Malaysia keeps markets guessing

By Nelson Graves

KUALA LUMPUR (Reuters): Malaysian Prime Minister Mahathir Mohamad is on the verge of easing five-month-old capital controls, but financial markets are still guessing what form the new measures will take.

Government officials said Mahathir had been presented with at least two alternatives for relaxing the controls which halted international trade of the ringgit in September and locked up all foreign portfolio investment for at least one year.

Both options would involve the imposition of an exit tax on foreign funds taken out of the country.

The exit tax would replace a rule that bars foreign firms from taking the principal of their portfolio investments out of the country before Sep. 1, 1999, or 12 months from the date of investment, whichever comes later.

Mahathir himself told 28 foreign fund managers this week that the government was considering an exit tax.

Government officials said the Treasury had completed a review into the income tax implications of the proposed measures, and the competing proposals had been sent back to Mahathir for his evaluation.

Speculation spread like wildfire through markets on Wednesday that the government would announce the exit tax that evening, before Mahathir left for Switzerland to address the World Economic Forum.

But no announcement came. "It's with the PM," one government official said. "The PM has to think about it."

Analysts who asked not to be identified said an announcement was expected any day. The exit tax is expected to be graduated, with a higher rate being applied to short-term investments.

For weeks, speculation had it that the top rate would be 30 percent. But analysts and government officials said the top rate now was expected to be 20 percent, tapering off to zero.

The 20 percent rate was expected to apply to investments held for zero to three months, with lower rates applicable to longer periods and no tax after 12 months, they said.

The major unanswered question, they said, was whether the tax would be on the flow of capital or capital gains.

"The assumption has been that the tax would be on capital flows," an analyst with a foreign securities house said.

"That would be administratively feasible, but investors would be unhappy. Now it appears there may be a graduated tax on profits."

A graduated tax on profits might appeal to foreign investors, but analysts said it could be a nightmare to administer.

"A tax on profits would be more acceptable to investors, but in terms of discouraging the outflow of capital, it would be less effective than a tax on capital flows," another analyst said.

A crucial consideration could be whether Malaysia will be readmitted into the Morgan Stanley Capital International (MSCI) Developed Market series once an exit tax is in place.

Malaysia was removed from the series on Sep. 30 after imposing the capital controls, on the grounds that they limited the repatriation of investment proceeds.

Malaysia was also removed from the MSCI Emerging Markets Free and All Country Free series at the end of November.

"If the red tape is complicated, it could discourage a whole chunk of investors and they would have to do more cajoling of MSCI," an analyst said. "It has to be something effective."

Another analyst said: "Without a tax on capital, there are no capital controls. I think a tax on profits is unlikely."