Mahathir's About-Face

A drop in foreign reserves leads to friendlier policies

Malaysia's central bank lost nearly $1 billion a month in foreign reserves in this year's first quarter, and there's speculation that a devaluation is around the corner. The country's economy is showing signs of stalling as the global slowdown undermines demand for its electronics exports. Amid all this anxiety, one would think that Kuala's Lumpur's chief economic officer would be hard at work. Instead, Malaysian Finance Minister Daim Zainuddin, the country's second most powerful politician, dropped out of sight in mid-April for what his office calls a "two-month leave." Except for a speech at the Asian Development Bank meeting in Honolulu on May 8, he hasn't been heard from.

What's going on? Daim isn't talking. But it appears that his boss and longtime patron, Prime Minister Mahathir Mohamad, has decided to take the financial reins himself in hopes he can bolster the economy--and his increasingly shaky political position. (Neither responded to requests for comment.) With Daim sidelined, Mahathir has quietly begun taking measures to reverse Malaysia's economic slide. Most significant is Mahathir's effort to undo the Fortress Malaysia approach to foreign investors, whom he angered and alienated in October, 1998, by locking in the ringgit at a fixed rate and imposing capital controls that prevented foreign companies from repatriating profits quickly.

Mahathir has already approved two radical policy changes. In early May, Bank Negara Malaysia, the central bank, announced that it was rescinding a 10% tax on money taken out of the country by foreigners. Next came a relaxation of restrictions on foreign investment in real estate. Both moves fit Kuala Lumpur's stated goal of boosting long-term investment. Dig deeper, and the real intent of the liberalizations seems to be to head off some potentially dire political problems. Some Malaysia watchers say a key aim of allowing investment in property is to assist Danaharta, the government's asset-management company. The outfit has taken over $8.2 billion in bad debt from the country's dysfunctional banks since 1997. Half the collateral seized is believed to be property.

The impact of a global slowdown is also forcing Malaysia's about-face. It's bad enough that the crash in the U.S. electronics market has walloped the country's high-tech exporters. The fall in many Asian currencies against the dollar has made the sting worse. That makes Malaysia, which has a fixed exchange rate of 3.8 ringgit to the dollar, a relatively expensive place to manufacture. The impact of its overvalued currency showed up in Malaysia's current-account data last year, when its surplus narrowed sharply to $8.2 billion, from $12 billion in 1999.

In April, the Malaysian Institute for Economic Research lowered its gross domestic product growth forecast for this year to 4%--a far cry from the 7% target Mahathir announced in a speech to Parliament Apr. 27. By then, rumors were spreading that to make exports more competitive, Bank Negara would devalue the ringgit. As a result, Malaysian exporters--including numerous industrial, electronics, and agriculture companies--circumvented the rules to avoid repatriating their earnings and converting them to ringgit, says economist Jomo K. Sundaram of Kuala Lumpur's University of Malaya. That caused currency reserves at Bank Negara to drop $2.7 billion during this year's first three months. The $27 billion in reserves today are enough to cover only four months of imports. Devaluation fears have helped drive Kuala Lumpur-listed stocks down by about 17% this year.

In recent weeks, government officials have resorted to moral suasion. Exporters have been quietly instructed to convert enough of their earnings to halt the decline in foreign reserves. It may be working: Recent Bank Negara data show reserves rose by $100 million in the second half of April. But one knowledgeable observer said most of the repatriated money came from Petronas, the state oil company. Petronas did not respond to requests for comments.

DOWN A NOTCH? Thus, the pressure is on for the government to take the last step and allow the currency, which is considered overvalued by as much as 10%, to float. Bank Negara Governor Zeti Akhtar Aziz denied on May 14 that a devaluation is coming. But bankers say one option may be to repeg the ringgit at 4.0 or 4.2 to the dollar. At any rate, some kind of devaluation seems likely.

Before it can make such a move, however, the government needs to build political support, since a devaluation would hurt the masses by decreasing the value of their savings and jacking up the prices of imports. That process seems to be under way. In his Apr. 27 speech, Mahathir proposed new subsidies for housing and resettlement of squatters, and a job-creation program.

As investors remember well, Mahathir loves to tangle with the markets. His intentions this time are hard to read. But since there is no sign that Daim is ready to come back from his peculiar "leave," Malaysia's mercurial leader may not yet be finished with his financial reshuffle.

By Michael Shari in Singapore

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