IMF: Malaysia's economy continues to perform well

An International Monetary Fund (IMF) team, led by Alex Mourmouras, visited Kuala Lumpur, Putrajaya and Kuching during January 11-22, 2016, to conduct discussions for the 2015 Article IV Consultation with Malaysia. The team exchanged views with senior officials of the Government of Malaysia and Bank Negara Malaysia (BNM), and met with representatives from the private sector, think tanks and academia.

At the conclusion of the visit, Mr. Mourmouras said despite challenging external and domestic conditions in 2015, the authorities have been able to maintain macroeconomic and financial stability, while making significant progress in improving the foundations for sustained economic growth over the medium term. Malaysia's economy has been affected by multiple shocks since late 2014, including a sharp fall in commodity prices, weak external demand, political developments and capital outflows.

However, the implementation of the goods and services tax (GST) last April, along with cuts in subsidies and operational expenditures, limited the impact on government finances of the oil price decline. Exchange rate flexibility has helped buffer the real economy and financial system from the sharp fall in commodity prices and volatility in global financial markets, while prudent monetary policy helped contain inflationary pressures arising from exchange rate depreciation and the implementation of the GST.

Malaysia's economy continues to perform well, although growth has slowed down and downside risks pre- dominate. The external environment for 2016 is shrouded in uncertainties, owing to a confluence of factors that include the global and regional trade slowdowns; China spillovers; the continued strength of the US dollar; and the uneven strength of activity in Malaysia's other trading partners.

Economic growth should remain solid in 2016, edging down to around 4.4 percent from an estimated 4.8 percent in 2015. Activity should be underpinned by healthy, albeit moderating domestic demand but constrained by weak external demand. Credit growth is expected to slow down, dampening the accumulation of debt, but financial conditions are expected to remain supportive of growth. Consumption growth will be supported by high rates of household formation, strong employment and expanded federal transfers to lower income groups. Inflation should rise temporarily as the impact of lower oil prices wanes and a more depreciated exchange rate passes through to prices. Despite the commodity price decline and weak global outlook, the current account should stay in surplus.

Continued uncertainty about external conditions, including the likelihood of persistently low oil prices and more capital outflows, require continued prudent macroeconomic management. Protecting the budget should continue to be a top priority, and in this context the mission applauds the authorities' determination to adhere to the federal government's deficit target of 3.1 percent of GDP for 2016 and the medium term aim of balancing the budget by 2020-21.

In response to capital outflows, BNM has allowed the ringgit to depreciate fol- lowing the oil and commodity price shock, thus providing a cushion to commodity sector and enhancing the competitiveness of the manufacturing exports. It also deployed reserves to smooth the capital flow cycle and ensure orderly conditions in foreign exchange and financial markets. While headline inflation is expected to rise temporarily in 2016, core inflation is well anchored, and BNM's current monetary policy stance is appropriate. The mission agrees with BNM"s stance that reserves should be rebuilt over time.

Malaysia's recent strong growth, high investment and improvements in business environment scorecards are impressive. But the lower potential growth in the advanced economies makes maintaining this growth performance more challenging and provides an additional imperative for structural reforms.

Implementation of reforms envisaged in the 11th Malaysia Plan and commitment to freer trade policies, including in the context of the Trans-Pacific Partnership Agreement, ASEAN Economic Community, and the proposed Regional Comprehensive Economic Partnership, should all help anchor structural reforms and raise Malaysia's potential growth over the medium term. Further raising the skills of Malaysia's labor force will be critical in the drive to become a high income nation. Steadfast implementation of education policies is needed to raise the quality of the educational system and student attainment standards. The mission also welcomes the authorities' plans to strengthen anticorruption measures, as this should improve the business environment and public confidence in official institutions.