The Sunday Review

Send your feedback or enquiries to [email protected]. You can also fax your comments to 65-734-6301.

Malaysia has to tackle structural weaknesses

STRAIGHT TALK By RAYMOND LIM

MALAYSIA recently announced its highest trade surplus ever -- US$1.7 billion (S$2.9 billion).

More significantly, the November trade surplus was generated largely by export growth rather than import compression.

The latest statistics, together with increasing passenger car sales figures, bottoming industrial production numbers, rising loan approvals and improved liquidity, strongly suggest that the Malaysian economy is stabilising.

The upshot of this is that the Malaysian economy may indeed achieve what the Malaysian government expects -- a 1 per cent growth in Gross Domestic Product in 1999.

In addition, government officials have sent strong signals recently that sooner rather than later, there could be a relaxation of some of the capital control rules, particularly those relating to portfolio investments.

Is it time then to get bullish on Malaysia? Not necessarily.

Why?

The critical issue for Malaysia, as in the other crisis economies in Asia, is not just growth -- Japan had real GDP growth of 5.05 per cent in 1996 on the back of a huge fiscal reflation but went downhill after that spike -- but the sustainability of the recovery beyond 1999.

Take capital controls, for instance.

Yes, there will be changes but these will likely be adjustments, fine-tunings and modifications rather than the dismantling of the capital controls regime.

So there may well be modifications to the one-year holding rule to allow investors to take their money out earlier subject to exit taxes, dual exchange rates, special arrangements such as the Blue Circle deal, which allows investors to take their money out earlier if these are matched by long-term inflows -- direct investments or long-term official aid and Chilean-style reserve requirements on short-term capital inflows.

But more than that, Malaysia must convince the world at large that its underlying hostility and distrust towards the free movement of international capital is a thing of the past.

This may take some convincing as the capital controls -- fixed exchange rate and regulation of capital flows -- are deemed by the Malaysian Prime Minister, Dr Mahathir Mohamad, as essential for maintaining the existing political paradigm in Malaysia in the absence of a major revamp of the world currency trading system.

That paradigm involves not just Malay political dominance but the enhancement of the wealth of the bumiputra elite.

Malaysia's economic crisis has affected the latter severely.

A significant part of this wealth of the new Malay business class has been created in the stock market through listed vehicles that obtained lucrative contracts and projects from the state because of their shareholders' political connections and loans by sympathetic financial institutions.

Others may regard this as political cronyism but in the Malaysian political lexicon, this is affirmative action to create a thriving Malay business class elite.

It is thus par for the course.

And this policy is enshrined in the two pillars of the Malaysian political economy -- the National Economic Policy and the National Development Policy.

Recognising that the IMF will have no truck with the continuation of the way business is done in Malaysia, Dr Mahathir acted to insulate the domestic economy from what he viewed as foreign economic subversion and neo-colonialism that threaten the very survival of the body politic, which he believed was what had happened in Indonesia.

By putting up the shutters, he hopes that his prescription of low interest rates to relieve corporate distress, restructuring and re-capitalisation of banks and the bail-out of troubled bumiputra companies will help maintain the existing political paradigm.

This then is the investment perspective from which we should view developments in Malaysia.

In a fundamental sense, the reason for care in investing in Malaysia remains -- asset prices in Malaysia are determined not by the market but by political goals.

And this translates, in economic terms, to an emphasis on macro-stabilisation without reform of the micro foundations -- the close nexus between business, government and banks which led to excessive and speculative lending and regulatory forbearance -- that made Malaysia vulnerable to currency and banking crises.

Malaysia is the only country among the crisis economies that has moved away from rather than towards structural reforms.

Thus banks will be re-capitalised and bumiputra businesses, saved, but very little is said about the imposition of incentives for better management in the future.

Instead, banking regulations are moving away from international best practice standards: the non-performing loans definition has been reverted to six months instead of three, lending targets are set and lending guided to non-productive sectors -- the property and stock markets where most of the politically-connected wealth is trapped.

Consequently, there is the risk that banks' operational efficiency and asset quality will deteriorate even as they are re-capitalised.

Yet unless these structural vulnerabilities are tackled effectively, the danger is that the next crisis is just around the corner for Malaysia.

Bear in mind also that the reason why capital controls are relaxed is that it is politically acceptable to the Prime Minister to facilitate foreigners buying stocks when the stock market index is around 600, not when it is 295 as in September 1998.

As he saw it, at 295, foreigners would simply take advantage of the crisis to buy Malaysian assets cheap.

There is also the awkward problem of a time bomb ticking away in the form of a one-year moratorium on the proceeds of foreigners' equity investments that will detonate come September 1999 when it is lifted.

Foreign investors will ask themselves: if relaxation fails to entice new capital in, what is the guarantee that they will not be tightened or re-imposed?

This then is the Malaysian government's challenge in 1999 -- to convince the world that structural vulnerabilities are being addressed effectively and that there is no visceral animosity towards foreign capital.

[The writer, a Straits Times guest columnist, is the Group Chief Economist of ABN AMRO Asia Securities.]

Mahathir gives Davos a jolt