Mal Mac

An Insight into
Macroeconomic Policy Management

and Developments in Malaysia
Mohd. Haflah Piei and Tiangchye Tan
Mohd. Haflah Piei is Deputy Director, Malaysian Institute of Economic Research.

Tiangchye Tan is Senior Research Officer, Malaysian Institute of Economic Research.
2 A STUDY OF FINANCIAL MARKETS
Introduction investment. Business confidence remained strong in
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1996 as seen in the continued increase in proposed
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Maintaining the delicate balance between high growth investment from the manufacturing sector through-
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and macroeconomic stability has become one of the out the year. With the consumer price index (CPI)
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most challenging tasks of the 1990s. Runaway growth increasing a mere 3.5 percent, inflation remained low.
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since the end of the 1980s has led to an overheating On the whole, economic growth in 1996 was still
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of the Malaysian economy, resource constraints, and considered rapid and the external position of the
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infrastructure bottlenecks, especially in the early economy improved significantly due to a much lower
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1990s. Shortages of labor became a serious concern growth in imports. The merchandise trade balance
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for investors. On the other hand, the increasing num- registered a much higher surplus of RM8.6 billion in
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ber of immigrant workers gave rise to serious con- 1996 compared to the 1995 figure of only RM233
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cerns. Eventually, limiting their recruitment became million. The current account deficit narrowed con-
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a policy option to sustain growth. Instead, Malaysia siderably in 1996 to RM13 billion from the previous
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began to recognize the importance of sustaining fu- year’s figure of RM18.7 billion as a result of a slightly
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ture growth and development through increasing pro- improved services balance, which recorded a lower
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ductivity. This will be imperative in addressing the deficit that year. As a proportion of nominal gross
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various challenges that have emerged during the pe- national product (GNP), this amounted to -5.5 per-
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riod. Strategically, it will be necessary to tackle the cent in 1996 as compared to the previous year’s fig-
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prospective loss of competitiveness vis-à-vis other ure of -9 percent. In macroeconomic terms, these
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emerging economies, inflationary pressures, and lag- developments indicated that the Malaysian economy
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ging labor productivity as a result of rising wages. was still expanding at a healthy rate in 1996.
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Growth in the Asia-Pacific region moderated As such, 1997 was ushered in with much opti-
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slightly in 1996, mainly as a result of a sharp slow- mism, despite indications that the peak was over.
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down in merchandise exports brought about by the Growth was expected to continue to remain strong
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declining demand for electronic products, especially and was projected at 8 percent for the year. Funda-
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semiconductors. Compared with robust growth of mentals could still be described as strong. Inflation
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9.5 percent in 1995, the Malaysian economy’s growth continued to be low. The current account deficit was
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fell to 8.6 percent in 1996. This was mainly due to expected to further narrow as a percentage of GNP,
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much slower growth in domestic demand especially

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while the public sector fiscal position was expected

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in private investment expenditure. As the second to be in surplus. This optimism was probably due to a
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largest component of real gross domestic product strong feeling that adjustment measures to address
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(GDP), with a share of 32 percent in 1996, private the existing economic imbalances would achieve a
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investment declined sharply from a high of 25.4 soft landing in terms of a more sustainable growth
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percent in 1995 to only 7.2 percent the next year. with stability (Bank Negara Malaysia [BNM] 1998).
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In the trade sector, the deficit on net exports fell by In a situation of full employment and capacity, and
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18.6 percent following a rise in the deficit of 105.1 infrastructure constraints, concern began to mount
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percent in 1995. Higher growth in exports relative on the adverse impact of too rapid growth. Excess
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to import growth contributed to a lower net deficit. demand pressures on the balance of payments and
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The federal Government budget was in surplus the disproportionate expansion in bank credit, espe-
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for the fourth consecutive year in 1996 and the defi- cially loans to finance unproductive sectors, had be-
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cit in the external payments (current account) was gun to raise questions. Another issue concerned the
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fully financed by a net inflow of long-term corporate intense competitive pressures on Malaysian exports
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AN INSIGHT INTO MACROECONOMIC POLICY MANAGEMENT AND DEVELOPMENTS IN MALAYSIA 3
from lower-cost producers. Remedial measures in- In tandem, the Malaysian bourse, the Kuala Lumpur
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stituted since 1995 to alleviate the situation seemed Stock Exchange (KLSE), saw prices diving during the
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to have produced some results, including a signifi- period. Thus the Malaysian economy, which had, until
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cant improvement in the external balance as well as early 1997, been regarded as one of the star perform-
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a moderation in the inflation rate in 1996. Further ers of emerging East Asia, began to experience a turn-
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prudential measures announced in the beginning of about in performance. Notwithstanding the acclaimed
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1997 boosted confidence that measures were in place fundamentals, the economy succumbed.
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to reduce credit and monetary growth as well as to The economic turmoil and instability following the
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preempt rises in asset inflation (BNM 1998). onslaught of the crisis raised various questions on
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Therefore, when the Thai baht was first hit by a the effectiveness of macroeconomic policies and
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wave of speculative selling in mid-May 1997, and governance in the region. The debate over East Asia’s
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the subsequent contagion effect was initially felt, “economic model” that brought years of phenom-
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Malaysians maintained a certain calm and optimism. enal growth to the region subsided. The cry of the
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After the free-floating of the baht in July and the “triumph” of Asian values over Western practices
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ensuing effect folded in, reality began to take hold. ○
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dissipated into naught. Malaysia’s immediate con-
The Malaysian Government’s first reaction was to cerns in the aftermath of the crisis were stabilizing
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try to maintain the status quo by rushing in to defend financial markets, restoring investor confidence, and
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the national currency. After July, the regional eco- strengthening the resilience of the economy to po-
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nomic situation took a radical turn for the worse. tential systemic risks arising from the contagion ef-
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In the half decade before the Asian crisis, the Ma- fects. The initial focus of macroeconomic manage-
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laysian ringgit exchange rate had been hovering in a ment was along these lines.
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narrow band of between RM2.36 and RM2.51 to the The first part of this paper will feature a brief
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dollar. The slide of the Malaysian ringgit against the overview of macroeconomic policies in Malaysia
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dollar and most other major currencies began in March before the crisis. Following this, it will deal with de-
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1997. From a level of 2.48 against the dollar that month, velopments during the crisis period, while comment-
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the ringgit slid to 2.52 in June. In the face of a specu- ing on and discussing measures taken by Malaysia
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lative attack in July, it then plunged to an average of to alleviate and remedy the situation.
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2.57. The central bank, BNM, tried to uphold the cur-

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Overview of Macroeconomic
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rency for about a week but was finally forced to float

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it on 14 July, by which time the bank had already lost

Policy Management in the
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close to $1.5 billion in its efforts to prop up the ringgit.

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Years Preceding the Crisis

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By the end of 1997, the ringgit depreciated to a low of

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RM3.77 against the dollar. Worse followed in 1998 as The main objective of Malaysia’s macroeconomic
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the ringgit plunged to an all-time low of RM4.88 to the policy is to promote the highest sustainable rate of
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dollar on 7 January, a depreciation of 48 percent within growth consistent with exchange rate and price sta-
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half a year. It eventually pegged at an average of bility, while at the same time keeping control on in-
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RM4.40 to the dollar for the month. By April 1998, flationary trends and improving external balances.
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the ringgit settled at an average of RM3.73 to the

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Interest Rates and Credit Policy

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dollar. More wide swings continued. All these trig-

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Instruments
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gered panic among businesses and policymakers, se-

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verely undermining confidence in the country (Malay- In 1987, guidelines and measures were instituted to
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sian Institute of Economic Research [MIER] 1998). improve and rehabilitate the financial sector. The gap
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between lending and deposit rates narrowed and creasingly difficult to interpret as a result of the
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competition began to intensify. The central bank re- interaction of externally induced growth of money
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viewed the interest rate system and in February 1991, supply with the rapid rise in money demand due to
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controls on the base lending rate (BLR) were lifted. the wealth effect of rapid economic growth and the
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The behavior of the BLR and interest rates fell more need to finance the buoyant stock market. The cen-
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in line with the market, and the spread between av- tral bank, in its interventions, had to ensure that rais-
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erage lending rates and the average cost of funds of ing interest rates to reduce consumption would not
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commercial banks further narrowed in the early dampen investments. Thus, as part of its strategy,
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1990s. BNM intervened in the foreign exchange markets.
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In 1989, the statutory reserve requirement (SRR) When foreign interest rates were lower, local inter-
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was revised to one uniform rate applicable to all com- est rates were reduced while maintaining the gap.
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mercial banks, merchant banks, and other financial BNM also used direct short-term borrowing from
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institutions to level the playing field (Economic and the interbank money market on a large scale to ster-
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Social Commission for Asia and the Pacific 1997). ilize the large inflow of funds. To prevent a further
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The central bank was also able to make use of this reduction of interest rates, Malaysian Government
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requirement as an effective tool for monetary control papers were issued. In 1993, a series of Bank Negara
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and to contain inflationary expectations. Between 1992 bills (BNB) and Malaysia Saving Bonds comple-
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and 1994, Malaysia experienced large capital inflows. mented these. Nevertheless, short-term inflows per-
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During this period, the central bank adopted a tight sisted and such funds normally result in an immedi-
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monetary policy and increased the statutory require- ate increase in the monetary base without a corre-
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ment to mop up excess liquidity in the system. sponding increase in fixed investments. The volatil-
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Among other monetary tools employed by BNM ity of these funds creates instability in both the do-
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to reinforce the policy impact were the minimum li- mestic and external sectors. In 1994, sterilization
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quidity ratio, the management of the Government’s measures were eased as tight liquidity was pushing
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excess funds, and the Employees’ Provident Fund interest rates up, resulting in continuous capital in-
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(EPF). (At the end of 1993, excess funds from the flow. Direct controls were then imposed. These in-
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EPF were placed in a money market account at the cluded the introduction of a ceiling on the net exter-
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central bank.) The management of these funds al- nal liability position of commercial banks, prohibition
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lowed the Government to mop up liquidity at source

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on the sale of short-term monetary instruments to

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to ensure consistency between its fund allocation and nonresidents, and prohibition on banks from buying
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monetary policy as well as to enhance flexibility in foreign currency forwards. Measures requiring
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monetary management. nontrade related foreign funds to be subjected to the

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Continuous capital inflow into the economy in the SRR were also imposed (nonspeculative funds and
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first half of the 1990s arising mainly out of relatively those placed in noninterest bearing external accounts
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low interest rates and liberal exchange control sys- were exempted). Similarly, limits on swap transac-
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tems in developed economies; Hong Kong, China; tions with foreign clients were imposed occasionally
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and Singapore increased pressure on BNM to con- (e.g. in 1988/89 and 1992).
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trol money supply. There were then conflicting ob- Malaysia also engaged in moral suasion to dis-
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jectives between a contractionary monetary stance courage excessive lending for speculation and to
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meant to control inflation and the need to maintain encourage long-term financing on the basis of viabil-
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low interest rates to discourage more speculative ity rather than collateral as well as to increase lend-
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funds. Similarly, monetary aggregates became in- ing to priority sectors. By the second half of 1994,
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differentials between domestic and international in- The Financial Sector
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terest rates had narrowed and even became nega- The Malaysian financial sector has experienced a
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tive, resulting in a net outflow of short-term funds. radical transformation and deepening in tandem with
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Direct controls were then lifted in response. In 1995, the development of its economy since the 1980s.
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the BLR framework was revised again and was Reflective of these developments, the current finan-
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aimed at enhancing the responsiveness of the BLR cial intermediation regime has become much broader,
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to money market conditions and the liquidity situa- deeper, better structured, and more purposefully or-
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tion of the financial system. This was meant to en- ganized compared with the relatively simple struc-
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hance institutions’ efficiency. ture during the postindependence years.
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Malaysia has not initiated full-scale financial lib-
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Exchange Rates
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eralization. In the past, the main pillars of reform
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In 1989 and similarly in 1992, BNM imposed restric- have been the reinstatement of interest liberaliza-
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tions on the liberalized exchange market to reduce tion, the liberalization of foreign exchange and capi-
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speculation by limiting nontrade related currency tal transactions, the easing of restrictions on busi-
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swap transactions (Claassen 1992). As the Malay- ○
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ness, the improvement and expansion of regulatory
sian economy began its high growth path and the and supervisory structures, and the development of
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Government implemented deliberate policy measures the capital market. Full-scale liberalization is inevi-
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to curb capital outflows, the situation began to re- table as the World Trade Organization (WTO) has
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verse when the value of the ringgit appreciated at made it mandatory for all member-nations to adopt a
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the start of the 1990s. These measures included the freer policy on services by the year 2003 through the
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sale of Government securities and increases in statu- General Agreement on Trade in Services (GATS).
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tory reserves. The position was also helped by a (Under Malaysia’s offer schedule for services, no
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weakening of most major currencies during the pe- new entrants are allowed into the banking subsector,
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riod. The ringgit’s rise began to reverse after 1991, except through share acquisition of existing firms.)
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mainly due to persistent current account deficits. The As the economy continued to improve in the late
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situation experienced a dramatic turn at the end of 1980s and early 1990s, more vigorous measures were
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April 1997, affected by the now historic consolida- instituted to strengthen and modernize the system.
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tion of the stock market and short-term capital out- They were also meant to promote greater competi-
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flows. tion within the banking system. In the early 1990s,

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Under a flexible exchange rate system, capital Malaysia began paving the way for a more devel-
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inflows will lead to the appreciation of the recipient oped securities market infrastructure in line with its
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country’s currency, a reduction in the relative price development. In 1992, the Securities Commission
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of imports, and a shift in consumption away from (SC) Act was passed. The SC, set up to oversee the
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nontradables. All these eventually tend to alleviate efficient and overall development of the capital mar-
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inflationary pressures. Under a fixed exchange rate ket, began operations in March 1993. Its responsi-
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system or a managed float, the impact depends on bilities include the regulation of the securities indus-
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whether the inflow leads to an expansion of the mon- try, unit trust schemes, and mergers and acquisitions
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etary base, heightened inflationary pressures, or a of companies. The Futures Industry Act, aimed at
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deterioration of the country’s external position. Ma- facilitating financial innovations to develop the op-
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laysia does not maintain a fully flexible exchange rate tions and financial futures markets, came into force
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regime. Occasional interventions by the Government the same year. This established the legal framework
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take place to smoothen fluctuations. for the protection of investors and stability in the
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marketplace by setting up the minimum standards lowed by a tighter monetary policy. The high-growth
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within which the markets should operate (MIER climate of the first half of the 1990s presented the
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1998). opportunity for the Government to address tax re-
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As foreign funds continued to flood the country in forms. Paradoxically, however, fiscal policy did not
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1992–1993, the Government prohibited all residents move in the direction it should have.
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from selling short-term monetary instruments (those In the preceding years, liberal personal and cor-
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with remaining maturity of one year or less, namely porate income-tax cuts, and other tax-based incen-
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BNBs, Treasury bills [T-bills] and Government se- tives were used to stimulate recovery. This under-
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curities) to nonresidents with effect from 24 Janu- mined the tax system as an essential source of rev-
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ary 1994 under the Exchange Control Act of 1953. enue. Given the increasingly competitive economic
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This restriction was subsequently extended to cover environment among regional countries, any move to
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private debt securities (PDS) including commercial reverse this would most likely have affected
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papers but excluded securities convertible into ordi- Malaysia’s competitiveness. However, an indirect tax
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nary shares, effective 7 February 1994. The move system could have been introduced whereby the po-
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was meant to discourage substantial holdings of mon- tential to raise revenue was restored. Although the
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etary instruments by nonresidents to enable the cen- need for such a system was recognized earlier in the
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tral bank to better manage liquidity. decade, nothing came of it (Narayanan, 1998). In
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When the Asian crisis hit, many claimed that the fact, from 1992, there was a move towards a fiscal
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Malaysian economy would not have been so badly loosening leading to further cuts in corporate and
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affected had the financial system been sound and personal taxes, the lowering or abolition of import
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better managed such as those of Singapore and taxes on a variety of imports (primarily consumption
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Taipei,China. Such an assessment is not easy to quan- goods), and increased federal Government spend-
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tify or prove. Nevertheless, it must be realized that ing. In 1992, expenditures increased with the deci-
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despite the financial reforms and adjustments since sion to raise the salaries of civil servants.
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the 1980s, weaknesses obviously prevailed and the Continued high growth in 1993 yielded a surplus
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question of efficiency still existed. in the public sector budget and eventually blinded the
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Government from realizing the urgency and wisdom

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Fiscal Policy of a turnaround in fiscal spending. In such periods, a

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Countries react differently to external shocks and in

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rationalized indirect tax structure would have helped

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many of those that have been successful in averting to remove distortions, contributed to moderating
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crises, sound fiscal management and stable exchange growth, and simultaneously curbed inflationary pres-
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rates have been among the elements playing a vital sures. It would also have laid down the infrastruc-
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role. In Malaysia, fiscal policy has generally been ture for an eventual introduction of a broad-based
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directed at revenue generation and the provision of tax on consumption such as the value-added tax
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expenditures to support basic infrastructure as well (VAT). Politically it would have been the right mo-
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as maintaining law and order. ment for such a move as incomes were fast rising. It
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As the economy continued to grow rapidly after was, however, not to be so.
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the crisis of the mid-1980s, there did not seem to be

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International Trade, Industrial and

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any need for large fiscal stimuli. When BNM cau-

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Investment Development
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tioned that the economy might be overheating in the

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early 1990s, prudence and measures to moderate Trade has been one of the essential elements con-
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growth were recommended. This was, in fact, fol- tributing to Malaysia’s growth over the past two de-
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cades. The country has a small domestic market and leges from these NIEs in 1988 and the economic
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as a trading nation, it has always adopted one of the and financial deregulation undertaken by East Asian
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most open policies in Asia. Essentially, its trade poli- countries in subsequent years. As manufacturing has
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cies are closely related to its industrial development been pinpointed as the engine of growth since the
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policies. late 1980s, emerging and rapidly industrializing econo-
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mies in East Asia aggressively competed for foreign
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INDUSTRIALIZATION AND INVESTMENT investment. As a consequence of this increased com-
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DEVELOPMENT POLICIES petition, the Malaysian Government launched the
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After the crisis of the mid-1980s, policy essentially domestic investment initiatives (DII) in 1993 to en-
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shifted from an inward-looking, domestic-oriented courage more domestic investment. Strategies under
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strategy to one that was outward-looking. The es- the DII include increased domestic content in local
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tablishment of the Industrial Master Plan (IMP) for output, strengthening and deepening of the local capi-
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1986–1995 provided a long-term indicative plan for tal market to support domestic investment as well as
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development. It emphasized export-led growth developing domestic anchor companies, and small- and
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through industrial diversification, provision of a lib- ○
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medium-size industries (SMIs) to provide greater and
eral investment climate, and promotion of industry- enhanced industry linkages. In the same year, the
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linkages. The second half of the 1980s thus saw the amount of approved domestic investment exceeded
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enhancement of private investment and the develop- foreign investment approvals by 19 percent.
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ment of a more focused policy orientation. The liber- While pursuing active industrial policies and at the
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alization measures under the IMP were consolidated same time promoting local industries, Malaysia con-
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in the 1990s and are considered to have been crucial tinued to adopt an effectively “open-door” policy in
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in lifting the country out of the crisis. the majority of sectors, encouraging foreign direct
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Official policy has been the main driving force in investment (FDI) inflows. It became one of the larg-
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the determination of industrial and technological de- est host countries for FDI during the period and in
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velopment in Malaysia. It has been substantially 1995 received the biggest share of FDI in the Asso-
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geared towards the promotion of foreign investment ciation of Southeast Asian Nations (ASEAN) region.
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in the country. The neoclassical approach often sug- In all, the electrical and electronics industry received
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gests an end to government regulation and interven- a substantial chunk of foreign capital and the prod-
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tion, or if not, only a market-enhancing role for the ucts were mainly directed to the export market. Since
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State. The State’s role should be limited to effective the early 1980s, this industry has grown tremendously,
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development planning. Nonetheless, in most of East and has generated massive growth and helped build
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Asia, government intervention in industrial and in- up downstream industries. It was also strongly in-
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vestment planning has always been a widespread strumental in contributing to overall manufacturing
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practice and in Malaysia, the success of industrial employment. Besides transferring capital technology
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development has been largely attributed to the gov- to developing economies, foreign capital also con-
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ernment-business nexus. tributes to locating new market outlets for the host
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1
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The Plaza Accord signed in 1985 was one of the nations as a substantial proportion of FDI flowing
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first catalysts of the relocations of investment and into Malaysia (as in most other Southeast Asian coun-
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production from Japan and the first-tier East Asian tries) is export-oriented, and thus elemental in en-
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newly industrialized economies (NIEs) to the region. hancing international trade.

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This thrust was further exacerbated by the withdrawal However, the high growth generated also meant
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of Generalized System of Preferences (GSP) privi- an acute shortage of labor, and hence rapidly rising
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labor costs. Rising costs unmatched by productivity reforms as well as changes necessitated by WTO,
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and inadequate skills became a serious concern to and regional trading arrangements such as AFTA
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the Government and investors alike. Recognizing the and Asia-Pacific Economic Cooperation (APEC).
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need to phase out labor-intensive industries, the Ma- As a result, the real sector began experiencing ac-
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laysian Government embarked on a strategy to at- celerated trade liberalization (Rasiah 1998).
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tract investments with high value-added by introduc- In order to benefit from better products and enjoy
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ing the Second Industrial Master Plan (IMP2). The access to better inputs, components, and technology,
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new Master Plan promotes the “Manufacturing Plus it will be important for a country to accept the re-
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Plus” concept and the cluster approach to enable sponsibilities and obligations that come with its level
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Malaysia to reach industrialized status. It concen- of development. Malaysia is thus committed to
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trates on the qualitative trend of FDI and stresses worldwide liberalization efforts. Nevertheless, it ad-
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global competitiveness and productivity as the prime heres to the doctrine that any liberalization will de-
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motivators for the future (Institute of Developing pend on each country’s capacity and ability to cope
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Economies [IDE] 1998). The cluster approach will with competition (IDE 1998). Malaysia has made
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provide the basis for a more integrated and cohesive the following commitments:
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framework for industrial development. The Govern- • continue to reduce tariffs on imports in line with
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ment has also set a target for the share of domestic trade liberalization efforts and multilateral com-
○
○
investment to make up 60 percent of total invest- mitments under WTO and AFTA;
○
○
ment in the long term. In 1996, the ratio of domestic • review nontariff measures with a view to relax-
○
○
investment to foreign investment stood at 50.1 per- ing them when appropriate;
○
○
cent (56.2 percent in 1995). The decline was due to • gradually liberalize the services sector under
○
○
a relatively high flow of foreign capital that year. GATS;

○
○
Overall, the new scenario is meant to develop and • eventually allow greater foreign participation in
○
○
enable Malaysian manufacturing to rapidly adapt to the stockbroking and leasing sectors under the
○
○
the globalized business and industrial environment. interim financial agreement;

○
○
New incentives will be proposed to enable manufac- • provide market access for various businesses
○
○
turing to remain competitive within the liberalizing such as telecommunications and hospitality ser-
○
○
trade regime through the realization of the ASEAN vices; and

○
○
Free Trade Area (AFTA). In all, industrial policies in

○
• undertake various facilitation measures in areas

○
○
the 1990s have been forward-looking and compre- such as standards and conformance, customs,
○
○
hensive. and protection of intellectual property rights.

○
○
○
Vulnerability and
○
INTERNATIONAL TRADE POLICIES AND

○
○
LIBERALIZATION
Underlying Weaknesses
○
○
The post-Soviet era has witnessed dramatic changes

○
○
in the international economy. As the process of glo- Nobody would have expected at the onset of the cri-
○
○
balization and internationalization of the world sis that its repercussions could have been so severe.
○
○
economy intensifies, an increasing number of coun- The beginning of summer 1997 still saw companies
○
○
tries are liberalizing their economies and adopting enthusiastic about investing in emerging Asia. Several
○
○
export-oriented growth strategies. During the 1990s economists in the West had cautioned East Asia about
○
○
and especially after 1995, export incentives and tar- the possibility of the bubble bursting in the mid-1990s.
○
○
iffs began to decline as a result of domestic policy Lau and Kim (1992) and Young (1994) commented
○
that East Asia’s growth had been more “a matter of attack on the Thai baht amid concerns of a slow-
○
○
perspiration than one of inspiration.” Nevertheless, down in exports, high short-term external debt posi-
○
○
when the going was still good, would most have taken tion, overvaluation of the currency, and the decline in
○
○
heed of “academic” theories? Warning signs had asset prices led to the belief that similar risks were
○
○
emerged by the middle of the decade. Overheating present in other regional economies.
○
○
economies, severe infrastructure bottlenecks, and big Looking at the situation, one must perhaps con-
○
○
deficits should have been the first signs for caution. cede that currency speculators, after all, are
○
○
The regional macroeconomic environment has messengers with a message that all may not be well
○
○
mostly been considered favorable. Malaysia’s mac- at home (Ariff 1999). Were there reasons for
○
○
roeconomic management was seen as sound by any Malaysia’s economy to be vulnerable then? To begin
○
○
standards with considerable fiscal discipline and with, macroeconomic figures can conceal underly-
○
○
monetary policy prudence. The economy posted bud- ing weaknesses. The economy was already over-
○
○
get surpluses for five years consecutively after 1993. heating due to the rapid high growth since the late
○
○
At the same time, BNM was able to maintain finan- 1980s. This may be evidenced by the persistently
○
○
cial stability by successfully sterilizing short-term ○
○
large balance of payments and current account defi-
capital flows. The Malaysian savings rate remained cits since 1990. In fact, it could be clearly inferred
○
○
at a high of nearly 40 percent of GNP. External debts from an analysis of the situation before the crisis
○
○
were low (about 42 percent of GNP) and external that internal and external factors played a part in
○
○
reserves were at a comfortable level. Capital inflows ending Malaysia’s “miracle.”

○
○
continued, but over a very short period, a reversal of During the initial phase of the crisis, Malaysia
○
○
fortune and confidence occurred. adopted a set of stabilization measures and financial
○
○
Essentially, contagion was only part of the story. sector reforms that were similar to the International
○
○
At the same time, it must not be denied that cur- Monetary Fund’s (IMF) prescription for the other
○
○
rency speculators played a predatory role in the event. crisis-affected regional economies, though Malaysia
○
○
Unfortunately, investors tended to perceive that all was not under the IMF program. The policy pack-
○
○
economies in the region are identical. Herd behavior age was essentially a combination of tight fiscal and
○
○
driven by panic and hysteria led to a wholesale pull- monetary policies accompanied by financial sector
○
○
out of funds from the region. Thus, the speculative reforms (Table 1).
○
○
Table 1: Wrong Turns Taken During the Initial Stage of the Crisis
○
○
○
Measures Particulars
○
○
Curb of credit growth Measures were introduced to drastically reduce credit growth. Among them were the impositions
○
of stringent limits on lending to the property sector and for purchase of shares and the introduction
○
of credit plan to limit loan growth.

○
○
Untimely merger program In January 1998, Bank Negara Malaysia (BNM) announced a merger program for finance compa-
○
for financial companies nies. This program, while intended to rationalize finance companies to increase their resilience,
○
was untimely.
○
Increase in interest rates BNM’s policy to increase interest rates by raising its three-month intervention rate from 8.7 percent
○
○
at the end of 1997 to 11 percent in early February 1998, while intended to address inflationary
○
expectations, raised the cost of loanable funds and debt service commitments.
○
Revision of nonperforming The reclassification of NPLs to strengthen prudential supervision was untimely. It increased losses
○
loan (NPL) classification to financial institutions and weakened their lending capacity at a time when liquidity was tight.
○
○
from six to three months

○
Approach used to In order to address the problem of tight liquidity in the financial system, BNM opted to lend its own
○
increase liquidity funds to the banking system at prevailing market rates causing unnecessary losses to banks.
○
○
Cut in Government Federal Government expenditure was reduced by 18 percent, resulting in the deferment of several
○
expenditure public sector projects and exacerbating the slowdown in economic activities.
○
○
Source: Malaysian Government 1999.

○
Erosion in Competitiveness percent but by 1995, the rate had risen to 28.6 per-
○
○
Malaysia’s exports began to experience an erosion in cent. In 1996, it eased slightly to 26.7 percent but in
○
○
competitiveness partly due to rising costs and partly early 1997, it increased again to reach a worrisome
○
○
because of the overvaluation of the ringgit. The de- level of close to 30 percent. As a percentage of nomi-
○
○
valuation of the People’s Republic of China’s (PRC’s) nal GDP, the loan-GDP ratio rose strongly from 103
○
○
yuan in 1994 and the depreciation of the Japanese yen percent between 1992 and 1994 to an excessively high
○
○
2
eroded Malaysia’s export competitiveness. At the same level of 135 percent in June 1997. Loans disbursed
○
○
time, the dollar appreciated in the couple of years pre- to the property sector accounted for the largest share,
○
○
ceding the crisis. With the ringgit and most East Asian constituting 31.8 percent of total loans in June 1997
○
○
currencies “quasi-pegged” to the dollar, this trend be- and were growing at a high rate of above 30 percent
○
○
3
gan to undermine the region’s competitiveness. for most of 1997. Substantial lending to the property
○
○
sector was attributed to the construction boom. The
○
Resource Misallocation
○
surge in property prices was reflected by the Malay-
○
and Loss of Efficiency
○
sian house price index (MHPI), which grew by 25.5
○
○
The high GDP growth was essentially input-driven percent and 12.2 percent in 1991 and 1992, respec-
○
○
and not productivity-driven. Total factor productivity tively. This encouraged involvement in the property
○
○
(TFP) was beginning to plunge into negative terri- market in view of profit expectations. “Moral hazard”
○
○
tory. Productivity could not keep up with rising wages. also played a large part in the rise in unproductive
○
○
It averaged 0.9 percent per year between 1991 and investment and loan disbursement, often leading banks
○
○
1996 and 2.9 percent between 1987 and 1990. Its to perform only a cursory review of projects and to
○
○
contribution to GDP growth declined from 28.7 per- provide loans for unprofitable or unproductive sectors
○
○
cent between 1991 and 1995 to 19.5 percent during such as property development, stock market specula-
○
○
1996-1997 (Malaysian Government 1999) . tion, and consumption credit.

○
○
As can be seen in the rising incremental capital-

○
○
output ratio, there has been inefficiency in capital Escalating Savings-Investment Gap
○
○
allocation. There has also been a diversion of re- and Current-Account Deficit
○
○
sources from the real sector into speculative activi- Malaysia may boast of one of the highest savings
○
○
ties; while within the real sector itself, there was di- rates in the world, hovering at about 38 to 40 per-
○
○
version into nontraded activities such as the property

○
cent; nevertheless, the rate of investments was con-

○
○
sector and the construction of various mega-projects. sistently higher at above 45 percent during the 1995–
○
○
Such an exaggerated expansion of investment led to 1997 period. By the middle of the 1990s, the sav-
○
○
a worsening of the current account deficit. ings-investment gap was behind the current account
○
○
deficit. In the past, this gap was bridged by Malaysia’s

○
Excessive Credit Expansion

○
heavy reliance on FDI. However, high inflows of

○
and Diversion of Resources

○
foreign investment and foreign debt actually resulted

○
to Nonproductive Sectors
○
in hefty investment income outflows overseas. (While

○
○
Over the period, excessive credit disbursement by the external debts remained comparably low, domestic
○
○
banking sector to nonproductive sectors (defined to debts were excessively high. They represented about
○
○
include the broad property sector, consumption credit, 160 percent of GDP by the end of 1997, which was
○
○
and loans for the purchase of stocks and shares), be- the highest level of domestic indebtedness in South-
○
○
came a major cause for concern. Between 1992 and east Asia [Athukorala and Warr 1999].) Arguably,
○
○
1994, loans were growing at an average rate of 12.2 the current account deficit per se may not be a prob-
○
lem but the financing of the deficit does matter. In liberalization, the long-term costs seem to have out-
○
○
1994 and 1995, the current-account deficit was only weighed the benefits.
○
○
partially financed by net long-term capital inflows.
○
Lack of Institutional Infrastructure
○
Reliance on short-term capital to cover the current-
○
and Deficient Governance
○
account deficit is not tenable in the long term be-
○
○
cause of the volatile nature of this form of capital. There have been accusations of nepotism, cronyism,
○
○
At the same time, sharp increases in the outflow of and bad governance prevailing in East Asian busi-
○
○
“reverse investments” between 1995 and 1997 by ness and malpractices within governments in the wake
○
○
Malaysian companies to finance long-term projects of the crisis. There may be a half truth in these alle-
○
○
(with no prospects of early returns) have inadvert- gations as many of these elements are not necessar-
○
○
ently exacerbated the country’s balance of payment ily unknown in developed nations either. It must, nev-
○
○
problems. In addition, many of these outward invest- ertheless, be admitted that, in terms of governance
○
○
ment projects in new emerging regions failed miser- and institutions, Malaysia (and most of East Asia)
○
○
ably because of the lack of proper analysis or de- still has a certain way to catch up. The country lacks
○
○
tailed studies prior to investment. ○
○
the necessary institutional infrastructure that should
go hand in hand with industrial deepening. Similarly,
○
Liberalization
○
institutions necessary to generate the required hu-

○
○
Since 1996, there has been a sharp decline in FDI man resources for these industries remain underde-
○
○
flowing into Malaysia. This has had significant reper- veloped. Even though Malaysia has launched sev-
○
○
cussions on the economy. The downturn was caused eral commendable initiatives to upgrade human re-
○
○
by factors such as the reduction in Japanese invest- sources through a strengthening of institutions and
○
○
ments overseas following the fall in value of the yen, the development of infrastructure and support sys-
○
○
and perhaps more important, the tight labor supply in tems, real progress has often been limited or ham-
○
○
Malaysia. In the past, the country’s abundant labor pered by problems of coordination. The transition from
○
○
supply had been one of the main attractions for labor- a labor-intensive economy to a technology-based one
○
○
intensive industries. To some extent, the decrease in necessitates institutional support. Similarly, a higher
○
○
FDI was offset by an increase in portfolio investment, degree of transparency will provide more fertile
○
○
which gained importance beginning in 1993 following ground for good governance to breed.
○
○
measures to liberalize the capital account. Short-term

○
High Debt-Equity Ratios

○
portfolio investments can be a source of instability as

○
○
they are notorious for being extremely “footloose” and At the micro level, debt-equity ratios of many corpo-
○
○
dependent on investor sentiment. Any slight hint of rate entities have been abnormally high. In addition,
○
○
economic, political, or social instability in the country there have been chronic mismatches, with short-term
○
○
or region may well result in capital flight. borrowings being employed to finance long-term in-
○
○
Capital account liberalization may have its ben- vestments (Ariff 1999). As a whole, nonperforming
○
○
efits, the most important of which would be access loans (NPLs) of the financial sector hovered at a not-
○
○
to international savings, but it could also prove to be too-alarming figure of 10 percent but certain banks
○
○
a precarious step if an economy is not ready for it. had NPL ratios exceeding 40 percent (based on the
○
○
Malaysia has tended to walk the thin line between international definition of bad loans as those not ser-
○
○
liberalization and the continued protection of certain viced during the preceding three months). In spite of
○
○
key industries at the same time, one of which is the the sweeping reform measures carried out following
○
○
financial sector. However, in terms of capital account the 1985–1986 crisis, unsound practices within the
○
financial system and poor corporate governance con- ever, evolved with the changing circumstances dur-
○
○
tinued. These, admittedly, also contributed to the fi- ing the course of the crisis. Although Malaysia re-
○
○
nancial crisis. Rising M2 relative to international rejected the IMF aid package, the initial approach was,
○
○
serves, the ratio of which increased from 3 percent in in fact, IMF-inspired. This section will discuss the
○
○
the early 1990s to 4.7 percent at the onset of the cri- evolution of Malaysian Government macroeconomic
○
○
sis, was another indication of the growing vulnerabil- policies since the onset of the crisis to the present.
○
○
ity of the Malaysian economy. This rise eroded the
○
○
ability of the economy to defend the currency THE INITIAL MONTHS: INTERNATIONAL
○
○
(Athukorala and Warr 1999). Thus, not all was well. MONETARY FUND-INSPIRED TIGHT
○
○
MONETARY AND FISCAL POLICIES
○
Further Comments
○
In the initial phase of the crisis, macroeconomic policy
○
○
Globalization has become an inevitable phenomenon generally focused on addressing areas of vulnerabil-
○
○
but free and uncontrolled capital movements will pose ity and priority, notably:
○
○
risks to the international financial system in the fu- • restoring confidence and stability in the financial
○
○
ture. Investors may have been blamed for their herd market,
○
○
behavior but are they not just behaving in a humanly • containing inflationary expectations associated
○
○
fashion when confronted with possible or impending with ringgit depreciation,

○
○
losses? Malaysia and a few other countries have • controlling excess domestic demand resulting
○
○
called for a revamp of the international financial sys- from rapid credit growth,
○
○
tem. While this may not be easy or readily accept- • managing the current-account deficit in the bal-
○
○
able to all, guidelines and prudential regulations could ance of payments,

○
○
and should be established gradually, in conformity • strengthening the resilience of the financial sec-
○
○
with international norms and practices, to reduce risks tor in order to avoid systemic risks, and
○
○
resulting from speculation and uncontrolled global • maintaining export competitiveness and the stan-
○
○
capital flows. Politically, more transparency and lib- dard of living.

○
○
erty will also serve to enhance the situation and cre- The tight monetary policy already in place before
○
○
ate a more fertile ground for better practices to breed. the crisis was further tightened. The policy pack-
○
○
Internal as well as external elements had a hand in ages announced during the final quarter of 1997 and
○
○
ending Malaysia’s (and the region’s) “miracle.” Un-

○
during the presentation of the 1998 Budget were

○
○
derstandably, as the country’s fundamentals have mainly directed at maintaining tight monetary and fis-
○
○
always been considered to be good, the Government’s cal policies while sustaining investor confidence in
○
○
initial response was to look for causes externally. the financial market. Further policy measures were
○
○
But there is still much work in store internally. announced as 1998 unfolded. The National Economic
○
○
Action Council (NEAC) was established to act as a

○
Macroeconomic
○
consultative body to the Cabinet to deal with the cri-

○
○
sis in early January.

Developments
○
○
Interest rates were raised in line with the expected

○
During the Crisis

○
higher rate of inflation. This would then ensure a

○
○
positive return rate to savers. The central bank fur-

○
Policy Initiatives
○
ther curbed loans and a credit plan was introduced

○
○
As turbulence struck, a series of policy packages to limit the growth of loans to 25 percent by the end
○
○
was introduced (see Appendix). The measures, how- of 1997, 20 percent by the end of the first quarter of
○
1998, and 15 percent by the end of 1998. Stringent THE EXPANSIONARY STAGE
○
○
guidelines on hire purchase and property lending (ex- Any easing of interest rates to boost spending would
○
○
cluding low- and medium-cost residential properties, have sent the ringgit and investor confidence on a
○
○
factories, and industrial buildings) were issued. further downward spiral while high interest rates
○
○
Fiscal spending was scaled down. Government would have continued to choke the business com-
○
○
expenditure was reduced and the implementation of munity. As the economy continued to plunge into a
○
○
various infrastructure projects was either cancelled deep recession in the first half of 1998, declining
○
○
or deferred. The objectives were to reduce imports 4.8 percent, policymakers began doubting the fea-
○
○
and to address the problem of excessive credit growth sibility of the combined tight monetary and fiscal
○
○
as well as the high leverage of some corporations. policy regime. The second quarter contraction of
○
○
Simultaneously, prudential regulations of the finan- 6.8 percent in the GDP (MIER 1998) prompted a
○
○
cial system were adjusted to bring them in line with rethink. After the brief experiment with IMF-style
○
○
international norms. NPLs were reclassified as loans macroeconomic measures, the Malaysian Govern-
○
○
in arrears for three months instead of six months as ment moved in the opposite direction, initiating mon-
○
○
Malaysia had previously stipulated. The rate for gen- ○
○
etary and fiscal expansion as the middle of 1998
eral provisioning was increased and the central bank unfolded. In July 1998, it launched the National
○
○
pursued a merger program for finance companies. Economic Recovery Plan (NERP), providing a com-
○
○
Nevertheless, maintaining this delicate balance of prehensive framework for an economic turnaround.
○
○
pursuing tight monetary and fiscal policies without Its objectives are to:
○
○
excessively affecting the already slowing economic • strengthen macroeconomic fundamentals,

○
○
growth was made difficult by a volatile external fi- • stabilize the national currency,
○
○
nancial environment. • restore market confidence,

○
○
The “virtual IMF policy” eventually brought more • restore severely affected sectors,
○
○
pain because it was contractionary. Given the strength • continue with the socioeconomic agenda, and
○
○
of the Government financial position, there was no • maintain financial stability.

○
○
need for such a drastic slash on expenditure. The NERP recommends the easing of monetary and
○
○
combination of a tight monetary policy, fiscal restraint, fiscal policies and lowering the cost of capital to re-
○
○
and financial sector restructuring measures managed vitalize the economy. Its recommendations include a
○
○
to contain price increases and succeeded in bringing wide-ranging proposal for economic stabilization and
○
○
the balance of payments from a deficit to a surplus structural reforms while at the same time, address-
○
○
position, but they severely dampened private sector ing socioeconomic priorities, the implementation of
○
○
business activity. The measures only served to worsen which will be scrutinized by NEAC.
○
○
the cash flow problem of businesses already badly Interest rates peaked in June 1998. The three-
○
○
affected by the ringgit’s depreciation. The effects of month interbank rate, which rose to an average of
○
○
the initial response could perhaps have been less se- 11.05 percent in June 1998, declined to 10.22 per-
○
○
vere if a more moderate policy had been imple- cent in August. In the same month, there were three
○
○
mented. Rapid increases in interest rates might have downward revisions in the three-month intervention
○
○
seemed a short-term measure but eventually such a rate of the central bank, bringing the rate down by
○
○
move would only further choke an already struggling 150 basis points (bp). By November 1998, it had fallen
○
○
economy. The interest rate rises could have been to 7 percent. The lowering of the SRR had, in fact,
○
○
more restrained while allowing other measures to be begun in mid-February as it fell from a high of
○
○
phased in. 13.5 to 10 percent. It continued to be subsequently

○
lowered in stages in the following months. The BLR laysia in the months following the onslaught of the
○
○
for commercial banks declined from 11.96 percent crisis did not result in an inflow of capital. Rather,
○
○
in March 1998 to 8.05 percent in March 1999. How- high interest rates during the period served to deter a
○
○
ever, BNM’s attempt to step up bank lending to flight of domestic funds in search of better returns
○
○
8 percent as announced late in 1998 failed, mainly offered by offshore facilities.
○
○
due to depressed credit demand. Loans for the lower Simultaneously, the Government introduced a fis-
○
○
end of the housing market were stepped up while a cal stimulus package of RM7 billion (Table 2), ex-
○
○
moratorium was imposed on loans for office and panded existing funds, and set up new specialized
○
○
shopping malls, which faced an acute glut. funds targeted at specific priority sectors. The stimu-
○
○
The lowering of interest rates, nonetheless, lus package would see the overall public sector ac-
○
○
sparked accusations that investment flows would be count registering a manageable deficit of 1.8 per-
○
○
discouraged. Such accusations are unfounded as low cent of GNP in 1998 and 5.5 percent in 1999 (Ma-
○
○
interest rates are a boon for the bond market and a laysian Government 1999). The Government also lib-
○
○
high interest rate is not the sole criteria to attract eralized the equity policy for the manufacturing sec-
○
○
foreign capital during “abnormal circumstances.” tor to further promote FDI. Certain sectors including
○
○
These investment flows include portfolio funds de- telecommunications, shipping and forwarding, insur-
○
○
spite the fact that interest rate considerations tend to ance, tourism, and Multimedia Super Corridor (MSC)-
○
○
be one of the factors that they are sensitive to. (FDI approved activities saw a relaxation of the 30 per-
○
○
is generally not influenced by the interest rate-ex- cent limit imposed on foreign ownership. (The relax-
○
○
change rate factor. Foreign investors tend to look at ation in equity policy applies to applications received
○
○
the regional market as a whole rather than focusing between 31 July 1998 and 31 December 2000, as
○
○
on an individual market.) High interest rates in Ma- well as those already received but pending approval.)
○
○
○
○
Table 2: Fiscal Measures to Restore Economic Growth

○
○
• Restoration of the previous cut in the federal Government expenditure for 1998.
○
• Provision of an additional allocation of RM7 billion for development expenditure for projects meeting the following criteria:
○
○
– enable import substitutions and increased exports of goods and services,

○
– generate demand for domestic goods and services,

○
– increase efficiency and national competitiveness,

○
– short gestation period,

○
○
– will not cause a decline in reserves nor outflow of liquidity, and

○
– provide assistance to the poor and lower income group.

○
• Based on these criteria, the above allocation was channeled towards infrastructure and public facilities, industrial
○
○
development, rural development, housing, education, and health.

○
• Provision by the National Housing Company Berhad of bridging finance to developers for the construction of houses
○
costing RM150,000 and below.

○
• Establishment of an Infrastructure Development Fund, with initial allocation of RM5 billion, to assist in the financing of
○
○
infrastructure projects.
○
• Tax exemptions on 70 percent of statutory income from the increased value of export sales for companies granted
○
international trading company status and that are at least 70 percent Malaysian-owned or using local facilities.
○
• Stamp duty exemption for the refinancing of loans for business purposes and for purchase of property under the Home
○
○
Ownership Campaign.
○
• Imposition of income tax on actuarial surpluses actually transferred to the Shareholders’ Fund as compared with the
○
present practice, which is based on accrual principle.

○
• Abolition of excise duty on refrigerators, television sets, and air-conditioners to enable local manufacturers to compete
○
○
with manufacturers from other Association of Southeast Asian Nations (ASEAN) countries when the ASEAN Free Trade
○
Area (AFTA) is implemented.

○
• Change in the tax assessment system from one based on the income derived in the preceding year to the current year
○
beginning from 2000.

○
○
• Introduction of tax incentives to promote domestic tourism.

○
○
○

○
In recessions, expansionary fiscal policy makes posed on 1 September 1998 to insulate the economy.
○
○
considerable sense although the question of financ- The dilemma was obviated. The controversial move,
○
○
ing large deficits may be of concern, especially since nonetheless, was both lauded and attacked by vari-
○
○
access to foreign funds is limited while there are other ous quarters all over the world. The objectives were
○
○
demands on domestic funds (Ariff 1999). Keynesian basically to:
○
○
policies, too often derided in the recent past, could • eliminate speculation by declaring offshore ringgit
○
○
have gone down as a better remedy, and perhaps, nonlegal tender,
○
○
helped avoid such a severe slide if they had been • contain speculative capital,
○
○
prescribed much earlier. For the present, financing • stabilize short-term capital flows, and
○
○
such budget deficits may not be a serious problem. • maintain the stability of the financial market in
○
○
The Government should, nevertheless, proceed with order to proceed with reforms unhindered.
○
○
caution as severe financial constraints may surface Many countries have, in fact, begun to see the
○
○
in the future because budget deficits are more than urgency and the necessity for some form of mecha-
○
○
likely to persist over the next few years. nism or regulation on short-term volatile funds in or-
○
○
○
○
der to avoid another crisis of this magnitude. This
SELECTIVE EXCHANGE CONTROLS—A MOVE was especially so after the effects of the Asian cri-
○
○
INTO CONTROVERSY sis spilled over to Latin America and Russia. Selec-
○
○
After the change in policy orientation, Malaysia be- tive controls may not necessarily be a bad thing pro-
○
○
gan to see some progress in containing inflation, im- vided that they are implemented only to provide a
○
○
proving its external balance, and maintaining low temporary respite for the affected country to under-
○
○
external debt exposure, as well as keeping external take reforms. It can then rejoin the world economy
○
○
reserves intact. However, the economy continued to once it is ready. However, distinction will have to be
○
○
remain vulnerable to external developments, espe- made between measures to discourage inflows and
○
○
cially the instability in regional financial markets. Simi- those to restrict outflows. As controls on outflows
○
○
larly, this also affected the progress of the reforms in are often imposed during times of crisis where there
○
○
the country. The increasing outflow of the ringgit, is increased volatility in financial variables and ex-
○
○
attracted by higher interest rates elsewhere within change rates, there is a possibility that they will dis-
○
○
the region (international offshore centers were of- courage potential investors because they are some-
○
○
fering between 20 and 40 percent while the onshore times thought to indicate “worse times on the hori-
○
○
rate was only 11 percent), was becoming a serious zon.” Following the imposition of capital controls, the
○
○
threat to the economy. With little room for maneu- central bank’s three-month intervention rate dropped
○
○
ver, selective capital controls (Table 3) and the peg- further to 7 percent. The controversial move enabled
○
○
ging of the national currency to the dollar were im- the system to accommodate an expansionary policy.
○
○
○
Table 3: Selective Capital Controls

○
○
Controls On No Controls On
○
• Ringgit-denominated transactions among nonresidents via

○
• Current account transactions. Amendments to rules

○
nonresident external accounts. require only that trade transactions for goods and
○
• Outflows of short-term capital by requiring such inflows to services are to be settled only in foreign currencies and
○
remain in the country for a minimum period of a year. no longer in domestic currency.
○
• Import and export of ringgit by travelers, residents, and • Repatriation of interest, dividends, fees, commissions,
○
○
nonresidents. and the rental income from portfolio investments and other
○
• Malaysian investment abroad by requiring approval as there forms of ringgit assets.

○
are insufficient funds to be taken out. Capital may, however, • Foreign direct investment inflows and outflows, including
○
be raised abroad, collateralized by foreign assets. income and capital gains.

○
○

○
INTRODUCTION OF THE GRADUATED EXIT LEVY ables? Also, the new measures would inevitably add
○
○
After five and a half months of controversy, Malay- to the already cumbersome administrative problems
○
○
sia, on 4 February 1999, modified the rule on the one- in investing in Malaysia and, therefore, discourage
○
○
year holding of portfolio capital. Foreign funds stuck investors. In any case, it is still too early to tell and
○
○
in the country would be allowed to be repatriated sub- short-term outflows cannot be discounted. However,
○
○
ject to a new graduated levy depending on the dura- it would be unfair to dismiss the new measures out-
○
○
tion of each investment and when the funds were right. The Malaysian economy has been recovering
○
○
brought into the country, with effect from 15 February since the second quarter of 1999 and these mea-
○
○
1999. The slow trickle of foreign funds seen over the sures could be a start to reinstate Malaysia on the
○
○
previous months while neighboring countries experi- world investment map.
○
○
enced renewed investor interest could have been one
○
○
of the reasons that propelled the Malaysian Govern- FINANCIAL AND CORPORATE SECTOR
○
○
ment to initiate this move. The measures are also aimed RESTRUCTURING
○
○
at addressing the possible outflow of funds upon the What began as a currency crisis evolved into a finan-
○
○
expiry of the 12-month moratorium on fund repatria- cial crisis before transforming itself into a full-blown
○
○
tion. This new levy is considered more “market- economic crisis, with banks and other financial institu-
○
○
friendly” than the moratorium (Table 4). tions taking the center stage as the drama unfolded.
○
○
The currency crisis fueled concerns about the health

○
Table 4: Exit Levy on Investments

○
of the banking system in the crisis-hit economies. Ex-

○
○
Investments Before 15 February 1999

cessive lending without adequate safeguards has been
○
• A levy of between 10 and 30 percent on the principal to

○
be repatriated within 12 months. the main drawback of financial institutions, resulting

○
○
• Repatriation after the 12-month period will not be

in soaring NPLs and gross capital inadequacy. In sev-
○
charged any levy.

○
eral crisis-hit economies, the banking system took a

○
• Profits repatriated within the 12-month period will not be

○
levied but those repatriated after this period will be

severe beating with many institutions folding altogether,
○
charged a 10 percent levy.

○
while the real sector in these economies suffered badly

○
Investments After 15 February 1999

○
as a consequence. Malaysia was, however, more for-

○
• The repatriation of the principal will not be levied.

○
• Profits repatriated within 12 months will be charged a

tunate in the sense that none of the banks caved in.
○
30 percent levy.
○
The toll on the corporate and financial sectors, never-

○
• Thereafter, profits will be charged a 10 percent levy.

○
○
Source: Malaysian Treasury press release, Repatriation of Portfolio Capital,

theless, has been extensive.
○
4 February 1999.
○
While Malaysia may be credited for maintaining

○
○
sound financial policies and good supervision, it must

○
○
The argument is that the top rate of 30 percent is not be denied that inherent weaknesses do exist within
○
○
onerous and as the levies are high, would investors the system. Thus, there are concerns about the health
○
○
remain in the country up to 1 September 1999? If of the banking system in the aftermath of the crisis.
○
○
they were low, then investors might decide to leave Rising NPLs in the banking sector prompted fears
○
○
the country. Similarly, would reinvesting in Malay- of systemic bank failures. Nevertheless, the NPL
○
○
sian markets defer payment of the levy? The Gov- problem in Malaysia pales in comparison with that of
○
○
ernment feels that the exit tax would, in fact, en- other crisis-hit countries in the region. It also pales in
○
○
courage a larger inflow of new capital rather than comparison with Malaysia’s own previous experi-
○
○
see large outflows as the economy is stabilizing and ence in the mid-1980s crisis when NPLs rose as high
○
○
recovery is anticipated. Would this be a little too op- as 33 percent of total loans. This time around, the
○
○
timistic despite the current positive economic vari- NPL ratio was at most, about half of what it was in
○
the previous crisis (14.9 percent in November 1998 cent. At the same time, Danamodal pumped RM6.2
○
○
if measured by the “three-months” classification). billion into the banking system. The risk-weighted
○
○
The Government has, therefore, taken measures capital ratio (RWCR) was also at fairly comfortable
○
○
to restructure and consolidate the financial and cor- levels, partly due to new capital injections and partly
○
○
porate sectors with the primary aim of: due to the tendency for banks to avert high-risk
○
○
• relieving institutions of their NPLs, lendings. Thus Danaharta and Danamodal have per-
○
○
• strengthening and recapitalizing banking institu- formed fairly well so far and the overhaul of the fi-
○
○
tions, nancial sector has received cautious praise from some
○
○
• facilitating corporate debt restructuring, and analysts. Nevertheless, more needs to be done.
○
○
• enhancing efficiency within the system.
○
Table 5: Danaharta Nasional Berhad: Objectives
○
The thrust of Malaysia’s banking and financial and Plans
○
○
sector reforms introduced during the crisis was two- Asset Management Company
○
○
fold. They aimed at stabilizing the banking system in • Established 20 June 1998, Companies Act of 1965
○
• Authorized share capital: RM10 billion
○
the immediate period, and building a strengthened, • Paid-up capital: RM250 million
○
○
more resilient banking sector over the medium to long ○
Main Objectives
• Remove nonperforming loan (NPL) distractions from
○
term. Short-term measures were initiated to ensure

○
financial institutions
○
the smooth functioning of the intermediation process, • Maximize recovery value of acquired assets
○
○
while rationalization, consolidation, and reform of the Stages of Acquisitions Plans

○
Stage 1 involves:
○
financial and banking sectors were initiated through

○
• secured loans,
○
the setting up of an asset management company, a • strategic sectors.

○
Stage 2 involves:
○
bank recapitalization agency, a corporate debt re-

○
• unsecured loans.
○
structuring committee, and mergers. These repre- Stage 3 involves:

○
○
sented part of the long-term strategy to strengthen • foreign currency loans,

○
• financial guarantees,
○
and consolidate the sectors. • private debt securities.

○
○
Two agencies, dubbed “special purpose vehicles,” Prioritization of Financial Institutions

○
Phase 1: Weaker financial institutions

○
namely, Danaharta and Danamodal, were established

○
Phase 2: Local financial institutions

○
to deal with NPLs. While Danaharta (Table 5) was Phase 3: Financial institutions of moderate strength
○
Phase 4: Stronger banks

○
created to buy up bad loans and take over the sup-

○

○
porting assets, Danamodal (Table 6) was established

○
○
to inject capital into banks that had to bear losses

○
○
resulting from the sale of NPLs. By the end of July The arduous task of buying up bad loans at rea-
○
○
1999, Danaharta had acquired and managed loans sonably discounted prices and financing them with
○
○
amounting to RM39 billion from the financial sys- zero-coupon bonds may seem easy compared with
○
○
tem, representing 1,999 loan accounts. From the bank- the more daunting task of managing the assets that
○
○
ing system alone, it acquired and managed NPLs have been acquired in the process. In many cases,
○
○
amounting to RM28.5 billion or 35 percent of total the restructuring of underlying businesses and as-
○
○
NPLs in the banking system. With this, the net NPL sets are necessary. Thus, besides debt restructuring,
○
○
ratio moderated to 7.9 percent based on a six-month operational restructuring is vital for the long term.
○
○
classification as at the end of June 1999 after peak- As evidenced in the Mexican experience, restruc-
○
○
ing at 9 percent as at the end of November 1998. If turing and recapitalization are lengthy and compli-
○
○
based on the international three-month classification cated processes. Danaharta will be working along
○
○
of bad loans, the NPL ratio would be about 13 per- the lines of the successful Swedish Securum Asset
○
○
Table 6: Danamodal: Objectives and Tasks
○
○
Restore and Revitalize the Catalyze Improvements in the Operate on a Commercially
○
Banking Sector Banking Sector Viable Basis
○
○
• Restore and improve solvency • Restructure the balance sheet • Earn positive return commensurate
○
• Provide liquidity • Restructure operations by with risk
○
• Enhance profitability introducing better practices • Meet Bank Negara Malaysia’s and
○
○
• Restore confidence • Improve corporate governance international banking standards
○
• Refocus intermediation • Improve technology • Achieve more independence and
○
• Reenergize lending activities • Influence and encourage bank transparency
○
restructuring and consolidations • Ensure effective corporate
○
• Institutionalize ownership governance
○
○
○
Source: Danamodal Fact Sheet, 1998.
○
○
○
○
○
Management Company and has projected to start theless, without any empowerment, and being just a
○
○
selling NPLs as soon as the acquisition phase is over facilitator bringing creditors and debtors to the nego-
○
○
but only after having first gone through an active tiating table, there is little that the CDRC can actu-
○
○
4
restructuring role. Apparently, Danaharta has now ally do. The overhang of corporate debts is certainly
○
○
emerged as the biggest owner of real estates in the a cause for concern. Banks and finance companies
○
○
country in the process. Disposing of these properties are still saddled with about two thirds of the NPLs
○
○
in an orderly fashion without upsetting the market is as Danaharta has managed to absorb only one third.
○
○
not going to be easy, given the supply glut. Also, for Even though Malaysia’s external debts are not large
○
○
how long will or can Danaharta continue to buy up relative to GDP by developing country standards, its
○
○
bad loans? total domestic debt is large. Bank loans, which rep-
○
○
The successful operation of these asset manage- resent the largest chunk of domestic debt, amount to
○
○
ment outfits requires a private sector approach fo- 145 percent of GDP (the precrisis peak was 135
○
○
cused on the following: percent), which is, by far, the largest in Southeast
○
○
• complete autonomy, Asia. This does not go very well with the central
○
○
• full transparency in their workings,

○
bank’s call for higher loan growth in order to stimu-

○
○
• commerciality, late the economy. Higher loan growth will raise the
○
○
• best practice, loan-GDP ratio, which is already too high, thereby

○
○
• equal opportunity for investors, and weakening the country’s macroeconomic fundamen-
○
○
• professionalism. . tals. One redeeming feature is that the central bank’s

○
○
At the same time, the Corporate Debt Restruc- reserves have increased significantly within the last
○
○
turing Committee (CDRC) was established to year.

○
○
complement the two agencies by providing a chan- For a small population of 22 million, Malaysia is
○
○
nel for banks and debtors in distress to sort out an considered overbanked with 21 commercial banks,
○
○
agreeable and workable loan restructuring exercise. 12 merchant banks, and 25 finance companies, not
○
○
As at 20 August 1999, 62 applications had been re- to mention foreign-owned institutions. In order to
○
○
ceived, of which 10 restructuring schemes involving further consolidate and rationalize the banking sys-
○
○
debts of RM10.2 billion had been completed and were tem to meet the challenges of an increasingly global-
○
○
in the process of being implemented. Three cases ized market, the central bank has encouraged banks
○
○
involving debts of RM1.1 billion have actually been and finance institutions to merge. In the initial phase
○
○
sold to Danaharta, while 12 other cases involving of the crisis, the number of finance companies was
○
○
debts of RM2.9 billion have been rejected. Never- reduced from 39 to 25 following central bank inter-
○
vention. The central bank then announced plans to sector to foreign competition. It is understandable
○
○
reduce the number of 58 domestic financial institu- that Malaysia will not liberalize the banking sector
○
○
tions to only six anchor institutions through mergers. immediately, but over the medium term, gradual lib-
○
○
This exercise will, nevertheless, not involve locally eralization will be necessary.
○
○
incorporated foreign banks. The two main objectives
○
○
of this consolidation process are to enlarge the capi- Issues and Policy
○
○
tal bases thereby ensuring a better management of
○
Recommendations
○
risks and enhancing the resilience of the system, and
○
○
to cut costs and improve the competitiveness of lo- It would not be accurate to simply say that contagion
○
○
cal institutions. On 20 October 1999, the Malaysian or a self-fulfilling prophecy prompted the Asian cri-
○
○
central bank announced that all banking institutions sis. Though there may be some parallels and simi-
○
○
will, henceforth, be allowed the flexibility to form their larities in regional economies, they should not be
○
○
own merger groups, a reversal from the previous lumped together and considered as identical. Certain
○
○
ruling, which saw the Government’s hand in the pro- countries were severely afflicted while others suf-
○
○
cess. Frequent changes and reversal of policies could ○
○
fered ripple effects much later. It would, thus, be
prompt perceptions of inconsistency and should be unfair to propound one theory to suit all cases. Ex-
○
○
avoided. ternal and internal factors were responsible. But why

○
○
It is true that a merger exercise of this size will were some countries more vulnerable than others?
○
○
enhance prudential supervision and reduce systemic It is more appropriate to identify the elements that
○
○
risks besides producing larger and stronger institu- could have rendered an economy more vulnerable
○
○
tions capable of meeting future global competition. on a country-by-country basis. The magnitude of the
○
○
However, questions arise as to how the operations crisis itself posits that favorable macroeconomic gov-
○
○
will be funded and where the thousands of retrenched ernance is necessary to sustaining economic stabil-
○
○
employees will go. More worrisome still will be the ity. Vulnerability itself would not have led any coun-
○
○
implications of this exercise on the day-to-day man- try into a severe crisis. Vulnerability of an economy
○
○
agement of the institutions if attention is diverted resulting from cracks within the system such as policy
○
○
away from such pressing problems as bad loans, not inefficiencies or policy errors may, nevertheless,
○
○
to mention significant interbank cultural differences when combined with some external factors, make
○
○
that would challenge postmerger harmonization. Fur- an economy succumb.

○
○
thermore, mergers alone cannot transform the bank- Before the crisis, macroeconomic management
○
○
ing system into a formidable force overnight. Some in Malaysia was considered sound by any standards.
○
○
small banks have performed better during the crisis Fundamentals were strong. The country enjoyed rea-
○
○
than some bigger ones. Size may still matter but it is sonable price stability, fiscal surplus, high foreign
○
○
not synonymous with professionalism, competence, exchange reserves, and high rates of savings and
○
○
and the level of sophistication and efficiency. All these investment. The suddenness and the severity of the
○
○
have much to do with the competitive environment financial reversal have sparked a debate on past mac-
○
○
within which banks operate and underscore the im- roeconomic management as well as the appropriate-
○
○
portance of deregulation and liberalization in the bank- ness of policy responses to the crisis. Policy man-
○
○
ing reform exercise. The merger exercise would agement in Malaysia has, since, been focused on
○
○
become more meaningful if banking reforms included reducing risks in the economy to ensure macroeco-
○
○
an agenda to expose the sector to increased compe- nomic stability and to promote a stronger financial
○
○
tition, paving the way for a greater opening of the system. It is targeted at maintaining price stability
○
while preventing a further contraction of the economy. of selective controls in September 1998. There is,
○
○
However, circumstances changed and the situation thus, an urgent need for capital infusion from exter-
○
○
evolved along the way, so policies and measures nal sources. This calls for policies to attract new for-
○
○
implemented had to be modified. eign capital. However, exchange controls are not
○
○
Considering the various stages that the recovery conducive to a massive injection of capital from
○
○
process has been through, it is clearly still too early abroad. Exchange controls and open economies are
○
○
to assess the success of the measures applied. The inherently incompatible. Therefore, when the intended
○
○
crisis has revealed serious shortcomings in the reforms have ultimately been completed, these con-
○
○
economy. Simultaneously, to a large extent, the crisis trols should be phased out.
○
○
in Malaysia has become one of confidence. As a Fears and concerns of a large capital pullout on
○
○
result, like other afflicted economies in the region, 1 September 1999, exactly a year from the date
○
○
the country now faces domestic policy reform chal- controls were imposed, prompted the Government
○
○
lenges in order to restore confidence and rekindle to ease its policy and implement a graduated exit
○
○
the economy. There are various areas in which im- levy in February 1999. Nevertheless, the fears were
○
○
portant reforms and changes need to be targeted. unfounded as there was no substantial outflow of
○
○
Briefly, these may be identified as follows: funds on the designated date. The selective con-
○
○
• macroeconomic policies, trols and the fixed exchange rate have been suc-
○
○
• financial sector reform, cessful in bringing stability back to the economy

○
○
• improving risk management and maintaining fi- and improved Malaysia’s external accounts. Busi-
○
○
nancial stability, nesses involved in international trading no longer

○
○
• corporate governance and institutional restruc- needed to factor in an exorbitant exchange rate risk
○
○
turing, and premium into their business plans. Capital costs have
○
○
• improving long-term competitiveness. reduced sharply and planning, into the medium term
○
○
at least, has become easier. Business sentiments in

○
○
Macroeconomic Reforms the manufacturing sector improved in the first half

○
○
CAPITAL CONTROLS AND MAINTAINING of 1999 and are continuing to progress gradually,
○
○
EXCHANGE RATE STABILITY perked up by improved sales performance. While

○
○
The imposition of selective controls and the pegging general business conditions remain subdued follow-
○
○
of the national currency at RM3.80 to the dollar were

○
ing a sharp recession in 1998, manufacturers ap-

○
○
meant to provide the economy with a temporary re- pear to be cautiously optimistic. Business conditions
○
○
spite from external volatility. The move also made began to show an upward trend in the third quarter
○
○
the Malaysian ringgit nonlegal tender outside of Ma- of 1999 but there was a slight moderation in the
○
○
laysia and therefore encouraged ringgit parked abroad fourth quarter (according to the MIER Quarterly
○
○
to be remitted back to the country. All receipts origi- Business Conditions Index). In all, the controver-
○
○
nating from capital account transactions (but not in- sial capital control move has been largely lauded by
○
○
cluding FDI) must be held in Malaysia for a year the local business community. Similarly, an upturn
○
○
from the date of purchase of ringgit-denominated in consumer sentiments has been registered in the
○
○
assets or securities before they are eligible for repa- MIER Consumer Sentiments Index.
○
○
triation. However, there is an argument that controls may

○
○
In the meantime, the Malaysian economy has be- be a short-term dream that will be detrimental to the
○
○
come anemic following the massive outflow of capi- economy in the long run. The peg may have been a
○
○
tal between the onset of the crisis and the imposition boon to businesses but they must not be led to be-
○
lieve that the current euphoric situation will be per- this has greatly favored exporters, a low ringgit
○
○
manent, and be lulled into a false sense of security. makes imports more expensive.
○
○
In the long term, should the controls continue or Any decision to float the ringgit will depend on
○
○
rather, be refined? Should the ringgit peg be reviewed whether it will subject the system to more volatility.
○
○
and if so, when? The idea of the Government holding on to controls
○
○
If foreign exchange controls remain in place for and the peg until changes occur in the international
○
○
too long, the ambition of turning KLSE into a re- financial architecture to address speculation and vola-
○
○
gional bourse of significance will remain a pipe dream. tility may be unrealistic. As long as the BOP current
○
○
Investor confidence will be dampened since other account remains in surplus, the capital controls and
○
○
markets in the region do not impose controls. Not the ringgit peg will remain sustainable. Nonetheless,
○
○
only will speculative activity be curbed, long-term such a policy flexibility will evaporate with a deterio-
○
○
overall investment activity will probably be affected ration in the BOP position as the economy recovers,
○
○
as well. Standard & Poor’s upgraded Malaysia on in which event, the capital account will have to be
○
○
1 April 1999 and Moody’s upgrading followed three liberalized.
○
○
weeks later. This may be good news, but the me- ○
○
It is thus imperative that the Government moni-
dium-term effects of controls and the ringgit peg still tors the situation closely in order to avoid severe
○
○
remain uncertain. Currently, the large current account shocks to the exchange rate system should and when
○
○
surplus and external borrowing have helped to alle- these take place. The choice to peg or float the ex-
○
○
viate short-term concerns on capital needs but the change rate in the long run will have to be carefully
○
○
longer controls and the peg remain in place, the considered. Lessons can be learned from a few
○
○
greater the distortion in competitiveness and capital cases. Pegs in Latin America have, in the recent
○
○
flows into the country. Once imports begin to grow past, helped to bring inflation down. However, infla-
○
○
again, external liquidity would most likely be affected. tion is not a serious issue in Malaysia (and in most
○
○
At the same time, it is questionable if the positive East Asian economies). Pegging brings out a risk in
○
○
events (stock market rally, balance of payments that any sharp devaluation can prove fatal if the fi-
○
○
[BOP] current account surplus, increased foreign nancial fundamentals are weak. On the other hand,
○
○
exchange reserves, interest rate reduction, etc.) sup- under a pure floating regime, small daily adjustments
○
○
posedly due to the imposition of controls are actually expose risks and encourage hedging but such flex-
○
○
attributable to these. Similar trends are present in ible exchange rates allow a country to undertake in-
○
○
other countries where there are no controls. dependent macroeconomic policies. A managed float
○
○
With the ringgit peg, it is difficult to determine is not viable because it normally degenerates into a
○
○
real exchange rates. Analysts believe that the ringgit single-currency peg. Malaysia has suggested peg-
○
○
is undervalued. At the same time, there has been ging to a basket of currencies instead of just one,
○
○
much speculation as to whether or when the ringgit having been through the recent experience of de-
○
○
peg will be adjusted. The Malaysian Government pendence on the dollar. Eventually, floating exchange
○
○
has said that the same rate would be maintained rates could be advisable though such a measure may
○
○
(unless some serious structural imbalances occur put the country through some initial turbulence such
○
○
in the economy). In real terms, the exchange rate as interest rate problems and bankruptcies. New
○
○
parity at RM3.80 to the dollar makes the ringgit the Zealand experienced these when it freed capital flows
○
○
second cheapest currency in the region after the and floated exchange rates in the 1980s. However,
○
○
Indonesian rupiah. This undervaluation allows Ma- as the economy was further opened and prudential
○
○
laysia to capitalize on competitiveness gains. While regulations, transparency, and good institutional
○
infrastructure were put in place, the problems were Banking and Financial Sector
○
○
eventually smoothed out and the exchange rate sta- Reforms
○
○
bilized. Reforms and liberalization are not limited to the fi-
○
○
nancial sector. Rather, they cut across the board
○
○
FISCAL STIMULUS though the financial sector would probably need to
○
○
Malaysia’s main concern during the crisis was the undergo extensive restructuring.
○
○
unprecedented contraction of the real economy in The crisis has revealed cracks in the financial sys-
○
○
the first three quarters of 1998. A top priority in such tem in Malaysia. In spite of the various reforms un-
○
○
circumstances would be to ensure that the economy dertaken in the late 1980s and early 1990s, risky lend-
○
○
is not trapped in a prolonged recession. Some impe- ing practices persisted in the banking system. Struc-
○
○
tus to rekindle the economy is necessary. The strat- tural reforms and prudential measures to strengthen
○
○
egy of maintaining fiscal surpluses should be reversed the financial system are, therefore, imperative and need
○
○
in favor of a deficit budget. In pursuit of a deficit to be accelerated as the country rebuilds its economy
○
○
budget, the Government project selection criteria in the postcrisis period. It is surprising that it has taken
○
○
should be geared towards performance-based ac- the crisis to highlight the need for financial sector re-
○
○
tivities. As such, viable small-scale projects should forms. The decade of high growth has led Malaysia
○
○
be encouraged as they entail greater risk diversifica- (and other countries in the region) to gloss over seri-
○
○
tion. (In this sense, some of the existing mega-projects ous problems and practices in the financial sector.
○
○
need to be scaled down or even abandoned in order Reforms must not be thought of only in terms
○
○
to achieve a more moderate deficit budget.) of recapitalization or liberalization. In the short

○
○
Financing a deficit from external sources at a term, adequate measures for recapitalization have
○
○
reasonable cost would have been difficult. There been undertaken (see Section on Danaharta and
○
○
was also a need to avoid the crowding out of the Danamodal). In the long term, reforms should be seen
○
○
private sectors’ sources of financing. Therefore, as an overhaul with new regulations put in place, and
○
○
the overall deficit should be kept at a sustainable unhealthy and high-risk practices of the past weeded
○
○
level. This would ensure that Malaysia’s external out. The restructuring must facilitate a competitive,
○
○
debt servicing ratio remained at a reasonable and transparent, open, and stable structure in order to
○
○
prudential level. better withstand future shocks to the financial sys-

○
○
○
tem. Similarly, market players must continue to en-

○
○
MONETARY POLICY hance their skills and knowledge. The infrastructure

○
○
To foster an economic recovery, domestic spending of the financial market must be constantly upgraded
○
○
needs to be stimulated. To this end, a low interest and complemented by dynamic, highly skilled, tech-
○
○
rate regime is essential as it will lead to a reduction nology savvy market players.
○
○
in the cost of financing economic activities. None-

○
○
theless, a low interest rate regime may encourage RESOLVING THE PROBLEM OF
○
○
the problem of moral hazard. Such a problem arises NONPERFORMING LOANS

○
○
when lenders are unable to observe the actions of Much effort has been poured into the management
○
○
borrowers after the granting of loans. To minimize and restructuring of NPLs and the recapitalization
○
○
this problem, a more thorough and prudent assess- of banks, which will be important in consolidating
○
○
ment of lending practices should be implemented. and rationalizing the banking industry. Stringent poli-
○
○
This includes a stricter definition of risks and greater cies and checks to prevent future buildup of NPLs
○
○
transparency in disclosure of information. to unhealthy levels need to be implemented. While

○
the move to revert to the precrisis definition of NPLs said that early deregulation and liberalization of the
○
○
as those in arrears for six months may downsize them financial sector have acted as a catalyst for crises.
○
○
on paper for now, it would probably be prudent to let In Asia, particularly, this has meant a departure from
○
○
the appraisal of NPLs be defined according to inter- the traditional norm of having the government’s guid-
○
○
national norms of classification once reforms have ing hand and intervention in external borrowing and
○
○
been completed and the situation has returned to credit allocation before the national economy was
○
○
normal. A correct and consistent appraisal policy of ready. This may be true but in the long run, greater
○
○
NPLs including an appraisal of lending to the corpo- liberalization will be inevitable. Nevertheless, it is
○
○
rate sector and the State will be necessary. important to ensure that the regulatory capacity of
○
○
the system is developed and fully in place before any
○
○
IMPROVING REGULATION AND SUPERVISION effort to liberalize is undertaken.
○
○
Greater transparency and accountability in the finan- Malaysian policymakers are still reluctant to open
○
○
cial system will be imperative for best practices to up the services sector, in particular, the financial sec-
○
○
germinate. Before policies can be implemented, stan- tor. The argument is that the financial services sec-
○
○
dardized principles and regulations for supervision ○
○
tor is not ready to face unfettered international com-
need to be defined. These could be undertaken petition. This argument is not without basis. The cri-
○
○
through the adoption of the Basle core principles for sis has highlighted the need and importance of liber-
○
○
effective bank supervision and after effective com- alizing the banking industry in order for it to benefit
○
○
parison with international norms, as well as finding a from new capital injections. Arguably, liberalization
○
○
suitable balance between traditional prudential and and deregulation in the financial sector should be
○
○
market-based regulatory systems. It is necessary for gradual. Gradual exposure to foreign competition
○
○
BNM to ensure proper implementation of better su- would compel domestic institutions to be more com-
○
○
pervision with a focus on the new global business petitive and innovative in the long term.
○
○
environment. Simultaneously, supervision and regu- Foreign ownership of Malaysian banks is still lim-
○
○
lation must not be impaired by political interference. ited to 30 percent. But the insurance industry has
○
○
The issue on central bank independence is thus of recently been subjected to further liberalization with
○
○
the utmost importance. In the wake of the recent foreigners now permitted to own up to 51 percent of
○
○
crisis, emphasis on risk management will be impera- equity (up from 49 percent in 1995 and 30 percent in
○
○
tive. With the implementation of AFTA, and the pros- 1993). New entrants to the financial sector should,
○
○
pect of greater regional integration and economic con- nevertheless, be allowed in on a gradual or a case-
○
○
vergence, new policies should be targeted towards by-case basis as they are potential candidates for
○
○
regional harmonization. the merging and recapitalizing of ailing institutions.

○
○
The Government could offer two options: first, the

○
○
DEREGULATION AND LIBERALIZATION new entrant could be allowed in on condition that it

○
○
While international financial interests have often merges with an ailing domestic institution; or second,
○
○
called for outright liberalization, this must not be swal- a limited number of new permits could be auctioned
○
○
lowed whole without taking into consideration the to the highest bidder, with the proceeds utilized in the
○
○
level of development of the individual financial sys- rehabilitation of the domestic banking system.
○
○
tem. Too rapid a liberalization process when the sys- A main focus of new policies should now be on
○
○
tem is still unable to cope may ultimately result in a the strengthening of the regulatory and supervisory
○
○
weak domestic banking sector unable to withstand framework to ensure a sound financial and banking
○
○
competition from abroad. Of late, many analysts have system in order to avoid another crisis.
○
Improving Risk Management and Problems in Malaysia’s financial sector could be
○
○
Capital Market Development traced to an overdependence on the sector to meet
○
○
Short-term speculative flows have played a role in the nation’s funding requirements, a phenomenon
○
○
undermining the stability of world capital and finan- often found in emerging economies. Deposits with
○
○
cial markets. Widespread currency speculation would the financial institutions tended to be short-term. Only
○
○
have been impossible under the Bretton Woods sys- a small percentage of deposits were those beyond
○
○
tem as almost all countries adopted strict capital con- 12 months. However, projects with long gestation
○
○
trols. The abandonment of these controls during the periods (such as those in the property sector) were
○
○
1970s after the breakup of the system, and in the financed by syndication of loans among financial in-
○
○
1980s, resulted in an explosion of speculation in world stitutions in Malaysia. There is thus a liquidity mis-
○
○
markets. In its wake, currency trading has ballooned match, where short-term deposits have been used to
○
○
out of proportion; by 1995, foreign exchange trans- finance long-term projects, exposed by the crisis. At
○
○
actions were estimated to be about 60 times greater the same time, cheap foreign borrowing meant that
○
○
than would have been necessary to fund international the economy was flushed with funds, most short-
○
○
trade in the same year. The volume of short-term term. Easy credit led to a rallying of the stock mar-
○
○
transactions has been increasing by about 50 per- ket and also allowed the diversion of resources from
○
○
cent every three years. In the 1980s, this was comple- the real productive sector into speculation. Thus, when
○
○
mented by the gradual abolition of exchange con- speculators began pulling out at the onset of the cri-
○
○
trols, giving birth to a cornucopia of new financial sis, the system fell apart.
○
○
instruments and derivatives, all of which were de- More stringent supervision may serve as a good
○
○
signed to take advantage of a new liberal financial check but will not, by itself, prevent future crises.
○
○
architecture conducive to short-term speculation. Further policies to attract and encourage long-term
○
○
This was compounded by the appearance of hedge capital flows such as FDI and equity portfolio flows
○
○
funds, which have a particularly destabilizing effect should be implemented. Speculative flows should be
○
○
due to their highly leveraged positions. discouraged and short-term flows should be limited
○
○
As the frequency and magnitude of financial cri- to financing short-term trade transactions. The Ma-
○
○
ses intensify, they should no longer be accepted as laysian capital market needs to be further developed.
○
○
mere aberrations in the world capital market. Inter- The bond market should facilitate more efficient long-
○
○
national financial markets are increasingly inherently

○
term funding. In the financial reforms of the late 1980s

○
○
unstable especially for those borrowing heavily from and the measures undertaken in the early 1990s, there
○
○
external sources in foreign currencies and in the short- were efforts to develop the local bond market.
○
○
term. Such financing is suitable to finance trade flows Progress has, nonetheless, been slow. Also, the re-
○
○
but should not be used for long-term investments. pressive regulatory processes and the lack of ad-
○
○
The risk is even higher if such short-term flows are equate bond market infrastructure in the country dis-
○
○
used to finance long-term on-lending by highly lever- courage the use of such fixed-income securities. The
○
○
aged financial institutions. Many of the East Asian Banking and Financial Institutions Act of 1989
○
○
economies overborrowed and as the short-term loans (BAFIA), defines the issuance of bonds as deposit-
○
○
could not be rolled over, the liquidity crunch rapidly taking and forbids it without approval of BNM. All
○
○
degenerated into a full-blown insolvency crisis. The new issues of debt instruments require BNM ap-
○
○
sharp nominal devaluations of domestic currencies that proval before applying for the approval of SC, which
○
○
followed led to a consequent increase in the local val- regulates the capital market. This dual approval and
○
○
ues of the mainly dollar-denominated liabilities. the delay involved discourages local companies from
○
seeking capital market financing. Thus, while a move to involve not only governments, but also lenders
○
○
to more secure financing in order to improve risk and borrowers. World financial centers will prob-
○
○
management is imperative, new policies need to be ably need to be brought under an international um-
○
○
implemented to encourage the changeover. Substan- brella regulatory body where there is enforcement
○
○
tial improvements in the infrastructure for the bond of transparent disclosures, and consistent interna-
○
○
market with a special focus on secondary market tional standards of cooperation and assessment.
○
○
trading systems, a competitive auction system, the These will all be difficult to achieve.
○
○
reinforcement of the role of credit rating agencies,
○
Corporate Governance and
○
and hedging instruments for short- and long-term in-
○
Institutional Restructuring
○
terest rate risks, will be necessary.
○
○
While much effort has been made through poli- There has been much debate since the onset of the
○
○
cies and prudential regulation to enhance and im- crisis about the factors and the structural weaknesses
○
○
prove the soundness of financial systems in order to in the afflicted economies that helped to trigger the
○
○
better manage risks, the magnitude of the Asian cri- crisis. Although it may not have been the prime fac-
○
○
sis has led some countries to call for reforms in the ○
○
tor, there is some truth in the claim that poor gover-
international financial architecture. Various recom- nance was partly to blame. In mature economies,
○
○
mendations have been made including levies on capi- this issue is addressed through the existence of ad-
○
○
tal flows. Reforms at international level are certainly equate institutions and the enforcement of a combi-
○
○
necessary, but the political will to arrive at an inter- nation of corporate laws and regulations. Economic
○
○
national consensus remains far off. The process of development in many countries in Southeast Asia
○
○
globalization is supposed to bring about better oppor- was not always accompanied by the parallel devel-
○
○
tunities for the world economy through a more effi- opment of necessary mechanisms of governance and
○
○
cient allocation of funds across borders. Recent ex- adequate institutional infrastructure. These shortcom-
○
○
perience has, however, shown that it has brought with ings have, to a certain extent, contributed to the vulner-
○
○
it risks that can be destabilizing. ability of the Malaysian economy to external shocks.
○
○
The international financial community is thus Unlike in the crisis of the 1980s where blame was
○
○
faced with the challenge of ensuring an efficient primarily on bad public sector governance, poor gov-
○
○
financial system that is not vulnerable to market ernance in the private sector has been a contributory
○
○
failures and volatile flows of capital. At the level of factor to recent problems. The use of short-term
○
○
individual economies, the question is now how to borrowings to finance long-term lending, and the
○
○
participate in and be an integral part of this new strong preference for debt financing to equity-financ-
○
○
international economy without being vulnerable to ing have all been commonplace practices in Malay-
○
○
destabilizing developments. The push for a more sia. Borrowing and investment decisions based on
○
○
liberal international financial environment has not noncommercial considerations prevailed. Crony alli-
○
○
been matched by parallel development to establish ances enjoying relatively easy access to credit or
○
○
rules to ensure the efficient functioning of markets other facilities have resulted in unproductive and
○
○
and improve safeguards to individual economies unviable investments and ventures. It must, never-
○
○
from the adverse effects of volatile capital flows. theless, be added that such practices know no bound-
○
○
It will not be an easy task to create a new interna- aries and are not restricted to or inherent only in Asian
○
○
tional architecture to regulate capital flows and business culture but are found in the developed world
○
○
hedge funds. Any such attempt will most likely have as well.
○
○
○
There is little that a government can do to actually The World Competitiveness Report of 1997, pub-
○
○
ensure good corporate governance other than put- lished by the International Institute for Management
○
○
ting regulations in place and enforcing them. Good Development, ranked Malaysia 17th (up from 23rd
○
○
governance evolves through time and experience. place in 1996) out of 46 developed and developing
○
○
However, it is important that such a regulatory frame- nations. Among the nonmembers of the Organisation
○
○
work, checks, and penalties are in place in order to for Economic Co-operation and Development
○
○
educate and instill the desired practice and conduct. (OECD), Malaysia was third after Singapore and
○
○
Steps taken to improve standards of corporate gov- Hong Kong, China in 1997. It was also favorably
○
○
ernance and institutional infrastructure will not only placed in several other studies. Nevertheless, its com-
○
○
lead to healthier business practices, but more impor- petitiveness is likely to be eroded over time.
○
○
tant, they will boost investor confidence, especially Being an open economy, Malaysia’s macroeco-
○
○
during times when confidence has eroded. nomic performance will essentially and largely be
○
○
It is imperative for Malaysia to complement mac- influenced by external developments. This is proving
○
○
roeconomic policies by making greater efforts to to be increasingly the case for any economy as the
○
○
implement new rules and set up infrastructures that process of globalization gathers pace. The globaliza-
○
○
will function more efficiently in the provision of gov- tion of markets and production centers, and the ad-
○
○
ernance, supervision, and regulation. This should go vent of new technologies have intensified the com-
○
○
hand in hand with increasing transparency. These petition. In view of this, the economy has to be pro-
○
○
measures may not be an antidote to future crises but pelled towards a higher level of competitiveness in
○
○
they will be a check on malpractices and irregulari- its role as an international player. The intense pace
○
○
ties within the economy, which may otherwise ren- of growth during the boom years has exerted much
○
○
der it vulnerable to shocks. Recognizing the role of pressure on the economy. The increase in labor costs
○
○
enhanced corporate governance, a high-level Finance and staff shortages (both skilled and unskilled) have
○
○
Committee on Corporate Governance was estab- posed serious threats to growth. Though current cri-
○
○
lished by the Government in March 1998. It has come sis conditions have alleviated this burden, it should
○
○
up with some 70 recommendations aimed at improv- be a major lesson for the future once the situation
○
○
ing market practices, including principles for good has stabilized if Malaysia intends to increase its mar-
○
○
governance targeted at listed companies. SC re- ket share. The country will eventually have to change
○
○
viewed and strengthened the rules. These measures

○
from a labor-intensive and low-value input economy

○
○
may be a relevant start but stringency and consis- to a technology-intensive and knowledge-based
○
○
tency over the long-term with periodic checks and economy. The future trading environment calls not
○
○
reviews will be of great importance. Otherwise, it only for an urgent improvement of competitiveness
○
○
would be pointless to continue. but also greater resilience from industry. This means
○
○
sweeping changes, improvements, and facing up to

○
Improving Long-Term
○
inadequacies. New growth strategies will have to be

○
Competitiveness
○
engineered and adjustments made. The alternative

○
○
Competitiveness will be a key issue in the post-crisis is losing out to regional competitors.
○
○
scenario for East Asia. Growing competition from In the long run, Malaysia will have to face the
○
○
emerging economies in other regions of the world has challenge of more efficient and optimal utilization of
○
○
threatened Malaysia’s export competitiveness. With its resources in order to increase productivity, and
○
○
the devaluation of East Asian currencies as a result of sustain and improve national competitiveness in the
○
○
the crisis, competition has become even keener. changing global environment. Unlike some Asian
○
newly industrialized economies, institutional inad- rency to the dollar were imposed in September 1998.
○
○
equacy is still lacking in various areas to sufficiently Both acrimoniously criticized as well as lauded by
○
○
and efficiently govern the pace of growth. New poli- many all over the world, the controversial measures
○
○
cies and measures will be required to deal with this. have given Malaysia a “breathing space” to concen-
○
○
In order to improve competitiveness, there are cer- trate on addressing domestic economic problems
○
○
tain long-term physical considerations to be taken while eliminating speculation and keeping external
○
○
into account. These include, among others, the ur- influences at bay. Interest rates have significantly
○
○
gent need to improve human resource assets in terms fallen and the improvement in the country’s external
○
○
of education, training, and skill upgrading. Skilled accounts has boosted investor confidence.
○
○
human resources are a crucial element in attracting The developments have so far been positive, with
○
○
investments into a country. Malaysia has a weak base low inflation, a favorable trade performance, in-
○
○
in research and development. This has to be seri- creasing external reserves, improved labor market
○
○
ously dealt with. Simultaneously, a gradual opening conditions, and a low external debt position, espe-
○
○
to allow greater foreign equity participation could cially short-term debt. Reflecting this, market sen-
○
○
eventually help bring in badly needed capital and ex- ○
○
timents have further improved as indicated by
pertise. This will improve professionalism in the higher capital market activities, continued loan
○
○
country’s corporations. Government measures need growth, higher private consumption, and an increase
○
○
to be implemented to complement macroeconomic in property transactions.

○
○
policies in order to spearhead Malaysia into the next The expansionary policies, therefore, went some
○
○
decade of growth. This time around it should be pro- way towards improving growth prospects for the
○
○
ductivity-led growth and not input-led growth. economy. However, there may be some time lag be-
○
○
fore the effectiveness of those policies fully filters into

○
Final Words
○
the system. After a decline over five consecutive quar-

○
○
The “virtual IMF policy” adopted by Malaysia dur- ters, the economy recorded a positive growth of 4.1
○
○
ing the initial period of the crisis produced negative percent in real GDP in the second quarter of 1999. In
○
○
results. It aggravated the situation and worsened the fact, the uptrend has been evident since February 1999.
○
○
crisis as it caused a rapid contraction of the economy. GDP growth emanated both from a strong external
○
○
This failure of the combination of tight monetary and demand as well as a recovery in domestic demand.
○
○
fiscal policies prompted the Government to change Since the fourth quarter of 1998, the expansion in the
○
○
its course and adopt an expansionary policy by the external sector has further strengthened. This has
○
○
middle of 1998. The Government continued to fine- generated increases in income, which provided the
○
○
tune macroeconomic policy instruments with the aim basis for a significant revival in private consumption.
○
○
of strengthening economic and financial sector fun- Similarly, the domestic labor market situation im-
○
○
damentals and restoring domestic and external sta- proved in the second quarter of 1999 with a reported
○
○
bility. Nevertheless, in spite of some positive devel- increase in job vacancies, mainly in the manufactur-
○
○
opments, namely, contained inflationary pressures and ing sector, and fewer retrenchments. At the same
○
○
an improved external balance, the national currency time, loan growth (including NPLs sold to Danaharta)
○
○
and the economy continued to remain vulnerable to has picked up again from a low of 0.4 percent in
○
○
external developments. Such a situation could gravely January 1999 to reach about 1.8 percent in May
○
○
aggravate the crisis and cause fundamental damage (-4.3 percent if NPLs acquired by Danaharta were
○
○
to the real economy. In response to this, selective excluded). The gradual acceleration in loan growth
○
○
capital controls and the pegging of the national cur- in 1999 reflects a moderate increase in demand for
○
loans as economic activities pick up. In fact, for com- firms may not expand as much as hoped for despite
○
○
mercial banks, loan growth has already reached a the low interest rates. They may be burdened by
○
○
level of 8 percent. Loan approvals were also main- large debts and may not be willing to expand during
○
○
tained at a higher quantum of RM7.6 billion in May a recessionary period, while banks may be overcau-
○
○
1999, much higher than the RM4 billion–RM5 billion tious in lending and reduce funds needed for invest-
○
○
average in 1998. ment and consumption. Moreover, funding require-
○
○
Simultaneously, manufacturers have also reacted ments for strengthening the banking sector and the
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○
favorably to the positive economic developments. additional fiscal expenditure may not be enough.
○
○
After six quarters of lackluster performance, manu- Serious attention must continue to be paid to long-
○
○
facturers are ready to kick start operations in view term reform measures. This is imperative in order to
○
○
of the improving demand conditions. The MIER Busi- rebuild and achieve the long-term goals of the coun-
○
○
ness Confidence Index surged past the 50-point try. Various pertinent issues can be identified and
○
○
benchmark in the second quarter of 1999 to a level these range from the persistent issue of how Malay-
○
○
of 60.3 points from 48.2 points registered in the pre- sia can maximize management of its financial sys-
○
○
vious quarter. On a scale measuring up to 100 points, tem and minimize risks to remaining competitive in a
○
○
levels beyond 50 points are viewed as a plus factor rapidly changing global environment.
○
○
in business activities. Against this backdrop, gross An important concern facing the Malaysian
○
○
fixed capital formation is expected to expand at a economy remains the issue of capital controls and
○
○
moderate rate of 3.9 percent in 1999, rebounding from the fixing of the ringgit exchange rate. Even though
○
○
a steep 42.9 percent fall in 1998. On the supply side, these measures have produced a certain calm within
○
○
recovery was broad-based with positive growth in the storm and even with all due reforms in the finan-
○
○
domestic and export-oriented industries. In tandem cial and the various other sectors achieved, what will
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○
with increasing sales, manufacturing production rose happen when the controls are lifted? When will or
○
○
sharply in the second quarter of 1999. should they be lifted? There has been little such pre-
○
○
The stock market has also recovered strongly to cedent and it is not possible to predict the outcome
○
○
record new highs in trading. However, this might not of such a move in the medium to long term. A close
○
○
necessarily reflect the performance of the real sector. scrutiny of the situation is warranted and the earliest
○
○
In this context, it is likely that the recovery in regional phasing out of these measures would probably be
○
○
markets has, in some way, contributed to the rebound.

○
the best solution.

○
○
The Malaysian economy is now expected to post a The present crisis, unlike the one in the previous
○
○
growth of about 3 percent in 1999, following a severe decade, has exposed deep crevices in private-sector
○
○
7.5 percent contraction in 1998. This growth is ex- practices. This provides the opportunity to overhaul
○
○
pected to be mainly driven by public sector spending and restructure the wrongs of the recent past and
○
○
rather than private sector expenditure. concentrate on building a competitive and resilient
○
○
However, one cannot rule out the possibility of system to face the challenges of future shocks.
○
○
downside risks. If the external environment does not Rather than adopting the single choice of monetary
○
○
turn out as expected and if Japan continues to re- or fiscal policy, a fiscal-monetary mix in combination
○
○
main in deep recession, Malaysia’s exports will be with other measures would probably be a more ef-
○
○
affected. The trade surplus would decline and for- fective tool, judging from experiences of the recent
○
○
eign reserves will be reduced. Under these condi- past. All said, the adversity that Malaysia is currently
○
○
tions, it would be difficult to maintain the exchange facing will, no doubt, be an opportunity for improve-
○
○
rate peg and exchange controls. At the same time, ment for the future.
○
Appendix ing to the broad property sector (7 September). Bank-
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○
Financial Measures to Promote ing institutions with the capacity to lend required to
○
○
Economic Recovery achieve a minimum annual loan growth rate of 8 per-
○
○
cent by the end of 1998 to ensure that viable projects
○
○
1998 receive financing (9 September). Liquid asset re-
○
○
February. Statutory reserve requirement (SRR) quirement of commercial banks reduced from 17 to
○
○
reduced from 13.5 to 10 percent (16 February). 15 percent of total eligible liabilities (16 September).
○
○
April. Margin of financing for hire-purchase loans Default period for classifying a loan as nonperforming
○
○
on passenger cars costing RM40,000 or less raised by banking institutions increased from three to six
○
○
to 85 percent and repayment period lengthened to months (23 September).
○
○
seven years (23 April). October. Sixty percent maximum margin for fi-
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○
June. Pengurusan Danaharta Nasional Berhad, nancing the purchase of nonowner occupied resi-
○
○
the national asset management company, set up to dential properties costing RM300,000 and above, and
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○
acquire and manage nonperforming loans (NPLs) of the purchase of land lots abolished (5 October).
○
○
banking institutions. ○
○
BNM’s intervention rate further reduced to 7.5 per-
July. SRR further reduced from 10 to 8 percent cent (5 October).
○
○
(1 July). The 85 percent financing margin for hire- November. Banking institutions required to es-
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○
purchase loans for lower-cost passenger cars ex- tablish loan rehabilitation units to enable more in-
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○
tended to all passenger cars and the limit on the maxi- tensive management of problem loans (20 Novem-
○
○
mum repayment period for cars completely removed ber). The minimum monthly repayment on credit
○
○
(28 July). Introduction of a framework for liquidity cards reduced from 15 to 5 percent of the outstand-
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○
management to enable banking institutions to man- ing credit card balances (20 November). The hire
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○
age their liquidity positions more flexibly without com- purchase guidelines for passenger cars abolished,
○
○
promising prudential standards (31 July). allowing banking institutions to determine their own
○
○
August. Danamodal Nasional Berhad, a special terms and conditions for hire-purchase loans
○
○
purpose vehicle, established to recapitalize banking (21 November).

○
○
institutions. Corporate Debt Restructuring Commit- December. The maximum finance charges pay-
○
○
tee, a joint public and private sector steering com- able by cardholders reduced to not more than
○
○
mittee, set up to facilitate and expedite corporate debt 1.5 percent per month or 18 percent per annum from
○
○
restructuring. Bank Negara Malaysia’s (BNM’s) in- 2 percent per month or 24 percent per annum (30
○
○
tervention rate reduced from 11 to 10.5 percent on 3 December).

○
○
August; 10 percent on 10 August; and 9.5 percent

○
○
on 27 August. 1999
○
○
September. Base lending rate framework re- January. Banking institutions no longer allowed
○
○
vised to allow a faster transmission of changes in to provide bridging finance for development of prop-
○
○
monetary policy to lending rates (1 September). SRR erties costing above RM250,000, except for ongoing
○
○
reduced from 8 to 6 percent on 1 September with projects (4 January). Banking institutions required to
○
○
further reduction to 4 percent on 16 September. achieve a minimum loan growth of 8 percent by the
○
○
BNM’s intervention rate reduced again to 8 percent end of 1999 (4 January). The tier system of banking
○
○
(3 September). Lending for the construction or pur- institutions discontinued. As part of efforts to
○
○
chase of residential properties costing RM250,000 strengthen BNM’s banking supervisory function,
○
○
and below exempted from 20 percent limit on lend- additional staff recruited. Finance companies
○
encouraged again to merge or be absorbed by banks, number to a smaller group of large and strong insti-
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○
given that the liquidity situation had improved and tutions. This process to be expedited to enable the
○
○
other financial sector restructuring measures were financial system to function quickly.
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○
already in place. The process of absorption/merger
○
○
to be market-driven and intended to reduce their Source: Malaysian Government 1999.
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Notes __________. 1999. In the Eyes of the Asian Financial
○
Maelstrom: Banking Sector Reforms in the Asia-Pacific
○
○
Region. A Regional Banking Sector Policy Paper based
○
1Agreement reached by France, Germany, Japan, United
○
on RETA 5770: Study of Financial Markets. Asian De-
Kingdom, and United States to drive down the price of the
○
velopment Bank, Manila, March.
○
dollar. Their coordinated efforts led to a 30 percent decline
○
○
of the dollar in the subsequent two years.
○
Athukorala, Prema-chandra, and Peter Warr. 1999. Vulner-
○
ability to a Currency Crisis: Lessons from the East Asian
○
2It further increased to 149 percent in December 1997 (BNM
○
Experience. (Preliminary draft). Asia Pacific School of
○
1998).
Management and Economics, ANU, Canberra, March.
○
○
3The rate reached 33 percent in December 1997 (BNM 1998).
○
○
Bank Negara Malaysia. 1998. Annual Report 1997. Ma-
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laysia: BNM
○
4Danaharta’s acquisition strategies and objectives involve
○
○
valuation methodology which was used as an asset valu-
Bhagwati, Jagdish. 1998. Yes to Free Trade, Caution on
○
ation method in various countries. Among the more promi-
○
Free Capital Flows. Asian Wall Street Journal. 18 No-
○
nent ones are the Swedish Securum Asset Management
○
vember.
Company and the US Resolution Trust Corporation.
○
○
○
Claassen, Emil-Maria. 1992. Financial Liberalization and

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its Impact on Domestic Stabilisation Policies: Singapore

○
and Malaysia. Journal of the Kiel Institute of Econom-

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References
○
ics. Tubingen, Germany.

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○
○
Ariff, Mohamed, Azmi Setapa, Solehah Abdul Hamid, Danamodal Berhad. 1998. Danamodal Factsheet. Malaysia.
○
○
and Musalmah Johan. 1998. Improved Management

○
of the Financial Sector for Its Enhanced Stability and __________. 1998. Danamodal Core Process Analysis.
○
○
Support to Trade and Investment Flows. Malaysia: Malaysia.

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MIER.
○
○
Ekonomika. 1998. Bulletin of the Malaysian Economic

○
○
Ariff, Mohamed, and Syarisa Yanti Abubakar. 1999. Do- Association. Vol. 10, No. 2. October.
○
mestic Reforms and International Co-operation: The

○
○
Malaysian Perspective. Malaysia: MIER. Economic and Social Commission for Asia and the Pacific.
○
○
1997. Financial Sector Reforms in Selected Asian

○
Ariff, Mohamed, Mohd Haflah Piei, and Tiangchye Tan. Countries. New York: UN.
○
○
1999. The Implications of the Asian Financial Crisis on

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Capital Flows-Malaysia. Malaysia: MIER. Hassan, Tan Sri Ali Abul. 1998. Challenges and Prospects
○
○
for Economic Recovery in Malaysia. (Keynote address).

○
○
Ariff, Mohamed. 1999. The Financial Crisis and Reshap- MIER, Kuala Lumpur, December.
○
ing of the Malaysian Economy: Trends and Issues.

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○
Malaysia: MIER. Institute of Developing Economies. 1998. Study on Trade

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and Investment Policies in Developing Countries–Ma-

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Alavi, Rokiah. 1996. Industrialisation in Malaysia-Import laysia. IDE, Tokyo, March.

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Substitution and Infant Industry Performance. Lon-

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don: Routledge. International Monetary Fund. 1998. Containing the Risks

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to the World Economy. Washington, D.C.: IMF.

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Asian Development Bank. 1998. Asian Development Out-

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look 1998. Hong Kong, China: Oxford University Press. Jomo, K. S., ed. 1998. Tigers in Trouble-Financial Gover-
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nance, Liberalisation and Crises in East Asia. Lon-

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__________. 1999. Rising to Asia’s Challenge: Enhanced don: Zed Books, Ltd.
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Role of Capital Markets. A Regional Capital Market

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Policy Paper based on RETA 5770: Study of Financial Lau, Lawrence J., and Kim, Jong-Il. 1992. The Sources of
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Markets. Asian Development Bank, Manila, March.

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Economic Growth of the Newly Industrializing Coun-

tries on the Pacific Rim. Stanford University: Centre for Ministry of Finance. 1995/1996, 1996/1997. Economic Re-
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Economic Policy Research Publication #295. port. Malaysia.
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Lopez, Leslie. 1999. After Controls, Malaysia’s Focus Narayanan, Suresh. 1998. MIER 1998 National Outlook
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Blurs. Asian Wall Street Journal. 17 June. Conference—Towards Economic Recovery: The Fiscal
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Policy Side. MIER, Malaysia, December.
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Malaysian Government. 1999. White Paper.
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Radelet, Steven, and Jeffrey Sachs. 1998. The East Asian
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Malaysian Institute of Economic Research. 1997. Malay- Financial Crisis: Diagnosis, Remedies, Prospects. US:
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sian Economic Outlook, First Quarter. Harvard Institute for International Development.
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__________. 1998-1999. Malaysian Economic Outlook, Rasiah, Rajah. 1998. Busting the Bubble: Causes and Con-
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Fourth Quarter Update. sequences of the Southeast Asian Financial Crisis.
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National University of Malaysia, January.
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__________. 1998. Currency Turmoil and the Malaysian
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Economy-Genesis, Prognosis and Response. Young, Alwyn. 1994. The Tyranny of Numbers: Confront-
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ing the Statistical Realities of the East Asian Growth
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Michie, Jonathan. 1999. Currency Speculation—Need for Experience. NBER Working Paper No. W4680, Cam-
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Reform. The Star. Malaysia, 6 April. bridge, MA, US, March.
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An Insight into

Macroeconomic Policy Management

Mohd. Haflah Piei and Tiangchye Tan

Mohd. Haflah Piei is Deputy Director, Malaysian Institute of Economic Research.

Introduction investment. Business confidence remained strong in

much slower growth in domestic demand especially

while the public sector fiscal position was expected

2.57. The central bank, BNM, tried to uphold the cur-

rency for about a week but was finally forced to float

it on 14 July, by which time the bank had already lost

close to $1.5 billion in its efforts to prop up the ringgit.

Years Preceding the Crisis

By the end of 1997, the ringgit depreciated to a low of

the ringgit settled at an average of RM3.73 to the

Interest Rates and Credit Policy

dollar. More wide swings continued. All these trig-

gered panic among businesses and policymakers, se-

lowed the Government to mop up liquidity at source

on the sale of short-term monetary instruments to

monetary management. nontrade related foreign funds to be subjected to the

differentials between domestic and international in- The Financial Sector

flows. tion within the banking system. In the early 1990s,

Government from realizing the urgency and wisdom

Fiscal Policy of a turnaround in fiscal spending. In such periods, a

Countries react differently to external shocks and in

rationalized indirect tax structure would have helped

the crisis of the mid-1980s, there did not seem to be

International Trade, Industrial and

any need for large fiscal stimuli. When BNM cau-

tioned that the economy might be overheating in the

newly industrialized economies (NIEs) to the region. hancing international trade.

a relatively high flow of foreign capital that year. GATS;

the globalized business and industrial environment. interim financial agreement;

trade regime through the realization of the ASEAN vices; and

Free Trade Area (AFTA). In all, industrial policies in

• undertake various facilitation measures in areas

hensive. and protection of intellectual property rights.

INTERNATIONAL TRADE POLICIES AND

The post-Soviet era has witnessed dramatic changes

reserves were at a comfortable level. Capital inflows ending Malaysia’s “miracle.”

of credit plan to limit loan growth.

from six to three months

Source: Malaysian Government 1999.

1996-1997 (Malaysian Government 1999) . tion, and consumption credit.

As can be seen in the rising incremental capital-

version into nontraded activities such as the property

cent; nevertheless, the rate of investments was con-

deficit. In the past, this gap was bridged by Malaysia’s

Excessive Credit Expansion

heavy reliance on FDI. However, high inflows of

and Diversion of Resources

foreign investment and foreign debt actually resulted

in hefty investment income outflows overseas. (While

institutions necessary to generate the required hu-

measures to liberalize the capital account. Short-term

High Debt-Equity Ratios

portfolio investments can be a source of instability as

fashion when confronted with possible or impending with ringgit depreciation,

able to all, guidelines and prudential regulations could ance of payments,

capital flows. Politically, more transparency and lib- dard of living.

ending Malaysia’s (and the region’s) “miracle.” Un-

during the presentation of the 1998 Budget were