SUMMARY

Malaysia has announced that it will further scaleback its system of controls on foreign capital movement. This announcement, following praise from Western economic institutions, is likely designed to increase investment confidence in Malaysia. Further foreign investment is definitely needed, as Malaysia and Prime Minister Mahathir Mohamad have bet on a high-tech, high-cost future.

ANALYSIS

Malaysia announced Sept. 21 that a flat 10 percent exit tax on foreign investment in the Malaysian stock market would immediately replace the existing two-tiered system, which taxed up to 30 percent. This alteration follows the Sept. 1 removal of the year-long exit levy on the principle from foreign portfolio investments.

The timing of this announcement is not incidental.   Prime Minister Mahathir Mohamad is capitalizing on the attention generated by recent endorsements from the West. Besides making foreign investments more profitable, the relaxed controls signal the country’s confidence in its economy. The relaxation of controls is as much a public relations statement as a simple policy adjustment.

As the world now knows, the original capital controls did their job extremely well. After contracting 6.7 percent in 1998, Malaysia’s gross domestic product rose 4.1 percent in the second quarter of 1999. Investors didn’t weren’t scared away by the controls, investing nearly $1 billion and applying to invest $1.85 billion from February to September of 1999, compared to a total of $3.32 billion for all of 1998.

Western economic institutions were slow to reverse their previous condemnations of the controls, but eventually acknowledged the economic realities. The International Monetary Fund, the World Bank and an advisory panel to the New York-based Council on Foreign Relations that included the international currency trader George Soros, have all commented on the usefulness of the controls for stabilizing Malaysia’s economy.

While it initially appears as though Mahathir’s latest move is an attempt to increase Malaysia’s economic lead, the reality is that Malaysia is nearly as desperate for investment as the rest of Southeast Asia. Mahathir has invested large amounts of government funds, as well as his own political capital, in high-tech infrastructure projects that were planned before the Asian economic crisis. The benefits of these projects remain largely unrealized.

The Malaysian government officially opened the Multimedia Super Corridor in July. This 750 square kilometer zone, which runs from the glistening Petronas Twin Towers in Kuala Lumpur to the new international airport 60 kilometers to the south, is designed to become an Asian "Silicon Valley." The Corridor already contains Putrajaya, the government’s new administrative center; Cyberjaya, an industrial park for high technology and software companies; and a Stanford-style Multimedia University that receives guest lecturers from such high-tech giants as Lucent Technologies. Amenities include a theme park and environmentally friendly residential developments.

Mahathir has spent about $1.35 billion on the Corridor, hoping to create the center of high-tech industry in Southeast Asia. Unfortunately, Mahathir’s enthusiasm for the project has not yet caught on with investors. Despite interest from major companies such as Microsoft, Sun,  Ericsson and SAP, investment commitments are less than one quarter of the expected $4 billion. While over 220 companies have signed up to invest in the Corridor, as of July 13 only nine of them had moved any operations there, despite such incentives as tax-free status and exemptions from Malaysian equity-ownership rules and Mahathir’s own capital controls.

Mahathir now has a high-tech industrial park and endorsements by the major global financial bodies. This is the time for him to increase high-tech investment into Malaysia. If it doesn’t happen now, it is unlikely that it ever will. Failure will bode ill for both Malaysia’s economy and Mahathir’s personal political power.

Expansionary projects such as the Petronas Twin Towers and the Corridor itself are planned on the assumption of high growth rates. While it is true that Malaysia’s growth is higher than most of Asia’s, it is still less than half of what was predicted when these projects were launched.

Malaysia has big goals and needs investment to pay for them. Mahathir himself has big goals and needs investment to legitimize them. The prime minister may flaunt the effects of his economic program, but he knows they are not the miracle cure for Malaysia’s economy.