unaffected as potentially higher debt

servicing costs would be offset by higher rates of return on savings including deposits. The

authorities highlighted steps taken in strengthening regulation of the financial sector, in particular,

the implementation of the Financial Services Act and the Islamic Financial Services Act, which

significantly expand the scope of BNM’s supervisory and regulatory powers. In particular, the power

in relation to consolidated supervision allows BNM to extend the perimeter of its regulation and

supervision to the subsidiaries of domestic banks operating in the Labuan International Business and

Financial Center. The authorities pointed out the challenges faced by domestic banks in meeting the

Basel III LCR requirement related to the Basel III standardized assumptions regarding run-off rates

for deposits in comparison to BNM’s behavioral modeling approach. Separately, the authorities have

been monitoring closely the growth in credit provided by nonbanks to households and have taken

steps to collaborate with the relevant regulator in issuing guidelines for responsible lending.

MALAYSIA

20 INTERNATIONAL MONETARY FUND

CAPITAL OUTFLOWS: VULNERABILITIES AND

RESILIENCE

28. Background. Like other EMEs, Malaysia was affected by capital flow volatility in May-June

2013 and in early 2014. During May through

end-July, foreign investors reduced their

exposures to Malaysian bonds and equities (by

3.5 percent and 1.3 percent, respectively, of early-

May allocations on a net basis). Over this period,

the yield curve for government securities

steepened, with 10year yields rising by 102 bps

peak-trough, while U.S. 10-year treasury yields

rose 69 bps. Malaysian corporate bonds sold off

during the summer turbulence with yields

increasing by 120 bps (JP Morgan JACI Malaysia).

On the equity side, there was no pronounced

impact despite some foreign investor outflow, as domestic investors stepped in with purchases and

stock prices rose by 1.3 percent between mid-May and end-July. The ringgit weakened by about

11 percent against the dollar (peak-to-trough).

29. Vulnerabilities and resilience. The spring-summer 2013 episode is the latest in a series of

risk on/risk off cycles that Malaysia has endured in recent years, resulting in significant volatility in

net portfolio flows (Figure 5). With UMP withdrawal and the normalization of interest rates in AEs,

the carry trade advantage for Malaysian assets, especially government securities, will likely become

less pronounced. While the mission’s baseline assumption is that UMP exit is likely to be gradual,

the possibility of sudden and significant portfolio outflows from Malaysia and other emerging

market countries cannot be ruled out. Malaysia’s vulnerability is related to its relatively high level of

federal debt and large foreign holdings of government securities (42 percent). These risks were

traditionally mitigated by Malaysia’s strong external position but have come to the fore recently,

following the decline in its current account surplus (to 3−4 percent of GDP in 2013−14 from an

average of 12½ percent of GDP in 2009−11). But, similar to its experience during bouts of volatility

in global capital flows in recent years, Malaysia dealt with the latest episode skillfully, allowing the

exchange rate to act as a shock absorber while intervening to avoid excessive volatility.

30. The role of domestic institutional investors. The Malaysian economy’s resilience during

the May-June episode was facilitated by offsetting opportunistic purchases by large domestic

institutional investors who provided depth to its financial markets. Staff confirmed that domestic

investors, including banks and saving funds, resorted to significant purchases of equities as well as

domestic government securities during the turbulent period, thus facilitating “financial” (as opposed

to “real”) adjustment (See Appendix 8 and WEO, October 2013, Chapter 3). Domestic investors play a

stabilizing role in the market: if foreign investors were to reduce holdings of domestic assets sharply,

the resulting depreciation of the ringgit would make sales of foreign assets by domestic investors

100

120

140

160

1234123412341234123

2009 2010 2011 2012 2013

EPF Foreign Banks

Malaysia: Federal Domestic Debt by Holder

(In billions of ringgit)

Sources: Bank Negara Malaysia; staff calculations

MALAYSIA

INTERNATIONAL MONETARY FUND 21

more attractive prompting an offsetting inflow. Staff’s illustrative calculations using data for the third

quarter of 2013 suggest domestic investors have additional capacity of about 6 percent of GDP for

purchases of MGS. By comparison, foreign outflows from MGS during Q2:2013 amounted to about

1 percent of GDP, and foreign investors held about 13 percent of GDP in MGS as of Q3:2013.

Nevertheless, caution is warranted: international exposure of domestic institutional investors,

estimated at about 20 percent of GDP, is well below that of total foreign ownership of domestic

equities and bonds; and, overseas holdings of domestic institutional investors may not be fully

liquid.

31. Authorities’ views. The authorities highlighted the growing depth of domestic capital

markets, which has led to a structural increase in nonresident holdings of government and BNM

securities. They noted that compared with past episodes of capital flight, Malaysia is now better

prepared to deal with potential risks of capital outflows on account of higher levels of international

reserves, better capitalized financial intermediaries, a wider range of monetary instruments to

manage liquidity, and much deeper capacity of domestic institutional investors to absorb selling by

nonresidents. The authorities also observed that the volatility in capital flows experienced during

May-September 2013 did not have any significant adverse impact on the real economy.

Estimated Capacity for Additional Holdings of Malaysian Government Securities Domestically

Assets Estimated Target Q3:2013 MGS Space in MGS Space Total

Entity (In percent MGS Allocation Underweight Stock of Assets in Flow MGS Capacity

of GDP)

EPF--Domestic Pension Fund 52.9 30.0 2.0 1.1 0.5 1.5

KWAP--Civil Service Employees Pension 10.1 25.0 3.0 0.3 0.1 0.4

LTH--Haj Support Fund 4.9 28.0 3.0 0.1 0.1 0.2

Khazanah 12.2 -- -- -- -- --

PNB--Permodalan National Berhad 25.7---- ------

Banks 205.9 5.0 0.5 3.1 0.5 3.6

Total 311.8 1.5 0.6 5.8

Total stock of MGS 51.6

Foreign holdings of MGS 13.2

MGS outflow (June-September) 1.0

Sources: Bank Negara Malaysia; GLICs; and IMF staff estimates (December 2013).

(In percent of GDP)(In percent)

MALAYSIA

22 INTERNATIONAL MONETARY FUND

EXTERNAL SECTOR DEVELOPMENTS

32. Background. In recent years, the Malaysian economy has undergone significant external

rebalancing, reflecting robust domestic demand (including from large investment projects under the

government’s Economic Transformation Program (ETP)) and weak external demand. This has led to a

dramatic narrowing in the external current account surplus, which declined to 3.8 percent of GDP

in 2013, from 6.1 percent of GDP in 2012 and 11.6 percent in 2011, while the nonoil current account

balance has swung into a deficit of about 2.4 percent of GDP from 4.2 percent surplus for 2011.

From a savings-investment perspective, about two thirds of the adjustment was due to a strong

surge in private investment and the large investment projects under the ETP, which bodes well for

the medium term growth outlook. Over the past year, the exchange rate has fluctuated more widely

than in 2010−2012, but around a fairly horizontal trend. International reserves have decreased

slightly and the IMF’s composite reserve adequacy metric stands at a comfortable 117 percent. The

net international investment position was a small positive in 2011 but has turned negative and now

stands at –2 percent of GDP.

33. Outlook and Assessment. Looking ahead, over the medium term, increased public sector

savings will be offset by sustained private consumption and investment activity and is expected to

result in a current account surplus of 3−4 percent over the medium term.

The significant reduction

in Malaysia’s current account surplus is reflected in a commensurate narrowing of Malaysia’s

estimated external imbalances or gaps (see Appendix 3). Staff views any remaining current account

and real exchange rate gaps as reflecting inadequate social protection (beyond that captured by

public health expenditure), the need to improve the risk sharing characteristics of the pension

system, investment bottlenecks, infrastructure

gaps, labor force skill mismatches, and rigidities in

the labor market. Staff’s estimate of the cyclically-

adjusted current account norm for 2013 is

1.5 percent of GDP, compared to the External

Balance Assessment’s (EBA) norm of -0.1 percent.

With a projected cyclically adjusted current

account surplus of 4.1 percent of GDP, this

implies a total current account gap of 2.6 percent

of GDP, with the policy gap contributing to the

bulk. Malaysia’s real effective exchange rate

(REER) is assessed as moderately undervalued by about 9 percent, reflecting savings and investment

gaps and consistent with the identified current account gap, with the estimate subject to

considerable uncertainty.

Staff estimates indicate that every 1 percentage point improvement in the fiscal balance could strengthen the

current account by about 0.4 percentage point.

MALAYSIA

INTERNATIONAL MONETARY FUND 23

34. Policies. Structural reforms aimed at strengthening social protection while safeguarding

fiscal sustainability, together with improvements in the investment climate, and population aging

should help reduce the saving-investment gap over time. However, these changes take time as they

involve the creation and reform of institutions.

 Staff recommended the introduction of unemployment insurance, which the authorities are

studying, and which would further strengthen the safety net and reduce precautionary savings.

 Staff also noted that there is scope to improve the coverage and adequacy of retirement

schemes in the private sector in order to provide more effective protection against poverty in

old age.

 These measures should be complemented by continued exchange rate flexibility with

intervention limited to dampening excessive volatility, which will likely be associated with a

gradual appreciation of the real exchange rate over time and support external rebalancing.

35. Authorities’ views. The authorities agreed with staff that the current account will remain in

small surplus for the foreseeable future; however, they disagreed with staff’s assessment of external

imbalances, particularly the exchange rate. They questioned the validity of the EBA exercise for

Malaysia where there are large unexplained residuals and argued that EBA’s cross-country approach

may not fully capture Malaysia's unique characteristics. The authorities questioned the assessment

of the exchange rate as undervalued in view of the selloff of the ringgit during periods of financial

turbulence. They emphasized that they do not manage the level of the exchange rate but intervene

only to smooth excessive volatility. In addition, the authorities questioned the staff’s assessment that

the current account surplus is too large in view of the sensitivity of the global financial markets to

current account deficits in emerging market economies, as reflected in the vulnerability of deficit

countries to capital outflows during crisis periods.

BOOSTING GROWTH AND INCLUSION: THE ROLE OF

HUMAN CAPITAL DEVELOPMENT

36. Background. Malaysia is implementing an extensive agenda of structural reforms aimed at

strengthening growth and making it more broadly shared, as elaborated in a number of multiyear

transformation programs to upgrade human capital, foster technological readiness, inject greater

competition in product markets, and strengthen the government’s performance (Appendix 9). In this

connection, and in the face of heightened international demand (and competition) for talents,

efforts to strengthen Malaysia’s education system have acquired heightened importance. Malaysia

has made important progress in raising school enrollments: secondary net enrollment has risen

sharply, as has enrollment in tertiary education. But Malaysia still faces shortages of high-skill

workers, and skill mismatches are an important constraint in efforts to raise potential growth and

reduce income inequality.

MALAYSIA

24 INTERNATIONAL MONETARY FUND

37. Policies. While Malaysia has achieved much in this area, additional reforms are needed to

make the education system more efficient and cost effective.

 The authorities have created an array of initiatives but, in the context of scarce resources, some

deliberate prioritization is needed. Priorities should include expanding access to tertiary

education and increasing availability of financing to underserved groups.

 Quality control in private universities and retaining Malaysian-grown talent in the domestic

economy are also important (World Bank, 2012).

 More work is needed to improve educational attainment (what students actually know) at the

basic and secondary level. In this regard, staff welcomes the authorities’ goal to place Malaysian

students in the top third of international assessments and to reform and improve the

performance of the Ministry of Education (see Malaysian Education Blueprint 2013−25).

38. Authorities’ views. The authorities stressed that their ambitious transformation programs

and blueprints are helping them achieve their goal of transforming Malaysia into an advanced,

high-income nation by 2020. They pointed out that they are engaged in a multifaceted effort to

improve skills, including through partnerships between businesses and higher education catalyzed

by government funding. They recently merged the Ministry of Higher Education into the Ministry of

Education and expect the requirement of greater accountability from teachers and researchers to

result in improved results in teaching and academic research. They are also intensifying human

capital development efforts in the elementary and secondary education with a view to bring

Malaysian students to the top one third of countries tracked by the Program for International

Student Assessment (PISA). Progress in improving educational attainment, as outlined in the

Malaysia Education Blueprint, 2013−2025, is a high priority for them. They agreed with the call for

achieving better performance in education in a tighter budgetary environment.

STAFF APPRAISAL

39. Outlook. The Malaysian economy’s near-term growth prospects are favorable, and the

transition to the post-UMP environment should be relatively smooth: real GDP growth picked up in

the second half of 2013 and this momentum is likely to be sustained in 2014. Continued robust

domestic demand, together with an improved external environment, should offset mild headwinds

from the timely, decisive, yet gradual fiscal consolidation. Underlying inflationary pressures remain

subdued, but headline inflation has picked up somewhat reflecting the effects of subsidy

rationalization.

40. Risks. Downside risks to growth include a bumpy exit from UMP, which could be associated

with a protracted period of economic and financial volatility in EMEs. However, Malaysia’s current

account should remain comfortably in surplus, and its financial system is deep and has

demonstrated its capacity to withstand such volatility and contain the impact on the real economy.

A flexible exchange rate regime combined with credible monetary policy have put Malaysia in a

MALAYSIA

INTERNATIONAL MONETARY FUND 25

strong position to manage the downside risks to the outlook, which include a sharp slowdown of

growth in China or a protracted period of slow growth in Europe.

41. Fiscal policy. Amidst capital outflows from EMEs and concerns about Malaysia’s relatively

high federal debt, the authorities undertook a timely and decisive, yet gradual recalibration of their

fiscal management and policies in 2013. In staff’s view, these efforts amounted to a breakthrough in

that they should secure the sustainability of Malaysia’s public finances while promoting efficiency,

equity and growth in the revenue and expenditure systems, and minimizing the drag on the

economy from fiscal consolidation. Implementation and political risks from fiscal reforms are, in

staff’s view, circumscribed by the authorities’ commitment to the reforms and by their sound

preparation and technical plans to carry them out.

42. Medium term fiscal strategy. Beyond 2015, the authorities’ policy priority is to gradually

bring down federal debt in the face of declining oil revenues and a rise in age-related and other

nondiscretionary spending. Staff supports this priority, which will require a concrete plan

underpinned by a debt target for 2020. Staff has provided some specific and quantified revenue and

expenditure measures evaluated according to their efficiency, equity and growth dimensions. Staff

also supports the authorities’ sustained efforts to strengthen public financial management and

statistical reporting in accordance with the GFSM 2001 format. Enhanced monitoring of fiscal risks is

a priority, including the publication of an annual fiscal risks statement.

43. Monetary policy. In view of its dual mandate, substantial downside risks to growth, and

very low inflation, BNM has been appropriately maintaining an accommodative monetary stance to

support the economy. Going forward, the central bank has to contend with higher headline inflation

in 2014–15. In staff’s view, while the risk of administered and tax-related price adjustments leading

to an economy-wide spiral in wages and prices is low, the monetary authorities should stand ready

to adjust their policy rates to curb second round effects. Their substantial policy credibility and close

monitoring of price developments should help maintain price stability over the medium term.

44. Dealing with potential capital flow volatility. Malaysian policymakers may face renewed

capital flow volatility going forward, amidst the gradual withdrawal of UMPs and lingering concerns

over slower growth in China and other EMEs. The authorities’ experience dealing successfully with

volatile capital flows; the recalibration of fiscal policies; substantial reserves; a comfortable current

account surplus; and a deep and sound financial sector should all help Malaysia weather bouts of

capital flow volatility. In the event of renewed financial turbulence, the exchange rate should be the

first line of defense, with intervention limited to smoothing excessive volatility.

45. Financial sector stability. Malaysia’s financial system is sound and well placed to withstand

potential stresses. As confirmed by the 2012 FSAP and again during the 2013 Article IV discussions,

Malaysian banks have ample capital, adequate liquidity buffers, and are backed by a strong

regulatory and supervisory framework. Nevertheless, ongoing global volatility, high household debt

and rising house prices all warrant continued vigilance. Staff welcomes steps taken by the authorities

to strengthen financial supervision and their targeted and phased approach to macroprudential

MALAYSIA

26 INTERNATIONAL MONETARY FUND

policy. In the event housing price increases continue unabated, the authorities should not hesitate to

adopt additional macroprudential measures.

46. External assessment. The rebalancing of Malaysia’s economy in recent years has been

reflected in a substantial narrowing of its current account surplus. Nevertheless, Malaysia’s external

position is still stronger than warranted by medium-term fundamentals and desirable policies, and

its current account surplus is still above the norm. From a saving-investment perspective, the

remaining current account gap likely reflects inadequate social protection (beyond that captured by

public health expenditure), the need to improve the risk sharing characteristics of the pension

system, investment bottlenecks, infrastructure gaps, labor force skill mismatches, and rigidities in the

labor market. Increased social spending related to population aging, as well as policies to

strengthen social safety net and boost investment, combined with exchange rate flexibility, should

help to gradually close the current account gap.

47. Strengthening human capital accumulation. Malaysia is undertaking a major effort to

upgrade its human capital in the face of heightened international competition for talent. Despite

important progress in human capital investments, Malaysia still faces shortages of high-skill workers,

and skill mismatches are an important constraint. Staff supports the authorities’ ambitious efforts to

raise the effectiveness of Malaysia’s education system further, make it more cost effective, increase

the availability of financing to underserved groups, improve quality control in private universities,

and retain Malaysian-grown talent in the domestic economy.

48. It is recommended that the next Article IV consultation with Malaysia take place on a

standard 12-month cycle.

MALAYSIA

INTERNATIONAL MONETARY FUND 27

Box 1. Malaysia—Fiscal Policy Committee

Background. In June 2013, amidst market turbulence that also affected Malaysia and concerns about the sustainability

of Malaysia’s public finances (public debt is a relatively high 55 percent of GDP) and “stasis” in fiscal reforms, Malaysia

announced the creation of a Fiscal Policy Committee (FPC), a strategic decision making body that includes the prime

minister, finance minister, central bank governor and other key economic policymakers. Following its inaugural meeting

on September 2, 2013, the FPC reinforced the government’s commitment to reducing the budget deficit and public

debt. It also announced strong fiscal measures to shore up the 2013−14 fiscal positions. These included price increases

for fuel and diesel, with immediate effect, as a first step in a gradual, multiyear effort to rationalize subsidies. The FPC

also indicated that additional fiscal measures would be forthcoming as needed, including the implementation of a GST,

later included in the 2014 Budget.

Mandate. The FPC has been tasked to play a leading role in ensuring fiscal sustainability and long term macroeconomic

stability. The FPC will develop guiding principles for the conduct of sound fiscal policy, endorse Malaysia’s medium term

fiscal strategy, review the government’s fiscal performance, and ensure alignment across ministries and agencies in

order to meet fiscal targets and manage fiscal risks. A Fiscal Policy Office (FPO) within the Treasury is being set up and

will act as the secretariat to the FPC. The FPO will provide analytical guidance in the formulation of fiscal policy, produce

fiscal forecasts and facilitate collaboration between the Treasury and different government agencies.

The FPC in international context. The creation of the FPC/FPO constitutes an important institutional innovation in

Malaysia. Although it is not a fiscal council,

the FPO’s objectives are similar in spirit to nonpartisan institutions set up in

recent years to monitor fiscal performance and enhance fiscal credibility and transparency. Thus lessons from the

international experience with fiscal councils, analyzed in a recent IMF paper,

can offer useful insights for Malaysia’s

FPO. For the FPO to be effective and deliver the credibility dividend associated with its creation, the following

conditions will be critical.

 Operational independence, ideally supported by legal guarantees. Although the FPO is not legally independent,

ensuring that it has sufficient operational independence is important. Belgium’s High Council of Finance (HCF) and

Netherland’s Bureau for Economic Policy Analysis (CPB) are examples of institutions that are not legally

independent, but that have, over time, built a reputation of professionalism and independence.

 Resources commensurate to the FPO’s remit. Ensuring the professional status of FPO staff and securing adequate

staffing and resources will be critical to build operational independence.

 Full transparency and strong media presence. Over time, publication of FPO analyses and assessments, including

of annual fiscal risks statements, would help increase fiscal transparency and build the credibility of FPO. Both the

HCF and the CPB have a strong media presence and publish their reports and analysis.

Evaluation. The FPC is a powerful high-level executive body. Unlike fiscal councils, which are independent advisory and

evaluation entities, it exercises broad responsibilities over matters of fiscal policy that are analogous to the mandate of

monetary policy committees over monetary policy. The FPC is thus a powerful decision-making and coordinating body

committed to sustainable public finances and sound fiscal policy that serves the general public. Its creation bodes well

for the design, execution and credibility of Malaysia’s future fiscal policy. The effectiveness of the FPO can be enhanced

over time by ensuring its operational independence, access to resources and a strong media presence.

_____________________________________

1/ A fiscal council is defined as “an independent public institution informing the public debate on fiscal policy” (IMF, 2013).

2/ “The Functions and Impact of Fiscal Councils,” International Monetary Fund, July 16, 2013.

3/ HCF is headed by the Minister of Finance, is supported by staff from the Ministry of Finance and aims at providing

high-quality inputs to budget discussions. But unlike the FPC/FPO, it is not a decision-making body and has a strong media

presence, which has over time enhanced its reputation of professional excellence and unbiased analysis. The Netherland’s

Bureau for Economic Policy Analysis (CPB), a fiscal agency that provides the government with economic analysis and forecast

and election platform and program costing, also has a similar framework. CPB is set up within the Ministry of Economic Affairs

and is therefore not formally independent. However, CPB has over time established itself as fully independent in its operations

and in its analysis and research. For instance, the CPB can set its own work agenda and is subject to regular independent

evaluations mainly by academics, many of whom are not Dutch citizens.

MALAYSIA

28 INTERNATIONAL MONETARY FUND

Box 2. Malaysia—Goods and Services Tax (GST)

Background. Malaysia plans to introduce a Goods and Services Tax (GST) in April 2015, to replace its current sales tax. Unlike

existing sales and services taxes,

the GST will be designed as a value-added tax, and its coverage will be broader. The

proposed standard rate at introduction is 6 percent, a relatively low rate compared to the current VAT rates in other ASEAN

countries (7 percent in Thailand and Singapore, 10 percent in Vietnam and Indonesia, and 12 percent in Philippines). Relative

to the standard rate at introduction in a group of OECD and Asian countries, Malaysia’s 6 percent is also somewhat low. Under

the GST, some essential food items will have a zero tax rate and some services such as public transport, financial services,

education and government services will be exempt from tax. The GST will be introduced together with offsetting income tax

cuts, one-off cash transfers to low income households and subsidies to SMEs for the purchase of accounting software. The GST

registration threshold of 500,000 ringgit (about 160,000 U.S. dollars), is high compared to other peer countries; but will cover

about 150,000 companies–a significant increase relative to the existing sales tax. Based on authorities’ simulations, lowering

the threshold would have no material impact on the revenue yield, while increasing the burden of tax administration.

Fiscal Impact. Staff projects the gross revenue yield of the

GST to be about 2.3 percent of GDP, assuming a

c-efficiency ratio

of about 60 percent. The relatively low

revenue yield is due to a low standard rate and a broad set

of exempt and zero-rated products.

From an efficiency

perspective, a low standard rate applied on a broad tax

base would have been preferable. However, lower rates on

basic goods and services consumed by low income

households are important to mitigate the regressive effects

of the GST and to ensure political feasibility in the absence

of an efficient social safety. The net direct revenue impact

of the GST will be even smaller at about 0.2−0.3 percent of

GDP initially, but increasing to about 0.5 percent of GDP in

the medium term, given that it will replace the existing

sales and service taxes and due to the introduction of

offsetting measures mentioned above. However, GST will

likely have indirect positive effects on revenue through

improving compliance and generating incentives for firms

to move to the formal sector. Although the net revenue

yield at introduction will be small, once the tax is operational and a more efficient social safety net system is in place, the

standard rate and the list of zero-rated and exempt goods can be revised to increase the revenue yield. The introduction of the

GST is strategically important for fiscal sustainability and tax base broadening as it gives the government a new lever to use to

respond to changes in fiscal conditions.

GST Implementation. The authorities have already started an active public outreach program, organizing nationwide

seminars, workshops and road shows to create awareness, explain the GST and how it will impact different prices. The

authorities are also taking steps on tax administration as well as issues related to implementation such as the establishment of

an efficient refund system and providing training to SMEs to ensure the smooth rollout of the tax. International experience has

demonstrated that best results are generally achieved when all major domestic taxes are administered by a single inland

revenue agency (In Malaysia, the GST will be administered by the Customs Agency). The voluntary registration procedures will

need to be carefully instituted to ensure administrative efficiency by avoiding the registration of many small businesses. The

authorities are fully aware of the importance of implementation and have formed a GST monitoring committee to better

address potential problems and challenges.

_____________________________________

1/ Malaysia’s current sales tax is charged on taxable goods at the manufacturer’s level. Its standard rate is 10 percent for most

taxable goods and a 5 percent tax is charged on select products such as food items. Services tax applies to certain services

provided by restaurants and hotels, telecommunications services and professional services.

2/ C-efficiency ratio is defined as the ratio of actual VAT revenues collected to the potential revenue base which is total

consumption times the standard VAT rate. The c-efficiency ratio would be 1 if there are no exempt goods or multiple rates and

if there is no tax avoidance. The c-efficiency ratio therefore reflects the productivity of the VAT. The median c-efficiency ratio in

a group of OECD and Asian countries is about 60 percent. Typically, there is an inverse relationship between c-efficiency and

the standard rate, reflecting lower tax avoidance and a broader tax base that is associated with tax systems with low rates.

3/ Based on staff’s estimate of “tax gaps” in Malaysia, there is additional scope (about 2.7−3 percent of GDP) to raise indirect,

consumption taxes.

Hungary

Iceland

Czech Re

ublic

Slovak Re

ublic

Finland

Poland

Chile

Norwa

Slovenia

Belgium

Greece

Portugal

China

Ireland

Bangladesh

France

Korea, Rep.

Sri Lanka

Ital

Netherlands

Spain

Sweden

Mexico

Australia

New Zealand

Denmark

Estonia

German

Turk ey

United Kingdom

Cambodia

Indonesia

Lao PDR

Mongolia

Nepal

Philippines

Vietnam

Austria

Israel

Luxembourg

Canada

Thailand

Switzerland

Malaysia

Ta iw a n P OC

Sin

ore

OECD and Selected Asian Countries: Rate at Introduction

(In percent)

Sources: International Bureau of Fiscal Documentation website; and Deloitte, Global Indirect

Taxes, 2013

MALAYSIA

INTERNATIONAL MONETARY FUND 29

Box 3. Malaysia—Medium-Term Fiscal Consolidation

Background. The Malaysian authorities have reaffirmed their commitment to sound public finances and a

medium-term fiscal consolidation which aims to lower the budget deficit to about 3 percent of GDP by 2015 and

balance the budget by 2020. The objective of achieving a balanced budget by 2020 implies a consolidation of

4.0−4.1 percent of GDP in terms of the cyclically-adjusted primary balance. However, declining oil revenues and a rise

in nondiscretionary spending pressures in the medium term is projected to drive up Malaysia’s fiscal deficit going

forward. These factors call for the adoption of further measures (above and beyond the announced adjustment) in

order to secure fiscal targets for 2020.

Fiscal consolidation. This box summarizes considerations in designing the composition of Malaysia’s medium-term

fiscal consolidation.

It first identifies revenue and expenditure measures that could be used and the size of

potential savings. These measures are then ranked based on three criteria—short-term growth, long-term growth

and equity—to determine the tradeoffs in using different measures. These trade-offs can be used to inform the

composition of Malaysia’s medium-term fiscal consolidation, based on the authorities’ priorities.

Revenue measures. Malaysia’s tax structure relies heavily on direct income taxes, especially on corporations, while

indirect taxation is underutilized. A cross-country tax gap analysis is used to assess potential to raise revenues.

The

tax gap analysis suggests that there is considerable scope to raise Malaysia’s indirect tax revenues. The predicted

norm for Malaysia’s consumption taxes

is 6−6.3 percent of GDP, which suggests

a gap of 2.7−3 percentage points.

Non-oil income taxes in Malaysia are

above the predicted norm, however, this

is due to high levels of corporate income

taxes (CIT), while personal income taxes

are relatively low (at about 2.5 percent

of GPD).

This seems to reflect relatively

low tax rates, in particular at the top of

the income distribution, and thus

personal income taxes can be made

more progressive while generating

additional revenues. CITs are relatively

high in Malaysia, despite the existence

of a broad set of exemptions and

incentives. This is potentially driven by a

high corporate income tax rate

(25 percent) and an efficient system of

revenue administration. The corporate

income tax rate will be reduced by

one percentage point effective 2016, as

an offsetting measure for the GST. Rationalizing tax incentives is the only tool that can be used to generate

additional revenues but it is hard to estimate the revenue yield from reducing tax incentives. We assume potential

fiscal savings could be in the range of 0.1−0.5 percent of GDP, while noting the uncertainty around such

assumptions. Finally, as in many other countries, property taxes are under-utilized in Malaysia and can be used more

extensively. All of the revenue measures could together generate about 4.5 percent of GDP in savings.

Expenditure measures. Expenditure measures are identified using the level and composition of Malaysia’s current

federal spending. Subsidy rationalization has the greatest potential to generate large and immediate fiscal savings.

Fuel subsidy rationalization alone could yield fiscal savings of 2.2−2.7 percent of GDP, taking into account offsetting

cash transfers. Rationalization of other subsidies, such as on cooking oil, rice and flour, could generate additional

savings of 0.2−0.3 percent of GDP. Containing growth in the public sector wage bill can also support the

consolidation effort. The wage bill has increased by 0.9 percentage points since 2008, to 6.2 percent of GDP,

reflecting improvements in the salary scheme, a time-based promotion scheme for teachers, and additional bonus

payments. Restricting hiring to essential personnel and limiting the establishment of new posts (as already adopted

by the authorities) can help going forward. Spending on education, in particular on emoluments, is not efficient and

may offer additional scope for savings.

Similarly, in the area of social safety net spending, there is scope to reduce

budgetary costs while enhancing social effectiveness by consolidating several programs that offer different benefits

(The authorities are already working towards establishing a comprehensive database of recipients). Broad-based

efficiency gains in public expenditure, including through improved procurement (already underway) can also be a

source of fiscal savings. Finally, there is limited scope (estimated at 0.2−0.4 percent of GDP) for fiscal savings in

development spending given its decline in recent years.

Required Measures to Reach

Fiscal Targets

Revenue Measures Expenditure Measures

Potential Revenue and Expenditure Measures for Medium-Term Fiscal

Consolidation

(In percent of GDP)

Source: IMF staff estimates.

Change in cyclically

adjusted primary

balance

Due to rising

non-discretionary spending

Due to decline in oil

revenues

Corporate income taxes

Property taxes

Personal income taxes

GST

Social safety net and other transfers

Pubic investment

Other public consumption

Wage bill

Subsidy rationalization

MALAYSIA

30 INTERNATIONAL MONETARY FUND

Box 3. Malaysia—Medium-Term Fiscal Consolidation (Concluded)

Key considerations. The composition and timing of tax and expenditure measures that can be adopted as part

of Malaysia’s consolidation strategy should be guided by their growth and equity implications. Figures below

show how different instruments rank along these dimensions. More negative values suggest a larger negative

impact on growth or equity; the converse is true for the positive values. These rankings can guide policy makers

in selecting the composition of fiscal consolidation, based on the preferences and weights they assign to

different goals. All revenue and expenditure measures would have a negative impact on growth in the short run,

with public investment and consumption having the largest impact. With respect to growth implications in the

long run, public investment is expected to have the highest negative impact, whereas subsidy rationalization is

the most growth-friendly fiscal measure, with an expected small positive impact on long-run growth. Subsidy

rationalization, property taxes and a progressive increase in personal income taxes are expected to have positive

distributional impact, while public investment and the GST are expected to have a relatively higher negative

distributional impact.

Conclusions. Subsidy rationalization and property taxes come out clearly as a desirable set of instruments to use

in fiscal consolidation from both growth and equity perspectives. Improvements in the efficiency of social safety

nets and other transfers and a progressive increase in personal income taxes also come out high in the relative

ranking of fiscal measures. In the context of Malaysia’s high fiscal adjustment needs, the GST is also a necessary

component of fiscal adjustment, given its large revenue-generating potential and its strategic importance. Public

investment is the least desirable instrument with adverse effects on growth and equity. Exact ranking of different

measures depend on many factors including societal choices regarding the role of government, but also on

cyclical factors and monetary policy space, for example for short-term growth.

_______________________________________________

1/ This box summarizes the results in the accompanying selected issues paper (SIP) titled “A Medium-Term Fiscal

Strategy for Malaysia.”

2/ We compare Malaysia’s tax revenues with its peers, controlling for a range of characteristics relevant for tax

revenues, using a regression analysis. We compare the predicted tax revenues from the regression model with

Malaysia’s actual revenues in 2012. The difference between the predicted and actual taxes is interpreted as a “tax gap.”

The regression controls for income per capita, the old-age dependency ratio, exports of oil and gas, and also includes

dummies for geographical regions to capture other unobserved regional characteristics.

3/ Consideration could be given to a revenue-neutral additional reduction in the CIT rate that would be offset by

rationalizing tax incentives, which would improve the efficiency of the CIT system, and raise investment and economic

growth.

4/ Malaysia’s Education Blueprint has found that spending on education in Malaysia has not resulted in better

educational outcomes and that there are important potential efficiency gains.

-2

-1

Growth short term

Growth long termEquity

Trade-Offs for Different Tax Measures

GST Property taxes

Personal income taxes Corporate income taxes

-3

-2

-1

Growth short term

Growth long termEquity

Trade-Offs for Different Expenditure Measures

Wage bill Other public consumption

Subsidies Public investment

Social safety nets and other transfers

MALAYSIA

INTERNATIONAL MONETARY FUND 31

Box 4. Malaysia—Household Debt

Household debt has grown rapidly in Malaysia

since 2008, increasing from 60 percent of GDP to

83 percent of GDP by end-September 2013. While

banks remain the most important source of credit

to households in Malaysia, lending by

Development Financial Institutions (DFIs) and

Nonbank Financial Institutions (NBFIs) has grown

rapidly since 2008 and accounts for about one-

quarter of the increase in debt. Approximately

55 percent of the debt is owed on residential

property, of which about 70 percent are variable

rate mortgages. Mitigating the risks somewhat

are strong financial buffers on aggregate, with

household financial assets amounting to

189 percent of GDP. However, there may be

pockets of vulnerability, including for example,

lower income borrowers (with a monthly income

of RM3,000 or less) that are more highly

leveraged than other income groups.

House prices have increased rapidly, outpacing

income and rental growth, along with strong

demand for residential property loans, driven by a

robust labor markets and falling lending rates.

However, underwriting standards do not appear

to have deteriorated, as evidenced by lower

default rates by month on book for more recent

vintages.

Loans for personal use have also grown rapidly,

with a strong increase especially from the DFIs

and NBFIs. Credit risk is reduced as most lending

is to government workers, serviced through

automatic salary deductions, and with an

aggregate deduction cap of 60% of a borrower’s

net income. Loans for personal use from the

NBFIs and DFIs increased to 9 percent of GDP

in 2012, up from 5 percent in 2008. Growth was

partially driven by increased offering of personal

finance products with unfavorable terms, such as

extended tenures and bullet payments on

retirement. With borrowers from the DFIs and

NBFIs tending to have lower incomes, the

vulnerability of this segment has increased. In

response to growing concerns, in July 2013, BNM

limited the tenure of personal financing loans to 10 years

(including prohibiting bullet payments on

retirement)

and prohibited the offering pre-approved personal financing products.

3/2007 1/2008 11/2008 9/2009 7/2010 5/2011 3/2012 1/2013

House Prices Loans for Purchase of Residential Property

Malaysia: House Prices and Housing Loans

(4-quarter percentage change)

Sources: CEIC Inc.; Staff Calculations

2007 2008 2009 2010 2011 2012

Other NBFI THLD DFIs Bankin

stem

Malaysia: Household Debt by Lender 2007-2012

(In percent of GDP)

Sources: Bank Negara Malaysia; Staff calculations

2007 2008 2009 2010 2011 2012

Personal Use Housin

Malaysia: Loans from NBFIs and DFIs by purpose

(In percent of GDP)

Sources: BNM; Annual Reports of NBFIs; and staff calculations

MALAYSIA

32 INTERNATIONAL MONETARY FUND

Figure 1. Malaysia: Growth and Exports

Growth has recovered following a slow start in the first

half of the year…

…as there is less drag from net exports, while domestic

demand remain robust.

The strong pick-up in investment, which is growing at its

fastest rate since the Asian crisis, has been a key driver,

but investment is still below its pre-Asian crisis levels.

The current account surplus fell as net exports of goods

declined.

Exports disappointed at the end of 2012 and in the first

half of 2013, but a recovery appears to be underway.

Growth in imports of capital and consumer goods had

been robust, compared with weaker intermediate goods

demand.

MALAYSIA

INTERNATIONAL MONETARY FUND 33

Figure 2. Malaysia: Inflation and Domestic Resource Constraints

Inflation remains low, although subsidy rationalization

pushed up headline inflation in September.

Core inflation remains subdued but has increased slightly...

…as have producer prices.

The labor market remains tight with low unemployment

and …

…strong wage pressures.

Dragged down by weak external demand, a small negative

output gap opened up early in the year but closed at the

end of the year.

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34 INTERNATIONAL MONETARY FUND

Figure 3. Malaysia: Monetary Developments

While interest rates are stable or declining… …real rates have declined again, as inflation picked up.

Malaysia’s current monetary policy rate is well calibrated

to cyclical conditions.

And, while other countries in the region have been more

activist recently, Malaysia has stayed put.

Yet, it has ample space to ease policy in a downside

scenario.

gainst a stable monetary policy, broad money growth

although slowing, has outpaced nominal GDP.

-600

-500

-400

-300

-200

-100

100

200

Vietnam

Australia

India

Korea

Philippines

Thailand

China

Indonesia

Japan

Malaysia

Cummulative policy action since January 2012

Cummulative policy action since May 2013

Current policy rate (right scale, in percent)

Selected Asia: Policy Rate Actions 1/

(In basis points)

Holders (since Jan.

2012)

Taiwan Province

of China

Cutters

Source: IMF staff calculations.

1/ Latest data as of December 2013.

MALAYSIA

INTERNATIONAL MONETARY FUND 35

Figure 4. Malaysia: Fiscal Policy Developments

The budget deficit is expected to decline in 2013−2014…

… even as revenue declines.

Expenditure on subsidies is expected to decline with the

recent and projected fuel price hikes…

…along with development spending.

Under staff’s baseline projection, federal government debt

would decline to 50 percent in the medium-term.

GST and subsidy reforms are critical to achieve the

medium-term fiscal consolidation as oil revenues are also

projected to decline.

MALAYSIA

36 INTERNATIONAL MONETARY FUND

Figure 5. Malaysia: Capital Inflows

Capital inflows have been volatile, but have remained

generally small in net terms as a share of GDP.

Malaysia, as with other emerging markets in Asia,

experienced outflows after May 2013,

…which led to a depreciation of MYR from its May 2013

peak..

…with a slight decline in reserves after May 2013.

The equity market held up well…

But the bond markets experienced an outflow and foreign

holdings of Malaysian Government securities declined but

have since recovered.

MALAYSIA

INTERNATIONAL MONETARY FUND 37

Figure 6. Malaysia: Financial Sector Developments

ggregate credit growth has slowed slightly but remains

close to 10 percent.

Growth in credit to households has moderated somewhat

but remains higher than credit to businesses.

The banking system is well capitalized, while credit quality

has steadily improved.

While claims by foreign banks in Malaysia are high as a

share of GDP…

…they reflect mostly claims by local affiliates, which tend

to be deposit-funded.

Corporate leverage has declined significantly since the

Asian Crisis.

MALAYSIA

38 INTERNATIONAL MONETARY FUND

Figure 7. Malaysia: Household Debt

Housing and personal loans have been growing rapidly… … which has led to an increase in household debt…

.. that is high compared to other countries…

… and above the ratio in countries with a similar GDP per

capita.

Over half of household loans by commercial banks are for

housing.

High household financial assets mitigate this vulnerability.

MALAYSIA

INTERNATIONAL MONETARY FUND 39

Figure 8. Malaysia: House Prices

House prices have risen steadily… … and have outpaced incomes and rents.

Although population growth is strong and urbanizing,,,

… nevertheless, this does not fully explain the increase in

house prices compared with other countries.

Residential supply is increasing.. …and is particularly strong in Johor.

MALAYSIA

40 INTERNATIONAL MONETARY FUND

Figure 9. Financial Soundness Indicators, 2013:Q3

Malaysian banks’ capital buffers are strong… …but one-year liquidity coverage could improve further.

Lending in proportion to deposits is reasonable… … while asset quality is moderately high

Banks are profitable … but net interest margin is getting squeezed

MALAYSIA

INTERNATIONAL MONETARY FUND 41

Table 1. Malaysia: Selected Economic and Financial Indicators, 2009–14

Nominal GDP (2012): US$305 billion

Main export (percent of total): electrical & electronic products (39%), commodities (23%)

GDP per capita (2012): US$10,387

Population (2012): 29.3 million

Unemployment rate (2012): 3.0 percent

Est. Proj.

2009 2010 2011 2012 2013 2014

Real GDP (percent change) -1.5 7.4 5.1 5.6 4.7 5.0

Total domestic demand -1.6 11.1 6.8 11.3 7.3 3.8

Consumption 1.4 6.2 8.6 7.1 7.3 3.4

Private consumption 0.6 6.9 6.8 7.7 7.6 3.3

Gross capital formation -9.4 25.3 2.3 22.3 7.2 4.6

Saving and investment (in percent of GDP)

Gross domestic investment 17.8 23.3 23.3 25.8 26.3 27.1

Gross national saving 33.4 34.2 34.9 31.9 30.1 31.4

Fiscal sector (in percent of GDP)

Federal government overall balance 1/ -6.7 -5.3 -4.8 -5.2 -4.3 -3.3

Revenue 21.7 19.9 21.0 21.3 21.8 21.1

Expenditure and net lending 28.4 25.2 25.7 26.6 26.1 24.4

Federal government non-oil primary balance -13.7 -10.4 -10.3 -10.6 -8.9 -7.5

Consolidated public sector overall balance 2/ -7.2 -2.6 -3.4 -5.2 -6.8 -6.5

General government debt 52.8 53.5 54.3 54.6 56.8 55.2

Inflation and unemployment (period average, in percent)

CPI inflation (period average) 0.6 1.7 3.2 1.7 2.1 3.3

Unemployment rate 3.7 3.3 3.1 3.0 3.1 3.0

Money and credit (end of period, percentage change)

Total liquidity (M3) 9.2 6.8 14.3 9.0 6.7 …

Credit to private sector 6.2 9.7 12.1 11.9 9.1 …

Three-month interbank rate (in percent) 2.2 3.0 3.2 3.2 3.2 …

Balance of payments (in billions of U.S. dollars)

Current account balance 31.4 27.1 33.5 18.6 11.8 14.5

(In percent of GDP) 15.5 10.9 11.6 6.1 3.8 4.2

Trade balance 39.8 42.5 49.5 40.7 32.6 40.4

Services and income account balance -2.8 -8.6 -9.2 -16.2 -15.9 -18.1

Capital and financial account balance -22.8 -6.2 7.6 -7.4 -4.8 -7.5

Errors and omissions -4.7 -21.7 -10.1 -9.9 -2.4 0.0

Overall balance 3.9 -0.8 30.9 1.3 4.6 7.0

Gross official reserves (US$ billions) 96.7 106.5 133.6 139.7 134.9 141.9

(In months of following year's imports) 6.1 5.9 7.0 7.2 6.9 7.2

(In percent of short-term debt) 3/ 250.4 207.3 230.3 259.5 239.2 240.9

Total external debt (US$ billions) 68.0 74.1 81.1 82.7 89.2 96.2

(In percent of GDP) 33.6 29.9 28.1 27.1 28.6 28.1

Of which: short-term (in percent of total) 3/ 56.8 69.3 71.5 65.2 63.2 61.3

Debt service ratio

(In percent of exports of goods and services) 6.6 7.8 10.2 10.1 9.7 9.4

(In percent of exports of goods and nonfactor services) 7.0 8.2 10.8 10.7 10.2 10.0

Memorandum items:

Nominal GDP (in billions of US$) 202 248 289 305 312 342

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

3/ By remaining maturity.

1/ Based on staff's estimate of the federal government fiscal balance using GFSM 2001, which differs from the authorities' cash-based measure of the fiscal

deficit.

2/ Capital expenditure in the budget includes foreign fixed assets and other items, such as purchase of shares and land, which are excluded from public

investment in the national accounts.

MALAYSIA

42 INTERNATIONAL MONETARY FUND

Table 2. Malaysia: Indicators of External Vulnerability, 2008–12

Est.

2008 2009 2010 2011 2012 2013

Financial indicators

General government debt (in percent of GDP) 1/ 41.2 52.8 53.5 54.3 54.6 56.8

Total liquidity (M3: percent change, 12-month basis) 11.9 9.2 6.8 14.3 9.0 6.7

Private sector credit (percent change, 12-month basis) 12.9 6.2 9.7 12.1 11.9 9.1

Treasury bill interest rate (percent, 12-month average) 2/ 3.4 2.1 2.6 2.9 3.2 3.2

External indicators

Exports (percent change, 12-month basis in U.S. dollars) 12.6 -21.1 26.9 14.9 -0.4 -3.7

Imports (percent change, 12-month basis in U.S. dollars) 6.7 -20.7 33.8 14.4 4.4 -0.2

Current account balance (in billions of U.S. dollars) 39.4 31.4 27.1 33.5 18.6 11.8

Current account balance (in percent of GDP) 17.1 15.5 10.9 11.6 6.1 3.8

Capital and financial account balance (in billions of U.S. dollars) -35.5 -22.8 -6.2 7.6 -7.4 -4.8

Gross official reserves (in billions of U.S. dollars) 91.5 96.7 106.5 133.6 139.7 134.9

In months of following year's imports of goods and nonfactor services 7.6 6.1 5.9 7.0 7.2 6.9

As percent of total liquidity (M3) 33.9 32.5 30.0 34.2 31.6 32.0

As percent of monetary base 461.3 603.8 532.6 440.2 420.7 451.8

Total short-term external debt by:

Original maturity (in billions of U.S. dollars) 23.1 22.6 25.9 32.7 30.4 33.2

Remaining maturity (in billions of U.S. dollars) 33.4 38.6 51.4 58.0 53.9 56.4

Original maturity to reserves (in percent) 25.3 23.4 24.3 24.5 21.8 24.6

Original maturity to total external debt (in percent) 33.8 33.3 35.0 40.3 36.8 37.2

Remaining maturity to reserves (in percent) 36.4 39.9 48.3 43.4 38.5 41.8

Remaining maturity to total external debt (in percent) 48.7 56.8 69.3 71.5 65.2 63.2

Total external debt (in billions of U.S. dollars) 68.5 68.0 74.1 81.1 82.7 89.2

Of which : public and publicly guaranteed debt 25.8 26.2 28.4 27.7 27.1 27.6

Total external debt to exports of goods and services (in percent) 28.3 34.7 30.5 28.8 29.6 32.6

External amortization payments to exports of goods and services (in percent) 1.6 5.2 6.6 9.0 9.1 8.6

Financial market indicators 200812 200912 201012

Kuala Lumpur Composite Index (KLCI), end of period 877 1,273 1,519 1,531 1,689 1,867

10-years government securities yield (percent per annum, average) 4.1 4.1 4.0 3.9 3.5 3.7

Sources: Haver Analytics; data provided by the authorities; and Fund staff estimates.

1/ Gross debt.

2/ Discount rate on 3-month treasury bills.

MALAYSIA

INTERNATIONAL MONETARY FUND 43

Table 3. Malaysia: Balance of Payments, 2009–14

Est. Proj.

2009 2010 2011 2012 2013 2014

Current account balance 31.4 27.1 33.5 18.6 11.8 14.5

Trade balance 39.8 42.5 49.5 40.7 32.6 40.4

Exports, f.o.b. 156.9 199.0 228.6 227.6 219.3 225.5

Imports, f.o.b. 117.1 156.6 179.1 187.0 186.7 185.1

Services and income account balance -2.8 -8.6 -9.2 -16.2 -15.9 -18.1

Receipts 39.3 43.8 53.3 51.6 54.9 56.8

Of which: income 11.2 11.9 17.2 13.7 15.1 15.6

Payments 42.1 52.5 62.5 67.8 70.8 74.9

Of which: income 15.3 20.1 24.3 25.4 26.2 27.0

Net transfers -5.6 -6.8 -6.9 -5.9 -4.8 -7.7

Capital and financial account balance -22.8 -6.2 7.6 -7.4 -4.8 -7.5

Capital account 0.0 0.0 0.0 0.0 0.0 0.0

Financial account -22.8 -6.2 7.6 -7.4 -4.8 -7.5

Net foreign direct investment -6.3 -4.3 -3.1 -7.0 -5.3 -5.8

Portfolio investment -0.5 15.0 8.5 18.9 14.1 15.4

Drawings 0.1 1.4 2.1 0.2 0.2 0.2

Repayments 1.9 0.3 2.0 0.2 0.3 0.3

Other investment -15.9 -16.9 2.1 -19.3 -13.5 -17.1

Errors and omissions -4.7 -21.7 -10.1 -9.9 -2.4 0.0

Overall balance 3.9 -0.8 30.9 1.3 4.6 7.0

Overall financing -3.9 0.8 -30.9 -1.3 -4.6 -7.0

Gross official reserves 96.7 106.5 133.6 139.7 134.9 141.9

In months of following year's imports of goods 6.1 5.9 7.0 7.2 6.9 7.2

and nonfactor services

In percent of short-term debt 1/ 250.4 207.3 230.3 259.5 239.2 240.9

Current account balance 15.5 10.9 11.6 6.1 3.8 4.2

(Excluding oil and gas) 8.9 4.1 4.2 -0.6 -3.4 -1.6

Trade balance 19.7 17.2 17.1 13.3 10.4 11.8

Exports 77.6 80.4 79.1 74.7 70.2 65.9

Imports 57.9 63.3 62.0 61.4 59.7 54.1

Services and income account balance -1.4 -3.5 -3.2 -5.3 -5.1 -5.3

Capital and financial account balance -11.3 -2.5 2.6 -2.4 -1.5 -2.2

Net foreign direct investment -3.1 -1.8 -1.1 -2.3 -1.7 -1.7

Memorandum items:

Export value growth (in U.S. dollars) -21.1 26.9 14.9 -0.4 -3.7 2.8

Export volume growth -12.8 10.4 5.1 -4.0 -3.0 4.5

Import value growth (in U.S. dollars) -20.7 33.8 14.4 4.4 -0.2 -0.8

Import volume growth -23.5 18.1 4.6 0.3 -2.1 1.3

Terms of trade -12.4 2.0 0.1 -0.7 -0.3 0.2

(In billions of U.S. dollars) 30.0 4.0 11.9 -4.8 … …

(In percent of GDP) 14.8 1.6 4.1 -1.6 … …

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

1/ By remaining maturity.

Net international investment position

(Annual percentage change)

(In percent of GDP)

(In billions of U.S. dollars)

MALAYSIA

44 INTERNATIONAL MONETARY FUND

Table 4. Malaysia: Illustrative Medium-Term Economic Framework, 2009–18 1/

Est.

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Real sector (percent change)

Real GDP growth -1.5 7.4 5.1 5.6 4.7 5.0 5.0 5.0 5.0 5.0

Total domestic demand -1.6 11.1 6.8 11.3 7.3 3.8 4.9 5.2 5.1 5.2

CPI inflation (period average) 0.6 1.7 3.2 1.7 2.1 3.3 3.9 3.0 2.7 2.7

Saving and investment (in percent of GDP)

Gross domestic investment 17.8 23.3 23.3 25.8 26.3 27.1 27.4 27.6 27.5 27.5

Private, including stocks 7.2 13.1 13.7 15.0 15.8 16.2 16.5 16.7 16.9 17.0

Of which: gross fixed capital formation 11.4 12.4 12.8 14.9 16.4 16.2 16.5 16.7 16.9 17.0

Public 10.6 10.2 9.5 10.8 10.5 10.9 10.9 10.9 10.6 10.5

Gross national saving 33.4 34.2 34.9 31.9 30.1 31.4 31.5 31.6 31.5 31.3

Private 25.4 23.9 26.8 22.8 22.3 22.8 21.8 21.5 21.6 21.7

Public 7.9 10.3 8.1 9.1 7.8 8.6 9.7 10.1 9.9 9.6

Fiscal sector (in percent of GDP)

Federal government net lending/borrowing -6.7 -5.3 -4.8 -5.2 -4.3 -3.3 -2.6 -2.2 -2.5 -3.0

Revenue 21.7 19.9 21.0 21.3 21.8 21.1 20.9 20.5 20.2 20.0

Tax 14.9 13.7 15.3 16.1 16.6 16.3 16.4 16.2 16.1 16.1

Non-tax 6.7 6.1 5.7 5.2 5.2 4.8 4.5 4.3 4.1 3.9

Expenditure 28.4 25.2 25.7 26.6 26.1 24.4 23.4 22.7 22.8 23.0

Current 22.0 19.1 20.8 22.0 22.3 20.7 19.7 19.0 19.1 19.2

Development 6.3 6.1 5.0 4.5 3.8 3.7 3.7 3.7 3.6 3.7

Federal government non-oil primary balance -13.7 -10.4 -10.3 -10.6 -8.9 -7.5 -6.2 -5.4 -5.3 -5.3

Consolidated public sector overall balance 2/ -7.2 -2.6 -3.4 -5.2 -6.8 -6.5 -5.5 -4.9 -4.8 -4.9

General government debt 52.8 53.5 54.3 54.6 56.8 55.2 53.2 51.4 50.2 49.6

Of which: federal government debt 50.8 51.1 51.6 53.3 54.8 53.3 51.7 50.1 49.3 48.8

Balance of payments (in billions of U.S. dollars)

Trade balance 39.8 42.5 49.5 40.7 32.6 40.4 45.5 49.9 54.0 58.1

Services and income account balance -2.8 -8.6 -9.2 -16.2 -15.9 -18.1 -20.2 -22.3 -24.3 -26.4

Current account balance 31.4 27.1 33.5 18.6 11.8 14.5 15.5 16.8 17.9 19.0

(In percent of GDP) 15.5 10.9 11.6 6.1 3.8 4.2 4.1 4.0 4.0 3.9

Capital and financial account balance -22.8 -6.2 7.6 -7.4 -4.8 -7.5 -16.0 -15.3 -14.8 -15.4

Errors and omissions -4.7 -21.7 -10.1 -9.9 -2.4 0.0 0.0 0.0 0.0 0.0

Overall balance 3.9 -0.8 30.9 1.3 4.6 7.0 -0.5 1.5 3.1 3.6

International trade (annual percent change)

Export value -21.1 26.9 14.9 -0.4 -3.7 2.8 2.9 3.7 4.3 4.5

Import value -20.7 33.8 14.4 4.4 -0.2 -0.8 0.7 2.2 3.3 3.6

Terms of trade -12.4 2.0 0.1 -0.7 -0.3 0.2 0.0 -0.1 -0.1 -0.1

Gross official reserves (in billions of U.S. dollars) 96.7 106.5 133.6 139.7 134.9 141.9 141.4 142.9 146.0 149.6

(In months of following year's imports) 6.1 5.9 7.0 7.2 6.9 7.2 6.9 6.7 6.7 6.7

(In percent of short-term debt) 3/ 250.4 207.3 230.3 259.5 239.2 240.9 231.9 227.8 226.8 224.9

Total external debt (in billions of U.S. dollars) 68.0 74.1 81.1 82.7 89.2 96.2 103.7 112.0 121.0 130.7

(In percent of GDP) 33.6 29.9 28.1 27.1 28.6 28.1 27.3 26.9 26.7 26.7

Short-term external debt (percent of total) 3/ 56.8 69.3 71.5 65.2 63.2 61.3 58.8 56.0 53.2 50.9

Debt-service ratio

(In percent of exports of goods and services) 6.6 7.8 10.2 10.1 9.7 9.4 9.1 8.7 8.0 7.3

Net international investment position (in billions of U.S. dollars) 30.0 4.0 11.9 -4.8 … … … … … …

Memorandum items:

Nominal GDP (in billions of ringgit) 713 797 884 941 984 1,081 1,177 1,273 1,371 1,477

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

1/ Period ending December 31.

3/ By remaining maturity.

2/ 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.

Proj.

MALAYSIA

INTERNATIONAL MONETARY FUND 45

Table 5. Malaysia: Summary of Federal Government Operations and Stock Positions, 2009–14

2009 2010 2011 2012

Budget Proj. Budget Proj.

Revenue 154,539 158,453 185,419 200,913 208,150 214,789 224,094 227,725

Taxes 106,504 109,515 134,885 151,643 159,154 163,506 171,970 175,719

Other revenue 48,035 48,938 50,534 49,270 48,996 51,283 52,124 52,006

Expenditure 202,361 200,729 227,511 250,016 246,755 256,660 259,165 263,501

Expense 157,148 152,429 183,639 207,358 204,820 219,203 219,572 223,908

Compensation of employees 42,778 46,663 50,148 60,016 58,621 61,625 63,610 63,931

Use of goods and services 29,035 26,507 32,660 35,553 37,607 38,605 39,952 41,980

Interest 14,222 15,621 17,716 19,537 22,245 21,603 23,186 22,710

Subsidies 20,345 23,106 36,256 44,075 37,612 46,698 39,408 40,683

Of which: fuel subsidies 6,190 9,605 20,375 27,898 20,015 28,900 22,341 23,616

Grants 39,937 27,862 32,157 32,632 33,890 34,344 36,245 36,245

Social benefits and other expense 10,831 12,670 14,703 15,545 14,845 16,328 17,171 18,359

Net acquisition of nonfinancial assets 45,213 48,299 43,871 42,658 41,935 37,457 39,593 39,593

Gross operating balance -2,609 6,024 1,779 -6,445 3,330 -4,414 4,522 3,817

Net lending/borrowing -47,822 -42,276 -42,092 -49,103 -38,605 -41,871 -35,071 -35,776

Overall fiscal balance (authorities' definition) 1/ -47,424 -43,275 -42,509 -41,951 -39,993 -37,933 -37,109 -37,814

Net acquisition of financial assets 2,771 -2,156 3,527 -5,773 … -4,938 … 2,038

By financial instrument

Currency and deposits 3,168 -3,156 3,109 -2,621 … -1,000 … 0

Loans and equity -397 1,000 417 -3,152 … -3,938 … 2,038

By holder residence

Domestic 2,771 -2,156 3,527 -5,773 … -4,938 … 2,038

Foreign ……………………

Net incurrence of liabilities 50,593 40,120 45,619 43,331 … 36,933 … 37,814

By financial instrument

Debt securities 56,879 36,456 45,069 43,344 … … … …

Loans -6,286 3,664 550 -13 … … … …

By holder residence

Domestic 44,365 3,567 15,811 15,204 … … … …

Foreign 6,227 36,553 29,808 28,127 … … … …

Revenue 21.7 19.9 21.0 21.3 20.8 21.8 21.2 21.1

Taxes 14.9 13.7 15.3 16.1 15.9 16.6 16.3 16.3

Other revenue 6.7 6.1 5.7 5.2 4.9 5.2 4.9 4.8

Expenditure 28.4 25.2 25.7 26.6 24.6 26.1 24.5 24.4

Expense 22.0 19.1 20.8 22.0 20.4 22.3 20.8 20.7

Compensation of employees 6.0 5.9 5.7 6.4 5.9 6.3 6.0 5.9

Use of goods and services 4.1 3.3 3.7 3.8 3.8 3.9 3.8 3.9

Interest 2.0 2.0 2.0 2.1 2.2 2.2 2.2 2.1

Subsidies 2.9 2.9 4.1 4.7 3.8 4.7 3.7 3.8

Of which: fuel subsidies 0.9 1.2 2.3 3.0 2.0 2.9 2.1 2.2

Grants 5.6 3.5 3.6 3.5 3.4 3.5 3.4 3.4

Social benefits and other expense 1.5 1.6 1.7 1.7 1.5 1.7 1.6 1.7

Net acquisition of nonfinancial assets 6.3 6.1 5.0 4.5 4.2 3.8 3.7 3.7

Gross operating balance -0.4 0.8 0.2 -0.7 0.3 -0.4 0.4 0.4

Net lending/borrowing -6.7 -5.3 -4.8 -5.2 -3.9 -4.3 -3.3 -3.3

Overall fiscal balance (authorities' definition) 1/ -6.7 -5.4 -4.8 -4.5 -4.0 -3.9 -3.5 -3.5

Liabilities (nominal value) 362,387 407,101 456,128 501,617 … … … …

By financial instrument

Debt securities 312,590 346,813 392,033 439,970 … … … …

Loans 49,797 60,288 64,095 61,647 … … … …

By holder residence

Domestic 306,477 315,344 333,755 352,359 … … … …

Foreign 55,910 91,757 122,373 149,258 … … … …

Memorandum items:

Cyclically adjusted balance (percent of potential GDP) -4.6 -4.8 -4.9 -5.4 … -4.3 … -3.3

Structural primary balance (percent of potential GDP) -2.6 -2.8 -2.9 -3.3 … -2.1 … -1.2

Primary balance (percent of GDP) -4.7 -3.3 -2.8 -3.1 -1.6 -2.1 -1.1 -1.2

Non-oil primary balance (percent of GDP) -13.7 -10.4 -10.3 -10.6 -8.2 -8.9 -7.3 -7.5

Oil revenues (percent of GDP) 9.0 7.1 7.5 7.4 6.6 6.9 6.1 6.3

General government balance (percent of GDP) 2/ -6.7 -4.7 -3.8 -3.6 … -4.6 … -3.5

Public sector balance (percent of GDP) 2/ -7.8 -2.6 -3.4 -5.2 … -6.8 … -6.5

Nominal GDP (in millions of ringgit) 712,857 797,327 884,457 941,238 1,001,800 984,451 1,056,558 1,080,737

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

(In millions of ringgit)

1/ Authorities' measure of the overall fiscal balance and the IMF's measure of fiscal balance (net lending/borrowing) are different due to differences in methodology/basis of recording (GFSM2001 versus authorities' modified-cash

based accounting) and differences in the treatment of certain items.

2/ General government includes federal government, state and local governments and statutory bodies. Public sector includes general government and NFPEs.

(In millions of ringgit)

20142013

I. Statement of Government Operations

II. Stock Positions

(In percent of GDP)

MALAYSIA

46 INTERNATIONAL MONETARY FUND

Table 6. Malaysia: Monetary Survey, 2009–13

2011 2012

Jul

Net foreign assets 288,170 284,190 356,968 347,381 332,373

Foreign assets 396,650 420,705 541,182 560,083 576,255

Foreign liabilities 108,480 136,514 184,214 212,702 243,882

Net domestic assets 703,882 780,755 863,756 981,330 1,067,960

Net domestic credit 929,831 1,005,859 1,127,900 1,254,165 1,339,798

Net credit to nonfinancial public sector 55,865 56,766 63,870 69,849 90,201

Credit to private sector 795,598 879,943 988,555 1,108,437 1,173,374

Net credit to other financial corporations 78,369 69,151 75,475 75,880 76,223

Capital accounts 182,714 164,564 191,463 207,478 221,247

Other items (net) -43,235 -60,540 -72,681 -65,358 -50,591

Broad money 992,052 1,064,945 1,220,725 1,328,710 1,400,333

Narrow money 213,869 239,784 272,942 308,954 325,245

Currency in circulation 43,438 47,685 53,488 56,798 62,058

Transferable deposits 170,431 192,100 219,454 252,156 263,187

Other deposits 749,555 798,978 919,714 992,648 1,042,908

Securities other than shares 28,628 26,183 28,058 25,885 26,900

Repurchase agreements 0 0 10 1,223 5,281

Net foreign assets 3.4 -0.4 6.8 -0.8 -1.0

Net domestic assets 4.4 7.7 7.8 9.6 8.1

Memorandum items:

Broad money (12-month percent change) 7.7 7.3 14.6 8.8 7.1

Currency in circulation (12-month percent change) 7.4 9.8 12.2 6.2 11.3

Money multiplier (broad money/narrow money) 4.6 4.4 4.5 4.3 4.3

Sources: IMF, International Financial Statistics; and Bank Negara Malaysia.

20102009

2013

(In millions of ringgit; end of period)

(Contribution to 12-month growth in broad money)

MALAYSIA

INTERNATIONAL MONETARY FUND 47

Table 7. Malaysia: Banks' Financial Soundness Indicators, 2009–13

2009 2010 2011 2012 2013

Sep.

Capital adequacy

Regulatory capital to risk-weighted assets 18.2 17.5 17.7 17.6 14.7

Regulatory Tier 1 capital to risk-weighted assets 14.1 13.5 13.2 13.4 13.3

Asset quality

Nonperforming loans net of provisions to capital 1/ 11.8 13.9 11.6 8.3 8.6

Nonperforming loans to total gross loans 3.6 3.4 2.7 2.0 2.0

Total provisions to nonperforming loans 82.5 89.1 99.3 98.7 97.9

Earnings and profitability

Return on assets 1.2 1.5 1.5 1.6 1.5

Return on equity 13.4 16.3 16.8 17.3 15.6

Interest margin to gross income 57.7 59.8 53.5 54.8 48.9

Non-interest expenses to gross income 45.2 41.5 45.2 45.0 52.5

Liquidity

Liquid assets to total assets (liquid asset ratio) 14.3 15.7 12.9 13.8 11.2

Liquid assets to short term liabilities 43.0 48.1 36.6 42.5 36.4

Loan-deposit ratio 2/ 77.9 81.3 80.9 82.1 83.9

Sensitivity to market risk

Net open position in foreign exchange to capital 3.9 9.3 11.7 8.7 12.6

Sectoral distribution of total loans to nonbanking sector

Residents 98.1 98.0 97.7 97.7 97.4

Other financial corporations 3.4 3.1 3.1 2.6 2.5

General government 2.0 2.7 2.7 2.6 2.4

Nonfinancial corporations 38.4 37.6 37.3 37.6 37.0

Other domestic sectors 54.4 54.6 54.4 54.9 55.4

Nonresidents 1.9 2.0 2.3 2.3 2.6

Sources: CEIC Data Co. Ltd.; and IMF, Financial Soundness Indicators database.

1/ Loans are classified as nonperforming if payments are overdue for three months or more. Total

loans include housing loans sold to Cagamas Berhad. Net NPL exclude interest-in-suspense and

specific provisions.

2/ Deposits include repos and negotiable instruments of deposit. Loans exclude loans sold to

Cagamas Berhad.

(In percent)

MALAYSIA

48 INTERNATIONAL MONETARY FUND

Table 8. Malaysia: Macroprudential Measures Since 2010

January 2010 Reintroduced 5 percent Real Property Gains Tax (RPGT) for properties sold in less than 5 years.

November 2010 Imposed caps of 70 percent on third and subsequent mortgages.

January 2011 Imposed a 5 percent RPGT on properties sold between 3 and 5 years and increased the RPGT rate to

10 percent on properties sold in less than 2 years.

March 2011 The minimum income eligibility for new credit card holders was set at RM 24,000 per annum.

Cardholders earning less than RM 36,000 per annum were limited to two credit card issuers and the

maximum credit per issuer capped at two times monthly income.

November 2011 Issued guidelines on responsible financing and the computation of debt service ratios (DSR) based on

a borrower's net income. Capital risk-weights were raised to 100 percent for mortgages with LTVs

exceeding 90 percent and were also raised for personal loans with a tenure more than 5 years.

December 2011 Introduced an LTV cap of 60 percent on housing loans for corporates.

April 2012 The minimum house price for foreigners was increased to RM 500,000 (from RM 250,000).

January 2013 Increased the RPGT rate to 15 percent on properties sold before 2 years and to 10 percent on

properties sold between 3 and 5 years.

July 2013 Imposed a maximum mortgage term of 35 years and a maximum tenure of 10 years on financing

extended for personal use. Prohibited the offering of pre-approved personal financing products.

October 2013 Distinguished between RPGT for Malaysians, foreigners and corporates. For foreigners, the RGPT is

30 percent for properties sold before 5 years and 5 percent after 5 years. For Malaysians, the RPGT is

30 percent for properties sold up to 3 years; 20 percent between 3 and 4 years; 15 percent between

4 and 5 years; after 5 years 0 percent for individuals and 5 percent for corporates. Increased Minimum

house price for foreigners to RM 1,000,000. Banned Developers Interest Bearing Scheme (DIBS).

MALAYSIA

INTERNATIONAL MONETARY FUND 49

Appendix 1. Malaysia—Staff Policy Advice from the 2011 and 2012 Article IV

Consultations

Staff Advice Policy Actions

Fiscal

Bring down debt to sustainable levels (e.g., pre2008 levels

by 2020) and articulate credible revenue and spending

measures to achieve that target (2011 and 2012).

The authorities agree on the need for fiscal consolidation and are

targeting a fiscal deficit of 3 percent of GDP by 2015 and a balanced

budget by 2020. They are in the process of developing a medium term

budget framework and have established a Fiscal Policy Committee (FPC)

that will endorse Malaysia’s medium-term fiscal strategy.

Issue a statement of fiscal risks (2011 and 2012). The authorities requested Fund technical assistance on fiscal risks. A

mission was fielded in January 2013. The Fiscal Policy Office, which will

act as the secretariat to the FPC, is tasked with preparing a fiscal risks

statement.

Broaden tax bases by implementing a GST and rationalizing

tax incentives (2011 and 2012).

The authorities announced the introduction of GST in the 2014 Budget,

effective April 2015. The authorities are undertaking a study on the

effectiveness and costs of tax incentives.

Phase out subsidies and replace with targeted cash transfers

to the needy (2011 and 2012).

The authorities have already reduced some fuel and food subsidies, and

plan to further rationalize subsidies going forward. The use of cash

transfers has increased and now benefit over 55 percent of households.

But the 2014 Budget announced the creation of a comprehensive

database on welfare recipients which could facilitate better targeting of

transfers.

Strengthen public financial management (2012). The authorities have taken steps to improve public procurement and

move towards performance-based budgeting. The authorities are also in

the process of transitioning to accrual accounting.

Financial

Continue to monitor the increase in household debt (2011

and 2012). Strengthen monitoring of risks through collection

of granular data on household assets and liabilities.

The authorities have taken a variety of macroprudential measures to deal

with rising household indebtedness. In addition, they have also issued

guidelines on responsible lending practices and are trying to boost

financial literacy. The BNM expects to complete collection of granular

data on households by end-2014.

Continue to monitor regional exposures; deepen cooperation

between home and host country supervisors (2012).

The authorities continue to expand the list of countries with which they

have signed Memorandum of Understanding for information sharing and

collaboration in cross border supervision.

Structural

Boost growth and productivity through steady

implementation of structural reforms, including reforms to

governmentlinked companies; liberalization of labor and

product markets; and enhanced education and training.

Many recommendations from previous Article IV reports also form part

of the authorities’ Economic Transformation Program and the

Government Transformation Program. Some progress has been made on

the strategic reform initiatives and the authorities' further plans to boost

growth are discussed in this staff report.

Consider introducing a carefullydesigned minimum

wage (2011).

The authorities enacted a minimum wage in 2012 and it came into effect

in January 2013.

Consider implementing an unemployment insurance

scheme (2011 and 2012).

The ILO has been tasked with drafting a paper on the appropriate design

of an unemployment insurance scheme for Malaysia.

Develop defined contribution private pension plans and

increase the age of withdrawal from EPF accounts

from 55 (2011). Increase the retirement age for public workers

to 60, in line with the private sector (2012). Provide an option

for workers to receive their pensions in the

form of annuities

(2012).

A private retirement scheme (defined contribution) has been introduced.

The retirement age for private workers has been increased to 60 from 55,

although workers can still withdraw savings from the EPF at 55. The

retirement age for civil servants was also raised from 58 to 60 in 2012.

MALAYSIA

50 INTERNATIONAL MONETARY FUND

Appendix 2. Malaysia—Risk Assessment Matrix 1/

Nature/Source of

Main Threats

Likelihood

of Risk

Transmission Channels

Expected Impact of Risk

Recommended Policy Responses

Side-effects from

global financial

conditions: Surges

in global market

volatility (related to

UMP exit), leading to

economic and fiscal

stress, and

constraints on

country policy

setting.

High

Higher financing costs and lower

access to foreign financing for

the sovereign, corporate and

banks. FDI would slow.

Weaker global growth would

reduce export volumes and

commodity prices, with second

round effects on domestic

demand.

Low to Medium

High share of foreign holdings of

sovereign and BNM securities makes

these markets vulnerable to risk-on,

risk-off cycles, but this is offset by

demand by domestic institutional

investors.

Domestic credit is resilient as a very high

share of bank funding is based on

domestic deposits.

Recent and earlier outflow episodes have

had limited impact on credit or the real

economy.

The exchange rate should be allowed to

act as a shock absorber, intervening only

to smooth excessive volatility. Monetary

policy decisions should be calibrated to

balance the trade-off between supporting

growth and managing capital outflows.

There is scope to provide liquidity support

in foreign currency to maintain financial

stability.

There is only limited room for

countercyclical fiscal support given the

relatively high fiscal deficit and debt levels.

Any temporary fiscal expansion should be

well targeted and anchored in a credible

medium term consolidation plan.

Sharp slowdown in

growth in China

(buildup of excess

capacity eventually

resulting in large

financial and fiscal

losses

(medium-term))

Medium

Trade (volumes and prices,

including of commodities) would

be the dominant channel, with

adverse second round effects on

domestic demand.

Limited financial spillovers

(directly through exposure of

Malaysian banks to Greater

China and indirectly via

slowdown domestically and in

rest of ASEAN).

Medium

China is Malaysia’s largest trading

partner, with an export share of

13 percent. Staff analysis in the 2012

Spillover Report finds that a 1 percentage

point investment slowdown in China

would reduce Malaysia’s growth by

0.6 percentage points.

The impact would be compounded by

spillover effects in other Asian countries

strongly integrated with both China and

Malaysia, particularly ASEAN countries.

Monetary easing should be the first line of

defense, providing it is consistent with the

inflation output trade-off.

There is also scope to let the exchange

rate absorb the shock, using reserves to

smooth excessive volatility.

However, only limited room exists for

countercyclical fiscal support.

Structural policies could be implemented

to rebalance growth towards domestic

demand

Protracted period

of slower growth:

Advanced

economies: (larger

than expected

deleveraging or

negative surprise on

potential growth);

and Emerging

markets: (earlier

maturing of the

growth cycle and

incomplete structural

reforms leading to

prolonged slower

growth.

High

(Europe)

Medium

(elsewhere)

Trade (both volume and price),

as above, would be the dominant

channel.

Low to Medium

Prolonged weakness in external demand

would likely affect the resilience of

domestic demand, lowering growth,

rising unemployment and falling house

and asset prices, especially if it led to a

protracted period of slow global growth.

This in turn would weaken bank,

corporate and sovereign balance sheets,

in a negative feedback loop.

The ability of policy to provide a longlived

cushion against a protracted slump is

limited; excessive stimulus could lead to

macro and financial instability.

Policymakers would need to adjust to

slower medium-term growth.

Implementation

risks associated

with fiscal

consolidation and

reforms envisaged

in the 2014 budget

Low to

Medium

Reforms, such as fuel subsidy

cuts and the GST introduction,

entail political, design, and

execution risks.

Realization of these risk would

slow down or derail reform

implementation, with adverse

consequences for the credibility

of fiscal policies.

Negative confidence effects

could interact with the relatively

high public debt and significant

contingent liabilities to raise the

sovereign’s financing cost and

result in higher interest rates

throughout the economy.

Medium to High

Higher financing costs for the sovereign,

a relatively high public debt, and failure

to implement fiscal reforms would

exacerbate concerns about public debt

sustainability together with a potential

sovereign credit downgrade.

The authorities’ ability to mount

countercyclical responses would be

limited, and policy procyclicality would

be heightened.

Higher borrowing costs would affect

investment and other interest-sensitive

components of spending and put a

further strain on fiscal finances.

Capital outflows further compound the

harmful effects of lack of fiscal resolve on

the economy.

Recent steps to strengthen fiscal

management, including the creation of the

Fiscal Policy Committee, along with the

decisive return of PM Najib to power

following the May election, limit political

and implementation risks.

But it would be critical to adopt an

appropriately paced fiscal consolidation

path to increase room to absorb

contingencies. It is imperative to introduce

mechanisms to monitor and control fiscal

risks, including from the granting of

government guarantees.

Sharp decline in

house prices in a

rising global

interest rate

environment

Low to

Medium

(house price

growth has

been rapid in

recent years)

The real economy would be

adversely affected through

weaker bank balance sheets and

slower credit, as well as negative

wealth and confidence effects.

Medium

Household debt is high at 83 percent of

GDP and one half of this is mortgages.

Offsetting this are high household

financial assets. The authorities are

monitoring the risk and have adopted

measures to cool the housing market.

As above, monetary policy easing,

exchange rate flexibility and temporary

fiscal stimulus anchored in a credible

medium term fiscal sustainability

framework. Financial sector policies, such

as recapitalization, could mitigate the

impact on the banking system.

1/ 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 mutuall

exclusive risks ma

interact and materialize

ointl

MALAYSIA

INTERNATIONAL MONETARY FUND 51

Appendix 3. Malaysia—External Sector Assessment

Current Account (CA)

Malaysia’s economy has undergone spectacular external rebalancing in recent years, and its once

mighty current account surplus has declined by almost 8 percentage points since 2011, to

3.8 percent of GDP in 2013. This turnaround has been primarily driven by a decline in the surplus of

the merchandise trade in goods, reflecting robust domestic demand and weak external demand,

although a significant decline in commodity prices also played a role. The current account narrowing

is largely structural, reflecting Malaysia’s comprehensive reform agenda, which has led to a broad-

based boost in investment and a higher investment-to-GDP ratio, while domestic consumption

growth has also been strong. Rebalancing by the rest of the world, as reflected in weak export

growth, has also contributed to the decline in the structural balance.

In terms of the saving-investment balance, the narrowing of the current account surplus reflects

both lower savings and higher investment. The savings rate declined sharply in 2008 at the onset of

the crisis, from about 38 percent to 35 percent, and then declined further during 2012 to 32 percent.

The fall in savings was driven by robust private consumption growth, while public saving has also

declined. Gross domestic investment jumped from 22 percent in 2008 to 26 percent in 2013, driven

by investment in large ETP-related projects, that are import intensive. This pickup in investment is a

welcome development—the first time in which the investment ratio increased significantly following

its slump during the Asian financial crisis—and could lead to an easing of supply bottlenecks and

help boost productivity, and support efforts to modernize the economy and raise incomes.

Real Effective Exchange Rate (REER)

Over the past year, the real effective exchange rate has fluctuated more widely than in 2010−2012,

as the currency came under stress during the capital outflow episode in spring-summer. In the

absence of large movements in inflation differentials, nominal depreciation of the ringgit led to real

depreciation. The REER depreciation was, however, short-lived and, overall, the REER moved around

a fairly horizontal trend. Since 2000, movements in the REER have been driven almost entirely by the

nominal exchange rate rather than inflation differentials. Fluctuations in the REER have been smaller

than those of the ringgit against the U.S. dollar, since currencies of other trading partners have had

similar movements against the dollar.

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52 INTERNATIONAL MONETARY FUND

The Financial Account and Reserve Accumulation

Malaysia has experienced volatile capital flows over the past few years reflecting both push and pull

factors, including shifting global risk aversion, low policy rates in advanced economies and

Malaysia’s strong fundamentals, but a healthy financial sector has limited the impact on the overall

economy (see Appendix 8). Malaysia has typically recorded net capital outflows. Although net FDI

flows are generally small, there are large gross foreign direct investment flows. In 2013, net outflows

were about 1.5 percent of GDP, with portfolio outflows accounting for 1.1 percent of GDP, and other

outflows accounting for 0.4 percent of GDP.

At end-2013, official reserves are about 117 percent of the IMF’s composite reserve adequacy metric,

and cover about 240 percent and 32 percent of short-term external debt and broad money,

respectively. Therefore, current reserve levels are adequate and there is no need for additional

MALAYSIA

INTERNATIONAL MONETARY FUND 53

accumulation for precautionary purposes. BNM intervention seeks to limit excess exchange rate

volatility and has generally been two-sided.

Thus, during the global financial crisis foreign

reserves fell by about 28 percent between

August 2008 and March 2009; a decline was

again recorded in August–September 2011 and

in June 2013. During June 2013, reserves fell by

in US$5 billion suggesting intervention by BNM.

The authorities have continued to liberalize FX

administration, including via greater flexibility

for resident companies to undertake foreign

direct investment abroad and obtain loans from

related resident and nonresident companies.

External debt is relatively low at about 29 percent of GDP in 2013, of which about 18 percent is

medium- and long-term debt. However, the current definition of external debt for Malaysia does not

include ringgit-denominated debt held by nonresidents (23 percent of GDP); once included the

external debt ratio shows a strong increase since the global financial crisis. Short-term external debt

has risen recently in the last few years, largely due to banking sector activity, it is matched by an

increase in short-term external assets and is well-covered by foreign reserves. The international

investment position is small and negative (-2 percent of GDP at end-2012).

Standard Benchmarks

Model analysis (EBA) suggests that the cyclically-adjusted current account is stronger (by about

4.2 percentage points of GDP) than the level consistent with medium-term fundamentals and

desirable policies. Applying the EBA methodology, based on data and projections available as of

November 2013 the estimated 2013 current account norm for Malaysia is -0.1 percent of GDP,

adjusted for relative output gaps and for commodity terms of trade. The current account balance in

2013 was 3.8 percent of GDP and the cyclically adjusted current account balance of 4.1 percent of

GDP. The resulting EBA-estimated gap of +4.2 percent of GDP comprises policy gap contributions of

about +1.5 percent of GDP, and an unexplained residual that needs to be interpreted.

2005Q1

2005Q3

2006Q1

2006Q3

2007Q1

2007Q3

2008Q1

2008Q3

2009Q1

2009Q3

2010Q1

2010Q3

2011Q1

2011Q3

2012Q1

2012Q3

2013Q1

2013

External debt

Ringgit denominated debt held by foreigners

Source: CEIC Data Co. Ltd.

External Debt and Ringgit Denominated Debt Held by Foreigne

(In percent of annualized GDP)

MALAYSIA

54 INTERNATIONAL MONETARY FUND

However, Malaysia’s current account surplus mainly reflects factors that are not well captured in the

EBA; in particular: insufficient social safety nets (not fully captured by health spending), which drive

up saving rates; bottlenecks to investment, resulting in relatively low private investment rates

(despite the recent increase). Taking these factors and the uncertainty surrounding model estimates

into consideration, we assess the CA gap to be of the order of 2.6 percentage points of GDP.

Turning to Malaysia’s real effective exchange rate (REER), the EBA estimates it to be 23 percent

below levels warranted by fundamentals and desirable policies, although most of the gap is an

unexplained residual.

Staff’s preferred estimate of the degree of REER undervaluation is about

9 percent. This range is consistent with staff’s view of the current account gap based on the

macrobalance approach and relies on the semi-elasticity of the current account with respect to the

REER. The estimate of the semi-elasticity takes into account Malaysia’s trade openness and

commodity exports and this approach yields a moderate REER undervaluation of less than

10 percent when an estimated semi-elasticity of -0.29 is used.

The Role of Fiscal Consolidation

Malaysia’s multiyear fiscal consolidation also affects the current account in the medium term. Staff

estimates that every 1 percentage point improvement in the fiscal balance could strengthen the

current account by 0.4 percentage point, although the composition of the fiscal adjustment matters

(see selected issues paper on “A Medium-Term Fiscal Strategy for Malaysia”). The impact on the

current account depends on how different measures affect saving and investment of private agents.

For example, fuel subsidy rationalization is likely to have a positive direct effect on the current

account. From a macroeconomic perspective, a stronger fiscal position should help reduce concerns

(evident during periods of EME market volatility) about Malaysia’s current account deterioration.

The Role of Oil and Gas Exports

Malaysia is an important commodities producer

and exporter, including non-reproducible

resources. Its oil and gas trade balance reached

6.2 percent of GDP in 2013, and its current account

balance excluding oil and gas, which became

negative in 2012, widened to -2.4 percent of GDP

in 2013. The EBA captures the fact that current

account surpluses are a salient characteristic of

oil- and gas-exporting countries. Two aspects are

important: first, from an intergenerational

perspective, it is optimal for countries to save part

of their earnings from exporting nonrenewable

resources, which results in an increase in their current account balance. Second, the fraction of their

resource earnings that is saved and exported also depends on the longevity of these resources—

according to the Permanent Income Hypothesis, short-lived increases in national income should be

The fit of the EBA REER regression for Malaysia has fallen off in recent years, and part of the problem arises from

the EBA proxy measure for trade openness.

MALAYSIA

INTERNATIONAL MONETARY FUND 55

primarily saved. Now, Malaysia’s proven oil reserves are the equivalent of about 27 years worth of

current production levels, while gas reserves are larger, about 42 years. In terms of the impact of oil

and gas exports on Malaysia’s current account, EBA estimates that Malaysia’s oil and gas reserves

contributes about 1.7 percent of GDP to the estimated current account norm.

Malaysia: Quantitative External Sector Assessment

Overall Assessment

Malaysia’s current account surplus is elevated on account of structural factors that boost private

savings and constrain public investment. From a multilateral perspective, and consistent with the

authorities’ intentions, stronger social safety nets and efforts to remove bottlenecks to investment

would help to further moderate the current account surplus.

Norm 1/ Projection 1/ Gap

Current account

EBA 2.0 current account -0.1 4.1 4.2

of which: Contribution of identified policy gaps 2/ 1.5

Unexplained residual 2.7

External sustainability approach 3/ 2.8

Staff assessment 1.5 4.1 2.6

of which: Contribution of identified policy gaps (based on EBA 2.0) 1.5

Other 1.1

Exchange rate misalignment (Percentage)

EBA 2.0 Equilibrium real exchange rate approach 4/ … … -23.0

Of which

Contribution of identified policy gaps 2/ … … -6.0

Unexplained residual … … -17.0

Staff estimate using elasticity approach

Staff estimated elasticity 5/ … … -9.0

4/ Misalignment based on EBA 2.0 November 2013 update.

(In percent of GDP)

5/ The semi-elasticity of the current account balance with respect to the REER is η_CA= -0.29, computed according to η_CA=η_Xnc s_Xnc-

(η_M-1) s_M-s_Xc, where η_Xnc is the elasticity of the volume of non-commodity exports with respect to the REER, η_M is the elasticity

of the volume of imports with respect to the REER, estimated at η_Xnc= - 0.82, η_M= 0.26, s_Xnc= 58.2 percent is the share of non-

commodity exports in GDP, s_Xc= 16.8 percent is the share of commodity exports in GDP, and s_M= 61 percent is the share of imports

in GDP.

2/ Policy Gaps refers to policy distortions can arise either from domestic policies or as a result of the policies of other economies. See

2013 Pilot External Sector Report.

3/ Based on 2012 NFA/GDP ratio of -1.5 percent of GDP and an adjusted CA projection of 3.2 percent for 2018.

1/ Staff’s estimate of the multi-laterally consistent cyclically-adjusted norm and projection for 2013, based on EBA 2.0 November 2013

update.

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56 INTERNATIONAL MONETARY FUND

Appendix 4. Malaysia—Public Debt Sustainability Analysis

1. Background. The new debt sustainability analysis (DSA) framework for market access

countries is used to assess Malaysia’s debt sustainability and other risks related to its funding and

debt structure. The new framework uses a risk-based approach and expands upon the basic DSA to

include: (i) an assessment of the realism of baseline assumptions and the projected fiscal adjustment;

(ii) an analysis of risks associated with the debt profile; (iii) macrofiscal risks; (iv) a stochastic debt

projection taking into account past macrofiscal volatility; and (v) a standardized summary of risks in a

heat map.

2. Macroeconomic assumptions. Growth is projected at 4.7 percent in 2013, rising to

5 percent in 2014 on the back of a recovery in global demand and a sustained strong domestic

demand. The GDP deflator is expected to increase in the medium term, from a low of about

0 percent in 2013 to 4.6 percent in 2014 on the back of fuel subsidy cuts, and improving terms of

trade. Growth will average 5 percent in the medium term and the growth in GDP deflator is projected

to fall gradually towards 2.5 percent.

3. Fiscal assumptions. In staff’s baseline projections, federal government deficit is reduced in

the near term from 4.3 percent of GDP in 2013 to 2.6 percent in 2015

. The projected fiscal

consolidation is consistent with the authorities’ targets and is supported by structural reforms

announced in the 2014 budget. In particular, staff projections assume that the authorities gradually

eliminate fuel subsidies and partially replace them with targeted cash transfers to the lower income

group. It also assumes that a goods and services tax (GST) is introduced in 2015. Fiscal deficit starts

to increase after 2016, due to the gradual decline in oil and gas related revenues, and increases in

pension and health care related costs.

4. Data coverage. Consistent with the data on government debt reported by the authorities,

the fiscal assumptions in this DSA are based on the federal government budget. This coverage

excludes local and state governments and statutory bodies which typically borrow from the federal

government or receive explicit government guarantees. The liabilities of these entities are therefore

captured in federal government’ gross debt and stock of loan guarantees

. Borrowing by

state-owned enterprises, which are in some cases under federal government guarantees, has

increased in recent years and is projected to continue to increase in the medium term.

5. Malaysia’s high level of government debt and gross financing requirement calls for

using the higher scrutiny framework. Government’s gross debt increased sharply in 2009,

reflecting sizable discretionary fiscal stimulus, declining real and nominal growth and a large fall in oil

prices. Although growth has recovered since then, primary deficits have remained high, pushing the

debt to GDP ratio to close to the authorities self-imposed debt ceiling of 55 percent. Gross financing

Authorities' measure of the overall fiscal balance and the IMF's measure of fiscal balance (net lending/borrowing)

are different due to differences in accounting standards (GFSM2001/accrual versus authorities' modified-cash based

accounting) and differences in the treatment of certain items.

Gross debt of consolidated general government is not published.

MALAYSIA

INTERNATIONAL MONETARY FUND 57

needs (GFN) are estimated at 11.1 percent of GDP in 2012 and are expected to remain around

9−10 percent in the medium term.

6. Realism of baseline assumptions. The median forecast error for real GDP growth

during 2004−2012 is zero, suggesting that there is no evidence of a systemic projection bias that

would undermine the assessment. The median forecast error for GDP deflator is 2.9 percent,

suggesting that the staff forecasts have been more conservative. The median forecast error for

primary balance suggests that staff projections have been slightly optimistic (a forecast bias of

0.72 percent of GDP), but the forecast bias has improved in the later years.

7. Cross-country experience suggests the projected fiscal adjustment is feasible. The

maximum 3 year adjustment in the cyclically-adjusted primary balance (CAPB) over the projection

period (2.75 percent of GDP) is ambitious but is premised upon concrete measures endorsed by the

government. As highlighted earlier, staff does not rule out the existence of implementation risks and

therefore considering a no adjustment scenario, as done in this DSA, is necessary to take that into

account. Finally, the maximum level of the primary balance (-0.5 percent of GDP) that is assumed in

the medium term is reasonable when compared to the experience in other market-access countries.

8. The DSA framework suggests Malaysia’s government debt-to-GDP ratio remains below

70 percent and its gross financing needs remain below 15 percent of GDP under different

macroeconomic and fiscal shocks.

 Under the baseline, the debt-to-GDP ratio is projected to decrease to slightly below 50 percent

by 2018, but if the projected consolidation does not take place, captured under the constant

primary balance simulation, it increases to 56 percent by 2018. Under most macro-fiscal stress

tests, debt-to-GDP ratio continues to decline, but if there is a one standard deviation shock to

real GDP growth, debt-to-GDP ratio initially increases to 57 percent in 2015 and declines

thereafter. The combined macro-fiscal shock and a permanent 20 percent oil price shock, imply a

flat debt-to-GDP profile in the medium term. Stochastic simulations based on historical

volatilities in Malaysia’s macroeconomic variables also show that the 90

percentile of

debt-to-GDP ratio simulations is below 70 percent. Gross financing needs under all scenarios

remain at about 9 percent, and rise to just below 12 percent by the end of the projection horizon.

 A contingent liability shock whereby the government would have to absorb all of the

government guaranteed loans (totaling 15 percent of GDP) over two years would increase risks

significantly. If the economy is also hit by a persistent shock to growth and interest rates rise by

150 basis points, the debt-to-GDP ratio would remain just below 70 percent debt benchmark.

Although this is a low probability scenario, the simulations underscore the growing vulnerability

posed by contingent liabilities.

9. Heat map. Despite its low share of foreign currency and short-term debt, Malaysia faces risks

arising from its external financing requirement and large share of public debt held by foreigners. At

13 percent, the external financing requirement is close to the upper threshold of early warning

benchmarks and the share of debt held by foreigners is relatively high at about 30 percent of total.

As discussed earlier, the existence of large domestic institutional investors who tend to make

opportunistic investments; provides some comfort along this dimension.

MALAYSIA

58 INTERNATIONAL MONETARY FUND

Malaysia Public Sector Debt Sustainability Analysis (DSA)—Baseline Scenario

(In percent of GDP unless otherwise indicated)

As of January 13, 2014

2011 2012 2013 2014 2015 2016 2017 2018 Sovereign Spreads

Nominal gross public deb

44.3 51.6 53.3 54.8 53.3 51.7 50.1 49.2 48.7 EMBI (bp) 3/ 135

Public gross financing needs 8.9 10.9 11.1 10.4 9.0 8.9 8.6 9.2 10.8 CDS (bp) 112

Real GDP growth (in percent) 5.1 5.1 5.6 4.7 5.0 5.0 5.0 5.0 5.0 Ratings Foreign Local

Inflation (GDP deflator, in percent) 4.3 5.5 0.7 -0.1 4.6 3.8 2.9 2.6 2.6 Moody's A3 A3

Nominal GDP growth (in percent) 9.7 10.9 6.4 4.6 9.8 8.9 8.1 7.7 7.7 S&Ps A- A

Effective interest rate (in percent)

5.4 4.4 4.3 4.3 4.2 4.2 4.3 4.5 4.7 Fitch A- A

2011 2012 2013 2014 2015 2016 2017 2018 cumulative

Change in gross public sector deb

1.1 0.51 1.72 1.5 -1.5 -1.6 -1.6 -0.9 -0.5 -4.6

Identified debt-creating flows 0.4 0.20 1.42 1.4 -1.4 -1.7 -1.5 -0.9 -0.4 -4.6

Primary deficit 2.3 2.8 3.1 2.1 1.2 0.5 0.1 0.4 0.8 5.1

Primary (noninterest) revenue and grants 20.9 21.0 21.3 21.8 21.1 20.9 20.5 20.2 20.0 124.4

Primary (noninterest) expenditure 23.3 23.7 24.5 23.9 22.3 21.4 20.6 20.6 20.8 129.5

Automatic debt dynamics

-1.7 -3.0 -1.1 -0.1 -2.8 -2.3 -1.8 -1.5 -1.4 -10.0

Interest rate/growth differential

-1.6 -3.0 -1.0 -0.1 -2.8 -2.3 -1.8 -1.5 -1.4 -10.0

Of which: real interest rate 0.4 -0.7 1.7 2.2 -0.3 0.1 0.6 0.8 0.9 4.4

Of which: real GDP growth -2.0 -2.4 -2.7 -2.4 -2.5 -2.4 -2.4 -2.3 -2.3 -14.3

Exchange rate depreciation

-0.1 0.1-0.1 ……………… …

Other identified debt-creating flows -0.3 0.4 -0.6 -0.5 0.2 0.2 0.2 0.1 0.1 0.3

General government net privatization proceeds (negativ

0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Other change in financial assets -0.3 0.4 -0.6 -0.5 0.2 0.2 0.2 0.1 0.1 0.3

Residual, including asset changes

0.7 0.3 0.3 0.1 -0.1 0.1 -0.1 0.0 0.0 0.0

Source: IMF staff.

1/ Public sector is defined as central government.

2/ Based on available data.

3/ EMBI.

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

5/ Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = 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 denominator in footnote 4 as r - π (1+g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

8/ For projections, this line 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.

-1.3

balance

primary

Debt, Economic and Market Indicators

2002-2010

Actual

Projections

Contribution to Changes in Public Debt

Projections

2002-2010

Actual

ebt-stabilizin

-20

-15

-10

-5

cumulative

-8

-6

-4

-2

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Debt-Creating Flows

Primary deficit Real GDP growth Real interest rate Exchange rate depreciation

Other debt-creating flows Residual Change in gross public sector debt

projection

(in percent of GDP)

MALAYSIA

INTERNATIONAL MONETARY FUND 59

Malaysia Public DSA—Composition of Public Debt and Alternative Scenarios

Malaysia Public DSA—Realism of Baseline Assumptions

Source : IMF Staff.

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

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

3/ Not a

licable for Mala

sia.

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.

Forecast Track Record, versus surveillance countries

Boom-Bust Analysis

Assessing the Realism of Projected Fiscal Adjustment

-10

-8

-6

-4

-2

2004 2005 2006 2007 2008 2009 2010 2011 2012

Year

Real GDP Growth

Interquartile range (25-75)

Median

Malaysia forecast error

0.03

44%

Has a percentile rank of:

Malaysia median forecast error, 2004-2012:

Distribution of

forecast errors:

(in percent, actual-projection)

-10

-8

-6

-4

-2

2004 2005 2006 2007 2008 2009 2010 2011 2012

Year

Primary Balance

Interquartile range (25-75)

Median

Malaysia forecast error

-0.72

35%

Has a percentile rank of:

Malaysia median forecast error, 2004-2012:

Distribution of

forecast errors:

(in percent of GDP, actual-projection)

-10

-8

-6

-4

-2

2004 2005 2006 2007 2008 2009 2010 2011 2012

Year

Inflation (Deflator)

Interquartile range (25-75)

Median

Malaysia forecast error

2.86

68%

Has a percentile rank of:

Malaysia median forecast error, 2004-2012:

Distribution of

forecast errors:

(in percent, actual-projection)

pessimisticoptimistic

-6

-4

-2

t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5

Real GDP growth

Malaysia

(in percent)

Less

-4

-3

-2

-1

Distribution 4/

Malaysia

3-Year Adjustment in Cyclically-Adjusted

Primary Balance (CAPB)

(Percent of GDP)

3-year CAPB adjustment

greater than 3 percent of

GDP in approx. top quartile

has a percentile

rank of

22%

Less

-4

-3

-2

-1

Distribution 4/

Malaysia

3-Year Average Level of Cyclically-Adjusted

Primary Balance (CAPB)

(Percent of GDP)

3-year average CAPB level

greater than 3.5 percent of

GDP in approx. top quartile

has a percentile

rank of

72%

MALAYSIA

60 INTERNATIONAL MONETARY FUND

MALAYSIA

INTERNATIONAL MONETARY FUND 61

Malaysia Public DSA—Stress Tests

Primary Balance Shock 2013 2014 2015 2016 2017 2018

Real GDP Growth Shock

2013 2014 2015 2016 2017 2018

Real GDP growth 4.75.05.05.05.05.0 Real GDP growth 4.72.52.55.05.05.0

Inflation -0.1 4.6 3.8 2.9 2.6 2.6 Inflation -0.1 3.9 3.1 2.9 2.6 2.6

Primary balance -2.1-1.8-1.1-0.1-0.4-0.8 Primary balance -2.1-1.9-1.8-0.1-0.4-0.8

Effective interest rate 4.34.24.24.44.54.7 Effective interest rate 4.34.24.24.44.64.7

Real Interest Rate Shock Real Exchange Rate Shock

Real GDP growth 4.75.05.05.05.05.0 Real GDP growth 4.75.05.05.05.05.0

Inflation -0.1 4.6 3.8 2.9 2.6 2.6 Inflation -0.1 6.3 3.8 2.9 2.6 2.6

Primary balance -2.1-1.2-0.5-0.1-0.4-0.8 Primary balance -2.1-1.2-0.5-0.1-0.4-0.8

Effective interest rate 4.34.24.65.05.45.8 Effective interest rate 4.34.24.24.34.54.7

Combined Shock

Real GDP growth 4.72.52.55.05.05.0

Inflation -0.1 3.9 3.1 2.9 2.6 2.6

Primary balance -2.1 -2.2 -2.1 -0.1 -0.4 -0.8

Effective interest rate 4.34.24.65.05.45.8

Contingent Liabilities from Government Guarantees Oil price shock

Real GDP growth 4.74.04.04.04.04.0 Real GDP growth 4.74.04.04.04.04.0

Inflation -0.1 4.6 3.8 2.9 2.6 2.6 Inflation -0.1 4.6 3.8 2.9 2.6 2.6

Primary balance -2.1-8.7-8.0-0.1-0.4-0.8 Primary balance -2.1-1.6-0.9-0.7-1.1-1.5

Effective interest rate 4.34.24.65.04.95.0 Effective interest rate 4.34.24.24.34.54.7

Source: IMF staff.

Macro-Fiscal Stress Tests

Baseline Primar

Balance Shock

Real GDP Growth Shock

Real Interest Rate Shock

(in percent)

Real Exchan

e Rate Shock

Combined Macro-Fiscal Shock

Additional Stress Tests

Baseline

Underl

Assum

tions

Contin

ent Liabilities from Government Oil

rice shock

2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt

(in percent of GDP)

200

210

220

230

240

250

260

270

280

2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt

(in percent of Revenue)

2013 2014 2015 2016 2017 2018

Public Gross Financing Needs

(in percent of GDP)

2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt

(in percent of GDP)

200

220

240

260

280

300

320

340

2013 2014 2015 2016 2017 2018

Gross Nominal Public Debt

(in percent of Revenue)

2013 2014 2015 2016 2017 2018

Public Gross Financing Needs

(in percent of GDP)

MALAYSIA

62 INTERNATIONAL MONETARY FUND

Malaysia Public DSA—Risk Assessment

Malaysia

Source: IMF staff.

Primary

Balance Shock

Debt Profile Vulnerabilities

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:

Change in the

Share of Short

Term Debt

Exchange Rate

Shock

Contingent

Liability shock

Debt level

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.

Foreign

Currency

Debt

Public Debt

Held by Non-

Residents

(Indicators vis-à-vis risk assessment benchmarks)

Market

Perception

Gross financing needs

Primary

Balance Shock

Real Interest

Rate Shock

Exchange Rate

Shock

Contingent

Liability Shock

4/ An average over the last 3 months, 15-Oct-13 through 13-Jan-14.

Real GDP

Growth Shock

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.

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.

Real Interest

Rate Shock

External

Financing

Requirements

Real GDP

Growth Shock

Heat Map

Upper early warning

Evolution of Predictive Densities of Gross Nominal Public Debt

(in percent of GDP)

Debt profile

Lower early warning

200

600

140

13%

0.5

0.1%

EMBI

External Financing

Requirement

Annual Change in

Short-Term Public

Debt

Public Debt in

Foreign Currency

(in basis points) 4/

(

ercent of GDP

)

(in percent of total)

2011 2012 2013 2014 2015 2016 2017 2018

10th-25th 25th-75th 75th-90th

Percentiles:

Baseline

Symmetric Distribution

2011 2012 2013 2014 2015 2016 2017 2018

Restricted (Asymmetric) Distribution

no restriction on the growth rate shock

no restriction on the interest rate shock

0 is the max positive pb shock (percent GDP)

no restriction on the exchange rate shock

Restrictions on upside shocks:

29%

Public Debt Held

by Non-Residents

(in percent of total)

MALAYSIA

INTERNATIONAL MONETARY FUND 63

Appendix 5. Malaysia—External Debt Sustainability Analysis

1. Background. Malaysia’s external debt is expected to remain on a steady downward trend

over the medium term, falling to 25 percent of GDP by 2018. The 2 percentage point decline in the

external debt to GDP ratio from 2012 to 2018 mostly reflects sustained current account surpluses

and some shift towards domestic debt. Stress tests indicate that external debt would remain

manageable under a variety of shocks, including weaker GDP growth, a lower current account

balance, and a one-time 30 percent depreciation of the ringgit. Under these scenarios, the external

debt to GDP ratio rises above the baseline over the projection period by only modest margins. In the

case of the exchange rate depreciation scenario, the debt ratio would rise sharply to 40 percent of

GDP in 2014, but would subsequently fall to 37 percent of GDP by 2018.

MALAYSIA

64 INTERNATIONAL MONETARY FUND

Figure 5.1. Malaysia: External Debt Sustainability: Bound Tests 1/ 2/

(External debt, in percent of GDP)

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.

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

Table 5.1. Malaysia: External Debt Sustainability Framework, 2008−2018

(In percent of GDP, unless otherwise indicated)

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Debt-stabilizing

non-interest

current account 6

1 Baseline: external debt 29.6 33.6 29.9 28.1 27.1 27.3 26.7 26.1 25.8 25.6 25.2 0.8

2 Change in external debt 0.4 4.0 -3.7 -1.9 -0.9 0.1 -0.6 -0.6 -0.3 -0.2 -0.5 0.0

3 Identified external debt-creating flows (4+8+9) -16.1 -13.0 -14.2 -13.1 -5.1 -3.2 -3.7 -3.5 -3.4 -3.4 -3.4 0.0

4 Current account deficit, excluding interest payments -18.3 -16.9 -12.1 -12.7 -7.1 -4.6 -5.0 -4.9 -5.0 -5.0 -5.0 -0.8

5 Deficit in balance of goods and services -22.3 -20.3 -17.0 -16.4 -11.9 -8.5 -9.3 -9.3 -9.1 -8.8 -8.4

6 Exports 99.5 91.4 93.3 91.6 87.1 79.3 74.0 69.2 65.7 63.1 59.9

7 Imports 77.2 71.1 76.3 75.2 75.3 70.7 64.7 59.9 56.6 54.2 51.5

8 Net nondebt creating capital inflows (negative) 3.4 3.1 1.8 1.1 2.3 1.6 1.6 1.6 1.6 1.6 1.4 1.6

9 Automatic debt dynamics 1/ -1.2 0.8 -3.9 -1.5 -0.4 -0.2 -0.3 -0.2 0.0 0.1 0.2 -0.8

10 Contribution from nominal interest rate 1.3 1.2 1.2 1.2 1.0 0.9 0.9 1.0 1.2 1.3 1.3 1.2

11 Contribution from real GDP growth -1.3 0.4 -2.1 -1.4 -1.5 -1.2 -1.2 -1.2 -1.2 -1.2 -1.2 -1.2

12 Contribution from price and exchange rate changes 2/ -1.2 -0.8 -2.9 -1.3 0.1 ... ... ... ... ... ... -0.9

13 Residual, including change in gross foreign assets (2−3) 3/ 16.5 16.9 10.5 11.3 4.2 3.3 3.0 2.9 3.1 3.2 3.0 0.0

External debt-to-exports ratio (in percent) 29.8 36.8 32.1 30.6 31.1 34.4 36.1 37.7 39.3 40.6 42.0

Gross external financing need (in billions of U.S. dollars) 4/ -6.1 7.2 24.3 24.5 35.3 44.6 44.4 45.5 45.9 46.5 47.6

In percent of GDP -2.6 3.6 9.8 8.5 11.6 13.6 12.3 11.5 10.6 9.8 9.2

Scenario with key variables at their historical averages 5/ 10-Year 10-Year 15.8 5.4 -4.5 -13.9 -22.8 -31.1 2.5

Historical Standard For debt

Key macroeconomic assumptions underlying baseline Average Deviation stabilization

Real GDP growth (in percent) 4.8 -1.5 7.4 5.1 5.6 5.1 2.5 4.7 5.0 5.0 5.0 5.0 5.0 5.0

GDP deflator in U.S. dollars (change in percent) 4.4 2.9 9.6 4.5 -0.5 6.2 4.1 2.8 5.0 5.0 4.1 3.7 4.7 3.7

Nominal external interest rate (in percent) 4.9 4.0 4.2 4.3 3.7 4.2 0.4 3.7 3.8 4.1 4.9 5.3 5.8 5.3

Growth of exports (U.S. dollar terms, in percent) 11.9 -19.6 24.9 14.6 0.3 10.0 12.5 -2.4 3.0 3.1 3.8 4.4 4.6

Growth of imports (U.S. dollar terms, in percent) 6.7 -19.3 31.3 15.0 5.6 10.4 13.3 0.8 0.8 2.1 3.3 4.2 4.5

Current account balance, excluding interest payments 18.3 16.9 12.1 12.7 7.1 14.4 3.4 4.6 5.0 4.9 5.0 5.0 5.0

Net nondebt creating capital inflows -3.4 -3.1 -1.8 -1.1 -2.3 -0.9 1.8 -1.6 -1.6 -1.6 -1.6 -1.6 -1.4

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

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

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

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

2/ The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based

on GDP deflator).

Projections

1/ Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S.dollar terms, g = real GDP growth rate,

Actual

INTERNATIONAL MONETARY FUND 65

MALAYSIA

66 INTERNATIONAL MONETARY FUND

Appendix 6. Malaysia—2013 FSAP—High Priority Recommendations

Strengthening Financial Sector Oversight

Implement proposed new Financial Services Act (FSA) at an early date; and strengthen legal and

regulatory requirements for Islamic banks.

The FSA and related Islamic Financial Services Act (IFSA) were implemented on June 30, 2013. The IFSA

strengthens legal and regulatory requirements for Islamic banks including those for capital, financial

reporting, and audit.

Strengthen framework for consolidated supervision of financial holding companies (FHC) including

capital standards and risk management.

The FSA / IFSA provide BNM with powers for consolidated supervision of FHCs in these areas.

Ground the operational independence of the Securities Commission (SC) by changing the legal provisions

on removal of Commission members and protections given to Commission members and its staff.

Related amendments to the SC Act are expected to be submitted to parliament in 2014.

Strengthen the definition of connected lending.

The BNM expects to issue a revised policy document to the industry in 2014.

Labuan International Business and Finance Center

Impose prudential and regulatory requirements on Labuan financial institutions in line with international

standards and best practice.

During 2012−2013, the Labuan Financial Services Act (LFSA) has issued guidelines relating to classification

and impairment provisions of loans, connected party lending, reinsurance, and single exposure limits.

Undertake more proactive engagement and effective communication of LFSA with home supervisors and

external auditors.

The BNM continues to sign new MoUs with home supervisors of Labuan entities (3 more added in 2013).

These cover exchange of supervisory information and collaboration in enforcement. Separately, it is seeking

confirmation that each Labuan entity is covered under consolidated supervision from the home jurisdiction.

Systemic Risk Management

Formalize a highlevel committee involving BNM, SC, PIDM and the fiscal authority with the responsibility

for ongoing systemic risk monitoring, information sharing and crisis action.

The Financial Stability Executive Committee (FSEC) formed in 2010 has this mandate and, as of

January 2013, includes permanent membership of the SC along with the BNM, PIDM and MoF.

Macro-Financial Risks

Enhance data capture for household sector to facilitate a more robust and granular monitoring and

assessment of household sector leverage and issues especially in accordance to income category; and

review effectiveness of macroprudential measures.

The BNM expects to complete collection of such granular data on households by end-2014.

Adopt multiyear top-down and bottom-up macroeconomic stress testing, and introduce more

conservative credit loss parameters in bottom up exercise.

The bank has already implemented a top-down multiyear framework, a bottom-up approach is expected to

be implemented in 2014.

MALAYSIA

INTERNATIONAL MONETARY FUND 67

Appendix 7. Malaysia—Stress Tests of Banking, Household and

Corporate Balance Sheets

1. Introduction. This annex describes stress tests carried out for Malaysia’s banks as well as

household and corporate sectors in aggregate. The impact of stress was observed for banks’ capital

and earnings; household debt servicing ratios (debt servicing costs relative to total income including

both wages and savings income); and corporate interest servicing ratios (interest expenses relative

to total earnings including interest on corporate cash). Stress factors included the following: MGS

yields; the OPR; banks’ deposit rates; and,

nonperforming loans (NPLs).

2. Methodology. Each of the factors above is

assumed to affect banks’ capital through its impact on

earnings and asset quality. Banks’ earnings are largely

driven by spread between lending rates and banks’ cost

of funds (net interest margin) and also include

contribution from fee-based income, which is estimated

at one-third of total earnings for the overall system. In

simplified form, banks’ starting level of capital plus

retained earnings is used as an estimate of capital at the

beginning of the next period. Retained earnings are

defined as gross earnings minus operational expenses,

which are assumed to include loan losses, additional

provisions, and taxes. Shocks to three of the stress

factors: MGS yields, deposit rates and NPLs are applied

independently; however, an increase in OPR is also

assumed to raise deposit rates.

3. Banks. Assets are comprised of loans

(58 percent), interbank exposure (18 percent),

government securities (5 percent), other securities, fixed

and other assets (figure). Other than earnings, the

impact of each factor was primarily tested on banks’

loan portfolios, which are comprised of exposure to

households and corporate, making up 47 percent and

43 percent of the total respectively; while the remainder

is assumed to be lending to government-related entities

at federal, state or local levels. In addition to loan assets,

banks have securities exposure, which includes holdings of government as well as private debt

securities. Although some of these securities would face a mark-to-market loss in case of higher

MGS yields, the bulk are assumed to be held to maturity. Interbank exposure is assumed to net out

for the overall system. Baseline system-wide interest rates on various types of loans, including

mortgage, auto, personal and corporate loans, were estimated based on information available from

websites of the four largest banks in the financial system.

4. Transmission mechanism. An increase in OPR is assumed to raise deposit rates by the same

magnitude. For example, 100 bps increase in OPR is assumed to lead to 100 bps increase in deposit

rates. Both factors are assumed to raise banks’ funding costs independently. An increase in MGS

yields will not have this impact because MGS are assumed to be held to maturity. It is assumed that

banks will pass on any increase in funding costs to customers on existing variable-rate loans if the

reference index allows; as well as on new loans. Both household and corporate borrowers will be

affected. Based on data from individual banks, nearly 70 percent of banks’ loans are variable-rate in

nature; while the remaining 30 percent are fixed-term loans. The bulk of variable-rate loans are

ultimately linked to OPR and will be subject to changes in that variable but will remain unaffected by

changes in MGS yields.

Malaysia Banking System Analysis

2013 Q3

(RM millions)

Capital

Tier 1 capital 165,329.67

Assets 2,059,702.06

Risk weighted assets 1,190,652.29

Tier 1 ratio 0.14

Earnings

Earnings before expenses,

taxes, dividends 29,000.96

Imputed Return on Assets (ROA) 0.01

Estimated expenses

(before provisions and recovery) 14,507.34

Losses

NPL ratio 0.02

Gross loans 1,204,478.76

Gross NPLs 23,861.11

Provisions 23,164.08

Estimated portfolio

duration (yrs) 5.00

Estimated expenses

(after provisions and recovery) 17,590.48

Retained earnings

Corporate tax rate 0.25

Estimated earnings

After taxes before dividends 8,557.86

Estimated dividend payout ratio 0.40

Retained earnings 5,134.72

Source: IMF Staff Estimates (November 2013)

MALAYSIA

68 INTERNATIONAL MONETARY FUND

5. Households. The impact of each factor was tested on the ratio of debt liabilities to wages

plus income from assets or debt servicing ratio (DSR). Wages were assumed to remain unchanged.

Making up aggregate liabilities of 83 percent of GDP, households carry exposure to mortgage,

personal and auto loans, revolving credit, and margin loans for securities. Banks are assumed to pass

on higher funding costs due to an increase in OPR to variable-rate loans in each category allowing

them to maintain typical margins on such lending. On the asset side, financial assets of households,

including cash, pensions savings, and stock and bond investments are 189 percent of GDP (based on

BNM data), while physical assets, comprising mainly houses and autos, are estimated to make up

nearly 67 percent of GDP (based on average LTV). Along with savings income, households benefit

from additional interest income from cash holdings, which are more than one-quarter of financial

assets. An increase in MGS yields has negligible impact on banks’ cost of funds and correspondingly

does not affect household debt servicing costs or income from cash deposits or savings instruments.

It is assumed that households do not have access to EPF savings income for the purpose of debt

servicing.

Household Balance Sheets (Q3:2013)

6. Corporates. The impact of each stress factor

was tested on the ratio of interest expense to

earnings, as a measure of the ability of corporate to

honor interest obligations. The aggregate corporate

balance sheet for Malaysia is inferred from various

ratios reported by the BNM, including leverage, the

interest coverage ratio, and the size of corporate

debt liabilities; it also uses data on the average level

of cash held by corporates for a large sample of over

750 nonfinancial Malaysian corporates covered by

Bloomberg. Corporate debt coming due in a given

period is assumed to rollover completely. As for the

household sector, an increase in OPR is assumed to

raise rates on variable-rate loans to corporates as

well as deposit rates by the same magnitude.

Domestic and external corporate debt spreads to

MGS and U.S. treasury securities respectively are

assumed to be unaffected purely by an increase in

OPR.

Annual Annual

Estimated Estimated

Annual Interest Principal

Amounts annual rate

annual yield Amounts Interest Rate Payment Payment

Assets (RM billions) return (RM billions) Liabilities (RM billions) (Percent) (RM billions) (RM billions)

Physical 670.7 Mortgage loan 385.0 4.8% 18.3 12.8

House 526.3 Auto loan 144.4 5.3% 7.6 28.9

Auto 144.4 Credit cards 87.2 15.3% 13.3 87.2

Financial 1,874.9 Personal loans 146.4 7.8% 11.4 29.3

Margin-financed Loans for securities 47.4 3.1% 1.4 47.4

equities and bonds 94.9 2.0% 1.9 Other 13.1 3.1% 0.4 13.1

EPF savings 525.0 0.0% … Total (liabilities) 823.4

Other savings 756.0 1.0% 7.6

Cash (deposits) 499.1 1.0% 5.1 Debt service amounts 52.4 218.7

Total (Assets) 2,545.6 (RM billions)

Savings income 14.5 Debt service 271.1

Annual wages 591.8 Wage income only 591.8

Total annual income 620.9 Result--HH DSR 45.8%

(RM billions)

Debt service 271.1

Total income 620.9

Result--HH DSR 43.7%

Source: Bank Negara Malaysia, IMF Staff Estimates (November 2013).

Corporate Balance Sheets

Baseline

(RM billions) Rates

Assets 4,113.7

Cash 613.6 3.2%

Liabilities 2,050.4

Debt liabilities 928.5

External debt 135.6 5.6%

Domestic debt securities 273.9 4.6%

Domestic bank loans 519.0 3.1%

Equity 2,063.4

D/E 45%

Interest expense 36.1

Earnings 144.2

Result--corporate ISR 25.0%

Source: Bank Negara Malaysia, Bloomberg,

IMF Staff Estimates (November 2013)

MALAYSIA

INTERNATIONAL MONETARY FUND 69

7. Results. Banks’ capital remained well above the minimum regulatory capital requirement

even with large shocks to stress factors. It is worth noting the following:

 Higher MGS yields raise corporate ISR but

have no explicit impact on household DSR

or bank capital. An increase in bank capital

from 13. 9 percent to 14.3 percent is only

because of retained earnings over the

course of a year. Household DSR is

unaffected because rates on liabilities do

not adjust with MGS yields, and savings

have a relatively small proportion of debt

securities holdings. Bank capital is

unaffected due to our modeling

assumption, in which NPLs and debt

servicing ability of households and

corporates are considered separately.

 Higher policy rates have a significant

impact on household and corporate DSRs

as well as on bank capital. A scenario with a

plausible increase in the OPR of 50 bps over

the course of one year has virtually no

impact on bank capital as earnings are

expected to be strong enough to cushion

such an increase, even though there would

be some compression of net interest

margins in such a situation. Also, corporate ISR rises by 130 bps while the household DSR rises

only slightly by 11 bps. If savings income is excluded for households, the DSR rises by 50 bps.

 Higher deposit rates lower household DSR while raising the corporate ISR. The assumption is

that higher funding costs for banks are passed on to both household and corporate lending

wherever possible; however households benefit from a higher proportion of cash deposits in

assets, 20 percent versus 15 percent for corporates; and also, the marginal benefit from an

increase in deposit rates is much greater for households that typically carry deposits at much

lower interest-rates compared with corporates.

 Finally, an increase of 200 bps in NPLs to 4 percent reduces bank capital significantly by 118 bps

even though banks’ net interest margins are unaffected by this stress factor. A gradual increase

in NPLs has less impact on bank capital than a sudden shock as it allows banks to build buffers

through additional earnings.

Results of Stress Tests

Factor

Increase

(bps)

Bank T1

Capital Ratio

(bps) HH DSR (bps)

Corp ISR

(bps)

MGS yields 50 64.1

100 128.2

200 256.4

50 10.6 132.2

100 -7.4 20.9 259.0

200

-110.6

41.2 497.7

50 -36.3 36.3

100 9.3 -71.6 71.1

200 -54.3 -138.8 136.6

NPLs Over 1 year

100 -9.1

200 -117.8

NPLs Over 2 years

50 118.9

100 92.3

200 38.9

Source: IMF staff estimates (November 2013)

OPR

Deposit rates

MALAYSIA

70 INTERNATIONAL MONETARY FUND

Appendix 8. What Explains Malaysia’s Resilience to Capital Outflows?

1. Background. Recent IMF research (World Economic Outlook, October 2013, Chapter 4) on

the resilience of emerging market economies (EMEs) to capital flow volatility emphasizes the

distinction between real and financial adjustment to capital outflows.

The starting point is the

familiar balance of payments identity that, as a consequence of double entry accounting, the sum of

the current account balance, net capital inflows, and changes in official international reserves must

be zero. Countries experiencing outflows of foreign capital may respond through a combination of

financial and real adjustment. Financial adjustment involves either a drawdown of official reserves or

offsetting inflows by residents of non-reserve assets. Real adjustment involves changes in domestic

absorption (the sum of private and government consumption and investment) which improve the

current account through a combination of real exchange rate depreciation, and fiscal and monetary

tightening. Real adjustment is usually more painful than financial adjustment, since it comes

following a boom in inflows which has resulted in higher domestic spending and a widening of the

current account deficit, which must now be reversed. Countries that can rely on financial adjustment

in response to capital outflows are therefore bound to be more resilient.

2. The role of gross flows. The WEO examines the quantitative role of gross flows in financial

adjustment, differentiating between capital movements initiated by foreigners from those initiated

by domestic investors.

A regression of gross inflows on the current account deficit is used to assess

whether countries adjust through real or financial adjustment in a sample of 38 EMEs

during 2000−12. These EMEs are ranked according to the estimated regression coefficients, and the

sample is split at the median. The group with larger positive coefficients, for which changes in gross

inflows are associated with large changes in the current account deficit, is referred as the less

resilient group, and those with a lower or negative coefficient, as the more resilient group. The

economic, political and institutional characteristics of the more resilient EMEs are then compared

with those of the less resilient ones and with those of a group of six resilient advanced economies.

3. Resilient EMEs. The resilient group of EMEs, Chile, the Czech Republic and Malaysia among

them, managed to buffer inflows of foreign capital with resident outflows in the 2000s, thus

achieving more stable current accounts , avoiding excessive real adjustment and insuring themselves

more effectively to capital flow volatility. The repatriation of domestic financial resources when

foreign investors flee helps to offset gross outflows and stabilizes net flows, thus enabling resilient

countries to avoid sharp exchange rate depreciation and overshooting and painful current account

Prepared by Jaime Guajardo (APD).

Simon, Benes, Guajardo and Sandri, “The Yin and Yang of capital flow management: balancing capital inflows with

capital outflows.”http://www.imf.org/external/pubs/ft/weo/2013/02/pdf//4sum.pdf

The analysis is in the tradition of recent literature that has honed in the role of gross inflows for insights into the

nature (and classification) of external vulnerabilities, including sudden stops and domestic capital flight. See, for

example, Forbes and Warnock, 2011, “Capital Flow Waves: Surges, Stops, Flight and Retrenchment,” NBER working

paper 17351 (September). These authors find, inter alia, that indicators of global risk are significantly related to

surges or stops when measured based on gross capital flows, but not when episodes are measured based on net

flows. This is because actions by foreign and domestic investors can counteract each other: lower global risk is

actually associated with an increase in both capital inflows from foreigners and capital outflows by domestic

residents. These large shifts in both types of flows may counteract each other so that changes in the aggregated net

capital flows are small.

MALAYSIA

INTERNATIONAL MONETARY FUND 71

reversals. This mechanism helped resilient countries experience smaller fluctuations in current

accounts, lowered the impact of outflows on GDP and consumption growth, and contained

unemployment increases.

4. Sources of resilience. The regression analysis demonstrates that EMEs that have

demonstrated resilience to the vagaries of international capital flows tend to share some common

characteristics, including

 Better indicators of macroeconomic management, such as lower inflation, more fiscal buffers,

and room to engage in countercyclical macroeconomic policies.

 Strong central banks, more flexible exchange rate regimes, higher net international investment

positions, more stable current accounts (net capital flows); and fewer restrictions on capital

flows, so that local residents can efficiently move capital across borders and have the

appropriate incentives to do so.

 Better institutions of economic management, including financial regulation and supervision that

prevent financial intermediaries from taking undue risks during periods of strong capital inflows.

In addition to the regression analysis, the WEO study examines the experience of case studies from

EMEs, including Chile, the Czech Republic, and Malaysia, for clues as to the identity of the players

that facilitated financial adjustment by repatriating their external financial assets to offset outflows

by foreigners. The nature of these domestic international investors varies by country. In Chile, the

pension fund and the country’s sovereign wealth fund were important. In Malaysia, the country’s

banks have played a big role.

5. Motives behind resilience. The emphasis on gross flows also allows a better understanding

of why domestic investors may be repatriating assets at a time when foreign investors flee. One is

consumption and investment smoothing by domestic agents in the face of temporary external

shocks, as suggested by intertemporal models of the current account. Home bias of domestic

investors in the face of a global shock like the one that hit EMEs this spring-summer recent would

also lead domestic investors to repatriate assets. Information asymmetries may also lead to buying

of domestic assets by investors with superior information. In sum, the stabilizing role of reserves,

coupled with the greater flexibility of the exchange rate and strength of domestic financial

institutions, which offset gross outflows, allowed Malaysia to weather this episode well, much as it

had during the global financial crisis.

6. Malaysia’s experience. Following the Asian financial crisis, Malaysia accumulated

substantial foreign assets, and these played an important role in 2008−09 and more recent episodes,

including in the spring-summer of 2013. Large domestic institutional investors have been investing

abroad during periods of capital inflows. When foreign investors started selling Malaysian

government securities and other domestic assets, these deep-pocketed domestic investors stepped

in to offset sales by foreigners, thus helping to reduce the impact of the outflows on yields. This

reality is reflected in the WEO analysis, where Malaysia belongs solidly to the group of resilient EMEs

(its estimated regression coefficient is close to zero; Figure 7.1, panel 1). Malaysia scores high in

most of these characteristics, even among the more resilient EMEs. It has a relatively flexible

exchange rate regime (Figure 7.1, panel 2), low inflation (Figure 7.1, panel 3), countercyclical fiscal

policy (Figure 7.1, panel 4), good institutions (Figure 7.1, panel 5), high net international investment

MALAYSIA

72 INTERNATIONAL MONETARY FUND

position (Figure 7.1, panel 6) and a high and stable current account balance (Figure 7.1, panels 7

and 8). Additional evidence comes from the latest outflow episode, in spring-summer 2013. As

described in the main text, outflows by foreign residents did affect interest rates on Malaysian

government securities, the exchange rate depreciated, and BNM intervened in foreign exchange

markets, but the effects of outflows on Malaysia’s real economy were muted compared with the

experience of other, less resilient EMEs.

7. Malaysia’s financial system. Malaysia’s efforts to improve its financial system and make it

more resilient following the Asian Financial Crisis have paid dividends. As explained in

Malaysia’s 2012 IMF-World Bank Financial Sector Stability Assessment, following the Asian Financial

Crisis (AFC), the Malaysian authorities embarked on a decade-long program of financial sector

reforms. Existing banks were strengthened, deregulation, liberalization and entry of new players all

promoted competition in banking. Outside of banking, domestic equity and bond markets were

nurtured, and financial regulation and supervision was strengthened. Malaysia’s financial system has

substantial strengths. Reforms in Malaysia’s financial sector following the AFC were accompanied by

a gradual easing of restrictions on capital flows. Initially, outflows were dominated by official

reserves being accumulated under the fixed exchange rate regime. When Malaysia moved to a

managed float in 2005, it also liberalized restrictions on international transactions. Accumulation of

foreign assets by private entities rose dramatically during 2005−09 as nonfinancial and financial

entities sought opportunities abroad and expanded foreign direct investment. The increase in gross

private outflows contributed to a considerable improvement in Malaysia’s net foreign asset position.

8. Growing resilience. The accumulation of foreign assets has played an important role in

reducing the volatility of net flows. During the global financial crisis, the reduction in capital inflows

was largely offset by sales of foreign reserves and the repatriation of domestic capital invested

abroad. Large sales of domestic bonds by foreign investors were absorbed with minimal impacts on

domestic yields. The stabilizing role of reserves and private outflows, coupled with the greater

flexibility of the exchange rate and strength of domestic financial institutions, allowed Malaysia to

weather the global financial crisis much better than during the crisis of the late 1990s, despite the

larger reduction in gross capital inflows. Malaysia’s resilience to swings in capital flows has also been

facilitated by fiscal policy, which has become much more countercyclical during the 2000s, especially

by providing fiscal stimulus during downturns.

9. Strengthening resilience further. Comparisons with other EMEs and AEs that exhibit

substantial resilience to capital flow volatility, including Chile, Australia and New Zealand, contain

lessons for ways in which Malaysia can further increase the extent of its resilience to volatile capital

flows. In these AEs, for example, foreign exchange intervention is rare, which discourages one-way

bets on the exchange rate and helps improve the buffering behavior of private domestic resident

capital outflows; and, as discussed in the main text, Malaysia can do more to increase the size of its

fiscal buffers, which have diminished following its effective countercyclical responses during the

global financial crisis. In addition, Malaysia’s institutional characteristics are still well below the levels

in advanced economies. Improving in all these areas would greatly contribute to further enhance

Malaysia’s already considerable resilience to international capital flow volatility.

MALAYSIA

INTERNATIONAL MONETARY FUND 73

Figure 7.1. The Yin and Yang of Capital Flow Management: Balancing Capital Inflows

with Capital Outflows—The Case of Malaysia

1/ Regression coefficient of the currect account as percent of GDP on gross capital inflows as percent of GDP.

2/ IMF AREAER exchange rate regime index, where 1 is the hardest peg and 8 is free floating.

3/ Bound between -1 and 1.

4/ ICRG Institutional quality indez, bound between 0 and 1.75.

Source: World Economic Outlook, Chapter 4, October 2013.

Less Resilient EMEs More Resilient EMEs Selected Advanced

Economies

2. De Jure Exchange Rate Regime (index) 2/

Malaysia

-4

-2

Less Resilient EMEs More Resilient EMEs Selected Advanced

Economies

3. Inflation (percent)

Malaysia

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Less Resilient EMEs More Resilient EMEs Selected Advanced

Economies

4. Correlation between cyclical deviations in Government

Spending and GDP (index) 3/

Malaysia

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Less Resilient EMEs More Resilient EMEs Selected Advanced

Economies

5. ICRG Institutional Quality (index) 4/

Malaysia

-120

-80

-40

120

Less Resilient EMEs More Resilient EMEs Selected Advanced

Economies

6. Net International Investment Position

(percent of GDP)

Malaysia

-15

-10

-5

Less Resilient EMEs More Resilient EMEs Selected Advanced

Economies

7. Current Account Balance (percent of GDP)

Malaysia

-1.5

-1.0

-0.5

0.0

0.5

1.0

Less Resilient EMEs More Resilient EMEs Selected Advanced

Economies

1. Impact of Gross Inflows on the Current Account

(elasticity) 1/

Malaysia

Less Resilient EMEs More Resilient EMEs Selected Advanced

Economies

8. Standard Deviation of Current Account Balance

(percent of GDP)

Malaysia

MALAYSIA

74 INTERNATIONAL MONETARY FUND

Appendix 9. Malaysia—Transformation Plans to Boost Growth and Inclusion

1. Malaysia has made substantial progress to strengthen the quality of economic growth and

inclusiveness. Starting in 1969, the New Economic Policy (NEP) pursued growth, the creation of

employment opportunities and income redistribution. More recently, these objectives have been

further elaborated in a series of multiyear transformation programs.

 The Government Transformation Program (GTP), launched in late 2009, aims to improve

public service delivery, raise transparency and enhance collaboration among public entities.

The GTP has achieved some good results, seen in new assistance reaching more than a quarter

of the hardcore poor, declining crime indices, online publication of government contracts, and

enhancements being put in place for preschool and primary education. Malaysia has become a

much more attractive country to do business.

 The New Economic Model (NEM) was unveiled in March 2010. It aims to transform Malaysia

into an innovative, knowledge intensive, and high˗income economy by 2020. The NEM identifies

strategic reform areas that include enhancing private sector participation in the economy,

improving workforce skills, supporting innovation, developing new sources of growth, and

strengthening public sector management.

 The Tenth Malaysia Plan (10MP), released in June 2010, provides the policy framework for

implementing the NEM’s strategic suggestions in 2011−2015. It aims to sustain annual GDP

growth at 6 percent and to bring gradually down the budget deficit to 3 percent of GDP

by 2015. Microeconomic objectives include a competition law, further liberalization of services,

divestment of public enterprises, market prices for subsidized commodities, an innovation

friendly environment, and reduced dependence on foreign labor.

 The Economic Transformation Program (ETP), launched in October 2010, builds on the NEM

and is part of a wider development agenda for Malaysia to become a high-income economy

that is both inclusive and sustainable by 2020. The ETP builds on the strategy outlined in 10MP

and specifies more concrete policy actions. In particular, the ETP: (1) focuses on the 12 key

growth engines, (2) encourages private sector investment, and (3) introduces 131 entry point

projects (EPPs) to jump start the program. In the 2011 Article IV consultation, the staff found

that out of 131 EPPs, 113 projects with a total value of RM 177 billion had been announced,

concentrated mainly in infrastructure, commodity related investments and construction.

 Malaysia Financial Sector Blueprint 2011−2020 was introduced by BNM. It lays out the vision

to develop the financial sector that keeps pace with Malaysia’s transition to the high-income

status, as well as the growing financial needs of emerging Asia. It aims to: promote effective

financial intermediation for a high-income country; develop deep and dynamic financial markets;

enhance financial inclusion; strengthen regional and international financial integration; further

strengthen regulatory and supervisory regimes; and raise risk management standards, and

internationalize Islamic finance; promote electronic payments for greater economic efficiency;

and empower consumers and develop talent to support a more dynamic financial sector.

MALAYSIA

INTERNATIONAL MONETARY FUND 75

2. Boosting growth. A key objective of these transformation programs and policies is to help

Malaysia avoid a middle income trap, by fostering technological readiness (including better access

to broadband internet) and injecting greater competition in product markets. Large-scale projects

under the ETP are boosting Malaysia’s infrastructure and helping to expand and rejuvenate strategic

sectors (such as oil and gas). Recently, these efforts have helped catalyze private investment, which

had declined significantly following the Asian financial crisis. Significant progress has been made in

improving the business climate: Malaysia’s ranking in the World Bank’s 2013 Doing Business survey

has improved to 12th, from 14th in 2012. Malaysia is on its way to becoming a high-income country

by 2020.

3. Strengthening Labor Policies and Institutions in the face of heightened international

demand (and competition) for talent and dramatic demographic change in the coming decades is

another key objective of Malaysia’s transformation programs and policies:

4. Education. Wages and living standards are closely related to the length and quality of

schooling. Malaysia has made important progress in raising school enrollment: secondary net

enrollment has risen sharply to 68 percent in 2009 (up from 32.7 percent in 1970). Enrollment in

tertiary education, which enjoyed a 10-fold increase since 1980, leads to a large wage premium of

more than 50 percent. Despite these gains, Malaysia needs to do more: enrollment ratios must be

further raised in order to increase the supply of skilled labor, meet the requirements of an

innovation-led economy, and close the gap with OECD levels. Among the priorities are to expand

access to tertiary education and availability of financing among under-served groups. Quality

control in private universities and retaining Malaysian-grown talent in the domestic economy are

also important. (World Bank, 2012). More work is also needed to improve educational attainment

(what students actually know), at the basic and secondary level. Here the approach taken (see

Malaysian Education Blueprint 2013−25) aims to put Malaysian students at the top third of

international assessments and to transform the Ministry of Education. The key in this area, as in all

others, will be sustained implementation.

5. Pensions. Malaysia’s population of

29 million (mid-2012 estimate) has been

growing at about 1.9 percent a year in

the 2000s, compared to 2.7 percent in the 1990s.

Fertility has been falling and the share of

working age population (15−64) has been

increasing, but the old age dependency ratio will

start rising after 2020, which could pose

economic and fiscal challenges. Malaysia

recently introduced a Private Retirement Scheme

(PRS), which helps supplement the government-

mandated Employees Provident Fund (EPF).

Consideration could be given to increasing the risk sharing characteristics of Malaysia’s existing

pension system by: (I) introducing a publicly funded, pillarone pension scheme for low or

noncontributors; and (ii) providing an option for workers to receive their pensions in the form of

1970 1980 1990 2000 2010 2020 2030 2040

Percent

Percent of population

Working age population (in percent of total population)

Old age dependency ratio (right scale)

Source: United Nations.

Malaysia: Working Age Population and Old Age Dependency

Ratio 1970−2040

MALAYSIA

76 INTERNATIONAL MONETARY FUND

annuities, to help reduce longevity risk. The minimum age for pension withdrawals for existing EPF

contributors should be gradually raised from 55 to 60 to match the increase in the retirement age in

the private sector.

6. Minimum wage. A minimum wage was introduced on January 2013, aimed at boosting

wages of low-skilled workers and enhancing productivity. Initial indications are that the minimum

wage will have a limited impact on inflation and unemployment, and should therefore help improve

the incomes of the poor. The minimum wage should provide incentives for affected firms to shift to

more capital-intensive production technologies and gradually raise their capital-labor ratios.

Together with complementary reforms to improve the business climate, it could lead to higher

productivity. The minimum wage is set at a relatively high level (50 percent of the mean wage in

Peninsular Malaysia), but flexibility in its implementation and the low share of labor costs in Malaysia

could offset its impact on employment. Firms were given (limited) time to adjust: micro and small

and medium-sized firms were given six months, while migrant workers were exempted for a year.

Consideration could have been given to granting more regional dispersion.

7. Female labor force participation. At 49.5 percent, the participation of women in the labor

force is low by regional standards. Raising it is both quantitatively important from a growth

accounting perspective and also helps promote gender equity and intra-family income distribution.

The World Bank estimates that raising Malaysia’s female labor participation by 11 percentage points

to 57 percent during 2000−2010 would have boosted growth by around 0.4 percentage points per

year (Malaysia Economic Monitor, October 2012.) Malaysia plans to boost this rate to 55 percent

by 2015. Legal reforms and incentives are in train to establish childcare facilities, employ and train

women after career breaks, and promote flexible work arrangements.

8. Strengthening social protection. Other dimensions of social protection need to be further

developed. Labor redundancy costs are high (Malaysia is ranked 108

out of 144 countries in this

area in the World Economic Forum’s Global Competitiveness Report). Additional measures needed,

such as introducing an unemployment insurance scheme funded by employers and employees;

improving the targeting of cash transfer programs; and making them conditional on access to

education and health care. Such conditional cash transfer schemes have proven effective in a

number of countries. Stronger social safety nets should also help reduce precautionary savings and

narrow the current account.

9. Outward orientation. Policy choices in Malaysia are made following extensive debate and

consultation internally and also after considerable input with international advisors and consultants.

IMF, World Bank, the Asian Development Bank, the International Labor Office and other

international organizations regularly provide technical input to the government in their fields of

expertise. The recently completed Financial Sector Assistance Program (FSAP), jointly conducted with

the IMF and the World Bank, provides a timely example. The FSAP confirmed the strong financial

position of Malaysian financial institutions and its sound supervisory and regulatory frameworks,

following extensive reform and consolidation in the period after 1997−98. In the public finances,

areas of interest over the years include tax and expenditure reforms. Malaysia is a provider of

technical services of its own, contributing to international development efforts of other countries.

MALAYSIA

INTERNATIONAL MONETARY FUND 77

The South-East Asia Center for Economic Research and Training (SEACEN), based in Kuala Lumpur,

has been providing training services to officials of over 80 countries since the early 1980s.

10. The future. Malaysia has set itself the goal of becoming, by 2020, a high-income nation, one

in which prosperity is broadly shared. This will require continuous transformation in Malaysia’s

economy and government. It is useful to ask what separates Malaysia from advanced countries like

Korea. Using the growth accounting approach, Gylfason and Hochreiter (2008) provided a simple

decomposition of differences in per capita income. Output per worker depends on endowments of

human and physical capital and endowments of infrastructure and institutions. Compare, for

instance, Malaysia with Korea. Roughly speaking, output per capita in Korea is 2.6 times that of

Malaysia. Korea’s capital-output ratio is 20 percent greater than Malaysia’s, while Korea’s human

capital (as measured by average school years per worker) is 13.95 for Korea and 11.42 for Malaysia.

Differences in institutions explain about half of the gap in output per worker in Korea and Malaysia;

differences in education (human capital) explain about 30 percent, and differences in capital per

worker explain the remaining 20 percent.

11. Conclusion. The comparison between Korea and Malaysia highlights several priorities for

Malaysia. One is the need for Malaysia to push through with the transformation of its education

system to ensure that graduates have the upgraded skills needed in an innovation-based economy.

Reforming the education system to raise attainment level closer to international standards

constitutes very good benchmarking. Second, Malaysia needs to modernize and upgrade

infrastructure systems and networks and further simplify regulatory regimes to spur innovation and

reward investment in skills. The Malaysian authorities are on the right track here—they have

identified a wide range of structural reforms to boost investment, raise productivity, improve the

effectiveness of education and enhance social insurance and protection. The minimum wage policy

and the other reforms being debated, including unemployment insurance, should go a long way to

insure workers from risk. Malaysia will also need to reform public spending to make it more

equitable. Better targeting of public expenditure in the context of a tighter fiscal envelope in the

coming years will be a priority, including the reform of costly fuel subsidies and the introduction of

conditional cash transfers.

MALAYSIA

STAFF REPORT FOR THE 2013 ARTICLE IV

CONSULTATION—INFORMATIONAL ANNEX

Prepared By

Asia and Pacific Department

FUND RELATIONS ________________________________________________________________________ 2

STATISTICAL ISSUES ______________________________________________________________________ 5

CONTENTS

February 14, 2014

MALAYSIA

2 INTERNATIONAL MONETARY FUND

FUND RELATIONS

(As of January 31, 2014)

Membership Status: Joined March 7, 1958; Article VIII

General Resources Account

SDR Millions Percent of Quota

Quota 1,773.90 100.00

Fund holdings of currency (exchange rate) 1,186.97 66.91

Reserve tranche position 586.93 33.09

Lending to the Fund

New Arrangement to Borrow

42.52

SDR Department

SDR Millions Percent of Allocation

Net cumulative allocation 1,346.14 100.00

Holdings 1,286.16 95.54

Outstanding Purchases and Loans: None

Latest Financial Arrangements: None

Projected Payments to the Fund: None.

Exchange Arrangement:

On July 21, 2005, Bank Negara Malaysia announced the adoption of a managed float with the

exchange rate of the ringgit to be monitored against an undisclosed trade˗weighted basket of

currencies. Based on information on the exchange rate behavior, the de facto exchange rate regime

is classified as “other managed.”

Malaysia maintains bilateral payments arrangements with 23 countries. The authorities have

indicated that these arrangements do not have restrictive features.

Capital control measures imposed in early 1994 and in 1998 in the wake of the Asian crisis have

mostly been lifted, except for the internationalization of the ringgit. In particular, since May 2001,

nonresident portfolio investors are freely allowed to repatriate their principal sums and profits out of

the country at any time. Malaysia further liberalized exchange control regulations during 2002−10.

The main measures were a relaxation of regulations on investment abroad by domestic institutions,

an easing of regulations on domestic credit facilities extended to nonresidents, abolition of

overnight limits on all foreign currency accounts maintained by residents and of the net open

MALAYSIA

INTERNATIONAL MONETARY FUND 3

position limit imposed on licensed onshore banks, allowing residents to open and maintain foreign

currency accounts for any purpose, easing requirements on foreign currency and ringgit credit

facilities from nonresidents, relaxation of rules on the provision of financial guarantees, abolition of

several reporting requirements, and a relaxation of the conditions on residents and nonresidents to

enter into foreign exchange forward contracts to hedge capital account transactions with licensed

onshore banks. Further measures were also taken to ease rules on residents’ borrowing in foreign

currency, and borrowing in ringgit by residents from nonresidents as well as lending in ringgit by

residents to nonresidents for use in Malaysia.

The Malaysian authorities view remaining exchange control regulations as prudential in nature and

necessary to ensure the availability of adequate information on the settlement of payments and

receipts as part of the monitoring mechanism on capital flows. These controls do not contravene

Malaysia’s obligations under Article VIII.

Malaysia, in accordance with the UN Security Council resolutions, maintains restrictions on payments

and transfers for current international transactions with respect to some designated individuals and

entities. These measures are maintained for the reasons of national and international security and

have been notified to the Fund pursuant to the IMF Executive Board Decision No. 144 (52/51).

Malaysia also restricts current international transactions between Malaysian residents and Israeli

companies and individuals; however, since these restrictions affect the underlying transactions

themselves, they are not subject to Fund jurisdiction under Article VIII, Section 2(b).

Article IV Consultation:

Malaysia is on the standard 12˗month consultation cycle. Discussions for the 2012 Article IV

consultation took place during November 29-December 12, 2012 (IMF Country Report No. 13/51).

Staff discussions for the 2013 Article IV consultation were conducted on a mission to Kuala Lumpur

during December 5–16, 2013. In addition, a staff visit took place during July 9−12, 2013.

FSAP Participation:

Malaysia conducted its first FSAP in 2012 (IMF Country Report Nos. 13/52, 13/53, and 13/56−13/60).

Technical Assistance:

FAD: Mission in October 2008 to analyze the distributional impact of social safety net programs. A

fiscal ROSC mission was fielded in May˗June 2011. A mission on debt management was fielded in

June 2012 to look at the institutional, legal, organizational and operational aspects of debt

management, monitoring of fiscal risks, and reporting of debt operations. A mission on fiscal risks

took place in January 2013.

LEG: Missions were fielded in May and September 2011 to help draft a Centralized Asset

Management Corporations Bill, in the context of a three-year project to assist Malaysia in

implementing an asset forfeiture regime.

MALAYSIA

4 INTERNATIONAL MONETARY FUND

MCM: Workshop in November 2008 on stress testing. Workshop in October 2009 on assessing the

systemic implications of financial linkages and developing early warning indicators for the insurance

and corporate sectors at BNM. Mission in October 2009 on macrofinancial risk analysis and

vulnerability analysis for corporate and financial institutions. Workshop in May 2010 on monitoring

financial risks. A technical assistance mission on stress testing is scheduled for April 2013.

STA: A mission to assist with the migration to the Government Finance Statistics Manual

(GFSM) 2001 was conducted during October-November 2012.

AML/CFT:

Malaysia (including the Labuan International Offshore Financial Center) underwent its second

Mutual Evaluation in February 2007 that was conducted by the Asia/Pacific Group on Money

Laundering (APG). The full report was adopted by APG members in July 2007

(http://www.apgml.org/documents/docs/17/Malaysian%20MER%20

%20FINAL%20August%202007.pdf).

Resident Representative/Advisor: None.

MALAYSIA

INTERNATIONAL MONETARY FUND 5

STATISTICAL ISSUES

(As of January 10, 2014)

I. Assessment of Data Adequacy for Surveillance

General: Data provision is broadly adequate for surveillance. However, further efforts to improve statistics

for the consolidated general government and public sector are necessary.

National accounts: Currently, the Department of Statistics Malaysia (DOSM) compiles and publishes

annual and quarterly estimates of GDP by activity and by expenditure at current and constant prices, and

annual estimates for gross disposable income, saving, and net lending for the economy based on

the 1993 SNA. The quarterly data are released about two months after the reference quarter.

Price statistics: The CPI and the PPI are available on a timely and comprehensive basis. A revised CPI was

introduced in January 2011; it covers all 14 states and features a more disaggregated measure of the

consumption basket and updated expenditure weights based on a 2009/10 comprehensive household

income and expenditure survey.

Government finance statistics: There is a need to improve the timeliness, detail, and availability of data

on NFPEs and the state and local governments. Dissemination of more detailed data on nonlisted NFPEs’

assets and liabilities and domestic and foreign financing by type of debt instrument and holder would be

desirable; efforts in this direction will require continued close collaboration among the Economic Planning

Unit (EPU), the Treasury, and Bank Negara Malaysia (BNM). There is also a need to disseminate more

information on public private partnerships.

Monetary statistics: The monetary and financial statistics (MFS) are reported on a timely and regular basis

and are broadly in conformity with the Fund’s data needs. There is a need to improve the institutional

coverage of the financial corporations, sectorization of the domestic economy, and classification and

valuation of financial instruments to ensure full adherence to the IMF’s Monetary and Financial Statistics

Manual. In addition, due to the growing importance of insurance corporations, pension funds, and other

financial intermediaries in Malaysia, coverage of MFS should be expanded to include these institutions. The

MFS missions of January 2004 and 2005 developed an integrated monetary database to be used for

publication and operational needs of the BNM, STA, and APD. The Bank Negara Malaysia reports data in

STA’s standardized report forms (SRFs) which provide more detailed classification of certain items, fuller

sectoral and instrument breakdown, and currency aggregation. MFS based on the SRFs are published in

the quarterly IFS Supplement on Monetary and Financial Statistics.

Balance of payments: Department of Statistics Malaysia compiles and publishes quarterly balance of

payments estimates in accordance with the fifth edition of the Balance of Payments Manual and the SDDS.

The quarterly data are released three months after the reference quarter. No data are shown for the capital

transfers or acquisition/sale of nonproduced nonfinancial assets, and transactions in reserve assets are

computed as differences in amounts outstanding and thus include valuation changes. The international

investment position data on other investment—assets and liabilities—are reported only in an aggregate

form.

II. Data Standards and Quality

Malaysia subscribes to the Special Data Dissemination Standard (SDDS). It is using a timeliness flexibility

option for general government operations (within six quarter lags after the end of reference year).

MALAYSIA

6 INTERNATIONAL MONETARY FUND

Malaysia: Table of Common Indicators Required for Surveillance

(As of January 3, 2014)

Date of

Latest

Observation

Date

Received

Frequency

Data

Frequency

Reporting

Frequency of

Publication

Exchange rates 1/3/2014 1/3/2014 D D D

International reserve assets and reserve liabilities

of the monetary authorities

12/13/2013 12/20/2013 Bi W Bi W Bi W

Reserve/base money 12/13/2013 12/20/2013 Bi W Bi W Bi W

Broad money 11/13 12/31/2013 M M M

Central bank balance sheet 12/13/2013 12/20/2013 Bi W Bi W Bi W

Consolidated balance sheet of the banking

system

11/13 12/31/2013 M M M

Interest rates

1/3/2014 1/3/2014 D D D

Consumer price index 11/13 12/13 M M M

Revenue, expenditure, balance and composition

of financing

—general government

2012 2013 A A A

Revenue, expenditure, balance and composition

of financing

—federal government

2013:Q3 12/13 Q Q Q

Stocks of central government and central

government guaranteed debt

2013:Q3 12/13 Q Q Q

External current account balance 2013:Q3 12/13 Q Q Q

Exports and imports of goods and services 10/13 01/14 M M M

GDP/GNP 2013:Q3 12/13 Q Q Q

Gross external debt

2013:Q3 12/13 Q Q Q

International Investment Position 2012 01/14 A A A

Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.

Both market based and officially determined, including discount rates, money market rates, rates on treasury bills, notes, and

bonds.

Foreign, domestic bank, and domestic nonbank financing is only available on an annual basis.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds)

state and local governments.

Including currency and maturity composition.

Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A).

Press Release No. 14/104

FOR IMMEDIATE RELEASE

March 14, 2014

IMF Executive Board Concludes 2013 Article IV Consultation with Malaysia

On March 7, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the

Article IV consultation

with Malaysia.

Malaysia’s growth moderated but registered a healthy 4.7 percent in 2013, and inflation

remained low. Activity was supported by strong investment, still-vigorous consumption and, in

the face of much needed fiscal tightening in the second half of the year, by improved foreign

demand. The momentum should continue in 2014, supported by a long pipeline of multiyear

investment projects, consumption underpinned by strong labor markets and supportive, albeit

gradually tightening, domestic financial conditions. Together with an improved external

environment, these trends should offset mild headwinds from fiscal consolidation.

Amidst capital outflows from emerging market economies and concerns about Malaysia’s

relatively high federal debt, the authorities undertook a timely, decisive yet gradual recalibration

of their fiscal policies in 2013. In addition to strengthening the sustainability of Malaysia’s

public finances, the authorities aim to promote efficiency, equity and growth in their revenue and

expenditure systems and are taking steps to minimize the drag to the economy from fiscal

consolidation. Their plans to rationalize fuel subsidies are appropriately measured, they have

allowed sufficient preparation time for the introduction of the GST, and are strengthening their

social safety nets. Last, but not least, the management of fiscal policy has been reinforced by the

Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually

every year. A staff team visits the country, collects economic and financial information, and discusses with officials

the country's economic developments and policies. On return to headquarters, the staff prepares a report, which

forms the basis for discussion by the Executive Board.

International Monetary Fund

700 19

Street, NW

Washington, D. C. 20431 USA

creation of a high level Fiscal Policy Committee—a powerful new player in Malaysia’s fiscal

process.

Bank Negara Malaysia (BNM) has been focused on its growth objective in recent years,

maintaining an accommodative monetary stance that is consistent with its dual mandate and

appropriate in view of substantial downside risks to growth and subdued inflation, at 2.1 percent

in 2013. Going forward, monetary policy makers must contend with somewhat higher headline

inflation in 2014−15 as fuel, electricity and other administered prices gradually rise and the GST

is implemented. BNM is well positioned to prevent second round effects from higher costs to

prices from becoming embedded in the wage-price structure. Timely detection and decisive

preemption, through gradual, well communicated, and credible interest rate action, will be

needed.

Malaysia’s financial system is sound, backed by a strong regulatory and supervisory framework,

and well-placed to withstand stresses, including from a potentially bumpy exit from UMPs—as

demonstrated most recently during the capital outflow episode of last spring-summer.

Nevertheless, the potential for risk on-risk off cycles together with high household debt and

rising house prices all warrant continued vigilance. Recent steps to strengthen financial

supervision, including the Financial Services Act and the Islamic Financial Services Acts, and

the targeted and phased approach to macroprudential policy, are welcome. The authorities are

monitoring property prices and credit growth closely and stand ready to act with additional

macroprudential measures as needed.

The authorities are implementing a wide range of multiyear transformation programs and

blueprints to strengthen growth and make it more inclusive, and Malaysia has made important

progress in human capital accumulation. The authorities are intent on reforming Malaysia’s

educational system, reduce shortages of high-skill workers, and alleviate skill mismatches, which

are important in raising potential growth and promoting equity within and across generations.

Executive Board Assessment

Executive Directors noted that near term growth prospects for the Malaysian economy are

favorable but exposed to risks from tighter global financial conditions and slower growth in

major trading partners. Directors agreed that Malaysia is well positioned to cope with the

uncertain external environment, noting the authorities’ skillful management during past periods

of market turbulence, healthy reserves, the flexible exchange rate regime, and deep capital

markets.

Directors supported the authorities’ recalibration of fiscal policy aimed at reducing federal debt

and rebuilding buffers. They welcomed the creation of the high level Fiscal Policy Committee

and the plan to reduce subsidies gradually. Directors underscored the importance of

improvements in targeting social transfers, restraining wage growth, and broadening the tax base,

including through the planned introduction of the Goods and Services Tax (GST) and greater

reliance on property taxes. These reforms should help secure the sustainability of Malaysia’s

public finances while promoting efficiency, equity, and growth objectives. Directors

recommended formulating a credible concrete plan, underpinned by a debt target for 2020, to

anchor consolidation efforts and reduce dependence on oil revenues in the face of rising age

related spending. Fiscal risks from contingent liabilities also warrant close attention.

Directors agreed that the monetary policy stance is appropriately accommodative, and that the

central bank’s credibility should help maintain price stability. They encouraged the authorities to

remain vigilant to inflationary pressures and stand ready to adjust their policy rates if subsidy

rationalization and the introduction of GST lead to higher sustained headline inflation.

Directors noted that Malaysia’s financial system remains sound, well capitalized, and resilient,

thanks to a strengthened regulatory and supervisory framework. They also acknowledged the

significant progress made in implementing the recommendations of the Financial Sector

Assessment Program. Directors highlighted nevertheless that ongoing global volatility, high

household debt, and banks’ exposure to real estate warrant continued vigilance, and may require

additional macroprudential measures.

At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of

Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers

used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

Directors welcomed the substantial narrowing of Malaysia’s current account surplus in recent

years and the attendant shift of the sources of growth toward domestic demand. They agreed that

increased social spending related to population aging, and structural reforms to strengthen social

safety nets and boost investment, combined with continued exchange rate flexibility, should help

facilitate further external rebalancing. Directors took note of the staff’s assessment that the

external position appears to be moderately stronger than the level implied by medium term

fundamentals but stressed the uncertainty surrounding such assessment.

Directors commended the authorities for their ambitious reform agenda, which aims to transform

Malaysia into a high income economy. They supported initiatives to upgrade human capital and

promote inclusiveness, stressing in this regard that priority should remain on improving

education and labor skills.

Malaysia: Selected Economic and Financial Indicators, 2009–14

Est.

Proj.

2009

2010

2011

2012

2013

2014

Real GDP (percent change)

-1.5

7.4

5.1

5.6

4.7

5.0

Total domestic demand

-1.6

11.1

6.8

11.3

7.3

3.8

Saving and investment (in percent of GDP)

Gross domestic investment

17.8

23.3

25.8

26.3

27.1

Gross national saving

33.4

34.2

34.9

31.9

30.1

31.4

Fiscal sector (in percent of GDP)

Federal government overall balance 1/

-6.7

-5.3

-4.8

-5.2

-4.3

-3.3

Revenue

21.7

19.9

21.0

21.3

21.8

21.1

Expenditure and net lending

28.4

25.2

25.7

26.6

26.1

24.4

Federal government non-oil primary balance

-13.7

-10.4

-10.3

-10.6

-8.9

-7.5

Consolidated public sector overall balance 2/

-7.2

-2.6

-3.4

-5.2

-6.8

-6.5

General government debt

52.8

53.5

54.3

54.6

56.8

55.2

Inflation and unemployment (period average, in percent)

CPI inflation (period average)

0.6

1.7

3.2

1.7

2.1

3.3

Unemployment rate

3.7

3.3

3.1

3.0

3.1

3.0

Money and credit (end of period, percentage change)

Total liquidity (M3)

9.2

6.8

14.3

9.0

6.7

…

Credit to private sector

6.2

9.7

12.1

11.9

9.1

…

Three-month interbank rate (in percent)

2.2

3.0

3.2

…

Balance of payments (in billions of U.S. dollars)

Current account balance

31.4

27.1

33.5

18.6

11.8

14.5

(In percent of GDP)

15.5

10.9

11.6

6.1

3.8

4.2

Capital and financial account balance

-22.8

-6.2

7.6

-7.4

-4.8

-7.5

Errors and omissions

-4.7

-21.7

-10.1

-9.9

-2.4

0.0

Overall balance

3.9

-0.8

30.9

1.3

4.6

7.0

Gross official reserves (US$ billions)

96.7

106.5

133.6

139.7

134.9

141.9

(In months of following year's imports)

6.1

5.9

7.0

7.2

6.9

7.2

(In percent of short-term debt) 3/

250.4

207.3

230.3

259.5

239.2

240.9

Total external debt (US$ billions)

68.0

74.1

81.1

82.7

89.2

96.2

(In percent of GDP)

33.6

29.9

28.1

27.1

28.6

28.1

Of which: short-term (in percent of total) 3/

56.8

69.3

71.5

65.2

63.2

61.3

Debt service ratio

(In percent of exports of goods and services)

6.6

7.8

10.2

10.1

9.7

9.4

(In percent of exports of goods and nonfactor services)

7.0

8.2

10.8

10.7

10.2

10.0

Memorandum items:

Nominal GDP (in billions of US$)

202

248

289

305

312

342

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

1/ Based on staff's estimate of the federal government fiscal balance using GFSM 2001, which differs from the authorities' cash-

based measure of the fiscal deficit.

2/ Capital expenditure in the budget includes foreign fixed assets and other items, such as purchase of shares and land, which

are excluded from public investment in the national accounts.

3/ By remaining maturity.

Statement by Abdul Ghaffour, Alternate Executive Director for Malaysia

and Mohd Ripin, Advisor to Executive Director

March 7, 2014

1. On behalf of the Malaysian authorities, we would like to thank the IMF team for the

focused and constructive discussions on macroeconomic developments and policy issues in

Malaysia. For the most part, there is broad agreement on almost all of the major policy thrusts.

We are further encouraged by the assessment that the current policy stance is appropriately

calibrated to reflect the outlook and risks facing the economy and the financial system. This

statement will provide an update on the latest developments in Malaysia and elaborate on

selected policy issues mainly for emphasis and clarification.

Economic Outlook for 2014

2. In September 2013, the authorities projected the Malaysian economy to expand between

5% and 5.5% in 2014, underpinned by resilient private domestic demand. Staff estimates are in

line with this assessment. Of significance, private investment is expected to remain robust,

supported by capital spending in the manufacturing and services sectors as well as on-going

implementation of multi-year projects, including infrastructure-related projects. Private

consumption will continue to be supported by sustained growth in income and favourable

employment conditions. Reflecting the on-going public sector consolidation, the public sector

growth is anticipated to moderate slightly but will remain supportive of growth. The gradual

improvement in the external sector will provide additional impetus to the economy.

Monetary Policy

3. The current monetary policy stance is appropriate and consistent with the current

assessment of the economic growth and inflation prospects. The authorities remain vigilant in

monitoring risks to inflation including those arising from the subsidy rationalisation.

Nevertheless, the risk of more pervasive and persistent inflation at this point is assessed to be not

very significant. Going forward, in addition to domestic conditions, BNM will continue to

carefully evaluate the global economic and financial developments and their implications on the

overall outlook for inflation and growth of the Malaysian economy. The Malaysian authorities

remain focused on ensuring medium-term price stability and ensuring a sustainable and balanced

growth of the economy.

Fiscal Policy

4. The conduct of fiscal policy in 2014 continues to be centered on ensuring sound public

finances while remaining supportive of policies for a sustainable and balanced economic growth.

Supported by a resilient expansion in domestic demand, improving external sector as well as

better expenditure and revenue management, the fiscal deficit is expected to further decline from

3.9% in 2013 to 3.5% of GDP in 2014. The Federal Government debt-to-GDP ratio will be

contained within 55% of GDP.

5. The Malaysian authorities are committed to strengthening public finances. The

establishment of the high-level Fiscal Policy Committee (FPC) in June 2013 is a testament to

political commitment at the highest level. The FPC, chaired by the Prime Minister, will oversee

the fiscal management of the nation. Its mandate includes charting policies and strategies to

ensure healthy public finances over the longer term in line with the country’s economic

aspirations. The FPC has since met several times to consider various policy proposals. Fiscal

reforms and a more strategic management of resources will be judiciously pursued on several

fronts without undermining economic growth and the wellbeing of the population, in particular,

the low-income and vulnerable groups. Subsidy rationalisation for fuel, sugar and electricity

tariff has been implemented as part of a phased approach to improve resource allocation,

minimise market distortions and reduce the fiscal burden of the Government. GST is on target to

be introduced in April, 2015. The move is expected to streamline the present tax structure to

make it more efficient, transparent and business friendly. Work is also underway to implement a

comprehensive social safety net and develop an integrated database of all aid recipients to ensure

targeted assistance across the public sector. Other initiatives to enhance fiscal sustainability

include a review of fiscal incentives to industry, implementation of accrual accounting at the

Federal level (2015) and the adoption of outcome based budgeting (2015). Apart from embracing

fiscal reforms to fortify the Government’s financial position, fiscal resources will be geared

towards reinvigorating high value-added investments, intensifying development of human capital

and enhancing public sector delivery.

Financial Sector

6. Financial stability continued to be preserved in 2013 supported by financial strength and

capital buffers both at the system and institutional levels. Internal and IMF stress tests have

demonstrated that the banking system is resilient to major economic and market shocks. Risk to

domestic financial stability arising from household indebtedness in Malaysia remains

manageable, supported by strong household fundamentals and financial capacity. Continued

supervisory vigilance over risk management and underwriting practices of financial institutions

and intensified financial education initiatives will further contain potential risks from household

indebtedness.

7. The Central Bank has also undertaken additional macroprudential measures in 2013 to

reinforce responsible lending practices by key credit providers. Among others, these include:

– Limiting the maximum tenure for personal financing to 10 years and loans for purchase

of residential and non-residential properties to 35 years, applicable to both banks and

non-bank financial institutions.

– Prohibiting the offering of pre-approved personal financing products.

– Requiring credit providers to observe a prudent debt service ratio in their credit

assessment to ensure that there are sufficient financial buffers to protect households

against rising costs and unexpected adverse events.

8. These measures have begun to show positive results, as evidenced by the substantial

decline in the growth of personal financing extended by non-bank financial institutions. These

initiatives were also complemented by additional measures announced in the 2014 Budget to

curb speculative property purchases which contribute to rising property prices and higher

household debt burdens. These measures include further increases in the property gains tax,

prohibition on the development and financing (both bridging and end-financing) of property

projects with elements of interest capitalization schemes (including Developer Interest Bearing

Scheme (DIBS)), requirement on greater transparency in property prices by developers and

raising the threshold of property purchases by non-residents. Moving forward, BNM is taking

steps to capture more granular data on households in collaboration with several Government

agencies. The newly established National Housing Council by the Government is an important

platform that will ensure a more holistic and coordinated approach in efforts to address structural

issues confronting the residential property market. Corporate sector leverage remained well-

contained despite a gradual increase in the overall debt level of businesses in recent years in

tandem with economic expansion. The higher leverage is supported by sustained financial

strength and debt servicing capacity of businesses that will continue to provide support against

potential challenges in the operating environment. Given these developments, BNM will

continue to focus its surveillance and supervisory vigilance over developments taking place in

the household, business and property sectors, and stands ready to introduce additional measures

to prevent the buildup of excesses in these sectors.

9. The regulatory and supervisory framework for the financial sector was further

strengthened with the coming into force of the Financial Services Act 2013 (FSA) and Islamic

Financial Services Act 2013 (IFSA) on 30 June 2013. This ensures that laws governing the

conduct and supervision of financial institutions in Malaysia continue to be relevant and

effective in maintaining financial stability, supporting a sustainable, balanced and inclusive

growth of the economy, as well as providing adequate protection for consumers. The laws further

strengthen BNM’s supervisory and regulatory powers, including comprehensive powers to carry

out consolidated supervision of financial groups and to extend the regulatory perimeter to

systemically important non-bank entities that undertake financial intermediation activities.

Reforms to Enhance Growth Potential

10. Reform initiatives to accelerate Malaysia’s transformation into a high-income economy

by 2020 have also made further progress. Under the Economic Transformation Programme, total

announced investments have amounted to USD66.8 billion (RM219.3 billion). These

investments will increase Malaysia’s productive capacity and competiveness over the medium

term. Various workplace transformation initiatives have also been undertaken by the

Government, focused on modernizing labour laws in line with the needs of a high-income

economy. This includes raising the private sector minimum retirement age from 55 to 60 years to

retain experienced and knowledge workers, and pave the way for higher productivity. In

addition, the minimum wage policy was implemented in 2013 to improve worker’s welfare and

incentivize firms to move up the value chain. In the long run, the minimum wage is expected to

contribute positively to productivity, mainly through higher automation and training. The

education system has also been enhanced through the introduction of the National Education

Blueprint 2013-2015. Improvements in the access, quality, equity, unity and efficiency of the

education will help facilitate human capital accumulation that is in line with the transition of the

economy toward higher value-added activities.

External Sector Assessment

11. In our authorities’ assessment, the external sector development in Malaysia reflects the

changing global environment and on-going structural transformation of the domestic economy.

The current account has narrowed in recent years as the robust import growth continued to

outpace exports. Exports remained modest following the gradual recovery in the global economy

and lower commodity prices. At the same time, import growth was driven by strong domestic

demand, particularly the expansion of investment activity. Malaysia has also experienced greater

two-way capital flows in view of its increasing integration with the global economy and financial

markets. Importantly, these flows have been effectively intermediated by the financial system,

supported by a well-developed capital market and the presence of a large domestic institutional

investor base. Greater exchange rate flexibility and the availability of a wide range of monetary

instruments also accorded authorities the policy flexibility to absorb external shocks. This is

further reinforced by Malaysia’s healthy level of international reserve, a prudent external debt

position and a stronger financial system. As such, the resilience of Malaysia’s external position

remains intact despite heightened uncertainty in the global economic environment.

Consequently, despite a sharp reversal of inflows from the region, including Malaysia, in the

recent period, orderly market conditions prevailed and the impact on the domestic economy was

rather muted.

Final Remarks

12. As Malaysia continues to embark on growth-enhancing reforms, the authorities remain

vigilant of the downside risks posed by the challenging external environment. As a highly open

economy, Malaysia is not insulated from the risks emanating from the uncertain global economic

landscape. Nevertheless, the country’s underlying fundamentals remain robust, creating

resilience against potential vulnerabilities. The strong external position accords policy flexibility

to absorb external shocks. Greater regional cooperation and policy coordination through

collaborative surveillance efforts, bilateral swap agreements between regional central banks, and

the Chiang Mai Initiative Multilateralisation liquidity support arrangement also provides

Malaysia with buffers against potential shocks. The authorities will monitor closely

developments in the external environment and will respond appropriately.

13. Finally, the authorities are pleased to inform the Executive Board that they agree to the

publication of the full suite of reports associated with the 2013 Article IV consultation.