Public Information Notice: IMF Concludes Article IV Consultation with Malaysia

August 10, 2000

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On July 25, 2000, the Executive Board concluded the Article IV consultation with Malaysia.1


The Malaysian economy has recovered from the sharp output decline experienced in 1998. Real GDP growth, led by exports, recorded 5½ percent in 1999 and has maintained its momentum so far this year. The manufacturing sector expanded by over 13 percent in 1999, as the production of electronics was boosted by buoyant exports. There are indications that output expansion is becoming more broad-based, including in the services sector. However, private investment remains subdued, and consumption has only recently shown signs of recovery. There are no apparent wage pressures reflecting the overall excess capacity, notwithstanding the fact that capacity utilization in several industries has risen to near pre-crisis levels, and inflation remains below 2 percent (year-on-year).

The recovery has been supported by a fiscal stimulus and accommodative monetary policy. The federal government deficit of 4 percent of GDP in 1999 provided a fiscal impulse estimated at nearly 4 percent of GDP and helped offset the decline in private demand. On the monetary side, the 3-month interbank market rate (Klibor) declined from 9 percent in 1998 to 4 percent in 1999 (year average). However, the transmission of lower interbank rates to bank lending rates has been slow. Net credit growth (adjusted for nonperforming loans (NPLs) sold to Danaharta, the asset management agency) was weak, although it did not appear to have constrained the recovery, in light of the still low demand for large-scale investments and retained earnings, which benefited from high export receipts.

Market confidence is cautiously growing in response to the recovery and gradual easing of capital controls. Although the commercial banks and the private sector reduced their foreign liabilities in response to the relatively low domestic interest rates in 1999, thereby weakening the capital account, portfolio inflows have resumed since early 2000, aided by the upgrading of Malaysia's ratings and the reinclusion of Malaysia in the Morgan Stanley Capital Index at end-May. Partly aided by these developments but also on account of domestic retail investors, the Kuala Lumpur Stock Composite Index recovered by 39 percent during 1999, and rose further by 10 percent by end-May this year while most neighboring countries' indices fell.

Performance of the banking and corporate sectors has improved as evidenced by indicators such as the banking system's level of NPLs, risk-weighted capital ratio, and banking and corporate profits. Consequently, Danamodal (the bank capitalization agency) required considerably less funding than originally envisaged, and Danaharta has ceased purchasing assets and is now focusing on the workout phase of managing the acquired assets. Restructuring of the nonbank sector has proceeded including in the context of debt restructuring under the Corporate Debt Restructuring Committee.

Executive Board Assessment

Executive Directors commended the authorities for the implementation of policies that have placed the economy on a path of recovery. They noted that improved economic performance has boosted confidence and helped improve banking and corporate balance sheets. A key challenge facing the authorities is to strengthen the recovery and achieve high and sustainable economic growth, while keeping inflation under control.

Against this background, Directors considered that the authorities' accommodative fiscal and monetary stance was appropriate, although it should be closely monitored so that the stimulus could be withdrawn as needed.

Directors commended the Malaysian authorities for their fiscal prudence, but noted that greater flexibility in the budgetary process could promote a more effective use of fiscal policy. In this connection, they welcomed the change in the income tax assessment year and the rationalization of the tax structure contained in this year's budget. Several Directors suggested that the horizon for budget formulation might be extended to cover the course of the business cycle.

Directors welcomed the plan to identify potential liabilities of the public sector more comprehensively and in a transparent manner. Explicit recognition of the role of privatized infrastructure projects and other off-budget activities in providing fiscal stimulus would further improve the effectiveness of demand management, and the identification of potential claims on the government arising from these operations. Directors urged, however, that government support be extended to privatized infrastructure projects only if there are clear social benefits, and that the cost of this support be reflected in the budget in a fully transparent manner. Directors encouraged the authorities to explore options for improving social safety nets.

Directors noted that the authorities' monetary policy stance was appropriate. They called for greater flexibility in the interest rate structure, which would sharpen the efficacy of monetary policy. In this regard, they supported the authorities' intention to remove the ceiling on lending rates, in the longer term, in conjunction with the development of risk-based supervision. In the interim, Directors recommended that the ceiling on lending rates be raised to allow better pricing of risks, that Bank Negara Malaysia's intervention rate be reflective of market-determined interbank rates, and that deposit rates reflect freely market conditions.

On the exchange rate, Directors considered that Malaysia's strong external position provided the authorities with the opportunity to consider greater flexibility in the management of the exchange regime. The ringgit appeared to be somewhat undervalued relative to economic fundamentals. If the undervaluation were to persist over an extended period, it could be incompatible with maintaining low inflation, lead to inefficient resource allocation, and attract speculative capital inflows. Several Directors observed that a move towards a more flexible exchange rate should be timed to coincide with the lifting of the remaining capital controls, and the authorities should consider taking advantage of the current favorable conditions to act soon on both fronts. Other Directors cautioned against a premature move towards exchange rate flexibility, given the continuing volatility in regional and global foreign exchange markets.

Directors considered Malaysia's external vulnerability to be manageable-with official reserves more than adequate to cover Malaysia's modest short-term debt-and their management to be fully in line with international best practices. The strengthened prudential framework, once in place, was expected to help Malaysia to better manage risks and to cope with adverse effects of market volatility. Adequate regulation and surveillance should further facilitate liberalization of the few remaining capital controls.

On structural reforms, Directors noted improvements in the financial performance of the banking and the corporate sectors. They supported the planned early exits of Danamodal and the Corporate Debt Restructuring Committee, as well as the shift of Danaharta's focus from nonperforming loan purchases to management of acquired assets. Directors urged the authorities to maintain the momentum in the operational restructuring of corporations.

Directors welcomed the authorities' goal to achieve a strong and resilient banking system. They advised Bank Negara Malaysia to assure the completion of the bank merger process in a transparent and market-based manner, and to monitor closely the performance of each bank's management team, so that any identified weaknesses could be addressed in a timely manner. Directors endorsed the emphasis placed on strengthening the prudential regulation and surveillance framework, and noted rapid progress in this area. Consolidated supervision, risk-based supervision, and enhanced supervision of offshore banks would be important tools to reinforce management of risks, including those from cross-border transactions.

Directors supported efforts to raise standards of corporate governance and disclosure requirements consistent with international best practices. They also welcomed progress in developing the domestic bond market, which would contribute to a more diversified corporate financing structure. The strategy toward a self-regulating market would also be appropriate in the framework of full disclosure and integrated supervision.

Directors commended the authorities for the steady progress made in trade liberalization, including in the context of Malaysia's commitments under the WTO and the ASEAN Free Trade Agreement.

Directors considered the overall quality of Malaysia's economic statistics good and recognized improvements made in recent years. They welcomed the recent publication under the Special Data Dissemination Standard (SDDS) of data on international reserves and foreign currency liquidity. Directors encouraged Malaysia to enhance further the quality of the national income accounts and price statistics and to compile and publish information on government off-budget activities and contingent liabilities.

Malaysia: Selected Economic and Financial Indicators

  1995 1996 1997 1998 1999

Real sector (percent change)          
Real GDP growth 9.8 10.0 7.3 -7.4 5.6
Real domestic demand 14.6 5.7 7.7 -25.2 1.9
CPI inflation (period average) 3.4 3.5 2.7 5.3 2.8
Saving and investment (in percent of GDP)          
Gross domestic investment 43.6 41.5 42.9 26.7 22.4
Gross national saving 33.9 37.1 37.3 39.6 38.2
Fiscal sector (in percent of GDP)          
Federal government overall balance 1.3 1.1 2.5 -1.5 -4.1
Revenue 23.0 23.3 23.5 20.0 19.8
Expenditure and net lending 21.7 22.3 20.9 21.5 23.9
Overall public sector balance 3.7 5.1 5.1 -0.1 -0.6
Monetary sector (annual percent change)          
M3 growth 1/ 12.6 19.7 19.5 1.4 7.1
Net domestic assets 1/ 26.4 19.3 29.6 -12.7 -0.3
Three-month interbank rate (period average; in percent) 6.1 7.2 7.8 9.4 4.2
Balance of payments (in US$ billion)          
Trade balance 0.0 4.0 3.7 17.6 22.0
Exports, f.o.b. 71.6 76.9 77.4 71.9 83.1
Imports, f.o.b. 71.5 72.9 73.7 54.3 61.1
Services account balance -7.7 -7.3 -8.1 -5.7 -7.6
Current account balance -8.6 -4.5 -5.6 9.4 12.5
(In percent of GDP) -9.7 -4.4 -5.6 12.9 15.8
Capital account balance 7.6 9.5 2.2 -2.6 -6.4
Medium- and long-term 6.6 5.4 6.8 2.7 3.1
O f which: Net foreign direct investment 3.3 3.5 3.9 1.9 1.9
Short-term 1.0 4.1 -4.6 -5.3 -9.5
Errors and omissions -0.6 -2.4 -2.6 -2.4 -1.4
Overall balance -1.6 2.6 -6.0 4.5 4.7
International trade (annual percent change)          
Export value 26.5 7.4 0.7 -7.1 15.6
Import value 30.3 1.9 1.2 -26.4 12.5
Gross official reserves (in US$ billion) 25.1 27.7 21.7 26.2 30.9
(In months of following year's imports of goods and services) 3.1 3.3 3.6 3.8 3.8
(In percent of short-term debt) 2/ 197.4 195.6 149.0 223.4 307.9
Total external debt (in US$ billion) 33.4 38.7 43.9 42.6 42.0
(In percent of GDP) 37.6 38.4 43.8 58.8 53.4
Short-term external debt (in percent of total) 2/ 38.0 36.6 33.2 27.5 23.8
Debt-service ratio 3/          
(In percent of exports of goods and services) 7.2 8.5 6.6 6.3 5.3
Ringgit/US$ (end of period) 2.5 2.5 3.9 3.8 3.8
NEER (1990=100; period average) 110 114 111 85 86
REER (1990=100; period average) 103 107 105 83 86

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

1/ Based on IMF monetary statistics framework. 2/ By remaining maturity. 3/ Including prepayment and refinancing.

1 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. 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. In this PIN, the main features of the Board's discussion are described.


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