As Prime Minister Anwar Ibrahim celebrates his first year in office, it is a good time to take stock of Malaysia’s prospects. Looking over the past year, what strikes us is how Malaysia has emerged from a period of extraordinary difficulties relatively intact and with reasonable hopes for doing better in the near term. This view does not underestimate the many difficult legacies from the past that need to be fixed, nor does it disregard the challenges that the current government faces in bringing about necessary changes.
For us, the question is not whether all the reforms that many aspire to see can be achieved, given the real-life challenges of governing a complex country in a turbulent world. The question is whether enough good can be done to put Malaysia on a much better trajectory. The answer seems to be a clear yes.
A country with some inner strengths
President Xi Jinping is fond of referring to “changes, the likes of which we haven’t seen in 100 years” in global affairs. This is certainly a big problem if, like Malaysia, you are one of the most open economies in the world. Wars in Europe and the Middle East have combined with the heated tussle between the US and China to create a host of challenges — weaker global demand, higher inflation, immense uncertainty that holds foreign investors back, a troubled global trading regime marked by more protectionism and inward-looking policies and feverish military activity in the seas close to Malaysia.
And that’s not all. Central banks all over the world have embarked on the most punishing pace of monetary tightening in 40 years, bringing great pressure to bear on emerging market currencies and triggering many episodes of financial market stress. And, China’s once-booming economy has stalled: that reduces demand and depresses commodity prices for exporters such as Malaysia while also depriving it of the tourism bonanza hoped for now that the pandemic is over. Finally, the electronics cycle which Malaysia is dependent on was also in the throes of a decline.
Making things worse, the domestic front has also not been easy. The inflationary shocks and the sharp rise in interest rates globally buffeted a Malaysian economy that was only just finding its feet after the ructions of the Covid pandemic. That did not help the voters’ mood and made the management of domestic political issues that much more challenging.
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Moreover, as Anwar’s Pakatan Harapan coalition lacked sufficient traction with Malay voters, its only route to power was to coalesce with its long-time rival, the Barisan Nasional, some of whose leaders were under a legal cloud on allegations of corruption. For many months until recently, Anwar’s government had to fend of fears that his government might fall as a result of parliamentary defections to Perikatan Nasional.
The domestic front was all the more challenging because some of the weaknesses in the economy are deeply entrenched, the result of decades of policy missteps. Challenges such as premature de-industrialisation, stagnant real incomes for lower-income groups and underinvestment have not only hobbled Malaysia’s high-income ambitions but also alienated large portions of Malaysian society. It is not a surprise that poorer constituencies bought into the ethnonationalist appeals of Anwar’s rivals for power — their narrative of Malay rights being under threat resonating with their economic woes.
Despite all these headwinds, the Malaysian economy is on the mend. The World Bank sees economic growth gathering pace from around 3.9% this year to 4.3% next year — at a time when it is pessimistic about overall global growth which it sees at around 2.4% in 2024, well below the 3%-plus rates of previous years. The Asean+3 Macro-Economic Research Office is even more bullish, seeing growth accelerating to 5.2% in 2024. We see the economy picking up on the back of a recovering electronics cycle and a continued rebound in tourism. In addition, there will be some pent-up capital spending which had been deferred because of the political uncertainty of previous years.
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Opportunities for Malaysia
All these are cyclical factors. The more important question is the longer-term outlook for economic growth. Malaysia has a lot going for it despite our concerns over the global economy:
• The reconfiguration of supply chains is gathering momentum. Because Malaysia is a place where global investors have been operating successfully for many decades, it is a natural destination for medium-value production that is being relocated out of China. The improving foreign direct investment approval numbers suggest that Malaysia is indeed benefiting from this mega trend in the world economy.
• Malaysia is also quite competitive from a cost perspective. The ringgit’s depreciation in recent years has not been offset by cost increases that are larger than those in competitor economies. So there has been a net gain in cost competitiveness. Foreign investors are also familiar with the established manufacturing ecosystems in the Penang-Kulim corridor, in the Klang Valley and in the Iskandar Region to the south which are globally competitive in several sectors. Recent high-profile investments in the semiconductors and electrical vehicle space by global giants such as Intel, Infineon, Geely, and Tesla testify to potential gains in this area.
• Malaysia has one added benefit that is not fully recognised. It has the advantage of being closely integrated with Singapore, whose cost structure has ballooned of late. With the right bilateral agreements in place, there would be a natural flow of activity from high-cost Singapore into Malaysia. That trend would benefit both economies significantly — Malaysia because of the inflow of higher-value activities from Singapore, and Singapore because better access to Malaysia would relieve pressures on land and other resources and so help alleviate rising costs. The recent leaders’ retreat at end-October saw Anwar and his Singaporean counterpart Lee Hsien Loong entrench cooperation in areas such as improving transport links and initiating serious discussions about a Special Economic Zone in southern Johor.
But before all these positive trends can fully benefit the country, Malaysia needs to address some structural gaps in its economy. The government’s willingness to reform will be the critical determinant in this case.
Only a cautious and phased approach to reforms is politically feasible …
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It would be ideal if reforms could be swift. But an aggressive pace of change would not be possible in today’s political environment and could even rebound because of potential political turbulence that might be caused. What is heartening is that government leaders appear to understand where the reforms are needed and are beginning to move in the right direction.
First, on the pressing need to get the fiscal house in order, a start has been made though more needs to be done:
• The government has committed itself to subsidy rationalisation, which essentially means shifting from broad-based subsidies towards more targeted ones aimed at the lower- and middle-income households who need them most. In line with this, electricity subsidies have been withdrawn for higher-income households and larger corporations, while still made available for SMEs and lower-middle-income consumers. Diesel subsidies are to be rationalised as well over the next budget year. However, not much has been said about addressing petroleum subsidies which would really move the needle on the fiscal position. Our understanding is that this step will be taken within this parliament.
• There has been good progress in fiscal governance. The newly passed Fiscal Responsibility Act and the upcoming Government Procurement Act would legislatively entrench selected fiscal targets and improved government procurement practices. Other institutional reforms include the strengthening of the auditor-general’s office and parliamentary committees so as to improve oversight and accountability.
• The disappointment has been on the tax side where the government appears still undecided on the critical question of generating sufficient revenues to fund pressing expenditure needs. A reintroduction of the goods and services tax (GST) seems politically toxic even though there is no other way to achieve a sound fiscal position. Over time, we expect the government to settle into a “stealth” return of the GST, probably through increasing the sales and services tax, combined with the e-invoicing system, which will deliver some of the benefits of the original GST without instigating a strong political backlash against the government.
Next, we are seeing a welcome focus on remedying Malaysia’s structural gaps. In recent months, the government has released well-thought out plans in a range of areas such as the New Industrial Master Plan (NIMP) focusing on higher-value-added manufacturing activity, most notably in semiconductors and green energy. The review of the five-year plan and the government’s energy transition plan also gave a clear picture of a government that is now more focused on longterm issues unlike what happened in the past five years when short-lived governments struggled to survive and did not provide the longterm guidance that investors need. In addition we have seen a renewed focus on streamlining regulation and licensing requirements.
… leaving many gaps in reforms
There is still some way to go, though, on such reforms. In particular, there is yet to be a clear strategy to remedy labour market defects and improve wages for Malaysians. While the government rightly seeks to more than double the median manufacturing sector salary, the concrete policy proposals to do so, including the much-vaunted “Progressive Wage Policy” have yet to be unveiled. We believe that a decisive move is needed to reduce the economy’s addiction to low-cost foreign labour, which we believe has impeded the growth of incomes for less-skilled Malaysians. In fact, the recent loosening of restrictions on foreign workers in selected sectors sends the wrong signal. More decisive steps are also needed to tackle the vested interests and corruption in foreign worker management as identified in a 2018 government review.
Another key area where the pace has been less than satisfactory is governance reforms. The government has been criticised for the cases of prominent leaders being effectively freed from pending charges after government prosecutors withdrew the charges citing the need for further investigation. Promised institutional reforms such as the separation of the attorney-general and public prosecutor have been relatively slow with no clarity on timeline or details.
Promises to make progressive moves in some causes championed by Pakatan before the election, such as citizenship reforms, equal access to constituency funding, and reforms of draconian security and sedition laws, have also been slow.
Conclusion: the glass is half full
In the end, the conclusion we draw is a positive one. Anwar’s own Pakatan Harapan bloc lacks a parliamentary majority, and needs to keep Barisan Nasional and the “Borneo bloc” of MPs onside. That constrains Anwar’s government since the scope of reforms that are acceptable to all will necessarily be narrower. Measured against the standard of what is feasible, the current government seems to be doing enough to set Malaysia on a much better economic trajectory over time. So long as reforms continue and there are no further major global shocks, we believe that Malaysia could surprise positively over the coming few years.
Manu Bhaskaran is CEO at Centennial Asia Advisors
