This paper examines the evolution of monetary and fiscal policies in Malaysia from the 1970s through the aftermath of the 2008 global financial crisis. It traces Malaysia's shift from monetary aggregate targeting to interest rate targeting in the mid-1990s, the government's countercyclical fiscal strategies, and the role of Bank Negara Malaysia in maintaining price stability and exchange rate management. The paper also addresses Malaysia's privatization reforms, tax restructuring, and aspirations toward developed-nation status by 2020. Drawing on IMF assessments and Bank for International Settlements publications, the paper evaluates how Malaysia's policy framework enabled it to weather global economic shocks with relative resilience.
Malaysia is a small, trade-dependent economy with a high degree of foreign presence in both the real and financial sectors. Globalization and capital flows have therefore had a considerable impact on the operation of monetary policy in the nation. Over the last decade, Malaysia has had quite a diverse experience in its monetary policy operations, with alterations in the monetary framework being made mostly in response to global developments (Cheong, n.d.).
During the 1970s, the Malaysian government played a key role in the economy, venturing beyond its customary functions and taking on a more direct and active part in the nation's overall social and economic development. This era saw the government's direct involvement in the private sector through the founding of large commercial enterprises. Government participation in the economy expanded further in 1980–82 as it pursued an expansionary countercyclical fiscal policy designed to stimulate economic activity and support growth in order to ride out the effects of the global recession. The countercyclical policy led to double deficits in the government's fiscal position and the balance of payments. When confronted with this double deficit problem, the government implemented widespread structural programs to decrease spending, realigned national objectives to match domestic resource availability, and ensured prudence in its recourse to external borrowing (Vijayaledchumy, n.d.).
The development of Malaysia's monetary policy framework can be broadly characterized by two key developments: the shift in monetary policy strategy from monetary targeting toward interest rate targeting in the mid-1990s, and the subsequent changes in introducing more market-based monetary policy implementation procedures following the financial crisis.
Prior to the mid-1990s, monetary policy strategy had been founded on targeting monetary aggregates. This was an internal strategy and was not officially announced to the public. Its use was based on evidence that monetary aggregates were closely connected to the final objectives of monetary policy. Given that price stability was the primary objective of monetary policy, monetary targeting was seen as an appropriate intermediate target. Throughout this period, the central bank, Bank Negara Malaysia (BNM), influenced the daily volume of liquidity in the money market, consistent with the monetary growth target. This was intended to ensure that the supply of liquidity was adequate to meet the demands of the economy, in line with the Bank's monetary policy objective of price stability.
However, subsequent developments in the economy and financial system throughout the early 1990s weakened this relationship and highlighted the problems associated with using monetary aggregates as policy targets. As Cheong (n.d.) notes, "the globalization of financial markets had altered the money demand function, making the relationship between monetary aggregates and output as well as prices less stable. The large capital inflows in 1992–93, followed by a reversal in the following year, brought to the forefront the instability of monetary aggregates as targets."
With the fall of Lehman Brothers in September 2008, the subsequent global liquidity squeeze greatly affected Malaysia. U.S. dollar funding pressures resulted in sharply wider cross-currency basis swap spreads and irregular evidence of difficulty in accessing credit, along with intervention and some depreciation of the exchange rate in response to capital outflow pressures.
According to Alp, Elekdag, and Lall (2012), "BNM cut policy interest rates by 150 basis points to 2%, and reduced reserve requirements to ease financial intermediation costs. In addition to other financial policy measures, two fiscal stimulus packages were implemented to cushion the economy. The swift and comprehensive policy response, against the backdrop of robust financial and corporate sector balance sheets, helped cushion the downturn. Despite the very severe shock to the economy, output contracted relatively modestly before rebounding rapidly in 2010." This response demonstrated the effectiveness of coordinated monetary and fiscal intervention during a period of acute global stress. More information on this assessment is available through the IMF's published working papers.
"Countercyclical fiscal measures and medium-term consolidation"
"Post-independence financial structure and development ambitions"
"Privatization, tax reform, and reduced public borrowing"
Malaysia appears to have weathered the global financial crisis better than some. The country appears to be on the right track, with sound economic policies in place to continue recovering and strengthening its economic framework going forward.
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