## Fiscal Policy Committee ## Source details **Canonical URL:** [Fiscal Policy Committee](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1480.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1480.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1480.pdf.json) --- ### Recent developments and context - General elections held on May 5, 2013; incumbent coalition won narrowly, ensuring smooth policy transition. - Authorities created a High-Level Fiscal Policy Committee (FPC); food and fuel subsidies and electricity tariffs are being rationalized; a Goods and Services Tax (GST) will be introduced in 2015. - Measures aim to rebuild fiscal buffers lost after expansionary policies during the global financial crisis. ### Economic developments and key indicators - Growth slowed to 4.7 percent in 2013, compared with 5.6 percent in 2012. - A small negative output gap opened up in 2013; domestic demand remained robust. - Headline inflation rose to 3.2 percent year‐on‐year in December 2013; core inflation was less than 2 percent in December 2013. - During spring-summer 2013 the ringgit weakened by about 11 percent (peak-to-trough) against the dollar. - Between end‑May and end‑2013, 10‑year MGS yields increased by 70 bps and the spread against the U.S. dollar widened by about 20 bps. - Financial markets: deep financial markets and a flexible exchange rate have facilitated adjustment without appreciable harm to date. ### Outlook and projections - Growth projected to accelerate to 5.0 percent in 2014. - Over the medium term, growth expected to average 5 percent. - Fiscal impulse in 2014 is about minus 1 percent of GDP (staff’s definition). - Inflation expected to modestly increase during 2014; inflation likely to reach about 4.0 percent in 2015 following GST introduction; in staff’s baseline scenario inflation is expected to gradually moderate to below 3.0 percent in the medium term. - Oil revenues are projected to decline by 0.5 percent of GDP. ### Risks to the baseline - External risks: - A potentially bumpy exit from unconventional monetary policies (UMP) in advanced economies (AEs) could trigger financial market turbulence and dampen external demand. - Vulnerability to capital outflows given sizeable foreign investor positions in domestic bond and equity markets (evidenced in spring-summer 2013). - Other external risks: further slowdown in China, protracted slow growth in Europe, commodity price shocks. - Domestic risks: - Federal debt is close to the government’s self-imposed ceiling of 55 percent of GDP and large contingent federal liabilities limit room for countercyclical fiscal policy. - Implementation risks associated with comprehensive fiscal reforms could undermine investor sentiment and trigger outflows and a jump in yields. - High house prices, rising household debt, and banks’ large exposure to real estate, especially if UMP unwinding tightens domestic financial conditions and raises interest rates. - Adjustments in fuel prices expected to add about 0.5 percentage point to annual inflation in 2014−15; the GST could add about 0.9 percentage point in 2015. - Staff assessment: implementation risks are low given authorities’ political will and technical expertise; low starting inflation and BNM’s policy credibility limit second‑round effects. ### Policy advice and authorities’ actions - Authorities have taken decisive steps to strengthen public finances in H2 2013 within a medium-term fiscal adjustment program; actions are consistent with past Fund technical assistance and staff advice. - Authorities are: - Monitoring financial sector risks and implementing additional macroprudential measures. - Collecting granular data on household assets and liabilities. - Allowing two‑way exchange rate flexibility. - Implementing wide‑ranging structural reforms with IMF and other international support. - Authorities’ views: - Anticipate growth increase in 2014; expect private investment growth to remain robust at about 13 percent; some moderation in private consumption growth likely. - Main risks are on the downside, especially external; uncertainty around UMP unwinding and heightened volatility are key concerns. - Committed to steadfast implementation of fiscal reforms; assess second‑round inflation effects from subsidy rationalization as limited. - Less concerned about financial stability risks from household debt and house prices, citing high household financial assets, healthy labor markets, and mortgage rates largely tied to the policy rate. - Targeted, phased macroprudential policies and financial literacy efforts have helped curtail risks. ### Near-term policy mix: achieving a smooth transition - Overall assessment: policy mix appropriate to address fiscal vulnerabilities amid low inflation and an improving but uncertain external environment. - Fiscal policy: decisive yet gradual tightening should help maintain market access at low funding costs while avoiding undue growth damage or igniting higher inflation. - Monetary policy: slightly accommodative stance has been supportive of growth given low inflation and a small negative output gap; recalibration may be needed as UMPs unwind and inflation risks rise. - Macroprudential tightening to date appears to have helped address financial stability risks; continued monitoring and potential additional measures are warranted. ### Fiscal policy details - Federal government recalibrated fiscal policy in September‑October 2013 and is on track to reach a fiscal deficit target of 4.0 percent of GDP in 2013. - Staff projects fiscal adjustment in 2013 of about 1 percent of GDP, driven by higher income taxes and lower development spending. - Current spending rose in recent years (driven by wages and subsidies) and was higher than budgeted in 2013 but is expected to remain stable relative to GDP. - Spending on subsidies increased by 0.6 percentage points of GDP in 2012 and remained elevated in 2013; fuel price adjustments in September 2013 reduced this. - The 2014 federal deficit target of 3.5 percent of GDP seems feasible if growth in current spending is contained and further fuel price increases occur. - Under staff’s baseline, 2014 fiscal adjustment will be driven by subsidies (about 1 percent of GDP) and the wage bill; development spending as percent of GDP will slow. - Fiscal impulse (staff’s definition) is about minus 1 percentage point of GDP. - Public sector deficit widened to 5 percent of GDP in 2012 and is expected to be about 6½ percent of GDP during 2013−2014, driven in part by higher development spending by Nonfinancial Public Enterprises (NFPEs). - Fiscal impulse at the broader public sector level was positive in 2013 but expected to turn negative in 2014. ### Monetary policy details - Bank Negara Malaysia (BNM) policy rate unchanged at 3 percent since May 2011. - Staff expects BNM to begin a gradual tightening cycle, warranted by external uncertainty and the need to safeguard financial stability given high household debt. - BNM’s near‑term task: allow pass‑through of cost‑related increases (cost‑push inflation) while detecting and preempting second‑round effects embedding in the wage‑price structure. ### Macroprudential policies (MAPs) - Household debt reached 83 percent of GDP at end‑September 2013, up from 55 percent five years earlier. - Over half of household debt is on residential property; nearly 70 percent of residential property loans are contracted at variable rates tied to the Base Lending Rate (BLR). - Since November 2010 and continuing through the 2014 budget, authorities imposed a series of targeted, gradual, and escalating MAPs primarily directed at speculative home purchases and unsecured credit. - The 2014 budget included special financing schemes and measures to raise supply of affordable housing to address affordability. - Early signs: recent measures have slowed approval of new loans and begun to cool the housing market; some inertia in loan growth can be expected from drawdowns of already committed loans. - If credit growth remains strong, additional MAPs should be introduced; possible options include: - capping loan‑to‑value ratios (LTV) on second and first mortgages, - explicit limits on debt service‑to‑income ratios, - additional capital charges on high LTV loans. - Design of additional MAPs should consider the evolving stance of monetary policy and aim to ensure effectiveness and avoid circumvention. ### Risks to the baseline and policy responses - If the growth outlook deteriorates significantly: - Flexible exchange rate can act as a shock absorber; BNM has room to cut its policy rate to support growth. - High fiscal deficit and public debt constrain space for sustained countercyclical fiscal response; any fiscal stimulus should be temporary, targeted, and anchored in a credible medium‑term fiscal consolidation program. - Structural reforms, subsidy rationalization, and GST implementation should not be delayed or compromised; sound public finances are paramount to macrofinancial stability. - Exchange rate flexibility, complemented by foreign exchange intervention to smooth excessive volatility, should be the main tool to respond to unpredictable capital flows. --- ### Authorities’ views ### Fiscal policy: A breakthrough - Authorities committed to meeting fiscal targets, pressing ahead with subsidy rationalization and implementation of the GST. - High-level Fiscal Planning Committee (FPC) established to strengthen fiscal management and provide assurance on fiscal sustainability while safeguarding growth. - Subsidies on fuel, electricity, and sugar are being rationalized; GST to be introduced in April 2015. - Social safety net strengthened by enhancing existing cash transfer program for lower income groups to mitigate impact of fiscal consolidation. - Authorities committed to careful design and execution to mitigate implementation risk. ### Fiscal sustainability and medium-term fiscal adjustment - Federal debt estimated at 54.8 percent of GDP at end-2013, up from about 40 percent of GDP at the start of the global financial crisis. - Under a no adjustment scenario (constant primary balance), federal debt-to-GDP would exceed the authorities’ self-imposed debt ceiling of 55 percent in the medium-term and continue to increase. - Staff supports reducing the federal deficit to 3 percent by 2015 and to about zero by 2020. - Mission baseline: cumulative improvement of about 4 percent of GDP in the cyclically-adjusted primary balance required to lower federal debt-to-GDP to pre-crisis level of about 40 percent. - Need to rebuild buffers to allow for countercyclical fiscal policy, absorb contingent liabilities, and ensure debt remains below 55 percent. ### Staff assessment and recommended medium-term strategy - Staff welcomes comprehensive fiscal reform package; notes timing, pace, and adequate preparation time for GST implementation, including public education. - Implementation and political risks considered circumscribed by authorities’ commitment and technical preparedness; fiscal reforms described as a marathon, not a sprint. - To achieve 2020 targets and sustained savings, staff elaborated a medium-term fiscal strategy relying on revenue and expenditure instruments with characteristics: low fiscal multipliers; reduced reliance on corporate and oil revenues; progressive (or at least less regressive) distributional impact. - Staff recommended structural reforms to promote efficiency, growth, and equity, restrict wage growth, improve efficiency of public spending (particularly education), raise contributions to the Civil Service Pension Fund (KWAP), and consider measures to address long-term pension sustainability. ### Key fiscal feasibility points and potential measures - Authorities’ target of reducing deficit to 3 percent of GDP by 2015 is feasible conditional on GST implementation and fuel subsidy rationalization; further measures needed beyond 2015 to balance the federal budget by 2020 as oil revenues decline and nondiscretionary expenditures rise. - Spending pressures include civil service pensions and aging-related costs; repayment of previous off-budget stimulus spending; obligations such as Mass Rapid Transit (MRT) project. - Staff supports authorities’ plan to elaborate, quantify and communicate medium-term fiscal consolidation strategy. - Potential Yield — Description (Percent of GDP): - GST: Broaden the tax base through revising the list of zero-rated and exempt goods. Increase GST rate from 6 percent to 8 percent. Potential yield: 1-1.5 - Property taxes: Broaden recurrent property taxes. Potential yield: 0.3-0.5 - Rationalize non-fuel subsidies: Rationalize subsidies on rice, flour and cooking oil and partially replace with targeted transfers. Potential yield: 0.2-0.3 - Restrict wage growth: Limit establishment of new posts, restrict bonus payments and achieve savings in emoluments in the education sector. Potential yield: 0.2-0.5 - Reduce inefficiencies in spending: Improve procurement, efficiency of education spending and social safety nets. Potential yield: 0.5-1 ### Tax policy - GST welcomed to broaden tax base and reduce reliance on oil and gas revenues over time; should help reduce informality and improve tax buoyancy. - Net revenue yield from GST estimated at about 0.3 percent of GDP initially due to relatively low standard rate and offsetting measures in 2014 budget. - Staff recommendations: - GST base broadening (reducing exemptions and zero-rated goods) should take precedence over increasing standard rate if needed. - Resist pressures to expand exempt and zero-rated goods to preserve GST efficiency. - Recurrent property taxes are underutilized—taxes on financial and property transactions and other property-related taxes are about 1.1 percent of GDP in Malaysia, lower than OECD median of 1.6 percent of GDP. - Authorities assessing effectiveness and costs of tax incentives; staff recommended better targeting of incentives based on cost-benefit analysis. ### Subsidy reform - Fuel subsidies exceed 10 percent of federal spending and are regressive and costly. - September price adjustments: prices of gasoline and diesel raised by 20 sen per liter, reducing price gap from 30 to 23 percent for gasoline and from 36 to 29 percent for diesel. After adjustment, subsidy remains of 63 sen per liter for gasoline (RON 95) and 80 sen per liter for diesel. - Staff recommendations: - Gradual but credible rationalization of fuel subsidies and eventual switch to an automatic price adjustment mechanism to preserve fiscal savings and depoliticize the issue. - Gradual reduction of off-budget subsidies on natural gas and electricity; bringing implicit subsidies on-budget to improve transparency and bolster support for reform. - Improve targeting of cash transfers (Bantuan Rakyat 1Malaysia (BR1M)); BR1M now benefits over 55 percent of households. Staff welcomes steps to create comprehensive database on welfare recipients and programs as announced in 2014 budget. ### Fiscal risks - Continued reliance on oil and gas revenues is a medium-term risk given resource depletion. - Oil price shocks or exchange rate shocks can cause unanticipated increases in subsidy bill, offsetting domestic savings. - Federal contingent liabilities sizeable; loan guarantees alone amount to 15 percent of GDP. - Staff recommendations on fiscal risk management: - Anchor budget targets on the non-oil primary balance to insulate budget and reduce procyclicality. - Improve monitoring and management of loan guarantees and other contingent liabilities; publish a fiscal risks statement with budget documents. - Warned of risk of pushing spending off-budget as federal gross debt approaches self-imposed ceiling, which would undermine budget credibility. - Support reforms to strengthen public financial management, including adopting accrual accounting, introducing a medium-term fiscal framework, and reducing use of supplementary budgets. - Welcome efforts to improve public procurement and move toward performance-based budgeting. ### Authorities’ views (summary) - Committed to medium-term fiscal consolidation, subsidy rationalization and introduction of GST in 2015, underpinned by strengthened fiscal management and other structural reforms. - Emphasized gradual approach to fiscal adjustment and subsidy rationalization, with protection for vulnerable households. - Consider implementation risks to be small given high-level political commitment and technical preparedness. - Agreed on need to outline a medium-term fiscal plan to be endorsed by the FPC; work underway. - Noted that recent increase in federal loan guarantees are primarily to commercial nonfinancial public enterprises with capacity to service debt; argued contingent liabilities should be analyzed accounting for their (low) probability of default. --- ### Staff position (areas warranting attention) ### Household debt - Household debt: 83 percent of GDP. - Banks’ exposure to the household sector: 47 percent of banks’ assets. - Concerns: vigorous house price appreciation and strong growth in unsecured consumer credit. - Policy considerations and staff suggestions: - Additional macroprudential measures may be needed given rapid credit growth to households and growing credit intermediation by nonbanks to households. - Options include: - Explicit limits on debt service-to-income ratios, which would need support from ongoing development of credit registries. - Capping LTVs on second and first mortgages. - Additional capital charges on loans with high LTVs. - Note: BNM guidelines require banks to set a prudent limit on the debt service ratio (DSR); there is no set limit for all borrowers—banks vary the DSR based on borrower creditworthiness. - Data and coordination: - Staff welcomed progress with the collection of granular data to support surveillance. - Authorities have issued guidelines for responsible financing to nonbanks similar to those applicable to banks. - Recent independent policy actions by state governments to curb price increases suggest scope for closer coordination between local and federal authorities. ### Banks’ exposure to real estate and nonfinancial corporates - Banks’ exposure to the nonfinancial corporate sector: 43 percent of banks’ assets. - Real estate exposure: - About 30 percent of the total stock of corporate loans. - Nearly 40 percent of recent flow of corporate lending. - Aggregate nonfinancial corporate sector assets: estimated to be more than 4 times GDP. ### Corporate debt - Financing structure: - Bank loans make up nearly 60 percent of total corporate liabilities. - Debt issuance is long term and mainly denominated in ringgit, averaging almost 80 percent of the total in recent years. - Aggregate indicators: - Earnings nearly four times interest expense on debt liabilities. - Liquidity: current assets nearly 1.6 times current liabilities. - Cash buffers estimated at 14 percent of assets. - Leverage: debt-equity ratio of about 45 percent. - Caveats: - Solvency situation varies considerably across corporates and could change rapidly as earnings are volatile. - Further detailed assessment of foreign currency assets and liabilities of domestic corporates is desirable. ### Asset quality - Nonperforming loans (NPLs): 2 percent of gross loans in 2013 (compared with 6 percent at end-2007). - Trend: long-term improvement with a trend decline in impaired loans, with a slight reversal since March 2013. - Provisions: banks’ provisions cover nearly 100 percent of all impaired loans. - Banks’ holdings of government and corporate securities: about 16 percent of total assets in August 2013, of which federal government securities are 4.5 percent. ### Foreign currency and cross-border exposures - Banking system foreign currency exposure: 4 percent of loans and 5 percent of deposits. - Authorities’ stress tests: indicate a manageable level of FX liquidity risk in the banking system. - Cross-border activity: - Overseas lending by the top five banks: nearly 24 percent of total lending. - Loans-to-local deposit ratios: about 84 percent. - Supervision and cooperation: - Authorities expanding MoUs for cross-border supervision; importance of deepening home-host cooperation emphasized. - Funding: cross-border assets mainly funded from host countries. ### Impact of higher interest rates (staff solvency sensitivity analysis) - Scenario: increase in MGS yields by 100 bps combined with an increase in the OPR of 50 bps over one year. - Estimated impact: little impact on aggregate household balance sheets or bank capital because of earnings and savings buffers. - Corporate interest servicing ratio rises by 2.6 percentage points to 27.6 percent. - More stringent stress tests (200 bps policy rate increase over one year): - Aggregate household debt servicing ratio (DSR) increases by 4 percentage points to nearly 48 percent ignoring corresponding income from savings; including income rises DSR by only half a percentage point. - Corporate interest service ratio rises by nearly 8 percentage points to 33 percent, assuming no change in corporate earnings and full rollover of debt coming due. - Banking system’s Tier 1 capital ratio falls by 1.1 percentage points to 12.8 percent (same effect as a doubling of NPLs). - Duration effects: the same rate shock over a 2 year period would have a much lower impact on bank capital because it would allow use of additional earnings as a buffer. - Data needs: - Results are at the aggregate level; availability of granular household data and more detailed analysis at individual corporate and banking level would provide more information on vulnerabilities. ### Authorities’ views (financial stability) - Agreement with staff on: financial sector is well-diversified; banking system is strongly capitalized, very liquid and reasonably profitable. - Enhancements noted: - Improvements in internal models used to stress-test banks’ solvency and liquidity, addressing FSAP recommendation for multiyear bottom-up analysis. - Implementation of the FSA and IFSA expands BNM’s supervisory and regulatory powers, including consolidated supervision covering subsidiaries of domestic banks operating in Labuan IBFC. - Household and corporate assessments: - Household debt burden has risen as a proportion of GDP but is supported by much larger financial asset buffers; household financial assets amount to 189 percent of GDP. - Corporate leverage remains moderate. - Policy approach: - Macroprudential policies pursued intentionally gradual to avoid unintended consequences and over-adjustment. - Rapidly increasing house prices are a concern; authorities argue increases reflect supply-demand mismatches, motivating increases in the Real Property Gains Tax (RPGT) and other measures to increase supply of affordable housing. - UMP withdrawal impact: - Authorities believe households will remain largely unaffected as higher debt servicing costs would be offset by higher rates of return on savings including deposits. --- ### Capital flows, external sector and reserves ### Capital outflows: May–July 2013 episode - Foreign investors reduced exposures to Malaysian bonds and equities by 3.5 percent and 1.3 percent, respectively, of early-May allocations on a net basis. - 10-year MGS yields rose by 102 bps peak-trough; U.S. 10-year treasury yields rose 69 bps. - Malaysian corporate bonds sold off with yields increasing by 120 bps (JP Morgan JACI Malaysia). - Equities: domestic investors stepped in; stock prices rose by 1.3 percent between mid-May and end-July. - Ringgit weakened by about 11 percent against the dollar (peak-to-trough). ### Vulnerabilities and resilience - Ongoing normalization of AEs’ interest rates reduces carry trade advantage for Malaysian assets. - Malaysia’s specific vulnerabilities: - Relatively high level of federal debt and large foreign holdings of government securities: 42 percent. - Current account surplus decline: to 3−4 percent of GDP in 2013−14 from an average of 12½ percent of GDP in 2009−11. - Mitigants: - Strong external position historically, exchange rate allowed to act as a shock absorber while authorities intervened to avoid excessive volatility. - Role of domestic institutional investors: - Domestic investors have additional capacity of about 6 percent of GDP for purchases of MGS (staff illustrative calculations, Q3:2013 data). - Foreign outflows from MGS during Q2:2013 amounted to about 1 percent of GDP. - Foreign investors held about 13 percent of GDP in MGS as of Q3:2013. - Caution: international exposure of domestic institutional investors estimated at about 20 percent of GDP and may not be fully liquid. ### External sector developments and outlook - External rebalancing driven by robust domestic demand (including large investment projects under the Economic Transformation Program (ETP)) and weak external demand. - Current account: - Declined to 3.8 percent of GDP in 2013 from 6.1 percent of GDP in 2012 and 11.6 percent in 2011. - Non-oil current account swung into a deficit of about 2.4 percent of GDP from a 4.2 percent surplus in 2011. - IMF composite reserve adequacy metric: 117 percent. - Net international investment position: –2 percent of GDP. - Medium-term projection: increased public sector savings offset by sustained private consumption and investment expected to result in a current account surplus of 3−4 percent over the medium term. - Staff estimates: - Staff’s cyclically-adjusted current account norm for 2013: 1.5 percent of GDP. - External Balance Assessment (EBA) norm for 2013: -0.1 percent of GDP. - Projected cyclically adjusted current account surplus: 4.1 percent of GDP. - Implied total current account gap: 2.6 percent of GDP, with the policy gap contributing the bulk. - Malaysia’s REER assessed as moderately undervalued by about 9 percent. - Staff view: remaining current account and REER gaps reflect inadequate social protection, need to improve pension risk sharing, investment bottlenecks, infrastructure gaps, labor force skill mismatches, and labor market rigidities. - Note: Staff estimates indicate that every 1 percentage point improvement in the fiscal balance could strengthen the current account by about 0.4 percentage point. --- ### Medium-term fiscal consolidation (Box 3) — design, measures and implications ### Background and objectives - Authorities aim to lower the budget deficit to about 3 percent of GDP by 2015 and balance the budget by 2020. - The objective of achieving a balanced budget by 2020 implies a consolidation of 4.0−4.1 percent of GDP in terms of the cyclically-adjusted primary balance. - Declining oil revenues and a rise in nondiscretionary spending pressures in the medium term mean further measures beyond announced adjustments will be needed. ### Revenue measures — findings and potential yields - Malaysia relies heavily on direct income taxes, especially corporate income taxes; indirect taxation is underutilized. - Predicted norm for Malaysia’s consumption taxes is 6−6.3 percent of GDP, suggesting a gap of 2.7−3 percentage points. - Corporate income tax (CIT) rate is 25 percent; CIT rate will be reduced by one percentage point effective 2016 as an offsetting measure for the GST. - Estimated fiscal yields from revenue-side measures: - Rationalizing tax incentives: potential fiscal savings in the range of 0.1−0.5 percent of GDP. - Property taxes are under-utilized and could be expanded. - Combined, all of the revenue measures could together generate about 4.5 percent of GDP in savings. ### Expenditure measures — findings and potential yields - Subsidy rationalization: - Fuel subsidy rationalization alone could yield fiscal savings of 2.2−2.7 percent of GDP, taking into account offsetting cash transfers. - Rationalization of other subsidies (cooking oil, rice, flour) could generate additional savings of 0.2−0.3 percent of GDP. - Wage bill and public employment: - Wage bill has increased by 0.9 percentage points since 2008, to 6.2 percent of GDP. - Measures to contain wage growth include restricting hiring to essential personnel and limiting establishment of new posts. - Broad-based efficiency gains: - Improved procurement can be a source of fiscal savings. - Development spending: - Limited scope for savings, estimated at 0.2−0.4 percent of GDP given its decline in recent years. ### Tradeoffs and policy implications - Short-run growth: all revenue and expenditure measures have negative short-run growth effects; public investment and consumption have the largest negative short-run impact. - Long-run growth: - Public investment is expected to have the highest negative impact on long-run growth if cut. - Subsidy rationalization is the most growth-friendly fiscal measure, with an expected small positive impact on long-run growth. - Distributional impacts: - Subsidy rationalization, property taxes, and a progressive increase in personal income taxes are expected to have positive distributional impacts. - Public investment and the GST are expected to have relatively higher negative distributional impacts. - Conclusions: - From growth and equity perspectives, subsidy rationalization and property taxes are desirable instruments. - Improvements in efficiency of social safety nets and progressive personal income tax increases rank highly. - GST is necessary given its revenue potential despite equity concerns. - Public investment should be protected from cuts where possible. --- ### Public Debt Sustainability Analysis (Appendix 4) — key findings and scenarios ### Framework and macro-fiscal assumptions - New DSA framework for market access countries used; includes stochastic debt projection and heat map. - Macroeconomic assumptions: - Growth: projected at 4.7 percent in 2013, rising to 5 percent in 2014; growth will average 5 percent in the medium term. - GDP deflator: about 0 percent in 2013, 4.6 percent in 2014, and projected to fall gradually towards 2.5 percent. ### Fiscal assumptions and baseline - Federal government deficit: reduced from 4.3 percent of GDP in 2013 to 2.6 percent in 2015 in staff’s baseline projections. - Projections assume: - gradual elimination of fuel subsidies with partial replacement by targeted cash transfers to the lower income group; - introduction of GST in 2015. - Fiscal deficit starts to increase after 2016 due to gradual decline in oil and gas related revenues and increases in pension and health care related costs. ### DSA baseline projections and stress tests - Baseline debt path: - Under the baseline, debt-to-GDP ratio is projected to decrease to slightly below 50 percent by 2018. - Under the constant primary balance simulation, debt-to-GDP increases to 56 percent by 2018. - Macrofiscal shocks: - One standard deviation shock to real GDP growth: debt-to-GDP initially increases to 57 percent in 2015 and declines thereafter. - Combined macro-fiscal shock and a permanent 20 percent oil price shock: imply a flat debt-to-GDP profile in the medium term. - Stochastic simulations: - The 90th percentile of debt-to-GDP ratio simulations is below 70 percent. - Gross financing needs: - Under all scenarios remain at about 9 percent, and rise to just below 12 percent by the end of the projection horizon. - Contingent liability + adverse macro scenario: - If economy is hit by a persistent shock to growth and interest rates rise by 150 basis points while government absorbs guaranteed loans (15 percent of GDP), debt-to-GDP would remain just below the 70 percent debt benchmark. ### Selected debt and macro indicators (as reported) - Nominal gross public debt: 44.3 (2011), 51.6 (2012), 53.3 (2013), 54.8 (2014), 53.3 (2015), 51.7 (2016), 50.1 (2017), 49.2 (2018). - Public gross financing needs (percent of GDP): 8.9 (2011), 10.9 (2012), 11.1 (2013), 10.4 (2014), 9.0 (2015), 8.9 (2016), 8.6 (2017), 9.2 (2018). - Real GDP growth (percent): 5.1 (2011), 5.1 (2012), 5.6 (2013), 4.7 (2014), 5.0 (2015−2018). - Inflation (GDP deflator, percent): 4.3 (2011), 5.5 (2012), 0.7 (2013), -0.1 (2014), 4.6 (2015), 3.8 (2016), 2.9 (2017), 2.6 (2018). - Effective interest rate (percent): 5.4 (2011), 4.4 (2012), 4.3 (2013−2015), 4.4 (2016), 4.5 (2017), 4.7 (2018). - Change in gross public sector debt (cumulative): 1.1 (2011), 0.5 (2012), 11.7 (2013), 21.5 (2014 cumulative), -1.5 (2015), -1.6 (2016), -1.6 (2017), -0.9 (2018), -0.5 (cumulative), -4.6 (total cumulative). ### Heat map and risk assessment - External financing requirement: 13 percent (close to the upper threshold of early warning benchmarks). - Public debt held by foreigners: about 30 percent of total. - Despite low share of foreign currency and short-term debt, risks arise from external financing requirement and large share of public debt held by foreigners. - Presence of large domestic institutional investors who tend to make opportunistic investments provides some comfort. ### External debt sustainability (summary, Appendix 5) - External debt expected to fall to 25 percent of GDP by 2018. - Stress tests indicate external debt remains manageable under shocks: - Weaker GDP growth, lower current account balance, and a one-time 30 percent depreciation of the ringgit all result in only modest rises in the external debt-to-GDP ratio. - The exchange rate depreciation scenario: external debt-to-GDP rises sharply to 40 percent in 2014, then falls to 37 percent by 2018. - Baseline external debt: 29.6 (2008), 33.6 (2009), 29.9 (2010), 28.1 (2011), 27.1 (2012), 27.3 (2013), 26.7 (2014), 26.1 (2015), 25.8 (2016), 25.6 (2017), 25.2 (2018). - Gross external financing need (percent of GDP): -2.6 (2008), 3.6 (2009), 9.8 (2010), 8.5 (2011), 11.6 (2012), 13.6 (2013), 12.3 (2014), 11.5 (2015), 10.6 (2016), 9.8 (2017), 9.2 (2018). --- ### Policies, structural reforms and staff appraisal ### Policies to reduce saving-investment gap and strengthen social protection - Structural reforms aimed at strengthening social protection while safeguarding fiscal sustainability, improvements in the investment climate, and population aging should help reduce the saving-investment gap over time. - Staff recommendations: - Introduction of unemployment insurance is recommended; authorities are studying this measure. - Improve coverage and adequacy of retirement schemes in the private sector. - Continued exchange rate flexibility with intervention limited to dampening excessive volatility to support external rebalancing. ### Human capital and education reforms - Malaysia implementing multiyear transformation programs to upgrade human capital, foster technological readiness, inject greater competition, and strengthen government performance. - Priorities: - Expand access to tertiary education and increase availability of financing to underserved groups. - Improve quality control in private universities and retain Malaysian-grown talent domestically. - Improve educational attainment at basic and secondary levels. - Malaysian Education Blueprint 2013−25 aims to place Malaysian students in the top third of international assessments. ### Staff appraisal — outlook and risks - Near-term growth prospects are favorable; transition to the post-UMP environment should be relatively smooth. - Real GDP growth picked up in the second half of 2013 and momentum likely to be sustained in 2014. - Continued robust domestic demand and an improved external environment should offset mild headwinds from timely, decisive, yet gradual fiscal consolidation. - Risks: - Downside risks include a bumpy exit from UMP, a sharp slowdown in China, or a protracted period of slow growth in Europe. - Fiscal policy and medium-term strategy: - Staff views 2013 fiscal recalibration as a breakthrough; supports gradual debt reduction and a concrete debt target for 2020. - Supports strengthening public financial management and publication of an annual fiscal risks statement. - Monetary policy: - Given dual mandate, downside risks to growth, and very low inflation, BNM appropriately maintained an accommodative stance in 2013. - BNM must contend with higher headline inflation in 2014–15; staff views the risk of economy-wide wage-price spirals as low but recommends readiness to adjust policy rates to curb second-round effects. - Financial sector stability: - Malaysia’s financial system is sound and well placed to withstand potential stresses. - Ongoing vigilance warranted due to global volatility, high household debt, rising house prices. - If housing price increases continue unabated, authorities should adopt additional macroprudential measures. ### Recommendation - It is recommended that the next Article IV consultation with Malaysia take place on a standard 12-month cycle. _Italicized source: IMF staff report excerpts for Malaysia (sections cited, including Fiscal Policy Committee, Authorities’ views, Staff position, Boxes and Appendices)._ ### 1. Fiscal Policy Committee ______________________________________________________________________ 27 ### 1. Fiscal Policy Committee ### Recent developments and context - General elections held on May 5, 2013; incumbent coalition won narrowly, ensuring smooth policy transition. - Authorities created a High-Level Fiscal Policy Committee (FPC); food and fuel subsidies and electricity tariffs are being rationalized; a Goods and Services Tax (GST) will be introduced in 2015. - These measures aim to rebuild fiscal buffers lost after expansionary policies during the global financial crisis. ### Economic developments and key indicators - Growth slowed to 4.7 percent in 2013, compared with 5.6 percent in 2012. - A small negative output gap opened up in 2013; domestic demand remained robust. - Headline inflation rose to 3.2 percent year‐on‐year in December 2013; core inflation was less than 2 percent in December 2013. - During spring-summer 2013 the ringgit weakened by about 11 percent (peak-to-trough) against the dollar. - Between end‑May and end‑2013, 10‑year MGS yields increased by 70 bps and the spread against the U.S. dollar widened by about 20 bps. - Financial markets: deep financial markets and a flexible exchange rate have facilitated adjustment without appreciable harm to date. ### Outlook and projections - Growth projected to accelerate to 5.0 percent in 2014. - Over the medium term, growth expected to average 5 percent. - Fiscal impulse in 2014 is about minus 1 percent of GDP (staff’s definition). - Inflation expected to modestly increase during 2014; inflation likely to reach about 4.0 percent in 2015 following GST introduction; in staff’s baseline scenario inflation is expected to gradually moderate to below 3.0 percent in the medium term. - Oil revenues are projected to decline by 0.5 percent of GDP. ### Risks to the baseline - External risks: - A potentially bumpy exit from unconventional monetary policies (UMP) in advanced economies (AEs) could trigger financial market turbulence and dampen external demand. - Vulnerability to capital outflows given sizeable foreign investor positions in domestic bond and equity markets (evidenced in spring-summer 2013). - Other external risks: further slowdown in China, protracted slow growth in Europe, commodity price shocks. - Domestic risks: - Federal debt is close to the government’s self-imposed ceiling of 55 percent of GDP and large contingent federal liabilities limit room for countercyclical fiscal policy. - Implementation risks associated with comprehensive fiscal reforms could undermine investor sentiment and trigger outflows and a jump in yields. - High house prices, rising household debt, and banks’ large exposure to real estate, especially if UMP unwinding tightens domestic financial conditions and raises interest rates. - Adjustments in fuel prices expected to add about 0.5 percentage point to annual inflation in 2014−15; the GST could add about 0.9 percentage point in 2015. - Staff assessment: implementation risks are low given authorities’ political will and technical expertise; low starting inflation and BNM’s policy credibility limit second‑round effects. ### Policy advice and authorities’ actions - Authorities have taken decisive steps to strengthen public finances in H2 2013 within a medium-term fiscal adjustment program; actions are consistent with past Fund technical assistance and staff advice. - Authorities are: - Monitoring financial sector risks and implementing additional macroprudential measures. - Collecting granular data on household assets and liabilities. - Allowing two‑way exchange rate flexibility. - Implementing wide‑ranging structural reforms with IMF and other international support. - Authorities’ views: - Anticipate growth increase in 2014; expect private investment growth to remain robust at about 13 percent; some moderation in private consumption growth likely. - Main risks are on the downside, especially external; uncertainty around UMP unwinding and heightened volatility are key concerns. - Committed to steadfast implementation of fiscal reforms; assess second‑round inflation effects from subsidy rationalization as limited. - Less concerned about financial stability risks from household debt and house prices, citing high household financial assets, healthy labor markets, and mortgage rates largely tied to the policy rate. - Targeted, phased macroprudential policies and financial literacy efforts have helped curtail risks. ### Near-term policy mix: achieving a smooth transition - Overall assessment: policy mix appropriate to address fiscal vulnerabilities amid low inflation and an improving but uncertain external environment. - Fiscal policy: decisive yet gradual tightening should help maintain market access at low funding costs while avoiding undue growth damage or igniting higher inflation. - Monetary policy: slightly accommodative stance has been supportive of growth given low inflation and a small negative output gap; recalibration may be needed as UMPs unwind and inflation risks rise. - Macroprudential tightening to date appears to have helped address financial stability risks; continued monitoring and potential additional measures are warranted. ### Fiscal policy details - Federal government recalibrated fiscal policy in September‑October 2013 and is on track to reach a fiscal deficit target of 4.0 percent of GDP in 2013. - Staff projects fiscal adjustment in 2013 of about 1 percent of GDP, driven by higher income taxes and lower development spending. - Current spending rose in recent years (driven by wages and subsidies) and was higher than budgeted in 2013 but is expected to remain stable relative to GDP. - Spending on subsidies increased by 0.6 percentage points of GDP in 2012 and remained elevated in 2013; fuel price adjustments in September 2013 reduced this. - The 2014 federal deficit target of 3.5 percent of GDP seems feasible if growth in current spending is contained and further fuel price increases occur. - Under staff’s baseline, 2014 fiscal adjustment will be driven by subsidies (about 1 percent of GDP) and the wage bill; development spending as percent of GDP will slow. - Fiscal impulse (staff’s definition) is about minus 1 percentage point of GDP. - Public sector deficit widened to 5 percent of GDP in 2012 and is expected to be about 6½ percent of GDP during 2013−2014, driven in part by higher development spending by Nonfinancial Public Enterprises (NFPEs). - Fiscal impulse at the broader public sector level was positive in 2013 but expected to turn negative in 2014. ### Monetary policy details - Bank Negara Malaysia (BNM) policy rate unchanged at 3 percent since May 2011. - Staff expects BNM to begin a gradual tightening cycle, warranted by external uncertainty and the need to safeguard financial stability given high household debt. - BNM’s near‑term task: allow pass‑through of cost‑related increases (cost‑push inflation) while detecting and preempting second‑round effects embedding in the wage‑price structure. ### Macroprudential policies (MAPs) - Household debt reached 83 percent of GDP at end‑September 2013, up from 55 percent five years earlier. - Over half of household debt is on residential property; nearly 70 percent of residential property loans are contracted at variable rates tied to the Base Lending Rate (BLR). - Since November 2010 and continuing through the 2014 budget, authorities imposed a series of targeted, gradual, and escalating MAPs primarily directed at speculative home purchases and unsecured credit. - The 2014 budget included special financing schemes and measures to raise supply of affordable housing to address affordability. - Early signs: recent measures have slowed approval of new loans and begun to cool the housing market; some inertia in loan growth can be expected from drawdowns of already committed loans. - If credit growth remains strong, additional MAPs should be introduced; possible options include: - capping loan‑to‑value ratios (LTV) on second and first mortgages, - explicit limits on debt service‑to‑income ratios, - additional capital charges on high LTV loans. - Design of additional MAPs should consider the evolving stance of monetary policy and aim to ensure effectiveness and avoid circumvention. ### Risks to the baseline and policy responses - If the growth outlook deteriorates significantly: - Flexible exchange rate can act as a shock absorber; BNM has room to cut its policy rate to support growth. - High fiscal deficit and public debt constrain space for sustained countercyclical fiscal response; any fiscal stimulus should be temporary, targeted, and anchored in a credible medium‑term fiscal consolidation program. - Structural reforms, subsidy rationalization, and GST implementation should not be delayed or compromised; sound public finances are paramount to macrofinancial stability. - Exchange rate flexibility, complemented by foreign exchange intervention to smooth excessive volatility, should be the main tool to respond to unpredictable capital flows. *Source: IMF staff report excerpt — “Fiscal Policy Committee” section.* ### 13. Authorities’ views. The authorities reiterated their commitment to meeting their fiscal ### 13. Authorities’ views. ### Fiscal policy: A breakthrough - Authorities committed to meeting fiscal targets, pressing ahead with subsidy rationalization and implementation of the GST. - High-level Fiscal Planning Committee (FPC) established to strengthen fiscal management and provide assurance on fiscal sustainability while safeguarding growth. - Subsidies on fuel, electricity, and sugar are being rationalized; GST to be introduced in April 2015. - Social safety net strengthened by enhancing existing cash transfer program for lower income groups to mitigate impact of fiscal consolidation. - Authorities committed to careful design and execution to mitigate implementation risk. ### Fiscal sustainability and medium-term fiscal adjustment - Federal debt estimated at 54.8 percent of GDP at end-2013, up from about 40 percent of GDP at the start of the global financial crisis. - Under a no adjustment scenario (constant primary balance), federal debt-to-GDP would exceed the authorities’ self-imposed debt ceiling of 55 percent in the medium-term and continue to increase. - Staff supports reducing the federal deficit to 3 percent by 2015 and to about zero by 2020. - Mission baseline: cumulative improvement of about 4 percent of GDP in the cyclically-adjusted primary balance required to lower federal debt-to-GDP to pre-crisis level of about 40 percent. - Need to rebuild buffers to allow for countercyclical fiscal policy, absorb contingent liabilities, and ensure debt remains below 55 percent. ### Staff assessment and recommended medium-term strategy - Staff welcomes comprehensive fiscal reform package; notes timing, pace, and adequate preparation time for GST implementation, including public education. - Implementation and political risks considered circumscribed by authorities’ commitment and technical preparedness; fiscal reforms described as a marathon, not a sprint. - To achieve 2020 targets and sustained savings, staff elaborated a medium-term fiscal strategy relying on revenue and expenditure instruments with characteristics: low fiscal multipliers; reduced reliance on corporate and oil revenues; progressive (or at least less regressive) distributional impact. - Staff recommended concrete structural reforms to promote efficiency, growth, and equity, restrict wage growth, improve efficiency of public spending (particularly education), raise contributions to the Civil Service Pension Fund (KWAP), and consider other measures to address long-term pension sustainability. ### Key fiscal feasibility points and potential measures - Authorities’ target of reducing deficit to 3 percent of GDP by 2015 is feasible conditional on GST implementation and fuel subsidy rationalization; further measures needed beyond 2015 to balance the federal budget by 2020 as oil revenues decline and nondiscretionary expenditures rise. - Spending pressures include civil service pensions and aging-related costs; repayment of previous off-budget stimulus spending; obligations such as Mass Rapid Transit (MRT) project. - Staff supports authorities’ plan to elaborate, quantify and communicate medium-term fiscal consolidation strategy. - Potential Yield — Description (Percent of GDP): - GST: Broaden the tax base through revising the list of zero-rated and exempt goods. Increase GST rate from 6 percent to 8 percent. Potential yield: 1-1.5 - Property taxes: Broaden recurrent property taxes. Potential yield: 0.3-0.5 - Rationalize non-fuel subsidies: Rationalize subsidies on rice, flour and cooking oil and partially replace with targeted transfers. Potential yield: 0.2-0.3 - Restrict wage growth: Limit establishment of new posts, restrict bonus payments and achieve savings in emoluments in the education sector. Potential yield: 0.2-0.5 - Reduce inefficiencies in spending: Improve procurement, efficiency of education spending and social safety nets. Potential yield: 0.5-1 ### Tax policy - GST welcomed to broaden tax base and reduce reliance on oil and gas revenues over time; should help reduce informality and improve tax buoyancy. - Net revenue yield from GST estimated at about 0.3 percent of GDP initially due to relatively low standard rate and offsetting measures in 2014 budget. - Staff recommendations: - GST base broadening (reducing exemptions and zero-rated goods) should take precedence over increasing standard rate if needed. - Resist pressures to expand exempt and zero-rated goods to preserve GST efficiency. - Recurrent property taxes are underutilized—taxes on financial and property transactions and other property-related taxes are about 1.1 percent of GDP in Malaysia, lower than OECD median of 1.6 percent of GDP. - Authorities assessing effectiveness and costs of tax incentives; staff recommended better targeting of incentives based on cost-benefit analysis. ### Subsidy reform - Fuel subsidies exceed 10 percent of federal spending and are regressive and costly. - September price adjustments: prices of gasoline and diesel raised by 20 sen per liter, reducing price gap from 30 to 23 percent for gasoline and from 36 to 29 percent for diesel. After adjustment, subsidy remains of 63 sen per liter for gasoline (RON 95) and 80 sen per liter for diesel. - Staff recommendations: - Gradual but credible rationalization of fuel subsidies and eventual switch to an automatic price adjustment mechanism to preserve fiscal savings and depoliticize the issue. - Gradual reduction of off-budget subsidies on natural gas and electricity; bringing implicit subsidies on-budget to improve transparency and bolster support for reform. - Improve targeting of cash transfers (Bantuan Rakyat 1Malaysia (BR1M)); BR1M now benefits over 55 percent of households. Staff welcomes steps to create comprehensive database on welfare recipients and programs as announced in 2014 budget. ### Fiscal risks - Continued reliance on oil and gas revenues is a medium-term risk given resource depletion. - Oil price shocks or exchange rate shocks can cause unanticipated increases in subsidy bill, offsetting domestic savings. - Federal contingent liabilities sizeable; loan guarantees alone amount to 15 percent of GDP. - Staff recommendations on fiscal risk management: - Anchor budget targets on the non-oil primary balance to insulate budget and reduce procyclicality. - Improve monitoring and management of loan guarantees and other contingent liabilities; publish a fiscal risks statement with budget documents. - Warned of risk of pushing spending off-budget as federal gross debt approaches self-imposed ceiling, which would undermine budget credibility. - Support reforms to strengthen public financial management, including adopting accrual accounting, introducing a medium-term fiscal framework, and reducing use of supplementary budgets. - Welcome efforts to improve public procurement and move toward performance-based budgeting. ### Authorities’ views (as stated) - Committed to medium-term fiscal consolidation, subsidy rationalization and introduction of GST in 2015, underpinned by strengthened fiscal management and other structural reforms. - Emphasized gradual approach to fiscal adjustment and subsidy rationalization, with protection for vulnerable households. - Consider implementation risks to be small given high-level political commitment and technical preparedness. - Agreed on need to outline a medium-term fiscal plan to be endorsed by the FPC; work underway. - Noted that recent increase in federal loan guarantees are primarily to commercial nonfinancial public enterprises with capacity to service debt; argued contingent liabilities should be analyzed accounting for their (low) probability of default. ### Financial stability - 2012 IMF-World Bank FSAP found Malaysia’s financial system sound with strong supervisory and regulatory system. - Banking sector: - Banks provide over 85 percent of domestic credit; nonbanks provide remaining 15 percent of credit and constitute 9 percent of financial system assets. - Tier 1 capital ratio of 13.9 percent at end-2012, positioning banks to meet Basel III target of 8.5 percent by 2019. - Liquidity coverage ratio (LCR) of 60 percent consistent with 2015 Basel III target; meeting 2019 target of 100 percent is more challenging. - Deposits dominated funding: deposits make up 80 percent of total; 17 percent of these deposits are classified as strictly callable. - Return on equity averages about 14 percent in recent years; competition for retail deposits has compressed net interest margins. - Risks noted: - Funding costs likely to increase as deposit rates rise with unwinding of UMPs; variable rate loans tied to BLR could lead to further compression of net interest margins. - BNM issued industry consultation paper in January 2014 proposing a new reference rate to replace the BLR, reflecting funding costs and increasing transparency. ### FSAP update - Authorities have implemented significant FSAP recommendations: - Financial Services Act (FSA) and Islamic Financial Services Act (IFSA) came into force on June 30, 2013, strengthening BNM’s powers, including prompt corrective action and consolidated supervision of financial holding companies. - Regulatory perimeter widened to include onshore nonbank financial entities and nonbank financial entities operating in Labuan IBFC (other than those licensed by Labuan Financial Services Authority). - IFSA provides Shariah-consistent legal framework from licensing to winding up. - Financial Stability Executive Committee expanded permanent membership to include the Securities Commission. - Authorities expect to complete collection of granular data on household assets and liabilities by income group by end-2014. *Source: _cr1480 — 13. Authorities’ views.* ### 24. Staff position. In staff’s view, the following areas warrant attention: ### 24. Staff position. In staff’s view, the following areas warrant attention: ### Household debt - Household debt: 83 percent of GDP. - Banks’ exposure to the household sector: 47 percent of banks’ assets. - Concerns: vigorous house price appreciation and strong growth in unsecured consumer credit. - Policy considerations and staff suggestions: - Additional macroprudential measures may be needed given rapid credit growth to households and growing credit intermediation by nonbanks to households. - Options include: - Explicit limits on debt service-to-income ratios, which would need support from ongoing development of credit registries. - Capping LTVs on second and first mortgages. - Additional capital charges on loans with high LTVs. - Note: In its guidelines on responsible financing for financial institutions, the BNM already requires banks to set a prudent limit on the debt service ratio (DSR); there is no set limit for all borrowers—banks vary the DSR based on borrower creditworthiness. - Data and coordination: - Staff welcomed progress with the collection of granular data to support surveillance. - Authorities have issued guidelines for responsible financing to nonbanks similar to those applicable to banks. - Recent independent policy actions by state governments to curb price increases suggest scope for closer coordination between local and federal authorities to ensure combined measures are not overly restrictive. ### Banks’ exposure to real estate and nonfinancial corporates - Banks’ exposure to the nonfinancial corporate sector: 43 percent of banks’ assets. - Real estate exposure: - About 30 percent of the total stock of corporate loans. - Nearly 40 percent of recent flow of corporate lending. - Implication: a price correction in the real estate market could have a significant impact on the value of banks’ collateral. - Aggregate nonfinancial corporate sector assets: estimated to be more than 4 times GDP. ### Corporate debt - Financing structure: - Bank loans make up nearly 60 percent of total corporate liabilities. - Debt issuance is long term and mainly denominated in ringgit, averaging almost 80 percent of the total in recent years. - Historical pattern: - Post-2008 surge in U.S. dollar-denominated debt issuance reverted to pre-crisis average since 2010. - Aggregate indicators: - Earnings nearly four times interest expense on debt liabilities. - Liquidity: current assets nearly 1.6 times current liabilities. - Cash buffers estimated at 14 percent of assets. - Leverage: debt-equity ratio of about 45 percent. - Caveats: - Solvency situation varies considerably across corporates and could change rapidly as earnings are volatile. - Resident companies hedge foreign currency exposure with onshore banks or by relying on foreign currency earnings from abroad. - No reports of concerns in the corporate sector from the depreciation of the ringgit during the summer of 2013. - Further detailed assessment of foreign currency assets and liabilities of domestic corporates is desirable and would require access to banks’ data on the size and nature of foreign currency hedging done by corporates. ### Asset quality - Nonperforming loans (NPLs): 2 percent of gross loans in 2013 (compared with 6 percent at end-2007). - Trend: long-term improvement with a trend decline in impaired loans, with a slight reversal since March 2013. - Provisions: banks’ provisions cover nearly 100 percent of all impaired loans. - Banks’ holdings of government and corporate securities: about 16 percent of total assets in August 2013, of which federal government securities are 4.5 percent. - Note: Many securities are held to maturity; there was no significant impact on banks’ capital from higher MGS yields in 2013. Accounting for government-guaranteed securities increases potential exposure. ### Foreign currency and cross-border exposures - Banking system foreign currency exposure: 4 percent of loans and 5 percent of deposits. - Authorities’ stress tests: indicate a manageable level of FX liquidity risk in the banking system. - Strategic priorities for banks: strengthen fee-based income and continue expansion overseas in ASEAN. - Cross-border activity: - Overseas lending by the top five banks: nearly 24 percent of total lending. - Loans-to-local deposit ratios: about 84 percent. - Major exposures and international earnings from: Singapore, Indonesia, Hong Kong, Thailand and Cambodia. - Supervision and cooperation: - Authorities are expanding the list of countries with which they have Memoranda of Understanding for cross-border supervision. - Importance of deepening home-host cooperation and supervision and strengthening crisis prevention and mitigation mechanisms, as outlined in Malaysia’s Financial Sector Blueprint. - Funding: At present, cross-border assets are mainly funded from host countries. - Risk note: Malaysian banking operations in Indonesia and Thailand remain profitable as of Q3:2013, but asset quality could weaken in response to recent developments. ### Impact of higher interest rates (staff solvency sensitivity analysis) - Scenario: increase in MGS yields by 100 bps combined with an increase in the OPR of 50 bps over one year. - Estimated impact: little impact on aggregate household balance sheets or bank capital because of earnings and savings buffers. - Corporate interest servicing ratio rises by 2.6 percentage points to 27.6 percent — could create difficulties for some individual corporates but unlikely to be systemic. ### More stringent stress tests (200 bps policy rate increase over one year) - A 200 bps increase in the policy rate over a one-year period would: - Increase the aggregate household debt servicing ratio (DSR) by 4 percentage points to nearly 48 percent ignoring the corresponding increase in income from savings; including the latter would raise the aggregate household DSR by only half a percentage point. - Note: asset and liability positions may not match across all household categories; some income groups may experience larger increases and become stressed. - Raise the corporate interest service ratio by nearly 8 percentage points to 33 percent, assuming no change in corporate earnings and full rollover of debt coming due. - Reduce the banking system’s Tier 1 capital ratio by 1.1 percentage points to 12.8 percent (same as a doubling of NPLs). - Duration effects: - The same rate shock over a 2 year period would have a much lower impact on bank capital because it would allow use of additional earnings as a buffer. - Data needs: - Results are at the aggregate level; availability of granular household data and more detailed analysis at individual corporate and banking level would provide more information on vulnerabilities. ### Authorities’ views - Agreement with staff on: financial sector is well-diversified; banking system is strongly capitalized, very liquid and reasonably profitable. - Enhancements noted: - Improvements in internal models used to stress-test banks’ solvency and liquidity, addressing FSAP recommendation for multiyear bottom-up analysis. - Implementation of the Financial Services Act and the Islamic Financial Services Act expands BNM’s supervisory and regulatory powers, including consolidated supervision covering subsidiaries of domestic banks operating in the Labuan International Business and Financial Center. - Household and corporate assessments: - Household debt burden has risen as a proportion of GDP but is supported by much larger financial asset buffers. - Corporate leverage remains moderate. - Policy approach: - Macroprudential policies pursued intentionally gradual to avoid unintended consequences and over-adjustment. - Rapidly increasing house prices are a concern; authorities argue increases reflect supply-demand mismatches, motivating increases in the Real Property Gains Tax (RPGT) and other budgetary measures to increase supply of affordable housing. - UMP withdrawal impact: - Authorities believe households will remain largely unaffected as higher debt servicing costs would be offset by higher rates of return on savings including deposits. - Regulatory coordination: - Authorities monitor growth in credit by nonbanks to households and have collaborated with the relevant regulator in issuing guidelines for responsible lending. - Operational challenge: - Domestic banks face challenges meeting Basel III LCR requirement related to standardized assumptions on deposit run-off rates versus BNM’s behavioral modeling approach. ### Capital outflows: vulnerabilities and resilience — background and episode summary - May–July 2013 episode: - Foreign investors reduced exposures to Malaysian bonds and equities by 3.5 percent and 1.3 percent, respectively, of early-May allocations on a net basis. - 10-year MGS yields rose by 102 bps peak-trough; U.S. 10-year treasury yields rose 69 bps. - Malaysian corporate bonds sold off with yields increasing by 120 bps (JP Morgan JACI Malaysia). - Equities: domestic investors stepped in; stock prices rose by 1.3 percent between mid-May and end-July. - Ringgit weakened by about 11 percent against the dollar (peak-to-trough). ### Vulnerabilities and resilience (analysis) - Ongoing normalization of AEs’ interest rates reduces carry trade advantage for Malaysian assets. - Baseline assumption: UMP exit likely gradual, but sudden significant portfolio outflows cannot be ruled out. - Malaysia’s specific vulnerabilities: - Relatively high level of federal debt and large foreign holdings of government securities: 42 percent. - Current account surplus decline: to 3−4 percent of GDP in 2013−14 from an average of 12½ percent of GDP in 2009−11. - Mitigants: - Strong external position historically, exchange rate allowed to act as a shock absorber while authorities intervened to avoid excessive volatility. ### Role of domestic institutional investors - Domestic investors (banks and saving funds) provided offsetting opportunistic purchases of equities and domestic government securities during turbulence, facilitating financial adjustment. - Staff illustrative calculations (Q3:2013 data): - Domestic investors have additional capacity of about 6 percent of GDP for purchases of MGS. - Foreign outflows from MGS during Q2:2013 amounted to about 1 percent of GDP. - Foreign investors held about 13 percent of GDP in MGS as of Q3:2013. - Caution: - International exposure of domestic institutional investors estimated at about 20 percent of GDP, well below total foreign ownership of domestic equities and bonds. - Overseas holdings of domestic institutional investors may not be fully liquid. ### Authorities’ views on capital outflows - Observations: - Growing depth of domestic capital markets has led to structural increase in nonresident holdings of government and BNM securities. - Malaysia is better prepared to deal with potential risks of capital outflows due to: - Higher levels of international reserves. - Better capitalized financial intermediaries. - A wider range of monetary instruments to manage liquidity. - Much deeper capacity of domestic institutional investors to absorb selling by nonresidents. - Volatility during May-September 2013 did not have any significant adverse impact on the real economy. ### External sector developments — background - External rebalancing driven by robust domestic demand (including large investment projects under the Economic Transformation Program (ETP)) and weak external demand. - Current account: - Declined to 3.8 percent of GDP in 2013 from 6.1 percent of GDP in 2012 and 11.6 percent in 2011. - Non-oil current account swung into a deficit of about 2.4 percent of GDP from a 4.2 percent surplus in 2011. - Drivers: - About two thirds of the adjustment due to a strong surge in private investment and large ETP investment projects. - Other indicators: - Exchange rate fluctuated more widely than in 2010−2012 but around a fairly horizontal trend. - International reserves decreased slightly. - IMF composite reserve adequacy metric: 117 percent. - Net international investment position: –2 percent of GDP. ### External sector outlook and assessment - Medium-term projection: increased public sector savings offset by sustained private consumption and investment expected to result in a current account surplus of 3−4 percent over the medium term. - Staff estimates and balance assessments: - Staff’s cyclically-adjusted current account norm for 2013: 1.5 percent of GDP. - External Balance Assessment (EBA) norm for 2013: -0.1 percent of GDP. - Projected cyclically adjusted current account surplus: 4.1 percent of GDP. - Implied total current account gap: 2.6 percent of GDP, with the policy gap contributing the bulk. - Malaysia’s real effective exchange rate (REER) assessed as moderately undervalued by about 9 percent. - Staff view: remaining current account and REER gaps reflect inadequate social protection (beyond public health expenditure), need to improve risk sharing of the pension system, investment bottlenecks, infrastructure gaps, labor force skill mismatches, and labor market rigidities. - Note: Staff estimates indicate that every 1 percentage point improvement in the fiscal balance could strengthen the current account by about 0.4 percentage point. *Source: IMF staff report excerpt (section 24 and surrounding paragraphs).* ### 34. Policies. Structural reforms aimed at strengthening social protection while safeguarding ### 34. Policies. Structural reforms aimed at strengthening social protection while safeguarding fiscal sustainability, together with improvements in the investment climate, and population aging should help reduce the saving-investment gap over time. ### Policies (saving-investment gap, social protection, exchange rate) - Structural reforms aimed at strengthening social protection while safeguarding fiscal sustainability, improvements in the investment climate, and population aging should help reduce the saving-investment gap over time; these changes take time as they involve the creation and reform of institutions. - Staff recommendations and observations: - Introduction of unemployment insurance is recommended; the authorities are studying this measure, which would further strengthen the safety net and reduce precautionary savings. - Scope exists to improve the coverage and adequacy of retirement schemes in the private sector to provide more effective protection against poverty in old age. - These measures should be complemented by continued exchange rate flexibility with intervention limited to dampening excessive volatility; this is likely to be associated with a gradual appreciation of the real exchange rate over time and support external rebalancing. ### Authorities’ views (external balances, exchange rate) - Authorities agreed with staff that the current account will remain in small surplus for the foreseeable future. - Authorities disagreed with staff’s assessment of external imbalances, particularly the exchange rate, arguing: - The EBA exercise may not be valid for Malaysia due to large unexplained residuals and that EBA’s cross-country approach may not fully capture Malaysia's unique characteristics. - The assessment of the exchange rate as undervalued is questioned in view of the selloff of the ringgit during periods of financial turbulence. - Authorities emphasize they do not manage the level of the exchange rate but intervene only to smooth excessive volatility. - They question the assessment that the current account surplus is too large, citing the sensitivity of global financial markets to current account deficits in emerging market economies and vulnerability of deficit countries to capital outflows during crises. ### Boosting growth and inclusion: Human capital development — Background - Malaysia is implementing multiyear transformation programs to: - upgrade human capital, - foster technological readiness, - inject greater competition in product markets, - strengthen government performance (Appendix 9 referenced). - Progress and remaining challenges: - Secondary net enrollment has risen sharply, as has enrollment in tertiary education. - Malaysia still faces shortages of high-skill workers and skill mismatches which constrain potential growth and efforts to reduce income inequality. - Heightened international demand (and competition) for talents increases the importance of strengthening the education system. ### Human capital policies (education reforms and priorities) - Additional reforms needed to make the education system more efficient and cost effective. - Staff recommendations and priorities: - Deliberate prioritization is needed in the context of scarce resources; priorities should include expanding access to tertiary education and increasing availability of financing to underserved groups. - Improve quality control in private universities and retain Malaysian-grown talent in the domestic economy. - Improve educational attainment (what students actually know) at basic and secondary levels. - Staff welcomes the authorities’ goal to place Malaysian students in the top third of international assessments and to reform and improve the performance of the Ministry of Education (see Malaysian Education Blueprint 2013−25). ### Authorities’ views on human capital - Authorities stressed their transformation programs and blueprints aim to transform Malaysia into an advanced, high-income nation by 2020. - Actions noted by authorities: - Partnerships between businesses and higher education catalyzed by government funding. - Merged Ministry of Higher Education into the Ministry of Education to increase accountability for teachers and researchers. - Intensifying elementary and secondary education efforts to bring Malaysian students to the top one third of countries tracked by PISA. - Progress in educational attainment as outlined in the Malaysia Education Blueprint, 2013−2025, is a high priority. - Agreement with the call for better education performance within a tighter budgetary environment. ### Staff appraisal — Outlook - Near-term growth prospects are favorable; transition to the post-UMP environment should be relatively smooth. - Real GDP growth picked up in the second half of 2013 and this momentum is likely to be sustained in 2014. - Continued robust domestic demand and an improved external environment should offset mild headwinds from timely, decisive, yet gradual fiscal consolidation. - Underlying inflationary pressures remain subdued, but headline inflation has picked up somewhat reflecting the effects of subsidy rationalization. ### Staff appraisal — Risks - Downside risks to growth include a bumpy exit from UMP, potentially leading to a protracted period of economic and financial volatility in EMEs. - Malaysia’s current account should remain comfortably in surplus; financial system is deep and able to withstand volatility and contain impact on the real economy. - A flexible exchange rate regime combined with credible monetary policy places Malaysia in a strong position to manage downside risks, which include: - a sharp slowdown of growth in China, or - a protracted period of slow growth in Europe. ### Fiscal policy and medium-term fiscal strategy - Fiscal actions in 2013: - Amidst capital outflows from EMEs and concerns about relatively high federal debt, authorities undertook timely and decisive, yet gradual recalibration of fiscal management and policies in 2013. - Staff views these efforts as a breakthrough that should secure sustainability of public finances while promoting efficiency, equity and growth, and minimizing drag on the economy from fiscal consolidation. - Implementation and political risks are viewed as circumscribed by authorities’ commitment and sound preparation. - Beyond 2015: - Authorities’ priority is to gradually bring down federal debt in the face of declining oil revenues and a rise in age-related and other nondiscretionary spending. - Staff supports this priority and recommends a concrete plan underpinned by a debt target for 2020. - Staff provided specific and quantified revenue and expenditure measures evaluated for efficiency, equity and growth. - Staff supports efforts to strengthen public financial management and statistical reporting in accordance with the GFSM 2001 format. - Enhanced monitoring of fiscal risks is a priority, including publication of an annual fiscal risks statement. ### Monetary policy - Given its dual mandate, substantial downside risks to growth, and very low inflation, BNM has been appropriately maintaining an accommodative monetary stance to support the economy. - Going forward, BNM must contend with higher headline inflation in 2014–15. - Staff view: - Risk of administered and tax-related price adjustments leading to an economy-wide spiral in wages and prices is low. - Monetary authorities should stand ready to adjust policy rates to curb second round effects. - Substantial policy credibility and close monitoring of prices should help maintain price stability over the medium term. ### Dealing with potential capital flow volatility - Policymakers may face renewed capital flow volatility amidst gradual withdrawal of UMPs and concerns over slower growth in China and other EMEs. - Factors helping Malaysia weather volatility: - Experience dealing with volatile capital flows, - Recalibration of fiscal policies, - Substantial reserves, - Comfortable current account surplus, - Deep and sound financial sector. - In event of renewed financial turbulence, exchange rate should be the first line of defense, with intervention limited to smoothing excessive volatility. ### Financial sector stability - Malaysia’s financial system is sound and well placed to withstand potential stresses. - Confirmations from prior engagements: - 2012 FSAP and 2013 Article IV discussions confirm banks have ample capital, adequate liquidity buffers, and strong regulatory and supervisory framework. - Ongoing risks warrant vigilance: - Global volatility, high household debt, rising house prices. - Staff welcomes steps to strengthen financial supervision and targeted, phased macroprudential policy. - If housing price increases continue unabated, authorities should adopt additional macroprudential measures. ### External assessment (current account and saving-investment gap) - Rebalancing has resulted in substantial narrowing of the current account surplus, but: - Malaysia’s external position is still stronger than warranted by medium-term fundamentals and desirable policies; current account surplus remains above the norm. - From a saving-investment perspective, the remaining current account gap likely reflects: - inadequate social protection (beyond public health expenditure), - need to improve risk sharing characteristics of the pension system, - investment bottlenecks, - infrastructure gaps, - labor force skill mismatches, - rigidities in the labor market. - Policy mix to close gap: - Increased social spending related to population aging, - Strengthen social safety nets and boost investment, - Exchange rate flexibility. ### Strengthening human capital accumulation (staff position) - Malaysia’s major effort to upgrade human capital is supported by staff. - Staff supports authorities’ efforts to: - raise education system effectiveness, - make education cost effective, - increase availability of financing to underserved groups, - improve quality control in private universities, - retain Malaysian-grown talent domestically. ### Recommendation - It is recommended that the next Article IV consultation with Malaysia take place on a standard 12-month cycle. _Italicized source: IMF staff report excerpts for Malaysia (sections 34–48, Boxes 1–2)._ ### Box 3. Malaysia—Medium-Term Fiscal Consolidation ### Box 3. Malaysia—Medium-Term Fiscal Consolidation ### Background - Authorities aim to lower the budget deficit to about 3 percent of GDP by 2015 and balance the budget by 2020. - The objective of achieving a balanced budget by 2020 implies a consolidation of 4.0−4.1 percent of GDP in terms of the cyclically-adjusted primary balance. - Declining oil revenues and a rise in nondiscretionary spending pressures in the medium term are projected to drive up Malaysia’s fiscal deficit, implying further measures beyond announced adjustments will be needed to secure fiscal targets for 2020. ### Fiscal consolidation design and criteria - Consolidation options are identified and ranked using three criteria: short-term growth, long-term growth, and equity. - The tradeoffs across instruments are used to inform the composition and timing of measures, consistent with authorities’ priorities. ### Revenue measures — findings and potential yields - Malaysia relies heavily on direct income taxes, especially corporate income taxes; indirect taxation is underutilized. - Cross-country tax gap analysis indicates considerable scope to raise indirect tax revenues. - The predicted norm for Malaysia’s consumption taxes is 6−6.3 percent of GDP, suggesting a gap of 2.7−3 percentage points. - Non-oil income taxes in Malaysia are above the predicted norm due to high levels of corporate income taxes; personal income taxes are relatively low (at about 2.5 percent of GPD). - Corporate income tax (CIT) specifics: - Corporate income tax rate is 25 percent. - The corporate income tax rate will be reduced by one percentage point effective 2016, as an offsetting measure for the GST. - CITs appear relatively high despite exemptions and incentives; rationalizing tax incentives is a tool to generate additional revenues. - Estimated fiscal yields from revenue-side measures: - Rationalizing tax incentives: potential fiscal savings in the range of 0.1−0.5 percent of GDP (noting uncertainty). - Property taxes are under-utilized and could be expanded. - Combined, all of the revenue measures could together generate about 4.5 percent of GDP in savings. ### Expenditure measures — findings and potential yields - Expenditure measures are identified from the level and composition of federal spending. - Subsidy rationalization: - Fuel subsidy rationalization alone could yield fiscal savings of 2.2−2.7 percent of GDP, taking into account offsetting cash transfers. - Rationalization of other subsidies (cooking oil, rice, flour) could generate additional savings of 0.2−0.3 percent of GDP. - Wage bill and public employment: - The wage bill has increased by 0.9 percentage points since 2008, to 6.2 percent of GDP. - Measures to contain wage growth include restricting hiring to essential personnel and limiting establishment of new posts (some measures already adopted). - Spending on education, particularly on emoluments, is identified as inefficient and may offer scope for savings. - Social safety nets and transfers: - Scope to reduce budgetary costs while enhancing social effectiveness by consolidating overlapping programs (authorities working towards a comprehensive database of recipients). - Broad-based efficiency gains: - Improved procurement (already underway) can be a source of fiscal savings. - Development spending: - Limited scope for savings, estimated at 0.2−0.4 percent of GDP given its decline in recent years. ### Key considerations (growth and equity trade-offs) - Rankings summarize expected impacts on growth (short term and long term) and equity; more negative values indicate larger negative impacts. - Short-run growth: All revenue and expenditure measures have negative short-run growth effects; public investment and consumption have the largest negative short-run impact. - Long-run growth: - Public investment is expected to have the highest negative impact on long-run growth. - Subsidy rationalization is the most growth-friendly fiscal measure, with an expected small positive impact on long-run growth. - Distributional (equity) impacts: - Subsidy rationalization, property taxes, and a progressive increase in personal income taxes are expected to have positive distributional impacts. - Public investment and the GST are expected to have relatively higher negative distributional impacts. - The GST has large revenue-generating potential and is strategically important in the context of high fiscal adjustment needs, making it a necessary component of adjustment despite equity concerns. - Public investment is identified as the least desirable instrument because of adverse effects on both growth and equity. - Exact rankings depend on societal choices, cyclical factors, and monetary policy space. ### Conclusions and policy implications - From both growth and equity perspectives, subsidy rationalization and property taxes are desirable instruments for fiscal consolidation. - Improvements in efficiency of social safety nets and other transfers, and a progressive increase in personal income taxes, rank highly among fiscal measures. - The GST is necessary given its revenue potential and strategic importance for adjustment, though it has distributional downsides. - Public investment should be protected from cuts where possible, given its unfavorable ranking for the consolidation mix. - The composition and timing of measures should reflect policy priorities and consider short-term cyclical and monetary policy conditions. *Source: IMF staff estimates.* ### Box 4. Malaysia—Household Debt ### Box 4. Malaysia—Household Debt ### Overview and recent trends - Household debt increased from 60 percent of GDP to 83 percent of GDP by end-September 2013. - Banks remain the most important source of credit to households, but lending by Development Financial Institutions (DFIs) and Nonbank Financial Institutions (NBFIs) has grown rapidly since 2008 and accounts for about one-quarter of the increase in debt. - Household financial assets amount to 189 percent of GDP. ### Composition of debt and interest-rate exposure - Approximately 55 percent of household debt is owed on residential property. - About 70 percent of residential mortgages are variable rate mortgages. ### Drivers and risk assessment - House prices have increased rapidly, outpacing income and rental growth. - Strong demand for residential property loans has been driven by a robust labor market and falling lending rates. - Underwriting standards do not appear to have deteriorated, as evidenced by lower default rates by month on book for more recent vintages. - Pockets of vulnerability may exist, notably lower income borrowers (with a monthly income of RM3,000 or less) who are more highly leveraged than other income groups. ### Personal loans (DFIs and NBFIs) - Loans for personal use have grown rapidly, with a strong increase especially from the DFIs and NBFIs. - Loans for personal use from the NBFIs and DFIs increased to 9 percent of GDP in 2012, up from 5 percent in 2008. - Most personal lending is to government workers, serviced through automatic salary deductions, with an aggregate deduction cap of 60% of a borrower’s net income. - Growth in personal finance was partially driven by products with unfavorable terms, such as extended tenures and bullet payments on retirement, increasing vulnerability because borrowers from DFIs and NBFIs tend to have lower incomes. ### Policy and macroprudential response - In July 2013, Bank Negara Malaysia (BNM) limited the tenure of personal financing loans to 10 years (including prohibiting bullet payments on retirement) and prohibited the offering of pre-approved personal financing products. *Source: Box 4. Malaysia—Household Debt (_cr1480).* ### Appendix 1. Malaysia—Staff Policy Advice from the 2011 and 2012 Article IV ### Appendix 1. Malaysia—Staff Policy Advice from the 2011 and 2012 Article IV Consultations ### Fiscal - Advice: Bring down debt to sustainable levels (e.g., pre­2008 levels by 2020) and articulate credible revenue and spending measures to achieve that target (2011 and 2012). - Policy action: Authorities agree on the need for fiscal consolidation and are targeting a fiscal deficit of 3 percent of GDP by 2015 and a balanced budget by 2020. They are in the process of developing a medium term budget framework and have established a Fiscal Policy Committee (FPC) that will endorse Malaysia’s medium-term fiscal strategy. - Advice: Issue a statement of fiscal risks (2011 and 2012). - Policy action: The authorities requested Fund technical assistance on fiscal risks. A mission was fielded in January 2013. The Fiscal Policy Office, which will act as the secretariat to the FPC, is tasked with preparing a fiscal risks statement. - Advice: Broaden tax bases by implementing a GST and rationalizing tax incentives (2011 and 2012). - Policy action: The authorities announced the introduction of GST in the 2014 Budget, effective April 2015. The authorities are undertaking a study on the effectiveness and costs of tax incentives. - Advice: Phase out subsidies and replace with targeted cash transfers to the needy (2011 and 2012). - Policy action: The authorities have already reduced some fuel and food subsidies, and plan to further rationalize subsidies going forward. The use of cash transfers has increased and now benefit over 55 percent of households. The 2014 Budget announced the creation of a comprehensive database on welfare recipients which could facilitate better targeting of transfers. - Advice: Strengthen public financial management (2012). - Policy action: The authorities have taken steps to improve public procurement and move towards performance-based budgeting. The authorities are also in the process of transitioning to accrual accounting. ### Financial - Advice: Continue to monitor the increase in household debt (2011 and 2012). Strengthen monitoring of risks through collection of granular data on household assets and liabilities. - Policy action: The authorities have taken a variety of macroprudential measures to deal with rising household indebtedness. In addition, they have also issued guidelines on responsible lending practices and are trying to boost financial literacy. The BNM expects to complete collection of granular data on households by end-2014. - Advice: Continue to monitor regional exposures; deepen cooperation between home and host country supervisors (2012). - Policy action: The authorities continue to expand the list of countries with which they have signed Memorandum of Understanding for information sharing and collaboration in cross border supervision. ### Structural - Advice: Boost growth and productivity through steady implementation of structural reforms, including reforms to government­-linked companies; liberalization of labor and product markets; and enhanced education and training. - Policy action: Many recommendations from previous Article IV reports also form part of the authorities’ Economic Transformation Program and the Government Transformation Program. Some progress has been made on the strategic reform initiatives and the authorities' further plans to boost growth are discussed in this staff report. - Advice: Consider introducing a carefully­-designed minimum wage (2011). - Policy action: The authorities enacted a minimum wage in 2012 and it came into effect in January 2013. - Advice: Consider implementing an unemployment insurance scheme (2011 and 2012). - Policy action: The ILO has been tasked with drafting a paper on the appropriate design of an unemployment insurance scheme for Malaysia. - Advice: Develop defined contribution private pension plans and increase the age of withdrawal from EPF accounts from 55 (2011). Increase the retirement age for public workers to 60, in line with the private sector (2012). Provide an option for workers to receive their pensions in the form of annuities (2012). - Policy action: A private retirement scheme (defined contribution) has been introduced. The retirement age for private workers has been increased to 60 from 55, although workers can still withdraw savings from the EPF at 55. The retirement age for civil servants was also raised from 58 to 60 in 2012. *Appendix 1. Malaysia—Staff Policy Advice from the 2011 and 2012 Article IV Consultations* ### Appendix 4. Malaysia—Public Debt Sustainability Analysis ### Appendix 4. Malaysia—Public Debt Sustainability Analysis ### Background - The new debt sustainability analysis (DSA) framework for market access countries is used to assess Malaysia’s debt sustainability and other risks related to its funding and debt structure. - The framework expands the basic DSA to include: - an assessment of the realism of baseline assumptions and the projected fiscal adjustment; - an analysis of risks associated with the debt profile; - macrofiscal risks; - a stochastic debt projection taking into account past macrofiscal volatility; and - a standardized summary of risks in a heat map. ### Macroeconomic assumptions - Growth: projected at 4.7 percent in 2013, rising to 5 percent in 2014; growth will average 5 percent in the medium term. - GDP deflator: about 0 percent in 2013, 4.6 percent in 2014, and projected to fall gradually towards 2.5 percent. ### Fiscal assumptions - Federal government deficit: reduced from 4.3 percent of GDP in 2013 to 2.6 percent in 2015 in staff’s baseline projections. - Projections assume: - gradual elimination of fuel subsidies with partial replacement by targeted cash transfers to the lower income group; - introduction of a goods and services tax (GST) in 2015. - Fiscal deficit starts to increase after 2016 due to gradual decline in oil and gas related revenues and increases in pension and health care related costs. ### Data coverage and contingent liabilities - Fiscal assumptions are based on the federal government budget; coverage excludes local and state governments and statutory bodies (their liabilities are captured in federal government gross debt and stock of loan guarantees). - Borrowing by state-owned enterprises, some under federal government guarantees, has increased and is projected to continue increasing in the medium term. - Government’s gross debt increased sharply in 2009; debt-to-GDP rose to close to the authorities' self-imposed debt ceiling of 55 percent. - Gross financing needs (GFN): estimated at 11.1 percent of GDP in 2012 and expected to remain around 9−10 percent in the medium term. - A contingent liability shock whereby the government would have to absorb all government guaranteed loans (totaling 15 percent of GDP) over two years would increase risks significantly. ### Realism of baseline assumptions and forecast track record - Median forecast error for real GDP growth during 2004−2012 is zero. - Median forecast error for GDP deflator is 2.9 percent. - Median forecast error for primary balance shows a forecast bias of 0.72 percent of GDP (staff projections slightly optimistic), with improvement in later years. - Cross-country experience: the maximum 3 year adjustment in the cyclically-adjusted primary balance (CAPB) over the projection period is 2.75 percent of GDP; the maximum level of the primary balance assumed in the medium term is -0.5 percent of GDP. ### DSA baseline projections and stress-test results - Baseline debt path: - Under the baseline, debt-to-GDP ratio is projected to decrease to slightly below 50 percent by 2018. - Under the constant primary balance simulation (projected consolidation does not take place), debt-to-GDP increases to 56 percent by 2018. - Macrofiscal shocks: - One standard deviation shock to real GDP growth: debt-to-GDP initially increases to 57 percent in 2015 and declines thereafter. - Combined macro-fiscal shock and a permanent 20 percent oil price shock: imply a flat debt-to-GDP profile in the medium term. - Stochastic simulations: - The 90th percentile of debt-to-GDP ratio simulations is below 70 percent. - Gross financing needs: - Under all scenarios remain at about 9 percent, and rise to just below 12 percent by the end of the projection horizon. - Contingent liability + adverse macro scenario: - If economy is hit by a persistent shock to growth and interest rates rise by 150 basis points while government absorbs guaranteed loans (15 percent of GDP), debt-to-GDP would remain just below the 70 percent debt benchmark. - Stress-test scenario outcomes (selected underlying assumptions shown in stress test tables): - Real GDP growth baseline: 4.7 (2013), 5.0 (2014−2018). - Inflation (GDP deflator) baseline: -0.1 (2013), 4.6 (2014), 3.8 (2015), 2.9 (2016), 2.6 (2017−2018). - Primary balance baseline: -2.1 (2013), -1.8 (2014), -1.1 (2015), -0.1 (2016), -0.4 (2017), -0.8 (2018). - Effective interest rate baseline: 4.3 (2013), 4.2 (2014−2016), 4.3 (2017), 4.5 (2018) [table shows variations under shocks]. - In the Contingent Liabilities from Government Guarantees scenario primary balance moves to -8.7 (2014) and -8.0 (2015) before reverting toward baseline. - Oil price shock scenario: primary balance moves to -1.6 (2014), -0.9 (2015), -0.7 (2016), -1.1 (2017), -1.5 (2018). ### Debt composition and indicators (selected values, as reported) - Nominal gross public debt: 44.3 (2011), 51.6 (2012), 53.3 (2013), 54.8 (2014), 53.3 (2015), 51.7 (2016), 50.1 (2017), 49.2 (2018). - Public gross financing needs (in percent of GDP): 8.9 (2011), 10.9 (2012), 11.1 (2013), 10.4 (2014), 9.0 (2015), 8.9 (2016), 8.6 (2017), 9.2 (2018). - Real GDP growth (in percent): 5.1 (2011), 5.1 (2012), 5.6 (2013), 4.7 (2014), 5.0 (2015−2018). - Inflation (GDP deflator, in percent): 4.3 (2011), 5.5 (2012), 0.7 (2013), -0.1 (2014), 4.6 (2015), 3.8 (2016), 2.9 (2017), 2.6 (2018). - Nominal GDP growth (in percent): 9.7 (2011), 10.9 (2012), 6.4 (2013), 4.6 (2014), 9.8 (2015), 8.9 (2016), 8.1 (2017), 7.7 (2018). - Effective interest rate (in percent): 5.4 (2011), 4.4 (2012), 4.3 (2013−2015), 4.4 (2016), 4.5 (2017), 4.7 (2018). - Change in gross public sector debt (cumulative): 1.1 (2011), 0.5 (2012), 11.7 (2013), 21.5 (2014 cumulative), -1.5 (2015), -1.6 (2016), -1.6 (2017), -0.9 (2018), -0.5 (cumulative), -4.6 (total cumulative). - Primary (noninterest) revenue and grants (percent of GDP): 20.9 (2011), 21.0 (2012), 21.3 (2013), 21.8 (2014), 21.1 (2015), 20.9 (2016), 20.5 (2017), 20.2 (2018), cumulative 124.4. - Primary (noninterest) expenditure (percent of GDP): 23.3 (2011), 23.7 (2012), 24.5 (2013), 23.9 (2014), 22.3 (2015), 21.4 (2016), 20.6 (2017), 20.6 (2018), cumulative 129.5. - Automatic debt dynamics contribution (percent of GDP): -1.7 (2011), -3.0 (2012), -1.1 (2013), -0.1 (2014), -2.8 (2015), -2.3 (2016), -1.8 (2017), -1.5 (2018), cumulative -10.0. - Of which: real interest rate contribution: 0.4 (2011), -0.7 (2012), 1.7 (2013), 2.2 (2014), -0.3 (2015), 0.1 (2016), 0.6 (2017), 0.8 (2018), cumulative 4.4. - Of which: real GDP growth contribution: -2.0 (2011), -2.4 (2012), -2.7 (2013), -2.4 (2014), -2.5 (2015), -2.4 (2016), -2.4 (2017), -2.3 (2018), cumulative -14.3. - Other identified debt-creating flows and other change in financial assets: small contributions (e.g., -0.3, 0.4, -0.6, -0.5, 0.2, 0.2, 0.2, 0.1, 0.1, 0.3 in projection years). ### Heat map and risk assessment - External financing requirement: 13 percent (close to the upper threshold of early warning benchmarks). - Public debt held by foreigners: about 30 percent of total. - Despite low share of foreign currency and short-term debt, risks arise from external financing requirement and large share of public debt held by foreigners. - Presence of large domestic institutional investors who tend to make opportunistic investments provides some comfort. ### Appendix 5 — External Debt Sustainability (summary) - External debt expected to fall to 25 percent of GDP by 2018 (a 2 percentage point decline from 2012 to 2018 reflects sustained current account surpluses and some shift towards domestic debt). - Stress tests indicate external debt remains manageable under shocks: - Weaker GDP growth, lower current account balance, and a one-time 30 percent depreciation of the ringgit all result in only modest rises in the external debt-to-GDP ratio over the projection period. - The exchange rate depreciation scenario: external debt-to-GDP rises sharply to 40 percent in 2014, then falls to 37 percent by 2018. - Table 5.1 (selected figures): - Baseline external debt: 29.6 (2008), 33.6 (2009), 29.9 (2010), 28.1 (2011), 27.1 (2012), 27.3 (2013), 26.7 (2014), 26.1 (2015), 25.8 (2016), 25.6 (2017), 25.2 (2018). - Change in external debt: 0.4 (2008), 4.0 (2009), -3.7 (2010), -1.9 (2011), -0.9 (2012), 0.1 (2013), -0.6 (2014), -0.6 (2015), -0.3 (2016), -0.2 (2017), -0.5 (2018). - Identified external debt-creating flows (4+8+9): -16.1 (2008), -13.0 (2009), -14.2 (2010), -13.1 (2011), -5.1 (2012), -3.2 (2013), -3.7 (2014), -3.5 (2015), -3.4 (2016), -3.4 (2017), -3.4 (2018). - External debt-to-exports ratio: 29.8 (2008), 36.8 (2009), 32.1 (2010), 30.6 (2011), 31.1 (2012), 34.4 (2013), 36.1 (2014), 37.7 (2015), 39.3 (2016), 40.6 (2017), 42.0 (2018). - Gross external financing need (in percent of GDP): -2.6 (2008), 3.6 (2009), 9.8 (2010), 8.5 (2011), 11.6 (2012), 13.6 (2013), 12.3 (2014), 11.5 (2015), 10.6 (2016), 9.8 (2017), 9.2 (2018). - Key macro assumptions underlying baseline: - Real GDP growth (in percent): 4.8 (historical average), projections: 4.7 (2013), 5.0 (2014−2018). - GDP deflator in U.S. dollars (change in percent): 4.4 (historical average), projections show variation (e.g., -0.5 in 2011, 6.2 in 2012, 4.1, 2.8, 5.0, 5.0, 4.1, 3.7, 4.7, 3.7 across years). - Nominal external interest rate (in percent): historical average 4.9; projections vary across years (e.g., 3.7, 3.8, 4.1, 4.9, 5.3, 5.8, 5.3). - Current account balance, excluding interest payments: 18.3 (2008), 16.9 (2009), 12.1 (2010), 12.7 (2011), 7.1 (2012); projected 3.4 (2013), 4.6 (2014), 5.0 (2015), 4.9 (2016), 5.0 (2017−2018). *Source: IMF staff (Appendix 4 and Appendix 5, Malaysia—Public Debt Sustainability Analysis).* ### Appendix 6. Malaysia—2013 FSAP—High Priority Recommendations ### _cr1480 - Appendix 6. Malaysia—2013 FSAP—High Priority Recommendations ### Strengthening Financial Sector Oversight - Implement proposed new Financial Services Act (FSA) at an early date; and strengthen legal and regulatory requirements for Islamic banks. - The FSA and related Islamic Financial Services Act (IFSA) were implemented on June 30, 2013. - The IFSA strengthens legal and regulatory requirements for Islamic banks including those for capital, financial reporting, and audit. - Strengthen framework for consolidated supervision of financial holding companies (FHC) including capital standards and risk management. - The FSA / IFSA provide BNM with powers for consolidated supervision of FHCs in these areas. - Ground the operational independence of the Securities Commission (SC) by changing the legal provisions on removal of Commission members and protections given to Commission members and its staff. - Related amendments to the SC Act are expected to be submitted to parliament in 2014. - Strengthen the definition of connected lending. - The BNM expects to issue a revised policy document to the industry in 2014. ### Labuan International Business and Finance Center - Impose prudential and regulatory requirements on Labuan financial institutions in line with international standards and best practice. - During 2012−2013, the Labuan Financial Services Act (LFSA) has issued guidelines relating to classification and impairment provisions of loans, connected party lending, reinsurance, and single exposure limits. - Undertake more proactive engagement and effective communication of LFSA with home supervisors and external auditors. - The BNM continues to sign new MoUs with home supervisors of Labuan entities (3 more added in 2013). These cover exchange of supervisory information and collaboration in enforcement. - BNM is separately seeking confirmation that each Labuan entity is covered under consolidated supervision from the home jurisdiction. ### Systemic Risk Management - Formalize a high­-level committee involving BNM, SC, PIDM and the fiscal authority with the responsibility for ongoing systemic risk monitoring, information sharing and crisis action. - The Financial Stability Executive Committee (FSEC) formed in 2010 has this mandate and, as of January 2013, includes permanent membership of the SC along with the BNM, PIDM and MoF. ### Macro-Financial Risks - Enhance data capture for household sector to facilitate a more robust and granular monitoring and assessment of household sector leverage and issues especially in accordance to income category; and review effectiveness of macroprudential measures. - The BNM expects to complete collection of such granular data on households by end-2014. - Adopt multiyear top-down and bottom-up macroeconomic stress testing, and introduce more conservative credit loss parameters in bottom up exercise. - The bank has already implemented a top-down multiyear framework; a bottom-up approach is expected to be implemented in 2014. *Source: _cr1480 - Appendix 6. Malaysia—2013 FSAP—High Priority Recommendations* ### 6. Malaysia’s experience. Following the Asian financial crisis, Malaysia accumulated ### 6. Malaysia’s experience ### Accumulation of foreign assets and role in capital flow episodes - Following the Asian financial crisis, Malaysia accumulated substantial foreign assets that played an important role in 2008−09 and in spring-summer of 2013. - Large domestic institutional investors invested abroad during periods of capital inflows; when foreign investors sold Malaysian government securities and other domestic assets, domestic investors stepped in to offset sales by foreigners, reducing the impact of outflows on yields. - In the WEO analysis Malaysia belongs solidly to the group of resilient EMEs (its estimated regression coefficient is close to zero). - Malaysia scores high in: - relatively flexible exchange rate regime, - low inflation, - countercyclical fiscal policy, - good institutions, - high net international investment position, - high and stable current account balance. - Evidence from spring-summer 2013: - Outflows by foreign residents affected interest rates on government securities and led to exchange rate depreciation. - Bank Negara Malaysia (BNM) intervened in foreign exchange markets. - Effects of outflows on Malaysia’s real economy were muted compared with less resilient EMEs. ### Financial system reforms and capital flow liberalization - Post-AFC decade-long financial sector reforms strengthened existing banks, promoted competition, nurtured domestic equity and bond markets, and strengthened regulation and supervision. - Restrictions on capital flows were gradually eased: - Initially, outflows were dominated by official reserves accumulation under a fixed exchange rate regime. - In 2005, Malaysia moved to a managed float and liberalized restrictions on international transactions. - Accumulation of foreign assets by private entities rose dramatically during 2005−09 as nonfinancial and financial entities expanded foreign direct investment. - The increase in gross private outflows contributed to a considerable improvement in Malaysia’s net foreign asset position. ### Growing resilience to capital flow volatility - Accumulation of foreign assets reduced volatility of net flows. - During the global financial crisis: - Reduction in capital inflows was largely offset by sales of foreign reserves and repatriation of domestic capital invested abroad. - Large sales of domestic bonds by foreign investors were absorbed with minimal impacts on domestic yields. - Greater exchange rate flexibility and stronger domestic financial institutions helped Malaysia weather the crisis much better than during the late 1990s, despite a larger reduction in gross capital inflows. - Fiscal policy contributed: became much more countercyclical during the 2000s, providing fiscal stimulus during downturns. ### Ways to strengthen resilience further - Lessons from resilient EMEs and AEs (Chile, Australia, New Zealand): - In those AEs, foreign exchange intervention is rare, discouraging one-way bets on the exchange rate and improving buffering behavior of private domestic resident capital outflows. - Malaysia can increase the size of fiscal buffers, which diminished following effective countercyclical responses during the global financial crisis. - Malaysia’s institutional characteristics remain below levels in advanced economies; improving institutions would enhance resilience to capital flow volatility. ### Appendix 9 — Transformation Plans to Boost Growth and Inclusion H3: Progress and programs - Malaysia has pursued multiyear transformation programs since 1969’s New Economic Policy (NEP); more recent programs include: - Government Transformation Program (GTP) — launched late 2009; aims to improve public service delivery, raise transparency, and enhance collaboration. Achievements: new assistance reaching more than a quarter of the hardcore poor, declining crime indices, online publication of government contracts, enhancements in pre-school and primary education, and improved business attractiveness. - New Economic Model (NEM) — unveiled March 2010; aims to transform Malaysia into an innovative, knowledge intensive, and high-income economy by 2020; strategic reform areas include enhancing private sector participation, improving workforce skills, supporting innovation, developing new sources of growth, and strengthening public sector management. - Tenth Malaysia Plan (10MP) — released June 2010; implements NEM in 2011−2015; aims to sustain annual GDP growth at 6 percent and bring down the budget deficit to 3 percent of GDP by 2015; microeconomic objectives include a competition law, further liberalization of services, divestment of public enterprises, market prices for subsidized commodities, an innovation-friendly environment, and reduced dependence on foreign labor. - Economic Transformation Program (ETP) — launched October 2010; builds on NEM and 10MP; focuses on 12 key growth engines, encourages private sector investment, and introduces 131 entry point projects (EPPs). In the 2011 Article IV consultation staff found that out of 131 EPPs, 113 projects with a total value of RM 177 billion had been announced, concentrated mainly in infrastructure, commodity related investments and construction. - Malaysia Financial Sector Blueprint 2011−2020 — introduced by BNM; aims to promote effective financial intermediation for a high-income country; develop deep and dynamic financial markets; enhance financial inclusion; strengthen regional and international financial integration; further strengthen regulatory and supervisory regimes; raise risk management standards; internationalize Islamic finance; promote electronic payments; and empower consumers and develop talent. H3: Boosting growth - Key objective: avoid a middle income trap by fostering technological readiness and increasing competition. - Large-scale ETP projects boost infrastructure and rejuvenate strategic sectors (such as oil and gas). - Recent efforts have catalyzed private investment, which had declined after the Asian financial crisis. - World Bank Doing Business ranking improved to 12th in 2013, from 14th in 2012. - Goal: Malaysia on its way to becoming a high-income country by 2020. H3: Strengthening labor policies and institutions Education - Secondary net enrollment rose to 68 percent in 2009 (up from 32.7 percent in 1970). - Enrollment in tertiary education increased tenfold since 1980 and yields a wage premium of more than 50 percent. - Priorities: expand access to tertiary education and financing among under-served groups; quality control in private universities; retain Malaysian-grown talent; improve educational attainment at basic and secondary levels. - Malaysian Education Blueprint 2013−25 aims to put Malaysian students at the top third of international assessments and transform the Ministry of Education. Pensions - Population: 29 million (mid-2012 estimate), growing at about 1.9 percent a year in the 2000s (compared to 2.7 percent in the 1990s). - Fertility falling; working age population (15−64) share increasing; old age dependency ratio will start rising after 2020, posing economic and fiscal challenges. - Malaysia introduced a Private Retirement Scheme (PRS) to supplement the Employees Provident Fund (EPF). - Considerations to increase risk sharing in the pension system: - (I) introduce a publicly funded, pillar-one pension scheme for low or noncontributors; - (ii) provide an option for workers to receive pensions as annuities to reduce longevity risk. - Suggestion: gradually raise the minimum age for pension withdrawals for existing EPF contributors from 55 to 60 to match private sector retirement age increases. Minimum wage - Introduced January 2013 to boost wages of low-skilled workers and enhance productivity. - Initial indications: limited impact on inflation and unemployment; should help improve incomes of the poor. - Minimum wage set at a relatively high level: 50 percent of the mean wage in Peninsular Malaysia. - Implementation features: - Flexibility in implementation and low share of labor costs could offset employment impacts. - Micro, small, and medium-sized firms given six months to adjust. - Migrant workers exempted for a year. - Consideration could have been given to granting more regional dispersion. - Expected effects: incentives for firms to shift to more capital-intensive production technologies and gradually raise capital-labor ratios; with complementary business climate reforms, could raise productivity. Female labor force participation - Female participation: 49.5 percent, low by regional standards. - World Bank estimate: raising participation by 11 percentage points to 57 percent during 2000−2010 would have boosted growth by around 0.4 percentage points per year (Malaysia Economic Monitor, October 2012). - Malaysia plans to boost female participation to 55 percent by 2015. - Reforms and incentives in train: establish childcare facilities; employ and train women after career breaks; promote flexible work arrangements. Social protection - Labor redundancy costs are high; Malaysia ranked 108th out of 144 countries in this area in the World Economic Forum’s Global Competitiveness Report. - Additional measures needed: - introduce an unemployment insurance scheme funded by employers and employees; - improve targeting of cash transfer programs and make them conditional on access to education and health care. - Stronger social safety nets should reduce precautionary savings and help narrow the current account. H3: Outward orientation and external engagement - Policy choices are made following extensive domestic debate and international input from IMF, World Bank, Asian Development Bank, ILO, and others. - The Financial Sector Assessment Program (FSAP), jointly conducted with IMF and World Bank, confirmed strong financial positions of Malaysian financial institutions and sound supervisory and regulatory frameworks after post-1997−98 reforms. - Malaysia provides technical assistance internationally; SEACEN in Kuala Lumpur has provided training to officials of over 80 countries since the early 1980s. H3: The future — narrowing the gap with advanced economies - Malaysia’s goal: become a high-income nation by 2020 with broadly shared prosperity; requires continuous transformation. - Growth accounting comparison with Korea (Gylfason and Hochreiter, 2008): - Output per worker in Korea is roughly 2.6 times that of Malaysia. - Korea’s capital-output ratio is 20 percent greater than Malaysia’s. - Human capital (average school years per worker): 13.95 for Korea and 11.42 for Malaysia. - Differences in institutions explain about half of the gap in output per worker; differences in education explain about 30 percent; differences in capital per worker explain about 20 percent. *International Monetary Fund* ### 11. Conclusion. The comparison between Korea and Malaysia highlights several priorities for ### 11. Conclusion. The comparison between Korea and Malaysia highlights several priorities for Malaysia. ### Education and human capital - Need to push through transformation of the education system to ensure graduates have the upgraded skills needed in an innovation-based economy. - Reforming the education system to raise attainment level closer to international standards constitutes very good benchmarking. - Authorities are intent on reforming Malaysia’s educational system, reduce shortages of high-skill workers, and alleviate skill mismatches, which are important in raising potential growth and promoting equity within and across generations. - IMF reporting: CPI inflation was 2.1 percent in 2013 (period average) and real GDP growth was 4.7 percent in 2013. ### Infrastructure, regulation, and investment climate - Malaysia needs to modernize and upgrade infrastructure systems and networks. - Further simplify regulatory regimes to spur innovation and reward investment in skills. - Authorities have identified a wide range of structural reforms to boost investment, raise productivity, improve the effectiveness of education and enhance social insurance and protection. - IMF reporting: Gross domestic investment was 26.3 (percent of GDP) in 2013 and projected 27.1 (percent of GDP) in 2014. ### Social insurance, labor market policies, and inclusiveness - The minimum wage policy and other reforms being debated, including unemployment insurance, should go a long way to insure workers from risk. - Authorities are strengthening social safety nets in preparation for subsidy rationalization and the introduction of the GST. - Directors recommended improving targeting of social transfers, restraining wage growth, and broadening the tax base, including through the planned introduction of the GST and greater reliance on property taxes. ### Fiscal policy and public spending reform - Malaysia will need to reform public spending to make it more equitable. - Better targeting of public expenditure in the context of a tighter fiscal envelope in the coming years will be a priority, including the reform of costly fuel subsidies and the introduction of conditional cash transfers. - Authorities undertook a timely, decisive yet gradual recalibration of fiscal policies in 2013 to strengthen sustainability of public finances while promoting efficiency, equity and growth. - IMF reporting—fiscal indicators: - Federal government overall balance: -4.3 (percent of GDP) in 2013; projection -3.3 (percent of GDP) in 2014. - Revenue: 21.8 (percent of GDP) in 2013; projection 21.1 (percent of GDP) in 2014. - Expenditure and net lending: 26.1 (percent of GDP) in 2013; projection 24.4 (percent of GDP) in 2014. - Federal government non-oil primary balance: -8.9 (percent of GDP) in 2013; projection -7.5 (percent of GDP) in 2014. - General government debt: 56.8 (percent of GDP) in 2013; projection 55.2 (percent of GDP) in 2014. - Consolidated public sector overall balance: -6.8 (percent of GDP) in 2013; projection -6.5 (percent of GDP) in 2014. ### Macro-financial stability and monetary policy - Bank Negara Malaysia maintained an accommodative monetary stance appropriate given downside risks to growth and subdued inflation; CPI inflation was 2.1 percent in 2013. - Going forward, monetary policymakers must contend with somewhat higher headline inflation in 2014−15 as fuel, electricity and other administered prices rise and the GST is implemented. - Timely detection and decisive preemption through gradual, well communicated, and credible interest rate action will be needed to prevent second-round effects. - Malaysia’s financial system is sound and well placed to withstand stresses, but high household debt and rising house prices warrant continued vigilance and may require additional macroprudential measures. - IMF reporting—financial and external indicators: - Unemployment rate: 3.1 (percent) in 2013; projection 3.0 (percent) in 2014. - Total liquidity (M3) growth: 6.7 (percent) in 2013. - Credit to private sector growth: 9.1 (percent) in 2013. - Three-month interbank rate: 3.2 (percent) in 2013. - Current account balance: 11.8 (US$ billions) in 2013; projection 14.5 (US$ billions) in 2014 (3.8 and 4.2 percent of GDP, respectively). - Gross official reserves: 134.9 (US$ billions) in 2013; projection 141.9 (US$ billions) in 2014. ### Structural reform priorities summarized - Improve education outcomes and labor skills to support an innovation-based economy. - Modernize and upgrade infrastructure and simplify regulatory regimes to encourage investment and innovation. - Strengthen social insurance and protection, including minimum wage policy, unemployment insurance, and improved targeting of transfers. - Reform public spending to enhance equity and target subsidies, including rationalizing fuel subsidies and introducing conditional cash transfers. - Maintain macroprudential vigilance and be prepared to adjust monetary policy as administered prices and GST affect headline inflation. *Source: MALAYSIA STAFF REPORT FOR THE 2013 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX (February 14, 2014) and IMF Press Release No. 14/104 (March 14, 2014).* ### 1. On behalf of the Malaysian authorities, we would like to thank the IMF team for the ### 1. On behalf of the Malaysian authorities, we would like to thank the IMF team for the ### Economic Outlook for 2014 - Authorities projected the Malaysian economy to expand between 5% and 5.5% in 2014 (September 2013). - Staff estimates align with the authorities’ assessment. - Private investment expected to remain robust, supported by capital spending in the manufacturing and services sectors and on-going implementation of multi-year projects, including infrastructure-related projects. - Private consumption supported by sustained income growth and favourable employment conditions. - Public sector growth anticipated to moderate slightly due to on-going public sector consolidation, though it will remain supportive of growth. - Gradual improvement in the external sector will provide additional impetus to the economy. ### Monetary Policy - Current monetary policy stance is appropriate and consistent with the assessment of economic growth and inflation prospects. - Authorities remain vigilant in monitoring risks to inflation, including those from subsidy rationalisation. - Risk of more pervasive and persistent inflation is assessed to be not very significant at this point. - Bank Negara Malaysia (BNM) will continue to evaluate global economic and financial developments and their implications for inflation and growth. - Authorities focused on ensuring medium-term price stability and sustainable, balanced economic growth. ### Fiscal Policy - Fiscal policy in 2014 centered on ensuring sound public finances while supporting sustainable and balanced economic growth. - Fiscal deficit expected to decline from 3.9% in 2013 to 3.5% of GDP in 2014. - Federal Government debt-to-GDP ratio will be contained within 55% of GDP. - High-level Fiscal Policy Committee (FPC) established in June 2013, chaired by the Prime Minister, to oversee fiscal management and chart policies for healthy public finances. - Fiscal reforms and strategic resource management to be pursued without undermining economic growth or wellbeing of low-income and vulnerable groups. - Subsidy rationalisation for fuel, sugar and electricity tariff implemented as a phased approach to improve resource allocation, minimise market distortions and reduce fiscal burden. - GST is on target to be introduced in April, 2015 to streamline the tax structure to make it more efficient, transparent and business friendly. - Work underway to implement a comprehensive social safety net and develop an integrated database of all aid recipients to ensure targeted assistance across the public sector. - Other fiscal sustainability initiatives: - Review of fiscal incentives to industry. - Implementation of accrual accounting at the Federal level (2015). - Adoption of outcome based budgeting (2015). - Fiscal resources to be geared towards reinvigorating high value-added investments, intensifying development of human capital and enhancing public sector delivery. ### Financial Sector - Financial stability preserved in 2013, supported by financial strength and capital buffers at system and institutional levels. - Internal and IMF stress tests demonstrated that the banking system is resilient to major economic and market shocks. - Risks from household indebtedness remain manageable, supported by strong household fundamentals and financial capacity. - Continued supervisory vigilance over risk management and underwriting, plus intensified financial education, to contain household debt risks. - Macroprudential measures undertaken in 2013 to reinforce responsible lending practices, including: - Limiting the maximum tenure for personal financing to 10 years and loans for purchase of residential and non-residential properties to 35 years, applicable to both banks and non-bank financial institutions. - Prohibiting the offering of pre-approved personal financing products. - Requiring credit providers to observe a prudent debt service ratio in their credit assessment to ensure sufficient financial buffers for households. - Measures have begun to show positive results, evidenced by a substantial decline in the growth of personal financing extended by non-bank financial institutions. - 2014 Budget measures to curb speculative property purchases include: - Further increases in the property gains tax. - Prohibition on development and financing (both bridging and end-financing) of property projects with elements of interest capitalization schemes (including Developer Interest Bearing Scheme (DIBS)). - Requirement on greater transparency in property prices by developers. - Raising the threshold of property purchases by non-residents. - BNM to capture more granular household data in collaboration with Government agencies. - Newly established National Housing Council to ensure a holistic and coordinated approach to structural issues in the residential property market. - Corporate sector leverage remained well-contained despite a gradual increase in overall business debt in recent years, supported by sustained financial strength and debt servicing capacity. - BNM will continue surveillance and supervisory vigilance and stands ready to introduce additional measures to prevent buildup of excesses in household, business and property sectors. - Regulatory and supervisory framework strengthened with the Financial Services Act 2013 (FSA) and Islamic Financial Services Act 2013 (IFSA) coming into force on 30 June 2013, enhancing BNM’s supervisory and regulatory powers, including consolidated supervision and extension of regulatory perimeter to systemically important non-bank entities. ### Reforms to Enhance Growth Potential - Economic Transformation Programme progress: total announced investments amounted to USD66.8 billion (RM219.3 billion). - Investments expected to increase productive capacity and competitiveness over the medium term. - Workplace transformation initiatives to modernize labour laws for a high-income economy, including raising the private sector minimum retirement age from 55 to 60 years. - Minimum wage policy implemented in 2013 to improve worker welfare and incentivize firms to move up the value chain; expected over the long run to contribute positively to productivity through higher automation and training. - Education enhancements via the National Education Blueprint 2013-2015 to improve access, quality, equity, unity and efficiency and facilitate human capital accumulation aligned with transition to higher value-added activities. ### External Sector Assessment - External sector developments reflect changing global environment and domestic structural transformation. - Current account has narrowed in recent years as robust import growth outpaced exports. - Exports remained modest following gradual global recovery and lower commodity prices. - Import growth driven by strong domestic demand, particularly expansion of investment activity. - Malaysia experienced greater two-way capital flows due to increased integration with the global economy and financial markets; flows effectively intermediated by the financial system supported by a well-developed capital market and a large domestic institutional investor base. - Greater exchange rate flexibility and a wide range of monetary instruments provided policy flexibility to absorb external shocks. - Resilience reinforced by a healthy level of international reserves, a prudent external debt position and a stronger financial system. - Despite a sharp reversal of inflows from the region in the recent period, orderly market conditions prevailed and domestic impact was rather muted. ### Final Remarks - Authorities remain vigilant of downside risks from a challenging external environment given Malaysia’s high openness. - Underlying fundamentals remain robust, creating resilience against potential vulnerabilities. - Strong external position accords policy flexibility to absorb external shocks. - Greater regional cooperation and policy coordination—through collaborative surveillance efforts, bilateral swap agreements between regional central banks, and the Chiang Mai Initiative Multilateralisation liquidity support arrangement—provide buffers against potential shocks. - Authorities will monitor external developments closely and respond appropriately. - Authorities agree to the publication of the full suite of reports associated with the 2013 Article IV consultation. *Malaysian authorities’ statement on the 2013 Article IV consultation.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr1480.pdf_