Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No. 19826

IMPLEMENTATION COMPLETION REPORT

MALAYSIA

ECONOMIC RECOVERY AND SOCIAL SECTOR LOAN

(Loan No. 43470-MY)

November 1, 1999

Poverty Reduction and Economic Management Sector UnitEast Asia and Pacific Region

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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CURRENCY EQUIVALENTS(as of September 1998)

Currency Unit = Ringgit (RM)RM 1 = US$ 3.8US$ I = RM 0.26

FISCAL YEAR

January 1 - December 31

ABBREVIATIONS AND ACRONYMS

AIM - Amnanah Lkthiar MalaysiaBNM - Bank Negara MalaysiaCDRC - Corporate Debt Restructuring CommitteeEPF - Employees Provident FundEPU - Economic Planning UnitERSL - Economic Recovery and Social Sector LoanESCL - Exchangeable Subordinated Capital LoansFDI - Foreign Direct InvestmentICR - Implementation Completion ReportKLCI - Kuala Lumpur Composite IndexKLSE - Kuala Lumpur Stock ExchangeMOF - Ministry of FinanceMSCI - Morgan Stanley Capital InternationalNEAC - National Economic Action CouncilNPL - Non-Performing LoansOECD - Organization for Economic Cooperation and DevelopmentPNB - Permodalan Nasional BerhadRM - Malaysian RinggitROC - Registrar of CompaniesRWCR - Risk-Weighted Capital RatioSC - Securities CommissionSMI - Small and Medium Scale IndustriesSAR - Staff Appraisal ReportSPV - Special Purpose VehicleSRR - Statutory Reserve Requirement

Vice President Jean-Michel Severino, EAPVPSector Manager :Homi Kharas, EASPRCountry Director: Ngozi Okonjo-Iweala, EACSMTask Manager Ejaz Ghani, Principal Economist, EACTF

FOR OFFICIAL USE ONLY

CONTENTS

PREFACE

EVALUATION SUMMARY ....................................................... i

PROJECT IMPLEMENTATION ASSESSMENT .................................... 1A. Project Objectives and Description ...................................................... 1lB. Achievement of Project Objectives ........................................................ 2C. Implementation Record and Major Factors Affecting the Project .............. 14D. Sustainability of Reform Program ...................................................... 15E. Bank Performance ...................................................... 15F. Borrower Performance ....................................................... 17G. Assessment of Outcome ...................................................... 17H. Future Operation ...................................................... 17I. Key Lessons Learned ...................................................... 17

STATISTICAL TABLES

Table 1: Summary of Assessments ................................................. 21Table 2: Related Bank Loans/Credits ................................................. 22Table 3: Project Timetable ................................................. 22Table 4: Loan/Credit Disbursement: Cumulative Estimate and Actual ........... 22Table 5: Key Indicators for Project Implementation ....................................... 23Table 6: Key Indicators For Project Operations .............................................. 23Table 7: Studies included in Project ................................................. 23Table 8a: Project Costs ................................................. 23Table 8b: Project Costs ................................................. 23Table 9: Economic Costs and Benefits ................................................. 24Table 10: Status of Legal Covenants ................................................. 24Table 11: Compliance with Operational Manual Statements .......................... 24Table 12: Bank Resources: Staff Inputs ................................................. 24Table 13: Bank Resources: Missions ................................................. 25

ANNEX A: BORROWER'S CONTRIBUTION TO THE ICR

ANNEX B: MATRIX OF POLICY ACTIONS

Tliis document has a restricted distribution and may be used by recipients only in theIperformance of their official duties. Its contents may not otherwise be disclosed withoutVLorld Bank authorization.

IMPLEMENTATION COMPLETION REPORT

Malaysia

Economic Recovery and Social Sector Reform Loan

(LOAN 43470-MY)

PREFACE

This is the Implementation Completion Report (ICR) for the Economic Recoveryand Social Sector Loan in Malaysia, for which Loan No. 43470-MY in the amount ofU$300 million equivalent was approved on June 1, 1998 and made effective on June 23,1998. The loan was fully disbursed the day of effectiveness. The loan was closed onDecember 31, 1998.

The ICR was prepared by Vivek Suri (EASPR), with inputs from Jill Armstrong(EASHD), Richard Duncan (EASFS), and Arvind Gupta (PSDBE). The ICR wasreviewed by Ejaz Ghani (EACTF) and Zafar Ahmed (Acting Director, EACSM).Carolyn Meyer Johnson (EACSM) provided helpful operational and editorialsuggestions. The report was prepared under the overall guidance of Homi Kharas (SectorManager, EASPR) and Ngozi Okonjo-Iweala (Director, EACSM).

Preparation of this ICR was begun during the Bank's final supervision mission inMay 1999. The borrower contributed to preparation of the ICR by commenting on thedraft ICR.

I

IMPLEMENTATION COMPLETION REPORT

MALAYSIA

ECONOMIC RECOVERY AND SOCIAL SECTOR LOAN

Loan No. 43470-MY

EVALUATION SUMMARY

A. BACKGROUND AND OBJECTIVES

1. Malaysia, under Vision 2020, expects to achieve a developed nation status by theyear 2020, and to be able to eliminate hard core poverty by year 2000. However, theonset of the regional crisis and the impending recession was a setback to Malaysia'sprogress in attaining this Vision. The crisis began to reveal structural weaknesses in theeconomy. While the Government had recognized some of these weaknesses even beforethe crisis and had begun implementing policy reforms, the crisis provided an impetus toaccelerate their implementation. The Government's intention was to implement thesereforms in a pre-emptive fashion so as to minimize the impact of the crisis, while at thesame time addressing emerging structural weaknesses relevant to its medium termgrowth.

2. In late 1997, the Bank restarted its relationship with Malaysia after a four yearperiod of low key contacts. The Economic Recovery and Social Sector Loan (ERSL)was an integral part of the Bank's renewed relationship and assistance strategy. The needfor the loan arose as contagion from the crisis in neighboring countries spread toMalaysia and the authorities felt that fiscal easing was required to limit the economicdownturn. The loan was a fast disbursing operation designed to support theimplementation of the Government's pre-emptive measures to:

* minimize the downturn in economic activity* implement policy reforms to resume robust and sustainable growth* expand safety nets to protect the hard core and the near poor from the adverse effects

of the crisis• protect investments in human resource base

3. The Government's strategy for achieving these objectives was to implement areform program focused in four key areas:

Maintaining sound macroeconomic policy with flexibility in the light of uncertaintiesin the economic environment;

. Strengthening the financial sector in the light of the regional crisis includingconsolidation of finance companies and pre-emptive recapitalization of bankinginstitutions; improving regulatory and supervisory framework;

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. Improving competitiveness by strengthening corporate governance, enhancingtransparency on disclosure of information; implementing market-based corporaterestructuring procedures; strengthening competition policies;

* Strengthening social safety nets to soften the negative impact of the economic crisison the lower income and vulnerable groups; maintaining access to key social sectorservices; tackling the problem of graduate unemployment and address medium-termsafety net issues

4. While there was no accompanying formal IMF program, the IMF at that time wassupportive of the Government's reform program, and the Bank's support of it through theERSL. The Bank consulted with the IMF on macroeconomic issues. Fund staffparticipated in the appraisal mission for the ERSL and there was very good cooperationamong staff.

B. IMPLEMENTATION EXPERIENCE AND RESULTS

5. The loan was disbursed as a single tranche release of $300 million on June 23,1998. There have been several supervision missions between August 1998 to May 1999to assess progress being achieved under the reform program. The key focus of thesupervision missions was to highlight the downside risks and the need for fine tuning thereform program. Overall, substantial progress has been made in implementing thestructural reform program. While there have been a few significant departures in thereform program (e.g., introduction of selective exchange and capital controls; regulatoryeasinig in the financial sector) most policy reforns as defined in the loan document are ontrack. Given the Government's strong ownership of the reform program, and broad basedsupport for the prograrn within the country, its sustainability is likely.

6. Being a highly open economy, the impact of external demand shocks anduncertainty in international financial markets was severe and greater t]han anticipaLed.This led the Malaysian Government to adopt certain policies (e.g. capital controls) -hatwere unforeseen at the time of the loan. Changes in the economic team, including theappointment of a new finance minister, also led to policy changes that reflected the viewsof the new economic team in the face of the deepening regional crisis. The adoptio n ofcapital controls coupled with political uncertainty that emerged at around the same time,adversely affected market confidence. The Government to its credit maintained the thrustof the reform program.

7. The overall performance and outcome was satisfactory. The loan has helpe: inresurning economic recovery and achieving macro stability. It has supported a progirarnof firnancial sector restructuring and helped set in motion a series of policy actions airmledat strengthening corporate governance. The loan has helped protect social sector bud! etsand has enabled the expansion of safety nets to protect vulnerable groups.

a) Growth and Macro stability

8. The downturn in economic activity turned out to be greater than anticipated at :hetime the loan was made. The downturn was smaller than in Thailand and Indonesia,

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though somewhat higher than Korea. The Government showed appropriate flexibility informulating macro policies as the depth of the crisis became apparent. Fiscal andmonetary policies were both eased as the crisis deepened. Selective exchange and capitalcontrols were introduced in September 1998 to allow monetary easing, and the breathingroom provided by them was well utilized in accelerating financial and corporate sectorrestructuring. The controls were selective - they were aimed at reducing excessivespeculation on the ringgit, and curbing short-term flows. They did not impact currentaccount transactions or FDI (some restrictions were, however, placed on dividendrepatriation).

9. The response of the international investor community to the capital controls wasin general not positive -- global credit-rating agencies reduced Malaysia's internationalrating to near-junk status and Malaysia was excluded from Morgan Stanley CapitalInternational indexes (MSCI) and the IFC Emerging Market Index. Market uncertaintyincreased -- it was feared that an estimated US$5 to 10 billion of portfolio capital mightleave the country in September 1999, and this could drive Malaysia into another round ofcurrency crisis or force drastic measures by the Government to address the issue.

10. In the face of market concerns and emerging signs of stability in the economy, thecontrols were modified in February 1999. Quantitative controls were replaced by a two-tier capital gains tax on foreign portfolio funds brought in after February 15 with the ratediminishing from 30% for funds remaining in the country for less than one year, to 10%for funds remaining in the country for more than one year. In September 1999 the two-tier levy was replaced with a flat 10% levy on repatriation of profits from portfolioinvestments.

11. The flexible policy stance adopted by the Government has helped put the brakeson declining output growth. The economy bottomed out in Q3 1998, and recovery isunderway -- GDP is expected to grow 3-4% in 1999 compared with -7.5% in 1998.There has been a favorable market response to the easing of capital controls, improvedgrowth prospects, and steady progress in financial and corporate restructuring.Compared with an earlier estimated US$ 5-10 billion, a net outflow of about US$ 1.4billion was recorded in September 1999 following the expiration of the initially imposedone year lock-in period for portfolio capital.

b) Financial and corporate sector restructuring

12. A new institutional framework for financial restructuring was set up in mid-1998and steady progress has been made in implementing the program. As of June 30, 1999,the asset management company, Danaharta, had acquired and/or managed RM 39.3billion of NPLs from the financial system of which RM 31.3 billion are from the bankingsystem (about 34% of total banking system NPLs). The weighted average discount on theloans purchased was 57%. Danaharta completed the acquisition process by June 1999which was 6-months ahead of its original schedule.

13. The special purpose vehicle, Danamodal, has injected capital into 10 bankinginstitutions in the form of Exchangeable Subordinated Capital Loans (ESCL) amounting

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to RM6.209 billion and has appointed 25 nominees in the intervened institutions asChairman/Deputy or directors. The capital injected into these financial institutions,which was equivalent to about 14% of the total Tier-I capital of the banking sector at thebeginning of 1998, boosted the risk weighted capital adequacy of the recapitalizedinstitutions from 9.9%/c, to 13.9% at end-May 1999. The entire banking system's RWCRstood at 12.7% at end-June. The Government has announced that Danamodal willrequire significantly less than the original estimate of RM16 billion to ensure sufficientcapitalization.

14. The Corporate Debt Restructuring Committee (CDRC) was established in July1998 to facilitate voluantary restructuring of corporate debt outside of courts throughvoluntary agreements between creditors and debtors. Progress, though slow as it is avoluntary process, is bieing made. As of July 31, 1999, CDRC has received applicationsfromr 62 companies with loans amounting to RM34.9 billion for assistance inrestructuring their debts. To date, 11 cases involving RM 3.4 billion have been resol vedwith the assistance of Danaharta, 13 cases involving RM 11.3 billion (including RM 8.4billion for the Renong Group alone) are in the implementation stage, while 27 cases (RM18.7 billion) are outstanding.

c) Corporate Governance and Competition Policy

15. On March 25, 1999, following a year of deliberation, the High Level FinaaceCommittee (HLFC) oni Corporate Governance released its report to the public. [hereport, the result of an in-depth corporate governance reform exercise, covers three ar, as:(a) the development of the Malaysian Code on Corporate Governance, (b) the reformr oflaw, regulations and rules to strengthen the regulatory framework for public lis,tedcompanies, and (c) training and education to expand the pool of persons suitable forappointment as company directors.

16. Measures have also been taken to strengthen provisions relating to corporatedisclosure and protection of minority interests. A Consumer Protection Bill was passedby the Malaysian Parliament in its July/August 1999 session and is expected to come intoforce by end-1999. A draft Unfair Trade Practices Bill has been prepared but has not yetbeen adopted by the Government.

17. One area where the Government has, however, relaxed competitive procedures i3

public procurement. This was done to accelerate the implementation of developml, ntprojects and increase the size of fiscal stimulus. Although the fiscal stimulus is neededfor recovery, the move away from competitive bidding should only be temporary sirceprolonging it would inevitably raise questions about the transparency of Governm,I ntoperations.

d) Social sector

18. The Government has taken measures to protect recurrent expenditures on soc ialassistance programs for needy children, the handicapped, the elderly and the hardcorepoor. A key objective of the ERSL was to restore public expenditure on health,

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education, and safety nets. This objective has been achieved. Although at the beginningof 1998, as part of its austerity program, the Government cut health and educationbudgets across the board, the budgets were gradually restored during the year.

19. The Government is implementing a number of programs to mitigate the effects ofthe slowdown on the poor and other vulnerable groups. The thrust of the governmentprogram is to enhance income-earning opportunities. Pure transfers to the needy arelimited to a modest social safety net for a small group of people. This practice isconsistent with Malaysia's underlying philosophy of providing the poor with the meansto improve their livelihoods rather than giving them cash transfers.

20. Additional allocations were made in the 1998 budget for a) Fund for Food scheme(RM 300 million) which provides low interest loans to small farmers and Farmers'Associations, b) expansion of programs run by Amanah Ikhtiar Malaysia (RM 100million), a nongovernmental organization that provides small loans to the very poor forincome generation projects in rural areas, and c) improving rural water supply in thepoorest areas (RM 100 million). In order to extend the safety net to those who are madenewly vulnerable by the crisis but who may not be directly covered under the programsfor the hardcore poor, RM 150 million was allocated for a new micro credit scheme toprovide assistance to petty traders and hawkers. Funds were also allocated for theenhancement of educational facilities (RM 200 million) and health facilities (RM 100million). The initial disbursement of these funds was, however, slow though it wassubsequently accelerated.

C. Bank Performance

21. Before the crisis, Malaysia had stopped borrowing from the Bank and the lastpiece of ESW was done in 1994. As a result there was a lack of up-to-date country andsector knowledge. This impediment was, however, overcome through effective use ofindividuals within the Bank who were familiar with the politics and economics ofMalaysia. This enabled the Bank to successfully process the loan under a very tightschedule. An important role of the operation was to re-establish a strong relationshipwith Malaysia. This process was well-managed. Bank staff provided policy notes asinputs to the Government in March, before the announcement of the reform program.

22. Bank staff undertook a series of missions in order to maintain the pace and qualityof the dialogue in a rapidly changing environment. An important contribution of theBank was making the authorities aware of the downside risks and the strong possibility ofan economic contraction at a time when the authorities expected to achieve low butpositive growth. Another key contribution of the Bank was in assisting the Governmentto take stock of its contingent liabilities arising out of guarantees provided to privatizedinfrastructure projects.

23. There was a divergence of opinion between Bank staff and the Malaysianauthorities on the design of the safety net. In part this arose from philosophicaldifferences (e.g. the authorities favored income generation policies over direct-transfers)as well as the fact that the actual social impact of the crisis turned out to be smaller than

vi

what the Bank had earlier anticipated. Bank's policy suggestions were aimed atmanaging a much larger adverse impact on unemployment and poverty. Actualunemployment in 19518 turned out to be 3.9% compared to Bank's projected 6-7%. Onereason why unemployment was lower than anticipated was the large reduction in foreignworkers from 1.2 million in 1997 to 0.78 million in 1998.

24. An area where the Bank was not fully successful in delivering early advice wasfinancial sector restructuring. This was mostly due to delays in mobilizing the requiredskills. With the Indonesia and Korea programs making similar demands, it was difficultto get a team together early on for Malaysia. When the team was finally mobilized, it didmake some contribution through assessment of the implementation of Malay;!ia'srestructuring strategy wvhich was formulated with the assistance of private sector experts.

D. FUTURE OPERATIONS

25. The ERSL has helped achieve Malaysia's objective of minimizing the downiumrnin the economy. Recovery is underway and it is important to ensure that it is sustainable.A follow-up fast disbursing operation would be of great value to the Governmen-: indeepening and strengthening its reform agenda, thereby laying a stronger foundation. forresuming robust growth, and ensuring that it is sustainable in the long run. Focusinj' onthe medium-term competitiveness issues would be a key component in this regard.

E. KEY LESSONS LEARNED

* Maintenance of country knowledge, even if there is no lending activity. The Bank'sstock of knowledge on Malaysia was relatively low when the crisis began and it liadto scramble to establish a workable knowledge base on Malaysia.

* Strong ownership of the reform program by the Government is crucial to its succt!ss.Even though there were changes at the highest level in the Government, the newveconomic team sustained the momentum of reform.

* Show flexibility in policy stance in the face of uncertainty and a rapidly changingsituation. As events unfolded and the depth of the crisis became apparent iheGovernment did nolt rigidly stick to pre-announced policies but adjusted its monetiLriand fiscal stance in accordance with the new realities.

• Fiscal flexibility requires increased coordination between MOF and line agencies inorder to implement the public sector programs. After having been initially advised byMOF to reduce expenditure, the line ministries found it difficult to reverse coursewhen the fiscal stimulus package was announced. As a result the fiscal stimulus vassmaller than envisaged.

* Appropriate fiscal and monetary policies, measures to recapitalize the banki ig;system, strengthening banking supervision, and corporate debt restructuring haveplayed a key role in stemming capital outflows and returning stability to 1 leMalaysian economy. While some observers attribute a key role to direct controls oncapital outflows, it is difficult to isolate their impact from the above factors.

vii

Malaysia's strategies to stem capital outflows and restore confidence in the economyincluded heterodox policies like direct capital exit controls. However, heterodoxpolices can lead to a further deterioration in market sentiments and have to be verycarefully designed and managed to gain market confidence. Overall the Malaysiancontrols have been well managed. However, when Malaysia introduced capitalcontrols, despite being carefully designed, the international markets were fuirtherunnerved by the sudden announcement and their initial reaction was stronglynegative. In light of market concerns and emerging signs of stability, theGovernment to its credit, consulted market participants and modified the controls byintroducing an exit tax. This helped restore confidence in the Malaysian economy.There were also problems in administering the controls (e.g. limits had to be placedon dividend repatriation; it is difficult in practice to differentiate between short-termand long-term capital) and the Government has to still contend with designing a fullphase out strategy.

• Taking stock of contingent liabilities in a transparent fashion and making provisionsfor them through the budgetary process should be an important priority A key factorthat caused a loss of market confidence was the lack of information on the size ofburden that would fall on the Government in case the contingent liabilities arisingfrom privatized infrastructure projects were realized.

3 Some form of temporary regulatory easing may be appropriate during crisis times if itcan be clearly demonstrated that these regulations are preventing banks from focusingon their key business. The tightening of regulatory standards announced in late 1997and early 1998, while a laudable objective, may have inadvertently contributed to thereduction in credit as banks became preoccupied with managing deterioration in assetquality and capital erosion. Regulatory easing in September 1998 met with success tothe extent that loan approvals increased significantly, although this coincides with thestart of recovery, so causality is hard to determine. A return to the highest prudentialstandards should be a priority as soon as recovery is established.

* Small open economies like Malaysia are vulnerable to boom and bust cycles andtherefore need mechanisms to manage them effectively. Modernization of publicsector institutions to better define, ex-ante, the rules of the game (e.g., strengtheningthe risk management capability of the public sector, making Government guaranteestransparent), will help prevent over-investment by the private sector and align therisks and rewards faced by them. Macroeconomic policies would need to be managedmore flexibly to increase the shock-absorptive capacity of the economy. In particular,fiscal discipline or the rule of maintaining a balance in the operating budget could beachieved over a business cycle rather than every year. In addition, the automaticstabilization capacity of the budget should be enhanced as there may be delays inimplementing fiscal stimulus packages during a downturn.

Economies like Malaysia need to develop a social sector strategy to manage the risksarising from globalization, especially mechanisms to reach the urban poor. Tillrecently most established programs were aimed at tackling rural poverty. Socialprograms should be an integral part of the strategy to cope with urban unemployment.Labor market reforms and training would help reduce structural unemployment.

IMPLEMENTATION COMPLETION REPORT

MALAYSIA

ECONOMIC RECOVERY AND SOCIAL SECTOR LOAN

Loan No. 43470-MY

I. PROGRAM IMPLEMENTATION AND ASSESSMENT

A. BACKGROUND AND OBJECTIVES

1. Malaysia, under Vision 2020, expects to achieve a developed nation status by theyear 2020, and to be able to eliminate hard core poverty by year 2000. However, theonset of the regional crisis and the impending recession was a setback to Malaysia'sprogress in attaining this Vision. The crisis began to reveal structural weaknesses in theeconomy. Even before the crisis the Government had recognized some of theseweaknesses and had begun implementing policy reforms to strengthen the financialsector, increase competitiveness, strengthen investments in human resource development,and to maintain well-targeted and efficient social safety nets. The crisis provided animpetus to accelerate the implementation of policy reforms. The Government's intentionwas to implement these reforms in a pre-emptive fashion so as to minimize the impact ofthe crisis. At the same time, emerging structural weaknesses relevant to its medium termngrowth would also be addressed.

2. In late 1997, the Bank restarted its relationship with Malaysia after a four yearperiod of low key contacts. The Economic Recovery and Social Sector Loan (ERSL)was an integral part of the Bank's renewed relationship and assistance strategy. The needfor the loan arose as contagion from the crisis in neighboring countries spread toMalaysia and the authorities felt that fiscal easing was required to limit the economicdownturn. The loan was a fast disbursing operation designed to support theimplementation of the Government's pre-emptive measures to:

* minimize the downturn in economic activity* implement policy reforms to resume robust and sustainable growth* expand safety nets to protect the hard core and the near poor from the adverse effects

of the crisis* protect investments in human resource base

3. The Government's strategy for achieving these objectives was to implement areform program focused in four key areas:

l Maintaining sound macroeconomic policy with flexibility in the light of uncertaintiesin the economic environment;

2

. Strengthening the financial sector in the light of the regional crisis includingconsolidation of finance companies and pre-emptive recapitalization of bankinginstitutions; improving regulatory and supervisory framework; and improving marketbased incentives for more efficient functioning of financial institutions;

. Improving competitiveness by strengthening corporate governance, enhancingtransparency on disclosure of information; implementing market-based corporaterestructuring procedures; strengthening competition policies; and liberalizinggradually and progressively foreign equity ownership to facilitate earlyrecapitalization; and

* Strengthening social safety nets to soften the negative impact of the economic crisison the lower income and vulnerable groups; maintaining access to key social sectorservices; tackling the problem of graduate unemployment and address mediumi-termsafety net issues

4. The loan would support and strengthen the Govemment's balance of paymnentsobjectives in the context of the regional crisis. In addition it would support the fiscalobjectives of the Government aimed at strengthening the social sectors.

5. The proposed operation was strongly owned by the Govemment as it was basedon policy reforms announced by the Finance Minister in Statement of March 24, 1998,(Comprehensive Stabilization and Structural Reform Package) and the Statement by theGovemnor of Bank Negara Malaysia (BNM) on March 25, 1998. A policy matrix wasdiscussed and agreed with the Govemment.

6. While there was no accompanying formal IMF program, the IMF at that time wassupportive of the Govemment's reform program, and the Bank's support of it throug h theERSL.

B. ACHIEVEMENT OF OBJECTIVES

7. In order to achieve the objectives outlined in the previous section, theGovernment adopted a flexible macroeconomic policy, implemented measures tostrengthen the financial sector and improve corporate governance, and to protect the poorand the vulnerable groups from the adverse affects of the crisis. Progress on selt!ctedoutcome indicators is detailed in the following sections.

Macroeconomic Policy

8. Initial rebalancing of macro policy: The loan was to support the pre-em]tiveprogram of the Government announced in March 1998. The program sought to rebaLhncemacroeconomic policy that was formulated in October 1997 when Malaysia was slillregistering robust growth, despite experiencing the initial shocks of the regional cz:isis.Fiscal policy was aimed at containing inflation and managing the current account de&icit,and was thus one of restraint aiming at a surplus of 2.7% of GNP. In December 1.997further austerity measures were announced involving expenditure reduction of 0%across the board and 8% on a selective basis. However, with the crisis becomiiing

3

prolonged, the March program sought to ease fiscal policy and reduced the targetedsurplus to 0.5% of GNP. The tight monetary policy that was adopted in 1997 washowever to be maintained. This was because at the beginning of 1998 there was a sharpincrease in the volatility of the ringgit, inflation began to move up as the impact of higherimport prices filtered through, and the outflow of short term funds increased. Creditgrowth was targeted to moderate to 12-15% in 1998 from about 30% in 1997.

9. Fiscal policy eased: The tight monetary policy and the restrained fiscal policyhelped improve the external balance and contain inflationary pressures. However, highinterest rates and a sharper than anticipated credit slowdown (see section on financialsector below) adversely impacted domestic economic activity. The cuts in publicexpenditure aggravated the declines in consumer and investment demand. With thedownturn being much steeper than anticipated the Government announced a fiscalstimulus package involving an additional allocation of RM 7 billion, thereby targeting afiscal deficit of 3.4% of GDP for 1998. The projects identified were those with strongdomestic multiplier effects, low import content, and short gestation period. Allocationsto the social sector was increased. The actual deficit however turned out to be only 1.8%of GDP owing to expenditure slippages arising out of inadequate inter-ministerialcoordination. The Government has however taken steps to improve inter-ministerialcoordination and has accelerated project implementation in 1999. A fiscal deficit of5.8% of GDP is planned for 1999.

10. Monetary easing and introduction of selective capital controls: Monetary policywas eased beginning in August 1998 to complement the counter cyclical fiscal policy. InAugust, BNM's 3-month intervention rate was reduced in steps from 11% to 9.5%. TheMalaysian authorities feared that attempts to further lower interest rates would lead tofurther speculative attacks on the ringgit in the off-shore markets. Yet, maintenance ofhigh interest rates would push the economy deeper into recession. Faced with thisdilemma, the authorities felt that it was imperative for Malaysia to ease monetary policyand lower interest rates without having to worry about exchange rate instability. Fixingthe exchange rate and introducing selected capital controls was seen by the Governmentas a measure that would enable Malaysia gain monetary independence.

11. In September 1998, the off-shore ringgit market was closed and funds broughtinto the country would need to be held for 12-months before they could be repatriated.These measures were clearly not anticipated under the reform package supported by theloan. The controls, however, were selective - they were aimed at reducing excessivespeculation on the ringgit, and curbing short-term flows. They did not impact currentaccount transactions or FDI' .

12. The response of the international investor community to the capital controls wasin general not positive - global credit-rating agencies reduced Malaysia's internationalrating to near-junk status and Malaysia was excluded from Morgan Stanley CapitalInternational indexes (MSCI) and the IFC Emerging Market Index. Market uncertaintyincreased; it was feared that an estimated US$5 to 10 billion of portfolio capital might

l Some restrictions were, however, placed on dividend repatriation.

4

leave the country in September 1999, and this could drive Malaysia into another round ofcurrency crisis or force drastic measures by the Government to address this issue. Also,signs of regional financial stability started to emerge in the fourth quarter of ] 998,making the some of t]he instruments of capital control redundant.

13. Modification of capital controls. In the face of market concerns and emergingsigns of stability iri the economy the controls were modified in February l 999.Quantitative controls were replaced by a two-tier capital gains tax on foreign portfoliofunds brought in after February 15 with the rate diminishing from 30% for tukidsremaining in the country for less than one year to 10% for funds remaining in the coiuntryfor more than one year. The principal would be taxable on a graduated scale for ifunldsbrought in before February 15, with the rate diminishing to zero for funds held for inorethan a year. In September 1999 the two-tier levy was replaced with a flat 10% levy onrepatriation of profits from portfolio investments. The breathing room provided by thecontrols has been used judiciously to expedite financial and corporate sectorrestructuring. BNM has also reduced its 3-month intervention rate to 5.5% in August1999 from 11% in August 1998. With inflation remaining low (around 3%) real intcrestrates remained positive.

14. The flexible policy stance adopted by the Government helped put the brakes ondec]lining output growth. The economy bottomed out in Q3 1998 and recovery is wellunderway.

* After contracting for five successive quarters, GDP grew 4.1% in Q2 1999, ard isexpected to record 3-4% growth for the whole year compared with -7.5% in 1)98.Manufacturing production has expanded at over 6% year-on-year (yoy) in the firsteight months of 1999. While private consumption grew 3% in Q2 1999, privateiinvestment continued to contract owing to excess capacity in a number of sectors.

•]Exports, led by the electronics sector, grew 14% yoy in US$ termns during Januiary-August 1999. Imports, having contracted through Ql 1999, picked up in Q2 '1999bringing their US$ value growth to nearly 7% yoy in January-August. Capital goodsimports have picked since June. The current account surplus for 1998 was 13%1o ofGDP.

* Foreign exchange reserves have increased to US$ 31.4 billion at end-Septmeber 1999(6.2 months of imports; short-term debt is less than 25% of reserves) compared withUS$ 20 billion at the time of the loan

* Loan disbursements have averaged RM 26 billion a month in the January-Aupustperiod in 1999 compared with RM 21 billion in the same period of 1998.

* Inflation has fallen from its peak of 6.2% in June 1998 to 2.3% in August 1999.13NM's key 3-month intervention interest rate has come down from 11% in Aug ust1998 to 5.5% in August 1999. The average lending rate for commercial banks hascome down from 13.5% in May 1998 to 8% at end-August 1999.

* The stock market has recovered substantially. In May 1999, the KLCI breached the700 mark for the first time in 13 months and stood at 738 on October 21. It hadplummeted to 263 on September 1, 1998.

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15. There has been a favorable market response to the easing of capital controls,improved growth prospects, and steady progress in financial and corporate restructuring.Malaysia will be reinstated into the MSCI indexes from February 2000. Compared withan earlier estimated US$5-10 billion, a net outflow of about US$ 1.4 billion was recordedin September 1999 following the expiration of the one year period after which theprincipal amount on the funds initially locked-in could be repatriated without any levy.

16. Issues: There are some concerns about the way in which monetary policy hasbeen eased. The Govermnent has narrowed the maximum allowable spread over the baselending rate that banks are allowed to charge. This could restrict banks' ability to priceloans according to client risks. It could undermine profitability, and perpetuate themanagement of interest rates through direct rather than indirect means. The Governmenthas, however, begun a review of the current base lending framework, which among otherthings, will focus on issues relating to a more efficient pricing system. The Governmenthas set a credit growth target of 8% for capable banks. However, enforcing this targetcould lead to further deterioration in asset quality. The supervision missions havediscussed these issues at length. The Government does not plan to enforce these credittargets at the individual bank level; instead, it plans to encourage bank lending throughmoral suasion.

Financial and Corporate Sector Restructuring

17. New Institutional Framework: In mid-1998 the Government set up a new andcomprehensive institutional framework for financial and corporate sector restructuring.Danaharta was established as an asset management company in June 1998 to acquireNPLs from financial institutions in order to strengthen their balance sheets and enhancetheir ability to lend. Danamodal was established in August 1998 as a special purposevehicle with the purpose of recapitalizing viable banking institutions whose capitaladequacy ratios fell below 10% and the shareholders faced difficulty in raising funds tomeet the additional capital requirement. As a strategic shareholder in the recapitalizedbanking institutions Danamodal would also facilitate the consolidation and rationalizationof the banking system and catalyze the merger process. As a pre-condition, bankinginstitutions that seek recapitalization are required to sell their NPLs to Danaharta. This isto ensure that the new capital injected is channeled towards financing new lending andnot to fund existing NPLs. The last component of the restructuring framework is theCorporate Debt Restructuring Committee (CDRC) which was established in July 1998to facilitate voluntary restructuring of corporate debt outside of courts through voluntaryagreements between creditors and debtors.

18. Steady progress in financial restructuring: Danaharta and Danamodal havemade steady progress. As of June 30, 1999, Danaharta had acquired and/or managed RM39.3 billion of NPLs from the financial system of which RM 31.3 billion are from thebanking system (about 34% of total banking system NPLs). Of the RM 39.3 billion, RM17.8. billion were acquired from financial institutions, while RM 14.5 billion NPLs fromSime Bank Group and RM 7.1 billion NPLs from Bank Bumiputra Malaysia BerhadGroup were only managed. The weighted average discount on the loans purchased was

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579%0. However, if orne large loan which was purchased for a nominal sum of RM 1 isexc:luded, the average! discount was 48%. Danaharta completed the acquisition prccessby June 1999 which was 6-months ahead of its original schedule.

19. Danaharta's financing requirements were estimated at RM 15 billion. These werepartly be met by cash contributions by MOF, Khazanah and EPF amounting to RVI 5billion. The rest are being met through issuing zero-coupon bonds with a nominal valueof RM 15 billion (present value: RM 10 billion). These bonds are issued to bankinginstitutions in exchange for NPLs. A totall amount of RM 9.174 billion in nominal valueof bonds have been issued so far. The yield on these bonds has come down from 7.1.50%during the first issue in November 1998 to 5.319% for the most recent round on July, 29.

20. Danamodal has injected capital into 10 banking institutions in the forrim ofExchangeable Subordinated Capital Loans (ESCL) amounting to RM 6.209 billion andhas appointed 25 nominees in the intervened institutions as Chairman/Deputy, ordirectors. Of these 10 institutions, Danamodal has signed Definitive Agreements withnine institutions for the conversion of the ESCL into permanent Tier-I and/or Ti -r-2capital. The capital injected into these financial institutions, which was equivalent toabout 14% of the total Tier 1 capital of the banking sector at the beginning of 1998,boosted the risk weighted capital adequacy of the recapitalized institutions from 9.9% to13.9% at end-May 1999. The entire banking system's RWCR stood at 12.7% at end-June. The Government has announced t'hat Danamodal will require significantly lessthan the original estirnate of RM 16 billion to ensure sufficient capitalization of theindustry. Funding requirements of Danamodal have been met through RM 3 billion ofseed capital from BNM and a bond issue through which RM 7.7 billion was raised. 'Tiebonds were fully subscribed by 57 banking institutions through liquidity released frobn areduction in SRR from 6% to 4% on September 16, 1998. The remaining RM 5.3 bill oa,if required, will be raised through a domestic and/ or global bond issue.

21. In January 1998, BNM announced a plan to reduce the number of financecompanies from 39 to 8 through a series of mergers. March 31, 1998 was set as a targetdeadline for the mergers to be finalized and activated, but the target was missed. A. ofJuly 31 1999, 12 finance companies have been absorbed by parent commercial ba]ks,while two have merged with two other finance companies. In addition, BNM announceda large scale merger program on July 29, 1999 whereby the present 21 dome,ticcommercial banks, 25 finance companies and 12 merchant banks would be consolidatedinto six domestic banking groups. The composition of each group including the lead or"anchor" bank was determined by BNM. However, there were strong objections fr3mnsome banks to being rmerged in this manner. In response, on October 21, 1999 B1NMchanged its earlier decision and allowed banking institutions the flexibility to form tf eirown merger groups and to choose their own lead institution. The number of groimpswould no longer be restricted to six. Merger partners are to be identified by January 2! 'l0Dand the entire merger process is to be completed by December 2000.

22. The CDRC is assisting in restructuring debt of viable companies. The comparniesshould not be under any insolvency administration. If the companies are already un'lerthe protection of Section 176 of the Companies Act 1965, they must withdraw all

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restraining orders against their creditor banks once all creditors agree to a standstillperiod. Progress, though slow as it is a voluntary process, is being made. As of July 31,1999, CDRC has received applications from 62 companies with loans amounting to RM34.9 billion (including RM 8.4 billion for the Renong Group alone) for assistance inrestructuring their debts. Out of the 62 applications, I1 companies with debts amountingto RM 2.9 billion either have been withdrawn or rejected. The rejected cases were thosethat did not meet CDRC's terms of reference. To date, 11 cases involving RM 3.4 billionhave been resolved with the assistance of Danaharta, 13 cases involving RM 11.3 billionare in the implementation stage, while 27 cases (RM 18.7 billion) are outstanding.CDRC secretariat has indicated that in all cases, on a proportionate basis, owners willtake bigger hair cuts than creditors -- through write down of existing share capital orthrough dilution.

23. Disclosure throughout the restructuring process has been good. Details ofsignificant developments concerning the CDRC, Danamodal or Danaharta have beenmade available in a timely manner on web sites, in press releases, and operational reports.In March 1999, Danaharta released detailed operational results providing information onthe amount of NPLs acquired and the discount to face value paid, in aggregate and on abank-by-bank basis; in April, it announced the loan restructuring guidelines it will followin restructuring NPLs; and in May, Danaharta's first annual report and operations reportwas made public. Danamodal released its first set of financial statements in the fourthquarter of 1998. The details of the cases resolved by the CDRC have been made publicand widely discussed in the Malaysian and international press.

24. Burden sharing is inherent in the operational processes of Danaharta andDanamodal. The financial institutions from which Danaharta acquires NPLs at adiscount must write off the difference between the face value of the loan and the pricereceived from Danaharta. Existing shareholders see the value of their investment reducedby such losses. Furthernore, the shareholders of banking institutions that receive capitalinjections from Danamodal experience a dilution of their equity stake in that institution.The degree of dilution increases in proportion to the losses incurred by the firm and bythe amount of capital injected by Danamodal. For example, the shareholders of MBfFinance Berhad suffered a severe dilution of their interest in that finance companyfollowing an injection of capital by Danamodal. At present, Danamodal's capitalinjection represents 93% of the capital base of MBf Finance Berhad. Danamodal'scapital injection currently represents more than 50% of the capital base of threeinstitutions. Write-offs have occurred in two of the cases which the CDRC has helpedresolve; in the other cases debts have been rescheduled rather than restructured throughwrite-offs or asset sales.

25. Initial tightening of Regulatory Standards: The Government introduced a seriesof pre-emptive measures between April 1997 and March 1998 to strengthen the financialsector -- stricter prudential standards were imposed and disclosure requirements wereenhanced. These measures included: tightening the definition of NPLs from 6-monthspast due to 3-months past due; a 20% automatic provision against the uncollateralizedportion of substandard loans; maximum limits of 20% of total loans on lending to thebroad property sector and 15% on lending for the purchase of shares and units. The

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measures introduced by the Government in October 1997 and March 1998 substantiallyincreased information disclosure by financial institutions to improve the quality andreliability of information provided to regulators, shareholders, and the general public.This was a bold move designed to improve market confidence. Banking institutions wererequired to publish quarterly data on key indicators of financial soundness, includingcapital adequacy and NPLs. This information was to complement the central bank'smonthly publication of information on capital adequacy, NPLs, and the provisioirlglevels of commercial and merchant banks and finance companies. The ERSL wassupportive of these measures.

26. Unanticipated impact of regulatory tightening: However, as the crisis deepe niedthe authorities felt that the imposition of these measures had resulted in banks beconliirgpre-occupied with managing deterioration in asset quality and capital erosion. Theintroduction of tighter banking standards, may have inadvertently contributed to thereduction in credit by pressuring banks to call in loans in order to improve their capitaladequacy ratios. Due to the difficulty of raising new capital during the crisis, reducingassets was the most efficacious means of meeting capital adequacy requirements from thepoint of view of the banks which wished to avoid being forced to merge by BNM at gi eatloss to existing shareholders. Although other factors contributed to the sudden decline incredit extension, including issues regarding the credit worthiness of borrowers and thereluctance to borrow on the part of industries already faced with overcapacity, inretrospect, the introduction of measures to improve the prudential standards of thefinancial sector may have been too aggressive in the case of Malaysia.

27. Issues: Relaxation of regulatory measures. In September 1998, a number ofinitially tightened standards were relaxed. The classification of NPLs was lengthened to6 months and banking institutions were required to set aside a 20% provision on 1heuncollateralized portion of substandard loans only if the overall loan loss provision Nvasinadequate (as determined by BNM). The limits on property loans and share financingwere eased. Property loans under RM 250,000 were exempted from the 20% limit, andlimits on share financing by commercial banks and finance companies were increased to20%. The frequency of the disclosure requirement was relaxed: key indicators are nuowonce again to be published only semi-annually. This action was contrary to the princip:leof imrproved transparency. BNM, however, has strengthened its supervision and itcontinues to gather information from financial institutions on NPLs (3-month and 6..month definition), and specific and general provisions, on a monthly basis.

28. While there may be some justification for having eased regulatory standailsduring a crisis, the Government should consider announcing that the policy easing is onilya temporary measure, forced by the crisis, and that Malaysia will reaffirm its commitmentntto the highest prudential standards once the crisis is over.

29. Recent measures to strengthen the banking system: In April 1999, newmeasures were announced to strengthen the banking system:

Frequency of on-site examination of banks will be increased to at least once a ye, arand the examination will be on a consolidated basis

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e The two-tier regulatory system will be discontinued. The large minimum paid upcapital requirement of tier-I banks had encouraged the shareholders to borrow short-term to enhance the capital base. Future bank capitalization will be allowed only iffunds are raised from less obligatory resources such as retained profits, equity or verylong-term bond issues.

. Different risk weighted capital requirements will be imposed on individual bankinginstitutions which will take into account loan concentration, sectoral exposure andinternal controls.

. Standards on credit risk management will be issued to banking institutionsTo address the problem of moral hazard, BNM will formulate a clearer set ofguidelines for its lender-of-last resort facility which will specify conditions if suchsupport is called upon.

* A financial deposit insurance scheme will be developed to replace the current blanketGovernment guarantee.

. Measures will be taken to deepen the repo market, and facilitate asset-backedsecuritization

Corporate Governance and Competition Policy

30. Relative to other East Asian economies (with the exception of Singapore andHong Kong), Malaysia has had better corporate governance structures backed by welldrafted legislation and regulations. Under the ERSL, the Government of Malaysia hascommitted itself to further improvements by completing actions already initiated and byintroducing new measures. Considerable progress has been made.

31. One area where the Government has, however, relaxed competitive procedures ispublic procurement. This was done to accelerate the implementation of developmentprojects and increase the size of fiscal stimulus. Although the fiscal stimulus is neededfor recovery, the challenge is to reintroduce competitive bidding procedures.

Improving Corporate Governance

32. Finance Committee Report and Recommendations. On March 25, 1999, followinga year of deliberation, the High Level Finance Committee (HLFC) on CorporateGovernance released its report to the public. The report, the result of an in-depthcorporate governance reform exercise, covers three areas: (a) the development of theMalaysian Code on Corporate Governance, (b) the reform of law, regulations and rules tostrengthen the regulatory framework for public listed companies, and (c) training andeducation to expand the pool of persons suitable for appointment as company directors.

33. The HLFC report is comprehensive and makes detailed recommendations relatingto corporate governance and disclosure issues. Implementation of the recommendationswill substantially improve corporate governance and disclosure. The report envisagesfour types of measures: (a) legislative actions; (b) amendment to Listing requirements ofExchanges (c) measures that can be implemented through Best Practice Notes andguidelines; and (d) voluntary actions by professional bodies, investors and companies.

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Full implementation of legislative action will take time. However, the regulatoryauthorities have already started implementing types (b), (c) and (d) measures.

34. Several concrete actions to improve corporate governance have already beentaken:

* Code of Ethics for Directors and Company Secretaries was published by the Registrarof Companies

* Section 67 A of the Companies Act was amended to remove ambiguities and en.iancesafeguards in share buyback programs

* The Securities Industry Regulations under the Securities Industry Act 1983 have beenamended to: (a) lower the threshold relating to disclosure of substantial sharehcldingto 2% of the norminal amount of voting shares and (b) reduce the grace peric d fornotification from 14 days to 7 days.

* KLSE listing rule:s were amended to widen the scope of rules on related-party andinterested-party transactions to also cover transactions between the compan:, andpersons connected with a director or substantial shareholder and parties in which thedirector, substantial shareholder or any person connected with the director orsubstantial shareholder has an interest.

* KLSE listing regulations amended to disallow interested directors from voting andrequire appointment of Corporate Advisers in a related or interested-party transaction.

* The enforcement powers of the Securities Commission (SC) have been enhanc,d. toalso allow the SC to petition to Court for winding-up of companies contravening anmysecurities laws. The SC may also apply to Court to disqualify clirectors or hiefexecutives of listed companies where they have been convicted of an offense l: nderthe securities laws.

* The SC has also made amendments to the Takeover Code to require higher stan. ardsof disclosure of information and to ensure adequate and timely disclosures to mirl mnityshareholders. Additionally, the Code specifically sets out the criteria on which theSC may make decisions to exempt a company from the requirements of the CoI.[e inrelation to a takeover. This would make the regulatory decision making process rioretransparent.

* KLSE listing requirements were amended to restrict the number of directorships thlatcan be held by a director of a public listed company to no more than 10 in I stedcompanies and 15 in non-listed companies.

35. In addition to specific actions (described above) the SC has also pub! iclyannounced a three year business plan (1998-2000) which articulates a detailed aidexplicit strategy for strengthening the capital market regulatory framework. Thecorporate governance component of the capital market development strategy has tiirzeelements: (a) Develop a code on corporate governance; (b) Formulate effectiveenforcement mechanisms; and (c) Raise the investor's awareness of corporate govern, ncestandards. The SC being a member of the High Level Finance Committee will carr; outits agenda on corporate governance through the Finance Committee.

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Improving Transparency.

36. Certain provisions of KLSE listing requirements have been revised. Risk basedcapital adequacy requirements and client asset protection rules for stockbrokingcompanies are being introduced, the implementation of which is subject to consultationwith the SC.

* KLSE listing requirements have been amended from time to time to strengthenprovisions relating to disclosure and protection of minority interests. Since theapproval of the Loan two important Practice Notes relating to corporate disclosurehave been issued. The first note requires all listed companies to make immediateannouncements in the event of default in interest and/or principal payments in respectof loan stocks, bonds, debentures or credit facilities. Companies are also required tocite the reason for default, remedial measures proposed and the financial and legalimplication of the default. This note became effective on June 1, 1998 and till the endof June 1999 about 57 companies had made announcements under this note. Thesecond note requires all companies to announce by June 30, 1998, details of overallpotential exposure to the Y2K problem and remedial actions taken.

* Rules on capital adequacy requirements have been introduced with effect from May28, 1999. Full monitoring and enforcement of the rules will be announced by KLSEin conjunction with SC. Client Asset Protection rules have been approved inprinciple by SC. The proposals are in line with best practices in Europe.

* As part of enhancing investor protection, KLSE has decided to publish periodicallythe amounts by which Exchange Members are in surplus/deficit with respect to theMinimum Liquid Fund Requirement. Restrictions have also been placed from time totime on stockbrokers and some of the exchange members have been put underenhanced on-site surveillance.

* KLSE listing requirements were amended to require all public listed companies tomake quarterly financial disclosure (previously half-yearly) with effect from thequarter ending on or after July 31, 1999.

37. Further, the SC's business plan envisages that by the Year 2001 the regulatorystructure will shift from a merit-based regime (i.e. based on Government approval) to adisclosure based regime. Under the new regime most of the responsibility for day-to-dayregulation will be delegated to the front-line agencies such as the KLSE. This approachis consistent with practices in more advanced capital markets. Compliance withInternational Accounting Standards adopted by Malaysia is proceeding as envisaged. Anumber of exposure drafts have been issued.

38. Quarterly statistics on commencement and completion of bankruptcy andreorganization case are being made available:

. The Registrar of Companies (ROC) compiles monthly statistics on winding-up(voluntary, court ordered and under Section 308) and re-organization cases (underSection 176). The information pertaining to winding-up cases is published in theROC's annual report. Private individuals can obtain company specific informationfrom the ROC.

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* KLSE requires all listed companies to immediately announce schemes of compromiseand arrangements (re-organization) application filed under Section 176 of theCompanies Act.

* Section 176 of the Companies Act was recently amended to require compal Iies toimmediately advertise as well as file information with the ROC on any restrainingorder issued to creditors by the Court under Section 176.

* Under the Danaharta Act, 1998, Danaharta will make public announcements, of allinstances of appointment of Special Administrator as part of a re-organizatioii planunder the Danaharta Act.

39. Issues. ROC should make quarterly newspaper announcements ofpending/completed winding-up and re-organization cases under the Companies Act..

Other Measures

40. Consumer Protection Bill. The Consumer Protection Bill was passed by theMalaysian Parliament in its July/August 1999 session and is expected to come intc forceby end-1999.

41. Unfair Trade Practices Bill. A draft Unfair Trade Practices Bill has been preparedbut has not yet been adopted by the Government.

42. Facilitate Contested Takeovers and Mergers. Recent changes in the tax regimewill make it easier to affect mergers and takeovers. A new code has been prepared but isyet to be drafted into a bill.

Social Sector

43. Impact of crisis on poverty: This crisis pushed roughly 226,000 more peSoplebelow the poverty line in 1998. Unemployment increased from 2.6% in 1997 to 3.*(%0/ in1998. Two main reasons for the relatively small increase in unemployment (giveil thesubstantial contraction in output) were a decline in real wages, and a large reduction inforeign workers from 1.2 million in 1997 to 0.78 million in 1998. Economic activities inthe urban areas, construction for example, experienced a sharper contraction thaneconomic activity in rural areas. Most labor is now employed in the urban formal s .ctor,so a large share of people hurt by the slowdown live in urban areas. The tradit: o:nalcushion of reverse migration (going back to the countryside), while still feasibL- forsome, will not be available for many urban laborers who lose their jobs. In addition,higher food prices have also hurt the poor and the near poor. These effects are .nostpronounced in the three states-Kelentan, Terengganu and Sabah- where over ha] f ihepOOr live.

44. Measures taken to protect the poor. The Government has taken measur4. s toprotect recurrent expenditures on social assistance programs for needy children, thehandicapped, the elderly, and the hardcore poor. Among the measures were: (i) retai ningthe original 1998 budget allocation for the Development Program for the Hardcore ]oor(PPRT); and (ii) making smaller cuts to the 1998 budgets of ministries involved in the

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provision of social programs, rural development, and agriculture programs which aremainly targeted for the poor and low-income group as well ensuring that the budget for1999 is sufficient to meet program objectives. Although at the beginning of 1998, as partof its austerity program, the Government cut health and education budgets across theboard (by 12% on the development side and 2% on the current side), cuts were graduallylifted during the year as the Government switched to the fiscal stimulus strategy andreinforced its commitment to safeguard the social sectors.

45. The Government is implementing a number of programs to mitigate the effects ofthe slowdown on the poor and other vulnerable groups. The thrust of the Governmentprogram is to enhance income-earning opportunities. Pure transfers to the needy arelimited to a modest social safety net for a small group of people. This practice isconsistent with Malaysia's underlying philosophy of providing the poor with the meansto improve their livelihoods rather than giving them cash transfers. Additional allocationswere made in the 1998 budget for a) Fund for Food scheme (RM 300 million) whichprovides low interest loans to small farmers and Farmers' Associations, b) expansion ofprograms run by Amanah Ikhtiar Malaysia (RM 100 million), a nongovernmentalorganization that provides small loans to the very poor for income generation projects inrural areas, and c) improving rural water supply in the poorest areas (RM 100 million).In order to extend the safety net to those who are made newly vulnerable by the crisis butwho may not be directly covered under the programs for the hardcore poor, RM 150million was allocated for a new micro credit scheme to provide assistance to petty tradersand hawkers. Funds were also allocated for the enhancement of educational facilities(RM 200 million) and health facilities (RM 100 million).

46. There have been long delays in disbursing funds for some social sector programs.At the time of the August 1998 supervision mission, while the budget for Amanah IkhtiarMalaysia had been approved it had not been disbursed, the Fund for Food program was ina stalemate as the Government and Bank Pertanian had not reached agreement on an on-lending rate, and the hawker's scheme had also not started by then. As of August 13,1999 AIM had provided loans amounting to RM 10.3 billion. As of August 25, 1999, RM41 billion had been approved by the Agricultural Bank of Malaysia to finance 72 projectsunder the Fund for Food scheme. Loans were disbursed under the micro-credit schemebeginning May 1999. As at mid-September 1,798 loans amounting to RM 5.7 millionhave been disbursed. The funds allocated to the rural water supply program, educationfacilities, and health facilities, have been fully spent.

47. Since cost-cutting is essential during the economic slowdown, in order tosafeguard employment, the Government has urged employers to use retrenchment as alast resort and instead to consider alternatives such as training, retraining, pay cuts orreduced working hours. In August 1998, the Government introduced a new amendmentof the Employment Act that requires prior notification of the Manpower Department byemployers who plan to implement pay cuts and temporary lay-offs. Moreover, theMinistry of Human Resources launched a RM 5 million Retraining of RetrenchedWorkers Scheme in May 1998. The Government is providing financial support to smalland medium-scale industries to improve their productivity, technology, and access tomarkets and to cope with the current crisis. A RM 1 billion fund (later increased to RM

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1.5 billion) for small and medium industries was established and financing of workingcapital under this fund was increased from 10% to 20% of the approved loan amount.

C. IMPLEMENTATION RECORD AND MAJOR FACTORS AFFECTING THE PROJECT

48. The loan was disbursed as a single tranche release of $300.0 million on Jule 23,1998. There were several missions between August, 1998 and May, 1999 to suplervisethe progress of the reform program. The key focus of the supervision missions ),as tohighlight the downside risks and the need for fine tuning the reform program. TheGovernment has responded to suggestions from Bank staff and the modification of c apitalcontrols in February 1999 is, in part, an example of this.

49. Overall, substantial progress has been made in implementing the structural rv formrmprogram. While there have been a few significant departures in the reform prc gram(e.g., introduction of selective exchange and capital controls; relaxing the definiti on ofNPLs) most policy reforms as defined in the loan document are on track.

50. Factors not generally under Government control: Malaysia was impacted bythe deepening regional crisis in East Asia. Being a highly open economy the impact ofexternal demand shocks, and uncertainty in international financial markets was severeand greater than anticipated. Events in Brazil and Russia created greater uncertairty infinancial markets and led to a further deterioration of market confidence. This led theMalaysian Government to adopt certain policies that were unforeseen at the time cf theloan (see Section B albove).

51. Changes in the economic team, including the appointment of a new firanceminiister, also led to policy changes that reflected the views of the new economic teamn inthe face of the deepening regional crisis. The adoption of capital controls coupled withpolitical uncertainty that emerged at around the same time, adversely affected marketconfidence. The Government to its credit maintained the thrust of the reform prograr-l.

52. Factors generally subject to Government control: In addition to maintainingthe thrust of the reform program, some elements were made more comprehensive ulndlerthe National Economic Recovery Plan. Capital controls were judiciously used to speedup financial and corporate sector reform. The market has responded positively ancl. theinternational rating agencies have upgraded Malaysia's outlook from negative to stable.However, some elements of uncertainty remain. Policy announcements on exchange rateand elimination of remaining capital controls will help considerably in strengthe lingmarket confidence.

53. There were delays in disbursing funds for social sector programs. At the tin e ofthe August 1998 supervision mission, while the budget for Amanah Ikhtiar Malaysia hadbeen approved it had not been disbursed. The Fund for Food program was in a stalermatein August as the Government and Bank Pertanian had not reached agreement on ar on-lending rate. The hiawker's scheme had also not started by then. Subsequently,disbursement on these components was speeded up.

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54. In order to speed up the implementation of development projects and increase thesize of the fiscal stimulus, the Government has relaxed competitive procedures in publicprocurement and has resorted to direct negotiations. Although the fiscal stimulus isneeded for recovery, the move away from competitive bidding should only be temporarysince prolonging it would inevitably raise questions about transparency of Governmentoperations.

55. Factors generally subject to implementing agency control: The implementingagency (MOF) staff established a good working relationship with the Bank. There weresome co-ordination issues between the MOF and the line ministries that led to a slowerthan targeted implementation of the fiscal stimulus package. After having been initiallyadvised by MOF (in October 1997 and March 1998) to scale back projects and reduceexpenditure the line ministries found it difficult to reverse course when the fiscal stimuluspackage was announced.

D. SUSTAINABILITY OF REFORM PROGRAM

56. A key factor that augurs well for the sustainability of the reform program is itsstrong ownership by the Government. Further, the National Economic Recovery Plan hasbroad based support within the country and was formulated after consultations with theprivate sector, industrial and financial groups, trade unions, professional associations,media, women's organizations, and non-governmental organizations. The Malaysianreform program is largely homegrown and the Bank played an advisory and facilitatingrole. This is unlike other crisis countries where international organizations provided theblueprint for reform programs.

57. The Government has shown an appetite not only for short-term economicmanagement of the crisis but also for managing medium to longer-term issues related toboom and bust cycles. This enhances the likelihood of achieving the ultimate objectiveof the reform program of resuming robust growth.

58. The downside risks to project sustainability are:

* inconsistencies may emerge in the macro framework between a fixed exchange rateand the conduct of monetary policy

. a lack of political commitment for corporate restructuring (operational andgovernance) may arise if there is an accelerated economic recovery.

* there may be a failure to institutionalize new policies and programs for the urban poor

E. BANK PERFORMANCE

59. Before the crisis, Malaysia had stopped borrowing from the Bank and the lastpiece of Economic and Sector Work (ESW) was done in 1994. There was, therefore,very little Bank activity in Malaysia and Bank staff working on Malaysia had been scaleddown. There was thus a lack of up-to-date country and sector knowledge. Thisimpediment was, however, overcome through effective use of individuals within the

16

Bank who were fanmiliar with the politics and economics of Malaysia. This enabled theBank to successfully process the loan under a very tight schedule.

60. An important role of the operation was to re-establish a strong relationshi 1 withMalaysia after a four year period of low key contacts. This process was well-ma laged.Bank staff provided policy notes as inputs to the Government in March, before thearnouncement of the reform program. The Bank's bilateral policy discussion, withBNM, EPU, Treasury, and NEAC helped build a good working relationship with thesekey Governnent agencies which, in turn, enabled a better understanding of client needsand helped tailor Bank's response to these needs.

61. Bank staff undertook a series of missions in order to maintain the pace and cualityof the dialogue in a rapidly changing environment. An important contribution of theBank was making the authorities aware of the downside risks and the strong possibi lity ofan economic contraction at a time when the authorities expected to achieve lo w butpositive growth. Bank staff were able to convince the authorities that the emergingsituation required a substantially easier fiscal stance than they were targeting. Aiiotherkey contribution of the Bank was in assisting the Government take stock of its conti ngentliabilities arising out of guarantees provided to privatized infrastructure projects.

62. The single tranche operation worked well and it acted as an appropriate crisisresponse instrument. The Government's National Economic Recovery Plan provided aframework for sustaining the reform program.

63. There was no formal IMF program accompanying the reform program, however,the IMF was supportive of the Government's reform program. The Bank consultec withthe IMF on macroeconomic issues. Fund staff participated in the appraisal mission forthe ERSL and there wvas very good cooperation among staff.

64. There was a divergence of opinion between Bank staff and the Malaysianauthorities on the design of the safety net. In part these arose from philosolhicaldifferences (e.g. the authorities favored income generation policies over direct tran ;fers)as well as the fact that the actual social impact of the crisis turned out to be smalle:. tianwhat the Bank had earlier anticipated. Bank's policy suggestions were aime d atmanaging a much larger adverse impact on unemployment and poverty. A ci:ualunemployment in 1998 turned out to be 3.9% compared to Bank's projected 6-7%. Onereason why unemployment was lower than anticipated was the large reduction in fc reignworkers from 1.2 mbillion in 1997 to 0.78 million in 1998. In 1998 the Governmentintroduced additional measures to ensure that employers gave greater priority to I iringlocal labor over foreign workers.

65. An area where the Bank was not fully successful in delivering early advice wasfinaicial sector restructuring. This was mostly due to delays in mobilizing the reqciiredskills. With the Indonesia and Korea programs making similar demands, it was difIicultto get a team together early on for Malaysia. When the team was finally mobilized, it didmake some contribution through assessment of the implementation of Malaysia'srestructuring strategy which was formulated with the assistance of private sector expt.!rts.

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E. BORROWER PERFORMANCE

66. The reform Program has been steadily implemented by the Government.Authorities have shown flexibility in formulating macro policies in the face ofuncertainty and a rapidly changing situation.

67. While the borrower generally performed well, a few drawbacks in theimplementation process have been:

* Slow disbursement of funds for social sector programs* Co-ordination issues between the MOF and the line ministries led to a slower than

targeted implementation of the fiscal stimulus package. The budget deficit in 1998was only 1.8% of GDP compared with the target of 3.4% of GDP.

* Slow progress in introducing an Unfair Trade Practices Bill. The authorities feel thatmore time is required to convince the private sector and other relevant agencies.

* Lack of predictability in policy changes led to a deterioration of confidence in theMalaysian economy.

G. ASSESSMENT OF OUTCOME

68. The overall performance and outcome was satisfactory. The loan has helped inresuming economic recovery and achieving macro stability. It has supported a programof financial and corporate sector restructuring, and helped set in motion a series of policyactions aimed at strengthening corporate governance. Steady progress is being made.The loan has helped protect social sector budgets and has enabled the expansion of safetynets to protect vulnerable groups. Since the ERSL was not an investment operation,calculation of benefits in terms of net present value and economic rates of return is notapplicable.

HI. FUTURE OPERATIONS

69. The ERSL has helped achieve Malaysia's objective of minimizing the downturnin the economy. Recovery is underway and it is important to ensure that it is sustainable.A follow-up fast disbursing operation would be of great value to the Government indeepening and strengthening its reform agenda, thereby laying a stronger foundation forresuming robust growth, and ensuring that it is sustainable in the long run. Focusing onthe medium-term competitiveness issues would be a key component in this regard.

I. KEY LESSONS LEARNED

Country knowledge must be maintained even if there is no lending activity. TheBank's stock of knowledge on Malaysia was relatively low when the crisis began andit had to scramble to establish a workable knowledge base on Malaysia. This wasachieved through effective use of staff familiar with Malaysia. Going forward, a keylesson is that Bank should continue to maintain a reasonable stock of knowledge onMalaysia even if there are no lending activities.

18

Strong ownership of the reform program by the Govermment is crucial to its success.Even though there were changes at the highest level in the Govemrnment, the neweconomic team sustained the momentum of the reform program and in comparison toother countries, made more rapid progress in certain areas including financial andcorporate sector restructuring.

Show flexibility iin policy stance in the face of uncertainty and rapidly changingsituation. As events unfolded and the depth of the crisis became apparenri theGovernment did not rigidly stick to pre-announced policies but adjusted its moni.-taryand fiscal stance in accordance with the new realities.

Fiscal flexibility requires increased coordination between MOF and line agencies inorder to implement the public sector programs. After having been initially advised byMOF (in October 1997 and March 1998) to scale back projects and reduceexpenditure the line ministries found it difficult to reverse course when the f.scalstimulus package was announced. As a result the fiscal stimulus was smaller thanenvisaged.

* Appropriate fiscal and monetary policies, measures to recapitalize the bankingsystem, strengthening banking supervision, and corporate debt restructuring haveplayed a key role in stemming capital outflows and returning stability to theMalaysian economy. While some observers attribute a key role to direct controls oncapital outflows, it is difficult to isolate their impact from the above factors.

M Malaysia's strategies to stem capital outflows and restore confidence in the economyincluded heterodox policies like direct capital exit controls. However, heterodoxpolices can lead to a further deterioration in market sentiments and have to be 'very

carefully designed and managed to gain market confidence. Overall the Malay ;iancontrols have been well managed. However, when Malaysia introduced capitalcontrols, despite being carefully designed, the international markets were furtherunnerved by the sudden announcement and their initial reaction was stronglynegative. In light of market concerns and emerging signs of stability, theGovernment to its credit, consulted market participants and modified the control; byi.ntroducing an exit tax. This helped restore confidence in the Malaysian econo ny.There were also problems in administering the controls (e.g. limits had to be placedon dividend repatriation; it is difficult in practice to differentiate between short-tirrmand long-term capital) and the Government has to still contend with designing a fullphase out strategy.

*The crisis in Malaysia has brought out strongly the need to account for contin.entliabilities arising out of Government guarantees. A key factor that caused a los; ofmarket confidence was the lack of information on the size of burden that would fallon the Government in case the contingent liabilities arising from privati -edinfrastructure projects were realized. Taking stock of contingent liabilities ill a

19

transparent fashion and making provisions for them through the budgetary processshould be an important priority.

Some form of temporary regulatory easing may be appropriate during crisis times if itcan be clearly demonstrated that these regulations are preventing banks from focusingon their key business. The tightening of regulatory standards announced in late 1997and early 1998, while a laudable objective, may have inadvertently contributed to thereduction in credit as banks became preoccupied with managing deterioration in assetquality and capital erosion. Regulatory easing in September 1998 met with success tothe extent that loan approvals increased significantly, although this coincides with thestart of recovery, so causality is hard to determine. A return to the highest prudentialstandards should be a priority as soon as recovery is established.

Small open economies like Malaysia are vulnerable to boom and bust cycles andtherefore need mechanisms to manage them effectively. This would require focus inseveral areas. First, modernization of public sector institutions to better define, ex-ante, the rules of the game (e.g., strengthening the risk management capability of thepublic sector, making Government guarantees transparent, striking a better balancebetween central bank's regulation and market-based regulation in the financial sector)will help prevent over-investment by the private sector and align the risks andrewards faced by them. Second, macroeconomic policies would need to be managedmore flexibly to increase the shock-absorptive capacity of the economy. Forexample, fiscal policy could be used more forcefully in demand management. Inparticular, fiscal discipline or the rule of maintaining a balance in the operatingbudget could be achieved over a business cycle rather than every year. In addition,the automatic stabilization capacity of the budget should be enhanced as there may bedelays in implementing fiscal stimulus packages during a downturn.

Economies like Malaysia need to develop a social sector strategy to manage the risksarising from globalization, especially mechanisms to reach the urban poor. Tillrecently most established programs were aimed at tackling rural poverty. Socialprograms should be an integral part of the strategy to cope with urban unemployment.Labor market reforms and training would help reduce structural unemployment.

20

Statistical Tables

Table 1: Summary of AssessmentsTable 2: Related Bank Loans/CreditsTable 3: Project TimetableTable 4: Loan/Credit Disbursement: Cumulative Estimate and ActualTable 5: Key Indicators for Project ImplementationTable 6: Key Indicators For Project OperationsTable 7: Studies included in ProjectTable 8a: Project CostsTable 8b: Project CostsTable 9: Econormic Costs and BenefitsTable 10: Status of Legal CovenantsTable 11: Compliance with Operational Manual StatementsTable 12: Bank Resources: Staff InputsTable 13: Bank Resources: Missions

21

TABLE 1: SUMMARY OF ASSESSMENTS

A. Achievement of Objectives Substantial Partial Negligible Not Applicable

Macroeconomic policies 4

Sector policies 4Financial objectives i

Institutional development 4

Physical objectives . 4

Poverty reduction 4

Gender issues 4

Other social objectives l .

Environmental objectives i

Public sector management 4

Private sector development . i

B. Project Sustainability Likely I Unlikely I Uncertain

C. Bank Performance Highly Satisfactory Satisfactory Deficient

Identification

Preparation assistance . _

Appraisal .

Supervision l J

D. Borrower Performance Highly Satisfactory Satisfactory Deficient

Preparation 4

Implementation 4

Covenant compliance 4

Operation (if applicable) __

Highly Satisfactory Unsatisfactory HighlyE. Assessment of Outcome Satisfactory _ Unsatisfactory

22

TABLE 2: RELATED BANK LOANS/CREDITS

Year ofLoan/Credit Title Purpose Approval Status

NONE

TABLE 3: PROJECT TIMETABLE

Steps in project cycle Date planned Date actual

IdentificationPreappraisalAppraisalNegotiations 5/98 5/98Board presentation 6/1/98 6/1/98Signing 6/18/98 6/18/98Effectiveness 6/23/98 6/23/98Project completionLoan closing 12/31/98 12/31/98

TABLE 4: LoAN/CREDIT DISBURSEMENT: CUMULATIVE ESTIMATE AND ACTUIAL(US$ million)

FY98

Appraisal estimate 300Actual 300Actual as % of adjusted estimate 100

Date of final disbursement 6/23/98

23

TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION

Estimated ActualKey implementation indicators in SAR Start Complete Start Complete

See Matrix of Policy Actions

TABLE 6: KEY INDICATORS FOR PROJECT OPERATIONS

See Matrix of Policy Actions

TABLE 7: STUDIES INCLUDED IN PROJECT

Study Purpose as defned at Status Impact of StudyAppraisal/Redefined

NO STUDIES

TABLE 8A: PROJECT COSTS(US$ million)

Appraisal estimate Actual/latest estimateItem Local Foreign Total Local Foreign Total

1. Balance of Payments Support 300 300 300 300

Total 300 300 300 300

TABLE 8B: PROJECT FINANCING(US$ million)

Appraisal estimate Actual/latest estimate

Source Local Foreign Total Local Foreign Total

1. IBRD 300 300 300 300

Total 300 300 300 300

24

TABLE 9: ECONOMIC COSTS AND BENEFITS

Costs Benefits NPV ERR (%)

N/A

TABLE 10: STATUS OF LEGAL COVENANTS

Cove- Original RevisedAgree- nant Present fulfillment fulfillmentment Section type Status date date Description of covenant Comments

Loan 3.02(b) I C Audit of Deposit Account Audit not yet r questedby Bank

Covenant Class: Status:I= Accounts/audits 8 = Indigenous people C = covenantcompliedwiih2 = Financial performance/revenue 9 = Monitoring, review, and reporting CD = complied with after delay

generation from beneficiaries 10 = Project implementation not CP = complied with partiall,3 = Flow and utilization of project covered by categories 1-9

funds 11 = Sectoral or cross-sect6ral4 = Counterpart funding budgetary or other resourcesS = Management aspects of the allocation

project or executing agency 12 = Sectoral or cross-sectoral policy/6 Environmental covenants regulatory/institutional action7 Involuntary resettlenment 13 = Other

TABLE 11: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS

There was no significant lack of compliance with an applicable Bank Operational Manual Statement (OD or OPi 3P)

TABLE 12: BANK RESOURCES: STAFF INPUTS

Plan Revised ActualStage of Project Cycle SW $ ('000) SW $ ('000) SW $ ('000)

Preparation 12.0 36.5Appraisal 9.6 29.5 5.4 16.4

Negotiations 8.0 23.9 7.9 23.9

Supervision 29.5 68.3 4.6 38.2

IC'R 8.0 20.0 6.0 15.C

TC\TAL 55.1 141.7 35.91 130.t

1. As of June 30, 1999.

25

TABLE 13: BANK RESOURCES: MISSIONS

Performance ratingSpecialized staff Imple- Devel-

Stage of project cycle Month/ Number of Days skills represented mentation opment Type ofyear persons in field /a status /b objectives problems /c

Preparation - Appraisal - 5/98 - 15 15 EC, FA, LC, 00,Negotiations - Board approval 6/98 RA

Supervision 1 8/98 5 7 EC, FA S S Implementationdelays in social

sectorSupervision 2 11/98 3 7 EC, FA S SSupervision 3 5/99 4 7 EC, FA S S

/a DO: Disbursement Officer; EC: Economist; EN: Engineer; FA: Financial Analyst; LC: Legal Counsel; 00: Operation Officer; RA:Research Analyst; RS: Resettlement Specialist; TE: Transport Economist; TS: Transport Specialist.

/b 1: Highly satisfactory; 2: Satisfactory.

/c Typical problems included: implementation delays in technical assistance and studies.

ANNEX A

BORROWER'S CONTRIBUTION TO THE ICR

Economic Recovery and Social Sector Loan(Loan No. 43470)

-mplementation Completion Report

1. Malaysia's objective in requesting the World Bank for the Economic

FRecovery and Social Sector Loan (ERSSL) was to minimize the economic and

social impact of the regional financial crisis that hit the country in early 1998. The

LUS$300 million that the World Bank approved for ERSSL was part of the US$3

billion loan assistance that Malaysia requested from the World Bank for the 1998-

1999 period.

:2. Malaysia appreciates the speedy manner with which the World Bank

processed and approved ERSSL. Proceeds from this loan was allocated to six

social sector programs, namely Fund for Food, Micro Credit, Educational

F:acilities, Health Facilities, Rural Infrastructure facilities and Amanah lkhtiar

Mvalaysia. The implementation of these programs together with other measures

undertaken by the govemment helped to alleviate the adverse social impact of

1the financial crisis and it also served as a catalyst in the economic recovery

process.

3. Coinciding with the implementation of the social sector program under

ERSSL, Malaysia undertook a reform program aimed at strengthening the

financial and corporate sectors with the view to restoring market confidence and

enhancing the country's overall competitiveness. The govemment took note of

the World Bank's policy notes when formulating the reform program aimed at

leading the country to economic recovery following the crisis. The policy matrix

led to close monitoring of various indicators in the reform program. As can be

seen from the latest update on the policy matrix, Malaysia has either

implemented or is in the process of implementing most of the targets set for the

reform program.

4. The interaction between government agencies and the World Bank

project team provided Malaysia the opportunity to present some of the policy

measures undertaken by the government in the wake of the financial crisis. The

World Bank team indicated during discussions that they found much of the issues

related to the financial and corporate sector reform program are being

implemented by Malaysia but because there was no publicity on it, they were not

noticed by the international financial community generally. Hence Malaysia

interaiction with the World Bank as a result of ERSSL provided, to a certain

extent, publicity on the progress achieved by Malaysia with regards to financial

and corporate sector reforms in the country.

5. Some differences of opinion between the World Bank and implementing

agencies surfaced in the course of this project, for instance in the design of the

safety net, where Malaysia preferred income generation policies rather the

World Bank recommenidation for direct transfers. The differences in opinion could

be partly attributed to the World Bank over reacting to the impact of the crisis -

for example, actual unemployment in 1998 was only 3.9% compared to the World

Bank's projected figure of 6-7%. Similarly the number of additional people who

fell below the poverty line in 1998 was much less than the projected 250,000.

Nevertheless, these differences did not affect the implementation of the ERSSL.

The government's comments on the ICR prepared by the WB are as given in

Attachment 2.

6. Among the noticeable outcomes of ERSSL, which is a fast disbursement

loan, is the fact that funds allocated especially to social development projects

were utilized more efficiently than is the case with normal project loans from the

World Bank. This can be seen from the fact that funds allocated to the Education

Facilities (RM200 million), Health Facilities (RM100 million), Rural Infrastructure

Facilities (RMRM100 n,illion) under this loan have been completely utilized in

slightly more than 1 year of the loan's implementation compared to other loans

where disbursement is much slower. This could be attributed to the fact that

under a fast disbursement loan, implementing agencies only need to follow more

familiar government procedures and do not have to abide with certain

conditionalities attached to project loans. In that sense, our experience with

ERSSL indicates that a fast disbursement loan is more beneficial than a project

loan as far as Malaysia is concerned.

6 The ERSSL restarted Malaysia's relationship with the World Bank with

which it had minimal contacts since late 1994. Following the approval of ERSSL,

MAalaysia took another three loans amounting to US$404 million and it also

signed agreements for 5 technical assistance grants in 1999. Malaysia hopes to

continue with this positive relationship with the World Bank.

Implementation of programs under the Economic Recovery and

Social Sector Loan

Program Total Allocation Implementing status

(RM million) Agency

a) Fund for Food 300 Ministry of Agriculture As of 25 August loans

amounting to RM41..i million

was approved for far ners and

fishermen.

a) Micro Credit 200 Ministry of RM150 million was allocated to

Entrepreneurial TEKUN and RM50 mnillion to

Development Credit Guarantee Corpc'-ation. As

of 15 September 1999, a total of

1,798 loans amounting to RM5.7

million was disbursed to small

entrepreneurs.

b) Educational 200 Ministry of Education The total amount allocated has

Facilities in Rural been spent for this programr

Areas

c) Health facilities 100 Ministry of Health The total amount allocated has

been spent for this progr.m.

d) Rural 100 Ministry of Rural The total amount alloc ittd has

infrastructure Development been spent for this progrie m

projects

e) Amanah Ikhtiar 100 .AIM As of 13 August, loans

Malaysia (AIM) amounting to RM10.3 maillion

was disbuwsed under this rogram

ANNEX B

MATRIX OF POLICY ACTIONS

MATRIX OF POLICY ACTIONS.

ACTIONS ACCOMPLISHED /IN PROGRESS

AS OF JULY 1999

30 AUGUST 1999

MINISTRY OF FINANCEKUALA LUMPUR

ANNEXPage I of 33

MalaysiaEconomic Recovery and Social Sector Loan

Matrix of Policy Actions

Objeqtive Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

1.0 Resume robust and Maintain sound andsustained growth flexible macroeconomic

policies in view of theuncertainties in theeconomic environment

1.2 Improve fiscal Make a fuller assessment oftransparency to the liabilities of therestore market Governmentconfidence

1.3 Improve monetary Remove distortions andmanagement enhance money market

efficiency:

* Ensure a more responsive Effective I September 1998, the BLRinterest rate framework framework was revised to allow a faster

transmission of changes in monetary policyto market interest rates. Essentially, theformula for computation of the ceiling BLRis now based on the prevailing BNM 3month intervention rate instead of thepreceding month's average KLIBOR. Inrelation to this, banking institutions are nowrequired to adjust their BLR within one weekof any revision in the computed BLR arisingfrom a change in either the intervention rateof the SRR.

AN~NEXPage 2 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (as_ ________________ . _______________________ of M arch 1999) of July 1999)

In addition, to promote greater operationalefficiency among banking institutions, thefixed administrative margin provided tobanking institutions in the BLR formula wasreduced from 2.5 percentage points to 2.25percentage points on I September. Tocomplement this, beginning 14 September,.the banking institutions were required toreduce the maximum margin over the quotedBLR from 4 percentage points to 2.5percentage points. The lower spread wouldspur banking institutions to further intensify

* Allow banking New money market operational procedures their efforts to improve their operationalinstitutions greater introduced on 30 April 1998 enable market efficiency.flexibility in the participants to better assess the liquiditymanagement of their surplus of deficit in the system via the 1. NEW MONEY MARKETassets and liabilities. provision of forecast cash flow of the OPERATIONAL PROCEDURED (30Facilitate flow of financial system by BNM at regular April 1998)liquidity. intervals during the day. In addition, to

enhance transparency, all BNM operations Enables market participants to better assessare now conducted via tender, with the the liquidity surplus or deficit in the systemexception of overnight lending/borrowing via the provision of forecast cash flow of theand some small liquidity support operations financial system by BNM at regular intervalsfor institutions facing tight liquidity. during the day. In addition, to enhance

transparency, all BNM operations are nowFor the status of the Liquid Asset conducted via tender, with the exception ofRequirement, please refer to page 11 overnight lending/borrowing and some small

liquidity support operations for institutionsfacing tight liquidity.

_ _,__._._.______I_-_ _._..L .I

ANNEXPage 3 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) ' of July 1999)

2. WIDENING OF DAILY VARIATIONBAND FOR SRR COMPLIANCE (IMay 1998)

The band for the permissible daily variationin the average balances that is required tomeet the SRR was widened to +2% of theprescribed SRR rate from the previous bandof + 0.5%. This accords financialinstitutions greater flexibility in dailyliquidity operations.

3. NEW LIQUIDITY FRAMEWORK (July1998)

The New Liquidity Framework improves theefficiency of liquidity management in thebanking system. Under the framework,financial institutions actively manage theirliquidity situation, taking into account theirfuture net cash-flow mismatch, thediscounted value of liquefiable assets andemergency credit lines. Introduced in July1998, the new framework is currently on aparallel run with the old framework, with 15financial institutions having already crossedover entirely to the new framework.

The government will be actively pursuingDevelop indirect the development of the bond market as anmonetary instruments alternative financing source for the private The government will be actively pursuing the

_ __________________ ___________________________ sector. With the increased availability of development of the bond market as an

ANINEXPage 4 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accom-lisled ormir Progress (asof March 1999) of July 1999)

instruments and large number of market alternative financing source for the privateplayers, BNM would be better able to use sector and therefore, diversifying risk awayits indirect monetary instruments, and rely from the banking system.less on direct instruments.

With the increased availability ofinstruments and large number of marketplayers, BNM would be better able to use itsindirect monetary instruments, and rely lesson direct instruments.

2.0 StrengtheningFinancial Sector

2.1 Finance companics Consolidate th1e finantce * To date, the operations of eight finance * To date, the operations of 14 FCs havecompanies sector through companies have been merged/absorbed been merged/ absorbed by their parentassisted mergers, witlh by their parent commercial banks of commercial banks or merged withimporant safeguards in merged with other institution. another institution.place to preservetransparency and to * 14 finance companies are in the final * On 29 July 1999, BNM announced aminimise the use of stage of absorption/merger. major consolidation programme for thegovernment resource. banking system.

* 5 finance companies which haveinitially identified to merge with the * The merges programme will consolidateanchor finance companies have been the present 21 domestic commercialallowed to operate on a stand-alone banks, 25 finance companies and 12basis. However, no government merchant banks into six large and strongassistance will be extended in the event domestic financial groups, with eachthese finance companies face group comprising of one commercialproblems/difficulties. bank, one finance company and one

merchant bank.* Rate of completion of

_ _ _mergers/absorption's is expected to * The six domestic banking institutions

ANNEXPage 5 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

accelerate during first half of 1999 due will form the nucleus of the bankingto the exemptions on stamp duty and system and will be able to operate I areal property gains tax, more competitive and globalizes

environment given its large size.

* The six domestic banking groups willalso be vJl-positioned to meet thedemands of the changing domesticeconomic structure, future challengesfrom globalisation and liberalisation aswell as contribute more effectivelytowards sustainable economic growth.

* All banking institutions are required tosign a Memorandum of Understanding

________________________ by end-September 1999.2.2 Banking Institutions BNM is promoting pre-

emtptive recapitalisation ofbanking inistitutions, withthe primary emphasis onmobiising private capital,exceptfor Government-owned banks. The processwill be assisted by:

(a) Intensified monitoring ofbanking system:

* Conducting monthlystress tests on individualbanking institutions toidentify problem banks. l

A_NNEXPagc 6 of 33

Objective Policy Measures f Actions Accomplished of in Progress (as l Actions AcconrpIished or in Progress (as________________________ of March 1999) of July 1999)

Conducting more * On going. On-site inspections offrequent and focused on- institutions rated unsatisfactory haveand off-site supervision been conducted and in some cases,of regulated institutions follow-up inspections were mountedwith emphasis on weaker within 6 months from the last inspectioninstitutions as identified to ensure that corrective measures haveby the supervision been implemented by the institutions.process, and taking The frequency of BNM on-sitenecessary corrective examinations of banking institutionsactions. will also be increased to at least once a

year with the examinations conductedon a consolidated basis. The focus ofBNM's supervisory approach wouldcontinue to stress on early detection ofpotential areas of vulnerabilities and tofacilitate the implementation of timelycorrective actions.

* Continually enhancing * The Early Warning System is in theand refining surveillance initial stage of implementation.processes to bring about Teething problems are being resolved.earlier detection ofpotential risks.

(b) Market-based and * Danamodal Nasional Berhad was * Total funding raised to date amounted totransparent approach to established as wholly-owned subsidiary RM10.7 billion:any recapitalisation. of BNM on 10 August 1998 with twoSpecifically, investment prime objectives:- - RM3 billion of seed capital by BNM;

ANNEXPage 7 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplislied or in Progress (asof March 1999) of July 1999)

in banking institutions by andthe Employee Provident i) to recapitalise and strengthen - RMI I billion nominal value, 5 year,Fund (EPF), Permodalan banking institutions; and zero-coupon bonds with net proceeds ofNational Berhad (PNB) ii) to act as a catalyst in facilitating RM7.7 billion.and other quasi-public the consolidation andinstitutions will proceed rationalization of the banking * The remaining RM5.3 billion will beonly on the principle of sector. raised from either domesti)dc courcesmaximizing value for * To date, Danamodal National Berhad hastheir shareholders or unit * Funding requirement of Danamodal has injected capital into the following 10holders. The been estimated at RM16 billion under banking institutions totalling RM6.209Government will inject the worst case scenario. billion in the form of Exchangeablecapital in Government- * Total funding raised to date amounted to Subordinated Capital Loans (ESCL):owned banking RM10.7 billion: RMinstitutions only. - RM3 billion of seed capital by RHB Bank 1,500 m

BNM; and Arab-M'sian Bank 800 m- RMII billion nominal value, 5 BSN Commercial 420 m

year, zero-coupon bonds with net Oriental Bank 700 mproceeds of RM7.7 billion. Sabah Bank 122 m

UMF 317 m* The remaining RM5.3 billion will be Arab-M'sian Finance 500 m

raised from either domestic source MBf Finance Bhd 1,600 m* As at end-March 1999, Danamodal has Arab-M'sian Merch. 200 m

injected RM6,217 million in the form of Perdana Merchant 50 mExchangeable Subordinated CapitalLoans (ESCL) into 10 bankinginstitutions: * Of these, Danamodal has signed

Definitive Agreements with 9 bankingRHB Bank RM1,500 m institutions to convert the ESCL into aArab-M'sian Bank RM 800 m permanent tier-I capital and/or in theBSN Comercial RM 210 m form of tier-2 capital.Oriental Bank RM 700 m * To safeguard its investments in the

ANNEXPage 8 of33

3r I Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (as_______________________ of March 1999) of July 1999)

Sabah Bank RM 140 m recapitalised banking institutions,UMF RM 317 m Danamodal will appoint at least twoArab-M'sian Fin RM 500 m nominees to sit in the Board of DirectorsMBF Finance Bhd RM1,600 m of the recapitalised banking institutionsArab-Msian Merch RM 400 m as either Chairman or Deputy ChairmanPerdana Mernchant RM 50 m and Executive Director. To date,

Danamodal has appointed 25 nomineesin nine banking institutions.

. Of tlicse, Danamodal has signedDefinitive Agreements with 9 bankinginstitutions to convert the ESCL into apermanent tier-I capital and/of in theform of tier-2 capital.

* To safeguard its investments in therecapitalised banking institutions,Danamodal will appoint at least twonominees to sit in the Board of Directorsof the recapitalised banking institutionsas either Chairman of Deputy Chairmanand Executive Director. To date,Danamodal has appointed nominees insix banking institutions.

* Danamodal's recapitalisation efforts aremarket-based and transparent.Danamodal has adhered to the First LossPrinciple in recapitalising bankinginstitutions. There is no bailout ofshareholders. Through a call optiongranted to Tanamoda!; existing

ANNEXPage 9 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (as_ ________________ ________________________ of M arch 1999) of July 1999)

shareholders of banking institutions takethe loss for all the current and projectednon-performing loans (NPLs). The firstloss principle will ensure equitableburden sharing of existing shareholdersof the recapitalised banking institutions.In this regards, the value of investmcntsof existing shareholders will be writtendown to reflect the net tangible assetsprior to capital injection.

In selecting the banking institutions tobe recapitalised, Danamodal has tobalance the objective of maximizingvalue for its shareholders with publicpolicy consideration. The criteria usedare:-

a) Future viability and competitivepositioning;

b) Critically deficient of capital;c) Systemic impact of banking

institution's failure;d) Non-feasibility of market solutions;

ande) Potential consolidation prospects.

2.3 Improve Regulatory Improve loan classificationand Supervisory and provisioning standards toFramework bring them to international

best practices

ANN-EXPage 10 of 33

I-I Objective 1 Policy Measures Acitions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

* Classify loans past due * In response to the severity of the * Loan with quarterly repayments or longerthree months and over as financial crisis and economic will be classified as NPL, 3 months afternon-performing. contraction, some adjustments to the first day of default.

prudential norms were introduced in thefinal quarter of 1998.

• Require 20% * The earlier tightening of NPLprovisioning against the classification from six to three monthsuncollateralized portion was relaxed.of substandard Loans.

* The relaxation on the period forclassification of NPL serves only as aminimum requirement and should not beseen as a deviation from prudentialstandards. On the contrary, theredefinition of NPL would enablebanking institutions to accord greaterattention on credit operations rather thanbe pre-occupied with managing thedeterioration in the asset quality andcapital erosion. The relaxation will alsoprovide the borrowers with somebreathing space to regularize theiraccounts. Under the prevailingeconomic conditions, even economicallyviable companies face temporary cashflow problems.

* Incorporate off-balance * Nevertheless, other prudential measuressheet items in the loans were retained Sperific:i!lv.the

ANNEXPage 11 of 33

Objective Policy Measures Actions Accomplisbed of in Progress (as Actions Accomplished or in Progress (as________________________ of March 1999) of July 1999)

classification and classification of NPL as bad debts isprovisioning system. retained at 12 months or more, while

accrued and uneamed interest will stillhave to be clawed-back to day one ofdefault.

Enhance capital adequacy * As a result of the prolonged financial * A differentiated risk-weighted capitalframework to further crisis and the subsequent economic adequacy framework will be introducedstrengthen the resilience of contraction had adversely affected fund- whereby BNM will impose different risk-the banking system. raising activities in the capital market. weighted capital ratio on each individual

This has affected and constrained the banking institution.* Increase minimum ability of some shareholders to raise

RWCR of finance additional capital for their institutions. * The minimum RWCR for each bankingcompanies from 8% to In this regard, compliance with the institution will be set (subject to a floor10% by end 1999. increased minimum RWRCR and of 8%) based on the overall rislt profile

* Increase minimum capital funds for the finance companies of the banking institution taking intocapital of finance were deferred until such time when the account loan concentration, sectoralcompanies from RM5m capital market has regained its exposure and internal controls.to RM300m by mid 1999 momentum and the economy has fullyand to RM600m by mid recovered from the effects of the crisis. * The framework is currently being2000. formulated and is expected to be

implemented before end of the year.

Improve prudentialguidelines I

* Reduce single customer * Implementedlimit from '30% to 25% * Implementedof capital funds.

ANNEXPage 12 of 33

Objective Policy Measures r Actions Accomplished of in Progres (as Aetions Accomplished or in Progress (asof March 1999) of July 1999)

Develop a new * Implementedprudentially-based * Implementedliquidity framework.

2.4 Improve market- Provide greaterbased incentives for transparency on the * Ranking institutions are no longer . Banking institutions which are listed onmore efficient financialposition of required to publish data on key the Kuala Lumpur Stock Exchange arefunctioning of individual position of indicators every quarter so as to reduce now required to publish data on keyfinancial institutions individual banking the increased administrative burden indicators on a quarterly basis.

institutions. Individual facing the banking institutions.banks of publish quarterlydata on key indicators of * Reflective of the efforts to promote * Implementedfinancial soundness greater transparency, the position ofincrluding RWCR and NPLs. NPLs both on a three-month and six-BNM to publish breakdown month classification period is publishedof NPL by economic sector on a monthly interval.every quarter.'

Increase transparency in theBank's liquidity supportoperations.

* Provide marketparticipants with dailyinformation on BNM'soperations and its impacton liquidity.

* Separate liquidity supportto banking institutionsfrom the normal liquidityoperations of BNM in the __

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Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (as________________________ of March 1999) of July 1999)

conduct of monetarypolicy.

2.5 Government to Conduct technical study onreduce moral hazard international best practices * The issues and implications of * The agreement on the technicalproblems in the practices on deposit introducing such assistance from the World Bank onbanking sector insurance and examine schemes are still under study. BNM is Deposit Insurance is expected to be

possible implications for also currently seeking technical concluded very soon.Malaysia. assistance from the World Bank on

this.

2.6 Further development Broaden and deepenof the financial financial markets: * 3 mergers of commercial banks will be * Please refer to item 2.1: Financesystem implemented in 1999. Comnpaniies on the recent announcement

* Promote a greater degree on the consolidation of the domesticof securitisation and - The securitisation of hire- banking sector.expedite the development purchase loans, i.s. sale of motorof the bond market to vehicle hire purchase to * No further update from previous reportreduce the reliance on the Cagamas with recourse has on regulatory framework.banking system for already commenced infinancing. December 1998.

* Develop a wide array of * On 31 March 1999, BNM introducedfinancial instruments to several measures to further strengthenimprove the management the supervisory and regulatoryof risks and facilitate the framework. This includes:-allocation of risks to - Minimizing double leveragingthose players that are within the banking system;able to bear these risks. - Disassociating banking

institutions from non-banking* Increase the number of institutions which are not

ANNEXPage 14 of 33

Objective | Policy Measures I Actions Arcomplished of in Progress (as1 Actions Accomplished or in Progress (as_ ________________ .___________________ _ . .of M arch 1999) of July 1999)

market participants. supervised by BNM;- Reviewing the appointment of

CEOs and Board of Directors ona two-year interval;

- Conducting on-site examinationat least once a year to enableearly identification of problems.

- Banking institutions areprohibited from providing creditfacilitu to its controllingshareholders.

2.7 Liberalizemanagement of EPF * Subcontract EPF Fundsand other asset fund to independent fund At present, four percent of EPF equity fundsmanagement managers. are subcontracted; the Government isactivities to provide committed to increasing it further.internationalbenchmarking for * Develop international Policy being reviewed.return on domestic investment program forinvestment, EPFimproving theefficiency ofintermediation andspurring thediversification anddeepening of thefinancial system

3.0 ImproveCompetitiveness ofCorporate Sector _

ANNEXPage 15 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

3.1 Improve corporate Develop an effective The YAB Prime Minister (who was then thegovernance frameworkfor corporate First Finance Minister) and the Second

governance and set best Finance Minister agreed for the report to bepractices circulated to selected bodies for

consultation to get their feedback on theirreport. The report was circulated on the 13 Ih

of November, 1998. The bodies that havebeen identified for this purpose are -

* Business Council for SustainableDevelopment Malaysia (BCSDM)

* Malaysia Institute of Directors (MID)* Malaysian Institute of Accountants

(MIA)* Malaysian Association of Certified

Public Accountants* National Chamber of Commerce and

Industry of Malaysia (NCCIM)* International Movement for a Just

World (JUSTWORLD)* Bar Council Malaysia* Malaysian Investors Association (MIA)* Malaysian Association of Asset

Managers (MAAM)* Economic Committee Malaysia

Pursuant to feedback received from theconsultation period (November 13 -December 3 1 1998), the Department, asSecretariat to the Finance Committee,

. _________________ _________________________ proposed revisions to the Finance

ANNEXPage 16 of 33

Objective j Policy Measures I Actions Accomnplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

Committee report. Revisions were alsoproposed to update the report, where therecommendations of the Committee hadbeen implemented. These revisions weresubsequently presented to the FinanceCommittee for approval on 29'h January.1999. The report was resubmitted to theMinister of Finance on 8'h February, 1999.

The report was released to the public at theSC's Seminar on Corporate Governance onthe 2 5'h and 26th of March, 1999. Theseminar highlighted key aspects of theFinance Committee Report and exploredprivate sector contribution to goodcorporate governance. Participants alsogained insight into efforts taken by othercountries towards corporate governancereform. Following the seminar, anImplementation Project Team (IPT) hasbeen set up to drive and coordinateimplementation of recommendations of theFinance Committee. Its membershipcomprises those agencies with primaryresponsibility for implementing therecommendations of the Committee. Theyare the Securities Commission, Registrar ofCompanies, Kuala Lumpur Stock Exchangeand the Federation of Public ListedCompanies. The IPI reports to the FinanceCommittee. The terms of reference of the

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Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

IPT are as follows:-

* To evaluate drive and overseeimplementation of the FinanceCommittee report including theMalaysian Code on CorporateGovernance;

* To establish detailed target timetables,monitor and manage the implementationprogramme;

* To evaluate all proposed drafts ofchanges to laws and rules for tabling tothe Finance Committee;

* To determine and co-ordinate thegeneral direction of training andeducation in corporate governanceincluding examining the content andsyllabus of such training and educationprogrammes;

* To ensure timely reporting onimplementation progress;

* To make recommendations to theFinance Committee on appropriatepublicity and awareness measures.

The agencies with responsibility forimplementation have already commencedefforts to implement the recommendationsof the Report."

Most of the recommendations made by the

ANNEXPage 18 of 33

I 1 Obiective 1 Policy Measures 1 Actions Accomptisphed of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

Finance Committee in relation to the ListingRequirements which is now pending theapproval of the Securities Commission.Only one of the recommendations iscurrently being studied further. Thisrecommendation is relating to the directorsmaking a statement on the going concern ofthe listed company in the annual report.

The draft revamped Listing requirementshave been submitted to the SecuritiesCommission (SC) for approval.

3.2 Improve Companies to provide Phase I of EDMS is 90% completed andtransparency accurate disclosure of expected to be completed by August 1999.

information. Phase 2 is in the System Requirement Studyand Design stage of approximately 25%completed. Phase 2 is expected to becompleted by October 1999. After Phase 2,further development will be undertaken toenhance the system as the system is highlymodular and scalable.

In terms of the deployment of EDMS to theexternal users, 381 of 730 Public ListedCompanies (PLCs) and/or theirrepresentatives or approximately 52% of thetotal number of PLCs now have access tothe system. The system has also beendeployed to 23 secretarial firms that are

___________________ ,_________________________ servicing the PLCs. Deployment to all

ANNEXPage 19 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (as_______._. _____ hof March 1999) of July 1999)

external users will be completed by June1999.

CAR (Capital Adequacy Requirements)Rules and CAP (Client Asset Protection)Rules are in the final stages of discussionwith SC.

Once the Rules are finalized, the CAR andCAP will be implemented. The tentativeimplementation date is 1 July 1999.

The proposed amendments to the ListingRequirements to impose a restriction on thcnumber of directorships that may be held bya director of a PLC were announced on 11March 1999. This restriction takes effect on1 April 1999 and states that a director ofPLC may only hold not more than 10directorships in listed companies and 15 innon-listed companies.

Phase 1 of EDMS which encompass thedevelopment of an announcement systemfor all public listed companies ("PLCs") hasbeen completed and all PLCs have beendeployed with the EDMS by 30 June 1999.

PLCs are now able to submit all CorporateAnnouncements to the Exchange

______ _____ _____ ________ _______electroni$ally which will then be

ANNEXPage 20 of 33

I Ob3ective I Policy Measures TActions Accomplished of in Progress (as Actions Accomplished or in Progress (as_______________________ of March 1999) of July 1999)

disseminated to the KLSE Home Page.Phase 2 which comprise the submission byPLCs of Quarterly Financial Reporting anddocuments such as Annual reports.

Prospectuses and Circulars electronicailyare currently under development andscheduled to be completed by 30 September1999.

Capital Adequacy Requirements (CAR)Rules (Rule 17G) have been incorporated inKLSE Rules and taken effect since 28 May1999. KLSE in consultation with SC willannounce the date that KLSE willcommence monitoring and enforcementbased on CAR.

The Client Asset Protection (CAP) ruleshave been approved by SC in principle.Certain issues been to be finalized by KLSEand SC before it is introduced.

Amendments have been made to the ListingRequirements to impose a restriction on thenumber of directorship that may be held bya director of a PLC effective September1999. This restriction states that a directorof a PLC may only hold not more than 10directorships in listed companies and 15 in

_non-listed companies.

ANNEXPage 21 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

Proposed amendments to the ListingRequirements pertaining to the treatment ofpublic listed companies (PLSc) withunsatisfactory financial condition theretohave been submitted to the SC forapproval.

Amendments to the Listing Requirementspertaining to suspension and the PracticeNote No 1/1999 on Requests for Suspensionhave been implemented on 14 June 1999.

Amendments have been made to theListing Requirements pertaining to quarterlyreporting of financial statements. Quarterlyreporting is mandatory for PLCs whosefinancial quarters end on or after 31 July1999.

Mandatory compliance of The proposed amendments in relation tocompanies with rules of compliance with accounting standardsMalaysian Accounting issued of approved by MASB have beenStandards Board and the submitted to the SC for approval in 1 JulyFinancial Reporting 1999.Foundation with a viewto making financialdisclosure consistent withintemational bestpractices.

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Objective I'olicy Measures Actions Accomplislied or in lProgress (its Actions Accomplished or in PXrogrcss (as.___________________ of March 1999) of jtlly 1999)

On 29 Junc l999, KLSE introduced a ncwRule 16A of Rules Relating to MemberCompanies which establishes the minimumstandards for the treatment of interest onnon-performing accounts and provision forbad and doubtful debts in the financialstatements of stockbroking companies(SBCs).

3.3 Facilitate contested Securities Commission to The amendments to the Listingtake-over and review the current code on Requirements pertaining to the revisedmergers Take-over and Mergers Code on take-over and Mergers were

1987. implemented on I January 1999.

Securities Commision (SC) has reverted toKLSE with comments on the draftrevamped Listing Requirements and thecomments are being addressed by KLSE.

Proposed amendments to the ListingRequirements pertaining to the treatment ofpublic listed companies (PLCs) withunsatisfactory financial condition and thePractice Note in relation thereto have beensubmitted to the SC for approval.

The Practice Note on request forSuspension by PLCs of Trading in Sharescame into effect on 14 June 1999. Theperiod of suspension ranges from one (1)market day up to a maximum of three (3)

_ _ _ _______ ---a_ _ _ _ _ _ _ _ _ _ _ _ !

ANNEXPage 23 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (as_________________ ___________________ .of M arch 1999) of .1ulY 1999)

The Malaysian Code on Take-over &Mergers 1998, together with its PracticeNotes, has been gazette on 31st December1998. Thc 1998 Codc rcplaccs the old 1987Code.

The 1998 Code came into force on 1January 1999. The new regulatoryframework on take-over and mergers underthe Securities Commission Act 1993includes provisions imposing criminalliability on the relevant partics to take-overoffer for proceeding false of misleadinginformation to the SC and shareholders

Similarly proposed amendments to theListing Requirements to shorten thetimeframe to issue annual audited accountswere also announced on 11 March 1999 andis made mandatory for PLCs whosefinancial year end on or after 31 July 1999.

3.4 Related Party and Promote high standards of Amendments to the Listing RequirementsInterested Party corporate governance and pertaining to related party transactions havetransaction disclosure in transactions been implemented on 2 July 1998.

between listed companiesand related an interestedparties, and protect interestof minority shareholders

. ,_______________ * Securities Commission The SC had on 2 July 1998, announced the ___.

ANNEXPage 24 of33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Acconiplished or in 1'rogress (asof March 1999) of July 1999)

to review and strengthen changes made to the existing KLSE listingKLSE rules governing rules governing related-party and interestedrelate-party and party transactions. These changes and otherinterested party consequential revisions are reflected intransactions. Rules I I 1 to 120 under Part 4 of the Main

Board Listing Requirements and Rules 5.1to 5.10 under Part 5 of the Second BoardListing Requirements. There will becontintLous moniitoing of compliancc by theSC.

The Securities Industry (Reporting ofSubstantial Shareholding) Regulations 1998came into force on 1 May 1998. Theseregulations are necessary to enable theSecurities Commission (SC) to administerthe provisions of the Malaysian Code onTake-over and Mergers 1987 and theprovisions relating to insider trading underthe Securities Industry Act, 1983 moreeffectively.

The information that is required to besubmitted and the persons who are requiredto submit the information are similar to thatwhich is governed under Section 69D of theCompanies Act, 1965.

The securities Industry (Amendment) Act1998, which came into force on I April_ _98 i__iiziv-cu a new se;iion 99B that

ANNXPage 25 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

imposes a duty on chief executives anddirectors of a listed corporation to disclosetheir interests in securities of the listedcorporation of the listed corporation. Thedeadline to submit the information was on IJuly 1998. Any changes of interest insecurities as stated in subsection 99B(2)(b)are to be notified to the SC within 14 daysof such a changc.

Enforce all legal andadministrative provisionsof Companies' Act in aconsistent manner.

3.5 Corporate Review status of winding up * CDRC, has to date, received * Update on the progress of cases referredrestructuring: allow and market-based corporate applications from 47 companies to CDRC is as follows:-market based restructuring procedures. (including Renong & UEM) tobankruptcy and restructure debts totaling RM25 billion Cases No RMcorporate from both listed and non-listedrestructuring to companies. Received/Rejected 62 34.9facilitate efficient Withdrawn 11 2.9liquidation/redeploy * CDRC's workforce has also been Sold to Danahaita 11 3.4ment of assets strengthened. Implementation stage 13 11.3

Outstanding 27 18.7* Progress to date are at various stages. A

number of cases are already at the finalstages of negotiation - independentconsultant report are ready and they arefine tuning the final draft restructuring

.____ _____ _____ _____ ___ __ plan.

Page 26 of 33

iPoicy Measures Actions Accompi'shed of in Progress (as Actions Accomplished or in Progress (asof March 1999) or July 1999)

* CDRC is also looking at ways forsecuring tax incentives for borrowersand lenders who restructure their debtsunder the auspices of the CDRC andDanaharta.

* Informal discussions with SecuritiesCommission and Bank Negara Malaysiawith respect to increasing the efficacyand expediting any approvals requiredfor restructuring scheme..

3.6 Competition Privatisation process will be (a) With regard to the Competition/Tradepolicies: Foster carried out on more Practices Bill, the existing draft law hascompetition and transparent principles to I to be improved further before it can beefficiency achieve efficiency, reduce introduced. A committee has been

the financial burden of established to determine elements whichGovernment and deliver should be included in the law to ensurebetter quality service. among other things, that the

implementation of the law will notjcopardize the achievements of

Introduce Trade Practices government's economic developmentBill with specific prisons policies. In addition, more work has toagainst price-fixing, market be done to convince the private sectorsharing and other collusive and other agencies on the importance ofagreements, and anti- the law.competitive M&A activity.Introduce consumer (b) With regard to consumer protection andprotection law and redress redressal mechanisms, the Malaysianmechanisms. Parliament h- -- n-d thew (>n-mer

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Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

Protection Bill in its July/August 1999sitting and it is expected to be enforced atthe end of 1999. The law providesfurther protection of consumers, theestablishment of the National ConsumerAdvisory Council and the tribunal forConsumer Claims not exceedingRM10,000.00 and for matters accouteredthcrewith. It is hoped that theimplementation of this law will providemore protection to consumers and in thelong run promote good business practicesand ethics.

4.0 Social ActionProgram

Strengthen the socialsafety net to softenthe negative impactof the economiccrisis on the lowerincome andvulnerable groups.

4.1 Maintain access to Protect budget share of i) The development budget for MOEkey social sector education and health. was increased from RM2,909 billion

in 1998 to RM 3,047 billion in 1999.As of 26 July 1998 the MOE hasspent RMI,667 billion or 54.71% ofthe allocation.

Page 28 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

ii) The operating budget for MOE wasincreased from RM9.8 billion toRM10.4 billion. As of 30 June 1999the MOE has spent 46.49% thea!!ocation.

4.2 Expand access to Increase public expenditure * Bank Negara Malaysia and the Ministry * The RM300 million has been released tofinancial assistance ont nlajor anti-poverty of Finance are in the process of Bank Pertanian Malaysia Berhad. As atand social sector prograims so as to protect preparing the relevant documentation end-June 1999, no approvals have beenservices to real spending per for the release of RM300 million to granted.accomimiiiodate tlhosc beneficiary. Bank Pcrtanian. Thc funid is Cxpcctcd Iowho are vulnerable be released in April this year.to the crisis

Expand safety net to those Anti-poverty programs such as BAKASwho are made newly (Rural sanitation and water supply ) wasvulnoerable by the crisis but provided with increased allocation. MOHwho may not be directly allocated in 1998 RM 15,515m for thecovered by the existinig BAKAS program. Expenditure was RMprogran,us.for the hard-core 1 5,3901n (99.2%). Additional allocationpOrl: WaS l)rwVilp d fcoi- Sarawak i'ftoirn PM 3

million to RM 8 million. Under the ruralhealth program for 1998 124 rural healthclinics and dental projects were completed.

Guidelines of the criteria under the Fund forFood Schemc (3F Fund) of RM300 millionhas been approved by Treasury towards endof 1998. The funds allocated has not beendisbursed to the Agriculture Bank ofMalaysia yet.

Y _ Beginning in Ma. 1999, YTN started to

ANNF-XPage 29 of 33

Objective Pllicy Meastilres Actions Accomiplished of in 1'rogress (as Actions Accomplished or in Progress (as.____________________ of March 1999) of July 1999)

received RMI50 million from the disburse loans. As at end of July 1999, 676government in Decemcher 1998 to) loans have been disbursed amounting toimplement micro-ciecdit program. RM2,188,500.

4.3 Maintain Provide financial support to * Total allocation for the Fund for Small * Progress of various Funds administeredEmployment small and medium industries and Medium Industries had been by BNM as at end-July 1999.

to assist them in improving increased from RMI billion to RMI.5 Approved Disbursedtheir productivity, billion since 8 May 1998. RM m RM mtechnology and access to SMI Fund 2,102.2 854.7markets. * At present, any productive activity Rehab Fund 166.2 74.3

which falls under the manufacturing,agro-based and services sectors, iscligible for financing from the Fund.The eligible borrowers are allowed toobtain up to RM5 million of financingunder the Fund.

* In addition, the Government has set upthe Rehabilitation Fund for the Smalland Medium Industries with totalallocation of RM750 million to assistthe SMIs which face NPL problems toobtain financing for their operations.Under the Rehabilitation Fund, SM1sare allowed to use up to 30% of theapproved amount to restructure theirexisting NPLs.

4.4 Deal with the Establish through the HRDF,increased costs for new schemes to retraintertiary education retrenched workers.

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Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (as__________________ of March 1999) of July 1999)

4.5 Address the problem The Government has decided To cater the increased in demands for placesof graduate and not to recall students from in tertiary education, the intake of studentsunmcilploylmlcllt ovcrscas. The capacities of to the local public universities has been

the local public institutions increased to 43,659 for the 1999/2000are to met higher demand for academic session, i.e. an increase of 40.5%places. compared to the 1998/1999 session.

4.6 Increase food Increase the employmentproduction opportunities for new

graduates.

| Expand on the food For the month of January 1999 tiheproduction capacity of states. Department of Agriculture has set up 903

location for direct selling activities in 11states of Peninsular Malaysia. Total salesvalue achieved amounts to RM4.06 million.

The Farmers Organization Board hasexpended its direct selling activities to two(2) more location in Kuching and Sibu,Sarawak. The total numbers of farmersinvolved in thcsc locations are 355 farmers.A total of 181 more new farmers haveparticipated in the existing programs offarmers market in the whole country.

The Fisheries Development Board through__v;tcrmcr assoc,ull i.lvc set

Page 31 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (asof March 1999) of July 1999)

more new outlets and operationalised in thisform:

- 4 Fish House- I Fishermen's Best- I Green Shop

4.7 Mitigatc the effccts Facilitate distribution of food As at 25 August 1999, a sum ofof inflation RM41,000.00 has been approved by

Agricultural Bank of Malaysia to finance 72projects under the Fund For Food (RM300million)

As of February 1999 the following activitieshave been transacted:-

No. of visitors -300(majority areentrepreneurs inagriculture)

No of Books/Posters sold - 300 (mostly

guidelines onmarketing ofagriculture products)

Renovation works of the one-stopinformation center were fully completed inApril 1999. The Ministry has just bcngiven the approval by the treasury topurchase additional equipment and facilitiesthat are required for the operations of the

ANNEXPage 32 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomplished or in Progress (as_______________________ of March 1999) o_ f July 199?) -- -

center. The necessary purchase will betaken within the next one or two months.

4.8 Enhance access to Provide affordable housing To assist low income buyers, thehousing for the low loans to the poor. government continues to provide end-income group financing facilities as loans, grants, interest

subsidies and saving schemes. Examplesinclude the following:

* Ministry of Housing and LocalGovernment and Local Governmentgrants an interest-free loan of amaximum of RM7,500 to low incomegroups to supplement other sources offunding to build a house on their land.An eligible borrower can build adetached house costing not more thanRM20,000 for owner occupation. Thetarget groups include workers livingnear to industrial areas, new villages,estates and mining areas. Squattersdisplaced as a result of implementationof development projects and whorequire financing to build a house innewly-allocated land are also consideredunder this scheme.

* The Ministry of Rural Developmentundertakes the provision of free housingfor the very poor. The government

providcs subsidies in the form of free

ANNRXPage 33 of 33

Objective Policy Measures Actions Accomplished of in Progress (as Actions Accomnplished or in Progress (asof March 1999) of July 1999)

building materials and the constructionin carried out through self-help labor oflocal-community participation withoutincurring any labor cost.

^ Eligible families earning betweenRM300 to RM500 per month enjoy thebenefit of interest-free housing loanunder the site and services scheme. Thefederal government provides endfinancing to participants selected by thestate governments.

* An eligible buyer under the Public Low-Cost Housing Programs can obtain ahousing loan of RM25,000 subject to anominal interest rate of 5.5 per annum.

* Under the guidelines of Bank NegaraMalaysia, private financial institutionsextend loans for houses costing belowRM100,000 subject to a maximuminterest rate of 9 per cent per annum.Bank Negara Malaysia also sets loandisbursement quotas by house pricecategory to insure the financialinstitutions allocate enough funds forlow-cost housing. The loan-to-valueration ranges from 70-100 per cent formedium-cost and as high as 100 per centfor low-cost houses.