Economic Scene: Link to Strong Dollar Proving to Be Malaysia's Weakness
Philip Bowring International Herald Tribune
Thursday, May 24, 2001
KUALA LUMPUR Trapped between a fixed dollar exchange rate and debilitating political uncertainty, Malaysia's economy and its capital markets are currently in a no-win situation.
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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.
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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.
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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.
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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.
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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 months' imports.
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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.
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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 deposits.
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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 budget.
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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 contributions.
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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.
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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.
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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.
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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.
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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 provides flexibility.
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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 direct investment.
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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.
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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.

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