## 1mysea2020001

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### Growth and Exports — Recent developments
- Growth
  - Growth is estimated at 4.5 percent in 2019 (4.7 percent in 2018), driven by private consumption.
  - Public investment contracted; net exports contributed to growth as a decrease in exports was more than offset by a sharp decline in capital imports.
- Inflation and credit
  - Headline inflation: 0.7 percent in 2019.
  - Core inflation (staff estimate, excludes food and energy): 1.5 percent year-on-year during January-November 2019.
  - Credit growth moderated with the estimated credit gap closing.
- External and reserves
  - Current account surplus: 3.5 percent of GDP in 2019 (2.1 percent of GDP in 2018).
  - Gross official reserves: US$ 103.2 billion in November 2019 — 115 percent of the ARA metric (adjusted for forward positions: 102 percent).
  - Portfolio investment outflows more than offset FDI net inflows through 2019Q3.
- Policy alignment and authorities’ actions
  - Authorities resumed fiscal consolidation starting with the 2019 budget.
  - Bank Negara Malaysia lowered the policy rate 25 basis points to 3 percent in May 2019 and left it unchanged thereafter (later MPC lowered Overnight Policy Rate to 2.75 percent in January 2020).

### Outlook and risks
- Baseline projections
  - Growth projected at 4.5 percent in 2020.
  - Headline inflation expected to increase to 2.1 percent in 2020.
  - Current account surplus expected to narrow to 2.7 percent of GDP as capital imports resume.
  - Medium-term: growth should converge to potential (4.8 percent) and inflation remain under control.
- Downside risks (tilted to the downside)
  - Vulnerability to escalating trade actions and weaker-than-expected trading partner growth.
  - Abrupt deterioration in market sentiment towards EMs could tighten financial conditions.
  - Contingent liabilities and sharp drops in real estate prices or deterioration in household debt service ability.
  - Domestic policy uncertainty could reduce investment.
- Upside risk
  - A durable truce following the phase-one deal between the US and China.

### Authorities’ views on outlook and policy
- Authorities projected growth at 4.8 percent in 2020 and expected inflation to rebound to about 2 percent in 2020.
- Committed to achieve an average fiscal deficit of 2.8 percent of GDP over 2020-2022.
- Authorities agreed broadly with staff’s debt sustainability analysis and are preparing a Fiscal Responsibility Act and a Debt Management Office.

### Fiscal policy — findings and recommendations
- 2019–2020 fiscal outcomes and plans
  - 2019 budget deficit: 3.4 percent of GDP (2018: 3.7 percent of GDP).
  - 2020 budget deficit target: 3.2 percent of GDP.
  - Wage spending decline from 5.4 to 5.1 percent of GDP (2019 to 2020 budgeted).
  - Total capital expenditure: about 3.5 percent of GDP (unchanged).
  - Tax revenue: broadly unchanged at 11.8 percent of GDP.
  - Non-tax revenues decline from 5.5 to 3.4 percent of GDP (one-off 2019 special dividend from Petronas).
- Medium-term consolidation and debt
  - Federal government debt limit: commitment to keep within 55 percent of GDP.
  - Staff’s illustrative medium-term target: debt decline to 46 percent of GDP by 2025 under continued gradual consolidation.
  - Staff DSA: a standard macro-fiscal shock would bring debt very close to 55 percent of GDP; contingent liabilities could push it above 60 percent of GDP.
  - Recommended: credible medium-term fiscal consolidation plan anchored by specific revenue and expenditure measures.
- Revenue and expenditure measures
  - Priority: revenue mobilization — tax revenue at just below 12 percent of GDP is low.
  - Fund TA to support a Medium-Term Revenue Strategy (MTRS).
  - Build on Tax Reform Committee suggestions (August 2019) to improve tax administration and identify new revenue sources.
  - Consider structured and targeted spending reviews (overlap of social assistance, cost recovery in higher education, duplication in transport and tourism).
- Debt management and procurement
  - Progress: high-level Debt Management Committee (DMC) established May 2019.
  - Planned: create a Debt Management Office within the Ministry of Finance; prepare a Government Procurement Act to enforce open tender procedures.
- Fiscal Responsibility Act (FRA)
  - Staff analytical work suggests keeping debt limit at 55 percent of GDP but applying it more flexibly (allow temporary breaches for large shocks) with clear definitions and complementary fiscal-strengthening measures.

### Monetary, exchange rate, and financial market policies
- Monetary stance
  - Broadly neutral monetary policy stance appropriate; policy should remain data dependent with space to lower policy rate if downside risks materialize.
  - BNM policy rate: lowered 25 basis points to 3 percent in May 2019; MPC lowered Overnight Policy Rate to 2.75 percent in January 2020.
- FX market deepening
  - Measures implemented: enhancing repo market liquidity and flexibility; expanding dynamic hedging; simplifying FX transactions and documentation; enhancing ringgit liquidity beyond local trading hours.
  - FX market turnover increased: Average daily FX transactions USD11.5 billion in 2018 and USD12.2 billion in 2019.
  - Dynamic hedging programme uptake: 84 investors managing USD30 billion in 2018; 104 investors managing USD37 billion in 2019.
  - Policy recommendations: continue deepening onshore FX markets; gradually phase out capital flow management measures with due regard to market conditions; consider publication of FXI data with appropriate lags and aggregation.
- Financial sector stability
  - Banks well capitalized; net impaired loans at 1 percent of total loans in October 2019.
  - Liquidity Coverage Ratio (LCR): 150 percent in October 2019; system-wide NSFR: 108.5 percent in 2019H1.
  - BNM lowered SRR by 50 bps to 3 percent in November 2019.
  - DSIB framework expected to be finalized in 2020.

### Household, housing, and macroprudential risks
- Household debt and housing market
  - Household debt increased from 60.4 percent of GDP in 2008 to 86.5 percent in 2016; stabilized around 82 percent in 2019.
  - Around 54.5 percent of total household debt is residential mortgages in 2019.
  - House price-to-income ratio: 4.1 in 2002 to 5.0 in 2016.
  - Econometric model suggests real house prices remain about 15 percent above fundamentals.
  - Unsold properties concentrated in upper segments: affordable housing considered below RM300,000; unsold units above RM1 million remain high.
- Policy measures and macroprudential recommendations
  - Policy measures: BNM Fund for Affordable Homes (RM1 bn), stamp duty exemptions, youth housing schemes, mortgage guarantees, rent-to-own guarantee support (30 percent of RM3 bn), Home Ownership campaign extensions.
  - 2020 Budget measure: temporary lower foreigner purchase threshold for completed but unsold apartments from RM1 million to RM600,000.
  - Staff recommends expanding macroprudential toolkit: introduce sector-wide LTVs on first and second properties and debt-service-to-income (DSTI) limits for all income groups; initial calibrations non-binding and adjustable.
  - BNM stress tests: banks can withstand a 50 percent decline in property prices per authorities' note; banks maintain capital buffers to absorb 1.5 times potential losses under severe stress.

### External sector, trade diversion, and external debt
- Trade and investment diversion (Jan–Oct/Sept 2019 preliminary findings)
  - Type-I diversion: average share-effect accounts for about 0.4 percent of GDP between January and September 2019 for E&E exports to the US (electronic integrated circuits highlighted).
  - Furniture exports to USA grew 29.5 percent y-o-y Jan–Oct 2019 while furniture exports to China decreased 12.5 percent.
  - Type-II diversion: intermediate E&E exports to Mainland China and Hong Kong SAR combined declined 6.8 percent y-o-y Jan–Oct 2019; compensated by increases to US (10 percent), Taiwan (45 percent), Philippines (21 percent), Vietnam (20 percent).
- Investment diversion and FDI
  - Approved FDI in manufacturing surged 60.8 percent y-o-y (US$ 6.1 billion) in 2019H1; US accounted for US$2.8 billion, China US$1.2 billion.
  - Approved FDI to E&E sector increased to US$3.9 billion in 2019H1 (2018 full year: US$2.6 billion).
  - Note: approved FDI typically takes about 12-18 months to translate into actual investment.
- External debt profile and risks
  - External debt: 60.7 percent of GDP at end-September 2019.
  - Share of FX debt in external debt: about two thirds.
  - Short-term external debt by original maturity: 43 percent of total external debt (about 25 percent of GDP) as of 2019Q3.
  - Gross external financing need: expected to remain above 7 percent of GDP over the medium-term; projected to moderate to about 25 percent of GDP by 2024.
  - Baseline projection: external debt-to-GDP ratio projected to fall to about 48 percent by 2024 under baseline drivers.
  - Stress scenarios: a 30 percent real exchange rate depreciation in 2020 could push external debt over 61 percent of GDP by 2024; contingent liability shock (absorb guarantees totaling 12 percent of GDP over 5 years) could push federal government debt above 60 percent of GDP.
- External position assessment
  - For 2019, external position assessed stronger than warranted by fundamentals and desired policies.
  - Staff CA gap: 3.5 percent of GDP in 2019 (Actual CA: 3.5 percent of GDP; EBA CA Norm: -0.3).
  - Policy implications: maintain exchange rate flexibility, limit FX intervention to disorderly conditions, deepen FX markets, gradually phase out CFMs.

### Structural reforms, governance, and productivity
- Reform agenda and progress
  - Shared Prosperity Vision 2030; progress on Mid-Term Review of the Eleventh Malaysia Plan and Malaysia Productivity Blueprint.
  - IMF staff: Malaysia needs about one additional percentage point of real growth per year above baseline to reach high-income status by mid-2020s.
- Growth-enabling and medium-term productivity measures
  - Simplify state-level procedures for starting a business (Malaysia ranks 12th overall, 126th in starting a business in 2020 Doing Business Index); example: shorten building permit approval from 390 to 90 days.
  - Promote trade openness: conclude domestic approval of the CPTPP and finalize RCEP in 2020.
  - Improve SMEs’ access to alternative financing, especially for manufacturing and innovating SMEs.
  - Enhance education quality and access, expand vocational and technical training, encourage innovation and digitalization, and boost female labor participation via flexible work arrangements and Employment Act amendments.
- Governance and anti-corruption
  - National Centre for Governance, Integrity and Anti-Corruption (GIACC) launched National Anti-Corruption Plan (NACP) in January 2019; 23 of 115 initiatives completed by mid-December 2019.
  - Priority legislative initiatives: procurement reform, freedom of information, independence of anti-corruption institutions, asset declaration requirements, Organizational Anti-Corruption Plans.
- AML/CFT and virtual assets
  - Anti-Money Laundering, Anti-Terrorism Financing and Proceeds of Unlawful Activities Act 2001 (Act 613) applies to virtual asset exchanges; Securities Commission became AML/CFT supervisor of virtual asset exchanges in 2019.
  - Recommendation: ensure all virtual asset service providers listed in international standards are regulated for AML/CFT.

### Key statistics (selected exact figures)
- Real GDP growth: 4.5 percent in 2019 (4.7 percent in 2018).
- Headline inflation: 0.7 percent in 2019.
- Core inflation: 1.5 percent year-on-year (Jan–Nov 2019).
- Current account surplus: 3.5 percent of GDP in 2019 (2.1 percent in 2018).
- Gross official reserves: US$ 103.2 billion in November 2019.
- 2019 budget deficit: 3.4 percent of GDP (2018: 3.7 percent).
- 2020 budget deficit target: 3.2 percent of GDP.
- Wage spending: decline from 5.4 to 5.1 percent of GDP (2019 to 2020 budgeted).
- Total capital expenditure: about 3.5 percent of GDP.
- Tax revenue: 11.8 percent of GDP.
- Non-tax revenues: decline from 5.5 to 3.4 percent of GDP.
- Staff illustrative medium-term target: debt decline to 46 percent of GDP by 2025 under continued gradual consolidation.
- Federal government debt limit: 55 percent of GDP.
- Nominal GDP (2019): US$364 billion.
- Population (2018): 32.4 million.
- GDP per capita (2019): US$11,173.
- Poverty rate (2017, national poverty line): 0.4 percent.
- Unemployment rate (2019): 3.4 percent.
- Main goods exports (2018 shares): electrical & electronics 37.7 percent; commodities 15.6 percent; petroleum products 7.5 percent.
- Household debt (2018): 82.7 percent of GDP; (2019): 82.0 percent of GDP.
- Banks' Financial Soundness Indicators (2019 Q2): Regulatory capital to risk-weighted assets: 18.0; Regulatory Tier 1 capital to risk-weighted assets: 14.7; Nonperforming loans to total gross loans: 1.6; Return on equity: 13.1; Liquid assets to short-term liabilities: 163.6; Loan-deposit ratio: 87.9; Liquidity Coverage Ratio: 153.0.

*Source: IMF staff report chapter "1. Growth and Exports" and associated appendices (content unit 1mysea2020001).*

### 1. Growth and Exports _________________________________________________________________________ 20

### 1. Growth and Exports

### Context
- The authorities are making progress on their reform agenda notwithstanding external and internal challenges.
- After taking power in mid-2018, the ruling coalition initiated governance reforms and measures to improve the transparency and management of public finances.
- Initial fiscal policy measures weakened the fiscal framework; the authorities resumed fiscal consolidation starting with the 2019 budget.

### Recent Economic Developments
- Growth
  - Growth is estimated at 4.5 percent in 2019 (4.7 percent in 2018), driven by private consumption given stable labor market conditions and low inflation.
  - Uncertainties surrounding trade tensions and domestic policies weighed on business confidence and private investment.
  - Public investment contracted due to completion of existing projects and delays in implementation of large infrastructure projects.
  - Net exports contributed to growth as a decrease in exports was more than offset by a sharp decline in capital imports, largely driven by weak investment.
- Inflation and Credit
  - Headline inflation was 0.7 percent in 2019, reflecting declining global oil prices, moderating wage growth, extension of seasonal price controls, and the replacement of the Goods and Services Tax (GST) with the smaller-base Sales and Service Taxes (SST) in 2018.
  - Core inflation, excluding the effect of consumption tax changes, remained stable at 1.5 percent year-on-year during January-November 2019.
  - Credit growth moderated with the estimated credit gap closing.
- Fiscal Outcome
  - The 2019 deficit declined to 3.4 percent of GDP (from 3.7 percent of GDP in 2018) as budgeted, on account of expenditure rationalization.
  - Expenditure savings included non-fuel subsidies targeting and lower spending on goods and services following the implementation of zero-based budgeting.
- External and Reserves
  - The current account surplus is estimated to have increased to 3.5 percent of GDP in 2019 (2.1 percent of GDP in 2018), driven by a decline in capital imports and an improvement in the primary income account deficit.
  - Portfolio investment outflows more than offset FDI net inflows through 2019Q3.
  - Gross official reserves are adequate at US$ 103.2 billion in November 2019—115 percent of the Assessing Reserve Adequacy (ARA) metric or, when adjusted for forward positions, 102 percent of the metric.
- Policy Alignment
  - Policies have been largely in line with past Fund advice, with some exceptions. While eliminating the GST went against Fund advice, authorities are preparing a Fiscal Responsibility Act in line with IMF recommendations.
  - The current broadly neutral monetary policy stance is consistent with advice to calibrate monetary policy to economic conditions.
  - Further enhancing the FX market’s functioning remains a priority supported by staff.
  - Structural reforms are largely in line with IMF advice.

### Authorities’ Views (on recent developments)
- Broad agreement with staff’s assessment of the outlook and risks but more optimistic on near-term growth.
- Authorities projected growth at 4.8 percent in 2020, driven by robust private consumption supported by stable employment growth, a minimum wage increase in urban areas, and government assistance programs.
- Expected investment to pick up moderately as approved investments are realized and several large infrastructure projects are resumed.
- Expected inflation to rebound to about 2 percent in 2020, contingent on global oil prices and on the closing of the output gap.
- Over the medium term, authorities saw growth at 4.5–5.5 percent, with risks mainly external and tilted to the downside.

### Outlook and Risks
- Baseline projections
  - Growth is projected at 4.5 percent in 2020.
  - Headline inflation is expected to increase to 2.1 percent.
  - The current account surplus is expected to narrow to 2.7 percent of GDP as capital imports resume.
  - Over the medium term, growth should converge to potential (4.8 percent) and inflation remain under control, while the current account surplus continues to moderate.
- Drivers and uncertainties
  - Domestic demand will remain the main driver of growth; private consumption sustained by stable employment and income growth.
  - Private investment is expected to gradually pick up as the business environment improves and uncertainties dissipate.
  - Public investment should begin to recover as public corporations reset investment plans and large infrastructure projects resume.
  - Despite signs of trade and investment diversion towards Malaysia, external headwinds may continue to weigh on exports in 2020.
- Risks (tilted to the downside)
  - Vulnerability to escalating trade actions and weaker-than-expected trading partner growth.
  - An abrupt deterioration in market sentiment towards EMs could lead to tighter financial conditions.
  - Contingent liabilities could pose fiscal risks.
  - A sharp drop in real estate prices or deterioration in household debt service ability could affect growth and financial stability.
  - Domestic policy uncertainty could reduce investment.
  - An upside risk: a durable truce following the phase-one deal between the US and China.

### Authorities’ Views (on outlook and risks)
- Authorities reaffirmed commitment to medium-term fiscal consolidation and fiscal-structural reforms.
- Committed to achieve an average fiscal deficit of 2.8 percent of GDP over 2020-2022 and to continue fiscal consolidation in the medium term, with specific measures to be identified.
- In case of negative shocks, fiscal policy would balance consolidation and growth objectives and focus on high-multiplier spending.
- Authorities broadly agreed with staff’s debt sustainability analysis and were open to considering interpreting the current debt limit more flexibly.
- Highlighted progress: institution of the high-level Debt Management Committee (DMC), publication for the first time of a debt sustainability analysis in budget documents, and plans to establish a Debt Management Office (DMO) within the Ministry of Finance.
- Reiterated commitment to push legislation to improve fiscal discipline and public procurement and plans to embed measures to improve public investment in the Twelfth Malaysia Plan.

### Key Statistics (selected from the chapter)
- Real GDP growth: 4.5 percent in 2019 (4.7 percent in 2018).
- Headline inflation: 0.7 percent in 2019.
- Core inflation (IMF staff estimate, excludes food and energy): 1.5 percent year-on-year during January-November 2019.
- Current account surplus: 3.5 percent of GDP in 2019 (2.1 percent of GDP in 2018).
- Gross official reserves: US$ 103.2 billion in November 2019 (115 percent of the ARA metric; adjusted 102 percent).
- 2019 budget deficit: 3.4 percent of GDP (2018: 3.7 percent of GDP).
- 2020 budget deficit target: 3.2 percent of GDP.
- Wage spending: decline from 5.4 to 5.1 percent of GDP (2019 to 2020 budgeted).
- Total capital expenditure: about 3.5 percent of GDP (unchanged).
- Tax revenue: broadly unchanged at 11.8 percent of GDP.
- Non-tax revenues: decline from 5.5 to 3.4 percent of GDP (due to one-off 2019 special dividend from Petronas).
- Federal government debt limit: commitment to keep within 55 percent of GDP.
- Staff’s illustrative medium-term target: debt decline to 46 percent of GDP by 2025 under continued gradual consolidation.
- Authorities’ targeted average fiscal deficit: 2.8 percent of GDP over 2020-2022.
- Monetary policy rate action: Bank Negara Malaysia lowered the policy rate 25 basis points to 3 percent in May 2019 and left it unchanged thereafter.

### Macroeconomic and Financial Policies — Overview
- Policy priorities
  - Put in place a credible medium-term fiscal consolidation plan while safeguarding growth and financial stability.
  - Monetary policy to remain data dependent; current broadly neutral stance appropriate under the baseline.
  - Financial policies to focus on household debt, real estate sector vulnerabilities, and cyber risks.
  - Address external imbalances over the medium term by creating fiscal space to expand social safety nets and by structural reforms to raise investment, labor force participation, and productivity.
  - In adverse shocks, response could combine available fiscal and monetary policy space and exchange rate flexibility; effectiveness enhanced by further deepening FX markets.

### Fiscal Policy — Findings and Recommendations
- 2020 budget
  - Envisages a reduction in the deficit to 3.2 percent of GDP.
  - Decrease in wage spending from 5.4 to 5.1 percent of GDP (expiry of one-off bonuses) offset by an increase in health and education expenditure.
  - Total capital expenditure unchanged at about 3.5 percent of GDP; priority on infrastructure upgrading programs.
  - Tax revenue broadly unchanged at 11.8 percent of GDP.
  - Non-tax revenues decline from 5.5 to 3.4 percent of GDP due to the one-off 2019 special dividend from Petronas.
- Medium-term consolidation needed
  - Fiscal policy anchored by commitment to keep federal government debt within 55 percent of GDP, but this limit could be breached if downside risks materialize.
  - Staff’s debt sustainability analysis: Malaysia’s public debt is sustainable, but a standard macro-fiscal shock would bring it very close to 55 percent of GDP and realization of contingent liabilities could push it above 60 percent of GDP.
  - Authorities target an average 2.8 percent of GDP deficit over 2020-2022.
  - If gradual fiscal consolidation continues at a similar pace afterwards, debt would decline to 46 percent of GDP by 2025 (Appendix IV).
  - Analysis suggests reducing debt-to-GDP ratio to 46 percent would bring probability of breaching 55 percent limit in the projection period to below 10 percent; under staff’s unchanged-policy baseline the probability rises above 20 percent.
- Fiscal Responsibility Act (FRA)
  - Opportunity to update the public debt limit framework.
  - Staff analytical work suggests the debt limit should remain at 55 percent of GDP but be applied more flexibly (e.g., allow temporary breaches in case of large shocks), with clear definitions and complementary fiscal framework strengthening.
- Revenue and expenditure measures
  - Revenue mobilization is a priority: tax revenue at just below 12 percent of GDP in 2019 is low compared to peers and OECD countries and is declining.
  - Fund technical assistance to support a Medium-Term Revenue Strategy (MTRS) to (a) reverse declining revenue trends and (b) achieve a sustainable higher revenue level to finance priority expenditure.
  - Build on Tax Reform Committee suggestions (August 2019) to improve tax administration, reduce tax leakages, and identify new revenue sources.
  - Consider structured and targeted spending reviews (e.g., overlap of social assistance programs, cost recovery in higher education, duplication in transport and tourism programs).
- Debt management and procurement
  - Progress: establishment in May 2019 of a high-level Debt Management Committee (DMC) chaired by the Minister of Finance.
  - DMC evaluates and endorses proposals impacting fiscal and debt positions, including federal government borrowing and government guarantees.
  - Planned steps to accelerate: creation of a Debt Management Office within the Ministry of Finance; preparation of a Government Procurement Act to enforce open tender procedures and enhance procurement transparency (expected submission to Parliament in the second half of 2020).
- Public investment efficiency (PIMA recommendations)
  - Initial progress: strengthened gatekeeping role of central agencies reducing fragmentation in public investment decisions.
  - Remaining agenda: introduce value management exercises to evaluate projects above MYR 50 million before approval; better separate project appraisal and budgeting procedures; update pipeline of approved projects.
  - Other important actions: develop a medium-term fiscal framework reconciling resource envelope with funding required to complete projects; develop an enhanced PPP policy framework specifying acceptance criteria and comprehensive reporting of PPPs and associated risks.

### Monetary, Exchange Rate, and Financial Market Policies
- Monetary stance
  - The broadly neutral monetary policy stance is appropriate.
  - After being on hold since January 2018, Bank Negara Malaysia (BNM) lowered the policy rate 25 basis points to 3 percent in May 2019 and left it unchanged in subsequent meetings.
  - The May rate cut helped bring the policy stance closer to neutrality following a significant drop in inflation expectations, a closing output gap, and broadly neutral financial conditions.
  - Monetary policy should continue to be data dependent; there is space to lower the policy rate should downside risks materialize.
- FX market deepening
  - Authorities implemented measures to deepen the domestic FX market: enhancing repo market liquidity and flexibility; expanding dynamic hedging of FX risks; simplifying FX transactions and documentation processes; enhancing ringgit liquidity beyond local trading hours.
  - Enhanced communication with foreign investors to raise awareness around increased opportunities for onshore hedging, including through Authorized Overseas Offices.
  - Partly as a result, FX market turnover has increased.
  - FTSE Russell decided in September to maintain Malaysian bonds in the WGBI, while retaining Malaysia on its watch list.
  - Continued efforts to deepen the domestic FX market are focused on improving access to hedging markets.

*Source: IMF staff report chapter "1. Growth and Exports" (Malaysia).*

### Appendix VI describes Malaysia’s policy framework. The frameworks followed by Malaysia and other ASEAN5

### Appendix VI describes Malaysia’s policy framework. The frameworks followed by Malaysia and other ASEAN5

### Exchange rate, FX markets, and external sector
- The exchange rate has been moving within a narrow range; recent research suggests that in some circumstances the exchange rate’s shock absorber function can be impaired or a flexible exchange rate can act as a shock amplifier (Appendix VII).
- IMF staff will work with the authorities, upon their request, to analyze the role of the exchange rate in Malaysia’s economy and explore further options to deepen FX markets.
- Policy recommendation: Authorities should gradually phase out existing capital flow management measures with due regard to market conditions.
- Policy recommendation: Authorities are encouraged to consider the publication of FXI data (with appropriate lags and aggregation to guard against market sensitivities).
- In the event of an inflow surge, some accumulation of FX reserves would be appropriate.
- External debt:
  - At end-September 2019, external debt stood at 60.7 percent of GDP.
  - The decline in external debt largely reflects portfolio debt outflows.
  - The share of FX debt in external debt remains stable at two thirds of total.
  - External debt remains vulnerable to exchange rate depreciation shocks (Appendix VIII).
- External position assessment:
  - For 2019, the external position is assessed to be stronger than warranted by fundamentals and desired policies (Appendix IX).
  - Projected current account surplus: 3.5 percent of GDP in 2019 (2.1 percent of GDP in 2018).
  - The 2019 increase reflects a one-off decline in public investment in 2019 expected to recover starting 2020 with the resumption of large infrastructure projects and return to a balanced growth path over the medium-term.
  - Contributing factors to the 2019 surplus: reduced investment amid global trade tensions and domestic policy uncertainty, low public healthcare spending, and credit constraints likely faced by private non-financial corporations.
- Corporate financing findings:
  - Recent IMF staff analytical work suggests corporates in Malaysia may be facing financial constraints.
  - A separate study indicates access to financing is not a main concern among SMEs although a diversified financing ecosystem could better cater to innovative SMEs.
- Policy recommendation: Create fiscal space to expand social safety nets and structural reforms to encourage investment by enhancing firms’ access to credit to facilitate external rebalancing.

### Authorities’ views on external and FX policy
- Authorities agreed with staff’s assessment of monetary and financial policies with some reservations.
- They viewed monetary policy as still accommodative and noted growth and inflation remain the principal determinants of monetary policy.
- Exchange rate flexibility will continue to be the first line of defense against external shocks.
- Authorities view the narrow range of FX volatility as inherent due to the reinforcement of rules underpinning Malaysia’s long-standing policy of non-internationalization of the ringgit aimed at containing high-volatility capital flows.
- Rationale for existing capital flow measures (authorities’ view):
  - (i) for the development of the onshore FX market;
  - (ii) to limit speculation that causes excessive exchange rate volatility;
  - (iii) to address foreign currency demand-supply imbalances;
  - (iv) to streamline prudential rules to prevent excessive accumulation of domestic debt by residents to fund investment abroad.
- On publication of FX intervention data, authorities preferred to wait for the outcome of ongoing Integrated Policy Framework analytical work.
- Authorities partly agreed with staff’s external debt sustainability analysis but expressed reservations on the external balance assessment methodology.
- Authorities’ buffers highlighted beyond official reserves:
  - (i) a sustained current account surplus over the medium-term;
  - (ii) ample and growing foreign assets, three-quarters of which is held by resident banks and corporates;
  - (iii) ringgit-denominated external debt accounting for about one-third of total external debt;
  - (iv) about three-quarters of FX-denominated external debt subject to prudential requirements;
  - (v) large share of medium/long-term external debt (over 55 percent).
- Authorities agreed with structural reforms advised to boost investment and productivity.

### Financial sector stability and policies
- Overall assessment:
  - The financial sector is stable and further enhancements to the regulatory framework are underway.
  - Banks are well capitalized and profitability has been maintained owing to enhancements in cost-efficiency and stable interest margins.
  - Asset quality is sound with net impaired loans at 1 percent of total loans in October 2019.
- Liquidity and regulatory metrics:
  - All banks record Liquidity Coverage Ratio (LCR) levels well above the 100 percent regulatory minimum requirement; LCR stood at 150 percent in October 2019.
  - In November 2019, BNM lowered the statutory reserve requirement (SRR) by 50 bps to 3 percent.
  - Finalized Net Stable Funding Ratio (NSFR) requirements to come into effect in July 2020; system-wide NSFR stood at 108.5 percent in 2019H1.
  - BNM issued a consultation paper in April 2019 on proposed assessment methodology to identify Domestic Systemically Important Banks (DSIBs); DSIB framework expected to be finalized in 2020.
- Household debt and real estate risks:
  - Household debt is high compared to peers, with pockets of vulnerability in lower-income groups.
  - House price increases have moderated recently, but house prices remain stronger than warranted by macroeconomic fundamentals (Appendix X).
  - A sharp decline in house prices could negatively impact developers and investors; combined with a household income shock and banks’ sizeable real estate lending, this could hurt banks’ financial performance and financial stability.
  - 2020 Budget measure: Government temporarily lowered the minimum purchase price for foreigners buying completed but unsold apartments from RM1 million to RM600,000 to help reduce oversupply of high-rise apartments in urban areas.
  - The measure is temporary and designed to better target housing supply to domestic demand; authorities should gradually phase out residency-based differentiation as systemic risks dissipate.
  - If market activity threatens financial stability again, authorities may consider macroprudential measures that target segments without differentiated treatment of nonresidents.
- Policy recommendations on macroprudential toolkit:
  - Complement microprudential supervision by expanding macroprudential tools.
  - IMF staff sees merit in tools such as LTV and DSTI.
  - Recommendation: Introduce sector-wide LTVs on first and second properties and debt-service-to-income limits for all income groups; initially calibrate to be non-binding and adjust as warranted by cyclical risks.
- Household resilience and consumer protection:
  - National Strategy for Financial Literacy launched in July 2019: a five-year roadmap to enhance financial literacy including expanding financial education into school curricula.
  - Proposed Consumer Credit Act to strengthen borrower protection through minimum standards on unsolicited financing, charges, credit assessments, debt collection and dispute settlements.
- Cybersecurity and climate-related financial risks:
  - National Cyber Security Policy (NCSP) established in 2006; National Cyber Crisis Management Plan (NCCMP) developed in 2011.
  - Authorities updating NCSP to incorporate enhanced security incident response and digital forensic capabilities.
  - BNM priority areas for cyber risk mitigation: (i) strengthen guidance on cyber security and risk management; (ii) improve information sharing on cyber threats; (iii) strengthen collective response and recovery capabilities; (iv) training.
  - BNM developing a framework for assessing climate change risks to the financial sector; member of NGFS; in September 2019 BNM and the Securities Commission formed a Joint Committee on Climate Change with industry representation.
- Fintech:
  - Fintech growing; regulators balance safeguarding stability and consumer protection while encouraging innovation.
  - Financial stability risks from fintech currently appear limited due to small sector size; continued regulatory vigilance is important.
  - To encourage fintech growth, address talent shortages and limited venture funding.

### Authorities’ views on the financial sector
- Authorities broadly agreed with staff’s assessment that the financial sector has necessary buffers to cope with sizable shocks and that household balance sheet risks require close monitoring.
- Authorities view risks from a real estate price adjustment or deterioration in household debt service ability as largely contained given sound bank housing portfolio quality and prudent lending practices.
- Authorities noted stress tests indicating banks can withstand a 50 percent decline in property prices.
- Lowering the foreigner apartment purchase threshold is temporary to reduce housing oversupply without creating long-term disincentives to build affordable housing.
- Authorities view sector-wide LTVs as unwarranted at this juncture but available to be introduced whenever strong shifts in the financial cycle warrant them.
- Authorities continue focus on testing operational resilience, including cyber risks and climate change risks.

### Structural reforms and governance
- Governance progress:
  - Government priorities reoriented towards improving transparency and public service efficiency.
  - National Centre for Governance, Integrity and Anti-Corruption (GIACC) launched a National Anti-Corruption Plan (NACP) in January 2019 focusing on six priority areas: political integrity and accountability; effectiveness of public service delivery; efficiency and transparency of public procurement; enhancing the legal and judiciary system; credibility of law enforcement agencies; and corporate governance.
  - Initiatives under NACP include introduction of asset declaration as an administrative requirement for Administrative Members and Members of Parliament (MPs) and enhancing corporate governance including in SOEs.
- Policy recommendations:
  - Sustain momentum in governance reforms and anchor them in legislation.
  - Priority legislative initiatives: procurement reform, freedom of information, and independence of anti-corruption institutions, especially appointment and tenure of the MACC Chief Commissioner and independence of MACC officers in investigations.
  - Enshrine asset declaration requirements for Administrative Members and MPs in law and enhance verification and enforcement for other high-level public officials.
  - Make mandatory for public sector institutions to develop Organizational Anti-Corruption Plans (OACPs).
  - Governance improvements would create synergies with other structural reforms and raise reform pay-offs when governance is strong.
- AML/CFT and virtual assets:
  - Malaysia’s Anti-Money Laundering, Anti-Terrorism Financing and Proceeds of Unlawful Activities Act 2001 (Act 613) applies to exchange of virtual assets to fiat currencies and vice versa, and to exchange among virtual assets.
  - In 2019, the Securities Commission took over from BNM the role of AML/CFT supervisor of virtual asset exchanges.
  - Recommendation: Pursue efforts to ensure all virtual asset service providers listed in the international standards (and not only exchanges) are regulated for AML/CFT purposes and implement AML/CFT measures effectively.
- Productivity and growth:
  - Total factor productivity (TFP) is moderating, with average growth of 1 percent during 2010–2017.
  - Boosting productivity is crucial to move up the value chain and achieve high income status; accelerating reforms to raise TFP growth is needed given a more challenging growth outlook.

*Source: Appendix VI, content unit 1mysea2020001.*

### 37.      The government has rolled out a comprehensive structural reform agenda aiming to

### 37. The government has rolled out a comprehensive structural reform agenda aiming to

### Reform agenda and progress
- The authorities have made progress in implementing targets established in the Mid-Term Review (MTR) of the Eleventh Malaysia Plan and the national-level initiatives identified in the 2017 Malaysia Productivity Blueprint.
- The recently released Shared Prosperity Vision 2030 outlines a long-term commitment to sustainable and inclusive growth.
- IMF staff calculations suggest Malaysia’s real growth rate would need to rise by about one additional percentage point per year above the baseline in order to achieve high income status by the mid-2020s.
- A comprehensive package comprising both growth-enabling and growth-incentivizing reforms is essential.

### Growth-enabling reforms (recommendations)
- Continue to enhance the business environment by simplifying state-level procedures for starting a business:
  - 2020 Doing Business Index: Malaysia ranks 12th overall, and 126th in the area of starting a business.
  - Example proposal: shorten the building permit approval period to 90 days from 390 days to ease bottlenecks.
- Promote trade openness and be prepared to absorb trade and investment diversion:
  - Speed up decisions on investment approvals, including through the revamped role of the National Committee on Investment (NCI).
  - Conclude domestic approval of the CPTPP and work with regional partners to finalize a high-standard RCEP agreement in 2020.
  - Work constructively with partners to strengthen the multilateral trading system.
- Continue to improve access to financing:
  - Malaysia performs relatively well compared to peers and the OECD average, but a gap remains with the most competitive countries (for instance, the United States).
  - Policy priority: improve SMEs access to alternative sources of financing, particularly for manufacturing and innovating SMEs.
  - Improving access to financing can unlock and magnify gains from labor market reforms.

### Medium-term productivity measures (TFP and skills)
- Accelerate implementation of the authorities’ agenda to boost productivity; measures that could improve TFP include:
  - Enhance the quality of and access to education by improving the quality of teachers and the design of curricula; and by expanding vocational and technical training to address skills mismatches.
  - Encourage innovation and technology adoption, including by promoting digitalization of the economy.
  - Boost female labor participation through promoting flexible work arrangements and returning to work initiatives; expediting the Employment Act amendment under consideration would help.

### Authorities’ views
- The authorities reaffirmed commitment to improving governance, highlighting progress with implementation of the NACP and ongoing legislation in important areas.
- Emphasized that improving governance requires changes in mindsets and practices in addition to legislation; efforts underway include strengthening governance education and outreach on social benefits of governance reforms.
- Agreed boosting productivity is necessary to achieve high-income status and inclusive development; stressed importance of policy clarity to shore up business confidence and continued measures to improve the business environment and attract quality FDI.
- Noted effectiveness of domestic policies and reforms is blunted by intense external uncertainties.
- Highlighted progress in labor market reforms, particularly boosting female labor force participation.
- Noted planned implementation of a progressive multi-tiered levy system by 2021 to reduce dependency on low-skilled foreign workers and encourage automation in manufacturing and agriculture.
- The authorities did not view access to financing as a main concern for SMEs but noted a diversified financing ecosystem could better cater to innovative SMEs.
- Aim to finalize RCEP negotiations with partners by 2020 and are reviewing the social and economic impact of the CPTPP to reach a decision on ratification.

### Staff appraisal — macroeconomic policy priorities and assessments
- General assessment:
  - Authorities are making progress on their reform agenda and the Malaysian economy remains stable.
  - Activity has broadly held up and inflation has remained subdued.
  - Risks to growth are to the downside.
  - Developments in 2019 suggest Malaysia’s external position remains stronger than warranted by fundamentals and desired policies.
  - Policy priorities: medium term fiscal consolidation while safeguarding growth and financial stability, and sustaining the momentum in governance reforms by anchoring them in legislation.
  - In case of negative shocks, the response could be a combination of use of available monetary and fiscal space, and exchange rate flexibility.
- Fiscal policy:
  - Should focus on building buffers through medium-term adjustment, underpinned by specific revenue and expenditure measures.
  - The pace of fiscal adjustment announced for 2020-2022 is appropriate and should be continued over the medium-term to build fiscal buffers, given that Malaysia’s fiscal space is at risk.
  - Specific measures need to be identified to support this adjustment, including in the context of the upcoming medium-term revenue strategy preparation.
  - The planned Fiscal Responsibility Act is an opportunity to increase flexibility of the current debt limit framework while embedding safeguards.
  - Push ahead with agenda to improve debt management, public procurement, and the public investment framework.
- Monetary policy:
  - The monetary policy stance is appropriate.
  - Malaysia’s monetary policy framework has performed well, delivering price stability and robust growth in recent years.
  - The broadly neutral stance is appropriate in the context of a closing output gap and broadly neutral financial conditions.
  - Looking forward, monetary policy should remain data dependent.
  - There is space to lower the policy rate should downside risks materialize.
- Exchange rate and FX markets:
  - Continue to deepen domestic FX markets to enhance the ability of the exchange rate to act as a shock absorber.
  - Recent actions have improved functioning of domestic FX markets, enhanced communication with foreign investors, and expanded FX hedging instruments and liquidity at longer maturities.
  - Authorities’ commitment to explore further options to deepen FX markets is welcome; IMF staff offer policy advice and technical assistance.
- Financial sector and macroprudential stance:
  - Financial sector is stable; bank profitability, capitalization and asset quality are sound.
  - Household debt is high compared to peers.
  - House prices remain stronger than warranted by fundamentals despite recent price stabilization.
  - Authorities should continue to monitor risks in this area.
  - Recent temporary easing of a residency-based differentiation in property market policies is a step in the right direction; the differentiation should be gradually phased out as systemic risks dissipate.
  - Authorities’ focus on micro-prudential supervision of lending standards could be complemented by expanding the range of macroprudential tools to ensure they are readily available when needed to manage the financial cycle.
- Governance and anti-corruption:
  - Sustaining momentum in governance reforms and anchoring them in legislation is critical.
  - Encouraged to push ahead with legislative initiatives currently underway on asset declaration, procurement reform, freedom of information, and independence of anti-corruption institutions.
  - Accelerate plans to develop Organizational Anti-Corruption Plans in public sector bodies.
  - Robust implementation of AML/CFT tools can help mitigate risks from corruption and virtual assets.

### Summary of structural reform priorities (condensed)
- Simplify procedures for starting a business at the state level (example: reduce building permit approval to 90 days from 390 days).
- Work with regional partners to promote trade openness; conclude domestic approval of CPTPP and finalize RCEP in 2020.
- Improve access to alternative financing, particularly for manufacturing and innovating SMEs.
- Enhance education quality and access; expand vocational and technical training.
- Encourage innovation, technology adoption, and digitalization.
- Boost female labor participation through flexible work arrangements, returning to work initiatives, and Employment Act amendments.
- Anchor governance reforms in legislation, strengthen anti-corruption measures, and expand macroprudential toolkits.

*Source: IMF staff report (excerpts).*

### 50.      It is recommended that the Article IV consultation with Malaysia be held on the

### 1mysea2020001 - 50.      It is recommended that the Article IV consultation with Malaysia be held on the 

### Growth and Exports
- Malaysia has been one of the faster growing economies among the large ASEAN countries.
- Private domestic demand has been the main driver of growth in recent years.
- On the supply side:
  - Services sector growth remains robust.
  - Low oil price weighed on the mining sector.
  - Manufacturing and construction sector growth moderated.
- Manufacturing exports have contracted since 2019Q1 due to external headwinds.
- Imports declined at a faster pace than exports in 2019 on account of lower capital imports, reflecting weak domestic investment.
- Leading to an increase in the current account surplus in 2019, which was also helped by the reduction in the primary income deficit.
- Real GDP Growth (selected label): Real GDP Growth (In Percent, Year-on-Year) shown for Malaysia and peers across 2010Q1–2019Q3 (chart referenced).

### Contributions to Real GDP, Sectoral Performance
- Contributions to Real GDP Growth (In Percentage Points; Year-on-Year) charted across 2008Q1–2019Q3 by component: Private consumption, Public consumption, Gross capital formation, Net exports.
- Real GDP by Industry (In Percent Change; Year-on-Year) components include Agriculture, forestry and fishing; Mining and quarrying; Manufacturing; Construction; Services (chart referenced).

### Exports and Imports Volumes
- Export Volumes Growth Contribution (In Percent, 3-mma Year-on-Year Growth) and Import Volumes Growth Contribution presented across Jan-12–Oct-19 by commodity groups including Manufactures and Machinery (charts referenced).

### Current Account
- Current Account Balance (In Percent of GDP) charted across 2006Q1–2019Q3 with contributions from Services, Goods, Income.

### Inflation and Labor Markets
- Headline inflation remained subdued in 2019, reflecting base effects due to changes in the consumption tax regime and low global oil price.
- Both headline and core inflation rebounded between June and August due to a base effect, as there was no consumption tax in the same period of the preceding year.
- Producer prices continued to decline in 2019.
- The output gap is closing as growth moderates.
- The unemployment rate has been stable as employment growth continues to match labor force expansion.
- Growth in manufacturing wages has moderated since 2018Q4; wage growth in the services sector remained low.
- Consumer Price Index (In Percent Change) and Inflation Developments (In Percent; Year-on-year) charts shown Jul-10–Nov-19; note: GST implemented / GST removed annotations.
- Output Gap (In Percent of Potential GDP) plotted 2010Q1–2019Q3.
- Unemployment rate and Employment growth plotted with values including Unemployment rate around 3.4 percent (annual average noted elsewhere).

### Monetary Developments
- The BNM eased monetary policy in May 2019.
- Real interest rates remained stable due to falling inflation expectations.
- Monetary aggregates are growing in line with GDP, supported by healthy deposit growth.
- The credit gap has nearly closed as it declined to a post-GFC low.
- As a share of GDP, foreign currency deposits have been largely stable in recent quarters.
- Interest Rates (In Percent per Annum) charted Jun-10–Oct-19 for KLIBOR (3-month), Overnight policy rate, Lending rate, Government bond yield (1-year).
- Real Interest Rates (In Percent per Annum) noted with nominal rates adjusted for 1-year ahead inflation expectations.
- Monetary Aggregates and Broad money (y/y growth) charted; Reserve money (in percent of rolling 4Q GDP) shown.
- Banking System Deposit Growth (In Percent; Year-on-year) charted across Apr-10–Nov-19.
- Credit Gap (In Percent of GDP) measure: note footnote 1/ credit gap measured using deviation of credit-to-GDP ratio from a one-sided Hodrick-Prescott filter with a large parameter over 2008Q2–2019Q3.
- Foreign currency and Non-resident deposits (In Percent of rolling GDP) plotted 2010Q1–2019Q3.

### Capital Flows, Foreign Exchange, and Asset Prices
- The financial account deteriorated in 2019 as FDI inflows in 2019Q1 were more than offset by increased direct and portfolio investment of residents abroad in Q2-Q3.
- Non-resident bond and equity portfolio flows were less volatile than in recent years.
- Foreign holdings of Malaysian government securities dropped in April and May but recovered since June.
- The BNM’s gross FX reserves have stabilized since 2018Q3. Net reserves have increased due to a decreasing net short position in forwards.
- Faced with a series of external shocks in recent years, the currency has depreciated from its 2013 peak; the stock market is sliding since the second half of 2018.
- Financial Account Balance (In percent of 4-quarter rolling GDP) plotted 2010Q1–2019Q3 with Direct Investment (net), Portfolio Investment (net), Other Investment (net) 1/ (Includes financial derivatives).
- Malaysia: Nonresident Portfolio Capital Flows 1/ (In billion U.S. dollar; as of Mar 2019) and Foreign Holdings of Local-currency Debt Securities (In billions of ringgit) charted.
- Official Foreign Reserves (In billions of US dollars) plotted Apr-09–Oct-19 with net forwards by maturity buckets and FX reserves adjusted for net forwards.
- Exchange Rates: Nominal and Real effective exchange rate indices (2010=100) and bilateral exchange rate ringgit/US$.
- Stock Market Performance: Stock market index (Kuala Lumpur Composite Index) and PE ratio (right scale) charted; note: blip in P/E ratio in February 2019 due to AXIATA profit drop and strong market capitalization.

### Fiscal Policy Developments
- The overall deficit started declining again from 2019.
- Revenue increased in 2019, mainly due to a one-off special dividend from Petronas used to finance the clearance of tax refund arrears.
- Current spending declined in 2019 as a ratio to GDP, driven by lower goods and services outlays.
- Development spending is in line with the historical trend.
- The federal debt will remain high at around 50 percent of GDP, absent additional fiscal consolidation.
- Guarantees, as a share of GDP, jumped up recently after remaining stable for several years.
- Federal Government: Overall and Non-Oil Balance (In Percent of GDP) charted 2011–2020 (Est./Proj.).
- Federal Government Revenue (In Percent of GDP) components shown including Income taxes, Taxes on goods and services, International trade taxes, Interest and investment income, Other, Oil-related revenue.
- Federal Government Current Expenditures (In Percent of GDP) components shown: Subsidies, Pensions, Transfers, Wages, Goods and services.
- Federal Government Development Spending (In Percent of GDP) charted 2010–2020 (Est./Proj.).
- Medium–Term Fiscal Outlook: Federal government debt and federal government deficit (RHS) plotted 2011–2024 (Est./Proj.) with debt around "around 50 percent of GDP" noted.

### Public Sector, Fiscal Stance, and Prospects
- The Non-Financial Public Sector (NFPS) deficit has improved after peaking in 2015.
- Public companies’ surpluses have been sustained.
- General government development spending has declined, with Petronas’ share lower than before.
- Fiscal Balance (In Percent of GDP) for Public sector, General government, Federal government charted 2006–2020 (Est./Proj.).
- Current Balance of the Public Sector (In Percent of GDP) components: Revenue, Net operating surplus of NFPEs, Current spending, Current Balance.
- Development Spending (In Percent of GDP) for General government and NFPEs charted 2006–2020 (Est./Proj.).
- Capital Spending by PETRONAS: Domestic and Outside Malaysia shares and PETRONAS share of total NFPE capital expenditure plotted.

### Financial Sector Developments
- Credit growth is broadly in line with nominal GDP growth.
- Slowing housing and investment demand has led to lower credit growth.
- Overall corporate sector leverage has been stable over the last 10 years and remains well below levels prior to the Asian Financial Crisis.
- The banking system is well capitalized and gross non-performing loans are low.
- The banking system’s reliance on short-term external debt, as a share of GDP, is broadly stable.
- Banks have a broadly balanced net external asset position.
- Banks' Credit to Private Sector and sectoral breakdowns plotted across 2010–2019 with year-on-year growth series.
- Corporate Debt-to-Equity Ratio (Median for nonfinancial corporates) by country and years 1998/2009/2018 shown.
- Banks' Financial Soundness Indicators (In Percent) include Non-performing Loans to Total Gross Loans and Regulatory Tier 1 Capital to Risk-Weighted Assets (series through 2019Q2).
- Offshore borrowing short term and Non-resident deposits plotted 2011Q1–2019Q3 (In Percent of GDP).
- Banking System External Assets and Liabilities (In billions of U.S. dollars) plotted 2009Q1–2019Q3.

### Financial Soundness Indicators (Cross-country and Domestic)
- Malaysian banks’ capital buffers are strong.
- Liquidity provides stronger cover for short-term liabilities relative to peers.
- Lending in proportion to deposits is in line with peers.
- Asset quality is high.
- Banks are profitable, partially reflecting stable interest rate spreads.
- Regulatory Tier 1 Capital to Risk-Weighted Asset, 2019Q2: Malaysia listed among peers.
- Liquid Assets to Short-Term Liabilities, 2019Q2: Malaysia high relative to many peers.
- Loan to Deposit Ratio, 2019Q3 and Nonperforming Loans to Total Gross Loans, 2019Q2 comparative charts.
- Return on Equity, 2019Q2 shown for peer group.
- Malaysian Commercial Banks: Interest Rate Spreads (In Percent) plotted Apr-10–Nov-19.

### Household Debt
- Housing loan growth has moderated.
- Overall household debt is stable as a share of GDP.
- Household debt-to-GDP ratio remains high compared to other countries and is above the levels observed in countries with similar GDP per capita.
- Household non-performing loans continue to decline and remain at a low level.
- High household financial assets help mitigate the vulnerability from household debt.
- Household Loan Growth (In Percent, Year-on-Year) charted Jan-10–Oct-19 for Residential property and Personal use.
- Household Debt (In Percent of GDP) charted 2010–2019Q3.
- Household Debt, 2018 (In Percent of GDP; End of Period) shows Malaysia among comparative country list.
- Net Domestic Credit and GDP per Capita scatter (Selected economies, 2010−18 average) plotted.
- Malaysia - Household Sector NPLs (In Percent) time series 2009–2018.
- Household Financial Assets (In Percent of GDP) 2010–2018 charted; value around 180.1 percent in 2015 per Table 1.

### House Prices and Residential Market
- House price growth has exceeded peers, but prices have recently stabilized.
- Price-to-rent and Price-to-income ratios stabilized (House Prices metrics, 2009Q1=100 baseline).
- Population growth is strong but alone cannot explain the rise in house prices relative to other countries.
- The housing market in Kuala Lumpur is moderating.
- Residential supply has been increasing; overall construction starts slowed.
- House Price Index (2010:Q2 = 100) plotted 2010Q2–2019Q2 for Malaysia and peers.
- House Prices in Kuala Lumpur (In Percentage Change; Year-on-year) show terraced house, high rise unit, detached house trends through 2019Q3.
- Residential Property Supply (Existing stock and Incoming Supply in thousand units) and Construction Started (thousand units) plotted 2010Q1–2019Q3; Kuala Lumpur and Johor series included.

### Key Statistics and Projections (Selected from Table 1, Table 2, Tables 3–7)
- Nominal GDP (2019): US$364 billion
- Population (2018): 32.4 million
- GDP per capita (2019, current prices): US$11,173
- Poverty rate (2017, national poverty line): 0.4 percent
- Unemployment rate (2019): 3.4 percent
- Adult literacy rate (2018): 95.9 percent
- Main goods exports (share in total, 2018): electrical & electronics (37.7 percent), commodities (15.6 percent), and petroleum products (7.5 percent).
- Real GDP (percent change): 2015:5.0; 2016:4.4; 2017:5.7; 2018:4.7; 2019:4.5; 2020:4.5; 2021:4.9 (Table 1).
- Federal government overall balance (in percent of GDP): 2015:-3.2; 2016:-3.1; 2017:-2.9; 2018:-3.7; 2019:-3.4; 2020:-3.2; 2021:-3.0.
- General government debt (percent of GDP): 2015:57.0; 2016:55.8; 2017:54.4; 2018:55.6; 2019:57.1; 2020:57.0; 2021:56.5 (Table 1).
- CPI inflation (annual average): 2015:2.1; 2016:2.1; 2017:3.7; 2018:1.0; 2019:0.7; 2020:2.1; 2021:2.1.
- Broad money (percentage change): 2015:3.0; 2016:2.7; 2017:4.8; 2018:7.7; 2019:4.8; 2020:6.7; 2021:7.1.
- Credit to private sector (percentage change): 2015:8.6; 2016:5.3; 2017:5.4; 2018:8.3; 2019:5.4; 2020:7.1; 2021:7.1.
- Household debt (in percent of GDP) 2018:82.7; 2019:82.0; 2019Q3: Household Debt (In Percent of GDP) charted.
- Current account balance (in percent of GDP): 2015:3.0; 2016:2.4; 2017:2.8; 2018:2.1; 2019:3.5 (Table 2).
- Gross official reserves (US$ billions): 2015:95.3; 2016:94.5; 2017:102.4; 2018:101.4; 2019:103.2 (Table 2).
- Total external debt (in billions of U.S. dollars): 2015:195.0; 2016:203.8; 2017:218.8; 2018:223.8; 2019:227.0 (Table 2).
- Selected Balance of Payments projections (Table 3): Current account balance (in billions of U.S. dollars) 2019:12.7; 2020:10.3; 2021:7.9; projected through 2024 (Table 3).
- Illustrative Medium-Term Macroeconomic Framework (Table 4): Real GDP growth projected 2020–24 around 4.9/4.8/4.8/4.8 (various years).
- Federal government operations and debt levels summarized in Table 5 with federal government debt in percent of GDP: 2019:52.6; 2020:52.1; 2021:51.8; projections through 2024.
- Monetary Survey highlights (Table 6): Broad money 2019:1,897.3 (billion ringgit); Broad money (12-month percent change) 2019:4.8.
- Banks' Financial Soundness Indicators (Table 7, 2019 Q2): Regulatory capital to risk-weighted assets: 18.0; Regulatory Tier 1 capital to risk-weighted assets: 14.7; Nonperforming loans to total gross loans: 1.6; Return on equity: 13.1; Liquid assets to short-term liabilities: 163.6; Loan-deposit ratio: 87.9; Liquidity Coverage Ratio: 153.0.

*International Monetary Fund staff compilation based on Malaysian authorities' data, CEIC Data Co. Ltd., Haver Analytics, World Bank, UNESCO, and IMF databases as presented in the source content.*

### Appendix I. Staff Policy Advice from the 2018 and 2019 Article IV

### Appendix I. Staff Policy Advice from the 2018 and 2019 Article IV Consultations

### Fiscal Policy
- Staff advice (2018, 2019): Follow a gradual consolidation path and improve the composition of fiscal adjustment by prioritizing revenue measures.
- Authorities’ actions and outcomes:
  - The authorities have returned to a fiscal consolidation in 2019.
  - The 2020 budget and the announced average deficit target for 2020-2022 are consistent with the medium-term fiscal consolidation advocated by staff, but specific measures need to be identified.
  - The authorities replaced the GST by the SST, which has narrowed the tax base and created a revenue shortfall.
  - Implemented other, albeit small, revenue measures: a special voluntary disclosure program, a sugar tax, and a departure levy.
  - A Tax Reform Committee established in September 2018 delivered a report to the government in August 2019. Building on this report, and with IMF TA support, the authorities plan to formulate a medium-term revenue strategy.
- Staff advice (2018, 2019): Broaden the tax base and reduce investment incentives (tax expenditures); strengthen the SST; revisit tax incentives; increase excise taxes; broaden the PIT tax base; introduce a capital gain tax.
- Staff advice (2018, 2019): Improve efficiency of public spending through better targeting of social spending, cost recovery in higher education, user fees for health care services, and limiting duplications; introduce targeted and strategic spending reviews on a rolling basis.
- Authorities’ actions:
  - After bringing back fuel subsidies in 2018 against staff advice, the authorities plan to target such subsidies to lower income groups starting in 2020.
  - Zero-base budgeting introduced in 2019 contributed to rationalizing current spending.
- Staff advice (2018, 2019): Enrich the recently introduced Medium Term Fiscal Framework with more detail; fully integrate in the budget preparation process annual fiscal risks statements; improve fiscal governance.
- Authorities’ actions:
  - The authorities are preparing a Fiscal Responsibility Act.
  - A recently created high-level Debt Management Committee will help enhance fiscal transparency and monitor fiscal risks.
  - With the 2019 budget, the authorities began enhancing reporting of federal government guarantees and possible future PPP-related payment dues.
  - The 2020 budget included for the first time a complete debt sustainability analysis.
  - The authorities are drafting a Government Procurement Act to enforce open tenders.

### Monetary, Exchange Rate, and Financial Policies
- Staff advice (2019): The broadly neutral monetary policy stance is appropriate; domestic economic and financial considerations should continue to guide monetary policy decisions.
- Authorities’ actions and outcomes:
  - Monetary policy decisions have been data dependent.
  - After staying on hold since January 2018, BNM lowered the policy rate 25 basis points to 3 percent in May 2019 and left it unchanged in subsequent policy meetings.
  - The May rate cut helped bring the policy stance closer to neutrality following a significant drop in inflation expectations and in the context of a closing output gap.
- Staff advice (2019): The December 2016 FX measures should be gradually phased out with due regard to market conditions.
- Authorities’ actions:
  - The authorities have implemented measures to deepen the domestic FX market and have requested technical assistance from the IMF to analyze the role of the exchange rate in Malaysia’s economy and to deepen FX markets.
- Staff advice (2019): The real estate market and household debt require close monitoring.
- Authorities’ actions:
  - The authorities continue to closely monitor real estate market related risks. Strong micro-prudential supervision is maintained to ensure sound lending standards.
  - The 2020 budget temporarily lowered the minimum threshold for non-resident purchases of high-rise apartments to reduce oversupply in that market.

### Structural and Governance Policies
- Staff advice (2018, 2019): Implement governance reforms and anchor them in legislation to secure independence of anti-corruption institutions, freedom of information, and asset declaration.
- Authorities’ actions:
  - The authorities launched a National Anti-Corruption Plan (NACP) in January 2019.
  - As of mid-December 2019, 23 of the 115 initiatives planned under the NACP have been completed.
  - The authorities are working on legislation on asset declaration, independence of the Malaysian Anti-Corruption Authority, and freedom of information.
- Staff advice (2018, 2019): Raise productivity growth within the framework outlined in the 11th Malaysia Plan (2016–20), the Mid-term Review of the 11th MP (2019), and Malaysia Productivity Blueprint.
- Staff recommended actions to significantly boost productivity and long-term growth:
  1. Further raise female labor participation;
  2. Improve the quality of teachers and the design of curricula, expand vocational and technical training to reduce skill mismatches, raise enrollment in higher education;
  3. Encourage R&D and address the lack of coordination in research, development, commercialization and innovation activities, and the low commercialization of R&D output (2018/19).
- Authorities’ actions:
  - The government is amending the Employment Act 1955 to increase maternity leave in the private sector and improve working conditions (e.g., increase the penalty for the sexual harassment offences). The government has implemented flexible working arrangements (FWA) as well as work from home and returning to work initiatives. The Budget 2020 provides cash incentives to promote FLFPR.
  - The government has (i) expanded the Dual Language Program (DLP) from 2018 and (ii) offered specialized programs in niche areas on aerospace, automotive, and furniture manufacturing and implementing National Dual Training System (NDTS) to improve the quality and delivery of TVET programs.
- Staff advice (2019): Promote trade openness and a move up the value chain. Malaysia supports the multilateral trading system, works closely with other countries to finalize a high-standard RCEP agreement, and the CPTPP is still under consideration.
- Staff advice (2018/19): Any reform to foreign labor policies should be market-based, clearly communicated, and gradually phased-in to allow sectors that rely on foreign workers to adjust.
- Authorities’ action per Mid-Term Review of the Eleventh Malaysia Plan:
  - A progressive multi-tiered levy system that is based on the proportion of foreign workers employed will be implemented to strictly reduce and regulate the number of foreign workers by 2021.
- Staff advice (2018/19): Updating public infrastructure and the regulatory framework would help further improve the business environment and support higher private investment, which would help with rebalancing.
- Authorities’ actions:
  - Following completion of reviews and renegotiations, several large infrastructure projects will resume in 2020 with improved participation of local companies.
  - The federal government is working with states to speed up procedures, such as shortening the building permit approval period from 390 to 90 days.

*Source: Appendix I. Staff Policy Advice from the 2018 and 2019 Article IV Consultations (as provided).*

### Appendix II. Trade and Investment Diversion

### Key context and findings
- Malaysia is a small open economy with a well-diversified export base and deep integration into regional and global supply chains.
- Trade openness historically exceeded 130 percent of GDP.
- China, Singapore, EU, and the US are Malaysia’s largest trading partners.
- The average export-orientation rate across all manufacturing industries exceeds 60 percent.
- Exports of E&E products account for nearly 40 percent of total exports in 2018; a large share are shipped to China and regional neighbors as immediate inputs.

### Export volatility related to US–China tensions
- Exports became more volatile following the escalation of trade tensions.
  - For Malaysia, the standard deviation of monthly E&E export value increased to 8.8 percent during May 2018 to September 2019, from 7.1 percent prior to the trade tensions (Dec 2016 to April 2018).
  - E&E exports experienced a 24 percent increase (m/m, seasonally adjusted) in July 2019, then fell substantially in August 2019.
- Commodity exports also recorded larger fluctuations over the past year.

### Distinction of trade diversion effects analyzed
- Type-I diversion: Gain from Malaysia’s exports to the US where Malaysia directly competes with China.
- Type-II diversion: Gain from Malaysia’s intermediate goods exports to other countries integrated into global supply chains that are adjusting to trade tensions.

### Preliminary staff estimates of trade diversion (Jan–Oct/Sept 2019)
- Type-I trade diversion:
  - Malaysia’s manufacturing sector benefited mainly from an increasing share of E&E exports to the US, particularly electronic integrated circuits (IC).
  - The average share-effect accounts for about 0.4 percent of GDP between January and September 2019, which gradually outweighs the negative size-effect resulting from the decreasing size of total IC imports of the US.
  - Malaysia’s exports of furniture to USA grew by 29.5 percent y-o-y during January and October 2019, while furniture exports to China decreased by 12.5 percent.
- Type-II trade diversion:
  - Malaysia’s intermediate E&E exports to Mainland China and Hong Kong SAR combined declined 6.8 percent y-o-y between January and October 2019.
  - This drop was compensated by increases in exports to other markets linked to the US’s E&E supply chain: US (10 percent), Taiwan (45 percent), Philippines (21 percent), and Vietnam (20 percent).

### Investment diversion and FDI
- While actual FDI inflows had not yet picked up, interest from foreign investors increased:
  - Approved FDI in the manufacturing sector surged 60.8 percent y-o-y (or US$ 6.1 billion) in 2019H1.
  - The lion’s share came from the US (US$2.8 billion), followed by China (US$1.2 billion).
  - Approved FDI to the E&E sector increased to US$3.9 billion in 2019H1 (2018 full year: US$2.6 billion), fueled by high-technology manufacturing firms.
- Notes on timing: Approved FDI typically takes about 12-18 months to translate into actual investment; lower actual inflows in 2019Q2–Q3 may reflect investor hesitation in an uncertain external environment.

### Policy recommendations to lock in gains from diversion
- Enhance domestic policy clarity amid protracted external uncertainties to attract high-quality FDI and encourage FDI materialization.
- Continue to promote open trade:
  - Malaysia remains worse-off overall from escalation of trade tensions and negative confidence effects on the global economy despite gains from trade diversion.
  - Finalizing the RCEP negotiations and accelerating the review of the CPTPP would help improve competitiveness, increase access to international markets, and attract quality foreign investments.

### 2020 budget measures noted (excerpt)
- Measures include, among others:
  - Up to 10 year tax break for the E&E sector;
  - RM1bn (US$0.24 billion) of customized incentives annually over 5 years and special investment tax allowance to attract Fortune 500 companies that invest at least RM5bn (US$1.2 billion) each in Malaysia;
  - National Committee on Investment to overcome delays in investment approvals, with additional RM10mn for post approval monitoring and realization;
  - Up to RM1bn in customized incentives annually over 5 years for local export champions.

*Source: Appendix II. Trade and Investment Diversion (as provided).*

### Appendix III. Risk Assessment Matrix 1/

### Appendix III. Risk Assessment Matrix

### External risks
- Sharp rise in risk premia (Short-term)  
  - Likelihood: High  
  - Transmission: An abrupt deterioration in market sentiment (e.g., prompted by policy surprises, renewed stresses in emerging markets, or a disorderly Brexit) could trigger risk-off events such as recognition of underpriced risk. Higher risk premia cause higher debt service and refinancing risks; stress on leveraged firms, households, and vulnerable sovereigns; disruptive corrections to stretched asset valuations; and capital account pressures—all depressing growth.  
  - Expected impact: Medium — higher debt service and refinancing risks; stress on leveraged firms and households; capital account pressures; and a broad-based downturn.  
  - Recommended policy responses: Liquidity support (including in FX) could be provided; the exchange rate can act as a shock absorber. If capital outflows threaten domestic activity, reserve requirements could be relaxed.

- Rising protectionism and retreat from multilateralism (Short- to medium-term)  
  - Likelihood: High  
  - Transmission: Escalating and unpredictable trade actions and a WTO dispute settlement system under threat imperil the global trade system and international cooperation; additional barriers including investment and trade restrictions in technology sectors reduce growth directly and via confidence and financial market volatility; medium-term geopolitical competition and fragmentation undermine investment, growth, and stability.  
  - Expected impact: Medium — Malaysia, as a highly open economy, is vulnerable to measures curtailing global trade; impact through direct channels and trading partner exposures.  
  - Recommended policy responses: Support multilateralism and the global trading system; accelerate ASEAN regional integration agenda and pursue new, high-standard regional trade agreements. In the absence of adequate automatic stabilizers, discretionary fiscal policy should only be temporary and if the shock is perceived as temporary. The exchange rate should continue to act as a shock absorber.

- Weaker-than-expected global growth (Short to medium-term)  
  - Likelihood: (Medium)  
  - Transmission: Idiosyncratic factors in the U.S., Europe, and China feed off each other to result in a synchronized and prolonged growth slowdown.  
  - Expected impact: Medium — reduced exports and manufacturing activity; higher unemployment; slower domestic demand; dampened housing and asset prices; weaker bank, corporate, and sovereign balance sheets in a negative feedback loop.  
  - Recommended policy responses: Limited macro cushion for a protracted slump; policymakers need to adjust to slower medium-term growth; carefully selected infrastructure projects and structural reforms could increase productivity and growth.

- Further build-up of financial vulnerabilities (Medium Term)  
  - Likelihood: High  
  - Transmission: Easing monetary policy encourages risk-taking and underpricing of risk, reducing financial resilience to shocks and risk-off events.  
  - Expected impact: Low/Medium — substantial capital inflows, asset price increases, FX appreciation, possibly followed by a bust cycle and heightened vulnerabilities in financial and corporate sectors.  
  - Recommended policy responses: Allow exchange rate to act as shock absorber; use inflow episodes to gradually build FX reserves; apply macroprudential policies to address financial stability risks.

- Large swings in energy prices (Medium-term)  
  - Likelihood: Medium  
  - Transmission: Risks to prices are broadly balanced; uncertainty translates to elevated price volatility, complicating economic management and investment in the energy sector; shocks may cause large and persistent price swings.  
  - Expected impact: Low — substantial declines in commodity prices could push Malaysia to a twin deficit and trigger adverse feedback of higher interest costs and weaker investor confidence.  
  - Recommended policy responses: Fiscal reforms to reduce reliance on oil revenues (e.g., broad-based taxes); investment in infrastructure and productivity-boosting structural reforms; allow exchange rate as first line of defense in the short term.

### Domestic risks
- Fiscal risks from public debt and contingent liabilities (Short- to medium-term)  
  - Likelihood: Medium  
  - Transmission: Realization of risks would raise sovereign financing cost and require stronger fiscal adjustment to restore sustainability.  
  - Expected impact: Medium/High — higher financing costs; relatively high public debt; contingent liabilities exacerbate debt sustainability concerns and could trigger spikes in domestic interest rates and foreign investor exit.  
  - Recommended policy responses: Medium-term fiscal consolidation to boost countercyclical capacity; adopt a fiscal risks management framework; publish an annual fiscal risks statement; increase transparency of GLC operations.

- Stronger-than-expected growth impact of budgetary measures  
  - Likelihood: Medium  
  - Transmission: The 2020 budget balances consolidation and growth; commitment to medium-term consolidation could raise growth and confidence.  
  - Expected impact: Medium — stronger growth via increased confidence, investment, and domestic demand.  
  - Recommended policy responses: Allow exchange rate to act as shock absorber to build FX reserves during inflows; continue structural reforms to increase productivity and growth.

- Cyber-attacks (Short- to medium-term)  
  - Likelihood: Low  
  - Transmission: Attacks on critical global financial or communication infrastructure and broader institutions could trigger systemic financial instability or widespread socio-economic disruptions.  
  - Expected impact: Medium/High — theft of personal information, SWIFT fraud, hacked crypto-asset exchanges, supply-chain business disruptions; larger attacks could be highly disruptive.  
  - Recommended policy responses: Strengthen existing IT security frameworks and build new lines of defense to eliminate risks and minimize impact.

- Sharp adjustment in housing market prices or ability to service debt (Short- to medium-term)  
  - Likelihood: Low/Medium  
  - Transmission: Large stock of unsold (luxury) residential and commercial properties may yield a sharp drop in real estate prices; household debt-service deterioration may trigger defaults and higher bank NPLs.  
  - Expected impact: Medium — adverse effects on real estate developers and downstream sectors; implications for banks’ balance sheets.  
  - Recommended policy responses: Vigilant micro- and macro-prudential oversight; consider risk weights and credit limits targeting construction sector; encourage developers to lease unsold housing stock to prevent sizable price adjustments.

*1/ The RAM shows events that could materially alter the baseline. “Low” indicates probability below 10 percent, “medium” between 10 and 30 percent, and “high” 30 percent or more. RAM reflects staff views as of time of discussions with the authorities.*

---

### Appendix IV. Public Debt Sustainability Analysis (DSA)

### Key headline findings and risks
- Under current policies, federal government debt is projected to decline slightly but to remain high at around 50 percent of GDP over the medium-term.  
- The federal government debt limit of 55 percent of GDP could easily be breached if downside risks materialize.  
- Sizable external financing needs and high contingent liabilities exacerbate debt sustainability risk.  
- A gradual fiscal consolidation is needed to build fiscal buffers and improve market confidence.

### Macro-fiscal assumptions
- Economic growth: projected to remain stable at 4.5 percent in 2020, then gradually recover and stabilize at just below 5 percent over the medium-term.  
- Federal government fiscal deficit: projected to decline to 3.2 percent of GDP in 2020 (from 3.4 percent of GDP in 2019).  
- Fiscal deficit over medium-term: projected to remain at around 3 percent in the absence of explicit policies underpinning the announced consolidation path.

### Financing needs and debt profile
- Gross financing needs (fiscal deficit plus maturing debt): expected to decline slightly but to remain above 7 percent of GDP over the medium-term.  
- Debt definition: DSA uses federal government budget debt covering more than 90 percent of general government debt; excludes local/state governments and statutory bodies that typically receive explicit guarantees.  
- Authorities’ announcement: federal government’s guarantees and PPP lease payment obligations risk bringing federal government debt to about 75 percent of GDP, should they materialize.  
- External financing requirement: high at 29 percent of GDP.  
- Share of foreign currency denominated debt: low at 3 percent of total debt.  
- Share of public debt held by foreigners: high at 24 percent.

### Realism of baseline assumptions
- Past assumptions on real growth and primary balance are neither too optimistic nor pessimistic.  
- Median forecast error for the GDP deflator: -1.8 percent, suggesting staff forecasts have been relatively optimistic; forecast bias has improved in recent years.  
- Under the baseline, projected 3-year adjustment in cyclically adjusted primary balance (CAPB) is relatively small, with a percentile rank of 41 percent compared to historical experience for high-debt market access countries.  
- CAPB level has a percentile rank of 71 percent.

### Stress tests, scenarios, and illustrative numbers
- Fan chart: under the worst quartile case, debt-to-GDP could reach 60 percent of GDP by 2025, exceeding authorities’ debt anchor.  
- Macro-fiscal stress tests: under individual primary balance, real GDP growth, and interest rate shocks, debt-to-GDP is not expected to breach 55 percent during the projection period. The combined macro-fiscal shock would bring debt to 54.2 percent of GDP, very close to breaching the debt anchor.  
- Contingent liability shock: assumes government absorbs all guarantees totaling 12 percent of GDP over 5 years and negative interest-rate feedback; debt-to-GDP would rise above 60 percent under this scenario.  
- Illustrative fiscal consolidation scenario: authorities’ announced target of an average deficit of 2.8 percent of GDP over 2020-2022; continuing similar pace after 2022 would lower debt-to-GDP to around 46 percent by 2025.  
- Heat map: Malaysia faces risks from large external financing requirement (above upper threshold of early warning benchmarks) and high share of debt held by foreigners (24 percent, exceeding lower threshold). Large domestic institutional investors who make opportunistic investments mitigate this risk.

### Baseline numerical projections (selected series from Figure 4 — Baseline Scenario)
- Real GDP growth: 2020: 4.5; 2021: 4.9; 2022: 4.8; 2023: 4.8; 2024: 4.8; 2025: 4.8  
- Inflation: 2020: 2.1; 2021: 2.1; 2022: 2.1; 2023: 2.2; 2024: 2.2; 2025: 2.5  
- Primary Balance (percent of GDP): 2020: -1.0; 2021: -0.9; 2022: -1.1; 2023: -1.1; 2024: -1.2; 2025: -1.2  
- Effective interest rate: 2020: 4.4; 2021: 4.2; 2022: 4.0; 2023: 3.9; 2024: 3.9; 2025: 3.8

### Stress-test input values (selected, from Figure 5)
- Real GDP growth (Baseline): 4.5, 4.9, 4.8, 4.8, 4.8, 4.8 (2020–2025)  
- Real GDP growth (Real GDP Growth Shock example): 4.5, 4.0, 3.9, 4.8, 4.8, 4.8  
- Inflation (Baseline): 2.1, 2.1, 2.1, 2.2, 2.2, 2.5 (2020–2025)  
- Effective interest rate (Baseline): 4.4, 4.2, 4.0, 3.9, 3.9, 3.8 (2020–2025)  
- Combined macro-fiscal shock example effective interest rate path: 4.4, 4.2, 4.4, 4.6, 4.8, 5.1

### Additional illustrative points from DSA charts and text
- Under the combined macro-fiscal shock, debt-to-GDP reaches 54.2 percent.  
- Contingent liabilities assumed at 12 percent of GDP absorbed over 5 years push debt above 60 percent of GDP.  
- Authorities’ announced target: average deficit of 2.8 percent of GDP over 2020-2022; continuing consolidation after 2022 could lower debt-to-GDP to around 46 percent by 2025.  
- Gross financing needs remain above 7 percent of GDP over the medium-term.

*Italic source attribution: IMF staff, Appendix III (Risk Assessment Matrix) and Appendix IV (Public Debt Sustainability Analysis) from the Malaysia country report materials contained in the source PDF.*

### Appendix V. Considerations in Reviewing Malaysia’s Public Debt

### Appendix V. Considerations in Reviewing Malaysia’s Public Debt Limit Framework

### A. Background and Main Takeaways
- The federal government debt is currently subject to a self-imposed policy limit of 55 percent of GDP.
- The current debt level is below this limit, projected at about 52 percent of GDP at end 2019, meaning the policy limit could easily be breached if downside shocks materialize.
- Recommendation: keep the debt-to-GDP limit at 55 percent but treat it more flexibly in case of negative shocks (e.g., include caveats in law to allow temporary exceedance), complemented by institutional changes and careful communication of rationale.
- Rationale: mixed evidence — some approaches suggest limited scope to relax the limit, while growth-impact literature warns of negative effects if debt rises above 55 percent.

### B. Debt Intolerance
- Metric: Institutional Investor Rating (IIR) (scale 0–100; higher = lower default risk). Malaysia’s IIR average was 67.3 during 2000-2014 versus a sample average of 56.5.
- Malaysia has remained within Club BI since 1980, except brief episodes in Club BII (1987-1989 and 1998-2000).
- Regression analysis (following Reinhart, Rogoff and Savastano) regresses IIR on public debt interacted with club dummies, history of high inflation, defaults, and GDP-per-capita.
  - Results align with literature: a history of default and high inflation reduces the IIR.
- Simulations using regression parameters:
  - Using whole-sample thresholds (114 countries) would suggest Malaysia could reach debt levels above 100 percent of GDP while remaining in the same creditworthiness club.
  - Using regression-specific thresholds (sample of 61 countries) yields a different conclusion: for two regression specifications the change in creditworthiness club could happen for debt-to-GDP levels as low as in the 50-65 percent range.
- Conclusion: debt intolerance methodology suggests some limited room to relax the debt limit, but it does not justify resetting the limit far above the current 55 percent.

### C. Sustainability of Debt Limit
- Sustainability approach: d* = pb/(r-g), where d* is sustainable debt-to-GDP, pb is primary balance-to-GDP, r is real interest rate, g is real growth rate.
- Importance of (r-g): Malaysia has experienced negative (r-g) recently, but a negative (r-g) is not compatible with long-run equilibrium; factors likely to push (r-g) positive include more moderate growth after high-income status and potential higher borrowing costs.
- Simulations (Table 4) show sensitivity of required primary surplus to (r-g):
  - For (r-g) = 1 percent, the primary surplus needed to keep debt at the current limit (55 percent of GDP) is 0.55 percent of GDP.
  - To keep debt at 60 percent of GDP under similar assumptions, the primary surplus would need to go from 0.55 percent of GDP to 0.6 percent of GDP.
- Historical context:
  - Malaysia has not run a primary surplus since 1998.
  - The average primary balance during 1998-2018 was a deficit of -1.8 percent of GDP.
- Policy implication: achieving a medium-term primary surplus target of 0.55 percent of GDP would require a substantial fiscal effort and a credible medium-term consolidation plan to improve borrowing costs and (r-g) dynamics.

### D. Cross Country Comparison
- Malaysia’s public debt-to-GDP ratio has been stable at about 50 percent of GDP in the last decade but is relatively high compared to several peers.
- A bivariate correlation between debt-to-GDP and GDP-per-capita suggests Malaysia’s debt is higher than the level warranted by its GDP-per-capita; a level substantially above 60 percent of GDP would bring Malaysia out of line with peers.

### E. Impact of Public Debt on Growth
- Literature highlights “tipping points” in the debt-growth relationship:
  - Reinhart and Rogoff: on average debt levels above 90 percent of GDP tend to harm growth.
  - Caner, Grennes and Koehler-Geib: for emerging markets the tipping point is likely at 64 percent of GDP.
- Malaysia-specific evidence:
  - Baharumshah, Soon, and Lau (2016) estimate a tipping point for Malaysia at 54.7 percent of GDP.
    - For debt levels below 54.7 percent of GDP, an additional percentage point of GDP of debt is estimated to increase growth by about 0.2 percent.
    - For debt levels above 54.7 percent of GDP, an additional percentage point of GDP of debt is estimated to lower growth by about 0.15 percent.
  - Note: their results are based on 1980-2014 data and summarize long-run averages; they do not necessarily imply temporary increases above 55 percent would reduce growth in the short term.
- Implication: existing debt-growth literature suggests Malaysia should not significantly increase public debt-to-GDP above 55 percent.

### F. Conclusions and Policy Recommendations
- Overall assessment:
  - Some limited room exists to relax the current debt limit framework, but caution is warranted.
  - Debt intolerance tests, debt sustainability analysis, and international comparisons point to limited scope for relaxation.
  - Debt-growth literature indicates negative average growth effects if debt exceeds the current 55 percent limit.
- Recommended approach:
  - Leave the statutory debt-to-GDP limit at 55 percent but treat it more flexibly (allow temporary breaches in case of large negative shocks).
  - When enshrining the limit in law, include appropriate caveats to permit temporary exceedances following large shocks.
  - Complement any change to the debt limit framework with appropriate changes to the institutional framework (to be discussed in the context of TA from FAD on the FRA).
  - Carefully communicate the rationale for any changes.

*Prepared by Giovanni Ganelli and Claudia Marchini; material summarized from Appendix V of the IMF Malaysia report.*

### 3.      The openness of Malaysia’s economy and balance sheet vulnerabilities are important

### 3.      The openness of Malaysia’s economy and balance sheet vulnerabilities are important

### Openness and balance-sheet channels
- Malaysia’s integration in the global economy and international financial markets has increased susceptibility to external shocks and spillover effects, including through volatile capital flows in the post GFC period of accommodative monetary policy in advanced economies.
- In small open economies, volatile capital flows can overwhelm domestic financial markets, causing large movements in asset prices (including in the real estate market), liquidity conditions and exchange rates and leading to a build-up of vulnerabilities.
- Balance sheet characteristics highlighted as important considerations: corporate external debt and government and household debt.

### Authorities’ policy toolkit and historical responses
- Policy tools used in response to external shocks have included:
  - FXI (foreign exchange intervention) to reduce excess exchange rate volatility;
  - Exchange rate adjustment;
  - Monetary policy recalibration;
  - Macroprudential policy tightening to mitigate systemic risks, including those stemming from capital flows and credit growth;
  - CFMs (capital flow management measures).
- Examples:
  - 2014-15 oil price decline: primary response was exchange rate depreciation.
  - 2016 offshore financial market shocks: response included FX intervention to contain excessive volatility.
- Domestic macroprudential policy has been actively used to mitigate financial stability risks related to elevated household debt.
- BNM also advises the Government on fiscal and structural issues; the BNM Governor is a member of the Fiscal Policy Committee and the Debt Management Committee.
- Structural policy efforts have focused on deepening domestic financial markets: reforms to simplify market regulation, enhance FX hedging instruments and extend trading hours.

### Exchange rate flexibility: shock absorber vs shock amplifier (key findings)
- The exchange rate can act as a shock absorber by improving competitiveness and reducing the probability of speculative attacks, but overshooting is possible and the competitiveness channel may be less effective in the short term.
- Large depreciations can depress corporate activity by increasing debt burdens of firms with FX liabilities; when liabilities are large and unhedged, negative balance-sheet effects can dominate competitiveness benefits.
- Macro evidence for Asian EMEs:
  - On average, FXI absorbs about 70 percent of net capital flows.
  - FXI is more pronounced where corporate FX liabilities are larger.
  - Asian countries with greater financial depth rely less on FXI.
  - Empirical estimate: a one percent real depreciation permanently lowers the investment ratio by ½ percent when markets are less-developed (effect not statistically-significant otherwise). A similar, more short-lived effect is observed for GDP growth. (IMF APD-REO, October 2019)
- Firm-level evidence:
  - A 30 percent currency depreciation shifts 7 percent of firms across Asia into a high probability of default category, with stronger effects when the share of FX debt is high.
  - Depreciation discourages investment in firms with FX liabilities accounting for over 20 percent of total debt.
  - FX liabilities hurt balance sheets more in countries with relatively less-developed financial markets and fewer cost-effective hedging opportunities.
- Modeling evidence:
  - A small open DSGE model suggests exchange rate flexibility helps absorb productivity shocks via competitiveness, but can amplify financial shocks via banks’ balance-sheet effects when foreign-currency liabilities are large and frictions exist.
  - FX intervention could mitigate negative real impacts of financial shocks by reducing excess exchange rate fluctuations.
  - CFMs could help stabilize the exchange rate but are more costly in terms of inflation and output than FXI in response to financial shocks.

### Malaysia-specific balance sheet and FX market observations
- Aggregate assessment:
  - Risks from corporate sector FX liabilities are likely contained, but FX market depth has room to improve given high trade openness and cross-border capital flows.
  - Malaysia’s corporate sector accounts for close to half of FX external debt (about 20 percent of total corporate sector debt or 20 percent of GDP) as of 2019Q3.
  - A large share of corporate external borrowing is subject to the central bank’s approval framework to ensure productive use and support from foreign currency earnings.
- FX market depth:
  - Authorities have implemented measures to develop the onshore FX market and transactions have increased.
  - The FX turnover-to-gross trade and capital flow ratio suggests Malaysia’s FX market depth remains below the median of its peers, implying further FX market development would enhance resilience and hedging availability.
- Trade openness context:
  - Malaysia is highly export-oriented with total exports and imports account for over 130 percent of GDP in the past decade.

### External debt sustainability: current status and projections
- Recent levels and composition:
  - External debt-to-GDP ratio: 60.7 percent of GDP as of 2019Q3 (down from 68.6 percent of GDP at end-2017; end-2018: 62.4 percent of GDP).
  - Non-resident holdings of local-currency debt securities declined by 3.6 percent of GDP, accounting for about half of the total decline in the debt ratio.
  - Decrease in FDI debt liabilities accounted for 2.0 percent of GDP of the decline.
- Currency profile (as of 2019Q3):
  - Close to one-third of external debt (about 20 percent of GDP) denominated in ringgit:
    - 63 percent of ringgit-denominated external debt is nonresident holdings of domestic debt securities.
    - 18 percent of ringgit-denominated external debt is ringgit deposits in domestic banking institutions.
  - Remaining two-thirds of external debt (about 40 percent of GDP) denominated in foreign currency (FC).
  - Non-financial corporate sector accounted for close to half of FC-denominated external debt, largely subject to prudential and hedging requirements.
  - Another 40 percent of FC-denominated external debt is interbank borrowings and FC deposits in the domestic banking system; three quarters of these are intragroup borrowings from related offices abroad.
- Maturity profile:
  - Short-term external debt by original maturity accounted for 43 percent of total external debt (about 25 percent of GDP) as of 2019Q3.
  - Close to half of short-term external debt are intragroup borrowings among banks and corporations.
  - 12 percent of short-term external debt are trade credits, largely backed by export earnings.
  - A 2017 data compilation reclassification revised short-term external debt by remaining maturity down by RM70 billion (about 5 percent of GDP).
- Medium-term projection:
  - External debt-to-GDP ratio projected to fall to about 48 percent by 2024 under the baseline.
  - Baseline drivers: sustained current account (CA) surpluses (excluding interest payments), robust growth supported by domestic demand, continued non-debt generating capital inflows, and low external financing rates.
  - Share of short-term debt by original maturity projected to stabilize at about 46 percent of total external debt by end of the medium term.
  - Gross external financing need projected to moderate to about 25 percent of GDP by 2024 (with a sharp decline in 2017 due to reclassification).
- Stress-test scenarios and vulnerabilities:
  - External debt is most vulnerable to exchange rate and current account shocks.
  - A 30 percent real exchange rate depreciation in 2020 could push external debt over 61 percent of GDP by 2024.
  - A permanent drop in CA balance (excluding interest payments) could lead to an external debt level over 58 percent of GDP in the outer years.
  - Other shocks (deceleration in real GDP growth, rise in interest rate) would lead to moderate increases in external debt.
  - Mitigating factors:
    - High share of ringgit-denominated external debt (more than 30 percent of total external debt).
    - Largely stable intercompany loans (12 percent of external debt).
    - Interbank borrowings account for 21 percent of external debt, about three quarters of which are intragroup borrowings from related offices abroad.

*Source: 1mysea2020001 — Chapter 3, IMF staff analysis.*

### 6.      Risks to Malaysia’s external debt sustainability arising from the above vulnerabilities

### 6.      Risks to Malaysia’s external debt sustainability arising from the above vulnerabilities

### Overall assessment of buffers and vulnerabilities
- Gross official reserves as of September 2019: $103 billion, or about 72 percent of short-term external debt by remaining maturity.
- Gross official reserves are adequate under the IMF reserve adequacy metric (ARA): about 115 percent of the metric.
- Net reserves adjusted for net forwards positions: about 102 percent of the ARA metric.
- Exchange rate flexibility, a moderate current account (CA) surplus, and the relatively large share of ringgit-denominated external debt are identified as important buffers against potential external shocks.
- Prudential and supervisory requirements apply to banks’ exposure (interbank borrowings, NR deposits, debt issuances) on liquidity and funding risk management.
- Corporations face an approval framework to ascertain that external borrowings are utilized for productive purposes and supported by foreign currency earnings.

### Profile of external debt (selected indicators from Table 1)
- Total external debt (staff estimate) (Percent of GDP): 2015: 64.7; 2016: 67.7; 2017: 68.6; 2018: 62.4; 2019Q1: 61.7; 2019Q2: 62.8; 2019Q3: 60.7.
- Medium- and long-term (Percent of GDP): 2015: 37.5; 2016: 39.7; 2017: 41.3; 2018: 35.1; 2019Q1: 36.6; 2019Q2: 36.6; 2019Q3: 34.6.
- Short-term (Percent of GDP): 2015: 27.2; 2016: 28.0; 2017: 27.3; 2018: 27.3; 2019Q1: 25.2; 2019Q2: 26.2; 2019Q3: 26.1.
- By currency (Memorandum): Local currency denominated (Percent of GDP): 2015: 36.0; 2016: 34.0; 2017: 34.4; 2018: 31.1; 2019Q1: 32.7; 2019Q2: 31.7; 2019Q3: 32.9. Foreign currency denominated (Percent of GDP): 2015: 64.0; 2016: 66.0; 2017: 65.6; 2018: 68.9; 2019Q1: 67.3; 2019Q2: 68.3; 2019Q3: 67.1.
- Nonresident holdings of ringgit-denominated debt instruments (Percent of GDP): 2015: 14.2; 2016: 14.9; 2017: 15.2; 2018: 11.4; 2019Q1: 12.1; 2019Q2: 11.8; 2019Q3: 11.9.
- Interbank borrowing (as share of total external debt and as share of GDP): as share of total external debt: 2015: 19.3; 2016: 18.7; 2017: 19.2; 2018: 21.8; 2019Q1: 19.2; 2019Q2: 21.1; 2019Q3: 22.2. as share of GDP: 2015: 12.5; 2016: 12.6; 2017: 13.2; 2018: 13.6; 2019Q1: 11.9; 2019Q2: 13.3; 2019Q3: 13.5.
- Gross official foreign exchange reserves (US$ billion): 2015: 95.3; 2016: 94.5; 2017: 102.4; 2018: 101.4; 2019Q1: 103.0; 2019Q2: 102.7; 2019Q3: 103.0.
- Note: Total external debt measured in US dollars was about 60.7 percent of GDP in September 2019 (end-2018: 62.3 percent), of which about two-thirds was in foreign currency and 43 percent in short-term debt, by original maturity.

### Stress tests and scenario analysis (Figure 1 highlights)
- Baseline external debt (percent of GDP) around 48 (baseline label shown).
- Individual shocks considered include:
  - Interest rate shock: permanent one-half standard deviation shocks to real interest rate.
  - Growth shock: permanent one-half standard deviation shocks to growth rate.
  - Current account (CA) shock: permanent one-half standard deviation shocks to CA.
  - Combined shocks: combinations of the above.
  - One-time real depreciation of 30 percent occurs in 2020 in the real depreciation shock scenario.
- Example scenario outcomes (figures in boxes represent average projections for variables in baseline and scenario): Growth shock box lists Baseline: 2.7; Scenario: 3.4; Historical: 2.4. (Growth shock described in percent per year.)
- Historical, baseline, and scenario paths are shown for external debt in percent of GDP under each shock; staff concludes resilience in several stress tests given buffers.

### External Debt Sustainability Framework (Table 2: selected entries)
- Baseline: External debt (Percent of GDP)
  - 2014: 62.2; 2015: 64.7; 2016: 67.7; 2017: 68.6; 2018: 62.4; 2019: 61.0; 2020: 58.9; 2021: 55.3; 2022: 52.2; 2023: 49.9; 2024: 47.7.
- Change in external debt (Percent of GDP): 2014: -2.5; 2015: 2.5; 2016: 3.0; 2017: 0.9; 2018: -6.2; 2019: -1.4; 2020: -2.1; 2021: -3.6; 2022: -3.0; 2023: -2.4; 2024: -2.2.
- Identified external debt-creating flows (4+8+9) (Percent of GDP): 2014: -5.9; 2015: 3.2; 2016: -4.5; 2017: -9.3; 2018: -8.4; 2019: -6.5; 2020: -5.8; 2021: -5.9; 2022: -5.4; 2023: -4.8; 2024: -4.3.
- Current account deficit, excluding interest payments (Percent of GDP): 2014: -5.4; 2015: -4.1; 2016: -3.6; 2017: -4.0; 2018: -3.5; 2019: -4.8; 2020: -3.5; 2021: -3.2; 2022: -3.0; 2023: -2.7; 2024: -2.3.
- Net non-debt creating capital inflows (negative) (Percent of GDP): 2014: 2.2; 2015: 1.8; 2016: -0.9; 2017: -2.0; 2018: 0.0; 2019: -0.6; 2020: -1.3; 2021: -1.3; 2022: -1.2; 2023: -1.2; 2024: -1.1.
- Automatic debt dynamics (Percent of GDP): 2014: -2.7; 2015: 5.5; 2016: 0.0; 2017: -3.4; 2018: -4.9; 2019: -1.1; 2020: -1.0; 2021: -1.3; 2022: -1.1; 2023: -0.9; 2024: -0.9.
- Contribution from nominal interest rate (Percent): 2014: 1.1; 2015: 1.1; 2016: 1.2; 2017: 1.2; 2018: 1.5; 2019: 1.6; 2020: 1.6; 2021: 1.4; 2022: 1.4; 2023: 1.4; 2024: 1.4.
- Contribution from real GDP growth (Percent): 2014: -3.7; 2015: -3.5; 2016: -2.9; 2017: -3.7; 2018: -2.9; 2019: -2.8; 2020: -2.6; 2021: -2.7; 2022: -2.5; 2023: -2.4; 2024: -2.3.
- External debt-to-exports ratio (in percent): 2014: 85.5; 2015: 93.2; 2016: 101.3; 2017: 97.9; 2018: 90.8; 2019: 90.1; 2020: 90.6; 2021: 87.0; 2022: 84.6; 2023: 83.1; 2024: 81.7.
- Gross external financing need (in billions of US dollars): 2014: 132.2; 2015: 139.0; 2016: 120.8; 2017: 104.7; 2018: 101.8; 2019: 107.9; 2020: 115.9; 2021: 116.2; 2022: 118.0; 2023: 121.0; 2024: 126.7.
- Key macroeconomic assumptions (selected):
  - Real GDP growth (in percent): Historical: 6.0; 2015: 5.0; 2016: 4.4; 2017: 5.7; 2018: 4.7; 2019: 4.7; Baseline projections: 2020: 2.4; 2021: 4.5; 2022: 4.4; 2023: 4.9; 2024: 4.8; 10-Year Average: 4.8.
  - Nominal external interest rate (in percent): Historical: 1.8; 2015: 1.6; 2016: 1.9; 2017: 1.8; 2018: 2.4; 2019: 2.4; projections: 2020: 1.3; 2021: 2.7; 2022: 2.7; 2023: 2.5; 2024: 2.6; 10-Year Average: 2.9; 10-Year Deviation: 3.0.

### External sector assessment — selected findings and policy implications (Appendix IX)
- Overall external position (2019): stronger than implied by fundamentals and medium-term desirable policies.
- NIIP (Background): Averaged about 1 percent of GDP since 2010. As of 2019Q3, NIIP improved to about –0.9 percent of GDP (compared with –5.4 percent of GDP at end-2018). Gross assets: 118.2 (Percent of GDP); Reserve assets: 28.9 (Percent of GDP); Gross liabilities: 119.0 (Percent of GDP); Debt liabilities: 61.3 (Percent of GDP).
- Assessment of NIIP trajectory: NIIP should rise gradually over the medium term reflecting projected moderate CA surpluses.
- Current Account (2019, Percent of GDP): Actual CA: 3.5; Cycl. Adj. CA: 3.6; EBA CA Norm: –0.3; EBA CA Gap: 3.9; Staff Adj.: -0.4; Staff CA Gap: 3.5.
- Drivers of the CA gap: Over half attributed to policy distortions. Low domestic public health care spending contributes 0.7 ppt to the CA gap; looser fiscal policy in the rest of the world relative to Malaysia contributes 0.7 ppt. Postponement of large infrastructure projects reduces capital imports by 0.4 percent of GDP (temporary shock).
- Real Exchange Rate (REER): Through September 2019, REER depreciated by 1.5 percent relative to the 2018 average and is about 12 percent lower than its 2013 level. EBA REER Index and Level models estimate REER undervaluation by about 26 and 39 percent, respectively. Staff assesses the REER gap in 2019 to be –7.6 percent (± about 2 percent). The REER gap is based on the estimated semi-elasticity of CA to REER at 0.46.
- Capital and financial accounts: Malaysia experienced periods of significant capital flow volatility driven largely by portfolio flows in and out of the local-currency debt market. Since late 2016, the Financial Markets Committee implemented measures to develop the onshore FX market.
- FX intervention and reserves level:
  - Official reserves fell by US$8.1 billion since May 2018 and stabilized at US$101.4 billion as of end-2018.
  - Reserves picked up in 2019H1 and stand at US$103.0 billion as of September 2019.
  - Under the IMF composite reserve adequacy metric (ARA), gross and net official reserves are about 115 percent and 102 percent of the ARA metric as of September 2019.
  - Policy implication: Given limited reserves and increased hedging opportunities since 2017, FX interventions should be limited to preventing disorderly market conditions. In case of an inflow surge, some reserve accumulation would be appropriate to increase the reserve coverage ratio.

### Policy recommendations and mitigation measures
- Maintain exchange rate flexibility; limit intervention to addressing disorderly market conditions.
- Continue planned medium-term fiscal consolidation accompanied by:
  - Policies to strengthen the social safety net.
  - Continued encouragement of private investment.
  - Reorient fiscal spending to accommodate further improvements in social protection and public health care.
  - Improve the quality of public infrastructure supported by enhanced public finance management.
  - Address structural impediments to private investment and productivity (improve SMEs’ access to credit, promote quality of education, reduce skills mismatch, encourage female labor participation).
- Gradually phase out capital flow management measures (CFMs) with due regard to market conditions while continuing efforts to develop onshore FX market and deepen domestic financial markets.
- Continue prudential and supervisory requirements on banks’ liquidity and funding risk management; maintain corporate approval framework for external borrowings to ensure productive use and foreign currency earnings support.

*Source: IMF staff report chapter — “6. Risks to Malaysia’s external debt sustainability arising from the above vulnerabilities.”*

### 4.      The strong supply response has led to overproduction in some segments of the

### 1mysea2020001 - 4.      The strong supply response has led to overproduction in some segments of the

### Overproduction in upper segments and undersupply of affordable housing
- Affordable housing in Malaysia is usually considered to be below RM300,000.
- Unsold properties in the upper segment (above RM500,000) increased sharply in 2018-19, particularly in the high-rise apartment segments.
- Unsold units above RM 1 million remain at a high level.
- There is an undersupply of housing at affordable levels, especially in urban areas.
- A common rule of thumb is that house prices should be below 3x median income, which would put an affordable housing threshold in the range of RM280,000-300,000.
- BNM’s program for affordable housing allows for house prices up to RM300,000 to assist first-time home buyers in lower-income groups where eligible home buyers can access financing at a concessionary rate.

### Affordability deterioration and income-group impacts
- House price-to-income ratio increased from 4.1 in 2002 to 5.0 in 2016.
- World Bank (2019) finds households in Kuala Lumpur and Petaling District with monthly incomes below RM5,000 experience severe unaffordability and can experience difficulty finding finance given low and often volatile income.
- Households with incomes from RM6,000-10,000 have moderate difficulty purchasing a home.
- Households with incomes above RM10,000 find ample supply within their capacity-to-pay.

### House price valuation
- Econometric model with fundamentals suggests real house prices remain about 15 percent above what fundamental macroeconomic variables would indicate.
- The overvaluation has slightly narrowed in recent years as house price increases have moderated.
- Housing-at-risk (HaR) approach indicates the mode of house price increase will stabilize around 1.5 percent four quarters ahead.

### Household debt dynamics and composition
- Household debt increased from 60.4 percent of GDP in 2008 to 86.5 percent in 2016.
- Household debt stabilized around 82 percent in 2019.
- Around 54.5 percent of total household debt is residential mortgages in 2019.
- Household debt by monthly income (as a share of total) has decreased for households making less than RM3,000, from 22.8 to 18.5 percent.
- Household assets exceed debt by more than twice the amount, and 2/3 of household assets are considered liquid.
- Household non-performing loans have declined and are somewhat below the banking sector average of 1.6 percent of total lending.

### Financial stability risks and stress testing
- High household debt raises financial stability risks, particularly for over-extended households facing severe income shocks.
- BNM enhanced stress testing using a net “Financial Margin” approach that establishes a baseline for disposable income after debt obligations and necessities while considering liquid financial assets.
- The latest BNM stress test assumed shocks: borrowing costs increase by 50 basis points, cost of living increases by 20 percent, and incomes decline by 10 percent.
- Borrowers’ debt repayment capacity was most affected under income and cost of living shocks, with a smaller impact from an increase in borrowing costs.
- The associated increase in potential losses to the banking system under stress scenarios remained within banks’ excess capital buffers as at end-June 2019.
- Banks continue to maintain capital buffers to absorb 1.5 times the potential losses under severe stress scenarios.
- Internally, BNM also models house price shocks within the Financial Margin framework; a significant share – 83 percent – of residential property loans is extended to owner-occupiers. Almost 70 percent of outstanding housing loans have a loan-to-value ratio of less than 80 percent.

### Policy measures to enhance affordability and contain risks
- Government and BNM initiatives include: stamp duty exemptions, youth housing schemes, mortgage guarantees, a BNM Fund for Affordable Homes, advisory assistance, and financial literacy programs.
- BNM established a fund with a total allocation of RM1 bn to assist first-time home buyers in lower-income groups. Eligible first-time home buyers with monthly household income of up to RM4,360 can access home financing at a concessionary financing rate of up to 3.5 percent per annum to purchase houses up to RM300,000. The Fund is available for two years starting in 2019, or until the RM1 bn is fully utilized.
- Stamp duty exemption on memorandum of transfer and loan agreement for the first RM300,000. Applicable for properties up to RM500,000 (primary and secondary market). The exemption is valid for a period of two years until December 2020.
- Financing up to RM10 bn will be provided by financial institutions with support from the Government via a 30 percent of RM3 bn guarantee (rent-to-own scheme announced in the 2020 Budget) for purchase of first home up to RM500,000; scheme allows rent up to 5 years with option to purchase after first year at fixed price.
- The Home Ownership campaign was extended to end-2019; the Youth Housing Scheme administered by Bank Simpanan Nasional was extended to December 2021 offering a 10 percent loan guarantee through Cagamas and RM200 monthly installment assistance for the first two years.
- The 2020 Budget lowered the property threshold for foreign property buyers from RM1 million to RM600,000 on completed but unsold high-rise property units in urban areas for one year to stimulate apartment demand and reduce unsold upper-end stock.

### Macroprudential measures
- Measures include limits on amortization periods, restrictions on unsecured loans, caps on loan-to-value ratios, real property gains tax changes, and prohibitions on interest capitalization schemes (ICS/DIBS).
- Effective December 2011, maximum LTV for all housing loans taken by non-individuals is 60%.
- Effective November 2010, maximum LTV for third and subsequent mortgages is 70%.
- Effective July 2013, maximum tenure for purchase of properties is 35 years; maximum tenure for personal financing is 10 years.
- Effective July 2013, preapproved unsolicited personal financing products are prohibited; new personal financing products or variations require BNM approval.
- Effective November 2013, developers are prohibited from implementing projects with elements of the ICS, including DIBS; financial institutions are prohibited from granting end financing for properties offered under ICS/DIBS.
- Floor prices and RPGT changes for non-residents and companies have been adjusted over time; the 2020 Budget lowered the floor price for completed but unsold high-rise property in urban areas purchasable by non-residents to RM 600,000 for one year.

### Summary and conclusions
- House price growth has moderated and household debt stabilized, but the real estate sector requires continued close monitoring and affordability challenges remain.
- Post-GFC house price increases outpaced incomes, leading to house price overvaluation and a deterioration in affordability.
- Current oversupply of apartments is concentrated in upper-price segments, while demand for affordable housing (below RM300,000) remains relatively stronger.
- Household debt remains high and poses vulnerabilities in a potential economic downturn, although systemic financial sector risks are partly mitigated by high household assets and strong banking sector capital and profitability.

*International Monetary Fund — Malaysia chapter excerpt*

### Box 1. Estimating an Equilibrium Level of House Prices

### Box 1. Estimating an Equilibrium Level of House Prices

### Methodology
- Approach builds on Igan and Loungani (2012): model and estimate main drivers of real house price changes and calculate the gap between actual house prices and model-predicted values.
- Real house price changes (ΔHPI_t) are modeled as a function of:
  - lagged affordability level (A_{t−1}), measured by the ratio of house prices to income per capita;
  - change in real income per capita (ΔYPC_t);
  - change in working-age population over the past year (ΔWAP_t);
  - change in stock prices over the year before last (ΔSP_t);
  - credit growth over the last year (ΔCr_t), defined as credit to the private non-financial sector by domestic banks;
  - real interest rate (i_t), defined as base lending rate.
- Reference year for calculating house price misalignment: 2010.

### Regression specification
- Estimated equation (ordinary least squares, quarterly data 1988–2018):
  ΔHPI_t = α + β1 A_{t−1} + β2 ΔYPC_t + β3 ΔWAP_t + β4 ΔSP_t + β5 ΔCr_t + β6 i_t + e_t
- In the absence of sufficiently long data on working-age population, total population data are used.

### Data and estimation sample
- Frequency: quarterly.
- Sample period: 1988 to 2018.
- Reference year for misalignment calculation: 2010.

### Regression results (Fundamental Determinants of House Prices - Regression Results)
- Explanatory Variable — Coefficients
  - Affordability: -41.4***
  - Per Capita Income: 0.69***
  - Credit: 0.4***
  - Population: -1.75**
  - Equity Prices: 0.05***
  - Interest Rate: -0.16
  - Constant: 17.7***
- Sample and fit statistics:
  - Observations: 120
  - R2: 0.48
- Note on significance: *p<0.1; **p<0.05; ***p<0.01

### Interpretation and use
- Large negative coefficient on lagged affordability (-41.4***) implies that higher past house-price-to-income ratios are associated with subsequent declines in real house price changes, holding other factors constant.
- Positive coefficients on Per Capita Income (0.69***), Credit (0.4***), and Equity Prices (0.05***) indicate these variables are associated with higher real house price changes.
- Population change enters negatively (-1.75**), conditional on other variables in the model.
- Interest rate coefficient (-0.16) is negative but not indicated as statistically significant at conventional levels in the table.
- The estimated model can be used to compute predicted real house price changes and hence the misalignment (gap) between actual and equilibrium house prices using the 2010 reference.

*Source: Box 1. Estimating an Equilibrium Level of House Prices, Malaysia — Staff Report for the 2020 Article IV Consultation (excerpt).*

### Introduction

### Introduction

### Authorities' opening and overall assessment
- On behalf of the Malaysian authorities, appreciation is expressed to the IMF team for the comprehensive report and constructive dialogue during the 2020 Article IV consultation.
- Authorities are encouraged by staff’s positive assessment on Malaysia’s economic and financial outlook, and acknowledge the appropriateness of the current macroeconomic policy setting and progress in Malaysia’s reform agenda.
- Authorities welcome the Fund’s greater recognition of the need for an expanded policy toolkit and an integrated approach to policy formulation, and urge the Fund to expedite its ongoing work on the integrated policy framework.

### Latest economic developments and outlook
- Malaysian economy moderated in 2019 amidst heightened uncertainty and considerable downside risks in the global economy; growth was underpinned by a diversified economy, the flexibility accorded by a floating exchange rate and healthy external balance.
- Authorities broadly agree with the IMF’s near-term assessment of the Malaysian economic growth and risks.
- The Malaysian economy grew by 4.6% in the first 3 quarters of 2019, supported by firm private consumption spending and positive net exports.
- Investment activity in 2019 remained modest, due to weak capital spending by both the private and public sectors.
- In 4Q 2019, unanticipated supply disruptions in the commodities sector and a contraction in net exports are expected to weigh on growth.
- Headline inflation averaged lower: 2019: 0.7%; 2018: 1.0%, mainly reflecting the extension of domestic retail fuel price ceilings and the lapsed effect of the changes in the consumption tax policy.
- Core inflation was broadly stable: 2019: 1.5%; 2018: 1.6%.
- Expectations for 2020:
  - Authorities expect gradual improvement in growth, supported by continued household spending amid stable labor market conditions.
  - Key Government initiatives from the 2020 Budget such as the higher minimum wage in urban areas, targeted fuel subsidy and cash transfers are expected to lift disposable income.
  - Investment activity is expected to record a modest recovery, underpinned by the realization of approved investment projects and resumption of large infrastructure projects.
  - In line with the expected improvement in global growth and trade, Malaysia’s exports are expected to experience a broad-based recovery.
  - E&E exports (37.8% share of Malaysia’s total exports) are poised to benefit from the pickup in the current global technology cycle given Malaysia’s position as the 6th largest semiconductor exporter globally.
  - Headline inflation is expected to average higher than in 2019 but remain modest; the trajectory will depend on global oil and commodity price developments and the timing of the lifting of the domestic retail fuel price ceilings.
  - Underlying inflation is expected to remain broadly stable, reflecting the continued expansion in economic activity and the absence of strong demand pressures.
- Risks to the growth outlook (tilted to the downside):
  - Uncertainty surrounding trade tensions.
  - Slower-than-expected growth in major trading partners.
  - Potential tightening of global financial conditions due to heightened risk aversion towards emerging markets.
  - Implications from prolonged Coronavirus outbreak.
  - Domestic risks: weakness in commodity-related sectors and delays in the implementation of projects.
- Mitigating factors:
  - Exchange rate flexibility with adequate levels of international reserves will continue to buffer against external shocks.
  - Malaysia’s diversified export base reduces reliance on any single product or market.
  - Deep financial markets, supported by demand from large domestic institutional investors and a sound banking system, will continue to intermediate capital flows during risk-off periods.
  - Government commitment to timely implementation of public projects and continued efforts to provide policy clarity will help cushion downside risks to growth.

### Fiscal policy and fiscal management reforms
- Authorities embarked on a holistic fiscal reform program focusing on strengthening governance and fiscal policy management while remaining supportive of sustainable and inclusive economic growth.
- The authorities continue to promote greater transparency and accountability through its second annual publication of the Fiscal Outlook and Federal Government Revenue Estimates.
  - The report highlights the Medium-Term Fiscal Framework for the next 3 years and includes comprehensive reporting of fiscal risks and liability exposures, including Government Guarantees and other liabilities such as those related to public-private-partnerships.
- A comprehensive assessment of debt management and an internal Debt Sustainability Analysis suggest Malaysia has a relatively manageable level of debt and financing needs; consistent with staff’s findings that the debt level is expected to gradually decline to a debt-to-GDP ratio of below 50% in the medium term.
- Authorities are establishing a Debt Management Office for a more holistic assessment of total debt and liabilities and more prudent debt management.
- The Government Procurement Act will further promote the credibility and efficiency of public finance while the enactment of the Fiscal Responsibility Act in 2021 will further enhance fiscal discipline.
- Commitment to fiscal consolidation:
  - Authorities remain steadfast in commitment towards fiscal consolidation and are confident in achieving further deficit reduction over the medium term.
  - Undertook a rigorous exercise to minimize fiscal leakages by improving spending efficiency, strengthening procurement processes and ceasing low priority projects with low multiplier effects.
  - Authorities will gradually reduce the broad-based fuel subsidy and move towards more targeted assistance through the implementation of the Targeted Fuel Subsidy Program.
  - Better spending efficiency created the required space for higher expenditures in health and education as well as other spending to support longer-term structural reforms.
- Revenue enhancement measures:
  - Committed to enhancing the revenue base by reducing the tax gap and improving tax efficiency through various initiatives, including rationalizing tax incentives, minimizing tax leakages and enhancing tax compliance through effective auditing.
  - Excluding the one-off PETRONAS special dividend payout in 2019, higher revenue collection is expected in (text ends).

*Source: Introduction (1mysea2020001).*

### 2020. More progressive personal income tax structure, higher chargeable income criteria for

### 2020. More progressive personal income tax structure, higher chargeable income criteria for corporates to benefit from the reduced tax rate for SMEs and new Digital Services Tax are among the key measures expected to enhance the revenue base in 2020.

### Fiscal measures and revenue strategy
- Key measures expected to enhance the revenue base in 2020:
  - More progressive personal income tax structure.
  - Higher chargeable income criteria for corporates to benefit from the reduced tax rate for SMEs.
  - New Digital Services Tax.
- The Tax Reform Committee (TRC) undertook a holistic review of the national tax system to broaden the tax base while supporting sustainable and inclusive growth.
- Recommendations from the TRC will be incorporated in the Medium-Term Revenue Strategy (MTRS).
- Support from the Fund in formulating and implementing the MTRS and other fiscal initiatives are most welcomed.

### Monetary policy
- Authorities concur with staff’s assessment that the monetary policy stance is appropriate.
- The Monetary Policy Committee (MPC) lowered the Overnight Policy Rate by 25 basis points to 2.75% in January 2020.
  - The adjustment was described as a pre-emptive measure to secure the improving growth trajectory amid price stability.
- The MPC will continue to assess the balance of risks surrounding the outlook for domestic growth and inflation.

### Exchange rate policy and reserves adequacy
- Malaysia is committed to exchange rate flexibility to enhance resilience against volatile capital flows and external shocks.
- Two-way foreign exchange market operations are undertaken to ensure orderly market conditions, particularly during periods of large and volatile capital flows.
- International reserves data is published every fortnight and is deemed as adequate.
- Publication of foreign exchange intervention data would be assessed once the work on integrated policy framework is completed.
- Authorities concur with the IMF’s assessment that international reserves remain adequate across a wide range of indicators, including the ARA metric.
- Going forward, declining external indebtedness and continued healthy current account surplus will further enhance Malaysia’s reserves adequacy.
- On external debt and IIP composition:
  - While external debt will rise most under the simulated exchange rate shock, Malaysia’s sizeable net foreign currency asset position implies exchange rate depreciation will result in a larger increase in external assets compared to external liabilities in domestic currency terms, improving Malaysia’s net international investment position (IIP).
- Authorities welcome the 2018 refinement to the External Balance Assessment model but note the model’s explanatory power remains weak in the Malaysian context.
- The current account surplus has narrowed significantly over the last decade; authorities recognize it partly reflects high savings and low investment and remain committed to reforms to promote investments and a more comprehensive social safety net.

### Financial market development policies
- The Fund’s acknowledgement of the effectiveness of domestic FX market deepening initiatives is welcomed; objectives remain accessibility and liquidity.
- Investor engagement and policy communication to inform policy responses will continue.
- Appointed Overseas Office (AOO) pilot programme expansion in 2019 received positive feedback for improved ringgit liquidity and price discovery beyond trading hours.
- Dynamic hedging programme uptake:
  - 84 investors managing an aggregate of USD30 billion registered in 2018.
  - 104 investors managing USD37 billion in 2019.
- Average daily FX transactions:
  - USD11.5 billion in 2018.
  - USD12.2 billion in 2019.
- Existing FX market measures are prudential in nature and form part of a broader policy toolkit; authorities will continuously review measures’ effectiveness and determine timeline and speed of phasing out.

### Financial sector resilience and prudential measures
- Authorities welcome staff’s assessment that the Malaysian financial sector remains resilient and stable.
- Policy initiatives aim to reduce financial imbalances from household and real estate exposures and strengthen sector soundness.
- Recognition of efforts to manage climate-related financial risks and cyber risks.
- Household debt monitoring:
  - Authorities closely monitor household debt given high indebtedness but assess potential risks as manageable.
  - Asset quality remains sound with low and stable ratio of aggregate impaired loans to total outstanding household debt for both banks and non-banks.
  - Households’ debt-servicing capacity supported by income and employment growth and ample aggregate financial buffers.
  - Internal simulations suggest potential losses to the banking system from household exposures under stressed scenarios are estimated to be manageable.
- Vulnerable households:
  - Vulnerable group defined as individual borrowers with monthly earnings of below RM3,000.
  - Exposures to this group continue to exhibit low impairment ratios and improved vintage analysis; proportion of exposures is on a declining trend.
  - Most new loans to this segment continued to be within prudent debt service ratios.
- Property market vigilance:
  - Majority of outstanding housing loans carry loan-to-value (LTV) of below 80%.
  - Bulk of housing loans are to owner-occupants.
  - Banks have sufficient capital buffers to absorb potential losses arising from up to a 50% decline in property prices and associated spillovers.
- Macroprudential and fiscal measures since 2010:
  - Assessed to have effectively contained risks from household indebtedness and credit-fueled speculative activities in the property market.
  - Complemented by measures to increase supply of affordable houses and enhance affordability (e.g. Home Ownership Campaign, stamp duty exemptions).
- On policy recommendations by staff:
  - Staff recommended sector-wide standardized LTV limits on first and second properties in the medium term and a debt-to-service ratio (DSR) limit on all individual borrowers.
  - Authorities maintain current macroprudential measures remain appropriate but note additional limits for LTV and DSR can be implemented under existing policy frameworks if warranted.
- AML/CFT and TFS for Financial Institutions:
  - Revised policy documents effective 1 January 2020 emphasize risk-based customer due diligence (CDD) and consolidated TFS requirements.

### Governance and structural reform for sustainable and inclusive growth
- Progress on governance reform:
  - Implementation of National Anti-Corruption Plan 2019-2023 (NACP) showed significant progress: 22 out of 115 initiatives in the plan implemented in 2019, including asset declaration by members of the administration.
  - Remaining initiatives, including those involving amending the Federal Constitution, are on track.
  - Special Cabinet Committee on Anti-Corruption (January 2020) agreed proposal for termination of service of the chief commissioner be made through a constitutional process by amending relevant law; a study will be carried out on appointment procedures.
  - Continuous review and strengthening of MACC Act, Witness Protection Act and Whistle Blower Protection Act.
  - Malaysia jumped 10 spots in Transparency International’s Corruption Perceptions Index (CPI) 2019.
- Development plans and investment climate:
  - 11th Malaysia Plan (11MP) period focuses on strengthening economic fundamentals, innovation, productivity, sectoral growth in services and manufacturing, and promoting private investment.
  - Shared Prosperity Vision 2030 sets longer-term policy direction toward high-value, high-technology economy and inclusive sustainable development.
  - Approved foreign direct investment in manufacturing hit an all-time-high in 2018 and continued to increase in 2019.
  - National Committee Investment established August 2019 expedited large investment approvals.
  - Comprehensive review and revamp of existing incentive framework expected to be ready by January 2021.
  - Authorities emphasize improving business climate, ports and logistics, and infrastructure to attract regional investment.
- SME and financial inclusion measures:
  - Encouraging digital financial innovations (Equity CrowdFunding, Peer-to-peer funding) through My Co-Investment Fund.
  - Providing tax incentives to attract venture capital and angel investors.
- Development Financial Institutions (DFIs):
  - Exposure draft on Corporate Strategic Plan for DFIs issued in January 2020 to enhance business strategies, funding plans, and performance measurement.
- Digital banking:
  - Exposure Draft on Licensing Framework for Digital Banks issued December 2019.
  - Up to five licenses may be issued to qualified applicants.
  - Digital banks expected to offer meaningful access, responsible usage of suitable and affordable financial solutions, especially for underserved and unserved segments.
- 2020 Budget highlights:
  - Capital development spending for digital infrastructure.
  - Incentivized digital application by businesses.
  - Leveling up of human capital.
  - Education remains largest allocation in 2020 with emphasis on quality, equity, access, unity, efficiency and inclusiveness.
  - Progress on labor market reforms, particularly boosting female labor force participation, remains on track.

### Concluding remarks and outlook
- Authorities will remain vigilant to adverse developments and potential risks to the economy and financial system.
- Strengths cited:
  - Diversified economy.
  - Flexibility from a floating exchange rate.
  - Healthy external balance.
  - Strong financial sector.
- Adequate policy tools and buffers allow effective and timely responses to preserve macroeconomic and financial stability.
- Authorities committed to key governance and structural reforms to achieve sustainable and inclusive growth.
- Authorities view the Fund as having an important role in reducing risks from disruptive cross-border spillovers for small and open economies like Malaysia.

*Source: 1mysea2020001 - 2020. More progressive personal income tax structure, higher chargeable income criteria for*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1mysea2020001.pdf_