## cr17101 ## Source details **Canonical URL:** [cr17101](https://www.imf.org/-/media/files/publications/cr/2017/cr17101.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17101.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17101.pdf.json) --- ### Economic performance and near-term outlook - 2016 outcomes: - Real GDP growth: 4¼ percent y/y (2015: 5.0 percent y/y); described as the slowest since the GFC in this source. - Alternative reporting: Real GDP growth: 4.2 percent in 2016 (2015: 5.0 percent) in other sections of the text. - Inflation: 2.1 percent y/y (unchanged from 2015). - Private domestic demand was the main driver of growth; net exports contributed negatively. - Credit expansion slowed, slightly narrowing the credit gap. - Capital inflows reversed in second half of 2016; the currency depreciated; interest rates on government bonds ended the year higher. - 2017 staff projections: - Real GDP growth: staff expects 4½ percent y/y in 2017. - Consumer price inflation: projected to average 2¾ percent y/y in 2017. - Current account surplus: expected to see a small decline as stronger imports and services deficits offset improved goods exports. - Authorities’ 2017 view: - Expected 2017 expansion of 4–5 percent y/y, driven by private domestic demand. - Inflation expected to remain in the 2–3 percent range in 2017. ### External position, external-sector assessment, and risks - 2016 external metrics: - CA surplus: 2 percent of GDP (2015: 3 percent of GDP). - REER: average REER depreciated by about 4¼ percent y/y in 2016; 2015 saw nearly 8 percent y/y depreciation. - Foreign reserves: US$94.6 billion (2015: US$95.3 billion). - Net IIP: about 6 percent of GDP in 2016 (in U.S. dollar terms). - Total external debt: about 68 percent of GDP in 2016. - External assessment: - 2016 cyclically-adjusted CA balance assessed to be about 1 percent of GDP higher than consistent with fundamentals and desirable policies. - Staff assessment: 2016 external position moderately stronger than warranted by fundamentals and desired policies. - EBA-adjusted 2016 CA balance: estimated at about 3¼ percent of GDP; EBA 2.0 CA norm: about ¾ percent of GDP; implying a CA gap of about 2½ percent of GDP under the EBA model. - Staff assessment (accounting for structural features): CA gap assessed at about 1½ percent of GDP, with a range of plus or minus 1 percent of GDP. - REER misalignment: - EBA regression approaches indicate undervaluation of about 28–36 percent relative to fundamentals and desired policies (index and level regressions). - Staff elasticity approach estimates 2016 REER gap at about –5¼ percent (plus or minus 3.4 percent). - Risks (Appendix IV): external risks include structurally weak growth in advanced and emerging market economies; retreat from cross-border integration; sustained low commodity prices; heightened global financial stress and capital outflows. ### Measures to develop onshore foreign exchange markets (BNM package, Dec 2, 2016) — announced measures - Key elements of the package: - Resident and nonresident institutional investors may take onshore forward positions on a portfolio basis up to 25 percent of invested foreign currency or ringgit-denominated assets respectively; one-time registration with BNM required. - Residents allowed to hedge and cancel hedging positions for US$/MYR and CNH/MYR with a licensed onshore bank without documentary evidence up to an aggregate net open position limit of RM 6 million per licensed onshore bank; one-time declaration of hedging intent required. - From December 5, 2016, resident exporters can retain up to 25 percent in foreign currency proceeds from exports of goods; converted balances could be deposited in a special facility earning 3.25 percent and available until end-2017; reconversion allowed to meet projected loans, imports, and other current account obligations for up to six months ahead. - Prudential limits on foreign currency (FC) investments by residents with domestic ringgit borrowing streamlined to include FC investments onshore and apply to all residents with ringgit borrowing; residents without domestic ringgit borrowing may continue to invest up to any amount. - Onshore banks engaging in ringgit FX transactions must obtain attestation from non-resident banks of non-participation in the NDF market (reinforced enforcement). - Note: Currently, investors can hedge up to 100 percent of their foreign exposure with underlying documentation. ### Measures — intended objectives, potential effects, and implementation considerations - Objectives: - Aid development of onshore FX markets. - Bolster resilience to external shocks. - Enhance onshore FX liquidity (via exporter retention and reconversion allowances). - Potential effects: - Conversion requirement and prudential limits limit capital outflows. - Exporter retention provisions could potentially increase transaction costs for exporters of goods. - Measures that allow more flexibility in onshore trading likely welcomed; some measures constrain capital outflows. - Implementation considerations: - BNM published Frequently Asked Questions and addressed stakeholder queries. - Market participants need time to adjust to compliance and risk management, clearing, netting and margin requirements, limited trading hours, and potentially lower onshore liquidity. - IMF staff recommendation: - Based on the Fund’s Institutional View, staff recommends reconsidering the conversion requirement and the prudential limits on FC investments, noting these measures limit capital outflows. - Macroeconomic policy adjustments should continue to play the central role in response to capital flow volatility. - Authorities’ stance: - Authorities view the IMF staff recommendation to reconsider the measures as inappropriate and premature. - Authorities describe measures as prudential, aimed at developing onshore FX markets, not limiting flows in and out of Malaysia; assert exporters may hold more than 25 percent of export proceeds if they have a business need; reconversion at the same rate with no additional cost to exporters. - Authorities report observed outcomes since introduction: daily average FX volume USD9.2 billion across all FX transactions; NDF volume reportedly declined by 75 percent; intraday movement narrowed to around 61 points from 82 points and bid-offer spread narrowed to 20 points in January; improved trade flow balance. ### Monetary policy, exchange rate, and reserves - Monetary stance: - BNM kept the overnight policy rate unchanged at 3 percent at its policy meeting on January 19, 2017. - OPR reduced by 25 basis points to 3.00 percent in July 2016 (after being maintained since July 2014). - BNM guidance: continue to carefully calibrate monetary policy to support growth while mindful of financial conditions; provide further easing if growth unexpectedly weakens; liquidity may be provided to prevent disruption in financial markets. - Exchange rate and reserves: - Foreign exchange reserves largely stabilized in 2016 and stand at about 80 percent of the IMF’s composite reserve adequacy metric (classifying Malaysia as “other managed”). - Under a “floating” classification, reserves would be about 115 percent of the metric (adequate range). - Staff judges current reserve levels to be adequate; reserves could be deployed in disorderly market conditions and accumulated in normal conditions. - Ringgit depreciation: between May 2016 – February 2017 the ringgit depreciated by 12 percent against the US dollar. ### Fiscal policy — objectives, recent developments, and medium-term scenario - Recent fiscal developments: - Oil revenue fell by 3.6 percent of GDP in 2014–17. - Several measures counteracted lost oil revenue, ensuring gradual consolidation of 0.4 percent of GDP in 2014–17. - 2016 Federal budget deficit: estimated at 3.1 percent of GDP, down by 0.1 percentage points from 2015. - 2017 deficit targeted at 3.0 percent of GDP. - Federal government debt expected to remain within self-imposed limit of 55 percent of GDP; consolidated public sector deficits fall by about 0.7 percent of GDP in 2016 and 2017, reflecting PETRONAS operations. - Medium-term anchor: - Authorities’ medium-term fiscal policy anchored on achieving a near-balanced federal budget by 2020. - Achieving near-balance will require additional measures amounting to about 1 percent of GDP. - Illustrative medium-term fiscal consolidation scenario (2017–20) — fiscal measures and impacts (percent of GDP): - Already in the baseline: 1.1 - Higher projected revenue (from higher compliance in corporate income tax): 0.1 - Expenditure growth restraint (as indicated by the authorities): 1.0 - Additional measures: 0.9 - 1.4 - Revenues: - GST: 0.6 - 0.9 - of which, removal of exemptions: 0.4 - 0.6 - of which, increase in rate: 0.2 - 0.3 (0.5 percentage point increase in the rate from 6.0 percent to 6.5 percent) - Expenditure: - Subsidy rationalization: 0.3 - 0.5 - Total balance improvement: 2.0 - 2.5 - Tax policy recommendations: - Mobilize additional revenues; improve tax collection and compliance (including via GST transaction data); upgrade GST framework by reducing exempt and zero-rated items and consider raising GST rate (currently at 6 percent). - A 0.5 percentage point increase in the GST rate (from 6.0 percent to 6.5 percent) would raise revenue by an estimated 0.25 percent of GDP; with a wider base the revenue impact would be larger. - Fiscal risks and contingent liabilities: - Loan guarantees by the government are estimated at 15 percent of GDP. - Contingent liabilities related to PTPTN (student loans) are about 3 percent of GDP. - Authorities established the Fiscal Risk and Contingent Liability Technical Committee; staff recommends publishing an annual fiscal risks statement and improving contingent liabilities monitoring. ### Public Debt Sustainability Analysis (Appendix V) — baseline projections and stress scenarios - Macro-fiscal baseline assumptions (selected): - Real GDP growth: 2016: 4.2 percent; projected recovery to 4.9 percent in 2019; converging to 4.8 percent in the medium term. - Federal government deficit: 2016: 3.1 percent of GDP; projected reduction to 1.4 percent of GDP in 2021. - Key baseline indicators — nominal gross public debt (percent of GDP): - 2014: 45.6 - 2015: 52.7 - 2016: 54.5 - 2017: 52.7 - 2018: 52.5 - 2019: 51.4 - 2020: 49.7 - 2021: 47.7 - Public gross financing needs (percent of GDP): - 2014: 9.1; 2015: 9.0; 2016: 9.4; 2017: 5.1; 2018: 7.7; 2019: 6.4; 2020: 6.6; 2021: 6.6 - Main DSA outcomes: - Baseline: debt-to-GDP ratio projected to decrease to below 46 percent by 2021. - Constant primary balance (no consolidation): debt-to-GDP ratio decreases slightly to 50 percent in the medium term. - One standard deviation shock to real GDP growth: debt-to-GDP ratio initially increases to almost 56 percent in 2018, then declines. - Combined macro-fiscal shock and contingent liabilities scenarios highlight vulnerability: contingent liabilities shock (government absorbs guaranteed loans totaling 15 percent of GDP over two years) can push debt-to-GDP ratio to almost 70 percent of GDP (characterized as low probability but illustrative). - Under all scenarios GFN remain below 10 percent of GDP except in the contingent liabilities scenario where GFN peaks at 15 percent. ### Capital flow volatility and stress testing (Appendix VII) - Historical capital flow episodes: - Cumulative inflows of 26¼ percent of GDP peaked by May 2013; major outflow episodes include the taper tantrum (May 2013), oil price fall, summer 2015, and post-U.S. presidential election volatility. - Associated dynamics: currency depreciation, increases in MGS yields, loss of reserves. - Stress scenario assumptions and calibrated shocks: - Exchange rate depreciation assumed: 25 percent. - Bond yields assumed to increase: 200 basis points. - Stock market decline assumed: 30 percent. - Specific calibrated outflow estimates (US$ billions, end-2016 values): - Foreign holdings of MGS: Value = 39.3; assumed fall by 50 percent (in ringgit) → estimated outflows = 14.7 - Short-term debt rollover: Value = 16.4; assumed rollover ratio declines to 70 percent → estimated outflows = 4.9 - Non-resident deposits: Value = 19.2; assumed fall by 30 percent → estimated outflows = 4.7 - Foreign holdings of equities: participation 22.6 percent at end-2016; assumed decline by 20 percent in ringgit terms → estimated outflows = 10.1 - Offsetting inflows: repatriation by domestic institutional investors estimated at US$8.6 billion. - Estimated net shortfall compared to baseline = US$25.9 billion (shortfall as percent of GDP = 8.6 percent). - Estimated reserves, at end 2017 = 68.7 (implied US$ billions in table). - Stress test results and mitigating factors: - Malaysia’s balance sheet strengths and exchange rate flexibility help support resilience to capital outflows. - Domestic institutional investor capacity to absorb additional government debt estimated total additional domestic capacity of 4.2 percent of GDP. - Standard DSA stress tests show external debt manageable under varied shocks; exchange rate depreciation scenario raises external debt ratio near 90 percent on impact, then to about 73 percent by 2021; permanent CA or combined shocks keep external debt closer to 65 percent over medium term. ### Financial sector, household debt, and macroprudential stance - Banking sector: - Strong capital buffers, adequate provisioning, liquidity, and stable funding conditions. - Banking system household NPLs remain low at 1.1 percent. - Household sector: - Household debt remains high and a key vulnerability; household financial assets were 183 percent of GDP at end-2015. - Distribution of household debt by monthly income: - 24%: < RM 3,000 - 21%: RM 3,000 to 5,000 - 55%: > Rm 5,000 - Household debt by financing purpose (percent): - Residential: 49% - Hire purchase: 15% - Personal financing: 15% - Non-residential: 8% - Securities: 6% - Credit card and others: 7% - Close to 30 percent of outstanding housing loans have an LTV ratio above 80 percent. - Policy position: no additional macroprudential measures recommended at this time; LTV caps on second and first mortgages could be considered if rapid house price growth resumes. - Corporate sector and vulnerabilities: - Pockets of vulnerability in construction and oil and gas sectors; non-residential property ~4.5 percent of bank loans. - Most FX corporate debt naturally or financially hedged. - Staff recommends BNM continue to increase loss absorbing capacity of banks with higher exposures to vulnerable corporates using Pillar II measures. - Regulatory and market developments: - BNM extended legal powers over finance holding companies and issued a concept paper on Credit Risk Management. - Malaysia is a world leader in Islamic finance; in April 2016 government issued fifth dollar-denominated sovereign sukuk for US$1.5 billion. ### Structural policies, productivity, and reform priorities - Medium-term growth and productivity: - Potential growth estimated below 5 percent; staff projects real GDP growth likely to stay between 4¼ percent and 5¼ percent over 2016–20, average around 4¾ percent. - Staff baseline projects average real GDP growth over 2016–20: about 4¾ percent. - Staff projects a moderate improvement in average TFP growth for 2016–20; regression-supported range between 1¾ and 2½ percent, staff considers estimates above 2 percent unlikely. - Policy priorities to achieve high-income status and productivity gains: - Labor market: further raise female labor force participation; research suggests per capita income would have been as much as 23 percent higher if gender gaps in participation and entrepreneurship were bridged. - Education: continue Education Blueprint (2013–25) implementation to boost human capital; student performance needs improvement. - Skills: address skill mismatches; a 1 percent increase in high-skilled workers could boost GDP per capita by about 0.3 percent. - Innovation and R&D: - By 2020, Malaysia aims for near doubling of R&D expenditure share in GDP from 2012/13 level. - Patent applications rose by 30 percent over 2010–15 relative to 2001–06, but applications per researcher ratio lower than upper middle-income country average. - Policy suggestions: encourage R&D, streamline institutional arrangements, finalize and implement five-year blueprint to boost productivity, provide incentives to new firms. - Structural reform implementation under 11MP is key; staff baseline conservative on productivity gains given worsening global prospects since adoption of the 11MP. ### Staff appraisal and policy recommendations (summary) - Macroeconomic policy stance: - Fiscal: anchor medium-term fiscal policy on achieving a near-balanced federal budget by 2020; further expenditure rationalization and additional revenues needed; pace of consolidation should reflect economic conditions and allow well-targeted temporary counter-cyclical measures if needed. - Monetary: current stance appropriate; BNM should carefully calibrate monetary policy to support growth while being mindful of financial conditions and to use reserves prudently. - Exchange rate: flexibility should be preserved as the main shock absorber; BNM should keep new FX market measures under review and maintain close consultation and communication with market participants. - Financial stability: continue monitoring household debt and pockets of corporate vulnerability; use macroprudential and supervisory tools as needed. - Institutional recommendation: Article IV consultation with Malaysia to be held on the standard 12-month cycle. *International Monetary Fund staff report (cr17101).* ### 1. Measures to Develop Onshore Foreign Exchange Markets _________________________________ 20 ### 1. Measures to Develop Onshore Foreign Exchange Markets _________________________________ 20 ### Economic performance and near-term outlook - Over the past few years, the Malaysian economy performed well despite significant external headwinds, remaining among the fastest growing economies at its income level. - 2016 outcomes: - Real GDP growth: 4¼ percent y/y (2015: 5.0 percent y/y), the slowest since the global financial crisis (GFC). - Inflation: 2.1 percent y/y (unchanged from 2015). - Private domestic demand was the main driver of growth; net exports contributed negatively. - Credit expansion slowed, slightly narrowing the credit gap. - Financial market developments in the second half of 2016: capital inflows reversed; the currency depreciated; interest rates on government bonds ended the year higher. - 2017 staff projections: - Real GDP growth: staff expects 4½ percent y/y in 2017. - Consumer price inflation: projected to average 2¾ percent y/y in 2017. - Current account (CA) surplus: expected to see a small decline as stronger imports and services deficits offset improved goods exports. ### External position, potential growth, and risks - External assessment: - 2016 cyclically-adjusted CA balance is assessed to be about 1 percent of GDP higher than consistent with structural fundamentals and desirable macroeconomic policies. - Real exchange rate is moderately undervalued by about 3¾ percent (Appendix II). - Potential and medium-term growth: - Potential growth is estimated to have fallen below 5 percent. - Real GDP is projected to grow at a 4½–5 percent y/y rate over the medium term (Appendix III). - Risks (Appendix IV): - External risks: structurally weak growth in advanced and emerging market economies; significant slowdown in other emerging market economies; retreat from cross-border integration and heightened global policy uncertainty; sustained low commodity prices; heightened global financial stress and capital outflows. - Domestic risks: public sector and household debt; pockets of vulnerabilities in the corporate sector; federal debt and contingent liabilities are relatively high; household debt-to-GDP ratio remains high though likely to decline. ### Authorities’ views - Authorities broadly agreed with staff assessment: - Expected 2017 expansion of 4–5 percent y/y, driven by private domestic demand. - Private consumption to be sustained by expanding employment, higher wages, and fiscal measures (including EPF contribution cuts, BR1M transfers, and civil servant salary increases). - Net exports expected to remain in surplus, supported by manufactured goods demand and higher commodities exports. - Inflation expected to remain in the 2–3 percent range in 2017. ### Macroeconomic and financial policy priorities - Staff recommended policy agenda: - Anchor fiscal policy to the medium-term consolidation objective to build fiscal policy space and strengthen resilience, supported by improvements in the fiscal framework. - Carefully calibrate monetary policy to support growth while being mindful of financial conditions. - Continue to use exchange rate flexibility as a key shock absorber, supplemented by limited intervention to counter short-term volatility. - Closely monitor financial risks and stand ready to adjust macroprudential measures, as necessary. ### Fiscal policy: objectives and measures - Medium-term anchor: - Authorities’ medium-term fiscal policy is appropriately anchored on achieving a near-balanced federal budget by 2020. - Achieving near-balance will require additional measures amounting to about 1 percent of GDP. - Expenditure policy recommendations: - Further expenditure rationalization is required to achieve the medium-term objective while meeting priority expenditure needs. - Scope for further cuts in subsidies following successful reform of fuel and other subsidies. - Improve effectiveness and efficiency of government expenditure: better targeting of social transfers; cost recovery in higher education; user fees for health care services; limiting duplication in transport and tourism programs; enhancing effectiveness of investment tax incentives. - Implement continuous expenditure reviews to identify savings while preserving efficiency; link with performance budgeting and medium-term fiscal framework. - Tax policy recommendations: - Need to mobilize additional government revenues. - Improve tax collection and compliance, including through increased information sharing between agencies; GST transaction data can help increase corporate income tax compliance. - Upgrade the GST framework as a growth-friendly revenue approach: - Reduce the number of exempt and zero-rated items (current coverage of these categories is broad by international standards, including fuel, tourism and passenger transport). - Consider raising the GST rate (currently at 6 percent). - A 0.5 percentage point increase in the rate (from 6.0 percent to 6.5 percent) would raise revenue by an estimated 0.25 percent of GDP; with a wider base the revenue impact would be larger. - Continue to improve international taxation, including strengthening anti-avoidance rules and pursuing international cooperation (Appendix VI). ### Illustrative medium-term fiscal consolidation scenario (2017–20) - Fiscal measures and impacts (percent of GDP): - Already in the baseline: 1.1 - Higher projected revenue (from higher compliance in corporate income tax): 0.1 - Expenditure growth restraint (as indicated by the authorities): 1.0 - Additional measures: 0.9 - 1.4 - Revenues: - GST: 0.6 - 0.9 - of which, removal of exemptions: 0.4 - 0.6 - of which, increase in rate: 0.2 - 0.3 (0.5 percentage point increase in the rate from 6.0 percent to 6.5 percent) - Expenditure: - Subsidy rationalization: 0.3 - 0.5 - Total balance improvement: 2.0 - 2.5 - Note: The scenario shows a mix of revenue and expenditure policies as a possible way forward; various different combinations of policy measures are feasible. *International Monetary Fund staff report excerpt* ### 11. The gradual consolidation called for under the 2017 Budget represents continued ### cr17101 - 11. The gradual consolidation called for under the 2017 Budget represents continued ### Fiscal consolidation and recent developments - Oil revenue fell by 3.6 percent of GDP in the period 2014–17. - Several measures counteracted lost oil revenue, ensuring a gradual consolidation of 0.4 percent of GDP in 2014–17. - For 2016: - The deficit of the Federal budget is estimated at 3.1 percent of GDP, down by 0.1 percentage points from 2015. - A revenue decline of 1.6 percent of GDP driven by oil related revenue was compensated by an increase of 0.8 percent of GDP in GST revenues and reductions in expenditure. - For 2017: - The deficit is targeted at 3.0 percent of GDP, continuing the moderate consolidation path. - Federal government debt is expected to remain within the self-imposed limit of 55 percent of GDP. - The consolidated public sector fiscal deficits will fall by about 0.7 percent of GDP both in 2016 and 2017, primarily reflecting the operations of the national oil company (PETRONAS). - This improvement largely reflects reductions in overseas capital spending, with limited impact on the domestic economy. ### Malaysia: Fiscal Developments, 2014–17 (Percent of GDP, positive sign =improves balance) - A. Oil and gas revenue: -3.6 - B. Policy reaction: 5.4 - B1. Introduction of GST: 1.4 - B2. Expenditure reduction: 4.0 - Subsidies: 1.9 - Goods and services: 1.0 - Grants: 0.8 - Compensation to employees: 0.3 - C. Other fiscal developments: 1.4 - Deficit reduction = A+B+C: 0.4 - Source: IMF staff estimates. ### Fiscal risks, contingent liabilities, and recommended improvements - Fiscal space assessment: - Malaysia has limited fiscal space in the near term but would have increased space in the medium term as the level of government debt falls over the next five years under the baseline (Appendix V). - Reaching a near-balanced budget by 2020 as targeted would require further fiscal measures. - Contingent liabilities: - Loan guarantees by the government are estimated at 15 percent of GDP. - Contingent liabilities related to PTPTN (student loans) are about 3 percent of GDP. - Malaysia’s relatively high contingent liabilities include liabilities stemming from PPP and loan guarantees. - Institutional and procedural recommendations: - The recently introduced Medium Term Fiscal Framework provides useful fiscal guidance and should be enriched with more detail. - Continuous monitoring of contingent liabilities and efforts to reduce risks from PTPTN would help contain associated risks. - Authorities are encouraged to publish an annual fiscal risks statement, fully integrated in the budget preparation process and used to develop risk mitigation strategies. - The authorities established the Fiscal Risk and Contingent Liability Technical Committee to evaluate overall fiscal risks and propose measures. - Further improvements could be implemented with help from the IMF’s Fiscal Affairs Department, including the PPP Fiscal Risks Management Model (PFRAM). - A Public Investment Management Assessment is being conducted to help improve effectiveness of spending. ### Authorities’ views (fiscal) - Authorities reiterated commitment to fiscal sustainability and a broadly balanced budget in the medium term. - Emphasis on diversifying revenue, reviewing expenditure, improving the tax system, and monitoring and mitigating fiscal risks. - Authorities noted that government loan guarantees have a low probability of being called because they are granted strategically to nonfinancial entities with healthy balance sheets. ### Monetary policy and exchange rate policy - Current stance: - The current monetary policy stance is appropriate in the baseline scenario of moderate growth, low inflation, and external uncertainties. - At its policy meeting on January 19, 2017 BNM kept the overnight policy rate unchanged at 3 percent. - Policy guidance: - BNM should continue to carefully calibrate monetary policy to support growth while being mindful of financial conditions. - BNM could provide further easing if growth unexpectedly weakens and liquidity might also be provided to prevent disruption in financial markets. - Exchange rate and reserves: - Exchange rate flexibility is central to adjustment and should remain a key shock absorber. - Foreign exchange reserves largely stabilized during 2016 and stand at about 80 percent of the IMF’s composite reserve adequacy metric (which currently classifies Malaysia’s exchange rate regime as “other managed”). - If Malaysia’s regime were to be classified as “floating”, the level of FX reserves would be in the adequate range (about 115 percent of the metric). - Staff judges current reserve levels to be adequate; reserves could be deployed in case of disorderly market conditions and accumulated in normal conditions. - FX market developments and BNM measures: - In late 2016, BNM announced measures to develop onshore foreign exchange markets and bolster resilience to external shocks, including facilitating onshore FX risk management and enhancing onshore market depth and liquidity, and reinforcing rules on domestic institutions’ participation in offshore ringgit transactions. - Subsequently, onshore liquidity normalized, spot exchange rate volatility declined, and bid-ask spreads narrowed. - Going forward, exchange rate flexibility and macroeconomic policy adjustments should remain the main line of defense; BNM should keep new FX market measures under review and maintain close consultation and communication with market participants. ### Authorities’ views (monetary and FX) - Authorities emphasized the exchange rate’s role in absorbing external shocks and that monetary policy is well calibrated and supportive of growth. - Reserves are adequate, and authorities expressed reservations about the binary classification of Malaysia’s exchange rate regime used in the Fund’s reserve adequacy calculations. - BNM described measures to promote a deeper, more transparent and well-functioning onshore FX market and reinforced the policy of discouraging offshore NDF activity in line with non-internationalization of the ringgit. ### Financial sector: stability, risks, and policy stance - Credit and banking sector: - Credit growth has slowed to a more moderate and sustainable pace after elevated growth since 2009. - Malaysia’s banking sector has strong capital buffers, adequate provisioning and liquidity, and stable funding conditions. - If current credit growth rates are maintained, the credit gap should gradually close. - Non-performing loan (NPL) ratios remain low but could increase as the economy moves through the cycle; macroprudential measures since 2010 should help reduce the risk of a sharp increase. - Household sector and housing market: - Household debt is relatively high and requires careful monitoring, but no additional macroprudential measures are recommended at this time (Appendix IX). - Household financial assets were 183 percent of GDP at end-2015. - Banking system household NPLs remain low at 1.1 percent. - 2017 Budget recalibrated macroprudential policies: stamp duty relief for first-time home buyers (expiring end-2018) and increased housing loan access for public servants; stamp duties on instruments of transfer on real estate above RM 1 million will be increased from January 2018. - House price growth has moderated; risks circumscribed by supply constraints, increases in public sector wages, and demographic factors; risk of a sharp decline should be monitored. - If rapid house price growth resumes, LTV caps on second and first mortgages could be considered. - Corporate sector and other vulnerabilities: - Corporate sector does not appear to present significant macro-financial risks overall, though pockets of vulnerability exist in construction and oil and gas sectors. - Non-residential property accounts for about 4.5 percent of bank loans. - Most foreign exchange corporate debt is naturally or financially hedged. - Corporate bond yields are expected to rise as Malaysian government bond yields increase and as domestic institutional investors reallocate toward government bonds. - To reduce potential impact on banks, BNM should continue to increase the loss absorbing capacity of banks with higher exposures to more vulnerable corporates using Pillar II measures. - Regulatory progress and market developments: - Progress continued in adopting remaining FSAP recommendations in financial oversight. - BNM extended legal powers over finance holding companies (FHC) and completed identification and designation of appropriate holding companies as FHCs for all financial groups. - In 2016 BNM issued a concept paper on Credit Risk Management applicable to all financial institutions, including FHCs. - Malaysia is a world leader in Islamic finance; in April 2016 the government issued its fifth dollar-denominated sovereign sukuk for US$1.5 billion using non-physical assets as collateral. The total outstanding stock of government Islamic securities is approaching that of MGS. - Anti-corruption and AML/CFT: - Effective implementation of plans to enhance anti-corruption measures will improve the business environment and public confidence. - Strengthening the Anti-Corruption Commission’s investigative capacity, asset declaration systems, and use of AML/CFT tools is recommended. - Effective international cooperation is important given Malaysia’s growing role as a regional financial center. ### Authorities’ views (financial sector) - Authorities largely agreed with staff views, stressing commitment to financial stability via rigorous oversight. - Banks are well-capitalized with adequate liquidity; credit conditions remain supportive of growth. - No further macroprudential measures are needed at this time; BNM is closely monitoring corporate sector risks. ### Structural policies to achieve high-income status - Progress and reform agenda: - Malaysia has made important progress toward high-income status with reforms including services sector liberalization and education reforms, increased private sector investment, improved female labor force participation, and higher minimum wages. - Productivity underperformance remains a key challenge; authorities have a comprehensive reform agenda under the 11MP to transform Malaysia into a productivity-driven and knowledge-based economy. - Staff baseline and reform incorporation: - Staff’s baseline medium-term outlook incorporates some gains from reforms (including improved female labor participation) but is conservative on productivity gains given worsening global prospects since adoption of the 11MP (Appendix III). - Policy priorities and potential gains: - Labor market: continue policies to encourage female labor force participation (measures to encourage return after prime child-bearing age, flexible work arrangements, equal opportunities in education and jobs). - Research shows Malaysia’s per capita income would have been as much as 23 percent higher if gender gaps in participation and entrepreneurship were bridged. - Education: maintain steady implementation of the Education Blueprint (2013–25) to boost human capital; student performance needs improvement despite relatively high public expenditure on education as percent of GDP. - Skills: address skill mismatches and support a higher share of high-skilled jobs; a 1 percent increase in high-skilled workers could boost GDP per capita by about 0.3 percent. - Productivity: focus on public infrastructure and human capital investment; improve business environment where Malaysia lags regional and global frontiers; facilitate trade integration and foreign investment; and attain governance standards consistent with high-income status. - Over the medium term, reforms that boost the capital/labor ratio by an additional 1 percentage point above the baseline would raise growth (text truncated in source). *Source: IMF staff report (cr17101).* ### 0.2 percentage point. ### cr17101 - 0.2 percentage point. ### Innovation and Research & Development (R&D) - By 2020, Malaysia aims for a near doubling of the share of R&D expenditure in GDP from its 2012/13 level. - R&D productivity appears low. - Malaysian patent applications have seen a 30 percent increase over 2010–15, relative to 2001–06, but the ratio of these applications per year to the share of researchers in population is significantly lower than the average for upper middle-income countries. - Policy suggestions: - Continue to encourage R&D, including through streamlining institutional arrangements. - Finalize and implement the five-year blueprint to boost productivity. - Secure a stable macroeconomic environment and provide incentives to new firms (rather than small firms) to support entrepreneurship and innovations. ### Authorities’ views - Authorities appreciate staff’s support of the medium-term structural reform agenda. - They noted heightened global policy uncertainties pose a risk to achieving some goals under the 11MP. - Authorities’ commitments include: - Improving the quality of education. - Lowering skills mismatch. - Investing in better public infrastructure. - Promoting research and innovation. - Expanding trade integration. - Pursuing a policy of economic openness. ### Staff appraisal — growth, external position, and macro policies - Real GDP growth is expected to improve slightly in 2017, while staying below the potential growth rate (estimated to remain between 4½ and 5 percent). - Risks to growth: - Weaker-than-expected growth in key advanced and emerging economies. - A global retreat from cross-border integration. - Worsening financial conditions affecting domestic markets. - External position: - The current account surplus has declined. - Malaysia’s 2016 external position is assessed to be moderately stronger than warranted by fundamentals and desired policies. - Fiscal policy: - Medium-term fiscal policy anchored on achieving a near-balanced federal budget by 2020. - Planned consolidation will help alleviate risks from elevated government debt levels and contingent liabilities and build fiscal space for expansionary policy. - The pace of consolidation should reflect economic conditions; any counter-cyclical fiscal measures should be well-targeted and temporary. - Further expenditure rationalization and additional government revenues are needed. - Improvements to the fiscal framework would help anchor medium-term fiscal adjustment and mitigate risks. - Monetary policy: - The current monetary policy stance is appropriate. - BNM should carefully calibrate monetary policy to support growth while being mindful of financial conditions. - Consumer price inflation is expected to rise slightly due to higher oil prices and subsidies reforms, while remaining within the range of the authorities’ projection (2–3 percent). - Global financial market conditions could affect the monetary policy space and should be watched carefully. - Exchange rate and reserves: - Exchange rate flexibility should play a central role in adjusting to external shocks. - Reserves could be deployed in the event of disorderly market conditions; in more normal conditions, reserves could be accumulated while remaining cognizant of underlying developments affecting the real exchange rate. - BNM should continue to review recently announced FX market measures to improve functioning of the onshore forward FX market, recognizing their costs and benefits. - Close consultation and communication by BNM with market participants will be essential in sustaining investor confidence and orderly functioning of the FX market. ### Financial sector and structural reforms - Financial sector risks appear contained and pockets of potential stress are being monitored closely. - Banking sector: - Slower credit growth will help keep loan portfolio quality in check while ensuring adequate provision of credit. - The banking sector remains well-capitalized, liquid, and profitable, with non-performing loan ratios in low single digits. - Vulnerabilities: - Household debt remains relatively high, representing a key vulnerability. - Emerging vulnerabilities in the construction and oil and gas sectors require close monitoring. - Structural reforms: - Steadfast implementation of the ambitious structural reforms agenda is key to boosting long-term economic potential. - Priorities include: - Further raising female labor force participation rate. - Improving the quality of education. - Lowering skills mismatch. - Boosting productivity growth. - Encouraging research and innovation. - Upholding high standards of governance. ### Institutional recommendation - The staff recommends that the Article IV consultation with Malaysia be held on the standard 12-month cycle. *INTERNATIONAL MONETARY FUND.* ### Box 1. Malaysia: Measures to Develop Onshore Foreign Exchange Markets ### Box 1. Malaysia: Measures to Develop Onshore Foreign Exchange Markets ### Announced measures (BNM package, December 2, 2016) - Resident and nonresident institutional investors may dynamically take onshore forward positions on a portfolio basis up to 25 percent of invested foreign currency or ringgit-denominated assets respectively, without documentary evidence with a licensed onshore bank or an appointed overseas office. A one-time registration with BNM is required. - Residents allowed to hedge foreign currency exposures and cancel hedging positions for US$/MYR and CNH/MYR currency pairs with a licensed onshore bank without documentary evidence up to an aggregate net open position limit of RM 6 million per licensed onshore bank. Participants must give a one-time declaration of hedging intent. - With effect from December 5, 2016, resident exporters can retain up to 25 percent in foreign currency proceeds from their exports of goods and the balance converted into ringgit with a licensed onshore bank. The converted amounts could be deposited in a special facility, earning a higher interest rate of 3.25 percent and available until end-2017. Exporters are allowed to reconvert their export proceeds to meet projected loans, imports, and other current account obligations for up to six months ahead. Previously, export proceeds were required to be repatriated within six months, but there was no conversion requirement. - Prudential limits on foreign currency (FC) investments by residents with domestic ringgit borrowing have been streamlined to include FC investments onshore and apply to all residents (including previously exempted exporters) with ringgit borrowing for prudential reasons. Residents without domestic ringgit borrowing may continue to invest up to any amount. - Onshore banks engaging in ringgit foreign exchange transactions in the onshore market are required to obtain attestation from non-resident banks of non-participation in the NDF market (enhanced enforcement of existing regulations on banks’ non-involvement in offshore ringgit transactions). Note - Currently, investors can hedge up to 100 percent of their foreign exposure with underlying documentation. ### Intended objectives and possible effects - Objectives: - Aid development of onshore foreign exchange (FX) markets. - Bolster resilience to external shocks. - Enhance onshore FX liquidity (via exporter retention and reconversion allowances). - Potential effects: - The conversion requirement and prudential limits on FC investments limit capital outflows. - Exporter retention provisions could potentially increase transaction costs for exporters of goods. - Measures that allow more flexibility in onshore trading are likely to be welcome, but some measures constrain capital outflows. ### Implementation and transition considerations - Recognizing adjustment needs, BNM has: - Published Frequently Asked Questions on the new measures on its website. - Been addressing queries from stakeholders. - Market participants will need time to adjust to issues such as: - Compliance and risk management. - Clearing, netting and margin requirements. - Limited trading hours. - Lower onshore liquidity. ### IMF staff assessment and recommendation - Based on the Fund’s Institutional View, staff recommends to reconsider the conversion requirement and the prudential limits on FC investments, noting these measures limit capital outflows. - Macroeconomic policy adjustments should continue to play the central role in response to capital flow volatility. *International Monetary Fund — Box 1, "Malaysia: Measures to Develop Onshore Foreign Exchange Markets" (content as provided).* ### Appendix I. Malaysia—Staff Policy Advice from the 2014 and 2016 ### Appendix I. Malaysia—Staff Policy Advice from the 2014 and 2016 Article IV Consultations ### Fiscal policy — staff advice and authorities’ actions - Policy advice (2014): Protect the fiscal position in the face of sharply lower oil and gas prices through gradual, growth-friendly multi-year fiscal adjustment. - Policy advice (2016): Allow the fiscal stabilizers to work if the economy is weaker than expected. - Actions and outcomes: - The authorities promptly revised the 2016 federal budgets (in January 2016) in response to sharp declines in oil and gas prices, maintaining the federal budget deficit ceiling close to original targets. - Policy advice (2014): Broaden tax bases by implementing a GST and rationalizing tax incentives (Narrow the list of exempt and zero-rated items). - Policy advice (2016): Increase GST rate. - Actions and outcomes: - The authorities introduced the GST in April 2015. - They are undertaking a study on the effectiveness and costs of tax incentives. - Policy advice (2014): Phase out expensive and poorly targeted fuel subsidies and continue gradual adjustment of administered prices for electricity and other services (tolls, utilities). Pass on to consumers changes in fuel prices with the objective of depoliticizing energy pricing. - Actions and outcomes: - Fuel and other subsidies were removed starting in December 2014. - Authorities have maintained a mechanism of monthly adjustment of fuel prices; adjustments of toll, electricity, and other utility tariffs are ongoing. - Policy advice (2014): Expand cash transfers to lower income groups as integral component of fiscal reforms eliminating fuel subsidies and introducing GST. - Actions and outcomes: - Cash transfers to lower income groups have been expanded starting with the 2015 budget. - The 2014 Budget announced creation of a comprehensive database on welfare recipients to facilitate better targeting. - Policy advice (2014): Gradually bring down federal debt to sustainable levels and near balance the federal budget by 2020. Introduce a medium-term fiscal framework. - Policy advice (2016): Publish an annual statement of fiscal risk. - Actions and outcomes: - Authorities announced intention to gradually balance the federal deficit by 2020, expected to substantially decline the federal debt to GDP ratio, but still need to identify concrete fiscal consolidation actions. - A medium-term fiscal framework has been developed and published and endorsed by the Fiscal Policy Committee. ### Monetary, exchange rate, and financial policies — staff advice and authorities’ actions - Monetary policy advice (2014): Move from the current accommodative stance toward a neutral stance to maintain price stability and curb financial imbalances. - Monetary policy advice (2016): Tighten interest rates if signs emerge of second-round inflation pressures; provide liquidity through open market operations and/or further lower the statutory reserve requirement. - Actions and outcomes: - Authorities raised policy interest rate in mid-2014 but stayed put given external uncertainty. - In July 2016, BNM cut the policy rate by 25 bps to 3.0 percent, citing weaker global growth, uncertain global environment, and receding risks from financial imbalances. - Exchange rate advice (2014): Maintain a flexible exchange rate as a shock absorber; use reserves and intervention to ensure orderly markets and avoid FX overshooting. - Exchange rate advice (2016): Given low level of reserves, greater reliance on FX rate flexibility is recommended. - Actions and outcomes: - Authorities allowed the exchange rate to depreciate substantially amid external shocks while deploying reserves to help adjustment. - Authorities agree that reserves will need to be gradually rebuilt and that they will rely more on greater exchange rate flexibility in response to shocks. - In December 2016, BNM introduced measures to further develop domestic FX markets. - Macroprudential advice (2014): Continue to employ macroprudential policies to dampen financial risks and monitor leverage across the economy, including household and corporate debt. - Macroprudential advice (2016): Provide liquidity and/or reduce statutory reserve requirement if needed. - Actions and outcomes: - Authorities maintain macroprudential measures to curb household indebtedness and an enhanced framework for risk-based pricing of loans. - BNM is collecting granular data on household debt. - Corporate borrowing in foreign currency is closely monitored to ensure borrowers are naturally or otherwise hedged. - These efforts have reduced risk from credit growth and increased resilience of banks. ### Structural policies — staff advice and authorities’ actions - Policy advice (2014): Boost growth and productivity through structural reforms including reforms of government-linked companies; liberalization of labor and product markets; and enhanced education and training. - Policy advice (2016): Uphold high standards of governance and communication in public financial management. - Actions and outcomes: - Many recommendations are part of the authorities’ Economic Transformation Program and the Government Transformation Program; some progress has been made on strategic reform initiatives. - Policy advice (2014, 2016): To achieve high income status, continue to: (i) prioritize infrastructure investment; (ii) further improve public financial management; (iii) boost spending on Research and Development to promote home-grown innovation; and (iv) improve quality of education to reduce skills mismatches and raise productivity. - Actions and outcomes: - In May 2015, authorities unveiled the 11th Malaysia Plan, spanning 2016–2020, continuing efforts to boost public capital through major infrastructure projects and to promote home-grown innovation and a knowledge-based society. - Policy advice (2014, 2016): Maintain an economic system that is highly open to trade and investment. - Actions and outcomes: - Malaysia remains a very open economy; ASEAN Economic Community came into being at the start of 2016. Malaysia is participating in discussion of a regional trade arrangement with China. --- ### Appendix II. Malaysia—External Sector Assessment (selected developments and benchmarks 2016) ### Current account and goods/services/income balances - 2016 current account (CA) surplus: 2 percent of GDP (2015: 3 percent of GDP). - CA trend: Declined from about 11 percent of GDP in 2011 to 2 percent of GDP in 2016; decline driven largely by a rise in investment and fall in saving in the nonfinancial corporate sector. - CA balance excluding oil and liquefied natural gas: remained in deficit in 2016. - Drivers in 2016: - Goods balance: surplus reduced by nearly 1½ percent of GDP as exports fell faster than imports in U.S. dollar terms. - Export volumes were up, cushioning price effects, supported by some weakening of the real exchange rate. - Services account: net services balance deteriorated in recent years due to increased use of foreign professional services and a drop in tourist arrivals in 2015 (tourist arrivals improved in 2016). - Primary income account deficit: about 2¾ percent of GDP (unchanged). - Secondary income account: improved by close to ½ percent of GDP. ### Capital and financial accounts - Capital outflows since late 2014; inflows returned in 2015:Q4. - 2016 dynamics: - Small net outflow in the financial account of about 0.3 percent of GDP in 2016 (compared with outflows of 4½ percent GDP in 2015 and 7¼ percent of GDP in 2014). - Deficits re-emerged in second half of 2016 as portfolio flows reversed, particularly after the U.S. presidential election. - Offset by direct investment flows: gross inflows increased while Malaysia’s direct investment abroad slowed. - Foreign investments by large nonfinancial public enterprises were cut to support the domestic economy. ### Real exchange rate and reserves - REER: average REER depreciated by about 4¼ percent y/y in 2016, following a nearly 8 percent y/y depreciation in 2015. Depreciation in the nominal effective exchange rate explains most changes in the REER. - Foreign reserves: - Malaysia’s foreign reserves in 2016: US$94.6 billion (2015: US$95.3 billion). - Reserves went up in first ten months of 2016 but fell in the last two months amid capital outflows. - Reserves were largely unchanged in January 2017. - IIP and external debt: - Net IIP position: about 6 percent of GDP in 2016 (in U.S. dollar terms), compared to 8¾ percent of GDP as of end-2015 (largely on account of valuation effects). - Total external debt: about 68 percent of GDP in 2016, slightly higher than 65½ percent of GDP in 2015. - The share of short-term external debt fell. ### Standard benchmarks and staff assessments - EBA-adjusted 2016 CA balance: estimated at about 3¼ percent of GDP; EBA 2.0 CA norm: about ¾ percent of GDP; implying a CA gap of about 2½ percent of GDP under the EBA model. - Identified policy gaps explain about half of the CA gap; domestic policies account for close to one-third of the total policy gap. - Domestic policy gaps point to need for further fiscal consolidation and higher allocation for public healthcare spending. - Staff assessment (accounting for structural features not fully captured by EBA): CA gap assessed at about 1½ percent of GDP, with a range of plus or minus 1 percent of GDP. Conclusion: Malaysia’s 2016 external position deemed to be moderately stronger than fundamentals and desired policies. - REER misalignment: - EBA index-based and level-based REER regressions indicate undervaluation of about 28–36 percent relative to fundamentals and desired policies (largely accounted for by regression residuals). - Staff’s elasticity approach estimates 2016 REER gap at about –5¼ percent (plus or minus 3.4 percent), implying a moderate undervaluation. - Reserve adequacy: - Under IMF composite reserve adequacy metric (classifying Malaysia as “other managed”), end-2016 official reserves estimated at about 80 percent of the metric, similar to 2015. - Under IMF reserve adequacy metric for “floating” regimes, end-2016 reserves estimated to be 115 percent of the metric (within adequate range). - Staff assesses foreign exchange reserves to be adequate, noting the Fund metric may overstate needs by not capturing increases in banks’ short-term assets corresponding to higher short-term liabilities. - Staff view: in normal market conditions, reserves could be accumulated as opportunities present while remaining cognizant of needed adjustments in the real exchange rate; in disorderly conditions, reserves could be deployed to reassure markets. ### Quantitative external sector assessment (selected figures from Table 1) - Current account (EBA 2.0): - EBA current account norm: 0.7 - Estimated outturn: 3.3 - Gap: 2.6 - Contribution of identified policy gaps: 1.4 - Of which domestic policy gaps: 0.4 - Unexplained residual: 1.2 - External sustainability approach: 1.0 - Staff assessment: - Staff norm: 1.8 - Staff estimate/outturn: 3.3 - Staff gap: 1.5 - Contribution of identified policy gaps (based on EBA 2.0): 1.4 - Of which domestic policy gaps: 0.4 - Other: 0.1 - Exchange rate misalignment (EBA regression approaches): - EBA Index REER regression approach: -36.1 percent (of which contribution of identified policy gaps: -4.0; unexplained residual: -32.1) - EBA Level REER regression approach: -28.1 percent (of which contribution of identified policy gaps: -4.5; unexplained residual: -23.6) - Staff estimate using elasticity approach: -5.2 percent *Source: IMF staff report excerpt — “Appendix I. Malaysia—Staff Policy Advice from the 2014 and 2016 Article IV Consultations” and “Appendix II. Malaysia—External Sector Assessment”* ### 11. Overall assessment. Malaysia’s CA gap is estimated to have declined in 2016 and the ### 11. Overall assessment. Malaysia’s CA gap is estimated to have declined in 2016 and the ### Overall assessment and macro policy stance - Malaysia’s CA gap is estimated to have declined in 2016 and the external position is assessed to be moderately stronger than warranted by fundamentals and desirable policies. - Macroeconomic policy adjustments should remain the central response to external shocks, in line with the Institutional View on capital flows: - Exchange rate flexibility should be preserved to act as a shock absorber. - Monetary and fiscal adjustments remain primary tools. - Fiscal consolidation should consider: - Further improving social protection—including through the introduction of an unemployment insurance system. - Higher public healthcare spending. - A reduction in labor market rigidity. - Medium-term expectations: - Higher public sector saving, driven by fiscal consolidation, is expected to be offset by a drop in private saving as fiscal policies shift toward measures that will help lower the need for precautionary saving by the private sector. - Private investment is expected to rise at a moderate pace as Malaysia addresses structural bottlenecks and pursues its potential to become a high-income country. - Together, these forces will lead to a smaller current surplus over the medium-term, contributing to a gradual rise in the net IIP. ### Appendix III — Medium-Term Growth Outlook: Introduction and context - Past staff estimates for Malaysia’s medium-term real GDP growth averaged around 5 percent in recent Article IV consultations. - Global and regional headwinds (slow growth, weak trade and investment, low global oil prices, feeble productivity gains, heightened global uncertainty) may have reduced Malaysia’s potential growth; statistical filters indicate a slowdown in trend growth over the next two years. - Between 2011 and 2016, five-year ahead growth forecast revisions across country groups ranged between ½ percentage point and 3 percentage points; Malaysia’s revision was about ¼ percentage point. - Malaysia’s actual growth outturn over 2011–15 largely met or exceeded prior staff projections. - Main uncertainty for medium-term projection: productivity growth. ### Data analysis for 2016–20 growth projection — framework and assumptions - Production function: human-capital augmented production function with: - Ht: human capital in year t. - φ: return on education (assumed at 7 percent). - St: years in schooling (Barro-Lee database). - Output elasticities approximated by shares of operating surplus and compensation of employees in national income (2006–14 official data). - Capital’s share averaged at about 70 percent over 2006–14. - For 2016–20, the 11th Malaysia Plan (11MP, 2016–20) goal: raise the share of labor income in output to 40 percent by 2020 from 34 percent in 2014. - Labor inputs: - Malaysia benefits from a demographic dividend, but population growth is slowing and population aging will accelerate, decelerating labor growth. - Gender-specific population growth projections from United Nations used, with no change in migration; gender-specific labor force participation rates used to forecast labor supply. - Labor force participation assumed to increase at the linear trend rate observed between 2009 and 2015: - About 7 percentage points further increase in the female labor force participation rate by 2020 (slightly higher than 11MP envisaged). - Male participation assumed to improve by about 1 percentage point. - Unemployment rate assumed to gradually decline to 2.8 percent in 2020 from 3.1 percent in 2015. - Human capital: - Years of schooling data from Barro-Lee (last reported as of 2010) extrapolated by linear trend for 2011–20. - Constant return to education of 7 percent assumed. - Physical capital inputs: - Capital stock growth assumed such that capital/labor ratio continues to grow along its post AFC trend growth rate. - Capacity utilization assumed to improve to its 2001–15 average rate of about 80 percent from 76½ percent in 2015. - Implied investment growth is slower than envisaged under the 11MP, reflecting a worsening global outlook since mid-2015. - Official capital stock data used for 2000–15; pre-2000 capital stock estimated using the perpetual inventory method. - Total factor productivity (TFP): - Three phases of productivity growth since early 1990s: pre-AFC; between AFC and GFC; post-GFC. TFP slowed considerably in the post-GFC phase. - For 2016–20, staff project a moderate improvement in average TFP growth from the previous five years, supported by policy measures to enhance labor skills and a pick-up in global growth aiding export-oriented sectors. - Regression analyses support a wide range of average TFP growth between 1¾ and 2½ percent over the medium term; staff considers estimates above 2 percent unlikely in the current global context. - Staff conservatively projects TFP growth at the trend rate observed during 1999–2015, aligned with capital/labor ratio maintaining post AFC trend growth. ### Projections, contributions, and plan comparisons - Projected average real GDP growth rate over 2016–20: about 4¾ percent. - Composition of growth (2016–20 projection): - Bulk of contribution from capital formation, followed by TFP; contribution from capital formation expected to drop relative to past. - Contributions from employment will drop below 1 percentage point. - 11th Malaysia Plan target: 5–6 percent growth over 2016–20. - 11MP assumptions were based on more optimistic global scenarios (example comparisons): - 11MP global growth assumption: 3.9 percent versus IMF WEO October 2016 projection of 3.4 percent. - 11MP oil price assumption: US$71 per barrel versus WEO October 2016 assumption US$51.5 per barrel. - In the last three plan periods, both actual growth and contribution of TFP underperformed plan aspirations. ### Conclusion and staff baseline projection range - Recent slowdown in real GDP growth partly driven by external shocks. - Malaysia faces domestic and external challenges to reach 5–6 percent medium-term growth. - Given slower population growth and moderate investment rise, productivity improvement is key to achieving medium-term objectives. - Staff projects Malaysia’s real GDP growth will likely stay between 4¼ percent and 5¼ percent over 2016–20, with the average seen at around 4¾ percent. ### Appendix IV — Risk Assessment Matrix (selected entries) - Notes on RAM: relative likelihood classifications — “low” = probability below 10 percent, “medium” = between 10 and 30 percent, “high” = 30 percent or more. RAM reflects staff views at time of discussions. - External risks - Significant slowdown in China and other large EMs/frontier economies (Short- to medium term). - Likelihood: Low/Medium. - Transmission: Liquidity for weak borrowers in the Chinese interbank market may dry up; investors may withdraw from EM corporate debt disorderly; exposes excess household and corporate (FX) leverage. - Expected impact: Medium. Trade (volume and price) is the dominant channel; adverse second-round effects on domestic demand; weaker external demand could suppress commodity prices, dampen domestic demand, lower growth, and increase unemployment. - Recommended policy responses: - Allow exchange rate to act as key shock absorber; intervene only to smooth excessive volatility. - Consider a more accommodative monetary policy stance if risks of fueling further financial imbalances are low. - Structural reforms and carefully selected infrastructure projects to enhance productivity; adjust to slower medium-term growth. - Significant further strengthening of the US dollar and/or higher rates (Short-term). - Likelihood: High. - Transmission: Investors reassess fundamentals; term premia decompress; faster Fed normalization; leveraged firms, lower-rated sovereigns, and entities with unhedged dollar exposures could be stressed. - Expected impact: Medium. Malaysia’s high household and corporate debt and high foreign holdings of MGS and equities increase vulnerability. - Recommended policy responses: - Allow exchange rate to act as shock absorber; intervene to smooth excessive volatility. - Provide liquidity support (including in FX) if needed. - Relax reserve requirements if capital outflows threaten domestic activity (as during the GFC). - Use macroprudential measures to limit systemic risk; consider a more accommodative monetary policy to compensate for loss of external credit access. - European bank distress (Short-term). - Likelihood: Medium. - Transmission: Strained bank balance sheets and weak profitability could lead to financial distress in one or more major banks with knock-on effects. - Expected impact: Medium. Could reduce cross-border borrowing and increase its cost, reinforcing the real cycle through weaker confidence and demand. - Recommended policy responses: as above (exchange rate flexibility, liquidity support, macroprudential measures). - Retreat from cross-border integration (Short- to medium-term). - Likelihood: High. - Transmission: Protectionism and economic isolationism could reduce trade, capital, and labor flows, harming growth. - Expected impact: Medium. Malaysia’s openness makes it vulnerable to trade curtailment, including potential non-materialization of TPP. - Recommended policy responses: - Allow exchange rate flexibility. - Deploy fiscal policy only if shock perceived as temporary. - Seek new regional trade agreements to mitigate impacts of TPP not materializing. - Lower energy prices (Short- to medium-term). - Likelihood: Low. - Transmission: Production cuts by OPEC and others may not materialize; lower commodity prices could reduce future investment and potential growth. - Expected impact: Medium. Lower growth and reduced oil revenues could stymie fiscal consolidation, risk twin deficits, higher interest costs, or run by foreign investors. - Recommended policy responses: - Exchange rate as first line of defense. - Fiscal reforms to reduce reliance on oil revenues (e.g., broad-based taxes). - Invest in infrastructure and productivity-boosting structural reforms. - Domestic risks - Fiscal risks from public debt and contingent liabilities (Short- to medium-term). - Likelihood: Low. - Expected impact: Medium/High. Realization would raise sovereign financing costs and exacerbate public debt concerns. - Recommended policy responses: - Medium-term fiscal consolidation to boost countercyclical capacity. - Reform fiscal institutions, adopt fiscal risks management framework, publish annual fiscal risks statement, and increase transparency of GLC operations. - Sharp downturn in the financial cycle (Short- to medium-term). - Likelihood: Low. - Transmission and expected impact: Low/Medium. Sharp credit decline could be accompanied by property price declines, weakening household, corporate, and bank balance sheets; high household debt at 89 percent of GDP (about ½ mortgages) increases vulnerability, though high household financial assets provide offset. - Recommended policy responses: - Macroprudential policies and improved underwriting standards to limit NPL increases and ensure banking system resilience. - Monetary easing, continued exchange rate flexibility, and temporary fiscal stimulus anchored in a credible medium-term fiscal sustainability framework could support growth. *International Monetary Fund — CR17101 (chapter content as provided).* ### Appendix V. Malaysia—Public Debt Sustainability Analysis ### Appendix V. Malaysia—Public Debt Sustainability Analysis ### Background and framework - The 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 framework includes: (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) macro-fiscal risks; (iv) a stochastic debt projection taking into account past macro-fiscal volatility; and (v) a standardized summary of risks in a heat map. ### Macro-fiscal baseline assumptions - Real GDP growth: - 2016: 4.2 percent - Projected recovery to 4.9 percent in 2019 - Converging to 4.8 percent in the medium term - Federal government deficit: - 2016: 3.1 percent of GDP - Projected reduction to 1.4 percent of GDP in 2021 - Projected fiscal consolidation is consistent with authorities’ targets and supported by structural reforms announced in recent budgets, but is lower than what is expected under policy commitments. ### Data coverage and contingent liabilities - Fiscal assumptions in the DSA are based on the federal government budget, excluding local and state governments and statutory bodies that typically borrow from the federal government or receive explicit government guarantees; liabilities of these entities are captured in federal government gross debt and stock of loan guarantees. - Borrowing by state owned enterprises, sometimes under federal government guarantees, has increased and is projected to continue increasing in the medium term. ### Choice of DSA framework and rationale - Malaysia’s high level of government debt and gross financing requirement justified using the higher scrutiny framework. - Historical context: government gross debt rose sharply in 2009 due to discretionary fiscal stimulus, declining growth, and a large fall in oil prices; debt-to-GDP ratio reached about the authorities’ debt ceiling of 55 percent. - Gross financing needs (GFN) peaked at 10.2 percent of GDP in 2013 and are expected to fall and remain at less than 8 percent in the medium term. ### Realism of baseline assumptions and forecast bias - Median forecast error for real GDP growth during 2007–15 is zero (no systemic projection bias). - Median forecast error for GDP deflator is 2.3 percent (staff forecasts more conservative). - Median forecast error for primary balance shows a forecast bias of –0.25 percent of GDP (staff projections slightly pessimistic), with improvement in later years. ### Feasibility of projected fiscal adjustment - Maximum three-year adjustment in the cyclically-adjusted primary balance (CAPB) over the projection period is 1.5 percent of GDP; considered ambitious but premised on concrete government measures. - Staff considers implementation risks and includes a no adjustment scenario (constant primary balance) in the DSA. - Maximum projected primary balance level of 0.1 percent of GDP is deemed reasonable relative to other market-access countries. ### Main DSA outcomes and scenario results - Overall assessment: government debt-to-GDP ratio remains below 70 percent and gross financing needs remain below 15 percent of GDP under different shocks. - Baseline and alternative scenario outcomes: - Baseline: debt-to-GDP ratio projected to decrease to below 46 percent by 2021. - Constant primary balance (no consolidation): debt-to-GDP ratio decreases slightly to 50 percent in the medium term. - One standard deviation shock to real GDP growth: debt-to-GDP ratio initially increases to almost 56 percent in 2018, then declines thereafter. - Combined macro-fiscal shock (higher interest rates and lower primary balance): similar pattern to GDP shock. - Permanent oil price shock: - Modeled as a 1 percent of GDP permanent reduction in oil income (commensurate with a 33 percent decline in oil price and an amplifying effect reducing oil companies’ profits by 66 percent). - Yields a flat debt-to-GDP profile in the medium term. - Contingent liability shock (government absorbs all government-guaranteed loans totaling 15 percent of GDP over two years, plus persistent shocks to growth and rises in interest rates): - Debt-to-GDP ratio grows to almost 70 percent of GDP. - This is characterized as a low probability but illustrative scenario highlighting vulnerability from contingent liabilities. - Gross financing needs (GFN): - Under all scenarios remain below 10 percent of GDP except in the contingent liabilities scenario where GFN peaks at 15 percent before falling below 10 percent by the end of the projection horizon. - Stochastic simulations: - Based on historical volatilities in Malaysia’s macroeconomic variables, the 90th percentile of debt-to-GDP ratio simulations is below 65 percent. ### Key baseline indicators and projections (selected figures from baseline table) - Nominal gross public debt: - 2014: 45.6 (percent of GDP) - 2015: 52.7 - 2016: 54.5 - 2017: 52.7 - 2018: 52.5 - 2019: 51.4 - 2020: 49.7 - 2021: 47.7 (percent of GDP) - Public gross financing needs: - 2014: 9.1 (percent of GDP) - 2015: 9.0 - 2016: 9.4 - 2017: 5.1 - 2018: 7.7 - 2019: 6.4 - 2020: 6.6 - 2021: 6.6 (percent of GDP) - Real GDP growth (percent): - 2014: 4.8 - 2015: 6.0 - 2016: 5.0 - 2017: 4.2 - 2018: 4.5 - 2019: 4.7 - 2020: 4.9 - 2021: 4.8 - Inflation (GDP deflator, percent): - 2014: 3.2 - 2015: 2.5 - 2016: -0.4 - 2017: 3.1 - 2018: 2.8 - 2019: 2.9 - 2020: 3.1 - 2021: 3.0 - Effective interest rate (percent; defined as interest payments divided by debt stock at the end of previous year): - 2014: 4.7 - 2015: 4.2 - 2016: 4.2 - 2017: 1.8 - 2018: 5.5 - 2019: 4.6 - 2020: 4.8 - 2021: 4.7 ### Debt-creating flows and automatic dynamics (selected items) - Change in gross public sector debt (cumulative projection to 2021): -9.0 (percent of GDP) - Identified debt-creating flows (cumulative projection to 2021): -8.0 (percent of GDP) - Primary deficit (percent of GDP): - 2014: 1.5 - 2015: 1.2 - 2016: 1.0 - 2017: 1.0 - 2018: 0.9 - 2019: 0.6 - 2020: 0.2 - 2021: -0.2 - Primary (noninterest) revenue and grants (percent of GDP): - 2014: 21.1 - 2015: 20.1 - 2016: 19.0 - 2017: 17.1 - 2018: 16.4 - 2019–2021: 16.3 (each year) - Primary (noninterest) expenditure (percent of GDP): - 2014: 22.6 - 2015: 21.3 - 2016: 20.1 - 2017: 18.1 - 2018: 17.3 - 2019: 16.9 - 2020: 16.5 - 2021: 16.1 - Automatic debt dynamics (cumulative projection to 2021): -9.8 (percent of GDP) - Interest rate/growth differential (cumulative projection to 2021): -9.8 (percent of GDP) - Of which: real interest rate (cumulative to 2021): 3.5 (percent of GDP) - Of which: real GDP growth (cumulative to 2021): -13.3 (percent of GDP) - Residual, including asset changes (cumulative projection to 2021): -1.0 (percent of GDP) ### Heat map and vulnerabilities - External financing requirement: 47 percent (above the upper threshold of early warning benchmarks). - Public debt held by non-residents: about 30 percent of total (relatively high). - Share of foreign-currency-denominated debt: low (below heat-map thresholds). - Short-term and foreign-currency debt share are low, mitigating some risks. - Large domestic institutional investors who tend to make opportunistic investments are a mitigating factor for external-financing and non-resident holdings risks. - Heat-map summary: despite low shares of foreign currency and short-term debt, risks arise from external financing requirement and relatively large share of public debt held by foreigners; contingent liabilities remain a key vulnerability. ### Stress test highlights (selected underlying assumptions shown in stress-test figures) - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock, Contingent Liabilities, Oil Price Shock are modeled with specific alternative paths for: - Real GDP growth, Inflation, Primary balance, Effective interest rate (see stress-test figures for year-by-year values). - Contingent liabilities from government guarantees scenario example: - Primary balance path includes a sharp deterioration (example shown: 2017 primary balance -8.4 percent in contingent liabilities path in stress-test figure). - Oil price shock example: - Primary balance path shows deterioration relative to baseline (e.g., primary balance in oil price shock: -1.0, -1.9, -1.6, -1.2, -0.8, -0.4 across 2016–2021 in stress-test figure). *Source: IMF staff.* ### Appendix VII. Malaysia—Capital Flow Volatility ### Appendix VII. Malaysia—Capital Flow Volatility ### Experience with capital flow volatility - Malaysia experienced several episodes of elevated capital flow volatility since the global financial crisis, largely triggered by external events. - Beginning in 2009:Q2 inflows surged, peaking at cumulative inflows of 26¼ percent of GDP by the time of the taper tantrum in May 2013. - Foreign holdings of domestic debt securities reached near-peak levels around May 2013. - Major outflow episodes: - Taper tantrum in May 2013. - Outflows as oil prices fell sharply. - Summer 2015 bout due to domestic political instability and uncertainty related to the outlook for China. - Volatility following the US presidential results. - Associated dynamics during outflow episodes: - Currency depreciation. - Short-lived increases in MGS yields. - Loss of reserves. - The bout following the US election results had a stronger exchange rate depreciation and a larger increase in yields, with larger outflows from equity and bond markets; impact on reserves was more muted. - Instruments and reserve dynamics: - Capital inflows into the MGS market and, until end-2014, into BNM bills coincided with an increase in international reserves. - BNM bills were used in monetary policy but also sold to foreign investors during inflow surges; issuance of BNM bills has declined since end-2014 and foreign investors have increased holdings of MGS. ### Stress scenario overview - The stress scenario is an extreme tail-risk scenario, analogous to the GFC: sharp slowdown in global growth and a sell-off by foreign investors. - Scenario outcomes assumed: the currency depreciates and the current account surplus narrows. - Baseline external financing needs: - External financing needs reflect short-term debt and amortization of medium- and long-term debt amounting to 38 percent of GDP. - In the baseline, external financing needs are met by debt and net equity inflows. ### Stress scenario assumptions (explicit) - Exchange rate depreciation assumed: 25 percent. - Bond yields assumed to increase: 200 basis points. - Stock market decline assumed: 30 percent. - Specific capital outflow assumptions and impacts (values at end-2016, in US dollars, billions): - Foreign holdings of MGS: Value at end-2016 = 39.3; assumed fall by 50 percent (in ringgit) → estimated outflows = 14.7 - Calibrated on 50 percent decline during the GFC. - 200 basis point increase in yields estimated to reduce ringgit value of MGS by 8.5 percent (assumption: 5-year bond trading at par). - Exchange rate depreciation of 25 percent implies additional losses for foreign investors. - Short-term debt rollover: Value at end-2016 (medium table shows 16.4) assumed rollover ratio declines to 70 percent → estimated outflows = 4.9 - Calibrated based on decline in short-term debt between September 2009 and March 2010. - Exchange rate depreciation of 25 percent implies losses for foreign investors. - Non-resident deposits: Value at end-2016 = 19.2; assumed fall by 30 percent → estimated outflows = 4.7 - Calibrated based on short-term debt assumption. - Assumed primarily denominated in local currency, implying exchange-rate related losses. - Foreign holdings of equities (22.6 percent participation at end-2016): Assumed decline by 20 percent in ringgit terms (falling participation to 18.1 percent share) → estimated outflows = 10.1 - Assumed stock market decline of 30 percent (smaller than 45 percent during GFC). - Exchange rate depreciation of 25 percent implies additional losses. - Offsetting inflows and other assumptions: - Current account balance: assumed to decline to zero in the stress scenario → offsetting inflows = 0 (current account projection for 2017 in table shown as 4.5; stress assumption reduces to 0). - Net FDI flows: no change assumed (offsetting reductions in gross inflows and outflows are assumed) → 0 impact. - Repatriation by domestic institutional investors: overseas assets conservatively estimated at 3.1 percent of GDP, equivalent to US$8.6 billion → creates an inflow of US$8.6 billion (repatriation of overseas assets). - Estimated net impact: - Shortfall compared to the baseline = US$25.9 billion. - Shortfall as percent of GDP = 8.6 percent. - Estimated reserves, at end 2017 = 68.7 (table label: US$ billions implied). - Notes on assumed market responses: - A 200bps increase in bond yields implies a reduction in bond prices of 8.5 percent (assumption: 5-year bond trading at par). - Foreign investors seeking to reduce holdings of MGS would face capital losses from sale of bonds and valuation loss from exchange rate depreciation. - Given initial MGS holdings of US$39.3 billion, a 50 percent reduction in holdings, accounting for capital and exchange rate losses, implies an outflow of US$14.7 billion. ### Stress test results and mitigating factors - Malaysia’s balance sheet strengths and exchange rate flexibility help support resilience to capital outflows. - Key mitigating elements: - Flexible exchange rate that allows expenditure switching. - Forex intervention capacity. - Response of domestic institutional investors reallocating on-shore and off-shore assets into the MGS market when yields rise. - Consequence: these factors mitigate the impact of capital flow reversals but would also lead to some decline in reserves. - Capacity for additional domestic holdings of government debt (Table 2 summary, percent of GDP): - Employees Provident Fund (EPF): Total assets 55.1; repatriation/flow entries and total indicate contribution to capacity (table rows show stock/flow details summing to a total of 4.2 percent of GDP capacity). - Banks and "Others (KWAP, Khazanah, TLH, PNB)" contribute to the sub-total leading to a total additional domestic capacity of 4.2 percent of GDP. ### External debt sustainability: summary findings - External debt level and composition: - Staff estimate: external debt rose moderately to about 68 percent of GDP by end-2016. - Data as of 2016:Q3 showed external debt at 72 percent of GDP, but capital outflow and valuation effects during Q4 2016 led staff to estimate end-2016 stock at about 68 percent of GDP. - The rise in the external debt-to-GDP ratio in the first nine months of 2016 was driven by valuation effects. - Increase reflects higher nonresidents’ holdings of domestically-issued medium- to long-term Malaysian government securities and higher private sector offshore borrowings. - Share of short-term debt fell further; short-term debt accounted for about 39 percent of total external debt as of 2016:Q3. - Debt denominated in domestic currency accounted for about 40 percent of total external debt as of 2016:Q1. - Net international investment position: - Surplus as of 2016:Q3. - Surplus declined to about 3 percent of GDP from about 8½ percent of GDP as of end-2015 (on the back of capital inflows). - Official reserves stood at about 45½ of GDP. - Net direct investment assets amounted to about 1½ of GDP. - Net portfolio liabilities accounted for nearly 38 percent of GDP. - Medium-term projection: - Under the baseline, the external debt-to-GDP ratio falls to about 55 percent by 2021. - Baseline macro assumptions are broadly unchanged since the 2016 Article IV consultation. - Malaysia enjoys a sustained current account surplus over the medium term, though at levels lower than the historical average. - Share of short-term debt (by original maturity) projected to gradually decline to about one-third of total external debt by the end of the medium term. - Net international investment position projected to grow as CA surpluses persist. ### DSA stress test outcomes - Standard DSA stress tests indicate external debt remains manageable under a variety of shocks. - Key scenario outcomes: - Exchange rate depreciation scenario: debt ratio would rise close to 90 percent of GDP on impact, then fall to about 73 percent of GDP by 2021. - Permanent CA balance shock or combined interest rate, growth, and CA shock: external debt-to-GDP ratio remains closer to 65 percent of GDP over the medium term. - Selected DSA metrics and projections (Table 1 key lines, in percent of GDP unless otherwise indicated): - Baseline: external debt (staff estimate) by year: 2012 = 62.6; 2013 = 65.7; 2014 = 63.1; 2015 = 65.6; 2016 = 68.1; 2017 = 66.8; 2018 = 63.4; 2019 = 58.9; 2020 = 56.9; 2021 = 54.9. - Change in external debt (yearly): 2012 = 5.8; 2013 = 3.1; 2014 = -2.6; 2015 = 2.4; 2016 = 2.6; 2017 = -1.3; 2018 = -3.4; 2019 = -4.5; 2020 = -1.9; 2021 = -2.1. - Identified external debt-creating flows (2012–2021 examples): 2012 = -4.6; 2013 = -4.6; 2014 = -6.6; 2015 = 1.9; 2016 = -4.6; 2017 = -5.8; 2018 = -5.3; 2019 = -4.7; 2020 = -4.1; 2021 = -3.8. - Current account deficit, excluding interest payments (2012–2021 examples): 2012 = -6.3; 2013 = -4.6; 2014 = -5.5; 2015 = -4.2; 2016 = -3.7; 2017 = -3.7; 2018 = -4.2; 2019 = -4.4; 2020 = -4.1; 2021 = -4.0. - Gross external financing need (in billions of U.S. dollars, 2012–2021): 2012 = 106.3; 2013 = 122.9; 2014 = 132.2; 2015 = 139.1; 2016 = 120.9; 2017 = 122.1; 2018 = 123.2; 2019 = 124.7; 2020 = 125.2; 2021 = 132.4. - Gross external financing need (as percent of GDP): 2012 = 33.8; 2013 = 38.0; 2014 = 39.1; 2015 = 46.9; 2016 = 40.8; 2017 = 39.4; 2018 = 36.4; 2019 = 33.2; 2020 = 30.5; 2021 = 29.5. - Key macro assumptions underlying the baseline (selected): - Real GDP growth (in percent): 2016 = 4.8; 2017 = 4.8; five-year projections include values around 4.9 to 4.8. - GDP deflator in U.S. dollars (change in percent): 2016 = 5.1; 2017 = 3.7 (comparison table shows values). - Nominal external interest rate (in percent): 2016 = 2.9; 2017 = 4.0 (comparison table). - Growth of exports (U.S. dollar terms, in percent): 2016 = 4.2; 2017 = 4.6. - Growth of imports (U.S. dollar terms, in percent): 2016 = 4.1; 2017 = 4.4. - Current account balance, excluding interest payments (in percent of GDP): 2016 = 3.4; 2017 = 4.1. - Net nondebt creating capital inflows (in percent of GDP): 2016 = 0.1; 2017 = 0.2. *Source: IMF staff calculations and analysis in “Appendix VII. Malaysia—Capital Flow Volatility” (cr17101).* ### Appendix IX. Malaysia—Household Debt ### Appendix IX. Malaysia—Household Debt ### Overview - Household debt remains high and represents a key vulnerability. - Macroprudential measures since 2010 were targeted at sources of systemic risk and have supported the resilience of the banking system. - Measures in July 2013 tamed the accumulation of debt, especially from the non-bank sector. - Household financial assets amounted to 183 percent of GDP at end-2015. - Footnote breakdown of household financial assets: - deposits: 43 percent of household financial assets - unit trust accounts: 6.3 percent - equities: 14 percent - EPF balances: 30.8 percent - insurance policies: 5.9 percent ### Credit quality - Banking sector credit quality has steadily improved with more stringent underwriting standards leading to reductions in NPLs by loan vintage. - Overall banking system household NPLs remain low at 1.1 percent. - Distribution of household debt by monthly income: - 24%: < RM 3,000 - 21%: RM 3,000 to 5,000 - 55%: > Rm 5,000 - Over half the debt is owed by higher income households (income above RM 5,000 per month) but about one-quarter is owed by lower income borrowers including some highly leveraged households. ### Housing-related debt - Housing-related debt accounts for about half of household debt. - House price growth has moderated and is now close to its two-decade average of about 5.5 percent. - Prior years saw several years of elevated growth and rapid increases in the price-to-rent and price-to-income ratios. - Risks: - The risk of a sharp decline in house prices should be carefully monitored. - Risk is circumscribed by ongoing supply constraints, increases in public sector salaries, Malaysia’s relatively young labor force, and urbanizing population. - Loan-to-value (LTV) concentrations: - Close to 30 percent of outstanding loans have an LTV ratio above 80 percent. - Policy consideration: - If rapid house price growth resumes, LTV caps on second and first mortgages could be considered. ### Personal lending - From the perspective of the financial sector, credit risk is reduced as most lending is to public sector employees and is serviced through automatic salary deductions. - Nevertheless, this segment continues to pose a risk. ### Household debt by financing purpose (percent) - Residential: 49% - Hire purchase: 15% - Personal financing: 15% - Non-residential: 8% - Securities: 6% - Credit card and others: 7% ### Household debt by lender 2007–2015 (qualitative) - Charts and staff calculations indicate shifts among lenders (banking system, THLD, DFIs, other NBFIs) over 2007–2015 measured as percent of GDP; macroprudential measures and non-bank sector actions influenced these shares. *Source: IMF staff compilation of Appendix IX. Malaysia—Household Debt* ### 5. Despite the challenging global environment, the Malaysian economy continues to perform ### 5. Despite the challenging global environment, the Malaysian economy continues to perform ### Economic performance in 2016 - Real GDP growth: 4.2 percent in 2016 (2015: 5.0 percent), led by private sector activity. - Private investment growth: 4.4 percent in 2016 (2015: 6.4 percent); slowdown in oil and gas investment offset by capital spending in services and manufacturing. - Inflation: 2.1 percent (2015: 2.1 percent). - Unemployment: 3.5 percent (2015: 3.1 percent). - Current account balance: surplus of 2.1 percent of GNI. - International reserves: USD95 billion at end February 2017, sufficient to finance 8.5 months of retained imports and are 1.1 times short term external debt. - Private consumption supported by continued wage and employment growth and Government measures. ### 2017 outlook and drivers - Projected growth for 2017: 4 - 5 percent, supported by continued expansion in domestic demand and an improving external environment. - Key growth drivers: private sector activity, on-going implementation of infrastructure projects, capital spending in manufacturing and services. - External environment: expected improvements in growth prospects of major economies and higher commodity prices. - Exports: between November 2016 and January 2017, exports grew by 10.6 percent, supported by higher external demand for manufactured goods and commodities. - Inflation expectation: higher in 2017, primarily reflecting pass-through of the increase in global oil prices into domestic retail fuel prices. ### Risks and authorities' assessment - Primary downside risks: uncertainties in the external environment and policies of major economies. - Authorities' resilience factors: diverse economic structure and strong fundamentals; capacity to undertake necessary policy measures in the event of shocks. - Upside potential: higher growth in major economies could increase demand for Malaysia’s exports; faster recovery in oil and commodity prices could encourage more mining investment and higher oil-related income. ### Adjusting to external shocks and exchange rate dynamics - Balance sheet strengths and exchange rate flexibility enhance resilience to capital outflows; stress tests indicate external debt remains manageable under a variety of shocks. - Ringgit depreciation: between May 2016 – February 2017, the ringgit depreciated by 12 percent against the US dollar. - BNM interventions: where needed, Bank Negara Malaysia (BNM) intervened and provided liquidity to prevent excessive exchange rate volatility. - Late-2016 developments: ringgit volatility intensified and the exchange rate moved well beyond levels consistent with fundamentals, influenced by imbalances in onshore FX demand and supply and speculative activity in the offshore NDF market. - Authorities’ view: imbalances are not self-correcting and a comprehensive long term approach is required to strengthen resilience to external headwinds. ### Measures to develop onshore foreign exchange markets (authorities' stance) - Authorities view IMF staff recommendation to reconsider the measures introduced on 5 December 2016 as inappropriate and prematurely prejudging intent and effect. - Policy intent: measures were implemented for development of onshore FX market and were purely prudential in nature; they do not limit flow of funds in and out of Malaysia. - Rationale and key features: - Part of a comprehensive strategy to develop a highly liquid and deep FX market commensurate with economic growth and needs of businesses and investors; also strengthens financial market resilience. - Data on non-resident holdings of government bonds indicate non-residents are not hindered in investment activities and can freely liquidate and exit. - Conversion of export proceeds into ringgit aims to address structural imbalances of supply and demand for foreign currencies in the onshore FX market; exporters may hold more than 25 percent of export proceeds in foreign currency if they have a business need; reconversion at the same rate with no additional cost to exporters. - Measures streamline rules relating to investment in foreign currency assets to mitigate potential systemic risk from residents with domestic ringgit borrowing; residents without domestic ringgit borrowings can invest in foreign currency assets onshore and offshore up to any amount. - Prudential limit aligns with IMF’s view that macroprudential measures are designed to limit systemic financial risk and maintain financial system stability. ### Observed outcomes since policy introduction - Onshore FX market volumes: recorded daily average volume of USD9.2 billion across all types of FX transactions, with spot and forward market transactions, particularly for ringgit currency pair, of above USD2 billion, similar to the level recorded in December 2016. - NDF market: NDF volume has reportedly declined by 75 percent; adverse spillovers have been curtailed; several global and regional financial institutions no longer participate and have undertaken orderly liquidation of outstanding positions. - Exchange rate volatility and transaction costs: average ringgit intraday movement narrowed to around 61 points from an average of 82 points in December last year; bid-offer spread narrowed to 20 points in January. - Trade flow balance: much improved balance between export and import related flows since measures were introduced. ### Authorities’ critique of IMF staff assessment - The IMF has not recognized members’ need for flexibility to preserve macroeconomic and financial stability; staff recommendation to reconsider measures deemed premature and not supported by a thorough assessment. - Authorities emphasize: - Malaysia’s openness to trade means excessive ringgit volatility can be destabilizing; authorities must have tools to respond to risks. - Structural imbalances and destabilizing influence of unregulated and opaque NDF market will not self-correct; other central banks have highlighted this issue. - Staff’s recommendation is contradictory to staff acknowledgments that liquidity normalized, spot volatility came down, and bid-ask spreads declined, and to the suggestion that “BNM should keep the new FX market measures under review”. ### Monetary policy - Overnight Policy Rate (OPR): reduced by 25 basis points to 3.00 percent in July 2016 after being maintained since July 2014. - Policy intent: reduction intended to ensure monetary accommodativeness consistent with balance of risks to growth amid stable inflation. - March 2017 MPC assessment: at current OPR level, degree of monetary accommodativeness is consistent with policy stance to support growth amid stable core inflation. - Monetary operations: BNM will continue to ensure liquidity sufficient to support orderly functioning of domestic financial markets and will closely assess risks to growth and inflation in deciding policy stance. ### Fiscal policy - Fiscal consolidation anchor: medium term fiscal policy well anchored on achieving a near-balanced federal budget by 2020. - Fiscal deficit: declined to 3.1 percent of GDP in 2016 and projected to reach 3 percent in 2017. - Federal government debt: reduced to 52.7percent of GDP in 2016 (2015: 54.5 percent of GDP). - Federal government foreign currency debt: 1.9 percent of GDP or 3.6 percent of total outstanding federal government debt. - Debt profile: about 70 percent of debt with maturities more than three years. - Expenditure and capital: - Operating expenditure: 4.5 percent decline in 2016 (2015: -1.2 percent), driven by lower expenditure on supplies and services and subsidies. - Net capital development spending: increased by 12.5 percent in 2016 (2015: 2.2 percent). - Revenue and tax policy: - GST impact: collection of GST is expected to increase by 3.9 percent to account for 18.2 percent of total revenue in 2017. - Ongoing initiatives to improve GST collection and enhance effectiveness of GST framework while minimizing leakage through enhanced enforcement and coordination. - Introduction of the new corporate income tax aimed at enhancing tax efficiency and stimulating business growth, including SMEs. - Subsidy reforms and social measures: - Comprehensive subsidy rationalization since 2011, including full removal of fuel subsidies in 2014 and subsidy cuts for sugar and cooking oil. - Replacement with more targeted assistance to low income group; 2017 Budget measures include increased direct cash transfers; supply- and demand-side measures to increase construction and purchasing of affordable houses; additional personal income-tax relief. - Contingent liabilities: - Growth in contingent liabilities declining since 2011. - About 36 percent of outstanding guarantees given to entities undertaking public transportation infrastructure projects. - Guarantees to the National Higher Education Fund Corporation (PTPTN) accounted for about 22 percent of total guarantees. - Repayment risks from PTPTN loans generally contained and further mitigated with listing of loan defaulters in the Central Credit Reference Information System. - Institutional capacity: - Fiscal Risk and Contingent Liability Technical Committee established in May 2016 to evaluate and propose measures to manage fiscal risks and contingent liabilities. - Authorities appreciated Fund’s TA on Spending Reviews and look forward to TA on Public Investment Management Assessment in April 2017. ### Financial stability - Overall assessment: Malaysian financial sector robust and continues to support the economy; near-term risks to financial stability remain low and contained. - Banking sector strengths: strong capital buffers, adequate provisioning and liquidity, stable funding conditions. - Asset quality: NPLs remain low; impaired loans of households at 1.1 percent of total banking sector loans. - Household sector: - Financial assets account for two times the debt level at the aggregate level. - About 41 percent of borrowers of newly approved loans have debt service ratios of less than 40 percent. - Mortgage and property markets: - Growth in aggregate house prices moderated since end-2013 following macroprudential measures. - Risks of oversupply in office space and shopping complex segments exist, but impaired loans ratio for these segments low at 1.3 percent as at end-2016. - Authorities view current macroprudential measures as sufficient but stand ready to act pre-emptively. - Corporate funding and resilience: - Funding of Malaysian business predominantly sourced domestically: 74.2 percent from domestic financial institutions and capital market, denominated in ringgit. - Aggregate corporate debt growth: 8.6 percent in 2016. - Banking system domestic exposures to oil and gas related sectors (including water transport): about 5 percent of business loans and 6 corporate bond holdings, or about 14 percent of total capital of banks. - Stress tests: excess capital of banks sufficient to cover more than two times the potential losses from simulated shocks (exchange rate, borrowing costs and earnings). - Corporate financial metrics (nine months ending September 2016): median interest coverage ratio (ICR) of 9.4 times; cash to short term debt ratio at 1.2 times. - Corporate debt-at-risk: 7.7 percent (2015: 6.2 percent) for the same period; increase mainly attributed to firms in automotive, real estate and oil and gas sectors and within BNM’s expectations. *IMF — cr17101, section 5* ### 25. Malaysia remains committed towards meeting its five year National AML/CFT Strategic Plan ### 25. Malaysia remains committed towards meeting its five year National AML/CFT Strategic Plan ### Strengthening AML/CFT framework and supervision - Malaysia remains committed to meeting its five year National AML/CFT Strategic Plan objectives. - 2016 focus areas: - Strengthening risk assessment on threats of serious crimes. - Increased vigilance on vulnerable sectors: money services businesses and designated non-financial businesses and professions. - Adequate resource prioritization for increased supervision and surveillance. - In line with international efforts to combat terrorism and proliferation financing: - Several guidance documents on Targeted Financial Sanctions relating to terrorism financing were issued to reporting institutions for greater clarity and better reporting. ### Reforms to enhance growth potential (policy framework and objectives) - Reforms are guided by the 11th Malaysia Plan (2016-2020), which aims to: - Accelerate Malaysia’s transformation into a high-income economy by 2020. - Promote more inclusive growth and raise productivity and competitiveness. - Social inclusion measures: - Important strides made in reducing poverty and inequality through anti-poverty and rural development programs focused on inclusion, livelihood and employment. - Removal of blanket subsidies accompanied by more targeted measures to assist low- and middle-income groups. ### Productivity and targets - Productivity background: - Productivity has generally increased in recent years but lags behind advanced economies. - Malaysia has set a productivity growth target of 3.7 percent per year from 2016 to 2020. - Productivity-boosting focus areas: - Accelerating innovation and entrepreneurship. - Leveraging advancements in technology. - Inculcating green technology. ### Human capital development - Key initiatives: - Malaysian Education Blueprint (2013-2025): elevate quality of school education via curriculum transformation, improve quality of teachers, and increase English proficiency. - Malaysia Education Blueprint (Higher Education) 2015 – 2025: outlines 10 strategic shifts to enhance higher education. - Redesigning Higher Education agenda: focuses on holistic student assessment methods, greater academia-industry collaboration, empowering and enhancement of work-based learning programmes. - Efforts to increase appeal of technical and vocational education and training to attract school leavers and improve workforce participation via upskilling of unemployed, female and elderly workers. - Outcome: - Graduate employability improved to 77.3 percent in 2016 (2012:74.4 percent). ### Long-term planning: Transformasi Nasional 2050 (TN50) - TN50: a 30-year national development initiative spanning 2020-2050. - The TN50 policy document will be published in early 2020 and will outline economic, social, cultural and environmental targets for 2050. - Engagement with various stakeholders is underway to develop targets that provide continuity in developmental goals beyond 2020. ### Final remarks: external risks and policy priorities - External environment: - The external economic and financial environment will remain fraught with uncertainty and risks. - As a small and highly open economy, Malaysia is highly exposed to external developments. - Authorities’ priorities: - Remain vigilant. - Strengthen macroeconomic fundamentals. - Build up policy buffers. - Reduce imbalances. - Pursue proactive and well calibrated policies, supported by robust policy frameworks, to preserve macroeconomic and financial stability and achieve sustainable and inclusive growth. *IMF staff report excerpt.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17101.pdf_