Strategy Conflict: Political Discord May Jeopardize Malaysian Economy
By DARREN MCDERMOTT
Staff Reporter of THE WALL STREET JOURNAL
KUALA LUMPUR, Malaysia -- Politics appears to be turning what
should have been a Malaysian economic slowdown into a nasty recession.
A year ago, Malaysia seemed to be among the most-likely Asian countries
to sidestep the looming crisis. Its factories were running full tilt and its
finances were in far-better shape than most of its neighbors. But a
widening rift between powerful Prime Minister Mahathir Mohamad and his
deputy now threatens to drag the country into the storm. A growing
number of economists and investors say that Malaysia could wind up
worse off than many of its neighbors, and that it will take longer to
extricate itself from the morass.
"They are dragging it out, and that will just make things worse in the end,"
says Bill Belchere, an economist at Merrill Lynch in Singapore.
Asian Policy Debate
Malaysia is in some ways at the epicenter of a widespread debate on just
what is the right policy approach to Asia's problems. It has avoided
approaching the International Monetary Fund for financial assistance,
which informally has been recommending Malaysia keep interest rates high
to stabilize its currency. The IMF hasn't cured the Asian crisis, however,
and its interest-rate recommendations have come under increasing
scrutiny. Yet most observers appear to agree that, whatever the
appropriate policy response might be, it doesn't include the sort of public
tug-of-war now being played.
The political confrontation worsened last week, with Deputy Prime
Minister Datuk Seri Anwar Ibrahim forced on Friday to deny widespread
rumors that he would quit under pressure from his patron. (Datuk Seri is a
title bestowed by the heads of Malaysia's royal households.)
Datuk Seri Anwar, who has been sidelined by the appointment of a former
finance minister as special economic adviser, has adopted a more passive
profile -- despite strong views about what Malaysia must do to save its
deteriorating economy, views that more clearly now than ever conflict with
those of Dr. Mahathir.
Perhaps most worrying to financial markets, Malaysia's central bank on
Monday cut a key interest rate by half a percentage point, the second time
it has done so in just over a week. While the central bank professes its
independence in such decisions, analysts widely saw the rate cut as a
move engineered by Dr. Mahathir. The ringgit slumped on the news, falling
to 4.2250 ringgit to the dollar; the stock market, which ought to have
recovered on expectations of easier credit for companies, also fell, on
concerns that the government now is desperately seeking to avoid a melt
down.
Even executives who maintain that Malaysia is in relatively good shape are
worried that Dr. Mahathir's periodic public outbursts -- such as calling
foreign portfolio investors "unnecessary" -- threaten to worsen the
situation.
"It is a three- to five-year turnaround scenario," says a senior U.S. banker
in Kuala Lumpur. "That isn't a long time, given what he has built here over
the years," the banker continues. "But Mahathir seems to have gone
completely myopic" on the matter of maintaining a measured,
confidence-building tone. That is "strange for a man with such strong
vision," the banker adds.
Ratings Downgrades
The recent chain of events has thrown Malaysia's economic stability into
question, prompting three ratings agencies in as many weeks to slash their
ratings for Malaysian sovereign borrowing. In financial markets,
confidence is eroding that Malaysia can pull out of its economic nose dive,
which saw gross domestic product contract 1.8% in the first quarter from
a year earlier.
The stock market has slumped to a 10-year low, losing 39% since Jan. 1
in local-currency terms, Southeast Asia's worst performer this year. A
survey of fund managers done by Merrill Lynch and Gallup last month
found that more were negative on Malaysia than on any other Asian stock
market, including crisis-racked Indonesia. Bankers say Malaysia will need
to raise $10 billion to $15 billion from international sources to recapitalize
its banks and cover a fiscal shortfall, and yet government officials just
postponed plans to approach the markets for their initial $2 billion, citing
"unfavorable market conditions."
Optimists at the outset of the crisis pointed correctly to Malaysia's lower
levels of foreign debt, and the appearance of a stronger regulatory regime.
But many overlooked Malaysia's mountains of domestic debt, which now
threaten the country's financial system.
A Difficult Process
Across Asia, dealing with debt is painful and politically tricky. Making
borrowers who can't repay loans give up their collateral or other assets is
difficult when those borrowers are part of the ruling elite. Yet failure to
clear away debt weighs on the economic growth that has been the key to
political success; several long-ruling individuals and institutions, including
Japan's Liberal Democratic Party and former Indonesian President
Suharto, recently lost their grip on power when they failed to deliver
economic growth.
Earlier this year, a few observers even began speculating whether Dr.
Mahathir might wind up in that club. His anointed successor, Datuk Seri
Anwar, had seized the economic reins and was driving Malaysia through a
tough austerity program based on International Monetary Fund principles.
But that drive put Malaysia into an economic contraction and threatened
some of the country's best-connected businessmen. It ultimately appears
to have put Datuk Seri Anwar in the political doghouse.
Dr. Mahathir has denied repeatedly that he is reining in his deputy. But in a
move widely interpreted as doing just that, he brought back as
cabinet-level economic counselor Tun Daim Zainuddin, who as finance
minister led Malaysia out of recession in the mid-1980s largely by
loosening the government's purse strings. In recent weeks, Malaysia has
announced ambitious fiscal-spending packages and cut a key interest rate
-- indications that it intends to escape the crisis through beefing up, not
slimming down.
A long-awaited report by Tun Daim's National Economic Action Council
was released to mixed reviews last month. Few argued with the report's
broadly stated goals, which include stabilizing the currency, maintaining
financial stability and strengthening economic fundamentals, but many
people were left wondering how those goals will be achieved.
And some observers say Malaysia is squandering its advantage, avoiding
making painful changes. The foreign-debt crisis forced other countries to
face their problems head-on, as unsympathetic lenders and investors
simply pulled out their money. In Malaysia, the government has spent its
own money -- and that of its pensioners -- to support the stock market,
and it has asked bankers to give customers more time to make payments.
"They aren't lifting the lid on the can of worms they have got there," says
Varun Sabhlok, who left Citibank early this year to start a financial
consulting firm, AVS Asia Ventures.
Ethnic Tensions Tamed
The reality under that lid is that much of Malaysia's wealth was massively
leveraged on the stock market. And much of that leverage, along with
huge piles of domestic debt, grew from Dr. Mahathir's sweeping
affirmative-action program. That policy helped tame ethnic rivalries
between the wealthy Chinese minority and poorer indigenous majorities --
tensions that have ripped neighboring Indonesia nearly apart. The program
gave the mostly Malay indigenes, called bumiputras, access to initial
public offerings at preferential prices. More established bumiputra
businessmen -- many of them with strong government connections -- were
handed lucrative privatization projects.
But these companies took on huge debts to pay for these projects. United
Engineers Malaysia Bhd., for example, the country's premier construction
conglomerate and a key bumiputra vehicle, has long-term borrowings of
8.11 billion ringgit ($1.9 billion), a sum greater than the marketable value
of its assets, according to Yeoh Keat Seng, head of Malaysia research at
Smith Zain Securities, a Merrill Lynch associate.
Stock giveaways created paper wealth and a freewheeling attitude that
drove Malaysia's stock-market capitalization by 1997 to three times the
country's gross domestic product -- about twice the level of any of its
neighbors and well above levels in developed countries such as the U.S.
The market's crash has kicked away the leg supporting billions of dollars
of borrowing against the value of blue-chip shares that are now penny
stocks.
"A large part of this process is about individuals who borrowed money,
and their relationship with Malaysia's leadership," says Douglas Beckett,
head of corporate and institutional banking at Standard Chartered Bank in
Kuala Lumpur. "There is a political dimension that has a bearing on how
the economic policy is put together."
Also worrying is the degree to which, unlike Thailand and Indonesia,
Malaysian banks own the finance companies and brokerage houses that
made loans to the stock market. Banks extended loans to their brokerage
arms, which lent to individuals, who pledged shares as collateral to buy yet
more shares.
Sime Darby Bhd., Malaysia's premier conglomerate, was hit recently with
its first loss since the Malaysian government bought it back from its British
masters more than 20 years ago. The firm has extended hundreds of
millions of ringgit in loans to its majority-owned Sime Bank, which in turn
lent similar sums to its subsidiary Sime Securities, which lent money to
individuals, who suffered losses in the stock market.
"It is this structure that will bring down Malaysia's banking system, if the
property market doesn't get them first," says Philippe Delhaise, president
of Thomson Bankwatch, one of three ratings agencies to slash Malaysia's
sovereign ratings in as many weeks.
But forcing investors to take their losses won't be easy, because it is the
politically sensitive bumiputra who, having gained the most recently, have
the most to lose, says Ramon Navaratnam, a former government
economist. The race-based incentives "may have been a mistake, but they
are done now, and if we take it all away there will be a blowup." Indeed,
last week Malaysia was racked by rumors, which proved to be false, that
race riots were imminent.
And so, unlike Korea, Indonesia and Thailand -- all of which have at least
partially lifted barriers to foreigners buying their banks -- Malaysia has
kept a 30% foreign-ownership cap on its banks. (It has lifted a restriction
that bumiputras own 30% or more of companies, with certain broad
restrictions.) That is going to reduce the prospects for foreign-capital
inflows, exactly what is needed as Malaysia stares down a fiscal deficit
that is starting to look worryingly large.
The government has committed to keeping this year's fiscal deficit at no
more than 3.8% of gross domestic product, and central-bank officials say
they would be very uncomfortable to see that rise. But Desmond Supple,
an economist at Barclays Capital in Singapore, estimates "conservatively"
that fiscal support of the banking sector will amount to at least 5% of
GDP, which he says will produce a budget deficit equal to 7% of GDP.
And for that reason, he argues against government and other economists
who support more fiscal spending.
Also slowing the restructuring process: a widely held belief that banks
should place the needs of the country first -- even above their own needs
to stay solvent. Dr. Mahathir has led the way in charging that bankers are
making "excessive profits" at the expense of struggling businesses. Others
echo his claims. "Banks aren't supposed to be money lenders," says Jimmy
Foo, senior manager in Kuala Lumpur at real-estate firm Jones Lang
Wootton, explaining why he expects banks to go easy on property
borrowers whose loans have soared.
Banking Losses Anticipated
Yet analysts expect many Malaysian banks to start posting losses when
they report earnings later this month. And on Thursday, Finance Minister
Anwar said the country's banking system is so troubled that an undisclosed
number of banks will need capital injections totaling 16 billion ringgit in
coming months.
Unsure how much worse things will get, many local banks have given up
lending altogether, hurting even healthy exporters who aren't able to obtain
working capital. That is why some economists are calling for lower interest
rates, though others argue that banks won't lend more even if rates are
lowered because they are too concerned about their rising nonperforming
loans.
Take the case of a Malaysian manufacturer of high-grade textiles, whose
executives asked not to be identified. Where once it would agree on prices
with customers for three or even six months at a time, the company now
receives orders just one month at a time because buyers expect prices to
keep falling, says the company's technical director.
With just one month's worth of orders in hand, the company can get only
one month's financing from its bankers, which gives it just enough cash to
buy one month's supply of raw materials. That leaves the company with a
patchwork of different yarns. "I can't keep changing my cotton every
month," says the director, who adds, "I need to keep the quality
consistent." |
