If controls go, will confidence falter?

Malaysia seems to have recovered better from the Asian crisis than some other countries in the region, not least because of the currency control policies that were introduced. Confidence was shaken a little last month by the volatility in US markets, but the fundamentals still appear to be sound.

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Kuala Lumpur stock exchange: from 250 to over 1000 in

"If you're not positive, then you're in the wrong business," boomed veteran broker David Chua at the gaggle of nervous young traders as they waited for the lift in their Kuala Lumpur tower block. Fear of local carnage in the aftermath of Wall Street's bloodbath in mid-April was in the air. In an echo of three years ago, one dared to reply with an over-used Chinese mantra: "There's opportunity in crisis". But after an exhausting Monday watching the Kuala Lumpur Stock Exchange plummet 6%, he didn't sound convinced.
Wall Street's jitters could not have come at a worse time for Malaysia, and indeed the rest of Asia, as it begins to show the first tentative signs of recovery. As confidence returns, Kuala Lumpur's bankers are in reflective mood, but some things do not quite add up. The country has one of the highest savings rates in the world, there is no immediate shortage of demand in the domestic capital markets, and there is even talk of overheating in the residential property market. So what happened? Has Malaysia really escaped the worst of the regional crisis, thanks to its bold currency control policies? Was there less of a problem there in the first place than was believed, or is it so much "smoke and mirrors", as one commentator put it?
Sound fundamentals
"There was so much emotion involved. It has been a really V-shaped kind of experience. The financial crisis did not have a lot to do with the fundamentals," insists ABN Amro Bank managing director Huibert Boumeester. Rasool Khan, managing director of Bank of Nova Scotia, is also bullish: "Business has picked up. It is evident at every level. The restaurants are getting occupied, hotels are increasing their rates, things have improved a lot," he says. His explanation for the extraordinary V-shaped nature of the Malaysian economy was more fundamental: "Momentum builds up both ways. When they rebound people realize it has gone overboard, but that is not just here, it is all over the world. The '97 correction in the Dow Jones was no different."

It is too early for Malaysians to be smug, and bankers are still choosing their words carefully, but the country's problems do seem to show curious anomalies. Ironically, there is no shortage of demand in the domestic capital markets, although foreign direct investment is less ebullient, and local business has actually taken a shine to the government's controversial exchange controls, so much so that there could be difficulties in removing or easing them. "The currency is undervalued, not overvalued, therefore that means we do not have the same problems usually associated with currency control such as a black market and all those kinds of things," says Boumeester. "It makes Malaysia very competitive and we can see that in the strength of exports. But in the long term it is not a good thing to maintain and therefore you need to revert to a more flexible relationship over time. The measures were first more a measure to control the economy, now business in general is quite favourably disposed, and it makes their life much simpler. The business community is starting to develop a liking for it."
Other analysts are less charitable. "Things are beginning to get a little bit better but we are not wonderfully out of the crisis," says one. "The capital controls have helped. They have made business much easier to run because no-one has to worry about hedging, and they have made Malaysia artificially competitive. The trouble is, the country's taxpayers and pensioners will be paying for it for the next 10 years."
The question now is how long the Malaysian business community's comfort zone will be maintained once the economic need for the controls has eased. "The government has always said it will come out of this at some stage," says Boumeester. "Over the last year it has been much more broadly accepted, it is just very difficult to come up with effective measures. The government over time probably always wants to release it, but there is no immediate need to go back," he says. The timeframe for lifting, or at least easing, controls is unclear, especially given the US market's dive. "When everything has returned fully to normal. If at the end of this year we have that same GDP we forecasted," predicts Boumeester, whose analysts have put growth for the year at 6.5%, against the central bank's forecast of 5.8%.
Many now attribute Malaysia's less dramatic downturn than that of its neighbours to the currency policies. "What added to the recovery was the exchange controls and currency peg, and central bank policies were very appropriate," says Bank of Nova Scotia's Khan. "The exchange controls prevented the flow of speculative money. There was no more money left so it did not prevent any more leaving the place but it assured people coming in they were going to have a stable currency and that added to the comfort." Homing in on the monetary policy of the central bank, Bank Negara, and the government's fiscal policies, Khan says: "The monetary policy was very appropriate. It was the right formula. Unfortunately for the IMF it was not their formula."
So how did Malaysia manage to come up with an apparent solution, one that had appeared to elude the combined economic talents of the entire IMF? "It was a carefully thought out set of processes and policies," says Khan. "I know from personal sources that a team of people, including the prime minister, was involved in considering the options of exchange control for over nine months before it was implemented. It was not something that was off the cuff. They thought through all the angles and they implemented it. The IMF is committed to a free-trade scenario and exchange controls work against the grain, so even if they did come up with it, it was not going to be an acceptable position."
This is not to say that Malaysia is not a supporter of free trade. "Malaysia is very very open," says Khan. "They understand that free trade is important for global growth and it is creating more opportunities than problems, and they are committed, but where you have a scenario like we had in 1997 you cannot think of free trade, you have to think of stability first. The ringgit was hitting 4.20 to the dollar before the 3.80 peg was imposed. At that time the general feeling was that the ringgit could go to 7.50. That was the mood, every Malay was talking about what it would do to their money. It was bad. Sentiment can drive things a long way."
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If controls go, will confidence falter?

Malaysia seems to have recovered better from the Asian crisis than some other countries in the region, not least because of the currency control policies that were introduced. Confidence was shaken a little last month by the volatility in US markets, but the fundamentals still appear to be sound.

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