Small Change

DAVID LIEBHOLDNever before have so many Malaysians streamed through the heavy iron gates of Mahathir Mohamad's Kuala Lumpur home. Last Tuesday an estimated 40,000 well-wishers queued in the lavish corridors to greet their battle-weary leader on the Hari Raya Muslim holiday. This is an expression of support for the government, declared the 73-year-old Prime Minister, visibly tired from the endless handshaking. And yet, like so much in contemporary Malaysia, the appearance may have been deceptive. Outside on the expansive lawns, the crowd evinced little interest in politics. Many of the visitors seemed to have been drawn largely by the spectacle-and the plentiful free food. This is the first and last time I will come here, laughed Pari Davi, a schoolteacher. He will soon be gone.That judgment may be premature, but there is little doubt that Mahathir has his work cut out for him. The political damage from the perceived mistreatment of his former deputy, Anwar Ibrahim, is proving difficult to repair. Mahathir's best hope of deflecting public attention from Anwar is to revive the sagging economy, a task he has taken on with characteristic determination. The pundits are now suggesting that Mahathir might call snap elections in April, hoping that a quick economic recovery will give him a lift at the polls. His daring experiment in imposing capital controls has fared better than many experts predicted. Even investment bankers, among the first casualties when the controls were introduced last September, are taking another look at Malaysia. The latest Merrill Lynch Gallup poll finds that Asia-Pacific fund managers have turned buyers of Malaysian shares for the first time since March 1998. Says Sani Hamid, an emerging-markets analyst with Standard & Poor's in Singapore: The controls have served Mahathir's purpose. What's less clear is whether they have accomplished any long-term benefits.Mahathir thumbed his nose at conventional free-market wisdom on Sept. 1, pegging Malaysia's ringgit to the dollar, eliminating offshore ringgit trading and barring foreigners from repatriating the principal of their portfolio assets within 12 months of the investment. Having sealed Malaysia against capital flight and external economic vagaries, the Prime Minister sacked Anwar, assumed personal control of the Finance Ministry and launched a raft of reflationary policies. He increased government spending (targeting a 1999 budget deficit of 6.1% of GNP, up from 3.1% last year) and lowered interest rates from 11.1% to their current 6.7%. Most controversially, given the high level of bad credit in the economy, Mahathir relaxed prudential standards in the banking sector by dropping the central bank's reserve requirements, changing the definition of a nonperforming loan and directing banks to increase lending.Five months after Malaysia was de-linked from the world's financial markets, the currency is stable, foreign exchange reserves have risen an average of $1.5 billion a month and the Kuala Lumpur composite index has more than doubled in value. Even the real economy is showing signs of life in response to Dr. M's unorthodox prescription: last year's sharp decline in industrial production has tapered off and exports, measured in dollars, are growing. Although tens of thousands of jobs have been lost since the economic crisis struck, the monthly rate of layoffs has been declining and unemployment remains low compared with most of Malaysia's neighbors. The bottom line: Malaysia is expected to achieve GDP growth of at least 1% this year, which would be an impressive turnaround from last year's nearly 6% decline.PAGE 1||
Links to all of TIME Asia's Malaysia coverage, including cover stories, polls and moreBut like the crowds at the Prime Minister's residence, signs of revival may be misleading. Many economists regard the recovery as shaky, noting that Malaysia has failed to use the breathing space capital controls provided to introduce badly needed reforms, especially in the unstable banking sector. Critics say the economy is still overextended, particularly in the property sector, and saturated with credit. Rather than prick the bubble, Mahathir has insisted that the money keep on flowing. Things appear rosy because the government has changed a few definitions here and there, says Johor businessman Ahmad Muzni Mohamed, but in reality it hasn't done much to tackle the structural problems.Perhaps the most controversial aspect of Mahathir's growth-at-all-costs approach has been a shifting of risk from the bloated private sector to Malaysian taxpayers. The stock market is heavily supported by state-controlled companies and the government-managed Employees' Provident Fund. No less than $6.9 billion has been spent to liquidate nonperforming loans and recapitalize nine ailing banks, most of it funded by government-guaranteed bond issues. And while other Asian governments have been attempting to ensure more prudent bank-lending practices, Malaysia has slashed the central bank's reserve requirement from 13.5% of eligible liabilities to just 4%. By allowing indebted companies to stay afloat, this loose money is merely putting off the inevitable, painful restructuring. It's like a free lunch for anybody to go out and borrow, says a Singapore economist. The only thing the capital controls achieved was to create a fence around the economy.More importantly, the controls have hurt Malaysia's reputation as an open investment environment, with stable, predictable rules of the game. Even if all the restrictions were lifted tomorrow, there's no telling how long it would take investors to get over the shock of last year's abrupt changes. Fund managers' newfound enthusiasm for Malaysian shares seems to be based mainly on government hints that foreigners may be allowed to take stock market assets out of the country inside of 12 months. Second Finance Minister Mustapa Mohamed said last week that the government was considering alternatives, such as an exit tax or preferential treatment for long-term investors. If the new rules are attractive, the reasoning goes, there could be a rush of portfolio investment-meaning quick gains for those who dive in early.It's not hard to see why the Finance Ministry is trying to come up with a new arrangement. Under the current regime, as much as 90% of the estimated $7 billion to $10 billion in foreign portfolio funds now trapped in Malaysia might scramble for the exit on Sept. 1. Whatever transpires, few analysts expect the currency peg to be lifted any time soon, even though the ringgit is widely regarded as undervalued by perhaps 10%. In the face of continuing political uncertainty, floating the currency would carry the risk of rapid fluctuations. And the Brazilian crisis has provided Mahathir with fresh ammunition in his crusade against unfettered capital flows.|2|
Links to all of TIME Asia's Malaysia coverage, including cover stories, polls and moreThe prospect of a large capital outflow in September is another reason Mahathir might choose to go to the polls well before then. Opposition leaders are instructing supporters to prepare for just such a move in April. That is the last possible date for elections in the state of Sabah, which the government is expected to lose by a large margin. In isolation, such a defeat would reflect poorly on Mahathir and boost opposition morale, says Tian Chua, chairman of Gagasan Malaysia, a pro-democratic alliance of four main opposition parties and 20 nongovernmental organizations. But timing is everything. If the economy starts to go down, then Mahathir will be trapped, says Tian. He won't be able to sell himself as the one who has saved the economy.Earlier this month, the Prime Minister postponed elections within his ruling United Malays National Organization until after the general polls. Neglecting a promise to let the members decide, Mahathir installed loyalist Abdullah Badawi as deputy president of the party (he automatically became Deputy Prime Minister). In so doing, the Prime Minister may have staved off a leadership challenge, but he has also upset the rank and file. People are disappointed, confides an UMNO division chief. The party should choose the leaders. Mahathir is like a drowning man, clinging to the last straw to stay afloat. Still, strong swimmers like Mahathir don't go under easily.Many predict Mahathir will start to relax some of the capital controls imposed last year1. The ringgit is pegged to the dollar at 3.8Forecast: No change likely soon2. The ringgit is worthless outside Malaysia, and billions in foreign funds are frozen inside the countryForecast: Liberalization this year3. Bank interest rates are slashedForecast: No short-term change4. Banks are obliged to lend widely for local projectsForecast: More of the sameWith reporting by Kim Gooi and David Yong/Kuala Lumpur and Ravi Velloor/Singapore||3
Links to all of TIME Asia's Malaysia coverage, including cover stories, polls and more