Malaysia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diversified exports
- Dynamic services sector
- Good infrastructure, high R&D
- Investment supported by expansion of local financial market and broader access to FDIs
- Exchange rate flexibility
- High per capita income
- Reliance on external demand
- Budget income highly dependent on performances in the gas and oil sector
- Very high private debt levels
- Erosion of price competitiveness due to high labor costs
- Persistent regional disparities
- Ethnic and religious disputes
Growth Expected to Remain Quite Strong
Particularly strong in 2017, growth will remain robust in 2018. Activity will continue to be driven by internal demand, and also by good export performance (75% of GDP). Exports should continue to benefit from the recovery in hydrocarbon prices, which represents 20% of total exports. However, the energy sector (natural gas and oil) might suffer from the suspension of Chinese pipeline projects (funded by the Export-Import Bank of China) amid corruption concerns. The country also exports high added-value manufactured products, such as semi-conductors and other electronic products (39% of exports), for which there is strong global demand. Investment in this sector will likely be sustained by the good outlook for these products, especially as the country benefits from growing integration in the regional value chain thanks to its ongoing membership in the Association of Southeast Asian Nations (ASEAN). Conversely, public projects could suffer from the promised new government review and potential renegotiation of large infrastructure projects awarded to foreign investors. The sectors associated with tourism are expected to continue to expand, but will further suffer from the lasting impact of the Malaysia Airlines disasters in 2014 and 2015, as well as from a less favorable security environment than those of local rivals like Thailand and Vietnam.
Despite high levels of household debt (84% of GDP at the end of 2017), private consumption is set to continue to be the main contributor to growth. The recent appreciation of the ringgit helped reduce the cost of imported goods and contain inflation, while the unemployment rate is still at its lowest. The new government removed the Goods and Services Tax (GST) after being elected, which will help to keep prices low and boost consumption. Households are set to benefit from tax cuts, as well as higher civil service wages. Meanwhile, a still accommodative monetary stance – with no further rise in interest rate to be expected in 2018 from the central bank after the 25th January’s basis-point rise to 3.25% – and higher public spending will also support growth. The negative implications of Malaysia’s integration into the regional electronics value chain is that the country's economy remains vulnerable to slowing demand from China, its main trading partner, especially in the context of the escalating trade war with the United States.
New Measures to Widen the Fiscal Deficit but Satisfactory External Accounts
In the short-term, the new government objective is to consolidate public debt, essentially made up Sukuk (Islamic bonds), as well as of traditional bonds. To this end, it is currently reviewing infrastructure projects implemented by the previous administration. However, those efforts might be insufficient to balance campaign promises, possibly leading to an increase in 2018’s fiscal deficit. The removal of the controversial 6% GST will indeed not be compensated by the reinstatement of the Services and Sales Tax, previously abolished in 2015. This loss in revenue, in addition to an increase in expenditures with the reimplementation of oil subsidies in a context of rising international prices, could hamper fiscal health in the long-term.
The current account surplus is expected to remain stable in 2018. The trade surplus should be sustained by the increase in oil prices and the lower dynamic in intermediate goods imports. Relatively lower investments, as well as lower exports in the electronics sector towards China, will reduce demand for intermediate goods, which will offset the rise in consumption goods imports. The income balance will continue to show a deficit because of profit repatriation by foreign companies. Likewise, the transfer deficit is expected to endure because of remittances by foreign workers to their country of origin. The services deficit is expected to fall slightly in connection with the increasing number of tourists.
External debt is currently relatively high (67% of GDP), mostly denominated in foreign exchange and over 40% short-term owed. However, high levels of foreign exchange reserves (almost seven months of imports) will help limit the associated risk, and enable the country to respond to any capital flight associated with a rapid tightening of US monetary policy. Meanwhile, the banking sector remains sufficiently capitalized and liquid, even if high household debt remains a risk.
An Unexpected Victory of the Opposition
Against all expectations, the 10th May general elections brought to power the center-left opposition coalition Pakatan Harapan (PH). The coalition defeated the ruling Barisan Nasional (BN), led by Prime Minister Najib Razak, and won 113 seats out of 222, enough to form a government. Amid corruption allegations against Mr. Razak regarding his management of the state-backed investment fund 1Malaysia Development Berhad (MYR 1 billion – approximately USD 365,320 – of the fund’s assets were placed into the Prime Minister’s personal account). PH leader Mohammad Mahithir has put an end to the six decades of power of the BN party.
Prime Minister Mahithir has announced a renewed fight against corruption in the country, the first visible effect of which has been the corruption charges against Mr. Razak at the beginning of July. Mr. Mahithir also stated that he intended to hand over power within two years to the de facto PH leader Anwar Ibrahim, who was in custody until he obtained a royal pardon. Nevertheless, the ruling coalition will face a challenge in managing the diverging interests of its constituent parties, especially regarding the country’s ethnic diversity. Despite its call for a “new Malaysia” reflecting the country’s ethnic diversity, the PH coalition is unlikely to dismantle affirmative action policies that favor ethnic Malays over other minorities (most notably the Chinese, prominent in the business community). However, suspicions regarding the Prime Minister and his cabinet, alleged to have misappropriated a share of the assets in the country’s sovereign fund (MD 1 billion) and placed them in their personal bank accounts, could be exploited by the opposition during the electoral campaign.