http://www.bangkokpost.net/today/050501_News25.html

Bangkok Post
6th May 2001

Exit tax removed, but currency peg to stay

During the Asian economic crisis, Prime Minister Mahathir Mohamad openly railed against foreign speculators for bringing down the value of the ringgit. The ringgit/dollar peg was meant to curb such activities. How then, can Mr Mahathir possibly remove the peg and still maintain political credibility?

S. H. Chong, Kuala Lumpur, Bangkok Post

Slightly more than two years after Prime Minister Mahathir Mohamad imposed stringent capital controls on the economy, the government has finally removed a levy on portfolio funds which has dampened foreign investor interest in the country.

Malaysia's ministry of finance announced on May 2 that it was removing, with immediate effect, the 10% exit tax on portfolio funds repatriated within a year.

However, one key remaining aspect of the controls-the pegging of the ringgit to the US dollar-is still firmly in place.

Everyone welcomes the latest move and the stock market's main index jumped to 6,111 points, up 4.61%, the biggest daily gain in 20 months.

But, this is still a far cry from its high of 1,009 points in February last year. It will probably be some time before we ever see the index rising to that level again.

It's a classic case of too little, too late.

Foreigners have already given up on Malaysia. All the stock market analysts and economists this writer interviewed say the same thing: The 10% exit tax was never the main concern although it was both a nuisance and a burden. Foreign investors were more worried about the country's political risk as well as its poor reputation with regards to corporate governance and protecting minority shareholder interests.

The Mahathir-led United Malays National Organisation is facing a tough time winning back the confidence and support of the Malay grassroots, who are still very divided over the Anwar Ibrahim issue.

A recent government crackdown on Anwar supporters has added to the climate of political uncertainty. So far, 10 activists have been arrested under the draconian Internal Security Act, which allows for detention without trial.

Meanwhile, Mr Anwar is serving a 15-year sentence on corruption and s###my. He claims to be a victim of a political conspiracy.

Foreign investors do not like countries with a high political risk. But what they do not like even more is poor corporate governance. Unlike many countries in the region which are trying to institute structural reforms to their economies, Malaysia's is still very much a political economy.

Critics often cite two recent cases as proof that Malaysia still has not learnt its lesson: the bail-outs of the debt-laden Malaysian Airline System and a troubled telecommunications unit of the Renong Group conglomerate. Both companies are politically well-connected and both were bailed out using public funds.

Foreign investors have been steadily pulling their money out of the country. It has been estimated that some US$18 billion in capital has left the country between 1998 and 2000.

Capital flight has serious consequences. According to the central bank, Malaysia's foreign reserves at the end of March had fallen 4% to US$27.81 billion from US$28.99 billion at the end of February.

Malaysia's reserves peaked at US$34.50 billion in June, last year.

To make matters worse, Malaysia's trade surplus narrowed 40% in March from a year ago due to lower demand for electronic goods. A shrinking trade surplus weakens the foreign reserves and this puts pressure on the ringgit peg.

The fact that other Asian currencies have weakened also puts added strain on the peg.

Lately, there has been intense market speculation that the government is considering devaluing the ringgit. Private economists generally say the ringgit would be fairly valued at 4.20 to the US dollar. Indeed, some business groups have been calling for a devaluation as this would make Malaysian exports more competitive in the international market.

While devaluation would make sense from a trade point of view, there is strong doubt the government would tinker with the peg, which is the cornerstone of Mr Mahathir's capital controls policy.

The controls are not just an economic issue. Like all things Malaysian, it has a political element to it as well. During the Asian economic crisis, a very vocal Mr Mahathir had openly railed against foreign speculators for bringing down the value of the ringgit. The peg was meant to curb such activities.

How can Mr Mahathir possibly remove the peg-the last bastion of his controls policy-and still maintain political credibility? Besides, a devalued ringgit would have a negative impact on the country's biggest corporations, many of which have foreign currency-denominated borrowings. A devaluation would see their repayments on these loans increase.

It would also cause consumer prices to rise because much of Malaysia's food and consumer products are imported. The political cost would simply be too high and the government cannot afford any more controversies at this juncture.

Zeti Akhtar Aziz, governor of the central bank, has said that devaluing the ringgit would only serve to create uncertainty and would not encourage domestic industries to be more productive.

And, she has not drawn any lines in the sand on what would cause the central bank to adjust the peg.

"We don't go by lines," she said. "Life is not so straight forward. It is very complex."How so very true-especially when you're talking about Malaysia.