Public Information Notice (PIN) No. 13/24 February 28, 2013

On February 11, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Malaysia.¹

Background

Malaysia’s economy continues to perform well. Robust domestic demand has offset external weakness and fueled growth, estimated at 5.1 percent in 2012. Key drivers of the expansion have been private and public investments, particularly in oil, gas, and infrastructure, including large projects under the government’s Economic Transformation Program. Consumption growth has also been strong, supported by a strong labor market and by government transfers to households. Net exports, on the other hand, have been a drag on growth, reflecting weak external demand. Inflation has continued to ease, on lower commodity prices and base effects. Average consumer price inflation eased to 1.7 percent in 2012, the lowest in three years and one of the lowest in the Asia­Pacific region.

With inflation subdued, Bank Negara Malaysia has kept its policy interest rate at 3 percent since May 2011, and market interest rates have remained also low and stable. Malaysia has experienced significant and volatile portfolio flows in recent years, reflecting unsettled global financial conditions. However, Malaysia’s sound financial system, liquid capital markets, and two­way exchange rate flexibility have facilitated the absorption of flows. Credit growth has continued to be robust. While credit to households has moderated somewhat, unsecured personal loans have continued to grow rapidly, and household debt remains high. Housing prices have also continued to climb.

The federal government’s deficit is estimated to have declined to about 4.5 percent of GDP in 2012, from 4.8 percent in 2011. Spending in 2012 exceeded original budget projections by about 2 percent of GDP, particularly in wages, pensions, fuel subsidies, and transfers. This, however, was offset by buoyant revenue, reflecting strong economic growth and one­off factors. The federal government’s debt is estimated to have risen to about 53 percent at end­2012, from about 52 percent in 2011.

Executive Board Assessment

Executive Directors commended the authorities for their skillful policies, which have underpinned Malaysia’s strong macroeconomic performance despite a weak external environment. Directors noted that the external rebalancing of Malaysia’s economy has gained momentum, and that domestic demand is increasingly driving economic growth. Looking ahead, Directors considered that Malaysia’s medium term prospects are favorable, as the authorities continue to focus on safeguarding financial stability, strengthening fiscal sustainability, and securing high and inclusive growth.

Directors endorsed the current settings for monetary policy and the mildly contractionary fiscal stance in the 2013 budget. They nonetheless encouraged the authorities to further develop their medium­term plans to restore a prudent level of federal government debt and rebuild fiscal space. Directors emphasized that fiscal consolidation would need to be supported by structural fiscal reforms and a move away from oil­ and gas­related revenues. Accordingly, they welcomed the authorities’ plans to introduce a goods and services tax, and to gradually replace universal fuel subsidies with targeted support for the most vulnerable. Directors took note of the authorities’ efforts to reform public financial management, and encouraged them to adopt the recommendations of the recent Fund technical assistance on fiscal risks.

Directors noted with satisfaction that the 2012 Financial Sector Assessment Program review found Malaysia’s financial sector to be robust, highly capitalized, and underpinned by a sound supervisory and regulatory framework. They welcomed the recent passage of legislation to further strengthen financial supervision. Directors also commended the use of targeted macroprudential policies to curb risks associated with rising household debt and housing prices, and the authorities’ readiness to take additional action as needed.

Directors welcomed the authorities’ intention to implement wide ranging reforms to boost growth and inclusiveness. In this context, they underscored the importance of increasing labor market flexibility, raising female participation, and fostering the skills needed for a high value­added economy. Directors welcomed the introduction of a minimum wage, and considered that adopting unemployment insurance and pension system reforms would further strengthen social protection.

Directors took note of the staff’s assessment that, despite the significant narrowing of the current account, Malaysia’s external position appears stronger than warranted by fundamentals and desirable policies. However, they agreed with the authorities that this mainly reflects structural factors. A few Directors also pointed to underlying methodological limitations in the assessment of the external position. Directors considered that the authorities’ policy of maintaining two­way exchange rate flexibility remains appropriate, and that a flexible exchange rate and ongoing structural reforms would facilitate the economy’s continued rebalancing.