For the past six months, Malaysia has been an investor darling. The economy is growing at a nice clip, the state-owned petroleum company, Petronas, is profitable, and the political transition from Prime Minister Mahatir to Prime Minister Badawi has been smooth. Inflation is low and the nation’s external debt is capably managed. We think that Malaysia enjoys the advantage of high oil prices. But when they fall, the nation is still poised to prosper as it has diversified its industrial base.\

Malaysia has one of the most open economies in Southeast Asia, and as a consequence it benefits from a greater boost from global growth (consensus estimates are that Malaysia will grow 7.0% in 2004) than many of its neighbors. The current account has been in surplus since 1998. As of Mid-October 2004, exports had risen 24% year-on-year. The strong balance of payments has allowed the central bank to accumulate more than a quarter of its international reserves in 2004 (US $54.5 billion as of August 2004), to the point that they now exceed the external debt.

Oil prices are high and this supports the Malaysian economy. Further, there has been some progress in passing structural reforms. Also, the Malaysian government has taken steps to reduce its external debt. The credit rating agencies have taken notice and we expect Moody’s to upgrade its “Baa1” rating of Malaysia by one notch to “A-”. Standard and Poor’s already rates the Malaysia credit “A-“.

A credit rating upgrade will be an important boost for Malaysian credit quality, but also an affirmation of the government’s fiscally prudent policies. The 2005 Budget, which proposes a moderate pace of fiscal consolidation, is realistic. In fact, it might be considered investor-friendly in that it eases foreign investor rules in brokerage, fund management, futures brokerages and venture capital firms. It also removes the tax on interest income for non-resident investors, which should drive more investor interest into Malaysia’s domestic bond markets.

Also, private investment growth seems to be picking up. The government estimates that investment will grow by 14.8% in 2004. In the meantime, the Central Bank (Bank Negara Malaysia) emphasizes caution in hiking interest rates such that no increase is expected for 6-12 months. While the government plans for fiscal consolidation, balancing the budget is not sacrosanct. The government intends to narrow the fiscal deficit from 4.5% of GDP in 2004 to 3.8% of GDP in 2005. The Malaysian Central Bank has also reinforced its commitment to a pegged exchange rate, which it regards as underpinned by low inflation and strong external accounts.

After years of stable, if partly authoritarian and confrontational government, under Prime Minister Mahatir, Prime Minister Badawi enjoys strong and unrivalled political support. Although some analysts suggest that Anwar Ibrahim could pose a political threat, we think that the mechanics of the Malaysian political system make this unlikely for the foreseeable future. Badawi has made progress in improving the public delivery system to lower the cost of doing business and increasing transparency (especially in the public bidding of projects).

The Malaysian economy is not without risks. It must continue to attract foreign direct investment when oil prices eventually decline. The Malaysian corporate sector must be made more competitive. Corruption remains a problem in both the private and public sectors. A tax system overhaul is needed to attract more multinational companies. In fact, in 2007 the Malaysian government plans to introduce a goods-and-services tax so that it can cut taxes for individuals and corporations. In the meantime, Malaysia’s corporate tax rate of 28%, is uncompetitive relative to Singapore’s 20 percent.

Malaysia is on the right track for balanced and steady growth going forward. It has been a strong economic performer since the 1997-98 financial crisis. There is every reason to believe that Malaysia will continue to provide an attractive environment for international investment.

© 2004 Jonathan Lemco for KWR International, Inc.
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