How Does Foreign Direct Investment Affect Economic Growth in Malaysia - Summary and Trends

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Malaysia has a modern and comprehensive financial system that continues to evolve in response to the changing domestic and international conditions.

A well-developed capital market comprising the equity and bond markets, provides a source of medium and long-term capital for corporates. With the evolution of a more diversified financial system, the capital market has assumed an increasingly significant role in mobilizing and allocating resources to finance capital expenditures in both the public and private sectors.

The financial system is made up of banks complimented by non-bank financial intermediaries (NBFIs).

NBFIs play an important role in the development of the capital market and in providing social security and consist of provident and pension funds, insurance companies, takaful operators, savings institutions and unit and property trusts accounts. Improved investment results and growth in lending and life insurance activity have historically contributed to an increase in assets of NBFIs.

As with most economies, Malaysia has been affected by the global financial crisis and some reports suggest that Asia has been affected more than western countries.

Malaysia, being a small open economy with a strong export-dependent manufacturing sector, has been particularly vulnerable to the global crisis. The very countries that generate the demand for Malaysian exports have been struck by the crisis, leading to declines in output in Malaysia.

The capital outflows from Malaysia increased with the onset of the crisis. Investment outflows that were high in the second half of 2007 (about MYR 21.9bn (USD 6.4bn)) slowed in the fourth quarter of 2008 to MYR 5.6bn (USD 1.7bn).

Although foreign direct investment (FDI) increased it did not compensate for portfolio outflows during the same period.

The crisis has also prompted a drop in the value of Malaysia’s foreign reserves. Although Malaysia’s reserves have been high in the years following the 1997 crisis, the present crisis has taken its toll on reserves. The declines in FDI, foreign reserves, and portfolio funds had been cushioned by the relatively stable current account balance but this dropped drastically in the fourth quarter 2008.

In response to the threat posed to the economy, the government reacted with the following measures:

  • a MYR 7bn (USD 2.1bn) stimulus package, announced on 4 November 2008,
  • a second stimulus package of MYR 60bn (USD 17.8bn), announced on 10 March 2009, and,
  • interest rate cuts by Bank Negara Malaysia.

In the life insurance market, whilst assets increased by 6.7% in 2008 it was the lowest increase for many years. Average growth over the five years has been 12.8%.

The life insurance industry has continued to play a key role in providing institutional support for the development of the capital market. This is reflected in the significant investments in corporate and debt securities which accounted for 51.2% of total fund assets at the end of 2008. The bulk of these investments are in private debt securities. The net investment yield in 2008 was 4.6% (excluding capital gains), down from 5.5% in 2007.

Demand from life insurers for long-term securities to match long-term liabilities remained strong.

With the liberalization of the foreign exchange administration rules from 1 April 2005 insurers have been increasing their share of foreign assets, although as a percentage this remains small at 1.4% in 2008.

The situation was somewhat different in the takaful market where total assets increased by 20.2%. A substantial portion of takaful funds are placed in Islamic private debt securities and the Islamic money market. The yield achieved in 2008 was 3.4%.

There have been no solvency issues for life insurers or takaful operators.

Malaysia - The Bond Market

The Malaysian bond market is one of the more developed bond markets in the region. Increasing market size, active issuance and trading of government and corporate issues, the introduction of new instruments (such as asset-backed securities), and improvements to the regulatory structure are all signs of its dynamism.

The government and corporate bond markets are active markets for both conventional and Islamic bonds. Domestic and foreign investors can buy and sell conventional and Islamic debt instruments through the exchange and over-the-counter markets.

In 2006 BNM released the “bond info hub”, a one-stop centre detailing all bond information in Malaysia.

The Asian Development Bank ranked the Malaysian debt securities market as the second largest in Asia after Japan in 2008. The Malaysian private debt securities (PDS) market (as a percentage of GDP) is also the largest relative to other regional economies.

Following the efforts undertaken to promote the private sector bond market, the composition of the Malaysian bond market has gradually changed. By the end of 2006, private sector bonds accounted for 50.7% of the total bonds outstanding as compared with 48.0% at the end of 1998. This increased further to over 60% in 2008 making Malaysia one of the few markets in the region where private sector bonds exceed those in the public sector.

Various types of bond are described below.

  • Malaysian government securities (MGS) are long-term government securities with interest payable half yearly. The term of MGS is normally above one year and the coupon rate is determined by the weighted average of the successful yield.
  • Malaysian treasury bills (MTB) are short-term government securities and are bidded on yield basis. The yield is specified as a rate of discount and the term of MTB is expressed in actual number of days.
  • Government investment issues (GII) are government securities issued based on Islamic principles and are placed on non-competitive tender.
  • Bank Negara Malaysia bills (BNB) are short-term securities issued by BNM and are bidded on yield basis. The yield is specified as a rate of discount and the term of BNB is expressed in actual number of days.

Other bond types include those described below.

  • Floating rate bonds - these bonds are of medium and long-term tenor with an adjustable coupon rate. The interest is payable either half yearly or quarterly.
  • Fixed rate bonds – these are fixed coupon medium and long-term bonds where the interest is payable half yearly.
  • Cagamas notes are short-term securities with the tenor of 12 months or less. The notes are similar to MTB and normally issued at a discount.
  • Islamic bonds (sukuk), based on sharia principles - Al Mudharabah are of medium-term tenor issued under the Islamic principle of Al Mudharabah with a pre-determined profit sharing ratio.
  • Commercial papers (CPs) - CPs are revolving short-term papers with tenors of not less than one month but not more than 12 months. The notes are similar to MTB and normally issued at a discount.
  • Medium-term notes (MTNs) have a term of more than one year but a maximum of five years, and may be issued based on conventional or Islamic principles. The mode of issue for MTNs can either be on direct placement and/or by way of tender.
  • Corporate bonds are long-term securities issued by the corporations to meet their financing needs. The issuer may issue these bonds based on Islamic or conventional principles, and with (fixed or floating rate bonds) or without interest (zero coupon bonds) attached. The interest may be payable quarterly, half yearly or annually depending on the cash flow of the issuer.

Both conventional and sukuk bonds are issued with maturities ranging from one to 20 years.

As at November 2009 government bonds were producing yields in the range of 3.3% for maturities in 2013 to 4.25% for maturities in 2019.

In the same month corporate bonds were producing yields of between 2.0% and 5.8% for similar maturities.

Malaysia - The Stock Market, Direct Investment and Interest Rates

Stock Market

Although the history of the Kuala Lumpur Stock Exchange (KLSE) goes back to the 1930s, the development of the exchange as it is today began in 1973. In the past there was a strong link between the KLSE and Stock Exchange of Singapore (SES) and Malaysian incorporated companies were listed and traded through SES, and vice verse for Singapore incorporated companies.

In 1990 Singapore incorporated companies were removed from KLSE and, similarly, Malaysian companies were de-listed from SES. This marked the beginning of KLSE as a stock exchange with a truly Malaysian identity.

In 2004 KLSE became a demutualized exchange and was renamed the Malaysian Stock Exchange Berhad (MSEB, or Bursa Malaysia).

The benchmark index is the FTSE 100 (comprising the 100 largest companies by full market capitalization). The index was launched in May 2006 with a value of 6,000.

At the end of December 2006 it had increased to 6,850 and had reached nearly 9,000 by the end of 2007. As with other global stock markets, the FTSE 100 fell dramatically during 2008 and hit a low of 5,563 in November 2008. It has since regained ground considerably.

Direct Investments

An increasing proportion of individual savings are in investment-linked insurance products.

The banks are the insurers main competition for investment funds. There are some mutual funds, but these tend to compete for the corporate market, rather than for individual investments.

Short-term saving is generally in the form of bank deposit accounts.

The use of property as an investment is also increasing.

Interest Rates

Key interest rates, according to the IMF, in 2008-9 were as follows:

  • Deposit rate - 3.13%
  • Lending rate - 6.08%
  • Money market rate - 3.47%
  • Treasury bill rate - 3.39%

Other Investments by Life Insurers

To ensure that the increased investment flexibility accorded to life insurers does not materially increase financial risks to policyholders the following applies:

  • investments in private debt securities with a rating below AA or its equivalent must not exceed 30% of an insurer’s margin of solvency
  • aggregate direct loans extended must not exceed 20% of an insurer’s margin of solvency.

The revised investment limits are not expected to generate any short-term re-balancing of current asset allocations by life insurers as the increased investment expected in private debt securities is more likely to result from investment of funds generated from new policies sold or existing surplus cash holdings.

Insurers that have complied with the minimum required margin of solvency in accordance with the admitted assets requirements remain free to invest their surplus funds in any assets of their choice.

With the liberalization of the foreign exchange administration rules from 1 April 2005 insurers have been increasing their share of foreign assets.

This post is part of the series: Global Investment Markets - Does FDI affect Economic Growth?

The series follows a theme about the global investment markets in various countries and provides a summary, details about bonds, private direct investments and foreign direct investments (FDI).

  1. Economic Growth in Malaysia and the Foreign Direct Investment