Jury still out on Malaysia's capital controls

Jury still out on Malaysia's capital controls

By Nelson Graves

KUALA LUMPUR (Reuters): Miracle cure? Or plain luck?

One year after Malaysia imposed capital controls, a debate
still rages over their impact on the economy and political
landscape.

Prime Minister Mahathir Mohamad credits the controls with
saving the nation -- and the rest of Asia -- from predatory
speculators.

Never one to duck a quarrel, plucky Mahathir relishes the
debate which pits his government against global economic
orthodoxy and political adversaries, and casts him as David
against Goliath.

Others are reluctant to give all the credit for Malaysia's
economic volte-face to either the controls on capital flows or
the fixed exchange rate.

Mahathir's strongest critics accuse him of using the controls
to pursue a Machiavellian strategy against his political nemesis
-- jailed former deputy prime minister Anwar Ibrahim -- in the
interests of business associates.

They say the true impact will not be known until pent-up
political tension is released -- perhaps years from now.

There is little doubt that Malaysia's economy has rebounded
since Mahathir took the global financial world by surprise and
slapped controls on foreign exchange flows last Sept. 1.

Economic indicators point to a resurgence of domestic demand
and production since the second half of 1998. Real gross domestic
product jumped by 4.1 percent in the second quarter, the first
year-on-year increase in five quarters.

Private consumption indicators show a strong rebound in car
sales, imports of consumption goods, service tax collection and
loan approvals.

Manufacturing production surged by 10.4 percent in the second
quarter year-on-year, driven by strong external demand,
especially for semiconductors and electronic components.

Foreign exchange reserves have risen by 50 percent since last
Sep. 1, inflation is moderate and interest rates so low that
savers have started to gripe.

Mahathir credits the controls for the turnabout. What is more,
he says they helped set the foundation for Asia's recovery.

"We believe that the recovery of other East Asian economies is
due to the currency traders stopping their manipulation of the
currencies," he recently wrote in Japan's Mainichi Daily.

"When Malaysia imposed controls, there was fear that the other
countries might do the same if the attacks continued."

Malaysia's government points to the 190 percent surge in the
Kuala Lumpur Stock Exchange's benchmark index since Sep. 1 --
among the strongest rallies in the region behind Korea.

But economists say Malaysia's rebound is in line with that of
the region and cannot be attributed to capital controls.

"It is impossible to honestly claim the Malaysian recovery has
been either due to or despite the September 1998 measures as
proponents and opponents of the Malaysian controls have been keen
to claim," University of Malaya professor Jomo Sundram said.

Dominic Armstrong, head of research for Singapore and Malaysia
at ABN Amro Asia Securities, likens Malaysia's economy to a
Malaysian Airline passenger jet which landed in London earlier
this year low on fuel.

"The Malaysian economy, too, has had a safe landing. But if
there had been any external shocks, it would have been ugly."

The head of a foreign bank said Malaysia was helped by two
unexpected events.

Five weeks after Malaysia pegged the ringgit to the U.S.
dollar, the American currency slid sharply against the yen,
giving the ringgit a competitive edge that has helped the export-
led recovery.

The near collapse of Long Term Capital Management Fund, the
large U.S. hedge fund that was bailed out last year by 14 banks,
caused banks to curb lending to hedge funds, taking some
speculative pressure off of other regional currencies.

"I think currency controls have worked, but more by luck than
good judgment," a Western diplomat said. "Malaysia has not been
the master of its own destiny and can't buck the regional trend."

The longer term implications remain unclear.

Tan See Yunn of the Malaysian Institute of Economic Research,
who defends the controls, said their sudden imposition had shaken
fund managers' confidence in Malaysia.

"This clearly shows capital controls come at a price," he
recently wrote in the New Straits Times newspaper.

Mahathir has shown no willingness to dismantle the controls or
a levy on repatriated capital gains. The central bank says the
ringgit peg will be adjusted only if fundamentals change.

"We do not think the repatriation levy is the factor that
deters potential investors into the country," Bank Negara said
last week, noting that the government might "simplify further the
administration of the system".

Sounding a dissonant note, The Star newspaper said this week
that it was perhaps time to ease the controls, for example by
"liberalizing" the ringgit peg for hedging purposes.

Mahathir's most severe critics do not question the economic
impact of the capital controls so much as their use.

Mahathir says the controls allowed Malaysia to buck the IMF's
prescription and bring down interest rates to stimulate growth.

But his political adversaries, led by Anwar, say the
government has used the controls to shield powerful businessmen
from the pain of restructuring. The same tycoons are still in
place, protected by the government, they say.

"For the Malaysian authorities, capital controls have been
part of a package focused on saving their friends, usually at the
public expense," Jomo said.

Critics point to a plan to merge 58 financial institutions
into six core groups, saying the project will punish Anwar's
allies and award those close to the government.

The politically charged debate fans suspicions among foreign
investors, leaving a question mark hovering above Malaysia that
some say will not go away until Mahathir and Anwar settle their
differences.

Armstrong of ABN Amro, who is upbeat on Malaysia's economic
outlook, said: "One of the factors that haunts Malaysia more than
any other market in Asia is specific political risk."