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Global Trends by Martin Khor

Sunday 18 January 2004

REVISITING HOW MALAYSIA OVERCAME THE FINANCIAL CRISIS

Tan Sri Nor Mohamed Yakcop’s appointment as Finance Minister II is an occasion to revisit the unorthodox
policy measures Malaysia took in the dark days of the financial crisis that was initially condemned by the
global financial establishment but subsequently acknowledged as being effective. The Malaysian crisis-
management strategy is now seen as an alternative which other countries can learn from.

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The appointment of Tan Sri Nor Mohamed Yakcop as Finance Minister II brought back to mind the innovative
package of policy measures that Malaysia embarked upon in the dark days of the financial crisis of 1997-
2000.

The then Prime Minster Tun Mahathir Mohamed took the bold political decisions to introduce and enforce the
measures. It was politically and technically a courageous act, as the policies flew in the face of orthodoxy
and Dr Mahathir and Malaysia were condemned by the global establishment when they were introduced.

Nor Mohammed is credited for explaining the mechanics of the international currency trade to Dr Mahathir
and for working out the details and mechanisms of important parts of the policy package, especially the fixing
of the ringgit peg to the US dollar, the selective foreign exchange controls and de-internationalisation of the
ringgit.

Today, the Malaysian measures are widely praised for being innovative and effective. The same International
Monetary Fund that heaped skepticism on them has acknowledged that useful lessons can be learnt from the
Malaysian experience.

History will recognize the Malaysian measures as a landmark as they posed a systematic challenge and a
practical alternative to the orthodox policies promoted by the “Washington Consensus”, or the group of
powerful institutions like the IMF, the World Bank and the US Treasury.

Many people today point to the Malaysian measures to show that alternative ways of resolving financial and
economic crises are possible, do exist and can work even better than the orthodox policies.

Malaysia was more lucky than other countries affected by the crisis, like Thailand, Indonesia and South
Korea. We were not in a debt default situation, and thus did not have to turn to the IMF for loans. Those
countries had to obey the IMF, and lost their policy autonomy.

The result was high interest rates, continued currency depreciation, and deregulation of foreign ownership
that led to the foreign takeover of many local assets.

Initially Malaysia also voluntarily took on IMF-type policies. But this did not work, as the high interest rates
added to the corporate and banking crisis; the flexible exchange policy enabled the ringgit to depreciate (at
one time almost touching five ringgit to the dollar); the freedom of capital mobility allowed funds to flow out;
and the cutbacks in government expenditure added to recessionary pressures.

In 1998, a year after the start of the crisis, the Malaysian model was introduced. This package comprised:

· The core macroeconomic measures of interest rates, monetary and fiscal policies. Interest rates were
significantly reduced, allowing firms and consumers to breathe again and then to borrow, thus improving
investment and consumption conditions.

The statutory reserve requirement was reduced to increase liquidity, and banks were encouraged to increase
lending. And government boosted its spending, to get the economy moving again when the private sector
was in the doldrums.

These measures are consistent with the policies advocated by the great English economist John Maynard
Keynes and are an integral part of Economics textbooks. They are taken by the US administration when the
US is in recession.

But they are forbidden to countries borrowing from the IMF, which has insisted on a combination of high
interest rates, tight money flows, and government expenditure cuts. Thus ironically the Malaysian economic
policies were seen as “radical” when they should be considered as standard Keynesian anti-recession
policies.

· Stabilising the exchange rate. The ringgit was fixed at 3.80 to the US dollar, thus ending the previous
flexible exchange rate system. This put an end to currency fluctuations and speculation. It allowed the
macroeconomic policies to be implemented, and prevented a possible debt servicing crisis, which could have
occurred if the ringgit had depreciated to below a certain level, as happened for example in Indonesia.

· Closing down the overseas trade of the ringgit, and the trade in Singapore of Malaysian shares. This
put an end to speculative activities in the currency and in local shares.

· Regulating capital flows, particularly short-term capital outflows by foreigners and local citizens.
Measures included an initial one-year moratorium on outflow of foreign portfolio capital and foreign-owned
financial assets denominated in ringgit. Restrictions were placed on capital transfers by local citizens and
companies.

The restrictions did not apply to the flow of funds relating to foreign direct investment, nor to trade. These
regulations were removed a few years later.

· Maintaining financial stability by deciding on a policy of not closing down financial institutions facing
difficulties, and announcing that the government would guarantee deposits placed in banks and finance
companies. This prompted depositors to retain confidence in the banking system, unlike in other countries
where bank closures (insisted on by the IMF) led to a run on the system and to capital flight.

· Restructuring and recapitalizing the banking and corporate sectors to enable a recovery in the micro-
economy. Among the measures were the establishment and work of Danaharta (an asset management
company) to deal with the non-performing loans problem, Danamodal (a special agency) to recapitalize
troubled financial institutions and the Corporate Debt Restructuring Committee to restructure corporate debt

· Revitalising the various economic sectors affected by the crisis.

· Maintaining certain key economic and social policies, in particular the regulation of foreign ownership of
assets, subsidies and price controls, policies relating to distribution and balance among local ethnic
communities.

If Malaysia had to turn to the IMF, it would have had to end many of these policies, and there might have
been social chaos.

But instead the country could continue to regulate the entry and degree of participation of foreign investors in
the domestic economy. It could assist local firms and financial institutions facing financial difficulties.

The policy of striving for balance in the distribution of assets and equity between locals and foreigners and
among the local communities (the New Economic Policy) was basically maintained.

Socially-oriented policies could continue, such as price controls on essential consumer items and subsidies
on consumer items and to farmers.

The government was also able to maintain its own policies on privatization, and on the extent and rate of
financial and trade liberalization.

Many countries taking IMF loans were pressurized to give up policies such as the above, and this led in some
cases to social unrest.

There are thus some important lessons from the Malaysian policy response to the crisis.

Firstly, there are alternatives to the IMF policies. The Malaysian case shows that such an alternative
approach exists, and can be applied in a relatively successful manner with good results.

Secondly, having policy space and flexibility is important to a developing country. The Malaysian experience
also shows that if a country is able to avoid turning to the IMF, it can be free of being in the straightjacket of
the IMF’s mainly one-size-fits-all policies, and can choose its own policies and also change them if they are
found to be unsuitable.

Thirdly, a coherent anti-crisis strategy should be seen as an integrated package of its elements and
policies. Policy makers often face dilemmas as there are multiple goals and the same policy instrument
meant to achieve one goal may impact negatively on other goals.

In a situation where there are many complex trade offs, it is useful to “think outside the box” and seek new or
extra policy tools.

In the Malaysian case, the various policy elements should be seen as parts of an integrated approach, or of a
whole policy package. Thus, each element should be considered not only on its own merits or for its own role
to achieve a particular goal, but also for its function of having an effect on another goal.

A particular element or policy may not have the same successful intended effect , unless done together with
some other element of policy. Thus, the inter-relationship of the elements and the interaction with one
another should be appreciated.

For example, lowering the interest rate was important for rescuing the micro economy and reviving the real
economy; but doing so would have brought down the ringgit’s exchange rate and threatened the country with
a debt default situation.

The interest rate had therefore to be decoupled from the exchange rate. A new policy instrument—fixing the
exchange rate—was thus introduced.

However, this alone would have been insufficient as speculation on the currency could still take place in
ringgit offshore markets; and capital flight could also threaten the foreign reserves position and maintainence
of the exchange rate would be unsustainable.

Thus, besides pegging the ringgit, the stabilization of the currency also required two additional policy
instruments—ending the overseas speculation by banning the currency’s trade abroad; and introducing
selective capital controls to regulate the outflows and inflows of funds.

Thus, starting with even one major policy goal (reviving the local companies and the local economy) and a
single policy tool (interest rate reduction), the Malaysian strategy also eventually involved several other policy
tools and goals.

Thus to appreciate the brilliance of the Malaysian model, it is vital to see the role or roles played by each
element, and to recognize that each of the measures was part of an integral policy package.

Perhaps Malaysians are still too close in time and in geography to be able to distance ourselves and
appreciate the full value of the Malaysian model.

There were also many measures on the downside, such as the wastage in resources and inappropriateness
of some of the rescue operations, especially in the big companies. These were heavily criticized at the time
as cases of favouritism and cronyism and as a waste of public funds.

In the past two years, Nor Mohamed played a key role in his capacity as Economic Advisor to the Prime
Minister to revamping the structure, ownership and management of several of the companies, and thus
assisted in giving a better image to Malaysian public and corporate governance.

The Malaysian crisis management strategy was of course the result not only of one or two people but a team
led by Tun Mahathir and comprising Ministers, the National Economic Action Council and its secretariat, and
the key government agencies and Ministries.

Nor Mohamed played an important role especially in the aspects involving the currency and the selective
capital controls.

There are high expectations that his skills will be well used to properly steering the finances and economy of
the country in the future.

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