Macroeconomic Problem in Malaysia Assignment

Introduction

Malaysia was created in 1963 through the merging of Malaya (independent in 1957) and the former British Singapore (West Malaysia), and Sabah and Sarawak in north Borneo, (East Malaysia). The first three years of independence were marred by hostilities with Indonesia. Singapore separated from the union in 1965.

As an emerging economy Malaysia has been a success. From 1970 to the mid-1990s its investment ratio was among the highest in the Asian region. This increasing investment shifted the economy from agriculture and mining to manufacturing and production of high technology electronics equipment. Because initial development was financed with public money, by the early 1980s growth was accompanied by increasing budget deficits and public debt. Today, exports (technology, oil) dominate the economy, and agriculture contributes only 10% of GDP, making Malaysia unique among developing countries.

1997-1998 CRISIS 1
Despite relatively favorable financial conditions in Malaysia in 1997, panic in the Southeast Asia region resulted in the collapse of the Ringgit from 2.6 to the dollar in July 1997 to 4.7 in January 1998. The Kuala Lumpur equity index fell from approximately 1000 to 300 and non-performing loans in the banking sector climbed to over 12 percent. Unlike most crises in developing countries, Malaysia did not have a short-term debt problem, experienced no excessive capital outflow, and was never forced to drastically deplete Central Bank reserves. Instead, the main reason for the steep decline in the ringgit was currency speculation in the offshore market located in Singapore.

The Malaysian government took action against this type of destabilizing speculation by first limiting to $2 million Malaysian bank currency swaps with non-residents in transactions unrelated to trade. The result, however, was a shift in borrowing to the Singapore offshore market (done purely for speculative purposes). The Malaysian government thus decided to make offshore ringgit transactions illegal in order to shut down commercial transactions with Malaysian banks. Also important is that these measures were not introduced under emergency conditions to control capital outflows, or to support unsustainable macroeconomic policies. Instead, the crisis was allowed to run its course, and changes were made under relative post-crisis calm. Rapid recovery in Malaysia has allowed the progressive removal of crisis-control measures as early as February 1999. Their success was confirmed by the fact that very little capital outflow occurred when the last of the controls were lifted in September 1999, an amount that actually flowed back in during the first quarter of 2000.the destabilizing Singapore market. In addition, measures were taken to prevent non-resident ownership of ringgit balances held abroad, making it impossible to settle ringgit contracts except through Malaysian banks in Malaysia. A final step toward insulating the domestic situation was the introduction of a fixed exchange rate (at 3.8 ringgit to the dollar).

Malaysia’s crisis response policies have generally been considered successful, and it is important to note that long term flows and FDI were not regulated, and the currency was always fully convertible for

CURRENT MACROECONOMIC SITUATION

GROWTH

With the exception of 1998, Malaysia has seen real GDP growth in each of the last seven years. In 2001, though, Malaysia experienced negative growth in nominal GDP, GDP/capita and real GDP/capita. The Ringgit’s appreciation against regional currencies, coupled with the 2001 world recession resulted in decreased exports and caused this GDP decline. According to Roger A. Arnold (2008), the gross domestic product (GDP) refers to the total market value of all final goods and services produced annually within a country’s borders. Based on the expenditure approach in computing GDP, a country’s GDP is the sum of its consumption, investment, government purchases, and net exports. While the GDP is a good measure of the total output capacity of a country, a country’s GDP omits certain underground activities (for example, the selling of illegal DVDs and VCDs), the sale of used goods, and financial transactions. Furthermore, a country’s GDP is only the aggregate total of an economy’s output and it does not represent the equality in income of its citizens.

Prior to the drop in commodity prices worldwide, Malaysian analysts was more concern over the impact of high oil prices rather than the US financial crisis on Malaysia’s GDP growth. The Malaysian Institute of Economic Research was quick to revise its GDP growth forecast upwards to 5.3 % as international commodity prices have retreated from their record high levels coupled with Malaysia’s higher than expected growth in the first half of the year (The Malaysian Insider, 2008). However, the independent research house lowered its GDP forecast to 3.5 % (the slowest pace in eight years) in 2009 amid poor global economic outlook and further predicted that Malaysia could fall in recession by the second or third quarter next year.

[pic]
|GDP vs. Real GDP Growth |Phillip 's Curve |

| |20.00% | | | |GDP | |14.00% | | | |

UNEMPLOYMENT & INFLATION

In 2001 Malaysia experienced its highest unemployment rate in seven years. Still, at 3.6%, its unemployment rate is not unwieldy. Inflation peaked in 1998 at 5.27%, and since then has steadily decreased. The inflation rate in Malaysia was recorded at 1.30 percent in November of 2012. Inflation Rate in Malaysia is reported by the Department of Statistics Malaysia. Historically, from 2005 until 2012, Malaysia Inflation Rate averaged 2.7 Percent reaching an all time high of 8.5 Percent in July of 2008 and a record low of -2.4 Percent in July of 2009. In Malaysia, the most important categories in the consumer price index are Food and non-alcoholic beverages (30 percent of total weight) and Housing, water, electricity, gas and other fuels (23 percent of total weight). Others include: Transport (15 percent); Communication (6 percent); Recreation and culture (5 percent) and Furnishings, household equipment and routine household maintenance (4 percent). The remaining components are Restaurants and hotels at 3.2 percent and miscellaneous goods and services at 6.3 percent.

Unemployment Rate in Malaysia remained unchanged at 3.20 percent in October of 2012 from 3.20 percent in September of 2012. Historically, from 1998 until 2012, Malaysia Unemployment Rate averaged 3.34 Percent reaching an all time high of 4.50 Percent in March of 1999 and a record low of 2.70 Percent in August of 2012. In Malaysia, the unemployment rate measures the number of people actively looking for a job as a percentage of the labour force.

Plotting Malaysian inflation rates against their corresponding unemployment rates, a trend line estimate of the Phillip’s Curve illustrates a relatively small trade-off between inflation and unemployment. This Phillip’s Curve estimate implies that monetary authority goals of limited inflation are in line with market expectations.

CURRENT ACCOUNT

The current account has been in surplus since 1998 and net exports have been positive since 1996. Though positive, net exports have been fallen in 2000 and 2001. The depreciation in 1997 caused a large increase in exports (24.7%) in 1998, while imports grew a modest 2.1%. Exports increased in 1999 and 2000, but at a slower pace than in 1998. Imports during 1999 and 2000 grew at a faster pace than in 1998. In 2001 Malaysia experienced negative growth in both imports and exports (about –9%). Notice that imports decreased twice after the crisis, but for different reasons. The first import reduction was the result of a sharply depreciated Ringgit. The second import reduction was necessary to maintain positive net exports and sufficient foreign reserves.

CURRENT PROBLEMS OF MALAYSIA

PROBLEM 1
Our blessing of oil and commodity resources which meant that we had little incentives to upgrade our manufacturing sector to rise to higher value-added chains. The blessing can be a curse in the long term.

PROBLEM 2
Subsidy policies: The subsidy implicit in the national car Proton at the expense of non-national cars which are overpriced due to high tax duties. The subsidy of food and fuel prices which makes cost of living artificially cheap so that wages can be low and cheap foreign labour can be employed. The hidden policy of keeping the Ringgit competitive vis the USD is also a subsidy for exporters. These subsidies prevent the proper allocation of resources and prevent manufacturing and other industries from rising up the value chain.

PROBLEM 3
The wealth distributive policies: The NEP if implemented properly should be to alleviate poverty of all races but instead is used as a political weapon. At the end of the day, affirmative action policies help no one except the rich and the political elite.

PROBLEM 4
Corruption from the top to the bottom. This is prevalent in the construction sector and other sectors where bidding for government contracts are not on open tender basis.

ANALYSIS

The consequences of these problems are evident in Malaysia’s macroeconomic data—GDP growth has sharply decreased since 2000 as a result of decreased exports.

In order to maintain its fixed exchange rate with the US Dollar, the Malaysian Central Bank must hold substantial foreign reserves (allowing it to back its currency in an exchange rate crisis). The existence of sufficient foreign reserves, then, is a necessary condition of a fixed exchanged rate.

Since the Malaysian government is currently holding sufficient foreign reserves, the fixed exchange rate regime is considered sustainable, at least in the short run. Malaysia has positive net exports and increasing foreign reserve s, but decreasing imports and exports suggest that the fixed exchange rate regime could face challenges in the future.

Several developing countries have tried fixed exchange regimes to protect their currencies from excessive devaluation and speculative attack. This solution has proven useful in the short-run, but may prove more harmful to the economy in the very long-run.

Recent South American examples illustrate the problems that come with maintaining a fixed exchange regime in the long term. During one period in particular, both Brazil and Argentina pegged their currencies to the US dollar. When Brazil’s economy began suffering under an overvalued currency, the government decided to give up on the fixed rate. The floating regime it adopted (with only limited Central Bank intervention) allowed Brazil to be more competitive in South America, while Argentina’s fixed regime undermined the economy and led to its eventual collapse in 2002.

Fixed regimes are also vulnerable targets for speculation. For example, if the Ringgit were under depreciative pressure to the US dollar, the Central Bank would have to buy dollar denominated assets and sell Ringgit denominated assets in order to maintain the fixed exchange rate. Thus, sufficient (convincingly sufficient ) foreign reserve is a requirement in a fixed exchanged system. Moreover, adopting a fixed exchange regime means giving up the ability to use independent monetary policy, since monetary policy in a fixed exchange regime is only used to maintain the exchange rate.

If the Ringgit starts depreciating against the US dollar, and the Malaysian central bank starts defensive operations, foreign reserves may be exhausted rapidly. Any economic downturn may challenge the future of the Malaysian fixed exchange rate regime.

RECOMMENDATIONS

Given the problems brought up by our analysis, we have three policy recommendations:

1. Gradually prepare its economy to adopt a floating exchange regime.

Step 1 - Malaysia should consider altering its exchange rate system away from the current peg (to the US dollar only), in favor of a peg combining a basket of currencies. Although Malaysia was able to limit the damage caused by the currency crisis through the imposition of a fixed exchange rate, this system may be harming the Malaysian economy. Reforming the fix regime by pegging to a basket of currencies (including trade competitors’) helps preserve Malaysia’s competitiveness on world markets. By including regional currencies, any pressure caused by US dollar strength will be offset by the currencies of Malaysia’s neighbors.

Step 2 – Once the Malaysian economy stabilizes, a semi- fixed regime (crawling band, crawling peg, or fixed band) should be implemented.

Step 3 – Finally, Malaysia should look to adopt a floating exchange regime for the very long run. Once a floating regime is instituted, Malaysia will not be forced to hold large foreign reserves ready to sustain the fixed or semi- fixed regimes. Foreign reserve monies can then be redirected toward investment in productivity and export diversification. In addition, monetary policy responses to eventual economic shocks will be made possible.

2. Maintain limited capital controls on Ringgit transactions.

The capital controls Malaysia installed after the currency crisis were not grand in scope, but limited to transactions in the speculation market. Investment in hard currency was not restricted, nor was foreign direct investment. Its capital controls have proved effective in shielding Malaysia from speculative attacks without substantially inhibiting foreign direct investment. This kind of limited capital control to protect the local currency from speculative attacks should continue in Malaysia—with or without IMF support.

3. Diversify Malaysian exports.

Economic prosperity and stability can hardly be achieved by financial policy alone—policies affecting the fundamentals are also required. Malaysia has made several public investments that may not help improve productivity. Examples of such investments include large highways and luxurious towers. While these investments may improve lifestyles, they do not improve productivity. Capital should be directed to projects that contribute to the diversification of exports and higher worker productivity (health and education). In particular, domestic food production should be encouraged so Malaysians will not be held captive by a depreciated currency and their need for basic foodstuffs.

Conclusion

The development of macroeconomics is one of the major breakthroughs of 21st century economics. The external factors lead to a much better understanding of how to combat periodic economic crisis and how to stimulate long term economics growth.
Macroeconomics issues dominated the Malaysia political and economics agenda since 1957. Malaysia had changed the economics patterns from agriculture to commodity and then to industrial sector. To enhance the industrial sector, Malaysia needs multinational firms to invest in the country. In 1985, Malaysia started to develop the heavy industry. In 1997, Malaysia started to develop its offshore finance territory in Labuan. By doing so, Malaysia started to attract the big investors both in manufacturing and services. Until 2005, Malaysia still needed USD12.6 billion FDI. So, today Malaysia needs to focus on the right FDI; manufacturing or services.

Bibliography

The Economist, 2008. A short history of modern finance: Link by Link. [online]. Oct 16th 2008, Available at: http://www.economist.com/displaystory.cfm?story_id=12415730 [Assessed 22 October 2008]

The Economist, 2008. Business in South-East Asia: The tigers that lost their roar. [online]. Feb 28th 2008, Available at: http://www.economist.com/world/asia/displaystory.cfm?story_id=10760174[Assessed 22 October 2008]

The Economist, 2008. Buttonwood: Heart of Glass. [online]. Jan 31st 2008, Available at: http://www.economist.com/finance/displaystory.cfm?story_id=10609325 [Assessed 13 October 2008]

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The Economist, 2008. Cross-Border Banking: Divided we stand. [online]. 16 Oct 2008, Available at: http://www.economist.com/finance/displaystory.cfm?story_id=12436205 [Assessed 22 October 2008]

The Economist, 2008. Echoes of the Depression: 1929 and all that. [online]. Oct 2nd 2008. Available at: http://www.economist.com/finance/displaystory.cfm?story_id=12342273&fsrc=rss [Assessed 22 October 2008]

The Economist, 2008. Economic Focus: Same as it ever was. [online]. Jan 10th 2008. Available at: http://www.economist.com/finance/displaystory.cfm?story_id=10496807 [Assessed 22 October 2008]

The Economist, 2008. Fannie Mae and Freddic Mac: end of illusions. [online]. Jul 17th 2008, Available at: http://www.economist.com/finance/displaystory.cfm?story_id=11751139 [Assessed 22 October 2008]

The Economist, 2008. Rescuing the banks: But will it work? [online]. Oct 16th 2008, Available at: http://www.economist.com/finance/displaystory.cfm?story_id=12432432 [Assessed 22 October 2008]

The Economist, 2008. Securitisation: Fear and loathing, and a hint of hope. [online]. Feb 14th 2008, Available at: http://www.economist.com/displaystory.cfm?story_id=10689043 [Assessed 22 October 2008]

The Economist, 2008. Special report- The world economy: Taming the beast. [online]. Oct 9th 2008, Available at: http://www.economist.com/specialreports/displaystory.cfm?story_id=12373748 [Assessed 22 October 2008]

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The Malaysian Insider, 2008. MIER says growth to fall from 5.3% in 2008 to 3.4% next year. [online]. Available at: http://www.themalaysianinsider.com/index.php/business/10623-mier-says-growth-to-fall-from-53-in-2008-to-34-next-year [Assessed 10 November 2008]

The Malaysian Insider, 2008. Nor Mohamed: Unemployment at 4 percent or lower. [online]. Available at: http://www.themalaysianinsider.com/index.php/malaysia/12696-nor-mohamed-unemployment-at-4-per-cent-or-lower [Assessed 16 November 2008]

The New York Times, 2008. An Insurance Giant, Brought Down. [online]. Available at: http://www.nytimes.com/imagepages/2008/09/27/business/20080928_MELT_GRAPHIC.html [Assessed 14 November 2008]

The Star, 2008. Bank Negara governor on the current situation in Malaysia. [online]. 15 November 2008, Available at: http://biz.thestar.com.my/bizweek/story.asp?file=/2008/11/15/bizweek/2547475&sec=bizweek [Assessed 26 November 2008]

The Star, 2008. Bank Negara says Malaysian banking system strong. [online]. 15 October 2008, Available at:http://biz.thestar.com.my/news/story.asp?sec=business&file=/2008/10/15/business/2278625 [Assessed 26 November 2008]

The Star, 2008. Consumer sentiment falls to all-time low, says MIER. StarBiz, 18 July 2008. p.B5.

The Star, 2008. Focus on new sources of growth. StarBiz, 27 June 2008. p.B12-13.

The Star, 2008. Focusing on balance sheets. StarBiz, 17 October 2008. p.B4.

The Star, 2008. Pump Priming the economy. BizWeek, 8 November 2008. p. BW8-11.

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Bibliography: The Economist, 2008. A short history of modern finance: Link by Link. [online]. Oct 16th 2008, Available at: http://www.economist.com/displaystory.cfm?story_id=12415730 [Assessed 22 October 2008] The Economist, 2008 The Economist, 2008. Buttonwood: Heart of Glass. [online]. Jan 31st 2008, Available at: http://www.economist.com/finance/displaystory.cfm?story_id=10609325 [Assessed 13 October 2008] The Economist, 2008 The Economist, 2008. Cross-Border Banking: Divided we stand. [online]. 16 Oct 2008, Available at: http://www.economist.com/finance/displaystory.cfm?story_id=12436205 [Assessed 22 October 2008] The Economist, 2008 The Economist, 2008. Economic Focus: Same as it ever was. [online]. Jan 10th 2008. Available at: http://www.economist.com/finance/displaystory.cfm?story_id=10496807 [Assessed 22 October 2008] The Economist, 2008 The Economist, 2008. Rescuing the banks: But will it work? [online]. Oct 16th 2008, Available at: http://www.economist.com/finance/displaystory.cfm?story_id=12432432 [Assessed 22 October 2008] The Economist, 2008 The Economist, 2008. Special report- The world economy: Taming the beast. [online]. Oct 9th 2008, Available at: http://www.economist.com/specialreports/displaystory.cfm?story_id=12373748 [Assessed 22 October 2008] The Economists, 2008 The New York Times, 2008. An Insurance Giant, Brought Down. [online]. Available at: http://www.nytimes.com/imagepages/2008/09/27/business/20080928_MELT_GRAPHIC.html [Assessed 14 November 2008] The Star, 2008 The Star, 2008. Bank Negara says Malaysian banking system strong. [online]. 15 October 2008, Available at:http://biz.thestar.com.my/news/story.asp?sec=business&file=/2008/10/15/business/2278625 [Assessed 26 November 2008] The Star, 2008 The Star, 2008. Focus on new sources of growth. StarBiz, 27 June 2008. p.B12-13. The Star, 2008. Focusing on balance sheets. StarBiz, 17 October 2008. p.B4. The Star, 2008. Pump Priming the economy. BizWeek, 8 November 2008. p. BW8-11.