## _cr10265

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### Executive summary — background and focus
- Malaysia emerged from the world recession with strong forward momentum driven by forceful counter‑cyclical policies, sound balance sheets, and intra‑regional trade.
- The government has formulated a multi‑pillar strategy to double per capita income by the next decade (New Economic Model (NEM) and associated Tenth Malaysia Plan (10MP)).
- Article IV discussions focused on policy requirements to support the recovery and priorities for structural reforms; authorities and staff were broadly in agreement on key issues.
- Malaysia has requested to participate in the Financial Sector Assessment Program (FSAP).

### Fiscal policy — assessment, reforms, and numerical targets
- 2010 budget marks a return to consolidation; deficit target has become more attainable due to stronger‑than‑anticipated growth and oil revenues.
- Staff caution that budgetary gains could prove transitory unless broader fiscal reforms are completed.
- Key recommended fiscal reforms:
  - Subsidy reform should not be delayed; fuel subsidies are particularly ill‑targeted and prime candidates for reform.
  - Introduction of the goods and service tax (GST) should not be unduly delayed.
  - Overhaul tax incentives and consider corporate tax reform.
  - Strengthen the budget framework by: (1) an indicative consolidation path; (2) including a statement of fiscal risks in budget documents; (3) benchmarking spending to an equitable drawdown of oil wealth to lessen oil price volatility’s impact.
- Authorities’ position and plans:
  - GST roll out announced; legislative details under development and outreach to public and SMEs planned.
  - IMF technical assistance sought on tax incentives to corporates.
  - Government Transformation Program (GTP) efficiency gains expected to contribute to consolidation.
- Key fiscal numbers preserved from the report:
  - 2010 central government deficit target: about 5½ percent of GDP (from 7 percent of GDP).
  - Subsidies (excluding education and health): some 20 percent of government spending or about 5 percent of GDP.
  - Oil revenues, including Petronas dividend: some 40 percent of total revenues—10 percentage points more than a decade ago.
  - Malaysia’s proven hydrocarbon reserves: 5½ billion barrels of oil and 88 trillion cubic feet of natural gas.
  - At current extraction rates of about 650,000 barrels per day, oil is expected to be depleted in about 22 years; gas in about 35 years.

### Monetary policy — normalization and guidance
- Policy normalization is underway; Bank Negara Malaysia (BNM) has raised the policy rate in three quarter‑point steps.
- Key policy rate and related figures:
  - Policy rate: 2.75 percent.
  - The BNM cut the overnight policy rate by 150 basis points between November 2008 and March 2009.
  - Reserve requirement cut: 300 basis points.
- Staff view:
  - Measured tightening aligned with Taylor‑rule calculations; real rates still below long‑term average and overall stance remains supportive given fragile global recovery and fiscal risks.
  - Further withdrawal of monetary support should be contingent on evolving risks and factors including global recovery vigor, subsidy reform second‑round effects, and asset market spillovers.
- Authorities’ view:
  - Gradual exit consistent with improved outlook and absence of price pressures; policy will adapt flexibly over next quarters.
  - BNM chose not to reverse the November 2008 cut in reserve requirements; credit‑support schemes could be reactivated if conditions deteriorate.
  - Exchange rate judiciousness required to lessen impact of sudden capital movements.

### Financial sector — resilience, reforms, and indicators
- Malaysia’s financial sector withstood the global recession well; loan books improved in H2 2009; banks and insurance companies remain well capitalized and liquid.
- Concerns about Basel III:
  - Some proposed Basel III requirements may be onerous for local banks (treatment of subsidiaries, wholesale deposits, levies, surcharges, through‑the‑cycle provisioning).
  - Staff suggest formal broadening of regulatory perimeter to encompass financial holding companies.
- Deposit insurance and safety‑net changes:
  - Plans to unwind blanket deposit guarantee by year‑end and move to an insurance system with higher coverage; adoption of enhanced deposit insurance schemes expected in 2011.
  - In Malaysia, deposit insurance will provide coverage for virtually all depositors including businesses and around 40 percent of deposits; insurance premium will remain risk‑based.
- Financial sector key numerical indicators (April 2010 and related):
  - Risk‑weighted capital ratio (April 2010): 14.6.
  - Share of loans to broad property sector (April 2010): 41.2.
  - Nonperforming loans (gross) to total loans (April 2010): 3.5.
  - Loan‑deposit ratio (April 2010): 78.2.
  - Aggregate debt‑to‑equity ratio: below 50 percent.
  - Interest coverage ratio: about 5 percent.
  - Households’ NPLs: 3.1 percent at end‑2009 (down from 4.1 in 2008).
  - Ratios of household financial assets to household debt: about 2.5; liquid financial assets to household debt: about 1.5.
  - Financial soundness indicators (RWCR across years): 2005 13.7; 2006 13.5; 2007 13.2; 2008 12.6; 2009 15.4; 2010 (Apr) 15.1.
  - Nonperforming loans (gross) to total loans (series): 2005 9.6; 2006 8.5; 2007 6.5; 2008 4.8; 2009 3.7; 2010 (Apr) 3.5.

### Islamic finance and systemic resilience
- Islamic finance business model focuses on financing real sector activities, linking transactions to productive flows and curbing excessive leverage.
- BNM notes the global crisis has highlighted Islamic finance; further development of Shariah‑compliant liquidity management and hedging instruments recommended.
- Malaysia requested participation in FSAP to reinforce fundamentals and identify enhancements; BNM suggests FSAP take place next year at the earliest.

### Structural reforms, NEM, and 10MP
- NEM objectives: transform Malaysia into an innovative, knowledge‑intensive, and high‑income economy by 2020; strategic reform areas include private sector participation, workforce skills, innovation, new growth sources, and public sector management.
- 10MP (2011−2015) operationalizes NEM:
  - Main macro objectives: sustain annual GDP growth at 6 percent on average; bring budget deficit gradually to less than 3 percent of GDP by 2015.
  - Micro objectives: competition law, further liberalization of services, divestment of some public enterprises, market prices for subsidized commodities, innovation‑friendly environment, reduced dependence on foreign labor.
  - 10MP to be revised after about two years based on progress.
- Staff recommended reform areas and sequencing:
  - Reform government‑linked companies.
  - Further product and labor market liberalization, including review of employment protection.
  - Improve education and vocational training.
  - Better targeted social safety nets and tax incentives.
  - Implementation should be pragmatic, steady, and exploit complementarities; develop "What if?" scenario analysis for contingencies.

### Exchange rate assessment — staff vs authorities
- Staff assessment (CGER and model‑based approaches):
  - The ringgit’s real effective exchange rate (REER) appears weaker than the level implied by medium‑term fundamentals.
  - A stronger ringgit over the medium term would facilitate NEM/10MP objectives by contributing to higher real incomes, capital deepening, productivity gains, and demand shifts toward services.
  - Macroeconomic balance approach suggests a relatively large undervaluation but qualitative indicators moderate the assessment (low core inflation, no asset bubbles, two‑sided intervention).
  - Under the Reform Scenario, the implied undervaluation would be modest.
- Authorities’ views and counterarguments:
  - Disagree that REER is weaker than medium‑term fundamentals imply.
  - Argue current account surplus largely reflects a temporary commodity boom and high private saving rather than durable competitiveness gains; exports of raw materials make up about two‑thirds of the current account balance.
  - Structural factors: high private saving due to demographics and underdeveloped social safety nets; investment abroad exceeds inward FDI.
  - Emphasize two‑sided intervention to smooth volatile capital flows and prevent overshooting; note large reserve draw‑downs and later rebuild.
  - Stress model limitations and risk that public disclosure of staff assessment could trigger capital inflows complicating macroeconomic management.
  - Policy implication favored by authorities: ringgit appreciation should complement structural reforms, not substitute for them.
- Intervention timing and regime context:
  - Exit from the peg: July 2005.
  - Post‑peg interventions (BNM selling dollars): late 2005; May‑June 2006; February 2007; July‑August 2007; August 2008 to June 2009 (unprecedented scale).
  - Exchange arrangement: managed float adopted July 21, 2005; de facto regime classified as “other managed.”

### Recent economic developments and key statistics
- Output and labor:
  - After three quarters of contraction, GDP began growing in the last quarter of 2009.
  - Seasonally‑adjusted GDP close to pre‑crisis levels, reversing a 6½ percent peak‑to‑trough loss.
  - Headline inflation fell to below 1 percent (y/y) in 2009; monthly inflation turned positive since last December with latest reading in May at 1.6 percent.
  - Unemployment rate for 2009 peaked at about 3¾ percent.
  - Job vacancies in manufacturing exceed pre‑crisis levels but slack remains elsewhere.
- Financial conditions and external sector:
  - Credit growth remained positive during output contraction and is gaining steam; base lending rates bottomed at 5½ percent and trended up since March 2010.
  - Equity prices rose about 50 percent since March 2009 lows and about 5 percent so far in 2010.
  - A U.S. dollar global sukuk issued in June was oversubscribed and priced at 180 basis points over U.S. treasuries.
  - Current account surplus fell modestly to 16½ percent of GDP in 2009.
  - Reserves fell from nearly $126 billion in mid‑2008 to just above $88 billion in March 2009 due to intervention; by end‑June 2010 reserves about $95 billion, roughly unchanged from a year earlier.
  - Light forward book suggests limited intervention.
- Selected level indicators (2009):
  - Nominal GDP (2009): US$206 billion.
  - Main exports (percent of total): electrical & electronic products (39%), commodities (23%).
  - GDP per capita (2009): US$7,141.
  - Population (2009): 28.3 million.
  - Unemployment rate (2009): 3.7 percent.
- Real GDP growth series (selected):
  - Real GDP percent change: 2005 5.3; 2006 5.8; 2007 6.5; 2008 4.7; 2009 -1.7; 2010 6.7; 2011 5.3.
  - Period average CPI inflation: 2009 0.6; 2010 2.0; 2011 2.1.
- Balance of payments and reserves:
  - Current account (US$ billions): 2005 20.7; 2006 26.1; 2007 29.7; 2008 38.9; 2009 31.8; 2010 32.3; 2011 33.0.
  - Current account (percent of GDP): 2009 16.5; 2010 14.8; 2011 14.0.
  - Gross official reserves series (US$ billions): 2007 70.5; 2008 82.5; 2009 101.3; 2010 91.4; 2011 96.7; 2012 106.1; 2013 113.1.
  - International reserves as of July 15, 2010: US$94.8 billion.

### Outlook, scenarios, and risks
- Near‑term projections:
  - GDP projected to expand by around 7 percent in 2010, narrowing but not closing the output gap.
  - Growth expected to moderate in 2011 as base effects fade and policy support is reined in.
  - CPI inflation expected to remain about 2 percent for the year, though administered price adjustments could cause spikes.
  - A pronounced bounce‑back of private investment unlikely in near term given unused capacity; capex at public enterprises expected to pick up.
- Risks:
  - Downside: withdrawal of policy support in advanced economies or adverse developments in Europe could undermine global demand and commodity trade; volatility in international markets could spill onto local markets.
  - Direct exposure to fiscally strained European countries is small (less than ½ of 1 percent of total assets and 5 percent of capital).
  - Upside: improved confidence, intra‑regional boost from the ASEAN‑China free trade agreement (in force January 2010), and rising commodity export revenues.
- Medium‑term scenarios:
  - Baseline: Under current policies, GDP growth converges to a rate short of that needed to double per capita income by 2020; at an approximately unchanged real exchange rate, current account surplus remains sizeable.
  - Reform scenario: With stepped‑up reforms across a broad front, GDP growth could reach 7 percent by the end of the projection period, meeting the 10MP goal. Private investment revived by the end of the horizon, compensating for rollback of public projects. Current account ratio about 3 percentage points lower than in the baseline.

### Data, statistics, and surveillance adequacy
- Data provision broadly adequate for surveillance; improvements needed for consolidated public sector statistics.
- National accounts: DOSM publishes annual and quarterly GDP estimates based on 1968 SNA; experimental institutional sector accounts in 1993 SNA developed; significant differences exist between systems.
- Price statistics: CPI and PPI timely and comprehensive; revised CPI introduced January 2006 with updated weights.
- Government finance statistics: need improved timeliness, detail, and NFPE/state/local coverage.
- Monetary and financial statistics: broadly conformant; recommendation to expand institutional coverage to include insurance corporations, pension funds, and other financial intermediaries.
- Balance of payments: quarterly estimates compiled per fifth edition BPM and SDDS; some data gaps noted (capital transfers, nonproduced nonfinancial assets).
- Malaysia subscribes to the SDDS and uses a timeliness flexibility option for general government operations.

### Recommendations and follow‑up
- Next Article IV consultation recommended on the standard 12‑month cycle.
- Staff recommendations emphasized:
  - Sustain fiscal adjustment and phase out poorly targeted fuel subsidies.
  - Proceed with GST introduction without undue delay, with outreach to mitigate concerns.
  - Maintain measured monetary normalization; wait‑and‑see approach warranted given external fragility.
  - Continue reform implementation under NEM/10MP and complement exchange rate evolution with structural change.
  - Participation in FSAP welcomed to reinforce foundations and identify further enhancements.
- Executive Board highlights (Public Information Notice):
  - Commended authorities for countercyclical policies and financial sector resilience.
  - Welcomed fiscal consolidation and subsidy reduction decision; encouraged perseverance with reforms mindful of the poor.
  - Supported GST introduction and stronger budget framework linking spending to intergenerationally equitable drawdown of oil wealth.
  - Considered monetary policy appropriately recalibrated and encouraged decisive implementation of structural reform agenda.

*Source: Executive Summary and selected excerpts, IMF Article IV staff report for Malaysia (2010).*

### Executive Summary ......................................................................................................

### Executive Summary

### Background and focus of discussions
- Malaysia has emerged from the world recession with strong forward momentum. Forceful counter‑cyclical policies, sound balance sheets, and intra‑regional trade have primed the recovery.
- The global downturn has led to a rethinking of the development model. The government has formulated a multi‑pillar strategy to double per capita income by the next decade.
- The Article IV discussions focused on the policy requirements to support the recovery and the priorities for structural reforms over the medium term. The authorities and the staff were in broad agreement on key issues.
- Malaysia has requested to participate in the Financial Sector Assessment Program (FSAP).

### Fiscal policy
- The 2010 budget marks a return to consolidation.
- The deficit target, which seemed ambitious when the budget was unveiled, now looks within reach thanks to stronger‑than‑anticipated growth and oil revenues.
- Staff view: budgetary gains could prove transitory if the broader agenda of fiscal reforms remains unfinished.
- Key fiscal reforms emphasized:
  - Subsidy reform should not be delayed.
  - Introduction of the goods and service tax should not be delayed.
- Authorities: both subsidy reform and the goods and service tax are high priorities, but a broad consensus on implementation modalities is still being forged.

### Monetary policy
- Policy normalization is underway.
- Bank Negara Malaysia has raised the policy rate in three quarter‑point steps but the stance remains supportive.
- There was agreement that the gradual monetary exit was consistent with the improved outlook, absence of price pressures, and concerns about side‑effects of abnormally low interest rates.

### Financial sector policies
- Malaysia’s financial sector has withstood the global recession well.
- There was agreement that some Basel III requirements may be onerous for local banks.
- A new Central Bank of Malaysia Act further strengthens the underpinnings of the financial system.
- The Malaysian authorities have requested to participate in the Financial Sector Assessment Program.

### Structural reforms and policy priorities
- Malaysia’s New Economic Model (NEM) addresses supply‑side impediments that have kept the country ensnared in a middle‑income trap.
- The Tenth Malaysia Plan (10MP) makes operational the economic strategy through 2015.
- Authorities and staff share the view that a meaningful uplift in trend growth requires structural reforms on a broad front.
- There are signs of renewed political commitment to push the agenda; authorities cautioned that molding the necessary social consensus would require time.

### Exchange rate assessment
- Authorities and staff shared the view that a stronger ringgit in real effective terms could facilitate over time the implementation of the economic transformation program by contributing to higher real incomes for households, greater capital deepening, faster productivity gains, and demand shifts in favor of services.
- Staff noted that the ringgit in real effective terms appears to be weaker than its estimated equilibrium level.
- Authorities disagree with staff’s assessment.

### Recent economic developments
- Output and labor:
  - After three quarters of contraction, GDP began growing in the last quarter of 2009 pulled by exports, private consumption, and public spending.
  - Seasonally‑adjusted GDP is now close to pre‑crisis levels, reversing a 6½ percent peak‑to‑trough loss.
  - Headline inflation fell to below 1 percent (y/y) last year; on a monthly basis, inflation has been positive since last December, with the latest reading in May at 1.6 percent.
  - The unemployment rate for 2009 peaked at about 3¾ percent.
  - Job vacancies in manufacturing are now larger than before the crisis, but slack in other sectors remains.
- Financial conditions:
  - Credit growth remained positive even as output shrunk and is now gaining steam; base lending rates bottomed out at 5½ percent and have been trending up since March 2010.
  - Equity prices have risen about 50 percent since the lows of March 2009, and about 5 percent so far this year.
  - Corporate bond issuance has been recovering; sovereign CDS spreads have risen in recent months in line with regional markets.
  - A U.S. dollar government Islamic bond (global sukuk) was issued in June, oversubscribed and priced at 180 basis points over U.S. treasuries.
- External sector and reserves:
  - The current account surplus fell modestly to 16½ percent of GDP in 2009.
  - Malaysia experienced net outflows throughout the year; portfolio inflows picked up in the second half of 2009, but outward FDI and “other investments” swamped the uptick.
  - Reserves fell from nearly $126 billion in mid‑2008 to just above $88 billion in March 2009 as BNM intervened; by end‑June 2010, reserves were about $95 billion, roughly unchanged from a year earlier.
  - A light forward book suggests limited intervention.

### Boxed findings on capital flows (summary)
- Malaysia has experienced net capital outflows on the financial account since the late 1990s, reflecting current account surpluses and structural factors favoring investment abroad by residents.
- Over recent years net FDI outflows have grown due to limited opportunities for domestic investment by foreigners and growing investment abroad by Malaysian companies.
- Over the last four quarters, capital flows on the financial account have rebounded somewhat but continue to be negative.
  - Net capital flows to the general government have bounced from crisis‑lows into positive territory.
  - Net flows related to sectors other than general government were negative and more than offset government‑related inflows.
  - Main drivers of nongovernment outflows: sustained current account surpluses, revival of trade credit from exporters to importers overseas, and increased willingness of the private sector to place funds abroad.

### Outlook and risks
- Near‑term outlook:
  - GDP is projected to expand by around 7 percent in 2010, narrowing, but not closing, the output gap.
  - Growth should moderate in 2011 as favorable base effects play out and policy support is reeled in.
  - CPI inflation should continue to remain low at about 2 percent for the year while slack is being taken up, although it could spike if key administered prices are adjusted.
  - A pronounced bounce‑back of private investment does not seem in the cards given still unused capacity; capital expenditure at public enterprises is expected to pick up.
- Risks:
  - Downside: withdrawal of policy support in advanced economies or adverse developments in Europe may undermine global demand and commodity trade; volatility in international markets could spill onto local ones.
  - Direct exposure to fiscally strained European countries is small (less than ½ of 1 percent of total assets and 5 percent of capital).
  - Upside: improved confidence at home and abroad, an intra‑regional boost from the ASEAN‑China free trade agreement in force since January 2010, and rising commodity export revenues.
- Medium‑term scenarios:
  - Baseline: Focusing on current policies, GDP growth converges to a rate short of that needed to double per capita income over the next decade as the NEM envisages; at an approximately unchanged real exchange rate, the current account surplus remains sizeable.
  - Reform scenario: With stepped‑up reforms on a broad front, GDP growth could reach 7 percent by the end of projection period, meeting the goal under the 10th Malaysia Plan. The growth‑dividend materializes in the outer years, contingent on implementation of a critical mass of initiatives. Private investment is revived by the end of the horizon, compensating for a rollback of public projects. The current account ratio is some 3 percentage points lower than in the baseline.

*Source: Executive Summary, IMF Article IV staff report for Malaysia.*

### 11.      The authorities broadly concurred with these assessments. The latest official

### 11.      The authorities broadly concurred with these assessments. The latest official

### Overall assessment and near-term outlook
- Latest official projection is for 2010 growth between 4½ percent and 5½ percent (predates the first-quarter GDP outturn); the range will likely be revised up in the next forecasting round.
- Authorities and staff agreed that inflation probably will remain in check and will not be a policy concern for the period ahead.
- For a meaningful uplift in trend growth, structural reforms on a broad front are required; there are encouraging signs of renewed political commitment but grass-root support is still being harnessed.

### Monetary policy
- Background and recent actions:
  - Policy normalization is underway after aggressive loosening in 2009.
  - BNM started normalization in March 2010 and has since raised the policy rate to 2.75 percent in three quarter-point steps.
  - The BNM cut the overnight policy rate by 150 basis points between November 2008 and March 2009 and slashed statutory reserve requirements by 300 basis points.
  - Robust activity in the second quarter motivated the latest rate increase on July 8; a flattening of the yield curve suggests a likely pause in the tightening cycle for the rest of the year.
- Staff’s views:
  - The measured pace of tightening is in line with Taylor-rule calculations and signals against investors’ complacency.
  - Real rates are still below their long-term average; policy stance remains supportive due to: (1) fragile global recovery; and (2) fiscal risks that suggest giving precedence to budgetary consolidation when sequencing exits from policy support.
  - Using fiscal policy rather than interest rates to contain demand pressures may discourage speculative inflows.
  - Further withdrawal of monetary support should be contingent on evolving risks to growth and the need for policy insurance; factors to inform decisions include vigor of the global recovery, second-round effects of possible subsidy reforms, and spillovers on asset markets from volatile capital movements.
- Authorities’ views and plans:
  - A gradual monetary exit is consistent with the improved outlook, absence of price pressures, and concerns about side-effects of abnormally low interest rates (e.g., under-pricing of risk, excessive leverage, financial disintermediation).
  - The policy rate hike has shored up the return on bank deposits and reduced vulnerabilities on the asset side of households’ balance sheets.
  - The return to a neutral stance will be informed by external and internal considerations; policy will need to adapt flexibly over the next few quarters.
  - The BNM chose not to reverse the November 2008 cut in reserve requirements; credit-support schemes for consumers and SMEs could be re-activated if the conjuncture deteriorated.
  - Judicious exchange rate policies remain required to lessen the impact of sudden capital movements on the real economy.
- Key numerical indicators referenced in this section:
  - Policy rate: 2.75 percent.
  - Reserve requirement cut: 300 basis points.
  - Overnight policy rate cut (Nov 2008–Mar 2009): 150 basis points.

### Fiscal policy
- Background:
  - The 2010 budget targets a reduction in the central government deficit to about 5½ percent of GDP (from 7 percent of GDP last year).
  - Adjustment is skewed to the expenditure side, with expected economies from improved procurement and cuts in discretionary spending and transfers.
  - Stimulus from 2009 packages not fully deployed yet will offset part of the policy withdrawal.
  - Roll out of the goods and service tax (GST) has been announced; legislative details are still in the works. GST is intended to broaden—and stabilize—the tax base by replacing two existing taxes in a revenue-neutral fashion.
  - Tax incentives to foreign and domestic companies are under review; a 2006 World Bank study estimated tax holidays represent a very large drain on the budget, about half of total tax revenues.
  - Subsidies (excluding education and health) account for some 20 percent of government spending or about 5 percent of GDP, with the bulk reducing the cost of fuel to consumers and industry.
- Staff’s views:
  - Fiscal risks have grown; policy has been procyclical in good times, increasing vulnerability during the crisis. Increased dependence on oil revenue further undermines public finances.
  - The 2010 budget is a welcome step toward consolidation; the deficit target now looks within reach thanks to stronger-than-anticipated growth and oil revenues, but gains will prove transitory if broader fiscal reforms remain unfinished.
  - Savings can be achieved by rationalizing subsidies and tax structures; subsidy reform should be gradual but sustained, with periodic reductions of key subsidies and compensatory cash transfers to the most vulnerable.
  - Fuel subsidies are particularly ill-targeted and prime candidates for reform.
  - The roll out of the GST should not be held back, though some technical delays may be unavoidable; more focused outreach and clearer communication may be necessary.
  - Overhaul of tax incentives and future corporate tax reform should be considered.
  - Recommended strengthening of budget framework along three dimensions:
    - An indicative consolidation path to bring the deficit back to more manageable levels.
    - Budget documents to include a statement of fiscal risks to assess vulnerabilities surrounding budget outcomes.
    - Emphasize evolution of the non-oil balance and benchmark spending against a framework that links spending to an equitable drawdown of oil wealth to lessen oil price volatility’s impact on fiscal planning.
- Authorities’ views and plans:
  - Ministry of Finance officials agreed on the desirable direction: government demand had compensated for sluggish private investment over the last decade; this is expected to change under NEM and 10MP reforms.
  - Transition to sustainable public finances has started; government securities remain attractive as shown by the successful launching of the global U.S. dollar sukuk.
  - The 10MP includes an indicative consolidation path for the deficit over the next five years; fiscal risks are routinely assessed in the budget process, and a formal statement could be considered for inclusion in budget documentation.
  - Reforming subsidies, social programs, and tax structures is a top priority but timing must be chosen carefully; reforms require political capital and sequencing with targeted relief measures to avoid backlash.
  - IMF technical assistance on tax incentives to corporates is being sought ahead of the next budget cycle.
  - Savings from greater efficiency in public service delivery under the Government Transformation Program will contribute to consolidation.
  - While GST roll out is on track, better outreach to the public and SMEs will increase buy-in; an anti-profiteering bill has been tabled in parliament to allay concerns about price gouging after GST introduction.
- Key numerical and factual items referenced in this section:
  - 2010 central government deficit target: about 5½ percent of GDP (from 7 percent of GDP).
  - Subsidies (excluding education and health): some 20 percent of government spending or about 5 percent of GDP.
  - Oil revenues, including Petronas dividend: some 40 percent of total revenues—10 percentage points more than a decade ago.
  - Malaysia’s proven hydrocarbon reserves: 5½ billion barrels of oil and 88 trillion cubic feet of natural gas.
  - At current extraction rates of about 650,000 barrels per day, oil is expected to be depleted in about 22 years; gas in about 35 years.

### Financial sector issues
- Background:
  - Malaysia’s financial sector withstood the global recession well due to BNM’s proactive supervision, measures to ensure financing access, and prudent lending practices.
  - Loan books improved in the second half of 2009; banks and insurance companies remain well capitalized and liquid; no obvious vulnerabilities in corporate balance sheets.
  - SMEs benefitted from government guarantee and credit-enhancing schemes and programs run by SME Corp.
  - Household debt has been rising partly due to initiatives promoting home ownership, but there are no signs of strains in servicing debt and no signs of systemic froth in property markets.
  - Islamic finance performed as well as conventional finance; Malaysia introduced the world’s first Shariah-compliant commodity trading platform using palm oil as the underlying commodity.
  - An international working group (BNM, Monetary Authority of Singapore, Hong Kong Monetary Authority) is coordinating exit modalities from blanket deposit guarantees; adoption of enhanced deposit insurance schemes is expected in 2011.
  - In Malaysia, deposit insurance will provide coverage for virtually all depositors including businesses and around 40 percent of deposits; the insurance premium will continue to be risk-based. A compensation scheme for holders of insurance and takaful products is also in the works.
  - The Central Bank of Malaysia Act (2009) provides more clarity on BNM’s mandate and strengthens its powers, surveillance ability, and governance framework.
- Staff’s views:
  - Efforts to develop capital markets, broaden intermediation, and strengthen risk management cushioned the system during the downturn.
  - Stricter international regulations on capital, liquidity and leverage (Basel III discussions) could be burdensome for local institutions: proposed treatment of subsidiaries may pressure capital adequacy of bank holding companies; proposed treatment of wholesale deposits could erode liquidity buffers; other reforms (levies, surcharges, through-the-cycle provisioning) are more speculative given lack of design specifics.
  - A case exists for formal broadening of the regulatory perimeter to encompass financial holding companies to institutionalize current practices.
  - Plans to unwind blanket deposit guarantee by year-end and move to an insurance system with higher deposit coverage are welcome; they ensure international consistency and should make removal of support a non-event.
  - As the regulatory landscape evolves, upgrading contingency planning and international coordination will be helpful.
- Authorities’ views and plans:
  - BNM broadly shared staff views; officials noted household debt buildup largely reflects fundamentals and Malaysia’s quickening pace of household formation—no imminent dangers from households’ liability side.
  - Key ratios cited: aggregate debt-to-equity ratio remains below 50 percent and the interest coverage ratio is about 5 percent; households’ NPLs were 3.1 percent at end-2009, down from 4.1 in 2008.
  - Concerns that adoption of some Basel III norms could create pressures: tighter liquidity and funding requirements may place onerous demands on some banks if sizeable deposits of the Employee Provident Fund are treated as wholesale funding.
  - The BNM noted the international consultative process needs to be more inclusive and that some discretion in implementation should be left to national authorities to assess local conditions without compromising regulatory outcomes.
- Key numerical and factual items referenced in this section:
  - Risk-weighted capital ratio (April 2010): 14.6.
  - Share of loans to broad property sector (April 2010): 41.2.
  - Nonperforming loans (gross) to total loans (April 2010): 3.5.
  - Loan-deposit ratio (April 2010): 78.2.
  - Aggregate debt-to-equity ratio: below 50 percent.
  - Interest coverage ratio: about 5 percent.
  - Households’ NPLs: 3.1 percent at end-2009 (down from 4.1 in 2008).
  - Deposit insurance to cover virtually all depositors including businesses and around 40 percent of deposits.
  - Ratios of household financial assets to household debt: about 2.5; liquid financial assets to household debt: about 1.5.

*IMF staff report excerpt.*

### 35.      In the BNM’s view, the global crisis has cast a sharp light on Islamic finance. In

### _cr10265 - 35.      In the BNM’s view, the global crisis has cast a sharp light on Islamic finance. In

### Islamic finance and systemic resilience
- Islamic finance business model: financing only extended to real sector activities that have economic value, establishing a close link between financial transactions and productive flows.
- Mechanism of resilience:
  - Exposure to excessive leverage and risk taking is curtailed, giving the system added resilience when shocks originate in the financial sector.
  - Appeal as "ethical banking" has grown, positioning Malaysia, a hub of Islamic financial services, to capitalize on the trend.
- Policy/market development need:
  - Task Force on Islamic Finance and Global Stability (chaired by Governor Zeti) recognizes that additional development of Shariah-compliant liquidity management and hedging instruments would further underpin the soundness of the system.

### Financial Sector Assessment Program (FSAP)
- Authorities’ request:
  - The Malaysian authorities have requested to participate in the Financial Sector Assessment Program.
- Background and timing:
  - Malaysia has undertaken more than a decade of capacity building and financial reforms under an ambitious Financial Sector Master Plan now in its final phase of implementation.
  - The BNM suggests that the FSAP take place next year at the earliest.
- Rationale:
  - Participation in the FSAP would reinforce strong fundamentals and facilitate identification of areas for further enhancements.

### Structural reform priorities and exchange rate assessment — background
- Development history:
  - Malaysia transitioned from a low-income country at birth in 1957 to upper middle-income status in the early 1990.
  - Sectoral shifts (from the primary sector to advanced manufacturing), strong foreign investment, a proactive government, and high saving rates facilitated the transition.
- Employee Provident Fund:
  - Administers a mandatory defined-contributions pension scheme for all non government employees and the self-employed in the formal economy.
  - It covers some 6 million workers, about half of the labor force.
- World Bank classification and per capita income:
  - The World Bank classifies countries as upper middle-income if GNI per capita is in the range $4,000−$12,000.
  - Malaysia’s per capita income is about $7,000.
- Stalled momentum:
  - Momentum stalled in the run up to the Asia crisis and has never been recovered; Malaysia has so far been unable to breach the high-income threshold.

### The New Economic Model (NEM) and the Tenth Malaysia Plan (10MP)
- NEM objectives:
  - Transform Malaysia into an innovative, knowledge-intensive, and high-income economy by 2020.
  - Strategic reform areas: enhancing private sector participation, improving workforce skills, supporting innovation, developing new sources of growth, strengthening public sector management.
- Tenth Malaysia Plan (2011−2015):
  - Provides the policy framework for implementing many NEM suggestions.
  - Main macroeconomic objectives:
    - Sustain annual GDP growth at 6 percent on average.
    - Bring gradually down the budget deficit to less than 3 percent of GDP by 2015.
  - Microeconomic objectives include: a competition law, further liberalization of services, divestment of some public enterprises, market prices for subsidized commodities, an innovation-friendly environment, and reduced dependence on foreign labor.
  - The 10MP is to be revised after about two years in light of progress toward macroeconomic and social goal-posts.
- NEM ambition:
  - Steps necessary to revive the business climate and double Malaysia’s per capita income by 2020 (Box 2).

### Staff views on reform strategy and sequencing
- Strategic choice:
  - NEM frames a stark choice between muddling through and a historical transformation of the economy.
- Recommended reform areas (consistent with prior Article IV discussions):
  - Reform of government-linked companies.
  - Further product and labor market liberalization (including a review of employment protection).
  - Improved education and vocational training.
  - Better targeted social safety nets and tax incentives.
- Implementation guidance:
  - Implementation needs to be pragmatic but steady; acting at a measured pace on a broad front to exploit policy complementarities.
  - Future roadmap elaborations could develop "What if?" scenario analysis to account for unforeseen contingencies.

### Exchange rate assessment and authorities’ views
- Staff assessment:
  - Model-based estimates suggest the real effective exchange rate (REER) of the ringgit is currently weaker than the level implied by its estimated medium-term determinants (Appendix I).
  - A stronger ringgit over the medium term will help achieve NEM and 10MP objectives by facilitating higher real incomes, greater capital deepening, faster productivity gains, and demand shifts in favor of services.
- Constraints and context:
  - Structural rigidities have generated a persistent excess of national savings over investment and a significant share of commodities in exports.
  - No feasible near-term reorientation of the policy mix (toward a more expansionary fiscal stance and a more restrictive monetary policy) can speed up external adjustment without compromising domestic stability or potentially triggering speculative inflows.
  - Under established exchange rate policies (captured by the appreciation of the ringgit in effective terms since the beginning of the year) the undervaluation could be eliminated over the medium term.
- Authorities’ position:
  - Agree that the ringgit will strengthen over the medium term but disagree with the staff’s assessment of the current level of the exchange rate.
  - Stress that exchange rate policies: (i) do not target a particular exchange rate; (ii) have been informed by the need to prevent overshooting in both directions, as evidenced by the massive draw-down of reserves last year; and (iii) are consistent with a gradual appreciation of the currency.
  - BNM argues it is naïve to think monetary policy can control the real exchange rate and that pre-committing to an appreciation path could invite disorderly capital inflows.
  - BNM views the assessment machinery as opaque regarding policy implications or the appropriate pace for balance of payments adjustment.

### Staff appraisal — macroeconomic and financial assessment
- Economic recovery and policy management:
  - Malaysia has emerged from the global recession with strong forward momentum; countercyclical policies and sound fundamentals paved the way for a broad-based recovery.
  - Smooth exits from extraordinary interventions are in train and policy is returning to more normal settings.
- Structural reform urgency:
  - The cyclical upswing has galvanized the policy debate; strategies that achieved current development are inadequate to move further up the income ladder.
  - The NEM could achieve the authorities’ goal of doubling per capita income by the next decade if implemented.
- Fiscal policy:
  - Authorities have taken first steps to bolster public finances; the 2010 budget marks a commendable return to consolidation.
  - Sustained fiscal adjustment is necessary to reconstitute policy space and put the debt ratio on a firmly declining path.
  - Budgetary gains will prove transitory if a broader agenda of fiscal reforms remains unfinished.
  - Specific fiscal recommendations:
    - Poorly targeted and distortionary fuel subsidies should be phased out sooner rather than later.
    - The introduction of a goods and service tax should not be unduly delayed.
    - Enhance budget framework by including a statement of fiscal risks and benchmarking budget decisions against a framework that links spending to an equitable drawdown of oil wealth.
- Monetary policy:
  - Monetary policy has been appropriately recalibrated to sustain non-inflationary growth.
  - Bank Negara Malaysia’s measured pace of monetary tightening has been on the mark; with real rates below their long-term average, the policy stance is still supportive.
  - Given fragile global recovery and fiscal risks, a wait-and-see approach is appropriate.
- Financial sector resilience:
  - The financial sector showed resilience in the global downturn; efforts to develop capital markets, broaden intermediation, and strengthen risk management have paid dividends.
  - The Central Bank of Malaysia Act of 2009 reinforces financial system underpinnings.
  - Plans to unwind by year˗end the blanket deposit guarantee and move to an insurance system with higher deposit coverage are welcome.
- Reform implementation and communication:
  - The structural reform agenda is daunting and requires difficult trade-offs; implementation should be calibrated to political realities and paced to exploit complementarities.
  - Careful communication will be needed to sustain the adjustment and pre-empt reform fatigue.
- Exchange rate and rebalancing:
  - Strengthening of the ringgit in real effective terms will facilitate implementation of the transformation program.
  - Model-based estimates suggest the real effective ringgit is below its equilibrium level; the currency is likely to continue to strengthen as structural reforms advance, facilitating rebalancing toward domestic demand.
- FSAP participation:
  - Malaysia’s request to participate in the FSAP is welcome; participation should reinforce strong foundations and facilitate identification of areas for further enhancements.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 54.      It is recommended that the next Article IV consultation take place on the standard

### _cr10265 - 54.      It is recommended that the next Article IV consultation take place on the standard

### Recommendation on Article IV consultation
- It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

### Real sector: developments and outlook
- Growth has rebounded:
  - Real GDP growth: 2005–2011 series (percent change): 2005: 5.3; 2006: 5.8; 2007: 6.5; 2008: 4.7; 2009: -1.7; 2010: 6.7; 2011: 5.3 (Table 1).
  - Projections/Illustrative medium-term (2008–2015): Real GDP growth: 2008: 4.7; 2009: -1.7; 2010: 6.7; 2011: 5.3; 2012: 5.2; 2013: 5.1; 2014: 5.1; 2015: 5.0 (Table 4).
- Domestic demand and components:
  - Real domestic demand (2005–2011): 2005: 6.0; 2006: -2.7; 2007: 5.6; 2008: 4.6; 2009: 4.9; 2010: 5.3; 2011: 5.6 (Table 4).
  - Private consumption (2005–2011): 2005: 9.1; 2006: 6.8; 2007: 10.5; 2008: 8.5; 2009: 0.7; 2010: 7.0; 2011: 4.5 (Table 1).
  - Private fixed capital formation (percent of GDP, 2000–2010 series shown in Figure 1).
  - Private investment continues to languish: Gross capital formation 2005–2011 series: 2005: -2.5; 2006: 11.3; 2007: 8.4; 2008: -2.3; 2009: -14.6; 2010: 6.1; 2011: 9.5 (Table 1).
- Inflation and labor market:
  - CPI inflation (period average): 2005: 3.0; 2006: 3.6; 2007: 2.0; 2008: 5.4; 2009: 0.6; 2010: 2.0; 2011: 2.1 (Table 1).
  - Unemployment rate (period average): 2005: 3.5; 2006: 3.3; 2007: 3.2; 2008: 3.3; 2009: 3.7; 2010: 3.5; 2011: 3.2 (Table 1).
- Key level indicators (2009):
  - Nominal GDP (2009): US$206 billion.
  - Main export (percent of total): electrical & electronic products (39%), commodities (23%).
  - GDP per capita (2009): US$7,141.
  - Population (2009): 28.3 million.
  - Unemployment rate (2009): 3.7 percent.

### Exchange rate, monetary conditions, and reserves
- Exchange rate and competitiveness:
  - NEER and REER indices (INS Trade weights, 2000=100) shown May-05 to May-10 in Figure 2.
  - Ringgit-U.S. dollar movements plotted alongside NEER and REER (May-05 to May-10).
- Reserves:
  - Malaysia: Reserves (In billions of U.S. dollars) shown May-05 to May-10; gross official reserves 2005–2011: 70.5, 82.5, 101.3, 91.4, 96.7, 106.1, 113.1 (Table 1/Table 3).
  - Reserves coverage (months of imports of goods and services) 2005–2011: 5.8, 5.9, 6.8, 7.6, 6.8, 6.9, 6.8 (Table 1/Table 3).
- Monetary aggregates and rates:
  - Total liquidity (M3: percent change, 12-month basis): 2005: 8.8; 2006: 13.6; 2007: 7.9; 2008: 10.5; 2009: 7.8; 2010: ...; (Table 2).
  - Private sector credit (percent change, 12-month basis): 2005: 9.1; 2006: 6.8; 2007: 9.2; 2008: 10.2; 2009: 6.5; 2010: ... (Table 2).
  - Three-month interbank rate (percent): 2005: 2.9; 2006: 3.7; 2007: 3.6; 2008: 3.6; 2009: 2.2; 2010: ... (Table 1/Table 2).
  - LIBOR vs. KLIBOR and overnight policy rate series plotted Jun-05 to Jun-10 (Figure 2).

### External sector: trade, current account, and capital flows
- Trade and external flows:
  - Exports (f.o.b., US$ billions): 2005: 142.5; 2006: 160.9; 2007: 176.1; 2008: 199.3; 2009: 157.3; 2010: 182.1; 2011: 196.8 (Table 1/Table 3).
  - Imports (f.o.b., US$ billions): 2005: 108.5; 2006: 123.5; 2007: 138.5; 2008: 148.1; 2009: 117.2; 2010: 141.4; 2011: 155.4 (Table 1/Table 3).
  - Exports rebounded sharply and imports rebounded (Figure 3).
- Current account and reserves:
  - Current account balance (US$ billions, 2005–2011): 20.7, 26.1, 29.7, 38.9, 31.8, 32.3, 33.0 (Table 1/Table 3).
  - Current account (In percent of GDP): 2005: 15.1; 2006: 16.7; 2007: 15.9; 2008: 17.5; 2009: 16.5; 2010: 14.8; 2011: 14.0 (Table 1/Table 4).
  - Current account surplus remains large; reserve coverage is ample (Figure 3).
- Capital and financial account:
  - Capital and financial account balance (in billions of U.S. dollars): -9.8, -11.7, -11.3, -35.4, -22.8, -23.0, -26.0 (2005–2011) (Table 1/Table 3).
  - Financial account components (2005–2011): Net foreign direct investment and portfolio investment series reported (Table 3).
- External debt and vulnerability:
  - Total external debt (US$ billions, 2005–2010): 52.3, 52.2, 56.7, 68.2, 68.3, 68.2 (Table 2/Table 4).
  - Total external debt (percent of GDP): 2005: 38.0; 2006: 33.5; 2007: 30.3; 2008: 30.7; 2009: 35.4; 2010: 31.2 (Table 1/Table 2).
  - Short-term external debt (percent of total) 2005–2010: 36.1, 33.8, 36.1, 48.7, 39.0, 39.3 (Table 1/Table 4).
  - Reserves in percent of short-term debt (2005–2011): 373.5, 466.2, 495.4, 275.8, 362.9, 396.2, 427.1 (Table 1/Table 4).

### Fiscal sector: revenue, expenditure, and balances
- Fiscal aggregates (federal government, percent of GDP, 2005–2010):
  - Federal government overall balance: -3.6, -3.3, -3.2, -4.8, -7.0, -5.7, -5.6 (2005–2011 series in Table 1 and Table 5).
  - Revenue: 20.3, 21.5, 21.8, 21.6, 23.3, 20.0, 22.0 (2005–2011) (Table 5).
  - Expenditure and net lending: 23.9, 24.8, 25.0, 26.4, 30.4, 27.7, 27.7 (2005–2011) (Table 5).
  - Federal government non-oil primary balance: -6.9, -8.6, -8.8, -11.2, -14.1, -11.5, -10.8 (Table 1/Table 5).
- Fiscal projections and medium-term:
  - Federal government overall balance (2008–2015 projection): -4.8 (2008), -7.0 (2009), -5.7 (2010), -5.6 (2011), -5.3 (2012), -5.0 (2013), -4.7 (2014), -4.5 (2015) (Table 4).
  - Total public sector debt (percent of GDP, Table 4): 2008: 48.7; 2009: 61.7; 2010: 62.3; 2011: 63.2; 2012: 63.8; 2013: 64.1; 2014: 64.1; 2015: 63.9.
- Budget composition (2005–2010, percent of GDP):
  - Total revenues and expenditures: revenue 20.3–22.0; expenditure 23.9–27.7 (Table 5).
  - Tax revenue and non-oil tax revenue series provided (Table 5).
  - Subsidies and transfers and fuel subsidies levels provided (Table 5).

### Medium-term macroeconomic framework (illustrative, 2008–2015)
- Growth, saving, and investment:
  - Gross domestic investment (percent of GDP): 2008: 19.3; 2009: 14.5; 2010: 17.6; 2011: 18.5; 2012: 19.3; 2013: 19.8; 2014: 20.6; 2015: 21.1 (Table 4).
  - Gross national saving (percent of GDP): 2008: 36.8; 2009: 31.0; 2010: 32.4; 2011: 32.5; 2012: 32.4; 2013: 32.1; 2014: 32.0; 2015: 31.6 (Table 4).
- Fiscal path:
  - Federal government non-oil primary balance (percent of GDP): 2008: -11.2; 2009: -14.1; 2010: -11.5; 2011: -10.8; 2012: -10.1; 2013: -9.4; 2014: -8.6; 2015: -8.0 (Table 4).
  - Consolidated public sector overall balance (percent of GDP): -5.6 (2008), -3.8 (2009), -1.3 (2010), -2.3 (2011), -2.1 (2012), -1.8 (2013), -1.6 (2014), -1.4 (2015) (Table 4).

### Monetary and banking indicators
- Monetary survey (selected levels and growth):
  - Net foreign assets, net domestic assets, net domestic credit, broad money, narrow money series shown (Table 6).
  - Broad money (12-month percent change) in memorandum: 7.9, 10.3, 10.1, 11.2, 10.5, 6.1, 5.2, 5.5, 7.8 (Table 6).
- Financial soundness indicators (2005–2010):
  - Risk-weighted capital ratio (RWCR): 2005: 13.7; 2006: 13.5; 2007: 13.2; 2008: 12.6; 2009: 15.4; 2010 (Apr): 15.1 (Table 7).
  - Nonperforming loans (gross) to total loans: 2005: 9.6; 2006: 8.5; 2007: 6.5; 2008: 4.8; 2009: 3.7; 2010 (Apr): 3.5 (Table 7).
  - General provisions of the banking system (percent): 2005: 1.8; 2006: 1.7; 2007: 1.7; 2008: 1.7; 2009: 1.6; 2010 (Apr): 1.8 (Table 7).
  - Return on Assets (ROA): 2005: 1.4; 2006: 1.3; 2007: 1.5; 2008: 1.5; 2009: 1.2 (Table 7).
  - Loan-deposit ratio (2005–Apr-2010): 80.5, 72.9, 74.1, 74.7, 73.6, 76.0 (Table 7).

### Key summary statistics and memorandum items
- Trade and external growth rates (annual percent change):
  - Export value growth (2005–2015 series in Table 4 and Table 3): examples: 2005: 12.4; 2006: 12.9; 2007: 9.4; 2008: 13.2; 2009: -21.1; 2010: 15.7; 2011: 8.1 (Tables 3–4).
  - Import value growth examples: 2005: 9.3; 2006: 13.9; 2007: 12.1; 2008: 7.0; 2009: -20.9; 2010: 20.7; 2011: 9.9 (Tables 3–4).
- Memorandum:
  - Nominal GDP (In billions of ringgit, Table 4): 2008: 741; 2009: 680; 2010: 744; 2011: 804; 2012: 868; 2013: 937; 2014: 1,012; 2015: 1,091.

*Sources: Data provided by the authorities and Fund staff estimates; IMF, World Economic Outlook; APD databases; Bank Negara Malaysia.*

### APPENDIX I: MALAYSIA—EXCHANGE RATE ASSESSMENT

### APPENDIX I: MALAYSIA—EXCHANGE RATE ASSESSMENT

### Staff’s Assessment
- The CGER applies three approaches to assess the level of the real effective ringgit in relation to the level implied by medium˗term fundamentals.
- According to the CGER, the ringgit is weaker than its estimated equilibrium level.
- Macroeconomic balance approach finding:
  - The current account norm is significantly below the projected current account (based on unchanged real exchange rate), implying a relatively large undervaluation.
- Qualitative indicators that moderate the assessment of large undervaluation:
  - Core inflation has been low.
  - There have been no asset price bubbles.
  - Intervention has been two˗sided.
- Drivers and context:
  - Malaysia’s current account surplus has been large and protracted.
  - A sizeable portion of the increase in the current account since 2001 can be traced to the commodity boom.
- Risks to external stability are mitigated by:
  - Established exchange rate policies (as captured by the trend appreciation of the REER so far this year) that would probably eliminate the bulk of the undervaluation over the medium term.
  - Reforms in the works that should reduce the savings˗investment balance over time.
- Scenario note:
  - Under the Reform Scenario in paragraph 10 of the main report, the implied undervaluation under the macroeconomic balance approach would be modest.

### Authorities’ Views
- Overall position: The authorities disagreed with the assessment that the real effective exchange rate is weaker than the value implied by medium-term fundamentals.
- Key arguments presented by the authorities:
  - Commodity boom vs competitiveness:
    - Malaysia’s current account surplus has reflected to a large extent a temporary commodity boom rather than durable gains in competitiveness.
    - Exports of raw materials make up about two-thirds of the current account balance and have accounted for nearly half of the 8½ percentage point increase in the current account as a share of GDP since 2001.
  - Structural factors:
    - The current account surplus also has a large structural component reflecting high private saving because of demographics and underdeveloped social safety nets, and relatively weak investment demand in a context of market imperfections and structural shifts.
    - Malaysia’s investment abroad exceeds inward foreign investment.
    - Reforms to strengthen the social security system and address rigidities in product and labor markets will take time to bear fruit.
  - Intervention and capital flows:
    - Official intervention has been two˗sided and in response to volatile capital flows, with the objective to smooth volatility and avoid overshooting in a market that remains relatively shallow.
    - Development of a ringgit bond market has exposed Malaysia to potentially volatile capital flows; exchange rate policies need to shield the economy from related instability and dislocations.
    - Sterilized intervention has provided a buffer against past surges in capital inflows—and the war˗chest to cope with their reversal in 2009.
    - Following the exit from the peg in July 2005, the BNM has intervened by selling dollars in late 2005, May˗June 2006, February 2007, July˗August 2007 and—from August 2008 to June 2009—on an unprecedented scale.
    - Note: Data on market operations are not publicly available, but the size and direction of intervention can be inferred from the reported change in official foreign exchange reserves.
  - Reserves and prudence:
    - Ample reserves are good policy in an open economy; Malaysia does not stand out by some metrics of reserve adequacy (e.g., reserves to total trade).
    - In the run up to the global crisis, reserve accumulation has also proved farsighted during a commodity upswing of uncertain duration.
  - Lack of typical signs of undervaluation:
    - There are no signs of instability or financial imbalances typically associated with an undervalued currency: absence of demand˗push price and wage pressures, or pockets of overinvestment.
  - Model limitations:
    - Model˗based estimates are too imprecise to be useful for policymaking and are marred by methodological shortcomings, including difficulty in accounting for country˗specific factors and structural changes.
    - The Fund should be more cautious in the application of these models—and more evenhanded in its exchange rate assessments.
  - Risk of divulgation:
    - Public divulgation of the current staff assessment could trigger unwelcome capital inflows that would greatly complicate macroeconomic management; the assessment provides no clue as to a desirable or feasible timeframe to manage external adjustment.
  - Role of the exchange rate in adjustment:
    - Over-emphasis on the exchange rate to do the heavy-lifting for adjustment is too simplistic; the ringgit appreciation should be seen as the complement of structural change, not the main driver. Policy focus should ensure the exchange rate does not inhibit the transformation.

### Intervention Timing and Exchange Regime Context
- Key dates and actions:
  - Exit from the peg: July 2005.
  - Post-peg interventions by the BNM (selling dollars): late 2005; May˗June 2006; February 2007; July˗August 2007; August 2008 to June 2009 (unprecedented scale).
- Exchange arrangement (as reported elsewhere in the document):
  - On July 21, 2005, the Bank Negara Malaysia announced the adoption of a managed float with the exchange rate of the ringgit to be monitored against an undisclosed trade˗weighted basket of currencies.
  - Based on exchange rate behavior, the de facto exchange rate regime is classified as “other managed.”

### Qualitative Assessment and Policy Implications
- Indicators consistent with limited macro imbalances:
  - Low core inflation.
  - No evidence of asset price bubbles.
  - No demand˗push price or wage pressures.
- Policy implications emphasized by authorities:
  - Continue two˗sided intervention and reserve accumulation as buffers against volatile capital flows and to protect financial stability during financial deepening.
  - Pursue structural reforms (social safety nets, product and labor market rigidities) so that ringgit appreciation complements rather than substitutes for structural change.
  - Exercise caution in using model-based exchange rate assessments for policy signals due to imprecision and country˗specific complications.
- Staff view on adjustment path:
  - Established exchange rate policies and ongoing reforms would probably eliminate most of the estimated undervaluation over the medium term; under the Reform Scenario the implied undervaluation would be modest.

*Source: APPENDIX I: MALAYSIA—EXCHANGE RATE ASSESSMENT (Staff Report for the 2010 Article IV Consultation—Informational Annex).*

### ANNEX IV: MALAYSIA—STATISTICAL ISSUES

### ANNEX IV: MALAYSIA—STATISTICAL ISSUES

### I. Assessment of Data Adequacy for Surveillance
- General: Data provision is broadly adequate for surveillance. Further efforts are necessary to improve statistics for the consolidated public sector.
- National accounts:
  - DOSM compiles and publishes annual and quarterly estimates of GDP by activity and by expenditure at current and constant prices, and annual estimates for gross disposable income, saving, and net lending for the economy based on the 1968 SNA.
  - Quarterly data are released about two months after the reference quarter.
  - DOSM has developed experimental institutional sector accounts in accordance with the 1993 SNA.
  - Significant differences exist in estimates for key aggregates (particularly GDP; final consumption expenditures—government, household, NPISH; and gross capital formation) between the 1968 SNA-based GDP system and the 1993 SNA-based institutional sector accounts system.
- Price statistics:
  - CPI and PPI are available on a timely and comprehensive basis.
  - A revised CPI was introduced in January 2006; it covers all 14 states and uses a more disaggregated consumption basket and updated expenditure weights based on a 2004/05 household income and expenditure survey.
- Government finance statistics:
  - Need to improve timeliness, detail, and availability of data on NFPEs and the state and local governments.
  - More detailed data on nonlisted NFPEs’ assets and liabilities and domestic and foreign financing by type of debt instrument and holder would be desirable.
  - Improvements will require continued close collaboration among the Economic Planning Unit (EPU), the Treasury, and Bank Negara Malaysia (BNM).
- Monetary statistics:
  - Monetary and financial statistics (MFS) are reported on a timely and regular basis and are broadly in conformity with the Fund’s data needs.
  - Need to improve institutional coverage of financial corporations, sectorization of the domestic economy, and classification and valuation of financial instruments to ensure full adherence to the IMF’s Monetary and Financial Statistics Manual.
  - Coverage should be expanded to include insurance corporations, pension funds, and other financial intermediaries.
  - MFS missions of January 2004 and 2005 developed an integrated monetary database for BNM, STA, and APD.
  - Bank Negara Malaysia reports data in STA’s standardized report forms (SRFs); MFS based on the SRFs are published in the quarterly IFS Supplement on Monetary and Financial Statistics.
- Balance of payments:
  - DOSM compiles and publishes quarterly balance of payments estimates in accordance with the fifth edition of the Balance of Payments Manual and the SDDS.
  - Quarterly data are released three months after the reference quarter.
  - No data are shown for capital transfers or acquisition/sale of nonproduced nonfinancial assets.
  - Transactions in reserve assets are computed as differences in amounts outstanding and thus include valuation changes.
  - International investment position data on other investment—assets and liabilities—are reported only in aggregate form.

### II. Data Standards and Quality
- Malaysia subscribes to the Special Data Dissemination Standard (SDDS).
- Malaysia is using a timeliness flexibility option for general government operations (within six-quarter lags after the end of reference year).

### Table of Common Indicators Required for Surveillance (as of June 15–17, 2010)
- Exchange rates: Latest observation 06/15/10; Date received 06/15/10; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International reserve assets and reserve liabilities of the monetary authorities: Latest observation 05/10; Date received 06/10; Frequency Bi-W; Frequency of Reporting Bi-W; Frequency of Publication Bi-W.
- Reserve/base money: Latest observation 05/10; Date received 06/10; Frequency Bi-W; Frequency of Reporting Bi-W; Frequency of Publication Bi-W.
- Broad money: Latest observation 04/10; Date received 06/10; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Central bank balance sheet: Latest observation 05/10; Date received 06/10; Frequency Bi-W; Frequency of Reporting Bi-W; Frequency of Publication Bi-W.
- Consolidated balance sheet of the banking system: Latest observation 04/10; Date received 06/10; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Interest rates: Latest observation 06/15/10; Date received 06/15/10; Frequency of Data D; Frequency of Reporting D; Frequency of Publication M.
- Consumer price index: Latest observation 04/10; Date received 05/10; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Revenue, expenditure, balance and composition of financing—general government: Latest observation 2008; Date received 09/09; Frequency A; Frequency of Reporting A; Frequency of Publication A.
- Revenue, expenditure, balance and composition of financing—federal government: Latest observation 2010:Q1; Date received 06/10; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q.
- Stocks of central government and central government-guaranteed debt: Latest observation 2010:Q1; Date received 06/10; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q.
- External current account balance: Latest observation 2010:Q1; Date received 06/10; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q.
- Exports and imports of goods and services: Latest observation 04/10; Date received 06/10; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- GDP/GNP: Latest observation 2010:Q1; Date received 05/10; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q.
- Gross external debt: Latest observation 2010:Q1; Date received 05/10; Frequency Q; Frequency of Reporting Q; Frequency of Publication Q.

(Notes from table: 1 Includes reserve assets pledged or otherwise encumbered as well as net derivative positions. 2 Both market-based and officially determined, including discount rates, money market rates, rates on treasury bills, notes, and bonds. 3 Foreign, domestic bank, and domestic nonbank financing is only available on an annual basis. 4 The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments. 5 Including currency and maturity composition. 6 Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A).)

### Statement by the IMF Staff Representative on Malaysia (July 30, 2010)
- Economic developments:
  - High-frequency data suggest Malaysia’s expansion remains on track.
  - Consumption indicators are strong; industrial production experienced in May the third consecutive month of double˗digit year˗on˗year growth.
  - Declining momentum for exports and industrial output suggest a slower pace of activity in the quarters ahead.
  - June CPI was 1.7 percent higher than a year earlier and in line with the staff’s projections.
- Policy developments:
  - On July 16, 2010, the government reduced subsidies for some key commodities:
    - Sugar price raised by 15 percent.
    - Low-octane gasoline and diesel prices increased by some 3 percent.
    - Price of liquefied petroleum gas increased by about 6 percent.
    - High-octane gasoline is no longer subsidized.
  - These measures mark the beginning of the subsidy reform program highlighted in the New Economic Model.

### Public Information Notice — IMF Executive Board Concludes 2010 Article IV Consultation with Malaysia (July 30, 2010; PIN No. 10/114; released August 13, 2010)
- Background and recent developments:
  - Malaysia emerged strongly from the world recession due to forceful counter˗cyclical policies, sound balance sheets, and intra˗regional trade.
  - Seasonally-adjusted GDP is close to pre-crisis levels, reversing a nearly 6½ percent peak-to-trough loss.
  - Unemployment rate for 2009 peaked at about 3¾ percent.
  - Malaysia’s financial sector withstood the recession well; banks and insurance companies remain well capitalized and liquid.
  - Credit growth remained positive during the downturn and is gaining steam.
- Near-term prospects:
  - GDP is projected to expand by around 7 percent in 2010.
  - Growth should moderate in 2011 as positive base effects play out and policy support is reined in.
- Executive Board assessment — key points:
  - Commended authorities for sound fundamentals and countercyclical policies.
  - Welcomed consolidation effort in the 2010 budget; stressed need for sound and sustained fiscal adjustment to put public debt ratio on a downward path.
  - Encouraged following the indicative deficit path proposed in the Tenth Malaysia Plan.
  - Commended subsidy reduction decision and encouraged perseverance with reforms while being mindful of the impact on the poor.
  - Welcomed intention to introduce a goods and service tax and encouraged timely implementation.
  - Suggested enhancing budget framework by benchmarking decisions against a framework linking spending to an intergenerationally equitable drawdown of oil wealth.
  - Considered monetary policy appropriately recalibrated; measured pace of monetary normalization is appropriate.
  - Noted staff’s assessment that the ringgit appears weaker than its equilibrium level in real effective terms and that a stronger ringgit could boost domestic demand and shift toward higher-value added industries.
  - Welcomed development of capital markets, broader intermediation, and strengthened risk management; welcomed new Central Bank Act and participation in the Financial Sector Assessment Program.
  - Supported comprehensive structural reform agenda of the New Economic Model and urged decisive and sustained implementation, including further gradual liberalization of product and labor markets.

### Malaysia: Selected Economic and Financial Indicators, 2005–11 (selected figures)
- Growth (percent change):
  - Real GDP: 2005 5.3; 2006 5.8; 2007 6.5; 2008 4.7; 2009 -1.7; 2010 6.7; 2011 5.3.
  - Total domestic demand: 2005 5.5; 2006 7.7; 2007 9.4; 2008 6.0; 2009 -2.7; 2010 5.6; 2011 4.6.
  - Consumption: 2005 8.5; 2006 6.4; 2007 9.7; 2008 9.0; 2009 1.2; 2010 5.5; 2011 3.2.
  - Private consumption: 2005 9.1; 2006 6.8; 2007 10.5; 2008 8.5; 2009 0.7; 2010 7.0; 2011 4.5.
  - Gross capital formation: 2005 -2.5; 2006 11.3; 2007 8.4; 2008 -2.3; 2009 -14.6; 2010 6.1; 2011 9.5.
- Saving and investment (percent of GDP):
  - Gross domestic investment: 2005 20.0; 2006 20.5; 2007 21.6; 2008 19.3; 2009 14.5; 2010 17.6; 2011 18.5.
  - Gross national saving: 2005 35.0; 2006 37.2; 2007 37.5; 2008 36.8; 2009 31.0; 2010 32.4; 2011 32.5.
- Fiscal sector (percent of GDP):
  - Federal government overall balance: 2005 -3.6; 2006 -3.3; 2007 -3.2; 2008 -4.8; 2009 -7.0; 2010 -5.7; 2011 -5.6.
  - Revenue: 2005 20.3; 2006 21.5; 2007 21.8; 2008 21.6; 2009 23.3; 2010 22.0; 2011 22.1.
  - Expenditure and net lending: 2005 23.9; 2006 24.8; 2007 25.0; 2008 26.4; 2009 30.4; 2010 27.7; 2011 27.7.
  - Federal government non-oil primary balance: 2006 -6.9; 2007 -8.6; 2008 -8.8; 2009 -11.2; 2010 -14.1; 2011 -11.5; 2011 (alternate) -10.8.
  - Consolidated public sector overall balance 1/: 2005 1.4; 2006 -0.3; 2007 1.5; 2008 -5.6; 2009 -3.8; 2010 -1.3; 2011 -2.3.
  - Total public sector gross debt 2/: 2005 59.3; 2006 54.2; 2007 48.6; 2008 48.7; 2009 61.7; 2010 62.3; 2011 63.2.
- Inflation and unemployment (period average, percent):
  - CPI inflation: 2005 3.0; 2006 3.6; 2007 2.0; 2008 5.4; 2009 0.6; 2010 2.0; 2011 2.1.
  - Unemployment rate: 2005 3.5; 2006 3.3; 2007 3.2; 2008 3.3; 2009 3.7; 2010 3.5; 2011 3.2.
- Money and credit (end of period, percentage change):
  - Broad money (M3): 2005 8.8; 2006 13.6; 2007 7.9; 2008 10.5; 2009 7.8; 2010 ...; 2011 ....
  - Lending to nonbank private sector: 2005 9.1; 2006 6.8; 2007 9.2; 2008 10.2; 2009 6.5; 2010 ...; 2011 ....
  - Three-month interbank rate (percent): 2005 2.9; 2006 3.7; 2007 3.6; 2008 3.6; 2009 2.2; 2010 ...; 2011 ....
- Balance of payments (US$ billions):
  - Trade balance: 2005 34.1; 2006 37.4; 2007 37.6; 2008 51.2; 2009 40.2; 2010 40.7; 2011 41.4.
  - Exports, f.o.b.: 2005 142.5; 2006 160.9; 2007 176.1; 2008 199.3; 2009 157.3; 2010 182.1; 2011 196.8.
  - Imports, f.o.b.: 2005 108.5; 2006 123.5; 2007 138.5; 2008 148.1; 2009 117.2; 2010 141.4; 2011 155.4.
  - Services and income account: 2005 -8.9; 2006 -6.7; 2007 -3.3; 2008 -7.1; 2009 -2.8; 2010 -2.6; 2011 -2.6.
  - Current account balance: 2005 20.7; 2006 26.1; 2007 29.7; 2008 38.9; 2009 31.8; 2010 32.3; 2011 33.0.
    - (In percent of GDP): 2005 15.1; 2006 16.7; 2007 15.9; 2008 17.5; 2009 16.5; 2010 14.8; 2011 14.0.
  - Financial account balance: 2005 -9.8; 2006 -11.7; 2007 -11.3; 2008 -35.4; 2009 -22.8; 2010 -23.0; 2011 -26.0.
  - Overall balance: 2005 3.6; 2006 6.9; 2007 13.2; 2008 -5.5; 2009 3.9; 2010 9.3; 2011 7.0.
  - Gross official reserves (US$ billions): 2007 70.5; 2008 82.5; 2009 101.3; 2010 91.4; 2011 96.7; 2012 106.1; 2013 113.1.
    - (In months of following year's imports): 2005 5.8; 2006 5.9; 2007 6.8; 2008 7.6; 2009 6.8; 2010 6.9; 2011 6.8.
    - (In percent of short-term debt) 3/: 2005 373.5; 2006 466.2; 2007 495.4; 2008 275.8; 2009 363.3; 2010 396.2; 2011 427.1.
  - Total external debt (US$ billions): 2008 52.3; 2009 52.2; 2010 56.7; 2011 68.2; 2010:Q1 68.3; 2011:Q1 68.2; 2011 (alt) 67.4.
    - (In percent of GDP): 2005 38.0; 2006 33.5; 2007 30.3; 2008 30.7; 2009 35.4; 2010 31.2; 2011 28.5.
  - Short-term external debt (percent of total) 3/: 2005 36.1; 2006 33.8; 2007 36.1; 2008 48.7; 2009 39.0; 2010 39.3; 2011 39.3.
  - Debt-service ratio (In percent of exports of goods and services): 2005 5.3; 2006 4.8; 2007 3.8; 2008 2.6; 2009 6.5; 2010 2.7; 2011 2.7.

(Notes: Sources: Data provided by the authorities and IMF staff estimates. 1/ Capital expenditure in the budget includes foreign fixed assets and other items, such as purchase of shares and land, which are excluded from public investment in the national accounts. 2/ Excludes financial public enterprises and nongovernment-guaranteed domestic debt of the nonfinancial public enterprises. 3/ By remaining maturity.)

*Source: ANNEX IV: MALAYSIA—STATISTICAL ISSUES (As of June 17, 2010).*

### 3. The measures introduced by the Malaysian Government in response to the global

### 3. The measures introduced by the Malaysian Government in response to the global

### Overview and impact of policy response
- Policy mix centered on three broad areas: fiscal policy, monetary easing, and measures to ensure continued access to finance.
- Two fiscal stimulus packages amounting to 9.9% of GDP.
- Monetary easing: Overnight Policy Rate reduced by a total of 150 basis points to 2.0%.
- Stability in the domestic financial system allowed financial intermediation to continue smoothly and reinforced expansionary fiscal and monetary influences on domestic demand.
- External demand support from stabilization and gradual recovery in the global economy since mid-2009, with a particularly strong recovery in Asian regional economies.
- Recovery in exports became more broad-based towards end-2009 as exports to several advanced economies began to recover.

### Growth outlook and domestic demand (2010)
- Growth expected to remain strong for the rest of 2010, supported by continued expansion in both domestic and external demand.
- Private sector activity to increasingly drive growth as fiscal stimulus winds down into 2011.
- Private consumption supported by strengthened consumer confidence and improvements in employment conditions, which have recouped most crisis-related job losses and seen a recovery in wages.
- Private investment beginning to turnaround, in line with strengthening global trade and increasing domestic demand, supported by improved business confidence and financing conditions.
- Regional trade importance: in 2009, Malaysia’s exports to Asia (excluding Japan) accounted for 56% of total exports.
- Authorities projected that real GDP could expand by 6% in 2010 compared with 4.5 – 5.5% projected earlier.
- Indicators for April and May 2010 continued to show strength despite expectations that the pace of growth may taper in the second half as base effects diminish.

### Inflation outlook
- Headline inflation (annual % change in CPI) averaged 0.6% in 2009 (2008: 5.4%).
- Disinflationary pressures driven by significant drop in global commodity prices, especially crude oil, and increasing slack during the downturn.
- Inflation in first half of 2010 averaged 1.4%.
- Inflation expected to rise slightly in the second half of 2010 reflecting improving economic conditions and adjustments to administered prices and subsidy reforms.
- In absence of further price revisions and price-related external developments, inflation in Malaysia expected to remain contained.

### External position and capital flows
- Trade surplus declined in 2009 but remained sizeable as contraction in exports offset in part a decline in intermediate imports; tourist arrivals from the Asian region were robust.
- External debt declined to the equivalent of 30% of GDP as at end-March 2010 (less than a third of which is short-term).
- International reserves: equivalent to US$94.8 billion as at July 15, 2010 (after declining from a peak of almost US$126 billion).
- Outward FDI by Malaysian companies increased, amounting to as much as 6.8% of GDP in 2008 and continuing to a lesser extent in 2009.
- Portfolio flow reversals in late 2008 were larger than net outflows at the height of the Asian crisis, but impact on the domestic economy was limited due to debt market development and a strong banking system.
- Availability of foreign reserves enabled Bank Negara Malaysia to accommodate outflows and minimize ringgit volatility.

### Monetary policy
- Bank Negara Malaysia (BNM) began normalizing interest rates since March 2010 as extraordinary conditions no longer prevailed.
- Concern that prolonged extremely low interest rates could encourage excessive risk-taking, unhealthy leverage build-up, and financial disintermediation.
- Overall stance of monetary policy to remain accommodative in 2010 to support domestic activity given lingering global uncertainties.
- Monetary policy focus in 2010: promote sustainability of economic recovery and ensure financing remains available to the private sector at reasonable cost.
- Price pressures expected to be modest; Government subsidy reforms assessed as transitory and manageable for supply-side price effects.

### Fiscal policy
- Fiscal consolidation to resume in 2010 following large, well-timed stimulus in prior year.
- Fiscal deficit from a peak of 7.0% of GDP in 2009 is expected to decline to 5.6% of GDP in 2010.
- Better-than-expected growth in recent quarters and improved oil revenues expected to strengthen Government finances.
- Priority measures to improve effectiveness and efficiency of Government expenditure and revenue collection articulated in the 10th Malaysia Plan, including:
  - cutting non-essential spending;
  - achieving greater value for money in procurement;
  - optimizing use of Government assets;
  - adopting outcome based budgeting;
  - rationalizing government organizations and structures;
  - intensifying public-private partnership programs;
  - rationalizing subsidies.
- Fiscal sustainability targets by 2015:
  - deficit anticipated to be less than 3% of GDP;
  - debt to GDP ratio anticipated to be less than 50% by 2015.
- Government role over the medium term to be an enabler and facilitator for private sector activities, including systematic reduction of holdings and divestment of non-core government-linked company businesses and privatization of MOF Inc. companies.
- Tax and revenue measures:
  - First reading of the bill on Goods and Services Tax (GST) tabled in Parliament in December 2009.
  - Changes to tax assessment system for upstream petroleum-related activities in Budget 2010 to eliminate lags.
- Subsidy rationalization:
  - Reduction in subsidies for fuel (petrol, diesel, liquefied petroleum gas) and sugar expected to yield savings of RM750 million in 2010.
  - Health and education sectors to benefit from savings.
  - Government putting in place offsetting support mechanisms for the poor and reviewing social safety net for better targeting.
- Government Transformation Program (GTP) launched late last year reported early results: new assistance reaching more than a quarter of the hardcore poor, declining crime indices, online publication of government contracts, and enhancements for pre-school and primary education.

### Financial sector resilience and reform
- Financial system displayed resilience in 2009; banking institutions and insurance companies remained well-capitalized and liquid.
- Banks took prompt measures in 2008 to shore up capital; loan growth expanded by 7%.
- Precautionary measures widened guarantees on deposits and expanded access to BNM liquidity facilities; none of these facilities were drawn upon.
- Banks proactively restructured facilities with viable borrowers; credit flows to SMEs sustained and supported by guarantee schemes.
- Islamic finance continued sustained growth; Malaysia reinforced role as international center for issuance of sukuk and introduced innovations such as a Shariah-compliant commodity trading platform.
- BNM enhancements: prudential framework, supervisory arrangements, surveillance frameworks, refinements in stress testing, improved supervisory cooperation, enhanced risk and information capture, liquidity support and resolution, and strengthening the financial safety net.
- Central Bank of Malaysia Act 2009 (CBA) strengthened BNM’s mandate and powers for financial stability, including resolution powers for institutions beyond BNM’s regulatory purview where they present a risk to financial stability.
- Implementation of the ten-year Financial Sector Master Plan almost completed; a new blueprint being prepared for transformation beginning 2011.
- Authorities agreed to a Financial Sector Assessment Program (FSAP) exercise to reinforce fundamentals and identify areas for further improvements.

### Exchange rate developments
- Managed float regime adopted in July 2005; exchange rate determined by market forces with interventions limited to ensuring orderly market conditions and preventing extreme volatility.
- Since adoption, ringgit broadly on a path of appreciation, reaching a high of RM3.1315 in April 2008 (an appreciation of 21.3%) before depreciating during the global financial crisis.
- Appreciating trend resumed from mid-2009; up to July 2010, the ringgit was the fastest appreciating currency in the region for the year.
- Authorities and staff agree that given strong fundamentals and reform initiatives, the ringgit could appreciate further over the medium to long term, with extent determined by market conditions and economic developments.
- Authorities remain unconvinced by model-based estimates of potential undervaluation, citing insufficient incorporation of country-specific features (including significant role of non-renewable commodities such as oil), low core inflation, and absence of asset price bubbles.
- Staff observed no feasible policy re-orientation that could more quickly reduce external surpluses without damaging macroeconomic stability.

### Structural reforms and long-term strategy
- Malaysia characterized as an upper middle-income economy that has slowed in the past decade and faces a risk of a “middle-income trap” without deep-rooted changes.
- Two parallel reform tracks: improving governance and public delivery under the GTP; structural economic transformation under the New Economic Model (NEM) and Economic Transformation Program (ETP) to double per capita income by 2020 and achieve advanced economy status.
- NEM’s eight strategic reform initiatives:
  - Reenergizing the private sector, including by creating an entrepreneurship ecosystem, removing barriers and costs to doing business, and encouraging competition.
  - Developing a quality workforce and reducing dependency on unskilled foreign labor.
  - Creating a competitive domestic economy, including removing price controls and subsidies that distort market behavior.
  - Strengthening the public sector, by creating a leaner, customer-focused government while widening the tax base and streamlining public finance management.
  - Implementing transparent and market-friendly affirmative action, which will transition from ethnic considerations to emphasize the lower income 40% of households.
  - Building the knowledge base and infrastructure, including an environment for innovation.
  - Enhancing the sources of growth, of which 12 national key economic areas have been identified with high growth potential.
  - Ensuring sustainability of growth, including environmental sustainability.
- The 10th Malaysia Plan outlines 10 Big Ideas and identifies 5 key strategic thrusts to operationalize reforms and achieve Vision 2020 objectives.

### Final remarks
- Authorities welcomed input in the Staff Report and found consultations useful.
- Malaysia is embarking on a far-reaching reform agenda to elevate growth and development, taking advantage of a firm recovery from the global downturn.
- The support of the international community, including Fund expertise, remains welcome.

*Source: IMF staff report excerpt.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10265.pdf_