IFR Asia Malaysia report: economy

IFR Asia Malaysia report, May 2010: Economy

The economic picture is brightening in Malaysia. Reasonably resilient through the financial crisis, it also appears to be emerging from it much faster than developed economies.

After a 1.7% contraction in GDP in 2009, the World Bank is now forecasting 5.7% growth for Malaysia in 2010, and growth in the 5 to 6% range for the following two years. Some are more euphoric still. Consider this note from HSBC economist Robert Prior-Wandesforde in April. “We have had a consensus-busting 6.8% 2010 GDP growth forecast for the past six months, but have now decided to change it – in an upward direction.” HSBC is now calling for 7.3% growth this year.

Others are not quite so bullish but nevertheless positive. Lee Heng Guie, chief economist at CIMB Investment Bank, expects 4.8% full year growth, expanding to 5.5 to 6% in 2011 to 2015. “Amid the unpredictable external forces, we believe the accelerated pace of government and economic transformation programmes to make the economy more competitive – and the business, economic, regulatory and oversight system more efficient and sensitive to new developments – should boost the country’s growth potential,” he says.

Several key economic indicators are turning positive. The Industrial Production Index (IPI), a barometer for the manufacturing sector, has registered positive growth for three consecutive months. Exports rose 27.6% in the first two months of 2010 compared to a year earlier, reversing a 16.6% fall through 2009. “When you put these together with other indicators such as consumer confidence, we think Malaysian economic growth for the first quarter could be near 10%,” says Manokaran Mottain, senior economist at AmInvestment Bank Group. “If that is right, then I would say full year growth for this year will be much better than the government estimates of 4.5 to 5.5% or even the prime minister’s target of 6%. I think we can achieve more than that.”

Malaysia emerged reasonably strongly from the financial crisis in the first place. “The full year contraction of 1.7% in 2009 was significantly better than expected amid the still-strong economic and financial fundamentals,” says Lee at CIMB. And it is bouncing back quickly too. “We had the right policies to steer the economy out of the negative growth last year,” says Manokaran. “Timely changes in fiscal and monetary policy, and reforms introduced by the government this year, have been instrumental in leading the economy out of recession.”

Manokaran is referring to a series of measures introduced by Najib Razak, Malaysia’s prime minister, over the last year. One was to allow 100% foreign ownership in 27 industries and sectors. Perhaps more significantly, a long-standing requirement for 30% stakes in listed companies to be allocated to Bumiputras, or ethnic Malays, has been relaxed. (See more on this in the equity chapter.)

Other measures seek to attract more foreign direct investment, such as the setting up of a Special Taskforce to Facilitate Business, or Pemudah (an acronym of the Malay translation). This body has been set up to address bureaucracy in business-government dealings and has been asked to simplify FIC [Foreign Investment Committee] rules and expedite the approval process. “We hope the agency will look into the constraints affecting investment inflow,” Manokaran says. “Why are investors not coming into Malaysia now compared to the 1980s and 1990s? They are looking at ways to minimise further the bureaucracy and speed up the approvals process.”

This shift in policy was crystallised in Najib’s New Economic Model, announced in late March. Najib hopes this will transform Malaysia into a high-income economy, with developed nation status by 2020, and with a more than doubling of Malaysian per capita income to US$15,000 by the end of the decade.

Part of this program will involve a reassessment of subsidy systems and a broader revenue base through the introduction of a goods and services tax (although some of these measures already appear to have been delayed). Among other initiatives, the Employees Provident Fund, Malaysia’s key institutional investor and pension fund, is to be allowed to invest more in overseas assets; a joint venture will be formed between the government and EPF to develop a new hub in the Klang Valley; several Ministry of Finance companies will be privatised; two Petronas subsidiaries will be listed on Bursa Malaysia; and Khazanah Nasional, the investment arm of the government, will divest its 32% stake in Pos Malaysia, the postal services company, through a two stage process.

These elements will also feed into the 10^th Malaysia Plan, which will take effect from 2011 to 2015 and whose details are expected to be introduced around June. Among other things, it is expected to include a commitment to New Key Economic Areas, or NKEAs, in which investment and innovation will be encouraged, such as IT, electronics, biofuel and tourism.

Foreign analysts have welcomed the NEM. “Prime Minister Najib understands exactly what the market wants and thus knows what Malaysia needs for its long term economic survival,” said Credit Suisse analyst Danny Goh in his response to the NEM launch. “The good news is that he has not attempted to whitewash Malaysia’s problems… like the NEP (affirmative action), the high cost of doing business in Malaysia due to bureaucracy and corruption, and low-skilled and low earning workforce.” Goh thought the proposals bold but politically challenging: “PM Najib now has to use his political judgement and backbone to push this through.”

This is a real challenge but absolutely necessary: FDI numbers need to improve. Inward FDI was RM24.1 billion in 2008, and just RM5.7 billion in 2009, a 76.5% decline. That 2009 number was the lowest since 2001. It could stay tough for some time. “The carry-through impacts of the financial and economic crises on international investment flows are expected to continue,” says Lee, though he adds “overall FDI flows will likely improve over the medium term,” helped by recent liberalisation measures. “Malaysia still lags behind its regional peers in wooing FDI, not only because of the ongoing structural issues as well as perception of policy risks, but also because other economies are fast catching up.” CIMB expects RM12-14 billion in FDI inflows in 2010.

Nevertheless, Manokaran thinks that reform can help trigger a revival. “The government will face some objections in introducing some of these reforms, like the one regarding equity ownership, but if they can be implemented by the end of the year I’m sure Malaysian economic growth can be in the range of 7 to 8%.”

If they can’t, the picture will look a bit more moribund. The World Bank, in a new economic report on Malaysia called “Growth Through Innovation”, urges Malaysia to push through with reform, in particular by improving innovation capabilities (by ensuring access to talent, technology and finance), promoting competition, and concentrating efforts on promising niche products such as high technology. “The experience of countries around the world suggests that if implemented well, the right combination of policies can make a big difference in unleashing a country’s innovation potential,” said Philip Schellekens, a World Bank senior economist, at the report’s launch in April. The report applauds the reforms under the new economic model, but warns that if reform stalls, it will hurt growth and worsen the government debt to GDP ratio.

And there are already some troubling signs. “The government’s recent decision to postpone, potentially indefinitely, the introduction of GST and a new fuel subsidy regime sends the wrong signal as far as structural reform is concerned,” says Prior-Wandesforde.

Reforms are needed because of a sense that Malaysian competitiveness has been stifled – and it is increasingly widely believed that the famous New Economic Policy of the 1960s, which sought to bring about affirmative action for Bumiputras (native Malays), may inadvertently have created a sense of complacency that has left Malaysian companies uncompetitive on a world scale. The cost of doing business is also relatively high in some areas compared to peers in the region, and infrastructure could be better in areas like high speed broadband. “The main things, and the areas the government is most clearly trying to address, are a shortage of skilled manpower and bringing down the cost of doing business here,” says Manokaran.

An interesting debate is the impact that credible political opposition has had in Malaysia. Anwar Ibrahim led a coalition of opposition parties to their best ever showing in 2008, leading to the prospect of political change for the first time in the country’s modern history. Socially, Malaysia appears more troubled than it has in the recent past, perhaps because of this emergence of opposition; but economically, and in terms of reform, it appears to have been positive in spurring change. “I would think that credible opposition will ensure checks and controls,” says Manokaran. “We need this as we are introducing more changes and reforms under the 1Malaysia and NEM.” (1Malaysia is another government policy initiative.) “The government is trying to win back the people’s confidence through these reforms.”

Malaysia has traditionally spurred economic growth with the mega-projects that became famous under Mahathir Mohamed. Nobody talks about mega-projects any more, but there are still major infrastructure developments underway as a prompt to activity, such as the Iskander development region just across the straits from Singapore. The next Malaysian Plan will be closely watched to see if more such projects – perhaps a high speed rail link – will be launched.

On the fiscal and monetary side, Malaysia’s central bank, Bank Negara Malaysia, has started raising rates again. It put rates up by 0.25% in March to 2.25%, in a sign that the economy is improving. Economists were positive about the move. “This is not going to choke economic expansion,” says Manokaran. “It is still below the neutral level; it is accommodative.” Manokaran expects at least two more 25bp hikes by the end of the year.

“Both fiscal and monetary policies are aimed at providing an enabling environment for sustainable growth,” says Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia. “Monetary policy will remain supportive of growth, while attention will continue to be focused on ensuring that the private sector, in particular SMEs, have access to financing.” She says the central bank is formulating a new financial sector blueprint to chart the development of the Malaysian financial services industry over the next decade, “so that the financial sector will reinforce transition of the Malaysian economy into a high value-added and high income economy.”