More reforms needed in Malaysia

GDP will grow by 4.3% in 2011. To maintain high growth rates and attract more foreign direct investment, more structural reforms are necessary.
Analisis Credito y Caución
Madrid - 02-mar-2011

The export-oriented Malaysian economy [commodities and electronics] was hard hit by the global economic crisis; in particular by the sharp fall in foreign demand for electronics. Real GDP contracted by 1.7% in 2009. However, the recovery started in the last quarter of 2009, as oil and palm oil prices again started to rise, manufacturing industry inventories were exhausted and the government launched a massive stimulus package to boost activity - especially in the construction sector.

Growth accelerated in the first half of 2010, by 10.1% and 8.9% year-on-year in the first and the second quarter, as private consumption, gross fixed capital formation and exports all picked up. Exports increased 20.4% year-on-year between January and September, due to increased demand for electrical and electronic products, which amounted to 40% of total exports, and for palm oil and liquefied natural gas. Imports surged by as much as 26.4%, mainly of machinery and transport equipment and manufactured goods. Production in manufacturing rose 12.7% year-on-year.

As demand for electronic products softened, exports of goods and services increased just 6.6% in the third quarter, according to the Central Bank of Malaysia, and GDP growth slowed to 5.3%. Growth in Q3 and Q4 of 2010 is however sustained by continued buoyant private consumption and private investment, driven by increased capital spending in the domestic oriented sectors. Overall, the Malaysian economy will grow by 6.8% this year.

Inflation is traditionally rather low, because of price subsidies. In Q3 of 2010, the consumer price index increased to 1.9% year-on-year [Q2: 1.6%], as higher prices for food and transports fuelled inflation. For the whole of 2010, an inflation rate of 1.8% is expected.

Economic policy

Weak fiscal discipline and huge expenditure on fuel subsidies [7% of GDP] have led to structurally large budget deficits. The country has not had a surplus since 1997, and, with two large stimulus packages, the deficit increased to 7% of GDP in 2009. As any improvement of Malaysias credit rating and to more long-term investment is constrained by the weak fiscal position, the government has committed itself to reducing the budget deficit to below 3% by 2015, by widening the tax base and cutting subsidies. A reduction of subsidies for food and gasoline this year will help to bring the deficit down to 5.6% of GDP. However, measures necessary to widen the tax base will meet strong resistance from businesses and consumers alike, and the government has so far refrained from committing itself to introduce a goods and service tax, which would make it less dependent on oil and gas revenues.

As a reaction to the strong economic rebound in the first half of 2010, the Bank Negara Malaysia [central bank] has tightened monetary policy by raising the overnight interest rate three times since March 2010, by a total of 75 basis points, to 2.75%. However, it left the interest rate unchanged in November in response to the expected economic moderation in the coming months and to curb the inflow of short-term investment into the country, as capital flows to emerging markets like Malaysia have increased substantially in the course of 2010.

the ringgit is pegged to a basket of currencies, and a ban on `off-shoring´ ringgits was in place until recently. However, in August 2010 the central bank relaxed currency controls, permitting local firms to use the ringgit to settle cross-border transactions.

In the Tenth Malaysia plan, a five-year development plan implemented by the Malaysian government covering the period 2011 to 2015, 12 national key economic areas for special promotion have been defined: oil and gas, palm oil, finance, retail, wholesale, tourism, information communication technology, education, electricity and electronic, commerce, private healthcare, and agriculture.

Some domestic sectors [the car industry and services] are still protected by high tariffs. Despite quite a favourable business climate in Malaysia, foreign direct investment [FDI] is still discouraged by the affirmative action policy, which has also triggered emigration of highly skilled non-Malay Malaysians [Chinese and Indians]. The government has started to relax the affirmative action rules: in April 2009 it announced the abolition of the 30% bumiputera [indigenous Malay] equity requirement in 27 trade sectors. Under the so-called Economic Transformation Programme [ETP] the government has reinstated its reform commitment, to further relax the affirmative action rules, curb red tape and liberalise the economy to attract more FDI and maintain economic growth.


The economic slowdown registered in the third quarter of 2010 will continue into 2011 as global demand decreases further. GDP will grow by 4.3% in 2011, sustained by household consumption and private and government investments, while exports [electronics] will decline. At 5.5% of GDP, the budget deficit will decrease only modestly, while inflation is expected to increase to 2.7% due to continued growth in domestic demand and as some more subsidies are cut. Despite a slowdown in export growth and rising imports, the trade and current account balance will continue to show large surpluses in 2011.

Malaysias sovereign payment capacity is guaranteed by a low foreign debt level and good liquidity. Like other Asian currencies, the ringgit will remain under appreciation pressure, as the recent US Federal Reserve decision to start another round of quantitative easing will probably decrease the yields on American assets, driving even more short-term investment capital to emerging markets like Malaysia. In contrast to its neighbours Indonesia and Thailand, Malaysia has to date not taken measures to restrict capital flows.

In the medium-term, further diversification of the economy towards higher value added sectors like technology, tourism, and Islamic banking is necessary to cope with increased competition from other countries. This should include an improvement of the education system and the provision of more incentives for research and development.

Additionally, to maintain high growth rates and attract more foreign direct investment, more structural reforms are necessary. This encompasses the cleaning-up of the large number of Government Linked Companies by selling stakes [in terms of market capitalization, currently 36% of the Malaysian stock exchange consists of such businesses], reducing red tape, and further reforms of the affirmative action policy, thus moving towards a liberalization of rules and quotas.

However, as such reforms would threaten the government with losing the ethnic Malays as its main support base, it seems rather unlikely that it will completely abolish the affirmative action in the near future, especially ahead of the next general elections, which is likely to be held in 2012. The same applies to a comprehensive revamp of the subsidy system and a tax reform, as both would be highly unpopular.

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