malaysia...rafidah aziz, retained their positions. economic policy outlook • bank negara malaysia...

Country Report

Malaysia

March 2006

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

Malaysia at a glance: 2006-07

OVERVIEW The prime minister, Abdullah Badawi, is likely to remain in power during the forecast period. However, he will find it difficult to maintain the support of other influential figures in his own party, the United Malays National Organisation (UMNO). Real GDP is forecast to grow by an annual average of 5.3% in 2006-07, supported by household and investment spending. Interest rates will rise further, but the general policy stance is expected to remain accommodative. The current exchange-rate system!a managed float against a trade-weighted basket of currencies!is likely to remain in place throughout the forecast period. The Economist Intelligence Unit expects the ringgit to appreciate to M$3.66:US$1 by end-2007. Although the current-account surplus is forecast to narrow in 2006-07, its nominal value will still be large compared with the levels seen in the 1990s.

Key changes from last month

Political outlook • The prime minister announced a long-awaited cabinet reshuffle in February,

but the changes proved to be minor. The ministers for tourism and higher education were replaced, but other senior ministers, including the minister of works, Samy Vellu, and the international trade and industry minister, Rafidah Aziz, retained their positions.

Economic policy outlook • Bank Negara Malaysia (the central bank) sanctioned a 25-basis-point increase

in the overnight policy rate (OPR) on February 22nd, the second interest-rate rise in the current tightening cycle.

Economic forecast • We have revised up our forecast for real GDP growth in 2006-07, owing to

recent data showing vigorous private consumption growth and strong export gains in the fourth quarter of 2005. We now expect the economy to expand by 5.4% in 2006 and by 5.1% in 2007. Growth will be underpinned in both years by relatively strong household spending, which will bolster growth in the services sector.

The Economist Intelligence Unit

The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide.

The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

London The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom Tel: (44.20) 7576 8000 Fax: (44.20) 7576 8500 E-mail: [email protected]

New York The Economist Intelligence Unit The Economist Building 111 West 57th Street New York NY 10019, US Tel: (1.212) 554 0600 Fax: (1.212) 586 0248 E-mail: [email protected]

Hong Kong The Economist Intelligence Unit 60/F, Central Plaza 18 Harbour Road Wanchai Hong Kong Tel: (852) 2585 3888 Fax: (852) 2802 7638 E-mail: [email protected]

Website: www.eiu.com

Electronic delivery This publication can be viewed by subscribing online at www.store.eiu.com

Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, online databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office

Copyright © 2006 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited.

All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it.

ISSN 0269-6703

Symbols for tables �n/a� means not available; �� means not applicable

Printed and distributed by Patersons Dartford, Questor Trade Park, 151 Avery Way, Dartford, Kent DA1 1JS, UK.

Malaysia 1

Country Report March 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006

Contents

Malaysia

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2006-07 7 Political outlook 8 Economic policy outlook 9 Economic forecast

13 The political scene

16 Economic policy

20 The domestic economy 22 Prices, wages and employment 23 Manufacturing 26 Oil and gas 26 Agriculture 27 Financial and other services

29 Foreign trade and payments

List of tables 9 Malaysia: international assumptions summary 10 Malaysia: gross domestic product by expenditure 12 Malaysia: forecast summary 21 Malaysia: real gross domestic product by expenditure 25 Malaysia: manufacturing production 26 Malaysia: oil and gas production 27 Malaysia: agricultural sector production 28 Malaysia: services sector performance 30 Malaysia: foreign trade 31 Malaysia: electronics and electrical goods exports 32 Malaysia: current account 33 Malaysia: financial account 35 Malaysia: external debt

2 Malaysia


List of figures 12 Gross domestic product 12 Consumer price inflation 22 Inflation indicators 25 Manufacturing production

Malaysia 3


Malaysia March 2006

Summary

The prime minister, Abdullah Badawi, is likely to remain in power over the forecast period, but various factors could prompt a challenge to his leadership from within his own party, the United Malays National Organisation (UMNO). A number of intractable problems within the region will remain unresolved. Further interest-rate rises are expected in 2006. GDP growth is forecast to average 5.3% a year in 2006-07. Consumer price inflation is expected to remain high in 2006 as the government continues to cut subsidies on fuel. Exports and imports are likely to maintain their strong growth momentum throughout the forecast period, but rates of trade growth will be much lower than those seen in 2004. The merchandise trade account and current account will continue to record large surpluses.

A long-awaited cabinet reshuffle finally took place on February 14th. There was no reduction in the size of the large (33-member) cabinet or fundamental change in what was still largely the cabinet chosen by the previous prime minister, Mahathir Mohamad. Controversial ministers, including the minister of works, Samy Vellu, and the minister of international trade, Rafidah Aziz, retained their positions. The overburdened prime minister kept his portfolios of finance and internal security.

Malaysia has signed a free-trade agreement (FTA) with Japan. Labelled the Japan-Malaysia Economic Partnership Agreement (JMEPA), the treaty will eliminate many tariffs on industrial, agricultural, forestry and fishery products in the next ten years. Malaysia hopes to complete initial negotiations with the US on an FTA by May. The deputy finance minister, Tengku Putera, has already warned that the allocation for the Ninth Malaysia Plan, for 2006-10, would be significantly less than that set aside for the eighth plan (2001-05).

Real GDP grew by 5.2% year on year in the fourth quarter of 2005, and by 5.3% in the year as a whole. Private consumption again provided the main growth impetus during the final quarter, but there were also signs of a strong recovery in external demand.

Malaysia"s current-account surplus increased to M$19.1bn (US$5bn) in the third quarter of 2005 (the latest period for which balance-of-payments figures are available), from M$17.9bn in the second quarter. There was no sign of a year-on-year decline. The surplus has now grown for 12 consecutive quarters.

Editors: Fung Siu (editor); Robert Ward (consulting editor) Editorial closing date: March 10th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Economic policy

The domestic economy

Foreign trade and payments

Outlook for 2006-07

The political scene

4 Malaysia


Political structure

Federation of Malaysia

Federated constitutional monarchy

The king appoints a prime minister and, on the prime minister"s advice, a cabinet

The Yang di-Pertuan Agong (king or supreme sovereign), elected by the Conference of Rulers from one of the nine hereditary rulers

Bicameral federal parliament. The Senate (Dewan Negara, the upper house) has 69 members!26 elected from the state legislatures, and 43 appointed by the king. The House of Representatives (Dewan Rakyat, the lower house) currently has 219 directly elected members. The Senate serves a six-year term of office and the House of Representatives a five-year term

There are state governments in each of the 13 states, in nine of which the head of state is a hereditary ruler. Each state has its own constitution, a council of state or cabinet with executive authority, and a legislature that deals with matters not reserved for the federal parliament. There are also three federal territories: Kuala Lumpur, Labuan and Putrajaya

March 21st 2004; the next election will be held by April 2009. The cabinet was reshuffled after the general election, in April 2004

The Barisan Nasional (BN), the governing 14-party coalition!the main component of which is the United Malays National Organisation (UMNO)!won 198 of the 219 seats in the lower house in the 2004 general election. The BN has the two-thirds majority required to pass constitutional amendments

Government!the main parties in the BN are UMNO, the Malaysian Chinese Association (MCA), the Malaysian Indian Congress (MIC), Parti Gerakan Rakyat Malaysia (Gerakan), Parti Pesaka Bumiputera Bersatu (PPBB) and the Sarawak United People"s Party (SUPP). Opposition!Parti Islam sa-Malaysia (PAS), the Democratic Action Party (DAP), Parti Keadilan Rakyat (Keadilan)

Prime minister, finance & internal security minister Abdullah Badawi Deputy prime minister & defence minister Najib Abdul Razak Second finance minister Mohamed Yakcop

Agriculture Muhyiddin Mohd Yassin Domestic trade & consumer affairs Shafie Apdal Education Hishamuddin Hussein Energy, communications & multimedia Lim Keng Yaik Foreign affairs Syed Hamid Albar Health Chua Soi Lek Home affairs Radzi Sheikh Ahmad Housing & local government Ong Ka Ting Information Zainuddin Maidin International trade & industry Rafidah Aziz Plantation industries & commodities Chin Fah Kui Public works Samy Vellu Science, technology & innovations Jamaluddin Mohd Jarjis Transport Chan Kong Choy

Zeti Akhtar Aziz

Head of state

National legislature

State government

National elections

National government

Main political organisations

Key ministers

Central bank governor

The executive

Official name

Form of state

Malaysia 5


Economic structure

Annual indicators

2001a 2002a 2003 a 2004 b 2005b

GDP at market prices (M$ bn) 334.4 362.0 395.0 449.6 a 494.5

GDP (US$ bn) 88.0 95.3 104.0 118.3 a 130.6

Real GDP growth (%) 0.3 4.4 5.4 7.1 a 5.3

Consumer price inflation (av; %) 1.4 1.8 1.0 1.5 a 3.0

Population (m) 24.0 24.5 25.0 25.5 25.9

Exports of goods fob (US$ m) 87,981 93,383 104,999 126,642 145,932

Imports of goods fob (US$ m) -69,597 -75,248 -79,289 -99,123 -116,936

Current-account balance (US$ m) 7,287 7,190 13,381 14,770 16,407

Foreign-exchange reserves excl gold (US$ m) 30,474 34,222 44,515 66,384 a 69,988

Total external debt (US$ bn) 44.6 48.9 49.0 52.3 50.4

Debt-service ratio, paid (%) 5.9 7.0 7.7 b 5.9 4.7

Exchange rate (av) M$:US$ 3.80 3.80 3.80 3.80 a 3.79

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2004 % of total Components of gross domestic product 2004 % of total

Agriculture 9.5 Private consumption 42.9

Mining 10.4 Public consumption 13.3

Manufacturing 31.2 Gross fixed capital formation 20.5

Construction 3.8 Stockbuilding 1.9

Services 48.6 Exports of goods & services 121.8

Others -3.5 Imports of goods & services -100.4

Principal exports (fob) 2004 US$ bna Principal imports (cif) 2004 US$ bna

Electronics & electrical machinery 67.6 Capital goods 14.6

Petroleum & liquefied natural gas 7.3 Intermediate goods 75.6

Chemicals & chemical products 7.3 Consumption goods 6.1

Palm oil 5.3 Dual-use goods 2.5

Textiles, clothing & footwear 2.7 Re-exports 4.5

Main destinations of exports 2004 % of total Main origins of imports 2004 % of total

US 18.8 Japan 15.9

Singapore 15.0 US 14.5

Japan 10.1 Singapore 11.1

China 6.7 China 9.8

Hong Kong 6.0 Thailand 5.5

a Customs basis.

6 Malaysia


Quarterly indicators 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrFederal government finance (M$ m) Revenue 17,735 21,826 24,576 35,260 21,147 26,599 26,375 n/aExpenditure 16,152 19,705 19,934 35,507 15,909 23,397 22,987 n/aBalance 1,583 2,121 4,642 -247 5,238 3,202 3,388 n/aOutput GDP at constant 1987 prices (M$ m) 59,133 61,766 63,411 64,645 62,798 64,483 66,757 67,976GDP at constant 1987 prices (% change,

year on year) 7.8 8.4 6.7 5.8 6.2 4.4 5.3 5.2Industrial production index (1993=100) 219.6 228.8 233.6 236.5 231.4 234.1 251.4 248.5Industrial production index (% change,

year on year) 14.3 13.3 10.5 7.6 5.4 2.3 3.3 5.1Prices Consumer prices (2000=100) 105.0 105.4 105.9 107.0 107.6 108.6 109.5 110.7Consumer prices (% change, year on year) 0.9 1.2 1.5 2.3 2.4 3.0 3.4 3.4Producer prices (2000=100) 111.3 113.6 115.5 117.3 117.0 120.7 125.9 n/aProducer prices (% change, year on year) 5.1 11.2 11.9 8.6 5.1 6.3 9.0 n/a

Financial indicators Exchange rate M$:US$ (av) 3.80 3.80 3.80 3.80 3.80 3.80 3.77 3.78Exchange rate M$:US$ (end-period) 3.80 3.80 3.80 3.80 3.80 3.80 3.77 3.78Deposit rate (av; %) 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0Lending rate (av; %) 6.1 6.0 6.0 6.0 5.9 6.0 5.9 6.0Money market rate (av; %) 2.7 2.7 2.7 2.7 2.7 2.7 2.7 3.0M1 (end-period; M$ m) 107,180 106,239 107,201 112,690 113,386 112,914 115,300 121,284M1 (% change, year on year) 19.3 14.6 12.4 8.5 5.8 6.3 7.6 7.6M2 (end-period; M$ m) 406,124 410,941 439,599 471,536 480,243 505,628 514,288 523,231M2 (% change, year on year) 11.6 7.7 14.4 19.3 18.3 23.0 17.0 11.0KLSE composite index (end-period; 1977=100) 901.9 819.9 850.0 907.4 890.3 888.3 927.5 899.8KLSE composite index (% change, year on year) 41.9 18.5 15.9 14.3 -1.3 8.4 9.1 -0.8

Sectoral trends Electronic & electrical products index (1993=100) 308.2 321.8 326.6 322.7 304.4 324.6 339.7 356.4Electronic & electrical products index (% change,

year on year) 25.1 23.9 19.4 5.1 -1.2 0.9 4.0 10.4Mining index (1993=100) 139.0 134.7 135.5 147.5 143.6 130.8 139.2 143.9Mining index (% change, year on year) 6.7 3.1 5.4 7.8 3.3 -2.9 2.7 -2.4Foreign trade (M$ m) Exports fob 107,835 117,996 128,205 126,705 122,576 130,733 137,859 142,534Imports cif -88,630 -99,876 -105,469 -106,102 -97,565 -107,854 -114,538 -113,993Trade balance 19,206 18,120 22,736 20,602 25,011 22,859 23,322 28,541

Foreign payments Current-account balance (M$ m) 14,481 12,384 16,709 12,937 20,915 17,890 19,072 n/aReserves excl gold (end-period; US$ m) 51,020 53,564 56,546 66,384 72,087 74,874 80,008 n/a

Sources: Central Bank of Malaysia, Monthly Statistical Bulletin; IMF, International Financial Statistics.

Malaysia 7


Outlook for 2006-07

Political outlook

Since independence in 1957, Malaysia has been ruled by coalition governments dominated by the principal Malay party, the United Malays National Organisation (UMNO). Superficially, the political scene in Malaysia is more stable than in some of the country"s South-east Asian neighbours. The contain-ment of political tensions within the country is the raison d'être of UMNO and the Barisan Nasional (BN) coalition government. However, rumbling dis-satisfaction with the prime minister, Abdullah Badawi, who does not have the authority of his predecessor, Mahathir Mohamad, will make it harder to paper over the cracks. The Economist Intelligence Unit"s central assumption is that Mr Abdullah will remain in power over the forecast period. But the weakness of his power base within UMNO could facilitate an internal challenge.

A general election must be held every five years, but governments may call an election earlier. The latest possible date for the next general election is March 2009, but it is widely expected to be held some time in 2008. It will be difficult for the BN coalition to improve on its remarkable success in the March 2004 general election, so that the opposition is likely to do better this time round. The key to the opposition"s success will be whether it can present a united front and find an effective leader.

Anwar Ibrahim, a former deputy prime minister, is a leading candidate for such a role. Released from prison in late 2004 after his controversial conviction for sodomy was overturned, Mr Anwar has yet to be readmitted to UMNO, and has been courted by the opposition parties. Although he agreed to campaign for the Parti Islam sa-Malaysia (PAS) in the Kelantan by-election last December, he has yet to declare his allegiance to any of the opposition parties. His answers to media questions about the possibility of rejoining UMNO have also been non-committal, fanning suspicions regarding his intentions. Mr Anwar may prefer to rejoin UMNO as a quicker way of becoming prime minister, even though he remains banned from standing for public office until 2008. Mr Abdullah would risk a major dispute within UMNO should he take steps to readmit Mr Anwar. In the meantime, Mr Anwar may choose to stay on the sidelines until some disruptive event creates a political opening for him. Religious and ethnic tensions may rise during the forecast period, but with no general election looming UMNO will remain firmly in power.

A number of intractable problems within the region remain unresolved. Violence in southern Thailand is likely to be a continuing source of tension between Malaysia and Thailand. The plight of a number of Thai Muslims who crossed the border into Malaysia in August 2005, and their request for sanctuary, remains a diplomatic problem for the Malaysian government. However, tensions have eased in recent weeks, following hints from Thai officials that they were no longer seeking the return of the fugitives. Malaysia maintains cordial relations with Singapore despite a range of outstanding issues, such as Singapore"s use of Malaysia"s air space and the renegotiation of

Domestic politics

International relations

8 Malaysia


long-term water supply contracts. Controversy still surrounds plans to build a bridge to replace the causeway linking the two countries. Following a proposal from Malaysia to build its half of the bridge first, the two countries continued to hold talks on the issue in February, with another meeting tentatively scheduled for end-March. Malaysia is set to strengthen trade links with Pakistan, Australia and New Zealand when free-trade agreement (FTA) initiatives are completed later this year.

Economic policy outlook

Monetary policy will be tightened over the forecast period. Further interest-rate increases are expected in 2006, but Bank Negara Malaysia (BNM, the central bank) is unlikely to adopt an aggressive stance, given the need to support economic growth over the short to medium term. The fiscal situation will continue to improve in 2006-07, despite further increases in development spending. The government is expected to implement a new five-year plan in April. Resources will continue to be channelled towards the eradication of avian influenza (bird flu) following an outbreak in February, the first of its kind in Malaysia for over a year. The government has already pledged more than US$10m towards surveillance programmes. Policy towards government-linked corporations is in theory being reformed, with the aim of improving competitiveness and raising the amount of revenue that such companies generate for the government.

Relatively strong economic growth resulted in Malaysia�s budget deficit narrowing from 4.3% of GDP in 2004 to an estimated 3.3% in 2005. A rise in revenue receipts was the main driver behind this improvement. Details of the 2006 budget point to a further reduction in the deficit. Increases in government expenditure will be partially offset by improved revenue collection, and particularly by income derived from the petroleum sector: export duties alone jumped by an estimated 30.7% year on year in 2005. The government�s forecast for 2006 is for a deficit of 3.5% of GDP. However, the Economist Intelligence Unit is more optimistic, owing to its forecast for continued strong revenue growth derived from petroleum and direct taxation. We forecast that this rise in revenue, coupled with efforts to contain expenditure, will result in the budget deficit falling to 2.7% of GDP in 2006. In 2007 the introduction of a goods and services tax (GST) will improve revenue collection, helping to reduce the deficit further.

The BNM is expected to tighten monetary policy further over the forecast period, but interest rates are expected to increase only gradually, given the BNM�s concern to bolster economic growth over the short to medium term. The BNM embarked on a tightening cycle in November 2005, when it sanctioned a 30-basis-point increase in the overnight policy rate (OPR) to 3%, the first increase since May 1997. The bank tightened monetary policy again on February 22nd. On this occasion, the OPR was increased by 25 basis points, to 3.25%, in a further sign of the bank"s incremental approach to policy tightening. The bank cited persistent price pressures and the strength of the economy as the main

Policy trends

Fiscal policy

Monetary policy

Malaysia 9


factors behind the move. The decision again coincided with the release of fresh GDP data, this time relating to the fourth quarter of 2005. These showed the economy expanding at 5.2% year on year, a similar pace to that seen in the previous quarter, but the most worrying aspect for the BNM was the continued strength of private consumption, which has the potential to stoke additional consumer price pressures. At the same time, negative interest-rate differentials with the US remain. The OPR is now 125 basis points below the US federal funds rate (the US"s benchmark interest rate), whereas in the past Malaysia"s interest rates have been at a premium to interest rates in the US.

Economic forecast

Malaysia: international assumptions summary (% unless otherwise indicated)

2004 2005 2006 2007

Real GDP growth World 5.1 4.5 4.2 4.0

OECD 3.2 2.6 2.5 2.3

China 10.1 9.9 8.8 8.0

EU25 2.4 1.7 2.1 2.2

Exchange rates ¥:US$ 108.1 110.1 112.5 104.5

US$:� 1.244 1.245 1.253 1.338

SDR:US$ 0.675 0.677 0.679 0.653

Financial indicators � 3-month interbank rate 2.13 2.15 2.64 3.33

US$ 3-month Libor 1.62 3.57 5.21 4.77

Commodity prices Oil (Brent; US$/b) 38.5 54.7 60.0 55.3

Gold (US$/troy oz) 409.5 445.0 525.0 493.8

Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.2 -0.5 -2.3

Industrial raw materials (% change in US$ terms) 21.0 10.4 -1.3 -10.7

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

World GDP growth (on a purchasing power parity basis) is estimated at 4.5% for 2005, but is forecast to ease to an average 4.1% a year in 2006-07 as growth in Japan, the US and China decelerates. The slowdown in all three countries will have a direct impact on Malaysia. The US is Malaysia"s largest export market, with Japan ranked third. The two countries combined absorb some 30% of Malaysia�s total exports, while China has claimed an ever-increasing share in recent years. World trade growth is expected to average 7.1% during 2006/07. Iran"s determination to go ahead with its nuclear programme has heightened geopolitical tensions in recent months. Although we do not envisage military action against Iran, we foresee a prolonged period of delicate negotiations. As a consequence, we have raised our oil price forecast for 2006 and 2007 to reflect an increase in the risk premium. We now expect international oil prices (dated Brent Blend) to average US$60/barrel (up from US$55/b) in 2006, before falling only modestly to US$55.25/b (up from US$46.75/b) in 2007.

International assumptions

10 Malaysia


There are a number of threats that could drag global economic performance down. Continuing high oil prices, into 2007 and beyond, pose a risk to corporate profitability in OECD countries, and hence to investment, which could undermine Malaysia�s efforts to attract foreign direct investment. In addition, there are still risks associated with China�s attempts to slow its economy and so deal with a potential investment bubble. Lastly, further outbreaks of avian influenza (bird flu) in poultry flocks in Asia, eastern Europe and Africa raise the possibility of a human flu pandemic, which could severely hamper economic activity in Asia and across the world.

Malaysia: gross domestic product by expenditure (M$ bn at constant 1987 prices; % change year on year in brackets unless otherwise indicated)

2004a 2005 b 2006c 2007c

Private consumption 120.2 131.2 138.5 145.9

(10.5) (9.2) (5.6) (5.3)

Public consumption 36.6 38.7 39.8 41.0

(6.0) (5.9) (2.9) (3.0)

Gross fixed investment 67.0 70.2 73.0 76.5

(3.1) (4.7) (4.1) (4.7)

Final domestic demand 223.7 240.1 251.4 263.4

(7.5) (7.3) (4.7) (4.8)

Stockbuilding 5.5 -1.7 0.5 2.0

(2.9) (-2.9) (0.8) (0.5)

Total domestic demand 229.2 238.4 251.9 265.4

(10.8) (4.0) (5.7) (5.4)

Exports of goods & services 292.5 316.9 344.2 382.1

(16.3) (8.4) (8.6) (11.0)

Imports of goods & services 272.7 293.4 319.8 357.4

(20.7) (7.6) (9.0) (11.7)

Foreign balance 19.8 23.5 24.3 24.8

(-2.5)d (1.5) d (0.3)d (0.2)d

GDP 249.0 262.0 276.2 290.2

(7.1) (5.3) (5.4) (5.1)

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Contribution to real GDP growth.

Real GDP is forecast to grow by 5.4% in 2006. On the supply side, growth is expected to be led by the services sector, which accounted for 58% of GDP at factor cost in 2005. The most dynamic sector will be that encompassing wholesale, retail sales and restaurants, which will be bolstered by relatively strong household spending and rising tourist arrivals. The manufacturing sector will continue to make a positive contribution to GDP growth, but the pace of growth will lag behind that of services, owing to weaker trends in global demand. On the demand side, further increases in interest rates in 2006 will lead to a deceleration in private consumption growth, from 9.2% in 2005 to 5.6% in 2006. However, consumption will be supported by the continued easy availability of credit, and is expected to post significant gains in the final months of 2006 as consumers bring forward purchases of goods and services ahead of the introduction of the GST in January 2007. Private investment spending is forecast to experience a mild deceleration in 2006. A fairly subdued performance by the manufacturing sector and high oil prices will take their toll on business sentiment. The external sector is expected to make a marginal

Economic growth

Malaysia 11


contribution to growth. Although exports are expected to maintain a steady pace of growth compared with 2005, export expansion will lag behind growth in imports as consumer demand stays firm and export-oriented industries demand greater volumes of imported inputs to meet rising global demand for electronic and electrical goods, particularly semi-conductors. Real GDP growth is forecast to slow to 5.1% in 2007, owing to moderating trends in private consumption growth brought about by the introduction of the GST and higher interest rates, although these trends will be partially offset by a slight pick-up in investment.

Consumer prices are forecast to increase by 3% in 2006 and by 3.3% in 2007. (These figures take into account the new methodology adopted by Malaysia"s Department of Statistics, under which the base year has been changed from 2000 to 2005.) Fuel prices, which were largely responsible for the spike in consumer prices in 2005, are expected to increase throughout the forecast period as the government continues to cut fuel subsidies, although this increase is likely to be more gradual in 2007 as international oil prices start to decline. Food prices, which were also partly responsible for the increase in the overall index in 2005, are expected to increase at a moderate pace in 2006. Price pressures will also be dampened by a decline in global non-oil commodity prices, along with a modest strengthening of the ringgit. In 2007 the introduction of the GST will push up the overall consumer price index, but gains will be partially offset by the moderating cost of food and weaker trends in commodity prices.

In July 2005 the BNM abandoned the fixed exchange-rate system that pegged the ringgit to the US dollar at M$3.80:US$1, in favour of a managed float against a trade-weighted basket of currencies. The new exchange-rate system is likely to remain in place throughout the forecast period, although there will be periodic speculation about the composition of the basket of currencies upon which it is based. The result of the currency change was not dramatic. As of March 8th the ringgit stood at M$3.7:US$1, representing an appreciation of 2.6% against the US dollar since the dropping of the peg. We assume that the ringgit will rise steadily but modestly against the US dollar to an average of M$3.73:US$1 in 2006, before firming further to US$3.68:US$ in 2007. There remains the risk that the adjustment could be far more abrupt than this, however, as concerns mount regarding the sustainability of the huge US current-account deficit. (Greater volatility of the US dollar in foreign-exchange markets would transmit uncertainty into the asset markets of emerging economies.) The ringgit is also vulnerable to movements in the yen and the renminbi: Japan is Malaysia"s main supplier, especially of parts and components, and China has become important both as a market for Malaysian exports and as a competitor.

Malaysia"s trade surplus (fob-fob basis) is estimated to have grown to US$29bn in 2005, US$1.5bn higher than in the previous year, owing to strong growth in both the volume and value of exports. Electronics exports continued to rise in value terms, and high commodity prices, particularly for crude oil, have also helped. The trade surplus is forecast to fall to US$27.6bn in 2006 as growth slows in some of Malaysia"s main export markets. Goods exports will continue

Inflation

Exchange rates

External sector

12 Malaysia


to post double-digit gains in both 2006 and 2007 in value terms, but growth will be tempered by lower commodity prices and the impact of slower growth in China. Goods imports, on the other hand, will be underpinned by growth in domestic demand, albeit at a slower pace than that posted in 2005. The services and income balances have traditionally posted deficits, and we expect this trend to continue throughout the forecast period. After reaching an estimated US$16.4bn (equivalent to 12.6% of GDP) in 2005, the current-account surplus is forecast to narrow to US$15.2bn (10.5% of GDP) in 2006 and to fall further, to US$14.7bn (9.2% of GDP), in 2007.

Malaysia: forecast summary (% unless otherwise indicated)

2004 a 2005 b 2006c 2007c

Real GDP growth 7.1 5.3 5.4 5.1

Industrial production growth 11.3 4.0 4.0 3.2

Gross agricultural production growth 5.0 2.1 2.8 3.2

Unemployment rate (av) 3.6 3.6 3.5 3.5

Consumer price inflation (av) 1.5 3.0 3.0 3.3

Consumer price inflation (year-end) 2.2 3.3 3.1 3.0

Base lending rate 6.0 6.1 6.6 6.8

Central government balance (% of GDP) -4.3 b -3.2 -2.7 -2.9

Exports of goods fob (US$ bn) 126.6 b 145.9 164.9 183.4

Imports of goods fob (US$ bn) -99.1 b -116.9 -137.3 -154.7

Current-account balance (US$ bn) 14.8 b 16.4 15.2 14.7

Current-account balance (% of GDP) 12.5 b 12.6 10.5 9.2

External debt (year-end; US$ bn) 52.3 b 50.4 50.3 53.1

Exchange rate M$:US$ (av) 3.80 3.79 3.73 3.68

Exchange rate M$:¥100 (av) 3.51 3.44 3.32 3.52

Exchange rate M$:� (year-end) 5.14 4.46 4.89 4.81

Exchange rate M$:SDR (year-end) 5.90 5.40 5.62 5.57

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

Malaysia 13


The political scene

Islamic rule in the northern state of Kelantan looked precarious after the federal coalition government, the Barisan Nasional (BN), won an important by-election on December 6th last year in the Pengkalan Pasir constituency. The BN"s victory reduced the majority of the ruling party in the regional parliament, the Parti Islam sa-Malaysia (PAS), to a single seat. Kelantan is the only state on the Malaysian peninsula that is controlled by an opposition party. PAS was up against the daunting electoral machinery of the dominant party in the BN and contender for the Malay vote, the United Malays National Organisation (UMNO). During an campaigning blitz, numerous government ministers descended on the constituency, promising to bring economic development. The former deputy prime minister, Anwar Ibrahim, meanwhile campaigned for PAS. An election petition filed by PAS against the results, citing electoral irregularities, may come to nothing. Moreover, UMNO may also soon succeed in persuading a PAS legislator to cross the floor in Kelantan, enabling it to claim Kelantan and to confirm UMNO"s position as the sole representative of the Malay population.

The election outcome may look like a victory for UMNO"s moderate, progressive version of Islam over PAS" austere Islamism, but this would give a misleading picture of Malaysia"s current political environment. During the past two decades, UMNO has become more Islamist as it has responded to the growing influence of conservative Islam and intense competition for the Malay vote. Under the previous prime minister, Mahathir Mohamad, the government initiated a policy of active support for Islam. UMNO"s current leader and the present prime minister, Abdullah Badawi, is a religious studies graduate, whose speeches and development-oriented personal philosophy, Islam hadhari, frequently make him sound more like a religious leader than a politician. UMNO"s direction is increasingly alarming the other races and religions in Malaysia as well as many progressive Malays, who feel that their constitutional rights and individual freedoms are being encroached upon.

What looked at first like an unforgivable indiscretion by a police officer turned into a major political controversy towards the end of 2005. Late in the year a film made by a policeman of a woman being made to perform squats in the nude while in custody!apparently a standard procedure after arrest, intended to dislodge objects such as drugs hidden inside the body!found its way on to the Internet. On November 24th a member of parliament (MP) for the opposition Democratic Action Party (DAP), Teresa Kok, who had shortly before exposed the alleged maltreatment by police of four women, all of whom were Chinese nationals, showed the video in the lobby of parliament. The ill-treatment by the police provoked outrage among politicians and in the mainstream newspapers, which reported that the woman shown in the video was a Chinese national. The issue was taken up by papers in Hong Kong and Taiwan as an example of the poor treatment that ethnic-Chinese people could expect in Malaysia. The then home affairs minister, Azmi Khalid, apologised

PAS loses the Kelantan by-election

Concern rises over growing Islamic influence

Police treatment of a detainee creates a political scandal

14 Malaysia


during a visit to China on December 6th, and called for the woman to come forward to help the investigation.

As it turned out, the woman at centre of the scandal was in fact a local Malay. On December 2nd the prime minister, who is also responsible for police as internal security minister, ordered an independent enquiry. The commission of enquiry revealed to the public on December 13th that that the detainee was a Malay Malaysian, raising suspicions that the authorities must have known her racial origin. But their denial of this was a reason for UMNO politicians and the Malay media to go on a witch hunt, demanding sanctions against Ms Kok (for spreading pornography) and against Chinese newspapers (for upsetting racial harmony). Two editors of the China Press, a newspaper owned by the largest ethnic-Chinese party, the Malaysian Chinese Association, were sacked, while a competitor Chinese newspaper, the Oriental Daily, was issued with a warning.

The report by the commission of enquiry into the body-search affair, which was made public on January 23rd, was scathing about the police. Its five members had also been part of an earlier royal commission, which took more than a year to investigate the operation and effectiveness of the police and produced a report with 125 recommendations in April 2005. The January 2006 report stated that Royal Malaysian Police (RMP) lacked transparency and accountability, were insensitive towards human rights and dignity and remained resistant to change, and said that a shift in the mindset of police officers was required. The commission noted that no obvious action had been taken by the police on the recommendations made in its previous report!a conclusion in direct contradiction of claims by the inspector-general of police, Mohd Bakri Omar, to the effect that 80% of the earlier document"s recommendations had been implemented. The commission repeated its major earlier recommendation, namely that an independent police complaints commission should be set up. On January 24th Mr Abdullah promised that such a commission would be formed soon. But some observers queried his ability to put the recommendations into practice, as the police appeared to be resistant to change and some members of his cabinet were in public disagreement with him.

In December last year two events caused a heated national debate on the position of Islam in society, a subject that is normally taboo in the media. The first was the passage of the Islamic family law. The second was the forced burial according to Islamic rites of a Hindu soldier who, unbeknown to his wife, was said to have converted to Islam. Malaysia has a secular constitution but Islam is the official religion. Both cases were clear examples of the erosion of the separation between state and religion.

The family law aims to harmonise existing regional Islamic shariah legislation. Islamic shariah laws and courts have steadily encroached on the civil sphere. The bill, which originated in the Prime Minister"s Department, appeared to be in obvious contradiction to Mr Abdullah"s professed progressive version of Islam. The new family law had a clear male bias, and made divorce and polygamy easier. Muslim men, who are already allowed to take up to four wives, would no longer have to prove their financial capacity or ability to treat

The Islamic family law upsets liberal Malays

Malaysia 15


all wives fairly. Husbands can now lay claim to the assets of spouses, whose right to maintenance has also been reduced under the new law. The result is that women could now become destitute after a divorce.

A storm of protest from civil society groups and Muslim women"s groups failed to prevent the passage of the bill on December 21st in the usually sedate Senate (the upper house), where 16 objecting BN female senators, many in tears, were forced to vote in favour. The prime minister was clearly taken aback by the national outcry, and on January 12th the government announced that it would delay implementation of the bill pending a review. However, it became clear in February that few changes were likely to be made.

In late December, non-Islamic opinion was outraged when a religious court ruled that a former army commando and member of the first Malaysian team to climb Mount Everest, Maniam Moorthy, had died a Muslim; his body was taken away for burial according to Islamic rites. His wife insisted he was a practising Hindu and could not have converted without his family"s knowledge. On December 28th, the High Court refused to hear the family"s evidence, invoking article 121 (1A) of the constitution, which stipulates that all matters connected with Islam should be dealt with by a shariah court. The court"s ruling suggested in effect that non-Muslims had no legal redress in issues related to Islam.

The Moorthy case caused a storm of protest from non-Muslims and moderate Muslims, as well as numerous calls for the repeal or amendment of article 121 (1A), which had been inserted into the constitution in 1988 when Dr Mahathir severely curtailed the powers of the judiciary. In an unprecedented move, nine non-UMNO ministers signed and handed a memorandum to Mr Abdullah on January 18th, requesting a review of the laws that were adversely affecting the religious rights of non-Muslims. The BN has a tradition of solving disagreements internally, which in practice usually involves UMNO forcing minority partners to conform. News of the memorandum opened a floodgate of indignation in the Malay press, calls for the resignation of the ministers from UMNO leaders and demonstrations by the Islamist opposition party, PAS. The public reaction to the incident embarrassed Mr Abdullah, who managed to persuade his colleagues to withdraw the memorandum.

Events in December and January left a clear impression that the forces of conservative Islam were gaining ground and that moderate, liberal forces were in retreat. Although the press has been less restricted under Mr Abdullah than it was under Dr Mahathir, the government did not hesitate in February to close down the Sarawak Tribune when the newspaper published one of the Danish cartoons featuring the prophet Mohammed that were causing upset among Muslim communities around the world. Sarawak is not a majority-Muslim state. The New Straits Times, a newspaper that is closely linked to UMNO, published a cartoon about the controversy in February. PAS quickly protested, prompting an apology from the New Straits Times, but the newspaper was not punished by the government. Mr Abdullah"s leadership, however well-meaning, remained weak and ineffective. While it seemed unlikely that Mr Abdullah"s position was in danger from dissatisfied factions within UMNO,

The High Court refuses to act in Islamic matters

Mr Abdullah's control of government is weakening

16 Malaysia


would-be challengers used the opportunities created by the prime minister"s less authoritarian attitude to point up his weakness, indecisiveness and loss of influence over his cabinet colleagues.

Mr Abdullah"s position was not strengthened by the long-overdue cabinet reshuffle, which took place on February 14th this year. There was no reduction in the size of the large (33-member) cabinet or any fundamental changes to what was still largely the line-up chosen by Dr Mahathir. Controversial ministers, such as the minister of public works, Samy Vellu, and the minister of international trade and industry, Rafidah Aziz, retained their positions. The overburdened prime minister kept his portfolios of finance and internal security. The reshuffle was in part an adjustment to the outcome of recent internal elections in the parties that make up the ruling BN coalition. Notwithstanding the prime minister"s anti-corruption agenda, incorruptibility was not taken as a yardstick for retaining a cabinet post.

Some commentators sensed the lingering influence on events of Dr Mahathir, who was slighted in January over the government"s policy towards the national carmaker, Proton. The verdict on January 12th in the Metramac case may have been a warning to the former prime minister not to interfere. Malaysian governments regularly influence the outcome of court cases that they consider politically important. Metramac was a road toll company that was bankrupted when its toll collection activities were suspended in September 1990; cronies of the then finance minister, Daim Zainuddin, bought the company for M$97.5m (US$25.7m), and received M$756m in compensation from the government as well as another M$32.5m in dubious reimbursements. The judge of the Court of Appeal castigated the behaviour of the three men involved, in effect accusing them of theft and deception, and pointed the finger at Mr Daim, who left his job as finance minister in March 1991. The Metramac verdict will give hope to Mr Anwar, who is suing Dr Mahathir for continuing to call him a sodomist after his conviction for sodomy was overturned in September 2004.

Economic policy

On January 13th this year the government and the management of the national maker, Proton, were surprised and shocked to hear that a German car manufacturer, Volkswagen (VW), had pulled out of a strategic alliance that had been under negotiation since October 2004. They first learned of the cancellation from news reports. VW"s chief executive, Bernd Pischetsrieder, stated that negotiations had broken down owing to the refusal of the Malaysian government to sell VW a significant stake in Proton. It would seem that the government and the management misread the signs. Malaysia"s official news agency, Bernama, reported at the end of December that VW had dropped its insistence on acquiring a controlling stake. The report also suggested that VW was negotiating from a position of weakness and was under pressure to build a presence in the South-east Asian market, where it had a weak position. In other words, VW needed Proton more than Proton needed VW.

Minor changes are made to the cabinet

A court case exposes corruption under Dr Mahathir

Proton loses one foreign partner and gains another

Malaysia 17


VW intended, according to sources close to the talks, to take control of Proton and downgrade the company from a fully fledged car manufacturer to a mere assembler of VW cars. Proton would no longer have been able to develop cars, which was unacceptable to the government. Surprisingly quickly, three weeks after VW"s cancellation, Proton announced that it had concluded a new co-operation deal with a second-tier Japanese carmaker, Mitsubishi Motors. The hastily assembled agreement covers the supply of automotive parts, technical support for engineering and quality control, and development of manu-facturing facilities. The advantages of the deal to Mitsubishi, which helped to set up Proton in 1985 but which sold its minority holding in early 2005 owing to its own mounting financial problems, are not obvious. It will not take a stake in Proton, and will not supply new car models for at least a year. Proton"s own new car is not due to be released until early 2007. Proton may end up assembling Mitsubishi cars again. Further slippage of Proton"s market share in Malaysia, which stood at 41% of passenger cars in 2005, down from 60% in 2002, looks inevitable.

On December 13th 2005, within the context of the ninth summit between Japan and the Association of South-East Asian Nations (ASEAN), held in Malaysia"s capital, Kuala Lumpur, Malaysia signed a free-trade agreement (FTA) with Japan. Labelled the Japan-Malaysia Economic Partnership Agreement (JMEPA), the treaty will eliminate many tariffs on industrial, agricultural, forestry and fishery products in the next ten years. By the end of the period, 97% of bilateral trade!94% of Malaysia"s exports to Japan and 99% of Japan"s to Malaysia!will be duty-free. The treaty includes automotive products, parts and components. For completed knocked-down units, tariffs will be abolished immediately; for automotive components and large (above 2000cc) passenger cars, they will be scrapped by 2010. The two countries also agreed to co-operate to promote the development of the automotive parts and components industry in Malaysia.

In January Malaysia started preliminary discussions with the US on an FTA, with the initial negotiations intended to be completed by May this year. Earlier, in May 2004, the US and Malaysia had concluded a Trade and Investment Framework Agreement (TIFA), which is a necessary precursor to an FTA. Officials involved in the talks stated that an FTA might be signed before July 1st 2007, when the US president"s Trade Promotion Authority runs out. Malaysia is following the example of other ASEAN countries. Singapore was the first to sign an FTA with the US, while the Philippines, Indonesia, Thailand and Brunei are already at various stages of FTA negotiations with the US. The US ambassador to Malaysia, Christopher LaFleur, said in February that a top priority for the US was the protection of intellectual property rights (IPR). He was encouraged by the establishment of an IPR court in Malaysia. Malaysia is notorious as an international centre for the production of pirated compact discs (CDs) and DVDs.

Malaysia"s economic policy is guided by a well-developed system of short-, medium- and long-term plans, in which the five-year plan takes a central position. The plans are important guides for the private sector, showing the areas on which policy is focusing and the expected new sources of economic

Malaysia is active on the FTA front

The Ninth Malaysia Plan will be ready by end-March

18 Malaysia


growth. The Ninth Malaysia Plan 2006-10 (9MP) will be presented by Mr Abdullah in parliament on March 31st. No budget figures have been published, but the government has been careful to deflate expectations. On January 13th, the deputy finance minister, Tengku Putera, declared that the allocation for the 9MP would be significantly less than the M$160bn (US$42.1bn) that was set aside under the Eighth Malaysia Plan 2001-05 (8MP) to deal with the negative impact of the 1997-98 Asian financial crisis. Large-scale projects were not needed under the current stable economic conditions, said Mr Putera. The second finance minister, Mohamed Yakcop, stated in February that some of the projects from the 8MP would need to be carried forward to the ninth plan.

In an optimistic assessment, a former deputy prime minister, Musa Hitam, said in January that the 9MP would include major initiatives, ending a rather barren stretch since Mr Abdullah came to power in October 2003. He also said that the prime minister would in future be more active and personally involved. In the past, claimed Mr Musa, major projects were implemented because Dr Mahathir wanted them to be, but under Mr Abdullah they were implemented because it was good for the economy.

Another key policy document, which will be published in April this year, is the Third Industrial Master Plan (IMP3), which will outline the government"s planned course of industrial development for 2006-2020 and will give a broader framework than the five-year plan. By 2020 Malaysia is supposed to have reached developed-country status, according to Vision 2020, an ambitious economic target set by Dr Mahathir in 1991.

An important element of the government"s economic and social strategy, to be included in the 9MP, is the development of the small and medium-sized enterprise (SME) sector, which is relatively small in Malaysia. The strategy has the double aim of promoting structural change in the economy and creating a vigorous sector of bumiputera (ethnic-Malay) entrepreneurs. In December last year the government unveiled a M$3.8bn SME action plan for 2006, which included 245 different programmes. Mr Abdullah, who is also the finance minister, said that Malaysia had some 470,000 SMEs, employing 1.6m people!around 1m in the services sector and 543,000 in manufacturing. SMEs had contributed 30% of the country"s economic growth in recent years. The development programme offers a wide range of programmes covering marketing, training, human-resources development, advisory services, entre-preneurial skill development, and product and technology improvement. Mr Abdullah pointed to the examples of Japan and South Korea, where small companies had played an important role in economic development. In early December Mr Abdullah had signed an agreement with South Korea to co-operate on SME development. In the middle of that month Bank Negara Malaysia (BNM, the central bank) opened an Internet information portal for small companies. On January 27th a special bank for SMEs was officially launched. Its mandate, according to Mr Abdullah, is to function as a "one-stop centre" offering financial and advisory services to SME entrepreneurs.

Malaysia 19


The BNM announced on December 28th that locally incorporated foreign banks would be allowed to set up four additional branches. The liberalisation, although in line with the strategies outlined in the Financial Sector Masterplan (the government"s central plan for long-term reform of the financial sector), came earlier than expected: it had originally been scheduled for 2007. For several years there had been a freeze on the opening of new branches for the 13 locally incorporated banks. It is expected that the liberalisation will increase competition between domestic and foreign banks and will lead to a more dynamic financial sector. In 2001 the government forced the merger of Malaysia"s 54 banks and finance houses into ten groups. The authorities appear to be in favour of further consolidation. In order to stop foreign banks concentrating exclusively on major towns, the BNM attached conditions to the liberalisation: of the four branches, one can be in a market centre, two in semi-urban centres and another in a non-urban area.

On January 11th the BNM eased its guidelines for the disposal of non-performing loans (NPLs) by banking institutions. The new rules could lead to the strengthening of the banks" balance sheets, higher bank profit margins, greater lending ability and a higher credit rating. Foreign investors are likely to be the main customers for NPLs, although they can buy NPLs only through a special purpose vehicle, in which they can have a 49% interest. Total outstanding NPLs (three-month classification) stood at M$54.6bn at end-January 2006, one-half of which was property-related. The net NPL ratio dropped from a peak of 13.6% during the Asian financial crisis to 5.9% by the start of 2006, but the rate improvement has slowed to a snail"s pace during the past year. In addition, this ratio is relatively high compared with that in developed countries, which typically have NPL ratios of 1-2%. Representatives of a US-based accountancy firm, PricewaterhouseCoopers, stated that it was likely that 25-30% of the NPLs would be sold in the next two years. Malaysian distressed debt was likely to fetch a good price, given the strength of the country"s legal system compared with those of other developing economies.

The second finance minister, Mr Yakcop, stated on January 24th that foreign governments and their state agencies would soon be allowed to issue ringgit-denominated bonds. The supply of high-credit quality bonds would increase the attraction of the Malaysian bond market for international investors. In 2004 the government permitted multilateral development banks and financial institutions to issue ringgit bonds.

On February 22nd the BNM announced that it had increased the overnight policy rate (OPR) by 25 basis points to 3.25%. The change came not long after the previous increase, of 30 basis points, to 3% on November 30th. In the accompanying monetary policy statement, the central bank mentioned the strengthening of economic growth, as it had done on the previous occasion. Growth was expected to gain momentum in 2006, the BNM stated, sustained by private-sector demand and strong expansion in the global and regional economies. On inflation, the central bank appeared slightly less relaxed than before. Inflation was not expected to intensify, but neither would it decline "for some time". The aim of the rise in the OPR was to bring monetary conditions

Foreign banks are allowed to open more branches

Banks are permitted to sell NPLs to foreign investors

Slower money growth reflects more subdued activity

The BNM raises the overnight policy rate to 3.25%

20 Malaysia


into line with the current environment. Its monetary policy stance continued to be supportive of economic activity, declared the BNM.

The domestic economy

Real GDP increased by 5.2% year on year in the fourth quarter of 2005, less than the most analysts had expected and also slightly below the preceding quarter"s 5.3% rise. Real GDP growth for the whole of 2005 was 5.3%, above the official forecast of 5% but well below the increase of 7.1% recorded in 2004. Weakness in the output of agricultural and mineral commodities limited the economy"s expansion in the fourth quarter. Services and manufacturing were the main drivers of growth, but the services sector showed a loss of momentum. The acceleration in manufacturing growth in the period, meanwhile, owed more to a production decline a year earlier than to the strength of its fourth-quarter recovery. The growth of domestic demand fell sharply, to 1.9% year on year from 7.6% in the third quarter, as inventories were depleted. By contrast, the export component posted strong gains. Net exports contributed 3.5 percentage points to GDP growth, well ahead of domestic demand"s 1.8 points. It was the first time in nine quarters that net exports had contributed more to growth than domestic demand.

Domestic demand"s subdued role was also caused by sudden weakness in gross fixed capital formation, which almost ground to a halt, rising by only 0.4% year on year. In the preceding quarter, an increase of 9.6% had suggested that gross investment had finally made a full recovery. The public sector is likely to have been the cause of the sharp drop; a breakdown of investment into public and private spending will become available at a later date, although only on an annual basis. Bank Negara Malaysia (BNM, the central bank) reported that private-sector investment remained firm, supported by capacity expansion, upgrading and new spending, especially in manufacturing and the upstream oil and gas sectors. Doubts were nevertheless raised about the strength of private investment as capital goods imports fell by 4.9% year on year, the first decline in nine quarters.

Private consumption remained strong in the fourth quarter of 2005, increasing by 9% year on year and accounting for 4.5 percentage points of the 5.2% increase in GDP. Consumer confidence was high, as household spending was boosted by year-end bonuses, a tight labour market, easy consumer credit, growing export earnings and rising rural incomes as a result of firm commodity prices. There was a surprise surge in public consumption, which raised growth in this component of GDP to 12.8% from 5.9% in the preceding quarter. The rise in year-end public consumption (owing to higher bonuses and payments for supplies, services and defence) was stronger than usual, as strong growth continued in government revenue.

GDP growth is firm in the fourth quarter of 2005

Malaysia 21


Malaysia: real gross domestic product by expenditure (M$ m unless otherwise indicated; at constant 1987 prices; non-seasonally adjusted)

2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrPrivate consumption 29,720 32,097 32,317 31,171 32,802 34,977 % change year on year 11.2 10.2 10.1 7.4 10.4 9.0

Public consumption 9,194 11,275 7,475 8,804 9,734 12,714 % change year on year 1.1 4.2 1.5 0.9 5.9 12.8

Gross fixed capital formation 16,997 16,930 16,070 18,472 18,630 17,003 % change year on year 3.2 2.2 2.0 6.7 9.6 0.4Change in stocks 2,248 464 -573 224 1,433 -2,792 % contribution to year-on-year GDP growth 3.5 1.5 -2.4 -2.7 -1.3 -5.0Net exports 5,251 3,879 7,510 5,812 4,173 6,073 % contribution to year-on-year GDP growth -2.9 -1.9 2.9 1.6 -1.7 3.4

Exports, goods and services 76,387 75,897 73,990 78,306 80,838 83,825 % change year on year 19.0 10.2 9.5 7.9 5.8 10.4

Imports, goods and services 71,136 72,018 66,480 72,494 76,665 77,752 % change year on year 24.3 12.9 7.6 6.9 7.8 8.0GDP 63,411 64,645 62,798 64,483 66,772 67,976 % change year on year 6.7 5.8 6.2 4.4 5.3 5.2

Source: Department of Statistics.

The change in leading roles from domestic demand to net exports was typical of the start of a new period of export growth. Exports of goods and services rose by 10.4% year on year, up from 5.8% in the third quarter, led by electronics exports, and bolstered by exports of chemical products, transport equipment and metal manufactures. The renewed vigour of manufactured exports was offset to some extent by weakness in agricultural exports, especially those of palm oil and rubber. However, import growth showed hardly any acceleration, rising from 7.8% to 8% year on year. Some commentators queried the strength and sustainability of the increase in electronics exports, pointing out the drop in the import levels of intermediate goods, which are needed to make manufactured exports. Whatever the merits of this argument, the coincidence of firm private consumption with export recovery was sufficient justification for the BNM to increase the overnight policy rate (OPR) by 25 basis points to 3.25% on February 22nd.

Manufacturing became the fastest-growing sector in the fourth quarter, increasing output by 7.3% year on year, boosted by strengthening global demand for electronic products. Growth in the manufacturing sector exceeded the 6% rise in services output for the first time since the second quarter of 2003. But even with its momentum reduced, the services sector!which is almost twice as large as manufacturing!contributed more to the growth in real GDP: 3.5 percentage points, compared with 2.3 points for manufacturing. The strength of services reflected firm consumer and business spending as well as the pick-up in trade activity. Within the sector, the steepest increases were for government services and commerce (wholesale and retail trade, restaurants and tourism-related activities). Continued weakness in construction, which declined by 0.6% year on year, its seventh consecutive quarterly fall, also depressed the domestic-oriented manufacturing sectors. The start of new construction projects

Export growth accelerates

The manufacturing sector rebounds

22 Malaysia


under the Ninth Malaysia Plan (9MP), covering 2006-10, may finally halt the sector"s decline.

Bad weather and the negative effect of the tree-stress cycle on palm oil output!which depresses yields every two or three years!caused a decline in the production in the agriculture, forestry and fishing sector, the output of which fell by 1.1% year on year in the final quarter of 2005, the first drop in almost four years. The downward trend in oil palm yields is likely to continue for the time being, although it will be offset to some extent by an increase in the area under cultivation. Malaysia is one of the world"s largest producers of palm oil. The output of rubber and cocoa also declined. Mining production fell by 2% year on year mainly, mainly because of a fall in crude oil output. Limits on output mean that there may be little scope for further production rises, at least in the case of crude oil, notwithstanding high energy prices. The contribution of the commodities sector to economic growth was negative: agriculture and mining each deducted 0.1 percentage point from GDP growth in the fourth quarter.

Prices, wages and employment

Consumer price inflation stood at 3.3% year on year in the fourth quarter of 2005, unchanged from the third quarter. (These data use the new base of 2005, which was adopted in January 2006.) This brought inflation for the whole of 2005 to an average of 3%, up from 1.5% in 2004. The fourth quarter is usually the most inflation-prone time because of the extra spending that takes place during the holiday period. The major causes of the rise in inflation were higher crude oil prices, higher government excise duties and cuts in subsidies. The price index for transport and communications, which has a weighting of some 20% in the consumer price index, stood 6% higher year on year in the fourth quarter, and food, which has the largest index weighting, at around 35%, was up by 4%.

The Federation of Malaysian Consumer Associations (Fomca) complained in January this year that the government"s price controls, which had been

Agricultural and mining output falls

Inflation remains high towards end-2005

Malaysia 23


extended to include a larger range of essential products, were not working. The national electricity supplier, Tenaga Nasional, which is supplied by the national oil producer, Petroliam Nasional (Petronas), with natural gas at artificially low prices, is likely to announce an increase in electricity tariffs in the first half of 2006. Newspaper reports suggested that it could be as high as 15%.

Producer price inflation slowed to an average of 7.1% year on year in the fourth quarter of 2005 from 9% in the third quarter, but prices remained volatile: in December, inflation accelerated to 9.9%, mainly owing to a pick-up in international crude oil prices, from 5.4% in November. Excluding commodities, producer price inflation continued to decline, dropping to 1.4%, as inflation in manufactured goods, machinery and transport equipment prices diminished.

The impact of the economic slowdown during 2005 was apparent in both the employment and unemployment figures. Official unemployment surged by 71,500 to 397,600, or from 3.1% to 3.8% of the labour force, in the third quarter of 2005 (the latest available data), which was still low by comparison with many South-east Asian economies. At the same time, the total number of employed workers dropped by 114,600 to 10.1m. No great faith can be placed in the accuracy of the labour market statistics, however, given the government"s limited resources and Malaysia"s porous borders. The deputy minister for human resources, Abdul Rahman Bakar, stated on January 15th that the number of legal foreign workers in the country rose to 1.7m in 2005, from 1.5m in 2004. He said that notwithstanding the ministry"s best efforts, it had succeeded in persuading only 600 Malaysians working abroad to return, out of a total of more than 350,000.

The employment and wages figures of the manufacturing sector painted a more encouraging picture. The monthly survey of manufacturing industries provides information on 73 industries in the sector. Growth in manufacturing employment, which, with an increase of only 0.1% year on year, had almost ground to a halt in September 2005, quickened to 0.9% in December. The peak in employment growth was a 3.8% year-on-year rise in the fourth quarter of 2003, during the recovery phase of the business cycle. The year-on-year rate of increase in the manufacturing wages and salaries bill fell to 3.5% in December, from 4.7% in September.

Manufacturing

The recovery in electronics production!and especially in consumer electronics, such as mobile phones, MP3 (digital audio file) players, digital cameras, televisions, personal computers and semiconductors!that began in the second quarter of 2005 turned into a double-digit increase by the fourth quarter. The recovery lifted the output of export-oriented industries by 8.7% year on year in October-December, well up from 4.6% in the preceding quarter. Reservations about the durability of the renewed growth were encouraged by the running down of inventories and the absence of an obvious acceleration of intermediate-goods imports during the fourth quarter. Doubts were also raised by a loss of momentum in production growth during December, when it

Crude oil raises producer price inflation

Unemployment surges to 3.8%

Electronics boost growth in the export-led industries

24 Malaysia


dropped to 7.4%, down from 10.9% in November, although the fall may have been a result of seasonal influences. In recent years the electronics cycle has been relatively short and less dynamic, in part as a result of a loss of Malaysian competitiveness. Most other categories among export-oriented industries showed an improvement, although the output of the electricals sector continued to decline, shrinking by 7.5%. Another exception was the deterioration in the resource-based industries, where lower production of palm oil depressed off-estate processing and drove a contraction of 2.9% in the quarter. Growth in the electronics sector benefited the chemicals and chemical products sector, which increased output by 11.6% year on year.

By contrast, the output of the domestic-oriented industries was weak, in effect stagnating, despite high levels of household and business spending. Production fell by 1% year on year, after dropping by 1.9% in the third quarter. The domestic-oriented industries account for just over one-quarter of total manu-facturing production, and the metal industries represent just over one-half of this sector; the major cause of the weakness continued to be a shortage of government orders placed with the metal industries. The declines in output of basic metals (down by 13.4% year on year) and fabricated metal products (down by 15.8%) had lasted for three or more quarters by the final quarter of last year. The manufacture of non-metallic mineral products increased by 0.4% in the last quarter of 2005, after seven consecutive quarterly falls. Production expanded in many of the industries connected with private consumption and business spending, such as transport equipment (up by 15.4% year on year), food (up by 8.6%) and petroleum products (up by 13.5%). By the second quarter of 2005, when the 9MP comes into force, new government orders will stimulate activity in the metal industries.

The extraordinary expansion of the rubber-glove industry showed no sign of abating during the fourth quarter of 2005. Malaysia is the top global producer of disposable natural rubber latex (NRL) gloves. During the first half of 2005, the export of gloves surged by 53% year on year to 37bn pieces, with the US the main export destination. Capacity is expected to expand by 30-40% annually during the next two to three years, according to brokers" forecasts. The industry is in the middle of a period of consolidation, which reduced the number of manufacturers from 50 to 42 during 2005. Only ten companies currently have an installed capacity larger than 2bn pieces a year, and it is likely that there will be a wave of mergers and acquisitions in the next few years. The world"s largest rubber-glove manufacturer, a Malaysian firm, Top Glove Corporation, announced on January 11th that it intended to increase its 16% global market share to 25 percent by 2007. The firm"s executive chairman, Lim Wee Chai, said that his target assumed annual growth of 12% in the global rubber-glove market and 40% annual expansion in Top Glove"s production, rising to 29bn pieces in the financial year ending August 31st 2007. Top Glove owns 12 factories in Malaysia, Thailand and China, and plans to open another four.

Domestic-oriented production continues to stagnate

Vigorous growth continues in the rubber-glove industry

Malaysia 25


Malaysia: manufacturing production (% change year on year in value added at 1987 prices)

2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrExport-oriented industries 12.8 7.8 5.4 4.1 4.6 8.7 Electronics 27.0 9.6 -0.1 2.9 6.6 13.8 Electricals -8.8 -13.8 -7.1 -9.2 -9.2 -7.5 Textiles & apparel -13.8 -14.5 -4.4 -4.6 6.4 8.6 Wood & wood products 11.3 5.1 -3.4 -6.6 -5.2 0.8 Chemicals & chemical products 8.7 13.3 16.0 10.8 8.6 11.6 Rubber products 7.5 9.1 10.9 -0.2 -3.7 0.3 Off-estate processing 1.5 17.9 24.6 18.9 7.3 -2.9

Domestic-oriented industries 7.2 6.3 6.4 -1.3 -1.9 -1.0 Non-metallic mineral products -4.6 -4.8 -3.6 -4.1 -1.5 0.4 Basic metals -1.9 4.7 -3.6 -6.1 -10.1 -13.4 Transport equipment 6.4 17.8 13.5 10.1 12.7 15.4 Food -1.8 -0.5 2.3 6.0 9.2 8.6 Fabricated metal products 38.0 21.4 15.9 -12.7 -15.1 -15.8 Petroleum products 7.1 5.4 10.4 5.8 5.2 13.5Total 11.6 7.5 5.6 2.8 3.1 6.6


Industrial production, which is a composite of manufacturing (70.4%), mining (22.2%) and the electricity sector (7.4%), expanded by 5.1% during the fourth quarter in year-on-year terms. As is usual when manufacturing exports pick up, the gains in overall industrial production were limited by the more sluggish activity in the mining and utilities sectors. The electricity, gas and water utilities disappointed by raising production by only 3.6% year on year in the fourth quarter, the lowest increase for more than three years, despite strong household demand and continued high capacity utilisation in manufacturing. Production in the mining sector!mainly crude oil and natural gas!declined, largely because of lower crude oil output.

Industrial production grows by 5.1%

26 Malaysia


Oil and gas

The production of crude oil and condensates fell by 3% year on year in the fourth quarter of 2005. In quarter-on-quarter terms output continued to recover, after dipping sharply in the second quarter of 2005 owing to the closure of oilfields and processing facilities for maintenance. Production of crude oil and condensates grew by 0.8% between the third and fourth quarters. Output limits are restricting growth, but the production level of 774,191 barrels/day achieved during the fourth quarter of 2004 was the highest ever. Production of natural gas declined year on year in the quarter, albeit by only 0.5%. The medium-term trend is for output of natural gas to grow.

Malaysia: oil and gas production 2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrCrude oil & condensates (b/d) 763,689 774,191 740,383 670,523 745,178 751,038 % change, year on year 5.4 1.4 -4.2 -9.2 -2.4 -3.0

Natural gas (m standard cu ft) 4,627 5,865 6,352 5,657 5,363 5,838 % change, year on year -1.5 10.3 21.1 12.1 15.9 -0.5

Source: Department of Statistics, Malaysia.

Malaysia LNG, a 60.6% subsidiary of the national oil company, Petronas, announced on January 23rd that it had agreed to begin supplying a Japanese electric utility, Shikoku Electric Power, with 420,000 tonnes of liquefied natural gas (LNG) a year for 15 years, starting from 2010. Petronas Gas, which holds a monopoly in the processing and transmission of gas in Malaysia, has six gas-processing plants. The latest contract confirms Malaysia"s role as a major gas supplier to Japan, where it has a 22% market share and its customer base numbers 13 power and gas utility companies. In 2004, 61% of Malaysia"s LNG exports went to Japan.

Agriculture

Value added in the agricultural sector contracted by 1.1% year on year in the fourth quarter of 2005. It was the first time in almost four years that production in the agriculture, forestry and fishing sector had declined. The fall was mainly owing to a cyclical decline in palm oil yields, but it was not limited to palm oil, also hitting rubber and cocoa output. High commodity prices are an incentive to expand the areas used for cultivation of the major crops. This applies to palm oil in particular; but high prices could also halt a declining trend in cocoa production and lead to renewed expansion in rubber. Saw log production has already stabilised in recent years. The 9MP (2006-10), which comes into force in April 2006, will pay special attention to the promotion of agriculture.

Oil and gas output falls

Petronas is to increase LNG deliveries to Japan

Agricultural production falls for the first time in four years

Malaysia 27


Malaysia: agricultural sector production 2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrCrude palm oil ('000 tonnes) 4,082 3,936 3,417 3,753 4,089 3,702 % change, year on year 5.2 16.5 27.5 14.5 0.2 -6.0

Rubber ('000 tonnes) 321 283 276 245 333 270 % change, year on year 20.7 7.2 -9.2 -6.0 3.7 -4.5Saw logs ('000 cu metres) 5,721 4,856 4,810 5,936 5,620 4,968 % change, year on year 5.3 2.7 7.9 -8.3 -1.8 2.3Cocoa (tonnes) 4,904 10,713 7,638 6,476 3,974 9,876 17.7 17.9 -10.9 -29.9 -19.0 -7.8


The palm oil industry continues to be optimistic about the outlook for the sector, especially because of the robust prospects for biodiesel, although production is increasingly showing the effects of the oil palm stress cycle, which typically depresses yields every two to three years. The downturn in production is overdue, and has been masked to some extent by a large programme of new plantations. The downturn this time could be all the more marked because of the bad weather that hit West Malaysia in late 2005. The production decline is one of the factors that have kept the price of crude palm oil (CPO) high; CPO"s use as an alternative to mineral oil is another. Plans for the development of a biodiesel industry have generated enormous enthusiasm. Biodiesel or biofuel is a mixture of diesel with 5% treated crude palm oil; high mineral oil prices and environmental concerns have created this new source of demand. The deputy prime minister, Najib Razak, stated on January 26th that Malaysia was aiming to be the world"s largest producer of biodiesel. In December last year the state government of Sabah announced the setting up of a joint venture that would build the largest biodiesel plant in the world, with a capacity of 150,000 tonnes a year by September 2007, rising to 300,000 tonnes a year by December 2008. Most of the production will be exported to South Korea. Sabah is Malaysia"s biggest palm oil-producing state.

Tight supplies and falling inventories have continued to push up the price of natural rubber. The high price has led to a revival of the exploitation of rubber, well over 90% of which is grown by smallholders. Production levels in 2004-05 were 22% higher than in the preceding two years. Malaysia also imports large quantities of rubber, mainly from Thailand. The minister of rural and regional development, Abdul Aziz Shamsuddin, warned on February 6th this year that the high rubber price was leading to "over-tapping". If farmers continued to tap twice a day, instead of once every two days as recommended, said Mr Abdul, the productive life of trees would be reduced from 15 years to a mere four.

Financial and other services

In the fourth quarter of 2005 value added in the services sector rose by 6% year on year, decelerating from 7.3% in the preceding quarter. The recovery of manufactured exports resulted in a smaller percentage contribution to GDP growth by the services sector in the fourth quarter. Nevertheless, the sector

The oil palm stress cycle depresses output

Rubber growers struggle to keep up with demand

The services sector holds on to its leading role

28 Malaysia


remained the major source of economic growth, accounting for 3.5 percentage points of the 5.2% year-on-year increase in real GDP in the quarter, still well ahead of the manufacturing sector"s contribution of 2.3 percentage points. In the third quarter services had added 4.2 percentage points to growth. However, these two leading sectors of the Malaysian economy are also complementary, as stronger global demand for manufacturing products boosts the demand for services. In 2005 activity in the services sector increased by 6.6%, comfortably above the 5.2% rate of GDP growth.

Malaysia: services sector performance (% change, year on year; at constant 1987 prices)

2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrTransport, storage & communications 7.6 9.3 10.4 5.5 3.8 5.5

Finance, insurance & business services 5.5 5.6 4.8 4.7 6.5 5.5Electricity, gas & water 8.0 7.3 5.9 6.0 6.6 3.7

Wholesale & retail trade & restaurants 6.0 6.9 7.7 7.1 10.0 7.1Government services 7.0 7.2 8.4 8.3 10.2 8.4

Other services 4.5 3.7 4.7 4.9 5.7 4.6Total services 6.2 6.5 6.9 6.0 7.3 6.0


After large upward revisions to government services in the first half of 2005, this subcomponent again surprised by its unusual strength in the fourth quarter. For the third consecutive quarter, the increase in the value added by government services was the highest of all major services categories. In the third quarter of 2005, government services grew by 8.4% year on year, suggesting that fiscal tightening was only moderate but also that the government was in receipt of ample revenue, enabling it to reconcile budget deficit reduction with generous spending. The sector that came closest to matching the strength in government services was commerce (wholesale and retail trade, restaurants and tourism-related activities), which increased output by 7.1% year on year. Accounting for nearly 25% of services output, commerce reflected both buoyant private consumption and the popularity of Malaysia as a tourist destination. Some quickening of activity took place in transport, communications and storage services as the renewed pick-up in exports became evident; output increased by 5.5% year on year after recording the slowest rate of growth for two years, at 4.2%, during the preceding quarter. Activity in the financial sector (comprising finance, insurance, property and business services) continued its solid expansion, rising by 5.5% year on year in October-December.

Money supply growth continued to lose momentum during the final quarter of 2005, owing to a more moderate pace of activity and a slower build-up of deposits. Narrow money (M1) growth stood at 8.5% year on year, compared with 9.9% at the end of the third quarter, as the growth of currency in circulation dropped to 5.5% from 7.1% at the end of the previous quarter. Demand deposits expanded by 9.6% year on year in the final quarter. Growth of the broadest measure of money supply, M3, slowed to 8% in October-December from 10.9% in the previous quarter as deposits placed with other banking institutions continued to decline. As before, broad money (M2)

Malaysia 29


recorded the fastest rate of growth, at 15.4%, but the build-up of deposits continued to lose pace, while fixed deposits and negotiable instruments of deposits declined compared with the third quarter.

Consumer lending and mortgages apart, there were also signs that bank lending was losing some of its vigour. At the end of December the increase in total bank loans outstanding had slowed to 8.6% year on year from 9.2% at end-September. The decline in bank lending to manufacturers deepened to a fall of 3.6% year on year, from one of 3.3% at end-September, in part because of the availability of alternative sources of finance. More surprising was the drop in lending to financial and business services, which was down by 2.6% year on year at the end of the final quarter!the first decline in five quarters. There was, however, no sign that consumption credit growth was flagging: loans for car purchases were up by 20%, credit-card borrowing jumped by 17.3% and loans for personal use increased by 15.2%. Bank lending for the purchase of residential property, meanwhile, was up by 12.3%.

Foreign trade and payments

The recovery of exports, of which the first signs appeared in the manufacturing sector during the second quarter of 2005, became clearly evident by the final quarter of the year as export growth accelerated. Led by the electronics sector, exports increased by 12.6% year on year (fob, in Malaysian ringgit value terms), up from 7.5% in the third quarter. The initial stimulus from stronger US demand had by the fourth quarter spread to other economies and reactivated demand from Malaysia"s major export customers. Until then, export growth had continued to slow from a peak of 27.5% year on year in the third quarter of 2004. Commodity exports remained subdued. Lower palm oil prices limited the increase in the value of agricultural exports to only 3% year on year in the final quarter. Mineral export volumes declined, but high commodity prices kept the growth in mineral export values at 25% year on year.

Some features of the latest export data seemed surprising and unusual. US demand appeared to stall in the fourth quarter compared with the previous quarter, but this may have been owing to seasonal influences. Exports to the US continued to post double-digit gains compared with the year-earlier period. Japanese demand remained peculiarly sluggish: although sales rose quarter on quarter in the second half of 2005, the year-on-year rate of growth was nil in the fourth quarter. By comparison with Japan, the EU seemed dynamic, as a 4% year-on-year decline in Malaysia"s exports to the trade bloc in the third quarter turned to 11.2% growth in the final quarter of 2005. Exports to China were exceptionally strong in October-December, surging 26.2% year on year after declining by 0.8% in the third quarter. On current trends, the value of exports to China is likely to exceed that of exports to Japan by 2008.

The export recovery intensifies

US demand falters in the fourth quarter

Official reserves decline as some foreign investors depart

Demand for bank loans eases

30 Malaysia


The share of Malaysia"s exports accounted for by the other countries in the Association of South-East Asian Nations (ASEAN) rose to 25.8% in 2005, from 24.9% in 2004, as regional economic integration deepened. Surprisingly, China"s share did not increase in 2005, but instead slipped slightly to 6.6%, from 6.7% in 2004. Japan"s share, meanwhile, dropped from 10.1% to 9.4%. The US became more dominant, however: its share of Malaysia"s exports rose to 19.7% from 18.8% the year before. The EU"s share fell from 12.6% to 11.7%.

Malaysia: foreign trade (M$ bn unless otherwise indicated; non-seasonally adjusted)

2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrExports fob 128,205 126,704 122,576 130,733 137,864 142,617 % change, year on year 27.5 16.1 13.7 10.8 7.5 12.6 Manufacturing 27.3 13.5 12.0 9.3 6.3 13.1 Agriculture 2.0 -0.4 2.5 5.6 -1.2 3.0 Minerals 46.0 20.6 34.5 26.0 26.8 25.0Imports cif 105,469 106,102 97,565 107,874 114,538 114,053 % change, year on year 31.1 19.1 10.1 8.0 8.6 7.5 Capital goods 38.4 37.2 0.7 16.3 21.0 -5.9 Intermediate goods 25.5 13.5 10.6 5.9 6.3 7.7 Consumption goods 38.8 16.4 10.7 4.3 5.2 4.4

Trade balance 22,736 20,602 25,011 22,859 23,326 28,565


As usual, the renewed rise in export values had its origin in the electronic and electrical goods sector, which accounted for 66% of manufactured exports in the fourth quarter of 2005. Exports of electronics and electrical goods rose by 14.7% year on year, up from 6.8% in the third quarter. Exports of these products are the major leading indicator of the Malaysian business cycle. Demand for semiconductors, computers and computer parts as well as industrial electrical machinery boosted production. But Malaysia did not seem to benefit as much as some other Asian countries from stronger global demand. Electronic equipment and parts recorded the largest increase in exports, with a rise of 24.7% year on year, following growth of 19.2% in July-September. In quarter-on-quarter terms, the rise in electronics and electrical goods exports was only 3.3%, which made the 23.6% surge in exports of industrial electrical machinery during the fourth quarter all the more remarkable. Apart from electronics and electricals, petroleum products, paper and pulp products, and rubber products all helped to boost the value of manufactured exports.

ASEAN's dominance of Malaysian exports grows

Electronic equipment and parts lead export expansion

Malaysia 31


Malaysia: electronics and electrical goods exports (M$ m unless otherwise indicated; customs-cleared basis; non-seasonally adjusted)

2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrSemiconductors 23,425 21,941 22,396 22,126 22,391 23,054 % change, year on year 9.5 -1.5 6.4 -3.3 -4.4 5.1

Electronics equipment & parts 26,798 26,024 24,439 29,429 31,948 32,450 % change, year on year 28.8 12.9 9.7 21.6 19.2 24.7

Consumer electrical products 6,379 5,744 5,205 5,613 6,110 5,711 % change, year on year 23.9 -0.6 9.9 5.7 -4.2 -0.6Industrial & commercial electrical products 6,758 7,147 6,178 6,515 7,115 8,793 % change, year on year 29.1 18.0 14.3 0.9 5.3 23.0Electrical & industrial machinery & equipment 4,411 4,338 5,087 5,429 4,983 4,981 % change, year on year 26.4 20.2 18.4 14.6 13.0 14.8

Household electrical appliances 813 770 696 735 694 706 % change, year on year 81.4 36.0 54.3 6.6 -14.6 -8.3

Total electronics & electrical equipment 68,585 65,964 64,001 69,847 73,241 75,693 % change, year on year 21.3 7.5 9.9 8.7 6.8 14.7


Import growth slowed to 7.5% year on year in the fourth quarter of 2005 from 8.6% in the third quarter, and import values dropped by 0.4% between the two quarters. It is possible that this apparent hesitation is nothing more than a seasonal effect. It may also be that the seasonal change is more noticeable because the export recovery to which it is linked is!so far, at least!not all that impressive. Three-quarters of Malaysia"s imports consists of intermediate goods, which are used as parts and components in the production of exports. Intermediate-goods imports dropped between the third and fourth quarters, although the year-on-year growth rate quickened from 6.3% to 7.7%. Data for the first quarter of 2006 may make it clear whether a pessimistic or an optimistic explanation of the changes in imports is correct. The final conclusion may well lie somewhere in between: the moderate movement in imports may reflect an export recovery that lacks vigour. This would also explain why capital goods imports could suddenly fall by 5.9% year on year in the fourth quarter of 2005 after nine consecutive quarterly increases. Capital goods imports are a good indicator of private-sector investment in plant and equipment. Growth in consumption goods was not particularly strong in October-December either, at 4.4% year on year, but at least import volumes continued to grow steadily.

The combination of stronger exports and stagnating imports produced a record trade surplus (on a fob-cif basis) of M$28.6bn (US$7.5bn). The previous high was a surplus of M$25bn, posted in the first quarter of 2005. Exports were worth 25% more than imports.

Imports stagnate in the fourth quarter of 2005

A record trade surplus is recorded in the final quarter

32 Malaysia


Malaysia: current account (M$ m unless otherwise indicated; non-seasonally adjusted)

2004 2005 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3QtrTrade Exports fob 118,138 128,360 126,849 124,917 131,383 137,956Imports fob 93,862 99,333 99,964 92,072 101,569 107,923Balance 24,276 29,027 26,885 32,845 29,814 30,033Services Credits 15,891 14,892 16,544 15,256 18,025 19,239Debits 17,639 18,227 19,325 18,653 20,210 20,804Balance -1,748 -3,335 -2,780 -3,397 -2,185 -1,565Income Credits 3,088 4,592 4,998 5,944 4,255 5,268Debits 9,799 10,219 10,831 9,769 9,261 10,906Balance -6,711 -5,627 -5,833 -3,825 -5,007 -5,638Transfers Credits 470 360 364 319 348 249Debits 3,902 3,717 5,698 5,027 5,082 4,007Balance -3,432 -3,357 -5,334 -4,708 -4,734 -3,758

Current-account balance 12,384 16,709 12,937 20,915 17,890 19,072

Source: Department of Statistics

Malaysia"s current-account surplus increased to M$19.1bn in the third quarter of 2005 (the latest period for which balance-of-payments figures are available), from M$17.9bn in the preceding quarter and a record high of M$20.9bn in the first quarter. The surplus was the second-highest ever recorded in any quarter, although in relative terms, at 14.8% of nominal GDP, it ranked well below the 18.1% in the first quarter.

Changes on the current account tend to be dominated by the merchandise trade account, as the value of trade transactions is four times larger than that of services, income and transfers transactions combined. Unusually, the major contributor to the expanding current-account surplus in the third quarter was not trade but services. The last time something similar happened was after the outbreak of Severe Acute Respiratory Syndrome (SARS) in 2003, following which tourism earnings bounced back in the first half of 2004. This time, however, the shift in growth stimulus was more a reflection of a structural change in the Malaysian economy, with the exporting manufacturing economy losing momentum and some of its dynamism being taken over by the services sector. The transformation is likely to be a slow process, but it will eventually lead to a structurally smaller current-account surplus.

Strong earnings growth in transport and "other services" reduced the services deficit to M$1.6bn in the third quarter of 2005, from M$2.2bn in the second. "Other services" is a volatile subcomponent, accounting for some 40% of services transactions, covering all services that are not connected with transport, travel or government transactions. The remaining 60% of services is equally divided between transport and travel services. Other services credits increased by 55.6% year on year, and transport credits grew by 56.9%. As a result, the transport deficit stood, at M$3.5bn, at its narrowest level for eight quarters.

The current-account surplus remains large

The services deficit narrows further

Malaysia 33


Government transport policy is aiming to boost income and contain payments, which were almost two-and-a-half times larger than transport income in 2004. The "other services" deficit, at M$2.4bn, stood at a five-quarter low in the third quarter.

The travel surplus slipped to M$4.4bn in the third quarter, from M$4.6bn in the second, as income from tourism stagnated and spending by Malaysians abroad continued to expand vigorously. The tourism industry is Malaysia"s second-largest foreign-currency earner after the electronics and electrical goods industry. Growth during 2005 was relatively sluggish, with tourist arrivals expected to increase to 16.3m, up from 15.4m in 2004. The government was upset by the near-halving of tourist arrivals from China during 2005, which it attributed to the publicity given to the poor treatment of Chinese tourists. However, it admitted that a shortage of direct flights from China, natural disasters and the increased choice of tourist destinations available to mainland Chinese might also have played a role. Malaysia eased its visa policy in order to hit its target of 1m Chinese tourists out of a projected total of 17.3m arrivals in 2006. The government forecasts some 20m tourist arrivals in 2007.

Malaysia: financial account (M$ m unless otherwise indicated; net figures; non-seasonally adjusted)

2004 2005 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 QtrDirect investment 3,847 1,511 2,859 101 2,552 -1,597 Abroad -1,592 -2,826 -1,416 -2,981 -2,329 -3,876 In Malaysia 5,439 4,337 4,275 3,082 4,881 2,279Portfolio investment 1,697 6,092 10,131 4,592 3,480 -1,084

Other investment -5,692 -11,137 -2,883 -1,391 -5,538 8,716 Official sector 2,511 -1,576 499 -2,824 -563 -3,522 Private sector -8,203 -9,561 -3,382 1,433 -4,975 12,238

Balance -148 -3,534 10,107 3,302 494 6,035


The income deficit deteriorated in the third quarter from M$5bn in the second quarter to M$5.6bn, largely owing to a sharp rise in direct investment debits. Nonetheless, the income deficit remained at a relatively low level, given the current stage of the business cycle. Outgoings on the income account consist largely of the profits and dividends accruing to foreign exporting manufacturing companies. During an upturn and mature phase of the business cycle, payments tend to rise as profits increase, which usually results in an increase in the income deficit. The reverse happens when the business cycle slows or turns down. Overall income received remained at a historically high level, with direct investment income rising again after some weakness in the second quarter. Receipts on the income account consist in the main of the profits, dividends, interest and investment income earned by Malaysian entities abroad.

The transfer deficit narrowed to M$3.8bn during the third quarter from M$4.7bn in the second. Malaysia"s large transfer deficit is the result of the repatriation of foreign workers" earnings. The demand for foreign workers fluctuates with the state of the Malaysian economy. The government has a policy aim of reducing the country"s dependence on foreign labour, but without such workers the

The income deficit widens

Foreign workers' remittances decline

34 Malaysia


construction, plantation, manufacturing and services sector could not operate. The high level of payments also indicates the failure of the policy to expel illegal foreign workers; an earlier attempt to do so resulted in a surge in transfers during the fourth quarter of 2004, to M$5.7bn. Transfer payments fell to M$4bn in the third quarter of 2005, from M$5.1bn in the second quarter.

The major change in the financial account during the third quarter was the reversal of portfolio flows from a net inflow to a net outflow. Net portfolio outflows stood at M$1.1bn during the third quarter, following a net inflow of M$3.5bn during the second quarter. Malaysia attracted a total of M$46.8bn in net portfolio inflows between the fourth quarter of 2003, when Abdullah Badawi became prime minister, and the second quarter of 2005, as foreign investors were optimistic about Malaysia"s economic outlook and likely changes in government policy. During the preceding four years, when Mahathir Mohamad was prime minister, there had been steady outflows. By the third quarter of 2005, the renewed outflows were caused by disappointment with portfolio investment returns and the better opportunities which were available elsewhere in the Asia region. The rise in the value of the ringgit against the US dollar had been disappointingly small after the rebasing of the currency link in July 2005; the Malaysian stockmarket continued to underperform; and the government failed to deliver the radical policy changes that had been hoped for. In addition, interest-rate differentials with the US continued to widen. The reversal of portfolio flows led to a decline in Malaysia"s official reserves.

Any doubts about the rising trend of Malaysian direct investment abroad were assuaged by the new record high of M$3.9bn achieved during the third quarter. It far exceeded the previous high of M$3bn that was reached in the first quarter. The government is encouraging Malaysian companies, especially those in the government-linked sector, to acquire overseas assets. The deputy prime minister, Najib Razak, declared on January 24th this year that, given the large gap between the national savings and investment and foreign direct investment inflows, Malaysia had a large basic surplus that needed to be recycled through the acquisition of foreign assets. Mr Najib said that Malaysia would become a major capital exporter and foreign investor in the medium term.

By contrast, net direct investment inflows (from foreign companies investing in Malaysia) dropped to M$2.1bn in the third quarter of 2005, from M$4.9bn in the second quarter, possibly as a result of slower GDP growth. A large proportion of the net inflows consists of unrepatriated profits of multinationals that are boosted when manufactured exports increase. Net foreign direct investment (FDI) inflows in the first three quarters of 2005 were well below those in the year-earlier period, standing at M$10.2bn, compared with M$13.3bn in January-September 2004.

Within the financial account, the "other investment" account, which traditionally tends to show a deficit, recorded a large surplus in the third quarter of 2005, at M$8.7bn, up from a deficit of M$5.5bn in the second quarter. It was caused by a turnaround in investment by the private sector!consisting of highly volatile, mainly short-term flows such as trade credits, loans and advances!from a shortfall of M$5bn to a surplus of M$12.2bn. The official

Portfolio flows reverse

Malaysian investment abroad reaches a new high

Malaysia 35


sector registered an increased net outflow of M$3.5bn in the third quarter, following the deficit of M$600m (US$160m) recorded in the preceding quarter.

Malaysia: external debt (M$ m unless otherwise indicated)

2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 QtrMedium- & long-term debt 151,759 156,849 160,099 155,740 152,570 149,615 Federal government 34,814 34,654 33,789 33,700 33,162 29,933 Non-financial public enterprises 60,471 62,244 60,958 59,554 57,500 56,150 Private-sector 56,474 59,951 65,352 62,486 61,908 63,532Short-term debt 43,294 43,737 40,524 43,144 50,757 46,183 Banking sector 34,623 35,333 33,047 34,316 43,176 38,871 Non-bank sector 8,671 8,404 7,477 8,828 7,581 7,312Total external debt 195,053 200,586 200,623 198,884 203,327 195,798External debt-service ratio (%) 4.7 4.3 5.5 4.1 4.3 n/a

Source: Bank Negara Malaysia.

Malaysia"s external debt fell to M$195.8bn during the fourth quarter of 2005, largely because of a reduction in the federal government"s medium- and long-term debt and a cut by the banking system in its short-term foreign debt. In relative terms, Malaysia"s external debt dropped to 39.6% of nominal GDP in the fourth quarter, from 42.1% in the third. The relative size of external debt has been steadily declining since the middle of 2003. Outstanding medium- and long-term debt fell by M$3bn to M$149.6bn as the federal government and non-financial public enterprises reduced their holdings. The government continued to repay foreign debt as it maintained its tighter fiscal stance. The foreign debt of non-financial public enterprises is mostly owed by the national oil company, Petronas, the state-owned electricity generator, Tenaga, and the national airline, MAS; it fell by M$1.3bn to M$56.2bn in the fourth quarter of 2005. Private-sector debt, however, rose by M$1.6bn to M$63.5bn. The steep rise in the short-term liabilities of the banking sector that had taken place during the third quarter was partially reversed during the fourth quarter. Short-term debt owed by the banking system fell by M$4.3bn to M$38.9bn in the quarter, while short-term debt owed by the non-bank sector dropped by another M$300m, to M$7.3bn.

The government continues to pay back foreign debt

malaysia...rafidah aziz, retained their positions. economic policy outlook • bank negara malaysia...

Documents