2nd divider - Monetary and Financial Conditions Overview ... · bouts of volatility due to global...

Overview of International Monetary and Financial ConditionsRinggit Exchange Rate DevelopmentsLiquidity and Money SupplyFinancial Market ConditionsFinancing of the Economy White Box: The Evolution of Financing Sources for the Malaysian Economy

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Monetary and Financial Conditions

2nd divider - Monetary and Financial Conditions

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Monetary and financial conditions remainedfavourable in 2007. Despite being subjected tobouts of volatility due to global financial marketsdevelopments, domestic financial marketsdemonstrated resilience and were supported bythe robust macroeconomic fundamentals.Globalisation and financial integration has led tofinancial markets adjusting more rapidly toexternal events and has resulted in a strongerinternational co-movement of asset prices acrosscountries. Thus, the increased volatility infinancial markets due to external developmentsand their consequent impact on the economycreates a more challenging environment formacroeconomic management.

OVERVIEW OF INTERNATIONAL MONETARYAND FINANCIAL CONDITIONS

After several years of robust growth, 2007signified a pivotal turning point in the globaleconomic and financial environment. Financialmarket conditions turned disorderly as theunfolding sub-prime and credit crisis in the USspread across the major financial markets. Thishas been accompanied by the sustaineddepreciation of the US dollar vis-à-vis other majorcurrencies, as well as the persistence of largeglobal imbalances and surging food andcommodity prices.


Global financial marketconditions were mainlyinfluenced by the unfolding USsub-prime crisis, sustaineddepreciation of the US dollar, aswell as the persistence of largeglobal imbalances and risingfood and commodity prices

pressures from high food prices, early signs of aslowing US housing market and geopoliticaltensions in the Middle East, investor optimismwas sustained in the early part of the year by thecontinued expansion of the global economy, theample global liquidity conditions and orderlyconditions in financial markets. As a result, equitymarkets turned in a robust performance in early2007, with emerging market equities achievingnew records. Sovereign yields rose in major bondmarkets, as expectations were for tighter futuremonetary policy, in light of favourable growthprospects amidst rising food and commodityprices. The positive outlook was also evident inthe emerging markets, with risk premiumsremaining low, as reflected by the continuousnarrowing of spreads in the early months of 2007.

The year 2007 began favourably with globalfinancial market conditions supported by abroadly positive global outlook. Major economieswere expected to sustain their expansion, albeitat a slower growth rate, while growth inemerging market economies was expected tocontinue unabated. Despite rising inflationary

Chart 2.1Gross Domestic Product Annual Change(Selected Industrialised Economies)

US Japan UK Euro

-3

-2

-1

0

1

2

3

4

5

1Q

2001

3Q 1Q

2002

3Q 1Q

2003

3Q 1Q

2004

3Q 1Q

2005

3Q 1Q

2006

3Q 1Q

2007

3Q

Annual change (%)

Source: Bloomberg

Chart 2.2Consumer Price Index Annual Change(Selected Industrialised Economies)

US Japan UK Euro

Source: Bloomberg

-2

-1

0

12

3

4

5

6

J D J D J D J D J D J D J D

Annual change (%)

2001 2002 2003 2004 2005 2006 2007

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Against the background of expectations forsteady expansion of the global economysupporting growth in employment and incomesamid diminishing spare capacity in most majoreconomies, the balance-of-risks to price stability inthe major economies in early 2007 was on theupside. While the US Federal Reserve kept itspolicy rate unchanged in the first-half of 2007, theFOMC statements during this period underscoredits predominant monetary policy concern thatinflation would persist for a longer period of time.Similar tightening biases were also expressed byboth the Bank of England and the EuropeanCentral Bank, which increased their key policyrates by 75 basis points and 50 basis pointsrespectively, between January and July 2007.

Among the regional economies, thesituation was somewhat more mixed. Highcapital inflows leading to a build-up of liquidityand faster money and credit expansion,contributed further to rising domesticinflationary pressures in several economies. Inview of the high liquidity growth and its impacton the asset markets, the Bank of Korea tookfurther tightening steps in 2007 by raising itspolicy rate and introducing other quantitativemeasures to curb the steady rise in asset prices.In addition to increasing the key policy rate,the People’s Bank of China adoptedsupplementary measures, such as increases inreserve requirements, to contain inflation andrapid credit expansion. In Thailand andIndonesia, however, concerns on the downsiderisk to growth dominated monetary policydecisions. Inflationary pressures were deemedto be under control following previousmonetary tightening that had been successfulin mitigating the impact of high commodityprices on domestic prices. Therefore, monetarypolicy was eased in these countries in 2007 tostimulate domestic demand.

Concerns on the prospects of a protracteddecline in US house prices and the implicationson the US economy began to surface at the endof the first quarter of 2007. The outlook for theUS mortgage market took a turn for the worst bymid-year, when risk premiums on the sub-primemortgage market rose significantly and triggeredwidespread sharp downward ratings of financialassets amongst global investors and causeddisruptions in the interbank markets. The loss ofconfidence in the valuation of structured creditproducts heightened uncertainty surrounding theextent and distribution of these losses across thefinancial system. As a result, liquidity demandincreased dramatically, but was met with morerisk averse lenders, leading to the surge in thecost of borrowing. Spreads rose sharply acrossthe credit universe in tandem with the rise ininterbank money market rates. Market volatilityincreased sharply and disorderly conditionsprevailed, which at times, led to malfunctioninginterbank markets in the major financial centresof the industrial world.

At the initial stage, the impact of the sub-prime turmoil was deemed to be confinedwithin the financial markets. Against an

Chart 2.3Performance of Global Equity Markets

MSCI Latin America Emerging Europe

S&P 500 MSCI Asia Pacific

Source: Bloomberg

Index

2007

90

100

110

120

130

140

150

160

J F M A M J J A S O N D

Chart 2.4Emerging Market Bond Index and Bond Spreads (EMBI)

JP Morgan EMBI JP Morgan EMBI Spread (RHS)

375

380

385

390

395

400

405

410

415


Index

130

150

170

190

210

230

250

270

290

310

Index

Source: Bloomberg

2007

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uncertain background of financial turbulenceand potential systemic implications, majorcentral banks responded with injections ofliquidity into the tight interbank markets, as wellas broadening the range of assets that wereallowed to be discounted with the centralbanks. In addition, the US Federal Reserveundertook an immediate cut in its discount rateby 50 basis points on 17 August 2007 topromote the restoration of orderly conditions infinancial markets.

While liquidity conditions in most emergingmarkets remained favourable given theirlimited exposure to the US sub-prime assetsand asset- backed securities markets, theintegration across financial markets and theongoing repricing of risks, did lead to a sharpsell-off in equities and selected currencies inthe region. Emerging markets equities,however, proved to be resilient, as the MSCI foremerging market recorded gains of about36.5% for the year as a whole.

Nonetheless, on a broader scale, the sub-prime crisis initiated a holistic reassessment ofrisks globally. First, the low risk premiumsenvironment that had prevailed for the recentthree years came to an end. Concerns anduncertainty about the location and size ofpotential losses in the credit derivative marketsled to the elevation of risk aversion, withinvestors returning to safe-haven assets, thusleading to the fall in yields of US Treasuries from5.02% at end-June 2007 to 4.02% at end-December 2007. Volatility in the US equity

market as measured by the VIX index, increasedto 30.8 index points on 16 August 2007 from16.2 index points on 1 July 2007.

Second, the sub-prime crisis also increasedthe volatility in the currency markets, due partlyto the unwinding of carry trade positions. Carrytrades or leveraged cross-currency positionswere profitable as long as investors benefitedfrom borrowing in a cheap funding currency toinvest in higher earning foreign currency assets;with gains from interest rate differentials notexpected to be overwhelmed by near-termexchange rate movements. With the sustainedperiod of low policy interest rates and lowperceived exchange rate risks in Japan andSwitzerland, the yen and the Swiss franc have

%

2007

0.1

0.6

1.1

1.6

2.1

2.6


Source: Bloomberg

Chart 2.53-month LIBOR less 3-month Treasury Bill Yield

Chart 2.6Chicago Board of Exchange (CBOE) Implied Volatility Index (VIX)

Source: Bloomberg

8

12

16

20

24

28

32


Index

2007

AUD-JPY NZD-JPY USD-JPY

90

95

100

105

110

115

120

125


Index

Source: Bloomberg

2007

Chart 2.7 Carry Trade Index (Cumulative Excess Return)

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been used to fund carry trade activities into highyielding currencies and other financialinstruments. However, these carry tradepositions had retreated somewhat, given theheightened risk aversion following the greateruncertainty in the financial markets in the periodafter the sub-prime crisis.

Third, the overriding concern arising from thesub-prime crisis was the extent to which thecontraction and higher pricing of credit hadrepercussions on the real sector. As economic datacontinued to show deteriorating conditions in theUS housing and job markets, the key policychallenge was to ascertain the extent of its spillovereffects on the real economy. Given the greatertrade and financial linkages between the majordeveloped economies and the rest of the world,any protracted slowdown would inevitably have animpact on the external demand in these economiesand thus on the global economic outlook.

Fourth, global commodity prices continuedto scale new highs in 2007, driven by strongdemand and a shift in asset allocation awayfrom financial assets, and thereby contributingto the build-up of global inflationary pressures.As a result, the prospect of significantly slowerglobal growth amidst a sustained increase inglobal commodity prices, has led to someconcerns of possible stagflation in thedeveloped economies. Nevertheless, theslowdown in the US and other developedeconomies would contain global demand, thuslimiting the probability of such a scenario.

Overall, emerging markets have remainedbroadly resilient, but face critical challenges ahead.Sustained periods of strong private capital inflowsto emerging markets and developing economieshave supported growth and the positivedevelopments in the domestic financial markets.Nonetheless, some economies have alsoexperienced inflationary pressures, due to the rapidexpansion of credit and liquidity. In addition, therisk of greater financial market volatility due to theimpact of the unfolding sub-prime crisis, theprospect of slower global growth and reducedtrade flows, as well as elevated inflationarypressures, would pose challenges tomacroeconomic management.

RINGGIT EXCHANGE RATE DEVELOPMENTS

Strong two-way trade and investment flowscontinued to influence ringgit performanceagainst major and regional currencies duringthe year. Underlying demand for the ringgitwas derived from the positive net tradebalance, sustained inward foreign directinvestment and substantial repatriation ofprofits and dividends by Malaysian companieswith investments abroad. Ringgit demand wasalso augmented by significant portfolio inflows,as expectations of strong earnings growth andfurther currency appreciation contributed tothe re-rating of Malaysian equities. This wasreinforced by the generally optimistic investorsentiments towards the region and the broad

280290

Gold Prices (RHS)

Reuters/Jefferies CRB Index (LHS)

Chart 2.8Commodities Index (CRB) and Gold Prices

300310320330340350360370380


Index

600

650

700

750

800

850

900

USD

2007

Source: Bloomberg

Chart 2.9Capital Flows to Emerging AsiaUSD billion

e Estimate Source: Institute of International Finance

Equity investment, net

Private creditors, net

-100

-50

0

50

100

150

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007e

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weakness of the US dollar. The upward ringgitpressure was to a certain extent balanced bythe demand for foreign currencies to fundlarger outward direct and portfolioinvestments, repayment and prepayment ofexternal loans by both the public and privatesectors and the repatriation of profits anddividends by non-residents. The strengtheningof the ringgit was also punctuated by severalexternal events during the year, such as theglobal equity correction in the first quarter andthe global financial disruptions following thedevelopments in the US housing market in thethird quarter, which had a restraining effect onregional currencies, including the ringgit.

mortgage market, particularly in the period Junethrough September. The weakness of the ringgitin the June to September period was especiallynoteworthy because it corresponded with amarked increase in ringgit exchange ratevolatility. These disruptions proved to betemporary as the ringgit resumed itsappreciating trend, arising from the positiveinvestor sentiment towards the Malaysianeconomy. The ringgit also reflected the general

KLCI Index RM (RHS)

Chart 2.10Performance of the Kuala Lumpur Composite Index (KLCI) and the Malaysian Ringgit (RM) against the US Dollar

Source : Bursa Malaysia

KLCI Index (31 Dec 06 = 100)

20072006

90

95

100

105

110

115

120

125

130

135

D J F M A M J J A S O N D94

96

98

100

102

104

106

108

110

RM/USD Index (31 Dec 06 = 100)

RM/USDImplied Volatility

Chart 2.11 Exchange Rate and Implied Volatility of the Malaysian Ringgit (RM) against the US Dollar

Implied Volatility (%)

20072006

2

3

4

5

6

7

8

9

10

D J F M A M J J A S O N D3.15

3.20

3.25

3.30

3.35

3.40

3.45

3.50

3.55RM/USD

Source : Bloomberg

RM/USD(RHS)

Implied Volatility(LHS)

Index (31 Dec 06 = 100)

* Regional currencies - Chinese renminbi, Indonesian rupiah, Korean won, Philippine peso, Singapore Dollar, New Taiwanese dollar, Thai baht. Each currency is of equal weight.

Note: An increase in the index represents an appreciation of the ringgit or of selected regional currencies against the US dollar.

Chart 2.12Exchange Rate of the Malaysian Ringgit (RM) and Selected Regional Currencies against the US Dollar

96

98

100

102

104

106

108

D J F M A M J J A S O N D

20072006

RM

Index of Selected Regional Currencies against the USD*

Strong two-way trade andinvestment flows continued toinfluence ringgit performanceagainst major and regionalcurrencies during the year

The strong demand for ringgit resulted inthe continued appreciation against the US dollarin 2007. The upward trend in the ringgit washowever disrupted by the withdrawals of fundsfrom the region following the correction in theShanghai equity market in February, anddevelopments related to the US sub-prime

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improvement in investor sentiment following themonetary policy action by the US Federal Reserveto normalize market conditions and address theemerging risk of a broader US economicslowdown, as well as the efforts by the othermajor central banks to ease the tight liquidityconditions in financial markets. For the year as awhole, the ringgit appreciated by 6.8% againstthe US dollar to end the year at the dollarexchange rate of RM3.3065 (noon rate).

The ringgit also ended the year marginallyhigher by 0.5% against the Japanese yen. Theringgit was generally stronger against the yen inthe first half of the year as the yen was thefavoured short currency for carry trade activities.The substantial unwinding of these positionsfollowing the rise in global financial marketvolatility in the second half of the year, however,led to a significant appreciation of the yenrelative to the ringgit. Nevertheless, the ringgitended the year firmer versus the yen on renewedcarry trades and concerns about the strength ofgrowth of the Japanese economy. Conversely, theringgit depreciated against the euro by 4.7%,following the marked strengthening of the euroagainst the major currencies. Key factorssupporting the euro were market expectationsfor continued monetary policy tightening by theEuropean Central Bank, the positive economicgrowth outlook for the euro zone, and thegreater role of euro as a reserve currency.

The performance of the ringgit against theregional currencies was mixed. Although theunderlying trend of the ringgit was broadlyconsistent with that of other currencies in theregion, country-specific factors resulted invariations in performance between the regionalcurrencies. In particular, the Philippine pesostrengthened due to strong remittances andexport receipts, and the relatively high interestrates of peso instruments. The Indonesianrupiah weakened as demand for foreigncurrency rose in line with import growthfollowing stronger economic activity and theincrease in world oil prices.

Chart 2.13 Exchange Rate of the Malaysian Ringgit (RM) against Major Currencies

90

92

94

96

98

100

102

104

106

108

D J F M A M J J A S O N D

Index (31 Dec 06 = 100)

20072006

Note: (+) indicates an appreciation of ringgit against the currency

YEN

USD

EUR

Chart 2.14Summary of Malaysian Ringgit (RM) Performance against Major and Regional Currencies

7.5

6.8

6.4

4.90.5

0.0

-0.1

-4.7

-10.2

0.4

9.2

-12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12

IDR

KRW

USD

TWD

GBP

YEN

SGD

THB

CNY

EUR

PHP

%

Percent change, 1 Jan - 31 Dec 2007

Note: (+) indicates an appreciation of the ringgit against the currency

Chart 2.15Volume of Interbank Transactions in the Kuala Lumpur Foreign Exchange Market

0

200

400

600

800

1,000

1,200

1,400

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 20070

200

400

600

800

1,000

1,200

1,400

Spot

Swap

Total

RM billion RM billion

Note: Data from 2002 onwards is based on the new Ringgit Operations Monitoring System (ROMS), whereas observations for previous years are based on transactions of the eight Authorised Dealers.

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The rapid expansion in the volume of interbanktransactions in the Kuala Lumpur foreign exchangemarket continued in 2007. At current exchangerates, total volume increased by 34.7% (at constant2006 exchange rates: 41.1%). The increase inturnover was driven mainly by the rise in spottransactions, which grew by 49.2% at currentexchange rates (at constant 2006 exchange rates:60.6%). For the recent two years, spot transactionshad overtaken swap transactions as the dominantcontributor to the overall volume, a reversal of thetrend since 2000. This may in part be attributed tothe increase in short-term financial flows into theregion. It is noteworthy that the 34.7% increase inthe average daily volume of spot and swaptransactions in the Kuala Lumpur foreign exchangemarket is higher than the annualized global averagegrowth of 20.2% over the 2005 – 2007 periodcovered by the Bank for International SettlementsTriennial Central Bank Survey of Foreign Exchangeand Derivatives Market Activity in 2007. Thisdevelopment reflects the larger two-way flows andthe growing vibrancy of the Kuala Lumpur foreignexchange market.

LIQUIDITY AND MONEY SUPPLY

In 2007, monetary aggregates expanded as aconsequence of both external and domesticfactors. Broad money, or M3, exhibited a relativelystable growth trend in the first half of 2007, whichsubsequently moderated towards the second halfof the year, and ended the year growing at anannual rate of 9.5% (end-2006: 13.0%).

Chart 2.16Transactions in the Kuala Lumpur Foreign Exchange Market by Currency

USD/EUR

STG/USD

USD/CHF

USD/SGD

USD/MYR

USD/YEN

2006(RM919.976 billion)

2007(RM1,239.211 billion)

93.2%

1.9%

2.4%1.2%

1.4%

0.03%

1.5%

2.9%

0.5%

1.5%

0.01%

93.5%

Large external flows and higherlending activity contributed tosustained growth in monetaryaggregatesInflows from the current account surpluses,foreign direct investments and portfolio fundswere the main drivers in the expansion ofliquidity, albeit at a lesser extent compared to2006. In particular, during the third quarter, netforeign assets exerted a contractionary impact onM3, reflecting to a large extent, the outflowsfrom the heightened risk aversion amongst

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Chart 2.17Monetary Aggregates

M1: 19.6%

M3: 9.5%

0.0

5.0

10.0

15.0

20.0

25.0

M J S D M J S D M J S D

Annual growth (%)

2005 2006 2007

Table 2.1Broad Money, M3

Change (RM billion)

2006 2007

M3 87.5 72.5

Currency in circulation 3.4 2.8Demand deposits 11.7 24.2Broad Quasi-Money 72.4 45.5

Fixed deposits 31.9 10.7Savings deposits 5.2 8.7NIDs 14.3 -15.3Repos 11.8 -72.4FX deposits 3.2 1.5Other deposits 5.9 112.2

Determinants of M3Net claims on Government 8.3 0.3Claims on private sector 34.7 51.6

Loans 36.8 48.5Securities -2.1 3.1

Net external operations* 59.7 76.4Bank Negara Malaysia* 32.1 50.9Banking system 27.6 25.4

Other influences -15.3 -55.8

* Pre-revaluation of the international reserves

Chart 2.18Financing-Deposit and Loan-Deposit Ratios

Deposit growth (RHS)

Loan growth(RHS)

Loan-depositratio (LHS)

Financing-depositratio (LHS)

60

65

70

75

80

85

90

J F M A M J

2006 2007

J A S O N D J F M A M J J A S O N D0

2

4

6

8

10

12

14

16

18

Ratio %

investors due to the US sub-prime crisis. Higherbank lending contributed significantly to M3growth in the second half of the year, in tandemwith the increased pace of economic activity.

Narrow money or M1, continued to recordstronger growth throughout the year, evidencedby the annual growth of 19.6% at end-December (end-2006: 13.7%), as the privatesector opted for higher transaction balances toundertake trading activities.

Meanwhile, banking system liquiditycontinued to remain ample, as evidenced by thefinancing-deposit and loan-deposit ratios. Duringthe year, the banking system’s lending to theprivate sector, as reflected by loans outstandingand holdings of private debt securities, expandedat a faster pace of 9.4%, compared with depositsgrowth of 7.0%. While this resulted in a higherfinancing-deposit and loan-deposit ratio to 80.8%and 72.2% respectively, liquidity remained ampleto enable the banking institutions to undertaketheir lending activities.

FINANCIAL MARKET CONDITIONS

Apart from brief periods of corrections, thedomestic financial markets proved resilient in theface of global financial market turbulence. In part,the resilience reflected strong macroeconomicperformance, with sustained private sector-ledgrowth. Nevertheless, given that global financialmarkets have become increasingly integrated, thedomestic financial markets experienced larger andmore volatile episodes of capital flows whichcoincided with the swings in risk appetite of theglobal investors.

In addition to the strong domesticfundamentals, domestic sentiments strengthenedduring the year following the announcements ofseveral projects under the Ninth Malaysia Plan andthe economic corridors. Sentiments were furtherlifted by other initiatives including thetransformation program for the Government-linkedcompanies (GLCs) and the Government’s incentivepackage for the property market. The incentivepackage for the property sector included therelaxation of rules on foreign property purchases,the exemption of the real property gains tax andincreased commitment for a more efficient publicdelivery system such as a faster approval process.These measures were complemented by the furtherliberalisation of the capital account transactions.

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Interest Rate DevelopmentsWith the Overnight Policy Rate (OPR) held at3.50% throughout the year, changes in thedomestic money market and retail interest rateswere driven primarily by market factors.

Money market and depositrates were generally stable.Lending rates, however,softened due to strongcompetition between banks

Chart 2.19 Interbank Rates

Overnight 1 week 1 month

2004 2005 2006 2007

M J S D M J S D M J S D M J S D

3.50

3.51

3.54

2.50

2.70

2.90

3.10

3.30

3.50

3.70

3.90

%

In the money market, the average overnightinterest rate remained close to the OPRthroughout the year, trading in a tight rangebetween 3.48% and 3.51%. The interbank ratesof the one-week and one-month maturities werealso relatively stable, with spreads against theovernight rate narrowing as the year progressed.The narrowing spread between the varioustenures may be attributed to market participantsparing down their expectations of adjustment tothe OPR.

The lending rates of commercial banks onthe other hand, moderated in 2007. While thebase lending rate was unchanged at 6.72%, theaverage lending rate (ALR) on outstanding loanstrended lower by 28 basis points to 6.29% as atend-December 2007. Compared to 2006, morebanks had their ALRs in the 6-7% range, downfrom the 7-9% range, providing further evidenceof the downward trend in lending rates. Theaverage lending rates on new loans approvedalso trended lower. The declining trend inlending rates reflected the ample supply of

Chart 2.20 Commercial Banks' Lending Rates (at end-period)

2004 2005 2006 2007

M J S D M J S D M J S D M J S D5.805.906.006.106.206.306.406.506.606.706.80

BLR ALR

%

Chart 2.21 Range of Commercial Banks' ALR

3% - 4% 4% - 5% 5% - 6%

6% - 7% 7% - 8% 8% - 9%

0

5

10

15

20

25

2003 2004 2005 2006 2007

Number of banks, at end-year

2004 2005 2006 2007

M J S D M J S D M J S D M J S D4.5

5.0

5.5

6.0

6.5

7.0

Businesses t Total t

Households

%

Chart 2.22: Commercial Banks' ALR on New Loans Approved (6 months moving average)

t Trend in the ALR on new loans was adjusted to remove the one-off effect of a large loan approved in the transport, storage and communication sector

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loanable funds, leading to more aggressivecompetition amongst the banks.

Fixed Deposit (FD) rates softened slightly in2007. The adjustments in FD rates, however,were modest in comparison to the downtrend inlending rates. The FD rates of the 1 and 12month tenures are supported by the floor ratesimposed by Bank Negara Malaysia on retail fixeddeposits. As at end-December, FD rates betweenthe 1 and 12 months tenures were between3.08% and 3.70% respectively.

Bond MarketsThe performance of the bond market in 2007was driven by both global and domestic factors.Expectations regarding the movement of theringgit exchange rate and the anticipation ofchanges in monetary policy stance, together withglobal financial market developments influencedthe movements in yields. Consequently, the yearsaw large two-way capital flows in the bond

MaximumMinimum Mode

3.38

3.703.46

3.193.11

3.34

3.73

3.29

3.153.08 3.08

3.043.023.01

2.5

2.7

2.9

3.1

3.3

3.5

3.7

3.9

1 3 6 9 12

Dec 06

Dec 05

Dec 07

%

Month

Chart 2.23 Commercial Banks' Fixed Deposit Rates

12-month

3-month

M J S D M J S D M J S D M J S D

2004 2006 20072005

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0%

Chart 2.24Real Fixed Deposit Rates

Yields in the ringgit bondmarket were relatively morevolatile, affected by thedisorderly conditions in theglobal financial marketsincluding in the foreignexchange markets, andchanges in inflationaryexpectations

J F M A M J J A S O N D3.00

3.20

3.40

3.60

3.80

4.00

4.20

4.40

%

Chart 2.25Malaysian Government Securities Yields

MGS 1 MGS 3

MGS 5 MGS 10

Overnight Policy Rate (OPR)

Source: Bank Negara Malaysia

2007

Liberalisationannouncement

Expectations of astronger ringgit Global

bondmarketssell-off

US sub-primerelated equitymarket downturn

Higherinflationoutlook

market, leading to greater volatility in bondyields, especially in the MGS market.

The expectation of a stronger ringgitresulted in larger foreign accumulation ofringgit-denominated assets, including bonds.Large inflows into the bond market pushedyields downwards and caused the MGS yieldsup to the 10-year maturity to dip below theOPR level in April. The large inflows alsoresulted in the narrowing of the spreadsbetween the 10-year MGS and the shorter termsecurities. Similarly in regional economies, theyield curve in Korea, Singapore and Thailandalso flattened.

While the MGS bond market enjoyed apositive rally in the first half of 2007 andcorrespondingly a significant decline in yields,

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the dramatic change in global financial marketsled to reversals in the direction of the yields inthe second half of 2007. The sub-prime andcredit crisis caused a sell-off in the Malaysian andregional bond markets, pushing yields sharplyupwards. However, market sentiments improvedin August 2007 following the aggressiveresponse from the US Federal Reserve.Expectations of higher inflation pushed the bondyields to rise towards year-end as investors pricedin the possibility of a monetary policy response.The spreads between the 10-year MGS and theshorter and medium-term MGS widened andeventually led to the steepening of the MGSbenchmark yield curve in December.Nevertheless, as inflows continued to enter thebond market, the rise in yields moderated.

(117)(703)

68202457

(12795)(11610)

(4926)

744811739

6759

13202

6976

2007

Chart 2.26Net Portfolio Investment Flows into theCountry

(15,000)

(10,000)

(5,000)

-

5,000

10,000

15,000


RM million

Net PortfolioInvestment

Equity Securities Debt Securities

Source: Bank Negara Malaysia's Cash of Balance of Payments System

Chart 2.27Yield Spread (10-yr against 1-yr) for Selected Countries

2007

-0.200.000.200.400.600.801.001.201.401.601.80


%

Malaysia Thailand Singapore Korea

Source: Bloomberg

Source: Bloomberg

Chart 2.28Regional 5-year Government Securities Yield

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

6.50


%

5.00

6.00

7.00

8.00

9.00

10.00

11.00

(%)

Global bond markets sell-off

Malaysia 5-yr

2007

Thailand 5-yr

Korea 5-yr China 5-yr

Phillipines 5-yr (RHS) Indonesia 5-yr (RHS)

Chart 2.29MGS Benchmark Yield Curve 2007

*OPR: Overnight Policy RateSource: Bank Negara Malaysia

3.00

3.20

3.40

3.60

3.80

4.00

4.20

MG

S 1

MG

S 2

MG

S 3

MG

S 4

MG

S 5

MG

S 6

MG

S 7

MG

S 8

MG

S 9

MG

S 10

Maturity

%

OPR*

December 07

December 06

May 07

Chart 2.30Corporate Yield Spread Against MGS (3-year)

AAA A

0.00

0.50

1.00

1.50

2.00

2.50

3.00


2007

%Global bond

market sell-offSub-prime

crisis


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In the corporate bond market, yields generallymoved in tandem with the movement ofGovernment bond yields, especially for thehigher rated credits. However, during periods ofuncertainty, the lower-rated issues weresubjected to a slight widening in the spreads.

Equity MarketsThe benchmark Kuala Lumpur Composite Index(KLCI) started the year on a bullish note andcrossed the 1,300 level in April for the first time in13 years. The KLCI continued its upwardmomentum and achieved several new highs toreach 1,445.03 at year-end, recording a gain of31.8% in 2007. Nonetheless, the rise in the equitymarket was punctuated by a number of marketcorrections and temporary withdrawals byforeigners due to the repricing of risks arising fromglobal and regional developments such as theShanghai market correction in February, the globalbond markets sell-off in June and the heightenedglobal market uncertainty in August following theUS sub-prime loans fallout. The KLCI, however,rebounded quickly, buoyed by the strongfundamentals of the domestic economy, robustcorporate earnings and rising commodity prices.Positive sentiments arising from the Government’spro-growth policies and an increase in mergersand acquisitions activity also provided addedimpetus to the local equity market.

Despite bouts of volatility dueto global financialdevelopments, the KLCI wasresilient in 2007, gainingsupport from strongmacroeconomic fundamentalsand favourable corporateearnings

8090

100110120130140150160

Index

Source: Bloomberg

Chart 2.31Regional Indices

Malaysia

Indonesia

Thailand

Philippines

Singapore

D2006

J F M A M J J2007

A S O N D

Chart 2.32Volatility of Returns on the KLCI1

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

J M M J S D F A J S N J M J A O D M M J S N

Returns

2004 2005 2006 2007

1 Refers to the 30-day rolling standard deviation of daily returnsSource: Bank Negara Malaysia estimates

** From September 10, 2007, the Second Board and MESDAQ was replaced with Second Board and FTSE MESDAQSource: Bloomberg

Chart 2.33Bursa Malaysia Indices**

20072006

Index

80

90

100

110

120

130

140

FTSE Second Board

Second BoardKLCI

FTSE MESDAQ

D F M A M JJ J A S O N D

MESDAQ Market

During the year, the Second Board and theMESDAQ Market underperformed the MainBoard which is more liquid with higher qualitystocks. A confluence of positive factors pushedthe plantation sector to emerge as the bestperforming sector in the market, followed by theproperty and construction sectors. The plantationsector gained 87.4%, while the construction andproperty sectors recorded increases of 56.5% and

49.3% respectively in 2007. Market turnover rosesignificantly during the year with the averagedaily volume of shares traded rising by 93% to1,548 million units, while the value of turnovermore than doubled to RM2,346 million.

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Strong gains in the underlying stocks and thehigh CPO prices were key factors in driving theinterest in the derivatives market. Total annualtrading volume for derivatives (comprising KLCIfutures, crude palm oil futures, 3-month KLIBORfutures and MGS futures) in 2007 was 6.6million contracts or an increase of 57.8% (2006:4.2 million contracts).

The KLCI’s valuation at current price-earnings(P/E) multiple of 16.1 times as at end-2007 wasslightly higher than the historical 5-year monthlyaverage multiple P/E of 15.1 times. Meanwhile,the plantation and construction sectorsoutperformed the overall market on improvedearnings outlook and reratings by investors.

The KLCI began on a positive note in 2008,with stronger interest in the plantation stockshelping the market to reach an all-time high of1,516.2 on 11 January 2008. However,

J F M A M J J A S O N DD2006 2007

80

100

120

140

160

180

Chart 2.34Bursa Malaysia Sectoral Indices

Source: Bloomberg

KLCI Construction Finance

Industrials Plantations Property

Index

Chart 2.35Average Daily Turnover of Bursa Malaysia

0

500

1000

1500

2000

2500

747.5 716.9

2,345.7

873.7

2003 2004 2005 2006 2007

RM million

020040060080010001200140016001800

Million Units

Value (RHS) Volume (LHS)

Source: Bursa Malaysia

1,018.9

Chart 2.36Bursa Malaysia Derivatives: Total Monthly Volume and Month-end Open Interest

100

200

300

400

500

600

700

800

J F M A M J J A S O N D J F M A M J J A S O N D70

90

110

130

150

170

190

210

2006 2007

Open Position (RHS)

Contracts ('000) Contracts ('000)

Volume (LHS)


Chart 2.37Regional Comparison of Price-Earnings Ratios

End-2007End-2007

Source: Bloomberg, Bank Negara Malaysia estimatesSource: Bloomberg, Bank Negara Malaysia estimates

12-Month Average12-Month Average 5-Year Monthly Average5-Year Monthly Average

16.815.3 15.2

12.6

16.1

19.920.1

12.8

18.418.115.1

19.8

13.8

19.616.1

21.1

15.215.1

0

5

10

15

20

25

Malaysia Hong Kong Indonesia Singapore Taiwan Thailand

Ratio

Active trading in the KLCI and the crudepalm oil (CPO) futures led to the strongerperformance of the derivatives market in 2007.

Chart 2.38Bursa Malaysia Comparison of Sectoral Price-Earnings Ratios

Source: Bloomberg, Bank Negara Malaysia estimates

End-2007 12-Month Average

Ratio

16.119.4

15.1

45.7

26.629.4

15.214.9

34.5

27.227.2

16.1

05

101520253035404550

KLCI Index Construction Finance Plantation Property Industrial

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Annual Report 2007

following the corrections in global equitymarkets arising from concerns about the severityof the US economic slowdown, the KLCI closedlower at 1,357.4 at end-February 2008. Thelosses were, however, cushioned by thecontinuing rise in plantation stocks as crudepalm oil prices hit new peaks.

FINANCING OF THE ECONOMY

Financing activity expanded in 2007 providingstrong support to the domestic economy. Amidample liquidity and low borrowing costs, totalnet financing channeled to the economy,encompassing both the public and privatesectors, increased at a higher rate of 9.3%(2006: 6.1%). In terms of financing to the privatesector, there was higher demand for financing

Table 2.2Bursa Malaysia: Selected Indicators

2006 2007

Price Indices (Index):FBM30 7,059.9 9,343.7Composite 1,096.2 1,445.0FBMEMAS 7,169.6 -Second Board 92.0 -MESDAQ Market 119.9 -FTSE Second Board - 6,732.4FTSE MESDAQ - 6,109.2

Total Turnover:Volume (billion units) 197.5 360.4Value (RM billion) 250.6 540.2

Average Daily Turnover:Volume (million units) 802.9 1,584.4Value (RM million) 1,018.9 2,345.7

Market Capitalisation (RM billion) 848.7 1,106.2Market Capitalisation / GDP (%) 148.2 172.4

Total Number of Listed Companies: 1,027 987Main Board 649 636Second Board 250 227MESDAQ Market 128 124

Number of Companies Delisted:Main Board 21 48Second Board 8 13MESDAQ Market 1 2

Market Liquidity:Turnover Value / Average Market

Capitalisation (%) 33.3 52.2Turnover Volume / Number of Listed

Securities (%) 59.2 98.9

Market Concentration:*Market Capitalisation of 10 most Highly

Capitalised Stocks / Total MarketCapitalisation (%) 35.4 38.3

* Based on market transactions only


The robust growth of theeconomy was well supportedby ample financing from thefinancial system

from both the business and household sectors, tosupport investment and consumption activities.Increased corporate expansion activity, includingmergers and acquisitions and privatisations, andprogress on projects under the Ninth MalaysianPlan provided additional impetus to the growthof financing during the year.

Chart 2.39Gross Financing through Banking System and Capital Market

Gross PDS issued Equity issued

Loans disbursed to businesses

Annual growth (%)

Loans disbursed to Households

-5

0

5

10

15

20

9.2

5.9

9.2

-3.0

17.6

200250300350400450500550600650700

2003 2004 2005 2006 2007

RM billion

Gross financing growth (RHS)

Chart 2.40Financing raised via Islamic Instruments

20

0

40

60

80

100

120

Note: The number in brackets represent percentage share of Islamic financing to total gross financing raised from banking system and PDS market

Sukuk Islamic financing

RM billion

(16.8%)

(12.8%) (11.9%) (10.6%)

(9.1%)

2003 2004 2005 2006 2007

Of importance, the turmoil in the globalfinancial markets in the second half of 2007 hada limited impact on domestic financing activity.Bank financing activity continued to record a

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strong growth of 8.6% (2006: 6.3%) during theyear. While there was greater risk aversion forsecurities below the AA-rating, the bond marketremained vibrant, with several large issuancescontributing to the highest annual amount offunds raised to date, amounting to RM66.5billion (2006: RM30.7 billion).

The concerted efforts undertaken by BankNegara Malaysia in positioning Malaysia as theleading Islamic financial hub have yieldedpositive results. In 2007, issuances of Islamicsecurities rose by 161.2% to account for 62.7%of total PDS issued. Two of the largest issuancesin the corporate bond market, amounting toRM22.4 billion, were sukuk. Meanwhile, thedisbursements of Islamic financing increased at

Table 2.3Financing of the Economy

Business1

Total of which: SMEsHouseholds Government Total Financing

RM million

Net Change in Financing (2006)

Financial IntermediariesBanking Institutions 10,011 8,705 26,605 (1,669) 34,948Development Financial Institutions (DFIs)2 2,404 942 5,172 - 7,576Other Domestic Intermediaries3 2,302 (167) 314 - 2,616

Capital MarketBond Market4 13,485 - - 15,120 28,605Equity Market 1,916 - - - 1,916Venture Capital 721 - - - 721

External FinancingForeign Direct Investment 22,183 - - - 22,183External Loan5 8,387 - - (10,850) (2,463)

Total 61,409 9,481 32,091 2,601 96,100

Net Change in Financing (2007)

Financial IntermediariesBanking Institutions 24,376 9,491 27,169 (328) 51,217Development Financial Institutions (DFIs)2 3,326 877 6,126 - 9,452Other Domestic Intermediaries3 13,421 (218) 1,112 - 14,534

Capital MarketBond Market4 32,849 - - 24,780 57,629Equity Market 7,126 - - - 7,126Venture Capital - - - - -

External FinancingForeign Direct Investment 27,939 - - - 27,939External Loan5 2,178 - - (13,926) (11,749)

Total 111,215 10,150 34,407 10,526 156,1481 Business includes non-bank financial institutions, domestic non-business entities and foreign entities.2 Refers to DFIs governed under the Development Financial Institutions Act, 2002.3 Other domestic intermediaries include insurance companies, Employees Provident Fund (EPF), housing credit institutions, leasing and factoring companies and the Treasury

Housing Loan Division.4 Bond Market refers to outstanding private debt securities (PDS) and all Malaysian government securities.

PDS includes irredeemable convertible unsecured loan stocks (ICULS) and medium term notes (MTN) issued by the corporate sector.5 External financing of Government includes financing to non-financial public enterprises (NFPEs).

By financing type/institutions

By customer

a rapid pace of 22% in 2007 (+11% in 2006) toaccount for 11.6% of total loans disbursed bythe banking system.

Financing to the Business SectorIn 2007, the demand for financing by businesseswas underpinned by the sustained growth inbusiness and investment activity. Businessessupported their activities by acquiring a largeramount of financing from bank loans and thecapital market, as well as from internal funds.Although bank loans continued to account for asignificant share in the total financing tobusinesses (25.9%), the types and mechanismsof financing have gradually changed over theyears, amid the evolving nature of the economyand the financial system (see Box Article). In

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Annual Report 2007

essence, businesses are relying more on the banksfor short-term financing to fund their workingcapital, whilst using the bond market to securelonger term financing for capital investments.

New loan applications and approvals to thebusinesses registered strong growth rates of63.1% and 88.4% respectively (2006: 4.8% and8.7% respectively). Compared to 2006, loandisbursements turned around to register astronger growth of 9.9% (2006: -1.2%). Thebulk of the loans disbursed to businesses werefor the purpose of working capital (75.6% oftotal loans disbursed), with larger amount offunds channeled to the manufacturing (mainlydomestic-oriented industries), wholesale trade,and construction sectors – economic sectors

Chart 2.41Business* Sector Loan Indicators

Approvals (LHS)Applications (LHS)

0

50

100

150

200

250

300

0

50

100

150

200

250

300

350

400

450

Disbursements (RHS) Repayments (RHS)

* Businesses includes non-bank financial institutions, domestic non-business entities and foreign entities

RM billion RM billion

321.0350.6

374.4 369.8406.4

330.7348.7 365.8 351.7 370.1

121.4143.3 153.6 161.0

262.6

76.8 80.7 88.6 96.3

181.5

2003 2004 2005 2006 2007

Chart 2.42Business Loan Disbursements by Sector in 2007

Wholesale & retail trade,and restaurants &hotels 24%

Construction 8%

Finance, insurance and business services 11%

Others 8%

Total : RM 406.4 billion

Manufacturing 34%

Real estate 3%

Education, health & others 1%

Transport, storage & communication 8%

Electricity, gas & water supply 1%

Primary agriculture 3%

Mining and quarrying 0.5%

Chart 2.43Loan Disbursements to SMEs by Sector in 2007

Total : RM 141.5 billion

Wholesale & retail trade,and restaurants & hotels 28%

Others 11%

Manufacturing 30%

Construction 12%

Electricity, gas & water supply 0.3%

Mining and quarrying 0.4%

Finance, insurance, real estate & business activities 10%

Transport, storage & communication 3%

Individual business 1%

Education, health & others 2%

Primary agriculture 3%

that experienced stronger activity during theyear. Mergers and acquisitions activity in thefinance, insurance and business services sectorspurred higher loans to this sector, which wasalso reflected in loans extended for the purchaseof securities. A significant development duringthe year was the disbursement of a largesyndicated bridging loan by several banks tofinance the privatisation activity of a company.The loan, however was refinanced in December2007 via the private debt securities market.

The SMEs, meanwhile, continued to enjoygreater access to financing from the bankingsystem and the development financial institutions(DFIs), including financing under the SpecialFunds administered by Bank Negara Malaysia.Outstanding SME loans of the banking systemrose at a higher growth rate of 9.1% in 2007(2006: 5.1%) to account for 17.7% of totaloutstanding banking system loans. While thedistribution of funds remained broad-based, themanufacturing, wholesale and retail trade, andconstruction sectors accounted for the biggestshares of 30%, 28% and 12% of total loansdisbursed to SMEs respectively. The year 2007also marked the introduction of a new avenue offinancing for the SMEs. In May, Cagamas SMEBerhad issued an inaugural syntheticcollateralised loan obligation amounting toRM600 million, which was backed by a SME loanportfolio residing at a banking institution.

Financing via the bond market (excludingCagamas and issuance by non-residents) wasbuoyant in 2007, with gross funds raised rising

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Table 2.4Special Funds for SMEs administered by Bank Negara Malaysia

RM million %

Loans UtilisationType of fund Allocations Approvals Disbursements RepaymentsOutstanding Rate1

Undrawn2

As at end-2007

Fund For Food 1,300.0 1,730.4 1,706.5 1,366.3 340.2 133.1 1.4New Enterpreneurs Fund 2 2,850.0 3,436.6 3,203.1 807.1 2,396.0 120.6 6.8Fund for Small and Medium Industries 2 6,750.0 10,117.9 8,776.3 3,981.5 4,794.8 149.9 13.3Bumiputera Enterpreneurs Project Fund 300.0 760.3 656.2 584.9 71.3 253.4 13.7Rehabilitation Fund for Small Businesses 200.0 17.7 19.9 10.5 9.4 8.9 12.4Special Relief Guarantee Facility 500.0 471.9 - - - 94.4 100.0

Total 11,900.0 16,534.9 14,362.0 6,750.3 7,611.7 138.9 13.1

Change during the year

Fund For Food - 37.9 24.3 384.5 360.2New Enterpreneurs Fund 2 - 229.9 338.9 259.3 79.6Fund for Small and Medium Industries 2 - 2,297.7 1,717.3 1,721.7 4.4Bumiputera Enterpreneurs Project Fund - 160.4 139.5 130.9 8.5Rehabilitation Fund for Small Businesses - 0.5 4.2 4.9 0.7Special Relief Guarantee Facility 500.0 471.9 - - -

Total 500.0 3,121.5 2,224.3 2,501.4 277.21 Ratio of approvals over allocations.2 Ratio of approvals minus disbursements, over approvals.

Chart 2.45PDS by Sector in 2007: In Terms of Amount Issued (Excluding Cagamas and Issuance by Non-Resident)


Finance, Insurance,Real Estate and Business Services 38.0%

Transport, Storageand Communications32.3%

Electricity, Gas andWater 15.4% Construction 8.1%

Manufacturing 4.5%

Agriculture, Foresty and Fishing 0.5%

Wholesale, RetailTrade, Hotels andRestaurants 1.2%

significantly to RM66.5 billion (RM30.7 billionin 2006). Despite large redemptions during theyear, the net issuance of debt securities(excluding Cagamas and issuance by non-residents) was still higher at RM19 billion(2006: RM10.1 billion). The bulk of the PDSissued during the year were used for newinvestment activity (48%), the refinancing ofexisting debt (34%) and for mergers andacquisitions activity (12%).

During the year, there were several large PDSissuances with the longer maturity profiles beingused to fund the privatisation of a majortelecommunications firm as well as the acquisition ofan energy provider. The share of PDS with tenures ofmore than 10 years rose to 30% of total PDS issued(2006: 27%). In addition, the year also witnessedconsiderable progress in asset securitisation, asreflected by the higher issuance of asset-backedsecurities (ABS). A total of RM7.4 billion was raised in

Chart 2.44PDS Financing by Purpose (Excluding Cagamas and Issuance by Non-Resident)


New Activity Merger & Acquisition

Refinancing Others

Restructuring

RM million

2000 2001 2002 2003 2004 2005 2006 200719990

10,000

20,000

30,000

40,000

50,000

60,000

70,000

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Annual Report 2007

Chart 2.48Total Financing Raised via the Equity Market

Total IPO

Others (right issues, warrant, private placement & etc.)

4.0 4.05.3

1.52.5

3.82.5

1.0

0.4

4.6

0.01.02.03.04.05.06.07.08.09.0

2003 2004 2005 2006 2007

RM billion

Source: Bursa Malaysia, Bank Negara Malaysia estimates

Chart 2.49Initial Public Offerings by Sectors in 2007

Industrial Product(3%)

Construction(2%)

Technology (1%)

Finance (4%)

Source: Bursa Malaysia and Bank Negara Malaysia estimates

Plantation (41%)

Trading/services(17%)

Consumer Product (15%) REITs (17%)


Chart 2.47PDS Issues by Type of Instruments (ExcludingCagamas and issuance by Non-Resident)

Straight Bonds Convertible Bonds Islamic Bonds

Asset Backed Bonds Islamic MTN

0102030405060708090

100

2003 2004 2005 2006 2007

%

Conventional MTN

the capital market through the issuance of ABS(including residential mortgage-backed securities orRMBS). This accounted for 11.1% of funds raised inthe capital market.

Financing via the equity market, was alsosignificantly higher in 2007. Total funds raised

Chart 2.46PDS Issues by Tenure (Excluding Cagamas and Issuance by Non-Resident)


1 - 5 yrs 5.1 - 10 yrs

15.1 - 20 yrs 20.1yrs and above

10.1 - 15 yrs

0102030405060708090

100

2003 2004 2005 2006 2007

%

from the market increased to RM7.1 billion fromRM1.9 billion in 2006. New funds were mostlyraised through rights issues (61%), followed byinitial public offerings or IPOs (35%). Theplantation, trading and services and Real EstateInvestment Trusts (REITs) sectors raised the mostfunds through IPOs.

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The Evolution of Financing Sources for the Malaysian Economy

Since the early 1990s, amidst relatively strong and sustained growth, the Malaysian economy hasundergone significant structural change and has become more diversified. The financial system,which plays a pivotal role in facilitating and supporting economic growth, has also undergonesignificant transformation. Financial deepening, coupled with the changing sources of growth of theeconomy, has contributed to the changing structure of the sources, types and level of financing.

The financing ratio (total financing1 as a percentage to GDP) has steadily moderated since 2001,with financing growing at a slower pace compared with nominal GDP (see chart 2.50). This is a cleardivergence from the trend for most of the 1990s, when financing growth exceeded the growth ofGDP. The moderating trend in the ratio can be largely attributed to structural changes in the economy,with private consumption gaining prominence over private investment as the key growth driver. Sucha marked shift in growth patterns was evident when comparing the periods before and after the Asiancrisis. During the pre-crisis period (1990-1997), the economy was driven mainly by investment, with ahigher volume of financing for capital-intensive industries and large infrastructure projects. Loansextended to the business sector experienced a strong average annual growth of 30% over the period.With the sources of growth of the economy shifting from investment to consumption, especially since2001, the financing needs of the economy became less intense. In the post-crisis period (2001-2007),the corporate sector focused on de-leveraging and following the period of over investment, privateinvestment began to decelerate. Consequently, the financing profile of businesses also changed, withbusinesses mainly borrowing short term to meet working capital needs, reducing their long–term loansfor investment and relying more on the bond market, thus causing loans outstanding of the businesssector to advance at a slower pace. At the same time, the shift in bank financing to the householdsector resulted in a significant reduction in the average size of loans disbursed, mainly becausefinancing to households for the purchase of fixed assets and consumption durables were smallercompared to the amount required for investment outlays by businesses. The combination of thesefactors led to a decline in the financing intensity by the banking institutions.

1 Total financing comprises of two main components: (1) Domestic sources which consist of loans from the banking institutions, PDS, equitiesand loans from other domestic non-bank financial institutions (development financial institutions, Employee Provident Fund, insurancecompanies, leasing and factoring companies, the Treasury Housing Loan Division and Malaysia Building Society Berhad). (2) External sourceswhich consist of foreign direct investments as well as short and long-term borrowings from abroad.

Types of financing/GDP % yoy

Chart 2.50Financing Ratio of the Malaysian Economy, 1990-2007

0

50

100

150

200

250

300

350

400

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

e

-5

0

5

10

15

20

25

30

PDS outstanding

Other loans

FDI

% annual growth of total financing

Banking system loans

Private external debt

Equities

Public sector

% annual growth of nominal GDP

e EstimateSource: Bank Negara Malaysia calculations

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Annual Report 2007

The different sectors of the economy also exhibited varying degrees of financing intensity, which isdefined as the ratio of financing to sectoral output. The construction sector, which was one of theprimary drivers of economic growth during the pre-crisis period, was characterised by a high financingintensity, as more capital was needed for construction and large infrastructure projects. Themanufacturing and services sector, which became the biggest contributors to economic growth afterthe crisis, have lower financing requirements. The lower financing intensity in the manufacturingsector could be attributable to the large presence of MNCs, which rely more on internally generatedfunds for their operations. The services sector requires less financing for their investments given thatthe nature of their operations are less capital intensive. The shift in the sectors that drive economicgrowth thus is also a key factor accounting for the moderation in the financing to GDP ratio.

Although the financing to GDP ratio has moderated over the past several years, it has remainedat a relatively high level. A cross-country comparison indicated that at 189%, the ratio ofoutstanding banking system loans and private debt securities to GDP for Malaysia was relativelyhigh given its level of development, compared to some other regional countries (see chart 2.51).This was due to several factors. With regards to bank financing, Malaysia has a successful policy ofpromoting financial inclusion across regions and sectors. Households, for example, faced minimalconstraints in accessing bank financing. Even as early as the first half of the 1990s, lending forthe purchase of properties and cars had already accounted 20.4% of the total outstanding loansof the banking system (2007: 41.8% of total outstanding loans). An added impetus to thegrowth in household loans was that in the aftermath of the Asian crisis, the banking institutionsshifted their focus from the business sector to the financing of the household sector as part oftheir business diversification strategies. Combined with the Government’s policy of raising homeownership, which was manifested through various measures, household borrowing experiencedmarked growth in 2001-2005.

Chart 2.51Financing1 to GDP Ratio and PPP Adjusted per Capita Income: Country Comparison in 2007

PPP adjusted per capita income (USD)

Ratio (%)

1 Financing comprises of only banking system loans as well as private and public

bonds outstanding

Source: Based on Bank Negara Malaysia calculations; data from Asian Bonds Online, CEIC and World Economic Outlook databases.

0

50

100

150

200

250

300

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000

IndonesiaChina

Philippines

Thailand

Korea AustraliaHong Kong

SingaporeTaiwan

New Zealand

Malaysia

There were also significant changes in the sources of financing for the economy. In the lastdecade, the financial system in Malaysia has strengthened significantly and undergone significanttransformation thus creating a more diversified and deeper financial system. Of significance hasbeen the growing importance of the capital market in providing medium to long-term funding forcorporates. Bank Negara Malaysia, together with other agencies undertook various measures todevelop a strong market infrastructure and a comprehensive legal and regulatory framework tosupport the growth of the bond market. The Asian Development Bank, in June 2006, ranked theMalaysian debt securities market as the second largest in Asia after Japan. The share of financingthrough the issuance of PDS grew substantially from 5% of total financing in 1997 to 12% in

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2007 (see chart 2.52). Although the share of loans extended by the banking system relative tooverall financing declined from 43% to 35%, the banking system, nevertheless, remains animportant source of financing for the working capital of businesses as well as for fundinghousehold investment and consumption. Over the same period, the share of household loans tototal banking system loans increased from 33% to 56%. The role of other domesticintermediaries, namely the development financial institutions (DFIs), insurance companies andhousing credit institutions as alternative providers of financing has also become more important.These institutions complemented the banking institutions by providing financing to selectedsectors of the economy. More specialised institutions such as the DFIs have been increasing theirfinancing, especially to the SMEs. As a result, financing from DFIs has expanded strongly at anaverage annual growth rate of 33% over the last seven years, to account for a larger share of5.1% of total financing as at end-2007 (1.0% as at end-1997).

Chart 2.52Sources of Financing

Privateexternal

debt5%

Privateexternal

debt8%

Other loans9%

Other loans4% Public sector

15%Public sector

16%

Bankingsystem loans

43%

Bankingsystem loans

35%

Equities10% Equities

8%

FDI15%

FDI15%

PDS12%

PDS5%

% share of financing, 1997 % share of financing, 2007

A distinctive development in the financing of the economy has been the growing importance ofIslamic financing. Bank Negara Malaysia has implemented a range of measures to develop the Islamicfinance industry, which have yielded significant results. Over the period of 2001-2007, financing viaIslamic instruments expanded significantly at an average annual growth of 23% to support funding fornew growth areas and to serve as an alternative source of financing for the economy.

In recent years, new measures have been introduced to deepen and enhance the efficiency ofthe financial system. Among others, key measures include the liberalisation of foreign exchangeadministration rules to allow multilateral financial institutions and multinational corporations toissue both ringgit and non-ringgit denominated instruments in the capital market; the launch ofMalaysia International Islamic Financial Centre (MIFC) initiative; allowing locally incorporatedforeign banks to establish Islamic subsidiaries; and the introduction of web-based FullyAutomated System for Issuing/ Tendering (FAST). With these measures, the financial system willcontinue to evolve and become more effective in intermediating financial resources and risks, andsupporting the continued transformation of the Malaysian economy.

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76

Annual Report 2007

Financing to the Household SectorFinancing of the household sector has been amajor focus of growth by the banking institutions.Of the total increase in banking system loansoutstanding in 2007, 55.6% was to the householdsector. During the year, bank loans disbursed to thehousehold sector advanced by 12.6% (2006: -1%).The strong performance was largely attributed tostrong income growth of households, underpinnedby stable employment prospects and rising wages.Wealth effects from the robust performance of thestock market, coupled by Government incentivesas well as attractive and competitively priced loanproducts offered by banks were among thecontributing factors to household loans reachingtheir highest level since 2005.

Loan disbursements for the purchase ofresidential property rebounded strongly to growby 12.5% in 2007 (2006: -5.6%). Positiveoutlook for income and employment prospectsunderscored the strong increase in the demandfor residential property. This was furtheraugmented by various measures and initiativesintroduced by the Government and otherregulatory agencies to boost the residentialproperty sector. Following the announcement ofthe exemption of real property gains tax in March2007, financing for the purchase of residentialproperty rose steadily to register firmer growth inthe second half of 2007. The trend is expected tocontinue with the introduction of additionalmeasures such as the 50% exemption of stampduty on purchases of houses below RM250,000as well as the monthly withdrawal from EPFAccount II for the repayment of housing loanseffective January 2008. This contributed to thestrong growth in housing loan applications and

approvals at 43.8% and 27.3%, respectively, in2007 (2006: -7.2% and -11.5% respectively).

During the year, consumption credit expandedamid higher utilisation of credit cards and thedrawdown of personal loans. Nonetheless, therepayment ratio2 for credit cards remained high at58.4% (2006: 58.2%) reflecting the continueduse of credit cards as a means of payment ratherthan as a mode of financing.

Financing for the purchase of passenger carsturned around to register positive growth insecond half of the year. For the year as a whole,car loans declined at a slower pace of -0.2%(2006: -27.2%). The rebound in growth wasconsistent with the revival of the car marketfollowing the launches of new mass-market andfuel-efficient models. More importantly, the usedcar market has also begun to see more stableprices, which facilitated consumer decisions to selland replace their cars.

Despite the robust growth in financing, theoverall level of household indebtedness remainedat prudent levels. This was evident from thesubstantial improvement in the non-performingloans (NPL) ratio of households from 7.1% in2006 to 5.3% in 2007. In addition, the NPL ratiosfor outstanding loans for residential property,passenger cars and credit cards were lower at7.2%, 2.6% and 2.5% respectively (2006: 8.8%,4.2% and 3.7% respectively).

2 Repayment ratio = [(Total spending + cash advance) – outstandingbalance] / (Total spending + cash advance).

ApprovalsApplications

Chart 2.53Household Sector Loan Indicators

120.6 134.8 151.7 150.2 169.099.8 112.9 120.7 127.3 148.9

106.1

130.5

151.8139.8

194.9

76.092.8

103.992.0

117.1

0

50

100

150

200

250

2003 2004 2005 2006 2007

RM billion

RepaymentsDisbursements

2003 2004 2005 2006 2007-202468

101214

Purchase of residential property

Purchase of passenger cars

Purchase of securities

Credit cards

Total household loan disbursements growth

Others

Chart 2.54Banking System Loan Disbursements to Households:Total Growth and Contribution by Purpose

8.9

11.812.5

(1.0)

12.6

Annual growth (%)

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