Capital controls anchor Malaysian recovery

By Eileen Ng

KUALA LUMPUR (AFP): The Malaysian economy has stabilized after six months of capital controls, but analysts say the short-term benefits must be followed by deeper banking and corporate reforms.

They warn that a rise in the perception of Malaysia's political risk might dampen economic recovery amid impending national polls and the nagging issue of a successor to Prime Minister Mahathir Mohamad.

An easing of the restrictive controls in early February has not managed to convince foreign funds to return, as many wait for Malaysia to be reinstated in closely-watched benchmark indexes, they add.

The controls, which included a fixed exchange rate and abandoning the ringgit's external convertibility, were introduced in September last year after Malaysia plunged into its first recession in 13 years.

A one-year holding period was, meanwhile, imposed on foreign holders of local stocks, bonds and properties, but this has been replaced with a capital gains tax from Feb. 15 to allow foreigners to remit their proceeds ahead of a September deadline. Taxes in the property market have also been lifted.

The controls have improved Malaysia's external accounts, and the government had managed to secure most of the US$16 billion needed to spur recovery despite recent downgrading of its sovereign debt.

A survey by global credit card issuer MasterCard International found consumer confidence had shot up dramatically after the controls were imposed.

The MasterIndex of consumer confidence -- with zero as the most pessimistic, and 100 as the most optimistic level -- surged from an all-time low of 23.8 in June last year to 67.6 in December.

"While still not at its pre-economic crisis highs when it was regularly recording MasterIndex scores in the 90s, there has been a dramatic improvement in consumer confidence," a company statement said.

Confidence in the stock market, economy and employment all showed notable upward shifts, it added.

The controls also brought a reprieve to Malaysian manufacturers, earlier burdened by rising interest rates.

"It is much easier for our members to obtain loans now and capital costs have been sharply reduced," said Paul Low, president of the Federation of Malaysian Manufacturers, which represents some 2,000 companies.

Manufacturers are able to fix prices with the ringgit peg of 3.80 to the dollar and secure longer-term orders, Low said.

There is a shift towards exports amid weak domestic demand, but the "main fear now is a recession in the global economy, which will pull us down," he added.

U.S. ratings agency Moody's Investors Services said last week the imposition of capital controls "discourages" new inward investment and hampered the ability of banks to raise foreign capital.

"The quality of bank regulation, formerly among the highest in the region, has been impaired by political interference as well as an added emphasis on short-term gains," it said in a report from New York.

Its financial strength ratings for Malaysian banks are low, ranging from "D-plus" to "E", with a negative outlook for all the ratings.

Moody's also cited the "political climate and the future of the country's leaders" as sources of major uncertainty following the sacking of deputy prime minister and finance minister Anwar Ibrahim in September.

But Neil Saker, head of economic research at SG Securities in Singapore, a unit of French bank Societe Generale, said there was major progress in banking reforms, notably with measures to acquire bad loans and inject fresh funds.

"Corporate restructuring is the next hurdle, and Malaysia must move fast into that," he said, noting that some 30 listed companies already were insolvent.

But the "perception of Malaysia's political risk has risen and this may deter some multinationals from investing," he said, citing worries over a successor to Mahathir, who has been in power for 17 years.

Malaysia is also due to hold elections some time over the next year or so. Although the current parliament's term does not expire until April next year, there has been speculation of a snap election given signs of economic recovery.

Saker said the ringgit peg was undervalued, but this would boost the country's export competitiveness.

He agreed that it was too early to tell whether Malaysia is out of the woods yet, but nevertheless predicts a recovery this year.