9th June 2001

Daim Zainuddin goes as Malaysia's finance minister.

ONCE more, Malaysia's prime minister has taken the reins at the finance ministry. In September 1998, Mahathir Mohamad snatched them away from his then deputy prime minister, Anwar Ibrahim, who is now in prison, and slapped capital controls in place to cope with regional turmoil. He eventually handed the job to Daim Zainuddin, a wealthy power-broker and long-time ally who had helped to devise the controls as part of a wider recovery plan. Malaysia's economy outpaced most of its neighbours in 1999 and 2000, defying predictions. Now the economy is back in trouble. And on June 5th Dr Mahathir announced that he would, temporarily, take over the finance job again, following Mr Daim's departure.

This time, however, a sharp change in policy seems unlikely. Whatever his differences with Mr Daim-and rumours of a rift began circulating a year ago-Dr Mahathir has given no hint that he might question parts of Malaysia's macroeconomic game-plan, such as its fixed exchange rate or its effort to prime the fiscal pump. More importantly, although the country's structural policies, and in particular its cosy brand of capitalism, did indeed drive a wedge between the two men, the differences appear to be largely ones of public relations. Several big bail-outs in recent months, of businessmen close to Mr Daim and the ruling party, have drawn ferocious public criticism. But, although Mr Daim's departure will take off some of the heat, it would be surprising if Dr Mahathir followed this up with real reforms.

Start with the macroeconomic problems. A worldwide slowdown has hurt Malaysia more than its neighbours, because of its dependence on exports of electronic goods, especially to America. After expanding by 8.3% last year, GDP grew by only 3.2% in the first quarter, with manufacturing output braking sharply. That will weigh on corporate balance sheets, many of which were never set in order after the region's financial crisis of 1997-98.

Falling regional currencies are also eroding Malaysia's edge. After fixing its exchange rate at 3.80 ringgit to the dollar in September 1998, it gained a competitive boost over its floating neighbours as the region recovered; but now that process has gone into reverse. The government is no longer relying on capital controls to prop up the currency, having removed all but the last barriers only a few weeks ago. But it dismisses any suggestion that it should abandon the fixed exchange rate, arguing that economic stability will outweigh any loss of competitiveness.

Now Malaysia is feeling the tug that dragged down so many fixed currencies before it. After posting impressive gains in 1999 and early 2000, the stockmarket has fallen by 36% over the past 12 months; it has been the worst-performing index in Asia this year. The slide has been driven partly by fears of a devaluation-and if it continues, it could help to make one necessary. A recent report by Deutsche Bank points to the repatriation of profits by multinationals and to private and other capital outflows. Pressure on the currency is likely to increase.

Dr Mahathir's government continues to coddle businesses with historic links to the ruling party, and has done little to encourage firms to use capital more judiciously. Last December, the government paid an associate of Mr Daim twice the market price for his 29% stake in Malaysian Airlines. In February, three government-run funds, including the state's central pension fund, snapped up stakes in TimedotCom, a telecoms firm controlled by another of Mr Daim's associates, after retail investors shunned its public offering. The subsequent losses led even Malaysia's docile trade unions to pipe up.

The bail-outs do not inspire investors, particularly overseas ones, to plunk their money on Malaysia. But the resulting public outcry has also added political risk to the equation. After two decades in power, Dr Mahathir has said that he will step down before the next elections, due by 2004. Many Malaysians do not believe him, however, and for others it will not be soon enough. Most troubling for Dr Mahathir is the strength of the backlash from members of his own party, the United Malay National Organisation (UMNO). But given UMNO's historic links to so many businesses, things could get even more interesting when Dr Mahathir fills another of the posts that Mr Daim has vacated: party treasurer.

(c) The Economist Newspaper Limited, London 2001. All rights reserved.

Source: ECONOMIST 09/06/2001

http://www.asiaint.com/adb/ADB352.asp#aib3

Asia Intelligence

8 June 2001

Mahathir reluctant to alter ringgit peg

Development: Malaysia's industrial output contracted for the first time in 27 months in April, with the manufacturing sub-index falling 2.1% year-on-year. National industrial output might register just 1% growth this year compared to 20% growth in 2000.

Assessment: The poor news for Malaysia's economy was blamed on the lagging effect of the slowdown in the US and the concomitant drop in world demand for electronics products, a staple Malaysian export. The US accounts for one-fifth of Malaysia's exports, and even though US factory orders rose 1.8% month-on-month in March, growth was too low to prevent a drop off in production in Malaysia.

Growth forecasts for the economy as a whole in 2001 have already been slashed this year, with the official target being cut from 7% to 5%-6%. The manufacturing sector is forecast to grow just 8.5% compared with almost 20% growth in 2000. A sharp decline in exports is the most worrying factor behind the pessimism - in April exports fell to 27.5bn ringgit ($7.23bn) from 28.9bn ringgit in April 2000.

Despite the downward trend, illustrated by falling international reserves and outflows of funds, Prime Minister (and acting Finance Secretary) Mahathir Mohamad is still reluctant to alter the ringgit peg of 3.8/$, which many economists see contributing towards poor export figures. Devaluation of other currencies in the region has not changed his mind. On Thursday he pointed out that devaluation would help exports only in the short-term, and would be offset by rising imports that would force up the cost of living and hence push wages higher. "Of course, there may be instances when we might have to devalue our currency", Mahathir said, "but not at the moment".

Mahathir does not want to abandon the policy that brought stability after the 1997-98 Asian financial crisis, and has been critical of external influences on Asian economic affairs. On Thursday he reiterated his opposition to globalization and resisted pressure to alter his idiosyncratic regulatory policies. Referring to the financial crisis, he said: "All that happened in Malaysia, in south-east Asia, and in east Asia [was] due to the operations of the free market. If this is what the free market holds for us, is there any reason why we should welcome it?" With this rationale any change in the ringgit peg in the near future looks unlikely.