## 1. Growth and Exports

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### Context and policy framework
- Malaysia registered strong post-pandemic recovery in 2022, supported by a well diversified economy, robust policy frameworks, and commodity exporter status.
- Authorities have a track record of fiscal prudence and a credible monetary policy framework; costly and untargeted spending on subsidies (the highest in Malaysia’s history) helped suppress inflationary pressures and the rising cost of living.
- The newly elected government must ensure policy continuity, coordination, and consistency while implementing the Twelfth Malaysia Plan (12MP) and the 2023 budget’s MADANI vision under a narrow policy space.

### Recent developments: growth, demand, and exports
- Real GDP growth: 8.7 percent in 2022.
- Contributions to 2022 growth:
  - Private consumption: 6.6 percentage points.
  - Investment: 1.4 percentage points.
- Credit growth: 4.7 percent in December 2022, driven by households.
- Exports: Goods exports growth broad-based, driven by electrical and electronic products and supported by higher commodity prices; export destination mix concentrated to ASEAN, the US, and less to China and the EU.
- Sectoral notes: Agriculture, mining, and construction lag manufacturing and services; tourism recovery remains below pre-pandemic trends; labor market remains fragmented and somewhat tightened.

### External pressures and exchange rate developments
- Portfolio investment: net outflow of US$3.4 billion in 2022Q2, mostly from non-residents’ reduction in debt securities holdings (US$3 billion).
- Ringgit movements:
  - Depreciated by 11.5 percent against the US dollar between the start of the war in Ukraine and end-October 2022.
  - Registered a total depreciation of about 5 percent for the year 2022.
- Gross international reserves: US$114.7 billion at end-2022.
- Reserve coverage relative to IMF ARA metric: 110.2 percent at end-2022 (121.3 percent at end-2021); change driven by a decline in gross reserves of US$2.2 billion and an increase in short-term external debt.

### Inflation and pass-through
- Headline inflation:
  - Peaked at 4.7 percent in August 2022.
  - Moderated to 3.7 percent in February 2023.
  - 2022 headline inflation reported at 3.4 percent.
  - Projected inflation for 2023: 3.3 percent.
- Core inflation: acceleration since beginning of 2022 appears to have paused in December, but remains high amid a positive output gap and signs of a steeper Phillips Curve (Appendix I).
- Factors mitigating pass-through from ringgit depreciation: price controls, record subsidies, small proportion (10 percent) of imported goods in CPI basket, limited capacity of firms to pass higher costs to consumers.
- Vulnerabilities: USD invoicing prevalence (about 80 percent of exports and imports in 2019) implies large and persistent depreciation could materially affect inflation, particularly after transition from broad to targeted subsidies.

### Fiscal developments
- 2022 fiscal outturn:
  - Headline deficit projected at 5.6 percent of GDP in 2022 (target was 6 percent; 2021 deficit 6.3 percent).
  - Federal government debt projected to fall to 60.4 percent of GDP in 2022, below the effective debt limit of 67.5 percent of GDP (Appendix II).
  - Strong revenue performance from higher oil prices and a doubling of Petronas dividend; total expenditure higher due to significantly higher subsidies spending.
- 2023 Budget stance:
  - Overall deficit decline forecast: from 5.6 percent of GDP in 2022 to 5.0 percent in 2023.
  - Budget measures: continued cash assistance to vulnerable households, ramped-up development expenditures, tax incentives to strategic industries and goals, introduction of progressive revenue measures (capital gains tax, luxury goods tax, excise on nicotine products, higher tax rates for higher income individuals), and tax cuts for SMEs and lower- and middle-income households (overall about revenue-neutral in 2023).
  - Subsidies: expiry of some COVID spending and a declining—yet elevated—subsidy bill in 2023; bulk of subsidy reform likely to materialize in 2024 and be fleshed out in the 2024 Budget.
  - Fiscal consolidation target: deficit of 3.2 percent of GDP in 2025 via gradual revenue mobilization and reduced spending leakages; shift towards targeted subsidy mechanism (no specifics on yields or timeframes).
- Selected fiscal indicators (In Percent of GDP — Est./Proj.):
  - Revenue and grants: 15.1 (2021), 16.5 (2022), 15.1 (2023)
  - of which oil-related revenues: 2.8 (2021), 4.6 (2022), 3.4 (2023)
  - Expenditure and net lending: 21.4 (2021), 22.1 (2022), 20.0 (2023)
  - of which COVID-related spending: 2.4 (2021), 1.7 (2022), 0.0 (2023)
  - of which subsidies: 1.5 (2021), 3.8 (2022), 3.0 (2023)
  - Overall balance: -6.3 (2021), -5.6 (2022), -5.0 (2023)
  - Memorandum item — Fiscal impulse: 0.9 (2021), 0.5 (2022), -1.5 (2023)

### Monetary policy and financial conditions
- Policy rate actions:
  - Bank Negara Malaysia (BNM) increased the overnight policy rate (OPR) four times since May (cumulative 100 bps) to 2.75 percent.
  - Monetary tightening paused in January and March 2023 to assess past hikes; BNM reiterated commitment to calibrate policy balancing price stability and sustainable growth.
- Financial conditions:
  - Tightened significantly during most of 2022 amid fears of aggressive Fed tightening; eased more recently as USD weakened against the ringgit.
- Financial soundness indicators (Q4 2022 / 2022Q4 unless noted):
  - Banking sector total capital ratio: 18.8 percent.
  - Common equity tier 1 (CET1): 15.0 percent.
  - Liquidity coverage ratio (LCR): 154 percent.
  - Nonperforming loans (NPL): 1.7 percent of total loans.
  - Loan loss coverage ratio (including regulatory reserve): 118.2 percent in December-2022.
  - Insurers and takaful operators (ITO) capital adequacy ratio: 226 percent.
  - Household debt support: share under repayment assistance declined from 18.8 percent in December 2021 to 1.9 percent of outstanding banking system and development financial institutions loans as of December 2022.
- Housing market: ongoing recovery; price growth has been on a declining trend for almost a decade.
- Limited direct exposure to troubled US and European banks.

### External position and current account
- Current account:
  - 2022 current account surplus: 2.6 percent of GDP (down from 3.8 percent in the previous year).
  - Deterioration driven by widening income deficit due to increased outflows associated with direct investment income and outward remittance.
  - Goods balance slightly declined as import growth outpaced export growth; services balance improved with reopening.
- External assessment:
  - Malaysia’s external position in 2022 preliminarily assessed to be stronger than warranted by fundamentals and desired policies (Appendix III).
  - Adjusting for cyclical and country-specific temporary factors, Malaysia’s residual current account gap is assessed in the range of 3-4 percent of GDP.

### Outlook and risks
- Near-term macro outlook:
  - Growth projected to moderate to 4.5 percent in 2023.
  - Output gap estimated to have turned positive in 2022, driven primarily by strong domestic demand.
  - Inflation projected at 3.3 percent in 2023, with likely persistence in core inflation amid a positive output gap.
- Risk assessment (selected, Appendix IV and Risk Assessment Matrix):
  - External risks (tilted to the downside): abrupt global slowdown or recession in major trading partners; spike in global risk premia and capital outflows; monetary policy miscalibration in major central banks; commodity price shocks; negative effects from geo-economic fragmentation.
  - Domestic risks: fiscal risks from contingent liabilities; political risks from managing a diverse governing coalition.

### Staff appraisal (summary)
- Malaysia registered a strong post-pandemic recovery in 2022 after reopening in April 2022.
- Downside risks, mostly external, cloud the near-term outlook.
- Fiscal policy:
  - The gradual fiscal consolidation strategy in the 2023 Budget is appropriate but should be credibly underpinned by high-quality and durable measures.
  - Finalizing the Fiscal Responsibility Act (FRA) is welcomed; developing a medium-term revenue strategy (MTRS) is an urgent priority.
  - Phased and transparently communicated subsidy reform alongside social safety net reforms is overdue.
- Monetary policy:
  - Monetary policy should tighten further to bring the stance to a neutral position.
  - BNM should continue clear communication of policy rationale given rapid changes and high uncertainty.
  - Continued commitment to exchange rate flexibility is welcome.

---

### Authorities' views and forecasts
- Authorities' growth outlook for 2023: between 4 and 5 percent.
- Authorities' inflation outlook for 2023: between 2.8 percent and 3.8 percent.
- Authorities reaffirm commitment to gradual fiscal consolidation; medium-term deficit target: 3.2 percent of GDP in 2025 to be achieved mainly through:
  - revenue measures (1.1 pp of GDP),
  - savings from planned subsidy reform (0.7 pp of GDP).
- Authorities developing a MTRS; technical assistance request to the Fund on MTRS noted positively.
- BNM stresses commitment to price stability and a flexible exchange rate regime; supports gradual and measured policy calibration.

### Staff–authorities convergence and differences
- Authorities broadly agreed with staff’s assessment of outlook and risks.
- Staff recommends earlier/more tightening of monetary policy than authorities, citing evidence of accommodative stance and positive output gap.
- Authorities retain reservations about aspects of the EBA model due to a large unexplained residual.

---

### Household, Macroprudential, and Financial Stability

### Household balance sheets and household debt
- Household debt: 81.2 percent of GDP as of 2022Q4 (2019Q4: 82.8).
- About 60 percent of household debt is in housing loans.
- About 78 percent outstanding of household debt, and almost all mortgage debt, is at floating rates.
- Median borrower debt service ratios (DSR) for outstanding loans: 37 percent.
- Despite a 100bps increase in OPR since May 2022, median DSR increased only marginally.
- Policy recommendations for household resilience:
  - Continue development of strong preventive ex ante measures (advice to debtors, informal debt restructuring).
  - Strengthen personal debt enforcement tools and address ex post debt, including personal bankruptcy liquidation and bankruptcy repayment plans.

### Macroprudential policy and lending standards
- BNM measures include LTV caps for third and above housing loans for individuals and for all housing loans for non-individuals; higher risk-weights for loans with LTV levels of 90 percent and above.
- Staff recommendations:
  - Pre-emptively expand the macroprudential toolkit with tools that can be swiftly and transparently adjusted.
  - Consider sector-wide LTVs on first and second properties.
  - Consider debt-service-to-income limits for all income groups.
  - Require stress testing of borrowers’ affordability with higher interest rates at loan origination.

### Corporate balance sheets and surveillance
- Interest coverage ratios for the corporate sector are above pre-pandemic levels and liquidity ratios remain strong as of 2022Q2.
- About 90 percent of corporates’ external borrowings (excluding intercompany loans and trade credit exposures) are either naturally or financially hedged.
- Staff recommendation: enhance corporate surveillance by adding balance sheet risk indicators including susceptibility to abrupt shifts in supply chains.

### Financial stability assessment
- Financial system appears resilient with systemic risks contained.
- BNM stress tests suggest banks remain able to support the economy; post-shock aggregate capital ratios at end-2023 remain comfortably above regulatory minimum levels.
- Monitoring priorities: profitability of ITOs, potential credit risks from BNPL schemes, spillovers from China’s property sector.
- Bank exposure to Chinese developers: 0.1 percent of total financial institutions’ exposures to businesses as of 2022Q4.

---

### Subsidy Reform, Social Safety Nets, and Structural Policies

### Subsidy reform rationale and timing
- Rationale: subsidy reform would support fiscal sustainability, rebuild buffers, create space for growth-enhancing public spending, and reduce emissions.
- Timing: subsidy reform expected to be initiated late 2023, primarily through phasing out electricity subsidies and gradual liberalization of select fuel prices, with further details in the 2024 Budget.
- Fiscal context: energy subsidy bills historically reached over 20 percent of current expenditures in periods of high commodity prices.

### Principles and sequencing for reform
- Key principles:
  - Part of a comprehensive reform plan with stakeholder consultation.
  - Implemented gradually and sequenced across products, starting with those with lower weight in low-income consumption baskets (such as Diesel).
  - Include an automatic pricing mechanism and transparent communication strategy.
  - Accompanied by mitigating cash transfers targeted at low-income households (e.g., BKM program) and SSN reform.
- Policy design needs:
  - Quantified mitigating cash transfers and clarity on sequencing of energy price increases and depoliticized price-setting mechanism.

### Medium-Term Revenue Strategy (MTRS) and tax options
- Urgent priority: develop a MTRS.
- Current tax revenue context: About 11 percent of GDP in 2021, Malaysia’s tax revenues are the lowest among its ASEAN-5 and OECD peers and have been declining.
- Carbon tax potential: staff estimate could generate 1 to 3 percent of GDP per year in fiscal revenues by 2030.
- Pipeline measures: enhancements to SST, income tax on digital economy, use of tax identification number, tax administration improvements, capital gains tax, luxury goods tax, and measures from introducing a MTRS. Reinstating an improved GST and introducing a carbon tax remain medium-term options.

### Structural policies and 12MP implementation
- Key measures under 12MP: labor market reforms, education upgrades, productivity drivers, digital economy, climate policies, active labor market policies, social protection upgrades, digitalization.
- Potential impact: full delivery of 12MP measures could raise medium-term growth above staff baseline.
- Governance concerns: progress on the 2019–2023 National Anti-Corruption Plan (NACP) stalled (about 53 percent implemented as of end-December 2022); passing the FRA is a major step to anchor fiscal governance reforms.

---

### Debt Coverage, DSA Highlights, and External Sustainability

### DSA coverage and baseline public debt projections (Percent of GDP)
- Debt coverage: Central government; covers more than 90 percent of general government debt.
- Public debt — Actual and projections:
  - Actual 2022: 60.4
  - 2023: 60.8
  - 2024: 60.9
  - 2025: 61.3
  - 2026: 61.8
  - 2027: 62.7
  - 2028: 63.3
  - 2029: 64.2
  - 2030: 64.7
  - 2031: 65.2
  - 2032: 65.8
- Primary deficit (percent of GDP):
  - 2022: 3.3
  - 2023: 2.6
  - 2024: 2.1
  - 2025: 2.0
  - 2026: 1.9
  - 2027: 1.7
  - 2028: 1.6
  - 2029: 1.6
  - 2030: 1.6
  - 2031: 1.6
  - 2032: 1.7
- Gross financing needs (percent of GDP):
  - 2022: 11.6
  - 2023: 10.6
  - 2024: 10.8
  - 2025: 9.8
  - 2026: 9.9
  - 2027: 9.5
  - 2028: 8.8
  - 2029: 8.5
  - 2030: 9.2
  - 2031: 8.4
  - 2032: 8.2
- Staff commentary: Public debt will gradually rise over the forecast horizon, reflecting a primary deficit that remains about 2 ppts of GDP above its debt stabilizing level in 2032.

### External debt and vulnerabilities (selected)
- Total external debt (in percent of GDP):
  - 2018: 62.2; 2019: 63.4; 2020: 70.8; 2021: 69.6; 2022: 63.8.
- Short-term external debt (original maturity, in billions of U.S. dollars): 2018: 97.9; 2019: 95.2; 2020: 91.5; 2021: 97.2; 2022: 109.2.
- Short-term external debt (original maturity to reserves, in percent): 2018: 96.5; 2019: 91.9; 2020: 85.0; 2021: 83.0; 2022: 95.2.
- Currency composition of external debt (end-2022):
  - Ringgit‑denominated: 33.1 percent of total external debt.
  - Foreign currency‑denominated: 66.9 percent of total external debt.
- External debt projections: baseline projects decline to about 55.7 percent of GDP by 2028.
- Reserves and coverage:
  - Gross official reserves: US$114.7 billion (end-2022).
  - Reserves coverage of IMF ARA metric: 110 percent at end-2022 (down from 121 percent at end-2021).
  - Reserve coverage: about 5 months of prospective imports, or about 85 percent of short-term debt.

---

### Policy Scenarios, IPF Simulations, and FXI Guidance

### Stylized downside scenarios (IPF / Appendix VIII)
- Scenario-1 (Adverse): severe and protracted slowdown in China → lower external demand, risk-off, ringgit depreciation, higher risk premia.
- Scenario-1 (Alternative, no risk-off): fundamental shocks only; foreign country cuts rates more aggressively than Malaysia → exchange rate appreciation and declines in inflation and output.
- Scenario-2 (Adverse): escalation of the war in Ukraine → higher global commodity prices, US core inflation up about 1 percentage point compared to baseline, risk-off with capital outflows.

### IPF model findings on policy responses
- Interest rate alone:
  - Scenario-1 (with risk-off): cutting policy rate to spur demand is muted by higher inflation and risk-off pressures.
  - Scenario-2 (stagflation): raising rates significantly required to contain inflation but slows growth markedly.
- Interest rate + FX interventions (FXI):
  - Scenario-1 (with risk-off): FXI limits depreciation, reduces pass-through, creates space for monetary easing; benefits limited if depreciation is short-lived and FXI costs high.
  - Scenario-2: FXI restricts large/persistent depreciation, limits pass-through to inflation, reduces required policy rate hikes and output losses.
- Fiscal policy:
  - Targeted transfers can contain demand losses but increase government debt and medium-term rates.
  - Subsidy removal combined with targeted transfers (alternative Scenario‑1): reducing fuel subsidies by about 10 percent offsets some fiscal cost of transfers and mitigates debt buildup; removal when prices are high would exacerbate inflationary pressures.

### FX intervention guidance and cautions
- FX interventions should be limited to preventing disorderly market conditions and addressing identified frictions.
- FXI is justified when:
  - Well‑identified frictions exist (shallow FX markets, unhedged FX risks, balance sheet mismatches, high exchange rate pass‑through risking inflation expectations).
  - Shocks are large enough to threaten macroeconomic and financial stability.
  - FXI targets risk premia rather than a specific exchange rate and is integrated into overall policy response.
  - Sufficient reserves are available for credible FX sales during outflow episodes.
- Staff finding: aside from somewhat shallow market indicators (UIP premium and bid‑ask spread), no material evidence of frictions (2) and (3) in Malaysia.
- Caution: persistent FX sales are costly—impede market development, dampen policy credibility, deplete reserves.
- Recommendation: opportunistic reserve accumulation during risk‑on episodes appropriate but should not interfere with needed real exchange rate appreciation over the medium term.
- BNM steps: ongoing liberalization and deepening of the FX market welcomed; existing CFMs should be gradually phased out with regard to market conditions.
- Publication: FXI data publication (with appropriate lag) could enhance communication.

---

### Climate Risks, Sustainable Finance, and Financial Sector Preparedness

### Climate-related risks and financial sector exposure
- Malaysia faces significant climate risks: flooding, cyclones and chronic heat stress.
- Transition to net zero by 2050 will have significant economic implications given large share of carbon-intensive sectors.
- Estimated cumulative investment to achieve net zero by 2050 (JC3, WWF-BCG estimates): RM 350-450 billion (c. $90 billion).
- About 8 percent of banking sector loans and 24 percent of insurance sector total assets are in sectors with high carbon intensity or potentially exposed to climate change.
- Specific ecosystem-service exposures in commercial loans portfolio:
  - Surface water deterioration: 29 percent
  - Climate regulation (carbon storage): 26 percent
  - Flood and storm protection: 16 percent
- BNM preparing industry-wide climate risk stress testing exercise in 2024 using NGFS scenarios.

### Sustainable finance market and policy actions
- Sustainable finance volumes: surged from $0.8 billion in 2017 to $4 billion in 2022.
- Malaysia issued the world’s first green Sukuk in 2017 and the world’s first sovereign US dollar sustainability Sukuk in 2021; sustainable Sukuk issuance volumes grew 307 percent since 2017 to $3.1 billion in 2022.
- Carbon tax potential: $25 to $75 per ton of CO2 could potentially raise fiscal revenues of 1 to 3 percent of GDP by 2030.
- Boxed firm-level exercise findings: a $25 per ton CO2e tax would cause notable declines in ICR/CR for energy generation and waste management firms; higher tax rates magnify vulnerabilities.

### Policy implications
- Banks and the broader financial system need to play a critical role in an orderly transition; strengthen monitoring, reporting, disclosure, and sustainable financing pipelines.
- BNM’s Financial Sector Blueprint (2022-2026) and Capital Markets Masterplan 3 aim to enhance climate risk monitoring and sustainable finance.

---

### Key policy recommendations (selected, staff view)
- Fiscal:
  - Finalize the Fiscal Responsibility Act (FRA) and develop a Medium-Term Revenue Strategy (MTRS).
  - Pursue gradual and credible medium-term fiscal consolidation to put debt on a firm downward path.
  - Phase and transparently communicate subsidy reform alongside strengthened SSNs.
- Monetary and FX:
  - Withdraw monetary accommodation further to bring stance to neutral; be data dependent given uncertainty.
  - Use FX intervention sparingly, targeted at risk premia and disorderly conditions; publish FXI data with lag.
  - Complement policy rate adjustments with clear communication to anchor expectations.
- Macroprudential and financial stability:
  - Broaden macroprudential toolkit (consider sector‑wide LTVs, DSR limits, stress testing borrower affordability).
  - Strengthen supervision of lending standards and monitoring of NBFIs and BNPL.
- Structural and climate:
  - Implement 12MP measures to boost productivity, digitalization, and education; accelerate climate mitigation and adaptation investments.
  - Strengthen governance, anti-corruption measures, and public procurement efficiency.
- Social protection:
  - Scale up and improve targeting of SSNs (BKM and related programs) to protect vulnerable households during subsidy reform.

*Source: IMF country report chapter "1. Growth and Exports" (content unit 1mysea2023001).*

### 1. Growth and Exports _________________________________________________________________________ 26

### 1. Growth and Exports

### Context and policy framework
- Malaysia registered strong post-pandemic recovery in 2022, supported by a well diversified economy, robust policy frameworks, and commodity exporter status.
- Authorities have a track record of fiscal prudence and a credible monetary policy framework; costly and untargeted spending on subsidies (the highest in Malaysia’s history) helped suppress inflationary pressures and the rising cost of living.
- The newly elected government must ensure policy continuity, coordination, and consistency while implementing the Twelfth Malaysia Plan (12MP) and the 2023 budget’s MADANI vision under a narrow policy space.

### Recent developments: growth, demand, and exports
- Real GDP growth: 8.7 percent in 2022.
- Contributions to 2022 growth:
  - Private consumption: 6.6 percentage points.
  - Investment: 1.4 percentage points.
- Credit growth: 4.7 percent in December 2022, driven by households.
- Exports: Goods exports growth was broad-based, driven by electrical and electronic products and supported by higher commodity prices; export destination mix concentrated to ASEAN, the US, and less to China and the EU.
- Sectoral notes: Agriculture, mining, and construction lag manufacturing and services; tourism recovery remains below pre-pandemic trends; labor market remains fragmented and somewhat tightened.

### External pressures and exchange rate developments
- Portfolio investment: net outflow of US$3.4 billion in 2022Q2, mostly from non-residents’ reduction in debt securities holdings (US$3 billion).
- Ringgit movements:
  - Depreciated by 11.5 percent against the US dollar between the start of the war in Ukraine and end-October 2022.
  - Registered a total depreciation of about 5 percent for the year 2022.
- Gross international reserves: US$114.7 billion at end-2022.
- Reserve coverage relative to IMF ARA metric: 110.2 percent at end-2022 (121.3 percent at end-2021); change driven by a decline in gross reserves of US$2.2 billion and an increase in short-term external debt.

### Inflation and pass-through
- Headline inflation:
  - Peaked at 4.7 percent in August 2022.
  - Moderated to 3.7 percent in February 2023.
  - 2022 headline inflation reported at 3.4 percent.
  - Projected inflation for 2023: 3.3 percent.
- Core inflation: acceleration since beginning of 2022 appears to have paused in December, but remains high amid a positive output gap and signs of a steeper Phillips Curve (Appendix I).
- Factors mitigating pass-through from ringgit depreciation: price controls, record subsidies, small proportion (10 percent) of imported goods in CPI basket, limited capacity of firms to pass higher costs to consumers.
- Vulnerabilities: USD invoicing prevalence (about 80 percent of exports and imports in 2019) implies large and persistent depreciation could materially affect inflation, particularly after transition from broad to targeted subsidies (Appendices I and VI).

### Fiscal developments
- 2022 fiscal outturn:
  - Headline deficit projected at 5.6 percent of GDP in 2022 (target was 6 percent; 2021 deficit 6.3 percent).
  - Federal government debt projected to fall to 60.4 percent of GDP in 2022, below the effective debt limit of 67.5 percent of GDP (Appendix II).
  - Strong revenue performance from higher oil prices and a doubling of Petronas dividend; total expenditure higher due to significantly higher subsidies spending.
- 2023 Budget stance:
  - Overall deficit decline forecast: from 5.6 percent of GDP in 2022 to 5.0 percent in 2023.
  - Budget measures: continued cash assistance to vulnerable households, ramped-up development expenditures, tax incentives to strategic industries and goals, introduction of progressive revenue measures (capital gains tax, luxury goods tax, excise on nicotine products, higher tax rates for higher income individuals), and tax cuts for SMEs and lower- and middle-income households (overall about revenue-neutral in 2023).
  - Subsidies: expiry of some COVID spending and a declining—yet elevated—subsidy bill in 2023; bulk of subsidy reform likely to materialize in 2024 and be fleshed out in the 2024 Budget.
  - Fiscal consolidation target: deficit of 3.2 percent of GDP in 2025 via gradual revenue mobilization and reduced spending leakages; shift towards targeted subsidy mechanism (no specifics on yields or timeframes).
- Text Table: Malaysia: Key Fiscal Indicators (In Percent of GDP) — Est./Proj.
  - Revenue and grants: 15.1 (2021), 16.5 (2022), 15.1 (2023)
  - of which oil-related revenues: 2.8 (2021), 4.6 (2022), 3.4 (2023)
  - Expenditure and net lending: 21.4 (2021), 22.1 (2022), 20.0 (2023)
  - of which COVID-related spending: 2.4 (2021), 1.7 (2022), 0.0 (2023)
  - of which subsidies: 1.5 (2021), 3.8 (2022), 3.0 (2023)
  - Overall balance: -6.3 (2021), -5.6 (2022), -5.0 (2023)
  - Memorandum item — Fiscal impulse: 0.9 (2021), 0.5 (2022), -1.5 (2023)

### Monetary policy and financial conditions
- Policy rate actions:
  - Bank Negara Malaysia (BNM) increased the overnight policy rate (OPR) four times since May (cumulative 100 bps) to 2.75 percent.
  - Monetary tightening paused in January and March 2023 to assess past hikes; BNM reiterated commitment to calibrate policy balancing price stability and sustainable growth.
- Financial conditions:
  - Tightened significantly during most of 2022 amid fears of aggressive Fed tightening; eased more recently as USD weakened against the ringgit.
- Financial soundness and housing:
  - Banking sector total capital ratio: 18.8 percent.
  - Common equity tier 1 (CET1): 15.0 percent.
  - Liquidity coverage ratio (LCR): 154 percent as of Q4 2022.
  - Nonperforming loans (NPL): 1.7 percent of total loans in 2022Q4.
  - Loan loss coverage ratio (including regulatory reserve): 118.2 percent in December-2022.
  - Insurers and takaful operators (ITO) capital adequacy ratio: 226 percent.
  - Household debt support: share under repayment assistance declined from 18.8 percent in December 2021 to 1.9 percent of outstanding banking system and development financial institutions loans as of December 2022.
  - Housing market: ongoing recovery; price growth has been on a declining trend for almost a decade, supported by expiring home ownership campaign and first-time buyer support measures.
  - Limited direct exposure to troubled US and European banks.

### External position and current account
- Current account:
  - 2022 current account surplus: 2.6 percent of GDP (down from 3.8 percent in the previous year).
  - Deterioration driven by widening income deficit due to increased outflows associated with direct investment income and outward remittance.
  - Goods balance slightly declined as import growth outpaced export growth; services balance improved with reopening.
- External assessment:
  - Malaysia’s external position in 2022 preliminarily assessed to be stronger than warranted by fundamentals and desired policies (Appendix III).
  - Adjusting for cyclical and country-specific temporary factors, Malaysia’s residual current account gap is assessed in the range of 3-4 percent of GDP.
  - Low public healthcare expenditure and relatively looser fiscal policy abroad contributed to Malaysia’s excess current account surplus.

### Outlook and risks
- Near-term macro outlook:
  - Growth projected to moderate to 4.5 percent in 2023, reflecting global external headwinds.
  - Output gap estimated to have turned positive in 2022, driven primarily by strong domestic demand.
  - Inflation projected at 3.3 percent in 2023, with likely persistence in core inflation amid a positive output gap.
- Risk assessment (Appendix IV):
  - External risks (tilted to the downside): abrupt global slowdown or recession in major trading partners, spike in global risk premia, capital outflows and sudden stop risks, monetary policy miscalibration leading to aggressive tightening by major central banks, commodity price shocks and volatility, and negative effects from geo-economic fragmentation (Appendix V).
  - Domestic risks: fiscal risks from contingent liabilities that could necessitate additional measures for medium-term fiscal sustainability; political risks from managing a diverse governing coalition.

*Source: IMF country report chapter "1. Growth and Exports".*

### 15.      The authorities broadly agreed with staff's assessment of the outlook and risks. They

### 15.      The authorities broadly agreed with staff's assessment of the outlook and risks. They

### Outlook and Risks
- Authorities' growth outlook for 2023: between 4 and 5 percent, driven by:
  - strong domestic demand,
  - improvements in employment prospects,
  - policy support for vulnerable households,
  - resurgent tourism-related activities,
  - continued capital spending in manufacturing and services,
  - moderate external demand.
- Authorities' inflation outlook for 2023: between 2.8 percent and 3.8 percent, reflecting stable commodity prices partly offset by persistence in core inflation.
- Labor market: not considered tight (though strengthened), with still-elevated unemployment and forthcoming labor supply metrics.
- Output gap: expected to close in mid-2023 and turn positive in the second half of the year.
- Primary external risks identified:
  - downside from weaker global growth and tighter monetary policy by major central banks in response to prolonged global inflation,
  - volatility in global financial conditions,
  - a prolonged Ukraine conflict,
  - continued supply chain disruption.
- Geo-economic fragmentation: authorities note potential gains in mild scenarios from trade diversion and 'China Plus One' strategies but recognize elevated uncertainty and have adapted policies to attract high value-added, complex, and digital-sector production.
- Authorities retain reservations about the EBA model due to a large unexplained residual.

### Fiscal Policy: Key Findings and Staff Recommendations
- Staff view: gradual and credible medium-term fiscal consolidation is warranted to put debt on a firm downward path because of:
  - limited fiscal buffers,
  - firmly positive output gaps projected in the next few years,
  - large contingent liabilities.
- Staff recommended path validates the 2023 Budget consolidation trajectory until 2025 and envisions more significant consolidation over the medium term.
- Revenue strategy and measures:
  - staff note progressive changes in income tax rates but caution some pipeline measures may not generate needed revenue streams;
  - achievement of durable revenue requires identifying further high-quality measures grounded in a medium-term revenue strategy (MTRS) and savings from transitioning to targeted subsidies.
- Near-term objective: gradual consolidation to safeguard the recovery against an uncertain global outlook.

### Fiscal Responsibility Act (FRA) and Fiscal Framework
- Recommendation: finalize the Fiscal Responsibility Act (FRA) as an important cornerstone to enhance fiscal sustainability, preserve macroeconomic stability, and strengthen governance.
- FRA status in text: draft scheduled to be tabled in parliament by Q3 2023 (delays from pandemic and elections).
- FRA key objectives and features:
  - prudent debt, sustainable fiscal balance, effective fiscal risk management,
  - strengthening governance of government-linked companies,
  - most elements of a modern principles-based fiscal responsibility law with adequate transparency provisions,
  - new reports: mid-year budget performance report and a tax expenditure statement,
  - provisions for exceptional circumstances/shocks allowing temporary deviations from targets,
  - requirement to publish a comprehensive fiscal risk statement and ensure rigorous process for government guarantees.

### Medium-Term Revenue Strategy (MTRS) and Tax Reform Options
- Urgent priority: develop a MTRS.
- Current tax revenue context: At about 11 percent of GDP in 2021, Malaysia’s tax revenues are the lowest among its ASEAN-5 and OECD peers and have been declining.
- 2023 Budget commitments: improve revenue collection by minimizing leakages and enhancing tax compliance, guided by adoption of a MTRS, but lacks specific medium-term revenue-enhancing measures and timeline.
- Preparatory work for reinstating GST: should be promptly initiated if not planned for reintroduction this year.
- Carbon tax potential: staff estimate could generate 1 to 3 percent of GDP per year in fiscal revenues by 2030.
- Staff urge: prioritize development of a MTRS with quantitative work to determine gaps and identify goals.

### Subsidy Reform and Social Safety Nets (SSN)
- Rationale: subsidy reform is long overdue and should be phased and transparently communicated alongside SSN reforms.
- Historical fiscal pressure: energy subsidy bills have reached over 20 percent of current expenditures in periods of high commodity prices.
- Principles for reform (drawn from past country experiences):
  - part of a comprehensive reform plan with stakeholder consultation,
  - implemented gradually across time and products, optimally starting with those with lower weight in consumption baskets of low-income consumers (such as Diesel),
  - include an automatic pricing mechanism (current mechanism in Malaysia calculates needed subsidies),
  - accompanied by mitigating cash transfers targeted at low-income households (e.g., BKM cash assistance program) coupled with SSN reform,
  - mindful of country circumstances (moderating oil prices and solid growth more favorable),
  - underpinned by a far-reaching and transparent communication strategy.
- Timing: subsidy reform expected to be initiated late 2023, primarily through phasing out electricity subsidies and gradual liberalization of select fuel prices, with further details in the 2024 Budget.
- Authorities’ stated considerations for reform: gradualism to limit inflationary effect, clarity on use of savings, and complementing reform with SSN enhancements and compensatory transfers.

### Authorities’ Fiscal Views and Planned Measures
- Authorities reaffirm commitment to gradual fiscal consolidation and fiscal reforms.
- Medium-term deficit target: 3.2 percent of GDP in 2025 to be achieved mainly through:
  - revenue measures (1.1 pp of GDP),
  - savings from planned subsidy reform (0.7 pp of GDP).
- Pipeline revenue measures include:
  - enhancements of the current sales and services tax (SST),
  - introduction of an income tax on the digital economy,
  - use of tax identification number, improvements in tax administration, and taxpayer awareness/compliance efforts.
- Additional possible revenue: capital gains tax, luxury goods tax, and measures from introducing a MTRS.
- Reinstating an improved GST and introducing a carbon tax remain in the pipeline but more likely in the medium term for effective implementation.
- Authorities are developing a MTRS; technical assistance request to the Fund on MTRS noted positively.

### Monetary and Exchange Rate Policies
- Staff recommendation: monetary policy should tighten further to bring the stance to neutral and BNM should clearly communicate rationale amid high uncertainty.
- Staff estimates: neutral real rate suggests policy currently accommodative.
- Rationale for tightening:
  - still elevated core inflation,
  - positive output gap,
  - evidence of build-up in demand-side pressures.
- Pace and magnitude: should remain data dependent given high uncertainty.
- Staff analysis: short-term output costs of monetary tightening (sacrifice ratio) are low in Malaysia partly due to high openness; transmission could be weakened/delayed in high-inflation environment, requiring early action.
- Communication: clarify uncertainties influencing outlook and incorporation into decisions to minimize market volatility.
- Exchange rate role: should continue to serve as a shock absorber.
- FX intervention (FXI) guidance:
  - not a substitute for policy adjustment,
  - role limited to addressing disorderly market conditions (DMC) and large shocks when frictions are present,
  - frictions-based FXI could be used to address premia from arbitrage frictions in shallow FX markets, counter FX mismatch financial stability risks, or preserve price stability when exchange rate changes risk de-anchoring inflation expectations.
- Staff finding: aside from somewhat shallow market indicators (UIP premium and bid-ask spread), no material evidence of frictions (2) and (3) in Malaysia.
- Caution: persistent FX sales costly—impede market development, dampen policy credibility, deplete reserves.
- Recommendation: opportunistic reserve accumulation during risk-on episodes appropriate but should not interfere with needed real exchange rate appreciation over the medium term.
- BNM steps: ongoing liberalization and deepening of the FX market welcomed; existing CFMs should be gradually phased out with regard to market conditions.
- Publication: FXI data publication (with appropriate lag) could enhance communication.

### Authorities’ Monetary and Exchange Rate Views
- BNM stresses commitment to price stability and a flexible exchange rate regime.
- BNM concurs policy stance remains accommodative and that inflation expectations are well-anchored.
- BNM approach: gradual and measured policy calibration to avoid overtightening amid receding inflation with some persistence and moderating global growth, carefully communicated.
- BNM sees no financial stability risks to monetary tightening based on stress tests, but its estimated sacrifice ratio is larger than staff’s and could be higher with nonlinearity in the Phillips curve.
- BNM notes important roles for asset price and interest rate channels in monetary transmission.
- BNM views occasional FX interventions to smooth excessive ringgit volatility as necessary.
- BNM considers some measures staff classify as CFMs to have contributed to onshore intermediation and market development; deems them critical for domestic financial market resilience.

### External Position, Reserves, and External Debt Views
- BNM view: FX reserves adequate; external debt expected to remain manageable.
- Observations:
  - FX reserves declined under external pressures (Fed tightening, portfolio outflows) but recovered later in the year.
  - Short forward position above historical levels not seen as significant risk.
  - FX swaps used by banks to manage ringgit liquidity.
- External debt mitigants noted by authorities:
  - one-third of total external debt is ringgit-denominated,
  - about two-third of FX-denominated external debt subject to prudential requirements,
  - large share of medium-term debt.
- Short-term external debt increase attributed to banks’ liquidity operations and interbank borrowings governed by prudential frameworks; not seen as major risk.

### Financial Sector Policies and Resilience
- Assessment: financial system appears resilient with systemic risks contained.
- BNM stress tests incorporating shocks (tightening global and domestic financial conditions, ringgit depreciation, protracted macro stresses) suggest:
  - banks remain able to support the economy,
  - post-shock aggregate capital ratios at end-2023 remain comfortably above regulatory minimum levels.
- Non-bank financial institutions (NBFIs), including insurers and takaful operators, expected to remain resilient despite sizeable exposures to market risks from bond and equity holdings per BNM stress testing.
- Policy recommendations for BNM and authorities:
  - maintain strong supervision of lending standards,
  - enhance monitoring of risk build-up, including due to higher interest rates amid weakening growth momentum,
  - monitor potential spillovers from financial stress in China’s property sector.
- Additional monitoring priorities:
  - profitability of insurance and takaful operators (ITOs),
  - potential new credit risk from growing buy-now-pay-later (BNPL) schemes.
- Bank exposure to Chinese developers currently small: 0.1 percent of total financial institutions’ exposures to businesses as of 2022Q4.

*Source: 1mysea2023001 - 15.      The authorities broadly agreed with staff's assessment of the outlook and risks.*

### 27.      Close monitoring of household balance sheets is warranted given rising interest rates

### 27.      Close monitoring of household balance sheets is warranted given rising interest rates

### Household balance sheets and household debt
- Household debt is 81.2 percent of GDP as of 2022Q4 (2019Q4: 82.8).
- About 60 percent of household debt is in housing loans.
- About 78 percent outstanding of household debt, and almost all mortgage debt, is at floating rates and thus will be sensitive to rate hikes.
- Overall median borrower debt service ratios (DSR) for outstanding loans stand at 37 percent.
- Despite a 100bps increase in OPR since May 2022, median DSR for overall household borrowers only increased marginally amid favorable income and labor market conditions.
- Policy recommendations:
  - Continue development of strong preventive ex ante measures (such as advice to debtors and informal debt restructuring).
  - Strengthen personal debt enforcement tools and address ex post debt, including personal bankruptcy liquidation and bankruptcy repayment plans to support orderly deleveraging.

### Macroprudential policy and lending standards
- The BNM maintains strong microprudential supervision through an enhanced framework for risk-based pricing of loans and prudent underwriting and affordability assessments.
- Existing measures introduced by BNM:
  - Loan-to-value (LTV) caps for the third and above outstanding housing loans for individuals and for all housing loans for non-individuals.
  - Prudential measures that apply to all housing loans such as higher risk-weights for loans with LTV levels of 90 percent and above.
- Staff recommendations:
  - Pre-emptively expand the macroprudential toolkit with tools that can be swiftly and transparently adjusted.
  - Consider sector-wide LTVs on first and second properties.
  - Consider debt-service-to-income limits for all income groups given the sizeable share of floating rate loans and rising interest rates.
  - Require stress testing of borrowers’ affordability with higher interest rates at loan origination to dampen further growth of household debt.
- Rationale:
  - Broadening macroprudential tools could help manage the price-financial stability trade-offs as rate hikes pose risks in a context of significant floating rate mortgages.
  - This would allow monetary policy to focus on price stability, especially given suggestive evidence on the asset price channel being relatively muted in Malaysia (Appendix VII).

### Corporate balance sheets and surveillance
- Interest coverage ratios for the corporate sector are above pre-pandemic levels and liquidity ratios remain strong as of 2022Q2.
- Labor shortages (in construction, agriculture, and manufacturing) and rising input costs could weigh on corporate financial conditions.
- About 90 percent of corporates’ external borrowings (excluding intercompany loans and trade credit exposures) are either naturally or financially hedged.
- Corporates most susceptible to exchange rate volatility have minimal domestic debt and thus pose limited direct risk to financial stability (Appendix IX).
- Staff recommendation:
  - BNM should continue to enhance corporate surveillance by adding balance sheet risk indicators, including susceptibility to abrupt shifts in supply chains given global fragilities and geo-economic fragmentation risks.

### AML/CFT, beneficial ownership, and tax compliance
- In 2020, authorities conducted the fourth iteration of the National Risk Assessment identifying money laundering trends related to beneficial ownership and domestic politically-exposed-persons (PEPs).
- Legislative and policy actions:
  - Companies (Amendment) Bill, an update to the 2016 Companies Act and the legal basis for the beneficial ownership transparency framework, is currently being drafted and is expected to be passed by Q3 2023.
  - Amendments should align with beneficial ownership transparency requirements in the revised Financial Action Task Force standards (Recommendation 24) enacted in March 2022.
- Staff recommendations:
  - Urge full implementation of the beneficiary ownership (BO) guideline.
  - Continue expanding collaboration between BNM and the Inland Revenue Board to share beneficial ownership information to combat tax-related offences.
  - Further strengthen measures to address areas identified in the National Risk Assessment including BO and domestic PEPs and monitor implementation consistently with FATF standards.
  - Strongly encourage authorities to volunteer for assessment of facilitation of transnational corruption in the 2024 Article IV consultation, given the role of professional enablers as a key AML/CFT challenge.

### Climate-related risks and financial sector preparedness
- Malaysia faces significant climate risks, particularly flooding, cyclones and chronic heat stress.
- Transition towards net zero target by 2050 will have significant economic implications, including for the financial sector, given large share of carbon-intensive sectors (BNM’s Financial Sector Blueprint 2022-2026).
- In 2022, financial institutions started reporting exposures in line with the Climate Change and Principle-based Taxonomy (CCPT).
- Staff welcome the planned Climate Risk Stress Testing exercise in 2024 to assess resilience of financial institutions, including for non-banks, to both physical and transition risks (Appendix X).
- Achieving the country’s emission targets will require billions of dollars of investments and significant private funding.

### Authorities’ views (financial stability)
- Authorities broadly agree with staff assessment that the financial sector remains sound; banks and NBFIs have strong buffers with limited risks stemming from NBFIs.
- Banks’ asset quality has turned out better than expected, and provisions remain adequate.
- Authorities noted household debt remains elevated and low-income households may have weak buffers amid earlier EPF withdrawals, but the share of debt exposures held by low-income households in total bank loans is relatively small.
- Authorities view current macroprudential toolkit as appropriate while focusing on effective operational arrangements.
- BNM highlighted limited direct exposures to troubled US and European banks and emphasized financial sector preparedness for managing the green transition, including implementation of CCPT, development of disclosure guidelines and climate stress test scheduled in 2024.

### Downside risk scenarios and policy coordination
- Two adverse scenarios tailored to Malaysia’s characteristics and initial conditions are considered:
  - scenario-1: a risk-off shock generated by a protracted slowdown in China.
  - scenario-2: a stagflationary shock in the US.
- Policy analysis findings:
  - A coordinated and integrated approach to monetary, fiscal, and exchange rate policies can help alleviate policy trade-offs.
  - FX intervention (FXI) can provide additional space for monetary policy to spur domestic demand in scenario-1 and can help limit interest rate hikes necessary to contain inflation and limit ringgit depreciation, thereby reducing the decline in output in scenario-2.
  - Fiscal policy plays a complementary role if deployed in a coordinated manner.
  - Removal of generalized subsidies when energy prices decline would limit the inflationary impact of such a policy change.
- Ongoing work:
  - Collaborative BNM-Fund work on operationalization of the Integrated Policy Framework (IPF) is ongoing; authorities appreciate flexibility in FXI use under the frictions-based IPF approach and note further refinements to the Quantitative IPF model would help capture Malaysian peculiarities.

### Structural policies, governance, and 12MP implementation
- Coordinated implementation under the 12MP is needed to minimize pandemic scarring, boost productivity, and address inequality.
- Key measures include:
  - Reforming labor markets and elevating education levels.
  - Encouraging broad-based productivity drivers, boosting the digital economy, and advancing climate policies including in the financial sector.
  - Active labor market policies to upskill workers displaced by the pandemic and incentivize movement from informal to formal employment.
  - Upgrading social protection: expand coverage, address fragmentation, and raise benefits to adequate levels; complement planned subsidy reform and targeted cash transfers.
  - Digitalization and improving digital financial literacy while considering cybersecurity, data privacy, and financial integrity.
- Potential impact:
  - Full and successful delivery of the measures outlined in the 12MP could raise medium-term growth above the staff baseline.
- Implementation and governance concerns:
  - Progress on the 2019–2023 National Anti-Corruption Plan (NACP) stalled: around 53 percent of initiatives had been implemented across 6 priority areas as of end-December 2022.
  - Passing the Fiscal Responsibility Act (FRA) is a major step to anchor fiscal governance reforms.
  - Priority reforms: public procurement efficiency and transparency, ensuring operational independence of anti-corruption institutions.
  - Authorities expect about 90 percent of NACP initiatives to be completed by end-2023; an updated progress report expected by Q3 2023.
  - A mid-term review of the 12MP is expected to be tabled in parliament in October this year.
- Education and productivity target:
  - Authorities remain focused on raising labor productivity, targeting annual labor productivity growth per worker under the 12MP that is 2.5 percent higher than under its predecessor.

### Staff appraisal (summary)
- Malaysia registered a strong post-pandemic recovery in 2022 after reopening in April 2022.
- Downside risks, mostly external, cloud the near-term outlook, including risks of abrupt global slowdown or recession, geo-economic fragmentation, supply disruptions, and rising input costs.
- Fiscal policy:
  - The gradual fiscal consolidation strategy in the 2023 Budget is appropriate but should be credibly underpinned by high-quality and durable measures.
  - Staff advise a path with more significant consolidation over the medium term to place debt on a firm downward path.
  - Finalizing the Fiscal Responsibility Act (FRA) is welcomed; developing a medium-term revenue strategy is an urgent priority.
  - Phased and transparently communicated subsidy reform alongside social safety net reforms is overdue.
- Monetary policy:
  - Monetary policy should tighten further to bring the stance to a neutral position.
  - BNM should continue clear communication of policy rationale given rapid changes and high uncertainty.
  - The flexible exchange rate regime has served Malaysia well; continued commitment to exchange rate flexibility is welcome.

*Source: 1mysea2023001 - 27.      Close monitoring of household balance sheets is warranted given rising interest rates*

### 44.      The authorities’ commitment to safeguarding the stability of the financial sector is

### 1mysea2023001 - 44.      The authorities’ commitment to safeguarding the stability of the financial sector is

### Financial stability assessment and emerging risks
- Findings:
  - Enhanced monitoring, especially of highly leveraged entities and non-bank financial institutions, is warranted given increased risks from rising interest rates, tighter financial conditions, exchange rate depreciation, and weaker expected growth.
  - The Malaysian financial sector is well-equipped to navigate any potential increase in volatility and global risk aversion.
  - There are no broad-based stability concerns.

- Policy implications:
  - Expanding the macroprudential toolkit should support efforts to monitor and mitigate these risks.

### Policy priorities under the 12MP and governance reforms
- Findings:
  - The authorities’ intentions under the 12MP to credibly enhance economic resilience, move toward net zero greenhouse gas emissions, and promote inclusive growth, is welcome.
  - The start of the new government provides a timely opportunity to forge ahead with a concerted reform agenda.

- Recommended areas of reform:
  - Robust governance and anti-corruption reforms, including the implementation of the strategies outlined in the National Anti-Corruption Plan, would strengthen the management of the public finances.
  - Implementing these governance and anti-corruption measures would improve public sector service delivery.

*Source: 1mysea2023001 - 44.      The authorities’ commitment to safeguarding the stability of the financial sector is*

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

### It is recommended that the Article IV consultation with Malaysia be held on the standard 12-month cycle.

### Growth, exports, and external position
- Real GDP (percent change): 2018: 4.8; 2019: 4.4; 2020: -5.5; 2021: 3.1; 2022: 8.7; 2023: 4.5; 2024: 4.5; 2025: 4.4; 2026: 4.4; 2027: 3.9; 2028: 3.9.
- Growth drivers in 2022: private consumption, investment and net exports; manufacturing recovery led by machinery and fuel exports boosted imports of intermediate inputs.
- Main domestic goods exports (share of total domestic exports, 2021): Machinery and Transport Equipment (39.2 percent), Miscellaneous Manufactured Articles (16.6 percent), and Manufactured Goods (10.8 percent).
- Current account balance (12-month basis, in billions of U.S. dollars): 2018: 8.0; 2019: 12.8; 2020: 14.1; 2021: 14.2; 2022: 10.7.
- Current account balance (12-month basis, in percent of GDP): 2018: 2.2 percent; 2019: 3.5 percent; 2020: 4.2 percent; 2021: 3.8 percent; 2022: 2.6 percent.
- Gross official reserves (in billions of U.S. dollars): 2018: 101.4; 2019: 103.6; 2020: 107.6; 2021: 117.0; 2022: 114.7.

### Inflation, labor market, and domestic resource constraints
- CPI inflation (annual average): 2018: 1.0; 2019: 0.7; 2020: -1.1; 2021: 2.5; 2022: 3.4; 2023: 3.3; 2024: 3.1; 2025: 2.4; 2026: 2.4; 2027: 2.4; 2028: 2.4.
- CPI inflation excluding food and energy (annual average): 2018: 0.4; 2019: 3.4; 2020: 1.1; 2021: 0.7; 2022: 3.0; 2023: 3.4; 2024: 3.0; 2025: 2.0; 2026: 1.7; 2027: 1.7; 2028: 1.7.
- Producer prices were elevated through 2021 and early 2022 and have started to decline.
- Labor market: unemployment rate (annual average) — 2018: 3.3; 2019: 3.3; 2020: 4.5; 2021: 4.7; 2022: 3.8. Wages picking up particularly in the services sector as the economy reopened; labor market has somewhat tightened.

### Monetary developments and financial conditions
- The BNM has started a gradual normalization with a cumulative rate hike of 100bps since May 2022.
- Real overnight policy rate, real deposit rate and real lending rate became positive after being in negative territory (note: real rates adjusted for inflation expectations of 1-year ahead).
- Broad money (12-month percent change): 2018: 7.7; 2019: 2.7; 2020: 4.9; 2021: 5.6; 2022: 15.7.
- Credit to private sector (12-month percent change): 2018: 8.3; 2019: 4.9; 2020: 4.0; 2021: 3.8; 2022: 4.4.
- Overnight policy rate (in percent): 2018: 3.25; 2019: 3.00; 2020: 1.75; 2021: 1.75.
- Financial conditions: after tightening amid US aggressive monetary policy, conditions have started easing driven by stronger ringgit and narrower USD debt spreads.

### Capital flows and exchange rate
- Capital inflows reversed following the War in Ukraine and monetary policy normalization in AEs; portfolio debt witnessed outflows and foreign holdings of ringgit-denominated government securities declined.
- Nonresident portfolio capital flows and gross FX reserves declined significantly in 2022.
- Ringgit behavior: depreciated sharply against the US dollar following the war in Ukraine; has regained some strength in recent months.
- Total external debt (in billions of U.S. dollars): 2018: 223.0; 2019: 231.5; 2020: 238.8; 2021: 259.1; 2022: 259.2.
- Total external debt (in percent of GDP): 2018: 62.2; 2019: 63.4; 2020: 70.8; 2021: 69.6; 2022: 63.8.
- Total short-term external debt (original maturity, in billions of U.S. dollars): 2018: 97.9; 2019: 95.2; 2020: 91.5; 2021: 97.2; 2022: 109.2.
- Short-term external debt (original maturity to reserves, in percent): 2018: 96.5; 2019: 91.9; 2020: 85.0; 2021: 83.0; 2022: 95.2.

### Fiscal developments, public finances, and medium-term outlook
- Key national accounts and demographic statistics:
  - Nominal GDP (2022): US$407.9 billion
  - Population (2022): 32.7 million
  - GDP per capita (2022, current prices): US$12,493
  - Poverty rate (2019, national poverty line): 0.2 percent
  - Unemployment rate (2022, period average): 3.8 percent
  - Adult literacy rate (2019): 95.0 percent
- Federal government overall balance (in percent of GDP): 2018: -3.7; 2019: -5.9; 2020: -6.2; 2021: -6.3; 2022: -5.6; 2023 (proj.): -5.0; 2024 (proj.): -4.6; 2025 (proj.): -4.6; 2026 (proj.): -4.6; 2027 (proj.): -4.5; 2028 (proj.): -4.4.
- General government debt (in percent of GDP): 2018: 55.6; 2019: 57.1; 2020: 67.7; 2021: 69.3; 2022: 65.7.
- Consolidated public sector overall balance (in percent of GDP): 2018: -2.9; 2019: -3.4; 2020: -7.3; 2021: -4.3; 2022: -4.4; 2023 (proj.): -6.9.
- Revenues and expenditures (federal government, in percent of GDP): Revenue 2022: 16.5 percent; Expenditure and net lending 2022: 22.0 percent.
- Development expenditure has trended up since 2019; government guarantees moderating from pandemic highs.
- Baseline medium-term outlook: deficit slightly improving and debt stabilizing at high levels.

### Financial sector and vulnerabilities
- Banking system:
  - Remains well capitalized; banks’ profitability remains positive and expected to recover as interest rate spreads pick up.
  - Non-performing loans have picked up but remain low.
  - System continues to rely on short-term external debt; banks’ net external asset position remains weak.
- Financial soundness indicators (selected):
  - Banking liquidity and capital buffers compare favorably with peers; lending in proportion to deposits remains moderate and in line with peers.
- Corporate sector:
  - Corporate leverage compares favorably to peers (Corporate Debt-to-Equity Ratio, 2021: Malaysia among listed comparators in figures).
- Household sector:
  - Household debt (in percent of GDP): 2018: 82.0; 2019: 82.8; 2020: 93.1; 2021: 89.1; 2022: 81.2.
  - Household financial assets (in percent of GDP): 2018: 176.0; 2019: 179.3; 2020: 204.6; 2021: 192.3; 2022: 167.9.
  - Household loans picked up for personal use and housing; household non-performing loans declined on loan moratoria and have since picked up but remain low.

### Key macrofinancial indicators and projections (selected)
- Gross domestic investment (percent of GDP): 2018: 23.9; 2019: 21.0; 2020: 19.7; 2021: 22.3; 2022: 23.9; 2023: 24.3; 2024: 24.3; 2025: 24.9; 2026: 25.1; 2027: 25.1; 2028: 25.2.
- Gross national saving (percent of GDP): 2018: 26.1; 2019: 24.5; 2020: 23.9; 2021: 26.1; 2022: 26.5; 2023: 27.0; 2024: 27.0; 2025: 27.7; 2026: 28.1; 2027: 28.1; 2028: 28.2.
- Goods balance (in billions of U.S. dollars): 2018: 28.4; 2019: 30.1; 2020: 32.7; 2021: 41.2; 2022: 38.5.
- Services balance (in billions of U.S. dollars): 2018: -4.3; 2019: -2.6; 2020: -11.2; 2021: -14.7; 2022: -10.3.
- Income balance (in billions of U.S. dollars): 2018: -16.1; 2019: -14.7; 2020: -7.4; 2021: -12.3; 2022: -17.4.

*Source: IMF staff report and statistical tables for Malaysia (as presented in the supplied content).*

### Appendix I. Drivers of Inflation in Malaysia

### Appendix I. Drivers of Inflation in Malaysia

### A. Supply and Demand Drivers of Recent Trends
- Headline and core inflation remain elevated after Malaysia exited COVID restrictions in April 2022.
- Key observed dynamics through mid-2022:
  - Phillips Curve steepened through mid-2022.
  - No second-round effects in manufacturing wages; medium-term inflation expectations remain well anchored.
  - Services inflation increased sharply, reflecting a structural rotation of demand away from durables toward tourism, mass entertainment and other previously restricted activities.
  - Labor market tightened, putting upward pressure on wages particularly in the services sector.
- Empirical approach:
  - A structural vector autoregression (SVAR) is used to decompose demand and supply drivers for eight emerging markets and developing economies in Asia with suitable data.
  - Model elements: (i) a constant, (ii) own past histories, (iii) demand shocks (GDP and CPI move in the same direction), (iv) supply shocks (GDP and CPI move in opposite directions).
- Main empirical finding for 2022:
  - Malaysia’s inflation in 2022 was predominantly driven by demand shocks.
  - Demand pressures increased upon reopening, with a particularly large impact in 2022 Q3.
  - Increasing demand pressures were widespread across the region in 2022 and not specific to Malaysia.

### B. Potential Drivers of Inflation in the Medium Term
- Fiscal policy and subsidy reform risks:
  - Increased support in the 2023 Budget for low-income groups with higher marginal propensity to consume could add demand-side pressure.
  - The 2023 Budget includes an intention to transition away from the current generalized fuel subsidies, increasing potential for external cost pressures to feed through to consumer prices.
  - Historical insulation in 2022 from subsidies implies consumers could face significantly higher impacts from future episodes of elevated commodity prices or shipping costs.
- External and trade-related risks:
  - An escalation of global trade tensions causing geoeconomic fragmentation could exacerbate supply chain issues.
  - Measures of trade uncertainty are associated with higher import prices even controlling for changes in actual trade barriers.
- Exchange rate pass-through analysis:
  - Imported goods share in the CPI basket: 20 percent.
  - USD invoicing was approximately 80 percent of exports and imports in 2019.
  - Panel local projection model specification used to estimate pass-through; controls include lags of CPI and exchange rate, global oil and food prices, country output gap and global output gap.
  - Grouping by country characteristic X (above/below cross-country median) to estimate differential exposure.
- Quantitative pass-through estimates:
  - Panel of 45 advanced and emerging markets: a one percent depreciation in local currency against USD.
  - Malaysia-specific local projection regressions (lags limited to two):
    - In the maximum sample (1992m1-2021m12), a one percent depreciation in MYR/USD corresponds to a 0.05 percentage point increase in inflation over 12 months.
    - In the shorter sample since the latest round of subsidy reforms in 2014 (2015m1-2021m12), pass-through is higher at 0.2 percentage points, and also faster, rising to above 0.3 percentage points over the first five months.
  - Impacts are weak but relatively persistent, with most not peaking for at least ten months.
  - Historical Malaysia-specific estimates include suppressing effects of current subsidies, and thus constitute a lower bound for potential pass-through in a post-transition regime.

### C. Conclusions and Policy Implications
- Diagnosis:
  - Evidence of demand-pull inflationary pressure built up through 2022 supports withdrawal of accommodative monetary policy and potential continuation into restrictive territory.
- Policy recommendations:
  - Monetary policy: withdraw accommodation and be prepared to tighten further if supply shocks persist or inflation expectations de-anchor.
  - Subsidy reform: transition away from generalized fuel subsidies increases upside risks to inflation; a gradualist approach to subsidy reform is advocated.
  - Fiscal policy: targeted fiscal support may be required to shield low-income households from external price shocks.
  - Overall: judicious policy responses are required to manage significant inflation pressures.

### D. Technical Annex — Method for Deriving Supply and Demand Shocks
- VAR specification:
  - Stack output and inflation into vector Yt; model: Yt = c + B1 Yt−1 + B2 Yt−2 + Et.
  - Et assumed homoscedastic and serially uncorrelated with variance Σ.
  - Define A0 as square root of Σ so A0−1 Et = Ut are orthogonal shocks with VAR(Ut)=I.
- Sign restrictions to identify shocks:
  - Demand shocks: GDP and CPI move in the same direction (both increase inflation and output).
  - Supply shocks: GDP and CPI move in opposite directions (increase output but reduce inflation).
  - Imposed sign pattern on matrix of loadings: supply shock reduces inflation (−) while demand shock increases inflation (+).
- Identification algorithm:
  - Start with Cholesky decomposition Ã0 of Σ.
  - Jitter Ã0 by random orthogonal matrix Q to obtain Â0 = Ã0 Q; repeat draws of Q until sign restrictions hold (Rubio-Ramírez et al., 2010 procedure).
- Estimation procedure:
  - Bayesian Gibbs sampling: vectorize coefficients b = vec(B) and set starting Σ0 = identity.
  - Draw b from multivariate normal f(b|Σ) with mean b̂ = vec((X′X)−1 (X′Y)) and variance v̂ = Σ0 ⊗ (X′X)−1.
  - Draw Σ from inverse Wishart f(Σ|b) with scale parameter (Y − X B1)′(Y − X B1) and T degrees of freedom.
  - Repeat draws 1000 times, discard first 100 iterations; take mean values across remaining iterations for overall estimates.
- Interpretation:
  - Demand and supply shocks series extracted satisfy the designed sign restrictions and are used to decompose historical headline inflation into demand- and supply-driven components.

*Source: Appendix I. Drivers of Inflation in Malaysia (IMF staff prepared material).*

### 1. Debt coverage in the DSA: 1/

### 1. Debt coverage in the DSA: 1/

### Debt coverage and scope
- Chosen coverage: Central government (CG).
- 1a. If central government, are non-central government entities insignificant? 0
- Commentary: Debt coverage is federal or central government, consistent with the data on government debt reported by the authorities. This definition of debt covers more than 90 percent of general government debt. However, it does not include local and state governments and statutory bodies which typically receive explicit government guarantees.
- Contingent liabilities: Malaysia’s contingent liabilities include government loan guarantees (GG) granted to non-financial government-related entities to execute mainly infrastructure and other strategic projects.

### Subsectors included in baseline coverage
- Budgetary central government: Yes
- Extra budgetary funds (EBFs): No
- Social security funds (SSFs): Yes
- State governments: No
- Local governments: No
- Public nonfinancial corporations: No
- Central bank: No
- Other public financial corporations: No

### Instrument and accounting notes (as presented)
- Reporting on Intra-Government Debt Holdings: table entries are 0 for holders across listed subsectors.
- Notes provided (verbatim key points):
  - 1/ CG=Central government; GG=General government; NFPS=Nonfinancial public sector; PS=Public sector.
  - 2/ Stock of arrears could be used as a proxy in the absence of accrual data on other accounts payable.
  - 3/ Insurance, Pension, and Standardized Guarantee Schemes, typically including government employee pension liabilities.
  - 4/ Includes accrual recording, commitment basis, due for payment, etc.
  - 5/ Nominal value at any moment in time is the amount the debtor owes to the creditor. It reflects the value of the instrument at creation and subsequent economic flows (such as transactions, exchange rate, and other valuation changes other than market price changes, and other volume changes).
  - 6/ The face value of a debt instrument is the undiscounted amount of principal to be paid at (or before) maturity.
  - 7/ Market value of debt instruments is the value as if they were acquired in market transactions on the balance sheet reporting date (reference date). Only traded debt securities have observed market values.

### Debt structure and holders (summary points from charts and commentary)
- Domestic creditors held about 73 percent of public debt in 2021.
- About 90 percent of external debt (and 97 percent of overall debt) is issued in local currency.
- Main domestic creditors: Employees Provident Fund and commercial banks.
- Governing law: All public debt, with the exception of Sukuk bonds, is governed by domestic law.
- Maturity strategy: A large proportion of debt is issued at longer maturities to reduce rollover risks and to establish a well-spread maturity profile.
- Residual maturity reported: 6. years (as presented).

### Baseline scenario — key projections (Percent of GDP unless indicated)
- Public debt:
  - Actual 2022: 60.4
  - 2023: 60.8
  - 2024: 60.9
  - 2025: 61.3
  - 2026: 61.8
  - 2027: 62.7
  - 2028: 63.3
  - 2029: 64.2
  - 2030: 64.7
  - 2031: 65.2
  - 2032: 65.8
- Change in public debt:
  - 2022: -3.0
  - 2023: 0.5
  - 2024: 0.1
  - 2025: 0.4
  - 2026: 0.5
  - 2027: 0.9
  - 2028: 0.6
  - 2029: 0.9
  - 2030: 0.5
  - 2031: 0.5
  - 2032: 0.6
- Contribution of identified flows:
  - 2022: -1.9
  - 2023: 0.6
  - 2024: 0.1
  - 2025: 0.5
  - 2026: 0.4
  - 2027: 0.5
  - 2028: 0.2
  - 2029: 0.3
  - 2030: 0.2
  - 2031: 0.1
  - 2032: 0.2
- Primary deficit:
  - 2022: 3.3
  - 2023: 2.6
  - 2024: 2.1
  - 2025: 2.0
  - 2026: 1.9
  - 2027: 1.7
  - 2028: 1.6
  - 2029: 1.6
  - 2030: 1.6
  - 2031: 1.6
  - 2032: 1.7
- Noninterest revenues:
  - 2022: 16.5
  - 2023: 15.1
  - 2024: 14.2
  - 2025: 14.0
  - 2026: 13.9
  - 2027: 13.9
  - 2028: 13.9
  - 2029: 13.9
  - 2030: 13.9
  - 2031: 13.9
  - 2032: 13.8
- Noninterest expenditures:
  - 2022: 19.7
  - 2023: 17.7
  - 2024: 16.3
  - 2025: 15.9
  - 2026: 15.8
  - 2027: 15.7
  - 2028: 15.5
  - 2029: 15.6
  - 2030: 15.5
  - 2031: 15.5
  - 2032: 15.6
- Automatic debt dynamics:
  - 2022: -5.1
  - 2023: -1.9
  - 2024: -2.0
  - 2025: -1.5
  - 2026: -1.4
  - 2027: -1.3
  - 2028: -1.3
  - 2029: -1.4
  - 2030: -1.4
  - 2031: -1.5
  - 2032: -1.5
- Real interest rate and relative inflation:
  - 2022: -0.2
  - 2023: 0.6
  - 2024: 0.6
  - 2025: 1.1
  - 2026: 1.2
  - 2027: 1.1
  - 2028: 1.1
  - 2029: 1.0
  - 2030: 1.0
  - 2031: 1.0
  - 2032: 0.9
- Real growth rate:
  - 2022: -5.1
  - 2023: -2.6
  - 2024: -2.6
  - 2025: -2.5
  - 2026: -2.6
  - 2027: -2.3
  - 2028: -2.4
  - 2029: n.a.
  - 2030: -2.4
  - 2031: -2.4
  - 2032: -2.5
- Contribution of residual:
  - 2022: -1.2
  - 2023: -0.1
  - 2024: 0.0
  - 2025: -0.1
  - 2026: 0.0
  - 2027: 0.4
  - 2028: 0.4
  - 2029: 0.6
  - 2030: 0.4
  - 2031: 0.4
  - 2032: 0.4
- Gross financing needs:
  - 2022: 11.6
  - 2023: 10.6
  - 2024: 10.8
  - 2025: 9.8
  - 2026: 9.9
  - 2027: 9.5
  - 2028: 8.8
  - 2029: 8.5
  - 2030: 9.2
  - 2031: 8.4
  - 2032: 8.2
- Of which: debt service:
  - 2022: 8.3
  - 2023: 8.0
  - 2024: 8.7
  - 2025: 7.9
  - 2026: 8.0
  - 2027: 7.7
  - 2028: 7.3
  - 2029: 6.9
  - 2030: 7.6
  - 2031: 6.8
  - 2032: 6.4
- Local currency debt service (memo):
  - 2023: 7.9
  - 2024: 8.7
  - 2025: 7.8
  - 2026: 8.0
  - 2027: 7.7
  - 2028: 7.2
  - 2029: 6.8
  - 2030: 7.6
  - 2031: 6.8
  - 2032: 6.4
- Foreign currency debt service (memo):
  - 2023: 0.0
  - 2024: 0.1
  - 2025: 0.1
  - 2026: 0.1
  - 2027: 0.0
  - 2028: 0.0
  - 2029: 0.0
  - 2030: 0.0
  - 2031: 0.0
  - 2032: 0.0
- Macro memo:
  - Real GDP growth (percent): 2022: 8.7; 2023: 4.5; 2024: 4.5; 2025: 4.4; 2026: 4.4; 2027: 3.9; 2028: 3.9; 2029: 3.9; 2030: 3.9; 2031: 3.9; 2032: 3.9
  - Inflation (GDP deflator; percent): 2022: 4.5; 2023: 3.2; 2024: 3.6; 2025: 2.8; 2026: 2.6; 2027: 2.9; 2028: 2.9; 2029: 2.9; 2030: 2.9; 2031: 2.9; 2032: 2.9
  - Nominal GDP growth (percent): 2022: 15.7; 2023: 8.0; 2024: 8.2; 2025: 7.5; 2026: 7.1; 2027: 6.1; 2028: 6.2; 2029: 6.0; 2030: 6.3; 2031: 6.3; 2032: 6.3
  - Effective interest rate (percent): 2022: 4.1; 2023: 4.3; 2024: 4.6; 2025: 4.7; 2026: 4.7; 2027: 4.7; 2028: 4.7; 2029: 4.6; 2030: 4.5; 2031: 4.4; 2032: 4.4
- Staff commentary: Public debt will gradually rise over the forecast horizon, reflecting reflecting a primary deficit that remains about 2 ppts of GDP above its debt stabilizing level in 2032.

### Realism of baseline assumptions (summary)
- Staff finds realism analysis does not point to major biases: median forecast errors for the medium-term primary deficit and public debt projections are neither optimistic nor pessimistic.
- The baseline does not incorporate any medium-term fiscal consolidation effort, beyond the budget year.

### Medium-term risk analysis — indicators and outcomes
- Debt Fanchart and GFN Financeability Indexes: Fanchart width: 33.8
- Probability of debt not stabilizing (pct): 61.9
- Terminal debt level x institutions index: 23.4
- Average GFN in baseline: 9.9
- Bank claims on government (pct bank assets): 11.2
- Change in claims on govt. in stress (pct bank assets): 3.6
- GFN financeability index (presented): 8.2
- Prob. of missed crisis, 2023-2028 (if stress not predicted): 9.1 pct.
- Prob. of false alarm, 2023-2028 (if stress predicted): 42.0 pct.
- Commentary: The two medium-term tools, the Debt Fanchart Module and the GFN Financeability Module, suggest moderate levels of risk.

### Long-term modules — key outcomes (high-level)
- Pension financing needs: scenarios report required permanent adjustments expressed as percent of GDP per year:
  - 3.23% to keep pension assets positive for 50 years
  - 7.74% to keep pension assets positive until 2100
  - 12.83% to keep pension assets positive for 30 years
- Climate change modules: outputs presented for adaptation and mitigation scenarios showing impacts on GFN-to-GDP and Total Public Debt-to-GDP ratios under standardized and customized scenarios (charts provided).

### Appendix III — External Sector Assessment (selected findings)
- Overall assessment: Malaysia’s external position in 2022 is preliminarily assessed to be stronger than the level implied by medium-term fundamentals and desirable policies.
- Current account and outlook:
  - Background notes: Current account (CA) surplus strengthened during the pandemic and narrowed in 2022 due to rebound in domestic demand, inventory accumulation, and widening primary income deficit.
  - Assessment: EBA CA model outputs:
    - 2022 (percent of GDP) CA: 2.6
    - Cycl. Adj. CA: 1.9
    - EBA Norm: -0.6
    - EBA Gap: 2.5
    - COVID-19 Adj.: 1.0
    - Other Adj.: 0.0
    - Staff Gap: 3.5
  - Staff assesses a CA gap in the range of 3.0–4.0 percent, with a midpoint estimate of 3.5 percent, after adjustments for transitory effects (lower travel receipts, higher transport costs, remittances).
  - Drivers of CA gap: relative policy gaps including weaker social safety nets (0.6 percent), increase in BOP reserve assets (0.6 percent), looser fiscal policies abroad (0.2 percent), and stronger credit growth contributing negatively (-0.8 percent).
  - Outlook: CA surplus expected to grow over the medium term as tourism recovers.
- Foreign asset and liability position:
  - Background: NIIP averaged about 1 percent of GDP over last decade, increased to 5.5 percent at end-2021, declined to 3.5 percent of GDP at end-2022.
  - 2022 (percent of GDP): NIIP: 3.5; Gross Assets: 124.5; Reserve Assets: 28.1; Gross Liab.: 121.0; Debt Liab.: 24.1
  - Total external debt: declined to 64 percent of GDP in 2022, compared to 70 percent at end-2021.
  - One-third of external debt is ringgit-denominated.
  - Short-term external debt: accounts for 42.1 percent of external debt; characterized as manageable because much is intragroup borrowing or trade credits.
  - Assessment: NIIP expected to increase over the medium term, supported by projected CA surpluses; balance sheet strength, exchange rate flexibility, and increased domestic investor participation support resilience.
- Real exchange rate:
  - Background: Ringgit depreciated about 12 percent against the US dollar between start of war in Ukraine and end-October 2022, then strengthened since November, resulting in a depreciation of about 5 percent for the year.
  - REER depreciated by 1.4 percent over the year; nominal effective exchange rate appreciated by 0.5 percent.
  - Assessment: Using a semi-elasticity of 0.51, staff assess CA gap implies REER undervaluation of 6.9 percent in 2022. REER index and level models estimate undervaluation of 25.2 percent and 29.3 percent, respectively. Staff assess REER undervaluation in range 5.8–7.9 percent, midpoint 6.9 percent.
- Capital and financial accounts:
  - Background: Malaysia experienced periods of significant capital flow volatility driven by portfolio flows in and out of local-currency debt market.
  - Assessment: Continued exchange rate flexibility and macroeconomic policy adjustments are necessary to manage capital flow volatility. CFM measures should be gradually phased out, with due regard for market conditions.
- FX intervention and reserves level:
  - Background: Gross international reserves increased to US$116.9 billion by end-2021, declined to US$114.7 billion by end- (text truncated).

*Source: 1mysea2023001 - 1. Debt coverage in the DSA: 1/.*

### 2022. Against the backdrop of large external pressures, reserves decreased significantly following the war in Ukraine, b

### 1mysea2023001 - 2022. Against the backdrop of large external pressures, reserves decreased significantly following the war in Ukraine, b

### Reserves, FX interventions, and preliminary assessment
- Reserves declined to about 110 percent of ARA at end-2022 (above the adequacy threshold of 100 percent), down from 121 percent of ARA at the end of the previous year.
- Reserve coverage declined to 5 months of prospective imports, or about 85 percent of short-term debt.
- The decline in reserve adequacy is partly driven by an increase in short-term external debt.
- Staff assess that BNM engaged in largely two-sided FX interventions over the year.
- Policy guidance:
  - FX interventions should continue to be limited to preventing disorderly market conditions.
- Note: Assessment prepared by Shujaat Khan and is preliminary, pending a complete analysis in the forthcoming July 2023 External Sector Report.

### Risk Assessment Matrix — conjunctural risks, transmission, impacts, and recommended responses
- Abrupt growth slowdown or recession in China
  - Likelihood: Medium
  - Expected impact: Medium
  - Transmission: China is Malaysia’s largest trading partner; a 1 percentage point investment slowdown in China would reduce Malaysia’s growth by 0.6 percentage points (staff estimate cited from the 2012 Spillover Report).
  - Recommended responses:
    - Exchange rate as first line of defense to absorb shock, using reserves to smooth excessive volatility.
    - Targeted fiscal policy support where possible.
    - Structural policies to rebalance growth towards domestic demand.
- Monetary policy miscalibration
  - Likelihood: Medium
  - Expected impact: Medium/High
  - Transmission: Narrowing interest rate differentials, outflows, Ringgit depreciation, upward pressure on bond yields, weak external demand; high public debt a vulnerability.
  - Recommended responses:
    - Calibrate monetary policy to balance supporting growth, taming inflation, and managing capital outflows.
    - Any temporary fiscal expansion should be well targeted and anchored in a credible medium-term fiscal consolidation plan.
    - Provide liquidity support (including FX) if needed.
    - Consider temporary outflow CFMs under imminent crisis circumstances as part of a broader policy package in line with the Fund’s institutional view (IV).
- Commodity price volatility
  - Likelihood: High
  - Expected impact: Medium
  - Transmission: Supply disruptions and demand fluctuations raise external and fiscal pressures; reliance on oil revenues increases fiscal vulnerability.
  - Recommended responses:
    - Rebuild fiscal buffers and pursue fiscal reforms to reduce reliance on oil revenues (e.g., broad-based taxes).
    - Invest in infrastructure and productivity-boosting structural reforms.

### Risk Assessment Matrix — structural risks, transmission, impacts, and recommended responses
- Deepening geoeconomic fragmentation
  - Likelihood: High
  - Expected impact: Medium/High
  - Transmission: Reconfiguration of trade and FDI, supply disruptions, fragmentation of payments/technology, higher input costs; risks to Malaysia’s manufacturing/Electronics sector given global value chain integration.
  - Recommended responses:
    - Continued careful and orderly reopening of the economy, especially targeting sectors well integrated into global value chains.
- Extreme climate events
  - Likelihood: Medium
  - Expected impact: Medium
  - Transmission: Floods and extreme events destroy infrastructure and capital, necessitate relief/recovery spending, reduce output and fiscal space.
  - Recommended responses:
    - Continue and accelerate mitigation and adaptation plans, including 12MP improvements to early warning systems and disaster response measures.
- Fiscal risks from public debt and contingent liabilities (Short- to medium-term)
  - Likelihood: Medium
  - Expected impact: Medium/High
  - Transmission: Higher sovereign financing costs, a relatively high public debt, realization of contingent liabilities could lead to spikes in domestic interest rates and exit of foreign investors.
  - Recommended responses:
    - Medium-term fiscal consolidation via a medium-term revenue strategy (MTRS).
    - Continue reforming fiscal institutions, improve fiscal risks management framework, publish annual fiscal risks statement, and increase transparency of GLC operations.
- Cyberthreats
  - Likelihood: Medium
  - Expected impact: Medium/High
  - Transmission: Cyberattacks could trigger financial and economic instability (SWIFT fraud, hacked crypto exchanges, supply chain/business disruptions).
  - Recommended responses:
    - Continued investment in cyber security strategy and strengthening IT security frameworks in line with the recent FinTIP.

### Annex: Malaysia’s exposure to geo-economic fragmentation — trade and financial linkages
- Trade integration and value chains
  - Malaysia’s export share of GDP remains above 60 percent.
  - The electronics sector is deeply integrated with global value chains: foreign value added constitutes more than half of gross exports (Figure 1, Panel 1 referenced).
- Trade partner shares (2020, source: CEPII BACI)
  - Exports: 14.5 percent to China, 12.7 percent to the USA, 11.1 percent to Europe.
  - Imports: 26 percent from China, 6.3 percent from the USA, 9.1 percent from Europe.
- Financial linkages
  - Malaysia’s financial integration is more skewed toward the USA and Europe for both outward and inward foreign investment.
  - Geopolitical shifts that move capital between blocs could raise banks’ funding costs and reduce credit provision, especially in emerging markets.
  - Financial fragmentation could reduce international risk diversification and increase macro-financial volatility.

### Uncertainty, investment effects, and friend-shoring dynamics
- Trade-related uncertainty has increased substantially in recent years.
- Investment effects of uncertainty
  - A one-standard deviation increase in trade uncertainty tends to reduce national investment by around 2.5 percent over three years (IMF, 2022b).
  - At the firm level, investment falls by around 5 percent over the same period, with larger effects in emerging markets with high openness to trade.
- Firm responses and friend-shoring
  - Multi-national firms are reconfiguring geographic footprints (reshoring, friend-shoring).
  - Malaysia could gain from Western firms diversifying production away from China, but outcomes depend on the extent supply chains re-adjust and whether tensions spill over to other Southeast Asian economies.

### Quantified illustrative fragmentation scenarios and impacts on Malaysia
- Cerdeiro et al. (2021) simulations (technological decoupling, high-tech trade falls at least 95 percent between hubs)
  - Baseline case (China-US technological decoupling): Malaysia benefits from trade diversion with potential output increasing by 0.4 percent.
  - If the whole of the OECD joins the US side: potential output gain rises to 4.4 percent.
- Severe fragmentation where non-hub countries must "pick a side" (preferential attachment)
  - Bipolar China-US scenario: Malaysia faces costs of 1.5 percent of potential output.
  - More fractured tripolar scenario: Malaysia faces costs of -2.1 percent of potential output.
  - If Malaysia attaches to a larger pole (e.g., OECD scenario), the cost of preferential attachment is reduced to 0.5 percent.
- IMF (2022b) extended scenarios (energy and high-tech divided between blocs, and broader sectoral barriers)
  - Fragmentation by UN General Assembly vote blocs: Malaysia faces costs of approximately 0.5 percent of GDP (additional fragmentation of energy markets increases costs but larger coalition offsets some effects).
  - An extreme scenario extending trade barriers to all sectors (non-tariff barriers raised to Cold War–height restrictiveness): Malaysia faces a cost of approximately 2.5 percent of GDP.
- Summary implication:
  - In stark fragmentation scenarios where Malaysia cannot trade simultaneously with opposing poles, Malaysia faces significant long-run costs. In milder scenarios Malaysia may benefit from trade diversion and friend-shoring.

*Prepared by IMF staff as contained in the source PDF.*

### 10.      The impact of geoeconomic fragmentation on Malaysia could be affected by several

### 10.      The impact of geoeconomic fragmentation on Malaysia could be affected by several

### Channels of impact and additional uncertainties
- Models used in the chapter abstract from investment dynamics and therefore do not account for changes to capital accumulation that could affect productivity in the medium and long term.
- Increased geostrategic tensions could:
  - Reduce global knowledge-sharing, FDI and technology diffusion, reversing positive innovation and productivity spillovers (IMF, 2023b; Branstetter et al., 2018; Bloom et al., 2016).
  - Lead to much larger output losses from fragmentation, particularly in emerging markets and developing economies.
  - Be compounded by a reduction in migration, raising labor costs in receiver countries and reducing potential remittance income in sender countries (Banerjee and Duflo, 2007; Islamaj and Kose, 2022).
  - Reduce global cooperation to provide global public goods such as climate change mitigation or pandemic preparedness, with significant negative repercussions for Malaysia (CR22/126 Appendix VIII on climate change and CR21/53 Appendices I and II on COVID).
- These additional channels would:
  - Reduce the gains from trade diversion under the ‘no preferential attachment’ scenario.
  - Exacerbate the losses under the ‘preferential attachment’ scenario.

### Adjustment dynamics and exposure
- Immediate costs of fragmentation could be significantly higher than long-run impacts as firms and workers take time to reoptimize (Boehm, Levchenko, and Pandalai-Nayar, forthcoming; Bolhuis, Chen, and Kett, forthcoming).
- Agglomeration and coordination effects can create non-linearities and tipping points that are hard to predict; relocation decisions by firms and workers can lead to sudden shifts.
- The alignment of each country — and thus the overall fragmentation pattern — can change rapidly in response to unforeseen geopolitical events.
- Alternative fragmentation patterns (based on trade intensity or historical geopolitical alignment) can place Malaysia in the non-US pole, indicating substantial exposure to both poles and a precarious position.
- Policy implication: continuous engagement with key stakeholders and monitoring of warning signs is required to identify risks early and respond expeditiously.

### Conclusions: risks to Malaysia and broad policy directions
- Stark fragmentation outcomes pose a significant risk to the global value chains that have been major drivers of Malaysia’s development.
- Malaysia’s integration with both poles in potential geoeconomic fragmentation scenarios leaves it particularly exposed when tensions force countries to trade sensitive goods with only one pole.
- Increased geopolitical tensions could reduce global knowledge-sharing, migration flows, and the provision of global public goods, with further negative repercussions for Malaysia.
- High degree of uncertainty around potential impacts of geoeconomic fragmentation hinders preparedness.

Policy recommendations and resilience measures:
- International and trade policy:
  - Ensure overlapping trade agreements of which Malaysia is a member do not contribute to fragmentation; promote open and non-discriminatory membership criteria.
  - Advocate open trading relationships and global value chains, and support norms that minimize trade policy uncertainty.
- Domestic policies to support investment and resilience:
  - Maintain an attractive policy environment to support continued investment.
  - Undertake structural reforms and improve infrastructure (IMF, 2023b).
  - Improve FX reserves and reduce debt to maximize policy space to respond to shocks (IMF, 2023a).
  - Diversify export markets and sources of inputs to increase supply-chain resilience (IMF, 2022c).
  - Produce more complex products and maintain high quality institutions and regulations to reduce vulnerability to reshoring of FDI (IMF, 2023b).

### Appendix VI — Transitioning from blanket to targeted subsidies: context and lessons for Malaysia
- Rationale for reform:
  - Time is right for subsidy reform in Malaysia given high fiscal, environmental, distributional, and opportunity costs and alignment with Twelfth Malaysia Plan goals.
  - Removing subsidies would support fiscal sustainability, rebuild buffers, create space for growth-enhancing public spending (including in the energy sector), and finance targeted transfers to the most vulnerable.
  - Subsidy savings used for transfers can help lower inequality because subsidies are regressive and usually benefit richer households.
  - Subsidy reform would reduce wasteful energy consumption and emissions, supporting Malaysia’s climate ambition of becoming a carbon neutral economy by 2050.
- Challenges to reform:
  - Lack of public information on the cost and scale of subsidies and on how domestic prices compare to international prices.
  - Concern about adverse impacts on the poor and mistrust in how savings will be used, especially where capacity for cash transfer programs or SSNs is limited.
  - Inflationary effects and potential volatility in domestic energy prices, particularly problematic during weak macroeconomic conditions or when international energy prices are high.
  - Opposition from interest groups benefiting from the status quo.

Subsidies in Malaysia — facts and past experience:
- Energy subsidy bills have often constituted a large share of government spending, reaching over 20 percent of current expenditures and 4 percent of GDP in periods of high commodity prices.
- Since 1983, an automatic pricing mechanism (APM) has been used in Malaysia to calculate the level of subsidies needed to cover the difference between fixed retail prices and market prices.
- Major subsidized fossil transport fuels: diesel, RON95 and RON97. Other subsidies: LPG, cooking oil and some food items like sugar.
- Past reform history:
  - 10th Malaysia Plan (2010–2015): subsidy reform program initiated in July 2010; only RON97 price was floated in 2010.
  - Progress resumed in Sept 2013 amid rising fiscal deficit and debt; prices of diesel and RON95 were first raised by about 10 percent each and then fully eliminated by Dec 2014, aided by the plunge in oil prices.
  - 2014 Budget announced half of savings from restructuring subsidies would be distributed as direct cash assistance to low-income groups and half used for development projects.
  - Removal of fuel subsidies pushed inflation above its historical average but did not cause generalized inflationary pressures at that time.
  - In 2018, subsidies for lower-grade petroleum were re-introduced along with a managed float fuel price mechanism and targeted subsidies for the low-income group effective 2019.
  - In 2022, Ministry of Finance repeatedly shielded consumers from surging commodity prices after the war in Ukraine, causing spending on subsidies to increase.

Lessons from international reform episodes (2015-2018 and earlier):
- Examples:
  - India significantly reduced oil and gas subsidies during FY2014-2017 and redirected LPG subsidies to consumers’ bank accounts, alongside communication campaigns.
  - Indonesia completed its 2015 gasoline and diesel subsidy reform with budgetary savings but suffered inconsistent price adjustments and political reversals by 2019.
  - IMF (2013) assessed 28 major reform episodes across 19 countries mostly during 1980-2012.
- Key complementary ingredients for successful subsidy reform:
  (i) Part of a comprehensive reform plan with clear long-term objectives and stakeholder consultation to build buy-in and prevent backlash (examples: Iran 2010; Philippines 1996 & 2001; Turkey 1998). Lack of consultation undermined Indonesia’s 2003 reform.
  (ii) Based on an automatic pricing mechanism to depoliticize energy prices; transparency and possible delegation to an independent body help maintain continuity. Price smoothing rules can mitigate transmission of sharp international price spikes.
  (iii) Implemented gradually with phased price increases, possibly sequenced across energy products, supported by appropriate macroeconomic policies, and committed to eventual elimination of subsidies. Pace should be calibrated using the gap between retail and international prices, available fiscal space, and ability to mitigate impacts on vulnerable households. Adjustment paths can be differentiated by fuel type based on consumption shares of income groups.
  (iv) Accompanied by mitigating measures targeted at low-income households, particularly where social safety nets are weak, and coupled with SSN reform. Cash transfers provide beneficiaries flexibility to purchase the energy type and level that suits their needs.

*Source: 1mysea2023001 - 10.      The impact of geoeconomic fragmentation on Malaysia could be affected by several*

### 1.      In countries with existing SSN, the most efficient of these programs can be

### 1mysea2023001 - 1.      In countries with existing SSN, the most efficient of these programs can be

### Social safety nets (SSN) and subsidy reform: core findings
- Existing SSN programs can be expanded to provide relief to vulnerable households by increasing benefit levels and coverage.
- Where safety nets are comprehensive enough, gradual price increases (e.g., LPG) can proceed without additional targeted social welfare mechanisms because large-scale cash transfer programs with energy components can mitigate impacts (example: Mexico).
- In countries with weak or absent SSNs, it is recommended to:
  - Leverage measures used in response to COVID-19.
  - Harness digital tools to identify eligible households and deliver assistance.
  - Complement subsidy reform with a reform strategy to strengthen SSN systems by addressing inefficiencies and improving targeting, including investing in information and delivery systems.
- Short-term relief alternatives for affected poor households include reducing education, health, or public transportation fees to the extent they reach targeted groups and can be effectively implemented.

### Country case studies and implementation modalities
- Mexico:
  - Existing large-scale cash transfer program includes a specific component to help households meet energy needs; this mitigated LPG reform impacts when LPG prices were gradually increased.
- El Salvador:
  - Replaced LPG subsidies with an income transfer identifying beneficiaries based on electricity consumption, initially via a barcode on electricity bills.
  - Later replaced with a payment system that paid subsidies directly to LPG vendors when beneficiaries purchased LPG, requiring ID and a personal identification number entered on a program-specific mobile phone.
  - Mobile phones were distributed to LPG vendors, who received special training; transaction information was collected in real time in a central database, improving enforceability.
  - In 2015, the government reported the new program provided benefits to around 74 per cent of households.
- Peru:
  - In 2012 the government created the Fondo de Inclusión Social Energético (FISE).
  - Under FISE, recipient households receive a monthly voucher providing financial support for the first LPG refill every month.
  - FISE eligibility criteria include average monthly electricity consumption, household income, house construction, etc.
  - The voucher is provided via a numeric code on the electricity bill.
- Malaysia:
  - Existing cash assistance programs can be used; Bantuan Keluarga Malaysia (BKM) introduced in the 2022 Budget as an improved version of Bantuan Prihatin Rakyat (BPR).
  - BKM is expected to reach more recipients and higher allocation compared to BPR.

### Design principles and sequencing for successful subsidy reform
- Account for country circumstances including business cycles, oil prices, and political cycles:
  - Subsidy reform is more successful when oil prices are falling, growth is relatively high, and inflation is low.
  - These favorable conditions are expected in 2023 with global commodity prices projected to moderate, Malaysia’s growth projected at around pre-pandemic average, and inflation remaining contained.
  - Achieving broad political consensus is important; the 2013 reform in Malaysia faced wide criticisms from opposition parties.
- Underpin reform with a far-reaching and transparent communication strategy that:
  - Clearly explains costs of subsidies and benefits of reform, including winners and losers.
  - Explains how expenditure savings from subsidy reform will be spent.
  - Uses public dissemination of information and data on subsidy magnitude, funding, distribution across income groups, comparison to priority spending, and price formulation.
  - Examples: Philippines nationwide road show; Malaysia publicized subsidy costs on posters at petrol stations and on monthly electric bills; India’s “Give It Up!” campaign encouraged voluntary renunciation of subsidized LPG by wealthier individuals.
- Policy sequencing recommendations:
  - Provide clear, well-defined, transparently communicated comprehensive reform plan in the Budget.
  - Quantify mitigating cash transfers and ideally include them as part of the Budget.
  - Clarify exact sequencing of energy price increases and a depoliticized price-setting mechanism to shape expectations and avoid public uproars.

### Conclusions (policy implications)
- Commitment to subsidy reform in the 2023 Budget needs to be complemented by a clear, well-defined, and transparently communicated comprehensive reform plan.
- The government should explain multifaceted costs of subsidies and why replacing them with targeted cash transfers plus stronger SSNs is more beneficial, particularly to poor households.
- More clarity is needed on:
  - Exact sequencing of energy price increases.
  - Exact depoliticized price-setting mechanism.
  - Quantified details of mitigating cash transfers to be included in the Budget.

### Appendix VII — Monetary policy transmission in Malaysia: key empirical findings
- Recent inflation dynamics:
  - Headline CPI Inflation rate reached 3.8 percent in December 2022, driven by food prices, averaging 3.4 percent over the year in Malaysia.
  - Core inflation (excluding administered and volatile food items) rose to 4.1 percent in December 2022, among highest recorded since 2016.
- Bank Negara Malaysia (BNM) monetary policy stance:
  - BNM has normalized policy by a cumulative 100 basis points (bps) over the last four meetings since May 2022.
  - In the Monetary Policy Statement of January 2023, BNM maintained the OPR at 2.75 percent to assess impacts of previous hikes.
  - ASEAN peers: Philippines hiked cumulatively by 350bps since May 2022.
- Channels of monetary policy transmission considered:
  - Interest rate channel, exchange rate channel, bank lending (credit) channel, asset price channel.
- Empirical identification of monetary policy shocks:
  - Monetary policy shocks (η_m^MP) are identified following Romer and Romer (2004) and Holm et al. (2021) using BNM monetary policy statement level data since May 2004.
  - Specification for change in policy rate ∆i_m includes lagged OPR, inflation forecasts (π_m,t and π_m,t+1), growth forecasts (y_m,t and y_m,t+1), and lagged MYR/USD exchange rate (E_m−1); η_m^MP is the residual.
  - Model explains about 30 percent of the variation in change in OPR.
- Regression results (Table 1 summary):
  - Coefficients (selected) from OLS estimation over meetings May 2004–July 2022:
    - i_m−1: -0.110*** (column 1), -0.112*** (column 2)
    - y_m,t: 0.024*** (column 1), 0.022*** (column 2)
    - π_m,t+1: 0.113** (column 1), 0.105*** (column 2)
    - N (observations): 115
    - R-squared: 0.271 (column 1), 0.274 (column 2)
- Local Projection empirical strategy to measure impact:
  - Uses local projection framework (Jordá, 2005) augmented to explicitly test exchange rate, asset price, and credit channels.
  - Outcome variables Y_t include log CPI, log industrial production index (proxy for output), or unemployment rate; horizons h = 0,1,..,24 months.
  - Channel magnitudes used for counterfactual total impacts:
    - Exchange rate channel: one standard deviation in change in NEER ≈ 1.2 percent appreciation.
    - Asset price channel: 25th percentile of stock market index growth ≈ -2.9 percent.
    - Credit channel: one standard deviation in base lending rate ≈ 7 basis points increase.

*1mysea2023001 — IMF PDF chapter content unit*

### 10.      We present cumulative impulse response functions (IRF) as deviation in percent of

### 1mysea2023001 - 10.      We present cumulative impulse response functions (IRF) as deviation in percent of

### Methodology and measurement
- Outcome variables measured as deviation relative to initial level in the month preceding the shock; impacts interpreted as percent of initial month’s value.
- Outcome variables are the log change times 100.
- Policy shocks measured as 1 percentage point or 100 basis points (bps) change in month 0.
- Unemployment results presented as deviation in percentage points compared to the initial month’s value.
- Lag selection based on the Akaike and Bayesian information criteria; industrial output specification uses 3 months of lagged values of the monetary policy shock and accounts for a structural break around 2009:M2.
- Data sources cited: International Financial Statistics (industrial production index, CPI index), CEIC (stock market index and base lending rate), Adler et al. (2021) for FXI proxy, Husted et al (2020) for US monetary policy uncertainty index.
- Newey-West standard errors (robust to autocorrelation) used; 90 percent confidence intervals shown in figures.

### Main findings — Inflation transmission
- Exchange rate channel: strong and persistent transmission of monetary policy shocks to inflation.
  - A 100bps increase in monetary policy shock (shutting off all channels) is negative and statistically significant only about 14-15 months, persists up to 21 months, and can reach about 2.5 percent reduction in inflation.
  - Focusing on the exchange rate channel specifically: in about 7 months the same monetary policy shock could reduce inflation by 5 percent cumulatively; effects persist and can be larger in the long term (13 months – with a cumulative peak impact at about 8 percent).
  - Implication example: for an initial inflation rate of 3 percent, a 100bps tightening could lead to an inflation rate of about 2.75 percent in 13 months.
- Asset price channel: testing yields a very similar IRF as the main effect, suggesting the asset price channel is relatively muted.
- Credit channel: a 100bps monetary policy shock shows a cumulative reduction in inflation by 3 percent in 18 months.
- Overall: exchange rate and credit channels are important; findings align with Brandão-Marques et al (2021) that the exchange rate channel is important for monetary policy transmission in EMs.

### Output cost and sacrifice ratio
- Industrial production: a 100 bps monetary policy shock could reduce industrial production cumulatively by between 2 percent (main impact) to about 3 percent in 24 months (when accounting for credit or exchange rate channels).
- Real GDP implication (back-of-the-envelope): reduction in real GDP between 3.6 percent and 5.4 percent over 24 months.
- Sacrifice ratio: implied sacrifice ratio close to one for 24 months; in a shorter period (13 months) the sacrifice ratio is below one.
- Unemployment: monetary policy tightening associated with an increase in unemployment by about 2 percentage points in 24 months.
- Interpretation: small sacrifice ratio consistent with relatively rapid pace of monetary policy transmission (through the exchange rate channel), BNM independence, and Malaysia’s openness.

### Nonlinearities — role of external and domestic factors
- Global commodity prices (including global food, energy, and input price indexes) do not impair monetary policy transmission in Malaysia.
  - Conditioning a 100 bps monetary policy shock on a one standard deviation in global commodity price inflation shows no significant change to baseline transmission for credit or exchange rate channels.
- Global monetary policy tightening amplifies domestic transmission.
  - Conditioning on a 1 standard deviation – about 13bps – global hike shows inflation could be cumulatively reduced by between 8 percent in 7 months (exchange rate channel) and about 10 percent (credit channel) in 18 months.
  - Synchronized tightening could have a persistent reduction effect on inflation up to 24 months; amplification weakened once controlling for global inflation dynamics (complementary role depends on global disinflation).
- Level of OPR:
  - Conditioning on the median level of the policy rate (of 3 percent) shows no impact on transmission compared to baseline.
  - Conclusion: transmission is independent of the level of the policy rate.
- High inflation environment:
  - Using the 75th percentile of inflation rate (3.2 percent) as proxy for high inflation shows monetary policy transmission is weakened and delayed.
  - Exchange rate channel impact statistically significant only around 13 months.
  - Effectiveness could be reduced between about 20 percent (credit channel) and 30 percent (exchange rate channel) based on peak impacts.
  - Implication: in high inflation, monetary policy tightening may need to be more aggressive and transmission may be delayed.

### Role of other policy levers — SRR and FXI
- Statutory Reserve Requirement (SRR):
  - A 100bps hike in monetary policy shock estimated for 1 standard deviation in the change of the SRR – about 19bps – shows SRR changes do not materially impact the exchange rate channel but amplify the credit channel, particularly in the medium term.
  - Result: cumulative reduction in inflation by 4 percent in 18 months compared to about 3 percent in the baseline.
- Foreign Exchange Intervention (FXI):
  - FXI purchases weaken the exchange rate channel while strengthening the credit channel.
    - FXI purchases amplify the credit channel, yielding a persistent reduction in inflation with a cumulative impact (for a 1percentage point of GDP increase) reaching about 4 percent reduction in inflation in 14 months.
  - FXI sales preserve the exchange rate channel and have a broadly neutral impact on the credit channel.
  - Interpretation: purchases can dampen credit to firms vulnerable to currency movements; leaning against appreciations weakens the exchange rate channel, while sales lean against depreciations and preserve it.

### Conclusions and policy recommendations
- Key conclusions:
  - Exchange rate and credit channels are important for monetary policy transmission in Malaysia with a potentially low sacrifice ratio.
  - Monetary policy tightening reduces both output and inflation, but the relative cost of output loss to price stability could be low.
- Policy implications and recommendations:
  - Given the estimated low sacrifice ratio and muted transmission in periods of high inflation, more tightening of the monetary policy stance should be considered.
  - The BNM could use complementary policy levers such as the SRR to contain inflation, particularly to mitigate financial stability risks from rate hikes; appropriate tightening of the SRR could support monetary policy via the credit channel.
  - FXI sales can support the exchange rate channel, but recent decrease in reserves calls for a prudent approach: rebuild reserve buffers to face potential severe downside risks.
  - Fiscal policy should support monetary policy through consolidation while addressing potential output challenges via carefully targeted support to the most vulnerable, who usually have a high marginal propension to consume.

*Source: 1mysea2023001*

### Appendix VIII. Simulating Downside Risks Scenarios Using the

### Appendix VIII. Simulating Downside Risks Scenarios Using the Integrated Policy Framework

### Post‑pandemic recovery and current macro position
- Malaysian economy grew at 8.7 percent in 2022; output gap turned positive in 2022.
- Core CPI projected to rise from 0.7 percent last year to 3 percent this year.
- Ringgit depreciation and decline in FX reserves partly reflected FX interventions by Bank Negara Malaysia (BNM).
- FX reserves coverage (measured as a percent of the IMF’s ARA metric) was 110 percent at end-2022, compared to 121 percent at end-2021.
- FX market turnover: averaging US$15.5b per day in 2023 YTD, compared to US$13.7b in 2022 and US$11.3b in 2021.
- Trade invoicing: about 80 percent of trade invoicing done in US dollar.

### Key downside risks and market frictions
- External headwinds: slowdown in major trading partners, tightening global financial conditions, elevated inflationary pressures, and risk of protracted war in Ukraine.
- Risk transmission amplified by shallow FX markets, reflected in large variations in the UIP premium and widened MYR/USD bid‑ask spreads during stress episodes.
- Channels of amplification include high dollar invoicing, FX mismatches, and firms with low liquidity buffers (referenced IMF study: Eklou, 2023).
- Shallow FX markets can lead to exporters withholding FX sales while importers’ FX demand rises, exacerbating depreciation pressures.

### Stylized downside scenarios simulated
- Scenario‑1 (Adverse): severe and protracted slowdown in China.
  - Growth in the foreign economy, represented by the US in the model, declines by about 2 percent relative to the steady state.
  - Decline in external demand for Malaysia; shift in market sentiment raises risk premia and triggers a risk‑off shock causing ringgit depreciation.
- Alternative Scenario‑1 (No risk‑off shock): fundamental shocks only; foreign country cuts interest rates more aggressively than Malaysia, leading to exchange rate appreciation and declines in both inflation and output.
  - Illustrative policy experiment: a 10 percent decline in oil prices; reduction in oil subsidies by about 10 percent maintains domestic oil prices broadly at steady state levels.
- Scenario‑2 (Adverse): escalation of the war in Ukraine → persistent supply disruptions and higher commodity prices.
  - US core inflation increases by about 1 percentage point compared to the baseline; inflationary pressures pass through to Malaysia and raise risk‑off sentiment with capital outflows.

### IPF model findings on policy responses
- Interest rate alone:
  - In Scenario‑1 (with risk‑off), relying solely on interest rate requires cutting policy rate to spur demand, but the interest rate response is muted due to higher inflation.
  - In Scenario‑2 (stagflation), relying exclusively on the interest rate requires raising rates significantly for an extended period to contain inflation, which slows growth markedly.
- Interest rate + FX interventions (FXI):
  - In Scenario‑1 (with risk‑off), FXI limits depreciation, reducing inflationary pass‑through and creating space for monetary easing to support output. However, when depreciation is short‑lived, FXI gains may be limited and costs may exceed benefits.
  - In Scenario‑1 (no risk‑off), FXI is less desirable because there is no material policy trade‑off to address; FXI that limits appreciation can improve trade balance but may reduce private domestic demand by keeping policy rates relatively tighter.
  - In Scenario‑2, FXI restricts large and persistent depreciation, limits pass‑through to domestic inflation, reduces the magnitude of required policy rate hikes, and results in smaller output losses.
- Fiscal policy:
  - Targeted transfers can contain short‑term demand losses (Scenario‑1) but increase government debt and medium‑term rates.
  - Expansionary fiscal policy can boost output but also raises inflationary pressures if the Phillips curve is steeper, amplifying trade‑offs in stagflationary scenarios.
  - Subsidy removal combined with targeted transfers (alternative Scenario‑1): reducing fuel subsidies by about 10 percent offsets some fiscal cost of transfers and mitigates debt buildup; removal when prices are high would exacerbate inflationary pressures.

### Policy design principles and caveats
- An optimal policy mix should not over‑rely on a single tool; complementary use of interest rate, FXI, and targeted fiscal measures can improve outcomes.
- FXI is justified only when:
  - Well‑identified frictions exist (e.g., shallow FX markets, unhedged FX risks, balance sheet mismatches, high exchange rate pass‑through risking de‑anchoring of inflation expectations).
  - Shocks are large enough to threaten macroeconomic and financial stability.
  - FXI targets risk premia rather than a specific exchange rate and is integrated into the overall policy response.
  - Sufficient reserves are available for credible FX sales during outflow episodes.
- Indiscriminate use of FXI is not condoned; FXI should not substitute for necessary macroeconomic adjustments.
- Model caveat: quantitative IPF model treats FX purchases and sales symmetrically, but empirical analysis finds asymmetry in FXI’s direction affecting monetary transmission.

### External debt and vulnerability statistics (summary from adjacent Annex)
- External debt‑to‑GDP: declined to 64 percent of GDP at end‑2022, down from 70 percent at end‑2021.
- Currency composition of external debt as of end‑2022:
  - Ringgit‑denominated: 33.1 percent of total external debt.
    - Of ringgit‑denominated external debt, 65.1 percent is nonresident holdings of domestic debt securities.
  - Foreign currency (FC)‑denominated: 66.9 percent of total external debt.
- Short‑term external debt by original maturity: 42.1 percent of total external debt as of end‑2022.
  - Over 40 percent of short‑term external debt are intragroup borrowings among parent banks and multi‑national corporates.
  - About 17 percent of short‑term external debt are trade credits.
- Projections and risks:
  - Total external debt projected to fall to about 56 percent by 2028.
  - Gross external financing needs estimated at about 28 percent of GDP in 2022, declining to around 25 percent by 2028.
  - Stress test: a 30 percent real exchange rate depreciation in 2023 could push external debt to about 75 percent of GDP by 2028; a persistent historical shock could lead to external debt around 75 percent of GDP in the outer years.

*Source: Appendix VIII. Simulating Downside Risks Scenarios Using the Integrated Policy Framework (Malaysia).*

### 6.      While risks to Malaysia’s external debt sustainability arising from the above

### 6.      While risks to Malaysia’s external debt sustainability arising from the above vulnerabilities have increased, they can be managed via a variety of mitigation measures.

### External vulnerabilities, buffers, and policy environment
- Gross official reserves: US$114.7 billion (end-2022).
- Reserves as share of short-term external debt: about 85 percent (end-2022).
- Coverage of gross official reserves under the IMF reserve adequacy metric (ARA): 110 percent of the metric at end-2022 (coverage “dropped significantly over the year”).
- Key buffers:
  - Exchange rate flexibility.
  - A moderate current account (CA) surplus.
  - Relatively large share of ringgit-denominated external debt.
- Prudential and approval frameworks:
  - Banks’ exposures (interbank borrowings, NR deposits, debt issuances) subject to prudential requirements on liquidity and funding risk management.
  - Corporations subject to an approval framework to ascertain external borrowings are used for productive purposes and supported by foreign currency earnings.

### Profile of external debt (Table 1 highlights; in percent of GDP unless otherwise mentioned)
- Total external debt:
  - 2017: 64.5
  - 2018: 63.8
  - 2019: 62.6
  - 2020: 67.6
  - 2021: 70.0
  - 2022: 64.0
- Medium- and long-term (2017–2022): 38.9, 35.8, 36.9, 41.7, 43.8, 37.0
- Offshore borrowing (2017–2022): 23.4, 22.9, 23.0, 25.5, 25.3, 21.4
- Public sector (2017–2022): 9.7, 9.5, 8.5, 10.1, 10.5, 8.2
  - Federal government (2017–2022): 1.2, 1.2, 1.6, 1.7, 1.6, 1.4
  - Public enterprises (2017–2022): 8.4, 8.4, 6.9, 8.4, 8.9, 6.8
- Private sector (2017–2022): 13.7, 13.4, 14.5, 15.4, 14.8, 13.2
  - Banks (2017–2022): 3.4, 3.3, 3.7, 3.9, 3.5, 3.0
  - Nonbanks (2017–2022): 10.4, 10.1, 10.8, 11.5, 11.2, 10.2
- Nonresident holdings of ringgit-denominated debt instruments (2017–2022): 14.3, 11.7, 12.8, 14.9, 15.9, 13.3
  - Government securities (2017–2022): 13.3, 10.9, 12.0, 14.1, 15.0, 12.6
  - Other securities (2017–2022): 1.0, 0.7, 0.7, 0.8, 0.9, 0.7
- Short-term (2017–2022): 25.6, 28.0, 25.8, 25.9, 26.3, 26.9
  - Offshore borrowing, short-term (2017–2022): 13.7, 16.2, 14.2, 14.0, 13.0, 13.6
  - Private sector short-term (2017–2022): 13.7, 16.2, 14.2, 14.0, 13.0, 13.6
  - Banks short-term (2017–2022): 12.5, 14.1, 13.2, 12.8, 11.4, 12.2
  - Nonresident holdings of ringgit-denominated debt instruments, short-term (2017–2022): 0.8, 0.8, 0.5, 0.7, 0.6, 0.5
- Nonresident deposits (2017–2022): 6.7, 6.8, 6.8, 6.7, 6.5, 6.2
- Other (2017–2022): 4.4, 4.3, 4.2, 4.6, 6.2, 6.7
- By original maturity (2017–2022):
  - Short-term: 39.7, 43.9, 41.1, 38.3, 37.5, 42.1
  - Medium- and long-term: 60.3, 56.1, 58.9, 61.7, 62.5, 57.9
- By currency (2017–2022):
  - Local currency denominated: 34.7, 30.3, 32.8, 33.9, 34.5, 33.1
  - Foreign currency denominated: 65.3, 69.7, 67.2, 66.1, 65.5, 66.9
- By instrument (selected, 2017–2022):
  - Interbank borrowing (as share of total external debt): 19.5, 22.1, 21.1, 19.0, 16.3, 19.1
    - as share of GDP: 12.5, 14.1, 13.2, 12.8, 11.4, 12.2
  - Bonds and notes (2017–2022): 17.1, 16.6, 16.5, 18.0, 18.2, 15.4
  - Intercompany loans (2017–2022): 14.8, 14.8, 13.4, 13.4, 13.3, 13.5
    - as share of GDP: 9.6, 9.4, 8.4, 9.0, 9.3, 8.6
  - Nonresident deposits (2017–2022): 10.4, 10.6, 10.9, 9.9, 9.2, 9.8
  - Loans (2017–2022): 6.1, 7.9, 8.3, 8.0, 6.8, 6.6
  - Others (2017–2022): 8.7, 8.5, 8.4, 8.7, 12.5, 14.1
- Gross official foreign exchange reserves (US$ billion, 2017–2022): 102.4, 101.4, 103.6, 107.6, 116.9, 114.7

### External debt sustainability analysis and scenarios (Figure 1 and Table 2 highlights)
- Debt-stabilizing non-interest current account: -2.5 (long-run, constant balance that stabilizes the debt ratio assuming key variables remain at levels of the last projection year).
- Baseline: External debt (2018–2028, in percent of GDP):
  - Est.2018: 62.2
  - 2019: 63.4
  - 2020: 70.8
  - 2021: 69.5
  - 2022: 63.8
  - 2023: 62.1
  - 2024: 60.5
  - 2025: 59.3
  - 2026: 58.2
  - 2027: 57.1
  - 2028: 55.7
- Change in external debt (2018–2028): -6.1, 1.2, 7.4, -1.3, -5.7, -1.7, -1.6, -1.2, -1.1, -1.2, -1.4
- Identified external debt-creating flows (2018–2028): -8.2, -5.0, 0.5, -12.1, -10.4, -6.3, -6.4, -6.2, -6.3, -6.1, -6.0
  - Current account deficit, excluding interest payments (2018–2028): -3.7, -5.1, -6.0, -5.0, -3.7, -4.7, -5.6, -5.4, -5.2, -5.0, -4.9
  - Deficit in balance of goods and services (2018–2028): -6.7, -7.5, -6.4, -7.1, -6.9, -6.8, -6.3, -6.2, -6.2, -6.3, -6.2
  - Exports (2018–2028): 68.6, 65.3, 61.6, 68.8, 73.8, 69.1, 70.7, 69.1, 67.6, 66.7, 65.3
  - Imports (2018–2028): 61.8, 57.8, 55.2, 61.7, 66.9, 62.3, 64.4, 63.0, 61.4, 60.5, 59.1
  - Net non-debt creating capital inflows (negative) (2018–2028): 0.1, 0.1, -0.2, -1.8, -0.9, -0.9, -1.0, -1.0, -0.9, -0.9, -0.9
- Automatic debt dynamics (2018–2028): -4.6, 0.0, 6.7, -5.3, -5.9, -0.7, 0.2, 0.1, -0.2, -0.1, -0.2
  - Contribution from nominal interest rate (2018–2028): 1.5, 1.6, 1.9, 1.2, 1.0, 1.9, 2.9, 2.6, 2.3, 2.0, 1.9
  - Contribution from real GDP growth (2018–2028): -2.9, -2.7, 3.8, -2.0, -5.5, -2.6, -2.6, -2.4, -2.4, -2.1, -2.1
  - Contribution from price and exchange rate changes (2018–2028): -3.1, 1.1, 1.1, -4.5, -1.4, ...
- Residual, including change in gross foreign assets (2018–2028): 2.1, 6.3, 6.9, 10.8, 4.8, 4.6, 4.8, 5.0, 5.2, 4.9, 4.6
- External debt-to-exports ratio (in percent, 2018–2028): 90.7, 97.1, 114.9, 100.9, 86.4, 89.9, 85.6, 85.8, 86.1, 85.5, 85.3
- Gross external financing need (in billions of US dollars, 2018–2028): 101.0, 106.9, 104.9, 103.0, 114.6, 123.2, 131.5, 136.6, 143.8, 150.8, 155.5
  - in percent of GDP (selected): 28.1, 29.3, 31.1, 27.6, 28.2, 10-Year, 10-Year, 27.7, 27.4, 26.3, 25.8, 25.4, 24.6
- Scenario with key variables at their historical averages (2018–2024 snippet): 62.1, 64.1, 66.8, 69.7, 72.2, 74.6, -0.5
- Figure 1 scenario notes:
  - Individual shocks are permanent one-half standard deviation shocks.
  - Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.
  - One-time real depreciation of 30 percent occurs in 2021 (in the real depreciation shock).

### Key macroeconomic assumptions underlying baseline (Table 2 excerpts)
- Nominal GDP (US dollars, 2018–2028, in billions):
  - 2018: 358.8
  - 2019: 365.2
  - 2020: 337.3
  - 2021: 373.0
  - 2022: 406.3
  - 2023: 445.1
  - 2024: 479.9
  - 2025: 518.4
  - 2026: 557.1
  - 2027: 593.0
  - 2028: 632.9
- Real GDP growth (in percent, 2018–2028): 4.8, 4.4, -5.5, 3.1, 8.7, 4.1, 3.7, 4.5, 4.5, 4.4, 4.4
  - Historical 10-year average / standard deviation references shown in table.
- GDP deflator in US dollars (change in percent, 2018–2028): 7.2, -2.5, -2.2, 7.2, 0.2, -1.4, 6.6, 4.9, 3.1, 3.5, 2.9, 2.5, 2.7
- Nominal external interest rate (in percent, 2018–2028): 2.4, 2.6, 2.7, 1.9, 1.6, 2.0, 0.4, 3.3, 4.9, 4.6, 4.1, 3.6, 3.6
- Growth of exports (US dollar terms, in percent, 2018–2028): 10.1, -3.1, -12.8, 23.6, 16.8, 2.6, 12.7, 2.5, 10.3, 5.6, 5.1, 5.1, 4.4
- Growth of imports (US dollar terms, in percent, 2018–2028): 10.1, -5.0, -11.7, 23.6, 18.1, 3.0, 12.5, 2.0, 11.5, 5.6, 4.8, 4.9, 4.2
- Current account balance, excluding interest payments (in percent of GDP, 2018–2028): 3.7, 5.1, 6.0, 5.0, 3.7, 4.5, 0.8, 4.7, 5.6, 5.4, 5.2, 5.0, 4.9
- Net non-debt creating capital inflows (2018–2028): -0.1, -0.1, 0.2, 1.8, 0.9, 0.1, 1.4, 0.9, 1.0, 1.0, 0.9, 0.9, 0.9

### Climate transition, corporate impacts, and financial sector role (Appendix X highlights)
- Malaysia pledged to achieve net zero greenhouse gas emissions by 2050 and upgraded its NDC target to reduce intensity of GHG emissions by 45 percent by 2030 relative to 2005 (July 2021).
- Energy path in 12th Malaysia Plan (12MP) assumes phasing out coal power generation.
- Malaysia’s share of global CO2:
  - Approximately 0.7 percent of the world’s annual CO2 emissions.
  - 0.35 percent of cumulative historical CO2 emissions globally (IMF 2022a).
- Malaysia 2019 emissions:
  - 115,644 CO2-equivalent (CO2e) gigagrams (aggregate).
  - 285 CO2e grams per US dollar GDP (per real US dollar GDP).
- Estimated cumulative investment to achieve net zero by 2050 (Malaysia’s JC3, WWF-BCG estimates): RM 350-450 billion (c. $90 billion). (Adaptation and resilience expenditure not included.)
- Corporate ESG uptake:
  - Almost all top 50 listed Malaysian companies are considering improvements along ESG criteria (PwC, 2022).
  - Malaysia has 26 companies in the MSCI All Country World Index (ACWI) ESG Leaders Index.
  - About 70 percent of index constituents have emissions reduction policies.
  - In a PwC survey, about 18 percent of Malaysian companies had made net zero commitments and 47 percent were still finalizing promises as of late-2021 (lower proportion among SMEs).
- ESG risk coverage and scores:
  - Malaysian firms share the same median ESG risk score as ASEAN-5 peers.
  - Highest sectoral median ESG risk scores in consumer staples, utilities, and IT.
  - ESG score coverage of listed firms in ASEAN-5 averages 17 percent.
  - Utilities firms: 42 percent ESG score coverage; IT, consumer discretionary, and materials: about 10 percent coverage.
- Carbon taxation potential:
  - Carbon taxes of $25 to $75 per ton of CO2 could potentially raise fiscal revenues of 1 to 3 percent of GDP by 2030 (IMF 2022).
  - Taxes larger than $75 per ton CO2 would be needed for Malaysia to achieve net zero greenhouse gas emissions by 2050.
  - Malaysia announced plans to introduce a carbon tax in 2022 and is considering an Emissions Trading Scheme.
  - Bank Negara Malaysia (BNM) estimate: phase-in of the European Carbon Border Adjustment Mechanism could affect around 60 percent of Malaysia’s exports to the EU by 2026 or about 5 percent of total exports (BNM 2023a).
- Corporate sensitivity to carbon prices:
  - High-emitting sectors (energy industries, transportation, manufacturing) constituted about 37 percent of Malaysia’s GDP in 2021 and are likely most affected by higher carbon prices.
  - Box 1 firm-level exercise (about 1,400 Malaysian companies, ~75 percent of ORBIS-based firms by assets) using hypothetical carbon tax rates $25, $50, $75 per ton CO2e:
    - Energy generation and waste management identified as hardest hit.
    - About half of energy generation firms and one fifth of waste management firms would have ICR declines to below 1 with a $25 per ton CO2e tax.
    - About 27 percent of energy generation firms and 13 percent of waste management firms would have CR declines to below 1 with a $25 per ton CO2e tax.
    - Higher tax rates ($50 and $75) greatly increase proportions of firms with ICR and CR declines to below 1.
    - Baseline sector vulnerabilities: transportation sector had 52 percent ICR below 1 and 48 percent CR below 1; accommodation and food services had 44 percent ICR below 1.
- Financial sector role:
  - Banks and the broader financial system will need to play a critical role in an orderly transition.
  - Strategic frameworks: BNM’s Financial Sector Blueprint (2022-2026) and the Capital Markets Masterplan 3 (Securities Commission Malaysia, 2021) aim to enhance monitoring and assessment of climate risks, reporting and disclosure, and promote sustainable financing for transition to a low-carbon economy.

*Sources: Bank Negara Malaysia; and IMF staff calculations.*

### 9. Malaysia financial institutions have sizable assets that could be exposed to

### 9. Malaysia financial institutions have sizable assets that could be exposed to environmental risks

### Exposure of financial institutions to environmental and nature-related risks
- About 8 percent of banking sector loans and 24 percent of insurance sector total assets are in sectors with high carbon intensity or potentially exposed to climate change.
- An explorative study by the BNM and the WB focusing on biodiversity found that about 8 percent of Malaysia’s banking system loans are extended to potentially exposed sectors as of November 2022.
- Over one half of commercial loans portfolio in the sample was exposed to sectors that depend to a high extent on ecosystem services, creating physical risk from ecosystem deterioration.
- Specific ecosystem-service exposures (commercial loans portfolio):
  - Surface water deterioration: 29 percent
  - Climate regulation such as carbon storage: 26 percent
  - Flood and storm protection: 16 percent
- Commercial loan portfolio exposures to sectors that strongly impact ecosystem services (and thus may face higher transition risk):
  - Greenhouse gas (GHG) emissions: 61 percent
  - Water use: 55 percent
  - Terrestrial ecosystem use: 43 percent
- There are wide differences between individual banks and bank types in exposure to physical and transition risk, linked to the target sectors those banks predominantly serve.

### BNM climate risk stress testing and scenario work
- The BNM is preparing for an industry-wide climate risk stress testing exercise in 2024.
- The exercise will assess resilience of Malaysian financial institutions to physical and transition risks arising from various climate scenarios.
- The BNM plans to use scenarios developed by the NGFS as a basis and will assume a variety of potential pathways for the evolution of relevant fiscal and regulatory policies, and physical climate environments up to 2050.

### Climate-related reporting and risk-management initiatives
- BNM initiatives to strengthen climate-related reporting and management include:
  - Climate Change and Principle-based Taxonomy (CCPT)
  - Value-based Intermediation Financing and Investment Impact Assessment Framework Sectoral Guides
- Objectives: clarify issuance of standards and frameworks, improve climate risk management practices by FIs, and promote consistent classification of exposures to climate-related financial risks.
- Reporting progress:
  - In 2H 2022, FIs were able to classify 95 percent of total new loans/financing and 73 percent of new financial investments.
  - As of December 2022, over 70 percent of outstanding loans and exposures via financial instruments were categorized under the CCPT.
  - The largest share of exposures was classified in the climate transition categories, particularly in electricity, gas, steam and air conditioning supply sector, where over 90 percent of outstanding loans were categorized, and in manufacturing.

### Climate strategy, ESG scores, and disclosure gaps
- Malaysia banks mildly beat regional and global averages on climate strategy and operational eco-efficiency and outperform peers on environmental reporting (based on S&P Global climate strategy scores).
- ASEAN-5 banks:
  - Score slightly better than the global average on climate strategy but trail peers in South Korea, Europe AEs, and Other AEs.
  - In S&P Global environment reporting scores, ASEAN-5 banks score much better than the global average, but trail peers in South Korea, Europe, China, and Other AEs.
- ARE 2022 survey findings for major Malaysian banks:
  - Maybank and CIMB reflect climate risks in the risk register, but disclosure of high-carbon sector exposure is limited.
  - Some climate strategies are in development, including net zero targets, but without short- and medium-term plans.
  - All banks have board committees overseeing climate change, but there is no evidence of requiring climate expertise in board nominations.
  - None disclose financed emissions or conduct climate scenario analyses.

### Bank strategies and sustainable finance targets
- Bank loans remain the dominant source of funding in Malaysia; banks represent a significant share of the economy.
- According to JC3 survey (Malaysia Joint Committee on Climate Change 2022), 30 percent of banks are implementing policies to reduce coal financing.
- Most targets envisage ceasing coal-fired power plants and coal financing in the coming years; many banks started to phase out new coal-related activities in 2021.
- Examples of announced sustainable finance plans:
  - Maybank plans to cumulative invest of $12bn in sustainable project financing and securities in 2021-2025 (slightly below 10 percent of its gross loan book).
  - CIMB plans to invest $7bn in 2021-2024 (compared to the current gross loan book of about $100 bn).

### Sustainable finance market development and policy support
- Sustainable finance volumes surged from $0.8 billion in 2017 to $4 billion in 2022.
- The bulk of issuances stemmed from sustainability bonds by the financial sector over the period.
- Malaysia is a pioneer in the sustainability Sukuk market:
  - Malaysia issued the world’s first green Sukuk in 2017, and the world’s first sovereign US dollar sustainability Sukuk in 2021.
  - Malaysia’s sustainable Sukuk issuance volumes have grown 307 percent since 2017, to $3.1 billion in 2022.
- Tax incentives and grant schemes used to support market development:
  - 2016: income tax deductions on SRI Sukuk issuance costs (initially available until Year of Assessment (YA) 2020; eventually extended to YA 2023).
  - Tax deductions on SRI-linked Sukuk issuance costs from YA 2023 to YA 2027.
  - 2018: tax-exempt Green SRI Sukuk Grant Scheme to assist issuers with external review costs; expanded in 2021 and 2022 to cover additional frameworks and extend tax exemptions to YA 2025.
- 2022: SC released the Principles-Based SRI Taxonomy for the Malaysian Capital Market to help market participants identify economic activities aligned with environment, social and sustainability objectives.

### Market challenges and barriers to scaling sustainable finance
- Major hurdles cited by most FIs in the JC3 survey:
  1. Poor data quality or availability
  2. Inadequate financial incentives
  3. Low market awareness
- About two-thirds of FIs think there are insufficient sustainable finance products on offer; most FIs plan to widen their range of sustainable products and solutions in the future.

*Source: 1mysea2023001 - 9. Malaysia financial institutions have sizable assets that could be exposed to environmental risks*

### References

### 1mysea2023001 - References

### References cited
- Asia Research and Engagement. (2022). Banking Asia’s Future: How to Align with National Climate Plans.
- Bank Negara Malaysia [BNM]. (2019). Annual Report.
- Bank Negara Malaysia. (2023a). Economic and Monetary Review.
- Bank Negara Malaysia. (2023b). Financial Stability Review — Second Half 2022.
- Economic Planning Unit, Prime Minister’s Department, Malaysia. (2021). Twelfth Malaysia Plan 2021- 2025 - A Prosperous, Inclusive, Sustainable Malaysia.
- International Monetary Fund. (2020). Norway Financial Sector Assessment Program Technical Note - Risk Analysis and Stress Testing.
- International Monetary Fund. (2022a). Malaysia: Staff Report for the 2022 Article IV Consultation.
- International Monetary Fund. (2022b). Approaches to Climate Risk Analysis in FSAPs. Staff Climate Note No 2022/005.
- Malaysia Ministry of Environment and Water. (2022). Malaysia’s Fourth Biennial Update Report (BUR) to the United Nations Framework Convention on Climate Change.
- Malaysia Joint Committee on Climate Change [JC3]. (2022). Joint Committee on Climate Change (JC3) Report on the Sustainable Finance Landscape in Malaysia.
- PricewaterhouseCoopers. (2022). PwC 25th Annual CEO Global Survey 2022.
- Sever, C, & Perez-Archila, M. (2021). Climate-Related Stress Testing: Transition Risk in Colombia. IMF Working Papers.
- United Nations Framework Convention on Climate Change. (2021). Malaysia’s Update of its First Nationally Determined Contribution.
- WWF-Malaysia, & BCG Malaysia. (2021). Securing our future: Net zero pathways for Malaysia.

### Fund relations — key institutional facts and arrangements
- Membership Status: Joined March 7, 1958; Article VIII.
- Quota (General Resources Account): 3,633.80 SDR Millions (100.00 percent of Quota).
- Fund holdings of currency (exchange rate): 2,559.13 SDR Millions (70.43 percent of Quota).
- Reserve tranche position: 1,074.70 SDR Millions (29.58 percent of Quota).
- New Arrangement to Borrow: 1.91 SDR Millions (labeled under Lending to the Fund).
- SDR Department: Net cumulative allocation 4,828.98 SDR Millions (100.00 percent of Allocation); Holdings 4,314.12 SDR Millions (89.34 percent of Allocation).
- Exchange Arrangement: de jure and de facto arrangements are floating. Malaysia maintains bilateral payments arrangements with 7 countries; authorities view remaining FEP rules as prudential and consistent with Article VIII obligations.
- Recent policy note: In April 2021, BNM announced further liberalization of FEP policy to improve business efficiency and flexibility for corporates, particularly export-oriented industries.
- Article IV Consultation: Malaysia is on the standard 12˗month consultation cycle; staff discussions for the 2023 Article IV consultation took place during March 8–20, 2023.
- Financial Sector Assessment Program (FSAP): First FSAP conducted in 2012 (IMF Country Report Nos. 13/52, 13/53, and 13/56−13/60).

### Technical assistance and capacity-building activities (selected)
- Fiscal Affairs Department (FAD): missions and seminars on fiscal responsibility law, treasury management, tax revenue strategy, Medium-Term Revenue Strategy, revenue mobilization, expenditure review, Public Investment Management Assessment (PIMA), and treasury modernization (missions cited spanning 2016–2020, PIMA in May 2017).
- Legal Department (LEG): missions in May and September 2011 on Centralized Asset Management Corporations Bill and asset forfeiture regime.
- Monetary and Capital Markets Department (MCM): missions and workshops on macrofinancial risk analysis, monitoring financial risks, stress testing capital markets, FX markets deepening, exchange rate role analysis, and ongoing technical assistance on Monetary Policy Modelling since December 2021.
- Statistics Department (STA): technical assistance and training on Government Financial Statistics (GFS) in March 2017, March 2018, March and December 2019, and follow-up during February 28–June 30, 2022.
- AML/CFT: On-site APG assessment in November 2014; Mutual Evaluation Report published September 2015; FATF full membership granted in February 2016; Third Enhanced Follow-up Report October 2018 noted progress but continued enhanced follow-up.

### Statistical assessment — data adequacy and priority recommendations
- Overall assessment: Data provision is adequate for surveillance.
- National Accounts:
  - DOSM publishes annual and quarterly GDP by production, expenditure, and (annual only) income approaches at current and constant 2015 prices, based on the 2008 SNA.
  - Recommendation: plan to update the base year of national accounts to a more recent period as recommended by the 2008 SNA.
- Price Statistics:
  - Monthly CPI and PPI available timely; quarterly Services PPI and monthly building cost index published.
  - CPI weights based on Household Expenditure Survey reference year 2016 — recommendation to update CPI weights.
  - PPI weights based on Census of Economy 2016 (reference year 2015) — recommendation to update PPI weights based on a new Economic Census.
- Government Finance Statistics (GFS):
  - Authorities submit annual GFS data on a cash basis for budgetary central government.
  - GFS transitioning to accrual-based accounting for federal government; adoption of accrual reporting necessary to capture consolidated assets and liabilities.
  - Need to improve timeliness, detail, and collection of data on nonfinancial public enterprises (NFPEs), statutory bodies, and state and local governments; disseminate more detailed data on non-listed NFPEs’ assets and liabilities and financing by type and holder; more information on public private partnerships recommended.
- Monetary and Financial Statistics (MFS):
  - MFS broadly aligned to Fund needs; BNM compiles using SRFs (1SR and 2SR).
  - Recommendations: improve institutional coverage of financial corporations, sectorization, classification and valuation of financial instruments; expand coverage to include insurance corporations, pension funds, and other financial intermediaries.
- Financial Soundness Indicators (FSIs): BNM reports 15 core FSIs and eight additional FSIs for deposit takers, plus two additional FSIs on real estate on a quarterly basis. FSIs for other financial corporations, nonfinancial corporations, and households are not available.
- Financial Access Survey (FAS): BNM reports several key series including mobile and internet banking, mobile money, gender-disaggregated data, and UN-adopted indicators (commercial bank branches per 100,000 adults and ATMs per 100,000 adults).
- External Sector Statistics:
  - DOSM compiles quarterly balance of payments and IIP estimates in accordance with the sixth edition of the BPM.
  - To improve estimates: separately identify data for other financial corporations in the financial account and IIP.
  - Malaysia participates in the Coordinated Direct Investment Survey and Coordinated Portfolio Investment Survey and compiles the Reserves Data Template.

### Data standards and dissemination
- SDDS subscription: Malaysia subscribed on August 21, 1996; metadata published on the DSBB.
- Malaysia met SDDS specifications on September 1, 2000.
- Malaysia is currently using a timeliness flexibility option for general government operations.
- No Data ROSC is available.

### Table of Common Indicators Required for Surveillance (selected entries, as of March 27, 2023)
- Exchange rates: Date of Latest Observation 03/27/2023; Date Received 03/27/2023; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International reserve assets and reserve liabilities of the monetary authorities: Date of Latest Observation 09/2022; Date Received 10/31/2022; Frequency M, Reporting M, Publication M.
- Reserve/base money: Date of Latest Observation 02/2023; Date Received 03/24/2023; Frequency M, Reporting M, Publication M.
- Broad money: Date of Latest Observation 02/2023; Date Received 03/24/2023; Frequency M, Reporting M, Publication M.
- Central bank balance sheet: Date of Latest Observation 09/2022; Date Received 01/14/2022; Frequency M, Reporting M, Publication M.
- Consolidated balance sheet of the banking system: Date of Latest Observation 09/2022; Date Received 01/31/2022; Frequency M, Reporting M, Publication M.
- Interest rates: Date of Latest Observation 02/2023; Date Received 03/24/2022; Frequency M, Reporting M, Publication M.
- Consumer price index: Date of Latest Observation 02/2023; Date Received 03/24/2023; Frequency M, Reporting M, Publication M.
- Revenue, expenditure, balance and composition of financing—general government: Date of Latest Observation 2022; Date Received 02/10/2023; Frequency A, Reporting A, Publication A.
- Revenue, expenditure, balance and composition of financing—federal government: Date of Latest Observation 2022: Q4; Date Received 02/10/2023; Frequency Q, Reporting Q, Publication Q.
- Stocks of central government and central government guaranteed debt: Date of Latest Observation 2022: Q4; Date Received 02/10/2023; Frequency Q, Reporting Q, Publication Q.
- External current account balance: Date of Latest Observation 2022: Q4; Date Received 02/11/2023; Frequency Q, Reporting Q, Publication Q.
- Exports and imports of goods: Date of Latest Observation 12/2022; Date Received 01/21/2023; Frequency M, Reporting M, Publication M.
- Exports and imports of services: Date of Latest Observation 2022: Q4; Date Received 01/21/2023; Frequency Q, Reporting Q, Publication Q.
- GDP/GNP: Date of Latest Observation 2022: Q4; Date Received 02/11/2023; Frequency Q, Reporting Q, Publication Q.
- Gross external debt: Date of Latest Observation 2022: Q4; Date Received 02/11/2023; Frequency Q, Reporting Q, Publication Q.
- International Investment Position: Date of Latest Observation 2022: Q4; Date Received 02/11/2023; Frequency Q, Reporting Q, Publication Q.

*Source: 1mysea2023001 - References (Informational Annex material extracted from the source PDF).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1mysea2023001.pdf_