Open and shut case: Malaysia flounders
while Thailand earns extra credits

By Peter Hartcher and Bruce Cheesman

When Malaysia's Prime Minister, Mahathir Mohamad, declared that "the free market has failed and failed disastrously", he closed his country off from the world's money exchanges. Next door, Thailand took the opposite course. 

Although the two South-East Asian neighbours were victims of the same phenomenon massive capital flight their reactions were in total contrast. While the Malaysians retreated from the free flow of capital, the Thais remained committed to it. 

So how do the two approaches compare today, two years after the crisis first broke in Thailand and 10 months after Malaysia imposed capital controls? 

Thailand began its recovery from the crisis in a worse position than Malaysia. It had a heavier burden of foreign debt, zero foreign exchange reserves, and a more severely damaged banking system. 

It was forced to go to the International Monetary Fund for emergency credit, and a condition of this credit was that it keep its system open. 

But Malaysia was stronger and was not obliged to turn to the IMF. This gave it the freedom to experiment with a more managed, less open set of policies. What happened next? 

"Why would you want to impose capital controls and fix the exchange rate?" is the rhetorical question from the director of the IMF office in Bangkok, Reza Moghadam, speaking on July 2, the second anniversary of the outbreak of the Thai crisis. 

"The reason is so that you can allow interest rates to fall, and so stimulate demand. Well the Thais got interest rates down as low as, and then lower than, Malaysia. Yesterday, for instance, overnight interest rates in Malaysia were 3 per cent and in Thailand 0.8 per cent. 

"And three-month interest rates in Malaysia were 3.4 per cent and in Thailand 2.75 per cent. So with an open capital account, you have lower interest rates. So there is no need for capital controls. 

"The Thais have achieved this by establishing credibility, and they did that by using monetary policy flexibly. 

"When there was talk that the Indonesians were thinking about a pause in their debt payments, we were quite worried about the effect that could have on Thailand. But nothing happened here, because the credibility of policy in Thailand had been restored. 

"And when the US Federal Reserve increased American interest rates, nothing happened. The point is, getting Thailand out of recession and into a position where it can withstand external shocks." 

The IMF, of course, has a direct interest in Thai success. It has been advising Thailand on policy and so its own credibility is at stake. And Moghadam agrees with the proposition that Thailand and South Korea have become the pin-up boys in the IMF locker-room as examples of success. 

Or, as he puts it: "It's probably right to advertise that there has been good policy implementation." 

Mahathir argues that his course has been successful: "We think that our currency control and also control of short-term capital has done a lot of good." 

And analysts do give Malaysia high marks for some aspects of crisis management. For instance, Mahathir's Government gets credit for a much more aggressive program of restructuring and recapitalising the banking system. 

But most regional economists do not attribute any of Malaysia's success to the twin decisions to impose capital controls and to fix the exchange rate. 

"Malaysia has gained no net advantage" from its approach, according to the regional economist at Nomura Securities in Hong Kong, Bill Overholt. 

"Its economy and markets would have revived anyway just as Thailand's are doing. And the cost is that foreigners are going to be relatively slow to come back into Malaysia. You get order by imposing controls, but from the investor's viewpoint it's disorder. 

"Every time a major firm buys Malaysian shares, they will ask themselves the question: Will the rules be the same next month, next year?" 

And most regional anaysts suspect that Malaysia has used the capital controls as a shield behind which to protect politically well-connected tycoons. 

The regional economist for Credit Lyonnais Securities (Asia), Jim Walker, says: "The thing I continually come back to is that bad companies in Thailand have had a shock and are forced into a clear up of bad investments and businesses they don't know how to run. They should be better run in future as a result. 

"That's not the case in Malaysia. The whole process has been aimed at ensuring the companies that caused the problem are preserved." 

Tomorrow: How Thai democracy has fared in economic crisis.