http://www.atimes.com/se-asia/CH25Ae01.html

Asia Times
25th August 2001

DIRE STRAITS

Persons before country

By Anil Netto

Malaysia has barely avoided slipping into a technical recession and faces a testing time as it scrambles to cope with the global slump in the electronics sector. Despite posting slightly better than expected second quarter GDP figures, the country is likely to struggle to stay in positive territory for the whole year. So far, it has been saved by some deft pump-priming and its more diversified economy compared with those of its neighbors, such as Singapore.

GDP grew by just 0.5 percent year-on-year in the second quarter after recording a revised 3.1 percent year-on-year growth in the first quarter. Last year, the economy grew by 8.3 percent. In a measure of how times have changed, the authorities seem relieved that the economy grew 1.0 percent over the first quarter to reverse a 3.9 percent quarter-on-quarter contraction in January-March, thus avoiding a technical recession.

The economy was hit by a 6.7 percent year-on-year drop in manufacturing in the second quarter, largely due to a 25 percent plunge in the electronics sector. Unemployment crept up to 4.0 percent as multinational electronics firms slashed production forecasts and trimmed their workforces. Some 20,000 workers have been laid off and the Malaysian Trades Union Congress predicts that the figure could rise to 90,000.

Other sectors, however, have cushioned the manufacturing slump. Services grew 6.1 percent as a result of low interest rates, which boosted bank lending for housing and consumer durables, and an expansion in the telecommunications sector. Construction rose 3.2 percent as the effects of the government's expansionary policies and pump-priming infrastructure projects began to be felt. Agriculture increased by 1.3 percent due to higher crude palm oil production while mining grew 0.7 percent, reflecting higher natural gas output.

"Based on the first-half performance [of the economy] and the global outlook, it is likely that the third quarter growth will be similar to that of the second quarter, while the fourth quarter will perform better," Zeti Akhtar Aziz, Malaysia's first woman central bank governor, said on Thursday.

That may be a trifle optimistic as no one can say for sure when the electronics industry will climb out of the hole it is in. The central bank has been way off the mark before: it earlier revised its economic growth to 5-6 percent for 2001. Now even that is way too high. A further downward revision in the official GDP growth forecast is in the cards for October, when the 2002 budget will be presented.

Economists polled earlier by Bloomberg News had forecast growth for 2001 to slow to 0.8 percent. Many private analysts are now forecasting anything from 0 to 2 percent growth for the whole year and that is assuming things don't get any worse.

While Zeti may be banking on brighter fourth-quarter prospects, not everyone in the electronics industry shares that optimism. "We are looking at a turnaround only in the third quarter of next year," says a components marketing officer at a giant Japanese multinational electronics firm based in Penang, Malaysia's "Silicon Island".

Such a delayed turnaround could have far-reaching consequences for the economy. Still, the positive GDP growth of 0.5 percent in the second quarter is slightly better than expected as many analysts were predicting a contraction. Some of them have suggested that the positive second-quarter growth figure may not be sustainable as it was secured on the back of government pump-priming (public sector consumption grew by 4.8 percent) at a time when private sector consumption remained weak, posting only 1.6 percent growth.

On a brighter note, net international reserves rose from RM98.8 billion (US$26 billion) in the second quarter to RM104.3 billion as of 15 August, largely as a result of the drawdown of proceeds from $1 billion 10-year Notes issued by the federal government, inflows from trade and foreign direct investment, and a net inflow of portfolio funds.

The reserve level is now equivalent to 4.1 months of retained imports while external debt was RM158.4 billion as of the end of June, equivalent to about 50 percent of GNP. The current account surplus dipped from RM13.3 billion in the first quarter to RM12.5 billion, but is expected to remain at 6-7 percent of GDP. But worryingly for future production capacity, imports of capital and intermediate goods fell by 11 percent each.

How will the banking system fare? Nonperforming loans (NPLs) rose from RM52.2 billion to RM58.6 billion during the second quarter, though a third of the increase was "due to reclassification of loans previously granted indulgence", said the central bank.

Based on an excess capital of RM18.6 billion above the 8 percent minimum RWCR (risk weighted capital ratio) requirement as of June 30 and unaudited pre-tax profits of RM4 billion not yet included in the capital base of the banking system, the central bank maintains "there is sufficient capital to absorb any potential losses from any increase in NPLs".

Zeti said the government's growth strategies would continue to stress the contribution of domestic demand to broaden the sources of growth and to develop a more diversified, resilient economy. At the same time, she said the authorities had introduced stronger measures in order to hasten corporate reforms. These included "initiatives to further de-leverage corporate debt and improve operational restructuring".

But the key question, as always, is whether such reforms will be enough in the wake of the departure of former finance minister Daim Zainuddin, whose tenure was marred by several controversial corporate deals that fueled allegations of cronyism and bail-outs.

In a recent commentary, political economist Terence Gomez predicted that, with Prime Minister Mahathir Mohamad now serving both as prime minister and as finance minister, government agencies would likely be used to take over the enterprises of Daim's business associates.

"Eventually, ownership of most of this equity will have to be passed back to the state or to individuals aligned to Dr Mahathir," he said.

With such executive hegemony over the state, the nature of corporate - and public - governance henceforth will depend entirely on Mahathir, who has now promised greater transparency and accountability, observes Gomez. "However, as long as power is centralized in the hands of a dominant executive, investors will be skeptical of corporate deals undertaken in the 'public interest'."