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Country review: Malaysia

Date 18/06/2001

After successfully, if controversially, bringing Malaysia's economy back from the 1997 crash, Dr Mahathir Mohammed is again preparing to avert crisis. And as before, his economic policies are informed by his belief in 'Asian values' - a healthy willingness to disregard the exact prescriptions of the IMF and other multilateral bodies, the imposition of exchange controls, and a degree of state-led stimulus. No one can accuse Dr Mahathir of fiddling while Rome burns.

A number of factors are concerning analysts, but it should be emphasised that growth in 2001 is still forecast by independent economists to be in the 3-4% range. First, as with the rest of Asia, is the spectre of a US slowdown, hitting Malaysian exports and confidence. Second is the overvaluation of the ringitt against the dollar, as well as other Asian currencies including the yen. The third is simply bad luck - palm oil and electronics, the two sectors that served the country so well in the Asian crisis, are both in the doldrums.

In order to encourage foreign investors, one crucial component of capital controls has been abolished, to the immediate approval of the Kuala Lumpur Stock Exchange (KLSE). On May 2nd the Ministry of Finance announced that, with immediate effect, the exit tax would be removed. The exit tax had been set at 10% of foreign portfolio investment profits repatriated within a year. It was of course designed to discourage capital flight (originally, in 1998, set at 30%), but one of its unintended effects was to discourage investment itself. Its removal is good news for investors, who can now move funds more freely and can assess stocks without needing to factor in the possibility of the exit levy. The KLSE's response was strong and immediate: the main index leaped to 4.61% to 6,111 points, the largest one-day gain in 20 months.

It is hoped that a gradual and prudent loosening of capital controls, combined with financial sector reforms, can also attract foreign direct investment back into Malaysia, rather than simply opening the floodgates to capital flight. FDI, so crucial in Malaysia's past development, will again be central to the fortunes of the wider economy. A number of special inducements are on offer for foreign companies coming to Malaysia, including discretionary incentives and a three-year extension to the 100% foreign ownership policy for certain sectors. This may help to continue an impressive upturn in FDI in 2000, which saw approved investment applications reach a record level of 19.8bn (see table below). In addition, Chinese accession to the WTO could well revive foreign-investor interest in the entire region.

Still, the stockmarket is nowhere near its highs of February 2000. Moreover, compulsive capital controls have not been entirely effective - an estimated USD18-20bn has left the country since 1998.

Against this, a series of successful measures to restore confidence in the banking sector, with more to come, means that Malaysian individuals become less inclined to stash their funds overseas.

Addressing the problem of the ringitt remains a priority. At the time of writing it was pegged at MYR3.8:USD1, wheras analysts see its fair value at over MYR4.10:USD1. The central bank has run down its reserves in order to maintain the peg as the dollar has strengthened, reducing the competitiveness of Malausian exports. The peg is a main component of capital controls, but there is considerable political pressure to devalue. However, Dr Mahathir maintains that to do so would leave the currency open to speculation and risk market chaos. In other words, he would prefer to manage the present, known situation, rather than expose Malaysia once again to the perils of the market, increase import prices, and increase borrowing costs for Malaysian enterprises with foreign-currency denominated loans.

So while freeing the currency appears to be out of the question in the short term, some observers expect the government to start adjusting the peg gradually in order to ease the situation. And if, as some predict, the dollar starts to weaken in the third quarter, while other Asian currencies strengthen, the problem may start to recede.

Aside from the travails of the ringitt, other indicators are promising. Relatively low interest rates are pushing money towards the capital markets and productive sectors, while inflation stands at a benign 1.5%.

Other initiatives have also received a warm welcome, including a fiscal stimulus package announced in April. The package, valued at MYR3bn (USD790m), is a first step intended to strengthen growth. It includes a construction programme for more government buildings, and encouragement both of private-sector and consumer borrowing and spending. There is also a MYR600m fund to help the palm oil industry, a cash crop which is a mainstay of the economy. The fiscal package has been well received, and if anything there have been calls for a larger package, which may be approved depending on how the first package works.

At the level of the capital markets, finance minister Daim Zainuddin announced an ambitious series of reforms in February (including the abolition of the exit levy), which appears to revive the ambition of making Kuala Lumpur a regional financial centre to rival Singapore or Hong Kong in the longer term. One of them, crucially, addresses corporate governance by insisting that company restructuring plans be submitted to the market regulator. If the plans are found to be inadequate, the company will be delisted - a powerful incentive to boards to put their houses in order. So far at least 80 companies have been told to submit better plans or be delisted.

The KLSE itself will see changes too. Mr Zainuddin said it would merge with the smaller MESDAQ by 2002, creating a single exchange that ought, in theory, to enjoy better liquidity. As seen elsewhere in Asia, the exchange would then be demutualised by 2003. Foreigners will also be allowed greater participation in brokerages, and foreign companies will be able to list on the exchange.

Other provisions in the plan concern protection of the rights of minority shareholders and increased transparency. It was well received by the financial sector, which is now watching to see how rigorously and energetically the reforms are implemented. One broad change hoped for by brokers is for state unit trusts to gradually reduce their involvement in the market. At present they account for at least 75% of funds under management, leaving private companies - increasingly seen as more transparent and professional than state institutions - with under 10%.

The rest of 2001 will be a telling time for Malaysia's economy and its capital markets. Much is dependent on imponderables such as how the US economy weathers, and on the strength of the dollar. An economic upswing would in turn reinforce Dr Mahathir's political position, creating a virtuous circle of growing investor confidence and reduced capital flight. His balancing act will be closely watched, both at home and abroad.

Investment in manufacturing, 1992-2000

Year Foreign investment approvals (MYRm)

1992

17,772

1993

6,278

1994

11,339

1995

9,144

1996

17,057

1997

11,473

1998

13,063

1999

12,274

2000

19,819

Source: Bank Negara Malaysia