## 1. Growth and Exports ## Source details **Canonical URL:** [1. Growth and Exports](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16110.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16110.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16110.pdf.json) --- ### Recent developments and shocks - Malaysia was in a favorable position in mid-2014 with strong growth, a large current account surplus and substantial reserves. - Multiple external shocks since late-2014: lower commodity prices, capital outflows, slowdown in external demand, and China-related financial volatility. - Ringgit depreciation: 25.5 percent against the U.S. dollar between July 2014 and December 2015. - Reserves deployed: US$36.5 billion used to cushion capital outflows and maintain orderly market conditions. ### Economic performance (2014–2015) - Real GDP growth: 6 percent in 2014; 5 percent in 2015. - Output gap: positive output gap narrowed. - Main drivers: private sector domestic demand; manufacturing and services resilient. - Exports: picked up in the second half of 2015 on stronger external demand and a depreciated currency; current account remained in surplus. - Investment: resilient due to long-gestation infrastructure and industry projects. - Inflation: subdued; GST and currency depreciation offset by weaker demand and lower oil prices. - Credit growth: slowing to a more moderate pace. ### Policy adjustments (authorities’ actions and Fund alignment) - Fiscal consolidation to offset lower oil and gas related revenues and deliver medium-term sustainability. - Key 2015 measures: - Introduction of GST. - Elimination of fuel subsidies. - Monetary policy: calibrated to support growth and contain inflationary pressure from GST and currency depreciation. - Macroprudential: targeted measures to build financial sector resilience as the financial cycle turns. - Authorities and staff: broad agreement on assessments and policy responses. ### Outlook (staff projections) - GDP growth: projected to ease to 4.4 percent in 2016. - Domestic demand: expected to remain healthy but moderating; constrained by weak external demand. - Credit growth: expected to slow, dampening accumulation of debt. - Private investment growth: projected to decelerate to about 5 percent. - Inflation: expected to rise temporarily in early 2016 as lower oil price effects wane and exchange rate pass-through occurs. - Medium-term potential growth: expected to remain close to 5 percent but likely slightly lower than previously projected. - Current account: projected to stay in surplus despite large negative terms-of-trade shock. ### Key statistics (selected) - Nominal GDP (2015): US$296 billion - GDP per capita (2015): US$9,556 - Population (2015): 31.0 million - Real GDP (percent change) Est./Proj.: 2011:5.3 2012:5.5 2013:4.7 2014:6.0 2015:5.0 2016:4.4 2017:4.8 - Export value growth (in U.S. dollars): 2015: -15.5 - CPI inflation (period average) Est./Proj.: 2011:3.2 2012:1.7 2013:2.1 2014:3.1 2015:2.1 2016:3.1 2017:3.1 - Unemployment rate (2015): 3.2 percent - Current account balance (in percent of GDP) 2015: 2.9 - Gross official reserves (US$ billions) 2015: 95.3 ### Risks (external and domestic) - External risks: - Global and regional trade slowdowns, China-related volatility and spillovers, and the normalization path of U.S. interest rates. - Vulnerability to further outflows given sizeable foreign investor positions in Malaysian Government Securities (MGS). - Possibility of sharper-than-expected slowdown in China in 2016–17; further decline in energy and commodity prices. - Domestic risks: - High domestic debt since the post-GFC period: elevated federal debt and contingent liabilities, external and household debt. - Realization of contingent liabilities could provoke financial market volatility and sovereign yield spikes. - Risk of severe downturn in the financial cycle judged relatively low given resilient banking system and macroprudential policies. - Need to monitor exchange rate pass-through to domestic prices. ### Authorities’ views (summary) - Growth expected between 4.0–4.5 percent for 2016, led by domestic demand. - Consumption growth: expected to remain healthy but slower. - Private investment: expected to moderate but supported by strategic infrastructure pipeline. - Manufacturing exports: expected to benefit from ringgit depreciation. - Broad concurrence with staff on persistence of externally driven volatility and low probability of fiscal contingent liabilities materializing. - BNM assesses probability of a sharp financial cycle turn as low and views risks as manageable. ### Adjusting to external shocks and fiscal details - Oil and gas related commodities account for about 10 percent of exports. - Current account surplus narrowed to 2.9 percent of GDP in 2015. - PETRONAS dividends to government: 26 billion ringgit in 2015 vs 29 billion ringgit in 2014. - PETRONAS profits: 21 billion ringgit in 2015 vs 48 billion ringgit in 2014. - NFPS deficit widened in 2015; outlook: deficit will gradually decline as public savings recover. - Investment ratio: projected to rise over time, but trajectory more modest. - Current account: expected to narrow further to about 1.6 percent of GDP over the medium term. ### Exchange Market Pressure (EMP) and capital flows - EMP: Malaysia experienced sizeable depreciation pressure in 2015; EMP broadly in line with cross-country regression predictions with export exposure to China and mineral fuels explaining much of it. - Ringgit depreciation (commonly cited): about 19 percent against the U.S. dollar in 2015 (other figures in text include 18.6 percent and 27.7 percent for different periods). - Reserves used to smooth cycles: US$36.5 billion deployed between July 2014 and end-2015 (decline of reserves noted at nearly US$37 billion between August 2014 and December 2015). - Capital flows: - Cumulative portfolio inflows post-GFC: US$81 billion (26 percent of GDP) between early 2009 and mid-2013 peak. - Foreign holdings of BNM bills shrank to near zero by mid-2015; foreign holdings of MGS remained relatively stable. - Non-resident deposits: 7.2 percent of GDP (two thirds comprise business deposits). - Outstanding liquidity placed with BNM: approximately RM 220 billion at end December 2015, of which approximately RM 50 billion statutory reserves (down from RM 320 billion in August 2014). ### Stress testing resilience (selected findings) - External debt increased from about 54 percent of GDP in 2009 to 65.6 percent at end-2015; about 36 percent of external debt is in local currency. - Severe stress test simulating further foreign capital outflow (magnitude similar to GFC) reaffirms risks from capital outflows remain contained. - Staff analysis: domestic institutional investors have balance sheet capacity to absorb additional MGS holdings of at least 5 percent of GDP. - Tail-risk scenario quantified shortfall: US$25.2 billion (8.2 percent of GDP), implying reserves would fall under that scenario (estimated reserves at end 2016: 70.1 US$ billions). ### Financial sector, household and corporate balance sheets - Financial cycle: turning; loan growth easing due to macroprudential policies and macroeconomic factors. - Credit-to-GDP ratio: rising historically, but credit growth moderating. - Household debt: increased by 15 percentage points of GDP since end-2009; household debt around 89.1 percent of GDP in 2015 (series shows 89.1, 89.3, 89.5 across 2015–2017 entries). - Composition of household debt: close to 50 percent on residential property; about 60 percent variable rate loans. - Banks: strong liquidity and capital buffers; NPL ratio low (2015: 1.6 percent); regulatory capital to RWA: 16.3; Tier 1: 13.9. - Corporate sector debt: 96 percent of GDP; less than 26 percent foreign-currency denominated; stress testing implies corporates resilient to income declines, exchange rate depreciation, and interest rate increases. - Non-bank credit intermediaries: contributed to household debt build-up; growth declined following 2013 macroprudential measures. ### Fiscal policy assessment and recommendations - 2015 deficit target of 3.2 percent of GDP achieved via GST, subsidy reform, restraint in recurrent spending, and lagged PETRONAS dividend adjustment. - Staff notes balancing the budget by 2020 could require additional measures up to 1.2 percent of GDP. - 2016 Budget target (after January recalibration): deficit of 3.1 percent of GDP. - Fiscal impulse: -0.8 percent of GDP in 2015 and –0.1 percent of GDP in 2016. - Measures supporting consumption for low and middle income earners: - EPF contributions reduced temporarily by 3 percentage points (until end-2017). - Additional tax relief for those earning RM 8,000 or below per month. - Fiscal measures (Annual Impact, Percent of GDP): - Decline in Petroleum Income Tax -1.9 - Decline in Petronas Dividend -1 - Introduction of GST +3.1 - Elimination of Sales and Services Taxes -1.6 - Increased Social Spending -0.3 - Elimination of Fuel Subsidies for Consumers +0.9 - Other Net Savings +1.1 - Overall Deficit Reduction +0.3 - GST rate: 6 percent; staff notes rate is low relative to other countries and could be increased to help meet medium-term fiscal objectives. - Federal debt: expected to remain below the 55 percent of GDP ceiling in the short- and medium-term. - Contingent liabilities: in excess of 15 percent of GDP require continuous monitoring; staff recommends publishing an annual statement on fiscal risks. - Staff supports adoption of medium-term fiscal framework, accrual accounting, outcome-based budgeting, and suggests Public Investment Management Assessment (PIMA). ### External sector assessment (2015) - EBA 2015 estimates cyclically-adjusted current account surplus at 4.6 percent of GDP; EBA CA norm 0.5 percent of GDP. - Staff estimate: current account norm 1.8 percent of GDP; CA gap 2.8 percent of GDP. - REER assessed by staff as moderately undervalued by 9.7 percent. - Reserves adequacy: reserves at end-2015 equal to 80 percent of IMF reserve adequacy metric (RAM), below suggested adequacy range of 100–150 percent. - NIIP: 8.4 percent of GDP at end-2015 (staff estimate). ### Structural reforms and medium-term growth strategies - 11th Malaysia Plan (May 2015) focuses on investments in hard and soft infrastructure (KL-Singapore high speed rail, KL metro expansion, Pan Borneo highway) and boosting productivity. - Reforms needed: workforce skills, home-grown innovation, technology adoption, improve education quality (Malaysia Education Blueprint 2013–25). - Trade integration: ASEAN Economic Community (January 2016) and Trans-Pacific Partnership (TPP) implementation starting in 2018 expected to improve productivity; TPP gains estimated at 5 percent of GDP by 2025 (estimate cited: Petri and Plummer 2016). ### Policy recommendations and operational guidance (staff) - Exchange rate flexibility: remain first line of defense; use reserves to smooth market functioning and gradually rebuild reserves opportunistically. - Monetary policy: remain accommodative while monitoring inflation pass-through; no policy rate change anticipated in 2016 per staff projections; cut risks re-igniting strong credit growth. - Macroprudential: maintain targeted measures; consider LTV caps on second and first mortgages if rapid house price and credit growth reappear. - Fiscal: persist with growth-friendly consolidation; allow automatic stabilizers if economy weaker than baseline; any fiscal stimulus should be temporary, targeted and anchored in a credible medium-term consolidation plan. - Fiscal transparency: publish annual fiscal risks statement; improve budget information and link to 11th Malaysia Plan. - Strengthen institutions and governance: enhance anti-corruption frameworks, AML-CFT implementation, asset declaration, and public financial management communication. ### Stress-test and DSA summary (selected) - External debt (staff estimate): increased to 65.6 percent of GDP in 2015. - Standard stress tests: external debt remains manageable under a variety of shocks. - One-time real depreciation of 30 percent in 2017: debt ratio rises to 84 percent of GDP on impact, falling to about 70 percent by 2021. - Contingent liability shock (absorb 15 percent of GDP in guarantees over two years): debt-to-GDP would rise to a little above 65 percent of GDP; gross financing needs peak at 16 percent. - Under baseline: federal government deficit projected to decline from 3.2 percent of GDP in 2015 to 1.3 percent in 2021; debt-to-GDP projected to decrease to below 45 percent by 2021 in staff baseline. ### Recommended timetable - It is recommended that the next Article IV consultation be held on the standard 12-month cycle. *Source: IMF staff report chapter "1. Growth and Exports" and related chapters and appendices in content unit _cr16110.* ### 1. Growth and Exports _________________________________________________________________________ 19 ### 1. Growth and Exports _________________________________________________________________________ 19 ### Recent developments - Malaysia’s highly open and diversified economy was in a favorable position in mid-2014, with strong economic growth, a large current account surplus and substantial reserves. - Multiple external shocks—lower commodity prices, capital outflows, slowdown in external demand, and China-related financial volatility—have been large and growth is slowing down. - The ringgit depreciated by 25.5 percent against the U.S. dollar between July 2014 and December 2015. - US$36.5 billion of reserves were deployed to cushion the capital outflows and maintain orderly market conditions. ### Economic performance (2014–2015) - Real GDP growth: 6 percent in 2014; 5 percent in 2015. - The positive output gap has narrowed. - Main drivers: private sector domestic demand. - Exports: picked up in the second half of 2015 on stronger external demand and a depreciated currency; current account remained in surplus. - Investment: resilient due to continued implementation of long-gestation infrastructure and industry projects. - Sector resilience: manufacturing and services sectors remained resilient. - Inflation: remained subdued as weaker demand and lower oil prices offset the impact of GST and currency depreciation. - Credit growth: slowing to a more moderate pace. ### Policy adjustments - Authorities’ responses were timely and aligned with Fund policy advice (Appendix I). - Fiscal consolidation aimed at offsetting lower oil and gas related revenues and delivering medium-term sustainability. - Policy measures in 2015: - Introduction of GST. - Elimination of fuel subsidies. - Monetary policy: calibrated to support growth and contain inflationary pressure from the GST introduction and currency depreciation. - Macroprudential: a series of targeted macroprudential policies helped build financial sector resilience as the financial cycle is turning. ### Outlook (staff projections) - GDP growth projected to ease to 4.4 percent in 2016. - Domestic demand: expected to remain healthy, albeit moderating; constrained by weak external demand. - Credit growth: expected to slow, dampening accumulation of debt. - Financial conditions: expected to remain accommodative of growth. - Factors supporting consumption growth: - Temporary reduction in mandatory Employee Provident Fund (EPF) contribution rates. - Tax relief for middle and lower income taxpayers. - Expanded federal transfers to lower-income groups. - Lower fuel prices. - High rates of household formation and strong employment. - Private investment growth projected to decelerate to about 5 percent. - Inflation: expected to rise temporarily in early 2016 as the impact of lower oil prices wanes and a more depreciated exchange rate passes through to prices. - Medium-term potential growth: expected to remain close to 5 percent but likely slightly lower than previously projected due to lower commodity prices, slower potential growth in China and other emerging markets, and lower potential growth in advanced economies. - Current account: despite the large negative terms of trade shock, projected to stay in surplus. ### Risks - Outlook for 2016 is uncertain owing to global and regional trade slowdowns, China-related volatility and spillovers, and the normalization path of U.S. interest rates (Appendix II). - External risks: - Despite significant capital outflows during 2015, foreign investors still hold sizeable positions in Malaysian Government Securities (MGS); Malaysia remains vulnerable to further outflows, especially during periods of heightened global financial stress. - Other risks: sharper-than-expected slowdown in China in 2016–17; structurally weak growth in advanced and emerging market economies; further decline in energy and commodity prices. - Domestic risks: - Sharp rise in domestic debt in the post-GFC period: federal debt and contingent liabilities are relatively high, as is external and household debt. - Realization of contingent liabilities could contribute to financial market volatility and potential spikes in sovereign bond yields. - Risk of a severe downturn in the financial cycle judged relatively low due to continuing growth and a resilient banking system bolstered by BNM’s macroprudential policies. - Need to monitor pass-through from the exchange rate to domestic prices. ### Authorities’ views - Broad agreement with staff’s assessment. - Growth expected to be between 4.0–4.5 percent for 2016, led by domestic demand. - Consumption growth: expected to remain healthy but slower. - Private investment: expected to moderate but be sustained by pipeline of strategic infrastructure projects. - Manufacturing exports: expected to benefit from the depreciation of the ringgit. - Authorities concur that externally driven volatility is likely to persist and emphasized the low probability of fiscal contingent liabilities materializing. - BNM assesses the probability of a sharp turn in the financial cycle as low and views risks as manageable. ### Adjusting to external shocks - Oil and gas related commodities account for about 10 percent of exports. - Large fall in commodity prices led to narrowing of the current account surplus to 2.9 percent of GDP in 2015, as weak commodity exports were only partially offset by a pickup in manufacturing exports (Appendix III). - The decline in the current account surplus was reflected in lower corporate saving initially. - Nonfinancial public sector (NFPS) deficit widened, reflecting, inter alia, the lagged adjustment of dividends to the budget by PETRONAS and continued implementation of domestic investment programs (Appendix IV). - PETRONAS dividends to the government: 26 billion ringgit in 2015 compared to 29 billion ringgit in 2014. - PETRONAS profits: declined to 21 billion ringgit in 2015 compared to 48 billion ringgit in 2014. - Offsetting measures left the federal budget deficit little changed. - Outlook for NFPS: deficit will gradually decline as public savings recover over time. - Investment ratio: projected to rise over time, but the trajectory will be more modest. - Current account: expected to narrow further to about 1.6 percent of GDP over the medium term. - Expenditure switching from a more competitive exchange rate should help boost exports but will be offset by large import needs. - Malaysia’s prior experience with adjusting to lower commodities prices highlights positive impact of fiscal reforms on growth (Appendix V). ### Spillovers from China - China is Malaysia’s largest trading partner; spillovers through trade and commodity channels are relatively important. - Malaysia’s exports to China comprise manufactures (part of regional supply chain) and palm oil and other non-oil commodities. - Direct spillover effects from China on Malaysia’s exports have been small thus far, confirmed by detailed goods exports data decomposed by commodities and non-commodities and by country of destination. - Much of the negative effect on the trade balance is from lower international prices of products Malaysia exports outside of China (for example, LNG exports to Japan and Korea). - There may be second-round effects as other countries are negatively impacted, decreasing overall external demand for Malaysia. ### Exchange Market Pressure (EMP) - EMP index (Appendix VI) gauges FX market impact relative to peer EMEs. - Malaysia’s EMP showed sizeable depreciation pressure and was higher than some Latin American EMEs. - Malaysia’s EMP was broadly in line with cross-country regression predictions; export exposure to China and to mineral fuels largely explain it. - Composition of EMP: changes in reserves contributed more in Malaysia than in most EMEs, reflecting reduction in foreign holdings of short-term BNM bills used to sterilize and smooth global capital flow cycles. ### Capital outflows: stress testing resilience - Capital inflows post-GFC: cumulative portfolio inflows of US$81 billion (26 percent of GDP) between early 2009 and peak in mid-2013. - Malaysian institutional investors, including the EPF, diversified portfolios abroad, easing demand for domestic assets and reducing net inflows. - BNM sterilized inflows by issuing bills; changes in foreign holdings of BNM bills matched by similarly sized changes in reserves. - Reserves accumulated during inflow surges were used to cushion capital outflows during 2013–2015. - Recent volatility (2014–2015): - Late 2014–early 2015: outflows primarily from the equity market in response to declining commodity prices and weak external demand. - Rest of 2015: outflows primarily from BNM bills reflecting unwinding of carry trades; by June 2015 foreign holdings of BNM bills had shrunk to near zero. - Foreign holdings of MGS have been relatively stable. - BNM used reserves and the exchange rate to smooth adjustments and maintain orderly market conditions. - Effects on domestic interest rates and the real economy were small, reflecting depth of Malaysia’s financial markets. - Key vulnerabilities: - High foreign holdings of MGS and equities. - High short-term debt of the banking system. - High household and corporate sector debt. - Offsetting resilience factors: - Deep-pocketed domestic institutional investors and sizeable bank liquidity with BNM. - Staff analysis suggests domestic institutional investors have balance sheet capacity to absorb additional MGS holdings of at least 5 percent of GDP. - Short-term external debt of the banking system increased to almost 23 percent of GDP by end-September 2015; rise related to centralization of overseas treasury operations of foreign branches and accompanied by increase in short-term banking sector assets. - Non-resident deposits amount to 7.2 percent of GDP, of which two thirds comprise business deposits; these have been stable so far but could pose vulnerability under withdrawal stress. - Outstanding liquidity placed with BNM was approximately RM 220 billion at end December 2015, of which approximately RM 50 billion represents statutory reserves (down from RM 320 billion in August 2014). BNM can release part of this liquidity to banks in a stress scenario. - Stress tests: - Malaysia’s external debt increased from about 54 percent of GDP in 2009 to 65.6 percent at end-2015, of which one quarter comprises foreign holdings of local currency debt. - A severe stress test simulating a further outflow of foreign capital (similar in magnitude to that observed during the GFC) reaffirms that risks from capital outflows remain contained (Appendix VII). - About 36 percent of Malaysia’s external debt is in its own currency and the exchange rate is flexible, allowing for more risk sharing with foreign investors: currency depreciation produces valuation losses for foreign holders, reducing the drain on reserves and incentives to exit. *Source: IMF staff report chapter "1. Growth and Exports" (pages excerpted).* ### 15. Authorities’ views. The authorities agree that Malaysia’s open economy and large ### _cr16110 - 15. Authorities’ views. The authorities agree that Malaysia’s open economy and large ### Authorities’ general assessment - Malaysia’s open economy and large financial sector expose the economy to capital flow volatility. - Accumulation of reserves during post-GFC inflow surges helped limit exchange rate appreciation and reduce excess liquidity in the banking system. - Use of reserves and release of liquidity when flows reversed insulated monetary conditions and the economy. - Exchange rate flexibility played a key role in adjustment to lower commodity prices. - Authorities and staff agree Malaysia’s resilience to capital flow volatility is strong, reflected in modest impact on the real economy during outflow episodes, supported by: - diversified sources of growth, - current account surpluses and FDI inflows, - manageable level of external debt, - liberal capital accounts, - a deep and diversified financial system. ### Response to shocks - Continued fiscal prudence and flexibility in fiscal, monetary, and exchange rate policies is required given external uncertainty. - With receding risks to price stability, monetary policy can focus more on domestic growth. - Fiscal policy: persist with growth-friendly consolidation over the medium term; use temporary and targeted measures anchored in a medium-term consolidation plan to support aggregate demand if needed. - Exchange rate flexibility should remain the first line of defense; reserves should be deployed to ensure smooth market functioning and, over the medium term, gradually and opportunistically rebuilt. - Staff supports authorities’ declaration to abstain from using capital controls on outflows. ### Monetary policy - Appropriate stance and recent actions: - Accommodative policies recommended given moderating growth, low inflation, and tightening credit conditions. - BNM has kept its policy rate unchanged since July 2014, resulting in low real interest rates supportive of domestic demand. - Capital outflows and LCR requirements led to tightening of domestic liquidity conditions. - A recent 50 basis point reduction in the statutory reserve requirement ratio should help prevent over-tightening of credit conditions. - Inflation expected to peak in the first quarter and remain moderate during 2016 due to modest exchange rate pass through. - Outlook and risk management: - No change in the policy rate anticipated during 2016, consistent with projections from an estimated Taylor rule (Appendix VIII). - Cutting the policy rate to aid growth near term risks re-igniting strong credit growth. - Interest rate tightening should be considered if second-round inflation pressures emerge from large exchange rate depreciation. - In a risk scenario of prolonged capital outflows and significant domestic liquidity tightening, BNM could provide liquidity through open market operations and/or further lower the statutory reserve requirement. - Given the lower level of reserves, greater reliance on exchange rate flexibility is recommended. - Authorities’ views: - Current monetary stance is supportive of activity; growth expected to moderate and inflationary pressures to remain subdued. - BNM will ensure sufficient liquidity to maintain orderly markets and support growth. - Authorities agree on importance of exchange rate flexibility and need to rebuild reserves over the medium term, but would not rule out using reserves to buffer short-term capital flows as in the past. ### Fiscal policy - Background and recent performance: - 2015 deficit target of 3.2 percent of GDP was achieved through introduction of the GST, subsidy reform, restraint in recurrent spending, and lagged adjustment in the PETRONAS dividend. - Staff notes balancing the budget by 2020 could require additional measures up to 1.2 percent of GDP. - 2016 Budget: - The 2016 Budget, including the January recalibration, targets a deficit of 3.1 percent of GDP. - Measures in response to declines in oil and gas revenues included cuts to supplies and services and grants, refocusing development expenditure on high impact projects with low import content. - Fiscal impulse: -0.8 percent of GDP in 2015 and –0.1 percent of GDP in 2016. - Measures to support consumption for low and middle income earners: - Employers Provident Fund (EPF) contributions reduced temporarily by 3 percentage points (until end-2017). - Additional tax relief for those earning RM 8,000 or below per month. - Policy response guidance: - If the economy is weaker than baseline, allow automatic stabilizers to operate and permit a slight rise in the federal deficit while keeping commitment to medium-term consolidation. - Given relatively high fiscal deficit and public debt, space for sustained countercyclical fiscal response is limited; any stimulus should be temporary, targeted, and anchored in a medium-term consolidation program. - Fiscal measures and impacts (Annual Impact, Percent of GDP): - Decline in Petroleum Income Tax -1.9 - Decline in Petronas Dividend -1 - Introduction of GST +3.1 - Elimination of Sales and Services Taxes -1.6 - Increased Social Spending -0.3 - Elimination of Fuel Subsidies for Consumers +0.9 - Other Net Savings +1.1 - Overall Deficit Reduction +0.3 - GST and revenue: - GST has been critical in adjustment to lower oil prices; narrowing exempt and zero-rated items could enhance effectiveness. - GST rate at 6 percent is low relative to other countries and could be increased to help meet medium-term fiscal objectives. - Federal debt and contingent liabilities: - Federal debt expected to remain below the 55 percent of GDP ceiling in the short- and medium-term (Appendix IX). - Contingent liabilities (in excess of 15 percent of GDP) require continuous monitoring. - A Public Sector Housing Financing Board was created to manage housing loans to civil servants starting in January 2016; associated assets and a portion of liabilities transferred to the new body, reducing federal debt by 2 percent of GDP but leaving general government debt unchanged. - Staff recommends publishing an annual statement on fiscal risks. - Fiscal institutions: - Staff welcomes adoption of a medium-term fiscal framework and inclusion of three-year projections in the 2016 budget. - Staff encourages additional budget information, including annual projections of revenue and expenditure and an explicit link with 11th Malaysia Plan. - Staff welcomes implementation of accrual accounting and outcome-based budgeting, and suggests a Public Investment Management Assessment (PIMA) would be beneficial. - Nonfinancial public enterprises: - NFPS deficit estimated to have increased from 5.9 percent of GDP in 2014 to 8.9 percent in 2015. - Increase largely due to fall in global oil prices lowering GLCs’ operating surpluses and continued GLC investment supporting the economy. - GLCs finance capital expenditure from retained earnings and issuance of debt and equity; clear communication of GLC investment and financing plans is important. - Authorities’ views: - Reiterated commitment to fiscal sustainability and achieving a broadly balanced budget in the medium term. - Noted significant contribution from GST revenues for the 2016 Budget and emphasized expenditure restraint on areas with low impact on aggregate demand. - Contingent liabilities sizable but government loan guarantees considered to have low probability of being called. ### The financial cycle and leverage - Financial cycle dynamics: - Financial cycle is turning; loan growth continues to ease due to macroprudential policies and macroeconomic factors. - Credit-to-GDP ratio increased and credit gap widened, but expected to reverse as nominal GDP growth picks up and outpaces moderate credit growth. - Tighter credit conditions and high debt levels will weigh on domestic demand. - Banks: - Strong liquidity position with BNM helped cushion capital outflows. - Low real deposit interest rates contributed to sluggish deposit growth and intensified competition for deposits amid LCR adjustments. - Banks’ capital position strengthened in 2015, but profitability weakened slightly. - Loan quality remains good; NPL ratio unchanged, consistent with slower growth. - Banks’ short-term FX debt increased but matched by FX assets—warrants careful monitoring. - Malaysian banks are well placed to meet Basel III capital and phased-in liquidity requirements. - Non-banks: - Non-bank credit intermediaries contributed significantly to household debt build-up; growth in non-bank lending and household debt stock has declined following 2013 macroprudential measures. - Direct linkages between banks and non-banks are limited and covered by BNM regulation on single counterparty exposures. - Household debt and macroprudential policy: - Household debt increased by 15 percentage points of GDP since end-2009 but growth has begun to moderate. - Close to 50 percent of household debt is on residential property and about 60 percent are variable rate loans. - Macroprudential measures have curbed household borrowing; reduced loan applications and approvals reflect enhanced risk-based pricing. - Risks mitigated by strong household financial assets (including EPF savings and banking system deposits) and low unemployment. - NPLs likely to increase slightly as the financial cycle turns, but any increase expected to be small. - House prices still growing; high-end properties in Kuala Lumpur have declined slightly. - No further measures recommended now; consider LTV caps on second and first mortgages if rapid house price and credit growth reignite. - Corporate sector debt: - Corporate sector debt at 96 percent of GDP; growth has moderated since the GFC. - Corporate debt risks from maturity, currency, and commodity exposure appear contained. - Bank loans represent about half of total corporate debt, are well diversified and predominantly medium term. - Less than 26 percent of total debt is foreign-currency denominated, below emerging market average of close to 35 percent. - BNM’s approval regime for external borrowing ensures corporates’ foreign currency debt is either naturally hedged or hedged via derivatives. - Commodities account for less than 20 percent of listed corporate sector debt. - Stress testing implies Malaysian corporates are resilient to income declines, exchange rate depreciation, and interest rate increases. - Authorities’ views: - Concur that financial cycle is turning; banks expected to remain resilient due to macroprudential policies and risk-based supervision. - High underwriting standards imply only a modest and manageable increase in NPLs anticipated. - No additional macroprudential measures needed at this time and no plans to wind down existing prudential measures. - Non-financial corporate debt risks manageable, supported by generally healthy balance sheets. - Close to 73 percent of external borrowings were of longer maturities, exceeding one year. - Outstanding non-financial corporate external debt is borne by domestic conglomerates and local affiliates of multinationals (mainly inter-company loans). - For external borrowings equivalent to RM 100 million and above, BNM requires adequate hedging or support by foreign currency receivables. ### External sector assessment - 2015 external position: - Malaysia’s 2015 external position assessed as stronger than warranted by fundamentals and desirable policies (Appendices XIII–XIV). - EBA 2015 estimates cyclically-adjusted current account (CA) surplus at 4.6 percent of GDP, with the CA norm at 0.5 percent of GDP. - Staff’s estimate of the current account norm is 1.8 percent of GDP, implying a CA gap of 2.8 percent of GDP, with the policy gap contributing –0.1 percent of GDP. - CA gap reflects structural factors such as low investment since the Asian financial crisis amid high saving. - Malaysia’s REER assessed as moderately undervalued by 9.7 percent, consistent with identified CA gap. - Reserves were above 100 percent of the IMF’s reserve adequacy metric prior to shocks in 2014–15; use of reserves to cushion outflows declined to 80 percent of the metric for 2015, below suggested adequacy range of 100–150 percent. - Staff recommends greater reliance on exchange rate flexibility and opportunistic increases in reserves when possible. - Net international investment position is 8.4 percent of GDP at end-2015, a significant improvement over 2014 attributed to capital outflows and valuation effects. - Quantitative assessment table highlights (2015, percent of GDP or percentages preserved as in source): - EBA 2.0 current account: Norm 0.5 / Actual 4.6 / Gap 4.1 - Staff assessment: Norm 1.8 / Actual 4.6 / Gap 2.8 - Staff estimate using elasticity approach: REER misalignment -9.7 percent - Authorities’ views: - Broad agreement with staff assessment. - Exchange rate adjustments absorb external shocks; exchange rate flexibility complemented by foreign exchange interventions using reserves during heightened volatility. - Despite decline, international reserves remain ample; reserves constitute only one-fourth of Malaysia’s total external assets. - Authorities note the Fund’s reserve adequacy metric classifies Malaysia’s exchange rate regime as “other fixed” instead of “free floating,” an unfavorable binary classification; emphasize need for judgment and avoid rigid metric interpretation. - Authorities expect current account to remain in surplus over the medium term. ### Structural reforms for real convergence and inclusion - Progress and challenge: - Substantial progress in real convergence under the 10th Malaysia Plan. - The challenge is to transition to advanced country status by boosting productivity. - 11th Malaysia Plan (May 2015) envisaged investments in hard and soft infrastructure, including: - a high speed rail linking Kuala Lumpur to Singapore, - expansion of the Kuala Lumpur metro system, - the Pan Borneo highway. - Expected benefits: - Improved connectivity with neighbors, - Alleviation of urban congestion, - Greater attractiveness to foreign investment and skilled labor. *Source: IMF staff report (content unit: _cr16110 - 15. Authorities’ views).* ### 37. Championing trade integration. Malaysia remains a champion of free trade and ### 37. Championing trade integration. Malaysia remains a champion of free trade and ### Trade integration and openness - ASEAN Economic Community (AEC) launched in January 2016 following Malaysia’s chairmanship is expected to help reduce extensive intra-ASEAN non-tariff trade barriers and strengthen trade and investment, especially in services. - Malaysia is a signatory to the Trans-Pacific Partnership (TPP); implementation starting in 2018 is expected to help improve productivity through greater competition and better governance. - Staff welcomes the authorities’ staunch support of free trade, despite domestic opposition. - Viewed in their totality, better infrastructure and adherence to free trade should help make Malaysia more competitive. - According to recent estimates (Petri and Plummer 2016), Malaysia’s gains from the TPP will amount to 5 percent of its GDP by 2025. ### Boosting human capital and home-grown innovation - Improvements needed: workforce skills, more home-grown innovation, more intensive technology adoption to avoid the middle income trap and become more inclusive. - Staff encourages steadfast implementation of the Malaysia Education Blueprint 2013–25, which aims to boost student educational attainment and raise scores to the upper third of international comparisons. - Education system transformations recommended: industry-led cooperative arrangements with universities and technical vocational institutes; sharpening incentives in allocation of research budgets; greater focus on commercialization of knowledge from research and development. ### Strengthening institutions and governance - Recent events around a government-owned strategic investment fund embroiled in scandal underscore the need to uphold high standards of governance and communication in public financial management. - Transparency International’s Corruption Perceptions Index for Malaysia declined from 52 to 50 in 2015 and the ranking fell from 50th to 54th. - Malaysia ranks 18th in the World Bank’s Ease of Doing Business Index in 2016. - Staff welcomes steps under consideration to strengthen the Malaysia Anti-Corruption Commission and Malaysia’s engagement with its Financial Action Task Force peers to strengthen the domestic framework and implementation of laws relating to Anti-Money Laundering and Countering the Financing of Terrorism (AML-CFT). - Staff encourages enhancing the asset declaration system and strengthening law enforcement agencies’ capacity to conduct financial investigations. ### Authorities’ views - Authorities agreed with the broad thrust of staff’s assessment. - Reiterated commitments: fiscal prudence; fiscal and structural reforms to raise efficiency and fairness of fiscal policy; improve education quality; strengthen investments in research and development. - Reiterated commitment to trade integration and economic openness as an anchor for reforms to improve living standards. - Authorities are confident that implementation of their wide ranging reform agenda will help Malaysia achieve high income status by 2020. ### Outlook - Malaysia’s highly open economy remains resilient despite multiple shocks since late 2014. - Growth is slowing, the economic environment has become more challenging, and downside risks have risen. - On-going re-balancing in China could imply additional spillovers in the near term. - Uncertainty about the external environment, including the likelihood of persistently low commodity prices and more capital outflows, requires continued prudence in selecting policy settings. ### Fiscal policy - Authorities have broadened and diversified revenue bases away from oil and gas related revenues in a timely manner. - NFPS deficit has risen as commodity prices declined, but this is expected to reverse in the medium term. - Protecting and strengthening the fiscal position should continue to be the authorities’ top priority: adhere to the federal budget deficit target for 2016 and balance the budget by 2020. - Automatic fiscal stabilizers should be allowed to operate if the economy is much weaker than envisaged, but there is relatively little room for countercyclical fiscal policies. - Given relatively high federal debt and contingent liabilities, any fiscal stimulus should be targeted, temporary and consistent with the medium-term fiscal consolidation plan. ### Monetary policy - In response to external shocks and capital outflows, BNM has allowed the ringgit to depreciate and deployed reserves to smooth the capital flow cycle and ensure orderly conditions in foreign exchange and financial markets. - Going forward, BNM should rely more on exchange rate flexibility, intervene judiciously, and gradually rebuild its stock of international reserves. - While headline inflation is expected to rise temporarily in 2016, core inflation is well anchored, and BNM’s current monetary policy setting is appropriate. - Authorities should monitor risks to inflation from stronger than expected exchange rate pass-through; a tightening of interest rates could be considered if signs of second-round effects emerge. ### Financial sector - Macroprudential policies and tighter financial conditions have resulted in lower credit growth after years of strong growth. - Household and corporate sector debt remains elevated. - Additional macroprudential policies are not currently recommended. - Liquidity remains adequate and supportive of growth. - Malaysian banks are well capitalized and are expected to remain strong as the financial cycle turns, but authorities should monitor risks from rising NPLs. ### Structural policies - Implementation of reforms envisaged in the 11th Malaysia Plan and commitment to freer trade policies should help anchor structural reforms and raise Malaysia’s potential growth over the medium term. - Further raising the skills of Malaysia’s labor force, through steadfast implementation of education policies, will be critical in the drive to become a high income nation. - Recent events underscore the need to uphold high standards of governance and communication in public financial management. *INTERNATIONAL MONETARY FUND* ### 46. It is recommended that the next Article IV consultation be held on the standard 12- ### _cr16110 - 46. It is recommended that the next Article IV consultation be held on the standard 12- ### Recommendation - It is recommended that the next Article IV consultation be held on the standard 12-month cycle. ### Growth and Exports - Malaysia’s growth has weakened but remains resilient, supported by still robust domestic demand despite a drag on private consumption from GST implementation. - Global oil prices have fallen dramatically and the exchange rate has helped absorb the shock, but the current account surplus has declined. - There have been very large declines in exports, measured in U.S. dollars in all sectors, though a weaker exchange rate helped boost manufacturing sector volumes until recently. Key statistics (selected) - Nominal GDP (2015): US$296 billion - Main export (percent of total): electrical & electronic products (39%), commodities (23%) - GDP per capita (2015): US$9,556 - Population (2015): 31.0 million - Real GDP (percent change) Est./Proj.: 2011:5.3 2012:5.5 2013:4.7 2014:6.0 2015:5.0 2016:4.4 2017:4.8 - Export value growth (in U.S. dollars): 2015: -15.5 ### Inflation and Domestic Resource Constraints - Headline inflation remains moderate but has been volatile reflecting fuel price adjustments and GST implementation. - GST implementation in April 2015 increased core inflation. - Producer prices continue to decline. - The labor market remains tight although the unemployment rate has increased since last year. - Wage growth continues to be strong. - The output gap has shrunk during the year, yet remains positive. Key statistics (selected) - CPI inflation (period average) Est./Proj.: 2011:3.2 2012:1.7 2013:2.1 2014:3.1 2015:2.1 2016:3.1 2017:3.1 - Unemployment rate (2015): 3.2 percent ### Monetary Developments - BNM has left the policy rate unchanged since July 2014 but market rates have increased slightly. - Real interest rates have increased as the expected inflation rate declined. - Policy rates are described as well calibrated to current conditions. - Broad money growth has declined along with deposit growth; reclassification of Islamic Banks’ liabilities in July led to a decline in measured deposits. - Foreign currency deposits have increased while non-resident deposits fell during the second half of the year. Key statistics (selected) - Overnight policy rate: 3.00 (2011–2013), 3.25 (2014), 3.25 (2015) (table shows "......" for later) - Broad money (12-month percent change): 2015: 3.0 - Credit to private sector (percent change, end of period) 2015: 8.3 ### Fiscal Developments and Public Sector Prospects - Sustained gradual deficit reduction, especially of non-oil primary balance, in an environment of decreasing revenue, with subsidy reductions and expenditure restraint. Development spending expected to grow moderately. - Debt and deficits are projected to fall; guarantees have stabilized after rising for several years. - The NFPS deficit grew significantly in 2015 as the fall in commodity prices hurt the NFPE surplus. Development spending is kept broadly constant, as has development spending by PETRONAS. - The NFPS deficit is projected to decline over the medium term, driving down debt. Key fiscal figures (selected) - Federal government overall balance (percent of GDP) 2011–2017: -4.6 -5.1 -4.2 -3.4 -3.2 -3.1 -2.8 - Revenue (percent of GDP) 2015: 17.2 - Expenditure and net lending (percent of GDP) 2015: 20.2 - Federal government non-oil primary balance (percent of GDP) 2015: -5.0 - General government debt (percent of GDP) Est./Proj.: 2011:52.6 2012:54.6 2013:55.9 2014:55.6 2015:57.4 2016:55.8 2017:55.8 Selected monetary/fiscal magnitudes (ringgit; 2015) - Nominal GDP (in millions of ringgit): 1,156,883 (2015) - Federal government revenue (2015): 219,155 (millions of ringgit) - Federal government expenditure (2015): 256,374 (millions of ringgit) - Net lending/borrowing (2015): -37,219 (millions of ringgit) ### Capital Flows and External Sector - In the post GFC-era, portfolio inflows and outflows have been large and very volatile. - Foreign holdings of debt securities rose steadily until mid-2014 and then declined with outflows from BNM bills and notes, although foreign holdings of MGS are less affected. - The stock market has declined on equity outflows. - BNM has intervened to cushion the impact of outflows and there was a very large depreciation in the exchange rate. Key external statistics (selected) - Current account balance (in billions of U.S. dollars) 2015: 8.7 - Current account balance (in percent of GDP) 2015: 2.9 - Goods balance 2015: 27.9 (billions of U.S. dollars) - Gross official reserves (US$ billions) 2015: 95.3 - Total external debt (US$ billions) 2015: 194.2 - Total short-term external debt (remaining maturity, in billions of U.S. dollars) 2015: 126.8 ### Financial Sector Developments and Household Debt - Credit growth is declining for both households and the nonfinancial corporate sector; however, slower nominal GDP growth implies the credit-to-GDP ratio continues to rise. - Corporate sector leverage remains below levels seen prior to the Asian Financial Crisis. - The banking system is well capitalized, while credit quality has steadily improved. - Banking system short-term external debt has increased along with non-resident deposits, but is matched by an increase in external assets. - Housing and personal loan growth is moderating and the increase in household debt has moderated but remains high compared to other countries and above the ratio in countries with a similar GDP per capita. - Loan approvals and applications continue to decline as the financial cycle begins to turn. High household financial assets mitigate the vulnerability from growing household debt. - House prices continue to rise but the pace is moderating slightly; house price increases have outpaced incomes and rents. Residential supply has been increasing and has picked up in Kuala Lumpur. Key financial statistics (selected) - Credit-to-GDP ratio (end of period) series (table formatting): 117.7 123.6 129.7 130.1 134.8 134.5 134.3 - Household debt (in percent of GDP) series: 76.1 80.5 86.1 86.8 89.1 89.3 89.5 - Household financial assets (in percent of GDP) 2014/2015 entries: 182.4 182.9 (table shows "......" for later) - House prices (percentage change) series: 9.8 11.8 10.9 8.5 6.0 6.4 6.5 Banking system soundness indicators (2015) - Regulatory capital to risk-weighted assets: 16.3 - Regulatory Tier 1 capital to risk-weighted assets: 13.9 - Nonperforming loans to total gross loans: 1.6 - Return on assets: 1.2 - Loan-deposit ratio: 88.7 ### Financial Soundness and Macroprudential Policy - Malaysian banks’ capital buffers are strong, but one-year liquidity could improve further. - Lending in proportion to deposits is reasonable while asset quality is moderately high. - Banks are profitable but interest rate spreads continue to decline, eroding profitability. - Macroprudential measures since 2010 include LTV caps, higher capital risk-weights on high-LTV mortgages, real property gains tax (RPGT) adjustments, minimum house-price thresholds for foreigners, limits on credit-card issuance and caps, maximum mortgage terms, responsible financing guidelines and DSR computation, and bans on Developers Interest Bearing Scheme (DIBS). Selected macroprudential measures (dates and actions) - January 2010: Reintroduced 5 percent Real Property Gains Tax (RPGT) for properties sold in less than 5 years; minimum house price for foreigners increased to RM 500,000. - November 2010: Imposed LTV caps of 70 percent on third and subsequent mortgages. - January 2012: Issued guidelines on responsible financing and computation of debt service ratios (DSR); increased RPGT rates. - January 2014: Distinguished RPGT for Malaysians, foreigners and corporates; increased minimum house price for foreigners to RM 1,000,000; banned DIBS. ### Illustrative Medium-Term Macroeconomic Framework (selected projections) - Real GDP growth (percent change) projections 2016–2021: 2016:4.8 2017:4.8 2018:4.9 2019:5.0 2020:5.0 2021:5.0 - Current account balance (in percent of GDP) projections 2016–2021: 2016:1.9 2017:1.8 2018:1.7 2019:1.6 2020:1.6 2021:1.6 - Gross official reserves (in billions of U.S. dollars) projections 2016–2021: 2016:112.2 2017:125.9 2018:142.2 2019:152.1 2020:161.0 (table shows series beginning 2015:95.3, continuing) *Source: IMF staff estimates and data presented in the IMF staff report for Malaysia (content unit _cr16110).* ### Appendix I. Malaysia—Staff Policy Advice from the 2013 and 2014 Article IV Consultations ### Appendix I. Malaysia—Staff Policy Advice from the 2013 and 2014 Article IV Consultations ### Fiscal Policy: findings and actions - Protect fiscal position through gradual, growth-friendly multi-year fiscal adjustment (2014). - Authorities revised the 2015 and 2016 federal budgets (January 2015 and January 2016 respectively), maintaining the federal budget deficit ceiling close to original targets. - Broaden tax bases by implementing a GST and rationalizing tax incentives (2014, 2013). - GST introduced in April 2015. - Authorities are undertaking a study on the effectiveness and costs of tax incentives. - Phase out expensive and poorly targeted fuel subsidies and adjust administered prices for electricity and other services (tolls, utilities) (2014, 2013). - Fuel and other subsidies were removed starting in December 2014. - Monthly adjustment mechanism for fuel prices maintained since then; adjustments of toll, electricity and other utility tariffs are ongoing. - Expand cash transfers to lower income groups as compensation for subsidy removal and GST (2014, 2013). - Cash transfers expanded starting with the 2015 budget. - 2014 Budget announced creation of a comprehensive database on welfare recipients to facilitate better targeting. - Gradually bring down federal debt and balance the federal budget by 2020; introduce a medium-term fiscal framework (2014, 2013). - Authorities announced intention to gradually balance the federal deficit by 2020, which will result in a substantial decline in the federal debt to GDP ratio. - Concrete fiscal consolidation actions remain to be identified. - A medium-term fiscal framework was developed and published and endorsed by the Fiscal Policy Committee. ### Monetary, exchange rate, and financial policies: findings and actions - Move from accommodative to neutral monetary stance when global uncertainty dissipates (2014). - Authorities raised policy interest rate in mid-2014 and have stayed pat since due to heightened external uncertainty. - Maintain a flexible exchange rate as a shock absorber while using reserves and intervention to ensure orderly markets (2014). - Authorities allowed substantial depreciation of the exchange rate in response to external shocks and deployed reserves to help adjust to lower commodity prices and capital outflows. - Authorities agree reserves need to be gradually rebuilt and will rely more on greater exchange rate flexibility going forward. - Continue macroprudential policies to dampen financial risks and monitor leverage (2014, 2013). - Macrouprudential measures maintained to curb household indebtedness; enhanced framework for risk-based pricing adopted. - BNM is collecting granular household debt data. - Corporate foreign-currency borrowing is closely monitored to ensure natural or other hedges. ### Structural policies: findings and actions - Boost growth and productivity through structural reforms: reform GLCs, liberalize labor and product markets, enhance education and training. - Many Article IV recommendations are part of the Economic Transformation Program and the Government Transformation Program; some progress made. - To achieve high income status and avoid the middle income trap, continue to: - prioritize infrastructure investment; - further improve public financial management; - boost spending on Research and Development to promote home-grown innovation; - improve quality of education to reduce skills mismatches and raise productivity (2014, 2013). - In May 2015 authorities unveiled the 11th Malaysia Plan spanning 2016–2020 emphasizing public capital, home grown innovation, cooperation between government, education and industry, and raising human capital quality. - Maintain openness to trade and investment; deepen regional integration and pursue high-quality trade agreements (2014). - Malaysia has joined the TPP; the ASEAN Economic Community came into being in early 2016. ### Risk Assessment Matrix — key risks, likelihoods, impacts, and recommended responses - Persistently low energy prices, triggered by supply factors reversing only gradually (Medium-term). - Likelihood: High. - Expected impacts: Lower potential growth; fiscal consolidation pressures; risk of twin deficits, higher borrowing costs or runs by foreign investors. - Recommended responses: Allow exchange rate to act as first line of defense; fiscal reforms to reduce reliance on oil revenues (e.g., increase GST rate, reduce exemptions); invest in infrastructure and productivity-boosting structural reforms. - Tighter or more volatile global financial conditions; sharp asset price adjustments and credit spread decompression (Short-term). - Likelihood: Medium. - Expected impacts: Capital flow reversals, further depreciation of the Ringgit, vulnerability from high household and corporate debt and sizeable foreign holdings of MGS and equities. - Recommended responses: Allow exchange rate to act as shock absorber; intervene only to smooth excessive volatility; provide liquidity support (including in FX) if needed; relax reserve requirements if outflows threaten domestic activity; fiscal expansion, if any, should be temporary, well-targeted, and anchored in a credible medium-term consolidation plan. - Improving U.S. economic prospects leads to further dollar surge (Short-term). - Likelihood: High. - Expected impacts: Capital outflows likely; similar mitigation and policy prescriptions as above. - Sharper-than-expected global growth slowdown, including significant China slowdown (Short- to medium-term). - Likelihood: Low/Medium. - Expected impacts: Trade channel dominant; weaker domestic demand; lower growth and higher unemployment. - Recommended responses: Allow exchange rate flexibility; consider more accommodative monetary policy if financial imbalance risks are low; temporary, well-targeted fiscal stimulus anchored in credible medium-term consolidation plan; pursue selected infrastructure projects and structural reforms to raise productivity. - Fiscal risks from federal contingent liabilities (Short- and medium-term). - Likelihood: Low. - Expected impacts: Adverse consequences for fiscal credibility and sovereign financing costs; higher public debt concerns if realized. - Recommended responses: Adopt fiscal risks management framework; publish annual fiscal risks statement; increase transparency of GLC operations. - Sharp downturn in the financial cycle, accompanied by a decline in house prices (Short- and medium-term). - Likelihood: Low. - Expected impacts: Weaker household, corporate and bank balance sheets; negative wealth and confidence effects. - Notes and responses: - Household debt is high at 89.1 percent of GDP and one half of this is mortgages. - Offsetting factors include high household financial assets and existing macroprudential policies and improved underwriting standards. - Recommended responses: Monetary policy easing, exchange rate flexibility, and a temporary fiscal stimulus anchored in a credible medium-term fiscal framework could help support growth. ### Appendix III — Malaysia’s trade: the role of commodities and China - Background: Malaysia’s economy is highly open and diversified; services account for 53.5 percent of GDP. Commodities account for about 19.2 percent of exports. - Distinct drivers: - Oil price rout primarily driven by global excess supply and structural changes in oil markets (including resilient U.S. shale production; decisions by Saudi Arabia and Russia to maintain output; lifting of sanctions on Iran; high output from Iraq and Libya). - China is a major force in non-energy commodity price declines (especially metals), accounting for about 50 percent of global demand for metals. China’s rebalancing from investment to consumption reduces commodity demand and prices. - Global financial market volatility spiked after August 2015 following changes in China’s exchange rate policy and sharp stock market declines. - Malaysia also affected by slowdown in global and regional trade driven by technological change and shorter supply chains. - Exports and imports in 2015: - Export prices (U.S. dollar terms) fell by about 20 percent in 2015. - Oil and gas prices declined by nearly 50 percent. - Unit price of palm oil exports fell by about 23 percent. - Direct income loss from lower prices of oil and other commodities at constant 2014 volumes estimated at 5.25 percent of GDP. - Depreciation of the ringgit in 2015 boosted export volumes and mitigated price impacts. - Exports declined by 14.6 percent (in U.S. dollar terms) in 2015. - Commodity exports declined by about 28 percent (in U.S. dollar terms) in 2015. - Imports declined by about 15.8 percent (in U.S. dollar terms) in 2015. - In ringgit terms, exports were up by nearly 2 percent in 2015; commodity exports were down by close to 14 percent. - Malaysia’s trade with China: - Exports to China averaged 13 percent of total exports during 2011–15. - Exports to China comprised mostly manufactures (intermediate inputs and capital goods: electrical goods and electronics and other machinery) and non-energy commodities such as palm oil. - Exports to China fell by about 8 percent in 2015 (in U.S. dollar terms), driven by a fall in machinery and transport equipment exports (about 50 percent of total exports to China). - China’s imports from Malaysia were relatively less affected than imports from most other countries in the region. - Current account developments and extreme oil price scenario: - Current account surplus fell from 4.3 percent of GDP in 2014 to 2.9 percent of GDP in 2015 as the oil and gas trade surplus shrank by 1.2 percentage points of GDP. - Non-oil and gas trade deficit around 2 percent of GDP; services and income account balances largely unchanged from 2014. - Extreme scenario examined: oil prices decline to around $10–15 per barrel over the medium term (i.e., lower by close to 60 percent over the medium term relative to the baseline). - Under assumptions of unchanged volumes and applying baseline elasticities to non-oil export prices, the analysis concludes Malaysia’s overall CA balance is unlikely to go into deficit solely because oil prices fall to $10–15 per barrel over the medium term; this extreme oil price shock alone is not as severe as the CA shock scenario in the external DSA. *IMF staff summary as presented in Appendix I of the source content.* ### 0.7 percent of GDP over 2016-21, as compared to a baseline of 1.8 percent of GDP. ### _cr16110 - 0.7 percent of GDP over 2016-21, as compared to a baseline of 1.8 percent of GDP. ### Current account (CA) elasticities and oil price sensitivity - Between 2006 and 2015, the average elasticity of the ratio of the current account balance in relation to GDP (CA/GDP) to oil price changes was -0.4. - The oil and LNG trade balance has been fairly stable around 6 percent of GDP since 2006 (2015: 5 percent of GDP). - Notable swings: 2009 saw a 2.3 percentage points of GDP drop from the peak of 7.5 percent of GDP in 2008; 2015 change was –1.2 percentage points of GDP. - Implication: the true elasticity of CA/GDP to oil price changes would be lower than -0.4 once trend declines in the nonoil-and-gas CA balance are accounted for. ### Robustness checks on import and deflator effects - Oil and gas imports are small, so oil prices have limited direct impact on import volumes. - If a further drop in oil prices is driven by global demand weakness, the import deflator should also fall, leading to lower import values for the same volumes. - Large shocks could cause import compression via slower domestic demand and/or exchange rate depreciation; these effects are abstracted from the core calculation. - Result: changes in imports may offset the 1.1 percentage drop in CA balance referenced elsewhere. - Adjusting the non-oil import deflator the same way as the non-oil export deflator yields a very small deterioration in the CA balance. ### GVAR analysis: China shock spillovers to Malaysia - Method: dynamic multi-country (GVAR) approach for international transmission of shocks. - A 1 percent permanent negative GDP shock in China reduces Malaysia GDP growth by 0.3 percentage points following a 1 percent one-off shock to GDP growth in China. - Malaysia is the second most affected ASEAN-5 country after Singapore. - If China’s slowdown coincides with global financial market volatility, spillovers to Malaysia could reach 0.5 percentage points after one year. ### Conclusion on China linkages and sectoral implications - China is Malaysia’s largest trading partner; trade and commodity channels are important for spillovers. - Malaysia’s exports to China are mostly manufactures within regional supply chains; Malaysia is also a major exporter of palm oil and other non-oil commodities to China. - Malaysia’s CA balance is unlikely to go into deficit in an extreme lower-for-longer oil scenario. - Structural shifts in Chinese demand (lower imports of manufactures, higher imports of services and consumption goods) likely to: - Hurt commodity exporters. - Benefit exporters of consumer services (tourism, health, other services). - Malaysia has comparative advantage in some services and could benefit from: - Chinese direct investment as producers relocate offshore. - Financing of infrastructure needs via the Asian Infrastructure Investment Bank based in Beijing. ### Malaysia’s trade contributions and export dynamics (figures referenced) - Figures presented characterize contributions to growth in export volumes (3-mma year-on-year growth), export prices growth contribution (3-mma year-on-year), and contributions to export values (3-mma year-on-year growth in U.S. dollar terms) across categories including Food, Beverages and tobacco, Crude materials, Mineral fuels, Animal and vegetable oils, Chemicals, Manufactured goods, Machinery, Other manufactured goods, Other, and Total. ### Government-linked companies (GLICs/GLCs) — overview and governance - Three groups identified: 1. Government-Linked Investment Companies (GLICs): Employees Provident Fund (EPF), Khazanah Nasional Berhad (Khazanah), Lembaga Tabung Angkatan Tentera (LTAT), Lembaga Tabung Haji (LTH), Permodalan Nasional Berhad (PNB). 2. Government-Linked Companies (GLCs): commercially oriented companies under control of a GLIC. 3. G20: selection of large GLCs controlled by GLICs; list currently totals 17 (originally 20). - Scope: GLCs/GLICs operate across banking and insurance, airlines and airports, transportation, water, energy, telecommunications, automotive, chemical and petrochemical, construction and infrastructure, media and communications, etc. PETRONAS is a Fortune 500 company. ### GLCs: financial metrics and transformation program outcomes - Employment and international presence: GLCs employ more than 270,000 people; about 35 percent of GLC employees are foreigners; more than one third are in overseas operations. - Market and profit metrics (2014 data unless noted): - Market capitalization of the G20 was about 35 percent of GDP in 2014. - Net profits were 2.5 percent of GDP. - Average ROE was 11 percent per annum in the last decade. - Revenue amounted to 21 percent of GDP in 2014, with a quarter being bank revenue. - Among non-banking revenue: 25 percent from the power sector, 17 percent from telecommunications, 17 percent automotive, 11 percent trading, 10 percent air transportation, 7 percent plantations. - GLC Transformation Program (May 2004–July 2015): focused on enhancing financial performance, institutionalizing corporate governance, and contributing to national development (linked to NEM, GTP, ETP). - International expansion: G20 have revenue-generating operations in 42 countries; 34 percent of total revenue from abroad (2004: 28 percent); overseas asset base of 26 percent (2004: 11 percent). ### PETRONAS: scale, performance, and recent adjustments - PETRONAS characteristics: fully integrated in oil and gas; among top five producers in Asia; most profitable among regional oil and gas companies; about 40,000 employees; presence in more than 50 countries; incorporated in 1974. - End-2015 financials (as percent of GDP unless noted): - Total assets: 51 percent of GDP. - Current assets: 16.2 percent of GDP. - Total debt: 15.2 percent of GDP. - Revenue: 22.8 percent of GDP in 2015, down from 30 percent in 2014. - Profits before taxation: 3.2 percent of GDP in 2015, down from 7 percent in 2014. - Earnings before interest, tax, depreciation and amortization (EBITDA): 6.5 percent of GDP in 2015. - Cash flow from operating activities: 6 percent of GDP in 2015. - Capital expenditures: 5.6 percent of GDP in 2015. - Response to price shock: announced a 50 billion ringgit (4.5 percent of GDP) reduction in capital expenditure over the next four years, affecting mostly foreign operations. - Assessment: company remains profitable and financially sound and is assessed to be a low cost producer. ### Macroeconomic relevance of GLCs and NFPCs fiscal impact - GLCs are significant drivers of corporate profits and savings; their investment projects are important to the five year national development plan. - Responses to the late-2014 commodity price shock included adjusted dividend payments to the federal budget with a one year lag and cuts in international capital expenditure while maintaining domestic investment programs. - Expectation: GLC deficits are expected to gradually decline as cost cutting and exchange rate depreciation boost competitiveness and profitability; investment plans will be adjusted to lower-for-longer commodity prices. ### NFPCs financial position, 2014–15 (RM billion and in percent of GDP) - Aggregate NFPCs totals (2014 Actual / 2015 Est. / Change): - Revenue: 471.4 / 400.7 / -70.7 - o/w PETRONAS: 337.4 / 261.9 / -75.5 - Current expenditure: 403.2 / 357.8 / -45.4 - o/w PETRONAS: 289.9 / 236.4 / -53.5 - Current balance: 68.2 / 42.9 / -25.2 - o/w PETRONAS: 47.6 / 25.5 / -22.1 - Capital expenditure: 105.7 / 113.4 / 7.7 - o/w PETRONAS: 61.9 / 67.5 / 5.6 - Prasarana Sdn Bhd: 2.2 / 5.4 / 3.2 - Overall NFPC balance: -37.5 / -68.4 / 30.9 - (in percent of GDP): -3.4 / -5.9 - PETRONAS-specific cash impacts in 2015: - Estimated drop in cash revenue: RM 75.5 billion to RM 261.9 billion. - Decrease in operating cash expenditure: RM 53.5 billion to RM 236.4 billion. - Resulting decline in the current balance by RM 25.2 billion in 2015. - Of the RM 7.7 billion increase in capital expenditure across NFPCs, RM 5.6 billion was contributed by PETRONAS; Prasarana Sdn Bhd accounted for RM 3.2 billion. ### Fiscal reforms and long-term growth lessons (earlier oil price slump and model calibration) - Policy responses since 2014: large cuts in poorly targeted fuel subsidies and other non-priority spending; introduction of a Goods and Services Tax (GST) in April 2015 to broaden the revenue base away from oil and gas. - Lessons from 1986–1990 oil price collapse: Malaysia implemented a large expenditure-based adjustment, deregulation, tax reform, rehabilitation and privatization of public enterprises (GLCs), which supported private investment and FDI inflows. - Endogenous growth model calibrations and simulation results: - A budget-balance neutral simulation where capital and labor taxes are reduced by 5 percentage points and offset by higher consumption taxes increases the long run growth rate by close to one half of 1 percent relative to the initial steady state. - Scaling up public investment by 1 percentage point of GDP, financed by cuts in unproductive spending, yields a growth dividend of about 0.2 percent. - Empirical approach: synthetic control method used to estimate the growth dividend of Malaysia’s 1986–1990 fiscal and economic reforms, with results indicating a substantial growth dividend (text truncated at this point in source). *Source: IMF staff report text as provided in the source content unit.* ### 2.25 percent. Growth averaged about 7 percent in the decade preceding reform (1976–1985), in line ### 2.25 percent. Growth averaged about 7 percent in the decade preceding reform (1976–1985), in line ### Growth and inequality - Growth averaged about 7 percent in the decade preceding reform (1976–1985). - Growth averaged about 7.25 percent in the following decade (1991–2000), compared to about 5 percent in the synthetic control group. - The synthetic control countries were Indonesia, Korea, and the Philippines. - The Gini coefficient after taxes and transfers declined by about 5 points. ### Impact of fiscal reforms (staff calculations) - Fiscal reform measures and estimated long-run growth effects relative to benchmark: - Reduction in capital tax of 5pp 1/: 0.15-0.2 pp increase in long-run growth. - Reduction in labor tax of 5 pp: 0.4-0.5 pp increase in long-run growth. - Increase in Public investment of 1 percent of GDP: (listed under Offsetting Measures). - Reduce unproductive spending by 1 pp of GDP: (listed under Offsetting Measures). - Increase consumption tax: (listed under Offsetting Measures). - Note: 1/ pp = percentage points. - Source: IMF staff calculations. ### Education and human capital - Enrollment rates for secondary education are rising; Malaysia has done better than some peers. - Gap with advanced countries in Asia is slowly narrowing but remains significant. - Tertiary enrollment rates have been steadily rising but still lag advanced countries in Asia. - PISA scores in Malaysia are relatively low, indicating an urgent need for reforms. - Cross-country research establishes a very close connection between economic growth and educational attainment—what students actually learn as opposed to input-based measures. - Malaysian authorities' targets and plans: - Aim to raise the percentage of highly educated workforce to 33 percent by 2020. - One of the six strategic thrusts of the 11th Malaysia Plan is to accelerate human capital development and provide students with “21st century education.” - The National Higher Education Strategic Plan, Malaysia Education Blueprint 2013–2025 (September) is cited. ### Composition of government spending and recent fiscal measures - Starting in late 2014, poorly targeted and costly fuel and other subsidies have been eliminated, with compensatory measures for lower income households. - Recent data show the share of social benefits and subsidies has declined. - Government investment share in Malaysia exceeds the average for all emerging market economies. ### Conclusions on fiscal reforms - FAD board paper conclusions reiterated: - Fiscal reforms make a difference for long-term growth: evidence shows growth increased by 0.75 percentage points in advanced economies and by even more in developing economies. - Reforms should be tailored to country-specific conditions; design matters. - Reforms are more effective when mutually reinforcing and complemented by structural and macroeconomic policies. - Large and complex reforms must contain measures to avoid equity-efficiency trade-offs to gain broad-based support. ### Exchange Market Pressure (EMP) in 2015 - Several global events during 2015 affected EMEs: sharp decline in global oil prices, financial market volatility related to China, and expectation of U.S. monetary policy normalization. - Malaysia experienced significant EMP in 2015, higher than the median EME. - The ringgit depreciated by about 19 percent against the U.S. dollar in 2015. - Bank Negara Malaysia deployed about 18 percent of its foreign exchange (FX) reserves to cushion capital outflows. - Despite EMP, the impact on Malaysia’s domestic financial markets was relatively muted. - Malaysia’s outstanding non-FDI liabilities were about 80 percent of GDP in 2014 (median for the EME: 49 percent of GDP). - Aizenman and Hutchison–style staff analysis: initial conditions as of end-2014 that helped explain variation in EMP in 2015 included export exposures to mineral fuel, China, and Russia; change in credit-to-GDP ratio and change in the real effective exchange rate (REER) in the preceding 2-3 years; and the share of FX denominated debt in nonfinancial corporate and household debt. - Regression models with several other indicators (expected growth and inflation differentials vis-à-vis the U.S.; trade openness; current account balance and its expected change in 2015; non-FDI external liabilities; monetary policy framework; FX reserve cover; banks’ loan-to-deposit ratio) did not perform well. ### Regression analysis results (selected findings from Table VI.2) - Dependent variable: EMP in 2015 (models A1–A7) - R-squared values ranged from 0.43 to 0.62 across models. - Change in credit-to-GDP ratio over 2012-14: coefficient 0.8 and significant in several models. - Share of FX denominated debt in non-financial corporate and household debt: coefficient 0.2 in models where included. - Actual (Malaysia) EMP reported as -36.5 (in percent); fitted values across models ranged, e.g., -35.8, -43.6, -30.7, -35.9, -30.7, -35.2, -35.0. - Note: *, ^, @, and # indicate significance at 1, 5, 10, and 15 percent levels respectively. - Dummy variable definition: equals unity if independent variable > in-sample median; for Malaysia, dummy for exports to Russia was zero, others were unity. - Dependent variable: change in exchange rate against the U.S. dollar in 2015 (models B1–B7) - R-squared values ranged from 0.49 to 0.71 across models. - Exports to China (dummy) showed negative and often statistically significant coefficients (e.g., -8.1*, -9.6*, -11.7* in some models). - Share of mineral fuel in exports (dummy) had negative coefficients in several specifications. - Change in credit-to-GDP ratio over 2012-14: coefficient around 0.5–0.6 and significant in several models. - Actual (Malaysia) change in exchange rate against the U.S. dollar in 2015 reported as -18.7 (in percent); fitted values across models included -21.5, -26.4, -18.2, -22.0, -18.9, -17.9, -18.4. ### Stress testing resilience to capital outflows — background and vulnerabilities - Past resilience: - Growth has averaged about 5.7 percent per annum since 2009. - Conditions: low inflation, full employment, and low real interest rates. - Current account surpluses and a structural liquidity surplus supported accumulation of sizeable foreign currency reserves. - Large institutional investors (pension funds, Khazanah Nasional, PETRONAS) provide cushions. - Malaysia’s bond markets are now the third largest in Asia. - New vulnerabilities: - Current account surplus declined to 2.9 percent of GDP in 2015 compared with 10 percent in 2010. - Non-oil current account moved into a deficit in 2012. - Reserves have declined, reflecting intervention and outflows from BNM bills and notes. - Overall debt increased: external debt rose from 55 percent of GDP at end-2010 to 65.6 percent at end-2015. - Local currency-denominated debt is 36 percent of total external debt. *Source: IMF staff report excerpts provided in the supplied content.* ### 3. Outline. There are two parts to this appendix. Section B provides a detailed discussion of the ### _cr16110 - 3. Outline. There are two parts to this appendix. Section B provides a detailed discussion of the ### Outline and key finding - Not all components of external debt present the same risk and significant buffers should be taken into account in assessing Malaysia’s external debt. - Final section illustrates a tail-risk severe stress scenario—not unlike the GFC—where Malaysia faces a sharp slowdown in global growth and large capital outflows triggering currency depreciation and a further narrowing of the current account surplus. - In this modified sudden stop scenario, the flexible exchange rate, forex intervention, and the response of domestic institutional investors all play an important role in mitigating the impact of the capital flow reversal and helping buffer the shock to the Malaysian economy. - Reduced fiscal space compared with during the GFC limits the scope for counter-cyclical fiscal policy. ### B. External Debt: Composition, Risks and Buffers - Several trends have driven the increase in external debt since end-2010, most significantly the increase in foreign holdings of local currency debt securities, both short-term and medium- and long-term. - Foreign holdings of MGS increased from 9.1 percent of GDP (at end-2010) to 14.0 percent of GDP at end 2015. - Short-term local currency external debt includes non-resident deposits and foreign holdings of BNM bills and notes: - Foreign holdings of BNM bills and notes reached 7.5 percent of GDP at end-2013 but declined to near zero as capital flows reversed. - Short-term banking sector FX debt increased from 8.2 percent of GDP at end-2010 to 15.2 percent by end 2015. - Exchange rate depreciation since mid-2014, along with US$5billion bond issuance by PETRONAS in March 2015, increased medium-term FX denominated debt to 27 percent of GDP at end-2015 (up from 21 percent of GDP at end-2014). ### Foreign holdings of BNM bills and notes - BNM used BNM bills and notes to absorb excess liquidity and sold them directly to foreign investors during capital inflow surges. - Outstanding issuance of BNM bills and notes peaked at end-2012 at just over US$50 billion, of which half were held by foreigners. - Foreign holdings were broadly unchanged in U.S. dollar terms until end-2014, although their share increased above 55 percent. - Since then portfolio rebalancing and the decline in oil prices contributed to non-resident selling and liquidation on maturity; foreign holdings declined to less than US$6 billion. - The decline in foreign holdings of BNM bills and notes represented about one-third of the US$36.5 billion decline in reserves between July 2014 and end-2015. ### The Malaysian Government securities (MGS) market - Federal government debt in Malaysia amounted to 54.5 percent of GDP at end 2015 and comprised MGS, sukuk bonds referred to as Government Investment Issues (GII), external debt, Treasury bills and others. - Outstanding MGS and GII are about 29.5 and 17.8 percent of GDP, respectively. - Foreign participation: GII market foreign participation is 4 percent of the market while MGS foreign participation is 45 percent of the market (amounting to 13.3 percent of GDP). - The second largest holder of MGS is the EPF whose holdings amount to 20 percent of outstanding MGS. - The share of MGS in EPF's portfolio declined as the EPF increased overseas investments. ### The role of domestic institutional investors - Domestic institutional investors provide depth and stabilize financial markets; market-based and opportunistic purchases by domestic investors offset pressures when foreigners exit (e.g., Taper Tantrum 2013). - MGS yields tend to be much less volatile compared to yields in other EM countries; correlation between MGS yields and the common factor in emerging market bond yields is lower than for other countries with similar levels of foreign ownership. - Example: EPF’s holdings of MGS increased by RM 9.4 billion between end-June 2014 and end-September 2015. - Large insurance companies can stabilize the MGS market mostly through portfolio reallocations along the yield curve. ### Balance sheet analysis of domestic institutional investors - Staff analysis using third quarter data for 2015 suggests domestic investors have the capacity to purchase an additional 5 percent of GDP of domestic securities (table VII.1). - The illustrative calculations rely on assumptions regarding current allocation of assets into MGS compared with an estimated target allocation. This represents the capacity under the ‘stock’ heading and is estimated to be about 0.5 percent of GDP. - Flow component based on new contributions (EPF) and maturing assets (banks and other investors) assumes target allocation is maintained. - EPF overseas assets: it is assumed about 20 percent of overseas assets could be readily liquidated and repatriated (conservative assumption). - Estimated Capacity for Additional Domestic Holdings of Government Debt (In percent of GDP) includes entries such as: - Employees Provident Fund (EPF): Total Assets 59.1, Stock 14.8, Flow 0.0, Total 0.4, Overseas Assets repatriation 0.43, From domestic balance sheet expansion and asset reallocation 3.0 - Banks: Total Assets 203.0, Flow and other entries as presented in the source. - Others 1/ : Total Assets 49.5, Stock 6.3, Flow 0.1, Total 0.1, Overseas Assets repatriation 0.2, From domestic balance sheet expansion and asset reallocation 0.4 - Sub-total stock 1.6, flow 3.3, Total 4.9 - 1/ KWAP, Khazanah, TLH, PNB. ### Short-term debt of the banking system - Short-term debt of the banking system increased from just under 15 percent of GDP in early 2009 to 22.9 at end-2015. - This debt is comprised of short-term offshore debt and non-resident deposits. - Offshore borrowing is primarily related to centralization of treasury operations of overseas subsidiaries of local banks. - This debt is matched—in terms of size—by liquid assets; external assets and liabilities of the banks together amount to about 10 percent of GDP. - In a stress scenario, if this portion is unwound smoothly, there would be no call on reserves; non-resident deposits could represent a vulnerability during a capital flight episode. ### Medium- and long-term debt - Foreign-currency denominated medium- and long-term debt amounts to 26.9 percent of GDP and is primarily related to public enterprises (8.4 percent of GDP) and the private non-bank sector (8.4 percent of GDP). - Corporate sector foreign currency denominated debt is predominantly hedged, either naturally or through financial instruments. - Stress testing indicates Malaysia’s corporates can be resilient to declines in income, depreciation of the exchange rate, and increases in interest rates. ### C. A Stress Scenario (tail-risk / modified sudden stop) - The stress scenario assumes an external shock of similar scope and magnitude to the GFC; Malaysia faces a sharp contraction in external demand and a sharp reversal of capital flows. - Scenario shock assumptions: - Exchange rate depreciates by 25 percent. - Bond yields increase by 200 basis points. - Stock market declines by 30 percent. - Baseline external financing context: - Malaysia has significant external financing needs reflecting short-term debt and amortization of medium- and long-term debt amounting to 38 percent of GDP. - In the baseline, external financing needs are largely met by debt and net equity inflows, offsetting net FDI outflow. ### Stress scenario assumptions and calibrated outflows (summarized) - Foreign holdings of MGS: - Assumed to fall by half in ringgit terms (calibrated on 50 percent decline during GFC). - MGS yields assumed to increase by 200 basis points. - An increase of 200bps in bond yields implies a reduction in bond prices of 8.5 percent (assumption: 5-year bond trading at par). - Given initial holdings of US$37.8billion, a 50 percent reduction, taking into account capital and exchange rate losses, would imply an outflow of US$14.5billion. - Rollover rate for short-term debt: - Assumed rollover rate for banks’ short-term debt declines to 70 percent (based on decline between September 2009 and March 2010). - Applied only to portion unrelated to banks’ treasury operations. - Such a reduction would create an outflow of US$5.2billion. - Non-resident deposits: - Assumed outflow of 30 percent, implying an outflow of US$4.8billion (primarily local currency). - Foreign holdings of equities: - Assumed to fall by 20 percent in ringgit terms, implying foreign participation rate falls from 21.6 percent to 17.3 percent. - Outflows are US$10billion; mitigated by stock price decline of 30 percent and exchange rate depreciation of 25 percent. - Current account balance: - Assumed to shrink to zero but not fall into deficit; exchange rate depreciation would aid expenditure switching. - Net FDI flows: - Malaysian inward and outward FDI flows are about 3.2 percent of GDP each in 2015. - In the stress scenario no change in net FDI flows is assumed. - Repatriation by domestic investors: - Overseas assets of institutional investors estimated at 3.3 percent of GDP, equivalent to US$9.3billion, generate a new inflow in the stress scenario. ### Quantified stress-test results and outcomes - Value at end-2015 and stress scenario impacts (US dollars, billions): - Malaysian Government Securities (MGS): Value US$37.8 → Outflow US$14.5 - Calibrated on 50 percent decline during the GFC. - 200 basis point increase in yields estimated to reduce ringgit value of MGS by 8.5 percent. - Exchange rate depreciation of 25 percent implies additional losses for foreign investors. - Short-term debt of the Banking System (1/): Value US$17.4 → Outflow US$5.2 - Banking system external debt fell by 70 percent between Sept. 2009 and March 2010. - Exchange rate depreciation of 25 percent implies losses for foreign investors. - Non-resident deposits: Value US$19.0 → Outflow US$4.8 - Calibrated based on short-term debt assumption. - Exchange rate depreciation of 25 percent implies losses for foreign investors. - Foreign holdings of equities (21.6 percent of stock market capitalization at end 2015): Value US$85.3 → Outflow US$10.0 - Foreign participation declined from 22 to 21 percent between 2008 and 2009. - Stock market assumed to decline by 30 percent. - Exchange rate depreciation of 25 percent implies additional losses for foreign investors. - Offsetting inflows: - Current account balance is assumed to decline to zero → Offset 0 (Value at end-2015: US$7.2; assumed to decline to zero). - Net FDI flows → Offset 0. - Repatriation of overseas assets by institutional investors → inflow implied (US$9.3 billion referenced earlier). - Shortfall compared to the baseline: - Shortfall of US$25.2billion. - Shortfall as percent of GDP: 8.2 percent. - Estimated reserves at end 2016: 70.1 (US dollars, billions). - Reserves are projected to decline by US$25.2billion under the scenario. - The composition of the adjustment is in line with other recent outflow episodes where adjustment was shared by reductions in reserves and changes in the exchange rate. *Prepared by Niamh Sheridan (APD). Source: IMF staff calculations and CEIC Data Co Ltd., extracted from the specified chapter.* ### Appendix VIII. Malaysia—Monetary Framework ### Appendix VIII. Malaysia—Monetary Framework ### Mandate and objectives - BNM has a dual monetary policy mandate: “to maintain price stability while giving due regard to the developments in the economy.” - Recent interpretation: maintaining a low inflation of about 3 percent and positive and low real interest rates conducive to sustainable growth. - Additional mandates: ensure financial stability through regulation and supervision of financial institutions under its jurisdiction, and promote a sound and inclusive financial system. - BNM coordinates with the Securities Commission and other financial regulators in the Financial Stability Committee. - Emphasis on sustainable growth over the medium-term distinguishes BNM’s mandate from inflation targeting regimes. ### Instruments and implementation - Principal policy instrument: overnight policy rate (OPR). - Other tools used at times: exchange rate and reserve requirements, to deliver monetary and financial stability. - Outcome: BNM has been successful in promoting monetary stability and Malaysia’s inflation has been relatively stable. ### Empirical estimates of policy reaction (estimated policy rules / Taylor rule evidence) - Method: estimation of monetary policy reaction functions using a thick estimation technique that uses bagging (bootstrap aggregation) across many specifications. - Main empirical findings: - The estimated coefficient on the lagged policy rate is large, implying a high degree of interest rate smoothing. - Malaysia’s monetary policy rule is more gradualist than typical. - Estimated inflation reaction coefficient is lower and generally insignificant for Malaysia; empirical results suggest greater relevance for inflation expectations than either headline or core inflation. - Output gap reaction coefficient is positive and significant for Malaysia; for other ASEAN countries it is insignificant—reflecting Malaysia’s dual mandate. - Little role found for changes in the exchange rate in influencing policy rate decisions. - Higher global uncertainty (captured with either a global financial crisis dummy or the VIX) tended to lower policy rates in Malaysia. - U.S. interest rates (Federal Funds Rate) have a positive impact on domestic policy rates in Malaysia but the estimated size of the impact is small. - Visual: chart of mean and one-standard deviation ranges shown for coefficients on: Lagged policy rate; Headline Inflation; Core Inflation; Expected Inflation; Output Gap; NEER; USD exchange rate; Federal Funds Rate; VIX; GFC dummy. ### Managing the capital flow cycle - Policy approach: reliance on both foreign reserves and the exchange rate to cushion swings in capital flows, commodities prices, and other external shocks. - During post-GFC inflow surge: - BNM partly sterilized liquidity impact by issuing bills purchased by domestic residents (primarily banks) and by foreigners. - Increases in foreign holdings of BNM bills matched by similarly sized changes in reserves. - Effect: limited ringgit appreciation and kept domestic real and nominal interest rates from falling as much as they would have otherwise. - When capital flow cycle turned (starting mid-2013) and after commodity price collapse (starting late 2014): - Reserves accumulated during inflow surges plus substantial ringgit depreciation were used to cushion outflows. - Impact on domestic interest rates was modest, shielding Malaysia’s real economy from interest rate volatility typical in other EMEs. ### Sustaining financial stability (macroprudential policies) - Macroprudential policies have complemented monetary policy since the GFC. - Several rounds of macroprudential measures (targeting property market speculation and curbing growth in personal unsecured lending). - Approach: gradual, phased implementation and targeted measures. - Example: In July 2014, as inflation increased and real rates turned negative, BNM increased the OPR amid concerns about financial stability. *Italic: Source: _cr16110 - Appendix VIII. Malaysia—Monetary Framework* --- ### Appendix IX. Malaysia—Public Debt Sustainability Analysis (DSA) ### Framework and scope - DSA framework: market access country framework using a risk-based approach including assessment of baseline realism, debt-profile risks, macro-fiscal risks, stochastic projections, and a heat map. - Coverage: federal government budget; local/state governments and statutory bodies that borrow from the federal government or receive explicit government guarantees are excluded (their liabilities captured in federal government gross debt and stock of loan guarantees). - Borrowing by state owned enterprises (some under federal guarantees) has increased in recent years, reflecting increase in the NFPS deficit after the decline in oil prices. - The NFPS and borrowing by GLCs are projected to decline over the medium term. ### Macro-fiscal baseline assumptions and projections - Growth projections: Growth is projected at 4.4 percent in 2016, recovering to 4.8 percent in 2017 and 5 percent in the medium term. - Federal government deficit: projected to decline from 3.2 percent of GDP in 2015 to 1.3 percent in 2021 in staff baseline projections. - Projected fiscal consolidation consistent with authorities’ targets and supported by fiscal and structural reforms announced in recent budgets. ### Choice of framework and financing indicators - Malaysia exceeds thresholds for higher scrutiny DSA framework due to levels of government debt and gross financing requirement. - Historical movements: - Federal gross debt increased sharply in 2009 due to discretionary fiscal stimulus, declining growth, and a large fall in oil prices. - Debt-to-GDP ratio reached about the authorities’ self-imposed debt ceiling of 55 percent. - Gross financing needs (GFN): peaked at 10.2 percent of GDP in 2013 and are expected to fall and remain at less than 8 percent in the medium term. ### Realism and forecast error assessment - Median forecast error for real GDP growth during 2007–2015 is zero (no systemic projection bias). - Median forecast error for the GDP deflator is 2.3 percent (staff forecasts conservative). - Median forecast error for the primary balance indicates staff projections have been slightly pessimistic (forecast bias of –0.25 percent of GDP), with improvement in later years. ### Feasibility of projected fiscal adjustment - Maximum 3 year adjustment in cyclically-adjusted primary balance (CAPB) over the projection period is 1.6 percent of GDP; considered ambitious but premised on concrete government measures. - Maximum level of the primary balance assumed is 0.8 percent of GDP; considered reasonable compared with other market-access countries. ### Baseline and stress-test outcomes (key quantified findings) - Under the baseline: - Debt-to-GDP ratio projected to decrease to below 45 percent by 2021. - Constant primary balance simulation (if projected consolidation does not take place): - Debt-to-GDP remains about constant before declining to 50 percent in the medium term. - One standard deviation shock to real GDP growth: - Would raise the debt-to-GDP ratio initially to above 55 percent by 2018 before it declines subsequently. - Combined macro-fiscal shock (higher interest rates and a lower primary balance) shows a similar initial rise. - Permanent oil price shock: - Assumed very large: permanent reduction in oil income of 1 percent of GDP (commensurate with a 33 percent decline in oil price, with an amplifying effect that reduces oil companies’ profits by 66 percent). - Implies a flat debt-to-GDP profile in the medium term. - Contingent liability shock: - Government absorbing all government-guaranteed loans totaling 15 percent of GDP over two years would raise risks significantly, accompanied by persistent negative growth shock and higher interest rates. - Debt-to-GDP would rise to a little above 65 percent of GDP in this scenario. - Gross financing needs peak at 16 percent in this scenario before declining to below 12 percent by end of projection horizon. - Stochastic simulations: - 90th percentile of debt-to-GDP ratio simulations remains below 65 percent. ### Heat map and risk indicators - Key vulnerability indicators: - External financing requirement: 47 percent (above the upper threshold of early warning benchmarks). - Share of public debt held by foreigners: about 30 percent of total. - Mitigating factor: existence of large domestic institutional investors who tend to make opportunistic investments. ### Selected baseline table and market indicators (as presented) - Nominal gross public debt (percent of GDP) series (2014–2021): 45.6, 52.7, 54.5, 53.0, 52.1, 50.5, 48.6, 46.4, 44.1. - Public gross financing needs (percent of GDP) series (2014–2021): 9.1, 9.0, 9.4, 8.0, 7.9, 7.9, 8.0, 7.9, 6.8. - Sovereign spreads and market metrics (snapshot as of March 15, 2016): - EMBI (bp): 369 - CDS (bp): 160 - Ratings: Moody’s A3/A3; S&P’s A-/A; Fitch A-/A - Real GDP growth (specified in table): 4.8, 6.0, 5.0, 4.4, 4.8, 4.8, 4.9, 5.0, 5.0 (across years shown). - Inflation (GDP deflator, percent): 3.2, 2.5, -0.4, 4.3, 2.6, 2.9, 2.6, 2.7, 2.5. - Effective interest rate (percent): 4.7, 4.2, 4.2, 4.3, 4.7, 5.1, 5.2, 4.9, 4.6 (across years shown). - Change in gross public sector debt (annual percent of GDP) row (2014–2021 cumulative): 1.2, -0.3, 21.8, 3, -1.5, -1.0, -1.6, -1.9, -2.2, -2.3, cumulative -10.4 (as presented). ### Stress-test scenarios summarized - Primary Balance Shock: large adverse primary balance paths simulated. - Real GDP Growth Shock: one-standard-deviation negative growth shock raising debt-to-GDP above 55 percent by 2018 initially. - Real Interest Rate Shock: higher effective interest rate paths simulated. - Real Exchange Rate Shock: exchange rate depreciation scenarios examined. - Combined Macro-Fiscal Shock: combines adverse growth, interest rate, and primary balance shocks. - Contingent Liabilities from Government Guarantees: absorption of 15 percent of GDP in guaranteed loans over two years; largest stress on debt and financing needs. - Oil Price Shock: permanent oil income reduction of 1 percent of GDP considered. ### Overall risk assessment - DSA conclusion: Malaysia’s government debt-to-GDP ratio remains below 65 percent and gross financing needs remain below 12 percent under a range of macroeconomic and fiscal shocks, except for extreme contingent liability scenarios. - Noted vulnerabilities: large external financing requirement (47 percent) and sizable share of debt held by foreigners (about 30 percent), with domestic institutional investors mitigating some risk. *Italic: Source: _cr16110 - Appendix IX. Malaysia—Public Debt Sustainability Analysis* ### Appendix X. Malaysia—Public Infrastructure: Trends and Quality ### Appendix X. Malaysia—Public Infrastructure: Trends and Quality ### Background - Infrastructure needs in Asia estimated at US$8 trillion over 10 years. - Malaysian policymakers aim to turn Malaysia into a high income nation by 2020. - Scaling up of public investment under the 10th Malaysia Plan, financed through budgetary resources and increased use of public-private partnerships (PPPs), has resulted in an increase in Malaysia’s public capital stock as a share of GDP while this ratio has declined in other Asia economies. - Increased use of PPPs in Malaysia mirrors trends observed in developing and emerging market economies. ### Record on Quantity, Access, and Quality - Malaysia fares well in surveys of infrastructure quality and access, scoring at the high end of the range and similar to advanced Asian countries. - Malaysia ranks close to advanced Asian countries on access to treated water and public education; it lags on roads, electricity production and public health infrastructure. - Public investment efficiency: - Average developing and emerging market country: 27 percent below the efficiency frontier. - Malaysia’s public investment efficiency gap: close to 11 percent, similar to the gap in advanced economies. ### Public Investment Management: Assessment and Tools - General assessment: Malaysia’s public investment management performance is good by international standards. - Total investment at sustainable levels. - Allocations between sectors stable. - Multi-year budgeting has been introduced. - Tools and diagnostics highlighted: - Public Investment Management Assessment (PIMA): a diagnostic tool to evaluate institutions in planning, allocation and implementation phases of public investment projects; can identify institutions and specific public investment management areas needing improvement. - PPP Fiscal Risks Management Model (PFRAM): assesses potential fiscal costs and risks arising from PPP projects; particularly relevant given Malaysia’s relatively high public debt level and significant contingent liabilities. - Policy transparency recommendation: - Publication of an annual fiscal risks statement in Malaysia would be extremely helpful, particularly to quantify, monitor and report PPP-related fiscal risks. ### Conclusion and Outlook - Malaysia has made important gains in scaling up infrastructure and progress is likely to continue during 2016–2020. - The 11th Malaysia Plan envisages major projects such as completion of the KL metro, the Singapore-KL high speed rail and the Pan-Borneo highway. - Empirical evidence cited: - Public investment can have a positive impact on growth directly or indirectly by crowding in private foreign direct investment. - High-quality infrastructure is correlated with declines in income inequality. *Prepared by Jeff Danforth (FAD) and Alex Mourmouras (APD).* ### Appendix XIII. Malaysia—External Sector Assessment, 2015 ### Appendix XIII. Malaysia—External Sector Assessment, 2015 ### External Sector Developments - Current account (CA) - CA surplus declined by 8 percentage points since 2011 to 2.9 percent of GDP in 2015. - Decline driven by emergence of a deficit in the nonoil-and-gas trade balance amid a rise in investment and a decline in gross national saving. - CA surplus decline in 2015 by 1.4 percentage points of GDP was driven by negative price impact from lower mineral fuel prices: - Trade surplus on account of crude oil and liquefied petroleum gas was lower by 1.2 percentage points of GDP. - Adverse impact from lower prices about 2.5 percentage points of GDP (estimated at constant 2014 volumes), partly offset by higher export volumes. - Depreciation of the ringgit in 2015 boosted manufacturing export volumes, but prices in U.S. dollars declined. - CA surplus projected to decline to 2.3 percent of GDP in 2016, primarily reflecting further weakening in the oil-and-gas trade balance; nonoil-and-gas balance expected to improve on softening domestic demand. - Real and nominal exchange rates - Average REER depreciated by 8 percent (y/y) in 2015. - NEER depreciated by 9 percent (y/y) in 2015. - Between December 2015 and February 2016 both the REER and the NEER appreciated slightly. - Capital and financial accounts - Malaysia has typically recorded net capital outflows. - Gross FDI flows are large though net FDI flows are generally small; pace of FDI abroad slowed in recent years. - In 2015, FDI abroad was about 3.25 percent of GDP (down from 6.1 percent of GDP in 2011), nearly matching FDI inflows. - Net total outflows under the financial account were 4.6 percent of GDP in 2015, lower than in 2014. - Over the medium term Malaysia is expected to receive net inflows, supported in part by further slowdown in outbound FDI. - Foreign reserves and international investment position - Official reserves declined by nearly US$37 billion (about 28 percent) between August 2014 and December 2015. - As of February 2016, FX reserves were slightly up from their December 2015 level. - NIIP recorded a net asset position of about 8.5 percent of GDP (in U.S. dollar terms) as of end-2015, improving from a net liability position of about 4.5 percent of GDP in 2013. - Assets about 131 percent of GDP; two fifths in direct investments abroad; one quarter in official reserve assets. - Portfolio investments accounted for about two fifths of gross liabilities (122½ percent of GDP); about 60 percent of those investments were in debt instruments. - Total external debt rose to 65.6 percent of GDP in 2015 (in U.S. dollar terms; 2014: 63.1 percent of GDP), of which 64 percent were in foreign currency. - Short-term debt accounted for 42 percent of total external debt (decline from 2011–14 average of 48.3 percent), as nonresident holdings of BNM bills and notes declined since late 2014. ### Standard Benchmarks - Current account (EBA and staff assessment) - EBA CA regression: cyclically-adjusted CA is stronger by about 4 percent of GDP than consistent with fundamentals and desirable policies. - Estimated policy gap about zero, similar to 2014; nearly entire gap accounted for by regression residual. - Country-specific structural factors (insufficient social safety nets; structurally low investment) lead to consistent underestimation of Malaysia’s CA in the EBA regression. - Private investment about 17 percent of GDP. - Staff assesses the norm to be 1.8 percent of GDP and the CA gap to be 2.8 percent of GDP (plus or minus 1 percent of GDP) in 2015. - Real exchange rate misalignment - EBA REER index regression estimates REER to be 30.5 percent below levels warranted by fundamentals and desirable policies; most of the gap is an unexplained residual. - EBA level REER regression provides an estimate of 24 percent undervaluation. - Staff estimate using elasticity approach: REER gap for 2015 is estimated to be 9.7 percent (plus or minus 5 percent). - Semi-elasticity of the current account with respect to REER is 0.29 (η_CA= -0.29). - Foreign reserves adequacy - As of end-2015 official reserves stood at 80 percent (2013: 98 percent) of the IMF’s composite reserve adequacy metric (RAM). - Reserves covered 75 percent of short-term external debt by remaining maturity (staff estimate) and 24 percent of broad money. - RAM is below suggested adequacy range of 100-150 percent. - Recommendation: authorities should gradually accumulate more reserves so that the RAM is closer to 100 percent. - Overall assessment - External position in 2015 was stronger than consistent with fundamentals and desirable policy settings, albeit less so than in 2014. - An adverse terms-of-trade effect contributed to softening of the external position. - Depreciation of the currency boosted export volumes in 2015, partially offsetting negative terms-of-trade shock. ### Potential Policy Response - Medium-term outlook and policy challenges - Growth model shifted more to domestic demand; CA surplus and CA gap have narrowed. - Over the medium term, increased public sector saving from Federal government consolidation will be offset by sustained private consumption and investment; expected CA surplus in range of 1.5–2 percent of GDP. - Staff views policy gaps as reflecting high precautionary saving and need for investment facilitation despite recent increases in the investment ratio. - Policy recommendations - Continue to improve social protection and social insurance institutions, including introduction of an unemployment insurance system. - Increase private investment, including in physical infrastructure. - Address labor-force skill mismatches and rigidities in the labor market. - Stronger social safety nets and efforts to further boost private investment would help to further moderate the current account surplus. --- ### Appendix XIV. Malaysia—External Debt Sustainability Analysis - External debt developments (2015) - Malaysia’s external debt increased by 2.5 percentage points of GDP in 2015 to about 65.5 percent of GDP (staff estimate). - Total offshore borrowing went up by 5 percentage points of GDP, mainly medium- and long-term, contributed about equally by public enterprises (including a US$5 billion (1.7 percent of GDP) PETRONAS bond issuance in early 2015) and the private sector. - Nonresident holdings of local currency debt securities declined by 2.2 percentage points of GDP, driven by capital outflows from short-term Bank Negara Malaysia bills. - As of end-2015, short-term debt by original maturity accounted for about 42 percent of total external debt, down from 48.6 percent in 2014. - Debt denominated in domestic currency accounted for 36 percent of external debt. - As of end-2015, NIIP recorded a net asset position of about 8.5 percent of GDP (in U.S. dollar terms). - Revisions to medium-term projections used in DSA - Exports and imports expected to grow at a slower average pace over the medium term compared with prior projections. - Current account projected to be weaker though still in surplus. - CA balance likely to remain in surplus even under a stress scenario where oil prices are significantly lower over the medium term than in the baseline. - Net non-debt-creating inflows expected to contribute more to the balance of payments as Malaysia’s outbound FDI is expected to slow. - External debt service payments updated in line with the new definition of external debt and revised assumptions on global interest rates. - Medium-term outlook (staff baseline) - External debt-to-GDP ratio expected to remain on a steady downward path, falling to 49.5 percent by 2021. - Decline mainly reflects sustained current account surplus averaging about 1.8 percent of GDP. - Share of short-term debt by original maturity expected to gradually decline to about one-third of total external debt by end of the medium term. - Selected macro figures (comparative 2014 vs 2015, Article IV periods) - Real GDP growth: 4.9 (2014), 4.8 (2015) - GDP deflator in U.S. dollars (change in percent): 4.2 (2014), 5.1 (2015) - Nominal external interest rate (in percent): 5.3 (2014), 2.9 (2015) - Growth of exports (U.S. dollar terms, in percent): 5.5 (2014), 4.2 (2015) - Growth of imports (U.S. dollar terms, in percent): 5.8 (2014), 4.1 (2015) - Current account balance, excluding interest payments (in percent of GDP): 5.5 (2014), 3.4 (2015) - Net nondebt creating capital inflows (in percent of GDP): -1.6 (2014), 0.1 (2015) - Profile of external debt (staff estimate; selected items) - Total external debt (staff estimate): 63.1 (2014), 65.6 (2015) - Medium- and long-term: 32.4 (2014), 37.9 (2015) - Offshore borrowing: 17.8 (2014), 22.5 (2015) - Public sector offshore borrowing: 7.9 (2014), 10.1 (2015) - Public enterprises offshore borrowing: 6.4 (2014), 8.4 (2015) - Private sector offshore borrowing: 10.0 (2014), 12.4 (2015) - Nonresident holdings of ringgit-denominated debt securities: 13.7 (2014), 14.5 (2015) - Short-term (original maturity): 30.7 (2014), 27.7 (2015) - Offshore borrowing (short-term): 13.5 (2014), 14.0 (2015) - Nonresident holdings of ringgit-denominated debt securities (short-term): 5.1 (2014), 2.1 (2015) - Memorandum items: - Total external debt (authorities): 67.5 (2014), 72.1 (2015) - Total external debt (authorities; billions of U.S. dollars): 211.8 (2014), 192.2 (2015) - Total external debt (staff estimate; billions of U.S. dollars): 213.3 (2014), 194.2 (2015) *Source: Appendix XIII and Appendix XIV, Malaysia—External Sector Assessment and External Debt Sustainability Analysis, 2015.* ### 4. Standard stress tests under the external DSA indicate that external debt would ### 4. Standard stress tests under the external DSA indicate that external debt would ### Stress test findings - External debt would remain manageable under a variety of shocks, including weaker GDP growth, a lower current account balance, and a one-time 30 percent depreciation of the ringgit. - Under most scenarios, the external debt-to-GDP ratio rises above the baseline over the projection period by only modest margins. - Exchange rate depreciation scenario: - One-time real depreciation of 30 percent occurs in 2017. - Debt ratio would rise sharply to 84 percent of GDP on impact, but would subsequently fall to about 70 percent of GDP by 2021. - Current account (CA) shock scenarios: - If the current account balance (excluding interest payments) is permanently lower, the external debt-to-GDP ratio will remain close to 60 percent over the medium term. - If the economy is impacted by a combined interest rate, growth, and the CA shock, the external debt-to-GDP ratio will remain close to 60 percent over the medium term. ### Key historical and baseline indicators (Table XIV.2 excerpts) - Baseline: external debt (in percent of GDP) - 2012: 62.6 - 2013: 65.7 - 2014: 63.1 - 2015: 65.6 - 2016: 63.6 - 2017: 59.7 - 2018: 56.9 - 2019: 54.1 - 2020: 51.6 - 2021: 49.6 - Change in external debt - 2012: 5.8 - 2013: 3.0 - 2014: -2.6 - 2015: 2.5 - 2016: -2.0 - 2017: -4.0 - 2018: -2.8 - 2019: -2.7 - 2020: -2.5 - 2021: -2.0 - Identified external debt-creating flows (4 + 8 + 9) - 2012: -4.6 - 2013: -4.7 - 2014: -6.4 - 2015: 2.1 - 2016: -6.3 - 2017: -4.8 - 2018: -4.4 - 2019: -4.0 - 2020: -3.6 - 2021: -3.3 - Current account deficit, excluding interest payments - 2012: -6.3 - 2013: -4.6 - 2014: -5.4 - 2015: -4.4 - 2016: -3.8 - 2017: -3.4 - 2018: -3.5 - 2019: -3.3 - 2020: -2.9 - 2021: -3.1 - Deficit in balance of goods and services - 2012: -10.8 - 2013: -8.5 - 2014: -9.2 - 2015: -7.6 - 2016: -7.1 - 2017: -6.6 - 2018: -6.4 - 2019: -6.2 - 2020: -5.9 - 2021: -5.8 - Exports (in percent of GDP) - 2012: 79.3 - 2013: 75.6 - 2014: 73.8 - 2015: 71.0 - 2016: 65.0 - 2017: 61.7 - 2018: 59.4 - 2019: 56.8 - 2020: 53.7 - 2021: 51.1 - Imports (in percent of GDP) - 2012: 68.5 - 2013: 67.1 - 2014: 64.6 - 2015: 63.4 - 2016: 57.9 - 2017: 55.2 - 2018: 52.9 - 2019: 50.6 - 2020: 47.8 - 2021: 45.3 - Net nondebt creating capital inflows (negative) - 2012: 3.7 - 2013: 1.0 - 2014: 1.5 - 2015: -0.2 - 2016: -0.5 - 2017: -0.2 - 2018: -0.1 - 2019: 0.1 - 2020: 0.3 - 2021: 0.5 - Automatic debt dynamics - 2012: -2.0 - 2013: -1.1 - 2014: -2.5 - 2015: 6.8 - 2016: -2.0 - 2017: -1.2 - 2018: -0.9 - 2019: -0.8 - 2020: -1.0 - 2021: -0.8 - Contribution from nominal interest rate (annual, percent) - 2012: 1.1 - 2013: 1.1 - 2014: 1.1 - 2015: 1.4 - 2016: 1.5 - 2017: 1.5 - 2018: 1.7 - 2019: 1.7 - 2020: 1.4 - 2021: 1.5 - Contribution from real GDP growth (annual, percent) - 2012: -2.9 - 2013: -2.9 - 2014: -3.8 - 2015: -3.6 - 2016: -2.8 - 2017: -2.7 - 2018: -2.6 - 2019: -2.5 - 2020: -2.4 - 2021: -2.3 - Contribution from price and exchange rate changes 4/ - 2012: -0.2 - 2013: 0.7 - 2014: 0.1 - 2015: 8.9 - 2016: -0.7 - 2017: ... - Residual, including change in gross foreign assets (2 − 3) 5/ - 2012: 10.4 - 2013: 7.7 - 2014: 3.8 - 2015: 0.3 - 2016: 4.4 - 2017: 0.9 - 2018: 1.7 - 2019: 1.2 - 2020: 1.1 - 2021: 1.3 - External debt-to-exports ratio (in percent) - 2012: 79.0 - 2013: 86.8 - 2014: 85.4 - 2015: 92.3 - 2016: 97.9 - 2017: 96.6 - 2018: 95.8 - 2019: 95.3 - 2020: 96.0 - 2021: 97.1 - Gross external financing need (in billions of U.S. dollars) 6/ - 2012: 106.3 - 2013: 122.9 - 2014: 132.5 - 2015: 138.7 - 2016: 119.7 - 2017: 121.5 - 2018: 125.2 - 2019: 130.9 - 2020: 136.8 - 2021: 142.7 - Gross external financing need (in percent of GDP) - 2012: 33.8 - 2013: 38.0 - 2014: 39.2 - 2015: 46.8 - 2016: 38.7 - 2017: 35.2 - 2018: 32.6 - 2019: 30.6 - 2020: 28.6 - 2021: 26.9 ### Scenario and model notes - Individual shocks are permanent one-half standard deviation shocks (shaded areas represent actual data). - For historical scenarios, historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead. - Combined shock 3/: Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance. - One-time real depreciation of 30 percent occurs in 2017 (Real Depreciation Shock 4/). - Gross external financing need is defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period. - Debt-stabilizing non-interest current account 1/: Long-run, constant balance that stabilizes the debt ratio assuming key variables (real GDP growth, nominal interest rate, dollar deflator growth, and nondebt inflows in percent of GDP) remain at their levels. - Malaysia has made a methodological change about external debt statistics; the new methodology statistics begin in 2009. ### Key macroeconomic baseline assumptions (selected) - Real GDP growth (in percent): 5.5 4.7 6.0 5.0 4.9 2.4 4.4 4.8 4.8 4.9 5.0 5.0 - GDP deflator in U.S. dollars (change in percent): 0.1 -1.8 -1.3 -16.5 2.7 10.6 0.0 6.4 6.2 6.3 6.4 5.9 - Nominal external interest rate (in percent): 2.1 1.8 1.8 2.0 3.2 1.6 2.4 2.7 3.2 3.3 2.9 3.3 - Growth of exports (U.S. dollar terms, in percent): -1.8 -2.0 2.1 -15.8 3.5 13.3 -4.5 6.0 7.0 6.5 5.8 5.6 - Growth of imports (U.S. dollar terms, in percent): 3.8 0.6 0.7 -14.1 4.5 13.6 -4.6 6.3 6.8 6.5 5.6 5.2 - Current account balance, excluding interest payments (in percent of GDP): 6.3 4.6 5.4 4.4 11.1 5.6 3.8 3.4 3.5 3.3 2.9 3.1 - Net nondebt creating capital inflows: -3.7 -1.0 -1.5 0.2 -2.2 2.5 0.5 0.2 0.1 -0.1 -0.3 -0.5 ### Policy implications and interpretation (from source text) - External debt dynamics are resilient to a range of shocks, but exchange rate depreciation can cause a sharp near-term increase in external debt-to-GDP (to 84 percent on impact) before a return toward baseline levels (about 70 percent by 2021). - Persistent deterioration in the non-interest current account or simultaneous adverse shocks to interest rates, growth, and the current account would keep external debt-to-GDP around 60 percent over the medium term. - The DSA scenarios underscore the importance of maintaining buffers, external position strength, and vigilance in policy to manage risks from exchange rate and current account shocks. *Source: IMF staff report excerpts (Table XIV.2 and accompanying text) provided in content unit _cr16110.* ### 1. On behalf of the Malaysian authorities, we thank the IMF team for the constructive and ### 1. On behalf of the Malaysian authorities, we thank the IMF team for the constructive and ### Economic Developments and Outlook - Malaysian GDP growth: 5% in 2015 (2014: 6%). - Inflation: 2.1% in 2015. - Unemployment: 3.1% of the labor force. - Current account balance: surplus of 2.9% of GDP. - Exchange rate and markets: - Ringgit depreciation in 2015: 18.6%; subsequent appreciation in 2016: around 9.5% against the US dollar. - Kuala Lumpur Composite Index increase in 2016: 1.5%. - Sectoral composition: - Commodities sector: 18% of GDP and 19.2% of exports. - Services: 54% share of GDP. - Manufacturing: 23% share of GDP. - Manufactured exports: about 80% of Malaysia’s exports; electrical and electronics: 36% of total exports. - Export markets: US, EU and Japan account for 29% of exports; China accounts for 13% of exports. - Domestic demand: private sector-led domestic demand accounts for 69% share of GDP. - Outlook for 2016: - Growth expected: within the range of 4.0-4.5% in 2016. - Headline inflation expected: 2.5-3.5% in 2016. - Staff sensitivity: China’s rebalancing could reduce Malaysia’s growth by 0.12 percentage points in 2016. - Current account balance: expected to remain in surplus, albeit smaller, even under an extreme oil price shock scenario. ### Adjusting to Multiple External Shocks - External shocks since late 2014: sharp decline in oil prices, sizable shifts in capital flows, slowdown in external demand. - Ringgit and reserves: - Ringgit depreciated by 27.7% against the US dollar between July 2014 and mid-January 2016. - Reserves declined by USD36.7 billion during the same period. - Reserves level cited: USD97 billion. - Reserves can finance 8 months of retained imports and are 1.1 times the short-term external debt. - Comparisons to benchmarks: 8 months vs. international prudential benchmark of 3 months; 1.1 times vs. 1 time. - Decentralization of reserves: banks and corporates accounted for 75% of Malaysia’s total external assets as at end-2015; Central Bank’s reserves are only a quarter of the actual total reserves. - Resilience: - Staff finding: under a severe stress capital outflow scenario (including assumptions more severe than the Global Financial Crisis), Malaysia’s external sector and domestic financial sector expected to remain resilient. - Policy stance: continued exchange rate flexibility, healthy reserves, and a wide range of monetary instruments to manage external shocks; authorities aim to maintain orderly financial market conditions and build foreign exchange reserve buffers. ### Monetary Policy - Monetary stance: accommodative and supportive of economic activity, consistent with price stability. - Overnight Policy Rate (OPR): current level assessed as appropriate given risks to domestic inflation and growth. - Monetary operations: directed to ensure sufficient liquidity to support orderly functioning of domestic financial markets amid volatility in capital flows. - Monetary Policy Committee (MPC) role: BNM’s MPC closely monitoring heightened external risks and their implications for macroeconomic stability. ### Fiscal Policy - Commitment: steadfast toward fiscal consolidation and consistently achieving fiscal deficit reduction targets. - Drivers of consolidation: cuts in recurrent spending, increased revenue generation from more diverse sources, enhanced tax efficiency and compliance; measures include implementation of GST, removal of fuel subsidies, and enhancing public service delivery efficiency. - Operating expenditure: expected to decline to about 17% of GDP in 2016 from 18.8% in 2015. - Oil-related revenue to Federal Government revenue: around 30% in 2014; 21.5% in 2015; expected to decline to 13-14% in 2016. - Protection for vulnerable groups: use of exempt and zero-rated GST items, quality public services, and cash transfers to low income households. - 2016 Budget recalibration: - October 2015 oil price assumption: USD 48 per barrel. - January 2016 oil price assumption: USD 30-35 per barrel. - Measures: compositional adjustments in Government spending; broaden revenue sources (e.g., bidding of telecommunication spectrum; streamlining foreign worker levy). - Fiscal deficit trajectory: expected to decline from 3.2% of GDP in 2015 to 3.1% of GDP in 2016 (seventh consecutive year of decrease). - Federal Government debt-to-GDP ratio: measures to contain within 55%. - Contingent liabilities: - Growth on declining trend; guarantees mainly for productive and strategic investments. - Examples and shares of total Government guarantees: National Higher Education Fund Corporation: 19.8%; DanaInfra: 11.6%; Prasarana: 9.9%. - Debt composition: - About 70% of debt expected to mature in more than 3 years. - Domestic currency denomination: 97% share of outstanding debt. - Policy framework: Medium-Term Fiscal Framework to anchor budgetary targets, improve expenditure prioritization and government performance; aligned with the 11th Malaysia Plan. ### Financial Sector - Financial stability in 2015: preserved, supported by sound financial institutions and orderly market conditions. - Stress tests: authorities’ and staff stress tests demonstrate banking system resilience to major shocks. - Market depth: Malaysia’s bond market is the third largest in Asia; presence of well-diversified domestic institutional investors. - Financing access: businesses including SMEs continue to have access to financing. - Liquidity and monetary operations: banking system liquidity remained ample; BNM’s operations ensured sufficient liquidity for money and FX markets. - Household sector: - Growth in household debt moderated to 7.3% as at end-2015 (peak in 2010 referenced). - About half of new loans approved were to borrowers with an aggregate debt service ratio not exceeding 40%. - Average debt service ratio for all new household borrowings remained below 60%. - Household financial assets remained healthy at above 2 times household debt. - Assessment: likelihood of a material impact from household sector exposures on financial system stability remains low. - Property market: - Malaysian House Price Index growth: slowed from 9.6% (2010-2014) to around 8% registered over five consecutive quarters since 2Q 2014. - Slower transactions in higher-priced segments; continued strong demand for affordable houses; rebalancing of housing supply. - Risk assessment: low probability of a more generalized correction in house prices; increasing supply of affordable housing remains key. - Non-financial corporate sector: - Staff and authorities find corporate sector debt does not present a significant vulnerability. - Corporate debt at risk (share of debt borne by firms with an ICR of less than 1.5 times): 8.9% of total corporate debt. - Median ratio of cash-to-short-term debt: 1.2 times. - About three quarters of outstanding corporate debt funded domestically. - Corporate external debt and ringgit depreciation: - Trade credits and non-resident holdings of ringgit-denominated bonds: account for about 22% of total corporate external debt. - Inter-company obligations: account for about 43% of total corporate external debt. - These factors mitigate currency, funding and liquidity risks. - Anti–ML/TF efforts: - September 2015 FATF Mutual Evaluation Report acknowledged well-developed legal and regulatory arrangements and strong inter-agency coordination. - National Coordination Committee to Counter Money Laundering formulated a five-year National AML/CFT Strategic Plan. - Malaysia granted full membership of the FATF in February 2016. ### Regional initiatives - Commitment to regional and global integration. - Achievements under Malaysia’s ASEAN Chairmanship in 2015: finalization and launch of the ASEAN Banking Integration Framework to provide greater market access and operational flexibility for Qualified ASEAN Banks. - Continued pursuit of integration mechanisms such as the Trans-Pacific Partnership and the Regional Comprehensive Economic Partnership. ### Reforms to enhance growth potential - 11th Malaysia Plan (2016-2020) objectives: accelerate transformation into a high-income economy by 2020; reduce income inequality; raise productivity; promote environmental sustainability. - Social and inclusion measures: anti-poverty and rural development programs; shift from blanket consumer subsidies to targeted income support; affordable housing schemes; minimum wage policy since 2013; promotion of financial inclusion. - Human capital and productivity: focus on education reforms, particularly industry-driven technical education and vocational training. - Business environment improvements: modernizing corporate insolvency law; measures to improve logistics and enhance trade facilitation. - Environmental commitment: submission of a target to reduce the emission intensity of GDP under COP 21 agreement. ### Final remarks - Authorities’ view: global economy faces important realignments, considerable uncertainty on global growth prospects, and increasing risk of international financial market and capital flow volatility. - Strengths cited: diversified economy, sound fundamentals, strong financial system and external position, credible policy framework. - Policy intentions: continue strengthening policy buffers, reducing vulnerabilities, and advancing structural reforms per the 11th Malaysia Plan to transform Malaysia into a high income economy by 2020. *On behalf of the Malaysian authorities, response to IMF staff report contained in the source document.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16110.pdf_