It all comes down to this: Can you put the genie back in the bottle? Once a country has embarked on the path of free-market capitalism, can it go backward, closing off some of the less desirable effects of market forces, and still attract the foreign capital and investment it needs to grow?
That is the hypothesis now being tested by Malaysia's Prime Minister Mahathir Mohamad. By imposing currency controls--outlawing trade in the ringgit and imposing onerous curbs on foreign stock investors--Mahathir is taking a huge gamble. If he succeeds, he could become a role model for developing nations starting to question the long-held model of economic globalization. And he could ignite a wildfire that spreads to other ailing nations. "If we don't get some help from the U.S., Europe, or Japan, we may have to close up, too," warns Stock Exchange of Thailand Chairman Amaret Sila-on, a leading reform figure.
Mahathir's bet is likely to be a loser. The economy is already in recession, with a 7% contraction forecast for this year. It will be further stunted by heavy-handed administrative controls. At the same time, Mahathir's attempts to reflate the economy could boost imports and thus run down foreign reserves, making devaluation likely and prompting trade restrictions.
A more pressing concern is that Malaysia now won't embark upon domestic reforms. Because Malaysia has effectively burned its bridges with foreign portfolio managers, its beleaguered companies will be deprived of an important source of capital to rebuild. By closing off parts of Malaysia's economy, Mahathir may find that he has crossed Malaysia off the world investment map.
GOLD SALES. Mahathir's currency controls aim to reliquefy the parched economy. He plans to sell off gold holdings, netting about $500 million, say sources familiar with the plans. He also intends to tap the international bond market for another $500 million. Regulators have cut banks' reserve requirements for the fourth time, freeing up more money for lending. The government is asking local bankers to extend fresh credits. And interest rates are tumbling, down 1.5 percentage points in early September. "We just want to insulate, not isolate, ourselves from the current turbulence," says Francis Yeoh, managing director of infrastructure developer YTL Corp.
Mahathir thinks he has enough money inside Malaysia to refloat the banks and defy the world. The state-run pension system could devote $520 million a month to propping up stocks, which have started climbing since the new policy took effect. State-owned oil and gas company Petronas also has cash that could be tapped. A high personal savings rate could play a part, too. But many analysts doubt Malaysia will be able to clean up its banks with local funds alone.
The currency crackdown flows from the assumption that using a big stick can force money back home. One source of Mahathir's ire was rampant futures trading of the Malaysian ringgit in Singapore, which stemmed from his ban on such trading at home. As Malaysia's crisis deepened and the ringgit weakened, more companies rushed to hedge their exposure to the currency in Singapore. Some players were speculators, but financial sources in Kuala Lumpur say that much of it involved prudent business decisions by companies trying to protect against a falling currency. The effect was to suck money out of Malaysia's economy--some $650 million to $1 billion. "Such activities created extreme instability," Mahathir's longtime confidant Daim Zainuddin said in a written reply to BUSINESS WEEK. Daim was brought in over ousted Deputy Prime Minister and Finance Minister Anwar Ibrahim to run economic policy.
Another risk is that Malaysia will drive away foreign direct investment, which has been the lifeblood of its rapid emergence as an export power and is the key to its economic success. Foreign electronics giants such as Intel, Motorola, and Seagate have invested billions in giant, low-cost industrial parks. They employ hundreds of thousands of workers and account for the lion's share of Malaysia's exports.
So far, the government has assured foreign exporters that they can still convert currencies to pay local bills and repatriate their earnings. "As far as we are concerned, this will have minimal impact on our business," says Wong Siew Hai, managing director of Intel Corp.'s vast operations in Penang, one of its biggest offshore bases for making Pentium II microprocessors and circuit boards. Intel still plans to spend $400 million on expanding output this year.
Even those who give Mahathir the benefit of the doubt hope that he phases out the currency controls quickly. The worry is that they will become permanent and extend to trade in goods and services as well. Confusion reigns over how Malaysia will authorize currency conversions for exporters. Will it be automatic and electronic? Or will it be cumbersome and bureaucratic? "The new policies are not permanent," said Daim, "but we are following closely what is happening outside Malaysia." He declined to comment on reform, insisting instead that "there has been no shift in the economic strategy."
The debate over reform was at the center of the dramatic events that led to Mahathir's successful purge of Anwar. Deputy Prime Minister since 1993, Anwar, 51, had pushed for more openness and less corruption, a freer press and more independent judiciary--especially as the economic downturn started to bite. He wanted to use the crisis to weed out cronies who dominate big companies. But Mahathir favored bailouts, including one for his businessman son. Now, Anwar is under investigation for sensational allegations ranging from sodomy to espionage. "It is not a legal case," insists Anwar. "It is political."
Anwar is not going quietly. "The government has failed to discredit Anwar," says supporter Abdul Rahim Ghouce, pointing to thousands at a local mosque who cheered Anwar after Friday prayers. "These people are usually the first to be convinced of charges of immorality." For the moment, though, Mahathir has discredited free markets. And the world is watching to see if his economics of defiance works.