Mahathir's desperate move

A desperate situation calls for extreme measures. This could have been the logic behind Prime Minister Mahathir Mohamad's drastic move on Tuesday to impose foreign exchange controls that make Malaysia virtually the only place where the ringgit can be traded. The measure is precisely the reverse of what the International Monetary Fund (IMF) has prescribed to address the economic crises in Indonesia, Thailand, and S. Korea.

Mahathir has firmly resisted turning to the International Monetary Fund for financial aid, and we fully understand if he also now feels unimpressed with the IMF's bailout programs in Indonesia and Thailand, where market confidence has yet to return.

The Malaysian central bank also moved on Wednesday to fix the ringgit at 3.80 to the U.S. dollar, up significantly from 4.2 on Monday.

It is not clear if Mahathir and his central bank governor became more confident about their decision to resort to foreign exchange controls after learning that U.S. economist Paul Krugman strongly advocated the system for crisis-hit Southeast Asian countries in a column in the latest issue of Fortune magazine. But one thing is for certain -- the Malaysian leader wanted to assert that he intends to map out his own economic strategy.

True, as the Malaysian central bank argued in defending the measures, the controls are necessary to allow an easing of the country's tight monetary and fiscal policy to reinvigorate the economy. Lowering interest rates without any foreign exchange controls could drive the ringgit, which has already lost 40 percent of its value against the American dollar, into a tailspin. Lower interest rates would make holding the ringgit a less attractive proposition and this could spark off a round of selling which would further fuel depreciation in the currency.

The foreign exchange controls will immediately shield the Malaysian economy from the contagious effect of external developments, which have become a more potent threat since the economic crisis in Russia took a turn for the worse. Furthermore, the controls hit directly at the currency speculators whom Mahathir has in the past blamed squarely for Southeast Asia's current economic woes.

By tightening the screw on speculators, the ringgit could receive a short-term boost which would give the government the breathing space it requires to stimulate the economy through a more relaxed fiscal and monetary stance. Mahathir did not appear to be worried about the devastating impact which the measure would have on foreign capital inflows, which in any case have virtually dried up over the past few months. He is much more worried about the crippling impact that excessively tight monetary and fiscal policy will have on his country's economy.

The foreign exchange controls may well prove to be effective as an emergency measure to stimulate the economy, reduce the rate of insolvencies in the business sector and consequently facilitate a restructuring of the banking sector. However the system is not an alternative to the comprehensive economic reforms that are needed to address structural weaknesses in the country's economy. That means the system should be abandoned as soon as the ringgit has been restored to relative stability on the financial markets.

Indonesia should not be tempted to copy Malaysia, no matter how successful the foreign exchange controls prove to be in stabilizing the ringgit. Not only because the IMF would certainly veto any such move but Indonesia's institutional capability is far from being fit to administer the massive amounts of paperwork and bureaucratic procedures that are required to manage foreign exchange controls.

Foreign exchange controls usually cause a lot of market distortions and would be highly prone to abuse in a vast archipelagic country such as ours. The biggest hurdle to the success of any such system in this country would be poor governance.

One cannot imagine how Habibie's administration, which is notorious for its lack of technical competence and its corrupt mentality, could prevent abuse by exporters who, faced with foreign exchange controls, may be inclined to inflate their import invoices to send hard currency out of the country and underinvoice exports to hide their earnings. Anyway, the country's heavy dependence on foreign aid and foreign capital and its huge external debts entirely rule out the possibility of taking such a drastic monetary measure in Indonesia.