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p. 18 of 81 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia Cambodia Indonesia Lao People's Democratic Republic Malaysia Myanmar Philippines Singapore Thailand Viet Nam South Asia Central Asian Republics The Pacific III. Preferential Trade Agreements in Asia and the Pacific

Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia : Southeast Asia

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Malaysia

GDP growth decelerated sharply in 2001 on the back of an export slowdown and weak domestic demand conditions. A surge in public spending in tandem with positive private consumption growth, over most of the year, averted a recession. Prospects are for a modest acceleration of growth.

Macroeconomic Assessment

The year 2001 was difficult economically for Malaysia, as it experienced its second major slowdown in 4 years. While policymakers were still grappling with the consequences of the Asian financial crisis that began in 1997, a series of shocks prevented the economy from achieving a full recovery. In the first half of the year, the global plunge in demand for ICT products, which led to a protracted and synchronized slowdown in the world economy, contributed to slow domestic GDP growth of under 1%. While early signs of a leveling off started to emerge during August–September, hopes of a turnaround were dashed by the events of September 11th in the US. With the potential to cause another downward adjustment in export earnings, particularly from trade and tourism, these events further weakened the Malaysian economy.

Nevertheless, compared with some other regional economies, Malaysia was better able to deal with weakness of activity in the industrial economies. Important contributory factors were the resilience of private consumption and the beneficial effects of the Government’s policy actions.

Among major expenditure categories, consumption spending grew, propped up by a surge in public spending. Given that total consumption accounts for about 60% of GDP, its resilience helped absorb some of the contractionary forces resulting from the collapse in external demand. While a fall in disposable income and a sluggish labor market exerted downward pressure on consumption spending, this was cushioned by retail discounts, tax deductions, a turnaround in palm-oil prices in the middle of the year, low interest rates, and a sharp increase in public spending. Private consumer spending growth, accounting for about 80% of total consumption, fell to 2.4% in 2001 from 12.2% in the previous year. Public consumption spending accelerated to 14.1% from 1.7% in 2000, as the Government adopted stimulus measures.

Stronger public investment could not prevent total investment from shrinking by 5.3% in 2001. Private investment was severely affected by the sharp contraction in manufacturing and the export slowdown. On inventories, it is encouraging to note that downward adjustments have been ongoing since the fourth quarter of 2000.

The main drag on the economy in 2001 was the export sector. The slump in global demand for manufactured goods, particularly ICT products, led to a sharp contraction in demand for Malaysia’s exports, starting in the fourth quarter of 2000. In the weakening global economy, prices of some of Malaysia’s primary commodity exports, including crude oil, were also softer, exacerbating the fall in nominal exports. Owing to the heavy import-dependent nature of exports and the decline in overall economic activity, import demand also fell sharply. The slump in imports was seen mainly in capital and intermediate goods; imported consumer goods experienced only a modest decline.

On the production side, manufacturing suffered a sharp contraction of 4.8% in 2001, from 21% growth in 2000. Within manufacturing, while domestic-oriented industries recorded growth of 8% in 2001, this did not fully offset the contraction in export-oriented industries. The agriculture sector was the only area, apart from construction, where growth actually picked up—to 2.3% from 0.6% in 2000. This was mainly due to the bumper harvest of palm oil. The services sector grew by 3.9%, primarily due to the resilience of finance, insurance, real estate, and business-related activities. A low interest rate environment was a catalyst for these activities.

At 1.4%, inflation in 2001 remained subdued due to weak domestic demand, a stable ringgit, and low inflation abroad.

The economic slowdown, apart from the inevitable loss of income and employment, did not impact on social conditions too severely, thanks to the Government’s actions. Though the main thrust of fiscal policy was to soften the impact of the slump in external demand, the Government, in addition to offering tax relief, continued to spend heavily on health, education, and social protection. Monetary conditions remained accommodative. In fact, a low interest rate regime was already in place prior to 2001, as a result of the Government’s desire to encourage more investment. Hence, the central bank made only a 50 basis point interest rate cut in 2001.

The merchandise trade balance remained in surplus, at $18.2 billion. This was despite the export contraction of 8.8%, and was mainly due to the similar fall in imports. The continued trade surplus helped the economy maintain a sizable current account surplus of $6.8 billion in 2001, as well as ward off pressures on the ringgit in the first half of the year. It also contributed to a steady rebound in foreign reserves from June, which ended the year at a comfortable $30.8 billion. The reserve position covered 5.2 months of retained imports and was six times the level of short-term external debt.

Policy Developments

Fiscal pump priming will continue in 2002 to act as a very important driver of growth, especially in the first half of the year when export expansion is expected to be moderate. Following the Government’s low level of usage of the fiscal stimulus packages announced in 2001—it managed to spend only 50% of these funds—it has introduced a number of administrative measures to speed up project implementation. Apart from giving ministries greater financial authority, project management consultants will be appointed to supervise projects, which are awarded on a build-own-operate basis. Work will be required to start immediately after the award of a tender and once the tendering procedures have been simplified. A special committee in the Treasury Department has also been set up to monitor the project implementation process.

The 2002 budget cut the individual tax rate in the top bracket marginally from 29% to 28% and increased government salaries by 10%. On the corporate front, the Government extended the reinvestment allowance from 5 to 15 years and implemented tariff concessions for a wide range of intermediate products. These measures were designed to boost domestic demand directly, rather than letting it rely on the traditional multiplier effects emanating from public infrastructure projects.

Despite an expansion in the fiscal deficit in recent years, Malaysia’s national debt at 50% of GNP remains manageable: its debt service ratio is only about 6%.

In the finance sector, the proportion of nonperforming loans picked up marginally to roughly 16.3% in 2001, primarily due to the deterioration in economic conditions. The credit intermediation channel remains effective through bank lending to households for mortgages and consumer loans. Companies have been tapping into a growing corporate bond market for financing on back of spread compression. It is expected that improved liquidity conditions and relatively low nonperforming loan levels will continue in the short to medium term and this should help stimulate consumption and investment-related activities in 2002 and 2003.

Malaysia’s economic slowdown has highlighted the problems associated with overreliance on an export-led growth strategy. Both the intensity of the financial crisis and the speed with which the slump in the US economy has been transmitted to trade- and finance sector-related activities have prompted policymakers to look for alternative means of promoting economic growth. While maintaining an open economy, they have started to look for untapped potential at home, especially in services (ports and tourism), agriculture, and resource-based industries to improve the economy’s resilience to shocks.

Outlook for 2002–2003

The outlook is predicated on the following assumptions. A modest recovery in the US will be seen in the first half of 2002 and will be followed by a stronger pickup from the second half of the year and into 2003. The stimulus packages implemented in the second half of 2001 and new policy changes in 2002 via lowering of personal and corporate tax rates are expected to have significant spin-off effects on domestic demand in the short to medium term. Destocking was quite significant by the fourth quarter of 2001 and inventories are likely to follow the expected upward trend in the US business inventory-to-sales ratio in 2002. US new orders of ICT products will probably stage a modest upturn in the second half of the year and this will lead to a moderate recovery in Malaysian exports.

Economic growth in the first half of 2002 is likely to be restrained, driven mainly by domestic demand underpinned by expansionary fiscal policy and a rise in inventory investment. The leading index rose in the third quarter of 2001 and is expected to continue to do so in 2002 (Figure 2.9). The recovery is likely to gather pace in the second half of 2002 as export demand accelerates. GDP growth is forecast at 4.2% and 5.8% in 2002 and 2003, respectively.

The outlook for inflation depends primarily on the speed and strength of the economic recovery. Prices should increase moderately as demand conditions improve, since some excess capacity may remain for much of 2002. The inflation rate for the year is projected at 2.3%, accelerating further to 2.8% in 2003.

The fiscal deficit is expected to narrow to 5.2% of GDP in 2002 due to stronger revenues stemming from an expansion of the tax base as GDP growth accelerates and as capital expenditures fall. In 2003, as the Government becomes less reliant on pump priming, the fiscal deficit is forecast to further narrow to 3% of GDP.

On the balance of payments, merchandise exports are forecast to register 7% growth in 2002 as the global economy strengthens. However, a stronger surge in imports, due to the replenishment of low inventories and to higher demand for intermediate inputs from ICT exporters, will likely reduce the merchandise trade surplus to $17.4 billion. With a forecast net services deficit of around $10 billion, the current account is expected to register a smaller but still considerable surplus of 5.3% of GDP in 2002.

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