Asiaweek, September 25, 1998

NO SECOND THOUGHTS

A confident Malaysia reinforces its rebel stance

By Jonathan Sprague and Assif Shameen


NOR MOHAMED YACKOP WAS once held in awe by currency traders from New York to Singapore as "Top Cat" - the biggest tiger in the global forex jungle. Then a top official at Bank Negara, Malaysia's central bank, Nor bet billions of dollars from Malaysia's reserves in the volatile markets, and earned hefty profits. But in 1992, Top Cat bet in favor of the British pound, and lost. The man on the other side of that bet - George Soros. Bank Negara wrote off more than $4 billion in losses that year and the next. Nor resigned, becoming an analyst and later a businessman. But last week, Top Cat was named an adviser to the central bank governor, back at the top of Bank Negara.

What's Malaysia up to? Another head-to-head contest with Soros? Not quite. Nor Mohamed Yackop's return to power is part of Malaysia's withdrawal from currency markets. He was a key adviser to the government in drawing up recently imposed capital controls, and his associates say he personally hatched the scheme to kill the Singapore bourse's foreign section - which until last week was a key market for trading Malaysian shares. An expert on banking and debt, Nor's return to the central bank not only signals his rehabilitation, says one Kuala Lumpur-based analyst, but also heralds the growing confidence of Prime Minister Mahathir Mohamad and his top policy makers that behind a firewall of capital controls and a fixed exchange rate, Malaysia can defy all odds and leapfrog to its next economic boom.

The return of Top Cat Nor and the naming as central bank governor of Ali Abul Hassan Sulaiman, who as Kuala Lumpur's head of economic planning oversaw the massive privatization and infrastructure boom that critics say fed overbuilding and cronyism, is being seen inside and outside Malaysia as part of a program of massive reflation and pump-priming to pull the country out of recession. It is a risky undertaking that flouts textbook economics and infuriates many international investors, but is being pushed aggressively inside the country through the nationalistic slogan Malaysia Boleh - "Malaysia Can." Bank Negara certainly has not lost any time. Since his appointment, Ali has told banks to reinstate withdrawn credit lines and boost year-end loan growth to 8% - double what current lending patterns would indicate - while cutting the maximum margin they can charge over the quoted base lending rates, all in an effort to keep money flowing to cash-starved businesses. With the additional measures, Ali said "prospects for early recovery will be more certain."

Really? U.S. investment bank Salomon Smith Barney thinks so. Capital controls, a fixed exchange rate and easier monetary policies "should improve government's ability to bring forward the timing of economic recovery," it said in a report issued last week. "The measures will help reduce corporate Malaysia's collective balance sheet, which means lower non-performing loans and greater success of corporate debt restructuring." But Salomon would say so. It was hired by Kuala Lumpur for a hefty fee to talk up the prospects for Malaysia's economic recovery and raise new money for the battered banking sector.

SALOMON ACKNOWLEDGES THE STRATEGY has risks. Malaysia must win the faith of locals and foreigners that its plan will work and thereby stop capital flight. It has to convince bankers and investors that Malaysia "remains a solid sovereign credit risk" by reassuring them about the likely impact of capital controls, political fallout from the sacking of deputy prime minister Anwar Ibrahim, and Kuala Lumpur's commitment to banking reform and corporate restructuring. "We at Salomon are not saying everything is great or that Malaysia has no problems," says John Sevilla, a Salomon analyst who co-authored the report. "What we are saying is that investors should look at the other side of the story too." The appointment of the Wall Street powerhouse will help. "People are more likely to believe Salomon's spin," says a senior executive at a rival U.S. investment house. "It's a great public relations coup."

It is not just spin. P.K. Basu at Credit Suisse First Boston in Singapore says Kuala Lumpur now has the policies in place to put the economy on the recovery track. Because Malaysia's downturn was caused by the tightening of fiscal and monetary policies rather than by external factors, CSFB reckons it will be first in line to recover among the recession-plagued economies of the region. With low external debt and Malaysian banks' insignificant reliance on foreign liabilities, the country had "a distinct advantage over the rest of East Asia," Basu says. Besides, Malaysia's defenders point out, the textbook prescriptions of higher interest rates and lower spending pushed by the International Monetary Fund - and championed in Malaysia by ousted deputy premier Anwar - have not yet brought recovery anywhere in the region. With the promised exchange rate stability, export boom and investment inflow nowhere in sight, Mahathir and top economic advisor Daim Zainuddin had reason to wall Malaysia off from international capital surges so that they could prime the economic pump without a financial market backlash.

The stock market seems to agree. The Kuala Lumpur exchange zoomed up 70% on the back of the new economic policy before running into profit taking. "With interest rates coming down fast and liquidity likely to surge, I believe in the short run the market may rally further," says Yeoh Keat Seng of Merrill Lynch in Kuala Lumpur. But others say the rally is an illusion. "Mahathir is keen on creating a wealth effect by pushing up stocks," says a local analyst who asked not to be named. He thinks government institutions have been instructed to push up shares. "The best performing stocks in the past three weeks have not been the ones with increasing profit growth but with political connections," he adds.

And even though many economists expect government-spurred spending and lending will boost the economy in 1999 following an expected 5% contraction this year, they say the darker side of capital controls will start to become apparent in the first half of next year as international investors shun the country and local businesses and savers seek ways around the restrictions. A black market in ringgit is already emerging both in Singapore and Thailand where Malaysians are flocking to change their money. "Capital controls almost always don't work in the long run," says Neil Saker, an economist with SG Securities Asia.

So will Malaysia's departure from economic orthodoxy work? The key, analysts say, is if it can overhaul its banks, which are straining under a rising mountain of bad loans, while using capital and currency controls as a short-term shield. The omens are not great - besides mandating greater lending, Bank Negara is easing some regulatory requirements. Salomon's efforts will be crucial - its main task is to raise funds for Danamodal, the special purposes vehicle for recapitalizing the banking system. Malaysia needs some $10 billion to fund Danamodal and Danaharta, the asset management company that will buy bad loans from troubled banks. Two months ago, a road show for a $2 billion bond issue by Danaharta was shelved after Malaysia's sovereign debt ratings were slashed. Following further cuts, Kuala Lumpur's long-term bonds now are barely investment grade, and its go-it-alone plan has not won it credit. "Additional heterodox measures by the government would prompt a downgrade to noninvestment grade," Standard & Poor's said last week following a downgrade. "Conversely, pursuit of credible financial sector reforms could help stabilize the ratings."

A drop to junk status could be devastating. Many international bondholders are barred from buying below investment grade. Salomon says it will do its own credit research which will be better than that of rating agencies like S&P or Moody's. It concedes raising money will be difficult, but argues things will get easier next year as Malaysia starts to turn around and external conditions stabilize. Otherwise, the nation's banks will have to rely on limited local resources. Banks and corporations seeking equity capital from abroad may be equally starved. Restrictions on repatriating money has forced many foreign funds to value their Malaysian stock holdings at zero, a situation set to discourage new investment. Credit Lyonnais Securities Asia says investors can safely remove Malaysia from their investment universe, and chastises the country in no uncertain terms. "Now to foreigners you are like your much misunderstood durian - prickly on the outside and stinking in the middle," it says in a recent report. But Mahathir is unlikely to bend. He knows that Malaysians love durian.


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