How Malaysia Handle the Asian Financial Crisis – Final Part
Vicious Cycle of Financial Crisis
Why no alarm Bells before the crisis?
What surprises everybody is that there are no signs on the impending crisis because the economic indicators show no signs of rapid deterioration. The only signs are the falling stocks and property prices. In January 1996, Thailand’s stock market felled 40% as with Korea’s bourse which also felled sharply at the end of 1996. Malaysia’s stock market also dived during the early 1997. The following is the timeline of events occur in Malaysia’s during the 1997 Financial Crisis.
|Column1||Timeline of Malaysia’s response to the 1997 Financial Crisis|
|Date||Chronicle of Events during the Asian Financial Crisis|
|2nd July 1997||After exhausted of funds defending the Baht. Thailand decides to float it|
|10th July||Bank Negara Malaysia intervene in the Forex market to defend the Ringgit|
|13th August||Mahathir attack rouge speculators and point finger at Soros|
|27th August||Malaysia designate the 100 Index linked counters and banned Short Selling|
|4th Sept||Malaysian Ringgit continue to plunge|
|20th Sept||Mahathir called for currency trading immoral and be banned in HK|
|21st Sept 1997||Soros calling Mahathir ‘a menace to his country’|
|2nd Oct 1997||Meeting in Argentina. Mahathir and Nor Yaakop finalising the Capital Control|
|5th Dec 1997||Malaysia impose tough market measures by Anwar Ibrahim|
|7th Jan 1998||NEAC was formed|
|16th Feb 1998||BNM reduce SRR from 13.5% to 10% in banks. Boosting liquidity in banks.|
|20th May 1998||Asian currencies continue to plunge|
|20th June 1998||Formation of Danaharta as an asset management company to handle NPLs|
|10th August 1998||Danamodal was formed to recapitalise the Banking Sector|
|16th August 1998||KLCI plunge to the lowest at 260 points|
|1st Sept 1998||Imposition of Capital Control|
In view of the deterioration of Malaysia’s internal and external sectors, time is of essence. To tackle the problem Malaysia established the NEAC (National Economic Action Council) in 7th January 1998, which was based on ideas and policies of NOC (national Operation Council). NOC was formed as a result of the 1969 racial riots. The NOC was given executive power so it can override all the red tapes and jurisdiction of different ministries to ensure the smooth implementation of policies.
The main objective of the NEAC are as follows :
- Restoring both public and investor confidence.
- Make sure it will be a soft landing for the economy.
- Reposition and revive the economy to enhance competitiveness and also its attractiveness to foreign investors again.
- Strengthen the economic fundamentals to ensure vision 2020 will be achieved.
The following is the flowchart of the NEAC structure
The NEAC consist of 26 members with the Prime Minister (Dr Mahathir) and Deputy Prime Minister (Anwar Ibrahim) as the Chairman and Deputy Chairman respectively. While the remaining consists of representatives from various Ministries , Governor of Bank Negara Malaysia, EPU, NEAC EXCO, Executive Director, Secretariat, Working Group and the NEAC Communications Team. The NEAC EXCO was chaired by the Prime Minister while the Executive Director was chaired by ex-Finance Minister Tun Daim Zainuddin. The Secretariat was staff by EPU officials and the Working Group members consist of Tan Sri Wan Azmi (Land and General), Datuk Dr Zainal Aznam Yusof (ISIS), Tan Sri Thong Yaw Hong (Public Bank Chairman) and Professor Mahani Zainal. From the above timeline it is clear that even after a series of measures adopted, the Ringgit and stock market is still plunging. Hence as a result, desperate situations needed desperate measures and capital control follows next.
The idea of capital control was originated during Mahathir’s trip to Argentina. The Chief architect of Malaysia’s capital control is Nor Yakcop. Formerly he was running the foreign exchange trading desk in Bank Negara and the very same man that caused Bank Negara Malaysia to lose about RM 30 billion 20 years ago. Other members of the group that caused the forex scandal includes ex-Prime Minister Dr Mahathir, ex-Finance Minister Daim Zainuddin and ex-Bank Negara Governer Datuk Jaffar Hussein. According to ex-Bank Negara Deputy Manager, Dr Rosli Yaakop the main culprits are Nor Yakcop and Datuk Jaffar in speculating and gambling away Bank Negara funds. To create an impression that Bank Negara had ‘a team of forex traders’ Nor Yackop used his and the staff’s computer to do the buying and selling.
The reason behind the loss of RM30 billion in the foreign exchange misadventure is due to Nor Mohamed Yackop’s bet that the Bank of England would float the Sterling during the 1992 European Financial Crisis. Mahathir ordered Bank Negara to purchase large amount of the Sterling in the hope that it will appreciate once it is floated. Meanwhile his rival on the other end of the bet is George Soros who through his Quantum Fund established short position using currency forward contracts and options to the tune of US10 billion. Other currency speculators sensed the kill soon join in the fray and they together drove the pound down. Soros walked away with US1 billion for a day’s work while leaving Mahathir with more than RM30 billion loss. Later Soros is known as ‘the man who broke The Bank of England’. This is the main reason why Soros was so unpopular with the Malaysian media. He and Mahathir have gone into many heated arguments and name calling later on during the Asian Financial Crisis.
While in Argentina Mahathir called upon Nor Mohamed Yackop (since he was the only dude that had the most experience with foreign exchange) to enlighten him on the inner workings of the foreign exchange market.At the same time Mahathir asked Nor Mohamed to design the country’s capital control policy. Practically what he (Nor Mohamed) done was he went through the Country’s Balance of Payments report line by line looking for any leakages to prevent any capital outflow from the country.
Needless to say this strategy proved to be too complicated to comprehend and also caused a lot of confusion later on. The border control forms and other forms that designed to track the movement of the ringgit proved to be very confusing. Due to the lack of time and to fast track the process these forms are copied from other countries, presumably from Argentina and other Latin American countries since they are the experts in capital control. For example one of the conditions for funds raised from the sale of equities and other investments had to be remained in the country for a minimum of 12 months. It is not specified whether the residents and the locals are required to do so and consequently it created a lot of confusion. As a result the NEAC Communications Team was formed to deal with the problem and also in educating the people.
Capital Control implementation
The NEAC had been toying with the idea of Capital control many times in the past. Bank Negara Malaysia had been the most ardent opposition to the use of capital control knowing its repercussions or after effects. From empirical analysis of other countries that have adopted capital control, any future capital raising in the international markets will be shunned by investors and hence the costs of funds.
Before we go further into Malaysia’s foray into implementing its capital control, I think its best for us to understand Capital control. When a country runs out of Monetary tools to stabilize its economy and confidence during a financial crisis, the last resort or attempt will be to implement capital control. It will only be implemented when funds are leaving the country in a big way.
Capital control is an attempt by any Government to introduce policies to control the free flow of funds in and out of the country and also within its borders. Below are some of the more common types of capital control.
- Controlling the foreign exchange transactions.
- Controlling the international bank transfers
- Confiscation of Precious metals like gold and silver
- Fixing the Exchange rate
- Controlling the amount for bank withdrawals
On the 1st day of September 1998, Prime Minister Dr Mahathir Mohammad announced the capital control. Malaysia’s capital control is a mix of the above measures (Rojak in Malaysian) and nothing new at all despite what the press claimed it was unique or one and only in the world because Malaysia did not embrace the IMF. The following measures are taken to ensure that the objectives of stabilizing the Ringgit and control the capital flows are accomplish.
- Overseas bound Local travelers are only allowed to take up to RM1,000.
- Remittance of funds by residents to overseas are capped at RM10,000.
- Ringgit is pegged to the dollar at the rate of RM3.80 to US1 to facilitate trade in the domestic sector.
- Any ringgit remains outside of Malaysia considered not legal tender. This is to prevent speculators from borrowing the ringgit offshore to sell it in the domestic market for dollars. In other words to perform short selling on the ringgit and when the ringgit depreciates they will buy it back to repay their offshore ringgit loan.
- Any credit facilities obtained overseas need to seek approval first and only companies that earn foreign exchange are allowed to obtain offshore credit.
- Funds raised from the sale of equities or other forms of investments need to be remain in the country for 12 months. This is to prevent short-term capital flight.
- Clearing of Stocks listed on the KLSE can only be done on the KLSE or its approved exchanges.
- RM500 and RM1000 currency notes are made non legal tender to prevent smuggling of Ringgit to neighboring countries.
- Dealing of shares in CLOB was made illegal to prevent the flow of funds to Singapore and also discourage the arbitraging of shares between the two exchanges.
Reasons for Malaysia’s success
The end result of the capital control is it does bring some stability to the economy because the exchange rate had been stabilize and also there is did not exist a black market for the Ringgit. There are many different views on Malaysia’s success in implementing capital without too many repercussions in the short run. The following may offer the best explanations for Malaysia’s success.
- Its Authoritarian Government.
- The Crisis is Urban confined
- Malaysia’s Debt/GDP was smaller
- Delayed response to the crisis.
- Absence of black market currencies
Why took so long?
However there have a lot of skeptics from many quarters as to why it took so long for the capital control to be implemented? It took more than one year since the crisis started on 2nd July in Thailand. The following may be the reasons for the delay.
- Running out of options. The authorities have tried many selective capital controls and unorthodox economic approach to stabilize the Ringgit to serve as a stop gap measure for it to buy more time so that when other countries recovering Malaysia will then participate in the recovery which will help to turn around their economy.
- Timing of the execution. A different approach between Dr Mahathir and his Deputy Anwar Ibrahim who is also the Finance Minister then. Anwar was the blue eye boy of Washington and even the Wall Street Journal called him the ‘calm voice of economic reason’ during the crisis. Anwar prefers the orthodox approach of free market enterprise policies like increasing the interest rate to protect the ringgit and also the contractionary fiscal policies to balance the budget following the lines of the IMF austerity program. Their difference led to the sacking of Anwar on 2nd September, a day after the imposition of the Capital control.
Malaysia’s bloated civil service will also needed to be trimmed. Loss making banks and other financial institutions will be either closed down or sold to foreign banks. Foreign banks are allowed to own up to 100% equity in local banks like those in Indonesia. Malaysia’s national car project PROTON, Perwaja Steel, all the IPPs (Independent Power Producers), Light Rail Transport, PLUS, Indah Water, AMMB, RHB, Bank Bumiputra, Renong Group and other remnants of crony capitalism will have to go. There will be no more ‘Bumiputra status’ because IMF believes in equal opportunity policies. In other words, Joseph Schumpeter’s creative destruction where survival of the fittest will prevailed.
Long Term Negative effects
Indonesia seems to be doing everything right in the past such as liberalizing its financial sector and also encouraging market reforms under President Susilo Bambang Yudhoyono. This year alone it managed to attract two mega FDIs to the tune of US$10 billion a piece. Malaysia’s Robert Kwok who had been forced to relinquished his sugar monopoly business in Malaysia is investing US10 billion into the palm oil plantation while Taiwan’s Foxconn is said to be pledging US10 billion to open a plant in South Jakarta next year to assemble Apple products such as iPods and PC. Another notable investment is Singapore’s DBS multi billion dollars acquisition of Bank Danamon this year.
The upgrading of Indonesia’s Sovereign rating to ‘investment grade’ by Moody’s and Fitch does help in attracting further FDIs. Companies that are previously unable to invest in Indonesia due to the ratings constraint can now have the opportunity. In the first half of this year total FDI increased 28.1% year-on-year to Rp 107.6 trillion. According to its investment chief M. Chatib Basri ‘Indonesia can achieve a target of 206.8 trillion Rupiah in FDI this year which would easily topped 2011’s record of 175.3 trillion rupiah and Indonesia potential still can rise’. Another thing is that the total FDIs in Indonesia is actually bigger than reported because investments in the oil and gas and the banking sector is not included such as the DBS deal.
Why Malaysia lagged?
- Crony Capitalism still persists until today. Should Malaysia have taken the IMF path and with its austerity measures, crony capitalism in Malaysia would have come to an end. With IMF’s austerity measures weak companies are forced to close down or be sold to foreign companies. There will be no more monopolies or duopolies in our economy. Bailouts will be out of the question and ‘creative destruction’ will work its way through the economy.
- Continued outflow of professionals to other foreign countries. This phenomenal is also known as ‘Brain Drain’ and the main cause is due to unequal opportunities. In Malaysia, to climb up the corporate ladder it is not what you know but who you know is that more important. In education more than 90% of the places in the tertiary education are allocated to the ‘Bumiputra’ and hence the chances for other minorities to enter universities are very slim even they have good grades. It must be noted that future economic growth depends on today’s investment in human capital. Singapore had a lot to thank Malaysia for its constant supply of high quality labor force from Malaysia. The Government is trying to balance the outflow of professionals by offering incentives to attract Malaysian talents abroad through Talent Corp failed miserably. It is reported that less than 1000 returned last year and many of those who came back earlier had also left.
- Flip Flop public policies. In Malaysia it is well known that new public policies are not ‘brain stormed first then implement’. Over here much to our delight, public policies are more of the ‘implement and try first’ kind of variety. This is the main reason for various public policy errors which not only defeat its purpose but also aided in the misallocation of public resources. Take for example even during my schooling days in the 1970s. I belonged to the first batch of students that did our school syllabus in the Malay language. Our government then converted the syllabus from English to Malay medium and we are required to take the SRP and SPM (year 7 & 9) examinations instead of the British LCE and MCE. Of course I don’t feel any difference until I furthered my study in Australia studying Economics. Imagine trying to understand terms like household income, yield curve, fiscal and monetary policies, inflation and etc in English coupled with the Aussie slang spoken by the lecturers. Heck ! It is like hell to me. I couldn’t find any reference book in Malay and so what I did was to get an English to Malay Dictionary as a reference and write down every single word that I don’t understand in Malay on the textbooks. Damn ! after a year or so, I became an expert in the field of translation.
- Malaysia’s Shadow Banking System. It is operated by Illegal money lenders or loan sharks. There exists a secondary market for funds in Malaysia for people that are either black listed by the financial institutions or do not have enough collateral. It is similar to those shadow banking systems that operates all over Asia especially in China. In these markets borrowers are able to get loans with little or no collaterals from the money lenders. They are charged between 1-3% per month as interest.
Malaysia’s competition in FDI
Malaysia’s short and long term goal of attracting more FDIs in the future will have to face more competition from the ‘frontier markets’ in the North. Countries such as Vietnam, Laos, Cambodia and Myanmar are also opening their markets to foreigners. China recently has been a big player in those countries by moving many of its labor intensive and uncompetitive industries over there. Wages have been increasing in China and it is losing its competitive edge. It had to move up its value chain by investing in more value added industries and relocating its labor intensive industries to its southern neighbors is the logical thing to do.
Recently the military juntas in Myanmar seem to be moving in the right direction. There are opening up their market albeit slowly and also at the same time implementing market reforms. Last year a record of US$20 billion worth of FDI is pledged. Coca cola and Heineken which left the country since 1986 and 1987 respectively are making a comeback at the end of this year. Standard Chartered and a group of Thai Banks are planning to open representative offices and a Thai led US$8 billion deep sea port project is under way. Myanmar seems to be one of the last frontiers to open up for investment after CUBA and North Korea. It is one of the three countries that Coca Cola had no presence.
Can Malaysia’s capital control be copied?
There are some quarters especially from the Malaysian side argued that their way of implementing capital control cannot be carbon copied to other economies. They added that it is only unique to Malaysia. Well if the following conditions are met, I am sure it can be carbon copied but not up to 100%.
- Authoritarian Government
- Debt/GDP lower than 50%
- Strong external sector
- A diversified economy
Anyway at present in view of the deteriorating global financial and economic conditions with slowing growth in China’s exports and other emerging economies like Korea, Singapore, Thailand, Indonesia and also Malaysia, any sign of a sustainable rebound in the economy is not likely until at least by next year. The thing that most people feared will be the deepening of the European and American financial crisis. With no end in sight after two rounds of capital injection there is a possibility that things might turn for the worse. So how do ordinary folks insulate themselves from the coming crisis?
What should we do?
Another event of late that happened without many people noticing is the ‘reverse flow’ of physical gold from central banks around the world. For the past 20 years or so, central banks around the world are net sellers of gold but since last year there are net buyers of gold. According to World Gold Council, between April and June this year central banks around the world bought a total of 157.5 tons. This represents a 138% increased quarter on quarter compared to last year. Central Bank of Kazakhstan and Russia added 5.4 and 22.3 tonnes respectively. Traditionally, gold had always been the safe haven investment of choice during troubled times. Ever since the debasement of currencies and also the looming systemic financial system collapse, it now provides more reasons to own gold.
Gold is now seen not only as a source of collateral for loans but also act as a venue for Centrals Banks to diversify their foreign reserves. Instead of depending on building up their foreign reserves with US$ or Euros and risked being devalued, they now accumulate physical gold to counter that.
Another reason for the accumulation of gold by Central Banks is that there are seeing something that we don’t. Legendary investor Soros is reportedly selling all his banking shares and converting them into gold investments. Even John Paulson, who made more than US20 billion by betting against the housing boom is diversifying more than 60% of his funds into gold. Big Money had been manipulating the gold price through the futures market like LME and CME to keep them low so that they can accumulate physical gold on the cheap.
There will come a time when they have accumulated enough gold and then without any notice they will push the price of gold ‘through the roof’. At the meantime the dollar will further devalued due to the ‘capital flight’ to gold. By that time Central Banks and Big Money will start liquidating their physical gold holdings to sterilize their debts or in other words there will be a ‘resetting of debts’. After that they will be solvent and continue the vicious cycle of debt accumulation-plundering-bailouts again. So isn’t it time for folks like us to liquidate our ‘paper investments’ to start accumulate physical gold?