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Malaysia Survives Dire Predictions

By Paul Blustein, Washington Post Staff Writer
Wednesday, May 19, 1999; Page E01

This article from the Washington Post on the Malaysia experience is remarkable because:

1. It comes from Paul Blustein, a very conservative, pro-globalization writer. His acknowledgement that Malaysia's capital controls worked, or at the very least did not apparent harm, is itself noteworthy.

2. It reports on a similar conclusion reached at the IMF.

3. It features IMF officials trying to contain the meaning of the Malaysia experience: Maybe capital controls can work, they say, but only as a temporary, desperation move in response to crisis. Why not on a more permanent basis? Well, because.

Robert Weissman
Essential Information
Internet: rob@essential.org

For anyone who recalls the nasty things Malaysia did to foreign investors last September, and who believed the predictions that dire consequences would befall the country for turning away from global financial markets, the latest twist in Malaysia's economic saga may come as some surprise.

In a remarkable illustration of bygones being bygones, Malaysia has announced plans this month to sell as much as $2 billion in bonds to international money managers, whose appetite for the bonds appears to be reasonably strong. The move comes as the country's main stock index, up 30 percent in the past month, yesterday reached its highest level since October 1997.

"Private market people always say that if a country reschedules its debts or otherwise treats them badly, they'll never go back in, but as soon as there's money to be made, it turns out they won't let those things cloud the opportunity to make new dough," said Morris Goldstein, a scholar at the Institute of International Economics, a Washington think tank. "So all the stories saying they won't be back for 10 years tends to be overdone."

Therein lie some awkward questions for the barons of the world economy: Was Malaysia's temperamental prime minister, Mahathir Mohamed, right to break with the economic orthodoxy preached by the International Monetary Fund and its backers in the Clinton administration by slapping controls on foreign capital? And is it really such a terrible idea for countries under financial siege to adopt such controls rather than subject themselves to the devastating impact of investor stampedes?

IMF officials say they are studying Malaysia's experience carefully to see what lessons may be drawn, and Managing Director Michel Camdessus sounded a conciliatory note in recent days.

"Consensus seems to be emerging that controls may have a place when there's risk of a crisis," he said Monday in Hong Kong, "but only as a breathing space while other fundamental measures can take effect." In a separate CNBC interview, he said: "I praise the way in which Malaysia has been able to adopt a soft system of controls," acknowledging that the government had minimized the controls' adverse impact on investors.

That's quite a switch from eight months ago, when Malaysia was widely viewed as an international financial pariah after Mahathir's announcement that he was taking drastic action against the currency speculators he had often denounced for their alleged conspiracies to subvert his country's once-thriving economy.

Like neighbors such as Thailand and Indonesia, Malaysia had suffered a major sell-off of its currency, the ringgit, by investors fleeing an economy that was suddenly branded as loaded with excess real estate and dodgy bank loans. With a deep slump already underway, Mahathir became convinced that the painful austerity measures recommended by the IMF for restoring investor confidence, such as high interest rates and budget cuts, weren't going to work.

Indeed, Mahathir wanted to pump up demand, and in order to do so without risking a renewed outflow of capital, he prohibited investors from taking their money out of the country for one year. He also fixed the value of the ringgit at 3.8 per U.S. dollar and effectively barred trading in the currency.

In Washington, appalled Treasury officials privately voiced hopes that the move would quickly boomerang so other countries wouldn't be tempted to follow Malaysia's example. Many foreign analysts and officials warned that investors would never return to a country that had treated them so shabbily. The perception of a country cutting itself adrift intensified when Mahathir's government brought charges of sexual improprieties and bribery against Anwar Ibrahim, the former deputy prime minister who had supported opening the economy and democratizing the political system.

But now, with the Malaysian economy projected to grow 1 percent to 2 percent this year -- better than Thailand or Indonesia -- and giant trade surpluses rolling in, investor enthusiasm has been high enough for the government to launch a bond issue, which is being managed by Salomon Smith Barney Inc. While some international investors say they will almost surely shun the bond, others say they will be watching closely to see if the yield is attractive enough to lure them in.

"Changing the rules for investors midstream is not a good thing, and people don't ever forget," said Janis McDonough, senior investment officer at John Hancock Mutual Life Insurance in Boston. But she added of the Malaysian offering: "I'd look at it vis-a-vis some of the other opportunities we have in Asia." (Based on current trading in old bonds, Malaysia is likely to pay interest of perhaps 2.5 percentage points more than equivalent U.S. Treasury bonds, which would be slightly more than the approximately 2 percentage points above Treasuries that South Korea is paying.)

Malaysia's decision to impose controls hasn't been vindicated, many analysts and officials insist. In the first place, they say, the country's success is attributable mainly to the sound financial policies it adopted, especially its moves to restructure its banking system by getting rid of bad loans and injecting fresh capital into banks. Had Malaysia undertaken those steps without controls, it might have done even better, critics contend, noting that Malaysia's Asian neighbors have also enjoyed solid rebounds in their stock and currency markets.

"Malaysia has moved very quickly to stabilize its banking system," said Gregory Fager, head of Asian research at the Institute of International Finance, an organization representing international banks and securities firms that invest in emerging markets. "That's the kind of thing that has really been the catalyst for recovery in Asia. Capital controls is a sideshow."

IMF officials make similar arguments and point out that Malaysia has also improved its relations with investors by changing the absolute prohibition on withdrawals of funds to a less onerous tax.

"They have certainly moved quite far ahead in terms of restructuring their financial sector, and their macroeconomic policies have been good," said Margaret Kelly, senior adviser in the IMF's Asia-Pacific Department. "They've wisely used the breathing space provided by the controls."

But whether or not Mahathir can claim his move proved justified, at the very least he can say it didn't turn his country into the perennial financial pariah some critics expected.

"All of this has to be looked at very carefully," said John Boorman, director of the fund's policy development and review department, who said historians may conclude that Malaysia might have emerged even stronger by sticking to more conventional policies. But, he added, "I think there's a sigh of relief that reforms continued."