IMF Executive Board Concludes 2006 Article IV Consultation with MalaysiaPublic Information Notice (PIN) No. 07/34
March 16, 2007
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 February 26, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Malaysia.1
Since the launch of Vision 2020 in 1991, Malaysia has made significant progress toward achieving advanced country status, underpinned by strong export-led growth, low inflation and the deepening of its financial markets. In 2006, economic developments were also generally favorable. Real GDP grew by an estimated 6 percent driven by buoyant private consumption and a continued recovery of private investment. Headline inflation has declined since a spike induced by fuel price adjustments earlier in 2006 and various measures of core inflation have remained low.
Malaysia's external position has remained strong. The current account surplus remains at above 15 percent of GDP while official reserves are at comfortable levels. The exchange rate has become more flexible, strengthening against the U.S. dollar by 7 percent in 2006. In real effective terms the ringgit appreciated by about 3 percent.
While the federal government deficit was in line with the 2006 budget target, the non-oil primary deficit increased to an estimated 9 percent of GDP in 2006 from 7¼ percent in 2005, reflecting the growing reliance on oil and gas revenue. At the same time, the consolidated public sector surplus fell to an estimated ½ percent of GDP, reflecting lower operating surpluses of major non financial public enterprises (NFPEs), including PETRONAS. Public sector gross debt is estimated to have declined below 60 percent of GDP.
The banking system is sound. Banks are generally well capitalized and highly liquid, and their asset quality is improving and profitability satisfactory. The rising exposure to the household sector is banks' main vulnerability as household indebtedness is high relative to other countries and disposable income, but appears manageable at present. Measures have been taken to further upgrade the supervisory and regulatory framework in line with ongoing financial sector liberalization and initiatives to promote greater international financial integration.
The Government-Linked Companies (GLC) transformation program has started bearing fruit while the Ninth Malaysia Plan adopted in 2006 emphasizes upgrading Malaysia's human capital base, promoting growth in high-value added sectors, and strengthening public institutions and service delivery.
Executive Board Assessment
Executive Directors welcomed the continued robust performance of the Malaysian economy with vigorous growth, low inflation, and a strong external position. Malaysia has progressed significantly towards reaching advanced country status and now benefits from deep financial markets and a low poverty rate.
Directors concurred with the Ninth Malaysia Plan's medium-term objectives, while noting the continuing challenges. Although near-term prospects are favorable, competition from low-cost regional economies is rising, highlighting the need for Malaysia to move up the value-added chain and to broaden the sources of growth in order to increase its resilience to external shocks. Enhancing long-term fiscal sustainability should also be steadfastly pursued, especially in view of the federal government budget's increasing reliance on oil and gas revenue, and the rise in the non-oil primary deficit.
Directors considered that a gradual reduction in the federal government non-oil primary deficit would ensure an equitable distribution of oil and gas wealth across generations. They encouraged the authorities to consider a fiscal adjustment over the medium term beyond that envisaged in the Ninth Plan, and welcomed their intention to revisit the fiscal path earlier and more frequently than currently planned to allow a timely adjustment to changing economic conditions. Efficiency-enhancing revenue and expenditure measures are needed to bolster non-resource revenue and improve expenditure quality, respectively. Directors noted, in particular, the desirability of introducing a value-added tax, streamlining tax incentives, and phasing out fuel subsidies while expanding social safety nets. While welcoming the recent progress, Directors called for continued efforts to improve consolidated public sector statistics.
Directors highlighted some key policies that would boost broader-based private sector growth: especially maintaining financial sector stability and increasing its global and regional integration, and the reform of Government-Linked Companies (GLCs). Also, Directors saw the private sector as the engine of growth, and suggested a lesser role for the government.
Directors noted that the Malaysian banking system is sound. Looking ahead, maintaining financial sector stability, together with further financial liberalization and international integration accompanied by appropriate risk management, would contribute to growth. The authorities' enhanced surveillance of the banking system's exposure to households is well-placed, but more systematic disaggregated studies of households' financial situation are needed. Directors welcomed the authorities' efforts to strengthen the legal framework for consolidated supervision, and the ongoing improvements of financial institutions' risk management practices to help manage the risks resulting from greater competition and international integration.
Directors were encouraged by the progress achieved in GLC reform, and stressed the importance of further efforts in this area. The GLCs' transformation program is a critical component of reducing the role of government in decision making, and expanding direct investments by government investment holdings needed to be carefully assessed. To further transparency, the main government investment house, Khazanah, should publish its audited accounts. Directors also supported the authorities' focus on upgrading human capital to promote higher value-added industries and on reducing red tape to improve the business environment.
Directors welcomed the greater exchange rate flexibility observed since early 2006, which they generally saw as an important step to support broader-based growth. Several Directors were of the view that the ringgit remains undervalued from a long-term perspective. Directors, however, recognized that the extent of the misalignment cannot be gauged with precision, underscoring the methodological weaknesses in assessing the equilibrium level of the exchange rate. A number of other Directors viewed that the currency reflected market fundamentals and had served the economy well. More generally, Directors agreed with the authorities' commitment to limit intervention for smoothing excess volatility.
Directors commended the Bank Negara Malaysia for its skillful monetary management, with inflation kept in check despite significant increases in administered fuel prices. They encouraged the authorities to continue to improve monetary policy communications, including by publishing measures of core inflation, to better anchor inflation expectations.