LUMPURTrapped between a fixed dollar exchange rate and debilitating
political uncertainty, Malaysia's economy and its capital markets are currently
in a no-win situation.
The economic fundamentals, such as
inflation, may not be as gloomy as the mood here. But in its current quandary,
Malaysia seems likely to lag any broader Asian market recovery.
That view received fresh support
Wednesday, when the government announced that gross domestic product had grown
only 3.2 percent in the first quarter, its slowest pace in two years, as
slumping demand for electronics exports forced manufacturers to scale back.
All this is why foreign investors greeted
the removal of the last control on foreign capital flows this month as occasion
to sell, not a signal to return to a once-favorite market.
The 2 percent decline in the Taiwan
dollar this week, following the earlier weakness of most other floating Asian
currencies, has underlined the exposure of the Malaysian currency, the ringgit,
to a rampant U.S. dollar.
The question of whether the fixed ringgit
rate of about 3.8 to the dollar will hold back the Malaysian currency is in the
news again because of the strength of the dollar, and the uncertainty is likely
to lead to further capital outflow and erosion of the foreign exchange reserves
that are the currency's main line of defense. Malaysia's reserves have fallen
over the past year to $27 billion from $34 billion, and real concern could set
in if they were to fall much below $25 billion - equivalent to just three
Of course, the dollar's strength may soon
reverse. If this does happen, the pressure will be off the ringgit. But it will
still be unattractive relative to other Asian currencies.
Malaysia's difficulty is that it has been
trying to have things both ways - maintain its currency's tie to the dollar but
use capital controls to prevent too much exposure to market forces. The problem
is that the controls are not working. Foreign companies are, legitimately,
repatriating spare cash because of the higher return they can get on dollar
Capital outflow has contributed to low
monetary growth and offset some of the impact of expansionary fiscal policy.
Further fiscal stimulation to offset weakness in manufactured exports was
announced in March, adding to the big public-sector deficit projected in the
But there are now concerns that the
bureaucracy will be slow to implement new project spending and that cautious
consumers will fail to respond to a reduction in their provident fund
The external environment is certainly
half the problem. Large layoffs in the electronics sector are hurting sentiment
as well as employment. Meanwhile, low prices for palm oil and rubber are having
a direct impact on rural spending power - in contrast to the situation in 1998,
when prices cushioned rural areas from the impact of the financial crisis.
But political and currency concerns are
offsetting the domestic demand stimulus that ought to be able to compensate for
the external downturn. There is huge scope to increase consumption, but
consumers remain reluctant.
One possible response to capital outflow
would be a rise in deposit but not lending rates, on the theory that it would
stem profit repatriation and help sentiment far more than it would undermine
banking recovery. Other possibilities include a heavy external borrowing program
to build up reserves and government pressure to force state companies to
repatriate capital and finance their foreign investment with borrowing offshore.
But no policy will work unless there is
confidence in its originators. Concern over policy direction has been
exacerbated by uncertainty over the future of Finance Minister Daim Zainuddin,
now on leave, and the role and views of two new economic advisers recently
appointed by the prime minister.
Even with all these problems, the
Malaysian economy is expected to grow 3.5 percent or so this year. Inflation is
low, and Malaysia's ability to shed some of its large foreign labor force
Longer-term fears, such as the
competitiveness of its electronics industry compared with that of China, may
prove groundless. Meanwhile, Malaysia's demographics, infrastructure and
resource base are intact and will continue to generate an inflow of foreign
But whatever merits a dollar peg and
capital controls might have had in 1998, they are now a liability. The sooner
Malaysia can find a way of moving to the flexible exchange rates of most of its
Asian neighbors, the more relaxed it will be able to feel about international
exchange rate movements.
The irony now is that the one country
that was most vociferous in its demands for an Asian currency system and swap
arrangements independent of the International Monetary Fund and Washington is
now hoist on a dollar standard, while the likes of South Korea and Thailand have
been able to take recent currency fluctuations in their stride. The dollar peg
is making domestic economic management more difficult and threatening the
progress of regional free-trade agreements by increasing Malaysian industry's
demands for protection.