Securities Association of China and Asian Securities Analyst Federation Joint Seminar in Dalian, China

MALAYSIA'S EXPERIENCE IN DEALING

WITH THE FINANCIAL CRISIS

By

Dr. Victor Wee,

National Economic Action Council Secretariat

28-30 June 1999

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MALAYSIA'S EXPERIENCE IN DEALING WITH THE FINANCIAL CRISIS

INTRODUCTION

Two weeks after the floatation of the Thai baht on July 2, 1997, the ringgit was allowed to find

its own level. By January 1, 1998, the ringgit had depreciated by 35% and the Kuala Lumpur

Composite Index fell by half. The currency depreciation and falling stock market worsened in

1998. Meanwhile, the rising number of corporate failures and non-performing loans affected

the willingness of banks to lend. The country was in the grip of a severe credit squeeze, and

the full impact of shrinking demand and rising corporate distress were felt by the entire

economy.

Early into the crisis, the Government recognised that the regional crisis would deteriorate

further rather than improve during coming months. It established the National Economic

Action Council (NEAC) on January 7 1998, to deal with the crisis and prevent the economy

from sinking into a deep recession. The Prime Minister is the chairman of the NEAC and the

First Finance Minister is its Executive Director. The Executive Committee (Exco) of NEAC

meets almost every working day to discuss wide-ranging issues and monitor economic

developments to ensure that economic problems are resolved expeditiously. The commitment

by this high-level committee to meet almost daily, illustrates the importance of economic

recovery on Malaysia's list of priority.

NATIONAL ECONOMIC RECOVERY PLAN

Immediately after the formation of the NEAC, the Executive Director and his Working Group met with

different groups of people representing different industries and segments of society. The feedback from

these meetings was invaluable in assessing the full extent of the crisis and provided the basis for the

National Economic Recovery Plan (NERP), which was launched on July 23, 1998. The NERP presents

the framework for action for economic recovery and reversed the "virtual IMF policy" policy that Malaysia

had earlier adopted. The Plan stipulates the following six objectives for economic recovery:

Stabilise the ringgit (including adopting an appropriate exchange rate regime, increasing external reserves and adopting a balanced interest rate policy)

Restore market confidence (through enhanced transparency, establishing rules for assisting ailing industries/companies, consistency of government policies, and improving

communication)

Maintain financial market stability (establishing agencies to take over non-performing loans and recapitalise banks, improving the capital market and developing the private debt

securities market)

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Strengthen economic fundamentals (improving the quality of investments, the balance of payments, and price stability, adopting an appropriate monetary policy, and increasing

labour competitiveness)

Continue with the equity and socio-economic agenda, and

Revive adversely affected sectors (with specific recommendations for each of the 13 sectors affected by the crisis).

To achieve these objectives, there were 40 lines of actions and a total of 585 line of actions to be

implemented by ministries, agencies and the private sector.

TWO APPROACHES TO RECOVERY

Malaysia's Economic Recovery Plan provides the blueprint for dealing with the crisis and

bringing about economic recovery in the country. The Malaysian solution differs from the IMF

approach adopted for countries under its assistance. In Malaysia, problem banks are to be

resolved rather than forced to fail since this would have systemic risks for the entire financial

sector. Among the Asian crisis-hit countries, Malaysia was first in prescribing lowering interest

rates and using a fiscal stimulus to jumpstart the economy. It established special-purpose

corporations to resolve non-performing loans and recapitalise banking institutions as well as a

Corporate Debt Restructuring Committee to work out an amicable loan solution for corporations

with financial problems resulting from the crisis.

Malaysia could go on its own to formulate its own recovery plan without asking for IMF

assistance also because it entered the crisis with strong financial sector and economic

fundamentals. Malaysia's short-term external debt is only $7 billion, which is less than 30% of

BNM international reserves. The external debt servicing is very low at 1% of exports for

government foreign debt, and 5.4% of exports for total foreign debt. The relatively low debts

and high savings rate made it possible for the country to fund its recovery programme through

increased Government domestic and foreign borrowing.

MEASURES FOR RECOVERY

The main features of the macroeconomic policies in the National Economic Recovery Plan

can be summarised as follows:

Relax the tight fiscal policy and provide fiscal stimulus

Ease monetary policy

Reform the financial and corporate sectors

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Fiscal Stimulus

The Government eased its fiscal policy and took immediate action to avoid a deeper

economic recession.

In July 1998, government expenditure was increased to RM7 billion to promote exports and counteract a decline in domestic demand. These measures

combined with a decline in government revenue resulted in a budget deficit of

RM5 billion or 1.9% of GNP in 1998. Priority was given to projects involving

agriculture, low- and medium-cost housing, education, infrastructure and public

facilities, health, rural development and poverty eradication.

The Government also announced the establishment of a RM5 billion fund for infrastructure projects, such as mass-transit railway transportation, ports, highways,

water supply projects, and waste disposal and sewerage projects.

Since the economic crisis affected certain sectors and the poor disproportionately, the Government increased the size of special funds to support the export sector,

small and medium enterprises, low- and medium-cost housing development, food

producing and processing, New Entrepreneurs Funds, and the rehabilitation of small

and medium industries.

The 1999 Budget continues with the expansionary fiscal policy, while maintaining fiscal

prudence and discipline. Emphasis is placed on agriculture and rural development and

protection of lower income groups from the adverse effects of the financial crisis. The larger

expenditure combined with the expected decline in Government revenue is expected to result in

a budget deficit of RM16.1 billion or 6% of GNP in 1999.

Liquidity, Interest Rate and Credit Growth

The availability of finance is essential for the business to continue generating economic activities

and avoid unnecessary business failure due to lack of access funds. Thus, measures were also

taken to ensure that productive activities continue to receive financial support:

Statutory reserves requirement (SRR) had been gradually reduced from 13.5% in February 1998 to 8% in July, 6% in September 1, and 4% in September 16, 1998 to

increase liquidity in the banking system. The reduction of the SRR helps to reduce

the banking transactional costs as well as increase liquidity in the banking system.

Part of the reduction of SRR, that is, from 6% to 4%, was for the purpose of

providing the funds for bank recapitalisation.

Actions have been taken to reduce the interest rates on loans and ease restrictions on debt repayments. The three-month intervention rate fell from a high 11% in June

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1998 to 6% currently. This will ease the pressure of loan repayment as well as

reduce the cost of business.

The period of the NPL has been reverted to 6 months in September 1998 from 3 months in March 1998 to give some breathing space to the affected companies and

business. Bank Negara Malaysia publishes the NPLs using both definitions of NPL

for comparability.

Selective Capital Control Measures

In order to stabilise the ringgit, the Government adopted capital control measures effective from

September 1 1998. The ringgit was pegged at RM3.80 to US dollar or at US$0.26. The

measures effectively make the ringgit non-tradable outside the country in order to stabilise the

ringgit, bring offshore ringgit back to the country, and reduce the ability of non-residents to trade

in ringgit. In order to ensure the effective operation of the capital control measures, the

unlicensed bourse trading of Malaysian equities outside the country was terminated in order to

prevent leakage. The Central Limit Order Book International (CLOB) was closed down on

September 15, 1998. There is also a 12-month holding period for foreign portfolio investment.

The Government had relaxed the capital control measures on February 15, 1999 by adopting

the repatriation levy in the place of the 12-month holding period to make Malaysia more

attractive to portfolio investors. Under this new measure, there are two sets of repatriation levy,

depending on whether the funds came in before or after February 15, 1999. For funds that came

in before February 15, 1999, a graduated taxation scheme will be applied to the capital value

depending on how long the funds are retained within the country. For funds brought into

Malaysia on or after February 15, there will be a levy on the repatriation of profits but not the

principal capital. It should be noted that the levy is only imposed on investments in shares,

bonds and other financial instruments but does not apply to investment in properties.

Danaharta, Danamodal and CDRC

The Recovery Plan gives top priority to programmes addressing the financial sector problems

brought about by the crisis. Danaharta, the Asset Management Company, is established to

remove the NPLs from the balance sheets of financial institutions at fair market value and to

maximise their recovery value. This will free the banks from the burden of debts that had

prevented them from providing loans to their customers. By mid-March 1999, Danaharta had

removed RM22 billion of NPLs from the banking system. Danaharta is expected to remove

RM40 billion of NPLs by June this year.

With the removal of NPLs from the banks' balance sheets, there is the need to ensure that

banks are sufficiently capitalised. For this purpose, Danamodal, the Special Purpose Vehicle,

was set up to capitalise and consolidate the banking sector by injecting capital into troubled

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banks. The injection of capital will enhance the resilience of banks and increase their capacity to

grant new loans, thereby speeding up the economic recovery process. By April this year,

Danamodal had injected RM6.16 billion into 10 banking institutions. As a result, the risk

weighted capital adequacy ratio rose from 10.2% to 15.1%, way above the minimum Basle

standard of 8%.

To complement the restructuring of the financial system by Danaharta and Danamodal, the

Corporate Debt Restructuring Committee (CDRC) was set up in August 1998 to facilitate debt

restructuring of viable companies. The aim is to minimise losses to creditors, shareholders and

other stockholders, avoid placing viable companies into liquidation or receivership, and to

enable banking institutions to play a greater role in rehabilitating the corporate sector. The

CDRC adopts a constructive approach and framework to enable creditors and debtors to devise

and implement workout plan without resorting to legal procedures.

Many investors and analysts are now starting to give the effort due credit to Malaysia at the

rapid progress of bank restructuring. Malaysia's response to the financial sector problem is

drawn from the best practices from around the world, for instance, the US in 1980s, New

Zealand in 1988, Mexico in 1993 and 1996, and Sweden in 1992.

RECOVERY MANAGEMENT MEASURES

The recommendations in the Recovery Plan are all under implementation, although some

measures have proceeded faster than others. Agencies are required to submit regular reports

on progress, which are presented to the Cabinet for their information. There is also a monthly

press release to inform the public on the progress achieved. After addressing the

macroeconomic issues, the NEAC is now examining specific issues that can pose a problem

to economic recovery. Among some of the measures that receive special attention are:

Accelerate implementation of public sector projects

Push for increased bank lending

Attract foreign direct investments (FDI)

Develop the banking sector for global competition

Strengthen corporate governance

Diversify into low import content, high linkage resource-based industries

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SIGNS OF ECONOMIC RECOVERY

The Malaysian economy is fast recovery after bottoming out in the third quarter of 1998. Since

last September, the stock market has more than doubled, foreign reserves and trade surplus

increased dramatically, the inflation rate fallen, while private consumption and investment

rebounded. In March and April this year, Malaysia's credit rating (BBB-/Baa3) has been

upgraded from negative to stable by Standard and Poor and Moody's.

Good progress has been made in financial and corporate sector reforms. Industrial production

is now registering positive growth rates after many months of contraction and running down

on inventory. The low interest rates in the economy will help to increase corporate earnings

and cashflow, as well as encourage consumer spending. The narrowing of spreads of

Malaysia's bonds also indicates the positive sentiment of foreign investors in Malaysia's

recovery. The country's diversified export base, sound infrastructure and fiscal flexibility will

help in providing further impetus to the recovery process.

Economic Indicators

The Kuala Lumpur Composite Index of the stock market has rebounded from 262 on 1 September 1998 to 758 on 25 May 1999.

In 1998, the trade surplus was 58.4 billion ringgit, a dramatic change from a deficit of RM45 million in 1997. Malaysia's trade surplus continues to widen to

RM6.5 billion (US$1.7 billion) in March this year, which would mark the 17th

consecutive month that exports exceed import. In March, exports rose 5.9% to

RM25.7 billion for a year ago, while imports fell 5.4% to RM19.2 billion.

The international reserves of Bank Negara increased from US$20.5 billion at end June 1998 to US$29.6 billion at mid-May 1999, equivalent to 6.5 months of

retained imports.

The 3-month intervention rate was reduced from 11% in June 1998 to 6.0%, which enabled the business sector to operate at reasonable cost and improve

their ability to service their existing loans. The three-month interbank rate is

currently at 4.03%, the lowest level in 11 years.

The weekly average disbursement of loans had risen to 31% from RM4.98 billion in June 1998 to RM6.55 billion in February 1999.

The NPL ratio of the banking system is 11.0% in March 1999 based on 6-month classification (12.3% on the 3-month classification).

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After 12 months of decline, the Industrial Production Index registered positive growth in February and March this year, reflecting increased exports and

domestic consumption.

The sales of motor vehicles rose to 19,106 units in March 1999, which is 160% higher than a year ago.

The Malaysian Institute of Economic Research (MIER) Business Conditions Index and Consumer Sentiments Survey indicate the return of confidence.

Total manufacturing investment approved by MITI increased to RM6.6 billion in the third quarter of 1998 compared with RM4 billion in the second quarter.

Retrenchment of workers has moderated. The number of retrenchments declined to 5,362 workers in March 1999, from a peak of 12,335 persons in July 1998. The

unemployment rate for 1998 is estimated at 3.9%.

PROSPECTS

While there is no doubt that the economy has bottomed out, the issue is the pace of recovery.

The government's real GDP growth estimate for this year is between 1-2%. Many analysts

have revised their projections of 1999 GDP growth for Malaysia to 2% to 3% (see Table 1).

We expect that the economy will pick up this year, and register a stronger growth for the

second half of 1999, which will continue into 2000. In the Mid-Term Review of the Seventh

Malaysia Plan, the growth rate for 2000 is expected to be around 5.0%.

The monetary and fiscal policies adopted under the NERP would have taken effect in the

economy. Meanwhile, the banking problems would be largely addressed by the middle of

1999. By the end of 1999, we would expect things to look positive for Malaysia. Total

investment will show positive growth, with increased public investment and the corporate

sector responding to rising demand and replenishing stocks. However, growth will be subject

to the uncertainties in the external environment. In addition, the domestic corporate sector will

require time to heal the wounds sustained during the severe economic crisis.

Malaysia's economic outlook for this year depends on several parameters. First is the

prospects of the international environment, which is vital to the performance of our external

accounts. The United States and the European Union are expected to grow around 2% to

2.5%. The Brazilian crisis has pulled back from the edge of the precipice without causing the

much-feared regional meltdown. The crisis-hit Far East has mounted a strong recovery,

particularly for South Korea, Malaysia and Thailand. The expansionary fiscal and monetary

stance in East Asian economies should help domestic demand to stabilise across Asia this

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year and lead to stable, and eventually growing, imports from the countries in the region.

Malaysia will be a primary beneficiary of stronger Asian demand since more than half of our

exports go to Asia.

Second, the Malaysian economy will continue to register strong current account position,

although we expect smaller surpluses later as imports for intermediate goods continue to rise.

Malaysia's large and growing foreign reserves can meet potential short-term capital outflows

with comfort. The high savings rate and large current account surplus ensure that there is

enough liquidity to support Malaysia's programme for economic recovery.

Third, in addition to improving export performance, domestic demand is expected to rise. On

the private demand side, there are signs that confidence is returning to the economy. This

would give rise to increasing private

Table 1 Forecast of GDP Growth for1999

Forecast Growth Rate

Official 1-2%

Credit Suisse First Boston 3%

Morgan Stanley Dean Witter 2%

Salomon Smith Barney Above 1%

Merrill Lynch 2%

Goldman Sach 2%

Table 2 Gross Domestic Product for 1999-2000 (Percentage Change)

1999 1999-2000

Real GDP 1.0 3.0 (RM billion) 132.6 139.1 Agriculture, forestry and fishery 5.0 5.2 Mining and quarrying -0.4 1.2 Manufacturing 0.8 3.4 Construction -8.0 -1.7 Services 2.5 3.4 Nominal GNP 2.4 4.9 (RM billion) 268.7 131.9

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Real GNP 1.5 2.9 (RM billion) 126.3 288.6 Private expenditure 1.1 4.5 Consumption 1.1 3.4 Investment 0.9 7.4 Public expenditure 11.4 10.0 Consumption 10.1 7.2 Investment 12.8 13.1

Source: Bank Negara Annual Report 1998, Mid-Term Review of the Seventh Malaysia Plan

consumption and investment in an environment of price stability. On the public investment

front, the unspent development allocation for last year will be carried forward and supplement

the fiscal stimulus that come in full swing this year. This is expected to give a boost to the

economy.

For 1999, growth on the demand side is expected to come from exports with recovery of the

region, and domestic demand, which is supported by fiscal stimulus, improved liquidity and

low inflation. The large current account surpluses provide growth margin without external

sector imbalance. Malaysia has also a good network of physical infrastructure that can

enable the economy to pick up quickly.

AREAS OF CONCERN

The East Asian crisis has also highlighted the havoc that can be caused by highly leveraged hedge

funds moving massive amount of funds rapidly across the world, without being subject to disclosure

rules. They distort and manipulate markets with complete impunity as they profit from the currency and

economic volatility that they initiated. Even small but well-run economies are powerless against the

resources that they can marshal. As a small, open economy, Malaysia was forced to adopt capital

control measures for self-protection, while the world engages in debate about reforming the financial

architecture.

But large rich economies are not entirely free from danger. The near collapse of LTCM shows that the

weakness in prudential oversights is not merely an Asian problem, but one affecting developed

countries too. There must be some concerted international effort to rein in cross-border speculation and

manipulation, such as the operations of hedge funds and highly leveraged offshore institutions.

The international community should mount a concerted effort to reform the global financial system so as

to avert future outbreaks of financial crisis in various parts of the world. Although international forums,

such as the Group of 7 (G-7), have given some recognition and considered proposals on the issue of

hedge funds and short-term capital flows, much more commitment has to be given. With the return of

stability to world financial markets, there is danger that the sense of urgency to push ahead with the new

international financial architecture might whittle away. Unless the international community is committed

to reform the international financial system, there would be no permanent solution to the currency crisis.

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Individual countries can only adopt local defensive measures, but for any solution to be effective, it has

to be international in nature because global capital flows traverse national boundaries. Both the

developed and developing countries should act together in setting up a new global financial architecture.

IntroductionNational Economic Recovery PlanTwo Approaches to RecoveryMeasures For RecoveryFiscal StimulusLiquidity, Interest Rate and Credit GrowthSelective Capital Control MeasuresDanaharta, Danamodal and CDRC

Recovery Management MeasuresSigns of Economic RecoveryProspectsAreas of Concern