Malaysia: Look, Folks, No Capital Curbs!

Mahathir bets big that investors will stay when controls end

Mahathir Mohamad's moment of truth is about to arrive. On Sept. 1, the Malaysian Prime Minister promises, he will lift the controls on capital movements that he imposed a year ago to protect his country from the financial meltdown that swept Southeast Asia. The move will enable foreign investors and banks to pull billions of dollars out if they wish to, and possibly spark market turmoil. This test of investor confidence comes as Mahathir is preparing for an election that will pit his embattled ruling party, the United Malays National Organization (UMNO), against a resurgent opposition.

Dark days for Mahathir? Don't bet on it. As usual, the crafty 73-year-old has a plan that could convert a challenge into political victory. He hopes to keep the markets buoyant by pushing the well-endowed national pension fund and other government vehicles to pump enough new money into local stocks to offset any funds yanked out by foreigners. Meanwhile, Bank Negara Malaysia, the central bank, is prepared to use its $32 billion in foreign reserves to defend the ringgit at around 3.80 to the U.S. dollar should there be a rush to the exits. "There will be no explosion," predicts Francis Yeoh, a real estate mogul who is close to Mahathir. "The fuse is damp."

If Malaysia can skate through the coming months with minimal damage, then Mahathir will be able to boast that he saved his nation from a meltdown by defying free-market convention. That, combined with a surprising 1.4% economic growth in the first six months of the year, could disarm his critics at home and abroad--and keep him in power after the election, which he must call sometime before June, 2000. Mahathir is even getting help from Wall Street. Morgan Stanley Capital International (MSCI) expects to reinstate Malaysia in two emerging-market indexes used by many Western portfolio managers.

Of course, the downside risk is enormous. A recent private survey of brokers in Kuala Lumpur found that one in four fund managers plans to pull his money out on Sept. 1. That's when penalties ranging from 10% to 30% on repatriating money brought into Malaysia expire. Brokers estimate that $2.6 billion could leave Malaysia. That could jolt the stock market and put pressure on the ringgit. If the markets tank, the psychological damage could imperil UMNO's candidates. A healthy stock market also is vital to UMNO because many of the party's key backers own major stakes in listed companies.

Propping up the Kuala Lumpur Stock Exchange shouldn't be too difficult--at least for a while. Many foreign investors have already shifted their funds from equities and parked them in local bank deposits, which they can do without paying penalties. Foreign funds now account for just 7% of the market capitalization of $140 billion. "Everyone who wanted out of this market has pulled out already," says a local fund manager. Also, the $38 billion Employee Provident Fund, which collects 21% of every Malaysian's monthly salary, could move the market by buying more of the handful of stocks, such as Telekom Malaysia and electric utility Tenaga Nasional, that account for the bulk of market cap.

RINGGIT'S DEFENSE. Malaysia also is in decent shape to protect the ringgit. Thanks to plunging imports during the crisis, Malaysia has a $9.5 billion current account surplus--a hearty 13% of gross domestic product. That "leaves them in a comfortable position" to defend the ringgit without spending too much reserves, says David Cohen, director of forecasting at Standard & Poor's/MMS International in Singapore. In fact, say some foreign analysts, if the ringgit were allowed to float, it could rise to more than 3.5.

There could be snags, though. To rejoin the MSCI indices, Malaysia must show greater market liberalization, says John Fildes, executive director of MSCI Asia. Besides lifting remaining capital controls, the firm wants Mahathir to settle a dispute in which $3.8 billion worth of Malaysian stocks trading on Singapore's Central Limit Order Book (CLOB) exchange were frozen. Investors holding these shares want to be able to sell them. But Malaysia still regards the CLOB as a rogue bourse.

Meanwhile, Malaysia's capital surplus could shrink fast should imports rebound, putting the ringgit at new risk. And because Mahathir has been forcing banks to pump fresh funds into companies run by his cronies, rather than enacting real reform, Malaysia's bad debt crisis could flare anew. But if all goes according to Mahathir's plan, he will be safely back in office by the time Malaysia must confront these problems.

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