Malaysia Economic Monitor June 2014 - Boosting Trade Competitiveness

Kamal Salih world bank report malaysia economic monitor 2014
World Bank

RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK

Malaysia’s economy overcame a weak start to the year and GDP grew by 4.7 percent in 2013. The economy expanded vigorously in the last three quarters of the year after a soft patch early on. This better-than-expected performance was mainly due to a recovery in exports: after contracting in 2012 and the first half of 2013 (-1.8 and -3.9 percent), exports expanded by 5.2 percent in the second half. This offset weaker domestic demand. As the Government implemented fiscal and credit tightening measures, domestic demand growth decelerated from 7.3 percent in the first half to 5.5 percent in the second half of 2013.

Better export performance led to a higher current account surplus. The recovery in exports was broadbased, including the long-ailing electrical and electronics (E&E) sector. The current account surplus hit a 15-year low of 0.8 percent of GDP in mid-2013, before improving to 7.9 percent in early 2014. This partly offset negative flows of 14.9 percent of GDP in the financial account in the first quarter. Global portfolio reallocation led to outflows in the financial account for the three quarters through March 2014.

Growth slowed in early 2014, but the outlook remains favorable given the positive external backdrop. Due to base effects, GDP is expected to grow by 5.4 percent and 4.6 percent in 2014 and 2015, respectively. The outlook for 2014 and 2015 will benefit from better conditions in advanced economies. Domestic demand faces headwinds: (1) subsidy cuts, tax hikes and public wage restraint in pursuit of fiscal consolidation; (2) likely higher interest rates as global monetary conditions normalize; and (3) the resulting pressures on household budgets. With foreign demand absorbing more than half of domestic value-added, a better external outlook outweighs domestic headwinds. 

Investments and imports of capital goods will remain robust as large projects move forward. Improved global conditions and the approval of the Pengerang Integrated Complex will result in further growth in investments – as well as growth in capital goods imports. The latter will keep the current account surplus at modest levels (4.4-4.6 percent of GDP in 2014 and 2015) despite the lift in exports. 

Medium-term fiscal consolidation remains on track, but gets harder. Helped by revenues from asset sales and large underspending of the capital budget, the Government bettered its deficit target of 4.0 percent of GDP despite overspending in subsidies and weak income tax collections. As a result, the debt-to-GDP ratio stabilized just below 55 percent. With domestic activity moderating and revenue growth constrained, spending measures towards further reducing the subsidy bill and capping emolument growth are needed for the Government to meet its 2014 deficit target of 3.5 percent of GDP. 

The central bank has signaled that it may have to tighten policy to avoid the build-up of financial imbalances. So far BNM has been managing risks to macroeconomic stability primarily through macroprudential regulations. Although such efforts have borne fruit (credit growth continued to decelerate), there is concern that household debt has continued to climb, reaching 86.5 percent in 2013, and that the real interest rate has become negative as inflation picked up to 3.7 percent in the first four months of 2014 largely on increases to administered prices. 

Healthy labor markets provide respite for households.  Higher employment levels (the employment-topopulation ratio increased 3.0 percentage points in 2013), real wage gains in manufacturing (up 4.7 percent in 2013), and the full implementation of the minimum wage of RM900 in peninsular Malaysia and RM800 in Sabah and Sarawak suggest higher labor incomes in the economy. Labor force participation and employment came down from a peak, but settled at a higher level likely due to participation by women.

External risks to the outlook have receded, but not disappeared. The high share of Malaysia’s debt held by foreigners means that volatility in international capital markets would be disruptive.

The delicate balancing act of tightening fiscal and monetary policies and Malaysia’s ability to leverage the improved global environment are key domestic risks. While necessary to rebuild buffers, policy adjustments carry risks of inducing excessive retrenchment in household spending. Boosting exports to fully leverage on the improved external environment is thus critical for sustained growth.

Kamal Salih world bank report malaysia economic monitor 2014

BOOSTING TRADE COMPETITIVENESS

Following the review of near-term developments and outlook, the thematic chapter of this Economic Monitor analyzes structural trends in trade competitiveness. Trade competitiveness is measured as Malaysia’s ability to grow its exports and the domestic value-added embodied within them, leveraging foreign demand and knowledge to support its transformation to a high income nation.  

Nearly 60 percent of value-added produced in Malaysia was ultimately consumed by foreigners in 2009 – one of the highest shares in the world. The share of Malaysia’s GDP consumed in foreign markets includes the value-added of exporting firms and also of suppliers to export-oriented industries. Thus the actual significance of external demand to the Malaysian economy is higher than it appears from net exports (22 percent of GDP) or the output from externally-oriented industries (38 percent of GDP). 

The export engine appears to have been faltering since before the Global Financial Crisis. The share of exports of goods and services in Malaysia’s GDP declined by nearly 30 percentage points between 2005 and 2013. Unlike Thailand, Vietnam and Korea, which saw market shares expand, Malaysia’s share shrunk from 1.35 to 1.22 percent in that period.  However, Malaysian exports have included a higher portion of domestic value-added, mitigating the impact of the decline in gross shares.  

The decline in exports has been concentrated in Malaysia’s core export product segment – E&E products. E&E exports as a share of GDP declined from about 38 percent between 2002 and 2004 to 18 percent in 2013, and Malaysia’s market share in the period declined from 5.25 percent to 3.74 percent of global E&E exports. Meanwhile, exports of commodities, and commodity-related manufactures such as petrochemicals expanded, but not enough to compensate the decline in E&E exports.  The domestic value-added of Malaysian E&E exports is relatively low due to limited domestic linkages.  Malaysia remains an integral part of the E&E global value chain, but at 44 percent the share of valueadded in exports is relatively low. This is partly due to limited domestic linkages. Compared to other countries, the contribution from domestic intermediaries to the value-added of exports is only 7 percent in Malaysia compared to 31 percent in Korea. This finding is supported by analysis of enterprise survey data, which finds that multinationals in Malaysia source less than 40 percent of their inputs

from domestic firms compared to 46 percent in Vietnam and 82 percent in China. 

Exports of services have also lagged and remain an area of significant potential. Malaysia has few services-exporting firms and at 12 percent of GDP services exports are below what would be expected for a country at its level of income.  

‘Behind the borders’ restrictions hinders export growth and limits linkages between domestic providers and export-oriented industries. Although the Government has recently embarked on a liberalization of services sectors, many are still relatively restrictive as measured by the World Bank’s Services Trade Restrictiveness index and assessment of the burden of non-tariff measures. Professional and transport services are more restrictive on average than most countries in East Asia for example. A restrictive domestic environment reduces incentives for exporting, and for exporting firms to buy more domestic value-added. Barriers are not limited to ownership restrictions, but extend to licensing and regulations that limit domestic competition.  

Engaging in higher value-added tasks in global value chains will also require addressing skills gaps. As energy prices have increased, so has the value of related assets. Thus it became relatively attractive for investors to come into the petrochemical sector.  Meanwhile, as Malaysia grew, the availability of lowcost labor dwindled, especially in comparison with neighboring countries. At the same time, skills mismatches remain an obstacle for firms looking to scale up higher value-added activities.  

Malaysia’s upcoming chairmanship in ASEAN offers three concrete avenues to boost trade competitiveness. First, Malaysia can deepen its liberalization efforts in services by achieving a commitment of ASEAN members to classify and disclose their ‘behind-the-border’ restrictions on services trade; Malaysia could take the lead and implement such classification and disclosure as part of its own autonomous liberalization of services.  Second, Malaysia can pursue mutual recognition agreements for professionals, both to create more competition but also to meet short-term skills gaps.  Third, Malaysia can lead in streamlining non-tariff measures by reviewing domestic regulations such as licensing requirements affecting firms potentially linked to global value chains.Kamal Salih world bank report malaysia economic monitor 2014

Read the full report HERE.