On February 7, 2020, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Malaysia.

Malaysia’s economy is stable despite domestic and external challenges. Growth has averaged just under 5 percent over the past 5 years, leading to higher per capita income. Economic growth has held up, and is estimated at 4.5 percent in 2019, driven by domestic demand. Headline inflation moderated from an average of 1 percent in 2018 to 0.7 percent in 2019, reflecting declining global oil prices, moderating wage growth, and the impact of replacing the GST with the smaller-base SST in 2018. Credit growth is moderating. On the external side, the current account surplus is estimated to have increased to 3.5 percent of GDP in 2019, driven by a temporary decline in capital imports and an improvement in the primary income account.

Growth is expected to remain stable in 2020 and to rebound in the medium term, with inflation slightly higher and the current account declining. Domestic demand will be the main driver of growth, with stable employment and income growth supporting private consumption. Private investment will gradually pick up as the business environment continues to improve and external uncertainties dissipate. Headline inflation is expected to increase to slightly over 2 percent as domestic demand rises, the base effect of the consumption tax regime change vanishes, and fuel subsidies become targeted. The current account surplus is expected to narrow to 2.7 percent of GDP as capital imports resume. Over the medium term, growth should converge to potential (just below 5 percent) and inflation remain under control, while the current account surplus continues to moderate.

Risks to the growth outlook are, on balance, to the downside. Malaysia’s highly open economy is vulnerable to escalating trade actions and weaker-than-expected trading partners’ growth. An abrupt deterioration in market sentiment towards emerging markets could lead to tighter financial conditions. However, a durable truce that may follow the recent signature of the phase-one deal between the US and China is an upside risk. Domestically, contingent liabilities could pose fiscal risks and a sharp drop in real estate prices or a deterioration in household debt service ability could affect growth and financial stability, while domestic policy uncertainty could reduce investment.

Executive Board Assessment [2]

Executive Directors welcomed that the Malaysian economy has been stable despite internal and external challenges. Directors recognized the progress made on the reform agenda and encouraged the authorities to remain committed to governance and structural reforms. To address the risks facing the economy, Directors recommended that policy priorities ahead should continue to focus on a medium-term fiscal consolidation plan, while safeguarding growth and financial stability.

Directors welcomed the planned pace of fiscal consolidation and encouraged the authorities to identify well-defined spending and revenue measures to support this adjustment, including in the context of the upcoming medium-term revenue strategy preparation. They also encouraged the authorities to push ahead with the adoption of a Fiscal Responsibility Act, and with plans to improve debt management, public procurement, and the public investment framework.

Directors supported the broadly neutral monetary policy stance, given a closing output gap and broadly neutral financial conditions. They agreed that monetary policy should remain data dependent. Directors commended the authorities’ commitment to exchange rate flexibility as well as recent initiatives to deepen the FX markets and encouraged them to explore further options in this area, as this would enhance the ability of the exchange rate to act as a shock absorber. In general, they advised the authorities to continue to review the effectiveness of FX market measures and consider gradual phasing out of such measures.

Directors agreed that the financial sector is stable, and that profitability, capitalization and asset quality of banks are sound. However, they noted that household debt is high compared to peers, with pockets of vulnerability among lower-income groups. Directors advised the authorities to closely monitor risks in the real estate and household sectors. Further enhancing the macroprudential toolkit would be helpful. Directors commended the ongoing efforts to strengthen financial literacy and manage cyber risks and climate change risks to the financial sector.

Directors commended the authorities’ progress in developing and implementing governance reforms. They stressed the importance of sustaining the momentum and anchoring the reforms in legislation, particularly to help secure the independence of anti-corruption institutions, freedom of information, and to establish an asset declaration system. Further strengthening the AML/CFT framework will also be important.

Directors underscored that continued structural reforms aimed at raising investment and productivity are important to safeguard macroeconomic and financial stability and help address the external imbalances over the medium term. They supported the authorities’ emphasis on raising productivity as it would help achieve high-income status and inclusive growth. Directors advised that priority be given to enhancing the business environment and improving access to credit for SMEs; promoting trade openness; enhancing the quality of and access to education; encouraging innovation, including through digitalization of the economy; and boosting female labor participation.