Pathways Through Financial Crisis: Malaysia

Abstract

Malaysia did not turn to the International Monetary Fund for assistance when pressure from the 1997-1998 East Asian financial crisis hit the country. The country was less vulnerable than its neighbors, not least because it had earlier imposed limits on foreign borrowing and prudential regulations and supervision of the banking sector. Although Malaysia's pathway through the 1997-1998 crisis included an orthodox adjustment program of the type the IMF would have required, this program was soon reversed in favor of reflationary monetary policies and the imposition of a short-term capital control regime. These responses took place against a backdrop of political intrigue and drama, but they reflected an underlying pragmatism and recent history of using capital controls and of not turning to the IMF. KEYWORDS: Malaysia, Anwar Mahathir, capital controls, currency and financial crisis, Asian crisis. ********** The 1997-1998 East Asian crisis, triggered by the collapse of the Thai baht in July 1997, led to a currency crisis, a financial crisis, and then economic recession in most countries of the region. However, the Malaysian economy and population were not as adversely affected as their counterparts in Thailand, South Korea, and Indonesia. While the precrisis level of indebtedness in Malaysia was very high, the level of foreign exposure was much lower--as a share of gross domestic product (GDP) and, especially, as a share of the open economy's extraordinarily high export earnings. Unlike in other countries in the region, Malaysia's level of foreign liabilities did not exceed its foreign exchange reserves, so the country was not in need of emergency credit facilities, including from the International Monetary Fund (IMF). After the severe banking crisis of the late 1980s, Malaysian prudential regulation had been improved and had not been as badly undermined by liberalization pressures as in the other three economies. In brief, Malaysia was the one country involved in the East Asian crisis that did not involve the IMF. In this article, I examine the political economy of the Malaysian crisis of 1997-1998. (1) I explain why Malaysia was less vulnerable to crisis than its neighbors--not least because a severe banking crisis in the late 1980s and reforms undertaken in its aftermath had led to preemptive reform, which limited foreign borrowing and ensured greater banking prudence. Nevertheless, in the 1990s, Malaysia was vulnerable to contagion because the authorities had encouraged massive, easily reversible portfolio investments, especially in its stock market. However, its vulnerability was mitigated by the use of capital controls applied in September 1998. I also argue that Malaysian economic policy during the crisis went through four distinct phases: an early phase of defensive policies, led by the prime minister, Mahathir Mohamad; economic orthodoxy, led by then finance minister Anwar Ibrahim; reflationary fiscal policies, also led by Anwar; and, finally, reflationary monetary policies, with a capital control regime imposed by Mahathir. While these policy shifts have been portrayed as the result of an ideological struggle between a nationalist prime minister and his more market-oriented finance minister, I argue that the ideological differences between the two men have been overstated. Rather than given to ideological extremism, Malaysian crisis management was underpinned by considerable pragmatism and flexibility, which allowed for a speedy recovery. The high-profile clashes between Mahathir and Anwar had more to do with the former's fears of a palace coup by the latter than with fundamental disagreements about how to handle the financial crisis. The Crisis After the value of the Thai baht collapsed in mid-1997, currency speculators turned their sights on other economies in the region perceived to have maintained similarly unsustainable US dollar quasi-pegs for their currencies. …