SUNS4499 Tuesday 31 August 1999

Malaysia: Emerging signs of improving economy

Penang, Malaysia, Aug (IPS/Anil Netto) -- Local investors are celebrating Malaysia's coming re-admission into a well-known international fund management index, seeing it as a stamp of approval for the improving economy. But some analysts are cautioning against premature euphoria.

Morgan Stanley Capital Internatinal Inc (MSCI) announced on Aug.12 that barring a reversal in the process of liberalisation of the Malaysian financial markets, the MSCI Malaysia Free Index would be re-included early next year in the MSCI Emerging Markets Free (EMF) index series and the MSCI All Country (AC) Free Index series, including the MSCI AC Far East Free ex-Japan Index.

The good news came close to the Sep 1, 1999 lifting of severe restrictions on repatriating capital, which were introduced a year earlier as part of sweeping measures to curb speculation and the outflow of the local currency, the ringgit.

A capital gains tax system, with rates depending on the holding period, would however remain in force. "Although this and other factors leave the investment framework in Malaysia less favourable than it was prior to Sept 1, 1998, it is nevertheless comparable to that of certain other markets included in the MSCI Emerging Markets Free index series," said the MSCI statement.

The news could not have come at a better time for Prime Minister Mahathir Mohamad, who is widely expected to call for snap elections to take advantage of a minor economic upturn even though the parliamentary term only ends next June.

"The worst is over," says economist Subramaniam Pillay. "I think it (the re-admission) will definitely help the inflow of funds and stop the outflow of some funds come Sep 1."

A lot will now depend on external factors such as the economic situation in Japan and the United States, he adds. Together, these markets absorb about 30 per cent of Malaysian exports.

Officials point to the steady rise in recent months of the benchmark Kuala Lumpur Stock Exchange's Composite Index (KLCI) as evidence of the success of the capital controls policy.

The rise should be seen in perspective, say some analysts.

Those pointing to the stock market recovery conveniently ignore the even stronger recovery in the Jakarta Stock Exchange, wrote Jomo Sundram, a professor in economics, recently. "Sadly, of the five crisis-hit economies (in the region), Malaysian recovery may be the slowest," he said.

Critics point out that the current KLCI level hovering around 800 is still well below the all-time high of 1,300 in January 1994.
So what impact did Malaysia's experiment with currency controls really have?

"The currency controls themselves were largely irrelevant," says the research head of a leading foreign stock brokerage in Kuala Lumpur. "And the controls on portfolio capital in the market came too late: practically all the hot money had already left."

Still, the economy has perked up in tandem with a regional economic upswing. Industrial production, which was shrinking at an annual rate of 11 per cent at the end of last year, has turned around to 8 per cent growth in June. "It's all helped by the ringgit being weak," says the research head.

"Exports are up and imports have fallen though they are now beginning to pick up." Lower interest rates are also making it easier to finance new cars and houses and reduce the risk of firms with high debts going bankrupt.

"A number of private sector economists are forecasting GDP growth of more than 4 per cent this year," he adds. That's a sharp turnaround from the negative 1.3 per cent posted in the first quarter and last year's 6.7 per cent contraction.

After months of favourable trade balances, Malaysia's external reserves now total 120 billion ringgit ($31 billion) or 6.9 months of retained imports - up from $20 billion or 3.8 months imports last September.

Malaysia's banks have also received a new lease on life after two specially created agencies began recapitalising shaky banks and buying their bad loans. Details of these bad loans, however, remain sketchy to the public and few know the recipients of the huge loans.

Meanwhile, the new plans by Bank Negara, the central bank, to restructure Malaysia's banking industry into six large institutions have created some confusion.

Many analysts agree that consolidation in itself is not a bad thing and that combining some banks could boost efficiency. Redundant branches would then be closed down and the new combined operations could enjoy economies of scale. Larger banks could also afford more sophisticated computer systems making them better prepared to face foreign competition.

But the implementation of the mergers has raised several questions. "What is the criteria in determining the six anchor banks? Why is it being done so hastily? What are the banks that are being acquired going to get?" asked the research head.

The mergers also deny any place for small, fairly well run banks that may be better off on their own. The speed of the process suggests that creating bigger banks quickly was the primary consideration, rather than value or management expertise or synergy, said a recent Asian Wall Street Journal editorial.

Although the worst may be over, a return to high economic growth is not likely to come quickly. The oversupply of commercial property - office buildings, hotels and retail complexes - is still weighing down on the economy.

Only 75% of office space in Kuala Lumpur is occupied and this is expected to fall to about 60% by the end of next year as more projects are completed. "Almost no new construction for this sector (commercial property) will be required in the next five to ten years," said the research head.

That may be a blessing in disguise. Slower but more sustainable and even distributed growth may be just what is needed after a decade of frenzied economic activity, which resulted in the concentration of wealth in the hands of a few.