AMRO: Malaysia's Economy To Grow Moderately By 4.2% In 2023

According to AMRO's 2023 report, Malaysia's growth momentum is expected to be sustained this year by resilient domestic demand and stronger tourism recovery amid the global slowdown, following an exceptionally strong economic recovery last year.

The report noted that inflation has moderated but remains elevated and that the authorities are encouraged to continue efforts to contain inflationary pressure, build up foreign reserves, restore medium-term fiscal space, and accelerate structural reforms to strengthen the economy's resilience to future challenges.

These conclusions were highlighted in the 2023 Annual Consultation Report on Malaysia published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report was based on AMRO's Annual Consultation Visit to Malaysia in May 2023, and data and information available up to 30th June, 2023.

Economic developments and outlook

The economy is projected to grow moderately by 4.2% in 2023 after an exceptionally strong rebound of 8.7% last year, reflecting strong external headwinds. Growth momentum remains robust, supported by resilient domestic demand and strengthening tourism recovery owing to border reopening by regional economies. Labor market conditions continue to improve. Unemployment rate has fallen to near pre-pandemic level and labor force participation has soared to a record high.

Inflation has peaked and is expected to gradually decline in the near term, but will remain elevated. Monetary policy normalization has been conducted at a gradual and measured pace since May 2022 to tame the broad-based increase in inflation amid the strong economic rebound. To mitigate the rise in cost of living, the government has capped the price increase of selected basic goods through higher subsidies and expanded social assistance, which led to an increase in fiscal expenditure in 2022. The revised 2023 budget indicates a smaller fiscal deficit, largely reflecting a reduction in subsidies due to lower commodity prices.

On the external front, robust trade surpluses and buoyant foreign investment inflows have kept the external position strong. However, tighter global financial conditions and greater risk aversion have led to heightened volatility in the ringgit throughout 2022 and H1 2023. Malaysia's banking system remains sound with sufficient buffers to withstand credit and interest rate risks against the backdrop of increasing uncertainties.

Risk, vulnerabilities, and challenges

Risks to the growth outlook are skewed to the downside in the near term, arising from the likelihood of a sharper-than-expected slowdown in the United States (U.S.) and a slower pace of recovery in China. The inflation outlook faces upside risks from global commodity price shocks and the government's planned shift from blanket to targeted subsidies. Tighter-than-expected global financial conditions could trigger capital outflows, leading to higher domestic funding costs.

Over the medium term, escalating tensions between the U.S. and China could lead to global economic fracturing, with ramifications on Malaysia's trade and investment. In the long term, population aging, inadequate retirement savings, and risks from climate change may aggravate the fiscal burden and weigh on Malaysia's economic potential.

Policy recommendations

Monetary policy has scope for further tightening to contain inflationary pressure amid sticky core inflation and a positive output gap. The tighter monetary policy stance would help anchor inflationary expectation more firmly while mitigating the risk of financial imbalances.

Although exchange rate flexibility should be maintained as a shock absorber, foreign exchange interventions should be used judiciously to address excessive exchange rate volatility. Such interventions need to be backed by strong external buffers to be effective. Given the recent decline in foreign exchange reserves, Bank Negara Malaysia (BNM) should continue to build up foreign reserves when market conditions allow.

The government's efforts to accelerate the pace of fiscal consolidation is warranted. However, achieving the medium-term fiscal target would be challenging without introducing major tax reforms. In this regard, the sales and services tax (SST) should be broadened in the near term as a precursor to the reintroduction of the goods and services tax (GST) in 2025, the latter possibly at a rate of lower than 6%. The enactment of the Fiscal Responsibility Act and the Government Procurement Act would be crucial to improve transparency and institutionalize sound public finance. A shift from regressive blanket subsidies to more targeted subsidies would also be necessary to increase spending efficiency and provide fiscal space to strengthen social protection.

Continued efforts to pursue structural reforms to enhance competitiveness can strengthen national resilience. The authorities are encouraged to continue attracting high-quality foreign direct investments, strengthen workforce upskilling and reskilling programs in line with concerted efforts in building a digital economy, improve the adequacy and coverage of social protection, and speed up the implementation of policies to incentivize the shift to a low-carbon economy.