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FY 1999: Malaysia |
CHAPTER II: ECONOMIC TRENDS AND OUTLOOKMajor Trends and Outlook
After a decade of sustained economic growth, during which real GDP increased in excess of 8% annually, Malaysia's economy at mid-year 1998 was headed for recession. Real GDP contracted by 1.8% in the first quarter, year-on-year, the first quarterly contraction since 1985. The decline was most severe in the construction sector, which contracted 10%, followed by smaller declines in manufacturing (2.4%) and agriculture (2.8%). In July, Deputy Prime Minister Anwar announced that the economy will likely contract 1-2% in 1998. In 1997, GDP increased by 7.8%, based primarily on strong (8.5%) first-half growth.
Despite its relatively stronger fundamentals, Malaysia since July 1997 has been buffeted by economic and financial problems that erupted with the Thai financial crisis, and quickly spread throughout much of Asia. Investor concerns increased after the government announced a series of measures in August and September to stanch ongoing speculative pressures against the ringgit and reverse the stock market slide. Some, such as a plan to purchase equity shares from Malaysian investors at above-market prices, were never implemented. Others, such as a the designation of stocks comprising the Kuala Lumpur Composite Index (KLCI), which required delivery of shares prior to payment, were subsequently rescinded. However, the net effect was a further erosion of confidence.
Faced with a continued rapid depreciation of the ringgit and plummeting stock prices, the GOM in October tabled a 1998 budget designed to reduce the current account deficit from 5.2% of GDP to 4% of GDP. The budget deferred several government-funded mega- projects, increased duties on heavy construction equipment and motor vehicles, and directed financial institutions to increase transparency and strengthen prudential measures. The government implemented further belt-tightening measures in December 1997 to reduce the current account deficit from 4% to 3% of GDP and shore up battered investor confidence. The centerpiece was a 10% across-the-board cut in federal spending, plus an additional 8% in selective cuts (on top of a 2% cut announced in October).
Bank Negara Malaysia, the central bank, announced additional measures to administratively restrict credit growth, particularly to the over built property sector. It tightened provisioning for nonperforming loans (NPLs) and mandated additional disclosure requirements. The central bank also instructed financial institutions to target lending toward priority sectors including export industries, high technology, and low-cost housing. It called on banks to reduce the growth rate in credit to 15% by year-end 1998. That rate, which had averaged 30% at the beginning of 1997, had dropped to 25.9% by year-end 1997. The GOM also announced the establishment of a National Economic Action Council (NEAC) to propose measures to help restore public and investor confidence. In June 1998, NEAC Executive Director Tun Daim Zainuddin was appointed to the cabinet as Special Functions Minister with responsibility for overcoming the current economic problems.
By year-end 1997, the Kuala Lumpur Stock Exchange Composite Index (KLCI) capitalization had declined 53% from its February 26 high of 1271.57. Over the same period, the Malaysian ringgit (RM) had nominally depreciated 56% against the U.S. dollar, from RM2.48/US$1 to RM3.89/US$1. The stock market and ringgit recovered some lost ground by early March, 1998, after dropping to historic lows in January. After a brief upturn, market sentiments again weakened as concerns mounted over the depth and duration of the economic downturn, the rapid braking of credit growth in the face of rising nonperforming loans, the continued weakness of the Japanese economy and yen, and regional uncertainty over develop- ments in neighboring Indonesia. By mid-July, the KLCI was in the low-400 range, and the ringgit had slipped to RM4.18/US$1.
The central bank reduced banks' statutory reserve requirements (SRR) from 13.5% to 10% in February 1998 in an effort to ease a severe liquidity crunch caused in part by a shift in deposits from local financial institutions to locally incorporated branches of foreign banks. It also announced it would guarantee all deposits in local financial institutions. As part of additional measures announced in March, 1998, Bank Negara indicated it would place greater reliance on interest rates as a tool of monetary policy, and took further steps to improve transparency and preemptively strengthen prudential management. As part of longstanding efforts to encourage financial sector consolidation, it directed Malaysia's 39 finance companies to consolidate into 6 core groups, each headed by a strong anchor institution.
In an effort to lower the effective cost of borrowing, the central bank again lowered the SRR to 8%, effective July 1. The move triggered concerns that the GOM might be softening its stance on keeping interest rates firm to protect the value of the ringgit and preserve purchasing power. The Base Lending Rate (BLR), the lowest rate at which banks extend loans to their most credit-worthy customers, had increased to 12.3% in June 1998 from 9.5% in June 1997. Banks are permitted to add up to 4 percentage points to the BLR based on credit risk assessment of the borrower.
The central bank also announced plans to establish an Asset Management Corporation, somewhat akin to the Resolution Trust Corporation, to purchase problem loans from local banks at market prices and thereby encourage banks to increase lending to viable enterprises. By end-May 1998, credit growth had dropped to 12% year-on-year, well below Bank Negara's target. Overall non-performing loans increased from 6.5% of outstanding loans at year-end 1997 to 8.5% at end-May 1998, and most analysts expected NPLs could exceed 20% of outstanding loans by year-end 1998. In July 1998, the government announced plans to establish a "special purpose vehicle" to inject capital into the banking system and accelerate the development of a core group of strong domestic banks. The government projected that under a worst-case scenario the banking system could require up to RM16 billion (US$4 billion) in order to maintain a risk-weighted capital ratio of 9%.
Also in mid-1998, the government reversed its policy of fiscal tightening and announced two economic stimulus packages, equivalent to 4% of GDP. In June, the GOM announced the allocation of RM7.03 billion (US$1.76 billion) for social, health, and education spending. In early July, the GOM announced it would restore RM5 billion (USD1.25 billion) in previously announced spending cuts to restart selected infrastructure projects that had been deferred as part of the 1998 budget measures. Those projects include the KL Monorail and various port development, highway, water supply, waste disposal and sewerage projects. As of July 1998, the government expected to run a 1998 budget deficit of RM10 billion (US$2.5 billion @ RM4=US$1), or 3.7% of GNP.
Balance of Payments
Against the backdrop of rapidly shrinking domestic demand, and increasing competition for slower growing export markets, Malaysia recorded a small (US$149 million) trade surplus (CIF imports/FOB exports basis) in 1997, its first since 1993. Malaysia is the United States' 11th-largest trading partner and its 16th- largest export market. In 1997, the United States became Malaysia's largest trading partner. Two-way bilateral trade totaled US$28.8 billion. U.S. exports totaled US$10.8 billion (FOB basis) while imports from Malaysia totaled US$18 billion (Customs basis).
Malaysia's two-way merchandise trade reached US$152 billion in 1997, equivalent to 154% of GDP.
Malaysia's trade surplus improved to RM16.2 billion (US$4.05 billion) in the first five months of 1998. Exports were up 40.5% to RM115 billion, while imports rose 20.8% to RM98.8 billion. Electrical and electronic products accounted for 52% of total export earnings. Palm oil, which constituted 5.7% of exports, was the second-largest revenue earner. As external adjustment continues, the government projects the current account to register a surplus of RM2 billion (US$500 million), or 1% of GNP -- the first current account surplus in 10 years. On the capital account, short-term portfolio inflows have virtually dried up, while medium and long-term flows from foreign direct investment are expected to remain positive in 1998, albeit at lower levels than in previous years.
As a measure to stem the outflow of foreign exchange, the government announced in July 1998 that foreign workers (excluding maids) will be required to contribute to the country's Employees Provident Fund. Those deposits may be withdrawn if the contributor leaves the country permanently.
Outlook
Relative to neighboring Indonesia and Thailand, Malaysia has been better equipped to weather the region's economic and financial turmoil. It has not asked for an IMF support package. At nearly 40% of GDP, Malaysia has one of the highest savings rates in the world. External debt, at 40% of GDP, is relatively moderate. Malaysia's official reserves of US$20.4 billion at end-March 1998, were equivalent to 3.3 months of retained imports. Reserves are sufficient to cover short-term debt falling due and exposure is better hedged. The unemployment rate is still under 3% and Malaysia continues to rely heavily on foreign workers for 20% of its labor force.
However, stresses on the financial sector are mounting as over-leveraged domestic companies caught in the economic down draft find it increasingly difficult to meet commitments. Nonperforming loans are likely to exceed 20% of loan portfolios by year-end as the impact of the economic downturn works its way through the real economy, particularly the over built commercial property sector. Malaysia's banking sector has domestic loans estimated at 152% of GDP, the highest ratio in Southeast Asia. In July 1998, the government announced the establishment of a joint public and private sector steering committee that will kick-start and expedite restructuring of corporate debt. The government is considering tax incentives to encourage creditors to participate in corporate debt restructuring and may review procedures related to foreign ownership and participation in some large corporations.
Inflationary pressures, while dampened as a result of selected price controls and reduced demand for goods and services, have nonetheless mounted. The consumer price index increased 5.4% in May 1998, year-on-year, its highest level since 1993. The government is currently forecasting an inflation rate of 7-8% for the year.
The duration of Malaysia's downturn, and the strength and timing of economic recovery will depend, among other things, on regional trends, the strength of exports, and the response of domestic consumer demand to the real income loss caused by the wealth loss due to the collapse of the equity market and depreciation induced inflation. Other factors of crucial importance to recovery include the ability of the financial sector to cope with rising nonperforming loans, while keeping credit available to productive enterprises, the government's commitment to firm interest rates to stabilize and maintain the ringgit, improved transparency and accountability, and permitting a greater role for the market in corporate restructuring and buyouts.
Malaysia remains an attractive foreign investment destination primarily for electronics export manufacturing and the petrochemical industry. The cumulative value of U.S. private investment in Malaysia probably exceeds US$10 billion, concentrated in oil and gas, followed by manufacturing, primarily semiconductors and other electronic products. According to USDOC statistics, U.S. investment on a historical cost basis was US$5.6 billion in 1997. However, while other countries in the region are moving to further open their economies, the government continues to limit foreign equity ownership in most sectors to 30%, and to restrict further liberalization of the financial services sector.
Infrastructure
Malaysia boasts a well-developed transportation and communications infrastructure. However, it will have to overcome significant challenges to reach its goal of becoming a fully developed nation by 2020. Water shortages in the past year that have resulted in costly plant shutdowns point out the critical need for better conservation and water catchment management policies. Despite the economic slowdown, bottlenecks persist in the supply of labor; shortfalls in training and technology are apparent, and bureaucratic obstacles sometimes make it difficult to obtain work visas for expatriate employees. Existing constraints to the entry and expansion of foreign financial institutions limit the offering of the most efficient, state-of-the-art financial services that, along with telecommunications, are likely to be the "bricks and mortar" of the 21st century knowledge-based, capital intensive economies.
The government of Malaysia has recognized the importance of the "Millennium Bug," or "Y2K" problem, the inability of many computers and software to recognize the year 2000. If not remedied, the glitch could cause widespread computer failure and related consequences on January 1, 2000. Malaysia has established a "Y2K Steering Committee," led by YB Datuk Leo Moggie, the Minister of Energy, Telecommunications and Posts, as well as a "Y2K Project Team." The two groups are charged with monitoring private-sector action and coordinating publicity programs, which so far have included seminars, speeches and the establishment of a web page dedicated to the Y2K issue (www.y2k.gov.my). In addition, the government is encouraging companies to register as "Year 2000-compliant." The Kuala Lumpur Stock Exchange has mandated that all listed companies disclose their plans to address the problem. The government itself, though, has so far not disclosed any details of how the public sector will address Y2K.
Improved Telecommunications and Financial Services
Infrastructure, as well as strengthened intellectual property protection are essential to Malaysia's objective of transforming its economy from labor intensive assembly operations to knowledge- based, capital-intensive information industries. The flagship project designed to catapult Malaysia to the front ranks of technology is the Multimedia Super Corridor (MSC). The MSC encompasses a 9-by-30 mile zone extending south from Kuala Lumpur to the new international airport. Within its borders the government plans to create, with substantial private sector participation, a high-technology environment incorporating a high-capacity global telecommunications and logistics infra- structure. Liberal investment and tax policies and cyberlaws are designed to encourage electronic commerce, multimedia applications, and research and development.
The government has targeted seven flagship applications to accelerate the MSC's growth. They include electronic government, model smart schools designed to enhance information technology literacy; telemedicine, enabling remote consultation, diagnosis and treatment; R&D clusters; a national multipurpose smart card; borderless marketing centers; and worldwide manufacturing webs designed to control, monitor, and support regional networks of design, manufacturing, and distribution.
Government Role In The Economy
The government has taken a strong pro-active role in the development and industrialization of the Malaysian economy. This has included significant state sector investment, a close alliance between government and the private business community, a steady trend of privatizing state enterprises, and a variety of policies and programs to bolster the economic status of the Malay and indigenous communities, commonly referred to as Bumiputras. Under its privatization program begun in 1986, the government plays a pro- gressively diminishing role as a producer of goods and services, but continues to hold equity stakes (generally minority shares) in a wide range of domestic companies. These entities are rarely monopolies; instead, they are usually one (often the largest) player among several competitors in a given sector. Thus, government-owned entities are major players in some sectors, particularly plantations, financial institutions and tele- communications. Partial or full privatization efforts in recent years include the national telecommunications, electricity, shipping, airline, automobile, water distribution and waste collection/ disposal firms. Seaports, some hospitals and other health care facilities are in various stages of privatization.
The dramatic braking of the economy and depreciation of the ringgit relative to the U.S. dollar will significantly affect U.S. export opportunities, particularly for agricultural products, for defense related procurement, and for major projects and infra- structure development, where U.S. companies will face stiffer competition for a dwindling number of projects. However, some key privatized infrastructure projects will proceed and it is possible that foreign investment restrictions on privatized infrastructure will be relaxed to lure capital. Opportunities will remain strong in priority areas of development, including high technology fields related to the MSC, industrial automation to enhance productivity, medical products and services, education/distance learning and the environment.
Principal Growth Sectors/Sectoral Results
Manufacturing: The manufacturing sector recorded a 2.4% decline in the first quarter of 1998. The decline was broad-based, and affected domestic and export-oriented industries. During 1997, manufacturing grew 12.5% and accounted for 35.7% of GDP. Principal manufactured products include semiconductors, consumer electronic and electrical products, textiles, and apparel. Malaysia is the third-largest producer after the U.S. and Japan and the world's largest exporter of semiconductors. U.S. electronics exporters account for almost 10% of Malaysia's manufactured exports.
Services: Services output increased by 2.9% in the first quarter of 1998, following 7.9% growth in 1997. Services accounted for 44.8% of GDP in 1997. Finance and insurance recorded strong gains, while utilities, transportation, and communications were affected by the slowdown in exports. The services sector recorded a net deficit of US$8.7 billion in 1997. The government has undertaken efforts to promote Malaysia's shipping and reinsurance industries, improve and expand port and air transportation.
Agriculture: Agricultural output declined by 2.8% in the first quarter of 1998, resulting from lower production of all commodities. Agriculture was the third-largest contributor to the Malaysian economy in 1997, accounting for almost 12.1% of GDP. Agriculture accounts for 10.5% of Malaysia's export earnings and employs 15% of the work force. Malaysia is the world's largest producer and exporter of palm oil, which was the principal commodity contributing to the agricultural sector's growth in 1997. After three years of strong growth in yields, a setting in of a capacity stress factor was apparent, and total palm oil output is expected to decline in 1998. Malaysia is also a significant producer of natural rubber, cocoa and tropical timber. Livestock production is expected to drop in 1998 as farmers cut production in response to a cost/price squeeze. Output of forest logs has also been scaled down in line with various state government decisions to lower production quotas over time.
Mining/Energy: Growth in the mining sector slowed to 2% in the first quarter, due to slower production growth of crude oil and condensates and the marginal decline in natural gas production. The mining sector accounted for 6.8% of 1997 GDP. Growth is expected to slow as a result of declining output of tin, copper, and crude petroleum. Although oil will continue to account for about half of Malaysia's primary energy supply through the year 2000, Malaysia's position as a net exporter of oil will likely be reversed by 2010.
At current production rates, Malaysia has 12-15 years of crude oil reserves, about 4.2 billion barrels. The country's 85 trillion cubic feet of gas reserves are expected to last another 40 years. Malaysia produced an average of 629,297 barrels of oil per day and 3,846 million standard cubic feet of gas per day in 1997.
Construction/Property: Construction activity suffered a 10% decline in the first quarter of 1998, following slowdown in implementation of infrastructure and nonresidential projects. Growth in the construction sector, which accounted for 4.8% of GDP in 1997, slowed from 14.2% to 10% in 1997. The rapid pace of construction in recent years has resulted in a looming oversupply of office and retail space, and luxury residential projects. Based on building construction and plans as of mid-1997, retail space was projected to grow by 150%, and office space to double by the year 2000. The stock of retail commercial space in the Klang Valley, which includes Kuala Lumpur, was 1.7 million square meters in 1997. An additional 1.4 million square meters of retail space was at various stages of construction, according to Bank Negara's Annual Report 1997.
With significant new oversupply, and lower or negative GDP growth, vacancy rates are projected to jump substantially from the 5-10% levels of late 1997, with resulting downward pressure on rents and valuations. In an effort to spur the sale of higher priced homes, the government in August 1997 removed a RM100,000 levy that had been imposed on foreigners who purchase property costing more than RM250,000.
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