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, such as Thailand and Indonesia. "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 figure in the country's market reforms.
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. Finally, 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 are aimed at reliquefying 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 in the next several months. Regulators are cutting banks' reserve requirements for the fourth time in seven months, freeing up more money for lending. The government is already jawboning bankers to start extending fresh credits. And interest rates are already 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. Malaysia's high personal savings rate could play a part, too. With the public-sector domestic debt at only 30% of gross domestic product--low by international standards--the government can still issue billions worth of bonds.
Analysts will be watching how quickly the cleanup of the banks and corporations proceeds. The Asset Management Corp., or Danaharta, is a new agency designed to sell off bad bank loans so that banks can start lending again. Loosely modeled on the Resolution Trust Corp., it has been hailed as a step forward. But many analysts doubt Malaysia will be able to clean up its banks completely with local funds.
Mahathir's currency crackdown flows from the assumption that using a big stick can force money back home. One source of Mahathir's constant ire was rampant futures trading of the Malaysian ringgit in Singapore, a trend that 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 of the players were speculators, but financial sources in Kuala Lumpur say that much of the activity reflected prudent business decisions by companies trying to protect against a falling currency.
The effect was to suck money out of the domestic economy--an estimated $650 million to $1 billion. "Such activities created extreme instability," Mahathir's longtime confidant Daim Zainuddin said in a written reply to questions from BUSINESS WEEK. Daim was brought in over ousted Deputy Prime Minister and Finance Minister Anwar Ibrahim to run economic policy.
Daim believes that these funds should now return to Malaysia. But many analysts think depositors will convert their Singapore-held ringgit to foreign currencies and stay offshore, since they won't want to risk having their money trapped inside Malaysia. "I'm quite happy to have my money in U.S. dollars in Singapore," says a Malaysian broker, who moved ringgit to Singapore to take advantage of the higher rates.
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. Companies on the fence about investing in Malaysia are likely to put those plans on hold, fearing more restrictions if the economy deteriorates further. Foreign electronics giants such as Intel, Motorola, and Seagate have invested billions in giant, low-cost industrial parks in Penang and Kuala Lumpur, employing hundreds of thousands of workers. They account for the lion's share of Malaysia's exports. Half of the gross domestic product comes from manufacturing. Without these multinationals, Malaysia's recession would have been much more severe.
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 is sticking with its plan to invest $400 million to expand output this year. Besides, with the 34% drop in the ringgit, Malaysia remains one of Asia's best investment sites for electronics, especially considering the political uncertainties and poor infrastructure of Indonesia, Thailand, and the Philippines.
FOREX POLICE. Even those willing to 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. First, Malaysia will have to set up a currency police--about 400 people initially at the central bank. If the controls last, they'll almost certainly become more intrusive, involving extensive checks of companies and individuals. Confusion reigns, also, over how Malaysia will authorize currency conversions for exporters. Will it be automatic and electronic? Or will the process be cumbersome and bureaucratic?
Also critical is the reform of Malaysia's rotten banking system and its overstretched, crony-ridden corporate sector. The controls were slapped on quickly, and the government is leaving itself room to keep them on indefinitely. "The new policies are not permanent," said economic czar Daim, "but we are following closely what is happening outside Malaysia." Daim declines to say what the new controls mean for reform, but insisted "there has been no shift in the economic strategy for Malaysia."
The debate over reform was at the center of the dramatic events that led to Mahathir's successful purge of Anwar. Since becoming Deputy Prime Minister in 1993, Anwar had pushed for more openness and less corruption, a freer press and more independent judiciary. He started pressing harder for change as the economic downturn began to bite. The 51-year-old former student radical wanted to use the crisis to weed out political cronies who dominated the big companies. Mahathir, though, favored bailouts, including one for his businessman son. Now, Anwar is under investigation for a raft of sensational allegations ranging from sodomy to espionage. "It is not a legal case," insists Anwar of the charges against him. "It is political."
Anwar is not going quietly. He has received a steady stream of visitors to his house in a hilly Kuala Lumpur district. "The government has failed to discredit Anwar," says Anwar supporter and United Malays National Organization (UMNO) official Abdul Rahim Ghouce, pointing to thousands of supporters at a local mosque who cheered him 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.