Moving in the Wrong Direction

DAVID ROCHEMalaysia is on the brink of bankruptcy. Its central bank, Bank Negara, has been forced to boost money supply to bail out the country's financial system. By cutting the amount of cash that the commercial banks are required to keep with the central bank, the government has released money into the economy equivalent to nearly 20% of GDP. As a result of this and what's to come, Malaysia's currency, the ringgit, will be debased.The roots of Malaysia's economic crisis are similar to those in other Asian countries. The cure its leader seeks is not. The crisis is based on a huge overhang of domestic debt. Bank credit now is equal to more than 160% of GDP. In September, Prime Minister Mahathir Mohamad imposed controls on capital flows to unhook Malaysia from the world economy and the currency speculators he loathes. But in wielding powers reminiscent of a Soviet-style master planner, he is merely adding to the country's debt and deficit woes.Malaysia's super-high savings rates were squandered by a financial system prone to political interference on behalf of prestigious mega-projects and unproductive real-estate deals. International bankers signed on, shoveling in their depositors' money. Such practices have now ended nearly everywhere in Asia, leaving empty buildings, bankrupt banks and deserted shopping malls to litter the post-bubble landscape. They are ugly, but they signify the painful adjustment that, handled right, should put Asia back on a growth track in a few years. Market mechanisms are being allowed to destroy the excesses of the Asian economic miracle. Not, however, in Malaysia. There, by prime-ministerial command, the party must go on. Unfortunately Mahathir's policies are not working. Capital isolationism has not stabilized the economy. While industrial production has virtually stopped falling in Thailand and is even rising in South Korea, the drop in Malaysia is accelerating and has reached double-digit levels. Applications to set up new manufacturing projects are down 50%.PAGE 1|
Links to all of TIME Asia's Malaysia coverage, including cover stories, polls and trial updatesIn this environment, Malaysia's banks might hope to trim lending to loss-making companies. Since the beginning of the year, overall bank lending is flat. But Mahathir (who also serves as Finance Minister) let Bank Negara's governor leave in August and then forced the central bank to take steps to increase lending. The bank cut commercial banks' statutory reserve requirement from 13.5% to 4% and reduced the bank's three-month intervention rate by 400 basis points to 7%. The cut in reserve requirements released more than $11 billion into the banking system. Meanwhile, the government is dictating a resurgence of bank lending. Mahathir says banks must increase corporate lending 8% this year. That would mean an extra $9 billion of loans by the end of the year--even as real GDP is falling.That's a recipe for inflation, especially since much of this extra money will go into unproductive sectors like property. Mahathir has personally launched a campaign to boost house-buying by allowing banks to lend up to 95% of purchase prices, compared with the previous 80% limit. The Prime Minister is handling the country's banking crisis with a troubling fiscal sleight-of-hand. His government has ordered Bank Negara to redefine non-performing loans to get many of them off the books. These measures will help reduce these problem loans to less than 10% of total lending portfolios. But changing the definitions doesn't mean the bad loans have suddenly turned good. I estimate the government will eventually have to come up with about $15 billion, or 22% of GDP, to restore the banking sector to anything remotely akin to health.The demands on government spending don't end there. Mahathir is trying to shore up the collapsing economy with $4 billion in fiscal-stimulus and infrastructure packages. Meanwhile, costly bailouts of well-connected firms continue. Renong, a bankrupt construction group, will get nearly $3 billion in money the state can ill-afford. The deep recession (real GDP fell by 8.6% in the third quarter) has already created a federal budget deficit that, between now and the end of 1999, is likely to total at least $7 billion, or 10% of GDP. It may be tempting to print money to fill the gap--except that it's about to yawn as wide as the Grand Canyon.Mahathir's policy of isolationism, in what used to be Asia's most internationalized manufacturing economy, is nothing short of a disaster. His policy of expanding power money--cash in circulation plus bank reserves--will feed inflation, which is currently at 5.2%. And it will destroy living standards in a country that has no means of financing a current-account deficit and so must eliminate it by shrinking domestic purchasing power. You can bet your last dollar that inflation will debase the currency as capital flees past the government's controls. And as social tension mounts, Mahathir will be hard-pressed to placate the masses and will no doubt have to step down. Eventually Malaysia will rejoin the world under a new, more-enlightened leadership. But not before its people and economy suffer terribly.David Roche heads Independent Strategy, a London investment firm|2
Links to all of TIME Asia's Malaysia coverage, including cover stories, polls and trial updates