Of currency turmoil, scapegoats and postponed dreams

Ensuring Socio-economic Justice

Mohammed Hassan

Rabi' al-Awwal 27, 1418 1997-08-01

South-East Asia

by Mohammed Hassan (South-East Asia, Crescent International Vol. 26, No. 11, Rabi' al-Awwal, 1418)

The thinly veiled reference by the Malaysian Prime Minister, Mahathir Mohammed, to the alleged role of George Soros in the precipitate fall of currencies in the ASEAN region belies a desperation which is beginning to grip the erstwhile over confident leaders of the emerging economies of the Far East. As the UK weekly Economist put it, these leaders who had taken to lecturing western leaders on anything from their phenomenal growth rates to the distinct nature of “Asian Values” will have to be more circumspect as the growth “miracle” is looking increasingly fragile and prone to a nasty downturn.

The stock markets in the region have fallen by over 25% this year, whilst those in London and New York are breaching new peaks. Fund managers who had taken a flutter on the emerging markets of the Far East in the hope of above average gains are nursing their wounds. If the situation does not change, then these very fund managers can precipitate an even larger fall in the stock markets of the region as they stampede out of these markets. In the currency falls the region has already had a taste famous herd instinct of fund managers .

Exchange Rates have weakened and all currencies are significantly weak against the US dollar. The Thai Bhat, in particular, has fallen very much like the Mexican Peso two years ago. Even with a US$16 billion rescue package being put together by the IMF and countries in the region, it is still unclear if the rot has been arrested. The economic cost at the very least would be a trimming of the Thai growth rate by over 3% per annum. Throughout the region, overseas investors - providers of private capital flows in World Bank parlance - are watching nervously. Their overall returns predicated on fixed exchange parities and appreciating stock values supported by 8-10% per annum GDP growth rates are under threat.

If the Thai setback is to be repeated in other countries in the region then growth rates will be revised downwards. If this downward revision is significant - say a scaling down of average growth rates from 8-10% to 5-7% range then further capital flows will become scarce and existing portfolio investments will begin to be liquidated. The virtuous circle of larger capital flows enabling higher growth rates to be financed can easily be reversed into a classic trap of faltering capital flows scuppering growth and heralding a recession. How did the present situation arise? Most countries in the region rely on export led growth fuelled by capital inflows. Thus the current account deficits are typically financed by capital inflows. However, care needs to be taken that the capital inflows continue at higher rates and that they are utilised for productive investments rather than conspicuous consumption or grandiose projects. For, sooner or later, there will be returns and profit repatriation on capital flows and these need to be financed from productive investment returns. Typically in a growing economy there is a mismatch between investment and returns, which is financed by capital inflows. However, this mismatch has to be carefully managed and investor confidence in a positive eventual outcome maintained. For this exercise to take place successfully liberal investment incentives and free capital flows are essential.

In Malaysia’s case, there are a number of problems which need to be addressed. The country is running a persistent current account deficit of US$4-5 billion per annum. This is too high and needs to be addressed. Secondly, the country has not yet succeeded in technology and know how transfer to the extent hoped for. Thus, for example, for the national car Proton - still some 45% by value of the components are imported from Japan. The Malaysians like to emphasise that over 75% by volume are now locally made, thus disguising the vital value added technology component which is imported. Thirdly, the country has been prone to periodic scandals which absorbs most of the surplus revenues from oil sales. Thus the BMF scandal in Hong Kong cost over RM$4 billion, this was followed by the propping up of non-performing loans of banks like Bank Bumiputra. Then the Malaysian Central Bank lost over RM$8 billion in currency speculation! Then ingenuous ways were found to fund the expansion of the ruling UMNO’s funding requirements. The list goes on.

This has been compounded by the launching of the Vision 2020, the year in which Malaysia hopes to attain industrialised country status. Malaysian planners have calculated that this requires annual growth rates of over 9% per annum for the next twenty years or so. They thus continually dream of mega projects to fuel growth. Typical of these is the ambitious Cyberjaya-cum-Multimedia Super-Corridor project. This comes on top of the near completion of the tallest building in the world and the commissioning of the longest building in the world! There are some US$20 billion projects in the pipeline. Malaysian planners reckon that these will boost growth rates to beyond 10% per annum and thus comfortably deliver Vision 2020.

Just as the hype was beginning to grip Malaysians and all ilks of global carpet beggars, the country’s export growth rate began to slow down. Similar trends in the region meant that investors began to scale down the region’s growth rate and the bubble began to burst with the precipitate fall in the Thai currency. Some projects like the Bakun Dam - have already been postponed or delayed . If capital flows do not resume their upward trend then many others will remain as pipe dreams.

The problem is that leaders like the Malaysian Prime Minister, would not listen to their planners now indicating that Vision 2020 may be delayed. Even the planners will find it very difficult to deliver this kind of a message to the haughty PM. The charade will go on, and instead of managing a soft landing for the economy, frantic activity to prop up an increasingly wobbly growth rate will continue in earnest. Already, several floatations on the Kuala Lumpur Stock Market, guaranteeing massive windfall gains to the “chosen” coterie of UMNO-linked functionaries have been postponed. While investors have been reacting to the changing economic realities in the region, politicians would like to blame their loss of credibility on unscrupulous speculators like George Soros. The fact of the matter is that in a regime of free capital flows economic realities will dictate the rates of exchange and capital flows. Speculators can distort it for a time, but they will only do so if they believe that their reading of the fundamentals is at variance with the market. In Malaysia’s case Soros seems to have had very little to do with the currency and market falls - investors’ worries about megalomania is at the heart of the problem. As he sees Vision 2020 in peril Prime Minister Mahathir’s concern is understandable. However, it is vital that the correct cause of the malaise be diagnosed and appropriate remedies applied. Otherwise, in an age where vast economies like China, India, Pakistan to name a few, are vying for the pool of global capital flows, the country can find itself in dire straits.

Malaysia’s problems are duplicated in the region with some variations. As such the region as a whole needs to understand that its tiger economy status has to cope with more difficult circumstances and find new ways to generate sustainable growth. The currency and market falls should form the catalysts for this kind of re-thinking instead of desperate tirade on “speculators”.

Courtesy: The Muslim News, London

Muslimedia - September 1-15, 1997

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