This first OECD Investment Policy Review of Malaysia presents an assessment of the investment climate in Malaysia, including the institutional and legislative framework for investment. Undertaken in partnership with the Secretariat of the Association of Southeast Asian Nations (ASEAN) it illustrates the growing ties between the OECD and Malaysia, and Southeast Asia as a region.

Malaysia is an open economy with trade accounting 174.3% of the GDP in 2012. As a result Malaysia is highly-exposed to developments in the global economy. Given the current global scenario, strengthening domestic demand would continue to be the key focus in driving growth.

Malaysia’s economic performance during the last half century has been impressive. From an agricultural economy in the 1950s, the country has now built global competitiveness in high-end manufacturing and is pushing out its technology frontier, an immediate goal of its national vision. This performance is the result of a sustained commitment to improving the business climate. Malaysia is attracting record levels of foreign investment and its companies are becoming increasingly global. The country is also shaping the regional dialogue on numerous policy fronts, from corporate governance to science and technology. These have brought Malaysia closer to the OECD policy community, with co-operation progressing beyond investment policy to areas such as competition, anti-corruption, regulatory reform, global value chains and innovation.

Malaysia stands out as one of the economic success stories in Asia over the past few decades. From a plantation economy at the time of independence, with rubber and tin representing one half of GDP, Malaysia has become a diversified, open economy. Poverty, which was widespread at the time, is now virtually eradicated, except in certain pockets of the country. GDP per capita is now seven times as high as it was in 1980 (in purchasing power terms) and Malaysia has become one of the countries the most integrated into the global economy through trade. The distribution of income among ethnic groups has also improved dramatically since the 1960s. Malaysia is now the second richest economy within the Association of Southeast Asian Nations (ASEAN) after Singapore.

This review assesses the investment climate in Malaysia, including both the institutional and legislative framework for investment and also a broad range of policies in other areas. It documents the reforms implemented by successive government administrations to improve the investment climate, describes the remaining challenges faced by Malaysia in moving towards becoming a high-income economy and discusses what further measures might help to revive both foreign and domestic investment. A good investment climate concerns more than just the rules and regulations faced by investors; it results from complementary policies across almost all of government. Equally importantly, a good investment climate is not static; it requires that governments and firms become more nimble in order to respond to new challenges and opportunities as they arise.

Malaysia was an early mover in export-led development based on multinational enterprises. Until the Asian financial crisis in 1997, it was a leading destination for FDI, particularly in the electronics sector. Its performance since then has deteriorated, and its share of total ASEAN FDI has fallen steadily over time. At the same time, established investors from many different countries and regions are continuing to reinvest. Malaysian firms, particularly government-linked companies, are also becoming major outward investors, and Malaysia is now a net outward investor on an annual basis.

Malaysia was one of the first emerging economies to welcome foreign investment in export-oriented manufacturing sectors beginning in the late 1980s. Foreign investors in domestic-oriented projects or providing services through local affiliates, on the other hand, traditionally faced numerous restrictions on their activities, notably on the maximum share of foreign equity.This dualistic approach to regulating foreign investment began to change following the Asian financial crisis in 1997. First, the export obligation tied to full foreign ownership was dropped for manufacturing projects. Then, starting in 2003, the government began to liberalise restrictions in the banking and insurance sectors. This was followed in 2009 by the deregulation of the Guidelines of the Foreign Investment Committee which had previously constrained foreign takeovers of Malaysian companies. At the same time, the government announced the liberalisation of 27 service sub-sectors, followed by another 18 sub-sectors announced in 2011.The result has been a substantial liberalisation of policies covering foreign investment, particularly over the past decade. Malaysia is now relatively open by the standards of emerging economies in Asia according to the OECD FDI Regulatory Restrictiveness Index, but still maintains far more restrictions than found on average in OECD member countries. Many of these remaining obstacles are in service sectors which play a key role in the overall competitiveness of the economy, including in manufacturing sectors. Further reforms of restrictions in these sectors could provide the needed impetus to revive private investment and propel Malaysia on a path to developed country status by 2020.

Strong protection of land ownership and intellectual property, effective compensation for expropriation, dispute settlement mechanisms accessible to all investors, and a protective network of international investment agreements are the building blocks of Malaysia’s efforts to improve the quality of its investment environment. Malaysia has gradually moved towards an enabling regulatory framework for investors and more effective investors’ rights. It has also made continuous efforts to improve the land ownership registration system. The electronic system has shortened registration times for land titles and transfers and has made formal recognition of land rights easier, but there remains a lingering problem of fraud of titles.The country is endowed with an enabling legal framework for the protection and promotion of intellectual property (IP) rights and has ratified the main IP-related conventions, bringing itself in line with international standards. As a complement to the legal framework, the government has made concerted efforts to ensure that the protection of IP rights is effectively implemented, through the establishment of specialised IP courts as well as various awareness programmes.Investors are also fairly well protected in the event of expropriation. Protection against illegal expropriation is soundly provided for both at a domestic level and in Malaysia’s investment treaties. The country’s standards of compensation for expropriation are consistent with international best practices.Malaysia has reformed its judiciary in order better to meet the needs of business. With the recent creation of commercial courts and the modernisation of the caseload management system, the government aims to address the lengthy and complex procedures for enforcing contracts. In parallel, Malaysia has actively and successfully promoted alternative dispute settlement (ADR) mechanisms through mediation, conciliation and arbitration. Kuala Lumpur has been promoted as a venue for arbitration, and Malaysia, which has enacted a fine-tuned Arbitration law, is now regarded as one of the top promoters of ADR in the region.Malaysia’s legal framework for FDI comprises a web of investment agreements, including an extensive network of bilateral investment treaties, broad preferential trade and investment agreements and its membership of ASEAN. Malaysia has not yet developed a consistent approach in its agreements but is clearly moving over time towards sounder investment protection and liberalisation. In a number of respects, Malaysia’s treaty programme is at the forefront of very innovative practices. It contains detailed investor-state dispute settlement provisions and commits Malaysia to consent to arbitration in the main international arbitration fora.

Within an overarching strategy for improving the investment environment, investment promotion and facilitation can help to increase both domestic and foreign investment and to enhance their contribution to national economic development. Success in promoting investment requires a careful calculation of how to employ resources most effectively and how to organise investment promotion activities within the government so that the overriding goal of economic development through improvements in the investment climate remains at the forefront of policymaking. Investment promotion and facilitation measures, including incentives, can be effective instruments to attract investments provided they aim to correct for market failures and are developed in a way that can leverage the strengths of a country’s investment environment. This chapter describes the various steps Malaysia has taken to reduce red tape and integrate the role of business in its development strategies. Particular attention is paid to dedicated measures to improve government efficiency for business, as well as to its investment promotion efforts and how they have become a global reference. The analysis draws out some lessons learned from Malaysia’s experience with industrial clusters and business linkages, which are at the core of the Malaysia’s private sector development strategy. Malaysia’s challenge in achieving Vision 2020 also entails addressing a skills-mismatch to meet the demands of a high-end technology and knowledge based economy, and this chapter highlights some areas for improvement in this regard.

The degree to which corporations observe basic principles of sound corporate governance helps to determine investment decisions, influencing the confidence of investors, the cost of capital, the overall functioning of financial markets and ultimately the development of more sustainable sources of financing. Malaysia has taken significant steps to strengthen its corporate governance framework, especially after the Asian financial crisis. This chapter analyses some of the government’s far-reaching reforms ranging from strengthening minority shareholder rights to enhanced enforcement measures. The role of government-linked companies (GLCs) and the associated GLC Transformation Programme as part of the government’s overall drive to increase competition and opportunities for private investment is also addressed. Given the recent momentum of corporate governance reforms, Malaysia and its private sector could now benefit from consolidation of the various initiatives.

Public policies promoting recognised concepts and principles for responsible business conduct (RBC), such as those recommended in the OECD Guidelines for Multinational Enterprises, help attract investments that contribute to sustainable development. Such policies include: providing an enabling environment which clearly defines respective roles of government and business; promoting dialogue on norms for business conduct; supporting private initiatives for RBC; and participating in international co-operation in support of responsible business conduct.The government of Malaysia’s efforts to promote RBC can be seen as part of the overall corporate governance reforms over the past decade. While the RBC culture is relatively new in Malaysia, recent measures, such as high-level endorsement of RBC initiatives, and the emergence of new non-governmental advocates play an important role. This chapter looks at these efforts and recommends ways of driving Malaysia’s RBC agenda forward, including by adhering to internationally recognised principles, such as the OECD Guidelines for Multinational Enterprises.

Developed financial sectors provide payment services, mobilise savings, and allocate financing to firms wishing to invest. When they work well, they give firms the ability to seize promising investment opportunities, especially small and innovative enterprises and entrepreneurs that need external funding to expand and develop their business ideas. Well-functioning financial markets also impose discipline on firms to perform, boosting efficiency, both directly and by facilitating new entry into product markets. They also enable firms and households to better manage risks.Malaysia has one of the most developed financial systems among ASEAN countries. Broad-based reforms undertaken following the Asian financial crisis have improved the size, depth and soundness of the financial sector. As a result of reforms Malaysia has become the world’s most important Islamic financial centre. Malaysia is moving away from a bank-dominated financial system and towards a more sophisticated and diversified financial sector. This chapter describes the measures implemented to strengthen the banking sector and further develop Malaysia’s capital markets, and briefly draws on data and comparisons with other Asian countries to highlight developments or challenges ahead. Malaysia could push for policies that promote further regional and international financial integration and further enlarge the capabilities of its financial sector in order better to address the challenges of making the transition to a high-value added, high-income economy by 2020.

Malaysia has good quality infrastructure and its population enjoys good access to basic services such as electricity and water. Infrastructure is a core part of government’s development policies and the bedrock of the economy, with the government allocating more funding to infrastructure than to any other sectors in each of its national development plans since 1966. The private sector has also played an active role in developing Malaysia’s infrastructure, providing USD 54 billion in investment between 1990 and 2011. Private investment has increased over time, thanks in part to the government’s efforts to liberalise the telecommunications, transport and electricity sectors. In the water sector, a major restructuring took place in 2006, leading to a smaller role for the private sector in financing projects. Moving forward, the government needs to find ways to bring the quality of infrastructure in Sabah and Sarawak up to par with that in Peninsular Malaysia. Moreover, the tendering process can be strengthened by reviewing the process of unsolicited bids and direct contract negotiation. The mismanagement of certain projects suggests that better upstream planning and project supervision is needed to improve efficiency. Given the expected increase in the urban population and rising demand for all infrastructure services, a concerted effort is needed to attract additional investment in the infrastructure sub-sectors and propel Malaysia into a modern and developed country.

Malaysia has placed increasing emphasis on pursuing a sustainable growth path, acknowledging that a “growth first, environment later” approach is no longer feasible. It leads the ASEAN region on environmental performance measures and the government has resolved to become a leader in the global green revolution. An array of policies and legislation has been put in place, including a National Policy on Climate Change, a Green Technology Policy and a Renewable Energy Policy and Action Plan. The government has also created dedicated funds to catalyse private investment in renewable energy, green buildings and low-carbon transport. In addition, the government offers financial incentives for investment in green sectors, such as import duty exemptions for solar PV equipment. In 2011, a feed-in tariff was introduced for various sources of renewable energy, complemented by power-purchase agreements, which led to strong interest from power producers and an increase in installed renewable energy capacity. Some challenges remain and must be addressed if Malaysia is to surge ahead with its environmental initiatives and attract additional private investment for its green sectors. Malaysia remains dependent on fossil fuels and fossil fuel subsidies are still in place, despite previous efforts to eliminate them. There is significant potential for renewable energy generation from biomass, solar power and hydro power but investor interest has been disproportionately skewed towards solar, at the expense of other energy sources. Also, more efforts are needed to attract the support of local financial institutions for funding green projects. Addressing these gaps can help make Malaysia a more attractive destination for green investment.