In 1998, Malaysia’s real GDP recorded a contraction for the first time since 1985 of 6.7% against a 7.7% growth in 1997. Consequently, per capita income in nominal terms declined to RM11,835 from RM12,051 in 1997. The contraction in real GDP, however, has been accompanied by a significant improvement in the external payments position, due to the sharper decline in import volume relative to export. The current account position of the balance of payments turned around to record a surplus of 13.7% of gross national product (GNP) from a deficit of 5.4% of GNP in 1997. This has led to a significant improvement in the external reserves position from RM59.1 billion at the end of 1997 to RM99.4 billion at the end of 1998, which was adequate to finance 5.7 months of retained imports.

During the year, output of all major sectors in the economy with the exception of the mining and services sectors were adversely affected by declining demand, excess supply or supply constraints. The most affected were the construction and manufacturing sectors which recorded a contraction of 24.5% and 10.2% (1997: +9.5%; +12.5%), respectively.

Aggregate domestic demand declined by 20.6% in current prices in 1998 (1997: +9.6%) due to cutbacks in private sector expenditure (-26.4%), while public sector expenditure contracted at a lower rate of 0.9%. The decline in private sector expenditure was attributed to the decrease in private investment and consumption. Public sector consumption, which mainly comprises the operating expenditure undertaken by the Government, declined by 1.5% in 1998, largely due to lower expenditure on supplies and services.

Private investment fell sharply by 53.3% in 1998, due to sluggish demand, excess production capacity, higher cost of financing as well as uncertainties created by the volatile financial markets. Public sector investment declined slightly by 0.3% mainly due to the 7.5% decline in Non-Financial Public Enterprises (NFPEs’) investment.

Malaysia’s net external trade position improved significantly in 1998, with a surplus of RM58.4 billion, against a deficit of RM45 million in 1997, largely attributed to declining imports. Exports of goods in ringgit terms increased by 29.8% (1997: 12.1%) due to higher export prices as a result of the depreciation of the local currency. Imported goods in ringgit terms increased at a slower rate of 3.3% (1997: 12%), reflecting declines in both volume and lower international prices for most major imports, which largely offset the impact of the depreciation of the ringgit. However, the value of imports in US dollar terms decreased substantially by 26.2% in 1998 for all categories of imports, following the weak domestic demand conditions and the reduction in import of inputs for manufacturing exports.

Inflation was higher in 1998, largely due to the impact of ringgit depreciation on prices of imported food as well as exportable local commodities such as palm oil. The consumer price index (CPI) increased by 5.3% (1997: 2.7%). Underpinning this higher rate of inflation was the 8.9% increase in the CPI for food items. On monthly basis, however, the annualized rate of increase in overall CPI has decelerated from 6.2% in June to 5.3% in December, due to the pegging of ringgit at RM1=US$0.2632 (US$1=RM3.80) on 2 September 1998 and slowdown in domestic demand, over capacity in production and less pressure on wages as unemployment rate increased.

The rate of unemployment increased to 3.9% in 1998 (1997: 2.6%), below the full employment level of 4% largely due to the contraction of the real economy. Total employment declined by 3% to 8.5 million in 1998 (1997: 4.6%), as the number of retrenched workers reported increased sharply to 83,865 during 1998 (1997: 18,863 workers) and was more pronounced in the construction, manufacturing and agricultural sectors. Nevertheless, the number of workers reported to be retrenched declined from as high as 12,335 in July 1998 to 5,556 in December, as the real economy stabilized in the fourth quarter of 1998.

The merchandise surplus rose to a record high of US$17.7 billion in 1998, due mainly to a reduction in import volume, particularly of capital goods. The expansion in the trade surplus was the result of the stronger expansion of merchandise exports compared with merchandise imports. The stronger expansion in exports was primarily due to valuation gains from the depreciation of the ringgit as international prices for most of Malaysia's major exports were lower while export volume remained stable. While that of imports, slower increased reflects declines in both volume and lower international prices which offset the impact of the weaker ringgit.

The trade surplus rose to an unprecedented level of RM58.4 billion in 1998, far exceeding the previous high of RM13.3 billion recorded in 1987. Export receipts grew by 29.8% in ringgit terms due in large part to the depreciation of the ringgit against most major currencies. Growth in imports declined to 3.3% in ringgit terms. By the end of 1998, the trade account had been in surplus for 14 consecutive months since November 1997 due to the sustained strong export growth in ringgit terms.

Reflecting the favorable valuation impact of the rapid decline in imports, the current account recorded an unprecedented surplus of RM36.1 billion in 1998 or 13.7% of GNP (1997: -5.4% of GNP). This was a significant turnaround from a deficit position of RM14.2 billion in 1997 and was the first current account surplus since 1989.

The long-term capital account declined to RM10.9 billion in 1998 (1997: RM19 billion) due to the decline in net borrowing by the NFPEs as well as lower foreign direct investment. The short-term capital account recorded a substantial net outflow for the second successive year amounting to RM21.7 billion. The overall balance of payments position recorded a large surplus of RM40.3 billion in 1998.

Malaysia’s overall external debt situation remained manageable in 1998 resulting from the Government’s prudent external debt management strategy. Malaysia’s total external debt outstanding declined by 6.4% to RM159.8 billion in 1998 (1997: RM170.8 billion). The ratio of external debt to GNP declined to 60.9% in 1998 (1997: 65.4%), entirely due to reduction in short-term debt. The share of short-term debt to total external debt declined to 18% at end-1998 (25% at end-1997). This makes Malaysia less vulnerable to credit outflows over the short-term.

Net foreign direct investment (FDI) shrunk to RM11.6 billion in 1998 from RM19.1 billion in 1997. The FDI was channeled mainly into the manufacturing sector (60%), the oil and gas sector (23%) and the services sector (14%). The value of proposed investment continued to remain significant in 1998, amounting to RM12.7 billion (1997: RM14.4 billion). The bulk of the investment were from the United States (51.6%), Japan (9%), the Netherlands (8.6%), Singapore (6.4%) and the United Kingdom (4.9%).

During 1998, the ringgit recorded a mixed performance against the major currencies depreciating marginally by 0.2% (1997: -31.4%) against the composite basket of currencies of Malaysia’s major trading partners. The ringgit appreciated by 2.3% against the US dollar and by 1.8% against the pound sterling. However, ringgit depreciated by 2.7% against Swiss franc, 4% against the Deutsche mark and 9.7% against the Japanese yen.

The fiscal policy during the early 1998 period focused on strengthening macroeconomic stability and restoring investor confidence. The government adopted counter-cyclical measures to revitalize the domestic economy. In July 1998, a fiscal stimulus package was announced involving an additional allocation of RM7 billion for projects with strong linkages within the domestic economy, short gestation period, and expenditures to meet socio-economic objectives.

Tax measures that were implemented in 1998 and announced in the 1999 Budget aimed at reducing the cost of doing business and providing tax incentives to boost exports. Tax incentives and exemptions were also introduced to expedite the shift to higher value-added and technology-intensive industries, especially for exports.

Several policy initiatives were introduced during 1998, including the establishment of National Economic Action Council (NEAC) and the formulation of the National Economic Recovery Plan (NERP). The NERP aimed at stabilizing the ringgit, restoring market confidence, maintaining financial market stability, strengthening economic fundamentals, continuing the equity and socio-economic agenda and revitalizing the affected sectors of the economy. Major policy decisions that have also been implemented include measures to address the problem of non-performing loans (NPLs) and to recapitalize the banking system that were announced in July 1998.

Total revenue collected by the Federal Government declined by an estimated 13.7% to RM56.7 billion in 1998 (1997: RM65.7 billion), largely due to a 33.9% drop in indirect tax. However, the direct tax collection declined marginally at 1.4%. Operating expenditure increased by an estimated of 4.7% to RM46.7 billion, due to higher debt service charges following the depreciation of the ringgit. The overall financial account of the public sector recorded a deficit of about RM4.7 billion (-1.8% of GNP) in 1998, against a surplus of RM17.3 billion (1997: 6.6% of GNP).

Monetary policy in 1998 can be classified into three phases, namely the adjustment phase from the outbreak of the crisis to early 1998; followed by the stabilization phase up to July; and subsequently, the recovery phase.

The most important objective of the policy during the first phase was to improve liquidity distribution and remove distortions in the intermediation process, thereby enabling the banking institutions to reduce their lending rates. The central bank has lowered the statutory reserve requirement (SRR) from 13.5% to 10% on 16 February, followed by another reduction to 8% on 1 July. A number of other initiatives have also been implemented to ensure the efficient management of liquidity and increase the efficiency of loan intermediation. Procedures were introduced on 30 April to make money market operations more transparent and to promote efficient liquidity management.

Following the introduction of the exchange control measures and the fixed exchange rate on 2 September 1998, additional monetary measures were introduced to improve the liquidity flows in the banking system to generate lending activities, as well as to ensure that viable businesses continued to received financing at lower cost. Consequently, the SRR was reduced to 6% on 1 September, and then again to 4% on 16 September. Similarly, the 3-month intervention rate was reduced from 9.5% to 8% on 3 September to 7.5% on 5 October, and to 7% on 9 November. As a result of the easing of monetary policy, the average BLR of the commercial banks and finance companies declined further from 11.70% and 14.17% respectively in August 1998, to 8.04% and 9.50% by November 1998.

The Malaysian economy is entering the recovery phase in 1999. Real GDP growth is expected to increase to 1% generated mainly by stronger domestic demand with the anticipated increase in private and public sector expenditures. Public sector investment and consumption are expected to increase significantly. Private sector expenditure is also expected to pick-up reflecting the better performance in both private investment and consumption.

The external sector, however, is expected to exert a lower net expansionary impact on real GDP and nominal GNP growth, as the surplus in the external payments current account position is envisaged to be smaller. Although exports are forecast to improve, imports are expected to increase at relatively stronger rate in tandem with the recovery in domestic demand and the need to replenish stocks.

With the mild recovery in overall aggregate demand, output of all sectors of the economy, with the exception of the construction and mining sectors, are expected to record mild to moderate growth.

Inflation is expected to be maintained below 4% in 1999. The absence of inflationary pressures from abroad due to a moderate appreciation of the ringgit, and low inflation in the industrial countries and lower commodity prices, particularly petroleum prices, would help to curb domestic price pressures.

The unemployment rate is also expected to remain low following the economic recovery. However, in view of the higher entrants into the labour market, the unemployment rate is expected to increase to 4.5%.The pressure for wage increases is also expected to remain moderate as adjustments in the labour market continue in 1999.

The current account surplus of the balance of payments is expected to decline to RM29.5 billion or 11% of GNP in anticipation of lower surplus in the merchandise account and improvement in the services account.

The Federal Government is expected to record a higher fiscal deficit of RM16.1 billion in 1999, with the expectation of lower revenue performance and stronger fiscal stimulus to spearhead economic recovery. However, the policy of fiscal prudence and discipline will continue to be maintained to ensure that the revenue will be sufficient to meet the operating expenditure. The budget deficit of the Federal Government’s is expected to be at 6% of GNP to be financed from domestic and international sources.

To address the problem of NPLs and to recapitalize the banking system, the Government has established an asset management company, known as Pengurusan Danaharta Nasional Berhad (Danaharta); a special purpose vehicle, known as Danamodal Nasional Berhad (Danamodal); and Corporate Debt Restructuring Committee (CDRC). As at 15 March 1999, Danaharta, the asset management company, has acquired and is managing gross non-performing loans (NPLs) amounting to RM15.1 billion. The CDRC has received 48 applications involving debt totaling RM22.7 billion. A rehabilitation fund was set up in 1998, for small and medium industries (SMIs) with an initial allocation of RM750 million to assist SMIs which are viable but have temporary cash flow problems and NPLs.

To ensure that there are sufficient funds to finance economic recovery, banking institutions were required to disburse loans to priority sectors such as construction or purchase of residential properties costing RM250,000 and below as well as for hire purchase of passenger cars. Several funds have also been established, such as the Small and Medium Industry Fund (RM1.5 billion), Export Credit Refinancing Facility (RM3 billion), Special Scheme for Low and Medium Cost Houses (RM2 billion) and Fund for Food (RM1 billion).

On 2 September 1998, the government introduced selective capital control and fixed the ringgit exchange rate to RM1=US$0.2632 with the aim to establish a stable exchange rate regime and, therefore, domestic prices, as well as to insulate the economy from adverse global developments. These measures eliminated access to ringgit by speculators by reducing the offshore market in ringgit and bringing the market for ringgit back to Malaysia.

The government has also embarked on additional measures to enhance the competitiveness of Malaysia’s exports, reducing imports and strengthening the services account of the balance of payments. The measures include giving tax incentives to companies in the manufacturing, agriculture and services sectors. Tax incentives were also given to assist the business/private sector in reducing their cost of exports and warehousing. To reduce imports, the government discouraged the import of construction machinery and equipment, given the excess supply of used construction machinery and equipment within the country.

Source: Data are as submitted by member economies, unless otherwise specified.

Notes:

(1) Percentage of GNP

Table 2. Forecasting Summary (% change from previous year)

Note: The IMF forecast is from the World Economic Outlook (IMF, April 1999). The ADB forecast is from the Asian Development Outlook (1999). The OECD forecast is from the OECD Economic Outlook (OECD, June 1999).