SUNS  4290 Tuesday 29 September 1998



Malaysia: Radical, but necessary, capital and exchange controls


by Walden Bello

Bangkok Sep (Focus-on-Global-South) -- While it is the unravelling of the economies of Thailand and Indonesia that has fixated world attention over the last year, the turn of events in Malaysia has been no less ominous.

Before the imposition of capital and currency controls on September 1, unemployment had risen to 6.7% and government statistics showed that 2600 people were losing their jobs every week. Average per capita income had been reduced from $5,000 to $3000 in less than one year. By mid-1998, the economy was in a freefall, with the contraction of production and trade coming to 6.8% in the second quarter, between April and June.

It is these trends that formed the backdrop for Prime Minister Mahathir Mohamad's fiery denunciations of global capital markets.

"That the unfettered, unregulated free market has destroyed the economies of whole regions and of many countries in the world does not matter," Mahathir wrote recently in Time. "The important thing is that the system is upheld."

Interestingly enough, some dyed-in-the-wool free marketeers appeared to agree. The Economist, for instance, conceded that "the economic pain being imposed [by global capital markets] on the ex-tigers is out of all proportion to the policy errors of their governments."

In a bold, dramatic move in early September, Mahathir carried out what was tantamount to secession from the global free market system by erecting a system of capital controls that effectively walled off Malaysia from the machinations of currency speculators, hedge funds, and other speculative marauders. Establishment circles uniformly condemned the move, often-times without even looking at the elements of the Mahathir Plan.

The fact that the strategy was accompanied by the ouster of Deputy Prime Minister Anwar Ibrahim and the concentration of even more power in Mahathir's hands also clouded its reception in many quarters. Yet, under the circumstances, the capital and currency controls made good economic sense. The period leading up to the emergency measures was marked by intense speculative activity, both against the ringgit, the Malaysian currency, and in the stock market.

Said Mahathir: "Every time we try to reduce the interest rates they will push down the value of the shares, they will push down the value of the currency so that creates a lot of damage to us. Each time we try to do anything they fiddle around with the currency and stock markets"

These speculative activities resulted in the currency, the ringgit, losing 40% of its value against the dollar and the stock market's capitalization being reduced by almost $500 million, or by 75% of its
total worth. Some RM 20 billion or US$ 4.7 billion found its way to banks and funds outside the country, much of it earmarked for currency speculation. Mahathir appealed to the International Monetary Fund to regulate currency trading, but, not unexpectedly, that request fell on deaf ears. Desperate conditions called for desperate measures, and these were imposed on Sept. 1. "This is probably the last resort as we see no other way," said the Malaysian leader.

The measures included making the ringgit nonconvertible by withdrawing it from international circulation; fixing the exchange rate at 3.80 ringgit to the dollar; allowing repatriation of investments and profits by investors only after a year; and limiting the amount of foreign exchange that can be brought out of the country by travelers.

To withdraw the ringgit from international circulation, the Malaysian authorities required that all ringgit held outside the country had to be repatriated to Malaysia by September 30. In words directed at currency speculators, said to hold billions of ringgit in bank accounts in Singapore and Hong Kong, Mahathir warned that "If not repatriated by then, we will regard such ringgit as invalid and we will not allow the ringgit to be returned to Malaysia in any form whatsoever."

By making the ringgit non-convertible, Mahathir made it possible for the government to fix the exchange rate, and opening the way to lower interest rates. Under the floating rate system that the country was forced to adopt last year, at the beginning of the financial crisis, keeping local interest rates high, and attracting dollars into the country, was the key mechanism to prevent the value of ringgit from falling. But high local interest rates had been killing local businesses and sending the economy into a downspin. Now, with the link between the exchange rate and interest rates broken, "our companies," said the Malaysian leader, "would be able to revive; they can now borrow more money." Moreover, lowering the interest rate would prevent more bankruptcies and upgrade the financial status of local banks since borrowers could once again service non-performing loans.

According to Mahathir, the 12-month restriction on foreign investment leaving the country is intended to discipline speculative investors, not bar them from the local stock market.

"If they want to invest in shares they can but such investment must stay in the country for at least one year. They cannot come and invest and dispose or push up or down the value of the shares. What has damaged the stock market is this practice of buying a share repeatedly so as to push the value of the share to a high level, so much so that the price of the share bears no relation with the performance or assets of the companies. Once it reaches a very high level, the investors will dump or sell off completely, take the money and go out of the country, leaving the locals with this company which has lost its value. We do not want them to come in and do that kind of thing."

As for "genuine long-term investors," although their investment would also be locked in for one year, Mahathir claimed that the measures would actually "facilitate their investment because they will know exactly how much money to bring in because the exchange rate will be fixed and if they can make any profit here and they want to remit their profit back home, then they can change their profits made here from ringgit into whatever currency and that currency can be remitted out of
Malaysia."

Mahathir took pains to stress this because, in fact, despite the gyrations in the stock market, fore direct investment has continued to come into the country, with FDI approvals up by 45% in the first
quarter of 1998.

"Despite criticism over grandiose projects," noted the Singapore Straits Times, "the fact is Malaysia has built some excellent infrastructure that makes it attractive to foreign investors seeking a
manufacturing base."

Indeed, it was partly to ensure a degree of macroeconomic stability that would keep FDI flowing in that the capital controls were adopted.

A lot of doomsday rhetoric was heard when the controls were imposed. But what has actually been the impact of the Mahathir strategy so far?

Moody's, the rating agency, downgraded Malaysia's credit rating to one notch above junk bond status, but that was expected. Otherwise, Mahathir's moves appeared to have had the desired effects so far.

By the third week of September, about RM 11 billion of the 20 billion that had been sloshing around in foreign banks had flowed back home, with their holders afraid of missing the Sept. 30 deadline, after which all ringgit held outside Malaysia will become worthless.

An analyst with Standard and Poor's, another rating agency, conceded that the inflow of ringgit had been accelerated and the outflow of short-term funds had been stemmed in an "unconventional manner."

Stocks have rallied, "creating an impression," according to the South China Morning Post, "that the economy is on the road to recovery." Car sales -- a good indicator of consumer confidence in the economy-shot up to 12,000 in September, from 5,000 a month earlier.

"For now," reports the Far Eastern Economic Review, "investors - foreign and domestic - are savouring the ringgit's stability." This stability, coupled with the slashing of interest rates, has eased the pressure on domestic producers, allowing planning and production to become predictable again.

Kuala Lumpur's technocrats expect not just to neutralize recessionary trends but to trigger a reflation of the economy to the tune of 10% of gross domestic product, or about 13 billion ringgit.

It is, of course, too early to judge the Mahathir experiment a success of failure. The political crisis spawned by the dismissal and arrest of Anwar may yet torpedo the economic recovery.

One thing is certain, however: there is no turning back for Mahathir. As he told the world recently: "Malaysia cannot wait. Malaysia has chosen to become a heretic, a pariah if you like. Our appeal to the world community to regulate and bring order to the market has gone unheeded. If the international community cannot change, then Malaysia must undertake its own reform. We may fail, of course, but we are going to do our damnedest to succeed, even if all the forces of the rich and
the powerful are aligned against us. God willing, we will succeed."

(Dr. Walden Bello is co-Director of Focus-on-the-Global-South, an autonomous programme of policy research and action of the Chulalongkorn University Social Research Institute, CUSRI, based in Bangkok, and which produces a regular electronic bulletin, Focus-on-Trade, providing updates and analysis on regional and global trade and finance. The above commentary is extracted from the bulletin)