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Malaysia and the IMF
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The IMF Executive Board on April 20, 1998 concluded the Article IV consultation1 with Malaysia.
Since the late 1980s, Malaysia’s economy, sustained by high levels of investment and savings, and generally strong macroeconomic fundamentals, has achieved considerable success, reflected in high growth and a very substantial reduction in poverty. However, in recent years, strong demand pressures and rapid money and credit growth led to a widening of the current account deficit and sharply buoyant asset prices. Following the float of the Thai baht in July 1997, Malaysia experienced considerable pressures in its stock and foreign exchange markets. The authorities’ initial response focused on supporting the ringgit through exchange market intervention and a sharp hike in short-term interest rates. Subsequently, the authorities quickly allowed the exchange rate to depreciate, lowered interest rates almost to pre-crisis levels, and introduced a series of measures. These measures included tightening fiscal policy and postponing major infrastructure projects; successively increasing constraints on credit growth and, more recently, raising interest rates; and a number of administrative actions.
However, financial markets remained volatile reflecting, in part, severe and prolonged contagion. From the second half of 1997, economic activity has slowed, and the capital account has recorded a large outflow of short-term capital. The favorable impact of exchange rate depreciation on exports, combined with deliberate policies to defer nonpriority projects, have brought about a progressive and significant improvement in the current account, beginning in the second half of 1997. Reflecting the tightening of policy, monetary growth—and, latterly, credit growth—have now also slowed considerably. However, CPI inflation has picked up to 5 percent in early 1998 as the depreciation of the ringgit has fed through to prices. Gross international reserves declined by US$7 billion from end-1996 to US$20½ billion as of end-April 1998, equivalent to 3½ months of imports or 140 percent of short term debt (including payments due in 1998 on medium- and long-term debt). The ringgit depreciated by 44 percent and the stock market fell by almost 50 percent between mid-1997 and January 1998; since then, the ringgit has strengthened by about 20 percent and the stock market has recovered by 9 percent.
The weakening economy, combined with the high level of corporate leverage, also resulted in increased pressure on Malaysia’s financial system, notwithstanding the generally well developed supervisory and regulatory framework. Nonperforming loans increased to 8.7 percent by February 1998, reflecting also the tightening of loan classification guidelines that took effect on January 1, 1998. In addition, in November and December 1997, there was some shift in deposits from small to large financial institutions, accompanied by segmentation in the interbank market, which required temporary liquidity injections by Bank Negara. In response, the authorities tightened provisioning and disclosure standards, accelerated mergers of finance companies, announced a deposit guarantee, and reduced the statutory reserve requirement (matched by an offsetting withdrawal of Bank Negara deposits at financial institutions) to improve liquidity flows in the interbank market; these measures also helped reverse segmentation.
In late March 1998, Deputy Prime Minister Anwar and Governor Ahmad announced a new package of measures, which builds on the earlier initiatives and is designed to broaden the overall policy response within the changed macroeconomic framework. The centerpiece is a series of preemptive actions to strengthen the financial sector and address emerging problems in financial institutions. The package also includes a rebalancing of the macroeconomic policy mix, with fiscal policy targeted at ensuring a small surplus, while increasing spending to strengthen the social safety net; a significant reduction in credit and monetary growth; and more active use of interest rates to stabilize the foreign exchange market and restrain inflation. The Deputy Prime Minister also renewed the government’s commitment to improve transparency and to the steady implementation of structural measures aimed at improving corporate governance and competition. Financial markets, which had strengthened in anticipation of the package have since moderated somewhat, owing, in part, to contagion effects from weaknesses in Japan.
Executive Board Assessment
Executive Directors noted that, after a long period of rapid growth and economic transformation, the Malaysian economy had been increasingly affected by the regional crisis in Asia over the past year. However, Malaysia’s relatively strong initial conditions had enabled it to avoid the most severe effects of the regional crisis. Thus, Malaysia’s longstanding prudent approach to external exposure, its relatively well-developed supervisory and regulatory framework for the financial system, and a strengthening of the fiscal position had helped keep domestic and external vulnerability lower than in many other countries in the region.
Nevertheless, Directors noted that Malaysia’s economy had come under considerable pressure. Growth had slowed, financial and foreign exchange markets had been volatile around a generally declining trend, capital inflows had declined, and the domestic financial system had come under stress. While contagion from the regional crisis had clearly contributed to Malaysia’s economic difficulties, Directors considered that sustained rapid money and credit growth was also a contributing factor.
Directors commended the authorities for taking a succession of important measures since the middle of 1997. In particular, Directors noted that periodic attempts had been made to slow credit growth and defer infrastructure projects, while fiscal restraint had remained a cornerstone of Malaysia’s economic policies. However, these measures had not been sufficient to restore confidence, in part because markets remained to be convinced of their comprehensive character and consistency. In particular, the periodic reliance on nonmarket strategies to counter financial pressures had weakened investor confidence, including in corporate governance.
Against this background, Directors welcomed the package of measures announced on March 24 and 25, 1998, which built upon previous initiatives and which constituted a proactive and much more comprehensive approach to the restructuring of Malaysia’s economy. If fully and consistently implemented, Directors considered that this package would provide a strong basis for Malaysia to recover from its current difficulties and to return to more rapid rates of growth over the medium term. Directors placed particular emphasis on the tightening of monetary policy, on improvements in corporate governance and fiscal transparency, and on the early implementation of commitments to deepen structural reforms.
Directors strongly endorsed the focus on financial sector reform as the centerpiece of the adjustment strategy. While the assisted merger program for finance companies involved risks, Directors noted the inclusion of a number of safeguards, and welcomed the program’s objective of consolidating the finance company sector without delay. Directors underscored the need for especially vigilant supervision of the newly created institutions, particularly with regard to their capitalization levels.
Directors endorsed the strategy to pre-emptively recapitalize the banking system, which was likely to face growing pressures over the coming year. They stressed that this should be vigorously implemented, and accompanied by the use of market-based resolution strategies,when needed, for institutions that fail to raise the necessary capital. In this context, the recent improvements in the prudential framework to achieve international best practices were welcomed. Many Directors strongly urged the early implementation of the authorities' intent to increase foreign equity investment in the financial sector, noting that it would contain the cost of recapitalizing financial institutions and help increase their competitiveness. Several Directors also encouraged the authorities to act as soon as feasible to introduce a formal deposit insurance scheme to replace the current blanket guarantee of all deposits in order to avoid a particularly strong moral hazard problem.
Directors strongly supported the authorities' proposed rebalancing of macroeconomic policies. They agreed that a reduction of the fiscal surplus, arising from the working of automatic stabilizers, was appropriate in light of the economic slowdown. The smaller budget surplus would permit additional social safety net expenditures, which Directors believed should be targeted toward those who would be most affected by the adjustment program. In this context, they urged the authorities to scale back price controls so that they would apply only to basic food products consumed by the poorest households. Directors also supported strongly the authorities' intentions to disclose transparently and regularly all quasi-fiscal liabilities of public sector institutions—noting that such transparency had also been sought by markets—and recommended that these items be brought on budget.
Directors supported the authorities’ monetary policy framework, comprising restraint over monetary growth combined with a floating exchange rate, with foreign exchange intervention limited to smoothing operations. In this context, Directors welcomed the authorities’ intention to bring credit growth down from past levels of 28–30 percent, and they encouraged them to keep it close to the bottom of the 12–15 percent range. Directors stressed that a more forceful use of interest rate policy in response to possible renewed exchange market pressures was a prerequisite for market stability and an enduring return of confidence. Such a policy would also serve to help control credit growth and contain inflationary pressures.
Directors underscored the need for special emphasis on improving corporate governance and transparency, including the avoidance of bailouts of troubled corporations, which would be crucial for sustaining the recent improvements in market sentiment. To this end, they recommended the introduction of specific safeguards, including restraints on the activities of public and quasi-public institutions, and the avoidance of government guarantees. They also emphasized the importance of liberalizing limits on foreign investment, reducing barriers to entry in key sectors of the economy, and reducing tariff and nontariff barriers, all of which would serve to strengthen market mechanisms, deepen competitive forces, and revive long-term capital inflows into Malaysia. Directors also welcomed the progress achieved in reducing income inequalities in Malaysia over a long period.
|Malaysia: Selected Economic and Financial Indicators|
|(Change in percent)|
|Real GDP growth||9.2||9.5||8.6||7.8|
|Real domestic demand||13.9||13.6||5.3||8.3|
|CPI inflation (period average)||3.7||3.4||3.5||2.7|
|Unemployment rate (percent)||2.8||2.8||2.5||2.7|
|Gross national saving (percent of GDP)||32.7||33.5||36.6||38.0|
|Gross domestic investment (percent of GDP)||40.4||43.5||41.5||42.8|
|(Percent of GDP)|
|Federal government balance||1.4||1.3||1.1||2.6|
|Expenditure and net lending||23.4||22.1||22.6||21.3|
|Overall public sector balance||0.9||3.7||4.8||3.3|
|(Change in percent)|
|Money and credit (end of period)|
|One-month interbank rate (period average, in percent)||5.0||5.9||7.2||7.9|
|Balance of payments|
|Services account balance||-6.5||-7.7||-7.7||-7.4|
|Current account balance||-5.6||-8.7||-4.9||-4.8|
|(Percent of GDP)||-7.8||-10.0||-4.9||-4.8|
|Capital account balance||2.5||7.0||7.4||-1.2|
|Medium- and long-term||4.4||6.6||5.4||6.6|
|Gross official reserves||26.6||25.1||27.7||21.7|
|(In months of imports)||5.8||4.2||4.6||3.5|
|(Change in percent)|
|Total external debt (percent of GDP)||39.5||38.3||39.4||43.6|
|Short-term external debt (percent of total)||19.4||19.1||26.0||23.9|
|Debt service ratio (percent)3||8.9||7.2||8.7||6.3|
|Nominal Effective Exchange Rate (1990=100, period average)||110.3||110.3||113.7||110.5|
|Real Effective Exchange Rate (1990=100, period average)||102.2||102.7||107.0||104.6|
Source: Information provided by the Malaysian authorities; and staff estimates.
1 Including errors and omissions.
2 Excluding lumpy imports such as aircraft, ships, etc.
3 Percent of exports of goods and services. Debt service includes prepayments and refinancing
1Under 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 directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
IMF EXTERNAL RELATIONS DEPARTMENT