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The Crisis and Policy Response

National Economic Recovery Plan
Chapter 1

Contents





Malaysia Prior to the Crisis

There are many favourable features of the Malaysian economy prior to the crisis in 1997. During the five years leading up to 1996, its real GDP growth averaged 8.7 per cent per annum, inflation was low around 3.8 per cent, and the unemployment rate for 1996 was only 2.5 per cent.

Unlike some other East Asian economies with high external debt, Malaysia has a relatively lower external debt of US$45.2 billion or 42 per cent of GDP as at June 1997. The debt service ratio was only 6.1 per cent of exports as at end-1996. The banking sector was healthy, with non-performing loans (NPLs) at only 3.6 per cent of total loans as at June 1997. The nationís saving rate at 38.5 per cent in 1996 is one of the highest in the world.

Although aggregate or macro numbers can sometimes mask some inefficiencies in the case of neighbouring countries, this was less so for the Malaysian economy. However, the nervousness of the market over some issues in countries such as Thailand, Indonesia and South Korea led to the ëcontagioní effect that brought the economic crisis to Malaysia and resulted in gross undervaluation of our exchange rate.

  • Causes for Concern

There were, however, some disturbing signs before the crisis. These are listed below:

  1. Economic Growth Above Potential Output.

    Since 1991, the economy has been consistently growing above what is deemed as its potential growth path. Zero output gap is when actual and potential GDP are equal in size. The output gap increased during 1994-96, as actual GDP grew faster than potential GDP. This has generated price pressures, especially in the form of wage increases above productivity gains. Instead of improvements to efficiency, growth during this period was primarily brought about through augmenting input, a situation that is clearly not sustainable in the longer term. It is a greater cause of concern when a significant proportion of these inputs (both capital and labour) was imported.



    Figure 1 : Total Factor Productivity Growth (%), 1987-1997

  2. Loss of Efficiency in the Economy.

    The efficiency in the utilisation of resources in the economy is indicated by estimates of Total Factor Productivity (TFP) and the incremental capital-output ratio (ICOR). Computations of TFP growth show that it had been declining over the years (Figure 1). Growth has been driven primarily by a high rate of capital stock accumulation. During 1995-97, the investment rate had been around 46 per cent of GDP. The ICOR rose from 3.0 in 1988 to 6.5 in 1997. The steeply rising ICOR, especially during the last 3 years, indicate that the use of capital have been increasingly less efficient. Had the ICOR been constant, one could argue that economic growth would have been much higher with the same amount of investment. The rising ICOR in recent years may also be due to increasing investments into capital-intensive projects with long gestation periods, leakages and initially underutilised capacity.

    Table 2: Savings-Investment Gap (RM million)
     

    1993

    1994

    1995

    1996

    1997 p

    Public gross domestic capital formation

    Public savings

    Deficit/surplus

    Private gross domestic capital formation

    Private savings

    Deficit/surplus

    Gross domestic capital formation

    (as % of GNP)

    Gross national savings

    (as % of GNP)

    Balance on current account

    (as % of GNP)

    23,760

    27,339

    3,579

    38,700

    27,195

    -11,505

    62,460

    39.8

    54534

    34.7

    -7,926

    -5.0

    24,833

    32,733

    7,900

    52,070

    29,400

    -22,670

    76,903

    42.5

    62,133

    34.4

    -14,770

    -8.2

    27,844

    32,763

    4,919

    67,305

    40,561

    -26,744

    95,149

    45.7

    73,324

    35.2

    -21,825

    -10.5

    27,970

    39,729

    11,759

    75,799

    51,788

    -24,011

    103769

    43.6

    91,517

    38.5

    -12,252

    -5.1

    32,183

    47,204

    15,021

    86,499

    58,078

    -28,421

    118,682

    45.1

    105,282

    40.0

    -13,400

    -5.1


    Source: Department of Statistics and Bank Negara Malaysia


  3. Rising Current Account Deficit. The deficit in the current account corresponds to the saving-investment gap. Despite having one of the highest savings rate in the world, Malaysia ran into current account deficit problems because of its high investment rate (Table 2). The investment boom led to the current account deficit, and when coupled with the declining efficiency in capital utilisation, is a legitimate cause of concern. The current account deficit was only partially financed by net long-term capital inflows for some of the years. At the same time, reverse investments have steadily increased from RM4.0 billion in 1993 to RM11.4 billion in 1996, an increase of 2.8 times. Malaysian investment overseas in 1997 was estimated at RM9.9 billion.

  4. Excessive Credit Expansion to the Non-Tradable Sectors.
    Since 1995, total loans had been growing at a rapid pace (Table 3).

    Table 3: Direction of Lending: Banking System and Financial Sector

     

    Total Outstanding Loans

    RM Millions

    Growth (%)

     

    y-o-y

    1990

    107,781

    23.9

    1991

    131,332.3

    21.9

    1992

    143,959.6

    9.6

    1993

    161,011.5

    11.8

    1994

    184,237.7

    14.4

    1995

    237,719.6

    29.0

    1996

    300,316.7

    26.3

    1997

    392,129.2

    30.6

    1997
    January

    329,824

    28.8

    February

    331,373

    27.9

    March

    344,701

    29.6

    April

    351,705

    28.5

    May

    359,047

    29.5

    June

    365,699

    30.0

    July

    369,485

    28.8

    August

    376,013

    28.6

    September

    384,796

    28.4

    October

    392,681

    28.4

    November

    398,545

    26.9

    December

    401,963

    25.9

    1998
    January

    425,093

    28.9

    February

    420,703

    27.0

    March

    420,168

    21.9

    April

    419,470

    14.7

    Source: Bank Negara Malaysia, Quarterly Bulletin

    The monthly total loans growth (year-on-year) was around 28-30 per cent in 1997, except for November and December. For most of 1997, loans to the property sector were growing above 30 per cent (year-on-year) and amounted to 26 per cent of total loans. Loans for the purchase of stocks and shares during 1993-97 grew at an average rate of 35 per cent per year. Following the rapid expansion of credit, private domestic debt escalated in the past few years.



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