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Implication of minimum wage regulation by Malaysia government starting May 2012 Recent announcement by Prime Minister, Datuk Seri

Najib Tun Razak regarding minimum wage on Labour Day (May 1) which is authorised under the National Wages Consultative Council Act of 2011 passed by parliament in July last year set RM900 per month minimum wage for workers in the peninsula and RM800 for Sabah and Sarawak. Because of the looming general elections, the announcement is likely to be construed as politically motivated, but there are also important economic consequences of a legislated minimum wage requirement. The minimum wage is likely to imply a significant 17% rise in the wages of unskilled workers, which according to Malaysia's Employers Federation 2010 Salary Survey, are earning an average RM852 a month. To put this in perspective, it compares with the average increase of wages in the manufacturing sector of only 6% per year. This poses an upside risk to inflation, in our view. First, overall labour productivity growth, which has been slowing in the last few years to an average of 2.7% (versus 5.3% pre-1998), is likely to substantially lag the potential increase in minimum wages, resulting in a rise in unit labour costs. Second, while one could argue that the legislation only affects a certain segment of the employed sector, in 2010 the share of private wage earners earning RM1,000 or below comprise nearly 50% of total employment, according to the Malaysian Institute of Economic Research. Given the significant share, this is also likely to affect wage negotiations among higher skilled workers, and could stoke higher wage expectations. As is common in other countries (e.g. Indonesia), minimum wages can be perceived as a wagesetting mechanism (which sets a floor to actual wages) rather than just a safety net for low-wage workers. Finally, given the current strength in domestic demand (indeed Bank Negara's annual report suggests that domestic demand will continue to be the anchor for growth,) firms are likely to pass on rising input costs, fueling CPI inflation. There are also longer-term concerns: Minimum wages could introduce rigidities into the labour market that may ultimately structurally raise unemployment rates. We think part of the reason Malaysian unemployment rates recovered quickly during the 2008/09 global financial crisis is that wage flexibility allowed downward adjustment in wages rather than employment losses during the downturn. Indeed, wages fell more sharply in 2008/09 than in the previous recession, and the unemployment rate recovered to precrisis levels more quickly and stayed there until now. The legislated minimum wages could reduce some of that flexibility. This could also hurt external competitiveness, which, as we have argued before, is facing some pressures that are not due to an appreciating real exchange rate. If a minimum wage of RM900 is set, Malaysia's labour costs will be nearly twice the regional average and will be the highest in South-East Asia except Singapore. Page 1 of 4

We understand that the Government is fully aware of these concerns and has pledged to address them by a broader set of structural reforms under Prime Minister Datuk Seri Najib Tun Razak 's New Economic Model and the 10th Malaysia Plan unveiled in 2010. The problem, however, is implementation has been slow so far and without more meaningful progress, these concerns will likely persist. One key argument of the proponents of the minimum wage is that this is supposed to complement these reforms by imposing a hard constraint on firms to improve productivity and reduce their reliance on low-skilled, low-wage foreign workers. The risk is the reforms lag the minimum wage implementation, and hence the argument fails to hold, while external competitiveness could suffer. The extent of the impact will still depend on the level of the minimum wage set, and the enforcement among firms. While the latter remains to be seen, for the former, we can draw on some findings from academic literature to gauge the optimal level of the minimum wage, i.e. whether it is high enough to improve living standards of wage workers but low enough to keep competitive pressures under control. A study by the World Bank suggests that a useful rule of thumb for developing economies is that the minimum wage at the national level should be no more than 40% of average wages. By this benchmark, a minimum wage set at RM900 for Malaysia seems appropriate on average, though there is considerable variation across sectors. For instance, it is around 41% of the current average in the manufacturing sector, but about 75% of the rubber sector. In terms of the near-term monetary policy implications, although headline inflation eased for the fourth consecutive month in February to 2.2% year-on-year from 2.7% in January, we see risks to our current policy rate forecast of a total 50 basis points cut in the second half of 2012. We think the risk of Bank Negara remaining on hold for the rest of 2012 has already increased given that in its recently released annual report, the central bank continued to assess that at the current level (3%) of the overnight policy rate, monetary conditions remain supportive of economic activity. Minimum wages implemented in May could provide additional upside risks to inflation, when fiscal policy is highly expansionary and commodity prices are elevated The implementation of minimum wage in Malaysia will eventually automate certain industries because employers will start finding alternative methods of production to reduce reliance on labour. Also, the higher wages will in turn support the move to transform Malaysia into a high-income nation. Industries that are highly reliant on low-cost labour will move away from their reliance on manpower to carry out these labour-intensive jobs, AMResearch director of economic research Manokaran Mottain told StarBizWeek. This is a good development economically, and employers will find more productive and efficient methods such as buying machines and automation to do the work and be less dependent on labour. This automates the supply chain promoting efficiency and productivity, he said.

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As a result, Malaysia would indirectly gradually reduce its reliance on foreign low-cost labour while moving to more efficient methods of production, consistent with the country's aspirations to eventually become a high-income nation, he added. Although this will in the short term incur higher labour costs for employers that are not paying the minimum wage yet, analysts opine that the move is positive for workers and are also expecting the affected companies to eventually pass down the additional costs to their customers. The potentially higher pay for these workers will benefit the Malaysian economy as a whole, as they will have more spending power, reducing the concentration of wealth on just a few people, thus ensuring stability of the country, another economist with a foreign research house said. I largely expect most if not all companies affected by this to eventually pass down these costs to the end-consumer, he added. Hong Leong Investment Bank Research said in a recent report the minimum wage policy would generate an additional disposable income of RM1bil, which could potentially translate into an additional 0.1% of gross domestic product (GDP) growth. In the near term, Hong Leong analyst Low Yee Huap said that the higher disposable incomes of the potential beneficiaries of 3.5 million workers were expected to help boost domestic demand. Maybank Investment Research, meanwhile, in a report said that the policy would have little impact on the companies under its coverage because they would be able to eventually pass on the extra cost. Our channel checks with companies under our research coverage reveal that the impact is either marginal' or nil', because industries/companies are able to pass on, or adjust to, any direct or indirect cost increases, Suhaimi Ilias, Ramesh Lankanathan and William Poh wrote in the report, referring to companies in the construction, property development, consumer, automotive sectors. They said the lowest salaries in these industries/companies were already above the minimum wage, mainly due to specific skills and demand-supply factors. For glove makers based in Malaysia, Maybank Research said they were eventually expected to pass on the higher incurred costs to their customers. The only sector that has a higher proportion of average wages below the minimum wage is the glove industry. It employs 2,500-5,000 workers at around RM700 per month average wage, they said. The impact from the minimum wage implementation is an estimated RM6mil-RM12mil per year, or 5%-10%, on the bottom line. But, as this is an industry-wide cost inflation, and given that the implementation of the minimum wage is not immediate, the industry should be able to pass on the higher costs, they added. The minimum wage policy is also not expected to impact Malaysia's competitiveness much as a growing number of countries in the region have also recently raised their minimum wage rates as well.Hong Leong's Low said some countries, especially China and Thailand, had recently raised their minimum wage levels aggressively.

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For instance, Malaysia's minimum wage level will be only slightly higher than Thailand's after the latest minimum wage hike. China has also recently raised its minimum wage in coastal cities to 1,450 yuan (RM703) per month, he added. With minimum wage enforced, employers may hire less or increase the prices of goods and services, according to a recent survey conducted by major local recruitment agency Jobstreet. Southeast Asias top online job search firm said 44 per cent of 1,520 employers it surveyed last month said they disagreed with Putrajayas move, edging out the 33 per cent who agreed. The remaining 23 per cent wanted the status quo kept. When asked if their company will hire less, lay-off or retrench its workers, it appeared to be a split decision. Forty-three per cent said they may do so while another 42 per cent said they would not, Jobstreet said in a media statement today. Employers also felt the pressure to increase pay for the higher-level skilled workers as 65 per cent believed that their employees would demand for a pay rise as well, it pointed out.It noted that the majority, 78 per cent, believed that their companies are already paying a fair wage to the lower income group. Citing employers, Jobstreet said 47 per cent said they predicted their companies would be forced to pass on the cost of hiking up wages to consumers nearly twice the number of employers, 26 per cent, who said they would not raise prices.The recruitment firm noted that the remaining 27 per cent were unsure of the decision. Jobstreet said over a third of employers polled, 35 per cent, said the wage floor should be kept below RM900, compared to 27 per cent who felt that RM900 RM1,100 is ideal and 15 per cent who found RM1,100 and above agreeable.Concerns about the effects of the minimum wage also come at a time when the country is poised to be hit by the ripples from its main trading partners and the global economy at large. Analysts have warned Malaysia to brace for a significant slowdown here due to rising linkages with top trade partners including China, the worlds second-largest market, which economists say is headed for a sixth consecutive quarterly drop in growth with worse to come. A Greek exit from the euro zone, which is growing threat, would cause a second recession in as little as four years in Malaysia as the knock-on damage to Europe poses a threat to the global economy, Bloomberg reported analysts and economists previously said. The World Bank also urged Malaysia last week to expedite reforms such as subsidy cuts and broadening the tax base, key initiatives that have stalled ahead of an impending federal election, if it wants to achieve Putrajayas target of being a high-income economy by 2020. Malaysia reported a 4.7 per cent GDP growth for the first three months of the year, a third consecutive quarterly drop since it posted a 7.2 per cent increase in Q2 2011

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