Reality check for Malaysia's stock market experiments

Reality check for Malaysia's stock market experiments

By Lim Say Boon

SINGAPORE: Today, Malaysia will resume trading of the hitherto-frozen Clob shares -- Malaysian stocks traded over the counter here until the implementation of capital controls in late 1998 -- thus ending an 18-month saga which had undermined seriously the country's standing with international fund managers.

But the rehabilitation of Malaysia is far from complete. Indeed, the country, which had outperformed other regional markets in the earlier part of the year, is about to witness the limitations of its experiment with capital controls, exit taxes and fixed exchange rates.

At the time of the introduction of capital controls, I argued the measures were legitimate in buying time for orderly restructuring. But I also warned then that over the longer term, they encourage insularity and complacency, and erode competitiveness.

Today, when the very people who criticized those controls are now extolling their virtues, let me sound the warning loudly and clearly: As a result of the distortion of market signals, Malaysians are in dire danger of hearing only their own voices.

And, in the process, ignoring the rapidly-growing demand by investors for market solutions and the depoliticisation of the economy and corporations.

To its credit, Malaysia has replaced the more rigid regime of capital controls with exit taxes. But the currency remains fixed. And more importantly, the time and comfort bought by government interference in market forces resulted in the belief that Malaysia can continue to beat the market.

Yes, the critics were proven wrong on capital controls, and the economy has staged a remarkable turnaround. But the breathing space bought by government intervention has been filled with even more intervention.

The "Malaysian way" appeared vindicated by its equities market, which only a few months ago defied the gravity of plummeting regional markets and even the Nasdaq.

But this was a mirage. It was as much about the sea of liquidity dammed behind the walls of capital controls as about a one-off adjustment by funds to Malaysia's scheduled re- instatement to the Morgan Stanley Capital International (MSCI) indexes. It had nothing to do with what international fund managers really thought of Malaysia.

Portfolio fund inflows have since reversed -- and the Kuala Lumpur Stock Exchange Composite Index (KLCI) is stagnating. With the one-off adjustment to MSCI out of the way, Malaysia now faces the real test of whether it can continue to thumb its nose at international markets. Chances are, it does so at considerable risk to its economy and capital markets.

After all, nothing has changed since April or May to explain the loss of momentum in the stock market. If anything, economic indicators are going from strength to strength. After an impressive turnaround from a 7.5-percent contraction in 1998 to 5.4-percent growth last year, the economy managed yet another stunner -- a blistering 11.7-percent growth in the first quarter of this year.

Industrial output has also been surging -- at 23.8 percent in that same quarter and 18.6 percent in April. The country is likely to finish the year with its GDP some 6.5 to 7 percent larger than when it started.

And that growth was achieved with very little inflation. Year on year, inflation is now running at 1.3 percent. That was for May. For the first five months of the year, we are looking at a figure of 1.4 percent year on year.

Malaysia's trade balance also continues to run strongly in its favor, piling up the country's external reserves.

So why is the market not continuing its rally? Or, for that matter, why are foreign direct investment proposals running below pre-crisis levels?

This takes me back to my earlier point about the dangers of suspending market judgments. For starters, international investors were uncomfortable with the manner in which Clob was "resolved"' -- that is, with the narrow range of alternatives and the serious fees -- estimated at nearly US$80 million -- going to the sponsor of the "final solution", Akbar Khan.

Then there was the apparent political obstruction to SingTel's proposed investment in Time Engineering. Time's boss, Halim Saad, needed the money, but Prime Minister Mahathir Mohamad did not seem too happy with SingTel -- so the deal was called off.

Then there is the use of public funds for DIY solutions to debt and other corporate problems. Shortly after SingTel was tossed out of Time Engineering, state-owned fund Khazanah stepped into the void.

Now, Khazanah's name has popped up in a long-standing standoff between auto group Hicom and state oil-company Petronas over the former's proposed sale of car distributor EON to the latter. Khazanah is now, apparently, considering buying EON off Hicom -- another member of that narrow corporate circle that makes up Malaysia Inc.

Then there are the policy flip-flops over the rationalization of the banking sector, and of stock brokers. And what about the recent change in chain-listing rules, which are now more accommodative of IPOs of subsidiaries planned by politically- connected conglomerate Renong to resolve its debt problems?

Beyond that, international market opinion has been cool for some time towards Malaysian corporate practices. Last week's market disappointment over the US$85 million in inter-company loans this year from Berjaya Sports Toto to Berjaya Land would not have helped much.

Then there is the sometimes bizarre and often odd circus of events that never seems far from Malaysian politics.

This is not a criticism of the government, nor of ruling coalition leader Umno. It is a comment on the apparent Malaysian obliviousness to the slack jaws that often greet news about its politics outside the country.

Economies can get away with suspending market realities for only a limited period of time. Take interest rates. The trapped liquidity -- a product of capital controls -- played a major role in bringing them down. With a declining Kuala Lumpur Interbank Offer Rate, the KLCI, not surprisingly, surged.

But with all that liquidity, it is only a matter of time before inflation starts picking up -- especially now that domestic consumption is starting to strengthen. And with that, interest rates will reverse, possibly as early as end of this year.

To complicate matters, Malaysian interest rates may start rising at a time when the rest of the world is just getting over the peak of their interest-rate cycle. The market will not be real happy if that awful scenario were to play itself out. As I said, you can suspend market reality only so long.

The writer is a director with OCBC Investment Research Private Limited. The views expressed above are his own.

-- The Straits Times/Asia News Network