Economy Report

(Extracted from 2002 Economic Outlook)

REAL GROSS DOMESTIC PRODUCT : The Malaysian economy remained resilient in 2001 in the face of a very challenging and uncertain external environment. While the world economic slowdown was more severe than expected and the unprecedented September 11 events in the United States had widespread implications for all economies, Malaysia was able to steer away from a major economic contraction and GDP growth for the year remained in positive territory.

However, given the openness of its economy with trade accounting for about 200 percent of gross domestic products (GDP), Malaysia was not spared from the negative effects of the United States economic slowdown and global electronics downturn, These were manifested in declining manufacturing production and negative export growth, particularly of electronics. Nevertheless, concerted efforts initiated by the government since the 1997/98 Asian financial crises to stimulate economic growth through accelerating domestic economic activities and reducing the over-dependence on exports helped the nation to sustain a positive real GDP growth, albeit at a modest rate of 0.4 percent in 2001 (2000: 8.3 percent). This growth was achieved within an environment of low inflationary pressures and full employment.

The fiscal stimulus measures and an accommodative monetary policy, coupled with the on-going financial and corporate sector restructuring initiatives, enabled the economy to weather the more challenging external environment. In particular, the increase in public sector expenditure with the introduction of two pre-emptive fiscal packages, amounting to about US$1.9 billion and targeted at encouraging domestic demand spending, helped to cushion the adverse impact of the weak external sector. Public investment expenditure maintained its double-digit growth of 15.5 percent (2000:19.9 percent), induced by the expansionary budget and augmented further by the need to improve efficiency of project implementation. Likewise, public consumption spending increased strongly by 11.9 percent (2000: 1.7 percent), due mainly to the procurement of office supplies related to e-government flagship applications, payments for professional services and bonus payments for the year. The direct contribution of the public sector was significant, contributing 3.8 percentage points to real GDP growth in 2001 and compensating for the negative 3.4 percentage points from other sectors, particularly the private sector. Private investment expenditure declined sharply by 19.7 percent (2000: +28.7 percent), reflecting the negative impact of lower external demand and excess capacity in certain sectors of the economy, particularly in the export-oriented manufacturing industries. Private consumption has, on the other hand, remained resilient despite lower export earnings following the positive impact of the fiscal stimulus measures. Supported by the government’s measures to increase household disposable income through the reduction in employees’ contribution to the Employees Provident Fund (EPF), provision of higher tax rebates to individual taxpayers and relaxation of Government employees’ eligibility for car loans, together with a low interest rates environment, private consumption continued to increase further, by 2.8 percent during the year (2000: 12.2 percent).

On the supply side, most of the major sectors were adversely affected by the greater-than-expected slowdown in the world economy and contraction of global demand for electronic products and components. The manufacturing sector in particular, which had achieved double-digit growth over the last twenty-one consecutive months since May 1999, experienced a sharp deterioration in output growth, especially in the export-oriented industries. However, the weaker growth in the export-oriented manufacturing industries was partly mitigated by a more resilient performance of the domestic-oriented manufacturing industries that benefited from the expansionary fiscal policy of the public sector. As such, the decline in the manufacturing value added was contained at a single-digit rate of 5.1 percent (2000: +21 percent).

Other major domestic sectors of the economy, especially the services sector continued to expand strongly by 4.9 percent (2000: 4.8 percent) on account of better performance of government services and other services sub-sectors. The fiscal stimulus measures, privatization of infrastructure projects and housing development within a low interest rate environment contributed to a stronger growth of 2.3 percent (2000: 1 percent) in the construction sector. Value-added in the agriculture sector expanded at a higher rate of 2.5 percent (2000: 0.6 percent), largely on account of greater palm oil production. Overall, the effectiveness of the policy measures introduced and Malaysia’s diversified economic structure have moderated somewhat the impact of the decline in output from export-oriented industries.

INFLATION : Inflation remained low in 2001. The consumer price index (CPI) moderated further to 1.4 percent because of the stability of the exchange rate, the low rate of inflation abroad, lower prices for many commodities, and excess capacity in several sectors of the economy. The moderate appreciation of the ringgit against non-US dollar currencies, as well as lower prices paid by the producer (PPI) which fell by 5.0 percent in 2001 also contributed to lower inflation in 2001.

EMPLOYMENT : In 2001, the impact of the slowdown in economic activity was also felt by the labor market, particularly in terms of retrenched workers in the manufacturing sector. However, given the flexibility accorded by the labor market, alternative measures that were adopted by employers (such as pay cuts and temporary layoffs) helped contain the number of workers retrenched. During the year, the slower growth environment resulted in both the total employment and labor force expanding at more moderate rates of 2.6 percent to 9.5 million workers and 3.2 percent to 9.9 million persons, respectively. The unemployment rate edged upwards from 3.1 percent in 2000 to 3.7 percent in 2001. However, in remained below the 4.0 percent deemed to be the full employment level. A total of 38,116 workers were retrenched (2000: 25,236) with 75.6 percent from the manufacturing sector. The electronics and electrical products sub-sector accounted for almost half (45.7 percent) of the total number of workers retrenched. The number of job vacancies increased more moderately, by 6.5 percent to 131,459 in 2001 (2000: 123,484).

EXTERNAL TRADE ACCOUNTS : Malaysia’s external position remained fundamentally strong despite the slowdown in the global economy. In fact, the overall balance of payments position turned around and recorded a surplus in 2001. The improvement was due partly to lower outflows in the financial account. The surplus in the current account remained large, though it narrowed slightly at US$7.2 billion or equivalent to 8.9 percent of nominal gross national product (GNP) (2000: US$8.4 billion or 10.2 percent of GNP). The sizeable surplus reflected a moderate decline in the trade account and improvements in the income and services accounts.

On the trade account, the impact of the world economic slowdown and the global electronics downturn on Malaysia’s external demand has been significant as growth in gross exports, which remained positive since 1987, declined by 10.4 percent in 2001. Almost all categories of exports were adversely affected, particularly electronics and non-household electrical appliances as well the primary commodities as crude oil and palm oil. Nevertheless, given the existing structure of a high import content in exports, coupled with moderation in domestic demand conditions, gross imports also declined by 9.9 percent. This has helped to contain the decline in the trade surplus that remained large at US$14.1 billion (2000: US$16.3 billion). The services account, on the other hand, registered a significantly smaller deficit of US$2.2 billion (2000: -US$3 billion), reflecting the marked improvements in the travel account and the smaller amount of payments related to export and import activities. With lower corporate earnings arising from weaker exports during the year, the deficit in the income account also improved to US$6.8 billion (2000: -US$7.5 billion) on account of lower repatriation of profits and dividends. The financial account of the balance of payments turned more favorable in 2001, with lower net outflows of US$3.9 billion (2000: US$6.3 billion). This was due mainly to lower short-term capital outflows and higher external borrowings by the federal government and non-bank private sector.

With the surplus in the current account more than sufficient to meet the deficit in the financial account, the overall position of the balance of payments recorded a surplus of US$964 million (2000: US$974 million). With this favorable development, Malaysia’s net international reserves strengthened further to US$30.8 billion as at end of 2001 (end 2000: US$29.9 billion). The reserves level is adequate to finance 5.2 months of retained imports and cover 5.1 times the short-term external debts. The strengthening of the reserve position is reflected by build-up in foreign exchange holdings from trade and long-term capital inflows.

GROSS EXTERNAL DEBT : Malaysia’s total external debt increased by 7.6 percent to RM169.8 billion (US$44.7 billion) in 2001. The increase is also reflected in the ratio of external debt to gross domestic product (GDP), which has increased to 51 percent in 2001 from 46 percent in 2000 (1997: 61 percent). This was largely due to the increase in the private sector’s short-term and the federal government debt.

The private sector’s short-term external debt increased significantly by 33.7 percent to RM23.3 billion (US$6.1 billion), equivalent to 13.7 percent of total external debt and 19.9 percent of international reserves. This was largely on account of the increase in short-term borrowings by commercial banks mainly to provide for their trade financing activities, revolving credits and inter-company loans.

Although the federal government external debt increased significantly by 29.3 percent to RM 24.3 billion (US$6.4 billion), it accounted for only a small share (14.3 percent) of total external debt. The increase was largely due to additional borrowings to finance the deficit, arising mainly from the implementation of fiscal stimulus measures. The government has also tapped the international capital markets to maintain a market presence as well as to take advantage of the favourable market conditions.

EXCHANGE RATE : The ringgit exchange rate remained pegged to the US dollar at the rate of RM3.80 per US dollar in 2001--an arrangement that has been effective since 2 September 1998. The ringgit appreciated against all major currencies, including regional currencies in tandem with the strong U.S dollar. In terms of its trade-weighted nominal effective exchange rate, the ringgit appreciated 5.5 percent during the year, in line with the appreciation of the US dollar. The pegged exchange rate regime continues to be supported by the strong fundamentals of the economy as reflected by the strong current account surplus, the low rate of inflation and the high level of reserves.

FISCAL POLICY : Prior to the financial crisis in 1997, the federal government recorded five consecutive years (1993-97) of budgetary surplus. From 1998 to 2001, the federal government budgetary position incurred deficits, largely because of expansionary fiscal policy designed to support economic growth and recovery. The focus of the 2002 budget is, therefore, to continue the recovery process to a level consistent with Malaysia’s growth potential. The three main thrusts of the 2002 budget as presented to parliament in October 2001 were directed at strengthening Malaysia’s economic growth through increasing domestic demand, enhancing the private sector’s resilience and competitiveness, diversifying the sources of growth and ensuring a more equitable distribution of wealth.

Although fiscal policy has been expansionary since 1998, Malaysia still enjoys fiscal flexibility, and the continued expansionary budget in 2002 would not create risks in the economy. This is because the federal government debt is expected to be contained at a manageable and sustainable level. Debt servicing of the federal government is also low, with interest payments accounting for about 16 percent of operating expenditure. The level of expenditure would be managed by taking into consideration the need to stimulate economic activities, maintain a surplus position in the current account, avoid excessive reliance on external borrowings, and avoid crowding out the private sector in terms of borrowings from the domestic financial system.

Expenditure allocation would continue to focus on programmes and projects that would have higher multiplier effects on domestic activity and raise the long-term productivity of the economy. In addition, the annual budget contained both tax and non-tax fiscal incentives focused on expanding domestic demand while strengthening the nation’s competitiveness and resilience. Apart from promoting new sources of growth, allocation is also aimed at developing skilled manpower and technological competence, and expediting the restructuring of the financial and corporate sectors. Regarding tax policy, the government continued with its tax reform programmes aimed at improving tax buoyancy and tax collection. Emoluments constitute the largest component of operating expenditure. As for development expenditure, education, transport infrastructure and trade and industry are the biggest components.

MONETARY POLICY : Monetary policy in 2001 was directed at promoting domestic activities to mitigate the effect of the global economic slowdown. The absence of inflationary pressures enabled monetary policy to remain accommodative, with interest rates remaining low and stable. Nevertheless, in the wake of the September 11 incidents, the central bank, Bank Negara Malaysia (BNM), reduced its intervention rate by 50 basis points to 5.0 percent on 20 September, marking its first cut in more than two years. The reduction was aimed at countering the impact from the worsening external environment and stimulating domestic consumer and business activities.

Money supply continued to expand in 2001, albeit at a more moderate pace in line with the weaker economic activities, with M1, M2 and M3 increasing by 3.2 percent, 2.2 percent and 2.8 percent, respectively. However, despite the more challenging environment, lending by the banking system continued to expand by higher loans extended to the household sector, particularly for the purchase of residential property and passenger cars.

MEDIUM-TERM OUTLOOK : Given that the outlook for the global economy has improved, supported particularly by positive developments in United States and the expected pick-up in world trade in tandem with a gradual upturn in the electronics sector, the Malaysian economy is well placed to strengthen further in 2002. However, some downside risks need to be addressed as the strength of global recovery is still uncertain and external demand may not be as strong as it was during the 1999-2000 period. The current economic upturn is taking place amidst global excess capacity, particularly in the information and communication technology sector. Malaysia, therefore, needs to ensure that the economic recovery gathers momentum and that the downside risks are minimized.

Toward this end, the government will continue to institute appropriate fiscal and monetary policies to support the recovery momentum. The measures implemented in 2002 budget are expected to contribute to improving the business environment through not only demand side measures, but also supply side initiatives. In this regard, policies and strategies are targeted to realize the full potential of the agricultural and services sectors, including tourism and education, as well as to promote domestic resource-based industries, including support services-related activities. Efforts are also intensified on building strong small- and medium-scale enterprises, developing effective human resources and enhancing productivity and competitiveness. The incentive structures that are provided for in the budget will remain favorable to both foreign and domestic investors.

In 2002, the total external debt is expected to decrease by 1.1 percent to RM167.9 billion (US$44.2 billion), equivalent to 47.9 percent of GDP. Nevertheless, the federal government external debt is expected to increase by 22.9 percent to RM29.9 billion (US$7.9 billion). However, it will continue to account for a small share (18 percent) of the total external debt. The increase is mainly due to higher borrowings by the federal government to finance the envisaged fiscal deficit. The external borrowings of Non-financial Public Enterprises (NFPEs) and the private sector are expected to be relatively small in 2002. The debt service ratio is expected to stabilize at 5.3 percent in 2002.

To further ensure an accommodative environment that would generate greater economic activities, the government’s financial policy in 2002 would be placed on meeting the objectives set out in the phase of the Financial Sector Master Plan. This involves enhancing the capacity of the banking groups by benchmarking, upgrading skills, strengthening corporate governance, encouraging new delivery channels and promoting greater operational flexibility so as to become more efficient and effective. In addition, the roles of the development financial institutions would be intensified further to complement the activities of the banking system, with the enforcement of the Development Financial Act Institutions Act 2002. This is also in the light of government’s efforts to expedite corporate restructuring and to intensify private sector involvement as well as to broaden the economic base in order to reduce vulnerability and to insulate the economy from external risks.

With strong macro-economic fundamentals already in place and early economic indicators already showing positive signs in consumption, production and investment as well as in anticipation of the gradual improvement of the global economy and trade, the recovery of the Malaysian economy will be modest, with real GDP expanding by 3.5 percent in 2002 (2000: 0.4 percent). All major sectors are expected to record positive growth, with manufacturing as the lead sector, gaining from the improvement in global demand for electronics. The services and construction sectors, on the other hand, are envisaged to continue to support domestic economy activity, benefiting from the impact of the pro-growth policies already in place. As growth gathers momentum, the private sector is expected to play greater role as the engine of the economy, with the public sector providing the necessary support. Domestic expenditure, both consumption and investment, is expected to improve further by 2.8 percent (2001: 2.3 percent), contributing positively by as much as 3.5 percentage points to GDP growth in 2002 (2001: 2.3 percentage point).

The current account of the balance of payments is expected to continue to register a small surplus position. The sharper trade surplus from higher exports is likely to be eroded somewhat by higher imports. Similarly, the services and income account deficit are expected to widen. The current account surplus, however, is forecast to remain large in 2002 at 7.9 percent of GNP (2001:8.9 percent).

The expected pace of economic recovery and sustainable domestic spending are very encouraging in the light of moderate inflationary pressures and improvements in the labor market. For the whole of 2002, inflation is expected to remain subdued although the increase in transportation costs and retail prices of several petroleum products, as well as the higher sales tax on cigarette and tobacco products announced during the 2002 budget, has had some effect pushing up the CPI slightly. This trend continued into the first three months of 2002, although CPI rose only 1.4 percent during the period. The increase in the prices of tobacco, transport and communication, and gross rent and fuels was partly offset by a decline in the prices of clothing and footwear. Continued excess capacity in some sectors and capacity-expansion programmes being undertaken in other sectors, as well as lower inflation abroad, are expected to mitigate any build-up of inflationary pressures.

The labor market situation is expected to improve gradually in 2002 in tandem with the recovery in the export sector. The unemployment rate is forecast to decline to 3.6 percent in 2002 (2001: 3.7 percent). The establishment of nine schemes for skill training and higher education, with an allocation of RM300 million, is envisaged to contribute positively to the development of skills of unemployed graduates and retrenched workers. While IT-related areas are expected to create new employment opportunities, the manufacturing sector will still be a major source of new employment opportunities.

Annex I

MALAYSIA: OVERALL ECONOMIC PERFORMANCE

Annex II

MALAYSIA: FORECAST SUMMARY (percent change from previous year)