Malaysia must upgrade economy to escape middle-income trap: Fitch Solutions

MALAYSIA'S average real gross domestic product (GDP) is likely to slow to just 3.4 per cent over the coming decade, and it should upgrade its economy so it can escape the middle-income trap.

That's according to Fitch Solutions, which said in a recent report that the South-east Asian country has exhausted its avenues of growth provided by lower-level industrialisation.

At the same time, extended political uncertainty during Malaysia's transition away from a one-party rule will likely lead to stalling - even backsliding - reform momentum, the research team wrote in a commentary.

Combined with less favourable demographics and reduced fiscal space to cushion against negative shocks to the economy, these factors together spell a "much lower growth rate" in the coming decade, Fitch added.

It forecast real GDP to grow at an average of 3.4 per cent over the next 10 years - dragged by the likely contraction this year due to the coronavirus pandemic - which is a slower pace than the average growth of 6.4 per cent in the past decade.

Malaysia is likely to put off key political reforms that could unlock further growth potential, according to Fitch.

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For instance, affirmative action policies favouring the ethnic Malay population (Bumiputra) is expected to continue to cause a "brain drain", whereby talented non-Malay individuals seek opportunities overseas.

Talent is key to the country being able to move up the value chain and escape the middle-income trap, the research team said.

The middle-income trap is a type of growth slowdown, whereby an economy that was previously rapidly growing now stagnates at middle-income levels, and fails to graduate into a high-income country.

Fitch noted that if Malaysia's "brain drain" is left unaddressed, that will "impede any such drive to upgrade the economy".

Also, the political uncertainty is expected to hinder investor interest. Fitch believes the political landscape will stay fluid and uncertain for much of the next decade, after the long-ruling Barisan Nasional coalition in 2018 experienced its first election defeat.

While a successful transition to a more stable multi-party or two-party system could eventually reap dividends for Malaysia, the uncertainty in the interim is likely to be a negative factor counted against it by potential investors, it added.

This is "inopportune", as business and countries are accelerating plans to move at least part of their operations outside China to build more diversified and resilient supply chains amid the US-China trade war and the Covid-19 pandemic.

"Malaysia would essentially be starting on the back foot against regional competitors, especially Vietnam, in the race to attract foreign direct investment," the research team noted.

Moreover, the shift to populism could lead to a worsening business environment over time as more protectionist measures are implemented, Fitch wrote. The PH government had mandated hikes to the minimum wage and sought to penalise the hiring of foreign workers, for example.

In terms of the nation's demographics, Fitch forecast the active population growth to slow to an average of 1 per cent over the next decade, compared to 2.3 per cent in the last 10 years. "Holding all other factors constant, this should result in slower real GDP growth over the coming decade," it added.

Malaysia is also in the process of an external economic rebalancing, as it moves away from export-driven growth and towards domestic private consumption.

While this will drag on overall headline real GDP growth, it will also support consumption, said Fitch. Private consumption growth is thus likely to outperform, creating investment opportunities catering to the domestic middle class rather than overseas demand.