## cr1861 ## Source details **Canonical URL:** [cr1861](https://www.imf.org/-/media/files/publications/cr/2018/cr1861.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr1861.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr1861.pdf.json) --- ### Economic performance and near-term outlook - Real GDP growth: - Estimated at 5.8 percent for 2017 (4.2 percent in 2016). - Projected to be 5.3 percent in 2018. - Projected to converge to a potential rate of close to 5 percent in the medium term; 5.0 percent projected for 2019. - Output gap and demand drivers: - 2017 growth exceeded potential, implying a small positive output gap. - Growth in 2017 driven by domestic demand: private consumption, private investment, and public consumption. - Employment and wage gains, stronger global demand for electronics, and improved commodity terms of trade supported activity. - Net exports’ contribution weakened due to growth in final and intermediate goods imports. - Inflation and credit: - Headline consumer price inflation: 3.8 percent in 2017 (2.1 percent in 2016); expected to moderate to 3.2 percent in 2018. - Core inflation (excluding food and energy): 1.6 percent in 2017 (2.6 percent in 2016); expected 2.2 percent in 2018 and 2.6 percent in 2019. - Private sector credit growth: 6.4 percent in 2017; projected 5.8 percent in 2018 and 5.6 percent in 2019. - Credit-to-GDP ratio: 129.7 in 2017; projected 126.4 in 2018 and 123.7 in 2019. - Broad money growth: 4.9 percent in 2017; projected 8.5 percent in 2018 and 8.0 percent in 2019. - House prices: 5.1 percent in 2017; projected 5.0 percent in 2018 and 5.2 percent in 2019. ### External sector and external position - Current account and balances: - Current account surplus: 2.8 percent of GDP in 2017; projected 2.4 percent of GDP in 2018 and 2.2 percent of GDP in 2019. - Current account balance (US$ billions): 8.9 in 2017; projected 8.3 in 2018 and 8.5 in 2019. - Current account gap (EBA): 2.4 percent of GDP in 2017; implies a real exchange rate undervaluation of about 5 percent (staff estimate). - Balance of payments and reserves (US$ billions): - Goods balance: 27.1 in 2017; projected 28.6 in 2018 and 30.7 in 2019. - Services balance: -5.0 in 2017; projected -5.8 in 2018 and -6.4 in 2019. - Income balance: -13.3 in 2017; projected -14.4 in 2018 and -15.8 in 2019. - Capital and financial account balance: 3.6 in 2017; projected 2.7 in 2018 and 3.2 in 2019. - Gross official reserves: 102.4 in 2017; projected 113.3 in 2018 and 125.0 in 2019. - Total external debt (US$ billions): 217.3 in 2017; projected 221.2 in 2018 and 227.5 in 2019. - Total external debt (percent of GDP): 69.1 in 2017; projected 63.0 in 2018 and 58.6 in 2019. - External sector assessment highlights: - NIIP about 1.7 percent of GDP in 2017Q3 (2016: about 5¼ percent of GDP). - Total external debt about 67¾ percent of GDP in 2017Q3 (2016: 69 percent of GDP); about two-thirds in foreign currency and 44 percent short-term. - REER: year-to-date average depreciated nearly 2 percent relative to 2016 annual average; REER remains about 14 percent depreciated from its 2013 level. - Under IMF composite reserve adequacy metric (regime classified as “floating”), official reserves at about 118 percent of the metric in 2017. ### Fiscal and public sector metrics - Federal and consolidated balances (percent of GDP): - Federal government overall balance: -3.0 in 2017; projected -2.8 in 2018 and -2.5 in 2019. - Consolidated public sector overall balance: -5.0 in 2017; projected -3.5 in 2018 and -3.0 in 2019. - Revenue and expenditure (percent of GDP): - Revenue: 16.7 in 2017; projected 16.6 in 2018 and 16.6 in 2019. - Expenditure and net lending: 19.8 in 2017; projected 19.3 in 2018 and 19.1 in 2019. - Federal government non-oil primary balance: -3.6 in 2016 and -3.6 in 2017; projected -3.5 in 2018 and -3.0 in 2019. - Debt and GDP: - General government debt: 54.2 percent of GDP in 2017; projected 53.6 in 2018 and 52.4 in 2019. - Nominal GDP (ringgit, billions): 1,352 in 2017; projected 1,467 in 2018 and 1,584 in 2019. - Nominal GDP (2017, est.): US$314.4 billion. - Fiscal consolidation design (staff baseline): - IMF staff baseline envisages fiscal consolidation of 1.3 percent of GDP evenly across 2018–22. - Under baseline, federal government debt would remain below 55 percent of GDP in the near term and fall below 45 percent of GDP by 2022. - Illustrative tax/expenditure adjustment (percent of GDP; staff illustrative): - Revenues (A) total: 1.5 - GST: 1.1 - removal of exemptions: 0.35 - increase in rate (assumes a 1.5 percentage point increase in the rate from 6.0 percent to 7.5 percent): 0.75 - Income tax (streamlining investment incentives): 0.3 - Service fees: 0.1 - Expenditure (B): -0.2 - Subsidy rationalization: 0.3 - Extra social and development spending: -0.5 - Total balance improvement (=A+B): 1.3 - Fiscal risk management: - Loan guarantees by the federal government stand at 16 percent of GDP (monitoring recommended). - Recommendation to integrate detailed accounts and annual fiscal risks statements into the budget process and complete accrual fiscal accounting implementation. ### Monetary policy, exchange rate, and FX market development - Monetary policy stance and indicators: - Bank Negara Malaysia policy rate: 3.00 percent (OPR kept at 3 percent since July 2016; bias signaled in November 2017 toward reduced accommodation). - Recommendation: If leading indicators suggest emerging inflationary pressures, the policy rate should be increased. - January 2018: MPC raised OPR by 25 basis points to 3.25 percent (authorities’ reporting). - Reserves and external debt: - BNM gross official reserves: about US$102 billion as of end-2017 (102.4 in staff tables). - Reserves described as "adequate" but closer to lower bound if adjusted for BNM’s forward book. - About one-third of external debt denominated in ringgit. - FMC and onshore FX market measures: - December 2, 2016 FMC package and subsequent measures (April/May, September, November 2017) aimed to deepen onshore FX market, liberalize hedging, extend trading hours, revise reference USD/MYR methodology, and introduce Code of Conduct. - Outcomes reported: increased hedging opportunities, improved turnover in onshore spot/forward/swap FX markets, narrowed bid-ask spreads, reduced ringgit volatility, decline in offshore NDF liquidity, and less-concentrated foreign positioning in the bond market. - Authorities’ view: measures are developmental/prudential, not CFMs, and have yielded positive outcomes (higher liquidity, narrowed spreads, increased net FX conversion). - Staff view: communicate strategy for onshore FX market development, address gaps, and phase out recent capital flow management measures while preserving financial stability. ### Financial sector conditions and macroprudential considerations - Financial soundness indicators: - Overall corporate sector NPLs: 2.7 percent. - Household NPLs: 1.4 percent of gross loans to households. - Household debt: 84.6 percent of GDP in 2017 (84.6 in 2017Q3 reported). - Primary homeowners share among mortgage holders: about 85 percent. - Investment property mortgages share: 3 percent of total. - LTV ratios for investment properties: 70 percent for individual owners of 3 properties or more; 60 percent for all legal entities. - Overhang of unsold houses: at a 10-year high at end 2017Q3. - Risks to monitor: - Household large mortgage exposures and oversupply in residential and commercial property sectors with potential spillovers to banks and nonbank creditors. - Exposures in real estate sector and household mortgages pose downside risk. - Possible macroprudential measures: - Risk weights and lending limits targeting construction sector. - Measures to encourage developers to lease unsold housing stock. - Sector-wide LTVs (on second and first properties) and debt service to income limits to supplement existing measures. - Consider higher risk-weighting for loans to unhedged borrowers to contain FX-related risks. - Authorities’ stance: - Authorities view financial sector risks as monitored and contained; no further macroprudential measures needed at that point. - Authorities developing holistic solutions for property market, including legislation for residential rental market and the second National Housing Policy. ### Labor market, productivity, and structural reforms - Labor and social indicators: - Unemployment rate: 3.4 percent in 2017; projected 3.2 percent in 2018 and 3.0 percent in 2019. - Population (2017, mid-year): 32 million. - GDP per capita (2017, current prices, est.): US$9,808. - Poverty rate (2016, national poverty line): 0.4 percent. - Adult literacy rate (2015): 94.6 percent. - Main exports (share in total goods exports, 2016): electrical & electronic products (36.5 percent), and commodities (13.5 percent). - Productivity agenda: - Malaysia Productivity Blueprint (MPB) launched May 2017; 11th Malaysia Plan (11MP, 2016–20) focuses on productivity and innovation. - 11MP targets 3.7 percent annual labor productivity growth. - Five MPB thrusts: building workforce of the future; driving digitalization and innovation; making industry accountable for productivity; forging a robust ecosystem; securing a strong implementation mechanism. - Targeted subsectors: nine subsectors including retail and food & beverages; agro-food; and chemicals and chemical products. - Policy priorities: - Encourage female labor force participation, improve education quality, expand vocational and technical training, reduce skills mismatches, encourage R&D, update public infrastructure and regulatory framework, and ensure market-based reforms to foreign labor policies. - Measures to support female participation include tax incentives for employer-provided childcare, flexible work arrangements, and fiscal shifts; Budget 2018 measures noted: increased maternity leave duration in private sector and temporary tax exemptions for women with career breaks. ### Risks to the outlook - External downside risks: - A global retreat from cross-border integration. - Structurally weak growth in advanced economies. - A significant China slowdown. - Tighter global financial conditions and policy uncertainty in advanced economies. - External upside risks: - Speedy approval and implementation of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). - Possibly lingering strong global demand for electronics. - Domestic risks: - Confidence effects related to cyclical upturn could be stronger than anticipated (upside). - Abrupt real estate price adjustment could cause macro-financial spillovers (downside). - Vulnerabilities in household mortgages and property development sector require vigilance. - Balance of risks: - Overall risks to the outlook assessed as balanced. ### Public and external debt sustainability (DSA and external debt framework) - Public debt DSA (high-level findings): - Debt-to-GDP ratio projected to decrease to below 45 percent by 2022 under staff baseline. - Under constant primary balance (no consolidation), debt remains broadly constant at about 50 percent of GDP. - Under most macro-fiscal stress tests, debt-to-GDP remains below 60 percent; oil price shock scenario can raise debt toward about 70 percent. - Contingent liability shock (government absorbs guaranteed loans totaling 15 percent of GDP over two years) could raise debt above 55 percent of GDP. - Stochastic simulations: 90th percentile of debt-to-GDP simulations is below 60 percent. - DSA numeric highlights (selected projection table entries preserved): - Nominal gross public debt: 52.7 (2017), 50.7 (2018), 50.1 (2019), 48.9 (2020), 47.6 (2021), 46.1 (2022). - Public gross financing needs: 9.9 (2017), 10.7 (2018), 7.7 (2019), 7.0 (2020), 7.0 (2021), 7.1 (2022). - Real GDP growth (in percent): 4.2 (2017), 5.8 (2018), 5.3 (2019), 5.0 (2020), 4.9 (2021), 4.7 (2022). - Primary deficit (years shown): 1.2 (2017), 1.1 (2018), 0.9 (2019), 0.4 (2020), 0.0 (2021), -0.3 (2022). - External debt and gross external financing needs (selected): - External debt (staff estimate path): 69.1 percent (2017); 63.0 percent (2018); 58.6 percent (2019); 55.9 percent (2020); 53.9 percent (2021); 54 (table entry formatting preserved as in source for later cell). - Gross external financing need (US$ billions): 123.3 (2017); 133.7 (2018); 135.0 (2019); 135.7 (2020); 137.7 (2021); 140.8 (2022). - Gross external financing need (percent of GDP): 39.2 (2017); 38.1 (2018); 34.8 (2019); 32.0 (2020); 29.7 (2021); 28.1 (2022). - External debt stress-test results: - Under a one-time real exchange rate depreciation shock, external debt-to-GDP would rise sharply to close to 90 percent on impact and subsequently fall to about 77 percent by 2022. - If CA balance permanently lower or combined interest rate/growth/CA shock occurs, external debt-to-GDP would remain between 56 and 67 percent over medium term. ### Main policy recommendations and guidance summary - Fiscal policy: - Follow a gradual consolidation path as envisaged under staff’s baseline, consistent with authorities’ public debt anchor. - Prioritize revenue-based consolidation to facilitate measures important for external rebalancing (broadening the tax base, eliminating GST exemptions, and eventual GST rate increase). - Continue progress on fiscal structural agenda, strengthen fiscal transparency and risk management, integrate fiscal risks statements, and improve project appraisal and gatekeeping. - Monetary and exchange rate policy: - Maintain monetary policy and exchange rate flexibility as the first line of defense against shocks. - Current bias toward reduced monetary policy accommodation is appropriate; raise policy rate if leading indicators suggest emerging inflationary pressures. - In event of capital inflow surge, combine further reserve accumulation with some exchange rate appreciation. - Financial markets and capital flows: - Communicate strategy on onshore FX market development, address gaps, and phase out recent capital flow management measures while maintaining financial stability. - Build on Financial Markets Committee successes to address further gaps. - Financial sector and macroprudential policy: - Closely monitor household mortgage and property development exposures. - Consider macroprudential measures (risk weights, lending limits, sector-wide LTVs, DTI limits) and encourage development of rental real estate market. - Structural reforms: - Accelerate reforms to improve labor market outcomes, productivity, and investment in line with the 11th Malaysia Plan (11MP) and Malaysia Productivity Blueprint (MPB). - Priority measures: encourage female labor force participation, improve education quality, reduce skills mismatches, encourage R&D, and update public infrastructure and regulatory framework. - Other: - Continue implementation of AML/CFT and anti-corruption measures; strengthen public asset declarations and anti-corruption institutions. *International Monetary Fund — Staff Report for the 2018 Article IV Consultation (Mission dates: November 28‒December 8, 2017; Data used in this report are as of January 24, 2018).* ### 5.8 percent for the year, driven by domestic demand and robust exports. While headline ### cr1861 - 5.8 percent for the year, driven by domestic demand and robust exports. While headline ### Economic performance and near-term outlook - Real GDP growth: - Estimated at 5.8 percent for 2017 (4.2 percent in 2016). - Projected to be 5.3 percent in 2018. - Projected to converge to a potential rate of close to 5 percent in the medium term; 5.0 percent projected for 2019. - Output gap and demand drivers: - 2017 growth exceeded potential, implying a small positive output gap. - Growth in 2017 driven by domestic demand: private consumption, private investment, and public consumption. - Employment and wage gains, plus stronger global demand for electronics and improved commodity terms of trade, supported activity. - Net exports’ contribution weakened due to growth in final and intermediate goods imports. - Inflation: - Headline consumer price inflation: 3.8 percent in 2017 (2.1 percent in 2016). - Headline inflation expected to moderate to 3.2 percent in 2018. - Core inflation (excluding food and energy): 1.6 percent in 2017 (2.6 percent in 2016); expected 2.2 percent in 2018 and 2.6 percent in 2019. - Increase in headline inflation in 2017 mainly reflected higher oil prices; core inflation remained contained. - Credit and financial conditions: - Private sector credit growth: 6.4 percent in 2017; projected 5.8 percent in 2018 and 5.6 percent in 2019. - Credit-to-GDP ratio: 129.7 in 2017; projected 126.4 in 2018 and 123.7 in 2019. - Credit-to-GDP gap estimated to decline to 3.2 percent of GDP in 2017 (9.4 percent in 2016). - Broad money growth: 4.9 percent in 2017; projected 8.5 percent in 2018 and 8.0 percent in 2019. - House prices: 5.1 percent in 2017; projected 5.0 percent in 2018 and 5.2 percent in 2019. ### External sector - Current account: - Estimated current account surplus: 2.8 percent of GDP in 2017. - Projected to soften to 2.4 percent of GDP in 2018 and 2.2 percent in 2019. - Current account balance (in billions of U.S. dollars): 8.9 in 2017; projected 8.3 in 2018 and 8.5 in 2019. - Balance of payments and reserves: - Goods balance (US$ billions): 27.1 in 2017; projected 28.6 in 2018 and 30.7 in 2019. - Services balance (US$ billions): -5.0 in 2017; projected -5.8 in 2018 and -6.4 in 2019. - Income balance (US$ billions): -13.3 in 2017; projected -14.4 in 2018 and -15.8 in 2019. - Capital and financial account balance (US$ billions): 3.6 in 2017; projected 2.7 in 2018 and 3.2 in 2019. - Gross official reserves (US$ billions): 102.4 in 2017; projected 113.3 in 2018 and 125.0 in 2019. - Total external debt (US$ billions): 217.3 in 2017; projected 221.2 in 2018 and 227.5 in 2019. - Total external debt (in percent of GDP): 69.1 in 2017; projected 63.0 in 2018 and 58.6 in 2019. ### Fiscal and public sector metrics - Federal government overall balance (percent of GDP): -3.0 in 2017; projected -2.8 in 2018 and -2.5 in 2019. - Consolidated public sector overall balance (percent of GDP): -5.0 in 2017; projected -3.5 in 2018 and -3.0 in 2019. - Revenue (percent of GDP): 16.7 in 2017; projected 16.6 in 2018 and 16.6 in 2019. - Expenditure and net lending (percent of GDP): 19.8 in 2017; projected 19.3 in 2018 and 19.1 in 2019. - Federal government non-oil primary balance (percent of GDP): -3.6 in 2016 and -3.6 in 2017; projected -3.5 in 2018 and -3.0 in 2019. - General government debt (percent of GDP): 54.2 in 2017; projected 53.6 in 2018 and 52.4 in 2019. - Nominal GDP (in billions of ringgit): 1,352 in 2017; projected 1,467 in 2018 and 1,584 in 2019. - Nominal GDP (2017, est.): US$314.4 billion. ### Labor market and social indicators - Unemployment rate: 3.4 percent in 2017; projected 3.2 percent in 2018 and 3.0 percent in 2019. - Population (2017, mid-year): 32 million. - GDP per capita (2017, current prices, est.): US$9,808. - Poverty rate (2016, national poverty line): 0.4 percent. - Adult literacy rate (2015): 94.6 percent. - Main exports (share in total goods exports, 2016): electrical & electronic products (36.5 percent), and commodities (13.5 percent). ### Risks to the outlook - External downside risks: - A global retreat from cross-border integration. - Structurally weak growth in advanced economies. - A significant China slowdown. - External upside risks: - Speedy approval and implementation of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). - Possibly lingering strong global demand for electronics. - Domestic risks: - Confidence effects related to the cyclical upturn could be stronger than anticipated (upside). - Exposures in the real estate sector and household mortgages pose a downside risk. - Vulnerabilities in household mortgages and the property development sector require vigilance. ### Main policy recommendations - Fiscal policy: - Follow a gradual consolidation path as envisaged under staff’s baseline, consistent with the authorities’ public debt anchor. - Prioritize revenue-based consolidation to facilitate measures important for external rebalancing. - Continue progress on fiscal structural agenda, including strengthening fiscal transparency and risk management. - Monetary and exchange rate policy: - Current bias toward reduced monetary policy accommodation is appropriate. - If leading indicators suggest emerging inflationary pressures, the policy rate should be increased. - Monetary policy and exchange rate flexibility should remain the first line of defense against shocks. - Financial market and capital flows: - Communicate strategy on onshore FX market development addressing existing gaps and phasing out recent capital flow management measures while maintaining financial stability. - Build on Financial Markets Committee (FMC) successes to address further gaps in financial market development. - Financial sector and macroprudential policy: - Closely monitor risks related to household mortgages and property development sectors. - Consider macroprudential measures to mitigate these risks. - Encourage development of a rental real estate market. - Structural reforms: - Focus on improving labor market outcomes, productivity, and investment within the context of the authorities’ 11th Malaysia Plan (11MP). - Priority measures: encourage female labor force participation, improve quality of education, reduce skills mismatches, encourage R&D, and update public infrastructure and regulatory framework to support private investment. ### Key statistics (selected from Table 1) - Real GDP (percent change): 2013: 4.7; 2014: 6.0; 2015: 5.0; 2016: 4.2; 2017: 5.8; 2018: 5.3; 2019: 5.0. - Total domestic demand (percent change): 2017: 6.4; 2018: 5.8; 2019: 5.3. - Private consumption (percent change): 2017: 7.0; 2018: 6.2; 2019: 5.6. - Private investment (percent change): 2017: 9.2; 2018: 8.0; 2019: 8.0. - Household debt (in percent of GDP): 2017: 84.6; 2018: 82.5; 2019: 80.7. - Nonfinancial corporate sector debt (in percent of GDP): 2017: 104.2; 2018: 103.1; 2019: 102.1. - CPI inflation (annual average, percent): 2017: 3.8; 2018: 3.2; 2019: 2.8. - CPI inflation excluding food and energy (annual average, percent): 2017: 1.6; 2018: 2.2; 2019: 2.6. - Overnight policy rate (in percent): 2017: 3.00. - Malaysian ringgit/U.S. dollar (period average): 2017: 4.31. *International Monetary Fund — Staff Report for the 2018 Article IV Consultation (Mission dates: November 28‒December 8, 2017; Data used in this report are as of January 24, 2018).* ### 0.2 percent of GDP in 2017, after a sharp drop of 2.5 percentage points of GDP in 2016. ### cr1861 - 0.2 percent of GDP in 2017, after a sharp drop of 2.5 percentage points of GDP in 2016. ### External position and current account - The external position "remains stronger than the level consistent with fundamentals and desirable policies," unchanged from the July 2017 External Sector Report. - The current account (CA) surplus is estimated at 2.8 percent of GDP in 2017, compared to 2.4 percent of GDP in 2016. - The current account gap, based on the IMF’s External Balance Assessment (EBA), is 2.4 percent of GDP, implying a real exchange rate undervaluation of about 5 percent. - Malaysia recorded a small net financial outflow in the first three quarters of 2017, reflecting: - lower net FDI inflows relative to a year ago, and - large nonresident portfolio debt outflows in 2017Q1. - Nonresident portfolio debt inflows resumed since 2017Q2. - Relative to end-2016 levels: - bilateral and real effective exchange rates have appreciated, - Treasury yields have stabilized, and - the stock market has registered gains. - The real effective exchange rate remains about 14 percent depreciated from its 2013 level, reflecting in part the impact of negative terms-of-trade shocks. ### Outlook and macroeconomic projections - Growth: - Growth is projected at 5.3 percent in 2018 and should remain above potential that year. - Growth is expected to decelerate from its 2017 peak and converge to its potential rate of close to 5 percent in the medium term. - Over the medium term, growth should converge to long-term trend supported by capital accumulation, improvement in total factor productivity, and gains in female labor force participation. - Inflation: - Core inflation should edge up to 1.9 percent in response to a positive output gap. - Headline inflation is expected to moderate to 3.2 percent in 2018. - Current account: - The current account surplus is expected to decline to 2.4 percent of GDP in 2018, as export growth normalizes. - Labor and capital dynamics: - The capital/labor ratio should continue to rise over the medium term as firms respond to labor’s rising share in income. - Risks to the outlook are balanced: - Main near-term external upside risk: strong global demand for electronics lasting longer than expected. - Downside external risks: policy uncertainty and tighter global financial conditions in advanced economies, potential spillovers to domestic financial markets, and financial stress for indebted households and corporations. - Main domestic risks: confidence effects stronger than anticipated; abrupt real estate price adjustment causing macro-financial spillovers. - Medium-term downside risks: global retreat from cross-border integration, structurally weak growth in advanced economies, and a significant China slowdown. - Medium-term upside risk: speedy approval and implementation of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). ### Authorities’ views (overview) - Authorities broadly agreed with staff’s assessment of the economic outlook and risks. - They expected growth to remain strong at 5–5.5 percent in 2018, mainly driven by domestic demand. - They expected inflation to moderate to 2.5–3.5 percent in 2018, with core inflation largely stable. - Over the medium term, they saw growth at 5–6 percent, with risks mainly external. - On the external sector assessment, authorities continued to see limitations in the IMF’s analytical framework given weak explanatory power of the current account regression model for Malaysia. ### Fiscal policy: stance, projections, and recommendations - Staff expects the authorities’ federal budget deficit target of 2.8 percent of GDP for 2018 to be met. - Budget components for 2018: - Revenue is budgeted to fall by 0.2 percent of GDP (largely due to a conservative estimate of GST collection). - Expenditure is budgeted to fall by 0.4 percent of GDP (driven by lower development expenditure and a lower wage bill). - The consolidated public sector deficit is projected to fall by 1.5 percent of GDP in 2018, reflecting an improved operating surplus of Petronas and lower development spending. - Medium-term fiscal consolidation: - IMF staff’s baseline projection envisages a fiscal consolidation of 1.3 percent of GDP evenly spread across 2018-22. - Under this path, federal government debt would remain below 55 percent of GDP in the near term and fall below 45 percent of GDP by 2022. - Malaysia has large external financing needs (about 39 percent of GDP). - Composition of consolidation: - Consolidation to date (2016–17) has been largely driven by expenditure reduction. - Recommendation: shift emphasis toward revenue measures, starting by broadening the tax base (including eliminating GST exemptions) and subsequently raising the GST rate. - Recommended tax/expenditure adjustments (illustrative; percent of GDP): - Revenues (A) total: 1.5 - GST: 1.1 - removal of exemptions: 0.35 - increase in rate (assumes a 1.5 percentage point increase in the rate from 6.0 percent to 7.5 percent): 0.75 - Income tax (streamlining investment incentives): 0.3 - Service fees: 0.1 - Expenditure (B): -0.2 - Subsidy rationalization: 0.3 - Extra social and development spending: -0.5 - Total balance improvement (=A+B): 1.3 - Other fiscal recommendations: - Further cuts in subsidies (including for liquefied petroleum gas, and fuel for fisheries and public transportation) and better targeting of social spending (e.g., health and education). - Increase cost recovery in health and higher education; minimize duplications in public programs. - Enhance fiscal transparency and fiscal risks management: - Fully integrate yearly communication of a more detailed set of accounts and annual fiscal risks statements into the budget process. - Explicit medium-term framework to identify risks and develop mitigation strategies. - Strengthen monitoring of contingent liabilities: loan guarantees by the federal government stand at 16 percent of GDP. - Progress to complete implementation of accrual fiscal accounting and undertake targeted spending reviews. - Improve project appraisal processes and strengthen gatekeeping role of central agencies in project selection. ### Monetary policy, exchange rate, and financial markets - Monetary policy: - Bank Negara Malaysia (BNM) has maintained an accommodative stance with its policy rate kept unchanged at 3 percent since July 2016. - In November 2017, BNM signaled a bias toward reduced accommodation, justified by above-potential growth but stable core inflation and no signs of financial sector stress. - Recommendation: Should leading indicators suggest the emergence of inflationary pressures, the policy rate should be increased. - Reserves and external debt: - BNM’s gross official reserves were about US$102 billion as of end-2017. - Reserves are "adequate" per the IMF’s Adequacy of Reserves metric (still adequate, but closer to the lower bound, if adjusted for BNM’s forward book). - Malaysia’s external debt-to-GDP ratio has stabilized since end-2016 after rising by about 13½ percentage points in the previous seven years. - About one-half of the increase in external debt was driven by a rise in nonresident investment in Malaysia’s local-currency debt market. - External borrowing by nonfinancial corporations has also increased in recent years. - Standard stress tests indicate external debt-to-GDP would remain close to baseline under various shocks except under an exchange rate depreciation shock. - About one-third of external debt is denominated in ringgit. - Compared to the median peer country, Malaysia’s external financing vulnerabilities are higher due to: - high amortization-to-GDP ratio, - lower share of FDI liabilities in gross external liabilities, and - slightly above-average potential claims on FX reserves from non-FDI liabilities. - Monetary policy and exchange rate flexibility should be the first line of defense; in event of a capital inflow surge, a combination of further reserve accumulation and some exchange rate appreciation would be appropriate. - Financial market developments and FX measures: - Financial Markets Committee (FMC) measures in July 2016 and thereafter revised the methodology for the reference USD/MYR exchange rate, extended trading hours on the onshore market, and revised the Code of Conduct for market participants (final policy document issued April 2017). - Selected outcomes and effects of December 2016 FMC FX market measures: - Some measures enhanced onshore FX risk management by liberalizing hedging (increasing FX liquidity onshore by requiring conversion of export proceeds to ringgit; extending prudential limits on foreign currency investments by residents with domestic ringgit borrowing to exporters). - Strengthened enforcement on banks’ non-involvement in offshore ringgit transactions. - Following these measures: - Hedging opportunities and supply of foreign exchange onshore both increased. - Turnover in the onshore spot, forward, and swap FX markets improved. - Bid-ask spreads narrowed and ringgit volatility declined. - Most banks stopped quoting non-deliverable ringgit forwards (NDF) offshore and liquidity in the NDF market fell sharply. - Foreign positioning in the bond market became less concentrated in very short maturities. - Some measures imposed compliance costs on market participants and may have temporarily protracted the portfolio capital outflow episode. - Capital flows and nonresident holdings: - Malaysia experienced higher capital flow volatility than its median peer since the Global Financial Crisis. - By October 2016, nonresident holdings in conventional Malaysian Government Securities (MGS) were 52 percent of the outstanding stock (17 percent of GDP); this share fell after the November 2016 US presidential election. - In 2017Q1, nonresidents’ share in MGS holdings fell to 38.5 percent by March 2017. - Malaysia’s weight in the JP Morgan GBI EM global diversified index was reduced from 9 percent at end 2016 to 7½ percent at end March 2017, and further to 5.6 percent as of December 2017. - Nonresident inflows into the MGS market resumed in the second quarter of 2017 and by December 2017 nonresidents’ share in the MGS market had risen to about 45 percent of the outstanding stock. - The equity market received net capital inflows in most months, although much smaller than debt markets. ### Policy guidance summary - Fiscal: - Proceed with gradual, revenue-based fiscal consolidation to reduce debt and address large external financing needs. - Prioritize broadening tax base (including elimination of GST exemptions) and eventual GST rate increase, streamline investment incentives, and rationalize subsidies. - Strengthen fiscal transparency, fiscal risks statements, and medium-term fiscal framework. - Monetary and FX: - Maintain monetary policy and exchange rate flexibility as first line of defense; consider reducing accommodation if inflationary pressures emerge. - Use reserves and exchange rate movements as needed to manage disorderly market conditions or capital flow surges. - Financial markets: - Improve onshore FX market functioning and hedging facilities; monitor costs and benefits of FX market measures and their impact on nonresident participation. - Structural: - Accelerate structural reforms to boost medium-term growth and assist external rebalancing (including public investment in physical and human capital, improvements in social protection, and reforms to encourage female labor force participation). *International Monetary Fund. Publication: cr1861.* ### 2017. The FMC continues to monitor financial market developments and, in consultation with market ### cr1861 - 2017. The FMC continues to monitor financial market developments and, in consultation with market ### Onshore FX market development and FMC role - Recent measures in November 2017 aimed to deepen the onshore financial market (Appendix VIII). - A comprehensive approach towards onshore market development would have potential benefits; the FMC provides an appropriate forum for BNM to consult market participants and the private sector. - The FMC should: - Articulate a high-level strategy based on broad market consultation. - Communicate the strategy to the public to enhance predictability and build confidence. - Ensure continued reliance on exchange rate flexibility and macroeconomic policy adjustments as the first line of defense against capital flow shocks. - Address existing gaps in market development and phase out recent capital flow management measures while preserving financial stability. - Market participants identified specific gaps: - Transaction costs associated with extensive documentation requirements. - Lack of liquidity in the forward market beyond very short-term (3-6 months) instruments. - To contain financial stability risks from exporters’ possible unhedged ringgit borrowing, authorities could consider alternative direct measures, such as higher risk-weighting for loans to unhedged borrowers by banks. ### Authorities’ views on FMC measures and market functioning - Authorities view current approach toward development of onshore FX markets as appropriate and effective. - They argued FMC measures successfully ensured an orderly and efficient functioning of onshore FX markets by addressing foreign currency imbalances arising from speculative activities. - Authorities did not see the recent measures as imposing excessive costs and pointed to continued healthy and improving onshore transaction volume throughout 2017 as evidence. - They did not view late 2016 measures as capital flow management measures, arguing they were not targeted to limit capital flows and did not have a sustained negative impact on market sentiment. - Authorities attributed the decline in MGS weight in JP Morgan’s GBI EM Global Diversified Index mainly to a broadening of the index’s country coverage. - Authorities disagreed with staff’s recommendation to phase out these measures, stressing the importance of preserving policy flexibility and remaining vigilant in implementing necessary policies to ensure efficient FX market functioning. ### Financial sector conditions and key statistics - Overall assessment: The financial sector is robust and overall risks appear contained. - Key indicators and statistics: - Overall corporate sector NPLs: 2.7 percent. - Sector FX borrowing: currently at 26 percent of total debt. - Household debt: 84.6 percent of GDP in 2017Q3. - Household NPLs: 1.4 percent of gross loans to households. - Primary homeowners share among mortgage holders: about 85 percent. - Investment property mortgages share: 3 percent of total. - LTV ratios for investment properties: 70 percent for individual owners of 3 properties or more; 60 percent for all legal entities. - House purchase transactions with foreign buyers: 1-2 percent of transactions only, in the 1 million ringgit and up segment where foreigners are allowed to buy. - Overhang of unsold houses: at a 10-year high at end 2017Q3. - Observations: - A large share of increased FX borrowing consists of intercompany loans and trade credits, which are subject to lower rollover risk and more favorable terms. - Most mortgages in Malaysia carry variable interest rates (that can adjust monthly), exposing holders to interest rate risk. - Supply of commercial retail space is expected to reach historic highs in coming years. - Banks’ direct exposure to developers remains low and is closely monitored by the BNM. ### Risks, monitoring, and possible macroprudential measures - Risks to monitor closely: - Households’ large mortgage exposures (nearly half of households’ total indebtedness). - Oversupply in residential and commercial property sectors and potential spillovers to banks and nonbank creditors. - Possible measures to mitigate financial stability risks: - For housing development market: risk weights and lending limits targeting the construction sector; measures encouraging developers to lease housing stock that remains unsold for an extended period. - To encourage rental market: reform regulations pertaining to rents and tenant-landlord relationships; consider granting developers tax exemptions for rental income on leasing units (within approved government budget envelope). - On mortgage lending: sector-wide LTVs (on the second and first properties) and debt service to income limits could supplement banks’ self-imposed measures and the existing limit for borrowers with income under 3,000 ringgits per month. - Recent policy action: authorities announced that high-rise luxury property projects with units with sale value above 1 million ringgits in selected locations will require special permission. - AML/CFT and anti-corruption: - Authorities should continue implementing AML/CFT and anti-corruption measures consistent with past policies and commitments. - Strengthening anti-corruption institutions, publication and robust verification of asset declarations (especially of high-level public officials) in line with international best practices would contribute to goals identified in the 11th Malaysia Plan. - Effective use of AML tools could further support anti-corruption efforts. ### Authorities’ views on financial sector risks and policy stance - Authorities largely agreed with staff’s view on prevailing financial sector conditions and noted: - Risks are monitored closely via stress-testing and other analyses indicating domestic financial stability remains preserved even under extreme scenarios. - Housing market exhibits signs of recovery; oversupply in commercial property segment is being closely monitored. - Banks can manage potential risks to the property market given the small size and sound quality of direct exposures. - Authorities are developing a holistic solution to promote a sustainable property market, including: - Legislation for the residential rental market. - The second National Housing Policy to drive a medium-term strategy. - Given contained domestic financial stability risks amid a favorable economic outlook, authorities view that no further macroprudential or other policy measures are needed at this point. - On AML/CFT: Malaysia Anti-Corruption Commission is periodically reviewing the Malaysian Anti-Corruption Commission Act 2009 and taking steps to strengthen measures following review recommendations. ### Medium-term challenges: labor markets, productivity, and rebalancing - Labor market trends: - Malaysia has recorded employment gains every year for the past three decades; overall unemployment rate largely stable. - Since 2010, higher female labor force participation and foreign worker inflows have expanded the labor force despite slowdown in working-age population growth. - Share of lower-skilled or less-educated workers in total unemployed has continued to decline. - Wage gap between lower and higher skilled/educated workers has declined, helped in part by minimum wage legislation effective in 2013. - Unemployment rate for tertiary-educated workers has been consistently higher than the national unemployment rate for over a decade, suggesting potential skill mismatches at the higher end of the labor market. - Capital deepening: - Capital/labor ratio grew at a faster average pace over 2010–16 compared to 2001–08, though manufacturing has seen a slowdown. - Policy priorities to raise productivity and investment (in line with 11th Malaysia Plan (11MP, 2016–20) and Malaysia Productivity Blueprint (MPB)): - Encourage female labor force participation, particularly for married or less educated women. - Improve quality of education and skills. - Expand vocational and technical training to reduce skill mismatches. - Raise enrollment in higher education (currently low relative to OECD average). - Encourage R&D. - Ensure any reform to foreign labor policies is market-based, clearly communicated, and gradually phased-in. - Update public infrastructure and regulatory framework to improve business environment and support higher private investment. - Recent measures: - Some 2018 Budget measures aim to support higher female labor participation. - Employment Insurance System Act passed to support eligible employees in event of job loss, including re-employment training opportunities, which could help lower private precautionary saving. - Authorities’ stated commitments: - Commitment to achieving high-income status, timing dependent on macroeconomic conditions. - Aspiration to place Malaysia among top twenty nations in economic development, social advancement, and innovation by 2050 (National Transformation Plan 2050). - Commitment to structural reforms, reassessing costs of high presence of low-skilled foreign workers, and investing in and attracting higher-skilled workers. - Continued public investment in soft and hard infrastructure and commitment to trade openness. ### Staff appraisal and policy recommendations - Economic outlook and macro policy stance: - Malaysian economy performing strongly; Real GDP growth likely to grow above potential in 2018 before reverting to potential in medium term. - Despite a small positive output gap, there are no signs of inflationary pressures at present. - Risks to the growth outlook are balanced. - Developments in 2017 suggest Malaysia’s external position remains stronger than warranted by fundamentals and desired policies. - Macroeconomic policies should strike the right balance between stability and growth; forward guidance on fiscal and financial policies should be enhanced. - Fiscal policy recommendations: - Follow a gradual consolidation path; planned pace for 2018 is appropriate to build buffers and maintain financial market confidence. - Fiscal consolidation should prioritize revenue measures: broaden tax base and the GST rate could be raised (for example, in line with staff’s illustrative consolidation measures). - Predominantly revenue-based adjustment would facilitate adoption of measures important for external rebalancing, such as higher social and health spending, and higher public investment. - Scope exists for improvements in fiscal transparency and fiscal risk management and progress on fiscal structural agenda. - Monetary policy: - Current bias toward reduced monetary policy accommodation is appropriate given above-potential growth and stable core inflation; bias signaled by BNM at November 2017 policy meeting is appropriate. - Should leading indicators suggest emergence of inflationary pressures, policy rate should be increased. - Monetary policy and exchange rate flexibility should be first line of defense against temporary shocks, given limited fiscal space. - Onshore market development: - A more holistic approach would have potential benefits; authorities should formulate and communicate a high-level strategy to enhance predictability, build confidence, and explain how BNM measures since late 2016 support developing onshore markets. - Strategy needs to address market development gaps and phase out recent capital flow management measures. - IMF stands ready to help prepare both the strategy and a roadmap to implement it. - Financial sector and housing: - Financial sector risks appear contained but household mortgage and property development exposures require continued review. - To contain risks from a possible real estate price correction, consider measures to strengthen prudential framework and encourage development of a rental market. - Structural reforms: - Emphasis on raising productivity and investment is appropriate and should prioritize improving labor market outcomes. - Step up efforts to achieve productivity targets and labor market reforms in 11MP and MPB: encourage female labor force participation, improve education quality, reduce skill mismatches, encourage R&D, and update infrastructure and regulatory framework. - Continue implementation of AML/CFT and anti-corruption measures. - Operational note: - Staff recommends that the Article IV consultation with Malaysia be held on the standard 12-month cycle. *Source: cr1861 - 2017. The FMC continues to monitor financial market developments and, in consultation with market* ### Box 1. The Malaysia Productivity Blueprint ### Box 1. The Malaysia Productivity Blueprint ### National aspiration and strategic context - Malaysia aspires to become a high-income nation. - The 11th Malaysia Plan (11MP, 2016–20) focuses on inclusive and sustainable development, with productivity and innovation as the main pillars. - The Malaysia Productivity Blueprint (MPB) was launched in May 2017 and describes the strategy to reach productivity targets under the 11MP. ### Diagnosis: role of productivity in growth - The 11MP and the MPB recognize that long-term growth should rely primarily on higher labor productivity. - Since the 1980s, Malaysia’s growth was largely driven by investments in industries and infrastructure; more recently, contributions from productivity declined. - The 11MP targets a 3.7 percent annual growth in national labor productivity. - The plan also targets an increase in labor’s income share, supported by: - higher female labor participation; - higher skilled labor employment; - improvements in education quality; - better alignment of labor skills to industry needs. ### Five thrust areas (national, sectoral, and enterprise initiatives to improve labor productivity) - Building workforce of the future — through national strategic workforce planning, with reduced reliance on low-skill workers. - Driving digitalization and innovation — through technology improvements and digitalization of the economy, including the small and medium enterprises. - Making industry accountable for productivity — reducing reliance on subsidies and linking liberalization efforts and funding mechanisms (including grants and soft loans) to productivity outcomes. - Forging a robust ecosystem — addressing regulatory constraints; building a robust accountability system for effective implementation of regulatory reviews. Immediate priorities include removing non-tariff barriers and improving efficiency in the logistics sector. - Securing a strong implementation mechanism — create a culture that values productivity; strong coordination and an effective governance mechanism. ### Targeted sectors and readiness - Nine subsectors have been identified for productivity improvement given their economic importance and readiness. - These include retail and food & beverages; agro-food; and chemicals and chemical products. *Source: IMF staff estimates.* ### Appendix I. External Sector Assessment ### Appendix I. External Sector Assessment ### Foreign asset and liability position and trajectory - Background: - NIIP averaged around 1¾ percent of GDP since 2010, rising in recent years mainly on valuation effects. - In 2017Q3, the NIIP was at about 1.7 percent of GDP (2016: about 5¼ percent of GDP), consisting largely of official reserve assets, and net portfolio and other investment liabilities. - Total external debt was at about 67¾ percent of GDP in 2017Q3 (2016: 69 percent of GDP), of which about two-thirds was in foreign currency and 44 percent in short-term debt.1/ - Assessment: - The NIIP is expected to rise gradually over the medium term reflecting projected moderate current account (CA) surpluses. - Malaysia’s balance sheet strength along with exchange rate flexibility would help support resilience to a variety of shocks, including potential outflows associated with external liabilities.2/ ### Overall assessment and policy responses - Overall Assessment: - The external position in 2017 is assessed to remain stronger than the level consistent with fundamentals and medium-term desirable policies. - The current account surplus in 2017, as a ratio to GDP, is estimated to be slightly higher than a year ago, following recovery in external demand and improvement in terms of trade. - Potential Policy Responses: - Macroeconomic policy adjustments, including exchange rate flexibility, and structural policies should address existing policy gaps. - The planned fiscal consolidation should be accompanied by further improvements in social protection and higher public healthcare spending. - Address structural bottlenecks (examples cited): labor market frictions (skills mismatch), low female participation, weak education quality. - Further improve physical infrastructure to support a rise in private investment and productivity and help with rebalancing. ### Current account - Background: - Malaysia’s CA surplus declined by about 7½ percentage points of GDP between 2010 and 2016, driven mainly by a decline in national saving, while investment also rose. - In the first three quarters of 2017, the CA surplus, as a share of GDP, was higher at 2.8 percent relative to a year ago. - Surpluses in goods balance are the main contributor; services and income accounts are in deficits. - In 2017, the CA surplus is estimated at 2.8 percent of GDP, with a recovery in exports partly offset by stronger imports owing to a resilient domestic demand. - Assessment: - The EBA CA model implies a 2017 CA norm at 1.2 percent of GDP after cyclical and multilateral consistency adjustments. - The 2017 cyclically-adjusted CA is estimated at about 3.6 percent of GDP, including staff adjustments of 0.1 percent of GDP to cyclical factors arising from changes in the share of commodity exports in Malaysia’s total exports. - This leads to a staff estimated 2017 CA gap of 2.4 percent of GDP (±1.2 percent of GDP), close to 2.3 percent of GDP 2016 CA gap reported in the July 2017 External Sector Report. - The identified policy gaps account for two-fifths of this CA gap, most of which are from external sources.3/ ### Real exchange rate - Background: - As of November 2017, year-to-date average REER was depreciated by nearly 2 percent relative to its 2016 annual average; it had appreciated nearly 4 percent since August 2017. - The REER remains depreciated by about 14 percent from its 2013 level, reflecting impact on the NEER from capital outflows and terms of trade shocks, with the latter contributing to a decline in the CA surplus.4/ - Assessment: - The EBA REER models (index and level based) estimate Malaysia’s REER to be about 28–37 percent below what is warranted by fundamentals and desirable policies. - Usual macroeconomic stresses associated with such undervaluation are absent (for example, high core inflation, sustained wage pressure, or significant FX reserve build up). - Consistent with the assessed CA gap, the REER gap for 2016 was close to -5 percent (± about 2½ percent).5/ ### Capital and financial accounts: flows and policy measures - Background: - Since the Global Financial Crisis, Malaysia experienced significant capital flow volatilities, largely driven by portfolio flows in and out of the local-currency debt market. - After the U.S. presidential election in November 2016, Malaysia experienced intensified portfolio outflows from the government debt market that continued through 2017Q1; these flows have returned since then. - Since late 2016, the Financial Markets Committee and Bank Negara Malaysia have been implementing a series of measures aimed at developing the onshore FX market.6/ - Assessment: - In line with the IMF’s Institutional View on capital flows, exchange rate flexibility and macroeconomic policy adjustments should continue to play the central role in response to capital flow volatility. ### FX intervention and reserves level - Background: - Foreign reserves stood at US$102.4 billion in 2017, an increase of nearly US$8 billion since end-2016. - Malaysia faced significant reserve losses in 2014 and 2015, while in 2016 reserves declined slightly. - Assessment: - Under the IMF’s composite reserve adequacy metric, which uses a binary classification of the exchange rate regime and classifies Malaysia’s regime as “floating”, official reserves, at about 118 percent of the metric, are currently within the adequacy range. - Not all short-term external debt creates a claim on reserves. - In case of disorderly market conditions reserves could be deployed. - In the face of a capital inflow surge, a combination of further reserve accumulation and some exchange rate appreciation would be appropriate. ### Technical background notes (selected points) - Ratios to GDP are based on staff estimates using U.S. dollar values and may vary with the authorities’ data mainly due to different exchange rate assumptions for converting the nominal GDP in U.S. dollar terms. As of 2017Q3, gross external assets were close to 132 percent of GDP.1/ - Close to one-third of external debt is denominated in local currency and largely of medium-term maturity, helping to reduce FX and rollover risks. Malaysia’s local currency external debt reflects holdings of domestically-issued debt (mainly MGS) by nonresident investors (about 12 percent of GDP as of 2017Q3). Short-term FX-denominated debt largely belongs to the banking system and a good portion is matched by short-term foreign currency assets, which is being closely supervised by Bank Negara Malaysia, including through frequent liquidity stress tests. Stress test analysis by staff suggests that the Malaysian economy could be resilient to a large reversal due to the depth of the domestic financial markets and the role of institutional investors.2/ - Since 2000, movements in the REER have been driven almost entirely by the nominal exchange rate rather than inflation differentials.4/ - The REER gap is based on the estimated semi-elasticity of CA to REER at –0.47. The elasticity estimate has been updated from the last assessment.5/ - On December 2, 2016, the Financial Markets Committee (FMC) announced a package of measures aimed at facilitating onshore FX risk management and enhancing the depth and liquidity of onshore financial markets. Additional liberalization measures were announced on April 13, 2017, and further measures were announced in September and November 2017 to help deepen the onshore financial market.6/ *Appendix I. External Sector Assessment* ### Appendix IV. Public Debt Sustainability Analysis ### Appendix IV. Public Debt Sustainability Analysis ### Background - 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 uses a risk-based approach and 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 considering past macro-fiscal volatility; and - (v) a standardized summary of risks in a heat map. ### Macro-fiscal assumptions - Growth is estimated at 5.8 percent in 2017, converging to 4.9 percent in the medium term. - In staff’s baseline projections, federal government deficit is reduced from 3.0 percent of GDP in 2017 to 1.5 percent in 2022. - The projected fiscal consolidation: - Is consistent with the authorities’ targets and supported by structural reforms announced in recent budgets. - Is lower than what is expected under policy commitments. ### Data coverage - Fiscal assumptions in the DSA are based on the federal government budget. - Coverage excludes local and state governments and statutory bodies which typically borrow from the federal government or receive explicit government guarantees; liabilities of these entities are therefore captured in the federal government’s gross debt and stock of loan guarantees. - Borrowing by state owned enterprises, some under federal government guarantees, has increased in recent years and is projected to continue to increase in the medium term. ### Choice of framework - Malaysia’s high level of government debt and gross financing requirement warrants the higher scrutiny framework. - Government gross debt increased sharply in 2009 due to discretionary fiscal stimulus, declining real and nominal growth, and a large fall in oil prices. - Primary deficit has remained high, pushing debt to 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 below 8 percent in the medium term. ### Realism of baseline assumptions and forecast errors - Median forecast error for real GDP growth during 2008−16 is zero. - Median forecast error for GDP deflator is -1.8 percent (staff forecasts more optimistic). - Median forecast error for primary balance indicates a forecast bias of –0.25 percent of GDP (staff projections slightly optimistic), with improvement in later years. ### Feasibility of projected fiscal adjustment - Maximum three-year adjustment in cyclically-adjusted primary balance (CAPB) over the projection period is 1.5 percent of GDP — characterized as ambitious but realistic by cross-country experience. - Maximum level of the primary balance assumed in projections is 0.1 percent of GDP and is reasonable relative to other market-access countries. - Staff considers a no-adjustment scenario to capture implementation risks. ### DSA key findings, scenarios, and stress-test results - Overall conclusion: Malaysia’s government debt-to-GDP ratio remains below 70 percent and GFN remain below 15 percent of GDP under different macroeconomic and fiscal shocks. - Baseline scenario: - Debt-to-GDP ratio projected to decrease to below 45 percent by 2022. - Under the constant primary balance simulation (no projected consolidation), debt remains broadly constant at about 50 percent of GDP. - Macroeconomic stress tests: - Under most macro-fiscal stress tests, debt-to-GDP ratio remains below 60 percent of GDP. - A one standard deviation shock to real GDP growth: debt-to-GDP ratio initially increases about 2 percent by 2020 and declines thereafter. - A combined macro-fiscal shock (higher interest rates and a lower primary balance) would keep debt at about 50 percent of GDP. - Oil price shock: - A permanent oil price shock implies a growing debt-to-GDP profile to about 70 percent in the medium term. - The oil price shock modeled assumes a 1 percent of GDP permanent reduction in oil income, commensurate with a 33 percent decline in oil price, with an amplifying effect that reduces oil companies’ profits by 66 percent. - Under the oil shock scenario, gross financing needs grow to almost 15 percent by the end of the projection horizon. - Contingent liability shock: - Government absorbs all government guaranteed loans totaling 15 percent of GDP over two years, combined with a persistent shock to growth and interest rate increases. - This shock would raise debt-to-GDP above 55 percent of GDP and significantly increase risks. - While low probability, it underscores growing vulnerability from contingent liabilities. - Gross financing needs: - Under all scenarios except the oil shock, GFN remain below 10 percent. - Oil shock scenario raises GFN to almost 15 percent by the end of projections. - Stochastic simulations: - Based on historical volatilities, the 90th percentile of debt-to-GDP simulations is below 60 percent. ### Heat map and risk assessment - Key vulnerabilities: - External financing requirement at 39 percent is above the upper threshold of early warning benchmarks (upper benchmark 15 percent of GDP for GFN? — note: benchmarks listed elsewhere). - Public debt held by foreigners is relatively high at about 30 percent of total. - Low share of foreign currency and short-term debt mitigates some risks. - Large domestic institutional investors who make opportunistic investments are a mitigating factor. - Market perception indicators reported in the DSA (as of January 02, 2018): - EMBIG (bp) and 5Y CDS (bp) referenced; ratings shown: Moody's A1/A3, S&Ps A-/A, Fitch A-/A- (as presented in source table). ### Figure and projection highlights (selected numeric projections from baseline table) - Nominal gross public debt: 48.7 (2016), 52.7 (2017), 50.7 (2018), 50.1 (2019), 48.9 (2020), 47.6 (2021), 46.1 (2022), 44.3 (2023), 42.3 (later year shown). - Public gross financing needs: 9.5 (2016), 9.9 (2017), 10.7 (2018), 7.7 (2019), 7.0 (2020), 7.0 (2021), 7.1 (2022), 7.1 (2023), 7.0 (later year shown). - Real GDP growth (in percent): 4.8 (2016), 4.2 (2017), 5.8 (2018), 5.3 (2019), 5.0 (2020), 4.9 (2021), 4.7 (2022), 4.9 (2023), 4.9 (later year shown). - Inflation (GDP deflator, in percent): 2.4 (2016), 2.0 (2017), 3.9 (2018), 3.1 (2019), 2.8 (2020), 2.5 (2021), 2.7 (2022), 2.6 (2023), 2.4 (later year shown). - Nominal GDP growth (in percent): 7.4 (2016), 6.3 (2017), 9.9 (2018), 8.5 (2019), 8.0 (2020), 7.6 (2021), 7.6 (2022), 7.6 (2023), 7.4 (later year shown). - Effective interest rate (in percent): 4.5 (2016), 4.2 (2017), 4.5 (2018), 5.1 (2019), 5.0 (2020), 5.0 (2021), 5.2 (2022), 5.3 (2023), 5.8 (later year shown). - Change in gross public sector debt (cumulative): -8.4 (cumulative over projection window shown). - Identified debt-creating flows (cumulative): -7.6. - Primary deficit (years shown): 2.8 (2016), 1.2 (2017), 1.1 (2018), 0.9 (2019), 0.4 (2020), 0.0 (2021), -0.3 (2022), -0.7 (2023), -1.2 (later year), cumulative -0.8. - Primary (noninterest) revenue and grants (percent of GDP, cumulative in table): 19.8 (2016), 17.0 (2017), 16.5 (2018), 16.3 (2019), 16.4 (2020), 16.5 (2021), 16.5 (2022), 16.5 (2023), 16.6 (later year), cumulative 98.8. - Primary (noninterest) expenditure (percent of GDP, cumulative in table): 22.6 (2016), 18.2 (2017), 17.6 (2018), 17.2 (2019), 16.8 (2020), 16.5 (2021), 16.2 (2022), 15.8 (2023), 15.4 (later year), cumulative 97.9. - Automatic debt dynamics contribution (cumulative): -6.8. - Real interest rate contribution (years shown cumulative): 0.9 (2016), 1.1 (2017), 0.2 (2018), 0.9 (2019), 0.9 (2020), 1.1 (2021), 1.0 (2022), 1.1 (2023), 1.4 (later year), cumulative 6.4. - Real GDP growth contribution (years shown cumulative): -2.1 (2016), -2.2 (2017), -2.8 (2018), -2.5 (2019), -2.3 (2020), -2.2 (2021), -2.1 (2022), -2.1 (2023), -2.0 (later year), cumulative -13.2. - Residual, including asset changes (cumulative): -0.8. ### Implications and vulnerabilities - The DSA indicates that existing policy and projected consolidation can keep public debt manageable (below 70 percent) under a range of shocks, but large permanent shocks to oil income or realization of contingent liabilities could materially raise debt ratios toward or above policy ceilings. - Contingent liabilities and external financing requirement are notable vulnerabilities: - Contingent liabilities equivalent to 15 percent of GDP absorbed by the government would significantly raise debt. - External financing requirement at 39 percent exceeds upper early-warning thresholds. *Source: IMF staff.* ### 5. A level of debt lower than projected for the medium term would be consistent with the ### cr1861 - 5. A level of debt lower than projected for the medium term would be consistent with the ### Debt ceiling calibration and fiscal stance - Under unchanged policies, a debt level of 34 percent of GDP would allow the overall debt to remain under the ceiling of 55 percent of GDP with 95 percent probability. - Such a level would allow reaction to shocks in the same way as in the last two decades without imposing additional restrictions to policymaking. - Gradual fiscal consolidation is an alternative to raise the probability of maintaining the debt-to-GDP ratio under the 55 percent ceiling. ### Fiscal projections and baseline - Debt has been falling at current deficit levels and is expected to fall, under staff’s baseline projections for the medium term, to 45 percent of GDP as the deficit is expected to fall to 1.5 percent of GDP. - Alternative consolidation paths could also be appropriate depending on the macroeconomic circumstances. ### External debt: recent trends and composition (high-level) - Since 2009, Malaysia’s external debt-to-GDP ratio trended upward, rising by 13½ percentage points of GDP by 2017Q3. - As of end-September 2017, Malaysia’s external debt stood at about 67¾ percent of GDP (2009: 54¼ percent of GDP). - A little more than one-half of the increase since 2009 was due to the rise in portfolio debt liabilities, particularly nonresident investment in Malaysia’s local-currency debt market. - As of September 2017, short-term debt accounted for about 44 percent of total external debt. - Debt denominated in domestic currency accounted for about one-third of total external debt as of 2017Q3. - Malaysia’s net international assets were about 1¾ percent of GDP as of 2017Q3, compared to 5¼ percent of GDP at end-2016. ### Medium-term outlook and stress-test results - Under staff’s baseline scenario, the external debt-to-GDP ratio is expected to decline steadily, falling to about 54 percent by 2022. - Baseline path reflects continued current account (CA) surplus (excluding interest payments). - In the one-time real exchange rate depreciation scenario, the external debt-to-GDP ratio would rise sharply to close to 90 percent of GDP on impact, and subsequently fall to about 77 percent of GDP by 2022. - If the CA balance (excluding interest payments) is permanently lower or the economy is impacted by a combined interest rate, growth, and CA shock, the external debt-to-GDP ratio would remain between 56 and 67 percent over the medium term. - Share of short-term debt is assumed to gradually decline to about one-third of total external debt by the end of the projection period. ### Key macroeconomic projection comparisons (selected) - Real GDP growth (Article IV): 2017: 4.8 percent; 2018: 5.1 percent. - GDP deflator in U.S. dollars (change in percent): 2017: 3.7; 2018: 4.0. - Nominal external interest rate (in percent): 2017: 4.0; 2018: 3.7. - Growth of exports (U.S. dollar terms, in percent): 2017: 4.6; 2018: 6.5. - Current account balance, excluding interest payments (in percent of GDP): 2017: 4.1; 2018: 4.3. (Note: table covers the five-year periods of 2017–21.) ### External Debt Sustainability Framework (highlights) - Baseline: external debt (staff estimate) path: 2017: 69.1 percent; 2018: 63.0 percent; 2019: 58.6 percent; 2020: 55.9 percent; 2021: 53.9 percent; 2022: 5 (table entry appears as "5" under Debt-stabilizing non-interest current account 1/ — preserved as in source). - Gross external financing need (in billions of U.S. dollars): 2017: 123.3; 2018: 133.7; 2019: 135.0; 2020: 135.7; 2021: 137.7; 2022: 140.8. - Gross external financing need (in percent of GDP): 2017: 39.2; 2018: 38.1; 2019: 34.8; 2020: 32.0; 2021: 29.7; 2022: 28.1. ### Determinants of nonresident bond flows — methodology - Model structure: supply and demand for bonds estimated; supply and demand equations identified and estimated via Two-Stage Least Squares (2SLS) with Prais–Winsten transformation to account for autocorrelation. - Quarterly sample: 2005Q1–2017Q2. - Controls used: nominal yield on 1-year US treasury bonds (usrate); consumer price inflation (inflation); general government debt (Debt); depreciation of ringgit/US$ exchange rate (depreciation); standard deviation of daily ringgit/US$ exchange rates within each quarter (stdevfx). - Dummies: PostGFCdummy, TtantrumDummy, PostMeasuresDummy. - 2SLS regression results (summary): - Dependent variables: Bondi (1st Stage); Nonresident flows (2nd Stage). - No. of observations: 70 (Bondi); 69 (Nonresident flows). - R-sq.: 0.67 (Bondi); 0.58 (Nonresident flows). - F-stat.: 9.66 (Bondi). ### Determinants of nonresident bond flows — key empirical findings - Bond yields respond to supply and demand factors as expected; coefficients on fiscal policy variable, US Treasury bond rate, and CPI inflation are of expected sign and statistically significant. - Nonresident flows respond to both domestic/pull and foreign/push factors (global liquidity and risk conditions as captured by the US TB yield and VIX respectively), demonstrating risk aversion. - Nonresident flows are deterred strongly by FX volatility as well as expected depreciation. ### Short-term dynamics and FX volatility (GARCH analysis) - Monthly sample: June 2005 through October 2017. - Method: Standard GARCH(1,1) for exchange rate depreciation/volatility dynamics; regressions include contemporaneous and lagged nonresident flows. - Baseline GARCH specification (columns 1–2) suggests contemporaneous values of nonresident flows are associated with lower exchange rate volatility. - Replacing contemporaneous nonresident flows with lagged values (columns 3–4) makes the relationship statistically insignificant, suggesting nonresident flows per se are unlikely to be a source of FX volatility. *International Monetary Fund — selected passages from the Malaysia staff report (chapters and appendices reproduced above).* ### 7. A third specification was also estimated. To account for other factors that may influence ### 7. A third specification was also estimated. To account for other factors that may influence ### Exchange rate specification and volatility results - A third specification included crude oil price change in equation 4 and postGFCdummy in equation (5). Results are reported in columns 5-6. - Key empirical conclusions (response to Question 2): - Exchange rate behavior demonstrates dependence on past realization of “innovation” and variance (estimates of both 1α and 2α are positive and significant), suggesting that exchange rate volatility in Malaysia has a persistent pattern. - A GARCH model shows no statistically significant positive contribution of nonresident flows to FX volatility (measured by the variance of the ringgit exchange rate). - Crude oil prices have an expected/predictable effect on devaluation and FX volatility has gone up since the start of the GFC. ### Regression and GARCH estimation: selected coefficients and statistics - Dependent variable: depreciation - Coefficients and z scores reported (columns summarized): - Depreciation - constant: -0.0062*** z = -2.80; -0.0054** z = -2.25; -0.0045** z = -2.26 - time: 0.00004 z = 1.45; 0.00005* z = 1.70; 0.00006** z = 2.04 - crude oil price change: -0.064*** z = -4.96 - Heteroskedasticity - dMGS: -0.0006*** z = -3.55 - dMGS lag: 0.00044 z = 1.07; -0.00004 z = -0.15 - postGFCdummy: 0.99** z = 2.15 - ARCH / GARCH terms - arch: 0.23** z = 2.01; 0.23** z = 2.17; 0.19* z = 1.70 - garch: 0.51*** z = 4.74; 0.67*** z = 4.77; 0.5* z = 1.87 - Number of observations: 148; 147 (reported) ### Policy implications from the exchange rate analysis - Given the unambiguously negative impact of FX volatility on nonresident MGS flows: - More FX flexibility could deter speculative flows. - To safeguard against potential large-scale selloffs, wider fiscal/treasury buffers would be advisable, despite the costs associated with keeping them. The latter should be viewed as an insurance premium for lowering the risks associated with large-scale selloffs. ### Appendix VIII — FMC onshore FX market measures (December 2, 2016; May 2, 2017; subsequent announcements) - December 2, 2016 FMC package (measures still in place): - Residents and nonresident institutional investors can dynamically take onshore forward positions on a portfolio basis up to 25 percent of foreign currency or ringgit-denominated assets, without documentary evidence, with a licensed onshore bank or an appointed overseas office. A one-time registration with Bank Negara Malaysia (BNM) is required. - Residents can hedge foreign currency exposures and cancel hedging positions for US$/MYR and CNH/MYR up to an aggregate net open position limit of 6 million ringgits per client per licensed onshore bank without documentary evidence; participants must give a one-time declaration of hedging intent. - From December 5, 2016, resident exporters can retain up to 25 percent in foreign currency proceeds from their exports of goods; the balance should be converted into ringgit with a licensed onshore bank. Exporters can hold or reconvert export proceeds (at zero bid-ask spread if undertaken simultaneously) to meet projected loans, imports, and other current account obligations for up to six months ahead. Converted amounts could be deposited in a special facility, earning 3.25 percent and available until end-2017, subject to further review. (Following the planned review, on December 15, 2017, the BNM announced that this facility will be discontinued at end-2017 and that the outstanding balances in the facility can continue earning 3.1 percent interest up to March 31, 2018.) - Prudential limits on foreign currency (FC) investments by residents with domestic ringgit borrowing were extended to include FC investments onshore and apply to all residents (including exporters) with ringgit borrowing for prudential reasons. - Onshore banks engaging in ringgit foreign exchange transactions must provide attestation of their non-participation or non-facilitation of offshore ringgit trading and obtain attestation from non-resident banks and securities companies of non-participation in offshore ringgit trading; the non-participation requirement dates to 1998. - April 2017 / May 2, 2017 FMC initiatives: - Registered investors can hedge up to 100 percent of their underlying assets and manage an additional 25 percent of FX exposures; framework extended to corporates to hedge up to 100 percent of obligations without documentary evidence (one-time approval from BNM required). - Aggregate net open position limit of 6 million ringgits per client per bank without documentary evidence expanded to include GBP, EUR, and JPY (in addition to US$ and CNH). - Principles for a Fair and Effective Financial Market and a Code of Conduct for Malaysian Wholesale Financial Markets introduced. - Regulated short-selling framework liberalized to allow all residents to participate in short-selling activities to improve liquidity in the conventional MGS market. - Information reporting and settlement infrastructure enhancements: RENTAS to develop segregated securities accounts up to fund manager level for improved reporting, real-time surveillance, and publication of detailed information. - November 17 FMC announcements (BNM Governor speech): - Extend short-selling framework to Malaysian government investment issues (MGII) by both conventional and Islamic banks. - Expand eligible collateral for liquidity operations with BNM to include Bankers Acceptances (BAs) and Negotiable Instruments of Deposits (NIDs) issued by AAA-rated onshore licensed banks. - Introduce Bank Negara Interbank Bills (BNIBs) in ringgit and foreign currency, available to onshore banks through auctions to manage ringgit and foreign currency liquidity and interest rate exposures. ### Appendix IX — Female and non–citizen workers in the labor market - Overview and objectives: - Focus on contributions of female workers and non–citizen workers to Malaysia’s economy in recent years. - The 11th Malaysia Plan (11MP, 2016–20) strategies and targets include boosting productivity, improving labor market efficiency and institutions, encouraging higher female labor force participation, creating more skilled jobs, and reducing reliance on low-skilled non-citizen workers. - Female workforce findings: - Labor productivity growth averaged at about 2 percent per annum over 2001–16. - Over 2010–16, contributions of female workers to employment and economic growth grew faster than males. - Staff finds that contribution from female employment to real GDP growth has more than trebled. Female employment growth more than doubled over 2010–16 compared to 2000–09 and was higher than male employment growth. - The gender gap in average years of schooling has shrunk; gross school enrollment ratios in secondary and tertiary education are higher for females, contributing to a higher share of skilled occupations in female employment. - Female labor force participation rate remains low in absolute terms and relative to male participation and some regional economies and the OECD average. Housework or family responsibility is the dominant factor for women not seeking employment, contributing to a sharp fall in participation rates among women aged 30 years and more. - Policy measures that could help improve female participation include tax incentives for employer-provided childcare, flexible work arrangements, and fiscal shifts (e.g., away from labor to consumption taxes) to boost labor demand. Budget 2018 measures noted: increasing duration of maternity leave in the private sector to match public sector and temporary exemptions from individual income tax for women with a career break of at least 2 years. - Non–citizen worker findings: - Non–citizen workers accounted for about 15½ percent of the labor force in 2016. - The non–citizen labor force is more male, more rural, younger, and with fewer years of schooling than the citizen labor force; non–citizen workers have much higher shares in lower–skilled jobs. - Faster growth in the non–citizen labor force over 2010–16, relative to 2001–09, contributed to an increase in the labor force by about 7 percent, adding an 0.4 percentage points per annum to real GDP growth (direct impact). - Sectoral distribution: non–citizen workers are primarily employed in agriculture, forestry, and fishing; manufacturing; and construction. Non–citizen workers account for significant shares of employment in crude palm oil and electrical & electronics (E&E) sectors. - Geography: Sabah and Selangor together accounted for more than one–half of overall non–citizen employment in 2016. - Observations since the GFC (no causality established): - The wage gap between lower–skilled/less–educated workers and higher–skilled/tertiary–educated workers has shrunk, reflecting implementation of a minimum wage policy from 2013 and relative tightness of the lower–skilled segment of the labor market. - For the entire economy, labor’s share in total income has risen. The capital/labor ratio has grown at a slightly faster pace relative to 2001–08. - Workers with no formal education or with primary education do not seem to have experienced unfavorable unemployment outcomes relative to the national average. Unemployment rate for tertiary–educated workers, majority citizens, has been consistently higher–than–national average and needs attention. - Table excerpt (Selected 11MP targets and actuals) - Real GDP growth (percent, average): 10MP actuals 5.2; 11MP goals 5-6; 2016 actuals 4.2 - Per capita GDP (US$, end of period): 10MP actuals 10,440; 11MP goals 15,690; 2016 actuals 9,850 - Labor’s share of income (percent, end of period): 10MP actuals ~35; 11MP goals 40; 2016 actuals ... - Female labor force participation (percent, end of period): 10MP actuals 54.1; 11MP goals 59; 2016 actuals 54.3 - Share of skilled employment (percent, end of period): 10MP actuals 25.5; 11MP goals 35; 2016 actuals 27.3 - Labor productivity growth (percent, average): 10MP actuals 1.8; 11MP goals 3.7; 2016 actuals 3.5 - Total factor productivity growth (percent, average) 1/: 10MP actuals 1.8; 11MP goals 2.3; 2016 actuals 0.1 - 1/ Staff estimates for the 10th Malaysia Plan period (10MP, 2011–15) and 2016. *MALAYSIA INTERNATIONAL MONETARY FUND* ### 9. Reforming non–citizen worker policies and processes will involve structural shifts in ### 9. Reforming non–citizen worker policies and processes will involve structural shifts in ### Policy rationale and objectives - Malaysia remains an attractive destination for immigrant workers in the region. - As Malaysian citizens become more educated and seek higher–skilled occupations, non–citizen workers can fill vacancies in lower–skilled occupations. - Authorities aim to increasingly rely on higher–skilled non–citizen workers within an overall limit, encourage increased employment in high–skilled jobs, and promote adoption of technology as the economy moves up the value chain. - The overarching aim is to improve productivity while managing the composition of the workforce. ### Phasing, consultation, and market mechanisms - Changes in non–citizen worker policies should be phased in to allow important sectors time to adjust. - Authorities should continue consultation with industries on the pace of adjustment. - Policy design should rely on market–based mechanisms, because fixed numerical limits tend to: - lose relevance over time, and - lead to distortions and/or misreporting. ### Evidence on labor market impacts and trade-offs - A World Bank study found positive impact of immigration on overall employment and wages for Malaysian citizens; however, it also finds that a 10 percent rise in immigration has: - a small negative impact on wages of the less–educated Malaysian workers, and - about five and half times larger negative impact on immigrant workers’ wages. ### Labor force composition and trends (selected statistics) - Female and foreign worker shares have risen in recent years. - Employment growth has kept pace with labor supply, helping maintain a stable overall unemployment rate for nearly a decade and a half. - Higher female labor force participation rates have helped partly offset the impact of slowing working-age population growth on labor supply. - Female labor’s average contribution to real GDP growth has grown faster than males’, reflecting faster growth in female employment and educational attainment. - Despite improvements, the female labor force participation rate remains lower than the OECD average, particularly for women aged 30 years or more; many women remain outside the labor force because of family responsibilities. ### Non–citizen worker characteristics and sector concentration - Non-citizen labor force has a higher share of male, younger, and less educated job seekers than citizens. - Demand for non–citizen workers is relatively greater in agriculture, manufacturing, and construction sectors. - Two states account for the employment of more than half of total foreign workers. - Non–citizen workers’ employment is concentrated in elementary and semi-skilled occupations. ### Wages, capital–labor dynamics, and unemployment patterns - Wages for less-educated/skilled workers have grown relatively faster, reflecting implementation of minimum wages and tightness of these market segments. - The capital–labor ratio has continued to improve as firms adjusted to a rising share of labor income in total income. - The unemployment rate is lower for less-educated workers and highest for tertiary-educated workers. *Source: IMF staff report excerpt (Malaysia Staff Report for the 2018 Article IV Consultation — informational annex).* ### 2017. After depreciating by 5.9% in 2016, the Malaysian ringgit appreciated by around 10.4% ### 2017. After depreciating by 5.9% in 2016, the Malaysian ringgit appreciated by around 10.4% ### Exchange rate and market developments - The Malaysian ringgit appreciated by around 10.4% against the US dollar in 2017 after depreciating by 5.9% in 2016. - The Kuala Lumpur Composite Index increased by 9.4% in 2017, backed by the resumption of capital inflows. ### Growth outlook and drivers (2018 and medium term) - For 2018, the Malaysian economy is projected to expand between 5.0 – 5.5% in line with staff’s estimates. - Domestic demand is expected to remain the key driver of growth, particularly: - Continued expansion in private sector expenditure. - Private consumption as the largest driver, supported by improvements in income and labor market conditions. - Investment sustained by implementation of infrastructure projects and continued capital investment by manufacturing and services firms. - External support: - Favorable global outlook expected to support exports. - Manufactured and services exports to record positive growth, benefiting from strengthening US and euro area growth and continued regional growth. - Higher commodity prices expected to lend support to Malaysia’s current account surplus. - Inflation: - In the medium term, inflationary pressure is expected to moderate. - Improvement in domestic demand will be accompanied by continued expansion in productive capacity, containing potential upward pressures on core inflation. - Headline inflation movement will be affected by uncertain movements in global energy and commodity prices. - Authorities’ view on risks: - Authorities concur that risks to the growth outlook are balanced. - Upside risks: better-than-expected global demand and stronger-than-expected spillovers from the external sector. - Downside risks: external developments, including performance and policies of major trading partners that could affect trade performance and financial market sentiments. ### External position and external debt - Malaysia’s external debt as at end-September 2017: - RM873.8 billion or USD204.7 billion, equivalent to 65% of GDP. - Comparative 2016: RM916.9 billion or USD202.3 billion; 74.5% of GDP. - Debt structure and assets: - About 34% of external debt denominated in ringgit. - Remaining external debt denominated in foreign currency mostly held by banking institutions subject to central bank prudential management. - Malaysia’s external assets are predominantly denominated in foreign currency (95% share). - A significant share of Malaysia’s liabilities are in domestic currency (59.5%). - Non-FDI foreign-currency assets exceed foreign-currency liabilities, limiting potential claim on international reserves from non-FDI liabilities. ### FX measures, authorities’ stance, and market outcomes - FMC measures introduced in December 2016: - Authorities state measures are for development of onshore market and for prudential reasons, not to limit capital flows; should not be classified as capital flow management measures (CFMs). - Authorities disagree with staff’s recommendation to phase out the measures and call for the Fund to apply the Institutional View on Capital Flow pragmatically, taking country-specific circumstances into account. - Authorities assert the measures are part of a comprehensive long-term strategy to develop a highly liquid and deep FX market. - Authorities dispute staff’s claim of no clear strategy and note extensive explanation and communication of measures. - Authorities report wide-ranging engagement with over 3,600 corporations and stakeholders; FMC measures made transparent via press statements, speeches and market updates on BNM’s website. - Specific policy clarifications: a. Conversion of export proceeds into ringgit: - Meant to address structural imbalances of supply and demand for foreign currencies in the onshore FX market. - Requirement does not hinder exporters from holding more than 25 percent of export proceeds in foreign currency if they have genuine business need. - Framework allows reconversion to foreign currency at the same rate with no additional cost to exporters. b. Prudential limit on foreign currency investments by residents with domestic ringgit borrowing: - Aims to mitigate potential systemic risk by managing large investments by residents with domestic ringgit borrowing. - Residents without domestic ringgit borrowings can invest in foreign currency assets onshore and offshore up to any amount. - Authorities’ rebuttals of staff concerns: - Suggestion that exporters with unhedged ringgit domestic borrowing are a source of financial instability is contested. - Claim that measures increased compliance costs or had sustained negative impact on market sentiment lacks evidence, according to authorities. - Reduced foreign investor interest was temporary and reflected intended sell-off by speculative investors; long-term investor interest has resumed. - Reported market outcomes since implementation: - Liquidity in the onshore FX market deepened (higher average daily turnover). - Bid-ask spread narrowed, reducing transaction costs. - Net FX conversion increased significantly, contributing to rebalancing foreign currency demand and supply. - Authorities assert measures have yielded clear positive outcomes. ### Monetary policy - After maintaining the Overnight Policy Rate (OPR) since July 2016, the Monetary Policy Committee (MPC) raised the OPR by 25 basis points to 3.25% in January 2018. - MPC assessment and rationale: - Faster expansion in global growth with more balanced risks. - Domestic economy on a steady growth path; headline inflation expected to average lower in 2018. - Adjustment is pre-emptive to prevent build-up of risks from interest rates being too low for prolonged periods. - Normalization contributes to preserving sustainability of growth while ensuring ample policy space. - At current OPR, the stance remains accommodative and supportive of growth. - MPC will continue to closely assess risks around growth and inflation in deciding future stance. ### Fiscal policy - Fiscal outcomes and projections: - Fiscal deficit declined to 3% of GDP in 2017 and is projected to reach 2.8% in 2018. - Federal government debt projected to be 50.9% of GDP in 2017 (2016: 52.7% of GDP). - Fiscal strategy: - Fiscal consolidation ongoing; Medium-Term Fiscal Framework (MTFF) is principal planning mechanism to optimize fiscal revenues and expenditures. - Fiscal deficit targeted to be gradually reduced during 2018 – 2020 with target to achieve a balanced budget in the next 5 years. - Initiatives implemented: enhancing tax administration and compliance; expenditure rationalization and optimization; strengthening budget management and control; improving fiscal policy institution. - Institutional measures: - 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 Public Investment Management Assessment in April 2017. ### Financial sector resilience and risks - Authorities welcome staff’s assessment that the financial sector is resilient and overall risks are contained. - Stress tests indicate the banking system is resilient to major macroeconomic shocks. - Strengths: strong balance sheets, asset quality, and capital buffers at system and institutional levels. - Remaining risks and authorities’ assessments: a. Household indebtedness: - Concerns mitigated by measures in recent years; household debt recording moderating growth trend for the sixth consecutive year. - Supported by macroprudential measures and prudent underwriting standards. b. Corporate leverage: - Corporate leverage, including external borrowings, supported by sound debt servicing capacity and hedging practices. - Increase in corporate debt in line with economic expansion and financing needs; healthy balance sheets and good debt servicing capacity mitigate concerns. c. Property market imbalances: - Imbalances contained to high-end high-rise residential and commercial property segments. - Banking system’s exposures to higher-risk segments are limited. - Banks have improved credit risk management, risk appetite, and underwriting standards. - BNM developing holistic solutions including legislation for residential rental market and second National Housing Policy. - Macroprudential stance: - Given risks are well-contained amid favorable outlook, BNM views no further macroprudential or other policy measures are needed at this point. - AML/CFT progress: - Malaysia committed to addressing deficiencies and meeting five-year National AML/CFT Strategic Plan objectives. - As at 2017, 80 percent of the action plans have been completed or are in progress to be completed within the estimated timeline. ### Structural reforms to enhance growth potential - 11th Malaysia Plan (11 MP) (2016-2020): - Aims to accelerate transformation into a high-income economy by 2020; main thrust to promote more inclusive growth and raise productivity and competitiveness. - Mid-term review led by Economic Planning Unit started in July 2017 to evaluate progress on targets, initiatives, programs and projects; review will identify gaps and steps needed to improve implementation. - Report of the 11 MP mid-term review will be presented to the parliament by July 2018. - Malaysia Productivity Blueprint (launched May 2017): - Defines five strategic thrusts to raise labor productivity: building workforce of the future; driving digitalization and innovation; making industry accountable for productivity; forging a robust ecosystem; securing a strong implementation mechanism. - Blueprint aims to achieve labor productivity growth target of 3.7% by 2020. - Transformasi Nasional 2050 (TN50): - A 30-year national development initiative in formulation, to provide continuity beyond 2020; engagement underway and policy document to be published in early 2020. - TN50 will outline economic, social, cultural and environmental targets for Malaysia by 2050. ### Conclusion - Malaysia has strong and resilient macroeconomic fundamentals enabling management of current challenges and pursuit of structural reforms. - Strengths: highly diversified economic structure, resilient external position, and policy flexibility. - Continued emphasis needed on enhancing economic resilience and broadening growth sources. - Structural reforms and pre-emptive policy measures are envisaged to provide greater support to Malaysia’s future growth prospects. *IMF staff and authorities content as provided in the source document.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1861.pdf_