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."