Ever since the International Monetary Fund launched its program to stem Asia's financial crisis last fall, Malaysian Prime Minister Mahathir Mohamad has been carping from the sidelines. The IMF's prescription of fiscal restraint and tight money to bolster Asian currencies, he asserted, would ruin the region's economies rather than help them.
Now, Malaysia is putting Mahathir's theory into practice. On June 26, Mahathir installed as economic czar Daim Zainuddin, a longtime confidant and an advocate of looser credit, even though Malaysia's banks have amassed bad loans that may reach $25 billion next year. Bank Negara Malaysia, the nation's central bank, has slashed local banks' reserve requirements while officials said they want to lower prime rates for corporate customers from 15% to 12%. Kuala Lumpur also said it plans to raise $1.2 billion to revive stalled public-works projects. The aim, says Daim, is to keep the economy aloft by pumping liquidity back into cash-starved companies. "The engine of growth here is the private sector," he explains. "If you kill the engine, what happens to the country?"
It's a sentiment that is resonating around Asia. As desperation spreads, so does the clamor for looser money. In Jakarta, where the economy has ground to a near halt, Bank Indonesia Governor Syahril Sabirin says corporate chiefs are haranguing him to abandon his high interest-rate policy. Fears of slower growth and rising unemployment are prompting Beijing to cut rates to state enterprises for the third time in nine months, even though that will likely set back efforts to clean up China's sick banks. And although Japan's rates already are a rock-bottom 0.5%, there is mounting pressure on Tokyo to print more money to reverse the nation's deflationary spiral.
"KILLING THE PATIENT." Even no less a fiscal conservative than Singapore Senior Minister Lee Kuan Yew has begun to call for rethinking of the IMF's policy. Asia's high lending rates are "hurting their economies," Lee said in an interview. That's because high rates have failed to achieve their purpose of bolstering Asia's battered currencies. Market sentiment is now so grim in much of Asia, Lee says, that "foreign exchange rates no longer bear any relation to the real economy." That view is widely shared by Asian businesspeople. "Countries that have raised their interest rates have not seen their economies improve," contends Francis Yeoh Sock Ping, managing director of Malaysian construction company YTL Corp. The IMF's medicine is "killing the patient."
The implications of reopening Asia's money spigots could be huge. If the strategy manages to halt Asia's slide without scaring away investors, countries that are sticking to IMF discipline, such as Thailand and South Korea, may question whether they could have averted their horrendous contractions. But if it fails, Asia could sink further into an abyss of high inflation, crashing currencies, and a deeper banking crisis.
The danger is that the Asians could cut rates too low, without completing the painful overhauls of their banking systems and glutted industrial sectors--triggering an ever greater outflow of capital. One reason Indonesia's central bank is holding the line on lending is that it is still trying to get a fix on the magnitude of the problem. Not long ago, banks reported that 25% of their loans were bad. Now, auditors believe the real figure is closer to 40%. In Japan, estimates get worse by the month. Banks and life insurers frustrated by low yields at home already are expected to buy $164 billion of foreign stocks and bonds over the next year, figures J.P. Morgan economist Jesper Koll.
Japan is a good example of why looser monetary policy alone won't be a magic bullet for the region's bad-debt overhang of more than $1 trillion. True, it makes sense to prevent cash squeezes from turning into panics by flooding banks with liquidity. Michael Howell, a London-based analyst with CrossBorder Capital, thinks the Bank of Japan must double the country's monetary base by injecting another $437 billion so that bad loans can be wiped out. But if weak lenders are bailed out at the expense of the strong, the overcrowded sector won't undergo its needed shakeout.
RUBIN LOBBY. But as the crisis grinds on, authorities are itching to lower rates, despite a recent lobbying tour by U.S. Treasury Secretary Robert Rubin, who urged Asians to hold the line. No Asian country is departing as openly from IMF doctrine as Malaysia, which has been keeping rates high even though it has not sought the agency's help. Malaysia now is willing to gamble that it can fix its financial system without putting the economy through the same wringer as Thailand and South Korea.
The government also hopes to clean up ailing banks by setting up the Asset Management Company. The agency will be able to seize and sell bad loans from banks, which officially are listed at 9.3% of total loans but are believed to be much higher. Banking sources say the plan also calls for reducing the number of banks from 22 to as few as 8 through mergers. "If we can save the banking sector," says Daim, "then I think confidence will be restored fairly quickly."
A crucial test of market confidence will come when Kuala Lumpur tries to raise capital for the AMC. Malaysia plans to float up to $3 billion in international bonds for the bank. It won't be easy to convince investors that the new funds will really be used to modernize the economy, rather than end up in the pockets of political cronies. Recent government-backed bailouts of companies whose investors have close political ties to Daim and Mahathir have undermined credibility. That's one reason why Standard & Poor's says it may downgrade Malaysia's sovereign rating.
But at this point, argue proponents of easier money, Asian economies are so devastated that lowering interest rates can't hurt. Indonesia's economy is expected to contract at least 10% this year, and the rupiah is near 15,000 to the dollar, some 75% lower than when the IMF stepped in. While mismanagement by former President Suharto is mainly to blame, Asians also fault IMF-imposed high interest rates. Lippo Group Deputy Chairman James Riady thinks the run on the rupiah may have stopped had Jakarta immediately hiked rates to 300% or more, and then lowered them dramatically when the rupiah stabilized. Instead, rates have hovered around 60%--not high enough to scare off speculators but high enough to bankrupt so many companies that the economy has been set back a decade. The IMF is helping Indonesia build the institutions for "economic democracy," Riady says. But it erred in trying to micromanage.
As the crisis marks its first anniversary, Asia is willing to try new solutions. The question is whether those solutions will put it on the road to recovery or further disaster.