Malaysia economic monitor : growth through innovation

 66569 MALAYSIA ECONOMIC MONITOR Growth through Innovation April 2010 • THE WORLD BANK MALAYSIA ECONOMIC MONITOR APRIL 2010 GROWTH THROUGH INNOVATION THE WORLD BANK This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The pictures on the cover are attributed to David Blaikie (solar), Blue Ship (terminal), Marisa Strutt (towers), Roslan Tangah (school) under the Creative Commons License. The report is based on information available as of end of March, 2010. Please address queries and comments to: Philip Schellekens The World Bank 30th Floor, Siam Tower 989 Rama I Road, Pathumwan Bangkok 10330, Thailand pschellekens@worldbank.org (662) 686-8300 www.worldbank.org/my  CONTENTS PREFACE ........................................................................................................................................................ 9 EXECUTIVE SUMMARY ................................................................................................................................ 11 Recent Economic Developments and Outlook ................................................................................................11 Growth through Innovation ............................................................................................................................12 Improving the Capabilities for Innovation: Talent, Technology and Finance .........................................12 Enhancing the Driving Force of Innovation: Competition ......................................................................13 Enabling the Amplifiers of Innovation: Niches and Clusters ..................................................................13 1. RECENT ECONOMIC DEVELOPMENTS ..................................................................................................... 17 Global Recovery Underway But Remains Fragile ............................................................................................17 Recovery in Malaysia Is Proceeding ................................................................................................................19 Recovery Is Also Gaining Breadth ...................................................................................................................24 Inventories Move into the Spotlight ......................................................................................................24 Manufacturing Is Making a Come-Back .................................................................................................26 Commodities and E&E Exports Leading the Way ...................................................................................27 Labor Market Is Churning ................................................................................................................................29 Movement of Workers Across Sectors Continued .................................................................................29 Industry Wage and Employment Dynamics Varied with Export Orientation .........................................35 Domestic Financial Conditions Remain Resilient ............................................................................................40 Earlier Volatility in Capital Flows Has Abated .................................................................................................41 Fiscal and Monetary Policy Adjustment Is Ongoing ........................................................................................50 2. ECONOMIC OUTLOOK ............................................................................................................................. 52 Global Recovery To Be Led by Developing Economies....................................................................................52 Recovery In Malaysia Expected to Gain Strength ...........................................................................................54 Growth Expectations Upgraded .............................................................................................................54 Solid Growth to Resume in 2010 ............................................................................................................56 Fiscal and Monetary Policy Support to Unwind over 2010 ....................................................................59 Risks to Near-Term Outlook Remain Significant ....................................................................................60 Medium-Term Outlook Expected To Improve ................................................................................................61 A New Economic Model Has Been Proposed .........................................................................................61 Medium-Term Growth Set To Benefit ....................................................................................................62 Reform Implementation Key Risk to Growth and Fiscal Sustainability ..................................................66 3. GROWTH THROUGH INNOVATION ......................................................................................................... 70 Innovation is Key for Long-Term Prosperity ....................................................................................................70 Why Does Innovaton Matter? ................................................................................................................71 What are the Drivers of Innovation-Led Growth?..................................................................................72 Does Innovation Produce Inclusive Growth? .........................................................................................74 Innovation Presents a Growing Challenge ......................................................................................................74 Broad Indicators Suggest Weakening Dynamism ...................................................................................75 Productivity Growth Has Slowed Down ......................................................................................75 Export Mix Registered Growing Sophistication… ........................................................................76 … But Export Value Added Has Stagnated ...................................................................................78 Surveys Reveal Need for More Innovation and Better Diffusion ................................................79 Narrow Indicators Point to Limited Improvement .................................................................................81 R&D Input Indicators Remain at Low Levels ................................................................................81 Patenting Activity Has Picked Up But Remains Low ....................................................................82 The Innovation Challenge: Intensify and Broaden Innovation ...............................................................84 Addressing the Innovation Challenge .............................................................................................................85 Facilitate or Orchestrate?.......................................................................................................................85 Approaches to Policy Intervention ..............................................................................................85 Scoping and Sequencing ..............................................................................................................86 Improving Innovation Capabilities: Talent, Technology and Finance .....................................................89 Nurturing, Attracting and Retaining Talent .................................................................................89 Upgrading Home-Grown Technological Capabilities ...................................................................93 Improving Access to Finance for Innovation .............................................................................102 Promoting the Driving Force of Innovation: Competition ....................................................................105 Leveling the Playing Field ..........................................................................................................106 Facilitating the Fluid Entry and Exit of Firms .............................................................................109 Supporting Labor Market Flexibility ..........................................................................................110 Managing the Side Effects of Greater Competition...................................................................110 Amplifying the Impact of Innovation: Niches and Clusters ..................................................................115 Focusing Efforts on Selected Niches ..........................................................................................115 Fostering Spatial Concentration in Clusters ..............................................................................116 Conclusion .....................................................................................................................................................117 REFERENCES .............................................................................................................................................. 118 6 BOXES Box 1. Malaysia’s Recovery in Regional Perspective ...................................................................................................20 Box 2. Why Is Informality Relevant to Malaysia? ........................................................................................................32 Box 3. Decreasing Poverty and Tackling Persistent Inequality ....................................................................................38 Box 4. How Did the Global Financial Crisis Affect Market Volatility in Malaysia? .......................................................44 Box 5. A Long(er)-Term Perspective on Capital Outflows and Investment .................................................................47 Box 6. What is New in Malaysia’s New Economic Model? ..........................................................................................63 Box 7. Monetary and Exchange Rate Pressures In East Asia: Implications for Malaysia .............................................64 Box 8. How Sustainable Is Malaysia’s Government Debt? ..........................................................................................67 Box 9. Why Do Markets Undersupply Innovation?......................................................................................................87 Box 10. Innovation Is Best Facilitated, Not Orchestrated ............................................................................................88 Box 11. Promoting Equality of Opportunities in Skill Formation .................................................................................91 Box 12. Geography in Motion: Japanese Perspectives on the Future of Foreign Direct Investment ..........................97 Box 13. Developing Broadband: Malaysia’s Ambitious Reform Agenda ...................................................................100 Box 14. Whither Malaysia’s Competition Policy? ......................................................................................................112 7  PREFACE In November 2009, the Government of Malaysia and the World Bank signed a three-year Partnership Agreement focused on the policy challenge of growing into a high-income economy. The Malaysia Economic Monitor series is a key pillar in this Partnership and represents an effort to promote discussion, analysis, and the sharing of knowledge on the challenges ahead. This second issue of the Malaysia Economic Monitor: Growth Through Innovation reviews recent economic developments, updates the World Bank’s view on the economic outlook, and analyzes—in the report’s thematic section—how Malaysia’s economy can improve its growth performance through innovation. The report is accompanied by an outreach effort to a wide audience of policymakers, private sector leaders, market participants, civil society, think tanks, journalists and the public at large. This report was prepared by Philip Schellekens (Task Team Leader) in collaboration with Yue Li and Ashley Taylor, with contributions from Natasha Beschorner, Ximena del Carpio, Louis Kuijs, Chanin Manopiniwes, Juan Pradelli, Martin Reichhuber, Vatcharin Sirimaneetham, Tihomir Stucka, and Roy Van der Weide, and under the overall guidance of Vikram Nehru and Mathew Verghis. An external contribution by Cassey Lee of the University of Wollongong is gratefully acknowledged. The team thanks Frederico Gil Sander, Manny Jimenez, Homi Kharas, Cassey Lee, Magnus Lindelow, Kaoru Nabeshima, Jeeva Perumalpillaies, John Roome, Tham Siew Yean, Xiaoqing Yu and Shahid Yusuf for helpful discussions and exchanges, Indra Irnawan for designing the cover and back, and Ruangrong Thongampai and Anissa Amador Tria for administrative and web production assistance. The Malaysia Economic Monitor benefited as well from fruitful discussions with and comments and information from the Bank Negara Malaysia, the Prime Minister’s Economic Council, the Economic Planning Unit, the Ministry of Finance, the Ministry of Science, Technology and Innovation, the National Economic Advisory Council, numerous other government ministries and agencies, private sector participants, think tanks and academics. The report benefited furthermore from the assistance provided by JETRO, JAIC and JICA in a related study on the electrical and electronics industry in Malaysia. Last but not least, the team is indebted to the Economic Planning Unit for their continued support and in particular the International Cooperation Section of the EPU for their assistance with the launch of this Monitor.  EXECUTIVE SUMMARY RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK A robust recovery is underway in Malaysia after the downturn in global trade in 2009 hit the economy particularly hard. The reduction in Malaysia’s GDP growth rate was the steepest amongst middle-income countries in East Asia. Private consumption and the boost from fiscal stimulus provided support earlier in 2009. Inventory investment has taken over in recent quarters. Exports continue their climb out of one of their most severe slumps in history, driven by regional and, increasingly, global demand. Manufacturing is becoming the locomotive of growth again after services had provided a beacon of strength through the crisis. Strong private capital outflows, particularly portfolio investments, were also experienced in late 2008 and early 2009 but the trend abated as global financial conditions and domestic activity improved over 2009 While aggregate unemployment has shown limited movement, the labor market churning that has been a feature through the crisis has continued. Shifts into self-employment have been particularly strong, which might be associated with a rise in informal employment, as expected during a downturn. Patterns of employment and wage dynamics through the downturn and rebound have varied across sectors, in part reflecting exposures to the external demand shock. The labor market outlook is improving with vacancies on the rise and retrenchments sharply down from their crisis levels. Monetary, fiscal and financial sector policies played a supportive role during the crisis. As in other countries, a key policy question has been when, and how, to withdraw support without derailing the recovery. The strength of the recovery to date, and the improved outlook, has prompted recent moves towards monetary policy normalization. With the stimulus packages pushing up the federal government deficit to around 7 percent of GDP in 2009, ongoing fiscal consolidation is required. Real GDP is expected to rebound strongly in 2010. Momentum behind domestic private consumption and investment is building as the recovery in external demand continues. As a result, growth of 5.7 percent is projected for 2010, following a contraction of 1.7 percent in 2009. The future strength of the external demand recovery is one of the main near-term risks. The other is the extent to which there is a transition to growth that is driven by the revival of domestic private investment and continued private consumption growth as fiscal and monetary policy support unwinds. Implementation of productivity-enhancing structural reforms put forward in the recently released New Economic Model is crucial to the medium-term outlook. Growth forecasts at 5.3 percent in 2011 and 5.6 percent in 2012 price in the implementation of structural reform measures at a gradual pace. The forecasts also reflect a fiercely competitive environment for trade and FDI, as the global economy continues its rebalancing and countries around the region catch up along the value chain. The main upside risk to the long-term outlook is if the reform program under the New Economic Model will be comprehensively and expeditiously implemented. Along with progress on fiscal consolidation it could also help reverse the recent sharp rise in Malaysia’s government debt due to the fiscal stimulus spending. On the flip side, the potential stalling of reform momentum could drive down growth prospects and lead to rising government debt relative to GDP. GROWTH THROUGH INNOVATION Innovation—the successful exploitation of new ideas—is the cornerstone of sustained growth and prosperity. It is also central to Malaysia’s high-income aspirations. Climbing up the income ladder through innovation-led growth is, however, easier said than done. Many countries aspire to innovate more. The challenge is therefore not only to boost innovation capabilities but also to do so quickly. The opportunities are vast. Malaysia can extract more value from its growing integration with global production networks and improve its productivity performance, which stalled after the Asia crisis. Malaysia can promote more innovation in business and encourage more businesses to engage in innovation. Government can also contribute to innovation by itself. Promoting innovation is a complex undertaking that requires a comprehensive approach. Innovation is a multi-dimensional outcome influenced by many factors and players. It applies to products, processes, and organizations, and involves both the creation and diffusion of knowledge. Given this complexity, policy approaches that facilitate rather than orchestrate innovation are likely to stand the greatest chance of success. Malaysia can address the innovation challenge by improving its innovation capabilities, enhancing the driving force of innovation, and enabling the amplifiers of innovation. Improving the Capabilities for Innovation: Talent, Technology and Finance  Nurturing, attracting and retaining talent. Innovation rests in the first place on the talent of people: their creativity to develop new ideas, their capacity to absorb knowledge, and their entrepreneurship and skill to turn ideas into results. A talented workforce is the bedrock of innovation. A key priority is to nurture entrepreneurial initiative and address skills shortages— which occur across the skills spectrum including social abilities such as communication, creativity and leadership. As strengthening the education system to address such challenges takes time, Malaysia could also tap into the global talent pool.  Upgrading home-grown technological capabilities. Malaysia has had mixed success in facilitating technology transfers from multinational companies and in multiplying domestic linkages with them. The capabilities of Malaysian firms are presently highly dispersed, creating room for the beneficial diffusion of knowledge through best practice programs, SME assistance and global technology brokers. Technology development takes time and requires continuous investments by firms in themselves. Yet, policies can support this process by strengthening the science base and infrastructure (e.g., broadband).  Improving access to finance for innovation. An agile banking system and a responsive venture capital market are further requirements for innovation. Malaysia tops the world in the Doing Business indicator of access to credit. Yet, according to the latest National Innovation Survey (2005-08), some 43 percent of innovating firms consider access to finance a ‘very important’ obstacle that could be addressed. Even if currently the limited deal flow represents most likely a lack of demand, the venture capital market can be strengthened to allow for future growth. 12 Enhancing the Driving Force of Innovation: Competition  Leveling the playing field. Competition—the main driving force of innovation—incentivizes those capable of innovation to innovate. The competitive landscape in Malaysia is however not even. Manufacturing is exposed to international competition, but many services subsectors lack both international and domestic competition. Investment climate surveys suggest that one fifth of services firms list anti-competitive practices as a ‘severe’ or ‘very severe’ investment obstacle (World Bank, 2009c). A competition law is being discussed in Parliament, which if enacted and well-enforced would be an important step forward. But fostering competition will also require a rethink of the overlap between public and private activity and potential crowding-out effects.  Facilitating the fluid entry and exit of Firms. Competition requires the entry and exit of firms. New entry can spur incumbents to innovate incrementally. New entrants are also more commonly a source of radical innovations. Barriers to entry and exit thus constrain the innovation process, the costs of which may not be immediately visible but slowly accrue over time through a gradual deterioration of productivity, price and quality competitiveness and relative market share. Improvements in the ease of starting and closing a business in Malaysia are crucial to facilitate the entry and exit of firms at the heart of the competitive process.  Supporting labor market flexibility. Greater competition in product markets will not yield its full potential without supportive labor market institutions and practices. Internal labor markets benefit from good workplace practices that motivate and reward performance. External labor markets benefit from flexibility in employment and wages to link the best talents with the best opportunities—and also to send correct signals for decisions on education and training. Of concern are Malaysia’s firing practices, whose restrictiveness stands out within the region.  Managing the side effects of greater competition. For competition to be effective in spurring innovation, elementary risk mitigation and coping mechanisms need to be in place to protect individuals—though not necessarily firms—from the downside risk of failure. Similarly, the upside benefits of innovation need to be protected temporarily with appropriate patent policies so innovators find it worthwhile to make costly upfront investments in innovation. Enabling the Amplifiers of Innovation: Niches and Clusters  Focusing efforts on selected niches. Malaysia would do well to specialize further on selected growth niches where it can achieve global excellence. Identifying these requires close collaboration with the private sector, reflection on current strengths and capabilities, and analysis of global demand conditions and the specific obstacles to private sector development. Subject to these caveats, it will be important for the scarce public resources to be sharply focused—so as not to dilute impact.  Fostering spatial concentration in clusters. Innovation thrives and spreads in clusters, but market forces produce less clustering than socially desirable. Policies to concentrate skills and infrastructure and to develop network linkages with other centers of economic activity domestically, regionally and globally will be critical to creating more economic density in Malaysia. To try and spread out economic activity is to discourage it—even though side effects such as congestion and pollution need to be managed. Providing good connectivity between leading and lagging regions, spatially unbalanced growth yields better outcomes. 13  THE MALAYSIAN ECONOMY IN PICTURES External revival, particularly from China, Industrial production is rebounding, is aiding Malaysia’s recovery especially for E&E and consumer goods Merchandise imports from all countries, nominal USD levels (Jan-07=100) Industrial production, year-on-year growth, percent 40 40 Export-oriented Domestic-oriented 160 E&E Construction Primary Consumer 140 20 20 120 0 0 100 80 US -20 -20 EU 60 Japan China -40 40 -40 Jan-08 Jan-09 Jan-10 Jan-08 Jan-09 Jan-10 Jan-07 Jan-08 Jan-09 Jan-10 Source: CEIC and World Bank staff calculations. Source: CEIC and World Bank staff calculations. Manufacturing is again a locomotive of growth Net capital flows improved with the recovery Contribution to real GDP quarter-on-quarter growth, sa, percentage points Net flows as share of GDP, percent 4 Portfolio Other 30 FDI Financial Account 2 15 0 0 -2 Agriculture -15 Construction Manufacturing -4 Mining and quarrying -30 Services GDP -6 -45 2007 Q2 Q3 Q4 2008 Q2 Q3 Q4 2009 Q2 Q3 Q4 2007 Q2 Q3 Q4 2008 Q2 Q3 Q4 2009 Q2 Q3 Q4 Q1 Q1 Q1 Q1 Q1 Q1 Source: Haver and World Bank staff calculations. Source: CEIC and World Bank staff calculations. Quarterly GDP growth set to maintain momentum Yet, spare capacity may temper private investment Real GDP year-on-year growth, actual and forecast, percent Capacity utilization, percentage points 10 90 8 6 80 4 8.5 7.4 6.6 6.8 2 4.8 4.5 4.9 0.1 2.9 70 0 -1.2 -2 -3.9 -6.2 -4 60 Export oriented -6 Domestic oriented -8 50 2008 Q2 Q3 Q4 2009 Q2 Q3 Q4 2010 Q2f Q3f Q4f Q1 Q1 Q1f 2007 2008 2009 Source: CEIC and World Bank staff projections. Source: CEIC. Growth outlook favorable, but conditional Reform implementation matters not only on implementation of reform agenda for growth itself, but also for debt sustainability Actual and forecast GDP percent growth, yoy, percent General government debt to GDP, percent 70 6 Baseline 65 Slower growth 4 60 6.2 5.7 5.3 5.6 4.6 55 2 50 0 45 -1.7 -2 40 2007 2008 2009 2010f 2011f 2012f 2005 2007 2009 2011p 2013p 2015p Source: CEIC and World Bank staff projections. Note: Slower growth is at an average of 4.2 percent over projection period. Source: Malaysian authorities and World Bank staff projections.  THE INNOVATION CHALLENGE IN PICTURES Growth in recent history has been driven Productivity gains slowed after the Asia crisis by capital and labor accumulation Contributions to labor productivity growth of total factor productivity (TFP), land, skills and capital, percentage points Capital TFP 2.5% 7 Land 5 Skills Labor 4.4 Capital Skills 7.8 2.7% 4.5 0.3% 3 2.3 Growth 2.2 3.4 6.8% Labor 1 1.3 productivity Land 3.7% 0.0% -1 -0.4 87-97 98-07 87-97 98-07 87-97 98-07 87-97 98-07 Total factor productivty Services Industry Agriculture Memo: 0.9% Manufacturing Source: World Bank (2008). Note: Period is 1987-2007; figures are growth contributions. Source: World Bank (2008). Growth through innovation occurs in multiple ways Innovation could be spurred by improving skills… Share of managers indicating skill as „poor‟ or „very poor, percentage points 60 IT Product 50 English Creation & Innovation Diffusion & commercialization Communication absorption 40 of knowledge of knowledge Creativity/innovation 30 Problem solving New to a firm, 20 New to the world Process Organizational industry, country Innovation Innovation 10 0 Manufacturing Services Manufacturing Services INNOVATION - LED GROWTH Local professionals Local skilled production workers Source: Based on Dutz (2009). Source: World Bank (2005 and 2009c). … reducing disparity in technological capabilities … ensuring adequate finance for innovation Share of technology capability activities being undertaken, percent Share of firms indicating „lack of appropriate source of finance‟ as 60% hampering innovation activities, according to importance, percent Investment 100% 50% 15% Production 23% 32% 29% Linkages 80% 40% 71% 41% 30% 60% 50% 38% 55% 47% 45% 20% 40% 32% 27% 25% 27% 10% 20% 19% 43% 30% 24% 23% 0% 10% 0% Large SME 1990-94 1997-99 2000-01 2002-04 2005-08 Source: World Bank (2005 and 2009c). Not important or slightly important Moderately important Note: Investment: activities such as project preparation, technology Very important identification. Production: activities such as process and product improvement. Linkages: activities such as knowledge and technology transfers. Source: MASTIC (2006); Lee and Lee (2006); and EPU. ...guaranteeing a level competitive playing field … and concentrating economic activity further Share of firms indicating „anti-competitive practices‟ as Urban share of population „severe‟ of „very severe‟ problem, 2002-2007, percentage points 25 Urban density: persons per hectare (capital city) 2002 250 Job density: jobs per hectare (capital city) 20 2007 200 15 150 10 20 100 16 14 14 50 5 0 0 MYS CHN THA IDN KOR PHP Manufacturing firms Services firms Source: WDI. Source: World Bank (2005 and 2009c).  1. RECENT ECONOMIC DEVELOPMENTS The downturn in global trade in 2009 hit Malaysia particularly hard. The reduction in its GDP growth rate was the steepest amongst middle-income countries in East Asia. However, a robust recovery is underway. Private consumption and the boost from the fiscal stimulus packages provided early support. Inventory investment has taken over in recent quarters. Exports continue their climb out of the most severe slump since 1967, increasingly driven by regional demand. As a result, the manufacturing rebound is increasingly the locomotive of growth after services had provided a beacon of strength through the crisis. High frequency indicators, although noisy, also point to the strong rebound in activity. While aggregate unemployment has shown limited movement, the labor market churning that has been a feature through the crisis has continued. Shifts into self-employment have been particularly strong, which might be associated with a rise in informal employment. The patterns of employment and wage dynamics through the downturn and rebound have varied across sectors, in part reflecting exposures to the fall in external demand. For example, although manufacturing production picked up in mid 2009 as export performance improved, the numbers employed have yet to rise. However, increasing number of vacancies suggest that companies actually want to hire workers but cannot find employees with the right skill set. Monetary, fiscal and financial sector policies played an important supporting role during the crisis. As in other countries, a key policy question has been when, and how, to withdraw economic stimulus measures without derailing the recovery. The strength of the economic performance to date, and the improved outlook, has prompted recent moves towards monetary policy normalization. With the fiscal stimulus packages pushing up the federal government deficit to around 7 percent of GDP in 2009, moves towards fiscal consolidation cannot be postponed. GLOBAL RECOVERY UNDERWAY BUT REMAINS FRAGILE The pace of the global recovery picked up in the second half of 2009. Extraordinary stimulus measures worldwide and inventory restocking have been key to the recovery in global GDP, along with the resilience of large emerging economies such as Brazil, India and China. While GDP growth has resumed in the major developed economies the recovery is in its early stages. Developed economy growth remains subdued and differentiated across regions (Figure 1.1). Supported by larger and timelier stimulus measures and lower reliance on exports, the GDP recovery in the US appears stronger than in Europe and Japan. In Q4 2009 US growth was 5.6 percent on a seasonally adjusted annualized rate (saar) basis, but much of the growth came from private inventory investment. Private consumption growth remains relatively weak. High frequency data have also provided a mixed picture, although with more positive releases in recent months, for example on consumer confidence. GDP growth for Q4 in Japan came in at 3.8 percent saar with the EU recording an anemic 0.5 percent. Wholesale and retail sales have also picked up but still remain down on the pre- crisis levels, by up to 25 percent in the case of Japan (Figure 1.2). MALAYSIA ECONOMIC MONITOR Figure 1.1. Developed economy growth has resumed Figure 1.2. Wholesale and retail sales remain at or Real GDP growth (percent, saar) below pre-crisis levels Wholesale and retail sales (sa, January 2007=100) US 120 6 EU 4 Japan 2 110 0 -2 100 -4 -6 90 -8 US -10 EU 80 Japan -12 -14 70 2008 Q2 Q3 Q4 2009 Q2 Q3 Q4 Q1 Q1 Jan-07 Jan-08 Jan-09 Jan-10 Source: CEIC and World Bank staff calculations. Source: CEIC and World Bank staff calculations. Note: Sales in local currency. Figure 1.3. Global imports have stabilized with the Figure 1.4. Spillovers to Asian credit markets from the exception of strong growth for China euro-zone debt crisis appear limited Nominal merchandise imports in USD (January 2007=100) Sovereign five-year senior credit default swap spread (basis points) 160 1000 900 Malaysia 140 800 Greece 700 Spain 120 Philippines 600 100 500 400 80 US 300 EU 200 60 Japan China 100 40 0 Jan-07 Jan-08 Jan-09 Jan-10 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Source: CEIC and World Bank staff calculations. Source: Thomson Financial Datastream. Emerging markets are driving the global recovery. For example, China’s GDP growth accelerated in Q4 2009 to 10.7 percent year-on-year driven by investment promoted by the stimulus packages. The strength of activity in China, and also other major developing economies such as India, has contributed to commodity prices steadily making up their earlier sharp declines of the second half of 2008. World trade volumes have risen due to the effects of stimulus packages and inventory restocking. This follows a contraction of 14 percent in 2009. The recovery in global external demand, which is of key importance to Malaysia and other export-oriented economies in the region, is increasingly due to China.1 Even during the pre-crisis period of 2003-2007 China’s annual contribution to global fixed investment demand was roughly equal to that of the US. While its contribution to global domestic demand growth was smaller it has been growing fast. Although all major economic blocs saw a sharp decline in imports during the crisis in late 2008, China’s recovery in imports started earlier and was stronger (Figure 1.3). 1 Timmer (2010). 18  RECENT ECONOMIC DEVELOPMENTS Financial and credit market normalization continues. The initial acute phase of the economic crisis involved intense financial and credit market turmoil. The normalization of many financial and credit market indicators, for example interbank lending rates, has continued in recent quarters. Tightening of bank credit standards has moderated in the US and the EU, according to lending officer surveys. Global equity markets have rebounded. The stock market indices of US, EU and Japan, which had halved from early 2007 to the lows of 2009, are now roughly between 20 and 35 percent down. Spillovers to Asia from the Euro-zone public debt turmoil have been limited. International bond issuance has jumped worldwide as fiscal financing needs have ballooned with stimulus expenditures. The risk of a fiscal debt crisis in Greece led to a sharp rise in sovereign credit default swap (CDS) spreads on certain other Euro-zone economies such as Portugal and Italy. However, the impact on the cost of default insurance for sovereign credits, and more broadly indices of spreads over US Treasuries, in emerging Asia, including Malaysia, has been muted (Figure 1.4). RECOVERY IN MALAYSIA IS PROCEEDING The downturn in global trade in 2009 hit Malaysia particularly hard. Total exports in 2009 were down by 17 percent against 2008 with the trade surplus declining by a similar proportion. The percentage point reduction in GDP growth from 4.6 percent in 2008 to -1.7 percent in 2009 was the steepest amongst middle-income countries in East Asia. The region in aggregate, excluding China, is estimated to have suffered a fall in growth from 4.5 percent in 2008 to 0.9 percent in 2009. Figure 1.5. Quarterly real GDP growth has remained Figure 1.6. Annual real GDP growth has also resumed strong in recent quarters Percentage point contribution to quarter-on-quarter GDP growth (sa) Percentage point contribution to year-on-year GDP growth 20 15 Private consumption Public consumption 15 Fixed investment 10 Inventory investment 10 Net exports GDP 5 5 0 0 -5 -5 -10 Private consumption Public consumption -10 Fixed investment -15 Inventory investment Net exports GDP -20 -15 2007 Q2 Q3 Q4 2008 Q2 Q3 Q4 2009 Q2 Q3 Q4 2007 Q2 Q3 Q4 2008 Q2 Q3 Q4 2009 Q2 Q3 Q4 Q1 Q1 Q1 Q1 Q1 Q1 Source: Haver and World Bank staff calculations. Source: CEIC and World Bank staff calculations. The tide turned in the second quarter of 2009. On the back of improved external conditions and fiscal stimulus, quarter-on-quarter growth resumed after two consecutive quarters of contraction. The positive momentum continued in the second half of the year, with quarterly growth at about 3 percent (Figure 1.5). Thanks to these developments, annual growth resumed in the fourth quarter (Figure 1.6), and the level of GDP has made up for its lost ground and exceeds the pre-crisis peak by 2 percent. As a result, the speed and strength of Malaysia’s recovery compares favorably with those other countries in East Asia similarly exposed to the external demand shock arising from the global recession (Box 1). 19 MALAYSIA ECONOMIC MONITOR BOX 1. MALAYSIA’S RECOVERY IN REGIONAL PERSPECTIVE The final quarter of 2009 saw all emerging East Asian economies enjoying robust annual output growth, after the sharp downturns seen in late 2008 and 2009. This box considers Malaysia’s recession and recovery in the context of the GDP performance of five other regional economies that similarly experienced a steep downturn followed by a sharp recovery, namely Hong Kong, China; South Korea; Singapore; Taiwan, China; and Thailand.a Despite a generally V-shaped recovery, the timing and length of the recessions vary rather markedly across crisis-affected economies (Figure 1.7). Growth performance became more diverse as the crisis deepened. On a quarterly, seasonally-adjusted basis GDP in Singapore and Hong Kong, China, already showed sharp contractions in the second quarter of 2008. Malaysia was the last country to enter the recession in East Asia, primarily due to more supportive private consumption (see Box 1 of the November Malaysia Economic Monitor; World Bank, 2009a).b The rebound in all six economies clearly commenced from the second quarter of 2009. This was first supported by resilient Chinese demand and later augmented by a turnaround in G-3 economies and revival in global trade from mid-2009. Nonetheless, the recovery remains somewhat uneven and fragile for some, as evident in the weak quarterly GDP growth for Korea and Singapore in Q4 2009, despite favorable headline year-on-year figures. In terms of levels, the trough for Malaysia’s seasonally adjusted real GDP (reached in Q1 2009) was around 7 percent below the pre-crisis peak of Q3 2008. This was a slightly shallower contraction than a peak-to-trough fall of over 9 percent for Singapore and Taiwan, China, but deeper than Korea’s 5 percent (Figure 1.8). Malaysia’s recovery was relatively strong—the seasonally-adjusted GDP level in Q4 2009 surpassed the pre-crisis peak by around two percent. Hong Kong, China, and Singapore remain 3-4 percent below their respective peaks, reflecting their particularly high trade openness and exposure to global demand (with exports of goods and services at over 200 percent of GDP in 2008). Malaysia emerged from the global recession stronger than others due to more resilient domestic demand and the recovery in net external demand. This was mainly led by robust private consumption (Figure 1.9), but also supported by public consumption and fixed investment (Figure 1.10 and Figure 1.11). All crisis-affected economies introduced extraordinary fiscal packages with priorities on minimizing job retrenchments and maintaining personal income. But what was noticeable for Malaysia and Korea, who both have recovered relatively quickly to pre-crisis GDP levels, was the relative timeliness of the support—Malaysia launched the first fiscal package in November 2008, in addition to the expansionary Budget 2009 announced in August 2008, ahead of the output contraction beginning early 2009. The contraction in Malaysia’s real exports of goods and services in the second half of 2008, seasonally adjusted, was second only to Taiwan (Figure 1.12). The fall in merchandise shipments is even greater given healthy tourism revenue. But net external demand contributed positively to growth because imports fell much more sharply than exports in the first half of 2009. Malaysia’s high-tech export products have high import content, so the free fall in export orders from advanced economies resulted in a sudden drop in intermediate imports. This was also reflected in huge inventory destocking. 20  RECENT ECONOMIC DEVELOPMENTS In terms of the structure of export demand, Malaysia, Singapore, and Thailand rely proportionally more on the (weak) G-3 economies and less on the (buoyant) Chinese market. This was one reason why their exports fell so markedly. For Malaysia, the G-3 economies plus other large East Asian economies excluding China, which are part of the regional production network producing goods finally destined to G-3 economies, accounted for around 72 percent of exports in 2007/2008. This is the highest in this sample of economies, for example for Korea the fraction is around 50 percent. Figure 1.7. A V-shaped recovery in East Asia but with Figure 1.8. Malaysia emerged from the global varying degree of output loss recession more favorably than others Real GDP growth, yoy, percentage point change Ratios of real GDP levels, sa, percent 10 Malaysia Malaysia Singapore 8 Thailand 6 Korea Korea Taiwan, China 4 Hong Kong, China 2 Taiwan, China 0 Thailand -2 -4 Hong Kong, China -6 Q4 09/peak -8 Singapore Trough/peak -10 08 Q1 Q2 Q3 Q4 09 Q1 Q2 Q3 Q4 80 85 90 95 100 105 Source: Haver and World Bank staff calculations. Source: Haver and World Bank staff calculations. Note: Peak is Q3 08 for Malaysia and Korea, and Q1 08 for others. Except Korea (Q4 08), trough is Q1 09. Figure 1.9. Resilient private consumption in Malaysia Figure 1.10. Public consumption also contributed has helped to sustain domestic demand positively… Real private consumption growth, percentage point change from Real public consumption growth, percentage point change from preceding period, sa preceding period, sa 6 14 12 H1 08 H2 08 H1 09 H2 09 4 10 2 8 6 0 4 -2 2 0 -4 -2 -6 H1 08 H2 08 H1 09 H2 09 -4 Malaysia Singapore Thailand Korea Taiwan, Hong Malaysia Singapore Thailand Korea Taiwan, Hong China Kong, China Kong, China China Source: Haver and World Bank staff calculations. Source: Haver and World Bank staff calculations. 21 MALAYSIA ECONOMIC MONITOR Figure 1.11. …along with fixed investment in late Figure 1.12. The decline in exports was relatively 2009 large Real gross fixed capital formation growth, percentage point change Real good and services exports growth, percentage point change from from preceding period, sa preceding period, sa 20 20 H1 08 H2 08 H1 09 H2 09 H1 08 H2 08 H1 09 H2 09 15 15 10 10 5 5 0 0 -5 -5 -10 -10 -15 -15 -20 -20 Malaysia Singapore Thailand Korea Taiwan, Hong Malaysia Singapore Thailand Korea Taiwan, Hong China Kong, China Kong, China China Source: Haver and World Bank staff calculations. Source: Haver and World Bank staff calculations. Notes: a These economies suffered at least two quarters of negative, year-on-year output growth during 2008-2009. Other large regional economies such as Indonesia, the Philippines, and Vietnam have so far been more resilient with positive growth throughout. b This is true for both GDP growth calculated on a year-on-year basis (which first declined in the first quarter of 2009) and on quarter-on-quarter, seasonally adjusted basis (which first declined in the fourth quarter of 2008). High frequency indicators, although noisy, also point to the strong rebound in activity. Tracking the recovery in the level of global imports, industrial production continued to rise through 2009 (Figure 1.13). The performance in January 2010 was particularly strong, up almost 6 percent on the month (sa). Focusing on the levels to gauge the extent of the recovery, the industrial production index excluding construction has made up around 12 percentage points of the 19 percent fall from its peak in January 2008. It is 2 percent above the level in September 2008 before GDP began to contract. The improvements in domestic, and external, demand supported the return of annual consumer price inflation to positive territory in December 2009 after the deflation of mid-2009 (Figure 1.14). Similarly, the direction of producer price changes has also seen a turn around—the roughly 2 percent rise in December followed 13 consecutive months of annual price declines. Confidence indicators suggest continuing improvement. Coincident indicators continue to rise and lagging indicators are making a come-back (Figure 1.15). Consumer and business sentiment indices have seen sharp improvement (Figure 1.16). What is particularly noticeable about the current crisis and the recovery is both the depth of the fall, and the speed of the rebound, of the consumer sentiment measures. This may reflect both the strong domestic policy response to the crisis and the change in perceptions over time from initial fears of a broad-based downturn through to the realization that much of the domestic economy was relatively insulated from a shock which focused on the manufacturing-for- exports sector. 22  RECENT ECONOMIC DEVELOPMENTS Figure 1.13. The industrial production revival gathers Figure 1.14. As activity recovers, consumer and steam producer prices are rising again Percent change in sa index Percent change, year-on-year 15 20 10 15 5 10 0 5 -5 0 Month-on-month -10 -5 Year-on-year -15 -10 CPI -20 -15 PPI (for goods in domestic economy) Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Source: Haver and World Bank staff calculations. Source: CEIC and World Bank staff calculations. Note: Industrial production excluding construction. Figure 1.15. Coincident and lagged indicators Figure 1.16. Sharp recovery in business and consumer continue to improve sentiment indices Month-on-month growth in 3mma sa index, percent Index 4 140 3 130 2 120 110 1 100 0 90 -1 80 -2 70 Business Coincident Index Condition Index -3 60 Consumer Lagging Index Sentiment Index -4 50 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 1994 1997 2000 2003 2006 2009 Source: CEIC and World Bank staff calculations. Source: Malaysian Institute of Economic Research (MIER), CEIC, Note: Seasonal adjustment using Tramo-Seats. Haver and World Bank staff calculations. Note: Shaded areas indicated recessions (defined as two or more consecutive quarter-on-quarter GDP contractions, sa). For Business and Consumer Sentiment Indices a value above (below) 100 indicates improvement (deterioration) of sentiment. Manufacturing surveys confirm these positive developments. For example, the assessment of the negative effect of the crisis on export sales and new orders has declined as the global high-tech and manufacturing cycle has moved into recovery mode (Table 1.1). The average assessment of the decline in profit has moderated through 2009. In addition, almost all indicators are also expected to improve going forward through Q1 2010. 23 MALAYSIA ECONOMIC MONITOR Table 1.1. Survey of manufacturers points to moderation of impact of global economic and financial crisis Percent of respondents considering global economic and financial crisis has negative/positive impact on factor 2Q2009 vs 1Q2009 3Q2009 vs 2Q2009 Oct 2009 – March 2010 Negative Positive Negative Positive Negative Positive Sales and production Sales-export 50.8 32.3 42.9 39.7 36.4 47.3 Sales-domestic 37.3 34.3 40.9 31.9 29.6 42.6 Production volume 44.6 32.5 40.3 33.4 30.6 46.8 New orders 51.4 23.6 42.0 33.3 30.5 42.4 Average sales prices 37.8 16.3 44.9 15.9 33.9 23.7 Labor Employment 35.2 11.3 26.1 23.2 19.6 28.5 Wage costs 19.1 17.7 24.2 18.2 21.1 31.6 Non-wage costs 22.7 24.2 28.1 26.5 22.2 35.2 Investment New capital investment 32.8 10.5 28.1 14.1 20.0 23.6 Capital expenditure 31.3 16.4 27.7 21.5 18.2 31 Credit Access to short–term credit 13.4 14.9 12.3 15.3 12.7 20.0 Access to long–term credit 12.3 13.9 14.3 14.3 14.5 18.2 Cost of credit 14.1 17.2 16.9 16.9 16.7 18.5 Credit terms 16.9 13.8 20.0 15.4 21.4 19.7 Performance Liquidity/ cash flow 40 18.5 38.2 23.7 42.1 26.4 Profit 52.7 28.4 52.1 31.0 52.5 30.5 Profit declined on average by 27.6% 17.9% 10.5% Source: Federation of Malaysian Manufacturers (2009a and 2009b). Note: “No Impact