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From: g2jomo <g2jomo@umcsd.um.edu.my>
Here is the
text of the testimony by the economist who appeared at the US Congressional
'Kangaroo Court' that appeared in the Singapore Straits Times (June 19)
available on ST interactive. Note that the author states the circumstances
under which Malaysia imposed capital controls though she does not credit
them for the economy's improvement. Also, there were 4 - not 3 -
subcommittee members at the hearing; this is TYPICAL i.e. it's obvious
there were only 7-8 SEATS available for the members as there are so many
hearings going on at the same time, few hearings have as many as 7-9 out
of 21 members attending. Bernama also did not mention the full house
of about 50 observers.
Malaysia's Response to the Asian Financial Crisis At the onset of the Asian financial crisis in July 1997, Malaysia was the most open of the five most severely-hit Asian crisis economies. Its exports accounted for 70 per cent of its GDP, its import barriers were low and declining, and the country received more foreign direct investment (FDI) as a share of GDP than any other in the world. Its domestic economic fundamentals were also strong, with a high savings rate at 38 per cent of GDP, low inflation, and a government budget that was typically balanced or in surplus. Its private financial institutions, infrastructure and education were superior to those in most neighboring countries. Statistically, the only significant weakness was a high domestic debt burden, at 170 per cent of GDP. There were also signs of excess capacity in the banking sector and in the property sector. A persistently large current account deficit approaching 10 per cent of GDP earlier in the 1990s had been nearly halved by 1996, and was readily covered by FDI. Foreign exchange reserves were healthy. Not surprisingly, Malaysia was a darling of foreign portfolio investors as well as direct investors. It was widely hailed as a model of openness and market-oriented development. Thus when Malaysia succumbed to the financial crisis, it was a surprise to most outside observers and to Malaysians themselves. Following a currency plunge of some 40 per cent, the economy nose-dived into a recession which saw a decline in real GDP of 6.8 per cent in 1998. This was as steep a decline as that experienced by Thailand and Korea, and much worse than that experienced by the Philippines-- all of which had much weaker pre-crisis fundamentals than Malaysia. Several explanations have been given for this unexpectedly deep decline. First, Malaysia¹s very openness made it extremely vulnerable to contagion from its neighbors. Second, the currency collapse and capital flight were aggravated by a loss of confidence in the Malaysian political leadership. This was occasioned by Prime Minister Mohammad Mahathir's verbal attacks on foreign currency traders, and his growing divisions with his then deputy and finance minister, Anwar Ibrahim. Policy disputes between Malaysia and Singapore, an important source of foreign capital in Malaysia, added to this loss of confidence and capital flight. Third, unlike the other four Asian crisis countries, Malaysia refused to go to the IMF for emergency funding. This could have arrested the capital flight and currency. Fourth, though Malaysia did follow initially the conventional crisis management policy of fiscal and monetary austerity, in the absence of IMF funding, and in the presence of domestic political uncertainty, this failed to stabilize the economy. It is in this context that Malaysia's eventual resort to less conventional policies needs to be evaluated. After only a few months of austerity, the government reversed course and began relaxing both fiscal and monetary policy, and exhorted banks to increase lending to the beleaguered property sector. But without an injection of foreign funds, such policies were bound to lead to continued capital flight and currency depreciation, especially in the wake of the contagion emanating from the Russian debt default of late 1998. The Malaysian government argues that having already tried devaluation and austerity without success, the imposition of exchange controls in September 1998, a day before the dismissal of Anwar Ibrahim, was the only course of action left. Capital controls allowed the government to fix the value of the Malaysian currency, pursue more fiscal and monetary stimulus, contain any damage to confidence likely from the dismissal of Anwar, and rescue heavily-indebted Malaysian companies undergoing restructuring, without further weakening the currency and prompting more capital flight. Following the imposition of capital controls, economic indicators did indeed start improving. But they also improved at the same time in other crisis-hit countries which did not impose such controls. All the crisis-hit countries' currencies stabilized, their inflation and interest rates fell, their current accounts moved from deficit into substantial surplus and private capital inflows increased. The decline in their GDP growth rates moderated sharply and have now reversed everywhere except Indonesia. Until very recently, the recovery in Malaysia actually lagged behind that of its neighbors who were IMF patients, particularly in inflows of foreign direct investment. My own opinion is that capital controls in Malaysia were neither necessary nor sufficient for economic recovery. Indeed, given Malaysia's much stronger macroeconomic position, one would have expected its recovery to be faster and stronger than most of its neighbours. That this has not happened suggests that capital controls may be exerting a drag on its recovery. The recovery of the Malaysian economy, like that of other crisis countries¹, is easy enough to explain without invoking capital controls. The severe recession it suffered in 1998 held down post-devaluation inflation and interest rates. The low prior level of public debt allowed the government to run a large fiscal deficit and issue a substantial amount of bonds. Currency depreciation encouraged exports and capital inflow, contributing to the rebuilding of foreign exchange reserves. Relaxation of austerity in the second half of 1998 helped arrest the GDP decline. And low interest rates and low asset values stimulated the recovery of stockmarkets. Global factors helped too. The continued strength of the U.S. economy helped increase exports and export-oriented inward foreign investment. Also, fears of an overvalued stockmarket in the U.S., a weakening euro and falling interest rates in Europe and recession in Latin America, made Asian assets more attractive to international investors. Regional recovery also created "positive contagion" just as the earlier decline had created "negative contagion". Thus there are many reasons why Malaysia¹s economy would have recovered even without capital controls, and might have recovered more quickly and strongly without them. Evidence from other countries suggests that the imposition of controls exacts a price in raising the cost of capital and discouraging some foreign capital inflow. Because of its pre-crisis strengths, Malaysia has so far been better able to withstand or counter the negative effects of controls than other countries that might wish to follow in its footsteps. Even so, it has been penalized by capital markets in having to pay a premium of 330 basis points over U.S. Treasuries (significantly more than Korea or Thailand) on recently-issued sovereign bonds. Press reports and anecdotal evidence suggest that the foreign capital pouring into the country's stockmarket is mostly "hot money". These are exactly the kind of short-term speculative funds that capital controls were supposed to discourage. Instead, Malaysia remains largely shunned by longer-term "value investors" discouraged by the capital controls and by the freeze on approximately US$4 billion of Malaysian shares which had been traded on the now-closed CLOB offshore stock exchange in Singapore, a prime source and conduit of foreign capital for Malaysia. The Malaysian government¹s policy pronouncements remain ambivalent and contradictory. On the one hand, there is continued denunciation of foreign capital market actors. On the other, there is an assiduous cultivation of these same foreign capital market actors, especially portfolio investors. This policy unpredictability is likely to discourage some long-term investors. That capital controls themselves remain in place, and the CLOB issue is unresolved, suggest that despite all the signs of economic recovery, capital flight is a potential problem that the government still fears. ______________
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