Capital control a right move, says Dr. Mahathir<\/p>\n
This is the first of two part series, based on Prime Minister
\nMahathir Mohamad's monthly column Dr. Mahathir's World Analysis
\nwhich was first published in Mainichi Shimbun.<\/p>\n
MALAYSIA: It is now almost a year since Malaysia introduced
\nselective capital control. Initially we were worried over whether
\nor not the control would work.<\/p>\n
The criticisms leveled at us by the international media and
\nforeign financial experts did not help to strengthen our
\nconfidence in the measures that we took to revive our economy.<\/p>\n
But our doubts soon disappeared as almost immediately we saw
\nsigns of economic recovery.<\/p>\n
Currency control as imposed by Malaysia is not generally
\nunderstood by the international financial community. Their
\ncriticisms are therefore based more on their text-book models
\nthan on proper examination of what Malaysia has done.<\/p>\n
To understand the measures we took it is necessary to look at
\nthe root cause of the financial turmoil that undermined the
\neconomy of the country.<\/p>\n
The Malaysian economy and finances were very sound prior to
\nthe July 1997 attack on the ringgit. We had good reserves and
\nvery little foreign debt either by the government or the private
\nsector.<\/p>\n
There really was no reason why the currency should have become
\nweak. But the currency traders, in their quest for big profits,
\nborrowed the ringgit and sold it down repeatedly, thus devaluing
\nit greatly.<\/p>\n
This meant our wealth was halved in terms of purchasing
\nimported goods. Inflation set in, and people found difficulty in
\nmaking ends meet.<\/p>\n
To make matters worse, the foreign investors in the stock
\nmarket began to dump their shares and to short-sell.<\/p>\n
They did this through the Singapore-operated Central Limit
\nOrder Book (CLOB), which traded in Malaysian shares without the
\napproval of the Kuala Lumpur Stock Exchange (KLSE) or the
\nMalaysian government.<\/p>\n
By registering all shares held by thousands of investors under
\nthe name of a few nominee companies, trading through CLOB did not
\nrequire registration with the KLSE.<\/p>\n
The nominee companies were able to lend the shares to
\nspeculators who short-sell them and caused the prices to plunge.
\nThrough CLOB the composite index of the KLSE went down from 1200
\nto 260 points.<\/p>\n
Between the depreciation of the ringgit and the severe fall in
\nshare prices, the companies and the banks rapidly deteriorated
\nand were bankrupted or became nearly so.<\/p>\n
The government, too, faced revenue shortfalls as businesses
\nwere unable to make any profit and could pay no tax.<\/p>\n
Clearly the country's economy would have collapsed completely
\nif the currency had continued to depreciate and the share prices
\nremained very low.<\/p>\n
To prevent this it was imperative for the government to regain
\ncontrol of the exchange rate of the ringgit and to stop CLOB from
\ndestroying the Malaysian share market any further.<\/p>\n
To devalue the ringgit the traders had to borrow and sell it.
\nSingapore offered high interest rates so as to lure the ringgit
\nto Singapore where it was lent to the currency traders.<\/p>\n
The Malaysian banks found themselves without money to lend.<\/p>\n
To stop this outflow of the currency, the government decreed
\nthat if within one month the offshore ringgit in whatever form
\nwas not repatriated to Malaysia it would not be allowed to be
\nbrought back at all.<\/p>\n
Effectively this rendered offshore ringgit worthless after one
\nmonth.<\/p>\n
This forced all offshore ringgits to be repatriated within one
\nmonth, leaving nothing for the traders to borrow and manipulate.<\/p>\n
Trading in ringgit ceased and the government was able to fix
\nand stabilize the exchange rate at RM3.80 to US$1.<\/p>\n
As for CLOB and the short-selling activities, this was stopped
\nby abolishing the right of nominee companies to hold the shares
\nof their clients.<\/p>\n
Since all sales of shares must be registered with the KLSE in
\nthe name of the shareholders and sales outside the KLSE are not
\nrecognized the business of CLOB stopped.<\/p>\n
Short-selling of borrowed shares held by the nominee companies
\ncould no longer be done and manipulation of share prices ceased.<\/p>\n
The net result was stability of exchange rates and a rise in
\nshare prices on the KLSE. The forced repatriation of funds from
\nSingapore resulted in more money being available for loans.<\/p>\n
It was therefore possible to lower the interest rates to
\nstimulate consumption and business activities.<\/p>\n
Many other measures were taken such as setting up an asset
\nmanagement company to deal with non-performing loans and the
\nrecapitalization of banks through a recapitalisation fund.<\/p>\n
Every aspect of the economy was studied by a National Economic
\nAction Council (NEAC) set up to take counter measures if the
\neconomy were faced with any problems.<\/p>\n
For example, imports of nonessentials were reduced while
\nexports were encouraged.<\/p>\n
The balance or payment which had been in deficit for many
\nyears was reversed and huge surpluses achieved in the trade
\nbalance. This enabled the reserves to increase from $20 billion
\n(RM76 billion) to $30 billion (RM114 billion) in the space of six
\nmonths.<\/p>\n
All other indicators show that the economy is now improving
\nrapidly and it is expected that the target of 1 percent growth in
\nthe gross domestic product for 1999 will be achieved easily.<\/p>\n
It is expected that the growth in year 2000 will be around 5
\npercent.<\/p>\n
The controls have apparently succeeded in bringing about the
\nrecovery of the Malaysian economy. Although many still condemn
\ncapital controls, others now say that controls can resolve the
\nproblems brought about by the rapid devaluation of the currency
\nby currency traders.<\/p>\n
Some even recommend that other countries open to attacks by
\ncurrency speculators should adopt currency controls.<\/p>\n
It is now easy to think that countries should at least try
\ncurrency controls in order to solve the problem created by
\ncurrency devaluation by unscrupulous traders. But deciding on
\nsuch controls is not easy.<\/p>\n
In the case of Malaysia, more than six months of intense
\ndebate preceded the decision by the executive committee of the
\nNEAC to impose controls.<\/p>\n
One member of the executive committee brought up 32 reasons
\nwhy currency controls would be bad for the country. But the
\narguments were demolished one by one.<\/p>\n
Other members of the NEAC also found difficulty in supporting
\nthe proposal.<\/p>\n
The deputy governor of the Central Bank was invited to give
\nhis opinion and he too was not supported. He gave all the
\nstandard reasons why it would harm the country, its economy and
\nits relations with the rest of the world.<\/p>\n
The former deputy prime minister was still a member of the
\nNEAC executive all the time the controls were being discussed.
\nAlthough he had favored and implemented all the International
\nMonetary Fund (IMF) solutions for dealing with the country's
\ndeteriorating economy and finances during the turmoil, he did not
\nargue against the controls.<\/p>\n
When the decision was finally made to impose the controls, he
\nagreed with the decision.<\/p>\n
It was decided that Sept. 1 was the date for the controls to
\nbe implemented.<\/p>\n
There is no particular reason for choosing this date except
\nthat we reached agreement in August 1998 and wanted to implement
\ncontrol as soon as possible.<\/p>\n
But when the date was almost due, the governor of the Central
\nBank and his deputy tried to scuttle it by resigning.<\/p>\n
This was a heavy blow as the Central Bank was the principal
\nimplementing authority under the law.<\/p>\n
Immediately, the most senior officer of the Central Bank was
\ngiven the responsibility for carrying out the various actions to
\nmake the Malaysian ringgit invalid outside the country and to
\nrequire all shareholders of Malaysian companies to register their
\nownership directly with the Malaysian Stock Exchange, thus
\neliminating the nominee companies.<\/p>\n
Currency controls mean different things to different people.<\/p>\n
To the text-book economists currency control means cutting the
\ncountry off from every kind of financial links with the rest of
\nthe world.<\/p>\n
The Malaysian control is not a simple turning your back to the
\nworld. Malaysia is a trading nation. Its economic growth and
\nwell-being depends largely on its commercial and financial links,
\nincluding direct foreign investment with the rest of the world.<\/p>\n
It is not like the United States, which can actually cut
\nitself off from the rest of the world and still survive and even
\nprosper.<\/p>\n
With only 22 million people and a relatively low per capita
\nincome there is no way for Malaysia to be totally independent
\neconomically and certainly no way for Malaysia to grow and
\nprosper.<\/p>\n
Malaysia must maintain strong economic links with the rest of
\nthe world.<\/p>\n
And so Malaysian currency control had to be so crafted that it
\nwould prevent the currency from being manipulated by foreign
\ncurrency traders while allowing normal business transactions to
\nbe carried out without hindrance.<\/p>\n
And that is precisely what was formulated and carried out.<\/p>\n
Trade has therefore not been in any way affected and it has
\nnot only grown much bigger but the surplus has increased
\nconsiderably.<\/p>\n
The foreign currency to pay for imports is thus readily
\navailable from the surplus.<\/p>\n
Foreign long-term direct investments have not been affected
\neither.<\/p>\n
The investment are flowing in because conversion to ringgit at
\na fixed rate within the country facilitates business budgeting.<\/p>\n
At the same time the exchange rate is more favorable than when
\nthe ringgit was stronger.<\/p>\n
The money invested can be taken out without any difficulty if
\nthere is a need to liquidate and take the money in foreign cur
\nrency elsewhere. Profits from such long-term investments can be
\nrepatriated.<\/p>\n
Clearly the movement of foreign funds in and out of the
\ncountry is not affected by our selective currency control.<\/p>\n
However, short-term investment in the stock-market are subject
\nto some tolerable conditions.<\/p>\n
The capital must stay in the country for at least a year and
\nearlier repatriation would be subjected to an exit tax.<\/p>\n
Apparently these conditions have not stopped foreign short-
\nterm investors from coming in.<\/p>\n
Today, Malaysia's economy is growing again. We believe it is
\ndue to the controls we have imposed.<\/p>\n
But our detractors disagree and point out that the economies
\nof other East Asian countries are also recovering. They say that
\neven without controls Malaysia would recover.<\/p>\n
We believe that the recovery of other East Asian economies is
\ndue to the currency traders stopping their manipulation of the
\ncurrencies.<\/p>\n
The are several reasons why they stopped.<\/p>\n
When Malaysia imposed controls, there was a fear that the
\nother countries might do the same if the attacks continued.<\/p>\n
Secondly, at about this time the Long Term Capital Management
\nFund collapsed threatening to destabilize the financial system of
\nthe rich countries.<\/p>\n
As a result, the banks stopped lending to the hedge funds,
\nthus stopping them from attacking and devaluing the currencies of
\nEast Asia.<\/p>\n
Freed of the threat posed by the currency traders the
\ncountries were able to ignore the IMF prescription for countering
\ncurrency devaluation.<\/p>\n
They lowered their interest rates and expanded their budgets.<\/p>\n
The big conglomerates which had been ordered to dismantle did
\nnot really do so.<\/p>\n
And so the economies of South Korea and Thailand recovered.<\/p>\n
Even the Indonesian rupiah strengthened. But Malaysia's
\nrecovery is earlier and stronger.<\/p>\n
The business community, both local and foreign, is convinced
\nthat controls have benefited them.<\/p>\n
The investing public returned to the stock exchange and helped
\npush up the Composite Index by almost 200 percent.<\/p>\n
With this the companies were freed from the need to meet
\nmargin calls by their banks and were able to do business again.<\/p>\n
The Reserve of the Central Bank shot up by 50 percent as the
\ntrade surpluses increased. All other indices indicate a positive
\nrecovery for the Malaysian economy.<\/p>\n
Malaysia's currency control is made possible by its strong
\neconomic fundamentals. The reserves stood at $20 billion (RM76
\nbillion) when controls were imposed. There was hardly any foreign
\ndebt.<\/p>\n
The financial system and the bankruptcy laws were already in
\nplace. The political climate was stable and the government was
\nbacked by a big majority.<\/p>\n
Inflation was low even when the currency was devalued.
\nReduction in imports and expanding exports had resulted in huge
\nsurpluses.<\/p>\n
The initial attempt to raise funds through bond issues was
\nfrustrated by Moody's and Standard and Poor's downrating
\nMalaysia's credit rating to almost junk-bond level.<\/p>\n
But the high savings rates of almost 40 percent and the
\nrepatriation of the ringgit from abroad enabled Malaysia to
\nignore the failure to raise funds from abroad. There were
\nsufficient funds within the system.<\/p>\n
At this stage Japan came to the rescue by making available
\nsubstantial soft loans amounting to several billion U.S. dollars.<\/p>\n
Japan was also prepared to guarantee any bond issued by the
\nMalaysian government. And so despite Moody's and Standard and
\nPoor's low ratings, when the government tested the U.S. bond
\nmarket in 1999, the issue was oversubscribed by three times.<\/p>\n
The country is now in a sound financial position. The economy
\nis growing and many predict that it will exceed the 1 percent GDP
\ngrowth estimated by the government.<\/p>\n
The ringgit is still pegged at RM3.80 to $1 even though the
\ncurrencies of the neighboring countries have strengthen further
\nagainst the dollar and therefore against the ringgit.<\/p>\n
We do not want to change the exchange rate because this will
\nupset the business transaction and profit forecasts.<\/p>\n
Besides, a weak ringgit makes us more competitive even if the
\ncost of imports is higher.<\/p>\n
This high cost of imports can result in inflation of course.
\nBut Malaysia has always had low inflation rates.<\/p>\n
We counter imported inflation by producing more for domestic
\nconsumption.<\/p>\n
Since food imports are the biggest item contributing to our
\nhigh cost, we have encouraged local food production.<\/p>\n
This has been so successful that we can now export more food
\nproducts, thus increasing our trade surplus.<\/p>\n
With the government in full control of the exchange rate we
\ncan easily enrich ourselves by strengthening the ringgit, even up
\nto the pre-turmoil level of RM2.50 to the U.S. dollar.<\/p>\n
But the downside to this is lesser competitiveness of our
\nexports and therefore less foreign and domestic investment for
\nexport industries.<\/p>\n
The power to change exchange rates must be used judiciously or
\nthe economy may be damaged. The recovery of the Asian economies
\nalso owe a lot to the Chinese government's decision not to
\ndevalue the yuan.<\/p>\n
Had the yuan been made freely convertible there is no doubt
\nthat the currency traders would have attacked it and plunged
\nChina and East Asia in even worse turmoil and recession.<\/p>\n
As it is, they tried to attack Hong Kong instead in an effort
\nto destabilize China.<\/p>\n
The Hong Kong government departed from its laissez-faire
\npolicy and defended the stock market strongly. The attack failed
\nbut Hong Kong's economy and its reputation have been damaged.<\/p>\n
It is really not fair to expect China not to devalue the yuan
\nforever.<\/p>\n
The devaluation of the currencies of East Asia has effectively
\nrevalued the yuan upwards, rendering China less competitive.<\/p>\n
The yuan can actually be devalued a little without affecting
\nthe economies of East Asian countries.<\/p>\n
But I must thank the Chinese government for holding
\nsteadfastly to its promise not to devalue the yuan. China is a
\nfriend indeed, much more so than some other so-called friends.<\/p>\n
As I mentioned the former deputy prime minister was still in
\nthe government when the decision was made to control exchange
\nrate and short-term capital flows. He did not object to the
\ndecision in any way. So economic reasons are not involved in his
\nremoval from office.<\/p>\n
He was removed purely for behavior that is not acceptable for
\na member of the government. It was certainly not a good time to
\nremove him. We were about to defy the world with a strategy that
\nwe could not be certain would work. We were in a state of
\nrecession and severe economic turmoil.<\/p>\n
No one in his right mind would want to add political
\ninstability to the already difficult economic situation.<\/p>\n
If the removal of the deputy prime minister was planned more
\npropitious time would have been found.<\/p>\n
But his misbehavior was such that his immediate removal was
\nnecessary. And so a political problem was added to the economic
\nproblem for the government to tackle.<\/p>\n
Upon dismissal the former deputy prime minister was allowed to
\nmove around the country freely to hold rallies to whip up anti-
\ngovernment feelings.<\/p>\n
The government did not stop him. This apparently did not suit
\nhis purpose. He wanted to convince his followers and foreign
\nobservers that the Malaysian government, and in particular the
\nprime minister, is dictatorial and violently oppressive.<\/p>\n
And so he organized demonstration and rioting by his followers
\nin Kuala Lumpur. The government was forced to arrest and detain
\nhim. With that his followers became truly incensed and violent.
\nThey started to demonstrate and to riot in Kuala Lumpur.<\/p>\n
The foreign media seized on this to depict Malaysia as an
\nundemocratic, unstable, potentially violent country.<\/p>\n
Day in and day out, pictures of rioting were shown by CNN,
\nCNBC, BBC and others. This compounded the difficulties in
\nreviving the economy.<\/p>\n
Investors and tourists avoided the country, and the hotels and
\nother service industries suffered very badly.<\/p>\n
But the demonstration and riots petered out and try as the
\ndetractors could not keep up with the picture that Malaysia is a
\nbad country.<\/p>\n
When the former deputy prime minister was found guilty after a
\nmuch prolonged trial witnessed by foreign and local journalists,
\ndiplomats and sundry NGOs, there was another bout of rioting, but
\nit did not last.<\/p>\n
Today the Anwar affair is no longer relevant as far as the
\neconomic recovery is concerned.<\/p>\n
In the meantime the economy is growing again. More and more
\nexperts are supporting currency control, condemning the IMF and
\neven indirectly the powerful and influential hedge funds and
\ncurrency traders.<\/p>\n
Even the Group of Eight is discussing regulating the
\nactivities of the hedge funds. It will be a long time before they
\nwill actually do something but at least they recognize the role
\nof the currency traders in causing worldwide economic turmoil.<\/p>\n
If they do it again, the funds will certainly be dealt with
\nappropriately.<\/p>\n
The question that has been asked repeatedly is when will the
\ncontrols be lifted. Many say that the objectives have been
\nachieved and Malaysia should go back to the freely convertible
\ncurrency. The ringgit should be allowed to cross the border
\nfreely.<\/p>",
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