The Asian Financial Crisis: The Malaysia Experience

1. The Asian Financial Crisis: The Malaysia Experience ECN 4149 Current Issues in Financial Economics Law Siong Hook Department of Economics, UPM

2. Introduction • Malaysia has undergone 4 major crises since independence • The two oil crises of 1973-74 and 1980-81 • The second commodity crisis of 1985-86 • The financial and currency crisis of 1997-98

3. Introduction… • There has been much discussion about the causes of this last crisis. • Two explanations 1.the key reason for the turmoil was simply panic, with sudden shifts in market expectations and loss of confidence resulting in financial chaos across Asia

4. Introduction… 2.Second hypothesis has argued that the crisis reflected an unsustainable deterioration in macroeconomic fundamentals and poor economic policies in the affected Asian countries

5. Introduction… • In Malaysia, the economic crisis evolved from the financial sector • Starting when there was a sudden withdrawal of short-term capital flows from the country following the floating of Thai baht in July 1997 • This created a wave of uncertainty and volatility in the foreign exchange and stock markets

6. Introduction… • Panic-stricken investors started to pull out short-term capital on a large scale causing a steep depreciation of the currency and higher interest rates • Property prices fell sharply owing to the overexposure of the property sector, fuelled by speculative demand during the period before the crisis

7. Predictable Crisis Conditions? • Before the crisis happened, there were sceptics regarding the Asian economic miracle • Paul Krugman had argued that: • Asian productivity levels were low and most countries had poor economic policies and fragile financial systems • Asian countries had relied too much on short-term foreign currency dominated debt

8. Predictable Crisis Conditions? • Some economic slowdown in Malaysia was seen in the decade since the mid-1980s • The slowdown interacted with factors such as weak financial systems, sizeable short-term international capital inflows to the private sector and erosion of confidence in the country – the result was crisis

9. Predictable Crisis Conditions? • Malaysia’s • lower debt service ratio • High savings and comfortable reserve position • Lower short-term capital inflows Gave it relatively strong economic fundamentals compared to neighbouring countries

10. Predictable Crisis Conditions? • The contagion effect spread quickly, reflecting the growing deterioration of confidence in the state of the economy • The Malaysian government’s inability to handle the crisis at the initial stage

11. The Impact of the Financial Crisis on the Malaysian Economy • Before the outbreak of the crisis, Malaysia had experienced: • Annual growth rates of 8.5% between 1991 – 1997 • Low inflation and unemployment rates • High savings and low external debt • Rising per capita incomes reduced the incidence of poverty from 16.5% to 6.1% during the same period • The Standard of living improved greatly

12. The Impact of the Financial Crisis on the Malaysian Economy • The crisis saw • GDP contract by 7.5% in 1998 • unemployment  from 2.7% to 6.4% in June 1998 • Inflation rate peaked at 6.2% in June 1998 • Private investment shrank as a result of uncertainties arising from volatile exchange rates, declines in both local and external demand • FDI declined sharply

13. The Impact of the Financial Crisis on the Malaysian Economy • The poverty rate increased to 7% in 1998 • Drastic decline in share and property prices caused a negative wealth effect and severely affected the consumption pattern of Malaysian people • Poor performance of stock market – fall in share prices • Increased interest rates

14. Malaysian Government in Response to the Crisis: IMF Policies • Malaysia initially implemented measures akin to the standard IMF prescriptions for crisis economies • Raising interest rates • Reduced government expenditure

15. The Impacts of IMF Policies • However, the IMF policies caused: • Severe liquidity problems in the corporate sector, which had adverse impacts on the real economy • As the real economy deteriorated further, and the financial system grew increasingly unstable in 1998 • The Government decided to alter its conduct

16. Malaysian Government Action • The National Economic Recovery Plan • Restructuring the Financial Sector • Control of External Influences

17. The National Economic Recovery Plan • In August, the Government consulted over 200 organisations and individuals through the National Economic Action Council (NEAC) and formulated the National Economic Recovery Plan (NERP) • NERP aimed to strengthen domestic economic fundamentals and deal with inherent weaknesses in the system

18. The National Economic Recovery Plan • The fundamental concern of the NERP was to restore the economy to its pre-crisis growth rate, if possible, to exceed pre-crisis growth performance • Specific measures were implemented to promote overall economic activity: • Reducing interest rates • Improving liquidity in the banking system • Reinstating public expenditures

19. The National Economic Recovery Plan • As identified by the NERP, the imperfect operation of the banking sector and the volatility of the international environment were among the major influences contributing to the 1997 economic crisis

20. The National Economic Recovery Plan • Two factors gave clear guidance to the NEAC in helping to formulate an appropriate recovery plan • The realisation that the crisis originated primarily out of an over-reliance on the banking sector to meet the funding needs of most economic activities • Strong external influences on the domestic economy

21. Restructuring the Financial Sector • Over-dependence on the banking system had led to a rapid growth in banking loans averaging 25% during the period prior to the crisis • When the crisis struck, non-performing loans (NPLs) rose sharply and paralysed the banking sector • Ensure the effectiveness of the banking system in carrying out its intermediary function

22. Restructuring the Financial Sector • Setting up of Danaharta, Danamodal, and the Corporate Debt Restructuring Committee (CDRC). • Bank consolidation programme among local banking institutions, through the Central Bank

23. Restructuring the Financial Sector • Two agencies were set up to restore confidence in banking institutions • Pengurusan Danaharta Nasional Bhd was set up in June 1998 – as an asset management agency to purchase and manage the NPLs • Danamodal Nasional Bhd was assigned the job of recapitalising banking institutions

24. Restructuring the Financial Sector • The CDRC was set up to help address corporate debt restructuring by providing an avenue for both debtors and creditors to find solutions to their debt problems outside the courts

25. Control of External Influences • Selective capital control measures were introduced in September 1998 for Malaysian reforms work • Convertability of the ringgit abroad • A moratorium on the outflows of capital and profits for 12 months and restrictions on exporting Malaysian currency • The ringgit was pegged at RM3.80 to the dollar

26. Control of External Influences • The selective capital controls seems restrictive, from time to time, they were relaxed sequentially to serve their purpose better • The Malaysian economy responded relatively well to these recovery measures

27. Control of External Influences • After 5 consecutive quarters of negative growth, economic growth turned positive in the second quarter of 1999 • Impressive recovery of the manufacturing and agriculture sectors • Demand from the external sector and public expenditure • GDP recorded a 5.8% growth rate in 1999 • Low inflation and improved employment