Sabah Economic Outlook 2024-2025

73 Figure 5.3 also illustrates the forecast model from 1992 to 2025. The forecast model evaluation criteria reveal that the coefficient of determination is 95%, explaining the original shares of the mining and quarrying to Sabah's GDP. Table 5.3 shows Sabah's mining and quarrying sector share of GDP with the forecast growth from 2022 to 2025. The four-year forecast data is an average of RM23,384 million shares of GDP. The model's forecast revealed that the shares of mining and quarrying to GDP will keep increasing in the forecast period. However, the mining and quarrying growth in Sabah is increasing at a decreasing percentage growth rate year-on-year. Like other sectors, mining and quarrying will have the risk of stagnant growth in 2024, giving an impression of less difference from 2023. Table 5.3: Sabah's Mining and Quarrying Sector Share of GDP and Forecast Year Sabah's Mining and Quarrying Share of GDP (RM Million) Forecast (RM Million) Percentage Growth (year-on-year) 2021 20,420 20,031 2.43% 2022 - 22,170 8.57%f 2023 - 23,315 5.16%f 2024 - 23,429 0.49%f 2025 - 24,624 5.10%f Note: Authors' calculations. f is the percentage growth year-on-year based on the forecasted values. Table 5.1 shows the regression results of ordinary least squares estimations on all important economic activity in Sabah's GDP. The result is quite revealing in several ways. Six of the proposed models for mining and quarrying significantly contribute to Sabah's GDP at a 99% confidence interval. Model 1 predicts that the magnitude change of mining and quarrying has a significantly positive relationship with Sabah's GDP. Every 1% increase in shares of mining and quarrying will significantly increase 0.939% of Sabah's GDP. 5.3 MANUFACTURING The manufacturing sector in Malaysia accelerated by 9.5 per cent in 2021 from a negative growth of 2.7 per cent in 2020 due to the COVID-19 pandemic. The positive growth among the sectors was followed by the services and mining and quarrying sectors, which managed to record positive growth of 1.9 per cent and 0.3 per cent in 2021, respectively. The manufacturing sector has contributed about 24.3 per cent to the national GDP, which amounted to RM337.2 billion. The biggest contributor was the services sector, which amounted to RM791.1 billion, equivalent to 57.0 per cent of the national GDP in 2021. However, in the case of Sabah, the manufacturing sector has contributed only 7.5 per cent of the total share of Sabah's GDP, which is driven by four sub-sectors, namely (1) Oils and fats from vegetables and animals and processed foods, beverages, and tobacco products, (2) Wood products, furniture, paper products and printing, (3) Non-metallic mineral products, basic metals, and manufactured metal products, and (4) Transportation equipment, other Manufacturing and repair.

74 Table 5.4: Correlation Matrix between Manufacturing, GDP, and Other Sectors in Sabah, from 1992 – 2021 Table 5.4 shows the correlation matrix results between GDP and five main sectors in Sabah from 1992 to 2021. The overall results indicate that all five main sectors positively correlate with GDP in Sabah. The correlation coefficient of 0.9923 shows that the relationship between Manufacturing and GDP in Sabah can be considered strong and positive. Based on the results of the correlation matrix shown in Table 5.4, the highest coefficient was generated between GDP and the services sector (0.9951), followed by the manufacturing sector. The finding of this correlation also can be supported by the scatter plot shown in Figure 5.4. The data trend depicts the bivariate evidence suggesting a strong positive relationship between the manufacturing sector and GDP. In this case, the correlation matrix predicts that changes in the manufacturing sector will give the same direction of changes by 99.23% in GDP for Sabah. Figure 5.4: Scatter plots of GDP and Manufacturing Sector in Sabah GDP Agriculture Mining & Quarrying Manufacturing Constructions Services GDP 1.0000 Agriculture 0.9323 1.0000 Mining & Quarrying 0.9823 0.8679 1.0000 Manufacturing 0.9923 0.9467 0.9667 1.0000 Constructions 0.9741 0.8845 0.9690 0.9767 1.0000 Services 0.9951 0.9193 0.9788 0.9855 0.9728 1.0000 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 0 10,000 30,000 50,000 70,000 90,000 GDP M anufacturing R=0.9923 RM Million RM Million

75 Figure 5.5: Share of GDP by Manufacturing Sector and Forecast, 1992 - 2025 Figure 5.5 and Table 5.5 show the forecasted trends of Manufacturing. The result revealed that about 95 per cent accuracy of the forecasted values is in line with the original series of the manufacturing sector from 1992 to 2021. The original series of this sector shows a consistently increasing trend until it reached the highest amount in 2018, which managed to earn RM6,514 million. This sector's achievement was influenced by four sub-sectors, where sectors of oils and fats from vegetables and animals and processed foods, beverages, and tobacco products contributed 71.4 per cent of total Manufacturing in 2018, followed by other sub-sectors such as wood products, furniture, paper products and printing (10.7 per cent), non-metallic mineral products, basic metals, and manufactured metal products (10.3 per cent) and transportation equipment, other manufacturing and repair (7.6 per cent). 0 2,000 4,000 6,000 8,000 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 Share of GDP by Manufacturing Sector Forecast Maximum Limit Minimum Limit (RM Million) 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 0 1,000 3,000 5,000 7,000 R²=0.95 Y=53.98+0.98X Share of G D P by M anufacturing S ector Forecast -1,000 -500 0 500 1,000 1,500 1995 2000 2005 2010 2015 2020 Forecast Errors

76 Table 5.5: Percentage Share of GDP Growth and Forecast for the Manufacturing Sector. RM Million (% Growth, year-on-year) Share of GDP by Kind of Economic Activity 2021 2022f 2023f 2024f 2025f Agriculture 12,492 13,012 (4.16%) 14,214 (9.24%) 14,268 (0.38%) 15,264 (6.97%) Construction 2,370 2,505 (5.70%) 2,714 (8.33%) 2,771 (2.12%) 2,841 (2.51%) Manufacturing 5,934 6,282 (5.87%) 6,681 (6.35%) 6,683 (0.03%) 7,033 (5.22%) Mining and Quarrying 20,420 22,170 (8.57%) 23,315 (5.16%) 23,429 (0.49%) 24,624 (5.10%) Services 37,215 39,156 (5.21%) 40,365 (3.09%) 41,211 (2.10%) 43,738 (6.12%) Note: The value in the parentheses is the percentage growth based on the year-on-year forecast. f indicates the forecast values proposed by the methodology sections. More importantly, the forecasted values of Manufacturing's growth for 2022 and 2023 steadily increase from 5.87 per cent to 6.35 per cent. Nonetheless, the concern here is more to the forecasted growth of this sector from 2023 to 2024, which it predicts to fall to 0.03 per cent and increase back in 2025 by 5.22 per cent. This scenario can be related to a fall in the global output 2023 by 2.8 per cent predicted by the IMF and World Bank in 2023. Based on Figure 5.6, the trends of employed person for manufacturing from 2018 to 2021 shows fluctuating trend. It can also be one indicator signalling the manufacturing sector's fluctuating movement for the upcoming four years (2022 to 2025). Figure 5.6: Annual Percentage Change of Employed Persons for Manufacturing in Sabah, 2018 – 2021 2.7 16.6 8.2 14.1 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 2018 2019 2020 2021 Percentage Change (%)

77 5.3.1 Manufacturing and its sub-sectors. In 2021, Sabah's manufacturing sector was facing a fall in the growth by 1.8 per cent, which is in line with a negative growth of its most crucial sub-sector, oils and fats from vegetables and animals and processed foods, beverages, and tobacco products by 8.1 per cent. It indicates that any changes in this sub-sector will lead to the same changes in the whole manufacturing sector in Sabah. Interestingly, the other three remaining sub-sectors achieved positive growth, where the highest growth, stated 24.8 per cent, came from sectors of wood products, furniture, paper products, and printing. This situation can be supported by the results from the correlation matrix and annual percentage of Manufacturing and its sub-sectors below. Table 5.6: Correlation Matrix for Manufacturing and its Sub-sectors in Sabah, 2015 – 2021 Sub sectors Coefficient 1) Oils and fats from vegetables & animals and processed foods, beverages, and tobacco products 0.9299 2) Wood products, furniture, paper products, and printing 0.0819 3) Non-metallic mineral products, basic metals, and manufactured metal products 0.3850 4) Transportation equipment, other Manufacturing, and repair -0.1299 Table 5.6 and Figure 5.8 present the correlation matrix and scatter plot to reveal the correlation between Manufacturing and its sub-sectors in Sabah. Based on both table and figure, the value of coefficients demonstrates that sub-sectors of oils and fats from vegetables and animals and processed foods, beverages, and tobacco products recorded the highest positive coefficient (0.9299), followed by non-metallic mineral products, basic metals, and manufactured metal products (0.3850) and wood products, furniture, paper products and printing (0.0819). Meanwhile, the sub-sectors of transportation equipment, other Manufacturing, and repair show the opposite correlation with the changes in Manufacturing (-0.1299). These findings conclude that there is a strong positive correlation between Manufacturing and sub-sectors of oils and fats from vegetables & animals and processed foods, beverages, and tobacco products, a weak positive relationship with both sub-sectors of non-metallic mineral products, basic metals, and manufactured metal products and sub-sectors of wood products, furniture, paper products, and printing, while a weak and negative relationship for sub-sectors of transportation equipment, other Manufacturing, and repair. Figure 5.7 shows the annual percentage change of Manufacturing and its subsectors to support the findings generated by correlation matrix and scatter plots. Based on the figure, from 2016 to 2021, positive and negative growth of total Manufacturing was followed by the same direction of growth by sub-sectors oils and fats from vegetables & animals and processed foods, beverages, and tobacco products. These trends align with the coefficient of the correlation matrix, which suggests that any changes in these sub-sectors will give the same direction of change in Manufacturing by 92.99 per cent. However, in the case of transportation equipment, other Manufacturing, and repair, any changes in these sub-sectors will give an opposite direction of growth in Manufacturing. It implies that the policies involved in Manufacturing should be revised to strengthen the correlation between Manufacturing and its sub-sectors.

78 Figure 5.7: Annual Percentage Change of Manufacturing and Its Sub-sectors, 2015 – 2021 Table 5.7 shows the magnitude of change of Sabah's five main sectors on GDP from 1992 to 2021 (30 years). The results were generated using the common econometrics method for time-series multiple linear regression analysis, namely the Ordinary Least Squares (OLS) estimation. For this estimation, the models are divided into six models based on the six sub-sectors in the services sectors. The results for Manufacturing indicate that all five models are statistically significant with 5 and 1 per cent levels. This statistical evidence proves that Manufacturing significantly and positively impacts GDP. The five significant models predict that a one percentage point increase in Manufacturing leads to about 3 to 5 percentage points in GDP. It also aligns with the results generated for the correlation matrix and scatter plot from Table 5.4 and Figure 5.4, which show a strong positive correlation between Manufacturing and GDP in Sabah. Figure 5.9 revealed the same direction of changes occurring for both Manufacturing and GDP in Sabah from 1993 to 2021. The highest growth for both macroeconomic variables was recorded in 2005, with a more than 120 per cent increase in GDP and 63.4 per cent in Manufacturing. The possible reason behind this highest growth in the history of Sabah was the implementation of the Sabah Industrial Action Plan (SIAP) from 2000 to 2005, whose main objective was to revive the development of industry and the state economy. -25.0 -20.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 30.0 2016 2017 2018 2019 2020 2021 Percentage Change (%) Manufacturing Oils and fats from vegetables & animals and processed foods, beverages and tobacco products Wood products, furniture, paper products and printing Non-metallic mineral products, basic metals, and manufactured metal products Transportation equipment, other manufacturing and repair

79 Figure 5.8: Scatter Plot of Manufacturing and Its Sub Sector, 2015 – 2021 3,900 4,000 4,100 4,200 4,300 4,400 4,500 4,600 4,700 5,900 6,000 6,100 6,200 6,300 6,400 6,500 6,600 Manufacturing Oils and fats from vegetables & animals and processed foods, beverages and tobacco products R=0.9299 RM Million RM Million 600 640 680 720 760 800 840 5,900 6,000 6,100 6,200 6,300 6,400 6,500 6,600 Manufacturing Wood products, furniture, paper products and printing R=0.0819 RM Million RM Million 630 640 650 660 670 680 690 700 710 720 5,900 6,000 6,100 6,200 6,300 6,400 6,500 6,600 Manufacturing Non-metallic mineral products, basic metals, and manufactured metal products R=0.3850 RM Million RM Million 460 470 480 490 500 510 520 530 5,900 6,000 6,100 6,200 6,300 6,400 6,500 6,600 Manufacturing Transportation equipment, other manufacturing and repair R=-0.1299 RM Million RM Million

Table 5.7: Regression Results of Ordinary Least Squares (OLS1992 – 2021 (Constant Prices) Notes: All models are estimated using the Time Series Ordinary Least Squares (OLS) regat the 1%, 5% and 10% levels, respectively. (1) (2) VARIABLES GDP GDP Agriculture 0.505* 0.236 (0.277) (0.154) Construction -1.690 -0.883 (2.628) (1.433) Import Duties 0.176 -1.365 (12.41) (6.682) Manufacturing 4.132** 3.809*** (1.755) (0.941) Mining and Quarrying 0.939*** 0.824*** (0.312) (0.164) Services 0.906*** (0.191) Types of Services Utilities, Transportation and Storage, Information and Communication 5.809*** (0.508) Wholesale and Retail Trade, Food & Beverage and Accommodation Finance and Insurance, Real Estate, and Business Services Government Services Other Services R-squared 0.997 0.999 Observations 30 30

80 S) Estimations Dependent Variable: GDP at Purchasers' Price, gression. Values in the parentheses are standard errors. ***, **, and * indicate significance (3) (4) (5) (6) GDP GDP GDP GDP 0.902*** -0.00512 1.034*** 0.716*** (0.178) (0.243) (0.289) (0.253) -3.523** 0.0820 0.836 0.544 (1.689) (2.146) (2.735) (2.459) -2.221 -9.520 9.089 -5.972 (7.863) (9.840) (13.07) (11.22) 3.079** 5.349*** 2.101 3.607** (1.137) (1.358) (1.966) (1.630) 0.601*** 1.378*** 1.105*** 1.140*** (0.207) (0.219) (0.299) (0.264) 3.446*** (0.368) 3.787*** (0.553) 3.114*** (0.672) 8.339*** (1.497) 0.999 0.998 0.997 0.998 30 30 30 30

81 Figure 5.9: Annual Percentage Change between Manufacturing and GDP in Sabah, 1993 – 2021 5.4 CONSTRUCTION The growth in the construction sector was recorded at 10.1 per cent in the final quarter of 2022. As the Department of Statistics Malaysia recorded, the construction sector's growth is mainly supported by non-residential construction and residential building subsector projects owned by the private. The focus of growth in this sector is more in the Klang Valley (i.e., Kuala Lumpur and Selangor), Sarawak, and Johor regions. The sector's growth performance is expected to extend into the first quarter of 2023. Figure 5.10: Value of Work Done by Sub-sector in Sabah, Quarter 1 2023 -40.0 -20.0 0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Annual Percentage Change (%) Manufacturing GDP

82 In Sabah, the construction sector only contributes as much as 5.5 per cent of Malaysia's total gross output for the year 2022, which is RM9.3 billion, sixth place behind Penang, Sarawak, Johor, Federal Territory of Kuala Lumpur, and Selangor. The total number of employees, salaries, and wages paid to employees are 64,399 people and RM1,608 million, respectively. Regarding the type of projects completed in Sabah, the total value was recorded at about RM1,977 million (Figure 5.10). The data revealed that 65 per cent of the total value was contributed by the civil engineering sub-sector (or RM1,285 million), followed by the non-residential buildings sub-sector, which amounted to about 20 per cent (RM397 million). Meanwhile, the residential buildings and special trade activities sub-sectors contributed 10 per cent (RM192 million) and 5 per cent (RM103 million), respectively. Figure 5.11: Share of GDP by Mining and Quarrying Sector and Forecast, 1992 - 2025 0 400 800 1,200 1,600 2,000 2,400 2,800 3,200 0 1,000 2,000 3,000 4,000 Share of G D P by C onstruction S ector Forecast R²=0.91 Y=17.07+0.97X -1,000 -750 -500 -250 0 250 500 1995 2000 2005 2010 2015 2020 Forecast Errors 0 1,000 2,000 3,000 4,000 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 Share of GDP by Construction Sector Forecast Maximum Limit Minimum Limit (RM Million)

83 Figure 5.11 depicts the share of GDP by the construction sector from 1992 to 2021 and reveals a slight increase up to 2012. Over the years, there was also a positive shock just after the Asian financial crisis period 97-98. After 2012, the construction sector grew at a steeper pace until 2019. However, the total output of this sector to Sabah's economy decreased in 2019 and 2020. Figure 5.11 also illustrates the forecast model from 1992 to 2025. The forecast model evaluation criteria reveal that the coefficient of determination is 91%, explaining the original shares of the construction sector to Sabah's GDP. Moreover, Table 5.8 provides Sabah's construction sector share of GDP with the forecast growth from 2022 to 2025. The four-year forecast data is an average of RM2,708 million shares of GDP. Based on the model's forecast value, the construction sector's share of Sabah's GDP will keep increasing up to the forecast period, such as 2025. Still, the percentage growth is projected to be smaller across the forecasted period. Table 5.8: Sabah's Construction Sector Share of GDP and Forecast Year Sabah's Construction Share of GDP (RM Million) Forecast (RM Million) Percentage Growth (year-on-year) 2021 2,370 2,397 7.87% 2022 - 2,505 4.51%f 2023 - 2,713 8.33%f 2024 - 2,771 2.12%f 2025 - 2,840 2.51%f Note: Authors' calculations. f is the percentage growth year-on-year based on the forecasted values. Figure 5.12: Scatter Plots of GDP and Construction Sector in Sabah An analysis of scatter plots of GDP and the construction sector in Sabah is depicted in Figure 5.12. It is found that there is a strong positive relationship between 0 400 800 1,200 1,600 2,000 2,400 2,800 3,200 0 10,000 30,000 50,000 70,000 90,000 GDP C onstruction R=0.9741 RM Million RM Million

84 GDP and the construction sector in Sabah. An increase in the construction sector will directly relate to Sabah's GDP, measured by the value of R close to 1, for example, 0.974. In addition, Table 5.1 shows that the construction sector in Sabah has no significant relationship with Sabah's economic growth except for Model (3). Models (1), (2), and (5) provide a negative relationship between construction and Sabah GDP, and Models (4) and (6) depict a positive impact on Sabah GDP, although the coefficients are not significant. In Model 3, the construction sector has a statistically significant relationship. However, this negative value reflects that assuming other variables are constant, a 1% increase in the construction sector reduces Sabah's total economic output to 4%. Based on the result, it is not surprising, given that the construction sector is not the leading sector to be the engine of economic growth. In addition, there was a reduction in contractor replenishment following the government's measures to curb the spread of COVID-19, which affected the government's financial structure in implementing public projects. The private sector has also been affected following the pandemic, reducing investors' confidence in this sector. However, MIDF Research expects the sector to increase its contribution to Sabah's economy by constructing the Pan Borneo Highway and expanding other road network projects. 5.5 SERVICES The gradual reopening of several economic sectors in 2021 is seen to have had a positive impact on the economic performance of the Service sector in a country. In 2021, the services sector in Sabah recorded an added value of RM37.2 billion (2020: RM36.5b), an increase of RM0.7 billion compared to the previous year, which had recorded a reduction of RM2.9 billion. The sector's contribution to Sabah's overall GDP in 2021 is 47.3 per cent (2020: 47.0%). The sector recorded a moderate growth of 1.8 per cent compared to a reduction of 7.3 per cent in the previous year. Performance by subsector in the Service sector is shown in Table 5.9. Table 5.9: Performance of the Service Sector, Sabah 2020-2021 Subsector 2020 2021 Value added (RM Million) Percentage Contribution (%) Percentage Growth (%) Value added (RM Million) Percentage Contribution (%) Percentage Growth (%) Utilities, transportation, and storage, information, and communication 6535 17.9 -8.7 6708 18.0 2.6 Wholesale and retail trade, food and beverage, and accommodation 12914 35.3 -13.7 12813 34.4 -0.8 Finance and insurance, real estate, and business services 5227 14.3 -8.0 5335 14.3 2.1 Government services 8784 24.0 5.1 9319 25.0 6.1 Other Services 3085 8.4 -5.6 3040 8.2 -1.4 Total 36544 100.0 -7.3 37215 100.0 1.8 Source : Laporan Sosioekonomi Negeri Sabah 2021

85 From Table 5.9 above, we can see that the contribution of subsector wholesale and retail trade, food and beverage, and accommodation is the biggest to Sabah's GDP, about 34.4 per cent in 2021 (2020: 35.5 per cent). However, the percentage growth of the subsector was negative because of the reduction in tourist arrival to Sabah due to the government's enforcement of the Movement Control Order (MCO). The contribution of tourism activity in this subsector is demonstrated by the accommodation subsector, which can detect the number of tourists who come to Sabah. Figure 5.13: Total Tourist Arrivals to Sabah, 2002-2022 Figure 5.13 depicts the total tourist arrivals to Sabah from 2002 until 2022. The graph shows that Sabah had achieved the highest tourist arrival in 2019 before the pandemic and drastically dropped in 2020. But after the border restriction was loosened by most of the countries in the world at that time, the total number of tourist arrivals progressively increased, which can boost our services sector this year and the year after. Other sub-sectors, such as utilities, transportation and storage, information and communication, subsector finance and insurance, real estate and business services, and subsector government services, recorded positive growth in 2021 due to the gradual reopening of the economy. Table 5.10: Sabah's Services Sector Share of GDP and Forecast Year Sabah's Services Share of GDP (RM Million) Forecast (RM Million) Percentage Growth (year-on-year) 2021 37,215 37,006 1.84% 2022 - 39,156 5.21%f 2023 - 40,365 3.09%f 2024 - 41,211 2.10%f 2025 - 43,738 6.13%f Note: Authors' calculations. f is the percentage growth year-on-year based on the forecasted values. 0 500,000 1,000,000 1,500,000 2,000,000 2,500,000 3,000,000 3,500,000 4,000,000 4,500,000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

86 Figure 5.14 reveals the in-sample and out-sample forecast for Sabah's services' shares of GDP from 1992-2025. The coefficient of determination revealed that 98 per cent of the forecast output fits the original series of Sabah's services sector shares of GDP. Figure 5.14: Share of GDP by Services Sector and Forecast, 1992 - 2025 From Table 5.11, it has been established based on the findings that it has a positive relationship with economic growth. In Model 1, where all sub-services are included, a 1 per cent increase in services leads to a 0.906 per cent rise in economic growth. It demonstrates that services are one of the most important sectors of the Sabah economy. We can see in Models 2 to 6, where services are disaggregated, that all forms of services have a significant positive relationship with economic growth. As for utilities, transportation and storage, information and communication, a 1 per cent increase in this form of service leads to an increase in economic growth by 5.809 per 0 10,000 20,000 30,000 40,000 50,000 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 Share of GDP by Services Sector Forecast Maximum Limit Minimum Limit (RM Million) 0 10,000 20,000 30,000 40,000 0 10,000 20,000 30,000 40,000 50,000 Share of G D P by S ervices S ector Forecast R²=0.98 Y=-185.54+1.01X -6,000 -4,000 -2,000 0 2,000 4,000 6,000 1995 2000 2005 2010 2015 2020 Forecast Errors

87 cent. Wholesale and retail trade, food and beverage, and accommodation affect economic growth. The result shows that a 1 per cent increase in this service segment leads to an increase in economic growth by 3.446 per cent. Finance and insurance, real estate and business services, government services, and other services have a significant positive relationship with economic growth. A one per cent increase in all segments above leads to an increase in economic growth by 3.787 per cent, 3.114 per cent, and 8.339 per cent, respectively. Table 5.11 Results of Ordinary Least Squares (OLS) between the Services Sector and Economic Growth Variable (1) GDP (2) GDP (3) GDP (4) GDP (5) GDP (6) GDP Services 0.906*** (0.191) - - - - - Types of services Utilities, transportation and storage, information, and communication - 5.809*** (0.508) - - - - Wholesale and retail trade, food & beverage, and accommodation - - 3.446*** (0.368) - - - Finance and insurance, real estate, and business services - - - 3.787*** (0.553) - - Government Services - - - - 3.114*** (0.672) - Other Services - - - - - 8.339*** (1.497) Source: Department of Statistics Malaysia (DOSM) & Authors' Calculations. Number of observations: 30 Values in parentheses are standard errors. Table 5.12: Correlation Matrix for Services and its Sub-sectors in Sabah, 2015 – 2021 Sub sectors Coefficient 1) Utilities, transportation and storage, information and communication 0.9967 2) Wholesale and retail trade, food and beverage, and accommodation 0.9951 3) Finance and insurance, real estate, and business services 0.9723 4) Government Services 0.9920 5) Other Services 0.9932 Based on Table 5.12, subsector utilities, transportation and storage, information and communication demonstrate the highest positive coefficient among others

88 (0.9967), followed by subsector wholesale and retail trade, food and beverage, and accommodation (0.9951). Subsector finance and insurance, real estate, and business services come next with a coefficient of 0.9723, followed by other services (0.9932) and government services (0.9920), respectively. a) Services and GDP b) Services and Utilities, Transportation and Storage, Information and Communication c) Services and Wholesale and Retail Trade, d) Services and Finance and Insurance, Food and Beverage Accommodation Real estate, and Business Services e) Services and Other Services f) Services and Government Services

89 Figure 5.15: Scatter Plot of the Relationship between Services and SubServices Based on Figure 5.15, Figure 5.15(a) shows the scatter plot of the relationship between the services sector and economic growth. Astrong positive relationship exists between the services sector and economic growth, as the residual is 0.9951, closer to 1. Figure 5.15(b) to (f) shows the relationship between the services and sub-services sectors. All scatter plots indicate a strong positive relationship between the services sector and its sub-services sector. The residuals are 0.9967, 0.9951, 0.9723, 0.9932, and 0.9920, respectively. 5.6 BACKGROUND OF SABAH'S GDP The negative growth of Sabah’s GDP was recorded in 1998 (-0.72 per cent) and 1999 (-1.16 per cent). Both years’ GDP amounted to RM11.6 billion and RM11.5 billion compared to RM11.7 billion in 1997. These contractions arose from the Asian Financial crisis 1998, which also impacted the overall real GDP growth in Malaysia contracted by 4.8 per cent compared to 7.7 per cent growth in 1997. Fortunately, the overall GDP of Sabah showed positive growth of 5.94 per cent in 2000 (RM12.2 billion), while slowed growth was recorded in 2001 with an annual growth rate of 0.62 per cent. The positive growth in 2000 was driven by the Second Outline Perspective Plan (1991 – 2000), which focused on reducing the imbalance in economic development between Sabah, Sarawak, and Peninsular Malaysia. Figure 5.16: Yearly Historical and Forecast of Sabah's GDP at Purchasers' Price, 1997-2025 Additionally, the Malaysian government promoted the growth triangle, namely The East ASEAN Growth Area (BIMP-EAGA), which was believed to be one of the key factors enhancing growth in Sabah (Habibullah and Affizzah, 2008). The GDP growth 0 20,000 40,000 60,000 80,000 100,000 120,000 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 GDP at Purchasers' Price Forecast Maximum Limit Minimum Limit (RM Million)

90 in 2005 drastically increased to RM32.4 billion from RM14.3 billion in the previous year. The Malaysian Economy in 2005 (BNM, 2005) revealed that agriculture was the main driver of this positive growth. The mature oil palm area increased significantly by 5.2 per cent, equivalent to 179,790 hectares, reaching 3.63 million hectares compared to 4.5 per cent growth in 2004. The growth was seen in all regions. Sabah’s mature land area increased by 3.9 per cent to 1.12 million hectares, Sarawak increased by 8.3 per cent (0.44 million hectares), and 5.3 per cent or 2.07 million hectares increased in Peninsular Malaysia. In this case, Sabah recorded a double-digit increase of 11.9 per cent in 2015, became the top palm oil producer, and contributed around 5.33 million tonnes, equivalent to 35.6 per cent of Malaysia's overall palm oil production. The other major contributor came from the oil and gas industry, with four discoveries offshore in Sabah from 2002 to 2004, further increasing the state’s GDP growth. Table 5.13: Yearly Historical and Forecast of Sabah’s GDP at Purchasers’ Price Year GDP at Purchasers' Price Forecast Year GDP at Purchasers' Price Forecast Maximum Limit Minimum Limit 1997 11,703 11,703 2012 44,434 45,104 1998 11,619 14,143 2013 63,226 46,874 1999 11,484 14,059 2014 66,361 65,666 2000 12,166 13,924 2015 73,776 68,801 2001 12,242 14,606 2016 77,518 76,216 2002 13,007 14,682 2017 83,793 79,958 2003 13,760 15,447 2018 85,012 86,233 2004 14,345 16,200 2019 85,642 87,452 2005 32,427 16,785 2020 77,785 88,082 2006 34,221 34,867 2021 78,670 80,225 2007 35,318 36,661 2022 81,110 92152 70068 2008 39,114 37,758 2023 83,551 94592 72509 2009 40,986 41,554 2024 85,991 97033 74949 2010 42,101 43,426 2025 88,431 99473 77389 2011 42,664 44,541 The continuous positive trend of GDP in Sabah is shown in Figure 5.16 from 2006 until 2015, which stated increases of 10.75 per cent in 2008 and 11.17 per cent in 2015. Despite the global financial crisis in 2008, Sabah recorded positive growth, mainly driven by the agriculture sector. Economic development in 2008 (BNM, 2008) reported Sabah as the highest producer of crude oil, which managed to double the crude oil output, an increase of 101.6 per cent, amounting to 150,792 barrels per day (BPD) compared to 74,800 bpd in 2007 (21.7 per cent of total national’s oil output). Implementing the Sabah Development Corridor (SDC) from 2008 to 2025 also significantly contributes to the positive achievement in Sabah’s GDP. In 2010 and 2011, Sabah experienced a slower growth of 2.72 per cent and 1.34 per cent, respectively. The main reason for this economic condition was the weaker performance of the mining industry, especially the oil and gas sector. Therefore, the various project from SDC is expected to stimulate growth in Sabah, such as the Kimanis Power plant, Sabah Oil and Gas terminal (SOGT), the Palm Oil Industrial

91 Clusters (POICs) in Lahad Datu and Sandakan, Sabah Ammonia-Urea plant (SAMUR) and the Kinabalu Gold Coast Enclave. From 2012 to 2015, Figure 5.16 shows a sharp increase in Sabah’s GDP from RM44.4 billion to RM73.8 billion in 2015, an increase of 11.17 per cent compared to 2014. In 2012, Sabah’s GDP increased to 4.15%, driven by positive growth in the mining and quarrying sector, while it fell in the agriculture sector, especially in the oil palm industry. The most contributor to 2012 Sabah’s GDP came from the services sector, with 47.4 per cent of the total GDP, followed by agriculture (20.8 per cent), 20.7 per cent of the total GDP from mining and quarrying, while manufacturing and construction sectors remain the lowest two contributors with 7.9 per cent and 2.9 per cent, respectively. In 2015, Sabah made up 6.3 per cent of the national GDP. The contribution rate dropped to 5.7 per cent in 2021. The Sabah state economy has struggled since 2018 due to low global commodity prices. The problem caused by the COVID-19 pandemic got worse when a quick state election was held in September 2020, which led to an increase in COVID-19 cases and a state-wide lockdown. Since 2018, the state's economy has grown slower than Malaysia's GDP. The contraction rate of -9.17 per cent in 2020 was greater than the national rate of -5.5 per cent. In 2021, the rate of economic recovery in Sabah (1.1 per cent) was substantially lower than the national average (3.1 per cent) as the infection rate increased in the fourth quarter of 2020. Sabah's economy was particularly hard hit by the falls in the tourism industry. The closure of international borders was one of the factors that contributed to the deeper recession in 2020 and the comparatively sluggish recovery in 2021. With a total GDP of RM78.7 billion in 2021, Sabah's GDP increased by 1.1 per cent compared to a contraction of 9.2 per cent in the prior year. An expansion in the construction sector (7.9 per cent), mining and quarrying sector (2.4 per cent) and services sector (1.8 per cent) were the main drivers of this positive growth. The highest growth in the construction sector was driven by double-digit growth of 29.7 per cent in the civil engineering subsector and 21.5 per cent in special trade. The residential and non-residential subsector recorded a negative 8.8 per cent growth in 2021. Meanwhile, a surge in natural gas activity was the main factor of the positive growth in the mining and quarry sector. An increase of 6.1 per cent in government services, 2.6 per cent in utilities, transportation and storage, information and communication subsectors, followed by 2.1 per cent growth in finance and insurance, real estate, and business services have contributed to a rise in the services sector by 1.8 per cent. Table 5.14: Sabah's GDP at Purchasers' Price and Forecast Year Sabah's GDP at Purchasers' Price (RM Million) Forecast (RM Million) Percentage Growth (year-on-year) 2019 85,642 87,452 0.74 2020 77,785 88,082 -9.17 2021 78,670e 80,225 1.14 2022 - 81,110 3.10a 2023 - 83,551 3.01b 2024 - 85,991 2.92b 2025 - 88,431 2.84b Source: Department of Statistics Malaysia (DOSM) & Authors' Calculations. Note: e is the estimated amount by DOSM; a is the percentage growth that is calculated difference by the forecasted 2022 and estimated amount by DOSM 2021; b is the calculated percentage growth difference from each sequence of forecast amount.

92 On the other hand, the manufacturing sector recorded a negative growth of 1.8 per cent in 2021 due to a fall of 8.1 per cent in the most significant subsector, namely the vegetable and animal oils and fats, food processing, beverages and tobacco products. Moreover, in 2020 and 2021, the agricultural sector shrank by 6.7 per cent and 2.4 per cent, respectively. This contraction was caused by a drop in the crop sector, particularly in the oil palm sector. The 25 years of historical data were then utilized to forecast Sabah's GDP from 2022 to 2025. The four-year sample data forecast revealed that if Sabah maintains its state's performance like 2021, its GDP will gradually increase by 3 per cent from 2022-2025. Analysis of the GDP of Sabah by kind of economic activity signalling agriculture (0.38 per cent), mining and quarrying (0.49 per cent), and manufacturing (0.03 per cent) sectors will potentially have stagnant growth in 2024. Sabah GDP at purchasers' price is expected to grow around 2.92 per cent in 2024. The study expects persistent unemployment and under-employment, as well as an economy generally performing below its potential, resulting in the stagnation of the growth of Sabah's GDP for 2023 and 2024. The economic shock, such as the post-pandemic, Russia-Ukraine conflict, US-China trade war, and global food security and energy crisis, fuelled and potentially prolonged the stagnant growth in Sabah's GDP. Most concerning with the potential of prolonged stagnant GDP witnesses fewer gains in the stock market and mutual funds in investment activity. The standard of living is expected to decline in certain Sabah's socio-economic classes or geographic areas, resulting from higher unemployment and falling wages, making it difficult for individual workers to compete for jobs and wages. During the Covid-19 period, various essential goods were shortages, which led to higher prices. Sabah states witnessed the post-pandemic, but the essential prices continued to rise, eventually affecting each Sabah's cost of living. For example, Sabah heavily relies on food imports, including beef from India, higher-grade beef from Australia, and Corn from Argentina. Given the depreciation in the Ringgit, higher dependence on foreign supply exposed the region to price fluctuation and supply chain disruptions, worsening the price level of essential goods in Sabah. The rice dependency and geopolitical risks are other factors that potentially influenced the rising cost of living in Sabah. For example, it is estimated that Sabah only produced 22 per cent of its paddy requirement, turning it heavily depending on rice imports. The geopolitical tensions potentially impacting rice-exporting countries like India, Burma, and Thailand concerning the Sabahan about the availability of rice and its price. The fishery is considered one of the important contributors to Sabah's agricultural sector. The uncertainties and limitations in fishing due to small boats and foreign fishing vessels, particularly from Thailand, China, and Vietnam, further affect local fish output and price. The addressed uncertainties are seriously impacting the standard of living and well-being of Sabahan citizens. The need for policy in producing the final product rather than exporting the intermediate goods from agriculture, mining, and quarrying will boost the value added and state revenues. The effort of the state government to transform the intermediate goods into final goods will be one stepping stone to transforming the manufacturing sector as one of the important contributors to Sabah's GDP. The rise in manufacturing production will attract more foreign investment and be vital in tackling the persistent unemployment rate in Sabah.

93 CHAPTER 6 INFLATION, UNEMPLOYMENT, POVERTY, AND STATE REVENUE 6.1 INFLATION AND UNEMPLOYMENT The three major causes of inflation pressures continue to gain momentum while the global economy encounters significant obstacles. The situation in Russia and Ukraine, rising living expenses, and the slowdown of the Chinese economy are impacting the World, including Sabah's economic outlook. Figure 6.0 depicts the year-on-year gross domestic product (GDP) and consumer price index (CPI) changes for Peninsular Malaysia, Sabah, and Sarawak. Although Sabah's total GDP at current prices is the lowest, the percentage growth from year-on-year revealed the highest, followed by Sarawak and Peninsular Malaysia. For example, Sabah's GDP in 2021 recorded the highest increase of about RM18,126 million (19.7%), followed by Sarawak at 18.5% and Peninsular Malaysia at 7.1%, respectively. The highest increase in Sabah's GDP is driven by the services sector (47.3%), mining and quarrying (26%), and agriculture (15.9%). The services sector remained the main contributor to Malaysia's shares of GDP. However, the mining and quarrying activity in Sabah recorded the second largest share of GDP, contradicting other states as the manufacturing sector is a common contributor. Most concerning the mining and quarrying indicate 0.5% of employed persons by sector compared to 54.9% in the services sector in Sabah. Source: Department of Statistics and Authors' Calculations. Note: Percentage Changes Year-on-Year. The GDP at current prices is categorised by the summation of each state's GDP. Figure 6.0: The Percentage Growth of Gross Domestic Product and Consumer Price Index in Peninsular Malaysia, Sabah, and Sarawak. An increase in the cost of living will pose an immediate threat as it jeopardises the macroeconomic stability in Sabah. Figure 6.0 also revealed that the CPI year-onyear growth in Peninsular Malaysia, Sabah, and Sarawak is within 4% from 2010 to

94 2021. Meanwhile, Figure 6.1 depicts Peninsular Malaysia, Sabah, and Sarawak inflation driven by food and non-alcoholic beverages, transport, restaurants, and hotels. In 2021, Sarawak recorded the highest CPI year-on-year, 4.3%, followed by Peninsular Malaysia and Sabah, 3.6% and 3.3%, respectively. Most concerning, the gap in growth from January 2023 and January 2022 shows a sharp increase in Sarawak at 2.2%, Sabah at 1.4%, and Peninsular Malaysia at 1.2%. The most negligible contribution to Malaysia's GDP and inflation is peaking, indicating that the Sarawak and Sabah are expected to reduce their real income. Source: Department of Statistics and Authors' Calculations. Note: Percentage Changes January, Year-on-Year. Figure 6.1: Inflation Driven by Food and Non-Alcoholic Beverages, Transport, and Restaurants and Hotels In 2023, the consumer price index (CPI) rose the fastest and has dominated since the COVID-19 pandemic. Figure 6.2 shows Sabah’s monthly scatter plots of the CPI from January 2022 to January 2023. The general change in the CPI is crucial to policymakers because the price stability in most cases of hikes in the inflation rate is a crucial target. The percentage change year-on-year revealed that all items' CPI is peaking compared to January 2023 and January 2022. Therefore, the CPI is considered a near indicator of the inflation scenario in Sabah. The CPI hike is one reason the Central Bank of Malaysia has been increasing the interest rate by means of moderate inflation. The scatter plot analysis revealed that most of the CPI in Sabah is driven by the general change in food and non-alcoholic beverages, transport, restaurants, and hotels. The percentage change year-on-year revealed that the vital category of CPI, food and non-alcoholic beverages, showed a stagnant movement from Jan 2022 to June 2022. However, the rapidly evolving economic environment influenced the CPI from July 2022, depicting going to a roof movement and peaking in January 2023. The

95 peaking since July 2022 can be explained by the subcategory and expenditure class increase, such as the CPI in meat, milk, eggs, and oils and fats. Transport is considered a vital category that impacts average spending in Sabah. The year-on-year CPI of transport revealed an increasing trend since March 2022, contributing around 9% out of the total changes of CPI in Sabah 2023. The primary contributor to the increase in transport is passenger transport by air, repair and maintenance of personal transport, and fuel and lubricants of personal transport. Source: Department of Statistics and Authors' Calculations. Note: Monthly Percentage Changes Year-on-Year,2022-2021 Figure 6.2: Monthly Scatter Plots of Inflations in Sabah Driven by Food and NonAlcoholic Beverages, Transport, and Restaurants and Hotels Restaurants and hotels significantly contribute to the rise in Sabah’s CPI. The year-on-year data depicts stagnant movement from January 2022 to December 2022. However, a sharp increase in the average person’s spending in restaurants and hotels depicted in January 2023 indicates the subcategories of restaurants, cafes, and accommodations increased drastically due to the Sabah economy reopening incentive. On the positive side, raises in inflation give us clues on how economic growth in Sabah is faring in such groups, indicating that money is being significantly 113.5 114.0 114.5 115.0 115.5 116.0 116.5 116 117 118 119 120 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 123 124 125 126 127 126 128 130 132 134 136 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 105 106 107 108 109 110 111 112 111 112 113 114 115 116 117 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Sep-22 Aug-22 Oct-22 Nov-22 Dec-22 Jan-23 134 135 136 137 138 139 136 140 144 148 152 156 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22Jul-22Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Consumer Price Index, All Items Food & Non-Alcoholic Beverages Transport Restaurants & Hotels

96 distributed around the economy and a positive sign of growth. Otherwise, the money is stripped from the economy, thus a weakening outlook. Table 6.0 and Figure 6.4(a) revealed Malaysia divergence segregated by peninsular Malaysia, Sabah, and Sarawak. The overnight policy rate (OPR) and core inflation patterns are revealed in several ways. The Central Bank of Malaysia (BNM) has generalised and increased the OPR more aggressively in Malaysia's divergence partly because of differences in underlying inflation dynamics and economic conditions. The heat of the OPR is more noticeable, especially in a region with slightly lower core inflation, such as Sabah. Table 6.0: Malaysia Divergence – The Overnight Policy Rate Versus Core Inflation Month Overnight Policy Rate (%) Core Inflation (% Change Year-on-Year) Peninsular Malaysia Sabah Sarawak January 2022 1.75 2.4 1.9 2.1 February 2022 1.75 2.3 1.8 2.0 March 2022 1.75 2.3 1.4 1.7 April 2022 1.75 2.4 1.4 1.9 May 2022 2.00 2.9 2.2 2.4 June 2022 2.00 3.5 2.8 3.2 July 2022 2.25 4.5 3.9 3.6 August 2022 2.25 4.7 4.3 3.9 September 2022 2.5 4.6 4.3 4.0 October 2022 2.5 4.0 3.8 4.3 November 2022 2.75 4.0 3.8 4.7 December 2022 2.75 3.7 3.8 4.1 January 2023 2.75 3.6 3.3 4.3 Source: Department of Statistics Malaysia (DOSM) & Authors' Calculations. Note: The authors calculate core inflation based on the changes year-on-year. Source: Department of Statistics Malaysia (DOSM) & Authors' Calculations. Note: (1)Theauthors calculate core inflation based on the changes year-on-year.(2) Authors estimate the correlation (R) based on the Pearson rank correlations. Figure 6.3: Malaysia Divergence; Scatter Plots and Correlations of Overnight Policy Rate Versus Core Inflation 2.0 2.5 3.0 3.5 4.0 4.5 5.0 1.6 1.8 2.0 2.2 2.4 2.6 2.8 Peninsular Malaysia Y=-0.15+1.63X R=0.73 1 2 3 4 5 1.6 1.8 2.0 2.2 2.4 2.6 2.8 Sabah Y=-2.01+2.25X R=0.83 1 2 3 4 5 1.6 1.8 2.0 2.2 2.4 2.6 2.8 Sarawak Y=-2.33+2.52X R=0.95 Overnight Policy Rate (%) Core Inflation (% Change Year-on-Year)

97 Figure 6.3 demonstrates the scatter plots for the OPR versus the core inflation in Peninsular Malaysia, Sabah, and Sarawak from January 2022 to January 2023. All regions demonstrate strong positive correlations between the OPR and core inflations, indicating that an increase in the interest rate raises more inflation. The correlation results in Figure 6.3 contradict the purpose of imposing the OPR by the central bank of Malaysia, burdening the households in Malaysia. Figure 6.4(a) reveals that the core inflation in Peninsular Malaysia and Sarawak rose sooner and has run higher than in the Sabah. These differences reflect Malaysia's regional divergence, especially in commodity price shock and transportation constraints. In addition, the gap in household income by region has closed more rapidly in Peninsular Malaysia and Sarawak, fuelling more of the underlying core inflation momentum. Source: Department of Statistics Malaysia (DOSM), Social Security Organisation (SOCSO), & Authors' Calculations Note: 1) The authors calculate core inflation based on the changes year-on-year. 2) The unemployment to the number of active registrants is multiplied by the percentage and calculated based on the data provided by the social security organization. 3) The unemployment to vacancies ratio obtained from the Social Security organisation is calculated by dividing the number of unemployed registrants by the number of vacancies in a particular month. The 25 30 35 40 45 50 55 Jan 22 Feb 22 Mar 22 Apr 22 May 22 Jun 22 Jul 22 Aug 22 Sep 22 Oct 22 Nov 22 Dec 22 Jan 23 Unemployment to Number of Active Registrants (%) 1 2 3 4 5 Jan 22 Feb 22 Mar 22 Apr 22 May 22 Jun 22 Jul 22 Aug 22 Sep 22 Oct 22 Nov 22 Dec 22 Jan 23 Core Inflation (% Change Year-on-Year) 0.0 0.1 0.2 0.3 0.4 Jan 22 Feb 22 Mar 22 Apr 22 May 22 Jun 22 Jul 22 Aug 22 Sep 22 Oct 22 Nov 22 Dec 22 Jan 23 Peninsular Malaysia Sabah Sarawak Unemployment to Vacancies Ratio (a) (c) (b)

98 unemployment to vacancies ratio provides insight into how tight or slack the labour market is.A ratio = of 1.0 means a job is available for every unemployed person. Ratios < 1.0 indicate stricter labour markets where firms have more vacancies than people actively looking for work. Ratios > 1.0 signal slack in the labour supply as more unemployed people compete for each vacancy. Figure 6.4: Malaysia Divergence; (a) core inflation as a percentage year-on-year; (b) a percentage of unemployment to active registrants; (c) unemployment to vacancies ratio The percentage of unemployment to the number of active registrants is essential to measure the number of persons actively looking for a job but not employed to the number of persons actively registered in the social security organisation databases. A percentage above 100% indicates that unemployment exceeds the number of active registrants. Otherwise, it is less than 100%. Figure 6.4(b) revealed that Sabah’s percentage of unemployment to the number of active registrants is above 40%, followed by Sarawak and Peninsular Malaysia, respectively. The highest percentage of unemployment to the number of active registrants indicates that more people are active registrants but not employed in labour markets. The result from Figure 6.4(c) deepens our unemployment-to-vacancies ratio analysis. All regions in Malaysia depict a ratio of less than 1.0, signalling tighter labour markets with more vacancies than people actively looking for work. The phenomena illustrated in Figures 6.4(b) and 6.4(c) give an impression that Sabahan's potential involves the informal job. Figure 6.5 shows the monthly inflation density in Malaysia divergence, monthly change year-on-year for 2021/2020 and 2022/2021. The inflation density analysis is vital, especially to measure the impact of policy mistakes, either under or overtightening. Under-tightening may cause a big flop to policymakers as it may risk a country experiencing deeper inflation, leading to a hike in the interest rate that significantly costs the country’s production and employment. Meanwhile, overtightening may risk the country’s economy into a prolonged recession. Figure 6.5 revealed that the inflation as a percentage change year-on-year for 2021/2020 in Malaysia divergence is widening, in some cases beginning to shift with a larger share of households expecting the inflation. The widening inflation for 2021/2020, perhaps due to the country’s effort to combat COVID-19, such as the moratorium, kumpulan wang simpanan pekerja (KWSP), global supply chain disruption and Russia-Ukraine crisis, causes inflation to rise. Moreover, Figure 6.5 also reveals the current policy by the Central Bank of Malaysia is quite operative in combating the inflations during post-pandemic. It is proven that the percentage year-on-year for 2022/2021 inflations is narrowing in Peninsular Malaysia, Sabah, and Sarawak. However, the study seeks an effort from the BNM in tuning the competitive OPR so it may not cost the country the risk of under and over-tightening concerning the regions’ CPI and household income. The differences in monthly year-on-year kernel densities in 2022/2021 and 2021/2020 prove that Sabah and Sarawak are most likely to struggle to defeat inflation, compared to Peninsular Malaysia, which has a narrower density with a shorter period.

99 Source: Department of Statistics Malaysia (DOSM) and Authors' Calculations. Note: The vertical lines indicate the mean of each distribution. Figure 6.5: Monthly Inflation Density as Percentage Change Year-on-Year 6.2 POVERTY Table 6.1 shows the administrative district's median monthly household gross income in Sabah, 2019. The table is quite revealing as three of the districts in Sabah exceed Malaysia’s urban median household income as Kota Kinabalu, RM6,004, followed by Penampang and Putatan districts, about RM5,493 and RM5,119, respectively. Meanwhile, the lowest median household income in Sabah is in Pitas district, about RM1,999. The compounded annual growth rate of median household gross income from 2016 to 2019 administrative districts’ in Sabah revealed that the highest growth is in Tawau (4.60%) followed by Sandakan (4.24%). Meanwhile, Figure 6.6 shows that ten districts in Sabah demonstrate negative compounded annual growth; the lowest is Kuala Penyu (-5.8%). Although Kota Kinabalu and Penampang have the highest median monthly household gross income in Sabah, their compounded growth is stagnant. On the other hand, the median monthly gross household income in Kuala Penyu is significantly higher than in Pitas. Still, it depicts a worrying compounded annual growth rate and needs policy adjustment. Stagnant and negative growth is 0.0 0.1 0.2 0.3 0.4 -2 -1 0 1 2 3 4 5 6 7 2022/2021 2021/2020 Density Peninsular Malaysia Monthly Inflation (% Change Year-on-Year) 0.0 0.1 0.1 0.2 0.2 0.3 0.3 -4 -2 0 2 4 6 2022/2021 2021/2020 Density Sabah Monthly Inflation (% Change Year-on-Year) 0.0 0.1 0.2 0.3 0.4 -4 -2 0 2 4 6 8 2022/2021 2021/2020 Density Sarawak Monthly Inflation (% Change Year-on-Year)

100 quite concerning, considering the hike in the CPI of Sabah. Effective policies from the federal and Sabah state governments are needed to mitigate the risk of degrading the residents’ standard of living. Table 6.1: Administrative District's Median Monthly Household Gross Income and Compounded Annual Growth Rate for Sabah in 2019. District Median Monthly Household Gross Income (RM) Compounded Annual Growth Rate (2016-2019) District Median Monthly Household Gross Income (RM) Compounded Annual Growth Rate (2016-2019) Beaufort 3,765 -0.54 Penampang 5,493 1.76 Beluran 2,849 -0.08 Pitas 1,999 -1.72 Keningau 4,097 1.87 Putatan 5,119 0.046 Kinabatangan 4,102 3.02 Ranau 3,571 -0.29 Kota Belud 3,025 1.03 Sandakan 4,680 4.24 Kota Kinabalu 6,004 1.83 Semporna 3,542 -1.50 Kota Marudu 2,425 3.12 Sipitang 3,944 1.68 Kuala Penyu 2,949 -5.80 Tambunan 3,581 0.70 Kudat 2,592 1.47 Tawau* 4,427 4.60 Kunak 3,723 -1.01 Telupid 2,757 NA Lahad Datu 4,186 -0.30 Tenom 3,525 0.64 Nabawan 3,613 -1.70 Tongod 2,197 0.02 Papar 4,571 1.10 Tuaran 3,736 -0.43 Source: Department of Statistics Malaysia (DOSM) Note: 1) NA is not applicable; 2) * Includes Kalabakan Figure 6.6: Scatter Plots of Sabah’s Compounded Annual Growth Rate Versus Median Monthly Household Gross Income in 2019. Beaufort Beluran Keningau Kinabatangan Kota Belud Kota Kinabalu Kota Marudu Kuala Penyu Kudat Kunak Lahad Datu Nabawan Papar Penampang Pitas Putatan Ranau Sandakan Semporna Sipitang Tambunan Tawau Tenom Tongod Tuaran -5.9 -3.9 -1.9 0.1 2.1 4.1 1600 2600 3600 4600 5600 Compounded Annual Growth Rate (2016-2019) Median Monthly Household Gross Income

101 Scatter plots showing the households' share and households’ income groups in 2019 are depicted in Figure 6.7. The highest distribution of households in Sabah is Kota Kinabalu, which accumulated about 15.7% of the total households in Sabah. Meanwhile, the second and third largest distribution of households in Sabah is contributed by Tawau and Sandakan, 9.9% and 9.4%, respectively. The scatter plots analysis also revealed that the districts with the highest distribution of households tend (above 9.4%) to have more of the Top 20% of the households group. For example, Kota Kinabalu has the highest distribution of households (15.7%), the percentage share of households group for Top 20%, Middle 40% and Bottom 40% are 25.8%, 17.0% and 9.4%. Meanwhile, the districts with the lowest distribution of households (below 5.3%) tend to have more Bottom 40% of the households group. It is proven in Kunak and Kuala Penyu districts, with both 1% distribution of households representing more evidence of the Bottom 40% rather than the Top 20% and Middle 40%. Figure 6.7: Scatter plots of the Distribution of Households (%) versus Households Groups (%) by Sabah Districts in 2019 In 2019, Malaysia’s median monthly gross household income was RM5,873, with RM6,561 in urban and RM3,828 in rural areas. Malaysia's median monthly gross household income data reported a 71.4% gap between the urban and rural areas. Meanwhile, Sabah’s median monthly gross household income was recorded at RM4,235, of which RM5,037 and RM3,172 were reported in urban and rural areas. On the one hand, Sarawak's median monthly gross household income is 7.3% higher (RM4,544) than the reported data of Sabah. However, the gap between the urban and Beaufort Beluran Keningau Kinabatangan Kota Belud Kota Kinabalu Kota Marudu Kuala Penyu Kudat Kunak Lahad Datu Nabawan Papar Penampang Pitas Putatan Ranau Sandakan Semporna Sipitang Tambunan Tawau TelupidTenom Tongod Tuaran Beaufort Beluran Keningau Kinabatangan Kota Belud Kota Kinabalu Kota Marudu Kuala Penyu Kudat Kunak Lahad Datu Nabawan Papar Penampang Pitas Putatan Ranau Sandakan Semporna Sipitang Tambunan Tawau Telupid Tenom Tongod Tuaran Beaufort Beluran Keningau Kinabatangan Kota Belud Kota Kinabalu Kota Marudu Kuala Penyu Kudat Kunak Lahad Datu Nabawan Papar Penampang Pitas Putatan Ranau Sandakan Semporna Tambunan Sipitang Tawau Telupid Tenom Tongod Tuaran 0 5 10 15 20 25 0 2 4 6 8 10 12 14 16 Households Group (Top 20%, Middle 40%, and Bottom 40%) Distribution of Households (%) T20 M40 B40 More Bottom 40% Middle 40% More Top 20% 5.3 9.4

102 rural median monthly gross household income is reported at 81.2% in Sarawak, significantly higher than the national level. However, the gap between urban and rural median monthly gross household income is 58.8%, which indicates it is lower than the national level. Table 6.2: Summary of Median Monthly Gross Income by Malaysia, Sabah, and Sarawak in 2019. Median Monthly Gross household income (RM) Gap Against National Level (%)A Urban Median Monthly Gross Households Income (RM) Rural Median Monthly Gross Households Income (RM) Gap (%)B Malaysia 5,873 0.00% 6,561 3,828 +71.4% Sabah 4,235 -27.9% 5,037 3,172 +58.8% Sarawak 4,544 -22.6% 5,789 3,195 +81.2% Source: Ministry of Economy and authors’ calculation Note: A is a median monthly gross household income (RM) gap for Sabah and Sarawak against the standard national level. It is calculated based on the percentage change of Sabah or Sarawak against Malaysia. A negative sign indicates that the median monthly gross household income is less than the standard national level and vice-versa. B is the urban and rural median monthly gross household income gap. It is calculated based on the percentage changes in urban and rural monthly gross households income.A positive signof the gap indicates that urban is more than rural median monthly gross households income, and vice versa. The study continues by analysing Figure 6.8, showing the scatter plots of the percentage distribution of households versus the incidence of relative poverty in Sabah’s districts in 2019. An estimation based on the incidence of relative poverty is not based on the poverty line income (PLI) but is measured based on the standard of living by household income. A higher percentage of incidence of relative poverty in each district gives an impression of more households earning less than 50% of the median monthly gross household income and vice-versa. In 2019, Pitas recorded RM1,999, the lowest median monthly gross household income in Sabah’s districts. An analysis of the incidence of relative poverty indicates that 56.6% of households in Pitas districts earn less than half of their median monthly gross household income. Tongod and Kota Marudu districts also recorded 49.1% and 42.3% of their households earning less than half of their median monthly gross household income. On the other hand, Penampang district recorded the lowest incidence of relative poverty in Sabah. Whereby 4% of households in Penampang earn less than 50% of their median monthly gross household income. Kota Kinabalu and Sipitang districts are amongst lowest incidence of relative poverty in Sabah, which recorded 5.1% and 6.2, respectively. The results are quite revealing, therefore, extending social assistance and implementing welfare programs in Pitas, Tongod, and Kota Marudu is a must to reduce the risks of a widening gap in the median monthly gross household income.

103 Source: Department of Statistics Malaysia (DOSM) and Authors' Calculations. Note:1) Incidence of relative poverty is estimated based on ½ of the median value. 2)* Includes Kalabakan. Figure 6.8: Scatter Plots of the Distributions of Households (%) Versus Incidence of Poverty by Sabah Districts 2019 Source: Department of Statistics Malaysia (DOSM), Ministry of Economy and Authors' Calculations. Note: * is the average Gini coefficient of all states in Peninsular Malaysia. ** is the average Gini coefficient of Sabah and W.P Labuan. Commonly recognized that a Gini index that is less than 0.200 corresponds with perfect income equality, 0.200 – 0.300 corresponds with relative equality, 0.300-0.400 corresponds with a relatively reasonable income gap, 0.400-0.500 corresponds with high-income disparity, above 0.500 corresponds with severe income disparity. Figure 6.9: Malaysia Divergence: The Inequality Among the Frequency Distribution of Income by Gini Coefficient. The Gini index is an important statistical dispersion measuring income inequality within a nation or social group. The national Gini index estimate ranges from 0.399 - 0.441 across Malaysia between 2007 to 2019, giving an impression of a high Beaufort Beluran Keningau Kinabatangan Kota Belud Kota Kinabalu Kota Marudu Kuala Penyu Kudat Kunak Nabawan Lahad Datu Papar Penampang Pitas Putatan Ranau Sandakan Semporna Sipitang Tambunan Tawau* Telupid Tenom Tongod Tuaran 0 10 20 30 40 50 0 2 4 6 8 10 12 14 16 Incedence of Relative Poverty Distributions of Households (%) 0.340 0.360 0.380 0.400 0.420 0.440 0.460 2007 2009 2012 2014 2016 2019 2022 Malaysia Peninsular Malaysia* Sabah** Sarawak

104 level of income inequality. However, with an effort from the Rancangan Malaysia Kesepuluh (RMK10), all Gini indices across Malaysia divergence recorded a relatively reasonable income gap within 0.300-0.400. The study compares the three divergences and revealed that the highest Gini index is predominantly from Sarawak, followed by Sabah and Peninsular Malaysia. The results from 2007 to 2019 revealed that the coefficient of Gini from Sarawak is 0.387 - 0.448, Sabah recorded a range of 0.365 – 0.421, and Peninsular Malaysia recorded a range of 0.359 - 0.400. 6.3 STATE REVENUE Taxes and government revenue is important tipping point to make a state viable and put it on a growth path. The governments collect revenues mainly for two reasons, to finance the goods and services they provide to each Malaysian and businesses and to fulfil their redistributive role. In 2021, Malaysia recorded 233.7 billion of total revenues, including non-tax and non-revenue receipts. The total revenue increased by about 2.9% after being hit hard by the COVID-19 pandemic. Figure 6.10 depicts shares of Malaysia's total revenue by difference divergence. It is estimated that 94.4% of Malaysian total revenue is contributed by Peninsular Malaysia, 3.3% and 2.3% by Sarawak and Sabah, respectively. Sabah state collected 5.4 billion of total revenues in 2021, whereby 54.7% is shared from tax revenue, 37.4% is contributed by non-tax revenue, and 7.9% is non-revenue receipts. Source: Department of Statistics Malaysia (DOSM), Sabah State Treasury Department, Ministry of Finance Malaysia, and Authors' Calculations. Figure 6.10: Malaysia Divergence: Share of Total Revenue in 2021 Figure 6.11 and Figure 6.12 illustrates the total revenue, operating and development expenditures for Peninsular Malaysia, Sabah, and Sarawak from 2017 to 2021. The allocation of the total revenue is dominated by operating expenditure in three regions. Sabah in 2021 depicted the lowest percentage for about 58% of its total revenue for operating expenditure. Meanwhile, 16% share of its total revenue from development expenditure. The total operating and development expenditures to total revenue in Sabah is 74.1%, which indicates that the government expenses are less than the revenue, giving us an impression of a budget surplus. Running a state with a surplus budget does not promise always to be beneficial. As such, it can sometimes Peninsular Malaysia 94.4% Sabah 2.3% Sarawak 3.3% Malaysia Total Revenue 2021 Peninsular Malaysia Sabah Sarawak

105 come with its problems. The risks of a surplus budget are the decline in investment revenue, public goods and infrastructure as the government is not spending and investing as much as other regions. Another risk that may concern the Sabah state is that operating budget surpluses slow down the economy by reducing aggregate demand, leading to high unemployment and decreased consumer spending. Peninsular Malaysia itself recorded 124.3% of its expenditures to total revenue. Sarawak recorded a budget deficit of 217% of expenditures to total revenue, indicating Peninsular Malaysia and Sarawak expenses are deficit and exceeding their total revenue. Source: Department of Statistics Malaysia (DOSM), Sabah State Treasury Department, State Financial Secretary's Office Sarawak, and Authors' Calculations. Note: The added total may differ due to rounding Figure 6.11: Malaysia Divergence: Total Revenue, Operating, and Development Expenditure from 2017 to 2021. 210,000,000,000 220,000,000,000 230,000,000,000 240,000,000,000 250,000,000,000 260,000,000,000 2017 2018 2019 2020 2021 Total Revenue of Peninsular Malaysia 3,500,000,000 4,000,000,000 4,500,000,000 5,000,000,000 5,500,000,000 2017 2018 2019 2020 2021 Total Revenue of Sabah 6,000,000,000 7,000,000,000 8,000,000,000 9,000,000,000 10,000,000,000 11,000,000,000 2017 2018 2019 2020 2021 Total Revenue of Sarawak 200,000,000,000 210,000,000,000 220,000,000,000 230,000,000,000 240,000,000,000 250,000,000,000 2017 2018 2019 2020 2021 Operating Expenditure of Peninsular Malaysia 2,800,000,000 3,200,000,000 3,600,000,000 4,000,000,000 4,400,000,000 4,800,000,000 2017 2018 2019 2020 2021 Operating Expenditure of Sabah 8,000,000,000 9,000,000,000 10,000,000,000 11,000,000,000 12,000,000,000 2017 2018 2019 2020 2021 Operating Expenditure of Sarawak 40,000,000,000 44,000,000,000 48,000,000,000 52,000,000,000 56,000,000,000 60,000,000,000 2017 2018 2019 2020 2021 Development Expenditure of Peninsular Malaysia 800,000,000 850,000,000 900,000,000 950,000,000 1,000,000,000 2017 2018 2019 2020 2021 Development Expenditure of Sabah 0 4,000,000,000 8,000,000,000 12,000,000,000 16,000,000,000 2017 2018 2019 2020 2021 Development Expenditure of Sarawak

106 Source: Department of Statistics Malaysia (DOSM), Sabah State Treasury Department, State Financial Secretary's Office Sarawak, and Authors' Calculations. Note: The added total to the percentage may differ due to rounding. A percentage of Expenditure to total revenue that is more than 100% indicates a budget deficit where government expenses exceed revenue, and vice-versa. Figure 6.12: Malaysia Divergence: Percentage of Operating and Development Expenditures to Total Revenue. 0 40 80 120 160 200 2017 2018 2019 2020 2021 Percentage Operating Expenditure to Total Revenue of Peninsular Malaysia Percentage Operating Expenditure to Total Revenue of Sabah Percentage Operating Expenditure to Total Revenue of Sarawak Percentage Development Expenditure to Total Revenue of Peninsular Malaysia Percentage Development Expenditure to Total Revenue of Sabah Percentage Development Expenditure to Total Revenue of Sarawak P ercentage to T otal R evenue (%)

107 CHAPTER 7 ADDRESSING STRUCTURAL WEAKNESSES, TRANSFORMING POTENTIAL, AND UNCERTAINTIES INTO OPPORTUNITIES The global economic scenario is still reeling from the pandemic and Russia-Ukraine crisis, fuelling the risks and uncertainties in the business environment. Meanwhile, the World's three largest economies, such as the United States, China, and the Euro area, are stalling, adding more consequences for the global outlook. The higher-thanexpected inflation in these three largest economies is tightening global financial conditions. The economic rebound in China and resilient labour market demand Malaysia to initiate an immediate recovery in its economy from elevated inflation and high interest rates. The economy is projected to grow around 4 to 5 per cent in 2023, expected to be driven by firm domestic demand. For Sabah, the study forecast that the GDP will gradually increase by around 3 per cent from 2022 to 2025 if the state maintains the same effort as 2021. 7.0 IMPACT FROM PREVIOUS DEVELOPMENT TARGET Issue and Uncertainty Sabah government underutilised the local resources. Underperform state's implementation efficiencies of policies, projects, and initiatives to achieve goals. Sabah heavily relies on food imports. The dependence on foreign markets can expose the region to price fluctuations and supply chain disruptions, burdening the state’s cost of living. Sabah needs to build its state reserve. Strong positive correlations between the overnight policy rate (OPR) and core inflation The state has a surplus budget of around 26 per cent. Potential and Opportunity The region is concerned about not fully utilising its natural resources, such as oil and natural gas, to produce its product. Instead, Sabah relies on importing final goods, leading to higher costs and dependence on external markets. Improving the state's implementation efficiencies will potentially improve the forecast figure for 2024. A higher implementation efficiency would mean more planned projects and policies are successfully executed and yield desired outcomes. The positive economic growth and job creation will significantly improve Sabah's development. Sabah government works closely with the local industries and universities to produce food, such as beef, meat, rice or local fruits. Awarding a research grant is vital for the state’s food security. Building a state’s reserve is crucial for Sabah to manage the risks, uncertainties, emergencies, and financial instability. Reserves enable the state government to proceed with its initiatives without immediate federal government funding.

108 Unlike the federal government, the state government may have limitations in borrowing money, making it even more important to have sufficient reserves for their financial needs. An effort to harmonise the OPR in all regions to defend the ringgit, even combating the inflation burdening the household in Malaysia, even more in Sabah, amongst the lowest median monthly household gross income. Current inflation is more cost-push-driven rather than demand-pull inflation. Bank Negara Malaysia (BNM) should be more friendly to the demand-sided Despite the perception of the limited funds, the state government has a surplus budget of 26%. There is a possibility to utilise these surplus funds for various projects and initiatives. 7.1 ALIGNMENT OF SECTORS AND INDUSTRIES Issue and Uncertainty Services sector economic leakage. The concern about the tourism sector with little money staying in Sabah suggests that a significant portion of income might leave the region through external ownership of businesses or outflow of profits to other parts of the state or internationally. Mining and quarrying activity in Sabah is the second-largest share of GDP but employed less than 1% of total employed persons The study forecasts that the agriculture, mining and quarrying, and manufacturing sectors will potentially have stagnant growth in 2024. The study expects persistent unemployment, under-employment, and an economy performing below its potential from 2023 to 2024. Sabahan fishermen face limitations in fishing due to small boats, and the presence of foreign fishing vessels, particularly from Thailand, China, and Vietnam, further affects local fish availability and prices. Sabah plantation owners need more involvement with the innovations. The rising cost of hiring foreign workers is a long-term threat to Sabah's growth. Potential and Opportunity Undoubtedly, an economic leakage in the tourism sector cannot be avoided. The state government must implement the cluster structure strategy through national and international agreements, whether at the export level, supplier level, or economic input level, which can be designed to reduce or minimise economic leakage. The state's policy of producing the final product rather than exporting intermediate goods from agriculture, mining, and quarrying will boost the value added and state revenues. It potentially is one of the stepping stones to transform the manufacturing sector as one of the important contributors to Sabah's GDP. The study sees the manufacturing sector as a key to dealing with the persistent unemployment in Sabah. Expanding the manufacturing sector will attract more foreign direct investment, stimulating Sabah's economic growth.

109 The fish department of Sabah needs to identify the significant fisherman community in Sabah and initiate or improve the existing policy to increase their revenues—the business capital or loan capital is to be subsidised or attractive rate so that their output increase. The use of traditional techniques should be replaced slowly by modern technology as well as bigger or more efficient size boats that are suitable for the Sabah environment. Using satellite imagery such as GPS or fish finder is considered vital. The DOSM reported that fish prices are amongst the cheapest in Malaysia. The government agencies on land transport should provide more active assistance on the marketability of Sabah’s fish products to potential markets, such as Brunei and Sarawak. The Pan Borneo project should be seen as a business opportunity instead of an easy travel time from Sabah to Sarawak. The plantation owners have benefitted from the industry, but there is a need for more innovation. The palm oil industry needs to evolve and explore new ways of improving productivity and sustainability to remain competitive in the global market. This will significantly attract the younger generation to get involved with modern farming. The East Malaysia Planters’ Association (EMPA) highlighted that the industry has faced labour shortages before and after the pandemic. There is a significant reliance on foreign workers due to a mismatch in the required skill set for harvesting jobs. The industry needs to focus on training and upskilling local workers to address this issue. The reliance on the Indonesian labour supply for the palm oil industry has created challenges and may not be a sustainable long-term solution. It is rising labour market demand in Sabah, increasing the wage of foreign workers. It is crucial for the State, through JPSM, to train and develop a skilled, mediumskilled, or low-skilled workforce to reduce dependence on foreign labour. 7.2 FUTURE PLANNING OF THE ECONOMY Issue and Uncertainty Sabah tourism industry slowly reviving, but always depends on uncertainties from outside. In 2020, Sabah’s state reserve was critically low, and it was essential for the government to have a sufficient reserve in case of disasters. The poverty rate is concerning in certain areas in Sabah. Currency depreciation and higher interest rates compared to other countries may lead to investors repatriating funds, affecting the country’s economy. The state government has a surplus budget of 26%. Potential and Opportunity Sabah has many potentials to become a rural tourism-hub, as well as other types of tourism such as agrotourism and ecotourism. However, this potential only can be utilised if there’s sufficient monitoring by the relevant bodies as well as giving incentives to encourage the local industry players involved in tourism. Special emphasis by the state government on tourism under the SMJ initiatives could be much help for reviving the tourism industry.

110 Having around five, six or ideally ten billion in reserve would provide immediate assistance to the people of Sabah during emergencies. Building reserves is crucial for the state government to ensure financial stability, manage risks, and handle contingencies effectively. And also having reserves allows state government to proceed with initiatives even without immediate federal government funding, providing better financial independence. The concept of “one district one industry” can be beneficial, impacting tourism products positively and helping reduce poverty in areas like Pitas. There is a need to increase exports to strengthen the currency, thus increase our national income. The surplus funds can be utilizes for various projects, either a small project or big projects and also provide more incentives or initiatives. 7.3 SCARRING FROM THE PANDEMIC Issue and Uncertainty In 2020–2021, businesses faced various problems such as a shortage of workers, shipping rates going through the roof, and enforced shutdowns due to lockdowns when Covid-19 infection rates spiked. After the reopening of the economy, more uncertainties are coming, making it hard for policymakers to decide what kind of policy is suitable for the current situation of the economy. After the unprecedented Covid-19 pandemic, businesses are still attempting to survive and rebuild in an uneven state of recovery. Business costs and domestic price pressures are becoming a bigger issue and will still exist in 2022. Cost pressures are coming from all directions for large, small, and midsized businesses. Many are trying to manage the same costs and overheads with less revenue. As the economy has recovered, a number of cost-driven factors have weighed on production and costs for businesses, squeezed margins, and threatened company profitability. These factors include supply chain disruptions and restrictions brought on by the pandemic, high shipping and logistics costs, rising raw material costs, higher energy costs, and commodity prices. Potential and Opportunity Under the Sabah Maju Jaya (SMJ) Plan, together with the 12th Malaysia Plan, the uncertainties can be managed and the plans can be optimised in order to make a better decision for the development of Sabah. Many incentives can be provided to businesses, particularly SMEs, to help them endure the post-pandemic crisis, but the incentives should be monitored to ensure that they are being utilised effectively. 7.4 EMPLOYMENT LOSSES RELATIVE TO PANDEMIC AND OTHER STATES Issue and Uncertainty The number of employed persons in Sabah dropped to 1,856.5 thousand in 2021 compared to 1869.7 thousand in the previous year. Sabah recorded the highest unemployment rate (5.0% to 8.2%), followed by W.P. Labuan (5.0% to 7.4%) from 2015 to 2021, higher than national unemployment (3.1% to 4.6%).

111 All the states in peninsular Malaysia and Sarawak showed a lower unemployment rate than Sabah, below the national unemployment rate. The lowest unemployment rate was recorded in W.P. Putrajaya (1.6%), followed by Melaka (2.0%) and Pahang (3.3%) in 2021. Melaka, Kedah, Terengganu and Kelantan were the states that managed to drop their unemployment rate (-2.31% to -9.1%). The mining and quarrying sector recorded 9.2 thousand (0.5%) employed persons, the lowest contributor in 2021. Sabah’s unemployment rate rose by 2.5% in 2022, affected mainly by a fall in employed persons by 4.7% in the services sector and 3.6% in the construction sector. The ratio of unemployment to vacancies is less than 1.0, signalling tighter labour markets with more vacancies than people actively looking for work, giving an impression of potential job mismatch and involvement in the informal job. The oversupply of engineers in the job market, mainly in the construction sector, is concerning. The stagnant momentum of Sabah shares of GDP in the agricultural sector continues in four years forecasts from 2022 to 2025. It is concerning as it gives an impression of reducing the number of employed persons in the agricultural sector in Sabah. Potential and Opportunity Focus on inclusive development. The government aims to achieve inclusive development by decentralising industries and creating job opportunities in various sectors. Projects like setting up industrial areas near residential areas can improve residents’ job prospects. Challenges with foreign workers. The influx of Indonesian workers and their lower wages may challenge local workers regarding wage expectations and skill sets required for specific jobs. It is essential to encourage local workers to progress in their careers and acquire relevant skills rather than remaining in low-skilled positions. Need for training and skill development. With automation, mechanisation, and AI on the rise, there is a growing need to train local workers to meet the demands of modern industries and technology. Need for training and skill development. With automation, mechanisation, and AI on the rise, there is a growing need to train local workers to meet the demands of modern industries and technology. States in Peninsular Malaysia focusing more on manufacturing sectors (more than 30% share of GDP) such as electronic and electronic (E&E) products and refined petroleum products leads to high exports and large job opportunities. Sabah still relies on the agriculture sectors, such as palm oil and natural rubber, contributing a small percentage of the local employed persons due to dependency on foreign workers, mainly from Indonesia. Mining sector potential growth. The previous Commercial Collaboration Agreement (CCA) with Petronas is expected to increase activities in the mining sector, particularly in petroleum-related industries. It could create more job opportunities and may lead to an increase in employed persons in this sector.

112 Skill-specific training prepares the workforce for Sabah’s services and construction sectors. The government is crucial in fostering a synergy between industry needs and workforce development. They must invest in training programs and initiatives that align with the industries they want to attract. Services play a crucial role in economic development, and addressing unemployment mismatch is important for inclusive development under the Sustainable Development Goals (SDG). The palm oil industry has faced labour shortages before and after the pandemic. There is a significant reliance on foreign workers due to a mismatch in the required skill set for harvesting jobs. The industry must focus on training and upskilling local workers to address this issue. The state government needs to consider the plight of unemployed engineers and the focus on workers in the industry. Diversifying the economy and creating more opportunities in different sectors is necessary. Focusing on sectors like manufacturing with higher value-added industries and job creation can help address unemployment among engineers and skilled professionals. Industrial Tree Plantation (ITP) in Sabah aims to replace some of the existing oil palm plantations eventually. Several companies are involved in ITP; all have a 100% Sabahan workforce from rural areas. Consider exploring alternative crops beyond oil palm that can benefit the state more significantly regarding revenue, employment, and downstream opportunities— diversification into herbal plantations. Encouraging plantation owners to explore other crops, such as herbal plants for the herbal medicine industry, could be a viable alternative. This industry presents significant potential, as evidenced by China’s substantial herbal medicine market. Emphasising herbal plantations could lead to new revenue streams and job opportunities. Kalimantan and Africa are becoming significant players in the palm oil industry, drawing investments away from Sabah. This competition reinforces the need for the state to consider diversifying its agricultural sectors to stay competitive and explore new opportunities. 7.5 STATE POLICY ON KEY ECONOMIC DRIVERS Issue and Uncertainty A specific policy for the forestry sector is needed to sustain and improve its potential, productivity, revenue and opportunity. There is a need for a policy that can lead to the skill development of local workers to meet the demands of industries in the various sectors. Lower contribution from the manufacturing sector compared to other states in peninsular Malaysia leads to a high unemployment rate and low GDP per capita. Lack of state’s policy that focuses on increasing local involvement in businesses and entrepreneurship activities. The issue of less effective agro-food policy in supplying food domestically and less dependence on food imports leads to higher food prices.

113 Potential and Opportunity Forest and agriculture sectors have distinct economic contributions and play different roles in Sabah's economy. By reporting on them separately, such as implementing the Integrated Timber Industry Policy (ITP), policymakers and stakeholders can better understand each sector's specific challenges, potentials, and opportunities, which can sustain the timber supply and make it a major sector in Sabah’s economy. Introducing a policy or strategy that can improve the workers' skills, such as the TVET program which essential for preparing the local workforce and ensuring they are ready for industry demands. Work with the higher learning education (IPTA and IPTS), skilled education and industry players to conduct some trainings which can align with the market and industries’ demand. Improve the role of Sabah Job Centre Portal as a one-stop portal which can provide more information regarding the skill training provided by the state government. The state government needs to focus and strengthen the manufacturing sector's contribution by applying a policy that can produce more local products and final goods from the agriculture, mining and quarrying sectors. Collaborate with the industries (local and international companies) and higher educational institutions (IPTA, IPTS and Skilled Institution) to conduct research and development (R&D) to enhance and produce a variety of locally made products which is marketable in both domestic and international markets. The encouragement of businesses and entrepreneurship activities among locals can be started from educational institutions by adopting the Malaysia Digital Economy Corporation’s (MDEC) strategies. In the entrepreneurship course, academic institutions can assist students in finding and gaining experiences from successful entrepreneurs. Easy access to financial assistance. State government can consider having straightforward and transparent policies addressing financial requirements to help local SMEs and those who intend to start their own business. Create a One-Stop Centre for the entrepreneurs consisting of all relevant stakeholders, including ministries, agencies, training and education providers and the private sector players. It is also expected to provide some platforms for local entrepreneurs to partner with domestic and foreign companies and successful businessmen or businesswomen. Uneven power between federal and state government is one of the factor that impeded the development of food sector in Sabah. Decentralization can be one of the initiatives where the state government is given an autonomous power in decision making and policy which can avoid the overlapping function between the federal and state government. The state government need to construct a policy that is able to boost crop production, especially paddy, such as the rice bowl project and improve further the Third Sabah Agriculture Policy, which focuses on how to increase the Self-Sufficiency Ratio (SSR) through the Jelapang Padi Kota Belud program, upgrade and further improve the paddy’s watery system and facilities, increase paddy plantation area and planting certain type or grade of

114 paddy which demanded domestically that leads to reduce the Import Dependency Ratio (IDR) on food sector in Sabah. 7.6 INVESTMENT UNCERTAINTIES Issue and Uncertainty Total investment and the effectiveness of investment towards Sabah economy. Collaboration and understanding among stakeholders. Challenges in attracting foreign direct investment (FDI) as it is the biggest value in Sabah’s total investment. Developing domestic direct investment (DDI) and FDI in Sabah becomes a focus for economic growth. However, investment efficiency can hinder the investment’s contribution to the economy. Geopolitical risks will indirectly affect the inflow of FDI to Sabah. Potential and Opportunity The function of government-link companies (GLCs) in this process and the requirement for effective delivery mechanisms to convert investment figures into concrete development results. Emphasis should be on how these investments can effectively lead to significant development and economic growth for Sabah. The total investment in Sabah is worth RM11.7 billion. However, there needs to be a yardstick regarding the achievement of the results of this investment. This investment value’s ability to translate into Sabah’s economic growth needs to be focused on from a physical perspective and in terms of human capital that can be realised. Continual understanding and collaboration among stakeholders are necessary to ensure the successful implementation of the investment. Regular progress tracking, from day to day and month to month, is crucial to achieving significant growth. External uncertainties could harm Sabah as an attractive investment destination. On the one hand, development projects in East Kalimantan are seen as competition in attracting foreign investors. It should also be an opportunity for Sabah to provide and promote investment opportunities in the state. The current implementation efficiency is modest, hovering around 44%. Consider a hypothetical situation in which implementation efficiency is increased by 60% and the possible effects on the forecasted numbers for 2024. This perspective emphasises the significance of effectively implementing policies, programmes, and initiatives to attain economic objectives. The estimated statistics for 2024 indicate improvements in the case of increased implementation efficiency of 60%. An increase in implementation efficiency would include more planned projects and policies being carried out successfully and producing the expected results. Increased

115 economic growth, the creation of jobs, and Sabah’s general development could all arise from this. 7.7 NEW EMERGING TRENDS IN THE ECONOMY Issue and Uncertainty Economic diversification and investment in industries with higher growth potential can reduce reliance on specific sectors and create a more resilient and balanced economy. The massive increase in the use of technology in communication also brings trends in the economy. However, infrastructure conditions may affect the development of this communication technology. Tourism's contribution to Sabah's economy is vast but lacks focus on understanding the sectors. Potential and Opportunity Sabah currently needs a developed economic value chain in several industries. However, there is a tonne of room for development. Sabah can improve the economy and open up several growth opportunities by putting strategic measures into place and anticipating upcoming developments. Finding solutions to this objective is crucial for enhancing Sabah's economic prospects. The government must upgrade infrastructure conditions and communication networks, i.e., internet connection. The imbalance of internet access speed across the region needs to be minimised. On top of that, the vast increase in the use of technology in communication also brings trends in the economy. Unfortunately, the existing infrastructure in Sabah is challenging to support the development of communication technology. Based on data provided by the Malaysian Communications and Multimedia Commission (MCMC) in the first quarter of 2023, broadband penetration was recorded as 29.7%, among Malaysia's lowest rates compared to other states. The contribution of tourism to the Sabah economy is enormous and has the potential to contribute significantly to the Sabah economy. However, focus is needed to understand the sector and explore new tourism products. In addition, the revenue from tourism products, if channelled to the proper use or purpose, can utilise the maximum tourism revenue 7.8 OTHER UNCERTAINTIES Issue and Uncertainty Sabah's position surrounded by international sea borders can cause Sabah to be exposed to security issues. The political uncertainty of neighbouring countries can harm Sabah's socio-economics. Health crises such as the COVID-19 pandemic have dealt a huge blow to the economic activities of almost all countries in the world. Efficiency in the production of agricultural output and environmental issues are often obstacles to agricultural exports, such as palm oil.

116 Potential and Opportunity Sabah's position surrounded by international sea borders can cause Sabah to be exposed to security issues. For example, the problem of overlapping areas is compounded by political uncertainty in neighbouring countries, which will create problems for the case of refugees/illegal immigrants, impacting social security in Sabah. Nevertheless, from a positive perspective, this position becomes a tremendous economic opportunity. Since Sabah is in BIMP-EAGA, cross-border trade and investment (both goods and services) can boost Sabah's economy. State government agencies in promoting local products to EAGA are significant. In addition, foreign policy with BIMP-EAGA countries also needs to be strengthened to protect the interests of Malaysia and Sabah in particular. Health crises such as the COVID-19 pandemic have dealt a massive blow to the economic activities of almost all countries. The measures to curb the pandemic have affected production, and many companies have even closed their businesses. Nevertheless, the experience of curbing this pandemic has opened up new opportunities to increase productivity among employees by practising the way of working from home. There is no denying that not all types of jobs can be done by working remotely. Economic and environmental balance must be the focus of Sabah's economic development agenda. Ecological sustainability practices help ensure that the needs of the present population can be met without compromising the ability of future generations to meet their needs. Greater resource efficiency means the use of fewer energy resources. Industry players need to apply innovation practices and create more environmentally friendly technologies. Since agriculture is one of the crucial sectors in Sabah's economic development, using advanced technology in agricultural productivity is essential.

117 CHAPTER 8 CONCLUSION Post-pandemic economic growth globally is challenging. It is compounded by geopolitical instability, such as Russia's invasion of Ukraine, which has not yet ended, also affecting the smoothness of the global economy. The slowdown from the three largest economies, such as the United States, China, and the Euro area, worsened the global outlook. The World Bank expects that the global economy will experience slow growth from 2023 to 2025. Even so, the Emerging Market and Development Economies (EMDE) countries partially contributed to the main drivers of the world economy in those years. On the other hand, the economies of developed countries, especially the U.S., Japan, and the Euro area, are slow. From a regional perspective, the overall economy experienced negative growth due to the Covid-19 pandemic. However, the growth pattern is different when entering post-pandemic. The gross domestic product (GDP) growth rate initially increased drastically for 2021. South Asian countries have recorded a higher growth rate than other regions. In contrast, the Sub-Saharan African region recorded positive growth but was relatively small compared to other regions. This positive growth will slow down in 2022. Comparatively, Europe and Central Asia (ECA) recorded the lowest growth. The geopolitical situation in Eastern Europe largely contributed to this slow growth. In addition, other indicators, such as the inflation rate, have recorded a sharp increase. Overall, world inflation is expected to increase by 8.7 per cent in 2022, and the inflation percentage will decrease slowly. Regionally, the ECA is estimated to have experienced the highest increase in inflation, which is close to 12 per cent. At the same time, the Middle East and North America (MENA) region recorded inflation figures that are still under control. A rapid increase in inflation will give a blow to central banks in managing their monetary policy instruments more carefully because it will affect the performance of investments, international trade, and the survival of financial institutions. Malaysia's economy is vulnerable to international crises that can influence its domestic growth and international trade activities. Global supply chains and domestic economic activities have been negatively affected by the COVID-19 crisis and the conflict between Russia and Ukraine, fuelling the risks and uncertainties in the business environment. Fortunately, the Malaysian government's broad economic basis and effective policies managed the country to survive those crises. The Malaysian economy achieved positive growth of 3.1 per cent in 2021, followed by 6.5 per cent in 2022. International Monetary Fund (IMF), through the World Economic Outlook 2023, stressed that global economic growth is predicted to fall by 2.9 per cent in 2023, which led to Malaysia's GDP being projected to achieve a moderate increase of 4.2 per cent this year. The services and manufacturing sectors are still the main drivers stimulating Malaysia's economy, which are expected to rise by 4.96 per cent and 3.86 per cent in 2023, respectively. The main goal of the Twelfth Malaysian Plan (12MP) to become a high-income nation in 2025 is consistent with its tremendous and significant potential for robust productivity growth in international trade. The Malaysian government has implemented several initiatives to boost the productivity of exports, including a faster adoption of digital technology and fostering innovation that could help positive economic growth. Furthermore, Malaysia is growing into new economic areas supporting the valueadded industries and maintaining strong trade partnerships with existing top trading partners and other emerging export markets. In 2022, Malaysia's exports experienced

118 double-digit rises of 25.0 per cent, driven by subsectors of electronic integrated circuits, refined petroleum products and other electrical and electronic (E&E). Singapore, China and the United States are the major trading partners, contributing around 39.4 per cent of Malaysia's total exports. Sabah has been a part of Malaysia for 59 years, since 1963, and it has continued to develop and advance with the rest of the nation. Sabah has transformed from a destitute state to a much better shape with impressive growth in many sectors, especially services, mining, quarrying, and agriculture. Implementing the Sabah Development Corridor (SDC) for 18 years from 2008 to 2025 as one of the five economic corridors initiated under the Ninth Malaysia Plan (9MP) is expected to enhance the standard of living for Sabah's people and stimulate the state's economy. Nowadays, Sabah can be considered one of the highest contributors to Malaysia's GDP. In 2021, Sabah's GDP recorded around 5.7 per cent of Malaysia's total GDP, the sixth place over 15 states behind Selangor, W.P. Kuala Lumpur, Johor, Sarawak and Pulau Pinang. For a record, around 72.3 per cent of the total GDP contributed by all these six states in 2021. Like the other states, Sabah has been affected by the COVID-19 crisis, where its GDP contracted by 9.2 per cent in 2020. Nonetheless, the state government's robust policies and effective initiatives managed to slow down the economic contraction with an increase of 1.1 per cent growth in 2021. This positive growth is expected to continue in the future, led by the services, agriculture, mining and quarrying sectors, as well as the potential of the construction sector. Under the SDC projects such as the Sabah Oil and Gas Terminal (SOGT), Sabah Ammonia-Urea plant (SAMUR), the Palm Oil Industrial Clusters (POICs) and the Kinabalu Gold Coast Enclave are several initiatives implemented by the state government to bring the positive growth for Sabah's economy. Sabah's services sector plays an essential role in advancing Sabah's economy in the future. The services sector comprises many industries and activities, but tourism-oriented services stand out among these activities. This is because most of Sabah's service sector is related to tourism, accommodation and food and beverages, transportation and storage, and wholesale and retail trade. Tourism is a significant contributor to Sabah's services sector. The influx of visitors benefits the tourism and hospitality industries, including hotels, restaurants, and tour operators specifically and to the services sector as a whole.

119 APPENDIX

120 ROUNDTABLE DISCUSSION 27 JULY 2023

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