Monday, 3 Aug 1998
How Malaysia avoided a debt trap
by Martin Khor, Director, Third World Network
Thailand, Indonesia and South Korea had to seek an IMF rescue because their private sector had taken on too much short- term foreign loans in the new environment of financial liberalisation. In Malaysia, financial rules were also relaxed and private sector foreign debt also rose rapidly. But Bank Negara retained one key regulation, which helped the nation escape the debt trap. Serious problems remain however and measures should be taken to build up reserves. (Second in a series on Background to the Asian crisis).
Why has Malaysia avoided (at least so far) the fate of Thailand, Indonesia and South Korea, whose financial crises were so severe that they had to go to the International Monetray Fund for rescue?
These three countries shared some common crucial features: they had gone through financial liberalisation and allowed their private sector to freely borrow in foreign exchange; they had built up large and particularly short-term external debts; they were hit by steep currency depreciation; and finally, their foreign reserves were no longer sufficient to service the loans.
Malaysia shared some of the features of the other three countries, but there were also some differences. And these differences in the end proved crucial in enabling the country to so far survive the crisis without having to seek an international rescue.
Liberalisation and debt: the Malaysian case
Like the other East Asian countries, Malaysia also went through a process of financial liberalisation. In recent years, there has been a relaxation of previous rules relating to inflows of funds from abroad, and the exit of funds to abroad.
There has been much greater freedom for foreign funds to invest in the stock market, for conversion between foreign and local currencies, and for both locals and foreigners to transfer funds overseas.
There were large inflows of foreign funds, but a large part of these entered not so much as bank loans but as portfolio investment.
According to the Bank Negara's Annual Report 1997, large amounts of short-term foreign funds entered in 1992 and 1993, mostly in the KL stock market, pushing its capitalisation to 375% of GDP at end- 1993. Bank Negara intervened to discourage such funds and the trend reversed so that there was a gradual outflow.
In 1997, there was a reverse problem, with a large outflow of funds by foreign portfolio investors. The value of shares in the KLSE fell by half in the second half of 1997, an unprecedented development.
The KLSE composite index fell from 1238 (end 1996) to 594 (end 1997) and market capitalisation from RM807 billion (end 1996) to RM376 billion (end 1997). On July 25, 1998 the KLSE composite index stood at 418.
Although Malaysia joined the rest of East Asia in the financial liberalisation process, it did retain control of one item. And that has made a great deal of difference.
Bank Negara still required that private companies wanting to borrow foreign-currency loans exceeding RM5 million must first obtain the Bank's approval.
Approval is generally given only for investments that would generate sufficient foreign exchange receipts to service the debts, according to the Bank Negara report.
Companies are also not allowed to raise external borrowing to finance the purchase of properties in the country.
Thus there was a policy of "limiting private sector external loans to corporations and individuals with foreign exchange earnings" and this, says Bank Negara, "has enabled Malaysia to meet its external obligations from export earnings."
According to Datuk Paul Low, president of the Federation of Malaysian Manufacturers, this ruling saved Malaysia from falling into the kind of foreign debt crisis faced by Thailand, Indonesia and South Korea.
It acted as a contraint on the rise of short-term private-sector borrowing, which also took place in Malaysia. As a result of this control, Malaysia's external debt has been kept to manageable levels.
Nevertheless, there are two problems: the debt has been rising in recent years, and the debt servicing burden in terms of local currenecy has been made heavier by the sharp ringgit depreciation.
Between the end of 1990 and end-1996, when the ringgit-dollar exchange rate was stable, Malaysia's external debt rose from RM45.9 bil to RM97.8 bil, according to Bank Negara's Monthly Statistical Bulletin for May. Of the total 1996 debt, only RM10.5 bil was government debt, RM29.2 bil was debt of non-financial public enterprises and RM58.1 bil was held by the private sector (including RM17.3 bil by the banking sector).
The high build-up of private corporate debt indicates that some corporations did get Bank Negara approval for significant foreign loans.
The second problem, more serious than the first, was the effect of ringgit depreciation on debt stock and servicing. Between end-1996 and end-1997, Malaysia's foreign debt shot up from RM97.8 bil to RM168.3 bil (a hefty 72% increase).
Most of this dramatic increase was caused by the ringgit depreciating from 2.53 to 3.89 to the dollar in the same period.
The debt had increased from US$39 bil to US$43 bil (only a 10% rise), using these exchange rates.
If the exchange rate had remained at the 1996 level, then the debt would have been only RM109 bil at end-1997 instead of RM168 bil.
Insofar as the ringgit's rate of decline has "overshot" what would have been justifiable by economic fundamentals, this imposes an unfair burden on the country.
The BN Annual Report 1997 (p51) reveals the following. In pre- crisis end-June 1997, the country's external debt was US$45.3 billion, or MR114.3 billion at the then exchange rate of RM2.52 to the dollar.
At end-December 1997, the external debt had reduced to US$42.7 billion, but this was now equivalent to MR166.2 billion as the exchange rate had fallen to RM3.895 to the dollar.
Of this end-of-year total, US$32.5 billion was medium and long-term debt whilst short-term debt was US$10.2 billion (RM39.7 billion) or 24% of total debt. This reflected the low reliance on short-term borrowing by the non-bank private sector.
"The bulk of the short-term debt was borrowing by commercial banks, and for the most part was fully hedged against contracts with their exporting clients," says Bank Negara.
Total short term private sector (bank and non-bank) debt was RM39.7 billion, substantially lower than Bank Negara's reserves of RM83.7 billion (ie external reserves of RM59.1 billion plus exchange rate revaluation gain of RM24.6 billion).
As at end-Dec. 1997, total external debt due in 1998 (ie short-term debt plus medium and long term debt with remaining maturity of less than one year) would amount to US14.4 billion or RM57.7 billion.
This, according to Bank Negara, is well below the ringgit equivalent of of reserves of RM83.7 billion. (This was equivalent to US$21.7 billion).
"While a substantial part of external loans due in 1998 are hedged, some corporations are likely to experience liquidity problems resulting from the magnitude of the currency depreciation. To address these problems, many of these borrowers intend to restructure their debts, including the option to roll over existing loans or to extend the repayment period." (BN Report 1997:p51).
The relatively low debt level, especially short-term debt, is what distinguishes Malaysia from the three countries that had to seek IMF help. This has given the country a better chance to fight its way out of the financial mess and the recession.
But we are not out of the woods yet. It is vital that the foreign reserves are kept high enough so that the external loans can be comfortably serviced.
The National Recovery Plan released last week has identified the need to raise the country's external reserves, and set a target of raising the level to the equivalent of five months of retained imports.
A serious attempt to reach this target should be one of the key priorities of the Recovery Plan, in order to protect the nation's ability to service its external debt.