The Real Economy1Overview

The full effect of the regional financial crisis onthe Malaysian economy was felt in 1998. For theyear as a whole, real output declined by 6.7%after 12 years of uninterrupted expansion averaging7.8% per annum. Per capita income in nominalterms declined to RM11,835 (US$3,018) in 1998from RM12,051 in 1997 (US$4,284).

Malaysia’s strong initial conditions and theadjustment measures pursued in 1997 did notrestore stability in the domestic financial markets.Instability in the international financial marketsintensified in 1998, particularly in the early part ofthe year, which in turn spilled over into thedomestic markets. Continued waves of adjustmentin both the currency and stock markets, coupled

with the decline in domestic and export demandsubsequently prompted a shift to more growthpromoting policies. As the regional crisis becamemore entrenched, the orthodox InternationalMonetary Fund (IMF) policy prescription of tightfiscal and monetary policies would only havedestabilised the situation further and induced amuch sharper contraction in real output.

The tight fiscal and monetary policies that wereadopted in an environment of weakening externaldemand caused aggregate demand to fall moresharply than anticipated. During this period,inefficiencies in the domestic money market andthe loan intermediation process that emerged inthe early part of the year were further factors

Agriculture6.2% Manufacturing

17.3%Mining3.7%Imports of non-factor

services9.4%

Construction1.9%

Imports of goods40.3%

Demand for goods and non-factor services (RM261.4 billion)

Supply of goods and non-factor services (RM261.4 billion)

Graph 1.1: The Economy in 1998(at 1978 Prices)

Services21.2%

Private investment1

7.8%Exports of goods

50.5%

Public investment1

6.2%

Private consumption21%

Public consumption6.9%

Exports of

non-factor services7.6%

Trade, etc. 26.4%

Finance, etc. 26.5%

Government Services 20.2%

Transport, etc. 16.6%

Utilities 5.7%Others 4.6%

1 Include stocks

Table 1.1: Malaysia – Key Economic Indicators

1996 1997 1998p 1999f

Population (million persons) 21.2 21.7 22.2 22.7Labour force (million persons) 8.6 9.0 8.9 –Employment (million persons) 8.4 8.8 8.5 –Unemployment (as % of labour force) 2.6 2.6 3.9 4.5Per Capita Income (RM) 11,228 12,051 11,835 11,831

(US$) 4,446 4,284 3,018 3,113

NATIONAL PRODUCT (% change)

Real GDP 8.6 7.7 –6.7 1.0(RM billion) 130.6 140.7 131.3 132.6

Agriculture, forestry and fishery 2.2 1.3 –4.0 5.0Mining and quarrying 4.5 1.0 0.8 –0.4Manufacturing 12.3 12.5 –10.2 0.8 Construction 14.2 9.5 –24.5 –8.0Services 9.7 8.0 1.5 2.5

Nominal GNP 14.1 9.8 0.5 2.4(RM billion) 237.7 261.1 262.5 268.7

Real GNP 8.3 7.8 –6.3 1.5(RM billion) 123.2 132.8 124.5 126.3

Real aggregate domestic demand 1 7.0 6.5 –25.9 4.3

Private expenditure 1 9.0 6.3 –32.2 1.1Consumption 6.0 4.7 –12.4 1.1Investment 13.4 8.4 –57.8 0.9

Public expenditure 1 1.3 6.9 –6.6 11.4Consumption 1.4 5.3 –3.5 10.1Investment 1.1 8.6 –10.0 12.8

Gross national savings (as % of GNP) 38.5 39.4 41.2 40.2

BALANCE OF PAYMENTS (RM billion)

Merchandise balance 10.2 11.3 69.3 57.1Exports (f.o.b.) 193.1 218.7 282.0 277.6Imports (f.o.b.) 183.0 207.4 212.7 220.5

Services balance –19.5 –21.8 –23.4 –21.0(as % of GNP) (–8.2) (–8.3) (–8.9) (–7.8)

Transfers, net –2.9 –3.7 –9.9 –6.6Current account balance –12.2 –14.2 36.1 29.5

(as % of GNP) (–5.1) (–5.4) (13.7) (11.0)Bank Negara Malaysia reserves, net 70.0 59.12 99.43 –

(as months of retained imports) (4.4) (3.4) (5.7) –

PRICES (% change)

CPI (1994=100) 3.5 2.7 5.3 < 4.0PPI (1989=100) 2.3 2.7 10.7 1.5

Average wages in the manufacturing sector 8.4 7.3 0.3 –

Note: Figures may not necessarily add up due to rounding.

1 Exclude stocks.2 In 1997, the foreign exchange gain on the balance sheet date was not recognised in the Bank's account, in view of the volatility of the exchange rates during that

year.3

Arising from the fixing of ringgit/US dollar exchange rate at RM3.80 in September, 1998, all assets and liabilities in foreign currencies have been revalued into ringgitat rates of exchange ruling on the balance sheet date and the cumulative gain has been reflected accordingly in the Bank's current year account. The US dollarequivalent of international reserves as at 31 December, 1998 was US$26.2 billion.

p Preliminaryf Forecast

Table 1.2: Malaysia – Financial and Monetary Indicators

1996 1997 1998pFEDERAL GOVERNMENT FINANCE (RM billion)Revenue 58.3 65.7 56.7Operating expenditure 43.9 44.7 44.6Development expenditure 12.6 14.4 17.1Overall balance 1.8 6.6 –5.0Overall balance (% of GNP) 0.8 2.5 –1.9Public sector development expenditure 30.8 40.0 47.2Public sector overall balance (% of GNP) 4.2 6.6 –1.8

EXTERNAL DEBTTotal debt (RM billion) 97.8 170.8 159.8

Medium & long-term debt 72.7 127.5 131.3Short-term debt 25.1 43.3 28.5

Debt service ratio (% of exports of goods & services)Total debt 6.9 5.5 6.7Medium & long-term debt 6.2 4.7 6.0

Change in 1996 Change in 1997 Change in 1998 RM billion % RM billion % RM billion %

MONEY AND BANKINGMoney supply M1 8.7 16.7 2.8 4.6 –9.2 –14.6

M2 39.3 19.8 54.0 22.7 4.3 1.5M3 57.8 21.2 61.1 18.5 10.6 2.7

Banking system deposits 74.5 26.3 76.1 21.3 –2.1 –0.5Banking system loans1 72.1 27.6 88.2 26.5 –7.6 –1.8

Manufacturing 4.6 9.5 9.9 18.5 –0.1 –0.2Property sector 30.8 41.9 35.5 34.0 6.2 4.4Finance, insurance and business services 0.9 3.0 3.4 10.3 0.9 2.5

Loan-deposit ratio (end of year) 89.3% 92.7% 91.4%

1996 1997 1998% % %

Interest rates (average rates at end of year)

3-month interbank 7.39 8.70 6.46

Commercial banksFixed deposits: 3-month 7.21 9.06 5.83

12-month 7.26 9.33 5.74Savings deposit 4.10 4.23 3.87Base lending rate (BLR) 9.18 10.33 8.04

Finance companiesFixed deposits: 3-month 7.32 10.32 6.43

12-month 7.36 10.25 6.57Savings deposit 5.02 5.49 5.01Base lending rate (BLR) 10.65 12.22 9.50

Treasury bill (3-month) 6.39 6.76 5.31Government securities (1-year) 6.70 7.01 5.79Government securities (5-year) 6.55 7.75 6.66

1996 1997 1998% % %

Movement of Ringgit (end-period)Change against composite 2.6 – 31.4 –0.2Change against SDR 3.9 – 30.8 –1.8Change against US$ 0.5 – 35.0 2.3

1 Beginning December 1996, loans by sector are classified using a new statistical reporting format.p Preliminary

contributing to this process. These inefficienciesresulted in higher lending rates than those reflectedby the official intervention rate. These higher lendingrates led to debt servicing problems in thecorporate sector and threatened the stability of thefinancial system. It was evident towards mid-yearthat growth in GDP would contract significantly.Consequently, the strategies were reassessedto break the vicious cycle of destabil isingdevelopments in the financial sector and theeconomy reinforcing each other. As a result ofthese reassessments, the National Economic ActionCouncil announced a comprehensive NationalEconomic Recovery Plan to expedite recovery.

Policy response since May 1998 focusedon counter-cyclical measures to avoid arecession-deflation spiral. Fiscal policy was relaxedin March 1998 and monetary policy was eased inearly August 1998 when inflationary pressuresbecame subdued. The volatility in the financialmarkets, however, persisted arising from severalexternal developments including that in Indonesiain May, the weakening of the yen in June and theevents leading to the devaluation of the Russianruble. By the end of August 1998, the ringgit haddepreciated by 40% against the United States dollarfrom the pre-crisis level, while the stock marketdeclined by 72% during the same period. Giventhis continued adverse external environment,Malaysia imposed the selective exchange controlmeasures on 1 September to eliminate theinternationalisation of ringgit and to stabiliseshort-term capital flows. On 2 September 1998,the ringgit was also fixed at RM3.80 against the

United States dollar. To complement the selectivecapital controls, further measures were introducedto improve the liquidity flows in the bankingsystem to enhance the intermediation process andgenerate increased lending to viable businesses.Monetary policy was also eased further. Interestrates were brought down to levels prevailing atend-1995 following the progressive reduction inthe intervention rate of Bank Negara Malaysia(BNM) and the statutory reserve requirement (SRR).The banking sector reform programme was alsoaccelerated. Overall, the exchange control measuresresulted in greater stability in the currency andstock markets and the financial system, as wellas revival in domestic consumer and investorconfidence. Although the economy continued tocontract in the second half-year, on a year-to-yearbasis, the fundamentals had begun to strengthentowards end-1998.

Overall, the developments in 1998 clearlyindicated that the financial crisis was not only dueto the build-up of vulnerabilities in the regionbut also due to the shortcomings in the internationalmonetary system in dealing with short-termflows. The “herd” behaviour among marketparticipants led to market expectations becomingself-fulfilling. The international rating agenciesalso contributed to further market volatility withfrequent rating reviews to compensate for earliershortcomings of not having recognised the risks inthe region. The positive features of the Malaysianeconomy that were acknowledged by the marketand the international rating agencies included thelow inflation, a high level of savings, Malaysia’sopenness to international trade and foreign

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

Graph 1.2Contribution to GDP Growth: Domestic Demandand Net Exports

percentage point

1993 1994 1995 1996 1997 1998p

Domestic demand Net exports Real GDP growth

% growth

-10

-5

0

5

10

15

20

-10

-5

0

5

10

15

20

Graph 1.3GNP Growth and Nominal GNP per Capita

% growth RM ('000)

1993 1994 1995 1996 1997 1998p

Nominal GNP per capita Nominal GNP Real GNP

investment, low external debt, strong fiscalposition and a well-regulated and supervisedbanking system. The risks in the Malaysianeconomy which prompted adverse investorsentiment towards Malaysia were mainly the highloan-GDP ratio, the deficit in the current accountof the balance of payments and strong creditgrowth. Although there was general recognitionthat Malaysia had relatively stronger fundamentals,investors did not differentiate the risks in countriesin the Asian region. As Malaysia was not underan IMF programme, it was also perceived thatwithout an IMF programme, Malaysia would beless committed to structural reform. Investorsfailed to recognise that Malaysia does not qualifyfor an IMF programme in view of its relativelystrong balance of payments position and itsrelatively lower external debt exposure. Throughoutthe crisis period, external reserves of Malaysiawere adequate to finance more than threemonths of retained imports. Since controls wereintroduced in September 1998, these reserves haveincreased significantly. The payments systemcontinued to function effectively and did notbreak down during this crisis period. More

importantly, Malaysia did not default on itsexternal payments obligations.

In 1998, real GDP declined by 6.7%, with realaggregate domestic demand declining by 25.9%.The decline in private expenditure was significant.Uncertain economic outlook and employmentprospects, the deferment of high import contentprojects, the negative wealth effects from thedecline in share prices and the consequentialbalance sheet adjustments in the financial andcorporate sectors led to a significant contraction inprivate sector spending. The adjustment wasreflected in reduced consumption and investment.The decline in consumption and export demand

Table 1.4Private Consumption Indicators

1997 1998Q1 Q2 Q3 Q4 Year

Sales ofpassenger cars,including 4WD(’000 units) 314.4 23.1 29.1 38.9 51.1 142.2

MIER ConsumerSentiments Index(points) – 88.5 79.1 80.0 80.5 –

Imports ofconsumptiongoods(US$ billion) 5.0 0.9 0.8 0.8 0.9 3.4

Total loansapproved bybanking system(RM million)• Personal use 7,414 600 417 499 554 2,070• Consumer goods 1,520 44 24 21 10 99

Stock marketindicators 1

• Marketcapitalisation(RM billion) 375.8 452.9 285.9 249.1 374.5 374.5

• KLSE composite index (points) 594.4 719.5 455.6 373.5 586.1 586.1

DOS BusinessExpectationsSurvey 1H 2H(RM billion)• Gross revenue 48.1 15.9 17.1 33.0

Wholesale 41.3 13.9 14.9 28.8Retail 6.8 2.0 2.2 4.2

1 End-period

Table 1.3Malaysia: Savings-Investment Gap,1997-99

1997 1998p 1999f

RM million

Public gross domestic capital formation 31,564 31,750 36,809

Public savings 50,314 42,330 30,102

Deficit/surplus 18,750 10,580 –6,707

Private gross domesticcapital formation 85,394 40,257 41,746

Private savings 52,493 65,745 77,991

Deficit/surplus –32,901 25,488 36,245

Gross domestic capital formation 116,958 72,007 78,555(as % of GNP) 44.8 27.4 29.2

Gross national savings 102,807 108,075 108,093(as % of GNP) 39.4 41.2 40.2

Balance on current account –14,151 36,068 29,538(as % of GNP) –5.4 13.7 11.0

p Preliminaryf Forecast

Source: Department of Statistics and Bank Negara Malaysia

led to a build-up in stocks and excess capacity,depressing further private investment.

Following the imposition of selective exchangecontrols since September, monetary policy waseased further resulting in improved liquidityconditions and lower cost of funds. There was arevival in investor and consumer sentiment towardsend-year. This improved sentiment was reflected inthe Business Conditions Index of the MalaysianInstitute of Economic Research (MIER), whichindicated an increase in the index to 44.7 pointsin the fourth quarter from 41 points in the firstquarter of 1998. In addition, other indicators suchas the higher passenger car sales and loanapprovals for personal use showed an improvementin domestic consumer sentiment. The ConsumerSentiments Index of MIER improved to 80.5 points

in the fourth quarter from 79.1 points recorded inthe second quarter of 1998. Reflecting mainly thesharp contraction in the first three quarters of 1998,private sector expenditure declined by 32.2% inreal terms in 1998. The counter-cyclical policyadopted by the Government contained the declinein public spending to 6.6% in real terms.

On the supply side, the latest estimates showedthat the annual decline in real GDP was mostpronounced in the third quarter of 1998 (-9%).The decline in GDP moderated to 8.1% in thefourth quarter. However, on a preceding quarterbasis, real GDP had begun to increase since thesecond quarter of 1998.

In 1998, activities in all sectors were affected,with the exception of the mining sector. Theadjustment was most severe in the constructionsector, followed by the manufacturing andagriculture sectors (decline in output of 24.5%,10.2% and 4% respectively). The sharp contractionin the construction sector was due to completionof large projects, deferment of selected newinfrastructure projects and the slow implementationof existing infrastructure projects as well aspostponement of non-residential projects. Activity inthe sector was sustained mainly by the lessadverse developments in the residential sub-sectorwhich recorded a smaller decline as Governmentpolicy continued to encourage the implementationof housing projects, especially low- and medium-cost housing. The lower output in the manufacturingsector was due to both weak domestic and externaldemand, particularly the decline in exports to theAsia-Pacific region, including Japan. The decline in

Table 1.5Private Investment Indicators

1997 1998Q1 Q2 Q3 Q4 Year

Sales ofcommercialvehicles,including 4WD(’000 units) 90.4 4.8 4.2 5.0 7.6 21.7

Imports ofcapital goods(US$ billion) 15.5 2.8 2.2 2.3 2.0 9.3

MIER BusinessConditions Index(points) – 41.0 42.3 41.8 44.7 –

(RM billion)

Applications toMITI

• No. of projects 849 191 165 171 202 729• Total capital

investment 34.2 4.7 6.7 3.1 4.5 19.0Foreign 14.4 2.7 4.2 2.1 3.6 12.7Local 19.8 2.0 2.5 0.9 0.8 6.3

Approvals byMITI

• No. of projects 759 261 167 199 217 844• Total capital

investment 25.8 11.2 4.8 7.0 3.4 26.4Foreign 11.5 4.8 2.0 5.2 1.1 13.1Local 14.3 6.4 2.8 1.8 2.3 13.3

Total loansapproved by thebanking system• Manufacturing

sector 27.6 2.0 2.2 2.6 3.7 10.5• Construction

sector 18.6 1.2 1.2 1.2 2.0 5.6

28000

29000

30000

31000

32000

33000

34000

35000

36000

37000

38000

-2.7%

7.4%

5.2%0.9%

-4.3%

6.5%

4.4% -0.4%

-12.2%

2.2%

0.5%

Graph 1.4Quarterly GDP and Growth over Preceding Period

1996 1997 1998

1.8%

RM million

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

,

,

,

,

,

,

,

,

,

,

,

output was broad-based and affected both export-and domestic-oriented industries, with the exceptionof the rubber products industry. The decline inoutput of 4% in the agriculture sector reflected anacross-the-board decline in the production of allmajor commodities. Output in this sector wasaffected by lower external demand that wasaggravated by inclement weather, labour shortages,unfavourable prices, reduced cultivated area andlower yields. Reflecting the contraction of activitiesin the other major sectors, the performance of theservices sector was sluggish, as evidenced by thedecline in the wholesale and retail trade, hoteland restaurants sub-sector and a deceleration inthe growth of the other services sub-sectors. Onlyoutput of the mining sector increased, mainly onaccount of higher crude oil production. Output oftin registered a positive growth in 1998 in responseto the favourable price for the commodity, whilegas production increased marginally.

On the positive side, the adjustment measuresimplemented succeeded in restoring the externalbalance and containing inflation. The currentaccount in the balance of payments turned aroundto record the first surplus since 1989, amountingto RM36.1 billion or US$9.2 billion. In terms ofGNP, the surplus amounted to 13.7% of GNP.The significant decline in investment, amidst anincrease in savings, contributed to a large resourcesurplus in the balance of payments. Theconsolidation in private sector investment activityled to a 40.3% decline in imports of capital goodsin United States dollar terms. With weak exportdemand, imports of intermediate goods alsocontracted, albeit at a lower rate of 21.3%.The increase in gross national savings (41.2% ofGNP) reflected both higher income levels duemainly to gains arising from the weaker ringgit aswell as the decline in consumer spending.Reflecting this trend, imports of consumption goodsalso registered a contraction of 32.7%.Developments on the export front in the fourthquarter were more encouraging. The decline inexports in United States dollar terms stabilised inSeptember and increased thereafter.

The favourable balance of payments position andthe stabilisation of short-term capital flows followingthe implementation of selective exchange controlsled to a significant strengthening of the externalreserves of BNM. The net international reservesincreased from US$21.7 billion at the end of 1997to US$26.2 billion at the end of 1998, adequate

to finance 5.7 months of retained imports. Externalreserves increased further to US$28.7 billion as atthe end of February 1999, adequate to finance6.2 months of retained imports. At the same time,total external debt outstanding declined by 6.4%to RM159.8 billion at the end of 1998 (end-1997:RM170.8 billion). In United States dollar terms,external debt was equivalent to US$42 billion.Consequently, the ratio of external debt to GNPdeclined to 60.9% in 1998 from 65.4% in 1997.The decline in total external debt was due entirelyto the decline in short-term external debt. Ofsignificance, the ratios of short-term debt to totalexternal debt and external reserves holdings wererelatively low. The share of short-term external debtto total external debt declined from 25% at theend of 1997 to 18% at the end of 1998. Thismakes Malaysia less vulnerable to credit outflowsover the short term. The nation’s medium- andlong-term external debt outstanding increasedmoderately by 3% to RM131.3 billion at the endof 1998, due largely to the drawdown of externalloans of RM4 billion by the Federal Government.In the pre-crisis period, total external debt of theFederal Government had progressively declined toRM9.1 billion or US$3.6 billion (3.5% of GNP).This favourable position accorded greaterflexibility to the Government to raise funds abroadto finance the stimulus package and strengthenthe banking system.

Inflation, which trended higher towards the endof 1997 and in the first half of 1998 under theimpact of the depreciation of the ringgit, declinedprogressively after June 1998. The sharper-than-expected contraction in aggregate demand andexcess capacity in the economy reduced inflationarypressures arising from the decline in the ringgit.The rate of increase in the Consumer Price Index(CPI) moderated progressively to 5.3% in December1998, after the year’s peak of 6.2% in June. For1998 as a whole, inflation rose by 5.3%, lowerthan the earlier expectations of 7–8%. Excludingfood, the adjusted CPI rose more moderately by3.1%. The fixing of the ringgit exchange rateagainst the United States dollar also reducedinflationary expectations.

On the employment front, the contraction inoutput led to a softening of the domestic labourmarket. The rate of unemployment is estimated tohave increased to 3.9%, below the full employmentlevel of 4%. During the year, 83,865 workers wereretrenched. Nevertheless, the demand for labour

remained strong in selected sub-sectors, with74,610 vacancies reported throughout the country.Reflecting labour market flexibility, wage increasesshowed a moderating trend in 1998.

Macroeconomic policy management in 1998focussed on reducing risks in the economy toensure macroeconomic stability and promote astronger financial system. The policies evolved atdifferent stages of the economic crisis. Throughoutthe crisis period, the objectives of policy remainedunchanged, namely to maintain price stability whileavoiding a further contraction of the economy.However, as circumstances changed, policies hadto be adjusted or modified to ensure objectiveswere realised.

Monetary policy was adjusted during the courseof 1998. At the start of the year, the policy ofmonetary restraint was aimed at containinginflationary pressures arising from the ringgitdepreciation as well as to preserve stability in thedomestic financial markets. BNM believed thathigher interest rates would not be effective insupporting ringgit exchange rates. The basicfundamental principle that was adopted indetermining interest rates was to ensure that theexpected real rate of return on ringgit deposits isnot eroded and to ensure adequate return on ringgitassets to avoid capital outflows. The tight liquiditysituation following the ringgit depreciation and theinefficiencies in the domestic financial markets wereaddressed by placement of RM34 billion by BNMinto the banking system to reduce pressures oninterest rates, which were kept relatively low in1997. Interest rates were, however, raised to thehighest level of 11% in February 1998 followingthe marked deterioration of the Indonesian rupiahby 45% and the depreciation of the ringgit toUS$1=RM4.88 on 7 January 1998. Although interestrates were adjusted upwards in line with theincrease in the expected rate of inflation duringthis period, consideration was also given to theneed to ensure that the productive sectors of theeconomy had access to financing at reasonablecost and the need to maintain price stability anda stable exchange rate. Hence, interest rates inMalaysia remained significantly lower compared withlevels in other countries in the region which werealso affetced by the crisis. At the same time, BNMalso reduced the SRR to lower funding costs forbanks. This contributed to removing marketdistortions which had emerged during the flight toquality as depositors shifted funds to larger

institutions. In order to offset the effects of higherlending rates on the more vulnerable segments ofsociety, special funds were set up to enhanceaccess to financing by selected sectors atconcessional rates. In addition, measures to improveliquidity flows were implemented, including furtherreduction of the SRR and measures to makemoney market operations more transparent and toensure efficient liquidity management.

Despite the injection of funds by BNM into thebanking system, weaker business expectations andmore cautious lending policies of the bankinginstitutions led to a sharper-than-expected slowdownin loan growth. Thus, with banking institutionscontinuing to be preoccupied with managing theirexisting asset portfolios, total loans extended bythe banking system generally declined sinceFebruary 1998. The lack of access to credit byborrowers contributed to dampening the Malaysianeconomy further. Real output contracted by 2.8%in the first quarter and further by 6.8% in thesecond quarter. In the first half-year, real GDPcontracted by 4.8%.

The adverse developments in the real andfinancial sectors led to the deterioration in theasset quality of the banking institutions. The lowerstock prices and higher interest rates made it moredifficult for companies to service loans. The non-performing loan ratio rose on the average by 1%a month. As at end-June 1998, the net non-performing loans (NPLs) to total loans ratio for thebanking system had increased to 8.9% based onthe 3-month classification from 4.7% as at 31December 1997. The risk-weighted capital ratio(RWCR), however, remained high at 11.2% as atend-June 1998 from 12% as at end-June 1997.While the RWCR of the banking system as awhole remained well above the minimum Bank forInternational Settlements (BIS) requirement of 8%,some banking institutions required recapitalisation.

Given these adverse developments from theprolonged crisis and the sharper-than-anticipatedcontraction in the domestic economy, Malaysiaadopted a comprehensive approach to avoid adeflation-recession spiral. Recognising the limitedcapacity of the private sector due to liquidityproblems, it was decided in early 1998 that thepublic sector would bear the major burden ofstabilising domestic demand. The successful fiscalconsolidation since 1982, which was evident in the

budget surpluses during the period 1993-97, gavegreater flexibility to the Government to adopt anexpansionary fiscal stance. In late July, the NationalEconomic Action Council announced the NationalEconomic Recovery Plan (NERP) to provide acomprehensive and action-oriented framework toexpedite economic recovery. The six objectives ofthe NERP are interrelated and complementary, thatis, stabil ising the ringgit; restoring marketconfidence; maintaining financial stabil ity;strengthening economic fundamentals; continuing theequity and socio-economic agenda; and restoringadversely affected sectors.

Fiscal policy was selectively relaxed beginningMarch 1998, following changing economic andfinancial conditions. At the time of the Budget 1998(October 1997), the Federal Government targetedto maintain a fiscal surplus of 2.7% of GNP. Thistarget was reduced to 0.5% in March 1998 andthereafter to a deficit of 3.7% of GNP. The fiscaldeficit remained manageable, funded by non-inflationary finance, mainly domestic savings. Thefiscal measures included selective increase ininfrastructure spending, setting-up of funds tosupport small- and medium-sized enterprises, higherallocation on social sector development as well asreducing taxes. Additional expenditures have beencarefully programmed to generate high multipliereffects, without rekindling inflationary pressures whilepreserving the improvement in the current accountposition of the balance of payments. Special fundswere also established or expanded to provide creditto priority sectors at concessional rates.

With the moderation in inflation, monetary policywas eased in August to be consistent with fiscalpolicy in promoting new activities. The SRR andBNM 3-month intervention rate were reducedin stages. To encourage banking institutions tobreak from the self-imposed mentality of cuttingback loans, banks which had the capacity tolend were encouraged to increase loan growthto at least 8%. Rules on recognition of NPLswere also adjusted to provide breathing roomto both financial institutions and the corporatesector, without sacrificing financial prudenceand supervision.

At the same time, BNM embarked on acomprehensive restructuring programme for thebanking sector. The approach was to provide amechanism to deal with the rising NPLs, the need

for recapitalisation of certain banking institutionsand corporate debt restructuring in a market-oriented and transparent manner. The approachwas also pre-emptive because the institutionalarrangement commenced as early as March 1998before NPLs reached high levels. The institutionalframework to restructure the banking institutionsstarted as early as January 1998 with the mergerprogramme for finance companies to consolidatethe sector. The final outcome would be a reductionin the number of finance companies from 39 toless than half of this number. Subsequently, inJune 1998, the Government set up PengurusanDanaharta Nasional Berhad (Danaharta), an assetmanagement company, to purchase NPLs from thebanking institutions. The objective was to enablethe banking institut ions to focus on loanintermediation to support economic activities. Thebanking system remained relatively resilientthroughout the crisis. The existence of highprudential and supervisory standards prior to thecrisis had placed the system on a strong foundationto cope with the stress from the crisis. However,while the industry as a whole remained resilient,certain banking institutions experienced capital loss.Danamodal Nasional Berhad (Danamodal), aspecial purpose vehicle was set up as an interimfunding vehicle which would meet the requiredcapital injections of affected institutions.

In order to contain the growth in NPLs, it wasessential to address financing problems of viablebusinesses which were affected by the crisis. InAugust, the Corporate Debt RestructuringCommittee (CDRC) was set up to complementthe restructuring of the financial institutions. TheCDRC’s main objective was to implement acomprehensive framework for debt restructuringthrough bringing together creditors and debtors fora voluntary debt workout. To co-ordinate theactivities of the three agencies, a SteeringCommittee, chaired by the Governor of BNM,oversees and monitors the policies, operations, andprogress of these agencies to ensure that theyoperate in a cohesive and structured manner toachieve the objectives. The financial corporaterestructuring exercises in Malaysia are based onthe following principles:

• Minimise the use of public funds;

• Transparency in the bank restructuring processas well as operating guidelines for theinstitutions established to undertake therestructuring process;

• Operations of institutions based on commercialand market-oriented principles;

• Recapitalisation of financial institutions mustbe tied to comprehensive restructuring of eachfinancial institution including, where appropriate,a change in management; and

• Ensure equitable burden-sharing amongstakeholders.

Despite the measures taken, uncertainty overinternational and regional developments remained.Instability in the ringgit exchange rates was furtheraggravated by outflows of ringgit to offshore ringgitmarkets. It was felt that ringgit exchange ratescould only stabilise with a return of positivesentiment and confidence and economic recovery.The need to stabilise the ringgit exchange ratesprompted the imposition of selective exchangecontrols on 1 September 1998. The controls weretargeted at containing potential speculation againstthe ringgit by reducing the avenues for offshoremarkets to fund ringgit activities. Convertibility ofthe current account transactions was maintained,and inflows and outflows of long-term foreigninvestment remained free. On 2 September 1998,the ringgit exchange rate was also fixed atUS$1=RM3.80. The exchange control measures arenot intended to disrupt or dislocate genuine trade-related activities or foreign direct investment (FDI).The rules on FDI have not changed. Indeed,Malaysia had further liberalised the foreign equityinvestment guidelines in selected sectors in orderto encourage the inflow of longer-term capital tofurther boost the foreign direct investment(FDI). The share of foreign equity investment hadbeen raised to 49% in the telecommunicationssector (61% for a period of 5 years on acase-by-case basis); 51% in the insurancesector (subject to certain conditions) and 49% inthe stock broking industry. In the manufacturingsector, 100% foreign ownership was allowed forapplications received between 31 July 1998 and31 December 2000.

While the exchange control measures did notact as a constraint, long-term investors, however,remained cautious due mainly to the uncertainglobal environment. While the value ofmanufacturing investment approved by theMinistry of International Trade and Industry (MITI)increased to RM26.4 billion in 1998 (RM25.8 billionin 1997), the value of applications received by

MITI for the establishment of manufacturing projectswas lower amounting to RM19 billion (RM34.2billion in 1997).

Overall, Malaysia ended the year on a positivenote, with the underlying economic conditionsgenerally favourable. Price pressures had abated,with CPI stabilising at 5.3% for 1998, lower thanthe earlier projection of 7–8%. The economy hadshown signs of recovery, although real GDP inthe second half-year, on a year-on-year basis,continued to contract due to the high base in1997. Of significance, exports in key sectors,including electronics, had improved in United Statesdollar terms. The external reserves of BNM hadnot only remained intact and unencumbered, buthad also continued to rise by US$8.5 billion fromUS$20.2 billion at end-August to US$28.7 billionat end-February 1999, adequate to finance 6.2months of retained imports. On the employmentfront, the situation is improving, with the numberof employees retrenched declining to 5,556 inDecember, from a peak of 12,335 in July. Thenumber of registered job seekers is on a decliningtrend (33,345 as at end-1998; 34,514 as at end-July 1998).

The fixed exchange rate had been positivefor economic activity. Lending rates had declinedto below pre-crisis levels, and loan approvals havebegun to increase. The value of loans approvedby the banking system has picked up to a monthlyaverage of RM7.1 billion in September-December,compared with an average of RM4.2 billion in thefirst eight months of 1998. On an annual basis,loans extended by the commercial banks rose by3.3% as at end-December 1998. This increasewas, however, more than offset by the decline inloans extended by the finance companies (–15%)and the merchant banks (–3.7%). The decline inloans extended by the finance companies was tosome extent due to the ongoing merger programmeand restructuring exercise that affected their lendingoperations. With the inclusion of NPLs soldto Danaharta, outstanding loans in the bankingsystem would have increased by 1.3% on anannual basis.

The progress on bank restructuring had beenon track. Danaharta had acquired and managedNPLs from the banking institutions amounting toRM15.1 billion, equivalent to about 20% of totalNPLs of the banking system. Including NPLs

Introduction

The East Asian crisis that began in July 1997was unprecedented in terms of the speed andseverity of the contagion effect which spread tocountries spanning three continents. At its initialstage, the crisis was perceived as an isolatedproblem affecting individual countries. However,as the crisis deepened and widened, aninternational consensus emerged that externalfactors also contributed to the crisis. This articlesummarises the evolving views on the roots ofthe Asian crisis and the corresponding policyresponses. It concludes that both domestic andinternational factors contributed to the crisis andthat the appropriate response would be neededto address weaknesses on both fronts.

Why is the Asian Crisis Different fromPrevious Crises?

The Asian crisis occurred following a decadeof strong economic performance in all crisis-affected countries. To varying degrees acrosscountries, the crisis resulted in a significantwealth loss, declines in asset prices, suddencapital flight and threats to currency and bankingsystem stability. Adverse consequences werereflected in corporate problems, rising non-performing loans in the banking institutions,declining output, rising unemploymentand deflation.

Unlike previous crises such as the global debtcrisis in the 1980s, which originated mainly fromthe public sector, the source of instability in theAsian countries emanated mainly from the privatesector. Conditions prevailing in the Asian crisiscountries prior to June 1997 showed that thesecountries had strong fundamentals — pricestability, high saving and investment ratios, fiscalsurplus and high foreign exchange reserves.Capital inflows financed investment rather thanconsumption. However, there were somesimilarities between the Asian and Mexican crises

The Asian Crisis: A Survey of Views on theCauses and Policy Response

in terms of large short-term capital inflows, largecurrent account deficits, and nominal and realexchange rate appreciation. In the case of theAsian countries, the general consensus is thatthe “trigger” for the crisis was the rapidaccumulation of private short-term foreign debt.

Causes of the Asian Crisis

The depth and severity of the contagion ofthe Asian crisis have created considerable debateon the cause of the crisis and theappropriateness of policy responses. The differentviews on the causes of the Asian crisis can bebroadly categorised into two groups. The firstview attributes the crisis primarily to policyweaknesses in the domestic economy, while thesecond view maintains that external factors wereresponsible for the crisis.

Among the proponents of the view that thecrisis reflected domestic policy weaknesses wasthe International Monetary Fund (IMF). Whileaccepting that fiscal balances were generallyfavourable in the crisis-affected economies, theIMF had raised concerns on overheatingpressures that became evident in many countriesin the region that was manifested by largecurrent account deficits and property and stockmarket bubbles. The IMF further suggested thatthe crisis stemmed from weaknesses in domesticfinancial systems and governance in thesecountries. According to this view, a combinationof inadequate financial sector supervision, poorassessment and management of financial risk,and the maintenance of relatively fixed exchangerates led banks and corporations to borrow largeamounts of international capital. Much of theborrowing was short-term, denominated in foreigncurrency, and unhedged. Sluggish growth in theadvanced economies, in particular Europe andJapan, made investments in fast-growing Asiancountries relatively attractive and thus led to the

Box I

build-up of foreign capital inflows. Over time, itwas argued that these inflows tended to beused to finance poorer-quality investments. It wasfurther suggested that this was exacerbated bygovernance issues, notably governmentinvolvement in the private sector and lack oftransparency in corporate and fiscal accountingand the provision of financial and economic data.As the crises unfolded, the questions that wereraised about the authorities’ commitment andability to implement the necessary adjustmentand reforms also exacerbated pressures oncurrencies and stock markets.

The World Bank shared this view that thekey problems were in the financial sector, wheredistorted incentives, weak regulatory standards,poorly managed financial liberalisation, andinadequate disclosure and supervisionencouraged excessive risk taking. It was arguedthat these financial sector weaknesses led topoor investments and a proliferation of non-performing loans. Large capital inflows amplifiedthese problems and fuelled domestic demandwhich, coupled with the depreciation of the yenagainst the dollar, caused real exchange ratesto appreciate. When the crisis broke out, thecurrency depreciation increased the local currencyvalue of the external debts owed by banks andbusinesses, creating solvency problems. As debtsmounted, the firms attempted to reduce theirforeign exchange liabilities by obtaining dollarsto close out open positions. This furtherincreased the demand for foreign exchange, thusleading to even greater depreciation of thedomestic currency. The crisis also resulted inimmense human suffering due to lack of socialsafety nets in crisis-affected countries as theyhad relied on rapid growth and employment toprovide social security to their people.

Among the academia, Professor PaulKrugman of the Massachusetts Institute ofTechnology (MIT) attributed the crisis tomacroeconomic policy slippages and weaknessesin financial systems in the affected countries.He suggested that the crisis originated fromfinancial intermediaries whose liabilities wereperceived as having an implicit governmentguarantee, but were essentially unregulated and,therefore, subjected to severe moral hazardproblem. This resulted in financial excesses,over-investment, unrealistic speculation,particularly in real estate, and inefficient resource

allocation to politically connected individuals, allof which inflated asset prices. Imprudent publicspending also contributed to the build-up to thecrisis, following several years of rapid growth.This view emphasises the reaction of currencyand equity markets to payments disequilibriumand weak economic fundamentals, which includelarge current account deficit and external debt.

According to Professor Rudi Dornbusch ofMIT, the Asian ‘capital market crisis’ reflectedthe varying degrees of exposure of Asiancountries to external capital or financialinstruments, which rendered the economiesvulnerable to various developments. Thesevulnerabilities arose from a mismatch ofmaturities and currency denominations of assetsand liabilities of financial systems and largecorporations in the Asian countries. Anothersource of vulnerability was market risk whereexternal funds were borrowed to purchase foreignstocks and commodities whose value fluctuatedwith the movements in the exchange rates. Sincethe banks and companies had collectivelyassumed a large risk position, the national creditstanding was also at risk. The build-up of thesevulnerabilities was the result of fragile financialstructures arising from negligent or deliberatelack of regulation, supervision and transparency.External factors did play a role in the run upto the crisis, namely the performance of theJapanese economy which adversely affected thetrade environment of the Asian economies. Theother factor was the sharp fluctuation of yen/dollar exchange rate.

In contrast to the earlier views that blamedthe crisis mainly on domestic economicconditions and policies in the Asian countries,an alternative view pointed to weaknesses inthe international financial system. The mainproponent of this view has been ProfessorJeffrey Sachs of Harvard University, who notedthat economic fundamentals in the crisis-affectedcountries were basically sound. The crisis wasseen as a classic case of financial panic withcapital flight aggravated by the mismatch ofmaturities and currencies of many Asian banksand borrowers. This view noted that the financialsystem in the affected countries was notadequately prepared to deal with the risks ofrapid financial liberalisation, which rendered thecountries vulnerable to external shocks. Theproblem was compounded by weaknesses in the

international financial system. Such weaknessespermitted massive and volatile cross-bordercapital flows that often overwhelmed therelatively small size of financial markets inemerging economies.

Professor Jagdish Bhagwati of ColumbiaUniversity has written that the Asian crisis wasdue partly to rapid financial liberalisation in thecrisis countries, without the adequate policy andinstitutional framework. He voiced concern thatwhile the benefits of free capital movementshad frequently been propagated, its costs wereoften underestimated, including that of anoutbreak of systemic crisis. The arguments infavour of free trade do not necessarily apply tocapital movements. Unlike trade, failures incapital markets can be severe because of lackof information and the problem of mismatch ofassets and liabilities.

In a recent speech, Mr. Joseph Yam, ChiefExecutive of the Hong Kong Monetary Authority,maintained that the crisis reflected the flaws inthe global financial system. He noted thatfinancial market liberalisation and globalisation,advancements in information technology and theincreasing sophistication of investment tools haveoutpaced improvements in the management ofthe global financial system, which remainedprimitive and fragmented and rendered theinternational financial architecture incapable ofcoping with the demands of global finance. Theessence of the problem was the operations ofthe highly leveraged institutions, which couldmove vast amounts of funds around the worldrapidly and with little or no regulation. Hemaintained that, by distorting or manipulatingmarkets in search of profits, the highly leveragedinstitutions were “capable of throwing manysmaller, vulnerable economies into chaos”.

Malaysia has been among the first countriesto voice the view that the Asian crisis reflectedshortfalls in the management of the internationalfinancial system. During the Joint AnnualMeetings of the IMF and World Bank inSeptember 1997, the Prime Minister, Dato’ SeriDr. Mahathir Mohamad, highlighted the dangersof volatile flows of speculative, short-term capitalin disrupting trade and real economic activities.Large market players had been able tomanipulate the financial markets to theiradvantage, to the detriment of the economic

well-being of many economies. Furthermore,trade in currency, which had become so muchbigger than real trade in goods and services,only contributes to huge uncertainties and volatilecurrency movements so as to cause financialcrisis for the country concerned. As such, hehad called for an international mechanism toregulate short-term capital flows. Despite theinitial differences in views, there is now agrowing consensus that the Asian crisis alsoreflected flaws in the international financialarchitecture.

Policy Response

At the initial stage of the Asian crisis, thepredominant view of the international communitywas that the crisis was an isolated case ofpolicy weaknesses in individual countries. Hence,the international response focused on efforts toencourage the crisis-afflicted countries toimplement economic and financial reforms,increase transparency of government policies andundertake macroeconomic adjustments andmeasures to strengthen domestic economic andfinancial systems.

Thailand, Indonesia and Korea initiallyinstituted measures to address their respectiveeconomic weaknesses and to stem speculativeattacks on their currencies. These countriessubsequently sought financial assistance from theIMF. In line with IMF programmes, conditionalitiesof tight monetary and fiscal policies, andstructural reforms were imposed, particularly inthe financial sector. The rationale was as follows:tight monetary policy was needed to restoreconfidence and contain inflation. Higher interestrates were viewed as necessary to supportdomestic currencies. Fiscal tightening wasneeded to correct macroeconomic imbalancesand to make up for the cost of cleaning up thefinancial sector. Rapid structural reform wasneeded to address financial sector weaknesses,imbalances in corporate finances, improvegovernance, and market imperfections. Trade andfinancial liberalisation were also included in theprogrammes to attract foreign capital.

In all three countries, fiscal and monetarypolicies were tightened significantly from theinception of IMF programmes. Financial sectorrestructuring was initiated. The intensity and

implementation of the reforms varied to reflectthe different institutional framework and machineryin each country. Non-viable financial institutionswere closed and legal and institutionalframeworks were established for the disposal ofassets, as well as bankruptcy and foreclosureprocedures. The remaining viable financialinstitutions were recapitalised, either throughdomestic or foreign capital, or a combination ofboth. Labour market reform was also carriedout. In some countries, structural reforms alsoincluded the dismantling of monopolies andabolition of subsidies which were subsequentlyreinstated, following social unrest.

The IMF programmes instituted in the threeAsian countries were fairly similar to the Mexicanprogramme in 1995. In the case of Mexico,apart from tight monetary and fiscal policies,adoption of a floating exchange rate, andadvances in structural reform and marketliberalisation, the Mexican government alsoimplemented measures to avoid contagion. Thesemeasures included provision of liquidity in foreignexchange by the central bank to commercialbanks to prevent them from becoming delinquenton their foreign obligations. Also included werethe activation of a programme to providetemporary capital to banks and a subsequentprogramme to increase the incentives forinvestment in distressed banks, legal reforms toallow greater foreign equity participation in banksand programmes to back certain categories ofbank debtors.

The difference though was in the timing ofefforts to address the external debt problems.In the case of Mexico, negotiations with foreigncreditors for debt restructuring purposes wereinitiated soon after the inception of theprogramme. In the case of the three Asiancountries, debt restructuring came later in theprogrammes. In Mexico, there were fiscalimbalances, with very high public sector’s short-term external liabilities. This was not the casein Asia. Thus, the cutback in public expenditureand fiscal consolidation, in addition to higherinterest rates, exacerbated the economicdownturn. As the domestic currencies continuedto depreciate, the liquidity problems of thefinancial systems and corporate sectorsworsened, because the depreciated currenciestranslated into rising debt denominated indomestic currencies. The problem was only

resolved when the affected countries startednegotiations for a rollover of short-term creditfor a period of three months until end-March1998 and to further convert them into medium-term bonds. In the case of Indonesia, otherfactors caused delays in assistance and theimplementation of IMF programmes.

There has been significant debate on the IMFpolicy response. The World Bank has suggestedthat the IMF’s prescription of high interest ratesand fiscal restraint has contributed to therecessionary forces. Jeffrey Sachs argued thatthe rescue package by the IMF should havedelivered more financial assistance and lessconditionalities. Meanwhile, Martin Feldstein fromHarvard University suggested that the demandsby IMF for far-reaching structural reforms toresolve Asia’s liquidity crisis were unnecessaryand counter-productive. Paul Krugman providedan alternative to the crisis countries byadvocating capital control, with certainpreconditions. The imposition of exchangecontrols should complement, not replaceeconomic and financial reforms and that thecontrols should not be used to defend an over-valued currency. Since it imposed distortions onthe economy, it should not be maintained anylonger than necessary, with a clear exit policy.

Contagion Dynamics

Contagion during the Mexican crisis waslimited to a few countries in Latin America. Incontrast, contagion was widespread in the caseof the Asian crisis. An attack on one currencyspilled over or spread to the currencies of othercountries with apparently sound fundamentals.This could be attributed to trade and capitalmarket linkages (through a devaluation in onecountry which adversely affected the internationalcompetitiveness of other countries) orinterdependence in the creditors’ portfolios (whereil liquidity in one market forces financialintermediaries to liquidate assets in othermarkets).

The Asian crisis, which was initially confinedto East Asia, spread to other regions by theend of 1997. This reflected market concern overthe emergence of vulnerabilities in these regionssimilar to those seen earlier in Asia. In contrastto the Mexican crisis, the international setting

prior to the outbreak of the Asian crisis wascharacterised by declines in non-oil commodityprices in 1996. The Asian crisis, which reducedaggregate demand in Asia, aggravated thisdownturn and partly led to the decline in oilprices. This weakened the balance of paymentsand partly, the fiscal position of commodity-exporting countries. On the other hand, currencydepreciation in Asia gave rise to market concernsover external competitiveness, particularly in LatinAmerica. In the case of Russia, both the fiscaland external debt positions were unsustainable.The devaluation of the ruble to significantinvestor pessimism over investments in emergingmarkets, and this adversely affected marketsentiment over Brazil’s fiscal position andtherefore, its exchange rate arrangement.

Another factor that led to the contagion wasthe herd behaviour among investors wheninvestors generalised the risks and grouped theAsian countries as having a common set ofvulnerabilities despite the fact that these countrieshad different economic and financial structures.It became self-fulfilling of market expectationsdue to the impact of massive reversal in capitalflows on the affected economies. The forcesthat allowed for this to occur included theadvances in telecommunication and informationtechnology, financial liberalisation, and thedevelopment of complex and innovative financialproducts.

In the Asian crisis, currency speculation byinternational investors proved more damagingbecause the amounts involved were very large.Less orthodox responses were implemented toprotect the economies and avoid furthereconomic contraction. In August 1998, HongKong Special Administrative Region (SAR), ThePeople’s Republic of China took action againstmarket manipulation by currency traders byinstituting general measures to counterspeculative attacks on its currency and stockmarkets. The Hong Kong government also madesubstantial purchases in its stock and futuresexchanges in an unexpected move to defend itsfinancial system against concerted speculativeattacks.

In the case of Malaysia, the authorities hadinitially focused on conventional macroeconomicmeasures to address the crisis. However, asconditions in the regional and global financial

markets worsened, and speculative pressuresagainst the Malaysian ringgit continued to buildup, Malaysia implemented, in September 1998,measures to curb the internationalisation of theMalaysian ringgit and discourage destabilisingshort-term capital inflows. The measures soughtto protect the domestic economy from potentiallydamaging external shocks in order to provide astable environment to facilitate ongoing economicand financial adjustments. The measures weresubsequently modified in February 1999 (seeBox III).

Towards a New International FinancialArchitecture

As the crisis became more prolonged andsevere than anticipated, there was a growinginternational recognition that remedial actionswere needed at the international level as well.It was noted that several external factors,namely, imprudent foreign investor behaviour,herding behaviour and speculative activity, playeda major role in aggravating the crisis. Thesedevelopments highlighted weaknesses in theinternational financial system, notably the lackof an appropriate framework to ensure orderlyglobal financial markets. One of the elements ofthe Basle capital-adequacy standard, for example,is that short-term lending requires lessprovisioning than long-term loans. This hasencouraged international banks to indulge in thepractice of lending short-term because such loanscarried a lower risk-weighting.

Proposals for reforms of the internationalfinancial architecture have been discussed atvarious fora, including the IMF, Bank forInternational Settlements (BIS), the Willard Groupor Group of 22, Association of South-East AsianNations (ASEAN), the Group of Seven (G-7),Group of Fifteen, Group of 24 and Asia-PacificEconomic Co-operation (APEC). The clearest signof the international recognition of the globalnature of the Asian crisis came in October 1998,when the G-7 endorsed several G-22 proposalson reforms in the international financial system.These included a recognition of the need toexamine the implications of the operations ofhighly leveraged and offshore institutions, with aview to encouraging offshore centres to complywith internationally agreed standards. The G-7also emphasised the need to review and

strengthen the role of the IMF, the World Bank,and other international financial institutions incrisis prevention and resolution.

It is recognised that the reform of theinternational financial system should, at least,include a number of important elements. First,there is a need for a more balanced approachto the issue of transparency and disclosure bynot only the public but also the private sector.Second, there needs to be surveillance of capitalflows, in particular short-term flows to ensurethe orderly functioning of the internationalfinancial markets and that the destructive volatilityof international capital flows can be prevented.Measures would be necessary to address theissue of cross-border manipulative activities infinancial markets and the need for appropriateinternational prudential standards in financialinstitutions, especially on exposure of commercialbanks to the highly leveraged financialinstitutions. Third, a mechanism is needed toensure that international rating agencies aremade more accountable for their actions, giventhe implication of their actions on financialmarkets. Lastly, a framework for the orderlyliberalisation of the capital account withappropriate criteria to serve as guideposts forcountries is needed.

Notwithstanding the international recognition ofthe need for a global solution to the Asiancrisis, progress in terms of building a consensuson concrete measures and initiatives toimplement the proposed reform in theinternational financial system remain slow. In this

connection, while moves on arrangements toreform the international financial system havebeen confined to the G-7 and multilateralinstitutions, developing and emerging marketeconomies have been drawn in to participate atG-7 initiated forums to present their views. Tobe effective, discussions on the reform ofthe international financial architecture needto include the advanced and developingcountries given the bond arising from theglobalisation process.

Conclusion

There is a growing literature on the causesand consequences of the Asian crisis. As thecrisis unfolded and its contagion spread,perceptions of the crisis have changed, frombeing a localised to a regional and internationalproblem. While it is recognised that individualcountries must implement economic and financialreforms to put their houses in order, there isalso a realisation that such efforts would not besufficient. As a result, the search for solutionshas focused increasingly on reforms to theinternational financial architecture to ensure thatglobalisation and financial liberalisation proceedin an orderly manner. In particular, there aregrowing concerns on the need to manage capitalflows and prevent manipulation of currencies. Inthis regard, appropriate safeguards andmechanisms need to be in place in order tomaximise the benefits of globalisation whilemitigating the potential destabilising effects ofvolatile short-term capital flows.

acquired from other financial institutions, the totalNPLs acquired and managed amounted to RM21.7billion. Danamodal had injected RM6.15 billion inthe form of Exchange Subordinated Capital loansinto ten institutions. CDRC had received 48applications for assistance with debt restructuring.Total debt of the companies amounted to RM22.7billion. A total of 26 creditor committees havealready been formed and two debt restructuringschemes have been implemented. CDRC hadalso recently announced the debt restructuringproposal for one of the largest conglomerate,involving RM8.4 billion, without any need forGovernment financial assistance. This is consistentwith the Government's policies where private sectorsolutions are applied for problems faced byMalaysian companies.

Overall, there are indications that the troughin the growth cycle had been reached in thethird quarter of 1998. Greater stability in termsof the foreign exchange and stock marketsand the financial system has encouraged asteady revival in consumer and investor confidence.Macroeconomic policies had been geared toensuring that the non-inflationary expansion ofoutput and employment would be maintained overthe medium term.

Sectoral Review

Manufacturing

The manufacturing sector was affected by theslowdown in the Asia-Pacific region as well as inthe domestic economy in 1998. Output of themanufacturing sector contracted by 10.2% duringthe year, the first decline since 1985. The declinewas broad-based with almost all industries recordinglower production levels although the declines weremore pronounced in industries producingconstruction-related materials and transportequipment. The impact of the regional financial crisiswas less severe in the first quarter as themanufacturing sector contracted by only 1.8%.However, the effects of the crisis became evidentin the second quarter when production fell by 8.9%.The situation worsened in the third and fourthquarters when the sector contracted sharply by14.5% and 14.7% respectively. Owing to thesevere contraction in domestic demand, outputof the domestic-oriented industries declinedsharply by 13.4% in 1998. Export-oriented industriesalso recorded a decline in production, albeit at a

less rapid pace of 7.3%, reflecting mainly theeconomic downturn in the Asia-Pacific region,which accounted for 40% of Malaysia’smanufactured exports.

Production of electrical machinery, apparatus,appliances and supplies as a group shrank by7.7% in 1998, attributable to weak demand fromthe Asia-Pacific region as well as a depressedglobal market for semiconductors. During the year,the global semiconductor market experiencedanother year of decline as the excess supply ofmemory chips continued to persist. The resultantsharp decline in prices prompted some major worldproducers to halt or cut back their production ofDRAM chips, contributing to some price stability,particularly towards the end of the year. Somemanufacturers in Malaysia had also taken a similaraction as the product was no longer profitable.Consequently, the output performance of theelectronics industry deteriorated from an increaseof 3.1% in the first quarter to a decline of 11.3%in the third quarter. Nevertheless, the performanceof the industry improved in the fourth quarter torecord a more moderate decline of 6%, boostedmainly by the revival in the disk-drive sub-sectoras well as higher sales of personal computers.Demand for disk-drives started to pick up towardsthe end of the year in line with the depletion ofinventories. The recovery was facilitated by the needto upgrade facilities in preparation for the Y2Kproblem.

In the face of the regional economic slowdown,the performance of the electrical appliances sub-

1Q 2Q 3Q 4Q

-20

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

Graph:1.5Manufacturing Production: Quarterly Annual Growth 1998

Total Export-oriented industriesDomestic-oriented industries

sector continued to deteriorate. As external demandstarted to dwindle, a number of companies resortedto shorter working days or reducing the number ofshifts, resulting in a more severe contraction inoutput from 1.5% in the first quarter to 26.1% inthe fourth quarter. The decline reflected mainlysharply lower production of air-conditioners andcables and wires.

Production of textiles declined by 8.8% in 1998due to sluggish demand from the Asia-Pacificcountries. In particular, the natural fibre spinningand weaving activities fell sharply due to cutbacksin production in response to the rising cost ofimported cotton. The decline, however, was offsetin part by an increase of 1.1% in the wearingapparel sub-sector, supported mainly by higherdemand from the United States and Europe. Onbalance, the textiles and wearing apparel industryas a group contracted by 5.3% in 1998.

Lower demand from Japan and The People’sRepublic of China, coupled with the downturn indomestic construction activities and weakdemand for furniture led to a sharp contraction of11.3% in the wood and wood products industry.The lower output was attributed mainly to asharp decline in the plywood, hardboard and particleboard sub-sector, which mainly catered for theexport market. However, the decline wasoffset partly by higher production in the sawn timbersub-sector.

Production in the off-estate processing industrywas affected by insufficient supply of raw materialsand higher crude palm oil prices. Following anincrease of 1.4% in the first quarter, outputcontracted sharply by 10.4% in the second quarteras production of crude palm oil fell markedly. Witha slower decline in crude palm oil production inthe second half-year, output of the off-estateprocessing industry improved to record a marginaldecline of 0.8% in the second half of 1998 (–5%in the first half of 1998). For the year as a whole,output declined by 2.7%.

Growth in the domestic-oriented industrieswas affected by the slowdown in thedomestic economy. However, due to the lageffect, the impact was less severe in the firstquarter as output of the domestic-orientedindustries declined only moderately by 3.4%. Asthe economic situation deteriorated, output declinedfurther by 12.4% and 19.2% in the second andthird quarters respectively. The decline moderatedto 17.9% in the fourth quarter as domestic demandimproved following the implementation of severalmeasures to stimulate the economy. For the yearas a whole, output declined by 13.4%.

Reflecting the sharp downturn in constructionactivities, output of the construction-relatedproducts industries contracted sharply by22.4% in the first half of 1998, followed by asharper decline of 34.6% in the third quarterand a more moderate decline of 30.6% in thefinal quarter. For the year as a whole, the outputof this group of industries declined by 27.6%.The postponement of several large projects,including the development of higher costresidential houses, caused demand for non-metallic mineral products and iron and steel tofall sharply, particularly in the third quarter.Consequently, these industries were faced with

Table 1.6Growth in Manufacturing Production (1993=100)

1996 1997 1998

Annual change (%)

Export-oriented Industry 8.2 10.3 –7.3Electrical machinery, apparatus, appliances and supplies 8.8 13.6 –7.7

Radio and television sets 6.0 –7.2 3.9Semiconductors 12.6 22.8 –4.2Cables and wires 12.6 10.4 –29.4

Manuf. of office, computingand accounting machinery –2.3 9.1 –4.5

Manuf. of refrigerating, exhaust,ventilating and air-conditioningmachinery –5.0 –0.7 –48.5

(Electronics) (12.6) (22.8) (–4.2)(Electrical) (3.2) (–1.7) (–14.8)Textiles and wearing apparel 0.0 5.3 –5.3Wood and wood products 11.4 –1.6 –11.3Off-estate processing 10.2 9.8 –2.7

Domestic-oriented Industry 16.9 14.6 –13.4Chemicals and chemical products 19.5 24.5 –1.8Construction-related products 21.1 11.3 –27.6

Non-metallic mineral products 24.5 10.1 –26.5Basic iron & steel and

non-ferrous metal 17.1 13.1 –29.1Transport equipment 22.3 14.3 –52.2Food products 4.4 3.8 –2.1Beverages 15.6 –0.2 –11.9Tobacco products 7.4 19.9 –9.1Rubber products 11.1 3.4 7.8Petroleum products 12.7 8.9 –11.5Fabricated metal products 23.1 11.9 –17.2Paper products –4.9 13.0 –8.7

Total 12.3 12.4 –10.2

Source: Department of Statistics

excess capacity and inventories. The situation wasaggravated by the expansion programmesundertaken by companies before the onset ofthe financial crisis in mid-1997.

The fabricated metal products industry wasnot severely affected by the economic slowdownin the first half of 1998 as its output declinedby only 5.1%. However, in the face of the sharpdownturn in the construction sector, outputcontracted sharply by 29.3% in the second halfof 1998. For the year as a whole, the industryrecorded an output decline of 17.2%. The loweroutput level reflected mainly the decline in theproduction of structural metal products attributableto slack demand from the heavy and lightengineering sub-sector, especial ly in theconstruction sector. Output of other sub-sectors,namely, tin and metal boxes, wire and wireproducts and brass, copper and aluminium alsodeclined due to poor domestic demand.

Despite the economic slowdown, outputof the chemicals and chemical productsindustry continued to record an impressive

growth of 8.3% in the first quarter of 1998,supported mainly by the expansion in the plasticproducts, fertilisers and pesticides and soap andcleaning products sub-sectors. As experienced byother industries, output of this industry alsodeclined in the last three quarters, albeit at arelatively low rate of 4.9%. The decline wasattributable mainly to lower production of industrialgases (mainly LNG) arising from lower demandfrom Japan and Korea. In addition, production inthe paints, varnishes and lacquers sub-sectoralso declined due to the downturn in theconstruction sector. For the year as a whole, thechemicals and chemical products industry declinedmarginally by 1.8%.

As output of the manufacturing sector weakened,especially in the electronics and electrical productsindustry, output of the paper products industryalso declined by 13.2% in the last three quartersof the year (+6% in the first quarter). The declinewas attributed to lower production of containersand boxes of paper and paperboard, which wereused for packaging purposes. In addition, output ofthe paper and pulp products sub-sector alsodeclined due to sluggish domestic demand.

The transport equipment industry was severelyaffected by the economic downturn, with outputcontracting by 52.2% as the demand for motorvehicles declined sharply. Sales of motor vehiclesfell from a high of 41,591 units in October 1997to a low of 6,872 units in February 1998. Thedecline was caused mainly by increased cost offinancing due to tight liquidity as well as difficultiesfaced by finance companies in sourcing deposits.Subsequently, with the easing of hire purchasecriteria since April 1998, reduction in interest ratesand promotion activities conducted by cardistributors, sales started to increase gradually toreach 23,058 units in December. Overall, output ofthe transport equipment industry sub-sectors, namelyassembly of motor vehicles, motor vehicle partsand accessories and assembly of motor cycles andscooters contracted by 59.5%, 40.1% and 42.1%respectively.

Spurred by strong external demand from theUnited States and Europe for rubber gloves, outputof the rubber products industry recorded a stronggrowth of 7.8% in 1998, representing the onlyindustry that continued to record a positive growthduring the economic downturn. The demand for

Table 1.7Manufacturing Production: Selected Indicators

1998 1997 1998

Output Annual change(%)

Integrated circuits (million units) 11,652 28.6 –7.3

Semiconductors (million units) 8,950 41.9 20.4

Television sets (’000 units) 8,057 –12.7 3.6

Room air-conditioners (’000 units) 1,284 –28.8 –39.3

Household refrigerators (’000 units) 206 –3.1 –17.3

Vehicles assembled (’000 units) 418 22.0 –52.6Passenger cars 149 15.7 –58.8Commercial vehicles 20 20.3 –78.9Motorcycles & scooters 249 28.5 –41.3

Pneumatic tyres (’000 units) 13,567 12.2 –1.1

Rubber gloves (million pairs) 10,588 4.8 –18.8

Plywood (’000 cu.metre) 3,660 1.5 –18.9

Veneer sheets (’000 cu.metre) 1,156 –4.3 –8.6

Liquefied petroleum gas (’000 tonnes) 1,271 –2.9 –6.1

Kerosene & gasoline (’000 tonnes) 2,184 3.1 –2.6

Diesel and gas oil (’000 tonnes) 5,974 7.4 –12.0

Fuel oil (’000 tonnes) 2,390 12.8 –24.2

Cement (’000 tonnes) 10,495 2.6 –17.2

Iron and steel bars and rods(’000 tonnes) 1,892 11.4 –43.9

Source: Department of Statistics

latex-based examination and surgical gloves wasparticularly strong for the high quality Malaysiangloves that met stringent international standards. Inaddition, sales were boosted further by competitivepricing of Malaysian products due to the depreciationof the ringgit. Nevertheless, the strong increasewas offset in part by the decline in the output ofthe tyres and tube industry caused by the sharpdecline in car sales. Despite its encouraging growth,the rubber products industry continued to facecompetition from Thailand.

With the slowdown in the car industry, thedemand for petroleum products also declined,particularly in the last three quarters (at an averageof –13.3%; –5.5% in the first quarter). For the yearas a whole, the industry recorded an output declineof 11.5%. The decline reflected lower productionby the crude oil refineries as well as lower outputof other petroleum products, such as lubricating oilfor motor vehicles and premixed asphalt for roadconstruction purposes.

In tandem with the slowdown in domesticdemand, output of the food, beverages andtobacco products industries as a group wasalso affected, particularly in the second half of1998 when its output fell by 9.8% from a marginalincrease of 0.4% in the first half of 1998.The decline was broad-based, affecting almost allsub-sectors.

Construction

In 1998, the construction sector experienced acontraction in output due mainly to lower aggregatedemand. Value added of the sector declined by24.5% in 1998, compared with a growth of 9.5%in 1997. To a large extent, the sharp adjustmentreflected the strong growth of the sector in recentyears. Following the sharp contraction in demandfor high end residential and commercial propertiesduring the course of 1998, the value and volumeof property transactions fell by 47.6% and 32.3%respectively by the end of the year. The declineof the sector was generally broad-based, affectingthe residential, non-residential and civil engineeringsub-sectors. However, sustained demand formedium- and low-cost residential properties mitigatedthe contraction of the sector. The adjustmentwas more severe in civil engineering due to thecompletion of large projects and the defermentof new projects. Construction activity was also

affected by a stock overhang, particularly of non-residential and high-end condominium properties asa result of the completion of several large projectsin the previous few years. Towards the latter partof 1998, several measures were introduced tostimulate residential construction activity in order tomoderate the over-adjustment of this sector to thefinancial crisis.

In the civil engineering sub-sector, growth wasaffected by the deferment of infrastructure projectstotalling RM65.6 billion as announced in the 1998Budget as well as completion of projects associatedwith the KLIA and the Commonwealth GamesVillage. The impact became more severe in thesecond half of 1998 as more projects were deferred,including the Dedicated KL-KLIA Expressway, thePeople Mover-Rapid Transit System (Phase 1) andthe South Klang Valley Expressway. As a result,growth was only supported by other on-goingprojects related to power plants, airports, roads,rail, water and sewerage and waste disposal.This was confirmed by the findings of the CentralBank’s Ad-Hoc Survey of the Civil EngineeringSub-sector which indicated that 75% of therespondents had deferred or stopped work on atleast one project.

Table 1.8Supply of Office Space and Condominiums in theKlang Valley

Office space Condominiums

No. of Area in No. of No. of Area inprojects sq. metres projects units sq. metres

1983 11 159,840 5 782 81,6981984 12 342,899 4 561 60,0651985 28 747,757 9 1,240 204,6381986 11 304,780 2 460 70,8571987 10 244,069 6 1,143 175,9751988 4 43,255 4 936 95,7711989 2 45,628 4 682 64,2481990 0 0 8 1,221 139,3861991 6 57,470 13 2,576 266,2521992 7 95,296 21 3,346 380,8971993 12 232,693 26 5,013 565,4391994 15 350,951 40 8,507 973,2021995 20 451,119 52 14,241 1,576,2971996 16 321,629 35 8,342 1,022,4441997 21 639,375 25 7,530 864,0571998 29 909,219 45 14,151 1,645,1721999e 19 639,673 28 9,215 967,751

Total 223 5,585,653 327 79,946 9,154,149

e Estimate

Source: Survey by Bank Negara Malaysia, Valuation and Property ServicesDepartment

Recognising the importance of infrastructuredevelopment to facilitate economic recovery, theGovernment announced in July 1998 an initial fundof RM5 billion for the development of infrastructure.The Fund would assist in reviving selectedinfrastructure projects which have low import contentand high spin-off effects on the economy. The 1999Budget had also dedicated RM4.04 billion specificallyfor the building of roads, bridges, rail, ports andcivil aviation. Although some of the projects havesince been revived, the effect on the economy isexpected to be gradual. This was confirmed byBank Negara Malaysia’s survey findings whichindicated that of the respondents (64%) whoexpected their projects to be revived, 86%expressed that activity would only begin in eitherthe first or second half of 1999.

The non-residential sub-sector contractedsharply by 29% in 1998 (+8.1% in 1997) due mainlyto the postponement or delay in the completion ofsome of the ongoing projects affected by fallingdemand and financing difficulties that wereexperienced in the early part of the year. At thesame time, growth was constrained by the largeincreases in capacity which occurred since 1995.The correction was reflected in the decline in thenumber and value of commercial propertytransactions by 44.1% and 43.9% respectively in1998. In particular, industrial property transactionscontracted by 48.1% in volume terms and 55.5%in value terms. The hotel sub-sector also sloweddown markedly after the completion of several hotelsprior to the hosting of the Commonwealth Gamesin September 1998.

In the purpose-built office space sub-sector,growth was mainly supported by ongoing projects,which had started before 1998. Despite thepostponement in the completion of some projects,a net lettable area of 0.9 million square metres inthe Klang Valley entered the market, bringing thetotal supply to 5.8 million square metres (+18.7%)at end-1998. Nevertheless, the new supply wassubstantially lower than the previous estimate of1.3 million square metres. Most of the officebuildings that were completed were located in thecentral areas of Jalan Sultan Ismail, Jalan Ampangand Jalan Tun Razak. With lower occupancy in thenew buildings, especially those in the peripheralareas of the Klang Valley, the average occupancyrate in the office space market continued to declineto around 79% at end-1998 from 95% at end-1997. Nevertheless, office buildings in the Golden

Triangle, on average, enjoyed higher occupancyrates compared with secondary areas of KualaLumpur and Petaling Jaya. Although the supply ofnew space will continue to increase due to pastcommitments, the economic downturn and curbs onfinancing for high-end properties had prompteddevelopers to postpone further or scale down theirprojects. As a result, the supply of office spacecoming on-stream in 1999 and 2000 are expectedto moderate significantly. Reflecting the oversupplysituation, the average monthly rental declined furtherto RM41.40 per square metre in 1998 (RM3.85 persquare foot) from RM49.75 in 1997. The declinewas more pronounced for office buildings inrelatively decentralised areas. Rentals in the primelocations in the Golden Triangle also declined, byabout 15%.

Similarly, reflecting the completion of projectsstarted earlier, the total stock of retail space incommercial complexes in the Klang Valley increasedby 0.4 million square metres to 2.1 million squaremetres at end-1998 (1.7 million square metres atend-1997), lower than an earlier estimate of anadditional 1.1 million square metres. Retail spaceunder construction amounted to 1.2 million squaremetres in 1998 (representing 55.6% of the existingstock), reflecting mainly the continuation of work ondelayed projects. The new supply, however, willnot come on-stream until 1999 and beyond. Withlower demand, occupancy rates in retail centres inthe Klang Valley fell to 65.7% at end-1998 (90.5%at end-1997). Nevertheless, commercial complexesin selected areas of Kuala Lumpur that were overtwo years old continued to have relatively highoccupancy rates, averaging 91%.

0

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1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Net lettable area(thousand sq.m.)

Rate (%)

Graph 1.6Supply of Purpose-Built Office Space in the Klang Valley

1996 1997 1998 1999e

Occupancy rate

Estimate Actual

0

20

40

60

80

100Stock

Construction activity was also lower for the hotelsub-sector, with supply of new hotels moderatingto 54 or 9,351 rooms (122 hotels or 27,832 roomsin 1997). The increased supply amidst lowerdemand from the tourism industry, resulted in adecline in the average occupancy rate to 49.9% in1998 from 58% in 1997. The decline was acrossthe board with the Klang Valley, Penang and JohorBahru recording lower occupancy rates of 53.2%,56% and 48.3% respectively (68.8%, 57% and56.5% in 1997).

Despite the strong underlying demand, theperformance of the residential sub-sector wasaffected by declining income, poor market sentimentand job uncertainties in 1998. Value added of thesub-sector declined by 16.5%. The value ofresidential property transactions fell by 36% toRM13.9 billion in 1998 (1997: +15.2% to RM21.8billion). The number of residential transactionsdeclined by 30% to 122,881 units. The contractionin residential construction was also reflected in slowconstruction starts. New sales and advertisingpermits for Peninsular Malaysia declined by 28.3%(1997:+18.9%). The number of renewals for salesand their advertising permits, however, increasedconsiderably by 38.8% (1997: –1.2%), reflecting theslowdown in the sale of houses, especially high-cost units costing RM250,000 and above. Similarly,BNM’s Ad-hoc Survey of the Residential Sub-sectoralso showed that construction activity for the periodJanuary-August 1998 had contracted by 21-30%,compared with the same period a year ago.Nevertheless, due to past construction activity, theestimated number of completed housing units roseby 7.2% to 154,519 in 1998. A sharp contractionin demand for high end units resulted in an

oversupply situation, particularly of condominiums.The situation was aggravated by the supply ofhigh-end condominiums (above RM250,000), comingon-stream in 1998, which increased significantly by87.9% to 14,151 units, with a total built-up area of1.6 million square metres.

The falling demand and oversupply situationcaused a downward correction in house prices forthe first time since 1988. The National House PriceIndex for the first half of 1998 declined by 8.5%compared with an increase of 1.9% for the wholeof 1997. The decline was more significant fordetached houses (–9%), followed by high-rise units(–5.9%), semi-detached houses (–5.4%) and terracedhouses (–4.3%). By region, the decline was morepronounced in Johor Bahru (–21.9%), the KlangValley (–11.2%) and Pulau Pinang (–11.5%). Amongthe states, the fall in house prices was most evidentin Kuala Lumpur, with prices of semi-detachedhouses declining by 17.3%, followed by detachedhouses (–8.8%), high-rise units (–6.8%) and terracedhouses (–5.0%). House prices in certain areas,however, declined by up to 30%, especially in areaswhere prices had recorded higher rates of increasein previous years.

The contraction of the construction sector hadsevere implications on the economy, affectingespecially the low-income group. Several measureswere, therefore, introduced during the year to avoidan over-adjustment of the sector and to continueto ensure that construction of medium- and low-cost houses would continue since demand for suchhouses remained strong. A balanced adjustmentamong the various sub-sectors in the constructionsector was also important as the sector has stronglinkages with other economic sectors, especially themanufacturing and services sectors. To meet theseobjectives, the measures to assist the constructionsector focused mainly on reducing the excess stocksbuilt up by several years of investment and ensuringthe lower-income group continued to have accessto affordable housing. The measures, therefore,supported mainly the construction of low- andmedium-cost houses where import content was lowand sectoral linkages were high and for which theunderlying demand remained strong. In May 1998,a RM2 billion fund for the Special Scheme for Lowand Medium Cost Houses was established, of whichRM1 billion was made available for bridging financeand another RM1 billion for end-financing. Thismeasure was deemed necessary as the number ofhouses built for this category had failed to meet

0

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600

800

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1,200

1,400

1,600

Occupancy rate

Stock

Net lettable area(thousand sq.m.) Rate (%)

1996 1997 1998 1999e

Graph 1.7Supply of Retail Space in the Klang Valley

Estimate Actual

0

20

40

60

80

100

demand. For the period 1996-98, only 24.4% ofthe low-cost and 20.2% of the medium-cost houseswere built out of the respective targets set underthe Seventh Malaysia Plan, compared with 80% forthe high-cost range. Other measures included theliberalisation of lending for the construction orpurchase of residential properties costing RM250,000and below. Lending for these purposes wereexempted from the 20% limit on lending to thebroad property sector. The 60% limit on margin ofloan financing for the purchase of non-owneroccupied properties was also abolished. To helpclear the excess stock of residential properties, theGovernment also assisted in the Home OwnershipCampaign (12 December 1998 to 12 January 1999).Financing incentives included exemption of stampduties and lower financing costs for housespurchased during this period. At the close of theCampaign, total sales amounted to RM3.5 billionfor 19,281 units of residential and commercialproperties, or about a third of the total number ofunits offered for sale (56,338) worth RM15.4 billion.

Measures were also introduced to stimulateforeign demand for high-end properties. TheRM100,000 levy on foreign purchases was removedwith effect from August 1997 and the Real PropertyGains Tax was reduced to 5% for disposal ofproperties after the fifth year as announced in the1998 Budget. Effective 22 April 1998, foreignerswere allowed to purchase all types of residentialunits, shop houses, commercial and office spacecosting above RM250,000 per unit, providedfinancing for such purchase was not obtained inMalaysia and the purchase was only confined tonewly completed projects or those which were atleast 50% completed. Encouraged by lower pricesand the effect of the above measures, foreignpurchases of residential property increasedconsiderably by 143% to 1,164 units valued atRM434 million in 1998 (–68.5% to 479 units valuedat RM215.6 million in 1997). The bulk of thepurchases was mainly for condominiums andterraced houses. Transactions for these propertiesincreased significantly by 141.5% to 891 unitsvalued at RM328.5 million and 564.6% to 165 unitsvalued at RM49 million respectively. In the case ofcommercial property, however, foreign purchasesdeclined sharply in value by 86.4% to only RM44.3million (+52% to RM326.2 million in 1997).

The measures to balance the adjustment in theconstruction sector helped to improve sentiment.The number of housing units approved by the

Ministry of Housing and Local Government forconstruction by private developers rose by 3.4% inPeninsular Malaysia to 194,092 by the end of 1998(63% to 187,625 units in 1997). These comprised26.6% low-cost units, 41.1% medium-cost units and32.3% high-cost units. In line with the Government’seffort to promote the construction of low andmedium-cost houses, approvals for medium and low-cost units rose significantly by 31.1%, while thenumber of high-cost units fell by 26.4%. Theincrease in housing approvals is expected to resultin greater construction activity for the residentialsub-sector in 1999.

Meanwhile, the downturn in the constructionsector had affected the performance of construction-related industries. The production of cement andconcrete, iron and steel, and construction-relatedproducts declined sharply by 40.8%, 35.6% and27.6% respectively in 1998. Prices of several majorbuilding materials were also adjusted downwardsamid a contraction in demand during the year. Theaverage price of glass sheet fell by 12.5% andsand by 17.9%. Nevertheless, the average pricesof mosaic floor tiles and glazed wall tiles continuedto rise steadily by 15.8% and 42.9% respectively.The price of ordinary portland cement fell by 2.4%to RM10.10, below its ceiling price of RM10.35 per50 kilogramme bag in Peninsular Malaysia, whilethe average prices of mild steel round bars andhigh tensile deformed bars fell marginally by 1.1%and 0.6% respectively.

Demand for construction workers also contracted,although this was moderated by flexible adjustmentin the wage rates. The average daily wage forskilled and unskilled foreign workers decreased by1.5% and 4.5% respectively in 1998 (+15% and–2.6% respectively in 1997). The average dailywage for semi-skilled foreign workers, on the otherhand, rose albeit marginally by 0.7% in 1998 (7.7%in 1997). The decline in wages was accountedmainly by the local construction workers. For allthree categories i.e. skilled, semi-skilled andunskilled workers, the average daily wage fell by14.3%, 13.3% and 8.6% respectively. Nevertheless,their wages were still higher by 18.9-24.7%(25–43.3% in 1997) compared to their foreigncounterparts.

In 1998, total employment in the constructionsector declined by 16.9% to 726,000 (8.5% of totalnational employment), of which 19.7% (30% in

1997) were foreign workers. The share of foreignworkers has become smaller following therepatriation of the surplus foreign workers duringthe year. Foreign workers in the construction sectorconstituted 18.3% of total foreign workers in thecountry.

With the slowdown in construction activities,growth in total loans extended by the bankingsystem to the broad property sector, comprisingresidential, non-residential, real estate andconstruction companies moderated to 4.4% (1997:34%) or RM6.2 billion to RM146.1 billion (includingloans sold to Cagamas). However, reflecting thelower volume of total loans extended by the bankingsystem in 1998, the share of loans to the broadproperty sector increased to 35.3% (1997: 33.2%)as at the end of 1998. Under the broad propertysector, loans for the construction sector, purchaseof residential property, purchase of non-residentialproperty and real estate accounted for 10.4%,13.6%, 7.2% and 4% respectively of the total loansextended by the banking system in 1998 (10.1%,12.1%, 6.8% and 4.3% respectively in 1997).Following the easing of the credit situation in thesecond half-year, the purchase of housing loans byCagamas moderated, accounting for 33.9%(1997:38%) of total outstanding housing loans.Reflecting the impact of the measure to limit lendingto construction and purchase of high-cost residentialproperties costing RM150,000 and above(subsequently revised to RM250,000), loan growthfor the purchase of high-cost properties(> RM150,000) moderated to 19.4% (1997:72.8%).In contrast, loans extended for the purchase ofresidential properties costing RM150,000 and belowwas higher by 17.2% as at end-1998 (end-1997 :-9.0%) to account for 34.5% of total outstandinghousing loans. The balance of the total housingloans were for purchases in the RM150,000-RM250,000 and above RM250,000 categories whichaccounted for 18.6% and 13% of total housingloans, respectively.

In 1998, total loans extended by the bankingsystem and housing credit institutions for purchaseof residential houses totalled RM56.8 billion in 1998,an increase of 13.2% compared with 1997.Financing of owner-occupied houses costingRM100,000 or less provided by the banking systemamounted to RM11.2 billion. As at end-1998, thecommercial banks and finance companies had madefirm commitments to finance 46,822 and 14,894 ofthese units respectively. Major housing credit

institutions comprising the Treasury Housing LoansDivision, the Malaysian Building Society Berhad, theBorneo Housing Mortgage Finance Berhad, SabahCredit Corporation, Bank Kerjasama Rakyat MalaysiaBerhad and Bank Simpanan Nasional, as a group,extended a total value of housing loans worthRM19.6 billion (RM18.7 billion in 1997) as at end-1998, representing an increase of 4.7% (4.8% orRM852.3 million in 1997).

Agriculture, Forestry and Fishery

Value added of the agriculture, forestry andfishery sector declined by 4% in 1998(1997:+1.3%), reflecting declines in the productionof all major commodities. The output performanceof the sector was affected mainly by adverseweather, labour shortages, unfavourable prices,reduced cultivated area and lower yields. Productionof crude palm oil declined by 8.3% due mainly tothe reversal in the biological yield cycle for oilpalm trees during the year. Meanwhile, the decliningtrend in rubber production persisted into 1998(–8.8%) as the industry continued to faceunfavourable prices, labour shortages and a declinein cultivated area. Saw log production alsocontracted by 27.2% as logging activities remaineddepressed because of lower demand from themajor markets in the region as well as thedownturn in the domestic construction sector. Inaddition, adverse weather conditions arising fromthe El Nino effect had also affected production.Cocoa production was also markedly lower by14.9% in 1998, being affected mainly by inclementweather. On the other hand, the production of fishincreased by 5.7% during the year. Overall, theagriculture, forestry and fishery sector accounted

Table 1.9Agriculture: Production

1997 1998p 1997 1998p

’000 tonnes Annual change (%)

Rubber 971 885 –10.3 –8.8Saw logs1 31,163 22,700 3.4 –27.2Crude palm oil 9,069 8,315 8.1 –8.3Fish 1,277 1,350 3.2 5.7Cocoa 106 90 –11.7 –14.9

1 Expressed in thousand cubic metresp Preliminary

Source: Department of StatisticsPORLAForestry Departments (Peninsular Malaysia, Sabah & Sarawak)Malaysian Cocoa BoardDepartment of Fisheries Malaysia

for a higher share of GDP, 12.3% in 1998 (1997:12%), 10.5% of gross exports (1997: 10.5%), and16.8% of total employment (1997: 17%).

Crude palm oil production recorded a declineof 8.3% to 8.3 million tonnes in 1998. The declinewas due mainly to lower yields brought about bythe reversal in the biological yield cycle of the oilpalm trees, which occurs once every three or fouryears. To some extent, the lower yields were alsoattributable to the lagged impact of the haze anddry weather, which occurred during the secondhalf of 1997, while labour shortages resulted in alower harvest as loose fruits tended to beuncollected. The decline in yields during the yearhad more than offset the expansion in the matureoil palm cultivated area. With the increasing viabilityof oil palm cultivation in the wake of attractiveprices in recent years, the total area under oilpalm cultivation expanded further by 2.6% to 2.9million hectares in 1998, with the mature areaincreasing by 2.4% to 2.5 million hectares. Despitethe decline in production, Malaysia maintained itsposition as the world’s largest producer of crudepalm oil, accounting for about one-half of theworld’s production, with Indonesia as the next majorproducer, accounting for 31%.

On a regional basis, production in PeninsularMalaysia declined by 9.8% to 6 million tonnes in1998, while Sabah recorded a decline of 5.6% to2 million tonnes and Sarawak by 8.1% to 0.3million tonnes. Growth in mature area under oilpalm cultivation was most marked in Sarawak (anincrease of 10.8%), followed by Sabah (6.4%) while

the mature area in Peninsular Malaysia increasedonly marginally (0.5%). Expansion of mature areain East Malaysia is expected to continue in thefuture as immature planted areas in Sabah andSarawak expanded further by 4.2% to 146,700hectares and 43.6% to 53,500 hectares respectively.Immature planted areas in Peninsular Malaysiadeclined by 3.5% to 179,600 hectares. In terms ofownership, private estates accounted for the largestshare of 55.2% of the total oil palm cultivatedarea or 1.6 million hectares. Organised smallholderschemes under the Federal Land DevelopmentAuthority, Federal Land Consolidated andRehabilitation Authority and the Rubber IndustrySmallholders Development Authority as a groupaccounted for 28.7% or 0.8 million hectares, whileschemes under the states and independentsmallholders, accounted for the remaining share of16.1% or 0.5 million hectares.

In 1998, a total of 19 new palm oil mill licenceswere issued by the Palm Oil Registration andLicensing Authority (PORLA). With the rapidexpansion of land under oil palm cultivation inSabah, the State was granted 14 licences for newmills bringing the total number of mills approvedin Sabah to 91. Two new licences were grantedin Sarawak and three in Peninsular Malaysia. Byend-1998, there were 242 mills operating inPeninsular Malaysia, 70 in Sabah and 13 inSarawak. These 325 mills in Malaysia had anaggregate capacity to process 59.1 million tonnesof fresh fruit bunches annually. Following theseasonal trend in crude palm oil production, theaverage rate of capacity utilisation of the millswas 68.4% in the first half of the year and 81.1%in the second half of the year. For the year asa whole, the average rate of capacity utilisationdeclined to 74.8% from 88.3% in 1997, in linewith the lower production of crude palm oil.

With the lower level of crude palm oil production,domestic processing of the commodity by refineriesdeclined by 2% to 8.8 million tonnes in 1998.During the year, there was no new refinery licenceissued by the Ministry of International Trade andIndustry. However, approvals were given to theexisting refineries to expand their installedproduction capacity. Hence, the total installedcapacity of the 45 refineries in operation was 12.7million tonnes. In order to increase the oil extractionrate (OER), which declined to 18.91% in 1998from 19.03% in 1997, the smallholders and smallestates were encouraged to harvest only the ripe

Table 1.10Oil Palm: Area, Production and Yield

1997 1998p

Annualchange (%)

Area (’000 hectares)Planted 2,819 2,893 4.7 2.6Mature 2,455 2,513 4.3 2.4

Production (’000 tonnes)Crude palm oil 9,069 8,315 8.1 –8.3

Yield (tonnes/mature hectare)Crude palm oil 3.69 3.31 3.9 –10.3

p Preliminary

Source: Department of StatisticsPORLA

1997 1998p

fruits. In this regard, training in the grading offresh fruit bunches was conducted by PORLA.

Natural rubber production declined by 8.8% to885,400 tonnes in 1998, representing the fourthconsecutive year of decline in production. Thedecline was due mainly to continuing low pricesas well as labour constraints. Slackening externaldemand amidst ample global supplies resulted ina further decline in prices. The price of SMR20fell from 274.50 sen per kilogramme at the turnof the year to 217.00 sen per kilogramme at end-year. As rubber was traded in ringgit, it did notbenefit from the valuation effects arising from thedepreciation of ringgit. Meanwhile, the persistentproblem of labour shortages has affected tappingactivities, resulting in a significant decline inproductivity. The Malaysian Rubber Board initiatedmeasures to address the declining productivity.Measures included the active promotion of labour-saving technologies such as the low intensitytapping systems, particularly among thesmallholders.

Imports of natural rubber, mainly latex, rosesignificantly by 30.7% to 564,100 tonnes in 1998

to meet the demand of domestic rubberproducts manufacturers. The major source ofimports was Thailand. Despite lower productionin 1998, Malaysia remained as the world’sthird largest producer and a net exporter ofnatural rubber.

On a regional basis, the production of rubber inPeninsular Malaysia, which accounted for 95% oftotal national output, declined by 10% to 842,220tonnes, with the production of smallholders andestates declining by a similar magnitude. Lowerproduction was also recorded in Sabah (–10.2%).On the other hand, production in Sarawak remainedat the previous year’s level. In terms of plantedarea, Peninsular Malaysia recorded a decline inrubber cultivated area by 4% to 1,244,560 hectares,accounting for about 80% of the total area underrubber, with the mature area declining by 4% to1,029,250 hectares.

With the declining interest in rubber cultivationaggravated by the prolonged weakness of pricesfor the commodity, there was a need for a revivalof the industry in order to sustain its long-termsurvival. In this regard, the Association of NaturalRubber Producing Countries (ANRPC) has proposedthat the International Natural Rubber PriceStabilisation Scheme under the ANRPC be revived.Meanwhile, Malaysia withdrew from the InternationalNatural Rubber Organisation (INRO) with effect from15 October 1998. On the home front, in an effortto improve the institutional role of the agenciesrelevant to the rubber industry, the MalaysianRubber Board (MRB) was established on 1 January1998, with the amalgamation of the three previous

Table 1.11World Elastomer: Production and Consumption

1998e 1997 1998 e

’000 % Annualtonnes share change (%)

Production 16,380 100.0 1.8 –0.6Natural rubber 6,315 38.6 0.3 –1.6

Thailand 2,100 12.8 3.2 3.3Indonesia 1,583 9.7 –1.5 5.2Malaysia 885 5.4 –10.3 –8.8India 500 3.1 7.4 –13.8The People's Republic of China 455 2.8 3.3 2.4Vietnam 212 1.3 6.3 5.5Sri Lanka 96 0.6 –6.0 –9.1Nigeria 87 0.5 –5.3 –3.3Others 397 2.4 8.1 –16.6

Synthetic rubber 10,065 61.4 2.8 0.0

Consumption 16,470 100.0 5.0 –0.4Natural rubber 6,540 39.7 6.0 0.5Synthetic rubber 9,930 60.3 4.4 –0.9

Deficit(–)/surplus(+) –90

e Estimate

Source: Department of StatisticsInternational Rubber Study Group

Table 1.12Rubber: Area, Production and Yield

Estates Smallholdings

1997 1998p 1997 1998p

’000 hectares

Planted area 206 197 1,404 1,365Replanting 4 4 34 30Newplanting 6 6 106 108Production (’000 tonnes) 216 199 755 686Yield (kg./mature ha.) 1,069 997 661 613

p Preliminary

Source: Department of StatisticsMalaysian Rubber BoardDepartment of Agriculture, SarawakSabah Rubber Fund Board

rubber agencies, namely, the Malaysian RubberResearch and Development Board, the MalaysianRubber Exchange and Licensing Board and theRubber Research Institute. MRB would beresponsible for all activities pertaining to thedevelopment of the rubber industry to bringabout a more co-ordinated and effective approachto the policies on development of the rubberindustry. Specifically, the new organisational set-upwould have research and development as its coreactivity. MRB would also consolidate all otherrelated functions and activities from the upstreamsector to the mid and downstream sectors interms of production, processing, value-addedmanufacturing and market promotion for raw rubber,manufactured rubber and rubberwood products.The MRB has formulated a Revised RubberStrategy to maximize production from existingrubber trees as well as to promote replantingwith Latex Timber Clones to maximize rubber andwood yields.

In 1998, the Rubber Industry SmallholdersDevelopment Authority (RISDA) allocated a total ofRM157 million to finance replanting projects and

an additional RM1.8 million for the rehabilitationprogramme to assist smallholders with financialdifficulties. The replanting projects involved 19,421hectares of rubber land, while the rehabilitationprogramme covered 1,272 hectares. Theseprogrammes were aimed at ensuring stableproduction by the smallholders, who accounted for78% of the nation’s rubber production.

Production of saw logs declined sharply by27.2% to 22.7 million cubic metres in 1998. Thedecline was due mainly to weaker demand fromthe traditional buyers, which were mainly from theAsia-Pacific region. Production in Sarawak andSabah was also affected by adverse weatherconditions. At the same time, logging activities werein line with the Government’s conservation policyand commitment to sustainable forest managementby the year 2000, in compliance with therequirement of the International Tropical TimberOrganisation. Production was lower in all regions.Sarawak’s production, which accounted for 49% ofthe total saw log production, declined by 33.9% to11.1 million cubic metres, while that for PeninsularMalaysia (28% of total production) was lower by13.6% to 6.4 million cubic metres. For Sabah (23%of total production), production declined by 25.3%to 5.2 million cubic metres.

The downtrend in the production of cocoacontinued in 1998 for the eighth consecutive year.Although cocoa prices improved significantly duringthe year, production of cocoa beans declined by14.9% to 90,200 tonnes, the lowest since its recordproduction of 247,000 tonnes in 1990. A severedrought, arising from the El Nino weatherphenomenon had affected fruit setting and had alsodelayed the fruit setting for the second season.Besides the weather factor, cocoa output was alsoaffected by rising production cost due to increasedlabour cost and higher prices of agricultural inputs.During the year, about 6,000 hectares of cocoaareas were converted into oil palm with noconversion of other crop areas into cocoa.Conversion was primarily carried out by thesmallholders in Peninsular Malaysia. In Sabah,where production accounted for 68% of the totalnational output, conversion activity was less active.In the face of lower production of cocoa beans,the domestic cocoa processing industry importedcocoa beans, particularly from Indonesia.Nevertheless, the overall processing of cocoa beansby the local grinders declined by 4.8% to 100,000tonnes in 1998.

-40

-30

-20

-10

0

10

20

-40

-30

-20

-10

0

10

20

Agriculture

Graph 1.8Production Growth Rate

-40

-30

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0

10

20

30

40

50

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10

20

30

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Overall

Tin

Crude oil

Natural Gas

Mining

Overall

Rubber

Saw logs

Crude palm oil

1996 1997 1998

1996 1997 1998

% %

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

% %

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

Production of the fishery industry increasedfurther by 5.7% to 1.4 million tonnes in 1998. Thecontinued favourable performance in fish productionwas due to the marked increase in the productionof aquaculture (23.2%) and marine fisheries (4.1%),which together accounted for 90.4% of the totalfish production. The marine fisheries, which includedinshore fisheries, recorded a production of1,087,380 tonnes while production from aquaculturetotalled 133,060 tonnes. Deep sea fishing, on theother hand, contributed 129,420 tonnes to totalproduction. The higher production of fish duringthe year enabled exports to increase by 1.9% to238,600 tonnes, mainly to Thailand, Singapore andJapan, while imports declined by 3.4% to 207,840tonnes, the bulk of which was from Thailand.Meanwhile, Malaysian per capita consumption offish increased to 42 kilograms in 1998 against 41kilograms a year ago.

Mining

Value added in the mining sector increasedfurther by 0.8% in 1998 (1997: +1%), reflectingprimarily higher crude oil and gas production anda turnaround in tin production. The quarrying sector,on the other hand, contracted sharply by 24.5% inline with the slowdown in construction activities.Overall, the mining sector contributed a slightlyhigher share of 7.3% of GDP in 1998 (1997: 6.7%),0.5% to employment (1997: 0.4%) and 5.2% tototal exports (1997: 6.9%).

The production of crude oil includingcondensates increased by 1.7% to 726,100 barrelsper day (bpd) in 1998. Excluding condensates,crude oil production was higher at 640,600 bpd(1997: 629,200 bpd). Output of condensates (fromgas fields) was higher at 85,500 bpd (1997: 84,700bpd). On a regional basis, the output of crude oiland condensates from Peninsular Malaysia (58%of national production) declined by 1.5% to 422,000bpd, while that from Sarawak which accounted for28% of production, declined by 7.7% to 205,000bpd. In contrast, Sabah’s crude oil productionincreased markedly by 59.6% to 99,100 bpd asone new oilfield commenced operations inDecember 1997. As at the end of 1998, therewere 37 oilfields in production, with two newoilfields in Peninsular Malaysia and one in Sabah.In total, Peninsular Malaysia had 16 oilfields, whileSabah and Sarawak had 13 and eightoilfields respectively. In the upstream sector, fiveproduction sharing contracts were signed in 1998,

of which three were in Sarawak and two inPeninsular Malaysia. One oilfield in offshoreTerengganu Darul Iman was discovered duringthe year. By end-1998, a total of 18 explorationwells and 81 development wells were drilledin addition to 68,693 kilometres of seismicdata acquired for exploration and developmentpurposes. Most of the development activitiesin 1998 were concentrated in Peninsular Malaysiaand Sabah.

Reflecting weak demand from domestic andinternational markets, natural gas productionincreased only marginally by 0.3% to 3,857 millionstandard cubic feet per day in 1998. Domesticdemand was sluggish due mainly to lowerconsumption by the power generation sector. Onthe external front, exports of LNG to Japan, Koreaand Taiwan as a group, declined by 2.6% to 14.7million tonnes (1997: +18.6%). A total of 10 gasfields were in production in 1998, with five eachin Peninsular Malaysia and Sarawak. A gas fieldlocated offshore Terengganu Darul Iman wasdiscovered during the year.

Production of tin-in-concentrates recorded apositive growth in 1998 after eight consecutiveyears of decline. Production grew by 10.8% to5,610 tonnes. The significant increase in tin pricesof 43.6% in ringgit terms triggered higher productionfrom the 35 tin mines operating in Malaysia.Meanwhile, domestic consumption of tin metaldeclined further by 15.4% to 5,575 tonnes, reflectinglower demand from the tin-based industries.Utilisation of tin metal by the solder industry, whichaccounted for 60% of local consumption, declined

Table 1.13Mining: Production

1997 1998p 1997 1998p

’000 tonnes Annual change (%)

Crude oil1 713,928 726,100 –0.5 1.7Natural gas2 3,846 3,857 12.7 0.3Tin-in-concentrates3 5,065 5,610 –2.1 10.8Bauxite 279 158 27.4 –43.4Iron-ore 216 372 –33.5 72.2Copper 81 63 –6.9 –22.2

1 Expressed in barrels per day2 Expressed in mmscfd3 Expressed in tonnesp Preliminary

Source: Department of MinesPETRONAS

by 6% to 3,350 tonnes as demand from theelectronics industry was lower. Similarly, demandby the tin plating industry declined by 32.2% to595 tonnes, while that by the pewter industrydeclined by 23.4% to 590 tonnes. As thedomestic production was insufficient to meet thedemand of local smelters, tin-in-concentratescontinued to be imported, mainly from Peru,Australia, Portugal, Bolivia and the United States.

Services

Following the contraction in the economy, thegrowth of the services sector moderated in 1998given its strong inter-linkages with the other sectorsin the economy. The services sector recorded agrowth rate of 1.5% in 1998 compared with 8% in1997. Growth continued to be led by theintermediate services sub-sector, while the finalservices sub-sector expanded at a much slowerpace. Despite weaker performance of theservices sector, it remained as the largest sectorin the economy in 1998, contributing to ahigher share of GDP of 48.8% and totalemployment of 47.5%.

Following the contraction in aggregate demand,intermediate services comprising transport, storageand communications; and finance, insurance, realestate and business services registered a slowergrowth of 3.1% in 1998 (1997: 9.1%). A markedslowdown was observed in the transport, storageand communications sub-sector, where growthmoderated to 1.2% from 8.4% in 1997. Transportactivities were affected by the decline in the volumeof domestic and international trade, particularlyimports. The decline in trade, particularly withregional countries, was reflected in the lower volumeof cargo handled at major ports. Estimates for thefive major ports in Malaysia showed that cargohandled by these ports declined markedly by 13.8%to 121.1 million freight weight tonnes (f.w.t) in 1998.In terms of container throughput, the growthmoderated significantly to 1.2% (1997: 17.1%) to2.8 million twenty-foot equivalent units (TEUs).Despite the slowdown, several ports embarked onexpansion plans to enhance their facilities andservices, while new ports were being completed ordeveloped. For example, the new port in TanjongPelepas, Johor is under construction and isexpected to be operational in early 2000. TheSegamat Inland Port began operations in October1998 and is mainly expected to attractshippers located in southern Melaka and

northern Johor. Similarly, the North Port BusinessPark in Port Klang, upon completion, would providesupport to downstream activities in the surroundingarea at Port Klang. Several major shippingcompanies also expanded their capacity byacquiring ships valued at RM3.5 billion. During theyear, the Government continued its efforts toenhance port facilities and to promote Port Klangas a load centre and a regional hub. Severalmeasures were undertaken to enhance cargovolume in order to attract main line operators tocall at the port, which yielded positive results. In1998, a total of 67 main line operators called atPort Klang compared with only 10 in 1992. Incentiveschemes in the form of rebates, volume discounts,and waiver of certain port charges were madeavailable to encourage main line operators to callat Port Klang. Additional warehousing facilities andinland clearance depot were also established. Inan effort to enhance its competitiveness, theGovernment abolished the inter-terminaltransfer fee for cargo at Port Klang, effective30 November 1998.

For air transport, the decline in cargo handledwas partly attributed to some redirection of cargoby domestic traders to Singapore for a brief periodafter the relocation of the cargo services to thenew Kuala Lumpur International Airport (KLIA) inSepang at the end of June 1998. Domestic andinternational air travel, on the other hand, wereaffected by the economic downturn and uncertaintiesas well as a weaker ringgit. In view of thesedevelopments, Malaysia Airlines stepped up effortsto restructure its operations. While the delivery ofseveral new aircraft during the year was partlyoffset by the sale of old aircraft, flight routes werealso rationalised to maximise passenger load.Service to unprofitable destinations was suspendedwhile more aircraft were redeployed to profitabledestinations in Europe and Australia.

In the case of rail transportation, revenue fromcargo declined during the year, while revenue frompassenger services recorded some growth. Inparticular, the Light Rail Transit extended its serviceto an increased number of destinations within KualaLumpur, thus resulting in greater ridership towardsyear-end. In the communications sub-sector, theperformance of telecommunications servicesremained buoyant in 1998, weakening only slightlycompared with 1997. The number of telephonesubscribers grew by 3.8% during the year. Thenumber of residential subscribers increased by 5.7%

to 3.2 million, while that of business subscribersdeclined by 1.2% to 1.2 million. The Governmentliberalised the limit on ownership oftelecommunication firms by foreigners to 49% from30% on 25 February 1998.

In the finance, insurance, real estate andbusiness services sub-sector, value added increasedmore moderately by 4.4% in 1998. Total loansextended by the banking system declined in 1998due in part to the contraction in economic activity.Meanwhile, the sharp decline in prices and volumeof shares traded on the Kuala Lumpur StockExchange also affected the performance of this sub-sector. At the same time, slower growth was recordedby the insurance industry, as evidenced by thesmaller increase of 1.9% in premium incomecollections in 1998 (1997: 14.4%).

In the final services group, comprising utilities;wholesale and retail trade; hotels and restaurants;government services and other services, growthdecelerated sharply to 0.4% from 7.2% in 1997.Within this group, the wholesale and retail trade,hotels and restaurants sub-sector, particularly thosetrading in non-essential and high-end products, were

severely affected by the economic downturn andcautious consumer spending. The Malaysian RetailAssociation’s survey findings showed that sales inthe retail sector fell by 17% during the period July1997-June 1998. Amongst the major items whichrecorded a substantial decline in sales weretelecommunication products, fashion and accessories,jewellery, toys and gifts, general merchandise, foodand beverages and entertainment. The downwardtrend was also reflected in the Malaysian Instituteof Economic Research (MIER) Consumer SentimentsIndex, which fell by 37.5 points to an average of82.5 points during the first three quarters of 1998.Subsequently, the index recovered slightly indicatingan improvement in sentiment in the fourth quarter.The poor consumer sentiment was attributed mainlyto the negative wealth effect of the sharp declinein the equity and property markets, uncertainty aboutemployment prospects and business losses. Theslowdown in the domestic trade sector was reflectedin lower sales tax collection (–38.7%). Value addedin hotels and restaurants also showed a significantdecline due mainly to lower tourist arrivals (–10.6%).The regional economic downturn affected touristarrivals in 1998. This, together with a sharp increasein the supply of hotel rooms (+9,351 rooms), ledto a decline in the average occupancy rate forhotels to 49.9% in 1998 (1997: 58%). Meetingsand conventions, however, showed a sharp increaseand provided some boost to the local tourismindustry.

During the year, value added in the utilitiessub-sector slowed down markedly to 3.6% (13% in1997), mainly attributable to the sharp reduction inelectricity supply during the second half of the yearin response to lower demand, particularly from theindustrial and commercial sectors. On the otherhand, growth in water consumption, anothercomponent of the utilities sub-sector, remainedstable, increasing by an annual rate of 3% to 8,710million litres per day in 1998, the same rate ofgrowth recorded in 1997. Overall, the productioncapacity of water in 1998 was 10,428 million litresper day, an increase of 5% compared with a growthof 2% in 1997.

Growth in the Government services sub-sectormoderated to 2.4% in 1998 (6.1% in 1997).However, its share to GDP increased to 9.9% from9% a year ago. The moderation was due mainlyto the freezing of all vacant posts that are non-critical, salary cuts by senior Government officialsand the reduction in allowances for civil servants.

Table 1.14Growth in the Services Sector in 1978 Prices

1997 1998p 1997 1998p

Annual % sharechange (%) of GDP

Services 8.0 1.5 44.9 48.8

Intermediate services 9.1 3.1 19.0 21.0

Transport, storage andcommunications 8.4 1.2 7.5 8.1

Finance, insurance, realestate and businessservices1 9.5 4.4 11.5 12.9

Final services 7.2 0.4 25.8 27.8

Electricity, gas and water 13.0 3.6 2.5 2.8Wholesale and retail

trade, hotels andrestaurants 7.0 –2.0 12.3 12.9

Government services2 6.1 2.4 9.0 9.9Other services3 7.2 2.5 2.0 2.2

1Includes imputed rent from owner-occupied dwellings.

2Includes general public services (general public administration, externalaffairs and public order and safety), defence, health, education and others.

3Includes community, social and personal services, product of private non-profit services to households and domestic services of households.

p Preliminary

Source: Department of Statistics and Bank Negara Malaysia.

Malaysia experienced a period of 12consecutive years of growth, which averaged7.8% after the economic recession in 1985.In 1998, following the regional financial crisis,Malaysia has entered a period of economiccontraction. While the magnitude of thecontraction in output in 1998 was larger,the overall impact has been less severe onthe population. In particular, unemploymentwas widespread in 1985. In contrast, inthe 1998 recession, structural changes inthe economy, the full employment situationand the development of a more flexiblelabour market have moderated the rise inunemployment. This box article examinesthe two recession periods, and analyses thecauses and the policy responses. Lessonsare also drawn from the experience in boththe periods.

Economic Structure and Risks

The prevailing structure of the Malaysianeconomy significantly influenced the depthand magnitude of the recessions. While bothrecessions emanated from external sources,the impact of the external shocks on thedomestic economy were different, given thestructural changes in the economy. Policyresponses have accordingly differed.

In 1985, the economy was vulnerable tofluctuations in world output and prices ofcommodities. During this period, the publicsector dominated investments, accounting for30.9% of total domestic demand . Thiswas due primarily to the implementation ofcounter-cyclical policies to ride out theprevailing global recession as well as theGovernment’s entry into heavy industries.While the counter-cyclical policies sustainedthe growth momentum, it led to the twindeficits in the fiscal and external paymentpositions, and an increase in the externaldebt position.

The 1985 and 1998 Recessions:A Comparison

Similar to 1985, the export sector remainedvulnerable in 1997-98, despite structural changes.The difference was in the product compositionof exports. While in 1985 the major export wascommodities, in 1998, it was electronics andelectrical products. The distribution of marketsfor export products was also more diversified in1998, with 40% from East Asia. However, thegreater integration of markets meant that theloss of market share in East Asia would alsoaffect demand from other markets. In this regard,diversification of products was less effective inoffsetting risks due to the additional vulnerabilitycaused by the integration of global productsand financial markets.

More important was the creation of new risksarising from volatile capital flows as the domesticeconomy became more integrated with the globaleconomy. The Malaysian economy is veryopen with imports and exports of goods andnon-factor services accounting for about 211%of GDP in 1998 (105% in 1988), while thelong-term capital account expanded with grossinflows of RM34.6 billion in 1998 compared withRM11.4 billion in 1985. The globalisation ofinternational capital flows and the relatively opencapital account exposed the economy to newareas of vulnerabilities, in particular to thesudden reversal of capital flows and thecontagion effect of a crisis emanating in otherparts of the world. This risk was heightenedwhen the share of short-term capital flowsexceeded foreign direct investments in financingthe current account deficit.

The shift from the public sector to the privatesector as the engine of growth also creatednew risks. The slow development of the bondmarket resulted in loans to the private sectorrising to 148.4% of GDP in 1998 from 98.5%in 1990. Loans were collateralised againstproperties and shares which made the bankingsystem vulnerable to declining asset prices. Themitigating factor to this risk was that loansto the property sector were secured at a

Box II

1985

• Economy small (nominal GDP ofUS$31.2 bil lion) and vulnerable toexternal shocks.

• Economy open with exports at 49.1% ofGDP, but concentrated in commodities(66.7% of total exports).

• Inflation low at 0.4%.

• Unemployment of 6.9%, no pressureon inflation.

• Weak fiscal position - large fiscal deficit(peak of 16.6% of GDP in 1982; publicsector deficit was 18% in 1982). Revenuebase was dependent on export taxes, andexpenditure was focused on heavyindustries. Deficit was reduced to 0.6% ofGDP in 1985.

• Public sector (including NFPEs) engine ofgrowth, accounted for 46.9% of investment(nominal) and 22.7% of consumption(nominal).

• External sector weak with current accountdeficit high at 2.1% of GDP, attributable tohigh consumption and high Governmentexpenditure.

• High external debt in 1986 (75.6% ofGNP), mainly by public sector (64.9%of GNP) and high debt service ratio (DSR)of 18.9%.

• Exchange rate stable, fluctuatingbetween US$1=RM2.41–2.60. No changein exchange rate policy, but therate depreciated following realignmentof yen/US$ rate under the PlazaAccord.

Economic Structure and Risks

1998

• Economy much larger (nominal GDPof US$71.1 billion) and fundamentallystronger.

• Economy more open, with exports at102.9% of GDP, but risks shifted tomanufacturing (82.9% of gross exports),especially electronics (39.8% of grossexports).

• Inflation much higher at 5.3%.

• Full employment, with foreign labour atabout 10% of total employment, exertinginflationary pressures.

• Strong fiscal position - fifth year of fiscalsurplus in 1997 (2.4% of GDP). Revenuewas broad-based, and expenditure hasbeen directed mainly to education, healthand infrastructure. Still in surplus in1997 (2.4% of GDP) but moved todeficit of 1.8% of GDP in 1998 tostimulate recovery.

• Public sector important in recovery process.Share of public investment amounted to44.1% (nominal) and consumption to 20.9%(nominal).

• Current account surplus at 12.9% ofGDP due mainly to export growth anddeclining imports.

• Low external debt of 60.9% of GNP andDSR of 6.7% due to improved debtmanagement and prepayments. Public sectordebt low at 26% of GNP.

• Extreme volatility of exchange rates,breaching intra-day trading levels of RM3.35to 4.88 between January-August. Fixedexchange rate regime adopted on2 September 1998, where the ringgit wasfixed at US$1=RM3.80.

• Basic thrust of monetary policy generallyexpansionary to revive economic growth inthe face of serious budgetary restraints anddeclining commodity prices.

• Loans to private sector equivalent to 85.2%of GDP. Growth was fuelled throughexpansionary fiscal policy.

• Authorised deposit-taking cooperatives thatwere relatively less regulated, and illegaldeposit-takers proliferated. Regulatedbanking sector in early stage of observingnew prudential regulations. Several bankinginstitutions experienced large losses, arisingfrom imprudent lending, poor managementand fraud in certain cases.

• Capital adequacy ratio of 7.5% at the endof 1985. NPL of 30.1% at the end of1988 based on the 12-month classification.

• By the end of 1989, four commercial banksand eight finance companies rehabilitatedthrough capital injection or assumptionof control by BNM and placed underreceivership prior to absorption by a largerbanking institution.

• Tight monetary policy stance in late 1997to address emerging inflation in early 1998,and to restore stability in the foreignexchange markets. Monetary policygradually relaxed as inflation eased, tosupport economic recovery.

• Domestic loans to private sector muchhigher at 148.4% of GDP.

• Comprehensive regulatory and supervisoryframework for licensed banking institutions,with provisions to extend purview ofBNM to other financial institutions whenrequired to preserve financial stability.Stronger banking system, and prudentialstandards largely in line with internationalstandards.

• At end-1998, RWCR of 11.8%; NPLs of7.6% (net) and 12.6% (gross) under thesix-month classification.

• Comprehensive bank restructuring planimplemented. For further details, pleaserefer to Box IV on "Restructuring theBanking Sector".

comfortable margin, at more than 100%, whilethe proportion of loans extended for the purchaseof shares was approximately 8%, well belowthe prudential limit of 20% for commercialbanks and finance companies, and 30% formerchant banks.

The Recessions in 1985 and 1998

Both the 1985 and 1998 recessions weretriggered by external developments. In 1985,there was a global decline in the prices ofmajor commodities. The slowdown in exports ledto a sharp cutback in private sector expenditure.Together with the dampening impact of the fiscalrestraint, this led to a severe deflationary effecton the economy. In 1985, real GDP declinedby 1.2%. On the business front, the sharpdownturn in aggregate demand resulted inexcess capacities, a drop in profits and rising

number of corporate bankruptcies. The propertymarket which experienced a boom in the period1983-84 was badly affected, with pricesestimated to have declined by between 10-30%.The prevailing unemployment situation deepenedwith the recession.

Amidst the slowdown in economic activity, thefinancial system was affected by a crisis ofconfidence, triggered by the failure of somedeposit-taking cooperatives (DTCs) as well asillegal deposit-takers, such as credit and leasingcompanies. The deterioration in the health ofthe DTCs and illegal deposit-takers was a resultof falling property and share prices as well asweak management, and in some instances,fraudulent and dishonest management. The crisisof confidence in this “unregulated” sector ofdeposit-taking institutions posed a systemic threatto the banking system. At the same time, thecombination of a sharp contraction in cash flows,

deflation in property and share prices, and arise in debt servicing exposed the financial over-commitments of many entrepreneurs, whichconsequently resulted in the deterioration in thehealth of the banking system. Non-performingloans (NPLs) as at end 1988 was approximately30% and several banking institutions experiencedan erosion in capital. By the end of 1989, fourailing commercial banks and eight ailing financecompanies had been rehabilitated via capitalinjection or assumption of control by BNM orplaced under receivership prior to absorption byother larger institutions.

While the 1985 recession was triggered bythe sharp decline in commodity prices, the 1998recession was, on the other hand, caused bythe adverse developments in the regionalfinancial markets following the speculative attackson the currencies of the East Asian economies.Markets panicked and foreign investor confidenceevaporated. Malaysia was not spared from thecontagion effect of these developments, despiteits relatively strong economic fundamentals. Theringgit and stock market experienced significantdownward pressures as a result of weak investorconfidence and large outflows of short-termcapital. The depreciation of the ringgit and thedecline in share prices reinforced each other,creating a vicious circle of exchange ratedepreciation and falling stock prices that furtherundermined confidence.

As the crisis prolonged, the fall in aggregatedemand in Asia affected Malaysian exports.Measures to stabilise the domestic economyalso caused severe declines in consumption andinvestment. As the financial crisis permeated tothe real economy, the financial system wasadversely affected. Banking institutions becamepreoccupied with managing the deterioration inasset quality and capital and curtailed theirlending operations. Total loans outstanding(including NPLs sold to Danaharta) extended bythe banking system increased by only 1.3%(26.5% in 1997). This development, combinedwith the negative wealth effectand the moderationin exports, had a dampening impact on economicactivities. Consequently, the economy experienceda contraction of 6.2% in the first nine monthsof 1998, and an overall contraction of 6.7% in1998. Furthermore, both the inflation andunemployment rate increased to 5.3% and 3.9%respectively in 1998.

Policy Responses

(a) Monetary Policy

The conduct of monetary policy in addressingthe recessions was particularly difficult in anenvironment of open capital account regimesand significant volatility in exchange rates.BNM was confronted with conflicting objectivesof maintaining stability in the foreign exchangemarket and reducing interest rates to reflectthe domestic economic conditions. In therecessionary environment of 1985-86, the basicthrust of monetary policy was generallyexpansionary to revive economic growth in theface of serious budgetary restraints and decliningcommodity prices. The easing of monetary policywas achieved principally through the easing ofbank liquidity and containing the upward pressureon interest rates. However, attempts to injectliquidity were neutralised to a large degree byoutflows of funds, fuelled by speculativepressures on the ringgit in the periods April-May and August-September in 1986. Only whenpressures on the ringgit subsided in mid-October1986 that BNM was able to further easemonetary policy to support economic recovery.

The situation was not dissimilar in 1997-1998.The difference was mainly in the magnitude ofthe speculative activities. Limits to theeffectiveness of monetary measures were greaterdue to the availability of large amounts of ringgitfunds abroad that continually destabilised theringgit exchange rate. In an environment ofunprecedented depreciation of the ringgit in late1997, BNM monetary policy was tightened tocontain inflation and restore stability in theforeign exchange market. While inflation wascontained and the current account balance hadimproved, the ringgit exchange rate continued tobe subject to speculative pressure. The tightmonetary stance amidst slowing aggregatedemand contributed to further weakening of theeconomy. As the adverse economic conditionsbecame evident by mid-1998, monetary policywas gradually relaxed to support economicrecovery. The easing of monetary policy wasfacilitated by the moderation in inflationarypressures. Several initiatives were also taken toimprove the liquidity situation in the bankingsystem, moderate the intermediation cost andgenerate lending activities. Subsequently, thestability achieved through the imposition of

selective exchange control measures on1 September 1998 enabled BNM to further easemonetary policy.

Inefficiencies in the intermediation process alsoemerged during the two periods of recession.There was undue competitive bidding by a smallnumber of banking institutions for deposits thatled to increases in the cost of funds for thesystem as a whole and slow downwardadjustment in the base lending rate when thesituation improved. As a result, measures wereintroduced to enhance the efficiency of theintermediation process as well as improve thetransmission of monetary policy and the flowof liquidity in the banking system. During theperiod 1985-87, the authorities suspended themarket determination of interest rates, andpegged the deposit rates and the base lendingrate. The authorities were pragmatic andrecognised that these moves, while not market-oriented, were necessary for the period to ensurethat the banking system functioned to supporteconomic recovery.

In 1998, monetary management focused onmaking liquidity management moretransparent as well as ensuring a betterdistribution of liquidity to improve theefficiency in the loan intermediation process.During both recession periods, the authoritiesalso introduced and expanded various specialfunds to ensure that viable borrowers and prioritysectors continued to have ready access to creditat reasonable rates. These funds also helped tostimulate new fixed investment and to rehabilitateviable borrowers and industries.

(b) Fiscal Policy

A major difference was in the stance of fiscalpolicy adopted by the Government in dealingwith the two recessions. During the 1985-86period, the policy response focused mainly onfiscal restraint. Government expenditure wasreduced through downsizing its role in theeconomy. Despite the fiscal restraint, the fiscaldeficit increased to 11.2% of GNP in 1986, duemainly to a substantial decline in revenue.

In contrast, during the 1998 recession, thehealthy fiscal position following five years of fiscalsurplus and low government external borrowingsprovided the Government greater flexibility in the

use of fiscal policy in stimulating economicactivity. While the Government continued topursue fiscal discipline and prudence at thebeginning of the crisis in late 1997, the severityof the slowdown and the threat of a recessionprompted the Government to switch to counter-cyclical fiscal measures in early 1998. However,the expenditure was directed at sectors that hadstrong economic linkages to maximise themultiplier effect on economic activity, and toprotect the vulnerable segments of society. Unlikethe situation in 1985-1986, the fiscal deficit in1998-1999 is not expected to cause strains inthe balance of payments position.

(c) Strengthening and Restructuring theBanking Sector

The deterioration in the health of the bankingsector during both recessions prompted theauthorities to undertake measures to strengthenand restructure the sector. The measures wereaimed at preventing the emergence of a systemiccrisis and thus, maintain public confidence inthe banking system. As a result, theintermediation function continued withoutdisruption during both periods of recession. Forthe greater part of the early 1980s, bankingsector policy was focused on strengthening theprudential regulations through the adoption ofcapital adequacy standards, single customer limit,prohibition of connected lending and ruleson the treatment of NPLs. In addition, a seriesof amendments and new provisions to thebanking legislation were also introducedin January 1986, which, among others, enabledBNM to control abuses by bank management;diversify equity control of banks; and lendto or inject equity into banking institutions whosecapital was impaired. These powers allowedBNM to promptly address the problems of ailinginstitutions that emerged during this period.Consequently, BNM assumed control of fourcommercial banks and eight finance companiesduring 1985-89, and rehabilitated them. By1998, three of these institutions had turnedaround, following which BNM’s investmentsin these banking institutions were sold to theprivate sector.

Another important development during thisperiod was the role of BNM in the resolution ofthe DTC crisis. The promulgation of the Essential(Protection of Depositors) Regulations, 1986,

provided BNM with wide-ranging powers to dealeffectively with the DTCs, and allowed BNM tosuspend the operations of the 24 ailing DTCsto facilitate investigative operations. The problemswere resolved with the formulation andimplementation of various rescue schemes, thelast of which was finalised in 1988.

The restructuring of the banking systemfollowing the 1985 recession enabled the bankingsystem to strengthen during the period of strongeconomic growth in the next decade. Hence,the banking sector entered the financialcrisis in 1997 from a position of strength.Nevertheless, the severity of the crisisweakened the banking sector. The first stepstaken to further strengthen the banking systemwas to strengthen prudential regulatory andsupervisory standards, and promote greaterdisclosure on the financial condition of bankinginstitutions. Subsequently, mechanisms and theinstitutional framework were put in place to dealwith potential banking sector problems andpromote market confidence, in the face ofdeteriorating economic conditions. Thesemeasures were pre-emptive and involved theconsolidation of the finance companies whichwere the most vulnerable segment in thebanking system, as well as the establishment ofPengurusan Danaharta Nasional Berhad,Danamodal Nasional Berhad and the CorporateDebt Restructuring Committee, to address theexpected rise in NPLs, erosion of capitaland deterioration in corporate performancerespectively. These measures providedmarket-oriented mechanisms to deal withpotential problems in a systematic manner. InJanuary 1999, BNM assumed control of twofinance companies as part of the ongoingmeasures to strengthen the banking system.These policy initiatives (discussed in detail inchapter 4 of the Annual Report) were differentfrom those measures adopted in 1985. Assetsof the banking system had expanded fromRM198.4 billion in 1985 to RM616.4 billion in1998. Capital and reserves were substantiallylarger, amounting to RM37.4 billion comparedwith RM4.1 billion in 1985.

(d) Selective Exchange Control Measures

The Government was aware that theuncertainty and instability of internationaldevelopments could undermine the progress of

various measures taken to support the eco-nomic recovery process. Hence, selectiveexchange control measures were introduced on1 September 1998 and the exchange rate wasfixed at US$1=RM3.80 on 2 September. Themeasures were aimed at insulating the domesticeconomy from the r isks of externaldevelopments, containing the speculation on theringgit and minimising the impact of short-termcapital flows, thus enabling the country to regaina greater degree of monetary independence.The measures have been successful in limitingthe contagion effects of external developmentson the domestic economy, while providing anenvironment of stability so that the authoritiescould focus on promoting economic recoverywith price stability and accelerate the plans torestructure the financial and corporatesector. For details, refer to Box III on "TheExchange Control Measures as a Policy Option".

(e) Other Policies

The centrepiece of the package introducedduring the 1985 recession to encourage theprivate sector to be the main engine of growthwas the introduction of the Promotion ofInvestments Act, 1986, which provided tax andother incentives to generate the expansion inprivate investment. This included theliberalisation on foreign equity ownership, whichacted as a catalyst in reviving privateinvestment. This led to a rapid recovery ofthe economy. FDI flows, which had declinedsince 1984, turned around in 1987 to recordnet inflows of RM1.1 billion and increasedfurther to RM1.9 billion in 1988. Since then,FDI flows had accounted for a significantportion of the financing of economic activitiesin Malaysia.

The economy in 1998, compared with 1985,was considerably more open. The foreign sharein the domestic market was high as reflectedin the significant foreign participation in allsectors of the economy. As a result, therewas limited scope for the Governmentto further liberalise the foreign investmentguidelines without marginalising domesticentrepreneurs. Nevertheless, the Governmenthas taken bold steps to allow 100% foreignequity irrespective of the level of exports forall applications received until the year 2000to set up manufacturing projects, with the

exception of specific activities and productsincluding paper packaging and plastic packaging.The foreign equity participation in the telecom-munications and insurance sectors has alsobeen relaxed.

During both recessions, the Governmenttook pre-emptive steps to protect vulnerablesegments of society. During the 1985 recession,these measures included the Government’sthree-year programme to build up to 240,000low cost houses as well as building moreroads, especially rural roads. In the currentperiod, the Government also promoted low-costhousing projects, as reflected in theestablishment of the Special Scheme for Lowand Medium Cost Houses with an allocation ofRM2 billion. In addition, funds have also beenmade available to finance social, health andeducation projects.

Conclusion

The recovery from the 1985 recession wasrelatively rapid with GDP expanding by 1.2% in1986 and 5.4% in 1987, aided by the favourableexternal environment. The policies implementedduring the period helped to set the stagefor the economy to record high growth in thesubsequent years. In contrast, the recovery fromthe 1998 recession is expected to be moregradual (growth of 1% in 1999). However, thestructural adjustments and financial sectorreforms would provide the foundation forsustainable growth and a stronger economy.Nevertheless, uncertainty and the threat ofcontagion and systemic risk remains, givenrecent developments on the internationalfront. It is clear that, given the opennessof the Malaysian economy, externaldevelopments would continue to significantly

1984 1985 1986 1996 1997 1998p

Real GDP growth (%) 7.8 –1.2 1.2 8.6 7.7 –6.7

CPI (% change) 3.6 0.4 0.6 3.5 2.7 5.3

Unemployment rate (%) 8.3 6.9 8.8 2.6 2.6 3.9

Federal Government overall balance –6.4 –6.1 –11.2 0.8 2.5 –1.9

(% of GNP)

Current account balance (% of GNP) –5.3 –2.1 –0.5 –5.1 –5.4 13.7

External debt (% of GNP) 50.1 59.0 75.6 41.5 65.4 60.9

Debt service ratio 11.8 15.8 18.9 6.9 5.5 6.7

(% of exports of goods and services)

Net international reserves (RM bil) 9.6 12.5 16.5 70.0 59.1 99.4

M3 growth (annual change, %) 15.6 9.8 8.8 21.2 18.5 2.7

Banking system deposits (annual 20.7 10.6 7.5 26.3 21.3 –0.5

change, %)

Banking system loans (annual 20.9 14.0 6.0 27.6 26.5 –1.8

change, %)

3-month interbank rate (average, %) 9.39 7.74 6.41 7.34 8.60 6.48

Average base lending rate 12.25 10.75 10.00 9.18 10.33 8.04

(commercial banks, %)

Risk-weighted capital ratio of 6.8* 7.5* 7.0* 10.6 10.6 11.8

banking system1 (%)

Non-performing loans (NPLs)2 / total

outstanding loans (%) n.a. n.a. n.a. 3.7 4.1 7.6

Movement of RM (against +1.8 –8.6 –13.7 +2.6 –31.4 –0.2

composite, %)

1 Minimum requirement of 8% based on Basle Capital Accord.* Commercial banks only (Pre-Basle Capital Accord) - minimum requirement of 4% for domestic banks and 6% for foreign banks.

2 Loans classified as NPLs based on individual banking institution's NPL classification policy, i.e. 3-month or 6-month classification.

P Preliminary

Table II.I: Key Macroeconomic and Financial Indicators

influence the growth cycle of the domesticeconomy.

The objectives of policy to maintain pricestability and achieve sustainable growth remainedunchanged during the 1985 recession and inthe current situation. The priority of theGovernment was to put in place policiesthat would support an early economicrecovery. The approach reflected the differentcircumstances and causes of the economiccrisis during these two recessions. In particular,given the more integrated nature of theworld economy and the more hostile externalenvironment, the policy responses in the 1998recession have been more dynamic andunorthodox. The imposition of selective exchangecontrols has provided an environment of stabilitywhich has enabled the Government to

continue with implementation of the necessarystructural reforms to support economic recovery.Similarly, the Government had to invokeemergency regulations to deal swiftly anddecisively with the DTC crisis in the mid-1980sin response to the erosion in depositorconfidence.

In both periods, the respective measuresrestored confidence and preserved stability inthe banking system and the intermediationprocess continued to function effectively. Theexperience during both recessions demonstratesthe need for policies to vary according tocircumstances. Success depends on the abilityto be pragmatic and flexible, while remainingcommitted to the objective of restoring financialand economic stability and supporting growthwith price stability.

Nevertheless, the Government services sub-sectorcontinued to provide improved public services andamenities to facilitate private sector activities duringthe year.

Domestic Demand Conditions

Aggregate domestic demand declined in 1998for the first time since 1986. The major correctionin the currency and stock markets and thesubsequent negative effects of balance sheetadjustments in the financial and corporate sectorsamidst weak external demand contributed to asignificant contraction in both private sectorinvestment and consumer spending. The reversalof fiscal consolidation and adoption of a stimulativebudget in the second half-year helped to avoid alarger contraction in aggregate demand. Asinflationary pressures abated, monetary policy alsoturned expansionary from August to complementthe expansionary fiscal measures. Increased liquidityfrom domestic and external sources, significantlylower cost of funds and greater stability in thecurrency and equity markets following theimplementation of selective exchange controlmeasures contributed to improved investor andconsumer sentiment towards year-end. Reflectingmainly the sharp adjustment in the first threequarters of 1998, aggregate domestic demand(excluding stocks) declined by 20.6% in currentprices, as against a growth of 9.6% in 1997 andan average annual growth rate of about 13.5% inthe period 1987-97. In real terms, the decline intotal domestic expenditure was more pronounced(–25.9%, 1997: +6.5%), with the decline in publicexpenditure exacerbating the sharp contraction inprivate sector expenditure.

Total consumption spending declined by 6.5%in nominal terms in 1998, following an increase of8% in 1997. In real terms, total consumptionspending, which accounted for about 67% of totaldemand, declined by 10.3% (1997: +4.9%). Thenegative wealth effects arising from the decline inshare prices, rising inflation rate and uncertainemployment prospects led to more cautiousconsumer sentiment. The major consumptionindicators pointed to a significant adjustment ashouseholds reduced consumption, increased savingsand reduced existing debt levels. Sales ofpassenger cars in 1998 registered a decline of54.8%, compared with an increase of 12.3% in1997. Total loans approved by the banking systemfor personal use and for purchasing consumer

goods declined markedly by 72.2% and 93.6%respectively. Similarly, the Business ExpectationsSurvey of the Department of Statistics showed thatrevenue from wholesale and retail trade declinedby 31.4% in 1998, compared with an increase of14.4% in 1997. Imports of consumption goodsin terms of United States dollars declined for thesecond consecutive year by 32.7% (1997: -0.7%).Reflecting the sharp decline in consumer spending,revenue from sales tax by the Federal Governmentdeclined by 37.7% (1997: +12.7%). Nevertheless,consumer sentiment picked up towards end-yearas evidenced by the upward trend in several majorindicators. Sales of passenger cars increased to20,248 units in December 1998, compared witha low of 5,724 units sold in February 1998. Thelatest Business Expectations Survey conductedby the Department of Statistics indicated thatgross revenue of the wholesale and retail sectorsare expected to increase by 7.3% during thesecond half year of 1998, compared with a declineof 37.4% during the preceding first half-year.This improved sentiment was also reflected in theConsumer Sentiments Index of the MIER, whichindicated an increase in the index to 80.5 pointsin the fourth quarter from a record low of79.1 points in the second quarter. Under therecent one-month Home Ownership Campaignwhich ended on 12 January 1999, propertiesvalued at RM3.5 billion were sold. For 1998as a whole, private consumption spendingdeclined by 7.7% in nominal terms and 12.4%in real terms.

Public consumption expenditure which accountsfor about 20% of total consumption also declined,albeit at a more moderate rate of 1.5% in nominalterms and 3.5% in real terms. Following theoutbreak of the financial crisis in mid-1997, several

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Graph 1.9Domestic Demand Aggregates

%

1990 1991 1992 1993 1994 1995 1996 1997 1998p

%(Real growth)

Private ConsumptionPrivate InvestmentPublic ConsumptionPublic Investment

measures were announced in the fourth quarter of1997 to manage the level of aggregate demandas a means to contain the current account deficitin the balance of payments. The economicadjustment measures included an across the board18% cut in Government spending. However, in thesecond half of the year, the Government reversedthe policy stance and adopted an expansionaryfiscal policy with the objective of avoiding furthercontraction in domestic demand. In practice, thefiscal policy outturn was tighter than planned owingto the implementation gap. Hence, the fiscal deficitis estimated at 1.9% of GNP compared with theGovernment’s 1999 Budget estimate of –3.7% asannounced in October 1998. This cutback in non-essential expenditure led to the reduction in publicconsumption spending on supplies and services anddefence expenditure.

The contraction in total investment wassignificantly higher at 39% in nominal termsand 44.9% in real terms. The key investmentindicators pointed to the consolidation of investmentactivities. Imports of capital goods, a leadingindicator of investment activity, declined significantlyby 40.3% in United States dollar terms(1997: +6.7%). Similarly, sales of commercialvehicles registered a sharp decline of 76.1%,following an increase of 8.4% in 1997. Loansextended by the banking system to the broadproperty sector (excluding loans sold to Cagamas)increased at a much slower rate of 5.3%, whileloans extended to the manufacturing sector declinedby 0.2% in 1998 (1997: 32.9% and 18.5%respectively). However, several key indicators haveturned positive since September 1998, reflectingsome revival in investor sentiment. The performanceof the capital market improved with the KualaLumpur Composite Index increasing by 123.1% to586.1 points as at 31 December 1998, from thelowest level of 262.7 points as at 1 September1998, while the market capitalisation of theKuala Lumpur Stock Exchange also improved by106.3% to RM374.5 billion from a low of RM181.5billion. Sales of commercial vehicles increased to2,545 units in December 1998 compared with alow of 1,148 units sold in February. The value ofproposed investment in the manufacturing sectorincreased to RM4.5 billion in the fourth quarter,compared with RM3.1 billion in the precedingquarter. The positive sentiment was also reflectedin the latest MIER Business Conditions Index,which improved to 44.7 points in the fourth quarterof 1998, from a record low of 41 points in thefirst quarter.

The preliminary estimate for 1998 as a whole,indicated that private investment declined markedlyby 53.3% in nominal terms. The breakdown ofprivate investment by sector showed that activity inthe services and construction sectors were moreaffected by the financial crisis and the adjustmentmeasures implemented to address the economicimbalances in the economy. The decline of 56.9%in capital outlay in the services sector reflectedmainly the completion of large infrastructure projectsand the slowdown in implementation of existingprojects, while selected new projects with high importcontent were deferred to strengthen the balance ofpayments position. Large infrastructure projectsdeferred in 1997 included the Bakun Hydroelectricproject, the Kuala Lumpur Linear City project, theNorthern Regional International Airport, PutrajayaAdministrative Centre Phase II, the CameronHighlands-Fraser Hill-Genting Highlands Road projectand the Malaysia-Indonesia Bridge project over theStraits of Malacca. The slower rate of investmentin the transport sub-sector was also attributed tothe delay in the implementation of the Express RailLink project and slow progress of the KL Monorailproject. The scaling down of investment in thefinance, insurance and business services sub-sectorreflected mainly the substantial reduction ininvestment in office space, hotels and retail outletsin shopping malls in view of the oversupply situationand weak demand following the economic downturn.Following the marked decline in capital outlays inthe services sector, the contribution of the servicessector to total investment declined from about 34%in 1997 to 31% in 1998.

The construction sector also experienced severeadjustment in 1998. Capital outlay in this sector,which accounted for a share of 13% of total privatesector investment, declined by 34.1%. With thedeferment and delayed implementation of several

Table 1.15Private Investment by Sector1

1996 1997 1998

RM billion

Private investment 77.1 86.1 40.2

Of which: % share

Manufacturing 26.5 25.7 34.1Construction 9.7 9.0 12.6Services 32.9 34.0 31.4

1 Estimates

privatised road projects, investment activity in theconstruction sector was supported mainly by theconstruction of low- and medium-cost houses. Thetwo privatised projects that were deferred in 1998were the South Klang Valley Expressway andKuala Lumpur-Kuala Lumpur International AirportDedicated Highway.

Structural changes in the economy and theuncertain business climate also affected investmentactivity in the manufacturing sector. Investment inthis sector, which accounted for 34% of total privateinvestment, declined by 38% in 1998 (1997:+8.3%). The decline was broad-based, affectinginvestment in both the domestic and export-orientedindustries. Gross inflows of foreign direct investmentinto the manufacturing sector was estimated tomoderate to RM10.5 billion in 1998, compared withRM18 billion a year ago. The uncertainty in theregion, in particular weak export demand and lessfavourable developments in investing countriescaused foreign investors to defer several capital-intensive projects, including wafer fabrication plants.New investment activity in the manufacturing sectorwas supported mainly by the commencementof several joint ventures in petrochemical projects.The total value of investment approved for theseprojects exceeded RM6 billion in 1998.

The value of investment approved in themanufacturing sector by the Ministry of InternationalTrade and Industry (MITI) in 1998 recorded anincrease of 2.3% to RM26.4 billion (RM25.8 billionin 1997). Of the total investment approved, fourlarge projects, each with proposed capital investment

exceeding RM1 billion, accounted for an approximateshare of 27.2%. The petroleum products (includingpetrochemicals) industry accounted for the largestshare of 24.4% of the total value of investmentapproved, followed by the chemicals and chemicalproducts industry (22.4%), basic metal products(10.8%), electrical and electronic products (9.1%)and transport equipment (6.3%) industries. In termsof ownership, the share of domestic investors andforeign investors was 51% and 49% respectively,compared with 56% and 44% respectively in 1997.Reflecting mainly the uncertainty caused by thecrisis, the value of applications for investment waslower for 1998, registering a decline of 44.5% toRM19 bil lion from RM34.2 bil lion in 1997.Nevertheless, there was a discernible reversal intrend in the fourth quarter of 1998, when the valueof applications increased to RM4.5 billion fromRM3.1 billion in the third quarter.

The share of foreign investment in approvedprojects varied among industries. Foreign investmentapproved in the chemicals and chemical productsindustry accounted for 31.7% of total approvals.The share of foreign participation was smaller inother industries, in particular, petroleum products(16.4%), electrical and electronic products (14.5%),basic metal products (7.6%) and textiles and textileproducts (4.8%). The top five foreign investors in1998 were the United States (49% of the totalforeign investment approved in 1998), Japan (14%),Taiwan (8%), Singapore (7%) and the Netherlands(5%). These countries together accounted for 83%of the total foreign investment approved by MITI.

In line with the objective of attracting foreigninvestment into the country, the Government hasfurther liberalised the foreign equity policy for themanufacturing sector in respect of new investment,expansion or diversification. Under this newguideline, foreign investors can now hold 100%equity irrespective of the level of exports. Thisrelaxation is applicable for all applications receivedbetween 31 July 1998 and 31 December 2000 toset up manufacturing projects. All projects approvedunder this policy will not be required to restructuretheir equity after the period, provided that thecompany continues to comply with the originalconditions of approval and retains the originalfeatures of the project.

In contrast to the developments in the mainsectors, capital investment in the agriculture and

5

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Graph 1.10Malaysia : Investment Approvals

RM billion No. of projects

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Investment approvals No. of projects

0 0

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400

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1,200

mining sectors increased during the year.Investment in the mining sector, which accountedfor 6% of total private investment, increased by18.8% mainly on account of the strong investmentin the oil and gas sub-sector. The more favourableexport prices for crude palm oil due to theexchange rate factor have also led to someincreases in investment in the agriculture sector(7% of total private investment).

Counter-cyclical fiscal policies adopted in early1998 helped sustain public investment, whichrecorded a marginal decline of 0.3% in nominalterms in 1998 (1997: +11.9%). In line with theimplementation of the fiscal stimulus programme,the Federal Government increased the allocationfor socio-economic development. Public sectorinvestment was also sustained by capital investmentby the non-financial public enterprises (NFPEs).Investments were mainly undertaken for the ongoingcapacity expansion and modernisation programmesby the major NFPEs and to meet higher importcost. PETRONAS continued to invest in bothupstream and downstream activities, including theconstruction of two new gas processing plants,central utility facilities in Kertih and Gebeng, severalpetrochemical projects, development of UniversityTechnology PETRONAS and Kuantan-Kertih Railwayproject. Capital investment by Tenaga NasionalBerhad (TNB) was mainly to expand and upgradeits power generation capacity and its transmissionand distribution networks to meet future demandfor electricity by commercial and industrial sectorsfor the industrialisation process. Major projectsundertaken by TNB included Phase I of the 500kwtransmission network, Phase III of the Port KlangSultan Salahuddin Abdul Aziz Power Station, therehabilitation and conversion plants in Melaka, PortDickson, Prai and Pasir Gudang, development ofelectricity infrastructure for Putrajaya and Cyberjayaand construction of Phase II of Tenaga NasionalUniversity Complex. Capital outlay by TelekomMalaysia Berhad was largely to upgrade itstelecommunication network, including implementationof a host of services and products for theCorporate Information Superhighway, an integral partof the Multimedia Super Corridor and the NationalInformation Infrastructure.

In 1998, gross national savings (GNS)continued to increase despite the contraction inthe domestic economy. As overall consumptiondeclined significantly, GNS increased further by5.1% in 1998 (12.3% in 1997 and 24.7% in

1996). The slower growth in 1998 reflectedthe marginal increase in nominal income. Interms of GNP, the share of GNS increased to41.2% in 1998, compared with 39.4% recorded in1997. With gross domestic capital formationdeclining by 38.4% (1997: +12.7%), the savings-investment gap turned around to register a recordsurplus of RM36.1 billion or 13.7% of GNP in1998, from a deficit of RM14.2 billion or 5.4% ofGNP in 1997.

In the public sector, public savings declined by15.9% to RM42.3 billion in 1998 (1997: +26.6%;RM50.3 billion) reflecting lower revenue performanceof the public sector arising from the economicdownturn and higher expenditure associated withthe weakening of the ringgit as well as the counter-cyclical fiscal stance adopted by the FederalGovernment to address the economic downturn.Nevertheless, the public sector continued to recorda surplus, albeit a smaller surplus of RM10.6 billionin 1998, as growth in public investment deceleratedto 0.6%.

While the export sector benefited from higherincome, due mainly to the depreciation of theringgit, earnings in other sectors were affected bythe erosion of profit margins following thecontraction in the economy. Therefore, the increasein private sector savings by 25.2% to RM65.7 billionwas mainly on account of the marked decline inprivate consumption. At the same time, the declinein private investment was significantly higher(–52.9%). Consequently, the private sector resourcebalance turned around to register a surplus ofRM25.5 billion in 1998, from a deficit of RM32.9billion in 1997.

The high rate of savings has represented one ofMalaysia’s strengths and has enabled Malaysia toachieve a decade of high growth that has beenfinanced primarily from domestic sources. This hasreduced reliance on external sources of financingand thereby had increased the resilience of thenation to withstand the effects of the depreciationof the currency. In the current environment, it hasallowed Malaysia to rely to a greater extent ondomestic sources of financing to support theexpansionary macroeconomic policy and therestructuring of the financial sector. While savingscontinue to be important, it is necessary torecognise that consumption is equally important. Inparticular, during this period of economic contraction,

increased consumption is important to support theeconomic recovery process. The private sectorshould, therefore, recognise the need to balancebetween consumption and savings. Over-cautiousspending behaviour and an over increase in savingswould result in a slowing down of the recoveryprocess.

Recognising the importance of the need tobalance consumption and savings, the efforts ofthe savings programme in 1998/1999 haveemphasised on the efficiency of managing householdincome and expenditure. Towards this objective,two publications were produced during the year,that is, the Household Accounts Book and a PocketMoney Book for students as part of this programme.The objective of the Household Accounts Book isto encourage households to plan and manage theirexpenses to be in accordance with their presentand future income. It also aims to promote moregoal-oriented consumption and savings, in particular,to encourage savings for a specific purpose, thatis, for a specific future expenditure, such aseducation, purchase of cars and houses. Greaterplanning and efficiency in managing income andexpenditure will result in greater benefits from thelimited resources and contribution towards betterliving standards. The student's Pocket Money Bookis aimed at introducing financial management ofpersonal accounts at a young age and, therefore,produce a society that has an awareness of thegains that can be obtained from such efficiency.This will contribute towards building the foundationfor future growth.

External Sector

Balance of Payments

In 1998, the balance of payments outturn wassignificantly better than expected. The mostsignificant development was the speed andmagnitude of the adjustment in the current accountbalance. Reflecting both the favourable valuationimpact of the weaker ringgit on export earnings aswell as the rapid decline in imports, the currentaccount recorded an unprecedented large surplusof RM36.1 billion (US$9.2 billion) in 1998, farexceeding the RM20.1 billion surplus projected inthe 1999 Budget announcement in October. Thiswas a significant turnaround from a deficit positionof RM14.2 billion (US$5 billion) in 1997 and wasthe first current account surplus since 1989. Interms of GNP, the surplus increased to 13.7%

Table 1.16Balance of Payments

1998eItem + – Net

RM million

Merchandise balance ( f.o.b.) 282,007 212,685 69,322

Balance on services 49,088 72,469 –23,381Freight & insurance 4,129 12,781 –8,652Other transportation 6,547 4,278 2,269Travel & education 9,344 6,273 3,071Investment income 5,789 21,500 –15,711Government transactions

n.i.e. 331 491 –160Other services 22,948 27,146 –4,198

Balance on goods andservices 331,095 285,154 45,941

Unrequited transfers 2,938 12,811 –9,873

Balance on current account 334,033 297,965 36,068

Official long-term capital 2,138Federal Government 4,001 2,182 1,819

Market loans 2,435 1,324 1,111Project loans 1,566 858 708Suppliers’ credit – – –

Non-financial publicenterprises 4,705 4,344 361

Other assets and liabilities –42

Private long-term capital 8,740

Balance on long-term capital 10,878

Basic balance 46,946

Private short-term capital (net) –21,700Errors and omissions 15,055

Overall balance (surplus +/ deficit – ) 40,301

Allocation of Special DrawingRights –

IMF resources –

Net change in internationalreserves of Bank NegaraMalaysia(increase – / decrease +) –40,301

Special Drawing Rights –315IMF reserve position –757Gold and foreign

exchange –39,229

Bank Negara Malaysiainternational reserves, net 1 99,424

1 Arising from the fixing of ringgit/US dollar exchange rate at RM3.80 inSeptember 1998, all assets and liabilities in foreign currencies have beenrevalued into ringgit at rates of exchange ruling on the balance sheet dateand the cumulative gain has been reflected accordingly in the Bank's cur-rent year account. The US dollar equivalent of international reserves as at31 December was US$26.2 billion.

e Estimate

Source : Bank Negara Malaysia and Department of Statistics

(1997: –5.4%), surpassing the previous high of8.9% achieved in 1987, after the last recession.The improved current account position reflected anexceptionally large surplus in the merchandiseaccount, which more than offset both thehigher services account deficit and the largeoutflows on the transfers account. The merchandisesurplus rose to a record high of RM69.3billion (US$17.7 billion) in 1998, due mainlyto a reduction in import volume, particularly ofcapital goods, reflecting the impact of thesharp contraction in domestic demand combinedwith the deliberate policy to defer non-criticalinfrastructure projects and rationalise the purchaseof imported goods by public agencies. At the sametime, export earnings increased sharply in ringgitterms, due mainly to valuation gains. Moresignificantly, exports in United States dollarterms recorded positive growth in the last threemonths of 1998, reflecting a surge in the exportsof electronic equipment and parts.

The global financial market turmoil and investors’risk aversion to emerging markets, includingMalaysia, resulted in a decline in new capitalinflows in 1998. The net inflow of long-term capitaldeclined to RM10.9 billion from RM19 billion in1997. This was attributable to the lower net inflowsof both official and private long-term flows, whichwere affected by the tightening of lending conditionsin international debt markets, continued uncertaintyin the region and the cautious approach of newlong-term foreign investors following the introductionof selective exchange control regulations inSeptember 1998. Meanwhile, the widening spreadsfollowing the downgrading of Malaysia’s sovereigndebt rating (but still at investment grade) madeexternal borrowing a more costly funding optionfor Malaysian borrowers. Nevertheless, Malaysiacontinued to receive official loans from the WorldBank and bilateral lenders, especially Japan.Reflecting the above developments, the basicbalance, comprising the current account and long-term capital account, recorded a large surplus ofRM46.9 billion in 1998 (RM4.8 billion in 1997).

For the second consecutive year, the short-termcapital account recorded a substantial outflow ofRM21.7 billion (1997: –RM11.3 billion), reflectingthe decline in short-term debt of the commercialbanks in response to the stagnation in domesticdemand, sluggish external trade and liquidation ofportfolio investment by foreign investors. Afteradjusting for errors and omissions of RM15.1 billion,

1994 1995 1996 1997 1998-25

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Graph 1.11Malaysia: Balance of Payments

RM billion

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Exports Import

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60

80

100

120

reflecting mainly the exchange rate gain from therevaluation of external reserves, the overall balanceof payments reverted to a surplus of RM40.3 billion(US$10.3 billion) from a deficit of RM10.9 billion(US$3.9 billion) in 1997. Net international reservesof Bank Negara Malaysia increased to RM99.4billion (US$26.2 billion) at the end of 1998 fromRM59.1 billion (US$21.7 billion) at end-1997. Thislevel of reserves was sufficient to finance 5.7months of retained imports (3.4 months in 1997).

The stimulative measures introduced since mid-July did not result in significant leakage abroad in1998. The additional funds were directed at projectswhich used, to a large extent, domestic rawmaterials and services to ensure sustainedimprovement in the balance of payments tostrengthen Malaysia’s external reserves position.Maintaining a strong reserves position is importantto both the short-term objective of economicrecovery as well as the long-term aim to maintaina sustainable external position. A large reservescushion is indeed a key element in protecting thecountry against unforeseen destabil isingdevelopments. This would help to sustain marketconfidence and stability, enhance creditworthinessand at the same time, provide the Governmentwith greater flexibility in the conduct of domesticpolicies.

In 1998, the performance of the merchandiseaccount exceeded all targets set during the yearto achieve a substantial surplus of RM69.3 billion,far higher than the RM11.3 billion recorded in 1997.The expansion in the surplus was the result ofthe stronger expansion of merchandise exports(28.9%) compared with merchandise imports (2.6%).In the case of exports, this was primarily due tovaluation gains from the depreciation of the ringgitas international prices for most of Malaysia’s majorexports were lower while export volume remainedstable. In the case of imports, both volume andprices declined to offset the higher import costsdue to the weaker ringgit.

The trade account performed better thanexpected. The trade surplus rose to anunprecedented level of RM58.4 billion in 1998, farexceeding the previous high of RM13.3 billionrecorded in 1987. Export receipts grew by 29.8%in ringgit terms to reach RM286.8 billion, due inlarge part to the depreciation of the ringgit againstmost major currencies, especially the United States

dollar. Growth in imports decelerated to 3.3% toreach RM228.3 billion. In United States dollar terms,imports recorded a large reduction of 26.2%,reflecting the sharp contraction in domestic demand.The Government also implemented deliberatemeasures to strengthen the external balance,including rationalisation of the purchases of importedgoods by public agencies and the deferment oflarge projects.

By the end of 1998, the trade account hadbeen in surplus for 14 consecutive months sinceNovember 1997. More importantly, the size of thesurpluses has also been rising. This has primarilybeen the result of the sustained strong exportgrowth in ringgit terms. In United States dollarterms, exports registered a decline of 6.9% for1998 as a whole. However, a positive developmentwas that the value of exports in United Statesdollars stabilised by September 1998 to levelsrecorded a year ago and expanded gradually forthe remaining months of the year.

Export earnings in ringgit terms rose by 29.8%in 1998, reflecting increases in the exports ofmanufactured goods (32.8%) and commodities(17.4%). However, export receipts in United Statesdollar terms contracted by 6.9%, as the marginalincrease in the export volume was offset by therelatively sharper slide in United States dollar exportprices. Despite recording lower earnings in UnitedStates dollar terms, manufactured exports remainedthe major contributor of foreign exchange earningsto account for 82.9% of total gross exports (1997:81%). Reflecting mainly the strong export growthof the electronic equipment and parts sub-sector,

-40

-20

0

20

40

60

80

Mfg. Exports (RM)

Mfg. Exports (US$)

Graph 1.12Manufactured Exports

1997 1998

Annual change (%)

Mar Jun Sep Dec Mar Jun Sep Dec

gross exports recorded a positive growth of 5.2%in the fourth quarter of the year (1Q: –11.3%; 2Q:–10.1% and 3Q: –10.8%).

Exports of manufactured goods in ringgit termsrose by 32.8% to RM237.6 billion in 1998 (1997:12.9% to RM178.9 billion). All industries recordedhigher export receipts except for wood andpetroleum products. Higher exports reflected mainlyexchange rate valuation effects as well as amarginal increase of 1.4% in export volume(exchange rate of ringgit vis-a

\-vis United States

dollar averaged US$1=RM3.92 in 1998 compared

with US$1=RM2.81 in 1997). Exports rose sharplyin the first half-year (44.2%) reflecting mainlyvaluation effects before moderating in the secondhalf of the year (23.8%). The moderation in thesecond half-year reflected partly the sharperdeterioration in the export volume in the thirdquarter before it recovered strongly in the fourthquarter. In United States dollar terms, manufacturedexports contracted by 7.8% in the first half-yearand its performance worsened to record a sharperdecline of 11.1% in the third quarter. However,during the fourth quarter of the year, a turnaroundwas recorded when exports rebounded toincrease by 8.8%, representing the first quarterly

Table 1.17Gross Exports

1998

RM Annual Annualmillion change % US$ change

(%) share million (%)

Manufacturing sector 237,649 32.8 82.9 60,797 –4.6Of which:

Electronics, electrical machinery andappliances 161,733 35.9 56.4 41,375 –2.4

Electronics 114,175 41.3 39.8 29,238 1.9• Semiconductor 54,483 33.3 19.0 13,931 –4.2• Electronic equipment & parts 59,692 49.6 20.8 15,307 8.2Electrical machinery & appliances 47,558 24.3 16.6 12,138 –11.4• Consumer electrical products 20,648 16.1 7.2 5,267 –17.3• Industrial & commercial electrical

products 15,065 25.5 5.3 3,841 –10.5• Electrical industrial machinery

and equipment 10,974 41.8 3.8 2,807 1.2• Household electrical appliances 871 19.0 0.3 223 –13.5

Textiles, clothing and footwear 9,442 24.0 3.3 2,408 –11.1Chemicals & chemical products 10,627 30.6 3.7 2,717 –6.6Wood products 5,982 –7.8 2.1 1,528 –34.3Manufactures of metal 8,255 45.8 2.9 2,114 5.0Transport equipment 8,064 62.6 2.8 2,085 17.1Rubber products 5,739 45.0 2.0 1,465 3.8Optical and scientific equipment 4,760 21.7 1.7 1,217 –11.8

Agricultural sector 30,201 30.4 10.5 7,704 –6.4Of which:

Rubber 2,829 –4.8 1.0 723 –32.5Saw logs 1,866 –20.5 0.7 475 –43.4Sawn timber 2,526 –9.0 0.9 644 –36.0Palm oil 17,779 64.4 6.2 4,533 17.8

Minerals 14,874 –2.4 5.2 3,786 –32.7Of which:

Tin 485 1.5 0.2 123 –29.2Crude oil 7,510 6.2 2.6 1,917 –23.8LNG 5,981 –4.4 2.1 1,525 –37.1

Other 4,032 16.9 1.4 1,039 22.1

Total 286,756 29.8 100.0 73,326 –6.9

Source: Bank Negara Malaysia and Department of Statistics

increase since the third quarter of 1997. As aresult, the decline in exports in United States dollarterms moderated to 4.6% in 1998 (+1.1% in 1997).A surge in the exports of electronicequipment and parts and rubber productscontributed to the rebound in exports during thefourth quarter.

Although exports in United States dollar termsdeclined, overall export volume of manufacturedgoods rose by 1.4% during the year. Thisref lected a 5.9% decline in export pricesexpressed in United States dollars. Pricecompetition in the major markets had intensifiedduring the year, owing to excess capacity andcompetition among countries affected by theregional financial crisis. At the same time,external demand was affected by poor ordersfrom the Asia-Pacific region, which accounted forabout 40% of total manufactured exports(including exports to Singapore which were mainlyre-exported to the Asia-Pacific region, the UnitedStates and Europe). Exports to the United States,which was the single largest export market,however, improved to increase by 9.3% in UnitedStates dollar terms (1997: 2.7%) and helped tooffset in part the declining trend in exports tothe East Asian countries. The United Statesaccounted for 25.4% of Malaysia’s totalmanufactured exports in 1998 (22.1% in 1997).

Exports of electronic goods in United Statesdollar terms rose by 1.9% in 1998, accountingfor 48.1% of total manufactured exports, duemainly to the contr ibution from electronicequipment and parts. The revival of the disk-drive sub-sector, coupled with improved sales ofpersonal computers and intensified efforts to dealwith the Year 2000 problem, boosted the demandfor electronic equipment and parts, which postedan increase of 8.2% during the year. Exports ofsemiconductors, however, shrank by 4.2% onaccount of the persistent oversupply of memorychips and the resultant sharp decline in prices.The severity of the downward adjustment in chipprices only moderated towards year-end followingthe decision of some major world producers tohalt or cut their production levels in an effort torestrain falling prices and rapidly dwindlingmargins. Meanwhile, according to the latest reportof the Semiconductor Industry Association, globalsemiconductor sales fell by 8.4% in 1998,al though the contract ion in annual salesmoderated towards year-end. In particular, sales

in the Asia-Pacific market increased by 2.4% inDecember 1998 after decl ining for eightconsecutive months.

Poor external demand caused the exports ofelectrical products in United States dollar terms todecline by 11.4% in 1998. Although exports to theUnited States were higher, they were not sufficientto offset the lower demand from the Asia-Pacificregion. The export performance of this industrywas also affected by aggressive price cutting byother producer countries. The decline in exports ofelectrical products was across-the-board,encompassing consumer electrical products (mainlyaudio-visual products), industrial and commercialelectrical products, electrical industrial machineryand equipment, and household electrical products.The introduction of digital electrical products (suchas digital television and digital video disk players)had not stemmed the downward trend of foreignorders, reflecting cautious consumer spending inthe face of the economic downturn.

Exports of textile and clothing valued in UnitedStates dollars also fell by 11.1%, attributed mainlyto sluggish demand from the Asia-Pacific region.Meanwhile, demand for wearing apparel in theUnited States and the European Union wassustained despite intense price competition.However, this was offset by lower exports oftextiles, particularly synthetic textiles to the EastAsian countries, including Hong Kong SpecialAdministrative Region (SAR), The People’s Republicof China; Japan; The People’s Republic of China;and Singapore. In the chemical products industry,Malaysian manufacturers succeeded in expandingtheir exports to the United States. Nevertheless,the slow pace of industrial activities in Hong KongSAR, Singapore and Japan resulted in reducedofftake of organic chemicals and chemical materialsfrom these countries. Overall, exports of chemicalproducts contracted by 6.6% during the year.

The wood products industry recorded a sharpdecline in exports of 34.3% in 1998, due to bothlower prices and external demand. Sluggishconstruction activities in The People’s Republic ofChina, Japan and Korea dampened demand forplywood, hardboard and particle board. Towardsthe end of the year, prices of plywood improvedmoderately due mainly to stock replenishment bymajor buyers. The market was also boosted bythe reconstruction activities in The People’s

Republic of China, following the big flood and theban on logging in some locations.

The downturn in the domestic construction sectorprompted manufacturers of metal products to seekexport markets. Higher export earnings wererecorded for the metal products industry (+5%),particularly from exports to the United States andHong Kong SAR. Exports of non-metallic mineralproducts, however, declined further (–13.2%) asconstruction activities in the Asia-Pacific region,which accounted for about 60% of the industry’sexports, remained sluggish. The decline in theUnited States dollar export price was also moresevere in the case of non-metallic mineral productsas compared with metal products.

Exports of transport equipment, on the otherhand, rose by 17.1% in United States dollar terms,owing to higher re-exports of aircraft uponcompletion of repairs and servicing. Meanwhile,the export performance of motor vehicles washampered by poor global sales of automobiles.The sluggish global demand had also affectedmajor world producers as reflected in theirmove towards consolidation through mergersand acquisitions.

Exports of rubber products rose by 3.8% inUnited States dollar terms in 1998, bolstered bysustained demand for examination and surgicalgloves from the United States, the European Unionand Australia. Stringent quality controls set by theMalaysian glove manufacturers to meet theinternational standard requirement of the majormarkets helped gain market shares. Meanwhile,intense competition from low-cost producingcountries which had abundant supplies of rawmaterials prompted the Malaysian manufacturers tomove towards higher value-added surgical gloves,particularly those which were powder-free. Theindustry is faced with a major challenge in theimmediate term as competing producers in themajor export markets are campaigning for greateruse of synthetic gloves.

The optical and scientific equipment industry,which has gained prominence in recent years,registered lower exports valued in United Statesdollars (–11.8%), due to lower demand formeasuring, checking and controlling instruments aswell as watches and clocks, particularly in

Singapore, Hong Kong SAR, Japan and the UnitedStates. Similarly, lower consumption in the regionhad affected the exports of food products.Meanwhile, sluggish industrial demand in the region,coupled with weak prices in the internationalmarkets also resulted in lower export earnings frompetroleum products.

The export performance of the commodity sectorremained strong during 1998. Export earnings fromthis sector increased by 17.4% to RM45.1 billion(1997: +8.2% to RM38.4 billion). Export prices inringgit terms increased by 29.7%, reflecting mainlythe valuation gains while the overall export volumeremained stable as the higher volume of crude oilexports was offset by the declines in the exportvolumes of other major commodities. However, inUnited States dollar terms, commodity exportearnings declined by 17.1% during the year, dueto lower export prices for all major commodities,except palm oil and cocoa.

Exports of agricultural commodities increasedsignificantly by 30.4% to RM30.2 billion (1997:+3.2% to RM23.2 billion), reflecting mainly amarked increase in palm oil exports, which morethan offset lower proceeds from the export ofrubber, saw logs, sawn timber and cocoa. Exportearnings from palm oil increased strongly by 64.4%to RM17.8 billion in 1998, reflecting mainly a sharpincrease in export unit value, thereby maintainingits position as the single largest export earner forthe commodity sector. During the year, the exportunit value of palm oil rose by 19.1% in UnitedStates dollar terms (66.1% in ringgit terms), onaccount of the decline in the global supply ofpalm oil. On the other hand, the export volume ofpalm oil declined by 1%, due mainly tosupply constraints. The nation’s crude palm oilproduction fell by 8.3% in 1998 attributableprimarily to the reversal in the biological yield cyclefor oil palm trees.

Export earnings from rubber continued to declineby 4.8% to RM2.8 billion, largely due to a furtherdecline in prices (–2%) as demand from the majorconsuming countries remained weak during the yearamidst excess global supplies of the commodity.Export proceeds from saw logs also declinedsharply by 20.5% to RM1.9 billion due to bothlower export volume (–15.3%) and export unit value(–6.1%). Similarly, export earnings from sawn timberand cocoa declined by 9% and 17.3% respectively.

Adverse developments in the market for saw logsand sawn timber were due mainly to lower demandfrom the Asia-Pacific region. Malaysia exportedalmost all of its saw logs and 61% of its sawntimber to the region.

Total export earnings from the mining sectordeclined by 2.4% to RM14.9 billion in 1998 (1997:+16.9% to RM15.2 billion). Crude petroleumremained as the top export earner accounting for50.5% of total export receipts of this sector and2.6% of total gross exports. The export volume ofcrude oil increased by 13.5% to 18 million tonnesas demand for Malaysian superior grade crude oilsremained favourable. However, arising from lowercrude oil prices which reflected weak global demandand excess supplies, the export unit value ofMalaysian crude petroleum declined by 32.8% toUS$14.00 per barrel. The decline in world crudeoil prices accelerated in the second half of theyear as global demand weakened in the face ofhigh inventories of crude oil and a mild winter inthe Northern Hemisphere. Nevertheless, in ringgitterms, the export unit value of crude oil declinedless sharply by 6.4% to RM417 per tonne fromRM445 per tonne in 1997. Export earningsfrom liquefied natural gas (LNG) fell by 4.4% toRM6 billion during the year, contributing to40.2% of total export proceeds of the miningsector. The export unit value of LNG declinedby 1.9% to RM408 per tonne, in line withlower crude oil prices. The volume of LNGexports also declined by 2.6% reflecting lowerdemand from the major buyers, namely, Japan andKorea as these economies experienced acontraction in output.

The weak growth in gross imports of 3.3%reflected both declines in volume and lowerinternational prices for most major importcommodities, which largely offset the valuationimpact of the depreciation of the ringgit. Importvolume was estimated to be lower by about 20.5%,while import prices declined by 7.2%. As a result,gross imports in United States dollar termswere lower by 26.2% (1997: +0.8%). Thedecline in the import volume reflected weakdomestic demand conditions, as well as thereduction in imports of inputs for manufacturingexports in response to the less favourable exportenvironment. The postponement of non-criticalinfrastructure and other large projects by both thepublic and private sectors also contributed to thereduction in imports.

Since 1970, Bank Negara Malaysia (BNM) hadbeen the only source of information for data ongross imports by economic function, which wascompiled based on the methodology suggested bythe United Nations Economic Commission for Asiaand the Far East (now known as the Economicand Social Commission for Asia-Pacific or ESCAP).However, in February 1998, the Department ofStatistics published for the first time in its MonthlyExternal Trade Statistics Bulletin, information onimports by end use classified according to theBroad Economic Categories (BEC) system. Theswitchover to the BEC methodology is timely forthe following reasons:

● The BEC classification ensures compatibility withthe national accounts data, which is alreadybeing compiled based on the System of NationalAccounts of the United Nations; and

● Malaysia’s adoption of the BEC classificationsystem brings us in line with practices in mostcountries and allows international comparison ofimports by economic functions.

Based on the BEC classification, the shares ofcapital and consumption goods imports are lower,while the share of intermediate goods is highercompared with the classification based on theESCAP system.

By economic function, all types of imports, exceptimports of intermediate goods, declined. Whenvalued in United States dollar terms, all categoriesof imports recorded substantial reductions. Importsof capital goods declined by 15.1% even in ringgitterms (–40.3% in United States dollar terms), asignificant decline following the sharp contractionin private investment during the year. The declinealso reflected deliberate adjustment measuresundertaken by the Government to reduce importsof lumpy capital goods to strengthen externalbalances. Imports of all categories of capital goodswere lower during the year. In United States dollarterms, the decline was most noticeable forconstruction and mining equipment (–93.9%),reflecting the severe downturn in the constructionsector, industrial machinery (–46.4%) and industrialtransport equipment (–46.4%) . Imports oftelecommunications equipment declined by 45.6%as most operators had either completed theirinvestment in the run-up to equal access or shelvedinvestment plans due to the economic downturn.Imports of generators and power transmission

equipment declined by 20.6% following thecompletion of the capacity expansion programmesin the utilities sector. Similarly, imports of shipsfell by 19.7% with the deferment of investmentplans. Imports of ships and aircraft togetheramounted to US$2.5 billion, lower than the US$2.7billion incurred in 1997.

Imports of intermediate goods in United Statesdollar terms, declined by 21.3%. The decline wasin line with the decline in manufacturing productionin response to weak domestic and export demand,especially from the East Asian countries. Thedecline in the imports of intermediate goods wasmainly the result of lower imports of processedindustrial supplies (–35%). Inputs used in domesticmarket-oriented industries in this category contracted

severely. Imports of metals, in particular, werelower by 42.1%, while those of metal productsdeclined by 25.5%. Imports of semi-manufacturedgold were lower by 70.9%, reflecting a decline indomestic demand for jewellery as well as a sharpdrop in tourist arrivals. Reflecting the severecontraction of activities in the construction sector,imports of mineral products declined by 57.4%.Inputs used in export-oriented industries in thiscategory were relatively less severely affected.Imports of non-electronic parts for electricalapparatus (–44.8%), textiles and fabrics (–24.3%)and chemicals (–20.4%) recorded substantialdeclines reflecting the poor the performance ofthese sectors within the manufacturing sector. Thedecline in imports of non-electrical parts forelectrical apparatus reflected, to some extent, lowercosts from the significant depreciation of other East

Table 1.18Gross Imports by Economic Function

1998

Annual AnnualRM change % US$ change

million (%) share million (%)

Capital goods 36,339 –15.1 15.9 9,258 –40.3Capital goods (except transport equipment) 29,757 –13.4 13.0 7,582 –38.8

Industrial machinery 10,965 –24.9 4.8 2,789 –46.4Transport equipment 6,582 –22.1 2.9 1,676 –46.4

Intermediate goods 159,958 9.8 70.1 40,875 –21.3Food and beverages, mainly for industry 4,166 27.8 1.8 1,065 –7.4Industrial supplies, n.e.s. 50,315 –8.5 22.0 12,846 –34.9

Metals 11,855 –19.3 5.2 3,026 –42.1Fuels and lubricants 4,627 3.6 2.0 1,183 –44.6Parts and accessories of capital goods(except transport equipment) 98,752 24.1 43.3 25,251 –10.5

Electronics 64,201 40.2 28.1 16,415 0.8Parts and accessories of transport equipment 2,098 –38.4 0.9 531 –57.0

Consumption goods 13,152 –6.1 5.8 3,361 –32.7Food and beverages, mainly for household

consumption 5,681 1.6 2.5 1,453 –27.0Transport equipment, non-industrial 37 –79.3 0.0 10 –85.4Consumer goods, n.e.s. 7,435 –9.8 3.3 1,899 –35.4

Consumer durables 1,107 –23.4 0.5 282 –45.5Consumer semi-durables 2,778 –13.2 1.2 709 –37.7Consumer non-durables 3,550 –1.3 1.6 907 –29.3

Dual use goods 3,826 –38.5 1.7 974 –56.1Motor spirit 2,286 21.7 1.0 583 –13.5Passenger motor cars 1,540 –64.5 0.7 391 –74.7

Others 4,215 –12.4 1.8 1,081 –37.9

Re-exports 10,819 45.7 4.7 2,799 6.1

Gross Imports 228,309 3.3 100.0 58,348 –26.2

n.e.s: Not elsewhere specified.

Source: Department of Statistics

Asian currencies. Imports of other accessories formotor vehicles and engines and engine parts formotor vehicles contracted by 63.1% and 55.7%respectively, reflecting the downturn in the motorassembly industry due to higher interest rates andtight credit conditions for the greater part of theyear. However, the moderate decline in imports ofparts and accessories of capital goods (excludingtransport equipment) of 10.5% helped slow theoverall decline in imports of intermediate goods.This was mainly the result of a 0.8% increase inthe imports of electronic component parts, in partreflecting the pick up in exports towards the endof the year.

Imports of consumption goods declined by32.7% in United States dollar term, reflectingweak consumer demand amidst uncertainty regardingincome and employment prospects as well as thenegative wealth effects arising from the decreasein asset values. This decline was mainly the resultof lower imports of durable and semi-durableconsumer goods. The weaker ringgit also resultedin greater domestic substitution of consumer durables.In particular, imports of sound and video reproducingequipment declined by 48.9%, while those of camerasand optical equipment were lower by 56.8%. Amongsemi-durable consumer goods, particularly significantdeclines were evident in imports of tapes andrecords (–37.6%), toys, games and sports equipment(–39.9%), clothing and footwear (–50.1%) andhousehold furnishings and goods (–39.4%). Importsof processed food declined by 27.1% while thoseof primary food fell by 26.8%. In United States dollarterms, imports of dual use goods, namely motorspirit (gasoline) and passenger motor cars, declinedby 56.1%, mainly on account of the 74.7%decline in the import of passenger motor cars. The1998 Budget had raised import duties on luxurymotor vehicles, which further contributed tothis decline.

The relatively more moderate decline inimports of intermediate goods resulted in itsshare of total imports increasing to 70.1% (1997:65.9%), primarily at the expense of a lower shareof imports of capital goods of 15.9% of grossimports (19.4% in 1997). Imports of consumptiongoods remained relatively stable to account for5.8% (6.4% in 1997).

The effects of the depreciation of ringgit wasseen in the expansion in Malaysia’s total trade by

16.6% (12.1% in 1997) to RM515 billion or 196%of GNP in 1998 (RM442 billion or 169% of GNPin 1997). In United States dollar terms, however,total trade declined by 16.5%, vis-a

\-vis the growth

in world trade of 3.4%. During the year, the relativeimportance of various trade partners shifted,reflecting domestic demand conditions prevailingboth in Malaysia as well as in partner countries.The United States continued to remain Malaysia’slargest trade partner and its relative importancegrew during the year. In terms of total trade, theUnited States increased its share from 17.7% in1997 to 20.8% in 1998. Singapore continued toremain a major trade partner with a share of15.5%, in view of the transhipment of a significantportion of Malaysian trade through the republic.However, Japan’s share of total trade fell from17.2% to 14.6%, reflecting the weak demandconditions in the Japanese economy. As a result,Japan slipped into third place, behind Singapore.Countries of the European Union continued tomaintain their share of Malaysia’s total trade at14.3%. Germany, the United Kingdom and theNetherlands remained the largest trading partnersin this group. Trade with these four major tradingpartners (including the European Union) accountedfor 65.1% of total trade.

In terms of export destination, the United Statesbecame Malaysia’s largest export market in 1998while Singapore was relegated to second position.Japan retained its position as the third largestexport market. In terms of import origin, theUnited States and Japan were the largest sourceof imports with a share of 19.6% each, followedby Singapore (13.6%). Reflecting the substitutionof imports from cheaper alternative sources, theshare of imports from Indonesia, the Philippines,The People’s Republic of China and Koreaincreased mainly at the expense of imports fromJapan and Europe.

In 1998, the depreciation of the ringgit yieldedsignificant improvement in Malaysia’s favour interms of bilateral trade balances. Malaysiarecorded larger trade surpluses with Singapore, theUnited States, the European Union (mainly theNetherlands, the United Kingdom and Belgium),Hong Kong SAR and India. Of significance,Malaysia’s trade surplus with the United Statesrose to RM17.4 billion, substantially higher thanthe RM4 billion surplus recorded in 1997. Thetrade surplus with the Eurupean Union alsoincreased sharply to RM19.4 billion (1997: RM692

million), especially with the Netherlands and theUnited Kingdom. In the case of several othertrading partners, the trade deficits turned intosurpluses in 1998, especially the trade balancewith The People’s Republic of China, Taiwan andAustralia. The significant improvement in the tradebalance was due in part to higher demand forcheaper Malaysian goods following the currencydepreciation as well as the valuation impact onexport earnings. Meanwhile, the persistent deficitwith Japan remained, albeit much smaller atRM14.6 billion (1997: RM21 billion). The discernibleshift by Malaysia to source imports from lowercost suppliers, especially from countriesexperiencing large currency depreciations led tothe widening trade deficits with Indonesia, thePhilippines and Korea.

For the first time since 1989, the surplus inthe merchandise account was more than sufficientto offset the higher services deficit and higheroutflows on the transfers account. In 1998, thenet outflow in the transfers account increasedsignificantly to RM9.9 billion (RM3.7 billion in 1997).This reflected mainly the one-time lump sum

repatriation made by nearly half a million foreignworkers returning to their home countries. Thedeficit in the services account widened by RM1.6billion to RM23.4 billion, reflecting mainly thevaluation impact of the depreciation of the ringgitas the services account valued in United Statesdollars recorded a smaller deficit of US$6 billion(US$7.7 billion in 1997). In terms of ringgit, thedeterioration was due mainly to higher grosspayments of RM72.5 billion (RM71.3 billion in1997). Overall, reduced demand for importedservices following the slowdown in economic activitywas more than offset by the higher cost oftransactions on account of the weaker ringgit. Grossreceipts were marginally lower at RM49.1 billion(RM49.5 billion in 1997). The poorer performanceof the services account essentially reflectedlarger net outflow of investment income arisingfrom higher cost of debt servicing during theyear. At the same time, the net surplus inthe travel and other transportation accountswere smaller, with receipts affected by thelower demand for Malaysia’s exported services dueto the regional economic downturn. Meanwhile,the freight and insurance and other servicesaccounts showed some improvements in 1998.

Table 1.19Direction of External Trade

1998

Exports Imports

RM million % share RM million % share

ASEAN countries 68,578 23.9 51,492 22.6 17,086Singapore 48,689 17.0 30,944 13.6 17,745Thailand 9,059 3.2 8,832 3.9 227Indonesia 3,932 1.4 5,778 2.5 –1,846Philippines 4,521 1.6 5,386 2.4 –864Brunei Darussalam 907 0.3 15 0.0 892Vietnam 1,470 0.5 538 0.2 932

European Union 46,432 16.2 27,072 11.9 19,361United Kingdom 10,328 3.6 5,067 2.2 5,261Germany 8,655 3.0 9,019 4.0 –364Netherlands 13,437 4.7 2,001 0.9 11,436Other 14,012 4.9 10,985 4.8 3,027

United States 62,130 21.7 44,762 19.6 17,367Japan 30,237 10.5 44,854 19.6 –14,618The People’s Republic of China 7,764 2.7 7,250 3.2 514Hong Kong SAR 13,300 4.6 5,943 2.6 7,356Taiwan 11,798 4.1 11,647 5.1 151South Korea 6,516 2.3 13,126 5.7 –6,610India 6,744 2.4 1,830 0.8 4,914Australia 6,617 2.3 4,997 2.2 1,621Rest of the world 26,640 9.3 15,336 6.7 11,303

Total 286,756 100.0 228,309 100.0 58,446

Source: Department of Statistics.

Tradebalance

Net payments in the investment income accountincreased further by RM1.9 billion to RM15.7 billionin 1998, affected by the deterioration in both theinterest income and profits and dividendscomponents. The interest income account remainedin deficit (–RM2.1 billion) for the second successiveyear, reflecting higher cost of debt servicing dueto the weaker ringgit and the increase in themedium and long-term external debt. Similarly, theprofits and dividends component recorded largernet payments, attributed to substantially lowerreceipts from Malaysian investment abroad duringthe year. Profits and dividends accruing to foreigninvestors from higher ringgit export earnings werelargely offset by increased import costs, higherprovisions for valuation losses as well as lower oilprices affecting profits of oil campanies. As inprevious years, net investment income outflowsremained the largest contributor to the servicesdeficit, with its share rising further to 67% (63%in 1997).

In 1998, the regional economic downturn affectedthe performance of the tourism industry. The netsurplus in the travel account fell to RM3.1 billion,representing an annual decline of 13.6%. Touristarrivals fell for the third consecutive year, by afurther 10.6% to 5.6 million, below the initial officialtarget of 6.8 million visitors for the whole of 1998.Average per capita expenditure of tourists alsodeclined, albeit at a marginal rate of 1%, dueprimarily to a 5% reduction in per diem expenditureas the length of stay of tourists per visit increasedto 5.5 days (1997: 5.3 days). Similarly, the numberof excursionist arrivals also dropped by 16.4%. Asa result, the combined earnings from tourists (whostayed for more than one day), excursionists (daytravellers) and transit passengers, fell by RM1.2billion to RM9.3 billion. On the payments front,expenditure on travel and education abroad fell by8% and 16.4% to RM4.1 billion and RM2 billionrespectively. The economic uncertainty, the negativewealth effect from falling asset price and theweaker ringgit resulted in a significant reduction inthe number of Malaysians travelling abroad as wellas a smaller number of students studying abroad,including Government-sponsored students. Thedecline in the number of students abroad wasalso attributable to the Government’s policy toincrease the intake at local universities and topromote the establishment of twinning programmesbetween foreign universities and private collegesand the setting up of branch campuses of foreignuniversities in Malaysia. The promotion of domestictourism also contributed to the smaller outflow on

the travel account. Meanwhile, payments forpilgrimage rose by 33.6% to RM200 million,reflecting mainly the exchange rate effect.

The net surplus in other transportation account(consisting of passenger fares; charter fees; andport and airport-related activities, such asstevedoring, bunkers and port and airportdisbursements) declined by 11.7% to RM2.3 billion,after registering a record surplus of RM2.6 billionin 1997. Gross receipts were marginally lower atRM6.5 billion, due mainly to lower earnings onpassenger fares by the national airline and lowerreceipts for port-related activities. Passenger trafficand the demand for port services were affectedby the regional economic slowdown. Several costcutting measures were implemented by the nationalairline during the year, mainly to rationalise capacityon the domestic and Asian routes, while focusingon long haul routes particularly to North Americaand Europe where traffic growth was largelyunaffected. At the same time, concerted efforts topromote Port Klang as a national load centre andtranshipment hub yielded positive results. Despitethe economic slowdown, the port recorded some136,000 twenty-foot equivalent units (TEUs) or an8% improvement in terms of throughput. Inparticular, transhipment volume increasedsignificantly in terms of tonnage (36.5%) andTEUs (57.3%). Gross payments for othertransportation increased by 5.9% to RM4.3billion, as most payments were settled in UnitedStates dollars.

The freight and insurance account improved in1998, with a smaller net payments abroad of RM8.7billion (RM9.5 billion in 1997). Gross paymentsabroad recorded a marginal increase of 0.6%, withthe gains associated with the contraction in importvolume and lower freight rates offset by highercost of transactions due to the weak ringgit. Totalearnings from provision of freight and insuranceservices increased further by 30.1% to RM4.1billion, reflecting mainly higher receipts in ringgitterms as overall cargo throughput declined. In termsof United States dollars, net payments abroaddeclined by US$1.2 billion. Consequently, the shareof net freight and insurance payments to totalservices deficit declined to 37% (1997: 44%).

The deficit in the other services accountnarrowed only marginally to RM4.2 billion fromRM4.5 billion a year ago, due to the valuation

loss from the weaker ringgit. The improvementreflected reduced demand for other services, intandem with the overall contraction in the economyand the completion or deferment of some bigprojects, particularly in the infrastructure sector.Consequently, the share of other services inthe overall services deficit fell to 18% from 21%in 1997.

Less favourable global economic conditions inthe wake of the prolonged financial crisis in Asiaand investors’ continued risk averse attitude towardsAsia led to the deterioration of the capital accountof the balance of payments in 1998. The long-term capital account declined to RM10.9 billion in1998 (1997: RM19 billion), reflecting the lower netinflows in both the official and private long-termcapital accounts. The short-term capital accountrecorded a substantial net outflow for the secondsuccessive year amounting to RM21.7 billion.

The official long-term capital accountregistered a smaller net inflow of RM2.1 billion in1998 compared with RM4.6 billion in 1997. Thiswas due mainly to the lower gross externalborrowings by the non-financial public enterprises(NFPEs) which declined sharply to RM4.7 billion(1997: RM9.4 billion). Following the tightening oflending conditions in international debt markets inthe wake of increased aversion to Malaysian creditrisk, the NFPEs revised their investment plans. Atthe same time, the scheduled repayment of loansby the NFPEs increased to RM4.3 billion in 1998(1997: RM3 billion), reflecting mainly the valuationlosses arising from the ringgit depreciation. Hence,on a net basis, the NFPEs recorded a much lowernet external borrowing of RM361 million in 1998(1997: RM6.4 billion). In contrast, gross externalborrowings by the Federal Government increasedsignificantly to RM4 billion in 1998 (1997: RM462million) to finance the recovery package. Repaymentof loans, however, was maintained at about theprevious year’s level of RM2.2 billion. There wasno prepayment of loans during the year (1997:RM911 million). Hence, in 1998, the FederalGovernment registered a net borrowing of RM1.8billion for the first time in seven years.

The private long-term capital account recordeda significantly lower net inflow of RM8.7 billion in1998 (1997: RM14.4 billion), reflecting mainly thelower net foreign direct investment (FDI) ofRM11.6 billion, compared with a net inflow of

RM19.1 billion in 1997. Domestic problems in themajor investing countries, global excess capacityand continued uncertainty in the region contributedto the lower FDI in 1998. Reinvestment by foreigninvestors in Malaysia also declined as a result ofhigher repatriation of profits and dividends, mainlyby the Japanese firms to meet liquidity needs oftheir parent companies. In addition, although theimposition of selective exchange control regulationsdid not affect FDI, foreign investors had adopteda cautious approach towards new investment.

The bulk of the FDI in 1998 was channelledinto the manufacturing sector, which accounted for60%, followed by the oil and gas sector (23%)and the services sector (14%). External loans fromparent and associated companies, although lowerin 1998 due mainly to the reduced corporateprofitability and liquidity problems faced by theparent companies, accounted for 36% of the FDI,followed by retained earnings by the existingcompanies (34%) and equity (30%). However, newinflows of equity increased in 1998, reflecting mainlyfunds brought in by foreign investors to acquirestakes in Malaysian companies following theliberalisation of foreign equity participation in thetelecommunication and manufacturing sectors.

Despite the economic slowdown in majorinvesting countries, the value of proposed foreigninvestments received by the Ministry of InternationalTrade and Industry (MITI) continued to remainsignificant in 1998, amounting to RM12.7 billion(1997: RM14.4 billion). In general, long-term foreigninvestors, particularly the existing foreign companiesin Malaysia, continued to maintain a positive outlookon the long-term prospects for the Malaysianeconomy. The applications for the expansion anddiversification projects by the existing foreigncompanies amounted to RM6.2 billion in 1998(49% of the total value of proposed foreigninvestment). In terms of sources of investment, thebulk of the applications were received from theUnited States (51.6% of total foreign investment),followed by Japan (9%), Netherlands (8.6%),Singapore (6.4%) and the United Kingdom (4.9%).Within the oil and gas sector, the United Statesand Netherlands continued to remain the majorforeign investors in the country.

Gross overseas investment by Malaysian-ownedcompanies declined to RM8.1 billion in 1998 (1997:RM11.5 billion). The slowdown in domestic

economic activity and uncertainty in the regionprompted a significant cutback in overseasinvestments. This declining trend was reinforcedby the Government’s directive to defer overseasinvestments that do not have direct linkages withthe domestic economy as well as the tightening ofexchange control regulations on overseasinvestment since 1 September 1998. The economicslowdown also resulted in the liquidation of someassets of Malaysian companies abroad to helpfinance the companies’ domestic operations andinvestments. Hence, the net outflow from overseasinvestment declined substantially to RM3.1 billion in1998 (1997: -RM8.2 billion). The major recipientcountries of overseas investment in 1998 wereSingapore (28% of total overseas investment), theUnited States (22%), the United Kingdom (11%),Thailand (7%) and Netherlands (4%). Investment inSingapore was largely concentrated in the financeand business services sector (mainly investmentholding companies) and in the manufacturing sector.Malaysian companies continued to participate inhigh value added industries on a joint venture basiswith firms in the United States and the UnitedKingdom as part of the corporate strategy toacquire technical know-how.

The short-term capital account recorded asubstantial net outflow of RM21.7 billion in 1998(1997: –RM11.3 billion) due mainly to the declinein net external liabilities of the commercial banksand the liquidation of portfolio investments byforeign investors. The decline in the net externalliabilities of commercial banks reflected both thedecline in short-term external debt of commercialbanks in response to the stagnation in domesticdemand, as well as the unwinding of trade-relatedhedging activities following a decline in forwardsales of export proceeds by the exporters.Heightened uncertainty, including increased concernsover the risks in the financial system and economicoutlook, led to the large outflows of portfolioinvestment, especially in the second and thirdquarters of 1998. However, short-term capital flowsstabil ised in the last quarter following theimplementation of the one-year holding period forportfolio investment in Malaysia effective from1 September 1998.

External Debt

Malaysia’s overall external debt situation remainedmanageable in 1998, despite the prolonged regionalfinancial crisis. This outturn reflected the

Government’s prudent external debt managementstrategy, as a result of which Malaysia did notexperience a payment crisis and has been able tomeet its higher external obligations in 1998 due tothe depreciation of the ringgit. Regular prepaymentexercises had contained the nation’s external debtat moderate levels while refinancing programmeshad improved the debt maturity profile, smoothenedthe bunching of repayments and lowered interestcosts. To a large extent Malaysia’s resilience tothe regional crisis was due to its relatively lowreliance on short-term financing. Short-termborrowings accounted for only 18% of the totalexternal debt and 29% of international reserves,while the bulk (60%) of the medium and long-termdebt were with remaining maturity of more thanthree years. In addition, the external loans werechanneled mainly to export-oriented industries andto fund overseas investments. Hence, thesecompanies had a natural hedge from their foreignexchange earnings to cover their increased debtservice obligations.

The nation’s total external debt outstandingdeclined by 6.4% to RM159.8 billion at the end of1998. In United States dollar terms, the total debtwas equivalent to US$42 billion (US$43.8 billion in1997). Consequently, there was an improvement inthe debt indicators in 1998. The ratio of external

Table 1.20Outstanding External Debt

1997 1998p

RM US$ RM US$million million million million

Total debt 170,757 43,840 159,775 42,046Medium &

long-term debt 127,500 32,734 131,271 34,545Short-term debt-1 43,257 11,106 28,504 7,501

As % of GNPTotal debt 65.4 47.2 60.9 62.8Medium &

long-term debt 48.8 35.3 50.0 51.6

As % of exports ofgoods and servicesTotal debt 63.7 46.0 48.3 49.8Medium &

long-term debt 47.5 34.3 39.6 40.9

Debt service ratio (%)Total debt 5.5 5.5 6.7 6.7Medium &

long-term debt 4.7 4.7 6.0 6.0

1 Refers to bank and non-bank private sector short-term debt.p Preliminary

debt to GNP and exports declined to 60.9%and 48.3% respectively (65.4% and 63.7%respectively in 1997).

External borrowing of medium and long-termloans registered a sharply lower net inflow of RM4billion in 1998 (1997: RM13.4 billion). Thedrawdown of loans by the non-financial publicenterprises (NFPEs) and the private sector fell by50% and 37% respectively in 1998. The lowerborrowings were due to revisions in investmentplans amidst the tightening of lending conditionsand wider spreads in the wake of investors’increased risk aversion towards lending to Asiancountries. The reassessment of lending to theregion, including Malaysia, was triggered byincreased uncertainty and the flight to quality inoffshore markets. The aversion of lenders to marketrisk also resulted in a shortening of the maturityperiod for loans. Consequently, both the privatesector and the NFPEs recorded smaller net inflowsof RM1.8 billion and RM361 million respectively in1998 (RM8.7 billion and RM6.4 billion respectivelyin 1997). The Federal Government, in contrast,recorded a net inflow of RM1.8 billion for the firsttime since 1991, reflecting official borrowing tofinance the fiscal deficit. As a result, the nation’smedium and long-term external debt increasedby 3% to RM131.3 billion at the end of 1998. InUnited States dollar terms, the debt increased by5.5% to US$34.5 billion (1997: US$32.7 billion).

Short-term debt, comprising mainly the externalborrowings of commercial banks and non-bankprivate sector, declined by 34% to RM28.5 billionat the end of 1998. This reflected lower short-termloans of the banking institutions as trade financingrequirements were reduced following the stagnationin domestic demand and reduction in external trade.As a result, the ratio of short-term debt to totalexternal debt declined to 18% from 25% in 1997.

In terms of currency composition, debtdenominated in United States dollar continued todominate the medium and long-term debt profilewith a share of 74% of total debt outstanding atthe end of 1998 (1997: 76%). The share of yendenominated debt increased to 17% (1997: 15%),reflecting the increase in new yen loans duringthe year as well as the exchange revaluation losswhich raised the yen debt in ringgit terms. Theshare of external debt denominated in otherinternational currencies including the French franc,

Singapore dollar, Deutsche Mark and pound sterlingremained at 9%.

The overall cost of servicing the external debtincreased significantly in 1998, due mainly to thevaluation losses arising from the ringgit depreciation.Total debt servicing payments increased by 50%to RM22.1 billion, due to both higher principalrepayment, especially by the NFPEs, and higher

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Graph 1.13Medium and Long-Term External Debt

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interest payments. In United States dollar terms,total debt servicing increased by 8%. Therefore,the total debt service ratio (ratio of debt servicingto export of goods and services) increased to 6.7%from 5.5% in 1997.

Public sector external debt: The FederalGovernment’s external debt which accounts for9.3% of total external debt, increased by 15.2% toRM14.9 billion at the end of 1998. While a largepart of its borrowing to fund the increased fiscaldeficit was met from non-inflationary domesticsources, the Federal Government also increasedits recourse to external borrowing in 1998. Grossborrowings increased significantly to RM4 billion,mainly from official creditors such as the multilateralinstitutions and bilateral lenders. There has beenless incentive to access the international capitalmarkets as interest spreads had widened followingseveral instances of downgrading of Malaysia’ssovereign debt rating by the international creditrating agencies. Although the sovereign ratings hadremained at investment grade, spreads forMalaysian issues widened significantly in 1998.Recently, following modification to the exchangecontrol rules on portfolio investments, these spreadshad narrowed considerably. In June 1998, theWorld Bank disbursed a US$300 million (RM1.2billion) loan to mitigate the adverse effects of theeconomic adjustment on the more vulnerablesegments of society. In December, Malaysia signedthe ¥74 billion (RM 2.4 billion) five-year term loanagreement/Euroyen bond with Sumitomo Bank Ltd./Nomura Securities Co. Ltd. The structured financingwas through a combination of a term loan andEuroyen bond issue guaranteed by Ministry ofInternational Trade and Industry, Japan. Drawdownof existing project loans totalled another RM381million during the year. There was no prepaymentin 1998. Malaysia made scheduled repaymentstotalling RM2.2 billion following the maturity of aSamurai bond of ¥30 billion (RM882 million) anda 100 million Swiss franc bond (RM274 million).

Gross borrowing of the NFPEs declined toRM4.7 billion (1997: RM9.4 billion). The drawdownof loans were mainly made by Tenaga NasionalBerhad and Telekom Malaysia Berhad to refinanceloans due in 1998 and for funding domestic capitalexpenditure and investment in subsidiaries abroad.The NFPEs recorded a small net inflow of RM361million (1997: RM6.4 billion) with scheduledrepayments increasing by 45% to RM4.3 billion,reflecting mainly the valuation losses arising from

the ringgit depreciation. Together with an exchangerevaluation loss of RM403 million largely due tothe appreciation of Japanese yen, the outstandingdebt of the NFPEs increased by 1.5% to RM53.2billion at the end of 1998.

Private sector external debt: In the face of aslowdown in domestic economic activity and acontraction in private investment, gross borrowingof the private sector declined by 37.4% to RM9.6billion in 1998 (1997: RM15.4 billion). About 67%of the external borrowings were undertaken by non-resident controlled companies (NRCCs). Theseloans were mainly long-term from their offshoreshareholders and parent and associated companies.Hence, NRCCs were less affected by the diminutionof credit in international debt markets. Repaymentsincreased by 16.7% to RM7.8 billion, reflectingmainly the impact of the ringgit depreciation. Whilea substantial part of external repayments due in1998 were hedged, the unprecedented magnitudeof the currency depreciation created liquidityproblems for some corporations. However, theseborrowers did not face problems in reschedulingthese debts. Many borrowers restructured theirdebts through refinancing to roll over existing loansor by extending the repayment period. Followingthese developments, private sector external debtoutstanding recorded a modest increase of 1.7%to RM63.1 billion at end-1998, due in part to theexchange revaluation gain of RM777 million,following the fixing of the ringgit exchange rate atRM3.80 to the United States dollar on 2 September1998. The private sector remained the single largestborrower in 1998, accounting for a large share of48% of the total medium and long-term debt.

The Government will continue to exerciseprudence in its recourse to external borrowing. Theaim of policy is to contain the nation’s externaldebt within prudent levels in order to minimise theimpact of adverse global financial marketdevelopments on the Malaysian economy. With thisobjective, the debt management strategy willcontinue to balance the need to ensure that thecorporate sector can have access to the mostcompetitive funding sources.

In the immediate term, however, the financingrequirements for the economic recovery packageand restructuring of the banking institutions willnecessitate some increase in the Government’srecourse to external borrowing. While the funding

requirements will be primarily met from domesticnon-inflationary sources, some external loans willbe raised in 1999, from multilateral institutions andbilateral sources. The Japanese Government, forexample, has offered bilateral financial assistanceto Malaysia under the ODA programme and theMiyazawa Initiative. Such assistance will includeloans from the OECF and EXIM Bank of Japan.Such borrowing from official creditors will notadversely affect the overall external debt profile,as they are offered on more favourable terms,including concessionary interest rates or lower riskpremiums and longer maturities.

International Reserves

The gross international reserves held by theBank, comprising gold, foreign exchange, reserveposition with the International Monetary Fund (IMF)and holdings of Special Drawing Rights (SDRs)rose significantly by RM40,305 million to RM99,438million at the end of 1998, following a decline in1997. After taking into consideration the currentexternal liabilities of the Bank of RM13.7 million,the net international reserves of the Bank stood atRM99,424 million at end-1998. The United Statesdollar equivalent of gross reserves was US$26.2billion at end-1998, a level sufficient to finance 5.7months of retained imports. In SDR terms, theinternational reserves held by the Bank amountedto SDR18.6 billion.

During the year, net holdings of gold andforeign exchange rose by RM39.2 billion toRM96.3 billion at the end of 1998. Foreignexchange holdings rose rapidly subsequent to the

introduction of selective exchange control measureson 1 September, and the fixing of the exchangerate on the following day. Between end-August andDecember 1998, reserves rose by US$6 billion.On the whole, the rise in foreign exchange holdingsreflected partly Malaysia’s large trade surplus in1998, as well as foreign currency loans from bothofficial and private institutions. The increase inreserves in ringgit terms was also due to therevision in the accounting policy of recognising theforeign exchange revaluation gain or loss in 1998.Since 15 September 1998, the exchange gain fromthe revaluation of foreign assets and liabilities hasbeen reflected in the Bank’s books, with assetsand liabilities in foreign currencies being revaluedat the exchange rate prevailing on the reportingdate. With effect from January 1999, foreignexchange revaluation will be calculated on aquarterly basis.

Holdings of reserves in the form of SDR roseby RM315 million during the year to RM793.9million at the end of 1998. The increase wasmainly on account of the receipts of remunerationfrom the IMF arising from Malaysia’s net creditorposition with the Fund as well as exchangerevaluation gain. During the year, Malaysia wasnot included in the quarterly SDR Designation Plansof the Fund, under which countries were requiredto provide convertible foreign currency in exchangefor SDRs upon request.

The reserve position of Malaysia with the IMFdefined in terms of SDR, reflected transactionswith the Fund during the year. In 1998, thiscomponent of external reserves remainedunchanged at SDR444.7 million. However the SDRholdings in ringgit terms increased by RM757.2million during the year to RM2,379.2 million at theend of 1998 on account of exchange revaluationgains for the year. The reserve position of Malaysiawith the IMF remained stable during the year.

The overall objective of the Bank in managingthe foreign reserves is to optimise returns withoutcompromising on safety and liquidity. The foreignassets of the Bank comprise major foreigncurrencies, which are held in the form of cash,investments in allowable fixed income securitiesissued by foreign governments and multilateralagencies, and gold. The concern for safetyencompasses the preservation of value anddiversification of assets to reduce portfolio volatility

Table 1.21Net International Reserves

As at end

1996 1997 1998

RM million

Net Reserves 70,014.6 59,122.8 99,424.4

SDR holdings 427.7 478.9 793.9

IMF reserves position 1,738.2 1,622.0 2,379.2

Gold and foreign exchange 67,848.7 57,021.9 96,251.3

US$ billion

Gross Reserves 27.7 21.7 26.2

Months of retained imports 4.4 3.4 5.7

and minimise risk. The foreign reserves aremanaged against a customised benchmark andwithin the investment guidelines of the Bank. TheBank ensures adequate supply of liquidity tomeet its obligations and has not entered intoany forward transactions in its investmentoperations.

Exchange Rates

During the year, the ringgit recorded a mixedperformance against the major currencies,depreciating marginally by 0.2% (1997: –31.4%)against the composite basket of currencies ofMalaysia’s major trading partners. The ringgitappreciated by 2.3% against the United States dollarand by 1.8% against the pound sterling. Theringgit’s rise against the pound sterling reflectedthe dollar’s strength, as well as concerns overBritain’s weaker export sector, the threat of slowereconomic growth and the advent of the Euro in1999. However, the ringgit depreciated by 2.7%against the Swiss franc, 4% against the DeutscheMark and 9.7% against the Japanese yen largelyreflecting the strength of these currencies againstthe dollar. Against the regional currencies, the ringgitappreciated by 1.4% against the Singapore dollarand 51.5% against the Indonesian rupiah, butdepreciated by 1.1% against the Philippine peso,20.5% against the Thai baht and 27.7% againstthe Korean won.

The prolonged and severe Asian financial crisiscontinued to exert downward pressure on the ringgitduring the first eight months of the year. However,

compared with 1997, the ringgit was relatively stablein 1998. The ringgit’s standard deviation againstthe United States dollar was 0.253 on a daily basisduring this period compared with 0.419 in thesecond half of 1997. Since 2 September when theringgit rate was fixed at US$1=RM3.8000, therewas reduced volatility of ringgit rates against majorcurrencies. Consequently, for 1998 as a whole, theringgit’s standard deviation against the United Statesdollar moderated to 0.222 on a daily basis (1997:0.437). Similarly, the ringgit’s volatility moderated to0.123 against the Deutsche Mark (1997: 0.231),0.198 against the Japanese yen (1997: 0.307) and0.326 against the pound sterling (1997: 0.749).

The most notable event in exchange ratedevelopments in 1998 was the adoption of a fixedexchange rate regime on 2 September 1998,following the imposition of selective exchangecontrols on 1 September. This is the first timeMalaysia departed from the floating exchange rateregime adopted in June 1973. With this significantdevelopment, the performance of the ringgit during1998 can be distinguished in terms of two distinctphases.

During the earlier phase of January-August1998, the ringgit continued to be affected by theturbulent regional developments as well as thecontraction in domestic economic activity. Threedistinct periods were observed prior to September1998. The ringgit experienced extreme volatility inthe early months of 1998. Following the sharpdepreciation in the Indonesian rupiah on 7 January,the Asian currencies, including the ringgit, weakened

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Graph 1.15Exchange Rate of the Malaysian Ringgit against SelectedASEAN Currencies

(End-month)

1997 1998

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Graph 1.14Exchange Rate of the Malaysian Ringgitagainst Major Currencies

Ringgit fixed at

US$1=RM3.80

during this period. The ringgit breached a historicalintra-day low of US$1=RM4.8800 on 7 January,with the ringgit’s standard deviation risingsignificantly to 0.233 in January. Subsequently, theringgit strengthened significantly and recovered toan intra-day high of US$1=RM3.3500 on 11February. Positive developments that supported theringgit included the improvement in Malaysia’s tradeaccount for 1997 and announcement of furtherstabilisation measures by the Government, includinga tightening of monetary policy. During the periodmid-February to June, the ringgit was relatively morestable, fluctuating within the range ofUS$1=RM3.5800 to RM4.1750.

Towards end-June until August, the ringgitexperienced another phase of downward pressurewhile the regional instability intensified. The pressureon the ringgit rates was also affected by thesignificant depreciation of the Japanese yen againstthe United States dollar. The yen reached an eight-year low of US$1=¥147.2650 on 11 August causingthe ringgit to depreciate to US$1=RM4.2430. Theother regional currencies were also influenced bythe yen’s performance in view of the region’ssubstantial trade and investment ties with Japan. Inaddition, the spill over effects from adversedevelopments in Indonesia as well as indicationsthat the region had entered a period of slowergrowth exerted further downward pressure on theAsian currencies, including the ringgit. On thedomestic front, the release of the first quarter GDPdata at end-May, which showed an economiccontraction for the first time since 1985, also fuelled

concerns over the adverse impact of thedepreciation on the corporate and financial sectors.Although the Government had been proactive inmanaging the negative impact of the domesticcontraction and to stabilise the economy and theringgit in particular, the efforts were constrained bythe vulnerability of the ringgit to sustainedspeculative activity, especially in offshore markets.

The rapid increase in the internationalisation ofthe ringgit since April 1998 also contributed to theringgit’s weakness during this period. Thisdevelopment caused outflows of ringgit depositswhich were attracted by higher offshore interestrates ranging from 20-40%. Onshore rates werethen around 11%. Opportunities to speculate onthe ringgit increased with the build-up of offshoreringgit leading to further depreciation of the currencyin July and August. The ringgit traded to an intra-day low of US$1=RM4.3260 on 10 July andsubsequently recovered to trade within a range ofUS$1=RM4.0900-4.2650 during the period July toAugust.

Following the introduction of selective exchangecontrol measures on 1 September, the ringgitappreciated to an intra-day high of US$1=RM3.8200.On 2 September, the ringgit was trading atUS$1=RM3.8000 in the foreign exchange marketprior to the fixing of the exchange rate at thatlevel at 11 a.m.. This was also the rate at whichthe ringgit was, on average, traded during Februaryto June 1998. The fixed exchange rate allowed

Table 1.22Movement of the Ringgit

RM to one unit of foreign currency1

1997 1998End-Dec. Sept. 2 End-Dec. Low High

Composite 69.70 72.11 69.57 58.23 77.38 –31.4 –19.8 –0.2

SDR 5.2539 5.1177 5.3505 4.6701 6.3076 –30.8 –22.3 –1.8US$ 3.8883 3.8000 3.8000 3.4600 4.7250 –35.0 –22.6 +2.3S$ 2.3200 2.1998 2.2879 2.1378 2.6516 –22.1 –12.2 +1.4100 Yen 2.9921 2.7742 3.3141 2.7439 3.5972 –27.3 –12.5 –9.7Pound Sterling 6.4449 6.3708 6.3313 5.6250 7.6604 –33.7 –25.7 +1.8Deutsche Mark 2.1729 2.1743 2.2640 1.9147 2.5754 –25.1 –25.6 –4.0Swiss franc 2.6742 2.6450 2.7497 2.3691 3.1861 –29.8 –25.5 –2.7100 Thai baht 8.2337 9.3713 10.3613 7.8031 10.6592 +19.8 –9.5 –20.5100 Indonesian rupiah 0.0721 0.0354 0.0476 0.0248 0.0671 +48.4 +176.3 +51.5100 Korean won 0.2305 0.2827 0.3190 0.2159 0.3418 +29.8 +14.8 –27.7100 Philippine peso 9.6024 8.8302 9.7064 8.5336 10.7031 +0.1 +8.3 –1.1

1 With the exception for 1996 data, where the Thai baht, Indonesian rupiah, Korean won and Philippine peso are based on customer rates, all other data is basedon the average of buying and selling rates at noon in the Kuala Lumpur Interbank Foreign Exchange Market.

* Compared with 2 September 1997’s levels.

1997Sept. 2*

19981998

Annual change (%)

Introduction

The exchange control measures introducedby Malaysia on 1 September 1998 were part ofa series of pre-emptive measures implementedto reduce several areas of vulnerabilities in theeconomy. Of significance, Malaysia did not rushto impose exchange control measures to addressissues arising from the contagion impact of thecurrency crisis. The use of exchange controlsas a policy option was imposed 14 months afterthe outbreak of the currency crisis followingmacroeconomic adjustment policies undertakento restore internal and external balance. Moreimportantly, the circumstances prevailing in thecountry in September were favourable to achievethe desired objectives of the exchange controlmeasures. Policy measures implemented inthe early part of the crisis had already improvedthe key areas of vulnerabilities in the economy.In terms of the overall macroeconomic framework,Malaysia had contained inflation and improvedits external balance. External reserves wereintact, while external debt exposure remainedlow. The banking sector continued to perform itsintermediary function. By end-August 1998,the institutional framework to restructure thefinancial sector was completed and its operationson track.

Objectives of the Exchange ControlMeasures

The exchange control measures adopted byMalaysia have been designed and implementedto achieve specific objectives in response tospecific circumstances. Malaysia imposedselective measures, directed mainly at reducingthe internationalisation of the ringgit. On its part,Malaysia had already undertaken adjustmentpolicies and implemented financial reforms toreduce the risks and vulnerabilities to externaldevelopments. The prospects for these initiativesto yield the desired results could only be achievedin a stable environment. However, the worsening

Exchange Control Measures as aPolicy Option

of the international financial environment led tocontinued domestic financial instability, contributingto a sharper-than-expected contraction of theeconomy of 4.8% in the first half of 1998. Despitemacroeconomic adjustment policies in all crisiscountries, exchange rates remained volatile andsusceptible to speculative pressures. Although ithad become clear that there was a need forgreater transparency among the large players,and for reforms in the international financialsystem, a concerted international effort to stemthis volatility was not forthcoming. For Malaysia,a major source of concern that was emergingsince April 1998 was the increase in the rateof internationalisation of the ringgit, resulting inan outflow of ringgit to offshore markets. Thisringgit outflow was attracted by higher interestrates in the region of 20% to 40% offered byoffshore centres, while onshore rates were in theregion of 11%. The strong demand for offshoreringgit and the consequent build-up of offshoreringgit increased the vulnerability of the ringgit.This trend, if left unchecked, would underminethe prospects for recovery and the ability toconduct monetary policy based on domesticconditions, thereby resulting in fundamentaldamage to the real economy.

Malaysia, therefore, designed the selectiveexchange control measures to specifically achievethe objective of reducing the internationalisationof the ringgit. This was achieved by eliminatingaccess to ringgit by speculators, both at homeand abroad. This involved the introduction ofrules relating to the external accounttransactions of non-residents and currency ofsettlement of trade transactions, while generalpayments, including movements of funds relatingto long-term investments and repatriation ofprofits, interest and dividends remainedunaffected. The measures are also aimed atstabilising short-term capital inflows, by requiringinflows of capital to remain in the country fora period of 12 months. The measures are

Box III

temporary and would be modified or removedwhen its objectives have been achieved. In thisregard, on 4 February 1999, the rule on theone-year holding of portfolio capital was modifiedto allow the foreign investors to repatriatethe principal capital and profits subject to agraduated levy.

Features of the Exchange ControlMeasures

The exchange control measures involved thefollowing:

• Selected ringgit-denominated transactionsamong non-residents effected via non-resident external accounts require approval;

• Short-term capital flows by requiring suchinflows to remain in the country for aminimum period of one year. These funds,however, could be actively managed in theform of ringgit assets;

• Import and export of ringgit by travellers,both residents and non-residents, arerestricted for amounts exceeding RM1,000;

• Malaysian investments abroad exceeding theequivalent of RM10,000 require priorapproval; and

• Malaysians travelling abroad require approvalto carry foreign currencies in excess ofRM10,000 equivalent.

The changes were directed at containingspeculation on the ringgit and at stabilising short-term capital flows. There are no controls on:

• Current account transactions (amendment inrules only require trade transactions, bothin goods and services, to be settled inforeign currencies and no longer in domesticcurrency);

• Repatriation of profits, dividends, interest,fees, commissions and rental income fromportfolio investment and other forms of ringgitassets; and

• Foreign direct investment inflows andoutflows.

The main change in rules, therefore, pertainsto external account transactions of non-residents. Under the new requirements, transfersof funds between external account holders whoare non-resident corporations and non-residentindividuals residing outside Malaysia are restricted.Prior approval is required for transfer of fundsbetween external accounts and for uses of fundsfor other than permitted purposes. The uses offunds from external accounts are freely permittedfor the following purposes, other purposes areallowed subject to approval by Bank NegaraMalaysia (BNM):

• Purchase of ringgit assets/placements ofdeposits;

• Payment of administrative and statutoryexpenses in Malaysia;

• Payment of goods and services in Malaysia;and

• Granting of loans and advances to staff inMalaysia according to the terms andconditions of service.

All external account holders are free to fundthese accounts from proceeds from:

• Sale of ringgit instruments, securitiesregistered in Malaysia or other assets inMalaysia;

• Salaries, wages, commissions, interest ordividends; and

• Sale of foreign currencies.

As part of the measures, the ringgit hasbeen fixed against the United States dollar toprovide a greater degree of certainty to themarket for the conduct of trade and investmentactivities. Following the introduction of thesemeasures, the ringgit strengthened against theUnited States dollar by 10.5% from the end-August level of RM4.22 to an intra-day high ofUS$1=RM3.82 on 1 September 1998. The ringgitappreciated further to US$1=RM3.80 afterwhich the ringgit’s rate was fixed at that rate,effective 11 a.m. on 2 September 1998. Duringthe period February to mid-June, the ringgittraded at about this level against the UnitedStates dollar.

Preconditions for Controls

The experience of countries in achievingthe objectives of capital control measures hasbeen varied. The use of controls has been widelycriticised by proponents of the free market systemon the grounds that it leads to distortions andinefficiencies. Capital controls have been identifiedas a major cause for creating distortions in someof the economies, undermining their prospectsfor growth and development. The potential costsassociated with controls on capital flows arelower real interest rates and capital flight, therebycontributing to higher rates of inflation anddeterioration in the balance of payments positionover the long term. Consequently, there hasbeen general perception that the measuresintroduced by Malaysia would create distortionsin the economy. In judging the use of exchangecontrols as a policy option, it is important toconsider when and under what circumstancessuch capital controls can be applied, in whatform they should take, the preconditions thatwould ensure it would yield the desired resultsand how it might be efficiently implemented.

Malaysia imposed the controls underconditions and circumstances that increasedthe prospects for successfully achieving itsobjectives. Firstly, capital controls have historicallybeen imposed by countries facing balance ofpayments constraints. Many of these countriesimposed restrictions on almost all transactionswith non-residents, including current accounttransactions, in the face of weak external reservesposition. Malaysia, on the other hand, hasmaintained free movement of all current accounttransactions. Prior to the controls, Malaysiaalready had taken corrective measures which ledto a significant improvement in the current accountfrom a deficit of 5.4% of GNP in 1997 to asurplus of 13.7% of GNP in 1998, thus resultingin a strong build-up of reserves.

Several of the countries that imposed capitalcontrols also faced capital flight. Malaysia hasgenerally not experienced significant capitaloutflows of the type and magnitude experiencedby countries facing balance of payments andreserves constraints. In Malaysia, capital outflowshave been in the form of prepayments ofexternal loans by both the public and privatesectors, Malaysian investments in ventures abroadin sectors which yield spin-off benefits for the

domestic economy and the liquidation ofinvestments by portfolio investors.

Meanwhile, the external reserves of the countrywas intact, unencumbered and increasing. Beforethe implementation of the controls, externalreserves stood at US$20.2 billion, sufficient tofinance 4 months of retained imports. To date,the build-up of external reserves has beensignificant. As at end-February 1999, internationalreserves stood at US$28.7 billion, an increaseof US$8.5 billion from end-August 1998 level,adequate to finance 6.2 months of imports. Thisgrowth in reserves would provide greater overallconfidence and place the Government in a betterposition to cope with any bunching of short-termcapital outflows that could occur on 1 September1999. In addition, the short-term debt is lessthan half the size of foreign exchange reserves.Malaysia is therefore, not vulnerable to creditoutflows over the short term, and 60% ofMalaysia’s external debt have remaining maturitythat exceeds three years. Furthermore, the bulkof the short-term debt is in the form of tradefinancing. Experience of countries has shownthat countries with strong balance of paymentsposition such as The People’s Republic of Chinaand Taiwan have achieved a greater degree ofsuccess with capital controls.

Other desired objectives of capital controls arenot achieved because they were implemented inan inflationary environment caused by aninappropriate mix of macroeconomic policies.Most of these countries have either had protectivetrade and payments regimes or public expenditurehad been diverted to less productive sectors.This in turn resulted in supply constraints anda general rise in prices of goods and services.In comparison, such risks for Malaysia are low.Inflationary pressures have been subdued due toseveral factors:

• On the domestic front, weak domesticdemand has more than offset the effects ofthe depreciation of the ringgit againstthe currencies of major trading partners.Excess capacity in product and labourmarkets contributed to lower inflation so thatconsumer prices rose by 5.3% in 1998, asagainst earlier expectations of 7-8%;

• Generally, the low inflation environment andthe strong expansion in income levels in the

last decade have resulted in high savingsand is expected to remain high at about40% of GNP. Consequently, the fiscalstimulus is being funded by non-inflationarydomestic sources of financing, primarilythrough the issuance of bonds and MalaysianGovernment Securities; and

• Malaysia also ranks favourably in terms ofoverall competitiveness. Malaysia haspursued an export-oriented industrialisationstrategy since the 1970s, which hasexposed the economy to internationalcompetition. Malaysia’s economy is open withhigh foreign presence in the domesticindustries, including financial services.Several policy measures have been put inplace to enhance productivity improvementson an ongoing basis to increase the nation’scompetitiveness. Given the low inflation rate,the ringgit is also not overvalued whenmeasured in terms of the real effectiveexchange rate.

It is important to recognise that Malaysiais not relying on controls to addressmacroeconomic imbalances in the economy. Inadministering the exchange control measures, theapproach has been that such measurescomplement other monetary and fiscal measuresto bring about sound and balanced developmentof the country. Malaysia is not substitutingcapital controls for sound and transparentdomestic economic policies. Malaysia has showncommitments to undertake the necessary structuraladjustment policies that are critical for long-termgrowth with price stability. The facts show thatthe breathing space provided by the exchangecontrol measures has been used effectively toundertake further macroeconomic policies andaccelerate structural reform measures. To date,the restructuring of the financial sector hasbeen comprehensive. The achievements of theprogramme to restructure the financial sector hasexceeded the targets. Furthermore, the targetdates for completion of acquisition of non-performing loans and recapitalisation of thefinancial institutions have been brought forward.Work on corporate debt restructuring to facilitatedebt workouts on a voluntary basis has alsobeen accelerated.

In the implementation of the selective exchangecontrol rules, the Government has also adopted

a flexible approach. The situation has beenclosely monitored. Emphasis has been placedon the efficiency of the implementation processas well as the dissemination of information onthe changes to the exchange control rules toprovide a greater understanding of the measures.Efforts have been directed to ensure that theadministrative machinery is in place to provideprompt response to emerging issues to ensurethat any disruptions are addressed.

Malaysia has a track record for showingflexibility in the implementation of policies.Similarly, once the policies have achieved thedesired results, such policies will be removed.Although Malaysia has adopted over time anincreasingly liberal exchange control regime, thecountry had, under certain circumstances, usedselective exchange control regulations tocomplement the macroeconomic policies to restorestability. Use of such selective exchange controlmeasures occurred in 1993-94 and were removedafter six months. These measures were effectiveand allowed stabilisation to be achieved withreduced cost to the economy. During this period,the distortionary effects were minimised.

The exchange control measures implementedon 1 September 1998, which included therequirement for portfolio capital to remain inMalaysia for at least 12 months, have contributedsignificantly to the stability of the economy.Accordingly, on 4 February 1999, the Governmentannounced a new rule to replace the one-yearholding rule for portfolio capital. Under the newrule, the principal capital and profits will beallowed to be repatriated subject to a graduatedlevy depending on when the funds were broughtinto Malaysia and the duration of investment.The details are as follows:

For funds brought in before 15 February1999• The principal capital repatriated after one

year from 1 September 1998 or one yearfrom the actual date (after 1 September1998) the funds were brought in will notattract any levy;

• If the principal capital is repatriated withinone year, it will be subject to a levy at adecreasing rate, depending on the durationthe principal is held (up to 7 months: 30%,exceeding 7 months and up to 9 months:

20%; and exceeding 9 months and up to12 months: 10%);

• No levy will be imposed on the repatriationof profits on investment made within the 12-month holding period;

• However, all profits on investments madeafter the 12-month holding period will besubject to a repatriation levy of 10%.

For funds brought in on or after 15 February1999• The principal is allowed to be repatriated

without any levy;

• However, profits made and repatriated within12 months after the investment is made aresubject to a levy of 30% of the profits;

• Profits realised and repatriated after 12months from the date of investment aresubject to a levy of 10%; and

• Profits realised during the 12-month periodof the investment, but repatriated after 12months from the date of investment arealso subject to a levy of 10%.

These measures are aimed at encouragingexisting portfolio investors to take a longer-termview of their investments in Malaysia, attract newfunds into the country, while at the same timediscourage destabilising short-term flows. Inaddition, the rule was designed to allow asmoother outflow of funds, rather than a sudden

and massive outflow upon the expiry of the one-year holding period. With respect to rules onexternal account transactions, Malaysia wouldremain cautious and lift the controls only whenthere are clear indications that the necessarysafeguards are in place in the internationalfinancial environment to contain excessivespeculative activities on currencies.

Conclusion

Initial indicators point to the success of theexchange control measures. The greater stabilityin the currency, stock markets and the financialsystem is contributing to some revival in consumerand investor confidence. The controls, althoughlimited in scope, have been sufficient to providea greater degree of independence for the conductof monetary policy to support the recoveryprocess. The measures have been positivelyreceived by long-term investors. The measureshave enabled an intensification of the ongoingreform. Malaysia has taken full advantage ofthe “breathing space” provided by these controlsto further expedite economic and financial reforms.On the international front, there has been animportant shift in thinking on the broader issueof policy response to the financial crisis in general,and on the issue of exchange controls inparticular. There is now increasing recognitionthat such controls are appropriate under specificcircumstances, particularly when they are targetedat short-term destabilising capital flows and whenthe controls complement, and are not a substitutefor policy adjustments.

Definition

An External Account is defined as a ringgitaccount maintained with a financial institution inMalaysia where the funds belong to a non-resident individual or corporation.

A resident and a non-resident aredefined, for exchange control purposes, inTable III.1.

Sources and Uses of Funds Held inExternal Accounts

External Accounts are mostly maintained byforeign non-bank entities, which includecorporations and individuals. Funds in theExternal Account represent a claim on Malaysia’sreserves. The types of deposits held in ExternalAccounts are as follows:

(i) Ringgit demand deposits from foreign non-bank entities;

External Accounts

(ii) Ringgit savings deposits from foreign non-bank entities;

(iii) Ringgit fixed deposits from foreign non-bank entities;

(iv) Ringgit fixed deposits from foreign bankinginstitutions;

(v) Islamic Banking ringgit deposits fromforeign banking institutions;

(vi) Islamic Banking ringgit deposits fromforeign non-bank entities; and

(vii)Ringgit vostro accounts of foreign bankinginstitutions.

Prior to the implementation of the selectiveexchange controls, the sources of funds in theseaccounts would be either in the form of ringgitreceivables, conversion of foreign currency, or

Non-Resident Resident

• Non-Malaysian citizen • Malaysian citizen

• Malaysian citizen with permanent resident • Malaysian citizen with permanentstatus abroad and resides abroad resident status of another country

but resides in Malaysia

• Foreign embassies, high • Non-Malaysian citizen with permanentcommissions, supranationals, resident status in Malaysia andcentral banks and international resides in Malaysiaorganisations

• Business entities established • Business enterprises or any body,abroad whether incorporated or

unincorporated, or registered withor approved by any authority inMalaysia.

Table III.1Definition of Non-Resident and Resident

ringgit earnings in Malaysia. There was no limitationas to the sources and uses of ringgit balancesin this account. A non-resident could freely transferthe ringgit balances from one External Account toanother for any purpose. Effective 1 September1998, balances in the External Accounts cancontinue to be used for settlement of ringgit assettransactions and payment of services andadministrative expenses in Malaysia. Othertransactions are detailed in Table III.2. In addition,External Account holders may also transfer fundsbetween their own External Accounts. Other thanthe permissible purposes mentioned above, useof these balances for other purposes, includingtransfers between External Accounts, requireapproval of BNM.

An increase in the External Account balanceat any particular time does not necessarilyreflect or indicate new inflow of foreign fundsinto the country as it could also reflect the saleof ringgit assets to residents of Malaysia, theproceeds of which are then deposited into theExternal Account. Similarly, decreases in theExternal Account balance do not necessarilyreflect an outflow of foreign funds from thecountry since the External Account balance couldalso be used to purchase ringgit assets fromresidents. However, the movements in ringgitbalances in the External Accounts to a certainextent reflect the activities of non-residents inthe country.

External Accounts and Money Supply

All External Account balances, except forthe vostro balances, are captured in thecomponents of money supply, as money supplyis a measure of the non-bank private sectorliquidity. As ringgit vostro balances of foreignbanking institutions represent transactionsbetween banking institutions, it is thereforeexcluded from the compilation of moneysupply. The various impact of the movementsin the External Accounts on money supply areas follows:

(i) When non-residents sell their assetsin Malaysia to residents, there shouldnot be an increase in money supply, asthe increases in the External Accountsfrom the proceeds of the sales wouldbe offset by corresponding withdrawals

of funds by residents to purchasethe assets.

(ii) In the event of non-residents bringingin foreign exchange and converting theminto ringgit and placing the ringgit fundsin their External Accounts, money supplywould increase.

(iii) Ringgit funds held abroad and broughtback to Malaysia and deposited into theExternal Accounts would increase moneysupply.

(iv) Increases in vostro balances would nothave an impact on money supply as theserepresent transactions among bankinginstitutions. Nevertheless, if the bankinginstitutions use the funds to extend loansto the non-bank private sector, this wouldincrease money supply.

Types of External Accounts

Apart from the External Accountsdescribed above, two other types ofExternal Accounts have been established. Thefirst is the Designated External Account (DEA).This Designated External Account is setup solely for non-residents wishing to trade onthe COMMEX and KLOFFE exchanges, andmust be funded from the sale of foreigncurrency. This measure was carried out toencourage participation in the domesticderivatives market. Funds in DEAs can freelybe converted to foreign currency and repatriatedwithout any levy.

On 4 February 1999, the Governmentannounced a new rule to replace the one-yearholding rule for portfolio capital. Under the newrule, the principal capital and profits will be allowedto be repatriated subject to a graduated levydepending on when the funds were brought intoMalaysia and the duration of the investment. Todistinguish between the different periods when thefunds were brought in, funds brought in on or after15 February 1999 will be placed in Special ExternalAccounts (SEAs). For the funds under the SEAs,the principal amount brought in is allowed to berepatriated without any levy. However, profitsmade are subject to a levy upon repatriationdepending on the duration of the investment.

Table III.2:Sources and Uses of Funds in External Accounts

Account Holder Sources of Funds Uses of Funds

Non-resident • Sale of ringgit assets • Purchase of ringgit assetscorporations not in Malaysia in Malaysiaincorporated in Malaysia

• Sale of foreign currency • Administrative and staturoryexpenses in Malaysia

• Interest, dividends and rental • Payment of goods and servicesfrom ringgit assets provided in Malaysia

• Fees and commissions for • Granting of loans and advancesservices done in Malaysia to staff in Malaysia pursuant to

the terms and conditions of service

• Payment of trade transactions foroutstanding contracts enteredinto prior to 1300 hours on1 September 1998

Embassies, consulates, • No restrictions • No restrictionscentral banks andinternational organisations

Non-resident individuals • Sale of ringgit assets • Purchase of ringgitresiding outside of assets in MalaysiaMalaysia • Sale of foreign currency

• Statutory expenses in Malaysia

• Payment of goods andservices provided in Malaysiaprovided in Malaysia

• Payment of import transactionsentered into prior to 1300 hourson 1 September 1998.

Non-resident individuals • No restrictions • No restrictionswith work permit andresiding in Malaysia

Offshore entities in • Sale of foreign currency • Administrative and statutoryLabuan International expenses in MalaysiaOffshore Financial Centre • Proceeds of permitted credit

facilities in ringgit • In the case of Licensed OffshoreInsurance entities, also for the

• Fees and commissions from purpose of reinsurance ofresidents domestic insurance business

• Other permitted activities

Offshore Ringgit Market

Definition

The offshore ringgit market encompassesall ringgit-related activities transacted outsidethe boundaries of Malaysia. These activitiesinclude ringgit trading as well as trading inderivatives on the ringgit such as options,forwards, futures and swap contracts. Theoffshore ringgit market also encompasses allringgit deposit-taking and lending activitiesoutside of Malaysia. The offshore ringgit marketactivities take place mostly in Singapore, and tosome extent, in other financial centres such asLondon, New York and Hong Kong SpecialAdministrative Region (SAR), The People’sRepublic of China.

Development of Offshore RinggitMarket and Sources of Funding

Prior to the introduction of selective exchangecontrols, there was an active market for tradingin ringgit outside Malaysia. The offshore ringgitmarket developed partly due to Malaysia’s liberalexchange control regime prior to 1 September1998. There were no restrictions on the sourcesof funds placed in External Accounts as well ason the transfer of funds into or out of theExternal Accounts. Before the selectiveexchange control measures were put in place,import and export settlements could bedenominated in ringgit. This had relieved residentimporters and exporters from the need to hedgetheir export proceeds and import payments. Atthe same time, this had given rise to thedevelopment of an offshore market in ringgitas the burden of hedging these tradetransactions had to be borne by thenon-resident counterparties.

Prior to the implementation of the exchangecontrol measures, funding for speculative activityin ringgit was obtained from:

(i) Offer side swaps with a resident bank.This was essentially a ringgit borrowingby non-residents to fund their speculative

ringgit activities. Bank Negara Malaysia(BNM) had limited the access of non-residents to ringgit through theimplementation of an outstanding limit ofUS$2 million for each bank group ofvostro accounts since August 1997.

(ii) Offer side swaps with another non-residentbank. This was effected through thetransfer of ringgit funds from one ExternalAccount to another External Account.

(iii) Repo transactions on ringgit instruments.This avenue arose from the borrowing ofUnited States dollars by banks in Malaysiafrom non-resident banks collateralised byringgit securities. The offshore banks inturn used the securities to obtain ringgitfunding through repo transactions withbanks in Malaysia.

(iv) Other sources of funding throughthe External Accounts are paymentsfor imports by residents in ringgit;outright purchase of ringgit with foreigncurrency; and dividends, interest,wages, salaries, commission and sale ofringgit assets.

Over the years, the existence anddevelopment of offshore ringgit activities,particularly in 1997 and 1998 had reached theextent of affecting domestic monetary policyimplementation. In early 1998, the offshoreringgit deposit interest rates started to increase.Offshore banks in Singapore were offeringinterest rates of over 20% for ringgit deposits.The differential arose due to a large demandfor ringgit offshore to meet the ringgit cash flowrequirement from the speculative ringgit tradingactivities. To limit the supply of ringgit offshore,BNM announced on 4 August 1997 a limit ofUS$2 million on Malaysian banks for non-commercial related ringgit offer side swaptransactions with foreign customers. With thisregulation, ringgit funding from swap transactions

for speculative activities in ringgit was severelycurtailed. This regulation drove a wedgebetween the demand and supply of ringgitoutside of Malaysia, causing the price of ringgitoffshore (i.e. the interest rate) to increase. Thislarge interest rate differential made theconduct of domestic monetary policy difficult asinterest rates could not be reduced significantlywithout facing a threat of a large capital outflowby residents.

Size of Offshore Ringgit Market

Although it is very difficult to estimate thesize of the offshore ringgit market, themagnitude of the amount is reflected in theExternal Account balance. Non-residents holdringgit balances in External Accountsmaintained with resident banks. These accountsare held in the form of vostro accounts in thecase of non-resident banks, or normal over-the-counter accounts maintained with the bankinginstitutions in Malaysia in the case ofnon-resident non-banks. As at end-August1998, the outstanding balance in the ExternalAccounts maintained with the banking systemwas RM9.1 billion.

The External Account balance essentiallyrepresents the amount of ringgit that isunder the control of non-residents. Any ringgitthat is placed with an offshore bank willultimately be reflected in a corresponding entryin the bank’s vostro account with commercialbanks in Malaysia. Transactions in ringgit amongoffshore players are ultimately settled throughcredits and debits to the External Accountsconcerned.

It should be noted, however, that theExternal Account balance is an estimate of thestock of ringgit offshore, and not the volume ofoffshore ringgit transactions. The actual volumeof transactions is many multiples of theunderlying stock figure. If trading in thesecondary market of ringgit-denominated contractsis active, the volume of trade can be a largemultiple of the underlying ringgit asset. Forexample, if a contract on RM100 million wastraded three times in a day, the volume oftransactions would be RM300 mill ion,even though the underlying asset is onlyRM100 million.

Effect of Exchange Controls on theOffshore Ringgit Market

To curb the ringgit-related activities outsideMalaysia as well as to repatriate ringgit currencynotes from abroad, Malaysia decided toimpose selective exchange controls beginning1 September 1998.

Details of the measures, which form part ofthe selective exchange controls, and othercomplementary measures are as follows:

Selective Exchange ControlMeasures

• Prohibit crediting of External Accountsamong External Account holders: Toreduce the volume of offshore marketactivity in ringgit among non-residents, thetransfer of funds among non-residentswas disabled by prohibiting the creditingof an External Account by anotherExternal Account holder. However, tofacilitate business transactions among non-residents who maintained External Accounts,the above prohibition was relaxed for thesale and purchase of ringgit assetsamong such non-residents. The measurecurtailed the availability of ringgit tospeculators, brought the ringgit market backto Kuala Lumpur, and trade in ringgit wasconfined only to trading hours inKuala Lumpur.

• Prohibit granting of credit line to non-resident banks and stockbrokers:Previously, banks in Malaysia wereallowed to grant a credit line of RM5mill ion to non-resident banks andstockbrokers, and permission of BNM wasrequired for any amount in excess of RM5million. To cut off ringgit funding to non-resident banks and stockbrokers, banks inMalaysia were prohibited from providing anycredit line to non-resident banks andstockbrokers. Offshore banks were,therefore, no longer able to overdrawtheir External Accounts to fund theiractivities in ringgit.

• Require imports and exports to bedenominated in foreign currency: As the

non-residents were no longer allowedto pay in ringgit for imports from Malaysiaand would receive payment for theirexports to Malaysia in foreign currency,they no longer had the need to hedgein ringgit. This would reduce the offshoreringgit market activity related totrade with Malaysia.

• Restricting the import and export ofringgit currency notes: The amountof ringgit currency notes that can be takeninto or out of Malaysia was limitedto RM1,000.

Other Measures

• Prohibit transactions in offer side swapsby banks in Malaysia with non-residentbanks: To eliminate this source of funding,the outstanding limit of US$2 million perbank group of vostro accounts was replacedby a total prohibition of such transactionswith non-resident banks.

• Prohibit reverse repo transactions withnon-resident banks: Banks in Malaysiawere prohibited from engaging in reverserepo transactions collateralised by ringgitinstruments with non-resident banks, toeliminate this avenue for non-residents toraise ringgit funds.

The selective exchange controls and othermeasures have effectively eliminated the offshoreringgit market. The supply of ringgit outsideMalaysia has ceased and this has resulted intraders and speculators being unable to trade inringgit-denominated contracts outside of Malaysia.While ringgit remains fully convertible, conversionof ringgit must be undertaken through banks inMalaysia.

The elimination of the offshore ringgit marketwill not affect the efficiency of trade. Whileimporters and exporters in Malaysia are requiredto settle their transactions in foreign currency,they are also allowed to maintain part of theirexport proceeds in foreign currency accounts withbanks in Malaysia.

stability to return to the foreign exchange marketand facilitated a greater degree of certainty fortraders, investors and consumers.

Subsequent to the adoption of the fixed exchangerate regime, the ringgit’s performance against majorcurrencies had been influenced by dollar movementin the international foreign exchange market. Duringthe period 2 September-31 December 1998, theringgit appreciated by 0.6% against the poundsterling but depreciated by 3.8% against the Swissfranc, 4% against the Deutsche Mark and 16.3%against the Japanese yen. Against the compositeindex, the ringgit depreciated by 3.5%. The ringgit’sdepreciation reflected movements of the dollar, whichhad weakened against the yen and Deutsche Markin the fourth quarter of 1998. Meanwhile, againstselected regional currencies, the ringgit depreciatedby 3.9% against the Singapore dollar, 9% againstthe Philippine peso, 9.6% against the Thai baht,11.4% against the Korean won and 25.6% againstthe Indonesian rupiah.

In terms of policy direction, Malaysia adopted aless orthodox approach. It has been suggested that

interest rates should be raised sharply to avoidfurther depreciation. Bank Negara Malaysia’s view,however, was that higher interest rates by itselfwould not strengthen the currency in view of theregional currency instability that was beingexperienced. Events outside Malaysia’s control couldtake the currency in the opposite direction, even ifinterest rates were raised. Not only would such amove not provide support for the currency, higherrates would be detrimental to the economy and thebanking system, and therefore contribute towardsfurther weakening of the currency. There was alsono evidence of outflows of foreign currency byresidents, indicating that Malaysia did not experiencecapital flight.

It was viewed that the ringgit exchange ratecould only stabilise with the resumption inconfidence, positive sentiment as well as an overalleconomic recovery. Interest rates were, therefore,only raised in small steps since October 1997mainly to address the expected increase in inflationdue to the ringgit depreciation. (Interest rate policyis discussed in detail under Monetary Policy 1998,in Chapter 2). Developments in the offshore marketsfurther constrained the use of interest rates to

Table 1.23Movement of the Ringgit

Foreign currency to one unit of RM1

1997 1998End-Dec. Sept. 2 End-Dec. Low High

Composite 69.70 72.11 69.57 58.23 77.38 –31.4 –19.8 –0.2

SDR 0.1903 0.1954 0.1869 0.2141 0.1585 –30.8 –22.3 –1.8US$ 0.2572 0.2632 0.2632 0.2890 0.2116 –35.0 –22.6 +2.3S$ 0.4310 0.4546 0.4371 0.4678 0.3771 –22.1 –12.2 +1.4Yen 33.4213 36.0464 30.1741 36.4445 27.7994 –27.3 –12.5 –9.7Pound Sterling 0.1552 0.1570 0.1579 0.1778 0.1305 –33.7 –25.7 +1.8Deutsche Mark 0.4602 0.4599 0.4417 0.5223 0.3883 –25.1 –25.6 –4.0Swiss franc 0.3739 0.3781 0.3637 0.4221 0.3139 –29.8 –25.5 –2.7Thai baht 12.1452 10.6709 9.6513 12.8154 9.3816 +19.8 –9.5 –20.5Indonesian rupiah 1,386 2,824 2,100 4,032 1,490 +48.4 +176.3 +51.5Korean won 433 353 313 463 292 +29.8 +14.8 –27.7Philippine peso 10.4141 11.3248 10.3025 11.7184 9.3431 +0.1 +8.3 –1.1

1 With the exception for 1996 data, where the Thai baht, Indonesian rupiah, Korean won and Philippine peso are based on customer rates, all other data is basedon the average of buying and selling rates at noon in the Kuala Lumpur Interbank Foreign Exchange Market.

* Compared with 2 September 1997's levels.

1997 Sept. 2*1998

1998

Annual change (%)

support ringgit rates. The need to stabilise theringgit exchange rate was the main reason for theintroduction of selective exchange controls on1 September 1998 and the fixing of the ringgit rateat US$1=RM3.8000 on 2 September 1998.

Inflation

The inflation rate increased in 1998 but wassubstantially lower than expected. The effects ofhigher import prices due to a weaker ringgit wasnot fully transmitted to domestic prices. Inflation asmeasured by the Consumer Price Index (CPI,1994=100) rose by 5.3% in 1998, lower than theearlier estimates of 7-8%. This was, however, thehighest level recorded since 1982 (5.8%). The28.3% depreciation in the average exchange rateof ringgit against the United States dollar in 1998would have raised consumer prices by about fivepercentage points, based on the findings that a1% depreciation in ringgit would increase CPI by0.176 percentage points. However, the full impactof the depreciation was not passed through to theconsumers as firms absorbed part of the increasein order to maintain market share in an environmentof weak domestic demand and excess capacity inthe economy. On the external front, low inflationabroad and lower oil and commodity prices in theworld markets also had a moderating effect ondomestic prices. During the first two month of 1999,the CPI rose at an average of 4.5%. On a regionalbasis, the CPI for Peninsular Malaysia, Sabah, andSarawak rose by 5.5%, 4.3%, and 4.2%respectively in 1998.

Excluding food, the adjusted CPI rose moremoderately by 3.1%. In Malaysia, a system ofadministered prices has been put in place forapproximately 11% of the basket, whereby pricesare administered to stabilise them at reasonablelevels. Hence, there is no price controls as such,contrary to general perceptions. The Governmentapproves price increases for the price administereditems based on their production costs as well asagreements arrived at after negotiations withproducers. Producers and distributors, however, arefree to lower prices below the determined prices.Except for Liquified Petroleum Gas (LPG), there isalso no subsidy element in the system. A totalof 46 items are currently covered under theSupplies Control Regulation and are classified undertwo groups. Supplies of 21 items are monitoredall year around. Of this total, prices of 11 itemsare administratively controlled, namely, white sugar,wheat flour, round steel bars, cement, petrol,diesel, sweetened condensed milk, LPG, standardloaf bread, chicken, and cooking oil (100% palmolein). For these 11 items, price adjustments areallowed to reflect changes in economicfundamentals such as higher imported prices.Supplies of another 25 items are monitored duringfestive seasons. Prices of these items aresupervised, but not administered. Meanwhile, onlyprices of locally-produced rice (which accountedfor 2.8% of the CPI basket) are controlled bylegislation. In terms of contribution to the basketof goods and services in the CPI, the 10 items(excluding round steel bars) whose prices areadministered accounted for 10.8%, while the otheritems under the Supplies Control Regulation whose

prices are supervised but not administered bythe Government accounted for another 4.2%. Ofthe latter 4.2% share of the CPI basket, only0.3% are supervised throughout the year,while the balance of 3.9% are supervised duringfestive seasons.

Inflationary expectations started to build uptowards the end of 1997 as the ringgitdeclined to successive lows, buffeted by a volatileexternal environment. The ringgit traded atUS$1=RM3.8883 as at the end of 1997, adepreciation of 35.1% from the level recorded asat the end of June 1997. The ConsumerSentiments Survey conducted by the MalaysianInstitute of Economic Research (MIER) in the fourthquarter of 1997 indicated that 83% of thehouseholds surveyed were expecting price increasesin the first half of 1998 (79% in the third quarterof 1997). However, as the financial crisis becamemore prolonged, the subsequent deterioration ininvestor and consumer demand as well as weakexport demand led to a sharper-than-expectedcontraction in domestic economic activities.Consequently, inflationary pressures abated,reflecting mainly the slack in the product andlabour markets. The rate of increase in the CPImoderated progressively to 5.3% in December1998, from the year’s peak of 6.2% in June. Theintroduction of the new exchange control measureson 1 September and the fixing of the ringgitexchange rate against the United States dollar atUS$1=RM3.80 on 2 September 1998 further reinedin inflationary expectations.

Reflecting mainly rising cost pressuresarising from higher import prices and cyclicalsupply shortage of essential food items, prices ofnon-durable goods rose at a faster rate of6.9%. Prices for services which were lessaffected by exchange rate changes also rose,albeit more moderately by 5.2%, attributable tohigher inflationary expectations and the highercost of business following higher prices in thegoods sector. Meanwhile, price increases forsemi-durable goods and durable goods such aselectrical and electronic goods and cars weremore subdued (1.4% and 0.4% respectively),reflecting adjustments to weaker global prices andweak consumer demand. For these categories ofgoods, producers had reconsidered their pricingstrategies and reduced their profit marginsto maintain market shares. Consumers hadgreater flexibility either to reduce consumption of

the non-essential goods or to substitute for lowercost products.

In terms of components, the CPI for food;miscellaneous goods and services; and medicalcare and health expenses, recorded strongerincreases exceeding 5.3%. The CPI for food, whichaccounted for 34.9% of the weight in the overallCPI basket, rose by 8.9% in 1998. Higher pricesfor both food consumed at home (9.1%) and foodconsumed away from home (8.4%) reflected, tosome extent, the stronger pass-through effect ofhigher imported food prices following thedepreciation of the ringgit. Prices of most importedessential items, namely, sugar; rice, bread andother cereals; oils and fats; and coffee and teaincreased at a faster rate during the year. Followingthe higher cost of imports, the Governmentapproved increases in the ceiling prices of twoessential items, namely, cooking oil (5% increase)and chicken (10%) from mid-December 1997. Thiswas followed by increases in prices of anotherthree administered items, namely, flour (20%), sugar(21%), and milk (6%), effective 1 February 1998.These five items together accounted for about 6%of the weight in the CPI basket. The total impact(direct as well as indirect effects) of higher pricesfor these items added nearly 1.1 percentage pointsto the rate of inflation.

Among the non-food sub-groups, above-averageprice increases were observed in the sub-groupsof miscellaneous goods and services; and medicalcare and health expenses, which togetheraccounted for 7.5% of the weight in the consumerbasket. Key imported consumer goods thatregistered substantial price increases under the sub-group of miscellaneous goods included items suchas jewellery; watches; toiletries; goods for personalcare; and writing and drawing equipment. Moderateprice increases, ranging between 3.3% and 4.4%,were recorded for gross rent, fuel and power, thesecond largest sub-group accounting for 21.1% ofthe weight in the CPI basket; as well as recreation,entertainment, education and cultural services;furniture, furnishing and household equipment; andbeverages and tobacco. The increase in importand excise duty on cigarettes, tobacco productsand alcoholic beverages in the 1999 Budget isestimated to have a direct effect of nearly 0.2percentage point rise in inflation. Prices of clothingand footwear registered a marginal increase of0.4%. Of significance, prices of transport andcommunication, the third largest sub-group

accounting for 17.9% of the weight in the consumerprice basket, declined by 0.1%. Within this category,prices of motor cars, motorcycles and bicyclesdeclined by 2.9% in response to a sharp reductionin demand and excess capacity in the transport-related industries. This decline was partly offset byincreases in fares paid for public transportation,particularly rail transportation.

While the pass-through impact of the weakerringgit on the CPI was evident with a longer timelag, the Producer Price Index (PPI, 1989=100),adjusted with a relatively short lag. The PPI, whichmeasures prices of both intermediate and finalgoods charged by domestic producers and paid byimporters in the country, started recording strongerincreases since October 1997. In the first eightmonths of 1998, double-digit increases wererecorded, with the largest increase of 17% recordedfor the month of July. The increase in producerprices, however, moderated from October, partlyreflecting the decline in prices of mineral fuels,lubricants and related materials. The decline in theprices of mineral fuels, lubricants and relatedproducts, which accounted for 18% of the weightof the PPI basket, reflected lower world oil pricesof US$13.00 per barrel in the fourth quarter of1998 (US$20.90 per barrel in the fourth quarter of1997). For 1998 as a whole, the PPI increased by10.7%. The largest increase in prices wasregistered in the animal and vegetable oils andfats sub-index (63.8%) due largely to higher pricesof palm oil arising mainly from valuation effectsfrom the weaker ringgit. Palm oil accounted for7% of the weight in the PPI basket. Meanwhile,higher import prices due to the weaker ringgit andhigher local production costs contributed to asubstantial increase in the prices of machinery andtransport equipment; manufactured goods;miscellaneous manufactured articles; and chemicaland chemical products, which together accountedfor 37% of the weight in the PPI basket.Excluding the prices of animal and vegetable oilsand fats, the adjusted PPI showed an increase of3.8% in 1998.

In 1998, the Government adopted a moreintegrated approach to address supply constraintsin the food sector. In March 1998, the Governmentwidened the activities financed by the Fund forFood (3F) to include rice production, ostrich, rabbit,quail and deer farming. The 1999 Budget alsocontained a number of supply enhancementmeasures. To reduce excessive reliance on importsand to promote investment in large-scale foodproduction, the Government would allow lossesincurred in the production of approved food itemsto be deducted from the profits of the companiesin the same group for purpose of income taxcomputations. For a start, food and feed itemssuch as cattle and maize have been identified toqualify for this incentive because they are largelyimported. At the same time, import duties andsales tax were abolished or reduced on selected

-2

0

2

4

6

8

10

12

Graph 1.16Inflation: Average Annual Rate of Change

1994 1995 1996 1997 1998

Malaysia: Consumer Price Index

Food Gross Rent Transport Medical Care

-2

0

2

4

6

8

10

12

14

16

1994 1995 1996 1997 1998

Domestic Economy Local Production Imports

Malaysia: Producer Price Index

2

4

6

8

10

12

Consumer Price Index: Selected Countries in East Asia

Thailand Philippines Korea Malaysia

1994 1995 1996 1997 1998

% change

% change

% change

(1994=100)

(1989=100)

food items, such as canned anchovies. Localimporters have also been urged to import foodfrom cheaper sources. With respect to non-fooditems, import duties and sales tax were abolishedor reduced on paper products and all types ofprinted paper for the purpose of reducing publishingcosts, particularly items used in schools. Meanwhile,under the ongoing programme to curb unjustifiedincreases in prices and ensure an adequate supplyof essential goods, the relevant Governmentagencies stepped up enforcement and price checks.Since mid-October, foreigners were prohibited fromcarrying across the border four essential items,namely, cooking oil, sugar, sweetened condensedmilk and flour. The Ministry of Domestic Tradeand Consumer Affairs also conducted weekly pricemonitoring exercises on 233 daily used itemsthrough 34 collection centers to improve the flowof information on prices of essential goods.

The downward movement in asset prices whichemerged towards the end of 1997 became morepronounced in 1998. In terms of share prices, theKuala Lumpur Composite Index (KLCI) touched alow of 262.70 points on 1 September 1998, adecline of 55.8% from the end-1997 level. Thisinitially reflected to a large extent the liquidation ofportfolio capital by non-residents. However, overallmarket sentiment weakened further in 1998 due toincreasing concerns over the health of the corporatesector as domestic output contracted at a fasterpace than anticipated. The KLCI, however,recovered following the implementation of theexchange control measures on 1 September 1998and other policy measures implemented tosupport economic recovery. The improvedperformance of the regional markets alsocontributed to greater investor confidence. TheKLCI ended the year at 586.13 points (end-1997:594.44 points).

With regard to property prices, the MalaysianHouse Price Index (MHPI) declined by 8.5% inthe first half of 1998 (+1.9% in 1997). By the endof 1998, residential property prices were about 10%lower than the peak level recorded in 1997. Inview of the linkages of the construction sector tothe services and manufacturing sectors and theoversupply of houses, Bank Negara Malaysiaselectively relaxed the requirements with respectto lending to the residential property sector. Inearly September, lending for the construction orpurchase of residential properties costing up toRM250,000 were exempted from the 20% limit on

lending to the broad property sector. With effectfrom 5 October 1998, the 60% maximum marginof financing was abolished for the purchase ofnon-owner occupied residential properties costingRM150,000 and above; the purchase of shophousescosting RM300,000 and above which are not forthe conduct of own business; and the purchase ofland lots. This relaxation was aimed at facilitatingefforts to clear the backlog of properties. It wascomplemented by the “Home Ownership Campaign”launched in October. (The details on policymeasures affecting asset markets are contained inthe sections on “Sectoral Review” in Chapter 1and “Financial Markets” in Chapter 4).

Labour Market Developments

In the face of a contraction in domestic economicactivity, the unemployment rate is estimated to

Table 1.24Inflation Indicators

1997 1998Weights

Annual change(%)

Consumer Price Index (1994=100) 100.0 2.7 5.3

Of which:Food 34.9 4.1 8.9Beverages and tobacco 3.6 1.3 4.3Clothing and footwear 3.6 –0.5 0.4Gross rent, fuel and power 21.1 3.2 4.4Furniture, furnishings and

household equipment 5.6 0.1 3.9Medical care and health expenses 1.9 3.6 6.2Transport and communication 17.9 0.6 –0.1Recreation, entertainment,

education and cultural services 5.8 0.4 3.3Miscellaneous goods and services 5.6 4.6 7.1

Peninsular Malaysia CPI 100.0 2.8 5.5Sabah CPI 100.0 2.0 4.3Sarawak CPI 100.0 1.7 4.2

Producer Price Index ( 1989=100 ) 100.0 2.7 10.7

Of which:Local Production 79.3 2.5 11.2Imports 20.7 2.8 9.2

House Price Index (1990=100) 1.9 –8.51

Of which:Klang Valley 4.4 –11.2Johor Bahru 0.1 –21.9Penang Island 4.3 –11.5

1 January-June.Source: Department of Statistics

Department of Valuation and Property Services

1994 1995 1996 1997 1998

Graph 1.17Labour Market Conditions

Employment by sector

Manufacturing Construction Services1

1Exclude Government services

('000 persons)

3,500

3,000

2,500

2,000

1,500

1,000

500

0

1994 1995 1996 1997 1998

-8

-6

-4

-2

0

2

4

6

8

10

1994 1995 1996 1997 1998

-8

-6

-4

-2

0

2

4

6

8

10

Output and Employment% change % of labour force

GDPLabour ForceEmployment

Unemployment Rate

have increased from 2.6% in 1997 to 3.9%,below the 4% or full employment level. During theyear, the number of unemployed increased by109,000 to 342,000 in 1998. A total of 83,865workers were officially recorded as being retrenchedin 1998. The slack labour market conditionscontributed to some moderation in wage increasesin 1998.

On a positive note, labour demand for selectedcategories of workers remained strong in 1998 witha total of 74,610 job vacancies. The quarterlyindicators also pointed to more favourabledevelopments in the fourth quarter, following theimprovement in the domestic economic and financialconditions in the fourth quarter of 1998. The numberof retrenchments declined to 6,039 workers permonth during the fourth quarter of 1998, from theyear’s peak of 12,335 in July 1998. At the sametime, the number of job seekers declined to 33,345persons at the end of 1998, compared with a peakof 34,514 persons at the end of July 1998. After

declining from 126.3 points at the end of 1997 to80.5 points in the third quarter of 1998, the MIEREmployment Index increased to 86.4 points in thefourth quarter.

In 1998, total employment declined by 3%. Thedecline was more pronounced in the constructionsector (148,000 persons); followed by manufacturing(86,000); and agriculture (61,000). Fewer jobopportunities created by the services and miningsectors also added to the weaker employmentconditions. Reflecting mainly the significant slowdownin the construction sector (-24.5%), the job loss inthis sector was the largest. Consequently, the shareof the construction sector in total employmentdeclined from 9.9% to 8.5%. The net job loss inthe manufacturing sector, which accounted for 27%of total employment, was lower compared with170,000 new jobs created in this sector in 1997.The decline in jobs was concentrated in industriesproducing construction-related materials and transportequipment. The services sector continued to createnew job opportunities, although at a slower pace.In 1998, an additional 27,000 jobs were created inthis sector, with the finance, insurance, real estateand business services sub-sector accounting for40% of the total, followed by transport andcommunication (11%), Government services (7%),and electricity, gas and water (4%) sub-sectors.However, employment in the wholesale and retailtrade, hotels and restaurant sub-sector was moreaffected by the contraction in the economy.Employment in this sector declined by 0.6%in 1998, following lower demand and closureof businesses.

As earnings contracted, employers reduced theirworkforce as part of the overall rationalisationprocess to reduce the cost of production. In 1998,a total of 83,865 workers were officially recordedas being retrenched, with 54% from themanufacturing sector. Of those retrenched in themanufacturing sector, 58% were workers in thetransport-related industries and another 18% werein industries producing construction-related materials.The services sector as a whole accounted for 28%of the total number of workers retrenched. Basedon data provided by the Ministry of HumanResources, the retrenchments were attributed to thedecline in demand following the downturn in activity(60%); financial constraints (13%); closure ofcompanies (8%); and restructuring of companies(6%). In terms of broad job category, the majorityof workers retrenched were production workers

(54%), followed by professional and technical staff(14%), clerical staff (12%), managers (7%), andothers (12%). In the production workers category,skilled workers accounted for 35%, semi-skilledworkers, 33%; and general workers, 32%.

During the year, the Government hadmonitored closely the employment situation andadopted pre-emptive measures to address theproblem arising from rising retrenchment and weakdomestic labour market conditions (the measuresare summarised in the Box on “MeasuresImplemented to Stabilise the Labour MarketConditions in 1998”). The measures includedthe amendment of the labour law which gavemore flexibility to companies to adjust wagesaccording to changing economic conditions andproductivity levels. Data compiled by the Ministry of

Human Resources showed that more employersadopted alternative measures such as pay cuts,temporary layoffs and voluntary layoffs beforeresorting to permanent layoffs during the periodAugust-December 1998. During this period, 795employers implemented pay cuts involving 22,514workers, while another 52 employers implementedtemporary layoffs involving 6,342 workers. Atthe same time, 336 employers implementedvoluntary layoffs involving 6,193 workers during thesame period.

Labour demand as reflected by the number ofjob vacancies remained strong as a total of74,610 job vacancies were reported throughoutthe country in 1998. The number of job vacanciescould have been under-reported as it isnot compulsory for firms to report vacancies tothe Manpower Department. Feedback fromindustry sources indicated that demand existedfor certain categories of workers, particularlyproduction workers. According to The BusinessExpectation Survey of Limited Companies, SecondHalf 1998 conducted by the Department of Statistics(DOS), selected manufacturing and non-manufacturing firms continued to demand forworkers. At the same time, the Government alsoapproved the intake of 55,463 new foreign workersto meet the demand for production workers in 1998.Of this total, 17% was for manufacturing, 8% eachfor plantation and construction, and 6% for services.The balance (61%) was for the domestic servicessub-sector.

The number of registered foreign workersemployed in the country declined to 781,548 from1.2 million in 1997. Foreign workers were mainlyemployed in the manufacturing sector (35%),followed by plantation (19%), construction (18%),domestic services (17%) and other services sectors(10%). In terms of country of origin, workers fromIndonesia and Bangladesh remained the biggestgroup, accounting for 60% and 31% respectively.During the year, the Government introducedadditional measures on foreign workers to ensurethat employers gave priority to hiring local labour,amidst the weak domestic labour market. Themeasures included the imposition of a new levystructure and the freezing of the recruitment ofnew foreign workers. The levy charges wereincreased to RM360 from RM300 for domestichelpers and plantation workers, while a levy ofRM1,500 was imposed on those in the construction,manufacturing and services sectors. In addition, it

Table 1.25Job Vacancies and Retrenchment in 1998

JobVacancies1

Number % Share Number% ShareTotal 74,610 100.0 83,865 100.0

Agriculture, forestry 5,231 7.0 5,108 6.1and fishing

Mining and quarrying 188 0.3 877 1.1

Manufacturing 52,159 69.9 45,151 53.8

Construction 2,156 2.9 9,334 11.1

Services 14,876 19.9 23,395 27.9

Wholesale and 5,281 7.1 10,434 12.4retail trade, hoteland restaurant

Finance, insurance, 3,070 4.1 6,596 7.9real estate andbusiness services

Transport, storage 1,066 1.4 2,007 2.4and communication

Electricity, gas and 122 0.2 1 …water

Social and private – – 4,242 5.1services

Other services 5,337 7.1 115 0.1

1 The number of job vacancies could have been under-reported as it is notcompulsory for firms to report vacancies to the Manpower Department.

Source: The Ministry of Human ResourcesManpower Department

Retrenchment

was made mandatory for registered foreignworkers to contribute to the Employees ProvidentFund (EPF).

With the retrenchment of workers and thereduction in salaries experienced by selected sectorsof the economy, wage pressures eased. Indicatorson wages showed moderating increases in the wagerates. As measured by the Malaysian EmployersFederation (MEF) survey, the salary increases inthe private sector slowed from 8.9% in 1997 to6.2% in 1998. The findings of the Monthly Surveysof Manufacturing Industries conducted by DOS alsoshowed a similar trend, with wages increasing ata slower rate of 5.6% in 1998, compared with10.2% in 1997. At the same time, the weightedaverage wage of the three-year collective wageagreements, covering 143,000 workers in the privatesector or 2% of the total labour force, increasedat a slower rate of 9.6% in 1998 (13.1% in 1997).All sectors, except for commerce and mining,registered slower wage increases. Following thewage agreements concluded in the manufacturingsector during the year, wages in the sector roseat a slower rate of 8%, while wage increases inthe services and agriculture sectors moderated to10.1% and 8.9% respectively. Wage increases inthe electricity sector also moderated to 10% in1998 from a strong growth of 18.1% in 1997. Incontrast, wage increases in both the commerceand mining sectors increased at a higher rate of13.8% and 10.6% respectively in 1998, comparedwith 11.8% and 7.7% respectively in 1997. However,this trend is not reflective of the wage profile forthe commerce and mining sectors as a whole, asless than 12% and 1% respectively of the workforcein these sectors were covered by the collectiveagreements concluded in 1998. The findings of theMonthly Surveys of Manufacturing Industries of DOSalso indicated that the labour cost in themanufacturing sector as measured by real averagewages increased at a slower rate of 0.3%, reflectinga decline in the nominal wage bill (–1.1%), and anincrease in the inflation rate.

Labour productivity, as measured by the ratioof GDP to total employment, declined by 3.8% in1998. In the manufacturing sector, labour productivitydeclined by 0.1%. The poor productivity results in1998 reflected the reduction in output in responseto the build-up in inventories due to the sharpcontraction in domestic demand as well as weakexternal demand. Recognising that productivitycontinued to lag behind wage growth, efforts have

been intensified to enhance productivity levelsthrough the implementation of productivity andquality management systems, improvements throughbenchmarking activities, intensifying the applicationof information technology, skill upgrading ofhuman resource, and quality products throughresearch and development.

In 1998, the Government implemented furthermeasures to upgrade industrial skills. Tostrengthen the quality of manpower to meet theincreasing demand for highly skilled manpower, theGovernment increased new intakes of trainees inthe existing training institutes. The number oftrainees in the nine Industrial Training Institutesincreased by 35.5% to 2,842 trainees, while 3,147instructors were trained by the Centre for Instructorsand Advanced Skill Training (CIAST). The existingbilateral training centers, namely, the GermanMalaysia Institute (GMI), Malaysia French Institute(MFI) and British Malaysia Institute (BMI) recruitedanother 701 trainees (742 trainees in 1997). Inaddition, the Japan-Malaysia Technical Institute(JMTI) was established under the technicalco-operation between the Governments of Malaysiaand Japan. The institute started operations in July1998 with its first intake of 58 trainees to specialisein computer engineering technology and electronicsengineering technology. In January 1999, the JMTIabsorbed another 31 trainees and has plans toincrease its intake to 100 in the July 1999 session.At the same time, two new courses, namely,mechatronics engineering technology andmanufacturing engineering technology would beintroduced in the July session to widen thescope of industrial training for both the industrialand public sectors.

In the 1999 Budget, the Government alsointroduced several fiscal incentives to promotehuman resource development. In line with theobjective of promoting Malaysia as the centre ofexcellence for education, the Government allocatedRM13.5 billion to provide and upgrade educationalinfrastructure as well as for curriculum development.Vocational schools would be upgraded and newtechnical schools constructed. With the additionalexpenditure of RM2.85 billion allocated to upgradeexisting education facilities, the intake of studentsinto local universities will be increased from 77,600to 84,000 students in 1999. A sum of RM1.145billion is allocated for skills training in the 79vocational and technical schools, 16 SkillsDevelopment Training Institutes and 135 Pusat Giat

Measures Implemented to Stabilise theLabour Market Conditions in 1998

Rationale

➮ To monitor the retrenchment situation closely,facilitate investigation and provide the necessaryadvisory services to employers to safeguard thewelfare of the retrenched workers.

➮ To help redeploy retrenched workers intoalternative jobs via tripartite cooperation involvingall parties, the Government, employers andworkers’ union.

➮ To raise productivity.

➮ To guide employers and workers onalternatives to retrenchment and if unavoidable,the procedures to be followed.

➮ To help and facilitate retrenched workersseeking alternative jobs.

➮ To maintain industrial harmony and labourmarket stability.

➮ To upgrade skills to meet demand for higherskilled workers while assisting retrenched workersseek alternative employment.

➮ To ease the financial burden of affectedemployers and moderate the level ofretrenchment.

Measures

With effect from 1 February 1998, it becamemandatory for employers to inform the DirectorGeneral of Labour Department at least onemonth before retrenchment exercise.

Task forces were set up to provideemployment services to retrenched workers atthe state and district levels, improving the mobilityof labour through publication of vacancies andregular dialogues with employers’ and employees’organisations as well as industry associations.

With effect from 1 August 1998, EmploymentAct 1955 was amended to promote more flexibleworking practices and encourage employers toprovide incentives for productivity.

On 1 August 1998, Guidelines onRetrenchment was issued.

Encourage employers to provide exit servicessuch as counselling service and career guidanceto assist those retrenched to find new jobs.

As an alternative to retrenchment, encourageemployers to resort to other cost cuttingmeasures, such as pay-cuts or reduced workinghours, temporary or voluntary lay-off.

On 2 May 1998, the Ministry of HumanResources established a RM5 million retrainingprogramme for retrenched workers.

Employers in particular sector which werefacing difficulties were exempted from paying alevy to the HRDC for 6 months, from 12February to 11 August 1998. In August, thisexemption was extended to some industries foranother six months till February 1999. Theindustries which benefited included manufacturersof plastic products; professional, scientific andcontrolling instruments and apparatus; rubber;

tobacco; electrical machinery; electronic apparatusand appliances; paper and paper products;telecommunications, postal services and courier;and air transport and shipping. However,industries which registered better performanceand were in a stronger financial position wererequired to re-contribute a levy to the HRDC.

MARA besides the construction of an additional 24new skills training centres.

Under the Human Resource Development Fund(HRDF), which was established in 1993, companiesconducted courses to retrain and upgrade skills ofa total of 2.1 million employees in 1998. Employerswho faced financial problems were given exemptionfrom contributing to the HRDF during the period 12February to 11 August 1998. This exemption wasextended for another six months to industries thatcontinued to face financial constraints. As a result,the value of levy collected under HRDF in 1998was lower at RM62 million, compared with RM144million in 1997. Of this total, RM340 million wasallocated for training. Meanwhile, the HumanResource Development Council (HRDC) implemented12 training schemes, involving 409,814 trainees andextended financial support for employees

participating in retraining and skill upgrading coursesof RM141 million. More importantly, the Councilestablished on 2 May 1998 a RM5 million retrainingprogramme for retrenched workers. Under thisprogramme, firms are allowed to seek financialassistance for retraining workers. Of the total of572 trainees under this scheme in 1998, 36% weretrained in computers, 28% in technical/engineering,and 37% in management.

Overall, some adjustment was observed in thedomestic labour market. All parties concerned,including the Government, the industry and workersdemonstrated greater flexibil ity to changingcircumstances in the domestic labour market. TheGovernment facilitated the adjustment throughchanges in the labour laws. The workers were morereceptive to salary adjustments while the industryaccelerated efforts in retraining workers.