The world economic outlook and implications for Malaysia

Abstract

The world economy is experiencing one of its most volatile and challenging periods in this century. Global financial markets have seen unprecedented turbulence, and investor confidence has been shaken not only in emerging markets, but also in advanced economies. Japan, the region's largest and the world's second largest economy, continues to be weighed down by overcapacity and a mountain of bad bank debt. As a small, open economy that has thrived on international trade and investment over the past decade, Malaysia inevitably has been impacted by the regional turmoil and worsening global outlook. Looking ahead, the world economy and global financial markets will continue to define some of the key policy challenges for Malaysia. This paper has four objectives. First, it provides an overview of the IMF World Economic Outlook (WEO). Second, it identifies key risks to the baseline WEO scenario. Third, the potential impact of these risks on the Malaysian economy and their implications for macro-economic policy are discussed. Here, the objective is to evaluate the capacity of the current policy arrangements, and the exchange rate regime in particular, to absorb external financial and demand shocks. Specifically, does the peg to the dollar deliver the intended insulation from external shocks? Finally, the current macroeconomic policy mix and structural reform strategy in Malaysia are assessed. The Asian financial crisis has raised profound questions on the efficiency of markets, the behavior of domestic and foreign investors, and the design of reform programs. A detailed treatment of these topics is beyond the scope of this paper, but some comments will be offered.