Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey : Favorable Prospects for Malaysia’s Diversified Economy

March 3, 2015

  • Growth likely to remain healthy in 2015, despite lower energy prices
  • End of fuel subsidies and start of Goods and Services tax is timely, and good for efficiency, equity, and the environment
  • Exchange rate flexibility will help non-energy exports

After a year of very strong growth of 6 percent, lower energy export prices in 2015 will likely contribute to growth moderating to a still impressive rate of close to 5 percent, say IMF economists.

Malaysia taxi driver fills car with natural gas.  Malaysia is a large net exporter of natural gas and other commodities (photo: Stringer/Malaysia/Reuters/Corbis).

Malaysia taxi driver fills car with natural gas. Malaysia is a large net exporter of natural gas and other commodities (photo: Stringer/Malaysia/Reuters/Corbis).

Economic Health Check

In their annual report on the health of the Malaysian economy, the report’s authors say growth is expected to moderate to about 4¾ percent this year while headline inflation will likely increase slightly to about 3¼ percent in 2015 as a result of an end to fuel subsidies, the introduction of a Goods and Services Tax (GST), and exchange rate depreciation.

Inflationary pressures are expected to remain subdued, helped by lower oil and gas prices. Activity will be led by consumption and growth in private investment in the non-oil sector, which is likely to benefit from lower energy costs and higher prices of non-commodity exports.

Private consumption growth is likely to moderate, reflecting the net effects of lower commodity prices, the impact of the new GST, and slower credit growth, as financial conditions tighten, but remain accommodative. The report’s authors added that the current macroeconomic policy mix was appropriate.

Exports and private demand offset lower public spending

Last year’s recovery in exports and continued strong private demand offset mild headwinds from lower public spending, while private investment continued to be fueled by accommodative financial conditions and the catalytic effects of long-term public investment programs. The report’s authors also highlighted the steady increase in the share of investment in Malaysia’s economy in recent years, while strong employment and wage growth supported private consumption.

The ringgit appreciated against the dollar through mid-August but subsequently depreciated by 10 percent as oil prices fell, for a cumulative depreciation by year-end of about 6 percent since January 2014, with further depreciation pressures in early January 2015.

Reserves have declined by over $15 billion between mid-August to end-December 2014 amid capital outflows. But Malaysia’s reserve buffers remain adequate, the IMF noted.

The impact of lower energy prices

The report assesses the projected decline in average crude oil prices for 2015 as a net negative shock for Malaysia, which is a large net exporter of natural gas, crude palm oil, and other commodities. Lower commodity prices will be a drag on the economy as investment in commodities and the energy sector falls and the negative income effect of a higher exchange rate will reduce demand for services.

However, manufacturing exports should get a boost, aided by a weaker exchange rate and higher growth in the United States. Also, lower energy costs should help stimulate the non-oil sectors. Consequently, only a modest negative impact on growth is expected.

Fiscal policy action and medium-term expectations

The IMF applauded the decisions to reduce fuel subsidies and implement a GST. The authorities took full advantage of the favorable conditions provided by the growing economy, full employment, and lower oil price to implement these key fiscal reforms.

In the near term, eliminating fuel subsidies at the pump will help offset the impact on the federal budget of lower energy revenues. Over the medium term, these reforms will also help the authorities diversify budgetary revenues, balance the budget, and lower the debt-to-GDP ratio. Eliminating fuel subsidies is also an environmentally friendly move.

The report explains how the authorities’ goal of balancing the budget by 2020 will help reduce the federal debt to levels prevailing before the global financial crisis of 2008-9 and give them more room to deal with major shocks in the future.

However, balancing the budget will need continued effort amidst pressures from oil revenues that are declining in relation to GDP and from rising expenditure commitments. If the decline in oil prices is permanent more measures would be required over the medium term to meet the fiscal targets, which remain feasible.

The report underscores that the current fiscal consolidation is well timed, appropriately paced, and remains on track. While monetary policy is on hold reflecting increased global uncertainty, a market-driven tightening of domestic liquidity and financial conditions is under way.

Inclusiveness and structural policies

Strengthening the social safety net is an integral part of the authorities’ fiscal strategy. Untargeted fuel subsidies were regressive as higher-income households benefited more from the subsidies than lower-income ones. Also, the elimination of fuel subsidies frees up resources that can be redirected to better support the poor.

To mitigate the impact of subsidy rationalization and GST, the 2015 budget calls for increased cash transfers to poorer households (those earning less than 4,000 ringgit per month). The authorities are also reviewing overlapping and fragmented cash transfer programs to improve their efficacy.

The authorities are implementing structural reforms on a wide front in support of Malaysia’s goal of achieving high-income status by 2020. Continued investment in infrastructure and in research and development can help spur home-grown innovation and increase incomes. Together with improvements in the quality of education, these efforts can help raise labor productivity, support higher sustainable growth, and foster a more inclusive society.