MALAYSIA ECONOMIC MONITOR i MALAYSIA ECONOMIC MONITOR JUNE 2016 LEVERAGING TRADE AGREEMENTS Southeast Asia Country Management Unit Country Director: Ulrich Zachau Chief Economist: Sudhir Shetty Comments to: Mathew A. Verghis mverghis@worldbank.org Rafael Muñoz Moreno rmunozmoreno@worldbank.org Sasana Kijang No. 2, Jalan Dato’ Onn 50480 Kuala Lumpur, Malaysia +60 (3) 2263 4900 www.worldbank.org/my Acknowledgements This edition of the Malaysia Economic Monitor was prepared by Rafael Muñoz Moreno (task team leader), Sjamsu Rahardja and Smita Kuriakose (lead authors, chapter on leveraging trade agreements), Shakira Teh Sharifuddin, Karuna Ramakrishnan, Guillermo Arenas, Mauro Boffa, Maryla Maliszewska, Nadia Rocha, Daria Taglioni, Zoryana Olekseyuk, Sufian Jusoh, Claire Honore Hollweg, Massimiliano Cali, Chunlin Zhang, Ronald Ping Hei Wu, Martha Martinez Licetti, Graciela Miralles Murciego, Guilherme De Aguiar Falco, Martin Molinuevo, Lillyana Sophia Daza Jaller, Anne Katrin Pfister, Sebastian Saez, Hiau Looi Kee, Barbara R Kotschwar, Laura Dachner, Roberto Echandi, Syed Akhtar Mahmood, Xavier Forneris, Daniela Gomez Altamirano, Julian Latimer Clarke, Priyanka Kher, Ioannis Vasileiou, Jose de Luna Martinez and Sergio Campillo Diaz, under the overall guidance of Ulrich Zachau, Faris H. Hadad-Zervos, Sudhir Shetty, Mathew Verghis, Mona Haddad, Shabih Ali Mohib and Lars Sondegaard. This report benefited from fruitful discussions, comments, and information from various sections of the Economic Planning Unit in the Prime Minister’s Department, the Economics Department of Bank Negara Malaysia, the Department of Statis tics Malaysia, the Ministry of Finance, the Ministry of International Trade and Industry, SME Corp. and many other Government ministries and agencies. We also thank representatives from the Federation of Malaysian Manufacturers, Penang Institute, Malaysia Institute of Strategic and International Studies, and analysts at several financial and rating institutions for helpful discussions. We are indebted to the International Cooperation Section of Economic Planning Unit for their ongoing collaboration with the World Bank and in particular their extensive support in the launch of this report. Leonora Aquino Gonzalez, Paul Risley, Kanitha Kongrukgreatiyos, Ben Alex Manser, Ching Thut Chan and Buntarika Sangarun provided excellent assistance in external relations, web production and cover design. Mei Ling Tan, Gillian Gan, and Alan Lau Sie Ping provided outstanding additional support. Photo credits: Nafise Motlaq. The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The report is based on information current as of June 21, 2016. i ABBREVIATIONS 1MDB 1 Malaysia Development Berhad AEC ASEAN Economic Community ACIA ASEAN Investment Agreement ACTFA ASEAN-China Investment Agreement ACTS ASEAN Customs Transit System ADB Asian Development Bank AFTA ASEAN Free Trade Area AKPK Credit Counselling and Debt Management Agency APEC Asia-Pacific Economic Cooperation ASEAN Association for Southeast Asian Nations ATIGA ASEAN Trade in Goods Agreement AVE Ad-Valorem Equivalent B40 Bottom 40 percent of the population BITs Bilateral Investment Treaties BNM Bank Negara Malaysia BR1M Bantuan Rakyat 1 Malaysia CEIC Census and Economic Information Center CENFOTUR Centro de Formación en Turismo CGE Computable General Equilibrium COFIDE Corporación Financiera de Desarrollo S.A. CORFO Corporación de Fomento de la Producción de Chile CPI Consumer Price Index CPO Crude Palm Oil CSS Country State-Owned Enterprise Shares DE Development Expenditure DOSM Department of Statistics Malaysia E&E Electrical and Electronics EAP East Asia and Pacific EP Employment Pass EU European Union FAT Technical Assistance Fund Chile FDI Foreign Direct Investment FIC Foreign Investment Committee Malaysia FONTEC Fondo nacional de desarrollo tecnológico y productivo FTA Free Trade Agreement FTAAP Free Trade Agreement of the Asia Pacific G&S Goods and Services GATS General Agreement on Trade in Services GDP Gross Domestic Product GEMS Graduate Employability Management Scheme GEP Global Economic Prospects GFCF Gross Fixed Capital Formation GLCs Government-Linked Companies GLCT GLC Transformation Programme GST Goods and Services Tax GTAP Global Trade Analysis Project GVC Global Value Chain HIPs High Impact Programs HRDF Human Resources Development Fund Malaysia ICSID International Centre for Settlement of Investment Disputes ICT Information and Communications Technology IIA International Investment Agreements ILMIA Institute for Labour Market Information and Analysis ILO International Labour Organisation IP Intellectual Property IPR Intellectual Property Rights ii ISDS Investor-State Dispute Settlement ISIS Institute for Strategic and International Studies Malaysia IT Information Technology LCR Liquidity Coverage Ratio LNG Liquefied Natural Gas LPG Liquefied Petroleum Gas LRT Light Rail Transit M&E Monitoring and Evaluation MAFTA Malaysia-Australia Free Trade Agreement MdI Malaysia Department of Insolvency MFN Most Favoured Nation MHPI Malaysian House Price Index MICECA Malaysia-India Free Trade Agreement MIDA Malaysian Investment Development Authority MIDF Malaysian Industrial Development Finance Berhad MIER Malaysian Institute of Economic Research MITI Ministry of International Trade and Industry Malaysia MNZFTA Malaysia-New Zealand Free Trade Agreement MoF Ministry of Finance Malaysia MONP Movement of Natural Persons Supplying Services under the Agreement MPC Malaysia Monetary Policy Committee MPOB Malaysian Palm Oil Board MRA Mutual Recognition Agreements MRT Mass Rapid Transit MTEF Medium-Term Expenditure Framework MyCC Malaysian Competition Commission NAFTA North American Free Trade Agreement NFPCs Non-Financial Public Corporations NOAA US National Oceanic and Atmospheric Administration NT National Treatment NTBs Non-Tariff Barriers NTM Non-Tariff Measure OBB Outcome Based Budgeting OE Operating Expenditure OECD Organisation for Economic Cooperation and Development OFIO Office of Foreign Investment Ombudsman Korea PDS Private Debt Securities PIAs Plurilateral Investment Agreements PISA Program for International Student Assessment PMI Purchasing Managers' Index PMT Proxy Means Test PPI Producer Price Index PROFO Proyectos Asociativos de Fomento PTA Free and Preferential Trade Agreements PVP Professional Visit Pass PwC Pricewaterhouse Coopers R&D Research and Development RCEP Regional Comprehensive Economic Partnership REER Real Effective Exchange Rate RTA Regional Trade Agreement SDP Supplier Development Program SDR Special Drawing Rights SIP Structured Internship Program SITC Standard International Trade Classification SME Small and Medium Enterprise SPS Sanitary and Phyto-sanitary Regulations SRR Statutory Reserve Requirement STR Service Trade Restrictiveness Index iii TalentCorp Talent Corporation Malaysia TBT Technical Barriers to Trade TIMSS Trends in Mathematics and Science Study TNC Trans National Corporation TPP Trans-Pacific Partnership TRIMs Trade-Related Investment Measures TRIPS The Agreement on Trade-Related Aspects of Intellectual Property Rights TVET Technical Vocational Education and Training UNCITRAL United Nations Commission on International Trade Law UNCTAD United Nations Conference on Trade and Development USD United States Dollars USDA United States Department of Agriculture USDA-FAS United States Department of Agriculture Foreign Agricultural Service VP Visit Pass WBG World Bank Group WTO World Trade Organisation iv TABLE OF CONTENTS EXECUTIVE SUMMARY ......................................................................................................................................................... 1 The Malaysian Economy in Pictures................................................................................................................................. 4 LEVERAGING trade agreement in Pictures .................................................................................................................... 5 1. Recent economic developments and outlook............................................................................................... 6 Malaysia’s GDP growth remained resilient in 2015 despite external headwinds .............................................. 6 Domestic demand continues to be the anchor for growth ................................................................................. 8 Manufacturing exports continued to increase strongly in 1Q 2016 ................................................................... 12 Despite lower oil-related fiscal revenues fiscal consolidation continues .......................................................... 14 Banking system’s health remain strong ................................................................................................................... 16 Overall lending remains supportive of economic activity .................................................................................. 16 The ringgit has strengthened in 1Q 2016 as external outflows reversed on improved investor sentiment . 19 Growth of the Malaysian economy is expected to moderate slightly in 2016 ................................................ 21 Domestic demand will continue to anchor economic growth in 2016 ............................................................ 22 Current account surplus is expected to narrow further in 2016 .......................................................................... 23 Monetary policy and financial conditions will remain supportive of economic growth ............................... 25 Fiscal policy will continue on its consolidation path, though some challenges remain ................................ 25 Potential risks to the Malaysian economy in the near horizon ............................................................................ 26 2. Leveraging Trade Agreements .................................................................................................................... 27 Strategic Relevance of Trade Agreements for Malaysia’s Successful Development .................................... 27 Trade is behind much of the employment creation in Malaysia .................................................................. 33 Implementing the new trade agreements can accelerate key economic reforms ..................................... 34 Services’ exports remain underexploited ............................................................................................................... 37 New trade agreements may not be binding enough to liberalise services sectors ....................................... 42 Implementing a plan that liberalises the services sector would further support export growth ............. 48 Investment Policy and Investment Protection ....................................................................................................... 50 New generation trade agreements such as the TPP can bolster FDI as well as investments abroad ... 50 Higher standards for Investor State Dispute Settlement under TPP can further improve the investment climate..................................................................................................................................................................... 54 A domestic “grievance mechanism” can reduce the risk of legal disputes developing into ISDS cases ........................................................................................................................................................................ 57 Competition Policy and GLCs .................................................................................................................................. 58 The new trade agreement will impact GLCs and can be leveraged in a more fundamental way for increased domestic dynamism and international competitiveness ............................................................ 58 Compliance with the TPP in the medium term will require a plan to set a more equal playing field for private sector vis-à-vis GLCs ................................................................................................................................ 63 Small and Medium Enterprises .................................................................................................................................. 65 Trade agreements can offer SMEs new trade and investment opportunities ........................................... 65 Raising productivity of SMEs and linking them with Global Value Chains will help SMEs to gain from trade agreements ................................................................................................................................................. 67 SMEs would benefit from a tailor-made legal and regulatory environment that serves their purpose . 71 Malaysian SMEs need to boost their innovative activity ................................................................................ 71 Annex 1: Non-tariff Measures .................................................................................................................................... 76 TPP’s main income gains will come from countries streamlining their no n-tariff measures ..................... 76 Malaysia can work together with other signatories in trade agreements on mutual recognition and risk management in SPS, TBT, and strengthen procedures for issuing new NTMs ....................................... 79 Annex 2: Summary of Results from Different Models about the Impact of TPP ............................................... 80 Annex 3: Comparison of Commitments for the Temporary Entry of Business Persons .................................... 82 Annex 4: Laws governing NTMs in Malaysia ........................................................................................................... 86 Annex 5: Estimating ad valorem equivalent of NTMs ........................................................................................... 90 Annex 6: Areas of potential large gains for SMEs as part of TPP ......................................................................... 91 Annex 7: Snapshot of the Malaysian Economy ..................................................................................................... 93 REFERENCES ....................................................................................................................................................................... 94 v BOXES Box 1: The Impact of El Niño on Malaysia’s Agriculture Sector .................................................................................. 7 Box 2: Cost of Living in Malaysia ..................................................................................................................................... 11 Box 3: Credit Resolution Mechanism in Malaysia ........................................................................................................ 17 Box 4: Summary of Results from Different Models About the Impact of TPP on Malaysia ................................... 32 Box 5: Depth of Commitments under Different Trade Agreements......................................................................... 35 Box 6: Two Key Services Strategies ................................................................................................................................. 38 Box 7: Malaysia’s Main Obligations in Trade in Services in the TPP - The Novelty of “Negative-Lists” ............... 42 Box 8: Malaysia’s Main Obligations in Movement of Temporary Business Persons ............................................... 47 Box 9: Strengthening Coordination and Reform in Services - Experiences from Chile and Peru ...................... 49 Box 10: Malaysia’s Reservations in TPP Investment Chapter ..................................................................................... 53 Box 11: Malaysia’s Experience with ISDS ....................................................................................................................... 56 Box 12: Reducing Barriers for SMEs in ASEAN ................................................................................................................ 70 Box 13: Government Support Programs that Increase SME Competitiveness in Chile ........................................ 72 Box 14: Tasks and Responsibilities of the National NTM Committee (ASEAN Work-Program on NTMs) ............. 79 FIGURES Figure 1: Malaysia’s GDP growth moderated in 2015 and into 1Q 2016 .................................................................. 6 Figure 2: …as growth in the region and EME remained subdued alongside soft external demand. ................. 6 Figure 3: Private consumption continues to be the key driver of growth ................................................................. 9 Figure 4: The average investment-to-GDP ratio moderated on lower expenditures in oil and gas ................... 9 Figure 5: The unemployment rate remains low, but labour force and employment growth decelerated ..... 10 Figure 6: Wage growth in manufacturing sector remains strong ............................................................................. 10 Figure 7: Headline inflation peaked in February 2016 ................................................................................................ 11 Figure 8: …driven by electricity tariff adjustments and base effect fr om lower fuel prices ................................ 11 Figure 9: Commodity exports posed larger decline as oil prices continued to decline ...................................... 13 Figure 10: Demand from the US helped to support manufacturing exports .......................................................... 13 Figure 11: The current account surplus narrowed further… ...................................................................................... 13 Figure 12: … as lower commodity prices led to a narrowing of the commodity surplus ..................................... 13 Figure 13: Fiscal consolidation continued despite lower oil-related revenues ...................................................... 15 Figure 14: The dependency on oil-related revenues continues to decline ........................................................... 15 Figure 15: Wage bill continues to be higher than the budgeted amount ............................................................. 15 Figure 16: Non-financial public corporations (NFPCs) continued to provide capital outlays ............................ 15 Figure 17: Net impaired loans of the banking system remains low .......................................................................... 16 Figure 18: Banking system’s liquidity remains ample and above the minimum LCR requirement .................... 16 Figure 19: Individuals’ Bankruptcy Cases in Malaysia ................................................................................................ 18 Figure 20: Categories of individuals Bankruptcy Cases in Malaysia ........................................................................ 18 Figure 21: Growth in working capital loans continues to drive business credit expansion .................................. 19 Figure 22: Household loan growth continued to decline mainly in the riskier segments ..................................... 19 Figure 23: Portfolio inflows have re-entered… ............................................................................................................. 20 Figure 24: …and foreigners appetite for government bonds rose .......................................................................... 20 Figure 25: Real effective exchange rate appreciated in line with other countries in the region ...................... 20 Figure 26: Reserves have recovered as financial inflows returned .......................................................................... 20 Figure 27: The median consensus forecasts for 2016 continued to moderate since 2H 2015 ............................ 23 Figure 28: Inflation projected to be between 2.5-3.0 percent in 2016 .................................................................... 23 Figure 29: PMIs further deteriorated across the board in 2015….............................................................................. 24 Figure 30: …dampening the outlook for Malaysian export growth ......................................................................... 24 Figure 31: The current account surplus is expected to narrow................................................................................. 24 Figure 32: Trade contribution to Malaysia GDP is above that of other East Asia countries ................................ 28 Figure 33: Malaysia has been gaining market share in exports ............................................................................... 28 Figure 34: Malaysia’s Network of Free and Preferential Trade Agreements .......................................................... 28 Figure 35: Non-negligible amount of Malaysian exports to the US are still subject to more than 5 percent MFN rate ...................................................................................................................................................................................... 29 vi Figure 36: FDI inflows have diversified in line with trade agreements .................................................................... 29 Figure 37: FDI growth in Malaysia has trailed that of comparator countries ......................................................... 30 Figure 38: Malaysia’s growth of labour productivity trails that of comparator countries .................................... 30 Figure 39: Economic impact of TPP for Malaysia is expected to be positive ........................................................ 31 Figure 40: Income gains in Malaysia will likely come from removal of NTMs ........................................................ 31 Figure 41: Malaysia is expected to have large sector specific gains by joining TPP, RCEP and FTAAP ............ 31 Figure 42: Malaysia’s trade and investment openness has translated into higher labour earnings and jobs . 33 Figure 43: Malaysia’s services contributions to exports trail that of other EAP countries ..................................... 39 Figure 44: The indirect share of domestic services va lue added embodied in Malaysia’s gross exports falls significantly below that of other countries ................................................................................................................... 39 Figure 45: Malaysia’s services sector contributed relatively less to services and retained we ak linkages to manufacturing activities .................................................................................................................................................. 40 Figure 46: Malaysia’s low use of services by manufacturing is most notable in these sectors ........................... 41 Figure 47: Services inputs for manufacturing exports in Malaysia that are most important are trade, finance and utility supply ............................................................................................................................................................... 41 Figure 48: Services sector in Malaysia is still relatively more restricted to foreign providers, compared to primary and manufacturing sectors ............................................................................................................................................ 43 Figure 49: Most services sector face some degree of restrictiveness ...................................................................... 43 Figure 50: Some distribution services face a number of restrictions on entry ........................................................ 44 Figure 51: Reviewing horizontal measures applied to services sectors can boost investment attractiveness and competitiveness of the services sector ................................................................................................................ 45 Figure 52: Undisclosed measures make up a significant share of restrictions related to the “establishment” and “operation” of foreign service providers .............................................................................................................. 45 Figure 53: Some key services sectors appear to be fully committed to the terms of TPP, while others remain heavily restricted........................................................................................................................... 46 Figure 54: Malaysia’s FDI performance has consistently surpassed the regional average ................................. 50 Figure 55: Services sector is an increasingly important source of FDI ...................................................................... 50 Figure 56: Malaysia has a significant presence in greenfield projects and mergers and acquisitions ............. 52 Figure 57: Malaysia may gain of TPP members further liberalizing NTMS ................................................................ 52 Figure 58: SME’s share of direct exports in any given sector, account for less than 35 percent of exports ..... 66 Figure 59: Share of SMEs’ direct exports in electrical equipment, machinery, and other manufacturing – is less than 5 percent .................................................................................................................................................................. 66 Figure 60: Almost half of SMEs exports were directed to TPP countries in 2014 ..................................................... 67 Figure 61: Main destination of SMEs exports in 2014 were Singapore, US and Japan .......................................... 67 Figure 62: Beyond textiles, gains are expected to happen in activities where SMEs are not yet present ....... 68 Figure 63: Labour productivity gap in SME is large… ................................................................................................. 69 Figure 64: … and it is crucial for the gap to be reduced .......................................................................................... 69 TABLES Table 1: GDP - Seasonally Adjusted Annual Rate (saar, q/q, percent) .................................................................... 9 Table 2: Summary – Selected External Sector Indicators ........................................................................................... 14 Table 3: Slower growth is expected in 2016 as private consumption cools… ....................................................... 21 Table 4: …but domestic demand will continue to drive growth. ............................................................................ 21 Table 5: Summary - Federal Government Finance (RM billion) ................................................................................ 22 Table 6: Total labour value added and job share of exports, 2011 ......................................................................... 34 Table 7: Disciplines beyond tariff elimination covered in selected FTA and PTAs of Malaysia ........................... 35 Table 8: Fostering Competition in Markets ................................................................................................................... 59 Table 9. Statistics for Manufacturing SMEs by Sector (2010) ..................................................................................... 65 Table 10. Number of Manufacturing Establishments by Sector (2010) ................................................................... 66 Table 11: Laws and regulations on NTMs in Malaysia ................................................................................................. 76 Table 12: Type of NTMs in Malaysia................................................................................................................................ 77 Table 13: Estimated ad valorem equivalent of Malaysia’s NTMs across broad sectors....................................... 78 Table 14: SMEs Participation in Main Supplying Industries for Storage Devices and Electronic Integrated Circuits ......................................................................................................................................... 91 vii viii EXECUTIVE SUMMARY RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK is expected to remain stagnant amid low commodity prices and weak global growth. However, a well- Malaysia’s economy has remained resilient to diversified export base, mainly in manufacturing external headwinds. The economy grew by 4.2 goods, continues to provide support for exports. percent in 1Q 2016 (seasonally adjusted annual rate Import growth will also moderate in line with lower (saar), q/q), after 6 percent in 2014 and 5 percent in export and investment growth. Against this backdrop, 2015. Robust private consumption anchored the current account surplus is expected to moderate economic growth, supported by higher utilities to 2.1 percent of GDP in 2016 from 3.0 percent in 2015 spending and special cash transfers from the (2014: 4.4 percent). government. Private consumption growth mitigated the decline in private investment, particularly in the oil Monetary policy and financial conditions continue to and gas sector. Sluggish demand for commodities support economic growth. Despite peaking in 1H also led exports to decline by 17.2 percent (saar, q/q) 2016, inflation is projected to be between 2.5 percent in 1Q 2016. - 3.5 percent in 2016, with no anticipation of second round effects. The financial system remains strong Gross Domestic Product (GDP) growth is projected to and overall lending remains supportive of economic be 4.4 percent in 2016. This projection compares with activity. Exchange rate flexibility should remain the the estimate of 4.5 percent in the December 2015 main shock absorber in the economy. Economic Monitor. It reflects a gradual deceleration in private consumption growth as a result of a softer Growth of the Malaysian economy faces risks, mainly labour market, and continued households’ from external developments. The main risks stem from adjustment to fiscal consolidation. Private investment the uncertainty over the global growth outlook and growth is also expected to moderate, as commodity its impact on Malaysia’s exports and commodity prices and global economy growth remain subdued. prices. Investor sentiments could be affected by Subsequently, Malaysia’s GDP is expected to grow at uncertainly in global financial markets, which could 4.5 percent and 4.7 percent in 2017 and 2018, be further reinforced by domestic developments. In respectively as commodity prices recover and global an adverse scenario, a sharp adjustment among economic growth improves. households due to a steep decline in real income growth and/or a weakening of the ringgit could Fiscal consolidation remains on track despite lower eventually have spill-over effects on overall consumer oil-related revenues. The federal government confidence sentiments, slowing economic growth achieved its fiscal deficit target of 3.2 percent of GDP significantly. in 2015 (2014: 3.4 percent of GDP). Despite a significant drop in revenues from lower oil prices, the While macroeconomic management has been solid, government’s decisive reduction in operating Malaysia’s main challenge—and opportunity—lies in expenditures was instrumental in achieving the fiscal accelerating structural reforms. The key for consolidation target. The implementation of the macroeconomic policy is to ensure sound fiscal Goods and Services Tax (GST) in April 2015 balances, with adjustments continuing as needed. compensated for the decline in oil-related revenues. Targeted social assistance and unemployment The 2016 public budget and the budget recalibration benefits will likely prove to be more cost effective in January 2016 introduced additional fiscal measures than income measures to support private to respond to falling oil prices, further containing consumption, such as through significant wage public expenditure and building up additional buffers increases, which would likely be difficult to sustain in should public revenues fall. the long turn. Recent trade agreements can facilitate the implementation of key domestic structural reforms. The narrowing of the current account surplus is expected to continue in 2016. Overall export growth MALAYSIA ECONOMIC MONITOR JUNE 2016 » 1 LEVERAGING TRADE AGREEMENTS advances in new areas, such as competition policy, government procurement, investment-state disputes, Trade has been an engine of growth for Malaysia in and investment policies. the last four decades. Malaysia is one of the most open economies in the world, with a trade to GDP Implementation of these trade agreements does not ratio of 136.3 percent (average 2010 - 2014) automatically translate into economic gains. Despite compared to 58 percent in developing countries in the intention to promote deeper liberalisation, trade East Asia and Pacific. Malaysia has benefited from agreements went through intense negotiations and foreign direct investment above the average of bargaining processes which introduced carve outs to upper and middle income countries. Over time, the protect domestic interests and provide policy space export basket has deepened and diversified out of for governments to regulate. For example, TPP commodities into manufacturing. commitments in services offer little commitments for new liberalisation while exemptions are given to GLCs Openness to trade and investment has been and government procurement. Also, trade instrumental in employment creation and income liberalisation may adversely affect businesses that growth. About 40 percent of jobs in Malaysia are have benefited from state protection or those with linked with export activities and total wages limited capacity to adapt to a more competitive supported by exports have quadrupled from USD13.2 environment. billion in 1995 to USD54 billion in 2011. These trade agreements can facilitate reforms to Trade agreements have been in large part support Malaysia’s transition to become a high responsible for Malaysia’s economic development. income nation. Achieving high income status will Malaysia has been a key player in trade negotiations, involve advances in overcoming key constraints, as reflected by the 14 free trade agreements signed such as the following: by the country. These agreements have reduced tariffs, facilitated market access, and have opened  Services: In terms of services contribution to GDP Malaysia to inward and outward direct investment. and exports, Malaysia still trails many EAP countries. An efficient services market is Malaysia has embarked on a wave of “new essential in enhancing the country’s generation” trade agreements that will set trade and competitiveness by supporting other export investment rules over the next few decades. Mega sectors. For instance, the value of services regional trade agreements, such as the Trans-Pacific embedded in gross manufacturing exports was Partnership (TPP), Malaysia-EU FTA (MEUFTA), and 12 percent in Malaysia, compared to 28 Regional Comprehensive Economic Partnership percent in Japan, 25 percent in the United (RCEP) come with deeper commitments beyond States and 22 percent in Canada. those already set by the multilateral trading system of  Investment: Improved investment policies can the WTO. They include areas such as competition further support Malaysia’s business environment policy, government procurement, investment policies and help to attract a new wave of FDI that and investors’ protection, intellectual property rights, supports the country's economic diversification. labour standards, and Government-Linked Furthermore, as Malaysia becomes more Companies (GLCs). integrated with the global economy, the new These new trade agreements open up opportunities trade agreements do provide additional for Malaysia to move up the value chain, diversify its investment safeguards for domestic firms exports, and create more and better jobs for its investing abroad. For example, the Investor workers. First, they widen Malaysia’s market access to State Dispute Resolution mechanism. large trade partners (i.e. TPP represents 40 percent of  Competition: A more open and level playing global GDP), potentially opening new opportunities field in the domestic economy facilitates the for FDI and trade in services. Second, commitments in entry of new firms, and a reallocation of these agreements go beyond trade—they can have resources to more productive companies. a significant positive impact on attracting investment, Competition provides strong incentives to including investment that spurs innovation and innovate, raise productivity and create jobs- technological upgrading. They can also spur policy issues at the core of the 11th Malaysia Plan. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 2  SMEs: SMEs in Malaysia represent 97.3 percent of  Continued implementation of policies that firms and accounted for 35.9 percent of GDP in increase competition can create a level playing 2015 but they only account for 17.8 percent of field for the private sector. Malaysia has exports. They are substantially less productive negotiated significant carve-outs on than large firms which limit their capacity to Government Linked Companies (GLCs) in the integrate into the global value chain. Thus, TPP agreement that provide time for these undertaking productivity enhancing reforms incumbents and the market structure to adapt that enable SMEs to compete effectively in the to heightened competition. In the short term, it global market would be essential. will be important to assess the impact that the different sector chapters may have on the GLCs The new trade agreements can strategically support participating in them. Also, it will be important to reforms in the areas mentioned above. Such reforms design an action plan to cover the transition have high payoffs, because they broaden market period. In the medium term, the Malaysia access and could also lead to higher investment. Competition Commission (MyCC) can Moreover, they are facilitated by firm-level incentives, implement existing regulations to prevent as heightened foreign competition will raise the need designated monopolies from engaging in anti- for less-performing firms to adjust. competitive practices and to foster compliance Malaysia has several policy options that can with competition-related commitments under complement its commitments under the new the TPP. MyCC may consider working together agreements to help ensure wider benefits. with Khazanah Nasional and the Government Investment Companies Division at the Treasury  In the short term, to the extent that Malaysia’s to ensure smooth implementation of the applied policies in services trade may remain competition related measures in relation to more restrictive compared to other countries in GLCs. the TPP—notwithstanding the recent  It will be critical to address the constraints that liberalisation of foreign ownership limits—the SMEs face in order to raise productivity and reap Economic Planning Unit (EPU) may consider the benefits of emerging trade opportunities. In strengthening the coordination mechanism for the short term, SME Corp. Malaysia can carry the implementation of the Services Blueprint to out a preliminary assessment of the boost competitiveness of the services sector. In implementation of the SME Masterplan to assess the medium term, the Ministry of International its effectiveness. This initiative can help ensure Trade and Industry (MITI) can further review that the programs being put in place are being policies affecting the establishment and targeted at the right SMEs and are being operations of foreign services providers. effectively implemented to realise their  The new trade agreements facilitate intended objectives. It can be complemented improvements in the business environment that with a review of current R&D support programs Malaysia offers to foreign investments. In the that are administered by various agencies, to short term, MITI may consider establishing a ensure that SMEs get adequate support. mechanism to domestically handle investors’ Supplier development programs, such as the grievances to ensure compliance of existing Supplier Development Program in Chile have policies with commitments on the investments also proven useful to raise the capacity of SMEs chapter and decrease the risk of ISDS cases, to participate in global value chains. In the which can be based either at the Malaysian medium term, a continued focus on an Investment Development Authority (MIDA) as enabling regulatory framework will be key, to part of the investor after care service or through foster strengthened competition, and to an independent ombudsman office within MITI. facilitate the bankruptcy process to allow Furthermore, the Malaysia Productivity entrepreneurs to reinvent their businesses and Corporation can strengthen its capacity to take more risk. conduct regulatory impact analysis on existing or proposed new policies affecting trade in goods and services. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 3 The Malaysian Economy in Pictures GDP growth moderated in 2015… …and growth for 2016 is expected to moderate further Real GDP, seasonally adjusted, annualised change from last Change from the previous year, percent quarter, percent 8.0 7.4 q/q SAAR,% y/y, % 7.0 5.9 8.0 7.6 7.2 6.0 6.0 7.6 5.3 5.5 7.0 6.2 5.9 6.3 6.1 5.0 4.8 4.7 5.0 4.4 4.5 4.7 5.7 5.8 5.7 6.0 4.0 4.8 5.0 5.0 3.0 4.1 4.2 3.8 3.5 2.0 4.0 1.0 3.0 0.0 2.0 -1.0 1.0 -2.0 -1.5 0.0 -1.0 -0.1 Growth is mainly driven by private consumption… …as exports continue to be weighed down by low Contribution to growth, year-on-year commodity prices 12.0 Change in export volumes of past three months from the previous year, percent 10.0 Rubber 60.0 Crude oil 8.0 50.0 LNG 6.0 40.0 Palm oil & products Petroleum products 4.0 30.0 2.0 20.0 0.0 10.0 0.0 -2.0 Private consumption Fixed investment -10.0 -4.0 -20.0 Change in inventories Government -6.0 -30.0 Net exports Real GDP -8.0 -40.0 The government’s fiscal consolidation remains on track The current account surplus is expected to narrow further Federal Government balance, percent of GDP Percent of GDP 18.0 17.1 0.0 15.5 16.0 -1.0 14.0 13.0 12.0 10.9 10.1 -2.0 10.0 -3.0 8.0 6.0 5.2 -3.1 4.4 -3.4 -3.3 3.5 -4.0 4.0 3.0 -3.8 2.1 2.4 -4.3 2.0 -5.0 -4.6 -4.7 0.0 -5.3 -6.0 -7.0 -6.7 2008 2009 2010 2011 2012 2013 2014 2015 2016f MALAYSIA ECONOMIC MONITOR JUNE 2016 » 4 LEVERAGING trade agreement in Pictures Trade contribution to Malaysia GDP is above other FDI inflows have diversified in line with trade East Asia countries agreements Trade, percent of GDP, 1970-2014 Origins of FDI inflows into Malaysia, percent of total FDI, 2001-2012 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 -10.0 2001-2003 2010-2012 Overall economic impact of TPP for Malaysia is Malaysia’s services contribution to exports trail other EAP expected to be positive countries Projected impact on Malaysian economy by 2030 Services, percent of GDP 80 74.9 74.4 no spillovers 63.9 6.7 70 GDP positive spillovers 57.6 54.8 60 51.0 51.7 8.0 46.3 50 43.3 41.6 40 18.0 30 Imports 20 20.5 10 0 17.7 Exports 20.1 Percent 0 5 10 15 20 25 Reducing the labour productivity gap in SMEs is key… … to take advantage of TPP in increasing SMEs’ exports share Median labour productivity by sector and size SME share in exports and expected gains from TPP 40 157 Apparel 18 35 Textiles SME share in sector exports 262 Chemicals 106 296 30 Electrical equipment 94 533 25 Food, beverages, tobacco Metals 50 Apparel Machinery 320 20 Transport 83 339 15 equipment Chemicals Metals 62 Other manufacturing 227 10 Other 59 manuf. Electrical 296 Textiles Food, 37 5 equipment Transport equipment 311 beverages, Machinery 81 0 tobacco 0 5 10 15 20 25 0 200 400 600 TPP export gains by 2030, USD billions Large SME MALAYSIA ECONOMIC MONITOR JUNE 2016 » 5 1. Recent economic developments and outlook Malaysia’s GDP growth remained resilient in 2015 despite external headwinds 1. Malaysia’s GDP growth moderated to 5.0 percent in 2015 compared to 6.0 percent in 2014 affected by external and domestic headwinds (Figure 1). Malaysia’s economic growth in 2015 was among the highest in the region (Figure 2), as well as among commodity producing countries. On the external front, commodity prices dropped by 39 percent1 in 2015, depressing the contribution of external demand to growth. This was reinforced by moderation in global trade and GDP growth which remained below projections. Financial market volatility was high throughout the year, as global markets adjusted to normalisation of the Federal Reserve’s monetary policy, and low commodity prices resulting large financial outflows in emerging economies. Financial markets were also affected by uncertainty surrounding domestic developments. Domestically, the implementation of the goods and services tax (GST) compensated for foregone oil-related public revenues. Yet, fiscal consolidation and softer income growth affected households’ cost of living and slower private consumption growth. Figure 1: Malaysia’s GDP growth moderated in Figure 2: …as growth in the region and EME 2015 and into 1Q 2016 remained subdued alongside soft external demand. GDP adjusted for inflation and seasonal fluctuations, change from the previous quarter, annualised (bars), and from the previous year GDP adjusted for inflation and seasonal fluctuations, change from (line); percent the previous quarter, annualised; percent q/q SAAR,% y/y, % 8.0 8.0 7.6 7.2 6.1 7.6 7.0 6.0 6.2 5.9 6.3 6.1 5.7 5.8 5.7 6.0 3.7 4.8 5.0 4.0 5.0 4.2 4.1 3.8 1.7 1.9 4.0 3.5 2.0 3.0 0.5 2.0 0.0 1.0 -2.0 0.0 -1.0 -0.1 -4.0 China ASEAN-4 USA Japan EU average Q32015 Q42015 Q12016 Source: CEIC, DOSM World Bank staff calculations Source: CEIC, DOSM World Bank staff calculations Notes: ASEAN-4 refers to the simple unweighted average for Malaysia, Thailand, Indonesia and Singapore. 2. Malaysia’s GDP growth in 2015 was supported by private consumption. Against the above challenges, the economy proved resilient due to the strong domestic demand, supported by slower-but-high growth in private consumption. The latter was sustained by stable labour market conditions and steady wage growth, with unemployment rate of 3.1 percent, and wage growth at 5.3 percent by end-2015. Conversely, private investment growth slowed to 6.4 percent in 2015 from 11.1 percent in 2014 mainly explained by lower capital expenditure in the oil and gas sector as commodities’ prices fell. Overall, public expenditure’s contribution to GDP growth was smaller as fiscal consolidation continued, mainly focusing on operating expenditures 1World Bank Commodity Price Database - Energy Price Index. Malaysia’s main commodity exports include crude oil, crude palm oil (CPO) and liquefied natural gas (LNG). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 6 (OE). The external sector affected GDP growth negatively, as exports growth moderated to 0.6 percent (2014: 5.0 percent) due to sluggish demand for commodities and despite strong manufacturing exports during the second half of the year, mainly of electrical and electronics (E&E). 3. On the supply side, the economy was supported by the manufacturing and services sectors. The services sector grew by 5.1 percent (y/y) in 2015 compared to 6.6 percent in 2014. This moderation was driven by slower growth in sub-sectors closely related to household spending such as retail and motor-vehicles, partially compensated by growth of information and communication. The construction sector grew at a more moderate pace, mainly in the residential segment, as projects are nearly completed and there are less new properties in the pipeline. Meanwhile, the manufacturing sector grew due to the export-oriented segment, particularly in E&E goods. Growth in the agriculture sector moderated to 1.2 percent in 2015 (2014: 2.1 percent) mainly affected by lower production of crude palm oil (CPO) as a result of adverse weather conditions (Box 1). Box 1: The Impact of El Niño on Malaysia’s Agriculture Sector El Niño had a fairly wide impact on the Asian region’s weather conditions in 2015, reaching its highest level2 since 1997-1998 in December 2015. In Malaysia, the current El Niño cycle has resulted in intensified droughts and water shortages. Until April 2016, four states in the country had recorded more than 24 days without rain. El Niño’s economic impact can be observed in the drop in agricultural sector output and in higher food prices. Malaysia’s agriculture sector growth declined to 1.2 percent in 2015 from 2.1 percent in 2014 and it has contracted by 3.8 percent in early 2016. The decline in the agriculture sector was not only due to El Niño, but was exacerbated by floods in the east coast of Peninsular Malaysia as well as strong haze conditions. Inflation was also affected by shortages in the supplies of fresh food given the unfavourable weather conditions. Prices of fresh vegetables increased by 7.7 percent in 2015 (2014: 1.6 percent), although the smaller weight of vegetables in the overall consumer price index (CPI) basket mitigated the overall impact. Palm oil production for 2015-2016 is estimated at 18.75 million metric tons, down 5.7 percent from the previous year. Although mature oil palm area is expected at 4.8 million hectares, up 2.4 percent, yield is estimated at 3.91 metric tons per hectare, down 7.9 percent. Overall, El Niño-related drought stress has caused monthly production to run well below normal for the past six months (USDA 2016). The global decline in CPO production is partially behind the upward trend in CPO prices, which have recently risen to a two-year high. Data from the Malaysian Palm Oil Board (MPOB) indicated a 21 percent drop in CPO production in Sabah, Malaysia’s biggest palm-growing state, which is partly due to the effects of El Niño. Furthermore, this impact is expected to be persistent in the near term as palm yields typically decline 4-12 months after a stress event has occurred. Nonetheless, there are several potential mitigating factors that could alleviate the El Niño effect. Newer trees of improved cultivar varieties that have been planted since the 1997-1998 cycle are reported to be more resilient to drought than those cultivated a decade ago. Additionally, young plantations are reaching maturity and could boost current production. Finally, the current drought intensity, at least for 2015, has been much less severe than at the same point in 1997. Furthermore, full assessment about the impact of the current El Niño cycle on rice has yet to be confirmed. According to the latest Rice Production Outlook prepared by the USDA-FAS, Office of Global Analysis, for the 2015-2016 growing season, rice production in Malaysia is forecasted to remain unchanged from last year at 1.8 million tons. Rice area in Malaysia for 2015-2016 is estimated at 0.69 million hectares, also unchanged 2 As measured by the Oceanic Niño Index (ONI). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 7 from last year. Finally, reports have also indicated that rubber production has also been affected but more precise data is needed to confirm it. To date, the price of natural rubber has shown significant recovery, rebounding from its lowest level in almost seven years at the end of January. As of May 2016, the effects of the current Niño cycle continues to decline and transition to weather-neutral conditions, after peaking at the end of 2015. For the coming period, most models predict the end of El Niño and a brief weather-neutral period by early Northern Hemisphere summer. Furthermore, in its May update, the US National Oceanic and Atmospheric Administration (NOAA) highlights favourable conditions for La Niña to develop within the next five months, with about a 75 percent chance of La Niña during the fall and winter of 2016-2017. La Niña is associated with increased wet spells, but the likelihood of flood events is dependent on the location and the duration of the rainfall. Source: Ioannis Vasileiou. Domestic demand continues to be the anchor for growth 4. Private consumption remains the key driver of domestic demand. Private consumption rose by 9.8 percent in 4Q 2015 (q/q, saar) boosted by higher vehicle purchases in anticipation of price adjustment in 20163 (Figure 3). Private consumption further accelerated to 12.2 percent (q/q, saar) in 1Q 2016 (Table 1) driven by higher utilities spending by households following the hot weather conditions, and special cash transfers by the government to civil servants and pensioners in January 2016. This was reflected in the increase in the Malaysian Institute of Economic Research (MIER) Consumer Sentiment Index in 1Q 2016 to 72.9, the first time after declining for six consecutive quarters. 5. Investment growth decelerated as a result of lower investment in the oil and gas sector. Private investment growth moderated to 14.3 percent (y/y) in 4Q 2015 (3Q 2015: 16.4 percent) supported by on-going projects in the manufacturing and services sectors (Figure 4). Investment in the manufacturing sector was driven by export-oriented industries, particularly E&E, while in the services sector it was stronger in transport and storage sub-sector, and tourism. However, private investment growth contracted by 5.7 percent in 1Q 201 in line with lower investment in the oil and gas sector, as well as lower spending on machinery and equipment. Public investment contracted as non-financial public corporations (NFPCs), particularly in the oil and gas and transportation sectors, reduced their investment. 3 Subsequently, sales of vehicles have declined in early 2016. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 8 Figure 3: Private consumption continues to be the Figure 4: The average investment-to-GDP ratio key driver of growth moderated on lower expenditures in oil and gas Contribution to GDP, y/y Share to GDP, percent 12.0 28.0 10.0 27.0 8.0 26.0 6.0 4.0 25.0 2.0 24.0 0.0 23.0 -2.0 Seasonally-adjusted -4.0 22.0 Private consumption Fixed investment -6.0 Change in inventories Government 21.0 Four-quarter moving average -8.0 Net exports Real GDP 20.0 Source: CEIC, DOSM, World Bank staff calculations Source: CEIC, DOSM, World Bank staff calculations Table 1: GDP - Seasonally Adjusted Annual Rate (saar, q/q, percent) 2014 1Q 2015 2Q 2015 3Q 2015 4Q 2015 2015 1Q 2016 GDP 6.0 5.7 3.8 3.5 5.0 5.0 4.2 Final Consumption 6.4 11.6 0.3 0.4 6.6 5.7 13.3 Private sector 7.0 10.2 -0.8 0.8 9.8 6.0 12.2 Public sector 4.3 17.3 4.9 -1.1 -5.2 4.4 17.6 GFCF 4.8 8.2 -20.9 16.4 14.3 3.7 -5.7 Exports of G&S 5.0 -1.9 -8.6 22.6 5.7 0.6 -17.2 Imports of G&S 4.0 -0.1 -15.3 26.8 8.5 1.2 -9.8 Sectoral Agriculture 2.1 -2.8 46.6 -16.0 -11.2 1.2 -22.6 Mining & quarrying 3.5 0.9 -0.6 -1.2 -4.9 4.7 8.8 Manufacturing 6.2 3.2 6.4 4.2 6.0 4.9 1.8 Construction 11.7 40.7 -26.3 28.5 0.1 8.2 42.4 Services 6.6 6.3 -0.1 5.6 8.0 5.1 7.0 Source: DOSM, World Bank Staff calculations 6. Overall labour market conditions remain stable and supportive of domestic demand. Malaysia’s unemployment rate remained broadly unchanged at 3.4 percent in 1Q 2016 (Figure 5), and labour force participation was steady at about 67.6 percent in 1Q 2016. Nonetheless, some indicators signal a softening of the labour market going forward, which could affect domestic demand. In particular, there has been a broad-based decline in the demand for new hires especially in the oil and gas sector, with the number of job vacancies decreasing by 50.0 percent between 3Q 2015 and 1Q 2016. Additionally, growth of labour force participation and employment have decelerated since 2H 2015, reflecting a softer labour market. Nonetheless, annual wage growth remains strong in the manufacturing and trade services sectors (Figure 6). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 9 Figure 5: The unemployment rate remains low, but Figure 6: Wage growth in manufacturing sector labour force and employment growth decelerated remains strong Unemployment, growth rates, Real wage and employment, growth from the previous year, percent percent (3-month moving averages) 9.0 15.0 Unemployment Rate Manufacturing employment Labour Force Growth 13.0 Manufacturing wages 8.0 Employment Growth 11.0 E&E employment 7.0 E&E wages 9.0 6.0 7.0 5.0 5.0 4.0 3.0 1.0 3.0 -1.0 2.0 -3.0 1.0 -5.0 0.0 Source: CEIC and World Bank staff calculations Source: CEIC and World Bank staff calculations Note: Series are seasonally unadjusted, 3-month moving averages 7. Inflation peaked in February due to adjustments in electricity tariffs and has since moderated without signals of second round effects. Headline inflation in Malaysia trended upwards to 4.2 percent in February 2016 (Figure 7), driven by increases in electricity tariffs in January 2016, and due to the base effect from the large decline in fuel prices in early 2015 (Figure 8). The higher inflation was in line with expectations and was unaffected by exchange rate depreciation given the relatively low import content of the CPI basket (7.2 percent). There is no indication of second round effects, with CPI moderating to 2.0 percent in May 2016, supported by low fuel prices. The producer price index (PPI) for local production remained on a downward trend, falling by 4.4 percent in 1Q 2016 (4Q 2015: -4.5 percent), mainly driven by lower global energy and commodity prices. The capacity utilisation rate continues to moderate to 77.0 percent in 2015, slightly lower than the 78.5 percent recorded in 2014. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 10 Figure 7: Headline inflation peaked in February 2016 Figure 8: …driven by electricity tariff adjustments and base effect from lower fuel prices Percent (y/y) Contributions to month-on-month changes in CPI, percent 5.0 1.5 Headline "Core" PPI Food Transport Housing etc. Other 3.0 1.0 1.0 0.5 -1.0 0.0 -3.0 -0.5 -5.0 -1.0 -7.0 -1.5 -9.0 -11.0 -2.0 Source: CEIC, DOSM, BNM and World Bank staff Source: CEIC, DOSM and World Bank staff calculations calculations Note: Core inflation is World Bank estimate which excludes transportation and food prices, PPI is for local production Box 2: Cost of Living in Malaysia The cost of living has become an important topic in Malaysia, with widespread concerns about the rising cost of living and inflation differences across income levels and regions. Yet, inflation has been moderate and reasonably stable. The CPI seems well-constructed in line with international standards, and meets the main objective of measuring aggregate price changes in the Malaysian economy. Indeed, introducing alternative cost of living index measures would likely not improve measuring and would even risk distorting wage-setting mechanisms, confusing the public, and distracting attention from the larger issue of ensuring broad-based and inclusive growth in real incomes. The perceptions of a rising cost of living, especially among the bottom 20 percent (B20) of the income distribution, where household expenditure grew above household income, may indeed reflect the impact of recent fiscal consolidation measures in combination with insufficient income growth. Some recent measures such as the public transit fare increases and the introduction of the GST may have increased the cost of living significantly for some groups, depending on location and income levels, and spending patterns. The government’s move to raise the minimum wage, increase civil servants’ salaries, give higher BR1M benefits and reduce pension contributions prove very timely. While these measures can support domestic demand in the short term, some of them may be fiscally too costly to sustain them moving forward. Instead of introducing costly additional measures to prop-up income growth, the government may explore targeted social assistance measures to support the more vulnerable groups. This could be achieved by reducing fragmentation across institutions, policy and delivery systems in the social assistance system, and streamlining the target outcomes across programs. One viable approach is the Proxy Means Test (PMT), a situation where information on household or individual characteristics correlated with welfare levels is used to proxy household income, welfare or need. PMT has potential budget savings of around 16 percent on targeted programs. Continued consolidation of beneficiary databases across e-kasih, BR1M and other MALAYSIA ECONOMIC MONITOR JUNE 2016 » 11 sources would also assist to reduce duplicative benefits. Also, establishing a high-level coordinating body for social assistance in Malaysia (i.e. Malaysia Social Protection Council) would help to improve efficiency, sustainability, and coherence of targeted social assistance measures, by first developing a national Social Protection Masterplan. Consolidating front-end service delivery in social assistance programs could also improve efficiency, client orientation and institutional coordination. A Single Window Service (also known as one-stop shops) is a desirable goal. In addition, introducing an unemployment benefit could also expand the protection for workers losing jobs and raise the efficiency of labour market matching. The benefit, likely funded from the existing Human Resources Development Fund (HRDF) levy to avoid additional tax burden, and with clearly defined implementation arrangements, would need to be closely linked to active labour market programs to promote job search. In addition, detailed incidence analysis of fiscal policies, both ex ante and ex post, would provide a basis for avoiding or reducing unintended adverse effects on segments of the population. Future reforms to maintain budgetary discipline, support cost recovery for services, or eliminate untargeted subsidies are likely to be adopted, and detailed incidence analysis when formulating and monitoring such policies can aid the design of mitigating measures by providing targeted compensation through the social assistance system to those vulnerable groups that are adversely affected. Source: Authors. Manufacturing exports continued to increase strongly in 1Q 2016 8. Manufacturing exports helped to mitigate the decline in commodities exports. Terms of trade in 2015 declined marginally by 3.7 percent (y/y) as a well-diversified export basket mitigated the fall in commodity prices. After growing strongly at 8.1 percent (y/y) in 4Q 2015, gross exports grew at a slower rate (1.0 percent) in 1Q 2016). Commodity exports led the decline (1Q 2016: -18.3 percent (y/y); 4Q 2015: -7.3 percent) following lower demand across all commodities during the quarter (Figure 9), with the exception of CPO. Non- commodity exports remained strong (1Q 2016: 6.4 percent, y/y) supported by a steady expansion in manufacturing exports, particularly in machinery and appliances, as well as E&E. The latter was supported mainly by demand for electrical machinery and telecommunication equipment, particularly from the US and the Association of Southeast Asian Nations (ASEAN) region (Figure 10). In turn, gross imports contracted in 1Q 2016 by 0.4 percent (y/y) from +3.5 percent in the previous quarter. The contraction was driven by a decline in capital imports (-12.9 percent, y/y) in line with lower investment, as well as a decline in intermediate imports (-3.1 percent, y/y), affected by the moderation in exports. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 12 Figure 9: Commodity exports posed larger decline as Figure 10: Demand from the US helped to support oil prices continued to decline manufacturing exports Change in export volumes of past three months from the previous year, Change in the value of exports from the previous year (MYR mn), percent percent Rubber 40.0 25.0 60.0 Crude oil 30.0 20.0 50.0 LNG Palm oil & products 15.0 40.0 20.0 Petroleum products 10.0 30.0 10.0 5.0 20.0 0.0 0.0 10.0 0.0 -10.0 -5.0 -10.0 -10.0 -20.0 High-tech manufacturing -15.0 -20.0 -30.0 Commodity-related -30.0 -20.0 Total -40.0 -40.0 -25.0 H1 2015 H2 2015 H1 2015 H2 2015 H1 2015 H2 2015 H1 2015 H2 2015 Q1 2016 Q1 2016 Q1 2016 Q1 2016 China EU US Japan Source: CEIC, DOSM, and World Bank staff calculations Source: CEIC and World Bank staff calculations 9. The current account surplus continues to narrow. In 2015, the current account surplus narrowed to 3.0 percent of GDP (2014: 4.4 percent) reflecting a lower trade surplus following lower commodity prices, and a higher deficit in services. The current account surplus further narrowed to 1.7 percent of GDP in 1Q 2016 (Figure 11, Table 2), as commodity prices remained low (Figure 12), and deficit in services grew, in part due to higher net payments for construction and telecommunication services. Figure 11: The current account surplus narrowed Figure 12: … as lower commodity prices led to a further… narrowing of the commodity surplus Balances, percent of GDP (last four quarters) Balances, percent of GDP (last four quarters) Current Transfers 15.0 20.0 Primary and Secondary Income Commodity Balance Services Balance 13.0 15.0 Goods Balance Non-Commodity CA Balance 11.0 Current Account 10.0 9.0 7.0 5.0 5.0 0.0 3.0 1.0 -5.0 -1.0 -10.0 -3.0 -15.0 -5.0 Source: CEIC and World Bank staff calculations Source: CEIC and World Bank staff calculations Notes: Commodity-related exports include food, beverages & tobacco; mineral fuels & lubricants; chemicals; animal and vegetable oils and fats MALAYSIA ECONOMIC MONITOR JUNE 2016 » 13 Table 2: Summary – Selected External Sector Indicators 1Q 2015 2Q 2015 3Q 2015 4Q 2015 1Q 2016 Trade balance (% of GDP) 7.7 7.2 7.6 10.1 8.2 Current account balance (% of GDP) 4.1 2.9 1.6 3.5 1.7 Total exports (% of GDP) 114.0 110.6 111.2 112.6 109.3 Total imports (% of GDP) 62.0 62.4 64.2 64.3 61.7 Net portfolio investment (RM billion) -7.9 -11.8 -24.4 15.9 13.1 Gross official reserves (RM billion) 389.8 398.2 415.2 409.2 381.6 (USD billion) 105.1 105.5 93.3 95.3 97.0 Source: CEIC, DOSM, BNM, World Bank staff calculations Despite lower oil-related fiscal revenues fiscal consolidation continues 10. Fiscal consolidation continued in 2015 for sixth consecutive year. The federal government fiscal deficit was reduced to 3.2 percent of GDP (Figure 15) in line with the target (2014: 3.4 percent of GDP). There was a reduction in public revenues to 18.9 percent of GDP (2014:19.9 percent) following lower oil prices which led to the decline of oil-related revenues to 4.1 percent of GDP in 2015 (2014: 6.0 percent) (Figure 14). However, expenditure cuts through the gradual removal of subsidies beginning in late 2014 and the implementation of the GST in April 2015 compensated for it. The GST replaced the sales and services tax, collecting 2.3 percent of GDP, in line with the government’s target. Furthermore, the adoption of additional fiscal measures in early 2015 to respond to the falling oil prices was instrumental in securing public expenditure containment within sufficient time. 11. Fiscal consolidation in 2015 was mainly achieved through reduction in operating expenditures (OE), mainly subsidies. OE declined to 18.8 percent of GDP in 2015 (2014: 19.8 percent of GDP) on the heels of lower subsidies, mainly on fuel, which declined to 2.4 percent of GDP (2014: 3.6 percent of GDP), as the automatic pricing mechanism (APM)4 was implemented. The wage bill5, the largest OE item (41 percent of total OE), exceeded the budgeted amount by 8.5 percent, mainly due to bonus to civil servants and special assistance to government pensioners. Higher actual wage bill above budgeted amounts have been on an upward trend for the last few years (Figure 13). 12. Development expenditure (DE) was preserved in line with 2014. The government’s actual DE (3.5 percent of GDP) was however well below the budgeted amount, in line with the last few years. Overall, the majority of public sector capital outlays (68.4 percent) was implemented by NFPCs (9.5 percent of GDP; Figure 16), including large projects such as the petroleum refinery facilities in Pengerang, the construction of the mass rapid transit (MRT) line and the extension of the existing light rail transit (LRT) line. 13. The conditions for public deficit financing remained stable in 2015. Overall, federal government debt remained stable in 2015, at 54.5 percent of GDP, within the government’s debt limit of 55.0 percent of GDP. In addition, 94.5 percent of total borrowing in 2015 was denominated in ringgit, minimising the impact of last year’s ringgit depreciation in the federal budget. Despite the volatility in the financial markets in 2015, foreign holdings of government debt remained steady (30.2 percent of government debt as at 2015, 2014: 28.0 percent). Government external borrowing rose in 2015, with issuance of a USD1.5 billion global sukuk used to redeem existing USDS1.25 billion sukuk and to finance DE. At the current juncture, the government’s contingent liabilities, as indicated by the amount of publicly guaranteed debt, remain stable at 15.4 percent 4 Under the APM, fuel pump prices are set based on the average cost of the Mean of Platts Singapore, a set of Singapore- based oil related products prices published by Platts, a provider of commodities-related information and a fixed margin is set for retailers. 5 Includes emoluments, pensions and gratuities. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 14 of GDP. Current discussions underway on the assets and liabilities of 1 Malaysia Development Berhad (1MDB) may impact the overall level of public debt, but the extent and direction of this impact is not yet known. Figure 13: Fiscal consolidation continued despite Figure 14: The dependency on oil-related revenues lower oil-related revenues continues to decline Balance of the Federal Government, percent of GDP Share of GDP, percent 30 0.0 25 -1.0 20 -2.0 15 10 -3.0 -3.1 5 -3.4 -3.2 -4.0 -3.8 0 -4.3 -5.0 -4.6 -4.7 -5.3 -6.0 Oil-related revenues Corporate income tax Other taxes (excl. oil) -7.0 -6.7 2008 2009 2010 2011 2012 2013 2014 2015 2016f Source: CEIC, MoF and World Bank staff calculations Source CEIC, MoF, and World Bank staff calculations Note: ‘Personnel’ includes emoluments, pensions and Note: Oil-related revenues include Petroleum Income gratuities Tax, export duties on crude oil, petroleum royalties, the PETRONAS dividend, income from the Joint Malaysia- Thailand Development Area and petroleum permits Figure 15: Wage bill continues to be higher than Figure 16: Non-financial public corporations the budgeted amount (NFPCs) continued to provide capital outlays Ratio to GDP, percent Deviation of actual expenditures from budget, percent change 20% 17% 25.0 16% 15% General government NFPC 10% 10% 20.0 10% 9% 7% 5% 5% 15.0 0% 10.0 -5% 5.0 -10% -15% - Revenues OE -20% Personnel DE 2009 2010 2011 2012 2013 2014 2015 Source: CEIC, MoF, and World Bank staff calculations Source: CEIC, MoF, World Bank staff calculations and projections MALAYSIA ECONOMIC MONITOR JUNE 2016 » 15 Banking system’s health remain strong 14. Banking sector indicators suggest that the banking system remains resilient. The banking sector remains well-capitalised with common equity tier-1 capital and tier-1 capital ratios stable at 12.8 percent and 13.8 percent of total capital as of end-2015, well above the minimum regulatory levels. Net impaired loans of the banking system as of end-2015 remained low at 1.2 percent (Figure 17). In terms of external borrowings by businesses, more than 40 percent of total external borrowings remained in the form of inter-company obligations which present limited potential of rollover and funding risks. Also, banking system liquidity remains sufficient and able to provide buffers against liquidity shocks. As at end 1Q 2016, the liquidity coverage ratio (LCR) stood at 126 percent (4Q 2015: 130 percent), well above the new minimum regulatory requirement, of 70 percent (Figure 18).6 Bank Negara Malaysia (BNM) also announced a reduction in the statutory reserve requirement (SRR) from 4.00 percent to 3.50 percent effective from February 1, 2016, to ensure that liquidity is distributed throughout all financial institutions. Figure 17: Net impaired loans of the banking Figure 18: Banking system’s liquidity remains ample system remains low and above the minimum LCR requirement Net impaired loans to total loans (percent) Liquidity coverage ratio (LCR, percent) 1.5 140% Min. LCR requirement 130% 120% 1.4 110% 100% 1.3 90% 80% 1.2 70% 60% 1.1 50% Source: BNM Source: BNM Overall lending remains supportive of economic activity 15. Household credit growth continues to moderate. Outstanding household loan growth moderated from 7.3 percent as of end 4Q 2015 to 6.5 percent as of end 1Q 2016, led by a slowdown in loans in the riskier segment e.g. credit cards and passenger cars (Figure 22). Impaired and delinquent ratios for households remained low, at 1.7 percent and 1.4 percent as of end 1Q 2016, supported by stable labour market conditions. Also, most of the household lending is backed by strong collateral in the form of real estate. After years of double digit growth, the annual growth of the Malaysian House Price Index (MHPI) has declined to 7.4 percent in 3Q 2015 (2Q 2015: 7.5 percent) mainly in the high-end property segment. Overall, the number of individuals with at least three outstanding housing loans 7 recorded a slower growth of 2.9 percent (y/y) in 1Q 2016 (4Q 2015: 3.2 percent). Yet, there is indication that there is structural mismatch in the more affordable housing segments as well as symptoms of households overstretching in the more expensive areas, which merits close monitoring. To this end, the Credit Counselling and Debt Management Agency (AKPK), set up 6 The minimum requirement for LCR increased from 60 percent in 2015 to 70 percent in 2016, in line with Basel III requirements. 7 Proxy used by BNM for speculative house purchases. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 16 by BNM, aims to mitigate potential rise in delinquencies by providing assistance to households to manage their debt, including to develop a personalised debt repayment plan (Box 3). Box 3: Credit Resolution Mechanism in Malaysia Malaysia has put in place a comprehensive corporate insolvency mechanism framework . This in part reflects Malaysia’s extensive experience in dealing with corporate sector restructuring during the 1997 - 1998 financial crisis. More recently, the Companies Act 1965 faced further enhancement with the implementation of the recently passed Companies Bill of 2015. The Bill introduces two new corporate rescue mechanisms, the Corporate Voluntary Arrangement and Judicial Management. The insolvency mechanism for secured loans at the corporate level currently takes one year and has a cost of 10 percent of the value of the assets used as collateral, with a recovery rate of 81 percent of total value of debt. The intended outcome of the new Bill is to decrease the number of bankruptcy cases and provide companies with new opportunities to restructure their debt and remain solvent and profitable, thus avoiding liquidation. In the Corporate Voluntary Arrangement mechanism, an independent insolvency practitioner evaluates the debt restructuring proposal and if 75 percent of the company’s creditors approve it, it becomes binding for all the creditors. Under the Judicial Management mechanism, the Court will appoint an independent insolvency practitioner who will manage the company while the directors are divested from their powers. The distressed company will have the opportunity to receive a moratorium to formulate a restructuring plan for the creditors’ approval. Additionally, under the new Bill the threshold of i nability to pay debts has been updated from USD125 (RM500) to USD7,500 (RM30,000). Individuals’ credit resolution in Malaysia has two stages. In the restructuring stage, assistance is provided to financially distressed individuals. In 2006, BNM established the Credit Counselling and Debt Management Agency (AKPK) that offers programs in financial education, financial counselling and debt management. The 1967 Bankruptcy Act provides that an individual bankruptcy can be initiated by a creditor when the debtor is no longer capable of paying USD7,500 (RM30,000), or by the individual on a voluntary basis to protect himself from his creditors’ claims. Individual bankruptcy is not very prevalent and according to the Malaysia’s Department of Insolvency (MdI) there are annually around 20,000 individual cases of bankruptcy between 2011 and 2015. The three main categories of bankruptcies were hire purchase, housing and personal loans. Given the economic performance of the country as well as improved living conditions, in 2015 the number of total cases of bankruptcy declined by 17 percent (y/y), with a remarkable decline of hire purchase and housing loans cases reported 31 percent (y/y) and 35 percent (y/y), respectively. The enforcement mechanism of collateral in the current Bankruptcy Act takes from one to three years, and the estimated recovery value of the assets, in case of a house, is less than 50 percent of loan value. Credit resolution mechanisms in Malaysia consider bankruptcy as a last resort for debtors and will have severe implications on their assets, employment opportunities, and travel abroad. A person that declares bankrupt has all his/her assets seized in order to repay pending loans, even if they were not given as collateral. As a result, he/she will not be able to work as a director on any type of business activity and cannot leave the country without a government permit. The only way to be discharged from bankruptcy is either through an order from the Court or through a certificate issued by the Director General of Insolvency. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 17 Moving forward, and in line with international trends, the Bankruptcy Act could evolve from a debt repayment scheme framework towards a second chance approach that established new mechanisms to settle debts, and could put in place voluntary arrangement procedures for both secured and unsecured loans. The intended effect of this policy will be to recover a higher percentage of the loan value at the least possible cost for both parties. Moreover, the revised Bankruptcy Act should introduce a new scheme for social guarantor as payer of last resort in cases of loans related to education, hire purchase, and housing. Figure 19: Individuals’ Bankruptcy Cases in Figure 20: Categories of individuals Bankruptcy Malaysia Cases in Malaysia Thousands percent 22.0 22.4 Hire Purchase Other 19.2 19.6 18.5 27.9 30.3 21.4 20.4 Housing Personal 11 12 13 14 2015 Source: MdI. Average participation in all cases from 2011 to 2015. Other includes business, corporate & social guarantor, credit card, and education loan Source: Authors. 16. Bank lending to the business sector remains healthy and supportive of economic activity. Financial intermediation remains conducive, with the banking system and capital markets providing adequate access to financing. In the banking system, demand for financing remained strong with loan applications growing 7.2 percent (y/y) and 11.9 percent as at 4Q 2015 and 1Q 2016, respectively. The manufacturing sector accounted for 18.7 percent of total loans disbursed as at end 1Q 2016, and financing to SMEs remained strong, growing by 15.0 percent and 9.0 percent in 4Q 2015 and 1Q 2016, respectively. The strong growth of working capital lending (Figure 21) may reflect cash constraints for SMEs. However, the fact that ample financing is being made available reinforces the relevance of the financing system for SMEs in weathering a potential economic slowdown. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 18 Figure 21: Growth in working capital loans continues Figure 22: Household loan growth continued to to drive business credit expansion decline mainly in the riskier segments Contribution to y/y change, pct points y/y change, Loans Outstanding (banking system), percent y/y change of 12-month moving averages, percent 12-month moving averages Construction Passenger cars 7.0 Working Capital 14.0 18.0 Residential property Securities Personal use 6.0 Non-residential Property 16.0 Credit cards 12.0 Commercial vehicle & fixed assets Total, Households 5.0 Total (RHS) 14.0 10.0 12.0 4.0 8.0 10.0 3.0 6.0 8.0 2.0 6.0 4.0 1.0 4.0 0.0 2.0 2.0 -1.0 - 0.0 Source: BNM and World Bank staff calculations Source: BNM and World Bank staff calculations 17. Businesses’ access to the capital market was higher on improved market conditions. The higher private debt securities (PDS) issuances in 4Q 2015 (RM40.6 billion) and 1Q 2016 (RM18.4 billion) reflected improved market conditions, as uncertainties in financial markets eased following the Federal Reserve’s interest rate increase in December 2015. Similarly, shares issued in the equity market amounted to RM7.5 billion in 4Q 2015 and RM1.1billion in 1Q 2016. The ringgit has strengthened in 1Q 2016 as external outflows reversed on improved investor sentiment 18. Portfolio inflows returned to Malaysia’s financial markets strengthening the ringgit against the US dollar. Net inflows of RM13.1 billion were recorded in 1Q 2016 (Figure 23) as volatility subsided and sentiments improved in the financial markets. After a period of net outflows, flows re-entered the domestic financial markets, in line with other emerging and regional markets, as investors’ uncertainty subsided. Overall, most of the portfolio outflows were concentrated in the short-term debt securities, while non-resident holdings of government securities8 remained stable at around 30.2 percent – 31.5 percent of total government securities in 4Q 2015 and 1Q 2016 (Figure 24). Foreign direct investments (FDI) also grew, with RM31.8 billion net inflows since 3Q 2015. The increase in FDI was largely due to equity capital mainly channelled to the services and finance sectors. To date, the ringgit exchange rate continues to be driven by the volatile movement in portfolio flows and developments in commodity prices and has strengthened against the US dollar by 5.1 percent in 2016 as at 27 May 2016. International reserves have also increased in tandem with financial inflows (Figure 26). The large decline in reserves observed in 2015 was explained by the use of BNM bills to manage the volatility of the ringgit following the financial outflows. The real effective exchange rate (REER) also strengthened during the period (Figure 25), appreciating by 7.0 percent between end 3Q 2015 to end-April 2016. 8Malaysian Government Securities (MGS), Government Investment Issues (GII), Treasury bills (T-bills) and Sukuk Pinjaman Perumahan Kerajaan (SPPK). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 19 Figure 23: Portfolio inflows have re-entered domestic Figure 24: …and foreigners appetite for government markets… bonds rose Proxies for portfolio flows, USD million, 3-month moving averages Percent of GDP (last four quarters) Other 5,000 Change in foreign holdings of Residents domestic government debt securities 15.0 Foreigners from previous period ($ million) Direct Investment in Malaysia 3,000 10.0 Direct Investment Abroad Financial Account Net equity flows ($ million) 5.0 1,000 0.0 -1,000 -5.0 -3,000 -10.0 -15.0 -5,000 -20.0 -7,000 Source: CEIC and World Bank staff calculations Source: CEIC, MIDF and World Bank staff calculations Figure 25: Real effective exchange rate appreciated Figure 26: Reserves have recovered as financial inflows in line with other countries in the region returned Real Effective Exchange Rate, Index, 2010=100 Reserves, USD millions Indonesia Thailand Singapore Net Forward Position 180,000 Other Foreign Currency Assets Malaysia China Japan Official Reserves Asset 170,000 130 160,000 150,000 120 140,000 110 130,000 100 120,000 90 110,000 80 100,000 70 90,000 80,000 60 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Source: Bank for International Settlements Source: BNM Note: Increases in the index denote appreciation of the Note: Net Forward Position represents aggregate short and currency long positions in forwards and futures in foreign currencies vis- à-vis the domestic currency (incl. the forward leg of currency swaps) MALAYSIA ECONOMIC MONITOR JUNE 2016 » 20 Growth of the Malaysian economy is expected to moderate slightly in 2016 19. Malaysia’s GDP growth is expected to moderate to 4.4 percent (YoY) in 2016. (Table 3, and Table 4). This is mainly explained by a gradual deceleration in private consumption amid a softer labour market and continued fiscal consolidation. Also, private investment growth is expected to moderate given a less optimistic business sentiment, and subdued external demand due to lower commodity prices and low and uneven growth in the global economy. The Malaysian economy remains affected by three external developments. Firstly, the pace of growth of the global economy, particularly in the advanced economies and Malaysia’s key trading partners will affect external demand and subsequently the current account. Secondly, low commodity prices will continue to weigh on the economy on two fronts; commodity-related exports and government finances through lower public revenues. Thirdly, uncertain global financial developments expose the economy to episodes of elevated financial volatility. Subsequently, economic growth is expected to grow at 4.5 percent and 4.7 percent in 2017 and 2018, respectively, as global economic growth is expected to accelerate further and commodity prices recover moderately. Table 3: Slower growth is expected in 2016 as Table 4: …but domestic demand will continue to private consumption cools… drive growth. Year-on-Year Growth Rates, percent Contributions to GDP Growth, percentage points 2015 2016f 2017f 2018f 2015 2016f 2017f 2018f GDP 5.0 4.4 4.5 4.7 GDP 5.0 4.4 4.5 4.7 Domestic demand Domestic demand (including stocks) 5.9 4.9 5.2 5.2 (including stocks) 5.3 4.4 4.7 4.8 Final consumption 5.7 5.5 5.4 6.0 Final consumption 3.7 3.6 3.6 4.0 Private sector 6.0 5.7 5.6 6.2 Private sector 3.1 3.0 3.0 3.3 Public sector 4.4 4.1 4.3 5.2 Public sector 0.6 0.6 0.6 0.7 GFCF 3.7 3.6 4.5 5.6 GFCF 1.0 0.9 1.2 1.4 Change in Stocks 0.6 -0.1 0.0 -0.7 External demand -3.8 -4.2 1.3 -1.2 External demand -0.4 0.0 -0.2 -0.1 Exports of G&S 0.6 0.2 2.0 3.4 Exports of G&S 0.5 0.1 1.4 3.3 Imports of G&S 1.2 0.7 2.1 5.6 Imports of G&S -0.8 -0.5 -1.3 -3.4 Source: World Bank staff calculations 20. Global growth for 2016 is projected at 2.4 percent, unchanged from 2015 (Figure 27).9 The recovery of the US economy is now projected to be softer than previously estimated (1.9 percent in 2016 against previous estimate of 2.7 percent). While the labour market slack is diminishing, the labour force participation rate is still below 2008 levels. Against this background, the pace of the US interest rate normalisation path remains unclear. Meanwhile, the recovery in the Euro area is expected to remain low, given weak external demand, domestic uncertainties and deleveraging pressures. Over the period 2016 to 2018, economic growth in the Euro area is projected to stabilise at 1.5 to 1.6 percent. In Japan, GDP growth for 2016 is estimated to be lower at 0.5 percent, affected by weak private consumption and external demand. China’s GDP growth is expected to decelerate from 6.9 percent in 2015 to 6.7 percent in 2016 as the economy continues to rebalance. For developing economies, growth is forecasted to be at 3.5 percent, 0.6 percentage points lower than earlier projections. The downward revision is mainly attributed to commodity-exporting developing economies continuing to adjust to lower global commodity prices. 9 Unless noted otherwise, all GDP forecasts are taken from June 2016 Global Economic Prospects (World Bank 2016). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 21 Domestic demand will continue to anchor economic growth in 2016 21. Private consumption is expected to be the main driver of economic growth in 2016 albeit at a slightly more moderate pace. Private consumption growth is expected to slow down to 5.7 percent in 2016 from 6.0 percent in 2015, due to softening in the labour market, and reinforced by ongoing adjustments to the rising cost of living, particularly from higher prices of administered goods. Furthermore, the high level of household indebtedness, especially among lower-income households, and the moderation of property prices might also have an income effect that further contributes to consumption growth moderation. Notwithstanding these factors, various mitigating measures such as the increase in the national minimum wage and BR1M cash transfers as well as salary increments for civil servants in July 2016 are expected to support private consumption. 22. Private investment is projected to expand at a slower pace on more subdued business sentiment. With the pace of global growth remaining uncertain, and with slow trade growth and commodity prices at low levels, business sentiment is expected to remain subdued. As a result, growth of gross fixed capital formation (GFCF) is expected to moderate slightly to 3.6 percent in 2016 (3.7 percent in 2015), in line with the trend seen in the last two years. While lower capital expenditure in the oil and gas sector is expected to continue, investments in the manufacturing sector, particularly E&E as well as ongoing infrastructure projects, are expected to support overall private investment. Investments in the construction sector are expected to moderate with new properties in the pipeline slowing down and less housing projects being approved. 23. Fiscal consolidation will continue, mainly at the back of lower public expenditure. In line with the 2016 budget recalibration, the government is projected to continue to trim down operating expenditures (Table 5). As such, growth in public consumption is forecasted to decline to 4.1 percent in 2016 from 4.4 percent in 2015. Similarly, public investment is also expected to decline in 2016 as the government plans to scale back and re-prioritise on its development projects. Capital outlays by NFPCs for the purchase of fixed assets is also expected to be lower in 2016. Nevertheless, investments by NFPCs that have already been committed for ongoing projects, such as the MRT expansion will continue helping to support public investments. Table 5: Summary - Federal Government Finance (RM billion) 2015 2016 Initial* Revised1 Actual Initial* Recalibrated2 Total revenue 235.2 222.9 219.1 217.9 216.3 Operating expenditure 223.4 212.4 217.0 211.2 210.7 Development expenditure 47.5 47.5 40.8 45.2 44.3 Overall balance -35.7 -37.0 -38.5 -38.5 -38.7 % of GDP -3.1 -3.2 -3.2 -3.1 -3.1 Source: DOSM, MOF, World Bank staff calculations Note: * Based on E-Report 2014/ 2015; **Based on E-Report 2015/2016, 1Based on 2015 Budget Revision, 2Based on 2016 Budget Recalibration 24. Inflation is expected to moderate by end 2016. Despite an uptick in inflation expected during the first quarter of 2016, no second round effects are anticipated. BNM has projected inflation to be between 2.5 percent - 3.5 percent in 2016 (2015: 2.1 percent) (Figure 28). Given that inflation has peaked and the base effect has taken effect, moving forward, upward pressure on inflation could emerge should oil prices pick up at a higher rate than anticipated. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 22 Figure 27: The median consensus forecasts for Figure 28: Inflation projected to be between 2.5- 2016 continued to moderate since 2H 2015 3.0 percent in 2016 Consensus forecasts of real GDP (2016), year-on-year growth, percent Percent 6.0 5.4 7.0 Consensus (high) Consensus (low) 5.0 6.5 WB 6.0 Consensus (median) 4.0 Median forecast for 2016 5.5 3.2 3.1 3.0 2.8 5.0 2.2 2.1 2.1 4.5 Shaded area indicates 2.0 1.7 1.6 range of forecasts for 4.0 2016 1.0 0.6 3.5 3.0 0.0 Apr-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Apr-16 Jan-15 Jun-15 Jan-16 May-15 May-16 Mar-15 Mar-16 Feb-15 Jul-15 Feb-16 Current account surplus is expected to narrow further in 2016 25. Overall export growth is projected to remain stagnant because of low commodity prices and the weak growth outlook among Malaysia’s main trading partners (Figure 29). Global trade is expected to remain weak, consistent with evidence of a persistent deterioration in the relationship between global trade and activity (Figure 30). Prospects for major advanced economies have deteriorated amid weak global trade and manufacturing activity. Commodity exports will continue to be hampered by low commodity prices, although they are expected to stabilise. Broadly, demand for manufacturing goods, particularly for semi- conductors is expected to remain steady and supportive of E&E exports. Exports of non-E&E goods such as rubber manufacturing products are also expected to remain steady on continued demand. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 23 Figure 29: PMIs further deteriorated across the Figure 30: …dampening the outlook for Malaysian board in 2015… export growth Seasonally-adjusted Purchasing Managers’ Index (P MI) Change from the previous year, percent 20 60 G3 Average China (PMI) 15 58 US (ISM) 56 10 MYS: 7.6 World: 7.5 54 5 3.4 2.0 52 0 0.6 0.2 50 Malaysia -5 Exports World Trade 48 Volumes -10 2002-2007 46 av Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 -15 2016f 2017f 2018f 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Markit (Japan, Euro area), Caixin (China), CEIC Source: CEIC, World Bank DECPG and World Bank staff (US) calculations Note: Simple average of PMIs for US. Euro area and Note: World Bank forecasts as of June 2016 Japan. Manufacturing PMI for China. Scores above 50 reflect expansion 26. The narrowing trend of the current account surplus is expected to continue. The current account surplus is projected to decline to 2.1 percent of GDP in 2016 from 3.0 percent of GDP in 2015 (Figure 31). The smaller surplus is due to lower net trade given expectations of stagnant exports growth, as prices of commodities remain subdued and as the prospect of the global economic growth remains weak. Conversely, while imports for intermediate and capital goods are expected to be lower as private investment moderates, consumption imports will continue to grow. Figure 31: The current account surplus is expected to narrow Current account balance, percent of GDP 18.0 17.1 15.5 16.0 14.0 12.9 12.0 10.9 10.1 10.0 8.0 6.0 5.2 4.4 3.5 3.0 4.0 2.1 2.4 2.0 0.0 Source: CEIC, DOSM, and World Bank staff projections MALAYSIA ECONOMIC MONITOR JUNE 2016 » 24 Monetary policy and financial conditions will remain supportive of economic growth 27. Monetary policy is expected to remain accommodative and supportive of economic growth. In the most recent BNM’s Monetary Policy Committee (MPC) meeting in May 2016, the MPC acknowledged that volatility in the financial markets have subsided and sentiments have improved. Nonetheless, it reiterated the risks in the global economic and financial environment, and as such, it confirmed that BNM will remain vigilant in closely monitoring and analysing its implications to the economy. The MPC expects that the sound financial and banking system will also ensure continued intermediation of funds in the economy and that financing conditions remain supportive of economic growth. 28. Ample liquidity in the financial system is expected to support the economy’s financing needs. The recent reduction in the SRR has led to an improvement in domestic funding conditions and has lowered funding rates slightly. In addition, despite the decline in deposit by 0.9 percent in 1Q 2016 (4Q 2015: 1.8 percent), competition for corporate deposits have also eased in 1Q 2016 and the loan-to-deposit ratio has declined to 87.7 percent as of 1Q 2016 (4Q 2015: 88.7 percent). Fiscal policy will continue on its consolidation path, though some challenges remain 29. The government continues to be pro-active in responding to the fall in commodity prices. Similar to 2015, the government announced a recalibration of its 2016 public budget in January 2016 after crude oil prices fell to their lowest level in 12 years at USD31 per barrel (Brent). The recalibration assumed a lower oil price of USD30 - 35 per barrel and lower GDP growth of 4.0 - 4.5 percent. The anticipated shortfall in government revenue is matched by expenditure containment to achieve the fiscal deficit target at 3.1 percent of GDP and maintain the federal debt below 55.0 percent of GDP. 30. The 2016 public budget recalibration continues to reduce government expenditure. With revenues expected to experience a shortfall of 0.6 percent - 0.8 percent of GDP, the government adopted measures to reduce OE by 0.4 percent of GDP. The latter included RM1.0 billion reduction in subsidies on diesel for public transportation and fishermen, and subsidies for liquefied petroleum gas (LPG). It also included RM1.8 billion in savings from lower supplies and services expenditure, including travelling expenses. DE was reduced by 0.4 percent of GDP, through rescheduling non-physical projects such as transfers to government owned investment funds, and re-prioritising physical projects. Furthermore, additional revenue measures such as increasing the levy on foreign workers and reducing leakages on duty-free islands were introduced, and are expected to generate approximately 0.4 percent of GDP, an amount that will be kept unallocated for precautionary purposes. The government’s steady commitment to fiscal consolidation to date has been acknowledged by key rating agencies, maintaining Malaysia’s sovereign rating.10 31. Lower oil-related public revenues and fiscal consolidation raise the need for further improving public expenditure management. The implementation of several ongoing initiatives such as the medium-term fiscal framework (MTFF) and reinforcing monitoring and evaluation (M&E) as part of the outcome based budgeting (OBB) could boost public expenditure containment. With on-going concerns of slower income growth and rising cost of living, incidence analysis on the impact that existing and upcoming fiscal policies may have on different income groups would allow for better identification of the vulnerable and most-impacted groups, their income prospects and challenges, as well as how best social assistance can support them. 10 Fitch and Standard & Poors affirmed Malaysia’s sovereign rating at ‘A-‘and Moody’s kept it as ‘A3‘. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 25 Potential risks to the Malaysian economy in the near horizon 32. The Malaysian economy faces risks emanating mainly from external developments. Much of these risks stem from the uncertainty over the trajectory of growth in the global economy. This involves, in particular, the uneven pace of growth in the Euro area, the slow momentum of growth in Japan and the pace of the economic recovery in the US. In addition, the ongoing rebalancing in China’s economy and unexpected shocks to that economy as part of this rebalancing process may affect the Malaysian economy, as China remains a major trade partner of Malaysia (13 percent of total exports). While the manufacturing sector is expected to continue to contribute positively to exports, the fragile status of the global economy could affect overall demand for Malaysia’s exports and commodity prices. 33. Deterioration in domestic sentiment could exacerbate risks. This could be triggered by several factors. The lingering public discourse surrounding 1MDB could impact investors’ sentiments and divert government’s focus from needed reforms. Also, a sharp adjustment among households to a higher cost of living or a more pronounced softening in labour market conditions and/or a weakening of the ringgit could eventually have spill-over effects on overall consumer confidence, slowing down private consumption. A pronounced correction in the property market could also affect sentiments as well as rental income to selected households. Financial volatility, associated with renewed uncertainties over the Federal Reserve’s monetary policy and the outlook of emerging markets, could also lead to financial shocks and volatility in the economy, potentially affecting foreign inflows to Malaysia. Additionally, lower than anticipated commodity prices could affect business sentiments, public expenditure and capital investments. On the upside, the appointment of the new Central Bank Governor has eliminated uncertainty and reaffirmed the credibility of a stable monetary policy. 34. Conversely, the current stabilisation of oil prices could provide some uplift to the economy. As of 10 June 2016, crude oil prices have averaged USD41 per barrel (Brent), and are expected to average USD41 per barrel for 201611, above the government’s assumption in the budget recalibration of USD30 -35. As such, the windfall from higher oil prices so far provides some buffer should oil prices fall in the second half of 2016. Moreover, if oil prices remain at current level throughout the year, it would provide some additional fiscal leeway in 2016 and positively affect the balance of payments. 35. Given a more constrained policy space, more targeted policy responses could mitigate existing risks. Malaysia has had an effective and proactive macro-fiscal management thus far, and it will be important to remain nimble and adaptive in navigating the uncertain economic environment. On the fiscal side, a more targeted social assistance could prove cost effective to assist households that may be affected by a potential economic slowdown. This may include the introduction of unemployment benefits and increased efficiency of social assistance. It is also important to preserve investors’ sentiment and to accelerate structural reforms to enhance public sector performance, human capital development and productivity. The implementation of trade agreements could open the door for moving forward on some of these areas. 11 June 2016 Global Economic Prospects. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 26 2. Leveraging Trade Agreements 36. This section on leveraging trade agreements explores the possibilities that the recent wave of trade agreements offer to Malaysia’s development. The section is divided in two main parts. First, it provides a historical background on how Malaysia’s economic growth and employment creation has benefited from its trade openness. It also explores the new features of the trade agreements that Malaysia has embarked on in recent years. Second, the section focuses on the reforms that can be leveraged by implementing these new trade agreements, mainly in areas that are key for achieving high income status. These include, raising productivity of SMEs, bolstering competition across sectors, liberalising services to further support exports, and attracting higher valued added foreign investment. To this end, the section analyses public data and builds on international comparisons to conclude with some policy considerations for Malaysia to reap the benefits and mitigate the potential adverse effects of implementing the new trade agreements. Strategic Relevance of Trade Agreements for Malaysia’s Successful Development 37. Openness to trade and investment is key to explaining Malaysia’s developmental success. To overcome its small domestic market, Malaysia resorted to trade as an instrument for facilitating growth and industrialisation, becoming one of the most trade dependent countries, with an average ratio of trade to GDP of around 136.3 percent between 2010- 2014. Gross export value increased from USD30.0 billion in 1990 to USD234.0 billion in 2014, pushing Malaysia’s ranking from being the world’s 28th largest exporter in 1990 to 23nd in 2014, above the average East Asian experience (Figure 32).12 Malaysia’s openness to trade and investment, and related export growth has translated into high labour earning and jobs. Between 1995 and 2011, total wages supported by Malaysia’s exports quadrupled in value, increasing from US D13.2 billion in 1995 to USD54.0 billion in 2011. By 2011, around 40.0 percent of Malaysia’s jobs were supported by exports. 38. Malaysia has also deepened and diversified its export basket. Between 1980 and 2014, Malaysian exports have grown at around 12.8 percent per year on average, higher than the global export growth of 10.5 percent for the same period. Furthermore, around 60 percent of Malaysia’s total exports comprise of products that are highly traded in the global market and have gained market share (Figure 33). It has successfully tapped into fast growing global exports of manufacturing, including electrical machinery (Standard International Trade Classification, SITC 77), office machinery and data processor (SITC 75), and professional instruments (SITC 87). As a result, fuel (petroleum and gas), rubber, and wood exports represent 30 percent of total exports in 2014 compared to 66 percent in 1980.13 Furthermore, the diversification towards manufacturing has also increased Malaysia’s ranking in “Economic Complexity”, reflecting increased capabilities to produce goods that involve relatively more complex tasks. 14 12 World Bank (2006). “East Asia Renaissance: Ideas for Economic Growth”. 13 Based on SITC category 23, 24, 3 and 4. 14 See Atlas for Complexity http://atlas.media.mit.edu/en/resources/about/.Malaysia war ranked number 59 th out of 103 countries in 1986 and number 25th out of 144 countries in 2014. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 27 Figure 32: Trade contribution to Malaysia’s GDP is Figure 33: Malaysia has been gaining market share in above that of other East Asia countries exports Trade openness, percent of GDP Change in market share vs. global export growth, percent, 1990-2014 Change in market share 1990 to 2014 6.0 5.0 Gas 4.0 Office machinery & 3.0 Professional data processor instruments Electrical machinery Petroleum 2.0 1.0 0.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 -1.0 Growth in global export 1990-2014 -2.0 Share in Malaysia's -3.0 Vegetable oils & fats 2014 export -4.0 Source: UN-Comtrade, WDI, World Bank staff Source: UN-Comtrade, World Bank staff calculations calculations 39. Malaysia has long been using trade agreements to foster its development and is embarking on a new wave of trade agreements. Malaysia is one of the founding members of the World Trade Organisation (WTO) and has 14 Free Trade Agreements (FTAs) signed and 13 are active (Figure 34). It is now engaging in a new generation of mega regional agreements that are unprecedented in their depth. It has recently signed the TPP with 11 other members. Also, Malaysia has been discussing an EU-Malaysia Free Trade agreement (MEUFTA) to create a long-term, stable legal framework for bilateral trade between the two partners. Like TPP, the MEUFTA is ambitious and comprehensive, covering tariff and non-tariff barriers for goods and services, as well as commitments on other trade-related areas, notably procurement, competition and sustainable development (following the recent model of the EU-Vietnam FTA). The MEUFTA will remove tariffs on most goods, open up trade in services beyond the current General Agreement on Trade in Services (GATS) commitments and boost bilateral investment, encouraging EU and Malaysian companies to expand their business into both regions. ASEAN is also working with its members to sign a higher standard FTA, the RCEP. the TPP agreement can be seen as a beginning of a bigger picture towards achieving the Free Trade Area of the Asia-Pacific (FTAAP) as agreed by the Leaders of Asia-Pacific Economic Cooperation (APEC) through the Beijing Roadmap for APEC’s Contribution to the Realisation of the FTAAP 2014. Figure 34: Malaysia’s Network of Free Trade Agreements Source: Adapted from ASEAN Integration Center https://aric.adb.org/fta-country MALAYSIA ECONOMIC MONITOR JUNE 2016 » 28 40. The new trade agreements can further open up market access for Malaysia's exports of goods and services. For example, TPP can provide greater access to countries which Malaysia currently does not have bilateral FTAs with, such as Canada, Mexico, Peru, and more importantly deepen US market penetration, which holds about 9.4 percent of market share of Malaysia's export of goods in 2015. Apparel is the sector facing the highest barriers in foreign markets, with the simple average tariff of 10.7 percent. Figure 35 suggests that while most of Malaysia's exports to the US market is subject to zero percent Most Favoured Nation (MFN) rate, several products that are mostly exported to the US are still subject to above 5 percent MFN rate. However, because average tariff is generally low already, strong commitments in trade facilitation and addressing issues on Non-Tariff Measures (NTMs) can have more of an impact in opening up market access. In this regard, commitments in trade facilitation and NTMs in RCEP can further open market access in countries with which Malaysia already has FTAs such as China and India. Similarly, securing an FTA with EU countries can provide Malaysia access to the largest single market in the world. Market access also applies to services export which Malaysia has been developing (e.g., financial, medical tourism, and higher education, ICT and professional services). By engaging in trade agreements, Malaysia can set clearer parameters by which Malaysia's service providers can enter or offer products to consumers in these markets. Figure 35: Non-negligible amount of Malaysian Figure 36: FDI inflows have diversified in line with exports to the US are still subject to more than 5 trade agreements percent MFN rate Origins of FDI inflow to Malaysia, percent of total FDI, 2001-2012 Average US MFN tariff and share of US market in total Malaysia’s exports, 5 digit SITC product 100 70.0 60.0 50.0 Share US market in total export 80 40.0 30.0 60 20.0 10.0 0.0 40 -10.0 20 0 0 10 20 30 Simple average US MFN tariff 2001-2003 2010-2012 Source: UN Trains database, World Bank staff Source: UNCTAD FDI database, World Bank staff calculations calculations Note: products are 5 digit SITC classification. Blue circles http://unctad.org/en/Pages/DIAE/FDIpercent20Statisti are products that have MFN tariff up to 5 percent. cs/Interactive-database.aspx 41. Trade agreements can help to diversify origins of FDI inflows to Malaysia as seen with growing FDI from countries which Malaysia already has FTAs (e.g. ASEAN, Australia, Japan, and Korea) (Figure 36). “New generation” of trade agreements come with stronger commitments for protecting investment such as on intellectual property rights (IPR), investor-state dispute mechanism, and the use of negative list for investment. They also contain provisions on trade facilitation and efforts to harmonise treatment in NTMs, which can attract more vertical FDI wishing to use Malaysia as a production platform for supplying goods and services globally. Opening government procurement can also have strategic implications for Malaysia. For instance with TPP, there is potential for more FDI inflow into Malaysia to utilise preferential access to supply goods and services to public entities in other FTA member countries. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 29 42. The new generation of trade agreements can provide the needed impetus for Malaysia’s economy to boost its efficiency and increase its competitiveness. The 11th Malaysia Plan puts competitiveness and productivity as important ingredients to raise standards of living in Malaysia. In this regard, trade agreements can influence that process through various channels, mainly opening up market access for goods and services, facilitating new types of FDI, opening up the economy for more competition, and greater access to skills and technology. Although FDI stock increased threefold between 2000-2004 and 2010-2014, FDI growth in the latter period has been lower than key competitors, such as China, several TPP members (Chile and Peru), as well as some ASEAN members (Indonesia, Philippines and Thailand) (Figure 37). The FDI slowdown in Malaysia may reflect a slow recovery from the fallout of the 2009 Global Financial Crisis, but it may also suggest deep rooted constraints in attracting FDI in export oriented and knowledge intensive activities. Between 2000 and 2014 Malaysia’s growth of labo ur productivity has been trailing behind other countries in the region and lower than average upper middle income country (Figure 38). Trade agreements can further open up the economy for competition and release productivity gains with reallocation of resources from less efficient firms to more efficient firms within sector (intra-sectoral allocation) or from activities with diminishing returns to new emerging opportunities. Figure 37: FDI growth in Malaysia has trailed that of Figure 38: Malaysia’s growth of labour productivity comparator countries trails that of comparator countries Average growth of stock of FDI, 2010-2014 Average growth of output per labour, percent, 2000-2014 6.0 25.0 5.0 20.0 4.0 15.0 3.0 10.0 2.0 5.0 1.0 0.0 0.0 -5.0 -1.0 Source: UNCTAD, World Development Indicator, World Bank Source: World Development Indicator, World Bank staff staff calculations calculations 43. The overall economic impact of TPP for Malaysia is expected to be positive. The highest gain of output and exports as a result of new trade agreements is projected to occur in chemicals, metals, machinery and electrical equipment. The computable general equilibrium (CGE) estimations of the impact of TPP on the Malaysian economy show a gain in GDP of 8 percent by 2030 relatively to the baseline scenario, mainly explained by a reduction in NTMs (Figure 39- Figure 40). At the sectoral level, the most important exporting sectors of Malaysia such as electrical equipment, machinery and chemicals15 generate 53 percent and 58 percent of the country’s total absolute increase in output and exports, respectively (Figure 41).16 The strongest increase of Malaysian exports in these sectors will be to Mexico, USA, Canada, Peru and Chile. Textiles production is projected to increase by almost 60 percent while exports would expand by 90 percent. For apparel and footwear, the rise of output would amount to 40 percent while exports would increase by 63 percent, mainly due to strong reductions in tariffs and NTMs in other TPP countries such as Mexico and USA. Another reason for such a high expansion of textile and apparel sectors is the improved access to intermediate inputs. Non-discriminatory trade liberalisation is projected to lead to cheaper 15These three sectors account for 57.3 percent of total Malaysian exports in 2015 (baseline scenario). 16Relatively low percentage increase of output and exports in these sectors occurs due to a high base (i.e., baseline output and exports) in calculation of percentage change compared to the baseline scenario. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 30 intermediates from other countries, which traditionally supply to Malaysia. For example, Taiwan (China) is projected to increase its exports of textiles to Malaysia by 28 percent.17 Trade liberalisation is projected to induce an increase of imports in all sectors, with the highest changes in services (financial services, trade and transport, communication). Figure 39: Economic impact of TPP for Malaysia is Figure 40: Income gains in Malaysia will likely come expected to be positive from removal of NTMs Percent change in GDP, imports and exports by 2030 relatively to baseline Absolute income gains and as percent of GDP by 2030 relatively to scenario baseline scenario 80 Absolute income gains, no spillovers USD billions 6.7 70 66.7 GDP positive spillovers Share in total income 8.0 60 gains, percent 50 Income gains as ashare of real GDP, 18.0 percent 40 Imports 20.5 28.4 27.1 30 20 11.6 17.7 6.2 Exports 10 3.9 2.6 1.6 20.1 0.4 0 Tariffs & TRQs Goods NTMs Services NTMs Percent 0 5 10 15 20 25 Source: Petri and Plummer (2016) Source: Petri and Plummer (2016) Figure 41: Malaysia is expected to have large sector specific gains by joining TPP, RCEP and FTAAP Projected effects of TPP, RCEP and FTAAP on output changes at sector level in Malaysia by 2030 relative to the baseline, USD million 3500 3000 2500 2000 1500 1000 500 0 -500 -1000 TPP RCEP FTAAP Source: Petri and Plummer (2016) 17This result may be overstated as not all of the growth of non-TPP suppliers may be allowed under the TPP's Rules of Origin (ROO). The model captures the ROO correctly on the export side, but it does not include a mechanism that makes sure that member country products that do get preferences use the required amount of inputs from TPP sources. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 31 Box 4: Summary of Results from Different Models About the Impact of TPP on Malaysia Malaysia Institute for Strategic and International Studies (ISIS, 2015) investigated the implications of the TPP from the perspective of Malaysia’s national interests and identifie d potential benefits, risks, opportunities and challenges of TPP participation by analysing all the pillars and sub-pillars of the released agreement text. In order to demonstrate a fair overall impact assessment, all sub-pillars are given an equal weight in terms of importance, relevance and influence. The analysis for each sub-pillar is conducted through extensive stakeholder engagement, final text reviews and secondary research. The study concludes that TPP participation is consistent with Malaysia’s New Economic Model and ambitions to become a high income economy. Consistent with Petri and Plummer (2016), they find that GDP growth is expected to increase as this is very much linked to the increase of Malaysian exports to other TPP members and increased foreign direct investments in attractive sectors in Malaysia. These will also have positive effects on wealth and job creation. They caution, however, that these estimates critically depend on the extent that Malaysia reduces its NTMs and undertakes domestic economic reforms – the less it liberalises, the smaller the effect of the TPP. Pricewaterhouse Coopers (PwC, 2015) investigates the impact of the TPP using a similar methodology as Petri and Plummer (2016). They apply a dynamic multi-regional CGE model based on the Global Trade Analysis Project (GTAP) 9 database with additional data on population and real GDP projections. The authors find that Malaysia’s participation in the TPP will generate a cumulative gain in GDP of USD107 billion or even USD211 billion over 2018-2027, assuming all tariffs are eliminated and NTMs are reduced by 25 percent (moderate case scenario) or 50 percent (high case scenario) across all 12 TPP member countries. In growth terms, TPP will raise the GDP growth by up to 1.2 percentage points by 2027 (high case). Consistent with Petri and Plummer (2016), more than 90 percent of the cumulative GDP gains are driven by the reduction in NTMs. An elimination of tariffs without any reduction in NTMs would reap a cumulative gain of only USD12 billion over the same period. Investment is also projected to increase by an additional USD136-239 billion by 2027. Regarding trade, export growth is projected to increase by 0.5-0.9 percentage points in 2027, attributable mainly to higher manufacturing exports. As already shown above, the main driver is the textile industry with largest increase in investment growth and projected export growth increase by 4.1-4.9 percentage points. Additionally, PwC (2015) sectoral analysis also indicates that export-oriented firms, particularly in textiles, automotive components, E&E sectors, are expected to benefit strongly from greater market access to TPP countries. Nevertheless, some firms in sectors such as oil and gas, construction and retail, may face increased competition. A number of earlier studies also estimate the impact of the TPP for a wide range of countries, including Malaysia. For instance, Ciuriak and Xiao (2014) use a CGE model to simulate a “best guess” scenario based on the best information available before the official release of agreement. Their result is consistent with Petri and Plummer (2016) as they find that developing economies of the country group represent the biggest winners with Vietnam and Malaysia on the top. In the case of Malaysia, they estimate a significant gain with real GDP and household income rising by 3.1 percent and 3 percent by 2035, respectively. Using similar methodology, Kawasaki (2014) confirms the findings of previous studies. His results also suggest that Malaysia will enjoy the largest benefits among the member countries with an income gain of 20.6 percent of the GDP in 2010. Hereby, the reduction of NTMs generates these high gains as elimination of tariffs would result in increase of welfare of only 3 percent of the GDP in 2010. Applying again a dynamic CGE model, Lee and Itakura (2014) simulate implementation of TPP in a combination with further regional integration. In particular, they assume that 12 TPP members and Korea will implement a trade accord over the period 2015-2022, while three additional countries (Indonesia, the Philippines and Thailand) are assumed to join the TPP in 2018. Moreover, they also include implementation of the FTAAP during 2023-2030. Given this MALAYSIA ECONOMIC MONITOR JUNE 2016 » 32 simulation setup, Malaysia is not the top winner, but still benefits strongly from regional integration with a welfare increase of 1.9 percent by 2030. Hence, all of the empirical studies are consistently indicating significant potential gains for Malaysia from the implementation of the TPP agreement. Source: Authors. Trade has been instrumental in employment creation in Malaysia 44. Malaysia’s openness to trade and investment, and related export growth, has translated into high er labour earnings and jobs. Between 1995 and 2011, total labour value added (total wages) supported by Malaysia’s exports quadrupled in value, increasing from USD13.2 billion in 1995 to USD54.0 billion in 2011 (Figure 42). By 2011, around 40 percent of Malaysia’s jobs were supported by exports, either directly or indirectly.18 This implies that backward linkages have become relatively more important for wage growth. However, the portion of unskilled labour earnings supported by exports have grown faster than skilled labour earnings since 2004. In 2011, labour value added of exports attributable to unskilled workers was four times higher than skilled workers. Figure 42: Malaysia’s trade and investment openness has translated into higher labour earnings and jobs Direct, indirect and total labour value added of exports 1995-2011 Skilled and unskilled labour value added of exports 1995-2011 Source: LACEX, World Bank staff calculations Source: LACEX, World Bank staff calculations 45. Compared to other TPP members, Malaysian exports create large employment but with limited labour value added relative to gross export values (Table 6). For instance, in 2011, every USD1 million of gross exports supported 22.3 jobs, significantly above other TPP countries. These jobs, in turn, represented 23 percent of gross export values in Malaysia, below other TPP countries, suggesting low export wages vis-à-vis comparators. 18 This section is based on the World Bank’s Labour Content of Exports (LACEX) database. It measures how exports have translated to jobs and wages in Malaysia and other TPP and regional countries (relative to total jobs and wages), in aggregate and across sectors, through direct and indirect channels and across types of workers (skilled vs. unskilled). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 33 Table 6: Total labour value added and job share of exports, 2011 LVAX share JOBX share Malaysia 23.1 22.3 Canada 37.6 6.3 Japan* 49.3 12.9 Korea, Rep. 26.7 12.6 Mexico 20.8 29.7 Singapore 19.2 3.3 Taiwan (China)* 32.3 17.2 USA* 58.5 9.3 Vietnam* 20.7 575.8 Source: LACEX, World Bank staff calculations Note: *JOBX share available for 2004. Labour value added in exports (LVAX) share is the total LVAX per USD100 of gross exports. Jobs supported by gross exports (JOBX) share is the number of jobs per USD1 million of gross exports. 46. Demand for skilled workers will increase as Malaysia intensifies efforts to shift towards higher value added activities in manufacturing and services. As suggested by CGE projections, the implementation of TPP potentially can boost the output of manufacturing activities with high skilled-labour intensity in Malaysia namely the machinery, electronics and electrical equipment industries. However, it is service exports that has the highest skilled-labour intensity particularly when considering their forward linkages. The non-export services sectors that use skilled labour most intensely are public administration, defense, health and education, other private services, and electricity, gas and water supply. There are labour shortages in high- end tasks in Malaysia, including in the services industries. The scarcity of skilled labour in Malaysia may have driven increases in earnings for high-skilled workers. This, along with some increase in the productivity of these workers (which may explain the ability to export such services), could also partly explain the high labour intensity. Implementing the new trade agreements can accelerate key economic reforms 47. Commitments in Malaysia’s recent trade agreements has evolved from a mere tariff reduction to competition and regulatory reforms. This evolution is in line with the gradual reduction in tariff rates, combined with the increasing coverage under FTAs of trade services, sanitary and phyto-sanitary (SPS) regulations and technical barriers to trade (TBT). This is in line with the “new generation” of FTAs that also cover competition policy, investment chapter (with or without investor-state dispute settlement (ISDS)), and opening up government procurement for foreign competition (Table 7). The coverage also reflects a high level of ambition of signatories to negotiate reciprocal commitments to open up their economies for competition, protect IPR and investments. However, the depth of commitments can vary within each discipline (Box 5). For example, TPP requires member states to provide the opportunity for private sector to comment on draft legislations on standards and TBT while Malaysia-Developing 8 FTA is silent on these issues. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 34 Table 7: Disciplines beyond tariff elimination covered in selected FTA Malaysia Year Agreement Competition Standard & IPR Services Investment Government signed TBT procurement 1992 ASEAN FTA 0 1 0 0 0 0 2005 Malaysia-Japan 1 1 1 1 1 0 2006 Malaysia-D8 0 1 0 0 0 0 Countries 2007 Malaysia- 0 1 0 1 1 0 Pakistan 2009 Malaysia- New 1 1 1 1 1 0 Zealand 2010 Malaysia-Chile 0 1 0 0 1 0 2011 Malaysia-India 0 1 0 1 1 0 2015 Trans Pacific 1 1 1 1 1 1 Partnership Source: Adapted from Dür, A., Baccini L., and Elsig M. (2014) Note: 0: not covered in the agreement, 1: covered in the agreement 1Article 3 calls signatories to grant preference for goods and services from member parties in procurement of international tenders by government entities Box 5: Depth of Commitments under Different Trade Agreements a. b. This box compares Malaysia’s commitments under the TPP with those under ASEAN Trade in Goods Agreement (ATIGA) and a possible FTA with the EU, using the recently signed EU-Vietnam FTA as a marker. Annex 3 contains a table of comparisons that sheds light on all chapters, but the Standards/TBT, investment, IPR and customs chapters provide useful examples for comparison. c. d. Customs and Trade Facilitation: ATIGA commitments include development of a trade facilitation program, covering the areas of customs procedures, trade regulations and procedures, standards and conformance, sanitary and phyto-sanitary measures, ASEAN Single Window and other areas as identified by the ASEAN Free Trade Area (AFTA) council as well as bi-annual monitoring assessment. The TPP’s Customs Administration and Trade Facilitation chapter is in line with WTO Trade Facilitation Agreement with more explicit commitment on time limits to facilitate express delivery. For example, TPP countries have committed to ensure that goods are released within 48 hours of arrival (on bond/payment of duties subject to appeal). TPP countries also have to provide decisions on key customs matters, including customs valuation, before goods are shipped, and commitments include customs rulings of no later than 150 days after receiving a request, and expedited treatment of express shipments. TPP is the first trade agreement to include disciplines on the imposition of customs penalties, and also expands on customs cooperation commitments in previous trade agreements by committing all TPP countries to cooperate on preventing duty evasion, smuggling, and other customs offenses, issues of concern to all TPP countries. e. Standards/Technical Barriers to Trade: ATIGA commitments are in line with WTO agreement on TBT including harmonising with international standards and practices; promoting mutual recognition of conformity assessment; developing and implementing sectoral mutual recognition agreements (MRAs) within ASEAN including on product markings; and encouraging the cooperation among National Accreditation Bodies and National Metrology Institutes. TPP’s TBT chapter includes many new features, building on those i n the WTO TBT Agreement and earlier FTAs. These include; new transparency requirements including public consultation requirements early in the development of new measures, enabling trade-related concerns to be vetted and addressed before new measures are finalised, requirements ensuring that information on regulatory decision making is publicly available, and greater clarification that companies will need to have their goods undergo conformity assessment procedures only once before being able to sell them in TPP markets. On regulatory convergence, parties to the TPP have settled on a dual approach. They have agreed on “transparent, nondiscriminatory rules for developing regulations, standards and conformity MALAYSIA ECONOMIC MONITOR JUNE 2016 » 35 assessment procedures, while preserving TPP Parties’ ability to fulfill legitimate objectives.” In this respect, the TPP rules broadly reflect, and in fact, directly incorporate some of the main rules already contained in the WTO, TBT, and SPS agreements. f. Investment: TPP’s Investment chapter includes core obligations of national treatment of foreign investment/investors, minimum standards based on customary international law on investment protection, expropriation for public purposes only, and with fully transferable compensation. Under TPP, governments are obligated to allow transfer of funds, but this is subject to exceptions, under circumstances of capital controls etc., and the chapter ensures freedom to appoint foreign managers. TPP’s investment chapter includes stronger safeguards to close loopholes and to raise the standards of ISDS including underscoring that countries can regulate in the public interest (health, safety, financial stability, and environmental protection); expanding the rules discouraging and dismissing frivolous suits; clarifying that the claimant bears the burden to prove all elements of its claims; allowing governments to issue binding interpretations of the agreement; making proceedings fully open and transparent; and providing for the participation of civil society organisations and others parties not a direct party to the dispute. The EU-Vietnam FTA’s investment chapter provides protection for investors, including usual obligations to provide “fair and equitable treatment” such as national and MFN treatment with important exemptions for certain protected industries such as mining, oil and gas, and communications. The Treaty guarantees that expropriation will be matched with prompt and adequate compensation. One of the key divergences of the EU-Vietnam FTA is the creation of a permanent court, where investor-state disputes will be decided in first instance, rather than a usually mandated ad-hoc tribunal. The tribunal will consist of nine members – three each from EU, Vietnam and third country nationals. Each member will serve a four-year term, renewable once, with specific ethical obligations. Decisions can be appealed within 90 days at an appellate tribunal. United Nations Commission on International Trade Law (UNCITRAL) rules on transparency apply, but decisions are only recognisable and enforceable in member states. Intellectual property protection: The TPP goes somewhat beyond the WTO’s Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). It requires penalties for the unlawful commercial exploitation of copyrighted work, and prescribes measures to reduce the illegal online distribution of copyrighted material and strengthen copyright terms. Some of the intellectual property (IP)-related TPP provisions are highly controversial, including those for biologics and trademarks. Proponents argue that strong rules and enforcement are necessary in order to support investments in innovation, whereas critics maintain that current levels of IP protection already stifle innovation and generate monopoly rents. Source: Authors. 48. As a small and open economy, Malaysia’s path to high-income status is tied to its trade performance. There are three main channels through which trade contributes to growth. First, trade represents a significant source of demand for Malaysi a’s goods and services, and has allowed Malaysia to take advantage of economies of scale that would not otherwise be possible in a small economy. Second, open international trade is important to inject competition into the economy, exposing domestic firms to the rigors of international markets and providing them with incentives to become more efficient and productive. Finally, under the right conditions, trade can generate learning and innovation spillovers by providing firms with access to foreign inputs, investment and know-how. 49. While trade agreements can benefit the overall economy, they expose SMEs to new challenges and potentially could adversely impact unskilled workers and businesses that depend on government support. In order to compete effectively in the globalised world economy, Malaysia needs to accelerate productivity- enhancing reforms by promoting innovation, upgrading skills in its labour force, creating a sound business climate that is conducive to attracting and retaining investment, and developing high-growth SMEs and their MALAYSIA ECONOMIC MONITOR JUNE 2016 » 36 linkages to Multi National Enterprises. Free Trade Agreements (FTAs) such as the TPP bring the potential for greater market access for Malaysia. With a market friendly government and a strong track record of reforms, there are new opportunities for reinvigorating structural reforms to support private sector led economic growth. 50. While the mega agreements are comprehensive and cover a wide range of areas, this report focuses on four key areas: (i) services (ii) competition policies and GLCs (iii) investment policies and investor-state disputes and (iv) SMEs.  An efficient services market is essential to enhance a country’s competitiveness by supporting other export sectors, in the context of internationalisation of production. In the 21st century, services are an important determinant of export competitiveness. Services can contribute to a country’s exports directly – for example, a domestic company performing business processing outsourcing services for overseas customers; or indirectly as inputs to other sectors’ exports – for example, the domestic trucking sector transporting manufacturing products to the port for export. Quality and sophistication of the manufacturing and agriculture sectors and their exports are thus determined by the ease of access to well-functioning and efficient services.  Greater competition and a level playing field in the domestic economy would provide the private sector, especially SMEs, greater opportunities, locally and globally. Firms facing vigorous competition have strong incentives to reduce their costs, to innovate, and to become more efficient and productive than their rivals. This process motivates firms to offer competitive prices, higher quality, and new and more varied goods and services. The new generation of RTAs include commitments to promote greater competition across markets that have a key role in promoting economic development.  Foreign investment remains very important for the diversification of the Malaysian economy. Foreign investment plays an important role in facilitating technological upgrading and innovation especially for SMEs. With increased competition for foreign investment, governments eager to attract more capital can actively influence investor perceptions of political risk by introducing policies, laws and institutions that make their business environments safer, alleviating investor concerns about protection.  With SMEs in Malaysia accounting for a large share of firms, production and employment, its transition to a high-income economy will depend highly on SMEs contribution to GDP growth. In order for SMEs to reap the benefits of FTAs, they would need to be more productive to be globally competitive. Services’ exports remain underexploited 51. Services have played a key role in the development of the Malaysian economy. The services sector has shown a healthy growth in the last two decades, with its share in GDP rising from 34 percent in 1980 to 53 percent in 2014. It is the main source of employment, with 8.4 million jobs representing 60.9 percent of total employment in 2014, 15 percent points increase over the past 15 years. In 2014, Malaysia’s commercial services exports19 amounted to USD39.4 billion or 14.6 percent of Malaysia’s exports and USD44.7 billion imports or about 20 percent of Malaysia’s imports.20 As set out in the 11th Malaysia Plan, the goal is that services contribute to 56.5 percent of GDP by 2020. Two major strategies set out the country’s next economic 19 Commercial services are total services excluding government services. 20 Overall services have taken a key role in the economy with manufacturing holding the biggest share of services to GDP (23 percent), followed by wholesale and retail trade (14,4 percent), agriculture (9,2 percent), and mining (9 percent). In terms of exports, transportation services, an important sector for the Malaysian economy, contributed to USD10.2 billion. Value added, an equivalent of 3.3 percent of total value added (2013) with a share of total employment of 4.4 percent. Respectively, finance and insurance services contributed to USD23.0 billion, standing for 7.5 percent of total value added in 2013 (WTO, 2015). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 37 steps in services, namely the Services Sector Blueprint 2015 and the Strategy Paper 18: Transforming Services Sector as part of the 11th Malaysia Plan (Box 6). Box 6: Two Key Services Strategies g. h. Services Sector Blueprint 2015: i. With the ambition to become a high-income advanced nation by 2020, the Services Sector Blueprint 2015 sets out challenges that the sector faces. It includes aspects such as shortages and skills mismatch, high regulation of the sector, and the domestic instead of international orientation of the country’s se rvice providers. These challenges were translated into four policy levers. First, an internationalisation strategy, encouraging services exports; second, addressing investment incentives, focused on quality and transparency; third, human capital development to respond to the needs of the sector; and fourth, a sectoral governance reform. j. Strategy Paper 18: Transforming Services Sector: The Strategy Paper 18: Transforming Services Sector is part of the 11th Malaysia Plan 2016-2020. It provides a general overview of the services sector in the economy, its challenges and government response. These are labour productivity, human capital and skills mismatch, exports capabilities, regulatory framework, access to financing, technology adoption as well as research and development (R&D). It lays out strategies for these areas and provides concrete sectoral strategies for specific subsectors identified as priorities, namely the Halal industry, financial services, tourism industry, whole sale and retail trade, private high education, professional services, private healthcare and the construction industry. k. Source: Authors. 52. Services contribution to Malaysia’s exports is below that of peer countries, particularly the indirect contribution through domestic supply chains. Malaysia’s services performance remains somewhat below what would be expected given Malaysia’s economy and its income level. Its share in GDP remain substantially below the East Asia Pacific (EAP) regional average and lower than middle income countries average (Figure 43). Over half of services value added is exported directly (57 percent) and about a third (30 percent) is exported by the manufacturing sector, a proportion similar to other TPP members, but below some high income economies. Notably, the indirect share of domestic services value added embodied in Malaysia’s gross exports falls significantly below that of other countries (Figure 44). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 38 Figure 43: Malaysia’s services contributions to GDP trail that of other EAP countries Services, percent of GDP 80 74.9 74.4 70 63.9 57.6 60 54.8 53.5 51.7 50 46.3 43.3 41.6 40 30 20 10 0 Malaysia Vietnam Philippines Singapore Thailand Indonesia East Asia & Low income Middle OECD Pacific income members Source: World Development Indicators (World Bank, 2016), DOSM Note: Malaysia’s figure is as at end-2015 Figure 44: The indirect share of domestic services value added embodied in Malaysia’s gross exports falls significantly below that of other countries Services, percent of GDP Direct Indirect 60 40 40 Share Share JPN USA 20 CAN USA SGP KOR SGP 20 JPN MEX CAN VNM MYS VNM MYS MEX KOR 0 0 6 8 10 12 6 8 10 12 Log GDP per capita (current USD) Log GDP per capita (current USD) Total 80 60 Share USA JPN 40 SGP CAN VNM MEX MYS KOR 20 0 6 8 10 12 Log GDP per capita (current USD) Source: OECD-WTO TiVA database (2015), World Bank staff calculations MALAYSIA ECONOMIC MONITOR JUNE 2016 » 39 53. Compared to TPP countries, Malaysia’s services sector contributed relatively less to services and retained only weak linkages to manufacturing activities. Services sector also uses other services as inputs (e.g. financial service use telecommunication) and in 2011 the contribution of Malaysia’s services activities in generating services value added was low compared to other TPP countries (Figure 45, left). In 2011, manufacturing contributed 51 percent of total exported value added in Malaysia but linkages between services and manufacturing in Malaysia was lowest among TPP members except Vietnam. In 2011, the value of services embodied in gross manufacturing exports was 12 percent in Malaysia, compared to 28 percent in Japan, 25 percent in the United States and 22 percent in Canada (Figure 45, right). This could be due to services linkages in Malaysia being in low-value added activities such as wholesale and retail trade, hotels and restaurants, and transport and storage. Also, Malaysia’s export sectors could not be in services -intensive sectors, or Malaysia’s position in these sectors’ global value chain (GVC) is one that does not demand high value-added services. Finally, it may be that Malaysia’s firms rely on imported services. Figure 45: Malaysia’s services sector contributed relatively less to services and retained weak linkages to manufacturing activities Contribution of services as inputs to services Contribution of services into manufacturing exports Services Manufacturing 80 80 60 60 Share Share 40 40 20 20 0 0 MYS CAN JPN KOR MEX SGP TWN USA VNM MYS CAN JPN KOR MEX SGP TWN USA VNM Direct value added Inputs into s ervices Direct value added Inputs from services Inputs into m anufacturing Inputs into prim ary production Inputs from m anufacturing Inputs from prim ary production Source: OECD-WTO TiVA database (2015), World Bank staff Source: OECD-WTO TiVA database (2015), World Bank calculations staff calculations 54. Services can contribute more to Malaysia’s key export sectors. The relatively low use of services by manufacturing is most notable in the chemicals, rubber & plastic and agri-food sectors, which together account for 33 percent of Malaysia’s value added exports (Figure 46).21 In Malaysia, exports of chemicals and chemical products and rubber and plastic products rely least on services relative to other peer economies, while the intensity of services inputs for agri-food exports is only above that of Vietnam. The most important services inputs for manufacturing exports in Malaysia are trade, finance and utility supply (Figure 47). On the other hand, the use of financial services is significantly higher than all peer countries, compared to lower use of wholesale and retail trade (distribution) services. Supply chain linkages between manufacturing and telecommunications is also more prominent than its peers. 21Rubber & plastic products (3.2 percent), chemicals & chemical products (5.6 percent), agri-food (10.2 percent), and electrical & optical equipment (13.7 percent). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 40 Figure 46: Malaysia’s low use of services by manufacturing is most notable in these sectors Inputs into GVC extensive exports Inputs into GVC extensive exports Chemicals Rubber & plastic 10 0 1 2 3 4 5 Share Share 5 0 KOR TWN KOR TWN CAN CAN VNM VNM MYS SGP MEX MYS MEX USA SGP USA JPN JPN Agri-food Electronics 15 10 20 30 40 10 Share Share 5 0 0 KOR TWN CAN KOR TWN CAN VNM VNM MYS SGP MEX MYS SGP MEX USA USA JPN JPN Direct value added Inputs from services Inputs from manufacturing Inputs from primary production Source: OECD-WTO TiVA database (2015), World Bank staff Source: OECD-WTO TiVA database (2015), World Bank calculations staff calculations Figure 47: Services inputs for manufacturing exports in Malaysia that are most important are trade, finance and utility supply Composition of services inputs into manufacturing exports, 2011 100 80 60 Share 40 20 0 MYS CAN JPN KOR MEX SGP TWN USA VNM Electricity, gas, water Construction Trade Hotels, restaurants Transport Post, telecomm. Finance Real estate Equip. rentals Computer R&D, other business Other Source: OECD-WTO TiVA database (2015), World Bank staff calculations MALAYSIA ECONOMIC MONITOR JUNE 2016 » 41 New trade agreements may not be binding enough to liberalise services sectors 55. Malaysia’s trade agreements offer valuable opportunities to Malaysia’s services. Expanding Malaysia’s services trade could be boosted by attracting international providers that can expand domestic capacity and enhance expertise. Many of Malaysia’s trade agreements aim at liberalising trade in services. FTAs with Japan, Pakistan, New Zealand, India, and Australia involve the services sector (MITI , 2016). Also, as a member of the WTO, Malaysia is a signatory to the GATS. ASEAN is the broadest integration initiative, meant to promote the ASEAN Economic Community as a “single market and production base”, with “free flow” of goods, services and investment. As part of the TPP, Malaysia has committed to a substantial degree of openness in the services sector although it has also excluded general and sectoral restrictions from the obligations of the agreement. Malaysia’s commitments span across all services sector, and they include substantial access to foreign participation in key sectors like professional and transport services. Box 7: Malaysia’s Main Obligations in Trade in Services in the TPP - The Novelty of “Negative-Lists” The services framework of the TPP is laid out in Chapter 10 (Cross-border trade in services). It covers services delivered across-borders (as defined in GATS/Mode 1), or in the territory of a TPP Party to a national or another Party (GATS/Mode 2), or through the temporary presence of a TPP national in the territory of another TPP Party (GATS/Mode 4). Commercial presence of a service provider (GATS/Mode 3) however, is contained in Chapter 9 (Investment) of the TPP. The TPP includes the core obligations, including i) national treatment, ii) MFN treatment, iii) “market access” (limitations on quantitative restrictions or the type of legal entity); and iv) prohibition of “local presence” requirements to provide a service. The extent and coverage of these substantive obligations, however, is not universal or unconditional, but is bound by country-specific lists of reservations (or “non-conforming measures”). The agreement features “negative-lists” of laws and regulations that are inconsistent with the chapter’s core disciplines and that are to be maintained, as well as sectors in which the governments wish to retain greater flexibility for the future. The negative list approach implies that if the TPP Party does not list any restriction for a particular sector, that sector is open to its partners in full compliance with the obligations of the agreement. The reservation lists are thus a key element of the obligations on trade in services, since they allow a degree of flexibility to the TPP parties to maintain certain measures that would otherwise be against the agreements, or to limit the sectoral scope of the agreement by carving out some sectors from the agreements obligations. The negative lists also entail, however, that the sectors and measures that are not expressly excluded from the agreement, are (or should be) in full compliance with the disciplines of the TPP. While the use of the negative list is common for countries with bilateral FTAs with the United States, this approach is relatively new for Malaysia, which is more familiar with the “positive list” approach of the GATS or the ASEAN Framework Agreement on Services. (World Bank, 2016). Source: Authors. 56. Malaysia has introduced unilateral reform in its services sector. Prior to 2009, foreign participation in the country was governed by the Foreign Investment Committee (FIC), which was tasked to screen incoming investments and to limit foreign equity to 30 percent for domestic-market oriented projects and for acquisitions of Malaysian firms. In 2009, the FIC was abolished and the FIC Guidelines governing foreign equity limit was repealed. In the same year, the government of Malaysia announced the liberalisation of 27 services sectors. Subsequently, Malaysia liberalised 18 more services subsectors in 2012. In addition, Malaysia has signed various FTAs at the bilateral, regional and multilateral levels, which provide greater market access for foreign firms to operate in Malaysia. Under the National Export Council (NEC), measures are also undertaken to implement and review measures to increase competitiveness of Malaysia’s services export, such as education services and medical tourism. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 42 57. Compared to primary and manufacturing sectors, services sector in Malaysia is still relatively more restricted for foreign providers (Figure 48).22 While the services sector remains one with the most reservations, it still presents a substantial level of openness. Out of 140 individual services activities, 40 percent feature no specific restriction for the establishment of a foreign-service supplier, yet most services, with the exception of business services and transport, face some degree of limitations. A more detailed analysis suggests business services fall largely under professional services, services incidental to the mining, fishing, manufacturing and energy, and real estate services, whereas most modern business services, including those related to IT, face no restrictions (Figure 49). Figure 48: Services sector in Malaysia is still relatively more restricted to foreign providers, compared to primary and manufacturing sectors Source: (Molinuevo & Saez, 2014), World Bank staff calculations Figure 49: Most services sector face some degree of restrictiveness Source: TPP list of restrictions, World Bank staff calculations 58. Malaysia can unilaterally review remaining restrictions in services to gain more from trade agreements. Some distribution services, in particular, face a number of burdensome restrictions on entry, such as authorisations, mandatory joint ventures, and nationality requirements (Figure 50). Malaysia’s most burdensome measures are concentrated on the distribution of cultural products like newspapers and magazines, heavily regulated consumer goods such as alcohol and tobacco, and some key food staples, like rice, sugar and flour. Also, the establishment of supermarkets and retail stores in general remains subject to stringent requirements regarding limits for foreign participation, nationality of directors and employees, 22The analysis does not count commitments under financial services, which are subject to its own specific disciplines (Chapter 11) and reservation list. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 43 and approval requirements. Construction services also face similar restrictions, although foreign establishment may be allowed provided that the board of directors is established with Malaysians. Figure 50: Some distribution services face a number of restrictions on entry Source: TPP lists of reservations, World Bank Note: The size of the bubbles represents the ratio of measures of that type found in that services subsector. The biggest bubble indicates 100 percent. 59. Reviewing horizontal measures applied to all services sectors can boost investment attractiveness and competitiveness of services sector.23 These measures center around three categories (Figure 51): First, “other undisclosed quantitative and discriminatory measures” for establishment as well as operation. “Undisclosed” typically allow the country to maintain or introduce any type of measure with the purpose of fulfilling a particular policy goal. They are hence particularly important in ensuring flexibility regarding any future regulatory ambition of the addressed sector. On the flip side, they also reduce the transparency of the agreement and undermine the openness of the sector, as the country essentially remains free to take any kind of policy measure in that sector. Second, “Nationality and Residency requirements (for senior personnel)” requiring that some or all the managers, boards of directors, etc. of the service provider have to be citizens or live (have residence, domicile or an establishment) in the country in which the service is provided. Third, a set of performance requirements which are not mandatory in its implementation, but again provide the government with certain flexibilities in the addressed matter horizontally and across all sectors. 23 “Horizontal” measures/requirements stipulate limitations that apply to all sectors included in the schedule of commitments. They often refer to a particular mode of supply, notably commercial presence and the presence of natural persons that applies to all sectors for this mode of supply. For example Malaysia has set out in its TPP commitments a horizontal, Mode 3 (commercial presence) requirement, which states that the “Acquisitions or dealings of land by non- citizens and enterprises owned by foreign nationals must be approved by the relevant State Authority, subject to such conditions and restrictions as may be imposed by that Authority” (TPP, annex II, p. 1). Hence any acquisition or dealing of land by a foreign service provider needs to be approved by the State Authority. Similar requirements related to land ownership is common in the 12 TPP members. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 44 Figure 51: Reviewing horizontal measures applied to services sectors can boost investment attractiveness and competitiveness of the services sector Source: TPP lists of reservations, World Bank Note: Mode 1: consumption abroad, Mode 2: cross-border consumption, Mode 3: physical presence (FDI), Mode4: temporary movement of professionals 60. Malaysia can also strengthen predictability of rules for entry and operation for foreign services providers. Malaysia introduced a number of “undisclosed” restrictions in the TPP, which ensure greater flexibility, especially during the entry stage of the foreign investment. However, undisclosed measures make up to more than half of restrictions related to the “establishment” of foreign service providers with 55 percent and up to 43 percent related to “operation” of foreign service providers in Ma laysia (Figure 52) Another big part of Malaysia’s restrictions are related to “Nationality for services supplier” with 33 percent for establishment and 34 for operation, followed by 52 percent for “authorisation/ permit” and 26 percent for “local presence” requirements, both establishment restrictions. Figure 52: Undisclosed measures make up a significant share of restrictions related to the “establishment” and “operation” of foreign service providers Source: TPP lists of reservations, World Bank staff calculations MALAYSIA ECONOMIC MONITOR JUNE 2016 » 45 61. Implementation of commitments on professional services may require assessing the regulatory landscape. Professional services are typically amongst the heaviest regulated services sectors in the economy, often needed to address information asymmetries between providers and consumers but also subject to strong political economy pressures that leverage regulation to limit competition, especially foreign participants. Some key sectors for the business environment, like accounting and taxation services, as well as medical and veterinary services, appear fully committed to the terms of the TPP (Figure 53). Other professions, like architecture, engineering, and especially legal services remain heavily restricted, including limitations on foreign ownership, nationality and residency, and performance requirements. Implementation challenges may result from the maintenance of existing restrictions that are not reflected in the listed reservations. For instance, implementation of TPP commitment on professional services may entail eliminating preferences to domestic professional firms, such as mandatory procurement to local/ Bumiputera professionals by firms established in Malaysia. In this context, the implementation of TPP commitments on professional services requires a detailed assessment of the current regulatory framework for the sector in light of the obligations and flexibilities resulting from the agreements. Figure 53: Some key services sectors appear to be fully committed to the terms of TPP, while others remain heavily restricted Source: TPP lists of reservations, World Bank 62. Trade agreements aim to facilitate temporary movement of business visitors to create a more dynamic business environment and bring in additional talent. TPP parties negotiated reciprocal commitments on the entry and temporary stay of skilled business persons to facilitate greater trade and investment under Chapter 12 of the Agreement. This commitment complements those under other chapters of the TPP, such as Cross- Border Trade in Services, Investment, and Government procurement, and provide enhanced certainty on entry and length of stay and reduced barriers to labour mobility. Business persons will be granted more flexibility to pursue trade and investment opportunities, oversee the management of a business and take advantage of opportunities to work in an overseas branch of their company or provide services to a local company. The Chapter does not affect measures regarding citizenship, residence or employment on a permanent basis. It goes beyond the commitments included in the GATS and its Annex on Movement of MALAYSIA ECONOMIC MONITOR JUNE 2016 » 46 Natural Persons Supplying Services under the Agreement (MONP) and it affirms prior commitments made by TPP Parties, including the support for the APEC business travel program (Box 8).24 Box 8: Malaysia’s Main Obligations in Movement of Temporary Business Persons Professions covered by the Agreement are divided into regulated and non-regulated professions. Regulated professions include white-collar jobs in different industries as well as skilled trades.  Intra-Corporate Transferees: business persons seeking to work in an oversees branch of their office;  Contractual Service Suppliers: business persons who possess specialist trade, professional and technical knowledge and offer services on a contractual basis;  Short-term business visitors: business persons who wish to stay in a TPP country for a short period of time to pursue business opportunities, including to attend a conference, trade fair or meetings, explore investment opportunities or engage in negotiations;  Independent Professionals: self-employed business persons seeking to travel to a TPP country temporarily, to perform a valid service contract without the requirement of a commercial presence;  Service sales persons: persons based outside the country where the service is being provided and receiving no remuneration from a source located within that country, and who are engaged in activities related to representing a service provider of another party for the purpose of negotiating for the sale of the services of that provider;  Investors: business persons responsible for setting up, developing or administering an establishment for which a substantial amount of capital has been or will be committed by the business person in a supervisory or executive capacity, or involves essential skills;  Technician: a business person seeking to engage, at a technical level, as an independent technician or as a contractual service supplier;  Installer and servicer: a person who is an installer or servicer of machinery or equipment, who is employed or appointed by a supplying company, where such installation or servicing by the supplying company is a condition of purchase of the said machinery or equipment, who does not perform activities which are not related to the installing or servicing activities which is the subject of the contract and who receives his or her remuneration from the supplying company;  Spouses and dependents: spouses and dependents of intra-corporate transferees, contractual service suppliers and investors. Malaysia sets out its commitments in accordance with Article 12.4 in its schedule under Annex 12-A. The categories of business persons included in Malaysia’s commitments are business visitors, intra -corporate transferees, contractual service suppliers, independent professionals, and installers and servicers. The schedule includes a quota for independent professionals, capping the number of foreign lecturers employed in an educational institution at 20 percent. Intra-corporate transferees have access in all sectors and sub-sectors except for legal services, custom agents and real estate agents. Annex 3 compares Malaysia’s commitments in respect of the temporary entry of business persons with those of other parties to the Agreement. Source: Authors. 24Malaysia is also a signatory of ASEAN Agreement on the Movement of Natural Persons (AAMNP), which commits to establish a mechanism to facilitate temporary movement of skilled labour. Signatories tabled their commitments to facilitate: (i) business visitors, (ii) intra-corporate transferees, (iii) contractual services suppliers, and movement of skilled labour in specific areas. Malaysia in this case commits to facilitate temporary movement of (i) and (ii). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 47 63. Movement of business professionals is still subject to regulations and could be further streamlined. Malaysia regulates business visitors and can issue passes at the point of entry for attending business meetings and conducting business negotiations. However, if they wish to engage in work in Malaysia, they must apply for a business or a professional pass or visa according to immigration rules. A clear and streamlined process for business visitors to obtain a business visa would make it easier to attract business visitors into the market. One way to underscore Malaysia’s commitment to this process would be to set up TPP business entry windows at immigration that expedite TPP service provider access. A common implementation challenge relates to the need of balancing business attracting objectives with security concerns and ensuring adequate internal coordination. One step is the increased use of modern information and communication technologies for visa processing, including interviews, official documents, or certificates and streamlining documentary requirements. Implementing a plan that liberalises the services sector would further support export growth 64. Commitments in cross-border trade in services, while not necessarily innovative, may pose important challenges for compliance. This is especially the case for countries like Malaysia that do not have previous experience with negative list agreements on trade in services. A general review of the commitments by TPP countries suggests that, overall, obligations in services may be oriented more to preventing roll-back of liberalisation than to bring about new market opening. However, Malaysia’s commitment in the services sectors has set ambitious obligations on key services, like professional and transport services. Conducting a detailed assessment of the regulatory regime for the services sector in general, and in particular of professional and transport services, would serve to facilitate implementation of the TPP. While the substance of the TPP includes de facto measures, an assessment of compliance should not be limited to actual laws and regulations and include a review of administrative practices relative to the services sector. Furthermore, to ensure compliance with the agreement –and enhance services competitiveness- Malaysia should not only reform existing regulation, but also consider establishing a body of best practices for future regulations. 65. Malaysia may want to continue to strengthen coordination in the services sector for regulatory reform. First, it is important that the coordination mechanism in charge of implementing the Services Sector Blueprint (Malaysia Services Development Council and Special Committee on Services) benchmarks regulatory restrictiveness in services in Malaysia with other members of TPP. Providing those committees with access to expertise in different fields, manpower, finance, and communication is crucial given the cross cutting and complex nature of services. Second, further assessing regulatory practices in services sector can help address regulatory constraints that undermine competitiveness and do not necessarily serve the objectives of addressing information asymmetry (in quality, standard, safety) and ensuring access to services (e.g., health, telecommunication). This assessment, which is currently being spearheaded by Malaysia Productivity Corporation, would serve to put in place a regulatory framework that accelerates reforms. Malaysia can also consider reviewing sector-level strategies guided by the macro-level strategy, and monitor progress of these efforts using the Service Trade Restrictiveness Index (STRI). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 48 Box 9: Strengthening Coordination and Reform in Services - Experiences from Chile and Peru Chile and Peru, both TPP parties, have recognised the importance of increasing trade in services and have developed comprehensive programs. The successful outcome of these two examples shows the crucial role of a high level institution serving as a strategic partner by coordinating and promoting services policies as a tool for trade. ProChile, an agency under the Chilean Ministry of Foreign Relations, is in charge of promoting trade in goods and services and attracting FDI and tourism. It has a national network composed of 15 regional offices located in each one of the country regions and two state offices which are also meeting places for the exporting sector. These offices have professionals who know the regional market and assist exporters. ProChile also has an external network with 55 commercial offices strategically located in the most important markets around the world, open to tho se in need of Chile’s services. These offices have professionals who monitor the opportunities and trends in the markets while linking the exportable supply with potential clients. The institution aims to increase Chile’s trade in services through differ ent approaches, including high quality information systems, participation in important international fairs, and programs designed at enhancing export capacity. Through PymeExporta, the institution provides tools and advice to SMEs wishing to export their services. The Services Trade Competitiveness Council, a public-private partnership, advices the president regarding policies that enhance innovation and competitiveness. The Corporación de Fomento de la Producción de Chile (CORFO), Chile’s Economic Development Agency, also has several support programs that help companies, business persons and entrepreneurs improve innovation and competitiveness through funding, technical advice, and tax credits. In 2014, Chile’s trade in services contributed to 13 percent of the country’s total exports, with 35 percent of its trade in services in non-traditional services. IT services represented 11 percent of total exports. Trade in non-traditional services has increased, most notably in professional services (which represented seventy percent of non-traditional trade), IT services, royalties and licensing fees, and financial services. The Commercial Office for Regional Trade was created by Peru’s Ministry of Trade and Tourism to provide information, capacitation, and technical assistance to small and medium-sized companies located in strategic zones for international trade. PromPeru was launched in 2007 to manage policies and initiatives that promote exports, tourism and the country’s image. Centro de Formación en Turismo (CENFOTUR) is another agency under the Ministry that is in charge of policies and programs for education, capacitation and specialisation of human resources. Corporación Financiera de Desarrollo S.A. (COFIDE), Peru’s development bank, provides funding as well as training and technical assistance to small and medium- sized companies wishing to export their services. Additionally, ExportaFacil, an interagency institution, helps SMEs access international markets through advice, decreased fees and participation in international fairs. In 2014, Peru’s trade in services represented almost 13 percent of its total exports. Most of the revenue from trade in services came from tourism (53 percent), followed by transport services (25 percent) and non- traditional services (22 percent). Sources: www.prochile.gob.cl, https://www.wto.org/english/tratop_e/tpr_e/s315_e.pdf, http://trade.ec.europa.eu/doclib/docs/2006/september/tradoc_111556.pdf, https://www.wto.org/english/tratop_e/tpr_e/s289_e.pdf, http://www.siicex.gob.pe/siicex/resources/sectoresproductivos/Reportepercent20depercent20laspercent20exportaci onespercent20depercent20serviciospercent202015.pdf MALAYSIA ECONOMIC MONITOR JUNE 2016 » 49 Investment Policy and Investment Protection New generation trade agreements such as the TPP can bolster FDI as well as investments abroad 66. Recent reforms towards greater economic liberalisation have helped Malaysia maintain its importance as a major recipient of foreign direct investment (FDI). The stock of inward FDI rose steadily from a quarter of GDP in 1990-1991 to 43 percent in 2012-2014, outpacing the regional average throughout the period (Figure 54). While in the past Malaysia relied on fiscal incentives and selective liberalisation to attract investment25 it has gradually ramped up efforts to improve the investment climate to greater openness. 26 Starting in 2003, the government began to liberalise restrictions in the banking and insurance sectors. In 2009, the government raised the limit on foreign equity in investment banks, Islamic banks and insurance from 49 to 70 percent27. It also reformed the FIC, reducing the mandated Bumiputera stake in locally incorporated companies from 30.0 to 12.5 percent and repealing its guidelines on the acquisition of interests, mergers and takeovers. Crucially, Malaysia also began to liberalise investment in services. In 2009, the government increased access to foreign investment in 27 previously restricted service sub-sectors, including computer-related consultancies, tourism, and freight transportation. In 2011, another 18 sub-sectors were opened to up to 100 percent foreign investment. A National Committee for Approval of Investments in the services sector was set up under the Malaysian Investment Development Authority (MIDA). Since 2009, Malaysia has seen an increased proportion of FDI approvals coming into services and less into the primary sector (Figure 55). Figure 54: Malaysia’s FDI performance has Figure 55: Services sector is an increasingly consistently surpassed the regional average important source of FDI Stock of FDI, percent of GDP Proportion of FDI approvals 70 80 70 60 60 50 50 40 40 30 Malaysian firms, particularly government-linked companies, have also become significant outward investors, and Malaysia is now a net outward investor on an annual basis. 30 20 20 10 10 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Primary Manufacturing Sector Services East and South-East Asia Malaysia Sector Sector Source: UNCTAD, World Bank staff calculations Source: UNCTAD, World Bank staff calculations 25 An investment incentive law adopted in 1968 provided corporate tax breaks for industries that exported finished and semi-finished goods. A 1971 law created free trade zones that centered on export processing activities. Malaysia aimed to shift to heavy industries with the establishment of the Heavy Industries Corporation Malaysia (HICOM), which promoted steel, cement, autos, chemicals and like industries. In the mid-1980s, slow growth led the government to adopt policies of privatisation, deregulation and economic liberalisation. The 1986 Promotion of Investment Act (PIA), removed restrictions on foreign investment for companies that exported a significant percent of their production or employed a certain number of domestic workers. Malaysia's opening to export-oriented investment, coupled with sound macroeconomic management, a well-functioning financial system, and sustained economic growth made Malaysia one of the most attractive emerging market FDI destinations. 26 See 10th Malaysia Plan, 1st pillar. 27 Malaysia has enacted the Financial Services Act 2013 and the Islamic Financial Services Act 2013 in June 2013. In both conventional and Islamic finance, the application for a license is now based on the prudential and “best interest of Malaysia” criteria. Similarly, the acquisition of a significant foreign equity interest in Malaysian banks and insurance companies could be up to 100 percent, subject to meeting the aforementioned criteria. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 50 67. Malaysian companies, particularly government-linked, have become significant investors abroad which has made Malaysia a net outward investor since 2008. By the mid-2000s, Malaysia had become the fourth largest exporter of capital in Asia, after Hong Kong, Singapore and Taiwan (China). Malaysia’s stock of outward direct investment doubled from 1.5 percent of GDP in 1990 to 15 percent in 2005 and has increased to over 40 percent in 2014, according to United Nations Conference on Trade and Development (UNCTAD) data. Malaysian firms tend to invest in services sectors, natural resources (particularly oil and gas) and, manufacturing. By 2014, Malaysia’s outward FDI stock had equaled its stock of inward FDI. This shows that domestic Malaysian firms have built up ownership advantage and become competitive enough to significantly expand their operations abroad. 68. Trade agreements can provide Malaysian firms more investment opportunities to expand their market base and take greater advantage of an increasingly globalised economy. Malaysia has a significant presence in global outward investment (Figure 56); its greenfield investments and mergers and acquisitions as a percent of world total is twice that of Malaysia’s proportion of world GDP. This trend has certainly been underscored by activities of the GLCs, particularly their investments in the financial sector. In addition to PETRONAS, the national oil company, four out of the six Malaysian companies ranked in the top 100 non – financial Trans National Corporations from developing countries in terms of foreign assets (UNCTAD) are government-linked companies. Over a third of Malaysia’s outward investments in 2012 went to Singapore, Australia, the United States and Vietnam. Studies of Malaysian companies (Ragayah (1999) and Hiratsuka (2006)) for example, found that expanding markets was the main motivation for Malaysian companies investing abroad. Trade agreements with strong investment provisions can help Malaysian investors access additional protection for their investments abroad. 69. Preliminary estimates on the ad valorem equivalent (AVE) of NTMs reveal that most of the TPP countries have more restrictive NTMs than Malaysia. The analysis separates NTMs into two groups: Sanitary and Phytosanity Measures and Technical Barriers to Trade (SPS/TBT) and the second group are the rest of the NTMs (non-SPS/non-TBT). Ad valorem equivalent of these countries are estimated using quantity based gravity models. On average, across all TPP countries, the average AVE for SPS/TBT measures is 8.7 percent. Likewise, the average AVE for non-SPS/non-TBT measures is 5.5 percent. Relative to the TPP averages, Malaysia is considered less restrictive at this aggregate level. The AVEs for SPS/TBT and non-SPS/non-TBT measures for Malaysia are 7.7 percent and 1.7 percent respectively. Countries that are considered more liberal are Mexico, and Peru. On the other hands, Australia, Canada, Japan, the USA and Vietnam all have considerably more restrictive NTMs (Figure 57). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 51 Figure 56: Malaysia has a significant presence in Figure 57: Malaysia may gain from TPP members greenfield projects and mergers and acquisitions further liberalising NTMS Number of announced greenfield projects Estimated ad-valorem equivalent of NTM, percent and mergers and acquisitions, 2003-2014 18 AVE for SPS/TBT Measures 350 Greenfield M&A 16 AVE for Non-SPS/Non-TBT Measures 300 14 250 12 200 10 8 150 6 100 4 50 2 0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 AUS CAN CHL JPN MEX MYS NZL PER SGP USA VNM Source: UNCTAD Source: Kee and Nicita (2016, forthcoming) 70. Trade agreements can complement Malaysia’s favourable investment climate and attract additional foreign investment. Malaysia’s relatively stable macro economy and high rank in the World Bank Group Doing Business indicator and Logistics Performance Index suggest good fundamentals for attracting FDI inflows. Locking commitments on investment policies, regulatory certainty, services and also trade facilitation may help further attract FDI beyond labour intensive sectors. 71. The TPP adds to Malaysia’s growing portfolio of International Investment Agreements (IIA) and is part of a “new generation” of IIAs.28 Since 2006, the Malaysian government has signed FTAs with Japan, Australia, India, Chile, and New Zealand as well as with China and Korea as part of ASEAN. This is in addition to the ASEAN Comprehensive Investment Agreement (ACIA) and 49 bilateral investment treaties (BITs) currently in force. The TPP goes beyond some of these IIAs or adds to Malaysia’s existing international investment commitments. Previously, IIAs –mostly BITs- were negotiated within a “jurisprudential vacuum”, that is, before the late 1990s when ISDS activism started. “New generation” IIAs incorporate modern jurisprudence in international investment law, including: (i) evolution from solely regulating protection to investment established according to the laws and regulations of the host country, to include clauses locking in levels of non-discrimination against foreign investors when attempting to establishment their investments in the host country; (ii) greater precision in the definition of the term “investment” ; (iii) clarification of the meaning and scope of certain key investment protection standards; (iv) inclusion of clauses clarifying that investment protection cannot be promoted at the expense of certain key public policy objectives; (v) promotion of greater transparency; and (vi) innovations in ISDS procedures themselves. 28http://investmentpolicyhub.unctad.org/IIA/CountryBits/127#iiaInnerMenu New generation of trade agreements, such as TPP or EU FTA, contains Investment Chapter which aims to create a predictable investment environment in member States, while safeguarding their governments' ability to regulate in the public interest. In particular, the provisions of the investment chapter aim to: (i) delimit the scope of application of the chapter, (ii) gradually eliminate discriminatory measures on pre-establishment of investment in host countries, (iii) establish clear standards of treatment and protection for foreign investors against political risks derived by unlawful government conduct and (iv) provide for detailed Investor-State arbitration procedures to enable investors to effectively enforce the guarantees included in the chapter. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 52 72. New generation of FTAs (including IIAs) provides not only for investment protection but also a gradual sector liberalisation without limiting regulatory capacity of the state. IIAs follow the “non-discrimination” principles by granting to cover foreign investors national treatment and MFN treatment, with respect to the right of establishment in the host State. This right of establishment is generally qualified by a “negative list” that allows the countries to specify sectors or activities of the economy in which the right does not apply. Such restricted sectors or activities of the economy are listed under annexes that form an integral part of the agreement. In addition, the Investment Chapter in TPP does not limit the regulatory capacity of the state to pursue legitimate objectives; but limits the possibility of promoting discriminatory policies in these regulatory activities (Box 10). Box 10: Malaysia’s Reservations in TPP Investment Chapter Annex I of the TPP on “non-conforming measures” lists existing laws and regulations that are inconsistent with certain obligations of the agreement (basically the obligations on non-discrimination and performance requirements). In this regard, each Party accepts an obligation not to make those measures more restrictive in the future. Annex II of the TPP, also known as Annex on “future measures” lists sectors or policy areas where Parties retain full discretion to introduce new measures (including more restrictive) inconsistent with the previously mentioned obligations of the agreement. Under TPP Annex I, Malaysia listed non-conforming specific measures at the central and/or regional level where the obligations of national treatment/ performance requirements/ senior management and board of directors do not apply. The sectors are the following: manufacturing, marine capture fisheries, patent and trademark agent services, some professional services, legal services, real estate services on a fee or contract basis, communications services, education services, private healthcare facilities and services allied health services, utilities, transport services, distribution services, construction and related engineering services, freight road transportation services, wholesale and distribution services, and oil and gas. As for the Annex II, Malaysia listed non-conforming measures at the local and/or regional level with respect to national treatment/ performance requirements/senior management and board of directors. As opposed to the measures listed in Annex I, Malaysia retains discretion to introduce a new level of restrictiveness on these measures. The sectors listed under TPP Annex II are: land and real state, oil and gas, explosive and weapons, betting and gambling, non-medical utilisation of atomic energy, cultural services, wholesales and distribution services, sewage and sanitation, air transport services, taxi services, legal services, and social services. Further, under Annex II, Malaysia has reserved the right to adopt or maintain any measures affecting the following activities:  Full or partial development to the private sector or services provided in the exercise of governmental authority;  Divestment of its equity interest in an enterprise owned by the Malaysia government;  Privatisation of government owned entities or assets;  Assistance to Bumiputera for the purpose of supporting Bumiputera participation in the Malaysian market through the creation of new and additional licenses or permits;  Differential treatment under bilateral or multilateral agreements and ASEAN member states;  Non-internationalisation of ringgit: requirement of international settlement to be made in foreign currency, limitation on the access to ringgit financing by non-residents for use outside Malaysia, and limitation on the use of ringgit in Malaysia by non-residents. Source: Authors. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 53 73. The TPP provision restricts countries’ ability to impose obligations, such as local content requirements and export requirements, as a condition for investment entry. To date, all Malaysia’s FTAs, except the ASEAN- China FTA, restrict the use of performance requirements,29 but provide no further limitations than those contained in the TRIMs Agreement. Several agreements – for example the Malaysia-Japan FTA and the ACIA suggest that parties might further review the performance requirement provision and include more detailed obligations in the future. The TPP, on the other hand, goes beyond the TRIMs limitations, specifying a wide range of potential performance requirements that will be prohibited under this agreement. This could have important implications for the Malaysian automotive sector as the elimination of local content requirements allows automakers in TPP countries to export cars into the Malaysian market without limitation (Moran and Oldensky, 2016). Multi-national companies in the automotive sector previously have had to bring knocked- down car kits into Malaysia for local assembly in subscale plants, leaving Malaysian consumers with more expensive and lower quality models to choose from.30 74. Malaysia’s IIAs also clarify and reinforce the capacity of the state to pursue public policy objectives, such as health, safety, cultural identity, the environment, and the promotion of internationally recognised labour rights. Following the same logic as ACIA and the Malaysia-Australia FTA (MAFTA), the TPP states that the countries have the right to adopt, maintain and enforce any measure otherwise consistent with the Investment Chapter that consider appropriate that investment activity is undertaken in a manner sensitive to environmental, health or other regulatory objectives.31 These clauses clarify that the investment promotion and liberalisation objectives of IIAs must not be pursued at the expense of these other key public policy objectives.32 Some IIAs have included general treaty exceptions while others have opted for positive language in order to strengthen commitments of the countries to safeguard certain values, and some have combined both. These normative developments seem to respond to the intention of host states to address the concerns of labour unions and environmental non-governmental organisations regarding international investment agreements. Malaysia’s IIAs typically include such exceptions to protect public welfare.33 Higher standards for Investor State Dispute Settlement under TPP can further improve the investment climate 75. Investor State Dispute Settlement (ISDS) provisions are a common feature of most IIAs. This neutral, swift and high standard mechanism of legal dispute resolution makes effective the substantive protections offered by investment treaties. ISDS reflects the intention to provide investors with an avenue to directly defend their rights, without having to depend on diplomatic protection of their home countries or on the domestic courts of the host country. ISDS also helps reestablish a measure of equilibrium to the disadvantaged position that foreign investors may have in comparison to domestic investors. This is particularly important in cases of uncertainty or where the investor may not feel that domestic courts are reliably neutral. ISDS is intended to be an instrument of last resort where all other recourse to amicable settlement has been exhausted. 76. ISDS mechanisms do not prevent countries from establishing environmental, health or other regulations. What they do prevent is for countries to discriminate against foreign investors. ISDS guarantees that fair compensation will be awarded to investors in case the latter is treated unfairly, e.g. are unlawfully expropriated or discriminated against, in violation of the IIA. There is currently a significant political debate 29 ACIA, for instance, prohibits performance requirements, export requirements and trade balancing requirements. 30 Moran and Oldenski (2016), p. 102. 31 The TPP also innovates in including a Corporate Social Responsibility clause. This provision encourages enterprises operating in a Party´s territory or subject to its jurisdiction to voluntarily incorporate into their internal policies those internationally recognised standards, guidelines, and principles of corporate social responsibility that have been endorsed by that Party. 32 Echandi, Roberto. "Bilateral Investment Treaties and Investment Provisions in Regional Trade Agreements: Recent Developments in Investment Rulemaking." Arbitration under International Investment Agreements: A Guide to the Key Issues (2010): 3-37. 33 The ACIA, for example, explicitly names protection of the environment in its exceptions. ACIA and MAFTA both include a similar provision specifying that measures based on legitimate public welfare objectives, such as protection of public health, safety and the environment may not be considered indirect expropriations. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 54 regarding ISDS as a means for investment protection, paradoxically, beyond what the factual figures would otherwise suggest. According to UNCTAD, in over 50 years of investment protection, there have been 568 documented cases of arbitral proceedings, of which 274 have been decided upon. Of these cases, 43 percent were decided in favour of the state, and 26 percent were settled. Only 31 percent of cases were found in favour of the foreign investor. 77. The TPP provides greater safeguards in the use of ISDS for Malaysia, as none of its previous IIAs incorporated a mechanism to avoid frivolous claims. ISDS proceedings entail a significant amount of time and resources, exposing governments to the risk of lost investment, reputational damages and costs of litigation and arbitral awards. To minimise these risks, new generation IIAs include some procedural innovations to foster the principle of judicial economy in ISDS procedures, such as: (i) the possibility to consolidate separate claims having a question of law or fact in common and arising out of the same events or circumstances (ii) preventing a particular investment dispute from being addressed in more than one adjudication forum at the same time and (iii) avoiding frivolous claims. TPP requires the claimant to submit with the notice of arbitration a written waiver of any right to initiate or continue before any court or administrative tribunal under the law of a Party, or any other dispute settlement procedures, any proceedings with respect to any measure alleged as a claim under the TPP. Further, the TPP includes a mechanism for expedited review and dismissal by host states of frivolous or unmeritorious claims and claims the tribunal is not empowered to resolve. 78. To respond to concerns by some non-governmental organisations, and increase transparency, the new generation of IIAs have included provisions aimed at improving the legitimacy of investor-state arbitration within civil society. Such rules on transparency include, for instance, the requirement of the respondent in an investment dispute to transmit to the home state and to make available to the public certain documents, including the notice of arbitration, the memorials, the transcripts of hearings, and the awards of the tribunal; the requirement that the hearings be open to the public; and the requirement to allow parties not involved in the dispute to submit briefs and authorise arbitral tribunals to consider submissions from any member of the society, the so-called “amicus curiae”. Recent Malaysia IIAs include transparency rules requiring the disputing party to make publicly available all awards and decisions made by the tribunal when such information is specifically designated as confidential (Malaysia-India FTA). The TPP, following the trend of new generation IIAs, incorporates rules of transparency of arbitral proceedings (arbitration hearings and documents open and available to the public), “amicus curiae” submissions and non-disputing party submissions. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 55 Box 11: Malaysia’s Experience with ISDS Some of the ISDS cases in which Malaysia has been involved in ISDS are: Case Name and Number IIA Outcome Philippe Gruslin v Malaysia ICSID Belgium and Luxembourg- In favor of Malaysia Case No. ARB/99/3 Malaysia BIT Telekom Malaysia v. Ghana (PCA, Malaysia-Ghana BIT Settlement under UNCITRAL Rule at the Hague) MTD Equity Sdn Bhd and MTD Chile Malaysia-Chile BIT In favor of Malaysian SA v. Chile ICSID Case No. investor ARB/01/07 Ekran Berhad v. China ICSID Case Malaysia-China BIT Settlement No. ARB/11/15 Malaysian Historical Salvors Sdn Bhd United Kingdom-Malaysia BIT In favour of Malaysia v. Malaysia ICSID Case No. Then annulled by ARB/05/10 annulment panel Source: Authors In “Gruslin v. Malaysia”, based on the Malaysia-Belgium & Luxembourg BIT 1979, the Belgian investor sued Malaysia under the IIA after making losses on portfolio investments in the Kuala Lumpur Stock Exchange caused by the introduction of the exchange control in September 1998 as a response to the Asian financial crisis. The Arbitral Tribunal rejected the claim on the ground that the investment was not an approved investment and fell outside the scope of the BIT which applies to investment in approved projects. In “Malaysian Historical Salvors Sdn Bhd v. Malaysia” the government awarded a contract to a locally- registered company owned by a UK national to “survey, identify, classify, research, restore, preserve, appraise, market, sell/auction and carry out a scientific and salvage of the wreck and content of Diana”, a ship which sank in 1817 off the Straits of Malacca. The contract was a normal salvage contract on the “no-finds, no-pay” basis. The salvors discovered 24,000 intact individual pieces of porcelain , which were auctioned by Christie’s in Amsterdam in March 1995 . However, the distribution of auction proceeds evolved into a dispute. The case was first referred to the Kuala Lumpur Regional Centre for Arbitration in July 1995, where the sole arbitrator dismissed the claim, and later to the High Court in Kuala Lumpur, where it was also dismissed. The claimant then referred the case to the International Centre for Settlement of Investment Disputes (ICSID) in 2004. In 2007, the sole arbitrator decided that the Tribunal had no jurisdiction of the dispute on the grounds that the salvage contract is not an investment within the meaning of Article 25(1) of the ICSID Convention. The claimants filed for the annulment of the decision and ICSID set an Ad Hoc Committee to hear the annulment application. The Committee, by a majority decision, decided that the original Tribunal had exceeded its power by failing to exercise the jurisdiction it was endowed with by the terms of the Agreement and the Convention, and that the Government of Malaysia should bear the full costs of the annulment proceedings. ISDS has also been used by Malaysian investors to defend their interests against host states abroad. In Telekom Malaysia v. Ghana, an UNCITRAL case which was referred to the Permanent Court of Arbitration, Ghana decided not to renew a management contract with the national Malaysian telecommunications company, Telekom. The case was settled bilaterally and Telekom later pulled out of Ghana. In MTD Equity Sdn Bhd v. Chile, the investor, which held shares in the construction of a residential and commercial complex in Chile, protested the government’s denial of a zoning modification that was allegedly necessary for the claimant to execute a residential development project in Chile. In Ekran Berhad v. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 56 China, the Ekran subsidiary challenged the Chinese government’s decision to revoke their rights to develop real estate in the province of Hainan. The subsidiary was initially given a 70-year lease over 900 hectares of land, but the government had revoked their rights due to an alleged failure to develop the land as stipulated under local legislation. The case was settled bilaterally. Malaysia’s involvement in the ISDS has provided it with the necessary experience to put in place the required mechanisms to avoid disputes as well as to defend itself in the event of any potential disputes. It has also provided Malaysian officials who handled the Gruslin and MHS Salvor cases discussed above with the necessary experience, which could be used to train other colleagues in dealing with ISDS procedures. Source: Authors. A domestic “grievance mechanism” can reduce the risk of legal disputes develop ing into ISDS cases 79. Aligning domestic legislations and harmonising level of minimum protection to foreign investors may bring Malaysia closer to good practices. Malaysia does not systematically grant national treatment (NT) to foreign investors in its BITs (e.g. Malaysia-Egypt BIT, Malaysia-Turkey BIT). Thus, national treatment is one area where Malaysia may consider upgrading its domestic legislation to align it with, and fully implement, its international commitments under TPP, ACIA and other IIAs that include this obligation. There is also variation across Malaysia's IIAs on how it would treat different foreign investors. Malaysia's BITs include an MFN clause, as do ACIA and investment chapters in FTAs though they contain some significant variations. The BIT with Saudi Arabia, for example, conditions MFN treatment on domestic legislation: the standard of protection is provided "in accordance with its laws and regulations". 80. Policies in the area of performance requirements may be adjusted according to the TPP Investment Chapter. The TPP assures international companies that they will not be required to meet "performance requirements" such as local content or technology-transfer/technology-localisation mandates.” Although local content requirements (LCRs) are prohibited under the WTO Trade-Related Investment Measures (TRIMs) Agreement, some countries include these types of measures as part of their policies to develop specific industries. It is important to note that the rules and disciplines under the TRIMs Agreement only cover those performance requirements affecting trade in goods –not in services- so some performance requirements fall outside the coverage of the TRIMs.34 81. “Grievance mechanism” may be a good way to address investor’s concerns early on before it develops into a legal dispute. ISDS proceedings entail a significant amount of time and resources. Investment procedures not only expose host governments to the risk of lost investment, but also to reputational damages and significant costs of litigation and arbitral awards. Several countries have fairly formal dispute management systems, focused on handling investor-State arbitration and more informal grievance management systems. In this regard, experiences from the following countries may be useful for Malaysia to design its own system to address investors’ concern. a. Korea has an Office of Foreign Investment Ombudsman (OFIO). The Ombudsman is commissioned directly by the president and heads the Investment Aftercare Division. The Investment Aftercare Division is staffed with nine experts in the fields of taxation, labour, finance, accounting, law, construction, IT, etc. The experts, also called "Home Doctors", provide foreign-invested companies one-on-one service in investigating and resolving a wide range of grievances. In the Korean model, "grievances" are very broadly defined and the OFIO addresses all types of grievances, ranging from corporate management to the living environment of foreign investors. To be more concrete, the 34 See Cimino-Isaacs, Hufbauer, and Schott (2014). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 57 OFIO's supports covers investment system, investment incentives, taxation, finance, foreign exchange, tariff, customs, construction, environment, law, selection of plant sites, visa/ immigration, IT, intellectual property, etc. b. Colombia, Peru, and Mexico have also put in place procedures and policies to address investor grievances related to government actions or inactions. All of these countries have fairly formal dispute management systems, which are systems focused on handling investor-State arbitration and more informal grievance management systems. Competition Policy and GLCs The new trade agreement will impact GLCs and can be leveraged in a more fundamental way for increased domestic dynamism and international competitiveness 82. Direct state participation through GLCs is significant and important for the Malaysian economy and influences market structure across key economic sectors. Malaysia not only has eight of the largest GLCs in the world but also stands amongst the top 10 countries with the highest Country State-Owned Enterprise Shares (CSS).35 Malaysia has followed an ambitious model of internationalisation of GLCs similar to the one of Singapore resulting in significant presence in a number of regional and non-regional markets.36 Malaysian GLCs span from network industries (telecommunication and transport) and public utilities services, such as sewage and energy distribution, to less capital intensive sectors such as agriculture, health care, education, tourism, construction and real estate.37 The government owned in 2013 around 36 percent of the total value of listed firms in the Bursa Malaysia and more than 50 percent of the market capitalisation of the Kuala Lumpur Composite Index. 38 GLCs market participation is greater than 50 percent in agriculture, banking, information communications, and retail trade.39 In 2014, the 17 largest GLCs employed 373,627 people, consisting of 225,050 Malaysian and 148,577 foreign employees. 40 Therefore, ensuring that GLCs behave in a pro- competitive way is key to enhancing Malaysia’s international competitiveness. 83. In practice, an effective competition policy framework fosters pro-competition regulations and government interventions; guarantees competitive neutrality (a level playing field between public and private enterprises) in markets and proper enforcement of competition law. Markets in developing economies often underperform due to anti-competitive behavior and restrictive regulatory frameworks by a few dominant players, adversely affecting consumers (individuals or firms). When certain firms agree to fix prices, empirical evidence reveals that consumers pay on average 49 percent more, and 80 percent more when cartels are strongest. Competition is limited if regulations restrict the number of firms or limit private investment; rules facilitate agreements among competitors; or if government interventions in markets discriminate against certain competitors or affect competitive neutrality. On the other hand, when competition policy is effective in tackling these restrictions, consumers and firms benefit from competitive prices, increased quality and higher productivity which positively affects international competitiveness and economic growth (Table 8). 35 See OECD (2013), “State-Owned Enterprises: Trade Effects And Policy Implications” Available at http://www.oecd- ilibrary.org/docserver/download/5k 4869ckqk7l.pdf?expires=1460820524&id=id&accname=guest&checksum=9C8416168404AD37DACEDE005FF7E407 36 For the model of Temasek in Singapore, see Ministry of Trade and Industry of Singapore (2002). “Report of the Entrepreneurship and Internationalisation Subcommittee”. Economic Review Committee, page 20. Available at https://www.mti.gov.sg/ResearchRoom/Documents/app.mti.gov.sg/data/pages/507/doc/6percent20ERC_EISC.pdf 37 Jayant Menon and Thiam Hee Ng. “Are Government-Linked Corporations Crowding out Private Investment in Malaysia? Asian Development Bank, Working Paper Series. No. 345 | April 2013, pages 5-6. See also for reference http://www.khazanah.com.my/Our-Investments/Sectors 38 U.S. Department of state. 2013 Investment Climate Statement - Malaysia. Report of the Bureau of Economic and Business Affairs. Available at http://www.state.gov/e/eb/rls/othr/ics/2013/204686.htm 39Jayant Menon and Thiam Hee Ng. Are Government-Linked Corporations Crowding out Private Investment in Malaysia? Asian Development Bank, Working Paper Series. No. 345 | April 2013, p. 2. 40 Putrajaya Committee, 2015. “GLC Transformation Program Graduation Report”. P211, P13, P16. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 58 Table 8: Fostering Competition in Markets Pro-competition Regulations and Competitive Neutrality and Effective Competition Law and Government Interventions: Opening Non-distortive Public Aid Antitrust Enforcement Markets and Removing Anti- Support Competitive Sectoral Regulation Reform policies and regulations that Control state aid to avoid Tackle cartel agreements that strengthen dominance: restrictions to favoritism and minimise raise the costs of key inputs and the number of firms, statutory distortions on competition final products and reduce monopolies, bans towards private access to a broader variety of investment, lack of access regulation products for essential facilities. Eliminate government interventions Ensure competitive Prevent anti-competitive that are conducive to collusive neutrality including vis-a vis mergers outcomes or increase the costs of GLCs competing: controls on prices and other market variables that increase business risk Reform government interventions that discriminate and harm Strengthen the general antitrust competition on the merits: frameworks that distort the level playing and institutional framework to field or grant high levels of discretion combat anti-competitive conduct and abuse of dominance Source: Authors 84. Recognising the importance of increasing competition, the new generation of RTAs include commitments to promote greater competition across markets that have a key role in promoting economic development. The TPP constitutes an explicit recognition that the effective implementation of trade commitments fosters open markets and limits anti-competitive behavior, either from private or public operators. The agreement requires parties to establish and enforce a procedurally fair and transparent competition law framework (Chapter 16), to implement the competitive neutrality principle (Chapter 17) as well as to promote pro- competitive regulatory environments in key sectors of the economy such as financial services, telecommunications and government procurement (Chapters 11, 13 and 15 respectively), among others. 85. In this sense, the potential implications of the competition-related obligations of the TPP for Malaysian markets could be significant. The core of TPP competition-related provisions support the implementation of the competitive neutrality principle across the economy and sectors, including the ones with strong presence of GLCs. Horizontal chapters like the ones on competition policy and GLCs when read together with vertical chapters on telecommunications and financial services offer basic elements to build comprehensive competition policy frameworks that account for the necessary interplay between antitrust and regulation. 86. First, Chapter 16 on Competition Policy focuses on embedding the principles of fair competition, consumer protection and transparency within the markets of TPP signatories. This chapter sets obligations aimed at developing a level playing field for direct government participation in the economy based on the respect of commercial considerations, non-discriminatory market practices and promotion of equal MALAYSIA ECONOMIC MONITOR JUNE 2016 » 59 regulatory treatment. This framework leverages the experience of the implementation of the competitive neutrality principle41 by some of the TPP parties, notably, Australia and the US. 87. Second, the TPP obligations of Chapter 17 on State-Owned Enterprises and Designated Monopolies focuses on guaranteeing that GLCs compete on a level playing field and are to a large extent behavioural in nature. This chapter sets obligations aimed at developing a level playing field for direct government participation in the economy based on the respect of commercial considerations, non-discriminatory market practices and promotion of equal regulatory treatment. 88. Third, sector specific chapters reinforce the promotion of competition by setting regulatory frameworks that eliminate entry barriers and foster a level playing field between public and private operators, and between national incumbents and firms from other TPP parties. For instance the telecommunications commitments are intended to guarantee a pro-competition framework in the sector, with the objective of increasing sector performance and consumer welfare. Chapter 13 of the TPP sets a pro-competitive framework for telecommunications based on (i) competition for the supply of services and equipment, (ii) non-discriminatory market conditions and (iii) market-oriented regulatory solutions. The goal is to increase consumer welfare and create positive externalities to sectors that depend on telecommunication services by addressing issues on fair access to government resources, transparency in rule making, fair procedures and rule of law. 89. Therefore, TPP offers an opportunity for Malaysia to further implement international best practice on competition policy, economy wide as well as sector specific, and thus reap the benefits of more dynamic markets and firm behavior. Competition drives productivity growth through two key mechanisms: it shifts market share toward more efficient producers, and it induces firms to become more efficient so as to survive. Firms facing vigorous competition have strong incentives to reduce their costs, to innovate, and to become more efficient and productive than their rivals. This process motivates firms to offer competitive prices, higher quality, and new and more varied goods and services. Competition in input (upstream) markets, such as transportation, financial services, energy, telecommunications, and construction services, is a key driver of efficiency and productivity growth in downstream sectors —the users of these inputs. Conversely, a lack of competition adversely affects productivity.42 90. In principle, the recently implemented Malaysian competition regulatory framework sets the basic procedural and institutional grounds for the enforcement of competition policy and foster the development of competition in markets. The Competition and Competition Commission Acts, both enacted in 2010, entrust the competition agency with investigatory powers, market study prerogatives and prescribed sanctions for anticompetitive violation. In 2011, the Malaysian Competition Commission (Suruhanjaya Persaingan Malaysia) was set up according to the Competition Act 2010 (Act 712) and the Competition Commission Act 2010 (Act 713).43 As at June 2016, the Competition Commission had issued four decisions that found evidence of infringement of the competition law. The infringements involved mainly cartel cases. No abuse of dominance has been found to date. 41 The principle of competitive neutrality which, as first proposed in Australia, requires that government business activities do not enjoy net competitive advantages over their private sector competitors simply by virtue of their public ownership. For a detailed discussion, see generally 2011 OECD Working Paper on “Competitive Neutrality and State -Owned Enterprises.” 42 See generally, World Bank Group (2012), “Competition Policy: Encouraging Thriving Markets for Development”, by M. Kitzmuller and M. Martinez Licetti, Viewpoint Policy Journal Note No. 331. 43 Competition Act 2010 (Act 712) available at http://www.mycc.gov.my/sites/default/files/CA2010.pdf. Competition Commission Act 2010 (Act 713) available at http://www.mycc.gov.my/sites/default/files/CCA2010.pdf. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 60 91. However, there are a few areas that may require improvements to increase effective implementation in practice. The Act allows the Ministry of Domestic Trade, Co-operatives and Consumerism to further restrict its application simply by amending the First Schedule through a ministerial order.44 The independence of the Commission remains open to discussion since four out of 10 Commissioners represent the government, including the Ministry of Finance, MITI, the Prime Minister Office and the Ministry of Domestic Trade, Co- operatives and Consumerism.45 Finally, the Competition Act prohibits anti-competitive behaviour of firms, but has no provision for reviewing mergers and acquisitions. 92. For Malaysia, implementing competitive neutrality measures to guarantee a level playing field in markets with GLC presence can increase efficiency and attract private sector investment. In principle, Malaysia’s institutional framework for GLCs is already structurally aligned with those of the TPP chapter on GLCs (Chapter 17). Malaysian public companies have independent corporate governance, GLCs compete in market economy environments and regulatory agencies have proper tools for providing equal policy enforcement.46 While the chapter on GLCs aims at guaranteeing a level playing field and does not trigger structural reforms per se of the national GLC model, other sectoral and horizontal chapters of the TPP might impact government policies towards GLCs. TPP governments would need to apply the chapter on GLCs as guidance to promote pro-competitive and market-oriented solutions to its GLCs’ practices and policies, especially with regards to the effective implementation of the competitive neutrality principle. 93. However, the impact of competition-related GLC commitments of the TPP may be limited, especially due to the broad carve outs of the chapter on GLCs. First, the scope of application of the chapter is limited to activities of GLCs and designated monopolies of a country that affect trade or investment between countries within the TPP free trade area. Further, the chapter does not cover enterprises that mainly perform public services. As such, although the Malaysian government controls firms in 24 out of 27 sectors surveyed,47 companies from at least eight of these sectors might not be considered GLCs under the TPP. Malaysia has government-controlled companies making available the distribution of goods or the supply of general infrastructure services to the general public in sectors such as telecommunications, water supply and sewage, electricity and gas distribution, and air, road and rail transports. Moreover, Articles 17.13.5 and Annex 17-A of the chapter establish that (i) non-discriminatory treatment and commercial considerations as well as (ii) non-commercial assistance and transparency obligations shall not apply to GLCs or designated monopolies with activities that amount to less than 200 million special drawing rights (SDRs) in revenue. In the case of Malaysia this threshold has been raised to 500 million for the first five years, amounting to close to USD789 million. The augmented 500 million SDRs threshold may leave a non-trivial portion of the Malaysian GLCs out of reach of the obligations set out in the chapter. As an illustration, the Asian Development Bank (ADB) gathered the revenue of GLCs listed in the Malaysian Bourse in mid-2012, with revenue figures from 2011.48 From the 948 listed companies in the stock exchange, 34 were GLCs. These 34 companies represented 43.7 percent of the assets and 32.2 percent of the operational revenue of all publicly held companies in Malaysia.49 From the 34 listed GLCs, only 15 have turnover above the threshold and therefore would be covered by the chapter.50 44 See Competition Act 2010 [Act 712], Article 3(3). 45 See Competition Commission Act 2010 [Act 713], Article 5(1)(b). 46 See infra at Section II.a and II.b. 47 Following the classification developed by the OECD for its Product Market Regulation Index, See OECD (2005). “Product Market Regulation in OECD Countries: 1998 to 2003”, page 38). 48 ADB – Asian Development Bank (2012). “Malaysia’s Investment Malaise: What Happened and Can It Be Fixed?” Menon, Jayant. ADB Economics Working Paper Series, n. 312, pages 10-12. 49International Monetary Fund. Data. SDR Valuation. Available at https://www.imf.org/external/np/fin/ data/rms_sdrv.aspx. There were 251 daily rates for 2011 – simple average for 2011 is SDR = 1.579411 US Dollars. Minimum value in the sample: 1.52365; maximum: 1.62321. 50 At the time, Proton Holdings Berhad was still under government control. Proton would also have been above the threshold but due to the divestment later in 2012, it was discarded from the analysis, MALAYSIA ECONOMIC MONITOR JUNE 2016 » 61 94. Several country-specific exclusions and exemptions further constrain the scope of the application of the chapter on GLCs to Malaysia. The most relevant exclusions relate to (i) sovereign wealth funds and independent pension funds, (ii) favourable treatment towards Bumiputera enterprises51, enterprises located in the states of Sabah and Sarawak as well as SMEs, and (iii) special regimes for Petronas and Felda Global Ventures Berhad. In practice, most sectors with GLC presence are affected by significant carve outs which severely limit the impact of the chapter to the Malaysian economy. 95. Therefore, the overall scope of application of obligations set in the chapter on GLCs could be noticeably reduced for Malaysia. Based on publicly available information and the application of the analytical framework developed by the World Bank Group, the cumulative application of the criteria and exceptions put forward in the chapter to the Malaysian economy results in only five companies – three in the financial sector and two with diversified activities – being fully subject to the obligations established by chapter.52 It is estimated that there are about 445 GLCs owned by the federal and state government.53 Considering the data from the ADB54 as a proxy, on the basis of revenue, only 15 GLCs would fall above the chapter’s threshold.55 96. While the horizontal impact of the chapter on GLCs might be limited, a large number of GLCs remain under sector-specific commitments with significant vertical impact given the prevalence of GLCs across markets regulated by other sector-specific TPP chapters. These include cross-border trade in services (Chapter 10); financial services (Chapter 11); telecommunications (Chapter 13); and government procurement (Chapter 15).56 Thus, the widespread presence of GLCs throughout the Malaysian economy increases the complexity of the country’s obligations under the TPP, demanding GLCs to comply with obligations from multiple chapters. An example of this approach can be found in the pro-competition obligations set in the chapters on telecommunications and government procurement: a. The telecommunications commitments are intended to guarantee a pro-competition framework in the sector, with the objective of increasing sector performance and consumer welfare. General principles and rules on accessibility and non-discrimination within the chapter on telecommunications ensure the right to access networks on a reasonable and non-discriminatory basis thus inducing portability, number access and fair international roaming for firms from other TPP countries. The chapter expands on accessibility and non-discrimination rules when it comes to dealing with entities with market power, establishing obligations for interconnection, non-discrimination, unbundling requirements, co-location 51 According to the Annex wording on p. 2 footnote 1, “Bumiputera Affirmative Action” is any measure that confers, safeguards, provides preference or render assistance, benefits or other forms of rights or interests to Bumiputera companies. Malaysia reserves the right to accord and grant Bumiputera status to eligible companies”. 52 This analysis considered a sample of 59 companies controlled by Malaysian government entities: (i) 32 listed in the Kuala Lumpur Stock Exchange (Bursa Malaysia) as of July 2012 (as provided by Asian Development Bank (2012) – Pos Malaysia and Proton Holdings were not considered due to their divestment), (ii) 19 other investments listed by Khazanah Nasional Berhad at its official website (available at http://www.khazanah.com.my/Our-Investments/Sectors); (iii) plus other 8 relevant public companies controlled by the government but not owned by Khazanah or covered by the ADB data – Malaysia Development Berhad, MRT Corp, Prasarana Malaysia, Keretapi Tanah Melayu, Perwaja Steel, Agro Bank Malaysia, Indah Water Konsortium and Radio Televisyen Malaysia. This exercise considers the revenue of holding companies and activities performed by all subsidiaries of comprises with available public information. A similar exercise could be made analyzing revenue and business activities of subsidiaries in order to assess possible carve outs to company subsidiaries. 53 Putrajaya Committee, 2015. “GLC Transformation Program Graduation Report”. P211, P13. 54ADB – Asian Development Bank (2012). “Malaysia’s Investment Malaise: What Happened and Can It Be Fixed?” Menon, Jayant. ADB Economics Working Paper Series, n. 312, pages 10-12. 55 National Interest Analysis of Malaysia’s Participation in The Trans -Pacific Partnership. Institute of Strategic and International Studies (ISIS). Malaysia, 2015 p. 168. For the first 5 years of the TPP, the threshold for Malaysia will be SDR 500 million. See footnote 35 to article 17.13.5 of the GLC Chapter. 56 Other transversal chapters such as Investment (Chapter 9); Intellectual Property (Chapter 18); and even Labour (Chapter 19) might have a significant impact for Malaysian GLCs. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 62 and access to poles, ducts, conduits, international submarine cable systems and rights-of-way owned or controlled by major suppliers. b. In the case of government procurement, the commitments are set to foster more open and competitive government procurement markets. TPP countries share an interest in accessing each other’s large government procurement markets through transparent, predictable, and non-discriminatory rules. In Chapter 15, Government Procurement, TPP countries commit to national treatment and non- discrimination, to treat tenders fairly and impartially, to award contracts based solely on the evaluation criteria specified in the notices and tender documentation, and to establish due process to question or review complaints about an award. 97. Malaysian GLCs competing in other TPP markets will also potentially benefit from regional promotion of a more level playing field within the TPP area.57 In practice, the competition related commitments of the TPP could offer a window of opportunity not only to implement an effective competitive neutrality policy in domestic markets but also to enhance the position of Malaysian companies, either private or public competing in international markets of TPP parties. In particular, the significant presence of Malaysian GLCs in international markets offers a perspective on the potential gains stemming from enhancing the position of these companies by limiting discrimination and leveling the playing field. This might also encourage GLCs to expand their portfolio of operations in other TPP markets in order to fully enjoy such regulatory and institutional benefits. Given the role of GLCs in the Malaysian economy, the TPP could be used as a tool to foster domestic competition and international competitiveness. Compliance with the TPP in the medium term will require a plan to set a more equal playing field for private sector vis-à-vis GLCs 98. Malaysia will enjoy several years of smooth entry into the TPP framework – which is an opportunity to correctly adjust for upcoming changes. Considering a comprehensive analysis of exceptions affecting Malaysia, particularly (i) limited influence over sovereign wealth funds, (ii) room for discrimination towards Bumiputera enterprises, (iii) SDR 500 million annual revenue threshold and (iv) general exceptions related to public interest, the TPP will not abruptly interrupt or prevent current government policies dependent on GLC special prerogatives. The presence of the TPP and increasing harmonisation of rules in the region will promote gradual alteration in the Malaysian landscape, reallocation of vested interests and competition for winner positions, while avoiding overnight losers. The immediate effect in the national market is greater transparency and discussion regarding market distortions of GLCs, adding momentum to the developments reached under the 10-year GLC Transformation (GLCT) Programme 58 completed in 2015.59 99. Malaysia will benefit from establishing additional mechanisms to guarantee competitive neutrality that could foster competitiveness. For instance, competition policy reforms heavily based on the implementation of a competitive neutrality framework boosted Australia’s GDP by at least 2.5 percent, due to their effect on 57 For example, Khazanah is present in more than 15 countries, five of them members of the TPP. In 2014, the top 17 GLCs were present in more than 40 countries, deriving about 34 percent of their revenue and allocating 26 percent of their total assets and employing more than 98,000 people overseas. Most of the 13 listed GLCs with revenue above TPP thresholds are highly internationalised – greater presence in investment in TPP countries will bring the benefit of competing in level playing field markets. Beyond Khazanah investment, that is the case of Petronas subsidiaries, Malayan Banking BHD and RHB Capital BHD. See ISIS (2015). “National Interest Analysis of Malaysia’s Pa rticipation In the Trans-Pacific Partnership”. Malaysia, page 168, available at http://fta.miti.gov.my/miti-fta/resources/ISIS_The_Grand_Finale.pdf. 58 See http://www.khazanah.com.my/National-Transformation-Initiatives/GLC-Transformation-Programme. 59 National Interest Analysis of Malaysia’s Participation in the Trans-Pacific Partnership. Institute of Strategic and International Studies (ISIS). Malaysia, p. 11. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 63 increased productivity and lower prices during the 1990s.60 Key measures to foster a similar approach in Malaysia could include: a. Guaranteeing the independence of antitrust enforcement decisions by reducing involvement of the Ministry of International Trade and Industry as well as other ministries represented at the Board while enhancing transparency and predictability in decision making, consistent with procedural fairness principles and international best practice. b. Improving the mechanisms to enhance transparency in order to assess/prevent potential negative effects of non-commercial assistance granted to GLCs: i. Implementation of inventories that consolidate information of non-commercial assistance to GLCs. ii. Assessment of the effects of granted non-commercial assistance to GLCs, including their proportionality and alternatives to minimise distortions on competition. iii. Design of mechanisms to prevent designated monopolies from engaging in anti-competitive practices and to foster compliance with competition-related commitments under the TPP. 100. Building on current progress on antitrust law, Malaysia could focus competition enforcement and advocacy efforts on key markets for competitiveness. Improving competition dynamics in markets that are key for consumers and have spillover effects for businesses will contribute to Malaysia’s vision to increase competitiveness. Special attention could be given to implementing pro-competition regulations in those markets covered by the TPP sectoral chapters. These measures will constitute building blocks of a more comprehensive analytical framework for the participation of the state in economy that aims at providing a level playing field among market players in the Malaysian economy. Initial measures could include: a. Systematically assessing and identifying existing regulatory and behavioural constraints to competition resulting in market distortions. b. Prioritise potential antitrust enforcement on markets prone to collusive behavior. c. Develop a national competition policy to embed competition principles in broader public policies including regulatory reform. d. Enhance cooperation between the Competition Commission and the sector regulators to foster regulatory neutrality in markets with GLC presence as well as to ensure application of competition principles in regulated sectors, especially in those excluded from the application of the Competition law, i.e. telecommunications and energy. This cooperation can be implemented through the signature of MoUs or the enactment of other platforms of public-private dialogue also involving the sector operators including GLCs as well as private sector representatives. 60This conservative estimate does not consider the effects of dynamic efficiency gains from more competitive markets Productivity Commission (2005); Crawford (2009). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 64 Small and Medium Enterprises Trade agreements can offer SMEs new trade and investment opportunities 101. Malaysian SMEs are vital to the country’s economic development, accounting for a large share of firms, production, and employment. The contribution of SMEs to overall GDP increased to 35.9 percent in 2014 from 32.2 percent in 2010.61 Since 2004, and especially with the establishment of the National SME Development Council in 2004, SMEs’ GDP growth outperformed overall economic growth consistently. In 2014, SMEs’ GDP grew 13.6 percent compared to 6.4 percent in 2013. 62 In 2014, SMEs accounted for 97.3 percent of firms, 65 percent of total employment, and 35.9 percent of GDP but only for 17.8 percent of exports. 81 percent of the 38,550 SMEs registered in 2010 were the apparel, food, beverages and tobacco, metals and other manufacturing sectors63 (Table 9). Despite accounting for a quarter of SMEs, the apparel sector is only responsible for 1.1 percent of SME turnover, 5.8 percent of employment and 3.3 percent of wages. 102. Malaysia’s transition to a high-income economy will depend highly on SMEs contribution to GDP growth. In recognition of this, the government of Malaysia developed a SME Masterplan for 2012–2020 setting the long-term growth strategy and focusing on six high-impact programs and 26 other initiatives. The SME Masterplan 2012-2020 envisions an increasing participation of SMEs in the national economy and set ambitious targets by 2020 in terms of GDP contribution (41 percent), employment (65 percent), and exports (23 percent). Table 9. Statistics for Manufacturing SMEs by Sector (2010) Number of Percentage of Manufacturing SME: firms Firms Turnover Employment Wages Apparel 9,482 24.6 1.1 5.8 3.3 Chemicals 3,070 8.0 21.7 17.2 19.7 Electrical equipment 1,136 2.9 6.4 8.3 8.6 Food, beverages, tobacco 6,159 16.0 34.8 15.7 14.9 Machinery 1,238 3.2 3.2 4.6 5.8 Metals 5,137 13.3 12.0 13.3 14.5 Other manufacturing 10,565 27.4 17.6 29.4 27.7 Textiles 968 2.5 0.7 1.8 1.5 Transport equipment 795 2.1 2.4 3.7 4.0 Total 38,550 100 100 100 100 Source: Economic Census (2011) 103. SMEs dominate in terms of number of firms across all sectors but they account for only a small share of exports. SMEs represent more than 95 percent of firms in most manufacturing sectors (Table 10) but they contribute to more than 20 percent of exports in only three sectors, namely: textiles, metals and apparel (Figure 58).64 Furthermore, the share of exports accounted by SMEs in the sectors that represent 80 percent 61 SME Annual report 2014/15, National SME Development Council. 62As of January 1, 2014, SMEs are defined as manufacturing firms with sales turnover not exceeding RM50 Million or full time employees not exceeding 200 and services and other sector firms as those with sales turnover not exceeding RM20 million or full time employees not exceeding 75. If the GDP data for the two years was based on the new SME definition, the growth of SME GDP would have been 7.9 percent instead of 13.6 percent. SME Annual report 2014/15, SME Corp Malaysia. 63 In the services sector, SMEs are mainly in the distributive trade sub-sector (wholesale & retail trade services), followed by food and beverages services and transportation & storages services. These percentages should be taken as an upper bound of SMEs export share. Because it is not possible to directly identify 64 SMEs from customs data and matches between customs and census data have not been possible, we defined large (non- MALAYSIA ECONOMIC MONITOR JUNE 2016 » 65 of total exports – namely electrical equipment, machinery, and other manufacturing – is less than 5 percent (Figure 59). Table 10. Number of Manufacturing Establishments by Sector (2010) Large SMEs Total Percent SMEs Apparel and Footwear 21 9,482 9,503 99.8 Chemicals 214 3,070 3,284 93.5 Electrical equipment 251 1,136 1,387 81.9 Food, beverages, tobacco 132 6,159 6,291 97.9 Machinery 44 1,238 1,282 96.6 Metals 110 5,137 5,247 97.9 Other manufacturing 249 10,565 10,814 97.7 Textiles 12 968 980 98.8 Transport equipment 83 795 878 90.5 Total 1,116 38,550 39,666 97.2 Source: Economic Census (2011) Figure 58: SME’s share of direct exports in any given Figure 59: Share of SMEs’ direct exports in sector, account for less than 35 percent of exports electrical equipment, machinery, and other manufacturing – is less than 5 percent SME share of sector exports, percent Share of total exports and SME export participation 40 34.8 35 Textiles SME share in sector exports 23.0 22.7 30 25 Metals 11.8 11.3 Apparel 20 Transport 4.4 2.8 2.2 2.1 equipment 15 Chemicals 10 Food, beverages, Other Electrical 5 equipment tobacco manuf. Machinery 0 0 10 20 30 40 50 Share of total exports Source: World Bank staff calculations Source: World Bank staff calculations 104. Preferential access into TPP countries can affect Malaysian SMEs in terms of increasing existing exports (intensive margin) or the potential entry of new firms (extensive margin). Malaysia has Free Trade Agreements with most TPP countries, although the TPP will also give access to the US, Canada, Mexico and Peru. Almost half (46.5 percent) of SMEs exports in 2014 were directed to TPP countries (Figure 60). In addition, on average more than 10 percent of exports to TPP markets come from SMEs. This suggests that preferential concessions SME) firms as those exporting over RM 50 million (turnover threshold for SMEs) which will guarantee that these firms are not SMEs as per the official definition. However, some firms classified as SMEs could be indeed large firms if they only export part of their turnover. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 66 that will be granted by TPP markets may represent significant export opportunities for SMEs. The main destinations of Malaysian SMEs exports in 2014 were Singapore (24.4 percent)65, United States (7.5 percent) and Japan (5.5 percent). In these markets, nevertheless, the SME share in exports was around four percent in 2014, suggesting that large firms will benefit most from the gains (Figure 61). Further research on the impact of the TPP on Malaysian SMEs exports in terms of preferential access should assess whether SMEs firms are currently exporting products with high preference margins, how much are they exporting, and how much they could potentially export once variable costs are reduced through preferential access. Figure 60: Almost half of SMEs exports were directed Figure 61: Main destination of SMEs exports in 2014 to TPP countries in 2014 were Singapore, US and Japan SME share in exports to TPP markets, percent Share of total exports and SME export participation 52.1 24.4 26.9 23.8 7.5 8.7 8.4 8.0 5.5 7.3 3.8 4.1 4.0 3.0 2.7 2.4 0.9 1.0 0.6 0.6 0.5 0.1 0.0 BN CL PE CA NZ AU VN US SG JP MX CH SG US JP AU VN BN MX CA NZ CL PE Source: World Bank staff calculations Source: World Bank staff calculations Raising productivity of SMEs and linking them with Global Value Chains will help SMEs to gain from trade agreements 105. Beyond textile and garments where SMEs are already active, gains are expected to happen in activities where SMEs are not yet present (Figure 62). Almost two thirds of export value gains associated with the TPP will take place in the electrical equipment (17 percent), machinery, and chemical sectors, in which SMEs account for only 2.2 percent, 2.1 percent and 11.8 percent of sectoral exports, respectively. In nominal values, export gains for textiles (USD9.1 billion) and apparel (USD1.4 billion), the two sectors with the highest SME participation in exports, are significantly smaller than in chemicals (USD22.5 billion), machinery (USD18.6 billion), electrical equipment (USD17 billion), which also represent Malaysia’s largest export sectors overall. 65In the figure, exports to Singapore are likely to reflect partly transit trade, given that the country is an export hub suggesting that a high share of its imports are likely to be re-exported into other markets. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 67 Figure 62: Beyond textiles, gains are expected to happen in activities where SMEs are not yet present SME share in sector exports vs TPP export gains by 2030 in USD billions 40 35 Textiles SME share in sector exports 30 25 Apparel Metals 20 Transport 15 equipment Chemicals 10 Other manuf. 5 Electrical equipment Food, beverages, tobacco Machinery 0 0 5 10 15 20 25 TPP export gains by 2030, USD billions Source: Authors’ elaboration using data from customs 106. Benefits from preferential access to TPP markets will only accrue if efforts to reduce the productivity gap between SMEs and large firms are made. There are significant productivity differences between SMEs and large manufacturing firms. Assuming the productivity of large firms as a benchmark for the productivity of a typical exporting firm;66 only a very small share of SMEs come close to reaching productivity levels of large firms across sectors (Figure 63). In fact, although the TPP is projected to generate the highest export growth in the textile and apparel sectors, and those sectors have a large amount of SMEs, the labour productivity gap in those sectors is so large that they may not reap the benefits (Figure 64). 66 The firm level data at our disposal do not allow to evaluate directly the productivity of exporting firms. The economic literature suggests that across all countries and sectors, most exports are accounted for by large firms (see for example Freund and Pierola), suggesting that the productivity of a median large firm may be an approximate, yet reasonable, proxy for the productivity of a typical exporter. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 68 Figure 63: Labour productivity gap in SME is large… Figure 64: … and it is crucial for the gap to be reduced Median labour productivity by sector and size Percentile labour productivity by sector and size Apparel 157 Apparel 18 Chemicals 262 Chemicals 106 296 Electrical equipment Electrical equipment 94 533 Food, beverages, tobacco Food, beverages, tobacco 50 320 Machinery 83 Machinery 339 Metals 62 Metals 227 Other manufacturing 59 Other manufacturing 296 Textiles 37 Textiles 311 Transport equipment 81 Transport equipment 0 200 400 600 0 200 400 600 Large SME SME 90th Large 10th Large 50th Source: Economic Census (2011), World Bank staff Source: Economic Census (2011), World Bank staff calculations calculations Note: The grey bar shows the labour productivity of the 10 percent most productive SMEs (measured as SMEs in the 90th percentile of the productivity distribution), the red triangles show the labour productivity of a large firm in the 10th percentile of the distribution (the 10 percent least productive large firms), and the black “x” shows the productivity of the median large firm (large 50th). 107. SMEs in key export industries could benefit indirectly from greater market access if they integrate in global value chain (GVCs). Despite low participation as direct exporters in sectors that will benefit greatly from the TPP (e.g. electrical equipment and machinery), SMEs have a strong participation in upstream industries that supply intermediate inputs to Malaysia’s top export products. The metal, plastic and rubber, and chemical sectors provide a significant share of inputs to main export and GVC products (and in general to most electronic and machinery products), many of them generated by SMEs. This suggests the presence of a critical mass of economic activity by SMEs in these sectors that could be (or already are) suppliers to domestic exporters. Services sectors (management, professional and administrative services, wholesale, transport) can also be providers to export products even though no data is available to ascertain the importance of SMEs in these services sectors. The estimated gains in electrical equipment and machinery sectors and oil and petrochemical industries could be substantial (Annex 6). 108. Raising SME productivity is key to achieving high income economy. For SMEs to reap the benefits of FTAs, productivity enhancing policies to better equip SMEs to compete more effectively and gain greater market access would be pivotal. This would complement on-going efforts to create greater value added from Malaysia’s growing integration with global production networks, which would involve upgrading SME capabilities so they can become first- or second-tier suppliers to multinationals or access international markets directly. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 69 Box 12: Reducing Barriers for SMEs in ASEAN Non-tariff barriers (NTBs) can be especially burdensome for SMEs, subjecting them to difficult market conditions and unfavourable pricing. Some of the major barriers affecting intra- ASEAN trade include custom surcharges, logistics inefficiency, repetitive testing of products, labelling requirements, and monopolistic measures. A work program has been developed to address these issues including enhancement of a non-tariff measures database and engagement with the private sector to obtain feedback on the issues. Furthermore, adhering to harmonised regional compliance requirements will be a stepping stone for SMEs to aim for global standards. The elimination of NTBs and improvement of regulatory frameworks in ASEAN countries will give SMEs a level playing field in the regional market. This will promote further growth by allowing them to upscale production, improve efficiency, and increase their standards. The establishment of the AEC in 2015 offers opportunities for SMEs in the form of a huge market of USD2.6 trillion. Engagement in a wider production network through supply chain links among ASEAN firms will provide for greater access to resources, benefit from economies of scale, as well as a larger market for goods and services. A core element for a single market and production base is the free flow of goods, which will be realised through the ASEAN Customs Transit System (ACTS). This automated system is designed to monitor movement of goods through ASEAN countries to the final destination. The purpose of the system is to expedite customs clearance of goods, resulting in significant savings in logistical cost and time for businesses in the member states. SMEs in particular are expected to benefit from the establishment of a more stable and secure supply chain that provides better connectivity of goods at lower costs and risks. This will embolden SMEs to expand their markets throughout the region, sustaining economic growth for themselves, their nations, and the region. The system will be piloted in Malaysia, Singapore and Thailand between May - October 2016. Prior to this ACTS procedure manuals for Customs, Transport and the private sector will be produced. Through the ASEAN Self-Certification Scheme, SMEs will be able to enjoy preferential tariffs under AFTA by self-certifying the origins of their products. The main aim of the Scheme is to increase efficiency by simplifying administration procedures and reducing costs. By promoting self-certification, ASEAN hopes to minimise the involvement of member state authorities, which would allow more efficient clearance of goods in the country of importation. SMEs typically do not have regional networks like multinational companies, nor are they familiar with the administrative certification procedures of other member states. The scheme makes it easier for them to branch out into regional markets through self-certification, and will facilitate and enhance intra-ASEAN trade, support a regional production network, encourage the development of SMEs, promote increased usage of AFTA preferential tariffs, and reduce the costs of doing business. Finally, a newly developed ASEAN Strategic Action Plan for SME Development encompassing the years beyond AEC from 2016-2025 proposes further measures to address concerns and strengthen efforts to support the redevelopment of ASEAN SMEs. These measures include: capacity building in areas such as ICT adoption, e-commerce, and standards conformance and compliance; facilitating inter-firm networks and linkages within ASEAN for economies of scale; and shared sectoral and geographical base. Source: SME Annual Report, government of Malaysia, 2014-2015, AEC website, 2016. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 70 SMEs would benefit from a tailor-made legal and regulatory environment that serves their purpose 109. The SME sector needs a strong enabling environment to realise its potential. The SME Masterplan aims to provide the framework and implementation mechanism to further facilitate business formation, encourage greater formalisation, stimulate the development of high-growth companies, and boost the productivity of SMEs in all sectors of the economy. This SME Masterplan also proposes measures to enable the legal and regulatory environments to encourage greater innovation within SMEs, to upgrade SME management capabilities and worker competencies, to ensure that creditworthy SMEs have access to needed financing, to improve the physical infrastructure needed by SMEs to operate effectively, and to assist in expanding the market for goods and services produced by SMEs. A few years into implementing the Masterplan, SME Corp has initiated a preliminary assessment of the effectiveness of the masterplan and how it could be strengthened. This would be an important initiative in making sure that the programs being put in place are being targeted at the right SMEs and are being effectively implemented to realise their intended objectives. 110. An appropriate legal and regulatory environment that fosters entrepreneurship and innovation is critical to achieving the stated goals for SMEs in Malaysia. This would include facilitative conditions that support the formation of new businesses and the growth of existing firms. a. Competition Law. Competition is a fundamental characteristic of dynamic market economies. In competing for customers, rival businesses are spurred to offer higher quality goods and services at lower prices. This gives rise to a continuous drive for innovation and increased productivity. With this in mind, policies are being put in place to address anti-competitive practices. The Competition Act was passed by Parliament in May 2010 and a Competition Commission was set up in April 2011 with the intention of implementing the Competition Act. b. Bankruptcy law. In most countries, bankruptcy legislation allows for the liquidation of insolvent businesses as well as the restructuring of distressed businesses to enable the continuation of operations. Bankruptcy enables companies to terminate or restructure operations in an orderly manner. This may lead more entrepreneurs to launch new business ventures by reducing the fear of failure. Different countries have made different decisions on balancing the interests of creditors and business owners. A review of the current bankruptcy law is expected to be completed soon. c. Business regulation. While regulations are needed to protect the interests of consumers and society at large, unwarranted or ineffective regulation imposes undue costs on businesses, especially on SMEs. The Government has taken steps to reduce regulatory burdens under an initiative led by PEMUDAH. Malaysian SMEs need to boost their innovative activity 111. R&D is largely driven by MNCs, GLCs, and public research institutes. Expenditures on R&D have risen from 0.6 percent of GDP in the 1990s to over one percent in 2014. R&D expenditure was mainly contributed by business enterprises (RM6.8 billion, 64.4 percent), followed by institutes of higher learning (RM3.0 billion, 28.7 percent) and public research institutes (RM0.73 billion, 6.9 percent).67 However, private research activity is concentrated in the E&E sector, carried out almost exclusively by multinationals. R&D among domestic firms is mostly in large GLCs which rely on government subsidies for their research (OECD, 2013). 112. Most SMEs do not engage in any R&D or do it with limited resources. SMEs in all sectors of the economy could benefit from the adoption of knowledge that already exists in the world, yielding dividends in terms of increased value added and higher productivity. Innovation can be made in terms of product enhancements in functionality and quality, improvements in production processes and customer service, and organisational 67 MASTIC: National R&D Survey, Malaysia, 2014. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 71 innovations. While Malaysia has established tax incentives for R&D, most small businesses, particularly startups, are not in a position to use these credits given their limited income. Moreover, only a small fraction of SMEs in Malaysia operate at the technological frontier, developing novel products or processes based on scientific or engineering advances. The Technology Commercialisation Platform, one of the six high impact programs under the SME Masterplan aims to remove market barriers to innovation by providing handholding to SMEs that have innovative ideas to proceed from proof of concept to the commercialisation stage. 113. Supplier development programs are an important source of innovation for SMEs globally. Supplier development programs can play a role in enhancing the capabilities and performance of SMEs. In general, supplier development programs aim to increase product quality, improve on-time-delivery, and lower total cost across the value chain. Increasingly, GVCs are evolving into tiered structures led by MNCs with an established brand, extensive customer base, and significant resources. The first tier of suppliers, typically other large companies, deals directly with the lead MNC. These first-tier suppliers are responsible for purchasing and combining components from lower-tiered suppliers and delivering sub-assemblies or systems to the MNC. In general, SMEs tend to be lower-tier suppliers. To be successful, all parts of the value chain need to operate effectively. An MNC or higher-tier supplier will not enter into a business relationship with an SME unless the supplier can meet its quality, delivery and price standards. SMEs also must have adequate production capacity to meet order volumes and be financially stable. Increasingly, MNCs are willing to invest in improving the performance of their existing suppliers, providing needed technical assistance and financing. Programs that are designed to help SMEs reach a point where they can qualify as suppliers and/or help existing suppliers make continuous improvements can be beneficial (Box 13). Box 13: Government Support Programs that Increase SME Competitiveness in Chile The Chilean Government invests a considerable amount of resources – between USD400 million to USD600 million annually – in a broad range of private sector support programs. These support instruments range from loans to credit guarantees and matching grants for business support services. The flagship agency for private sector support – CORFO – manages the bulk of the programs under a mandate to improve competitiveness and investment, contribute to job creation for skilled workers, and insure equal access to business development services. The philosophy of CORFO’s programs gravitates on promoting a demand - led approach to resolve clear and identified market failures including diseconomies of scale, imperfect information about markets and technology, barriers to inter-firm cooperation, and limited access to finance. The leading CORFO programs that provide business development services include, the National Productivity and Technological Development Fund, Fondo nacional de desarrollo tecnológico y productivo (FONTEC), which was established in 1991 and has supported more than 1,700 private sector projects totaling USD250 million in matching grants and credit financing lines to eligible projects in the area of development of product and production processes and technology transfer. The Group Development Projects Program, Proyectos Asociativos de Fomento (PROFO), targets groups of companies by providing incentives to overcome scale-based barriers in the areas of access to technology, markets and management skills. PROFO finances a share of joint group private project expenses, including training, market research and product marketing, typically during three to four years. Since its launch in 2001, it has supported 445 projects totaling about USD23 million. The Supplier Development Program (SDP) aims to promote vertical linkages by providing incentives for multinational firms investing in Chile to provide training on quality standards and product design to local Chilean SMEs. In 2001, 82 eligible projects were selected totaling USD3.4 million in support activities. The Technical Assistance Fund (FAT) is a matching grant facility that subsidises the costs of technical assistance to address individual SME business development challenges including marketing, product design, MALAYSIA ECONOMIC MONITOR JUNE 2016 » 72 production processes, information systems and pollution control. While having just 350 SMEs as grantees upon inception in 1994, the use of FAT grew to about 7,000 companies annually by 2000. In addition, CORFO also provides a plethora of credit lines and loan guarantee programs to SMEs. These include credit lines for productive investments and SME debt restructuring initiatives. On assessing the effectiveness of the different SME programs in Chile, academic research - Alvarez and Crespi (2000), Benavente and Crespi (2003) and Benavente, Crespi and Maffioli (2007) - have found evidence that participation in these programs was associated with improvements in intermediate and short term outcomes such as sales and production. Additional research conducted in 2010 by the World Bank found evidence of positive and growing time effects from program participation, typically 4-10 years after starting and for final outcomes such as sales, production and labour productivity. Positive effects were also found by type of program, with participation in FAT and PROFO, and (to a lesser extent) FONTEC having the most consistent positive impacts on several final outcome measures. Specifically, the study finds no evidence that credit programs alone are successful at promoting employment, productivity, or wages. While there are positive outcomes linked to the provision of subsidised technical assistance, funding alone is not enough and interventions that encourage technology upgrading were found to be beneficial to firms. Source: World Bank. 2010. Impact Evaluation of SME Programs in Latin America and Caribbean. Conclusions and Policy Options 114. The ‘new generation’ of trade agreements that Malaysia has embarked on can potentially open up new opportunities for the economy. New mega regional trade agreements such as RCEP, TPP, and Malaysia –EU FTA can further increase access to large trade partners (e.g., 40 percent of global GDP in the case of TPP) and consolidate rules for cross-border trade and investment which otherwise would be costly to comply with in bilateral FTAs. Also, reciprocal commitments in these new trade agreements go beyond opening up market access and facilitating trade and aim to set the rules for international trade and investment for the next few decades. They promote greater competition, certainty in investment policies, digital trade, GLCs alignment with market discipline, and protection of intellectual property rights. TPP in particular also intends to align domestic practices on labour protection and labour rights with ILO conventions. 115. Implementation of these trade agreements does not automatically translate into economic gains. Despite the intention to promote deeper liberalisation, trade agreements went through intense negotiations and bargaining processes which introduced carve outs to protect domestic interests and provide policy space for governments to regulate. For example, TPP commitments in services offer little commitments for new liberalisation while exemptions are given to GLCs and government procurement. Also, trade liberalisation may have an adverse impact, particularly on businesses that have benefited from state protection or those with limited capacity to adapt to a more competitive environment. 116. Malaysia can leverage the recent wave of trade agreements to accelerate its reform agenda in areas that will support its transition to high income status. Achieving high income status will be difficult without meaningful reforms in key areas where Malaysia has the potential to improve substantially, including raising productivity of SMEs, bolstering competition across sectors, liberalisng services to further support exports, and attracting higher valued added foreign investment. Also, as the Malaysian economy reaches high income status it will also become more diversified, gaining foreign market access, investing abroad and diversifying export production. These trade agreements raise the need for domestic reforms to be accelerated. First, the pay-offs of many of these reforms are higher as they are associated with wider market access and the ability to attract more investment. Second, the incentive for the reforms is also higher as heightened foreign competition will raise the need for less performing firms to adjust. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 73 117. Proactive measures will be needed to complement the commitments under the mega regional agreements and ensure wider benefits. Malaysia’s government has a broad range of policy options to mitigate the challenges that the trade agreements pose and leverage the opportunities that they present:  In the short term, to the extent that Malaysia’s appl ied policies in services trade may remain more restrictive compared to other countries in the TPP —notwithstanding the recent liberalisation of foreign ownership, the EPU may consider strengthening the coordination mechanism for the implementation of Services Blueprint to boost competitiveness of the services sector. In the medium term, MITI can further review “horizontal policy measures” affecting the establishment and operations of foreign services providers such as “undisclosed restrictions” reserved for regulators and “nationality or residency” requirements for senior personnel of foreign services providers.  The new trade agreements further improve the conducive business environment that Malaysia offers to foreign investments. In the short term, MITI may consider establishing a mechanism to domestically handle investors’ grievances that would ensure compliance of existing policies with commitments on investments chapter and decrease the risk of ISDS cases. This could be done either by MIDA hosting the investor grievance mechanism as part of investor after care service or through an independent ombudsman office within MITI. In addition, reviewing current practices that link FDI with performance requirement (e.g. local content, technology transfer) could avoid non-compliance with trade agreements. Furthermore, the Malaysia Productivity Corporation can further strengthen its capacity to conduct regulatory impact analysis on existing or proposed new policies affecting trade in goods and services and investments. Additionally, Malaysia may consider to take on the role as a regional champion in ASEAN to advocate other members on improving transparency and streamlining procedures for complying NTMs, opening market opportunities for Malaysians firms.  Continued implementation of policies that increase competition and can create a level playing field for the private sector. Malaysia has negotiated significant carve outs on GLCs in the TPP agreement that provide time to adjust incumbents and market structure to heightened competition. In the short term, it will be important to assess the impact that the different sector chapters may have in GLCs participating in them. Also, it will be important to design an action plan to ride the transition period. In the medium term, the Malaysia Competition Commission (MyCC) can implement existing regulations to prevent designated monopolies from engaging in anticompetitive practices and to foster compliance with competition-related commitments under the TPP. MyCC may potentially work together with Khazanah Nasional and the Government Investment Companies Division at the Treasury to ensure smooth implementation of the competition related measures in relation to GLCs.  Creating a conducive environment and addressing the constraints that SMEs face to raise productivity and reap the benefits of emerging trade opportunities. A few years into implementing the Masterplan, SME Corp has initiated a preliminary assessment of the effectiveness of the masterplan and how it could be strengthened. This would be an important initiative in making sure that the programs being put in place are being targeted at the right SMEs and are being effectively implemented to realise their intended objectives. This can be complemented with a review of current R&D support programs that are administered through a number of agencies, to ensure that SMEs get adequate support. SIRIM Berhad, an agency under the purview of the Ministry of Science, Technology and Innovation, Malaysia can also pursue further efforts for mutual recognition in standards and technical regulations with other members of RTA to benefit Malaysia’s exporters, particularly SMEs. Supplier development programs such as the one in Chile have also proved useful to raise the capacity of SMEs to participate in global value chains. In the medium term, Malaysia should continue supporting an enabling regulatory framework that exposes SMEs to more competition and facilitates bankruptcy process to allow entrepreneurs to reinvent their businesses and take more risk. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 74 MALAYSIA ECONOMIC MONITOR JUNE 2016 » 75 Annex 1: Non-tariff Measures TPP’s main income gains will come from countries streamlining their non-tariff measures 118. NTMs are defined as policy measures, other than tariffs, that can affect quantity or value of international trade flows. NTMs include a large variety of trade regulations, including sanitary and phyto-sanitary (SPS) regulations, technical (TBT) regulations, rules of origin, licensing, price-control measures, and distribution restrictions (UNCTAD, 2013). Often, the primary NTMs' objective is not directly trade related but the achievement of "common goods" for the broader population, such as the protection of environment, human and animal health, etc. Nonetheless, this type of NTMs can also have restrictive or distortionary effects on international trade. 119. Identifying NTMs in Malaysia require going through laws and regulations that have impact on trade flows. The analysis determining the scope of NTMs of Malaysia comprises 66 laws and regulations ranging from the Poison Act 1952 to the Malaysian Rubber Board (Licensing and Permit) Regulations 2014 (see Annex III for the list of regulations).68 Most of the laws and regulations in Malaysia pertain to health, sanitation and environment. Many of these laws and regulations explicitly imposed permits or licensing requirement for both imports and exports, which constitute the majority of the NTMs of Malaysia. Finally, the presence of NTMs may not indicate significant barriers to trade, unless the NTM is restrictive and the trading partners have problems meeting the requirement. Table 11: Laws and regulations on NTMs in Malaysia NTM code69 # of laws and regulations Description B7 145 Product quality or performance requirement A22 122 Restricted use of certain substances in food and feeds and their contact materials B31 79 Labelling requirement for TBT reasons A31 67 Labelling requirement for sanitary and phytosanitary reasons B6 37 Product identity requirement P13 34 Licensing- or permit requirements to exports B14 24 Authorisation requirement for TBT reasons D12 17 Antidumping duties A14 13 Special authorisation requirement for SPS reasons P69 12 Export technical measures, n.e.s. Source: UNCTAD, ERIA survey, World Bank staff calculations 120. Malaysia’s NTMs are mainly concentrated in agriculture products. Malaysia has a large plantation sector so the NTMs are generally designed to protect the trees from plant diseases and insects. The NTMs take the form of authorisation or permitting requirements for both imports and exports, licensing fees, prohibition, 68 This report summarises the main findings from the Non-Tariff Measures (NTM) data collection of Malaysia in 2015/2016. Under the guidance of ERIA and UNCTAD, NTM data on Malaysia and other ASEAN countries were collected. The purpose of the exercise is to create the first comprehensive database on the NTMs for these countries detailing the products and partner countries affected by the NTMs of these countries. There are limitation of this first data collection efforts as some laws or regulations might be omitted despite the efforts of data collection, due to time constraints. However, despite the best effort in collecting data, not all laws or regulations that affect the participation and extent of trade are included in the data. For example, Customs Act 1967, which imposed import and export licenses, also known as Approved Permit (AP), on a set of sensitive products (such as cars, steel and sugar), is not included in the dataset. Thus, the results presented in the next sections will only include NTMs and products affected by the laws and regulations listed in Table 14. 69 According to UNCTAD classification. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 76 quality and quarantine restrictions and certificate/inspection requirements. Malaysia also frequently uses NTMs to ensure quality and labeling.70 Overall, about 50 percent of the HS 6 digit products faced at least one NTM in Malaysia, while nearly 100 percent of HS 6 digit products faced at least one NTM in Singapore and Thailand. Malaysia therefore seems to impose less onerous non-tariff requirements than neighbouring economies, as Malaysia imposes about half the number of NTMs of Singapore and Thailand. Table 12: Type of NTMs in Malaysia Product code Number Description (HS 6 digit) of NTMs 060290 25 Other live plants (including their roots), cuttings and slips; mushroom spawn, include palm seedlings and aquatic plants. 121190 23 Plants and parts of plants (including seeds and fruits), of a kind used primarily in perfumery, in pharmacy or for insecticidal, fungicidal or similar purposes, fresh or dried, whether or not cut, crushed or powdered, christinumon 120710 22 Palm nuts and kernels 030760 21 Snails, other than sea snails 010620 20 Reptiles (including snakes and turtles) 030791 20 Other molluscs, including flours, meals and pellets, fit for human consumption 030627 20 Other shrimps and prawns 010619 20 Other live animals 030625 20 Norway lobsters (Nephrops norvegicus) 030626 20 Cold-water shrimps and prawns (Pandalus spp., Crangon crangon) 030622 20 Lobsters (Homarus spp.) 030621 20 Rock lobster and other sea crawfish (Palinurus spp., Panulirus spp., Jasus spp.) 030624 20 Crabs Source: UNCTAD, ERIA survey, World Bank staff calculations 121. Table 13 presents the AVEs of NTMs of Malaysia by broad sectors. Sectors that have very restrictive SPS/TBT measures are Dairy, Sugar, Bovine Meat, Beverages/Tobacco, and Food Products. The AVEs on SPS/TBT measures of these sectors exceed 25 percent. On the other hands, most sectors face easy to meet Non-SPS/Non-TBT measures, with the exceptions of Beverages/Tobacco and Bovine Meat, with AVEs on non- SPS/non-TBT measures exceeding 15 percent. 70In comparison, the products that faced the most NTMs in Singapore were meat and fish products for human consumption, while water, meat and fresh fruits faced the most NTMs in Thailand. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 77 Table 13: Estimated ad valorem equivalent of Malaysia’s NTMs across broad sectors Sector SPS/TBT Non-SPS/Non- Sector AVE of Non- TBT SPS/TBT SPS/Non-TBT Beverages and tobacco 29.2 35.7 Oil 0.7 0.9 products Bovine meat products 33.3 15.6 Machinery and 0.9 0.1 equipment Chemical, rubber, plastic 0.3 0.0 Manufacturing 0.0 0.2 products Electronic equipment 0.8 0.0 Minerals 0.0 0.0 Metal products 0.0 0.0 Meat products 4.1 1.2 Forestry 5.6 0.0 Transport equipment 0.0 0.2 Fishing 15.2 0.0 Plant-based fibers 0.7 0.0 Gas 0.3 0.0 Paper products, 0.0 0.0 publishing Ferrous metals 0.1 0.0 Petroleum, coal 13.6 0.0 products Leather products 1.6 0.3 Sugar 36.0 0.0 Wood products 0.4 0.0 Textiles 0.2 0.0 Dairy products 44.7 0.0 Vegetable oils and 23.0 0.1 fats Motor vehicles and parts 0.0 0.2 Vegetables, fruit, nuts 8.4 1.9 Metals 0.0 0.0 Wearing apparel 0.5 0.4 Mineral products 0.0 0.1 Wool, silk-worm 0.0 0.1 cocoons Animal products 10.6 0.7 Crops 13.5 0.1 Food products 27.0 0.0 Source: UNCTAD, ERIA NTM, World Bank staff calculations 122. New generation of trade agreements, such as ATIGA and TPP, tend to establish more specific guidelines on how NTMs should be handled. Specific guidance on NTMs’ legitimacy is provided by WTO only in the areas of SPS, TBT and licenses. Bilateral FTAs and RTAs, therefore, cover in some more detail this matter, although often on a best endeavor basis. Under the ATIGA, Malaysia has committed to catalog its entire existing stock of NTMs, and get this information on-line and shared in the National Trade Repository, which would eventually interoperate with the ASEAN Trade Repository. NTMs should also be notified to the ASEAN Secretariat which is mandated to maintain a regional database. Moreover, under the ASEAN Work-Program on NTMs, Malaysia has undertaken to set up a National NTM Committee tasked to classify, review and streamline NTMs. Malaysia is also expected to eliminate prohibitions and quantitative restrictions, NTBs and foreign exchange restrictions on the importation of any goods of other ASEAN Member States, in addition to streamlining import licenses. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 78 Box 14: Tasks and Responsibilities of the National NTM Committee (ASEAN Work-Program on NTMs)  Collect, and classify all regulations on NTMs  Develop guidelines on operating procedures for each NTM  Notify NTMs inventory to the ASEAN Secretariat  Publish NTMs in a web portal (NTR) to be connected with ATR  Review stock of NTMs, establishing criteria to assess impact or undertake cost-benefit analysis  Establish criteria for streamlining NTMs, assessing rationale and considering alternatives: issue recommendations and go to higher level if there is disagreement  Enforce/monitor modifications of NTMs according to recommendations Source: Authors 123. Implementation arrangements and dispute settlement for SPS and TBT in the TPP could be more demanding than in the ATIGA. The TPP has more detailed modalities under which members can or should implement agreements on SPS and TBT. For instance, TPP will make it possible for members to comment on other members’ proposed SPS and TBT measures, and to question why technical regulations are not accepted as equivalent by other members. Regarding SPS, TPP requires that import checks be risk-based (instead of full inspections), while ASEAN agreements reconfirm WTO agreements on using risk analysis to determine the appropriate level of SPS requirement. The dispute settlement process in the TPP also has differences compared to ATIGA. Both agreements facilitate consultations between parties to resolve disputes, but also provide options for the complaining party to request the establishment of a panel to settle the dispute, should the parties fail to resolve the matter within a given time frame. However, in the ATIGA the decision to establish a panel rests with Senior Economic Ministers (SEOM) (World Bank, 2016). Malaysia can work together with other signatories in trade agreements on mutual recognition and risk management in SPS, TBT, and strengthen procedures for issuing new NTMs 124. Malaysia can strengthen its management of NTMs while using free trade agreements to seek mutual recognition for practices and conformity assessment for SPS and TBT. Some of the areas that Malaysia can get further strengthened are: a. Risk-based inspection for import. TPP requires member countries to implement risk-based inspection in cargo clearance, including for TBT and SPS reasons. b. Malaysia can further harmonise SPS practices with members of trade agreements and seek mutual recognition in TBT to gain the most from greater market access. Studies suggest that these efforts bring greatest impact on compliance cost to trade agreements (Cadot and Gourdon, 2016). c. Strengthening good regulatory practices which provide opportunity for private sector and trading partner to give feedback on proposed NTMs. Malaysia can implement ASEAN Work Program on NTMs which is based on ATIGA to strengthen predictability and transparency of its NTMs. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 79 Annex 2: Summary of Results from Different Models about the Impact of TPP Study Methodology Main assumptions Key macro results Mostly affected sectors Ciuriak Dynamic multi- Simulation period: 2016-2035. "Best Real GDP and and Xiao region GTAP- Guess" scenario is based on the best household (2014) FDI model - FDI information available before the income rise by in services official release of agreement. It is 3.1percent and 3 sectors is simulated on a sequential basis, percent by 2035, endogenously introducing in tern: tariff liberalisation; respectively. incorporated adjustments for preference under- Reduction of NTMs to capture utilisation and utilisation costs, on goods is the Mode 3 adjustments for liberalised rules of major driver of services trade origin, reduction of NTMs on goods and gains (1.86 (commercial cross-border services, liberalisation of percent welfare presence). FDI in services and Mode 3 services increase). trade. The recently concluded Japan- Australia Economic Partnership Agreement (JAEPA) is included in the baseline scenario. Kawasaki Extended CGE Scenario assumptions: 100 percent Income gain of (2014) model based tariff reduction, 50 percent reduction of 20.6 percent on the GTAP NTMs among member countries and 25 measured as a model. percent reduction of NTMs to non- share of members due to positive spillovers. equivalent "Actionability" of NTMs is assumed to be variation from the 50percent following Ecorys (2009). GDP in 2010. Tariff reduction only would generate a small benefit of 3 percent of GDP. Lee and Dynamic multi- Simulation period: 2015-2030. Scenario Increase of Itakura region GTAP 2-A (TPP-track A): TPP members and welfare by 1.9 (2014) model. Korea implement a trade accord over percent the period 2015-2022; Indonesia, the measured as Philippines and Thailand join the TPP in percentage 2018; FTAAP is implemented during deviation of 2023-2030. Assumptions on reduction in equivalent barriers: Elimination of tariffs and variation from the reduction of NTMs in services as well as baseline by 2030. time cost of trade by 20percent during the periods in consideration among the member countries (rice is excluded from trade liberalisation). Baseline scenario incorporates the following RTAs: ASEAN Free Trade Area (AFTA), the ASEAN-China, ASEAN-Korea, ASEAN-Japan, ASEAN-Australia-New Zealand, ASEAN-India, EU-Korea and Korea-US FTAs. Petri and Dynamic multi- Simulation period: 2017-2030; NAFTA, Increase of real The highest increase of Plummer region CGE AFTA, the ASEAN-Japan FTA, the GDP and exports output and exports in (2016) model with ASEAN-Australia-New Zealand FTA and by 7.98 percent textiles and apparel. heterogeneous the P4 Agreement are incorporated in and 20.1 percent Other manufacturing firms the baseline scenario. Elimination of by 2030, industries such as (consideration nearly all tariffs by 2030 (tariff cuts are respectively. metallurgy, chemical of welfare mitigated by less than full utilisation rate Income gains of industry, production of effects along of preferential tariffs and additional USD 42.6 billion machinery, electrical the extensive costs to meet rules of origin (measured as and transport margin). requirements); NTMs on goods and equivalent equipment expand services are reduced according to the variation) amount their output and fraction of actual reductions in to 5.85 percent of production. actionable barriers in KORUS GDP. agreement including some MALAYSIA ECONOMIC MONITOR JUNE 2016 » 80 Study Methodology Main assumptions Key macro results Mostly affected sectors modifications based on analysis of the TPP text; positive spillovers: 20 percent reduction of NTMs against non-member countries. PwC GTAP GDyn Simulation period: 2018-2027. ASEAN Cumulative gain Textile industry with (2015) model: Free Trade Area agreement and the in GDP of USD 107 largest increase in dynamic multi- ASEAN-China FTA were implemented in billion or 211 billion investment growth regional CGE the baseline scenario. In the TPP over 2018-2027 in and projected export model based scenario all tariffs are eliminated and moderate and growth increase by on the GTAP 9. NTMs are reduced by 25 percent high case 4.1-4.9 percentage (moderate case scenario) or 50 scenario, points. Automotive percent (high case scenario) across all respectively. components, 12 TPP member countries. Hereby, Increase of GDP electrical and tariffs are reduced to zero over 10 years growth by up to electronics sectors will (10 percent reduction every year), 1.2 percentage also strongly benefit while NTMs are reduced by 50 percent, points by 2027 in from TPP. 25 percent or not at all over 10 years, high case depending on the scenario. scenario. Export growth is projected to increase by 0.5-0.9 percentage points in 2027. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 81 Annex 3: Comparison of Commitments for the Temporary Entry of Business Persons Malaysia Peru Chile Vietnam Singapore Temporary entry Temporary entry Temporary entry is N/A Temporary entry is for Business visitors is for up to 90 is for up to 183 for up to 90 days, up to 30 days days days which may be extended Entry is subject to the fulfilment of eligibility requirements prevailing at the time of application Temporary entry Temporary entry Temporary entry is Temporary entry is N/A is for up to two is for up to one for up to one year, for up to three years, years and may year, renewable which may be which may be be extended for consecutive extended, extended subject to every two years periods, the provided the the term of for a total term number of times conditions on operation of those not exceeding 10 that it is which it is based entities in Vietnam years for senior requested, to the remain in effect, managers and extent that the without requiring For any commercial Intra-corporate transferees not exceeding conditions which that business presence five years for motivated its person to apply established in the specialists or granting are for permanent territory of Vietnam experts maintained residence by an enterprise of another party, at Foreign natural least 20 percent of persons may not the total number of represent more managers, than 20 of the executives and total number of specialists shall be employees of an Vietnamese enterprise and nationals. However, their pay may a minimum of three not exceed 30 non-Vietnamese percent of the managers, total payroll for executives and wages and specialists shall be salaries of the permitted enterprise Temporary entry Temporary entry Temporary entry is Temporary entry is N/A is for up to one is for up to 90 for up to one year for up to six months year or the days, renewable which may be or the duration of duration of the for one year extended for the contract, Contractual service suppliers contract, subsequent whichever is shorter. whichever is less periods, provided Extensions may be the conditions on possible which it is based remain in effect, The number of without requiring Contractual Service that business Suppliers covered person to apply by the service for permanent contract shall not be residence larger than necessary to fulfill Contractual the contract, as it service suppliers may be decided by and their family the laws and MALAYSIA ECONOMIC MONITOR JUNE 2016 » 82 members may regulations and freely enter and requirement of leave Chile Vietnam without having to apply for separate re-entry permissions for the duration of their visas, on the basis of reciprocity Temporary entry Temporary entry Temporary entry is N/A N/A is for up to one is for up to one for up to one year year or the year, renewable which may be duration of the for consecutive extended for contract, periods, the subsequent whichever is less number of times periods, provided that it is the conditions on Not more 20 requested, to the which it is based percent of extent that the remain in effect, Independent professionals lecturers conditions which without requiring employed in an motivated its that business educational granting are person to apply institution who maintained for permanent possess the residence necessary qualification, Independent knowledge, professionals and credentials, or their family experience dependents may freely enter and leave Chile without having to apply for separate re-entry permissions for the duration of their visas, on the basis of reciprocity N/A Temporary entry Temporary entry is N/A Temporary entry is for is for up to one for up to one year up to 30 days year, renewable which may be for consecutive extended for Entry is subject to the periods, the subsequent fulfilment of eligibility number of times periods, provided requirements that it is the conditions on prevailing at the Investors requested, to the which it is based time of application extent that the remain in effect, conditions which without requiring motivated its that business granting are person to apply maintained for permanent residence MALAYSIA ECONOMIC MONITOR JUNE 2016 » 83 N/A Temporary entry Temporary entry is N/A N/A is for up to one for up to one year year, renewable which may be for consecutive extended for periods, the subsequent number of times periods, provided that it is the conditions on requested, to the which it is based extent that the remain in effect, conditions which without requiring Independent technicians motivated its that business granting are person to apply maintained for permanent residence Independent technicians and their family dependents may freely enter and leave Chile without having to apply for separate re-entry permissions for the duration of their visas, on the basis of reciprocity Temporary entry N/A N/A N/A N/A servicers Installers is for up to six and months N/A N/A N/A Temporary entry is N/A for up to six months persons Service sales N/A N/A N/A Temporary entry is N/A responsible for commercial for up to one year setting up a presence Persons N/A N/A N/A Temporary entry is in N/A conformity with the term of the concerned Other personnel employment contract or for an initial period of three years whichever is shorter, which may be extended subject to the employment contract between MALAYSIA ECONOMIC MONITOR JUNE 2016 » 84 them and the commercial presence Source: Countries’ Schedules of Commitments for the Temporary Entry of Persons MALAYSIA ECONOMIC MONITOR JUNE 2016 » 85 Annex 4: Laws governing NTMs in Malaysia Regulatory Agency Implement Law or Regulation Regulation Title ation Date Ministry of Health Poison Act 1952 1952-09-01 Poison Regulations 1952 (Revised 1989) Ministry of Health Laws of Dangerous Drugs Act 1952 - Incorporating all 1952-11-01 Malaysia, Act amendments up to 1/1/2006 234 Ministry of Health Laws of Dangerous Drugs Regulation 1952 1952-11-01 Malaysia Act (Incorporatng latest amendment P.U.(A) 234 333/2006) Ministry of Natural Laws of Assignment of Export Duty (Mineral Ores) Act Resources and 1964-10-01 Malaysia Act 1964 Environment 396 Ministry of Human Laws of Factories and Machinery (Steam Boiler and Resources 1970-02-01 Malaysia Act Unfired Pressure Vessel) Regulations 1970 139 Ministry of Agriculture Laws of Pesticides Act 1974 - amendments up to and Agro-Based Industry 1974-08-29 Malaysia, Act 1/1/2006 / Pesticides (Amendment) Order 149 2010 Ministry of Agriculture Laws of Plant Quarantine Act 1976 - Incorporating all and Agro-Based Industry 1976-03-11 Malaysia, Act amendments up to 1/1/2006 167 Royal Police Laws of Explosives Act 1957 (amendments up to 1978-11-15 Malaysia, Act 1/1/2006) 207 Ministry of Home Affairs Laws of 1978-11-15 Malaysia Act Arms (Fees) Regulations1977 206 Ministry of Home Affairs Laws of 1978-11-15 Malaysia Act Arms Act 1960 (amended 1/1/2006) 206 Ministry of Agriculture Plant and Agro-Based Industry Quarantine 1981-01-31 Plant Quarantine Regulations 1981 Regulations 1981 Ministry of Finance Laws of Common Gaming Houses Act 1953 Malaysia, Act (Incorporating all amendments up to 1983-08-18 289 1/1/2006)/ Common Gaming Houses (Amendment) Act 2013 Ministry of Health Laws of Control of Drugs and Cosmetics Regulations 1984-01-01 Malaysia Act 1984 368 Ministry of Human Laws of Petroleum (Safety Measures) Act 1984 Resources 1984-06-28 Malaysia Act (incorporating latest amendment Act A807, 302 1991) Ministry of Agriculture Laws of and Agro-Based Industry 1984-08-01 Malaysia, Act Pesticides Regulations (Labelling) 1984 149 Ministry of Health Laws of Food Regulations 1985 (updated until Jan 1985-01-10 Malaysia, Act 2014) 281 Ministry of Natural Laws of Environmental Quality (Control of Lead Resources and 1985-02-01 Malaysia Act Concentration in Motor Gasoline) Environment 127 Regulations, 1985 MALAYSIA ECONOMIC MONITOR JUNE 2016 » 86 Regulatory Agency Implement Law or Regulation Regulation Title ation Date Department of Fisheries Laws of 1986-01-01 Malaysia, Act Fisheries Act 1985 (Act 317) - as at 1/11/2012 317 Ministry of Science Laws of Radiation Protection (Licensing) Regulations Technology and 1986-01-01 Malaysia Act 1986 Innovation 304 Ministry of Health Laws of Prevention and Control of Infectious Diseases 1988-09-08 Malaysia, Act Act 1988 - Incorporating latest amendment - 342 P.U.(A) 374/2006 Ministry of Natural Laws of Resources and 1988-12-31 Malaysia Act Tin Control Act 1954 (amended 1/1/2006) Environment 362 Ministry of Science Laws of Radiation Protection (Transport) Regulations Technology and 1989-01-01 Malaysia Act 1989 (Incorporating latest amendment Innovation 304 P.U.(A) 146/91) Ministry of Health Poison Act 1952 Poisons (Psychotropic Substances) 1989-04-15 (Revised 1989) Regulations 1989 Ministry of Health Poison Act 1952 1989-04-15 Poison Act 1952 (Revised 1989) (Revised 1989) Energy Commission Laws of Electricity Regulation 1994 (Incorporating 1990-08-30 Malaysia Act latest amendments - 431/2003) 447 Energy Commission Laws of Gas Supply Act 1993 (Incorporating 1993-02-04 Malaysia Act amendments up to 1/1/2006) 501 Ministry of Natural Laws of Environmental Quality (Prohibition on the Use Resources and 1993-12-31 Malaysia Act of Chlorofluorocarbons and Other Gases as Environment 127 Propellants and Blowing Agents) Order 1993 National Paddy and Rice Laws of Control of Paddy and Rice Act 1994 Board (BERNAS) 1994-07-07 Malaysia, Act (amendments up to 1/1/2006) 522 Ministry of Agriculture & Laws of Control of Padi and Rice Act 1994 (amended Agro-Based Industry 1994-07-07 Malaysia Act 1/1/2006) 522 Ministry of Natural Laws of Environmental Quality (Control Resources and 1996-09-01 Malaysia Act of Emission from Diesel Engines) Environment 127 Regulations 1996 Sabah Wildlife No.6 of 1997 1997-12-24 Wildlife Conservation Enactment 1997 Department Sarawak Wildlife Laws of Department 1998-10-01 Sarawak, Wild Life Protection Ordinance 1998 Chapter 26 Ministry of Natural Laws of Environmental Quality (Halon Management) Resources and 2000-01-01 Malaysia Act Regulations 1999 Environment 127 Ministry of Natural Laws of Environmental Quality (Refrigerant Resources and 2000-01-01 Malaysia Act Management) Regulations 1999 Environment 127 Malaysian Laws of Communications and Multimedia (Technical Communications and 2000-04-01 Malaysia Act Standards) Regulations 2000 (incorporating Multimedia Commission 588 latest amendment P.U.(A) 280/2001) Ministry of Health Laws of Occupational Safety and Health (Use of 2000-04-04 Malaysia Act Standards and Exposure of Chemicals 514 Hazardous to Health) Regulations 2000 MALAYSIA ECONOMIC MONITOR JUNE 2016 » 87 Regulatory Agency Implement Law or Regulation Regulation Title ation Date Ministry of Natural Laws of Environmental Quality (Control of Emission Resources and 2004-01-01 Malaysia Act from Motorcycles) Regulations 2003 Environment 127 Ministry of Health Laws of Control of Tobacco Product Regulations 2004 2004-09-23 Malaysia Act (Amendment Regulations 2013) 281 Ministry of Foreign Affairs Laws of Chemical Weapons Convention Act 2005 2005-06-16 Malaysia Act (amended 1/9/2006) 641 Palm Oil Board (MPOB) MPOB Licensing Malaysian Palm Oil Board (Licensing) 2006-01-01 Regulations Regulations 2005 (amended 3/3/2011) 2005 Palm Oil Board (MPOB) MPOB Quality Malaysian Palm Oil Board (Quality) 2006-01-01 Regulations Regulations 2005 2005 Ministry of Agriculture & Laws of Agro-Based Industry 2006-03-16 Malaysia Act Animals Rules, 1962 647 Ministry of Agriculture & Laws of Agro-Based Industry 2006-03-16 Malaysia Act Animals (Importation) Order 1962 647 Ministry of Natural Laws of Environmental Quality (Control of Petrol and Resources and 2007-04-01 Malaysia Act Diesel Properties) Regulations 2007 Environment 127 Ministry of Natural Laws of Resources and 2007-08-29 Malaysia, Act Biosafety Act 2007 Environment 678 Department of Fisheries Fisheries Fisheries (Control of Endangered Species of 2008-01-31 Regulations Fish) Regulations 1999 (amendment 2008) 1999 Department of Wildlife Laws of International Trade in Endangered Species and National Parks 2008-02-14 Malaysia, Act Act 2008 Peninsular 686 Ministry of Plantation Laws of Industry and 2009-01-08 Malaysia Act National Kenaf and Tobacco Board Act 2009 Commodities 692 Department of Fisheries Fisheries Fisheries (Quality Control of Fish For Export to 2009-02-26 Regulations the European Union) Regulations 2009 2009 Department of Fisheries Food Export Food Export (Issuance of Health Certificate 2009-02-26 Regulations for Export of Fish and Fish Product to the 2009 European Union) Regulations 2009 Ministry of Health Laws of 2009-02-28 Malaysia Act Food Hygiene Regulations 2009 281 Department of Fisheries Laws of 2009-09-03 Malaysia, Act Feed Act 2009 698 Department of Wildlife Laws of International Trade in Endangered Species and National Parks 2009-12-28 Malaysia, Act Regulations (Permit, Authorisation, Peninsular 686 Registration and Fees) 2009 Department of Fisheries Fish Marketing 2010-04-09 Regulations Fish Marketing Regulations 2010 2010 MALAYSIA ECONOMIC MONITOR JUNE 2016 » 88 Regulatory Agency Implement Law or Regulation Regulation Title ation Date Malaysian Laws of Communications and 2010-06-10 Malaysia Act Strategic Trade Act 2010 Multimedia Commission 708 Department of Wildlife Laws of and National Parks 2010-11-04 Malaysia, Act Wildlife Conservation Act 2010 Peninsular 716 Malaysian Timber Laws of Malaysian Timber Industry Board Industry Board (MTIB) 2011-03-15 Malaysia, Act (Incorporation) Act 1973 - as at 1/12/2011 105 Department of Laws of Malaysian Quarantine and Inspection Quarantine and 2011-08-18 Malaysia, Act Services Act 2011 Inspection Services 728 Department of Fisheries Fisheries Fisheries (Fish Disease Control, Compliance 2012-03-26 Regulations for Exports and Imports) Regulations 2012 2012 Ministry of Plantation Malaysian Industries and 2012-10-02 Cocoa Board Malaysian Cocoa Board Regulations 2012 Commodities Act 1988 Royal Customs Laws of Department 2012-10-31 Malaysia Act Excise Duties Order 2012 176 Ministry of Health Laws of Occupational Safety and Malaysia Act Health (Classification, Labelling 2013-01-01 514 and Safety Data Sheet of Hazardous Chemicals) Regulations 2013 Department of Laws of Veterinary Services 2013-03-20 Malaysia, Act Animals (Amendment) Act 2013 647, Act A1452 Ministry of Health Laws of 2013-07-01 Malaysia Act Medical Device Regulations 2012 737 Malaysian Rubber Board Malaysian Malaysian Rubber Board (Licensing and (MRB) 2014-04-30 Rubber Board Permit) Regulations 2014 Act 1996 WTO Committee on Antidumping and WTO Committee on Antidumping and Government publications Government publications MALAYSIA ECONOMIC MONITOR JUNE 2016 » 89 Annex 5: Estimating ad valorem equivalent of NTMs How does the presence of NTMs affect import for Malaysia? One way to measure the effect of NTMs on imports is to measure the equivalent ad valorem tariff of such NTMs, which is called the ad valorem equivalent (AVE) of NTMs. In this section, we will first discuss briefly the methodology behind the estimation of AVE. For details of the estimations, please refer to Kee and Nicita (2016). Let m denote the quantity imported. We estimate the following specification based on the cross sectional country-pairs of the 30 importing countries we have new NTM data on: (1) f(m|X) = exp{-μ}μ^{m}/ m! where X include all control variables and trade policy variables. Let NTM1 be a dummy variable indicating whether importing country imposes at least one SPS or TBT measure on products from the exporting country, NTM2 is a dummy variable indicating whether importing country imposes at least one non-SPS and non-TBT measure on products from the exporting country. t is the ad valorem tariff of importing country. In logarithms: (2) lnm =α+εt+βNTM1+ µNTM2 +u. To control for selection bias due to zero trade between country pairs, we follow Helpman, Melitz and Rubinstein (QJE, 2008), and use religion as an instrument for the first stage selection regression for whether the country-pair participate in trade. We then include the inver se Mill’s ratio from the first stage in (2) as a control variable. (3) lnm =α+εt +βNTM1+ µNTM2 +δmills +u. To calculate AVE estimate, we use the following equation: AVE1=(exp(β)-1)/ε, AVE2=(exp(µ)-1)/ε, where ε is the import elasticity, directly obtain from the estimated coefficient of tariffs. MALAYSIA ECONOMIC MONITOR JUNE 2016 » 90 Annex 6: Areas of potential large gains for SMEs as part of TPP The gains from TPP are estimated to be the largest for the top four most important export products: two products from the electrical equipment and machinery sectors and two products from the oil and petrochemical industries, respectively that accounted together for USD80.6 billion and 34.6 percent of total exports in 2014.71 For each product, highly detailed US input-output tables72 were used to calculate the share of inputs sourced from other sectors of the economy. The main supplying sectors to these products are shown in rows in decreasing order of importance in the table. The first column indicates the percentage of inputs from that sector over total intermediate inputs demanded by that product, and the second column (percent SME) indicates the share of SMEs relative to total firms present in that sector. Table 14: SMEs Participation in Main Supplying Industries for Storage Devices and Electronic Integrated Circuits Storage devices (NAICS 334112) Electronic Integrated Circuits (NAICS 334413) percent percent percent inputs percent SME inputs SME Computer and Electronics 44.1 4.2 Primary Metal 16.7 34.3 Wholesale Trade 18.0 N.A. Chemical 11.5 34.8 Management of Companies 8.0 N.A. Wholesale Trade 11.0 N.A. Management of Fabricated Metal 6.3 62.6 7.4 N.A. Companies Professional and Scientific Electrical Equipment 3.2 39.9 7.2 N.A. Services Administrative and Support Professional and Scientific Services 2.0 N.A. 7.0 N.A. Services Administrative and Support Services 2.0 N.A. Computer and Electronics 6.9 4.2 Plastics and Rubber 2.0 51.7 Fabricated Metal 6.0 62.6 Truck Transportation 1.8 N.A. Utilities 4.4 N.A. Utilities 1.6 N.A. Plastics and Rubber 3.1 51.7 Top 10 supplying industries 89.0 - Top 10 supplying industries 81.2 - Natural gas (NAICS 325120) Petroleum oils (NAICS 324110) percent percent percent inputs percent SME inputs SME Petroleum and Natural Gas Petroleum Refineries 16.8 0 87.0 0 Extraction Petroleum and Natural Gas Extraction 15.9 0 Petroleum Refineries 2.7 0 Other Basic Inorganic Chemicals 9.7 11.4 Wholesale Trade 2.1 N.A. Management of Companies 7.9 N.A. Pipeline Transportation 1.3 N.A. Ethyl Alcohol Ethyl Alcohol Manufacturing 4.7 18.7 1.1 18.7 Manufacturing 71 In 2014, electronic integrated circuits (composed of HS codes 854231, 854239, and 854290) accounted for USD30 billion and 12.9 percent of total exports while storage devices and parts (composed of HS codes 847330 and 847170) accounted for USD8.4 billion and 3.6 percent of total exports. 72 The analysis using IO tables has two steps. First, using the US IO table we get a glimpse of which supplying sectors are important for key export sectors. Second, we look at the key supplying sectors from the previous step and use the Malaysia census data to calculate participation/importance of SMEs in each supplying sector in Malaysia. For the first step we are assuming that the US is a good benchmark to get these input coefficients because it is close to (or at) the technological frontier in most industries and because the size of the economy and details of the IO table allow us to have a greater level of granularity (389 sectors). MALAYSIA ECONOMIC MONITOR JUNE 2016 » 91 Industrial Building Wholesale Trade 4.3 N.A. 1.0 N.A. Construction Petrochemical Manufacturing 3.9 6.7 General Transportation 0.9 N.A. Natural Gas Distribution 3.8 N.A Iron Ore Mining 0.5 N.A. Management of Other Ore Mining 2.9 N.A. 0.5 N.A. Companies Other Basic Inorganic Iron Ore Mining 2.6 N.A. 0.5 11.4 Chemicals Top 10 supplying industries 72.5 - Top 10 supplying industries 97.6 - Source: Economic Census (2011) using U.S. input-output tables. 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