Nevertheless, the recent Annual Meetings of the World Bank and the International Monetary Fund made some progress. They established a new Grouping, dubbed the G20, made up of the major industrial countries and selected emerging market economies to take up issues connected with reform of the global financial system.
This paper attempts a brief overview of the crisis and takes stock of what has been learnt from the crisis. It takes up in particular the experience of Malaysia and the socio-economic and political ramifications. It goes on to highlight a number of policy issues that will require close focus in the year ahead.
The Regional Crisis: Almost twenty - nine months ago, this region of the world suffered a major economic set back as the era of fast growth ceased. The Asian Miracle gave way to a crisis. That crisis has been attributed to many causes – cronyism, market failure, imprudent borrowing, the creation of bubble economies supported by volatile capital flows, poor economic fundamentals and the ravaging and marauding activities of greedy hedge fund managers, currency speculators and the rating agencies. There is no real agreement as to what were the real causes. But fair and objective analysis indicates that both external and domestic factors contributed to the devastation.
The East Asian financial crisis of 1997 needs to be seen as the most recent in a series of global crises that have occurred over the past two decades, each of which had unique characteristics and yet were similar in nature. The Mexican default in 1982 saw a withdrawal of commercial lending to developing countries and a series of crises that led to painful adjustment. The 1987 Wall Street market collapse stemming from a loss of confidence, was countered by concerted expansionary action on the part of the authorities of the major economies. This served to minimize the contagion effects and protect the real economy from the effects of the fall in equity prices. The EMU crisis of 1992-93 highlighted the role that speculators can play when exchange rates are out of alignment with economic fundamentals and how strong contagion effects can affect neighboring countries. Weak fundamentals, unsustainable public sector borrowing and a flight of capital triggered the Mexican crisis of 1994 when markets lost confidence. The tequila effect of this crisis, felt throughout Latin America, reinforced the concerns about contagion effects.
The 1997 East Asian crisis has been described as a crisis of confidence, stemming from unsustainable levels of private short-term debt affecting a group of countries with strong macro economic fundamentals. These countries had enjoyed high levels of savings, strong growth rates and a steady inflow of private capital. The crisis was unexpected and shook the consensus view that East Asia’s strong performance would catapult into becoming a dominant economic force on the global stage in the new millennium.
The region’s extraordinary economic and social transformation in the past decade had been seen as a vindication of economic policies that built upon globalization of trade and capital flows with domestic policies that encouraged market forces to drive growth and bring prosperity. It was acknowledged that a degree of political authoritarianism accompanied the market friendly policies. The populations generally accepted the policy-mix. Political debate was muted and the absence of transparency and accountability on the part of the ruling elites generally accepted. Corruption and nepotism inevitably emerged and distorted the proper functioning of markets.
There has been a tendency to think of the crisis as a single phenomenon brought about by a loss of confidence on the part of foreign providers of capital and their subsequent herd-like behavior in withdrawing from the financial markets of the region. Coupled with this, currency speculators played a role. This is perhaps too simplistic a view. Complex forces were at play. Conditions in each of the countries differed. In understanding the evolution of the crisis, it is imperative to look at the situation prevailing in each country preceding the onset of the crisis.
While it is true that the crisis was largely a product of a rapid accumulation of private debt, both domestic and foreign, rather than the emergence of large and sustainable macroeconomic imbalances, pegged exchange rates - somewhat overvalued - created a situation in which speculators were able to trigger a crisis. A weakly regulated financial system provided speculators with the opportunity to take positions that were destabilizing. Contagion did play a significant role in the spread of the crisis. In addition, experience suggests that the rapid growth and large influx of short-term capital flows increased vulnerability and threatened economic and financial stability. Excessive short-term foreign currency borrowing is particularly problematic. With hindsight, it is evident that there were fundamental errors in premature and badly-sequenced liberalization of the capital account. This permitted large-scale bank and corporate foreign borrowing, the bulk of which was unhedged. Getting the economic "fundamentals" right did not necessarily provide a sufficient defense against speculation. Differentials between domestic and foreign interest rates, when coupled with fixed exchange rates and unhedged foreign borrowing can create conditions for a crisis.
As the crisis unfolded, there was a growing recognition that issues connected with governance, transparency and accountability, and corruption were factors that played a role in the emergence of the crisis. Each country had its own weaknesses. In Thailand it was the powerful military-business complex that had controlled the levers of the economy. The Korean situation was different in that the large chaeboles dominated the economy and exercised real power. Similarly, in Indonesia an army-backed authoritarian regime with strong links to a handful of powerful family controlled businesses ran the economy. The Malaysian case was somewhat dissimilar in that the political party in power exercised hegemony and had a strong role in business. Although it may be argued that this may represent an over-simplistic view of the political scene in the major countries affected by the crisis, most analysts would agree that poor governance and a degree of authoritarianism prevailed.
In the aftermath of the crisis, Indonesia, Korea and Thailand turned to the IMF for assistance. That assistance, much criticized, came with conditionality. Beyond the economic prescriptions, the IMF insisted on reforms aimed at promoting " good governance". Political reforms were demanded; greater transparency and accountability were sought, and democratic processes were insisted upon. In all three countries new governments that had popular mandates replaced the old regimes. The new governments were committed to reforms. Whether these political changes have aided the recovery process or not can be the subject of debate. However, the salient point is that the governments in these three countries have acted by taking unpopular measures to address fundamental weaknesses and set the stage for sustainable recovery.
All of the crisis-affected countries are now in recovery. The pattern and rate of recovery has differed. The jury is however still out on the question of how sustainable that recovery is likely to be. Much will depend on the evolution of the global economy. Within the region there are uncertainties concerning health of the Japanese economy. Policy actions by the Chinese authorities to sustain growth and to continue with internal reforms represent uncertainties. The commitment to a program of reform on the part of the crisis-affected countries constitutes the single most important element of uncertainty. Indonesia faces particular uncertainties associated with the continuing political turmoil in regions of that country. The internal situation in Indonesia will have a particular bearing on the attractiveness of the region as a destination for foreign investment.
Malaysia stands out alone in one sense in that the pre-crisis ruling elite continues to hold power and resists calls for reform. The recent election returned the government to a new five - year term. Many analysts have questioned the fairness of the electoral process. However, the opposition Barisan Alternative has gained a significant position and is committed to seeking fundamental reforms. Its ability, however, to push the weakened BN government to embark upon reforms may be limited but it is clear that the status quo will be increasingly questioned and challenged. Some analysts have suggested that full and sustainable recovery in Malaysia may be delayed until issues of governance are addressed. Furthermore, the Malaysian experimentation with capital controls and a pegged currency raise concerns about its ability to create the right conditions for sustainable recovery.
The Malaysian Scene: As in the case of the other countries affected by the crisis, Malaysia had experienced high growth rates averaging 8% per annum. Inflation was low for a variety of reasons (controlled prices of essentials, a lid on wages made possible by importing labor), the ringgit was in a managed float, exports of petroleum products and electronics and reasonably stable primary commodity prices contributed to buoyant exports. The government was able to maintain a strong fiscal position because of revenue growth whilst expenditures were artificially curbed by heaving off activities to the private sector through an aggressive policy of privatization of services and the award of concessions for infrastructure development. Sizable flows of foreign direct investment, along with short-term borrowings and some portfolio investment flows enabled the huge external deficits to be financed with ease.
The mix of economic policies of the Barisan National Government created a sense of complacency. Seemingly, the so-called economic fundamentals appeared strong. Rising income and private consumption levels supported the public mood of "feel good"; unemployment remained low; absolute poverty levels were in decline. All in all these were boom times. Euphoric ministerial statements of an unending pattern of growth and prosperity aided public perceptions.
Behind this facade, the economy was developing in a manner that was unsustainable. Rapid privatization, without putting in place regulatory and supervisory mechanisms, detracted from the protection of the public interest. Much of the privatization was undertaken in a non-transparent manner. Services and concessions were essentially handed over to the "friends" of the ruling elite or to corporations controlled by UMNO. Much of the activity was financed through loans from the banking sector on the basis of inflated valuations and revenue projections. These loans by the banking sector, based on "directions" from the executive arm of the government led to an explosion of debt – in 1998/99 the total debt in the economy amounted to some 150% of GDP. Mega projects launched by the private sector at the behest of the Prime Minister – Perwaja, Putrajaya, Cyberjaya, the Twin Towers, the Kuala Lumpur International Airport (KLIA), the Bakun Dam, the Purtra LRT, tolled highways etc., - were largely funded by such loans augmented in many cases by funding from official agencies such as Petronas, EPF and Tabong Haji. The latter either loaned funds or took equity positions. At the same time, in the absence of fiscal transparency, the Ministry of Finance extended soft loans to the privatized entities. The Ministry also guaranteed loans taken by these private entities, thus assuming large "contingent" liabilities on behalf of the public exchequer, which to this day have not been fully disclosed.
It is also pertinent to note that concessionaires and beneficiaries of privatized undertakings and the corporations given responsibility for the mega projects took their profits upfront through inflated pricing of construction activity carried out by subsidiary or associated entities. These profits were then channeled into either other construction projects or the poorly regulated stock market driven to dizzying heights by the same set of beneficiaries. The property market boom in the major urban centers of the country along with the proliferation of golf courses and resorts is symptomatic of the bubble that was being rapidly created.
These then were the circumstances that prevailed in early 1997, just prior to the onset of the crisis. As previously noted, the crisis originated in Thailand and spread to Malaysian shores through contagion. It is not suggested that the crisis could have been avoided had not Thailand succumbed. With the benefit of hindsight, it would appear that the crisis could have at best been postponed. Clearly the economic policies of the Government coupled with the patterns of governance were such that a crisis was inevitable.
When the crisis broke in mid-1997, a number of policy measures were taken. The then Finance Minister Datuk Seri Anwar Ibrahim in the first instance embarked on a program to bring stability to markets. He essentially shadowed the IMF programs being followed in Thailand, Indonesia and Korea by curtailing and postponing mega projects, thereby protecting fiscal stability; raising interest rates to curb the outflow of funds; directing the banking system to curtail lending and closer monitoring of non-performing loans. Concurrently, he announced a number of safety net programs to protect those most severely affected by the crisis. The ringgit was allowed to float and find a market-sustainable level. However, these policies were to a large degree undermined by the intemperate and contradictory speeches of the Prime Minister. His widely reported attacks on currency traders, foreign investors and essentially being in denial about domestic circumstances and policy miscues, alarmed the markets. His almost daily remarks seriously eroded any market confidence in the policies of the government. He appeared to be driven by the need to protect his protégés whose financial empires were in a state of collapse as the burden of debt began to weigh upon their operations. While following IMF policies, the government studiously avoided recourse to the IMF. It has been argued, with the benefit of hindsight, that this decision was taken in order to avoid IMF scrutiny and interference in the essential policies that supported cronyism and other cosy arrangements.
In early 1998, it was obvious that Anwar was losing the policy debate and that Mahathir was under increasing pressure from the corporate elites to launch corporate bailouts. The return of Tun Daim as the Special Functions Minister sealed the fate of Anwar as the economic policy czar. Daim then proceeded to orchestrate the recovery program under the National Economic Action Council (NEAC) package. The overriding policy objective of the government became salvaging the fortunes of its corporate friends.
The policies had three thrusts – to pump liquidity into the system to prime the pump, to isolate the economy from the discipline of markets and behind the curtain to handout public resources to the chosen few. The 1999 Budget was crafted to inject RM16 billion through a deficit. While there can be little quarrel with the notion of pump-priming, what raised concerns was the manner in which public funds were being squandered. A large part of the increased allocations were to be expended on more grandiose mega projects, the beneficiaries of which were to be the cronies - who would receive construction and other contracts not through open and competitive bidding but through backdoor deals. Wasteful public expenditure, including the building of Putralaya, a new private jet, and the revival of other mega projects ensued. Although it was the mega projects that got the economy into trouble in the first place, the policy in place represented a continuation of past policies. The budget reversed the earlier decision to defer these projects. Another large part of the allocations was to be for bailouts. Thus cronies were aided in two ways: straight bailouts and the award of more contracts. The deficit was to be financed on the backs of the poor – for it was their life savings in the Employees Provident Fund (EPF), Tabung Haji, and SOCSO. Beyond the budget, the so-called "restructuring" of the banks and bankrupt corporations was being financed with raids on the very same entities.
The over-hang of non-performing loans on the books of commercial banks posed a particular danger to financial stability. The issue was addressed through Dahanaharta acquiring the non-performing loans (NPLs). These acquisitions were financed through the issuance of bonds taken up largely by official agencies. In one sense, private debt has been transformed into public debt. Although Dahanaharta is committed to liquidating the assets on its books, to-date no firm guidelines or approaches have been announced. The implications of these steps are clear. In overall terms, the economy continues to be saddled with a large debt over-hang. Meaningful corporate restructuring, along the lines of what is being done in the other crisis-affected countries has yet to commence. The clear danger is that inaction in this regard will contribute to the creation of a new crisis down the road. True and sustainable recovery will therefore not occur in the near term. Compounding the issue is the fact that foreign capital inflows have not resumed. Without such inflows, the economy is unlikely to regain the momentum it needs. Capital controls and the ringgit peg are factors that continue to impact on a resumption of foreign capital flows.
Capital Controls and the Ringget Peg: In Sept 1998, the Prime Minister, against the advice of the competent and scrupulously honest technocrats at Bank Negara and the Treasury, embarked on a policy of imposing capital controls and pegging the external value of the ringgit. He attempted to rationalize his actions on several counts: that the controls would prevent speculators, bent upon a conspiracy to weaken Malaysia, from attacking the currency; the controls would introduce stability in capital inflows thus permitting the Government to engineer a recovery, restructure and re-capitalize the financial and banking system; and permit importers and exporters to have greater certainty in transacting trade. He further embarked on an expansionary monetary and fiscal policy. Many were skeptical but he was given the benefit of the doubt. With the benefit of hindsight, it is patently clear that the controls and related pegging of the ringgit were measures taken with far different motives. The controls have been so porous that the cronies could still move funds out of the country. The currency peg also permitted these very same individuals to reduce their external liabilities.
The experience with capital controls is chequered. They were imposed at a time when they were no longer relevant. They have no not contributed in a material fashion to the economic recovery now being experienced. The damage inflicted by them in acting as a disincentive to new flows into the country has become obvious. Beginning in early 1999, some capital controls have been relaxed, and a few foreign investment advisers have restored Malaysian shares to their emerging-market indexes. These steps have been late in coming. David Roche had predicted that just as before, a lot of the credit will end up in the stock market or in property speculation. This then is the new bubble being inflated. Roche continued : "Even so, Malaysia’s credit boom could go on through 2000 before Mahathir’s Miracle is exposed as another conjuring trick. Then Malaysia will pay for the deception with low economic growth, diving financial markets and political confusion". Malaysia’s economic recovery has been attributed to the role of capital controls and the currency peg. Most observers discount these factors. Malaysian recovery has been no more robust than that of its neighbors. What recovery that has occurred is largely due to the growth of exports of electronics because of a surge in demand in overseas markets. The devaluation effect must also be factored in. However, these elements will not sustain a further growth in exports as existing capacity is fully utilized. Capacity increase is unlikely given the absence of new investments, curtailed by both present economic policies and the political uncertainties that continue to be a factor. The second essential element that has contributed to the modest recovery is existence of an expansionary fiscal policy. Yet, this has not led to a revival of consumer demand or private investment. Public investment continues to be channeled into mega projects that contribute little to generating growth in the medium term.
An issue of the utmost concern is the rising tide of red ink represented by the country’s debt levels. The foreign debt of the country is estimated at RM161.3 billion or 55 per cent of the country’s Gross National Product (GNP). Moreover, between 1998 and 1999, the country borrowed from abroad RM24 billion. Of this RM161 billion, the private sector was responsible for RM59 billion. The rest of RM72 billion was the debt of the public sector, meaning the Federal Government, public corporations and state agencies. The domestic debt of the Federal Government alone, excluding public enterprises and state corporations, amounts to RM91.8 billion as of June 1999, up RM24.7 billion since September 1998. These amounts excluded contingent liabilities that lurk below the surface as an iceberg. For 1999, it is projected that 20 sen of every RM1 in the government's operating expenditure will be for debt servicing. This is the highest since 1994.These levels of debt are clearly unsustainable. The budget for the current year fails to address this issue. The budget for the coming year, presented in October 1999 and which will be re-presented to the new tenth Parliament at the end of February this year, was an irresponsible budget targeted at creating a "feel good" factor for the purposes of aiding an electoral victory for the Barisan. It failed to address the critical longer-term problems faced by the country. The country will be called upon to pay a heavy price.
It is becoming increasingly clear that the government has found it extremely difficult to borrow in the international capital markets; private foreign investors are loath to return and international financial institutions, such as the World Bank, are weary of lending particularly to finance bailouts. It is no secret that the World Bank has deliberately dragged its feet in lending to Malaysia, as against its operations in Korea, Thailand and Indonesia, where speedy disbursements were the order of the day. While the institutional investment funds may well return to invest in the KLSE, after the re-incorporation of Malaysia in the Morgan Stanley indices, this is not in the long-term interest of the nation. The funds that will enter the market would be of a short-term nature, therefore volatile and will contribute to instability.
The most severe criticism that can be made of Government economic policies is that it has failed to pursue in a systematic manner the restructuring of the corporate and financial systems. Corporate governance remains weak. Enforcement of laws is selective. Corporate managers are subject to selective prosecution. The re-capitalization of corporate entities has yet to be seriously tackled. There appears to be a heavy reliance on the injection of loan funds, either from the bond markets or the banking sector. No serious attempt has been made to seek equity financing or new equity capital through mergers and acquisitions as has been the case in other crisis-affected countries such as Indonesia, Thailand and Korea. The solutions being pursued, with heavy reliance on loans, are laying the foundations for future corporate crises. For instance, the Renong restructuring through the issuance of zero coupon bonds is illustrative. Renong will ultimately need to redeem these bonds but how will that be done given its bleak outlook for earnings.
While the Government has come to recognize the need for some restructuring of the banking sector, it has lost sight of the longer-term issues. Its ham-fisted attempts to force mergers were driven by concerns about ownership and concentration – not the viability and health of the system as such. It is clear that the Government’s prime goals, both in the context of the corporate and banking sectors, are to address issues of ownership and control, with little attention paid to issues of efficiency, viability and strengthening capacities to compete in an open global system. It is significant that Mahathir has in recent statements criticized globalization. These statements may be a prelude to strengthening protectionist policies on the grounds of the "national" interest.
The Appropriate Economic Policy Mix
The Barisan Alternative (BA) has taken commendable steps through the
presentation of the Alternative Budget in terms of the short term. Its
Common Manifesto was also a welcome step towards articulating alternative
economic policies. It is clear that if the BA is to gain momentum and credibility
for its agenda, it will have to take a much more coordinated and systematic
approach, such as a multi-step approach, viz:
For the present, it is imperative that the effort be focussed on
exposing the Barisan Nasional message about the economic recovery,
the fallacies of current policies and their linkage to corruption and cronyism.
The Malaysia must be made to realised the risks and unsustainability of
a debt-financed strategy to grow out of the crisis and to mobilise their
support for a national program of revival based on a six-point strategy
as follows:
(16/1/2000)