East Asian Crisis - Malaysian Perspective

8/8/2019 East Asian Crisis - Malaysian Perspective

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East Asian Crisis Malaysian Perspective

The crisis originated from Thailand on July 1997, with the financial collapse of Thai Baht.The decision of Thai government to float the baht, cutting its peg to USD was the mainreason for the crisis. At the time Thailand was holding huge amount of foreign debt and by

this the country became bankrupt even before the downfall of its currency. Many East Asiancountries including Japan were affected by the crisis. There was downfall in currencies, stockmarkets and even in assets prices.

How the Crisis Shifted to Malaysia from Thailand?

Though the crisis was started from Thailand, it shifted from one country to another affectingalmost all economy of East Asia. The major reasons for the crisis shifting are as follows:

Trade Linkage:

Malaysia was one of the greatest trade partners of Thailand. When the Thailand was involvedin crisis it also affected Malaysia. The Thai Baht depreciation resulted in the high increase ofexport of Thai product. Due to this Thai product became cheap as well as more competitivein international market. In Malaysian market its own domestic product became moreexpensive than Thai product and because of this Malaysian export went down whereas importwent up. In the situation of trade deficit Malaysia need to pay large amount of Baht toThailand whereas Malaysia was getting little amount of ringgit back as its export was low.This situation led to increase in Baht demand and decreased ringgit demand. The downfall ondemand for currency led to the depreciation of its value.

Speculative Attack:

When Thai Baht went down, all the investors took out their money from the Thailand becausethey were afraid of more currency downfall. At that time Malaysian trade was highly linked

with Thai trade. So, investors tried to get their money back from Malaysia as well. They allsold the ringgit and purchased USD. This led to higher demand of USD. The low demand ofringgit ultimately led to downfall to value.

Situation before and after the crisis in Malaysia:

Prior to july 1997, Malaysian economy was growing at rate of 8% per annum, with currentaccount deficit of around 5% of its GDP. It was providing financial liberalization for theforeign investors and due to this it was a popular investment destination. Malaysian stockmarket was also doing well and the stock index was above 1200. The ringgit was tradingabove 2.50 with USD and also the overnight rate was below 7%.

Just after July 1997 Malaysian stock market lost more than 60% from its peak in February.This was because of the devaluation of Malaysian currency (ringgit) by 35%. When the crisismoved toward Malaysia, the entire market scenario changed rapidly. Due to theliberalization, foreign funds were excessively invested in Malaysia as bank loan or capitalinvestment. When the crisis started all the investors wanted their money back and due to thisthe demand for the Malaysian ringgit went down and the US dollars demand increasedrapidly. Ringgit which was trading above 2.50 with USD before crisis rapidly jumped to

below 4.10. Overnight rate also increased rapidly from 7% to 40%. Due to this scenarioMalaysian stock index went down by 600 points and stock market almost lost around 60%.


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The situation became worst for Malaysia with no other option instead of IMF help. But

Malaysian government did not called IMF for the help. In order to control the situation thePrime Minister Mahathir Mohammed imposed strict capital controls and introduced a 3.80

ringgit fixed exchange rate with USD.

Actions taken by Malaysian government in order to tackle the crisis:

The following are the measures imposed by Malaysian government to get rid of the crisis:

y Imposed sweeping control on capital outflowy Moved the ringgit from free float to a fixed exchange ratey Interest rate were reduced and increased the spendingy From September 2 1998, foreigners were not allowed to remove the portfolio capital

for one year

y Ringgit held abroad was considered to be invalidThe impact of each of these measures is described below:

The primary objective of imposing the capital control in Malaysia was to stop the speculation

on ringgit which was coming from the Singaporean market. Speculators were providinghigher interest to attract the ringgit deposits and it was creating shortage of currency. In order

to minimize the trading, government imposed the rule that the entire ringgit sale should gothrough some domestic intermediaries. People faced lots of difficulties while trying to float

the currency outside the country after the capital control was imposed.

When Malaysian government imposed strict capital control large numbers of foreigninvestors were not interested to hold their investment inside Malaysia. Investors were willingto put out their investment from Malaysia and invest it in either country. After this there was

high chance of capital outflow from the Malaysia to other countries. Due to the fear of rapidcapital outflow and more depreciation of ringgit, Malaysian government banned theforeigners to remove the capital from the country for one year. It also started that stock tradecan be done only through the Kuala Lumpur Stock Exchange (KLSE) in order to stopspeculation on currency from outside the country.

Instead of fixing the currency by exchange board system, Malaysia used the ringgit with

foreign exchange system which provided more freedom for government to determine itsdomestic interest rate. Malaysia used fixed exchange rate system because by maintaining the

fixed rate it can predict the future without fear of the later change in exchange rate. Thiscertainty on exchange rate increased the investment. Fixed exchange system will help in

reducing the speculation on the currency. Incentives on speculation will become very low if

the exchange rate is fixed because there is no chance of getting higher return in future byholding it.

The goal of invalidating the abroad held ringgit was to encourage the inflow of the currency.When people know that the money which they are holding have no value left, they were

afraid of utilizing the money. If they are willing to get the value back for their money theymust bring their money inside the countrys boundary. Furthermore, ringgit lending byMalaysians to foreigners was prohibited. This procedure helped Malaysian government tocollect its ringgit which was invested or held outside the countrys boundary.


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The lower interest rate was charge in order to relieve consumers and companies from their

heavy debt service burden. Higher spending was encouraged to increase the demand for businesses which ultimately helped in increasing income for workers. Bank Negara

aggressively reduced interest rates: within a week, daily interbank interest rates had fallenfrom nearly 8.5% on September 1 to 5.5% on September 5. The government passed a fiscal

stimulus program, which it was finally able to fund through the sale of government bonds ondomestic market.

After the imposition of capital control Malaysian recovery was faster. Stock market also didwell and interest rate moved downward. Malaysia was able to maintain its competitive edgewith its fixed ringgit which boosted exports. The action of making fixed ringgit rate restoredgreater financial stability by reducing the uncertain conditions under which businesses andconsumers had to operate. Growths were settled to a sustainable pace.

Conclusion:

The main reasons for success of the capital control in Malaysia are good banking system and

strong leadership. Bank Negara had high level of foreign exchange reserves; in additionMalaysia had very little external debt. These led to quick recovery of Malaysia.

At the time of imposition of capita control Malaysia had enough foreign reserves. Foreign

reserves were already been stabilized before the capital control. When the ringgit went downMalaysian product became more competitive in foreign market which increased the export.

Due to the increase in export, the current account surplus was actually increasing at the timeof currency downfall which helped in increasing reserves. By analysing the situationMahathir already recognized that country was not about to run out of money.

From the experience of 1980s crisis, Bank Negara imposed restriction on foreignborrowings. This resulted in low foreign debt for Malaysian firms. While the neighbouringcountries were in danger because of foreign currency obligation Malaysia was secure withlow foreign obligation.

Mahathir Mohammed analysed the entire situation. He was aware about the countrysstrength and weaknesses. So, we can conclude that imposing capital control was good ideafrom the Malaysian perspective.

Comparison with Korean recovery:

Instead of taking help from IMF, Malaysia took totally opposite path for crisis handling.Though it was able to handle the crisis, but as compared to Korea it is not able to grow much.

Despite the economic downturn Korea was quite able to triple its per capita GDP in dollarsterms. In current context Korea is one of fastest growing economy of the world with percapita above $21000. With the help of IMF Korea was able to increase market confidence

whereas by the imposing capital control, initially Moodys rating downgraded all Malaysianbonds almost to junk or zero level. At the end of summer 1998 interest rates in Korea were onsingle digit but interest rate in Malaysia was at 20-40%. But, after imposing fixed exchangeand by self determining the interest rate Malaysia was able to come out of the crisis.


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From Malaysias experience it is evident that if capital control is designed carefully then itwill become good crisis resolution technique for short-run. Capital controls can be said as the

emergency measures for crisis resolution or we can say that capital controls are necessary butnot sufficient conditions for crisis resolution. Because infrastructure development, strong

capital position and trade benefit for the country can be achieved only after the freedom forcapital inflow and outflow. So, both financial liberalization as well as capital control systems

is necessary but policy makers should be able to decide at what situation which systemshould be imposed.

Viewing the situation from Nepalese perspective:

Nepalese economy is one of the poorest economies of the world. Investors are not muchinterested on investing here. But, if we look at the situation of last 5-6 years large amount offoreign direct investment has entered into the country. Huge amount investment is beinginvolved in real estate and housing sector. This has helped the country for generating somerevenue as well as many people has got employment.

Currently our country is facing high inflation with low GDP. This has led to low demand for

the product and services. This situation has de-motivated the investors to hold their moneyinside the Nepalese boundary. They all are willing to take out their money as well as the local

investors are also looking for better investment opportunities in foreign market. So, the fearof capital flight has emerged. If government does not take necessary steps in order to control

the situation then the Nepalese market may go down with rapid speed.

Firstly, government should encourage people for saving by increasing the bank interest rates.If people get more return from saving then they will spend less. This will reduce the demandfor the product; decreasing demand will result in the price downfall for that product.

The decrease in the price will attract more consumers toward the product. As the product hasbecome cheaper, consumers can get the product without increasing their expense. This willresult in increasing demand for the product and income for the producer.

Secondly, government should restrict commercial banks for providing huge amount of loanfor a single investor. The bank should first check the soundness of the investor. It should notflow the money freely to anyone. This will help in maintaining low default rate of theinvestors.

Thirdly, Nepal Rastra Bank should take all the control over the determination of interest rate.This will help to reduce the competition between the commercial banks. Otherwisecommercial banks will provide huge amount of loan in low rate in order to become morecompetitive in the market. This may lead to excess money supply in the market which

ultimately results in inflation.

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East Asian Crisis - Malaysian Perspective