Malaysia WT/TPR/S/156 
 Page 1 
 
 
I. ECONOMIC ENVIRONMENT 
(1) OVERVIEW  
1. Until the Asian financial crisis of 1997-98 Malaysia  had enjoyed a decade of consistently fast 
growth (over 8% per year) with economic expa nsion driven by manufacturing investment and 
exports.1  Malaysia has benefited from the surge in global demand for information and 
communication technology (ICT) goods, which pulled it out of recession in 1999, but it was hit by a downturn in global demand by 2001.  Malaysia's heavy dependence on exports of electronics and 
electrical goods means that economic growth is vulne rable to global fluctuations in the demand for 
these products.  GDP in 2001 grew only 0.3%, due to a contraction in exports, although a substantial 
fiscal stimulus package mitigated the worst of the recession (Table I.1).  Malaysia's economic 
slowdown highlighted the problems of over-reliance on an  export-led growth strategy, particularly in 
electrical and electronic products and the consequent  vulnerability to the indus trial countries' business 
cycle.  Measures have been taken to develop new so urces of growth, focusing on agriculture, services, 
and resource-based industries to improve the economy' s resilience to shocks.  A significant challenge 
is the speed at which new domestic sources of grow th are found, which depends considerably on gains 
in total factor productivity (TFP) and resolving the pr oblem of the shortage of skills.  According to the 
target of the Eighth Malaysia Plan (EMP) (2001-05), TFP was projected to grow at an annual rate of 2.8%, but reached only 0.8% for th e period 2001-03, due to external shocks.  According to the mid-
term review of the EMP, carried out in October 2003,  growth was expected to continue to be mainly 
input-driven over 2004-05, although the contribution of TFP growth  was expected to return to around 
1.7%. 
Table I.1 
Selected macroeconom ic indicators, 2001-04  
  2001 2002 2003 2004 
 (Percentage change, unless otherwise indicated) 
National accounts     
Real GDP (1987 prices) 0.3 4.4 5.4 7.1 
Private consumption expenditure 2.4 4.4 6.6 10.5 
Government consumption e xpenditure 17.3 10.4 11.5 6.0 
Gross domestic fixed investment -2.8 0.3 2.7 3.1 
Exports of goods and non-factor services -7.5 4.5 5.7 16.3 
Imports of goods and non-factor services -8.6 6.3 4.2 20.7 
Unemployment rate (%) 3.6 3.5 3.5 3.5 
Productivity     
Labour productivity in manufacturing -3.4 3.3 5.3 6.1 
Total labour productivity 0.3 .. .. .. 
Total factor productivity -0.6 .. .. .. 
Prices and interest ratesa     
Inflation (CPI, 2000=100) 1.4 1.8 1.2 1.4 
Fixed 3-months deposit rate (%) 3.21 3.20 3.00 3.00 
Savings deposit (%) 2.28 2.12 1.86 1.58 
Base lending rate (%) 6.39 6.39 6.00 5.98 
Money, credit (end period)     
Money supply (M1) 3.2 10.3 14.6 11.9 
Money supply (M2) 2.2 5.8 11.1 25.4 
Table I.1 (cont'd)  
                                                      
1 Between 1988 and 1997, real annual GDP grow th, at 1987 prices, averaged 8.24%.  WT/TPR/S/156 Trade Policy Review 
Page 2 
 
 
  2001 2002 2003 2004 
Money supply (M3) 2.9 6.7 9.7 12.4 
Credit to private sector 4.2 5.5 5.8 5.3 
Exchange rate     
Nominal effective exchange rate (2000=100) 105.8 105.0 98.0 93.3 
Real effective exchange rate (2000=100) 105.5 105.7 97.1 91.9 
RM/US$ 3.8 3.8 3.8 3.8 
 (Per cent of GDP, unless otherwise indicated)  
Government policy     
Overall Government balance -5.5 -5.6 -5.3 -4.3 
Current Government balance 4.7 4.1 4.4 1.8 
Current revenue 23.8 23.1 23.4 22.1 
Tax revenue 18.4 18.5 16.4 16.0 
Current expenditure 19.1 19.0 19.0 20.3 
Development expenditure 10.2 9.7 9.7 6.1 
Public sector total debt  43.6 45.6 47.8 48.2 
Domestic debt 36.3 35.5 38.3 40.5 
Savings and investment     
Gross national savings 32.2 32.4 34.4 35.2 
Gross domestic investment 23.9 24.0 21.6 22.6 
Savings-investment gap 8.3 8.4 12.8 12.6 
External sector      
Current account balance 8.3 8.4 12.9 12.6 
Net merchandise trade 20.9 19.9 24.7 23.2 
Exports 100.0 99.0 101.0 107.0 
Imports 79.1 79.1 76.3 83.8 
Services balance -2.5 -0.2 -3.8 -2.0 
Financial account -4.4 -3.3 -3.1 3.4 
Direct investment 0.3 1.4 1.1 2.2 
Balance of payments 1.1 3.9 9.9 18.5 
International reserves, net (US$ million)b 30,843.0 34,577.0 44,856.0 66,714.0 
in months of imports 5.1 5.4 6.6 8.0 
Total external debt (end period, US $ million) 45,636.6 48,857.9 49,112.6 52,776.3 
Debt service ratioc 6.8 6.6 6.2 4.4 
a Commercial banks' interest rates. 
b Including gold. 
c As percentage of gross export of goods and services.  
Source : Bank Negara Malaysia, Monthly Statistical Bulletin, various issues;  IMF, International Financial Statistics  
(various issues),  and Asian Productivity Organization, Total Factor Productivity Growth:  Survey Report. 
2. With the exchange rate pegged to the U.S. do llar (until July 2005), compensatory fiscal policy 
sustained Malaysia's growth momentum between 2001 and 2003 in the face of softening global 
demand and uncertainties created by the 11 September attacks, the war in Iraq, and SARS.  In the 
process, federal government debt rose appreciably, albeit from relatively low levels.  Post-crisis 
reforms to restructure the financial sector and cl ean up balance sheets have almost been completed 
and the financial and corporate sectors have been strengthened.  Restrictions on foreign exchange 
transactions have been lifted gradually and the liber alization of the trade and investment regime has 
continued.  By 2004, economic growth had become  buoyant, led by stronger external and domestic 
demand.  Unemployment has remained broadly unch anged and low, at under 3.5%, and the Malaysian 
economy has enjoyed a low inflation environment for most of the period under review.  According to 
the Malaysian authorities, real GDP growth for 2005 is expected to be 5%, down from 7.1% in 2004, Malaysia WT/TPR/S/156 
 Page 3 
 
 
due to slower expansion in world growth a nd trade activities, the downtrend in the global 
semiconductor cycle, higher imported inflation aris ing from relatively higher world oil prices, and 
lower prices of commodities, particularly palm oil, Malaysia's main agricultural export.  In 2006, the 
authorities expect the economy to grow by 5.5%. 
3. Malaysia's gross national savings rate remains among the highest in the world, averaging 34% 
of GDP since 2001 and thus exceeding its gross dome stic investment by between 9 and 13 percentage 
points of GDP.  According to the central bank, Ba nk Negara Malaysia (BNM), this high level of 
savings has reduced Malaysia's reliance on foreign sav ings, enabling it to fund its investment needs 
domestically.  The large gap between gross national sa ving and gross domestic investment is reflected 
in a corresponding current account surplus, which rose from 8.3% of GDP in 2001 to 12.6% of GDP 
in 2004 (Table I.1).  The current account position is  largely determined by the merchandise trade 
account although Malaysia has a persistently large deficit in invisibles trade. 
4. The consumer price index (CPI) generally rema ined low, at below 2%, during the review 
period until November 2004 when inflation showed an upward trend slightly above 2%.  This was due 
largely to an adjustment made in several price co ntrol items in the CPI basket such as petrol,  
beverages, and tobacco.  The successive hike in re tail petrol prices, together with an increase in 
transportation costs, led to the inflation rate acceler ating to 3.2% in June 2005.  The Government's 
fuel subsidy has until recently helped to insulate the economy from the inflationary impact of higher 
oil prices in the world market.2  However, as the Government gra dually reduces the subsidy by raising 
prices of retail petrol and diesel, the impact on in flation may become more pronounced.  Inflation is 
likely to remain at around 3% if the Government fu rther reduces its fuel s ubsidy, well within BNM's 
tolerable rate of 4%, as labour market conditions remain stable supported by productivity growth and 
an expansion in production capacity.  
(2) RECENT ECONOMIC DEVELOPMENTS  
(i) Macroeconomic policies 
(a) Monetary and exchange rate policies 
5. Following the 1997-98 Asian financial crisis, the ringgit was pegged to the U.S. dollar, and 
foreign exchange restrictions on capital flows we re imposed with Bank Ne gara Malaysia (BNM) 
pursuing a policy that ensured nominal interest rate stability.  The Government's objective was to eliminate offshore trading of the ringgit, which, like other currencies in the region, had come under 
intense speculative pressure, and to insulate the domestic economy from the effects of short-term 
capital flows.  Foreign direct investment flows, dividends, interest, and rental income earned in 
Malaysia were exempted from controls.  
6. For most of the period under review, BNM ma naged credit prudently, consistent with 
maintaining the peg, while taking steps to liberali ze interest rates and foreign exchange transactions.  
                                                     
 
2 Malaysia, as a net oil exporter, gains directly from higher global oil prices (net oil export revenues 
jumped by RM 1.1 billion to RM 7.4 billion in the first half of 2005). On the other hand, as a major exporter of manufactured products and commodities, it is vulnerable to secondary effects from softer global economic 
growth induced by higher oil prices.  Direct fuel subsidies, though reduced, are still expected to cost the 
Government RM 6.6 billion in 2005, up from RM 4.8 billion in 2004.  To maintain its fuel subsidy allocation of RM 6.6 billion (of which the diesel subsidy accounts for 70%), the Go vernment will have to raise the price of 
retail petrol and diesel again, thus passing the increased  cost to the consumer.  Tax exemptions on gasoline and 
diesel will cost the Government an additional RM 7.9 billion in foregone revenues, bringing the overall 2005 
subsidy bill to RM 14.5 billion or about 2.9% of GDP.   See International Energy Agency (2004), p.10.  WT/TPR/S/156 Trade Policy Review 
Page 4 
 
 
The BNM reduced its intervention rate  sporadically between 1999 and 20033 and this, together with a 
fiscal stimulus, helped to dampen the adverse e ffects of a weakening global economy, the Iraq war, 
and SARS.  During the period covered by this revi ew, capital control measures imposed in the wake 
of the Asian crisis have been mostly lifted.  In  particular, in May 2001 the Government completely 
eliminated one of the most controversial of th e selected controls when it abolished a 10% tax on 
profits by foreign investors on portfolio investments taken out of the country.  Malaysia further liberalized exchange contro l regulations during 2002-04.
4  The main remaining exchange controls 
include the restriction on foreign borrowing to  quantitative limits and approval, and a ban on 
speculative trading in ringgit.5 
7. The sizable current account surpluses during the pe riod under review could be interpreted as a 
sign that the ringgit was substantially undervalued.   However, other indicators suggest that the 
undervaluation of the ringgit was modest.  In part icular, the sharp increase in the current account 
surplus in 2003 levelled off in 2004 as import grow th significantly outpaced that of exports;  in 
addition, Malaysia's export share in key markets re mained broadly stable.  As per September 2004, 
the IMF estimated that in real effective terms the ringgit was about 3-5% below its natural level.6  
8. Since 1998, Malaysia had pegged the ringgit at RM 3.80 against the U.S. dollar, the 
authorities regularly stating that the ringgit peg would not be reviewed unless there were major 
structural changes in the international or regional financial system.  The ending of China's fixed yuan 
peg with the U.S. dollar constituted such a structural  change.  In July 2005, the ringgit fixed exchange 
rate regime was dismantled and replaced by a manage d float system based on a basket of currencies.  
This marked the end of almost all of the capital controls established since September 1998.  The 
foreign exchange rate regime w ill now operate in similar fashion to how it was managed before 
currency controls were introduced, and the ringgit will rise or fall within a trading band based on the 
weighted values of a number of selected currencies.7   
9. The value of the ringgit will no longer be dictated  solely by the movement of the US dollar in 
the foreign exchange market but will be determin ed more by the country's economic fundamentals, 
according to Bank Negara Malaysia.  The bank will manage the float against a basket of currencies to 
ensure the currency maintains its "fair" value, define d by BNM as the exchange rate that is beneficial 
to the economy.8  Although the peg has been removed, stab ility of the ringgit continues to be the 
overriding objective  of the country's exchange rate policy.  This is reflected in the Government's 
decision to maintain the non-internationalization of the ringgit, meaning it would not be traded 
offshore, thus reducing the volatility of the ringg it movement in the foreign exchange market. 
10. It appears that exporters will bear the brunt of the change in the short term as they undergo a 
small loss of competitiveness, as ringgit-denominated exports become more expensive.  They will 
also be exposed to exchange rate volatility for th e first time in seven years, although the ringgit's 
                                                      
3 In May 2003, BNM reduced its intervention rate by half a percentage point to 4.5%.  In April 2004, 
BNM introduced a new indicator interest rate, the so-ca lled overnight policy interest rate (OPR), which replaced 
the three-month intervention rate.   
4 The main measures included:  a relaxation of regulations on investment abroad by domestic 
institutions and on domestic credit facilities extended to non-resident controlled companies, and an increase in 
the maximum overnight limit on foreign cu rrency accounts for export proceeds.  
5 Forward and swap exchange contracts to buy/sell fo reign currency against the ringgit are allowed as 
long as transactions are supported by a firm underlying commitment (for example, an export sales contract). 
6 IMF (2005c). 
7 Although details on the basket of countries were not revealed, it is widely assumed that among the 
currencies that will be used are the Chinese yuan, Si ngapore dollar, Japanese yen, and the U.S. dollar. 
8 Given that Malaysia is a trading nation, BNM would like to see the ringgit gravitate towards its 
equilibrium point;  and it will intervene if the market-deter mined rate is too far away from the "fair" value.  Malaysia WT/TPR/S/156 
 Page 5 
 
 
movement against the dollar is generally not expected  to deviate significantly from the current level.  
Import costs, on the other hand, will be reduced, lowering business costs and improving profits.  Regarding fuel bills, Malaysia is a net exporter of crude oil, but its limited refining capacity means 
that it is a net importer of gasoline and other oil pr oducts;  as these are denominated in U.S. dollars, 
they will become relatively cheap er as the ringgit appreciates.   
11. The restructuring of the Malaysian economy from one based on agriculture to one based on 
manufacturing and services has continued.  Servi ces, with a share of 60.3% of GDP in 2004, 
constitute the largest sector (Table I.2).  Manuf acturing forms the second largest sector (31.6%), 
followed by agriculture (8.5%), and mining (7%).  Growth since 2001 has been generated mainly by 
the manufacturing sector, including construction;  performance in other sectors was less pronounced, 
with agriculture lagging behind, although Malaysia  remains a major producer of plantation timber, 
rubber, and palm oil.  This is consistent with Malays ia's development strategy, which emphasizes 
industrialization, especially growth based on capital- intensive industries, but which has taken a shift 
towards the expansion of knowledge- and high-tech nology-based industries, and of the domestic and 
international services sector.  The restructuring of th e economy is also reflected in the labour market.  
Manufacturing, with its rapid rate of growth, even  though capital intensive, has attracted labour from 
the agricultural sector.  As a conse quence, the share of total employme nt in agriculture has declined, 
although still over 13% (Table I.2). 
Table I.2  
Basic economic and social indicators, 2001-04 
 2001 2002 2003 2004 
Real GDP (1987 prices;  ringgit million)  211,227.0 220,422.0 232,359.0 248,954.0 
Real GDP (1987 prices;  US$ m illion) 55,586.1 58,005. 8 61,147.1 65,514.2 
Nominal GDP (ringgit million) 334,404.0 362,012.0 395,017.0 449,609.0 
Nominal GDP (US$ million) 88, 001.1 95,266.3  103, 951.8 118,318.2 
GDP per capita (US$) 3,664.7 3,884.1 4,150.1 4,625.2 
 (Annual percentage change)  
GDP by industry at 1987 prices     
Agriculture, livestock and fishing -0.6 2.8 5.6 5.0 
Mining and quarrying -1.5 4.3 5.8 3.9 
Manufacturing -5.9 4.3 8.4 9.8 
Services 5.8 6.2 4.3 6.4 
Electricity, gas, and water 3.5 5.9 4.9 8.1 
Construction 2.1 2.0 0.1 -0.2 
Wholesale and retail trade, hotels/restaurants 2.5 2.6 1.5 7.1 
Transport, storage and communications 8.3 4.1 5.7 8.5 
Finance, insurance, real estates and business 9.5 14.2 5.5 6.3 
Government 4.6 5.3 8.3 6.5 
Other services 6.9 4.3 3.3 4.9 
 (Per cent)  
Share of main sectors in real GDP     
Agriculture, livestock and fishing 8.8 8.6 8.7 8.5 
Mining and quarrying 7.2 7.2 7.2 7.0 
Manufacturing 30.0 30.0 30.8 31.6 
Services 60.3 61.3 60.7 60.3 
Electricity, gas, and water 4.1 4.1 4.1 4.1 
Construction 3.4 3.3 3.1 2.9 
Wholesale and retail trade, hotels/restaurants 15.1 14.8 14.3 14.3 
Transport, storage and communications 8.6 8.6 8.6 8.8 
Finance, insurance, real esta tes and business 13.9 15.2 15.2 15.1 
Government 7.1 7.2 7.4 7.3 
Table I.2 (cont'd)  WT/TPR/S/156 Trade Policy Review 
Page 6 
 
 
 2001 2002 2003 2004 
Other servicesa 8.1 8.1 8.0 7.8 
Share of main sectors in nominal GDP     
Agriculture, livestock and fishing 8.2 9.2 9.6 9.5 
Mining and quarrying 10.1 9.4 10.4 12.6 
Manufacturing 30.4 30.5 31.1 31.4 
Services 51.2 50.9 49.0 46.5 
Electricity, gas, and water 3.4 3.4 3.2 3.0 
Construction 4.2 4.0 4.0 3.4 
Wholesale and retail trade, hotels/restaurants 14.6 14.1 13.3 13.0 
Transport, storage and communications 7.1 6.9 6.8 6.6 
Finance, insurance, real esta tes and business 12.4 12.7 12.0 11.1 
Government 7.2 7.6 7.5 7.1 
Other servicesa 2.3 2.3 2.3 2.2 
Share in employment     
Agriculture, forestry and fishing 14.8 14.3 13.8 13.3 
Mining and quarrying 0.4 0.4 0.4 0.4 
Manufacturing 26.8 27.3 28.1 29.1 
Services 58.0 58.0 57.7 57.3 
Construction 8.1 8.0 7.8 7.6 
Transport, storage and communications 5.2 5.2 5.2 5.2 
Financing, insurance, real estate and business 
services 6.0 6.2 6.4 6.4 
Government services 10.3 10.1 10.1 9.8 
Otherb 28.4 28.6 28.3 28.2 
.. Not available.  
a Including other services less imputed ba nk service charges plus import duties. 
b Including electricity, gas and water, wholesale and retail trade, hotels and restaurants and other services.   
Source : Bank Negara Malaysia, Monthly Statistical Bulletin, various issues and Annual Report 2004.  Ministry of Finance 
(2001 to 2004), Economic Report 2004/05, Malaysia. 
(b) Fiscal policy 
12. Three major development plans define the frame work of fiscal policy objectives within which 
annual budget proposals are made.  Vision 2020, pub lished by the Prime Minister's Department, sets 
2020 as a deadline for Malaysia to become a fully de veloped country.  An Outline Perspective Plan,  
currently the Third Outline Perspective Plan 2001- 10 published by the Economic Planning Unit of the 
Prime Minister's Department, marks each ten-y ear phase of the work to accomplish Vision 2020.  A 
five-year Malaysia Plan, currently the Eighth Ma laysia Plan (EMP) 2001-05, provides more detailed 
projections and guidance for annual budgets.  The Mala ysia Plans are subject to a mid-term review;  
the review for the EMP was in October 2003.  The annual budget is prepared and presented within the 
broad macroeconomic framew ork provided by the current development plans. 
13. Among the main macroeconomic concerns during th e first part of the review period was the 
decline in private sector investment arising from we ak external demand.  The Government therefore 
undertook measures to boost domestic  demand mainly through the implementation of pro-growth 
fiscal policies, given the limited scope for a looseni ng of monetary policy owing to the currency peg.  
In 2001, two stimulus packages were introduced to spur domestic economic activities.  The focus of 
fiscal policy in 2002 was on boosting short-term domestic demand and enhanc ing long-term industrial 
competitiveness and labour productivity throu gh spending on infrastructure development and 
education.  To boost domestic demand directly the i ndividual tax rate was cut from 29% to 28%;  on 
the corporate front, the Government extended the reinvestment allowance from 5 to 15 years and 
implemented tariff concessions on a wide  range of intermediate products.  Malaysia WT/TPR/S/156 
 Page 7 
 
 
14. The Government had aimed to reduce its budget defi cit in 2003, but due to the effects of the 
SARS outbreak on the tourism and retail sectors, a nd weak international demand it adopted a policy 
of fiscal stimulus.  This included tax incentives fo r investment and consumption, directed lending 
programmes and extra public spending.  The package cost the Government nearly 2% of GDP (the 
2003 budget deficit was 5.3% of GDP, well above the ta rget of 4%), but it helped keep the recovery 
on track.   
15. Led by strong expansion in cons umption spending, the economy accelerated to its fastest pace 
in four years in 2004, with a combination of strong external and domestic demand outweighing a 
reduction in fiscal stimulus.  The Government therefore tightened fiscal policy, and in the 2004 
budget initiated a process of fiscal consolidation with  large cuts in government development spending 
(it had second thoughts during 2004 about speed of deficit reduction, allocating an extra 
RM 10 billion of expenditure).  The budget deficit as a share of GDP narrowed to a five-year low of 
4.1%, below the official target of 4.5%.  During the period under review, total public sector debt has 
remained high at about 69% of GDP9 but, according to the IMF, is manageable.10  Public sector debt 
is projected to decline from 69% of GDP in 2003 to 46% of GDP in 2009, of which federal 
government debt would peak at 50% of GDP in 2004  then decline gradually to 38% by end 2009.  
16. The 2005 budget continues the process of fiscal c onsolidation, albeit at a more gradual pace 
than anticipated, forecasting a dec line in the fiscal deficit to 3.8% of GDP in 2005 (and to 1.5% in 
2007).  Deficit reduction is to be carried out thr ough cutting spending, improved revenue-collection, 
the gradual reduction of subsidies on gasoline and diesel  fuels, and changes to the tax structure.  The 
2005 budget speech included a review of the tax syst em and foreshadowed the introduction of a single 
consumption tax, a Goods and Se rvices Tax (GST) in 2007.  The budget speech did not link the GST 
to its deficit reduction plan, but given the recen t history of difficulties in reducing development 
expenditure, improving revenue collect ion may help to achieve deficit reduction.  The Government is 
committed to a gradual and progressive reduction of the federal government deficit without 
constraining overall economic growth. 
(ii) Structural policies  
(a) Financial and corporate sector restructuring 
17. The 1997-98 financial crisis wa s a watershed for the financial sector, which had been 
overextended and undermined by imprudent lending.  During the decade before the crisis, credit had 
expanded by an annual average of nearly 30%, la rgely for property development and stock market 
investments.  When the crisis hit, the economy tu rned downwards, helping to precipitate a serious 
banking crisis. The Government played an activ e role in solving the bad debt problem and 
restructuring the financial sector and its response is generally acknowledged to  have been rapid and 
well-coordinated, which subsequently set the fi nancial system on a much more solid foundation.11 
18. After the crisis broke, the authorities provided liquidity support to banks and established 
three agencies:  (i) a recapitalization agency (Dan amodal) to lessen the impact on the real economy;  
(ii) a voluntary debt workout mechanism (Corporat e Debt Restructuring Committee) to aid large 
viable borrowers resolve non-performing loans;  a nd (iii) an asset management company (Danaharta) 
to help banks resolve impaired assets.  The work  of these state agencies is almost complete:  
                                                      
9 In 2003, total public sector debt accounted for 69% of GDP, of which domestic debt was 45.3% and 
external debt (medium and long-term debt) was 23.7%. In the same year, federal government debt was 47.9%, of which 38.4% was domestic debt and 9.5% external debt (of which market loans were 6.4%). IMF (2005a).  
10 See IMF (2005c).  
11 For example, net non-performing loans of commercial banks declined from 10.6% in 1998 to 6.9% 
by December 2004;  the commercial banks accounted for 74% of total ou tstanding non-performing loans.  WT/TPR/S/156 Trade Policy Review 
Page 8 
 
 
Danamodal Nasional Berhad closed in early 20 04, having strengthened commercial bank balance 
sheets through the injection of RM 7.6 billion during its  five years of operations;  the Corporate Debt 
Restructuring Committee, ended its operations in la te 2002;  and Danaharta had received 94% of its 
key recovery target of RM 30 billion as at end 2004,  and is on track to cease operations by end of 
2005. 
Financial sector 
19. The Government used the financial crisis as an opportunity to push through a restructuring of 
the financial sector, which was considered neces sary to ensure the emergence of strong, well-
capitalized institutions capable of competing eff ectively with foreign banks.  The Government's 
policies were guided by the ten-year Financial Sect or Master Plan unveiled in 2001.  The Plan is 
aimed at building competitive domestic banks, mainly  through banking consolid ation, and defers the 
introduction of new foreign competition until after 2007.   In addition to compulsory mergers, the 
central bank used stiffer capital requirements to strengthen lending institutions.  The so-called 
"anchor" banking groups, which resulted from the conso lidation of the sector,  were required to have 
minimum shareholder funds of RM 2 billion and assets of at least RM 25 billion by end 2001.  Foreign-owned banking institutions were also fo rced to increase capital funds to RM 300 million 
(from RM 20 million).  During the first three years of the plan, 31 of its 119 recommendations were 
fully implemented;  another 24 are being impl emented on a continuous basis.  The 2005 budget 
included new measures including opening stock br okering activities to foreign brokers (initially 
allowing international brokerage lic ences to be granted to five ma jor foreign brokerage firms), and 
allowing the entry of five global fund managers  and full foreign ownership of venture capital 
companies.  
20. During the review period, the asset quality of the banking system improved consistently.  A 
slowdown in new NPLs, better loan recovery, bad debt write-offs, and a widening loan base brought 
down the net NPL ratio of the banking system, based on six-month arrears, to 6.9%, the lowest level 
since the Asian financial crisis.  In addition, th e banking institutions' risk-weighted capital ratio, at 
13.7%, was considerably higher than the Basle minimum requirement of 8%.  
Corporate sector 
21. The corporate sector too has been strengthened si gnificantly since the crisis.  In particular, 
regulation concerning corporate governance and disclos ure has been strengthened.  The 1999 report of 
the High-Level Finance Committee, set up to develo p a framework for the enhancement of corporate 
governance, constitutes the Malaysian Code on Corporat e Governance.  This sets out the principles of 
best practices and recommends actions for stre ngthening the overall regulatory framework for listed 
companies.  The recommendations have been implem ented by:  updating laws , regulations, and rules 
in line with international best practices;  ame nding the listing requirements of the Kuala Lumpur 
Stock Exchange (renamed the Bursa Malaysia);   and developing accreditation programmes for 
directors of listed companies.  KLSE's, new listi ng requirements, launched in January 2001, focus on 
enhancing corporate governance and transparency, improving efficiency, strengthening investor 
protection, and promoting investor confidence. 
22. In 2001, the Government published a ten-year Capital Market Master Plan (CMMP) to 
establish an internationally competitive capital mark et, comprising the equity and bond markets.  The 
main objectives of the first phase of the plan  were to strengthen corporate governance and 
surveillance, to develop a broad corporate bond ma rket, to make fundraising more efficient and 
reduce transaction costs, to unite the existing exchanges and to boost the liquidity of the stock market.  
The second phase, which started in 2004, involves  the demutualization of the stock exchange, 
liberalization of stockbroking and investment mana gement, removal of structural impediments to Malaysia WT/TPR/S/156 
 Page 9 
 
 
market access, deregulation, enhancing secondary ma rket liquidity, and allowing greater international 
participation in the domestic capital market.  The capital market is becoming an important source of 
corporate finance;  total capitalization of the KLSE rose from 136% of GDP in 1998 to 163% in 2003, 
and the total number of companies listed increas ed from 736 to 906.  Corporate sector financial 
performance appears to have improve d overall during the review period. 
(b) Reform of government-linked companies   
23. The Government continues to play an active ro le in the development and industrialization of 
the Malaysian economy.  This includes significan t state investment, a number of policies and 
programmes to improve the economic status of indigenous communities12, and a close alliance 
between government and the private business sect or.  The "Malaysia Inc" model of close 
collaboration between the public and private sectors a dopted in the early 1980s, was a way of shifting 
from an agrarian resource-based economy to a dive rsified industrial one, w ith directly acquired 
private equity in companies and commercial banks  was an important part of that model.  
24. In May 2004, the Prime Minister announced a remaking of "Malaysia Inc", changing the 
relations between the Government and more than 40 partially state-owned firms, or Government-
Linked-Companies (GLCs).13  These play an important role in the Malaysian economy through the 
provision of critical services such as transporta tion, energy, telecommunications, and financial 
services.  This change, which got under way in 2005,  aims to consolidate the equities held by the 
Ministry of Finance (MoF) and Khazanah, wh ich was established by MoF in 1993 as the 
Government's investment arm, into one holdi ng company overseen by the latter;  introduce 
performance indicators;  install depoliticized and professional managers;  and enforce higher 
standards of corporate governance (see Chapter III(4 )(v)).  It appears that the Government expects 
GLCs to increase investment and spending to off set the shortfall arising from the Government's 
efforts to cut expenditure and reduce the budget defi cit.  The reforms also aim to prepare companies 
for privatization through rationalization and internal  reform.  According to the Government, GLCs 
play a critical role in the operation of virtually every commercial concern in Malaysia and improving 
their performance would benefit the compe titiveness of the economy as a whole.   
25. The Government has followed a privatization po licy since 1983, althou gh it still holds large 
equity stakes in a wide range of companies.  The 1997-98 economic downturn exposed weaknesses 
and problems in several privatized entities and the G overnment assisted a number of them, primarily 
for national or strategic reasons.  Industries th at received assistance include telecommunications, 
urban infrastructure, transportation, steel, and au tomobile production.  The Government also re-
acquired a number of previously privatized entiti es, including the national air carrier, Malaysian 
Airlines System (MAS), and Kuala Lumpur's light rail transit system.   
                                                      
12 Under the Government's 1971 New Economic Policy, the bumiputera majority were given 
preferential access to education, housing, jobs, business  licences, public sector c ontracts, government grants, 
bank credit, and share capital.   
13 According to press reports in early 2004, the joint holding of Ministry of Finance and Khazanah 
amounted to 72% of individual GLCs.  Other public se ctor entities with substantia l equity stakes included 
Petronas, the Employees Provident Fund, and Permodal Nasional Bhd (PNB), a non-financial public enterprise managing unit trusts and property trusts for the bumiputera community. WT/TPR/S/156 Trade Policy Review 
Page 10 
 
 
(c) Improving productivity 
26. Efforts to improve corporate governance and on- going reforms of GLCs are part of the 
broader move in the corporate sector to improve competitiveness.14  In its bid to address the 
challenges of transition into a more innovation an d knowledge-driven economy,  Malaysia is focusing 
on improving total factor productivity (TFP) growth.  
27. The Government's EMP aims for 7.5% annua l growth in 2001-05 with the objective of 
becoming a fully developed nation by 2020.  It wa s revised down to 4.2% in October 2003 after 
external shocks in 2001-03, led to a marked declin e in private investment and consumption.  Growth 
is expected to accelerate to 6% during 2004-05 led by  recovery in private sector demand and exports 
(Table I.3);  it will continue to be input-driven over 2004-05, although the contribution of TFP growth 
is expected to return to around 1.7% (Box I.1).  The projected increase in TFP growth is expected to 
be underpinned by continuous efforts at shifti ng production toward highe r-value-added goods and 
services, fostering innovation and addressing the shortage of skills.15  The challenge of moving from 
an input-driven to a productivity-driven growth stra tegy will be accentuated when Malaysia starts 
complying with new bilateral and regional tradin g rules between 2005 and 2008, which will further 
open its markets to competition. 
Table I.3 
Eighth Malaysia Plan, 2001-05 
(Per cent) 
 Original target Actual result Revised target 
 2001-05 2001-03 2004-05 2001-05 
 Contribution Share of 
total Contribution Share of 
total Contribution Share of 
total Contribution Share of 
total 
GDP 7.5 100.0 3.0 100.0 6.0 100.0 4.2 100.0 
Labour 1.6 21.5 1.2 40.0 1.7 28.6 1.4 32.6 
Capital 3.1 41.3 1.0 33.3 2.6 43.0 1.7 40.0 
TFP 2.8 37.2 0.8 26.7 1.7 28.4 1.1 27.4 
Source:  EPU (2003), Mid-Term Review of the Eighth Malaysia Plan 2001-05 . 
Box I.1:  National Productivity Corporation and estimate of Total Factor Productivity 
As part of its mandate to improve productivity in Malaysia, the National Productivity Corporation (NPC) 
estimates Total Factor Productivity (TFP) and sectoral pr oductivity trends in Malaysia. TFP, which reflects the 
efficiency with which all factors of production, including labour and capital, are used, is a useful measure of 
competitiveness.  It should be distinguished from la bour productivity, which is the amount of output per 
employee.   
According to the NPC, economic growth was driven to a co nsiderable extent by TFP in recent years.  Measures 
taken by the Government and private sectors, such as business restructuring, merging of financial and 
telecommunication institutions, benchmarking and skills upgrading have been successful in improving TFP 
growth. 
The main contributors to TFP growth between 1994 and 2004 were education and training (38.1%), demand 
intensity (27.6%), economic restructuring (13.2%), cap ital structure (12.5%) and technical progress (8.6%). 
Source:  National Productivity Corporation (2004), Productivity Report 2004 . 
                                                      
14 The Government has focused on a reform agenda to:  fight corruption;  improve delivery of 
government services, reduce red tape and lower the cost of doing business; improve the investment climate;  reduce barriers to trade in services;  and simplif y and improve the targeting of fiscal incentives. 
15 In a 2003 survey undertaken by EPU, skills shortage  was reported as the most important constraint 
for businesses, causing an estimated loss of 8-10% of potential manufacturing output  See Vision 2020 and 
Enhancing Competitiveness, paper presented in the JUSA series 28 No. 2/2003. Malaysia WT/TPR/S/156 
 Page 11 
 
 
(3) DEVELOPMENTS IN TRADE AND FOREIGN INVESTMENT  
28. Exports remain essential for Malaysia.  Merchandi se trade has grown by an average of 8.8% 
annually since 1994, with total exports of goods eq uivalent to 107% of nominal GDP in 2004, and 
imports equivalent to 89% .  As a small and open economy, Malays ia's international trade performance 
depends to a considerable extent on world growth  and expansion in global trade.  When stronger 
global growth in 2004 resulted in a 21% growth in Ma laysia's exports, imports also increased by 26%;  
imports of intermediate goods are largely used for exports. 
29. Since its last Review, Malaysia has intensif ied efforts to provide a conducive and cost-
competitive environment for foreign investors.  Malays ia's investment rules have been liberalized to 
allow foreign companies to own 100% of a compa ny and manufacturing companies no longer have to 
comply with equity or export conditions.  Other relaxations include expatriate employment policies 
for manufacturing and related services sectors.   
(i) Composition of trade 
30. Most of Malaysia's merchandise trade i nvolves manufactured goods (Chart I.1 and 
Tables AI.1 to AI.4).  Exports of manufactured good s accounted for 75.4% of Malaysia's total exports 
in 2004, down from 80% in 2001.  Office machines and telecommunications equipment continued to 
account for the largest export share in 2004 despite declining to 44.4% from 51% in 2001.  Electronic goods production is heavily dependent on imported pa rts.  The heavy dependence on electronic and 
electrical goods increases vulnerability to the fluctu ations in global demand for the products:  the 
surge in global demand for information and comm unication technology goods pulled Malaysia out of 
recession in 1999, but by 2001 it was hit by a downtur n in demand.  The export structure is relatively 
unchanged from that of 2001 with the major export ear ners being electronic integrated circuits, palm 
oil and palm oil-based products, which have benefited from increas ing average unit values and higher 
export volumes, chemicals and chemical products, crude petroleum, and liquefied natural gas.  
(ii) Direction of trade 
31. Malaysia's main trading partners continue to  be the United States, the EU (15), Japan, and 
Singapore, which together accounted for 55.7% of e xports and 52.9% of imports  in 2004 (Chart I.2).  
The United States remains Malaysia's largest export ma rket and its most important trading partner in 
aggregate.  Japan remains Malaysia 's principal source of imports alt hough its share of total imports is 
gradually declining as Malaysia diversifies its trad e and intensifies its regional trading links.  Trade 
between Malaysia and other East Asian economies continues to grow  and accounts for over half of 
Malaysia's exports and nearly two thirds of imports.  Malaysian trade figures are also affected by the 
expansion of port facilities in Malaysia, which h as taken entrepot trade away from Singapore.  
32. Growth in exports to ASEAN off set the decline of Malaysia's share in its key markets – the 
United States and Japan – and suggests there may be an  element of trade diversion.  Malaysia's export 
performance has been buoyed by high global demand for electronic and electrical products.  Higher 
prices and volumes of commodities such as palm oil, crude petroleum, and liquefied natural gas also 
played a role.  Malaysia's ASEAN neighbours absorbed  a quarter of its total exports in 2004, a share 
that is likely to grow with further liberalizati on of intra-ASEAN trade under the CEPT scheme.  An 
important change in trade patterns comes from the ri se of China, which was Malaysia's fifth largest 
single trading partner in 2004 with a 6.7% share of  exports and 9.9% share of imports.  China has 
become a significant market for Malaysian products , especially edible oils, rubber products, and 
electronic and electrical parts and components. 
 WT/TPR/S/156 Trade Policy Review 
Page 12 
 
 
Chart I.1
Product composition of merchandise trade, 2001 and 2004
2001 2004
(a)    Exports (f.o.b.)
Other consumer 
goods
7.3
Manufactures
80.0
Total:   US$88.0 billion Total:  US$126.5 billion
(b)    Imports (c.i.f.)
Chemicals
7.4Iron & steel
3.0Transport  equip.
4.1
Manufactures
82.0
Office machines &
 telecommunication equipment
37.8Other electrical
machines  
8.8
Non-electrical 
machinery
9.6Non-
electrical
machinery
7.7Other
3.1
Other electrical 
machines
7.4Office machines & 
telecommunication equipment
44.4
Other semi-
manuf.   4.2Transport equipment
4.9
Chemicals
8.1
Manufactures
80.2
Office machines &
telecommunication equipment
37.7
Total:   US$73.1 billion Total:   US$104.3 billionPer cent
Manufactures
75.4Other electrical
 machines
5.7Fuels
11.6Other electrical 
machines
5.6
Other consumer
 goods   6.8Other
3.1Mining
12.7
Office machines & 
telecommunication equipment
51.0Textiles &  clothing  
3.6Other
1.5
Other semi-
manuf.  5.8
Non-electrical 
machinery
3.1Agriculture
10.4
Fuels
9.7
Source :  UNSD, Comtrade database (SITC Rev.3).Other
  consumer goods
7.0Mining
10.0Other
consumer
 goods
8.0Textiles & clothing
  2.8
Other semi-manuf.
5.8
Non-electrical
machinery
3.1
Other semi-manuf.
  4.3Mining
10.7Agriculture
8.2
Agriculture
6.7Agriculture
6.6
Mining
8.3
Iron & steel
3.5Other mining  1.0
Other mining 
1.1Chemicals  4.3
Chemicals  
5.6Other 
1.1
 Malaysia WT/TPR/S/156 
 Page 13 
 
 
Chart I.2
Direction of merchandise trade, 2001 and 2004
2001 2004
(a)    Exports (f.o.b.)
Other East Asia
29.2
Total:   US$88.0 billion Total:  US$126.5 billion
(b)    Imports (c.i.f.)
Other 
5.8Philippines  2.5China
5.2
EC15
13.0Middle East
2.5Singapore
12.7United States
16.2
EC15
11.9China
9.9
    Thailand
5.6
Singapore
11.2United States
14.6
Total:   US$73.1 billion Total:   US$104.3 billionPer cent
Other East Asia
29.6
Middle East
2.7Japan
13.3
Middle East
2.4Korea,  Rep. of
5.0Korea, Rep. of   4.0United States
20.2South Asia  2.7
Oceania  3.7
Philippines  2.7  United States
18.8Other 
 4.8
Source :  UNSD, Comtrade database (SITC Rev.3).Japan
16.1China
6.7
Singapore
15.0
EC15
11.8China
4.3
Middle East 
2.1Singapore
16.9
Other East Asia
39.2Other East Asia
37.0Japan
19.4
Other
5.6Oceania  2.1  Hong Kong,
China
6.0
EC15
13.6Other
4.3Oceania  2.7Chinese Taipei
   3.6Hong 
Kong,
China
4.6Japan
10.1
Thailand
4.8South Asia  3.5
Thailand  4.0Oceania   2.6Chinese
 Taipei
5.5Chinese  Taipei
     5.7
Indonesia  3.1
Indonesia  4.0Thailand
3.8Chinese Taipei
   3.3
Korea, Rep. of   3.5Korea, Rep. of   3.3
ASEAN
24.2ASEAN
22.9ASEAN
25.1ASEAN
25.1
Other ASEAN
3.4Other ASEAN
3.1Other ASEAN
4.4
Other ASEAN
5.3
 WT/TPR/S/156 Trade Policy Review 
Page 14 
 
 
(iii) Trade in services 
33. Malaysia's exports of services reached US$18 billion in 2004 while imports amounted 
US$19.2 billion (Table I.4).  The services account of the balance of payments continues to be in 
deficit largely because of outflows for freight and insu rance, and repatriation of profits and transfers.  
The services balance tends to deteriorate when growth in the merchandise exports is strong.  
Repatriation of profits is inevitable, given Malaysia's  openness to FDI;  transfers are mainly related to 
expatriation of incomes by migrant workers.  Wh ile transportation and "other" services are generally 
in deficit, the surplus on the travel account – ac tivities related to tourism – offsets these to some 
extent.  Tourism has grown steadily since the late 198 0s and is now Malaysia's major services export.   
Table I.4 
Malaysia's trade in commercial services 
(US$ million at current prices) 
 2000 2001 2002 2003 2004 
Exports      
Commercial services 
(excl. government services) 13,812 14,331 14,753 13,459 18,006 
Transportation 2,802 2,748 2,855 2,767 3,151 
Travel 5,011 6,863 7,118 5,901 9,697 
Other commercial 
services 5,999 4,719 4,781 4,791 5,159 
Imports      
Commercial services 
(excl. government services) 16,603 16,539 16,248 17,323 19,151 
Transportation 5,890 5,736 5,892 6,260 8,022 
Travel 2,075 2,614 2,618 2,846 3,166 
Other commercial 
services 8,638 8,189 7,739 8,217 7,963 
Source: WTO database . 
(iv) Trends in foreign direct investment 
34. Global foreign direct investment (FDI) inflows increased sharply in the 1990s reaching a peak 
of US$l,388 billion in 2000.  A high share of the inflows were concentrated in high technology and 
telecommunications activities and US$3.8 billion were invested in Malaysia.  In U.S. dollar terms, 
FDI inflows into Malaysia then declined markedly  to 0.6 billion in 2001, before picking up to 
3.2 billion in 2002, falling to an estimated 2.5 billion in 2003.  Howe ver, FDI inflows rebounded 
strongly in 2004, almost doubling to an estimated US$4.6 billion with broad-based flows to all major 
sectors, namely services, manufacturing and the oil and gas sectors.16  Most of the inflows appear to 
involve earnings reinvested by existing multinationals. 
35. According to the Malaysian authorities, Malaysia  has a role as gateway to the ASEAN market 
and is offering incentives, including pioneer stat us and investment tax allowances, to foreign 
companies that use Malaysia as such a gateway.   The main foreign investors between 2000 and 2003 
were the United States with US$4.2 billion, Ge rmany (US$2.5 billion), Japan (US$2.2 billion), 
Singapore (US$1.7 billion), and the United Kingdom (US$1.3 billion), which together accounted for 
nearly 70% of total FDI in Malaysia.  
                                                      
16 IMF (2005a).  The Malaysian authorities did not prov ide data relating to FDI inflows.  Although no 
data are available on the breakdown between private domestic and foreign investment, the decline in private 
investment (from 30% of GDP in 1997 to 8% in 2003) has coincided with a decline in net FDI inflows (from 6% to 2% over the same period), according to the IMF.  See also UNCTAD (2004). Malaysia WT/TPR/S/156 
 Page 15 
 
 
36. The investment pattern for FDI is changing in li ne with Malaysia's effo rts to develop into a 
services-based economy.  Until 1997, inflows were predominantly directed at the export-oriented manufacturing sector and in particular electronics.  While the manufacturing sector accounted for two-thirds of FDI during 1993-97, its share declined to an average 38% during the period 1999-03.  
At the same time the share of services has risen in line with  moves towards a knowledge-based 
economy under the Eighth Malaysia Development Plan . Within services there has been a shift away 
from financial and business services towards wholesale and retail trade and hotels, transport and communications, and high value-added services e.g. regional headquarters and R&D. The 
Government is promoting new growth areas to diversify its manufacturing base and to counter 
competition from China in traditional manufacturing ac tivities.  Growth areas include information and 
communications technology (ICT), biotechnology,  optics, photonics, nanotechnology, medical 
devices, and advanced materials.  The authorities main tain that foreign investment remains crucial for 
Malaysia's industrial development as foreign inv estors bring technology transfer, capital, and access 
to international markets.  
37. China's rise as a global manufacturing base has siphoned off considerable foreign investment 
that in the last decade that might otherwise ha ve been destined for countries like Malaysia.  
Recognizing that Malaysia is no longer a cost-com petitive location for labour-intensive operations, 
the Government is encouraging labour-intensive  manufacturing to relocate to cost-competitive 
countries like China.  Malaysian companies invested US$3.1 billion in China for the period 1996-03.   
(4) O
UTLOOK  
38. Healthy foreign exchange reserves, a relativel y small external debt, as well as financial and 
corporate sector restructuring have improved Malaysia 's ability to withstand crises similar to that of 
1997.  Nonetheless, the economy remains vulnerable to  downturns in the United States, Europe, and 
Japan, its top export destinations and key sources of  foreign investment. The Government aims to 
balance the budget in the medium term, without cutting spending so much that it slows the economy too abruptly.  The near-term outlook is favourable with  real GDP growth projected to moderate to 5% 
in 2005 in line with global trends.
17  The Malaysian Government is developing its Ninth Malaysia 
Plan (2006 to 2010) and the Third Industrial Master Plan (2006 to 2015) to provide a continued framework for its overriding economic goal of achievi ng developed country status by 2020.  The main 
short term concern relates to lower than anticipated  growth in demand for Malaysia's exports due to 
the high world oil prices.  In the medium term, Malaysia is likely to remain vulnerable to the 
industrial countries' business cycle.  Domestically , a significant concern is the slower growth in TFP 
and continuing skills shortages.  On the other hand, sound macroeconomic policies and sustained 
structural reform efforts could diversify the industrial and export structure more rapidly than anticipated and strengthen Mala ysia's resilience to shocks. 
39. On the trade and investment front, import competition is expected to intensify as domestic 
barriers are dismantled through bilateral and regi onal FTAs and through WTO negotiations.  Malaysia 
expects trade with ASEAN to grow due to further liberalization of intra-ASEAN trade;  recognizing the increased competition from China, Malaysia is  focusing on higher valu e-added exports, while 
shifting some of its manufacturing operations to Ch ina and encouraging services exports. With respect 
to foreign investment, Malaysia recognizes that it h as a role as a gateway to the ASEAN market and is 
offering incentives to foreign companies.  A flex ible exchange rate regime, backed by sound 
economic fundamentals, may enhance investors' pe rception of the country and encourage inflows 
capital. 
                                                     
 
17 Asian Development Bank (2005) and Ministry of Finance (2005b).