Economy of Malaysia - Background - Asian Financial Crisis and Recovery

Asian Financial Crisis and Recovery

The year 1997 saw drastic changes in Malaysia. There was speculative short-selling of the Malaysian currency, the ringgit. Foreign direct investment fell at an alarming rate and, as capital flowed out of the country, the value of the ringgit dropped from MYR 2.50 per USD to, at one point, MYR 4.80 per USD.The Kuala Lumpur Stock Exchange's composite index fell from approximately 1300 to nearly merely 400 points in a few short weeks. After the controversial sacking of finance minister Anwar Ibrahim, a National Economic Action Council was formed to deal with the monetary crisis. Bank Negara imposed capital controls and pegged the Malaysian ringgit at 3.80 to the US dollar. Malaysia refused economic aid packages from the International Monetary Fund (IMF) and the World Bank, surprising many analysts. By refusing aid and thus the conditions attached thereof from the IMF, Malaysia was not affected to the same degree in the Asian Financial Crisis as Indonesia, Thailand, and the Philippines.

Regardless, the GDP suffered a sharp 7.5% contraction in 1998. It however rebounded to grow by 5.6% in 1999. The Government of Malaysia predicted 5.8% real GDP growth in the year 2000, but most analysts predicted growth will exceed 8% for the year.

In order to rejuvenate the economy, massive government spending was made and Malaysia continuously recorded budget deficits in the years that followed. Economic recovery has been led by strong growth in exports, particularly of electronics and electrical products, to the United States, Malaysia's principal trade and investment partner. Inflationary pressures remained benign, and, as a result, Bank Negara Malaysia, the central bank, had been able to follow a low interest rate policy. The Malaysian economy recovered from the 1997 Asian Financial Crisis sooner than neighbouring countries, and has since recovered to the levels of the pre-crisis era with a GDP per capita of $14,800.

The post Y2K slump of 2001 did not affect Malaysia as much as other countries. This may have been clearer evidence that there are other causes and effects that can be more properly attributable for recovery. One possibility is that the currency speculators had run out of finance after failing in their attack on the Hong Kong dollar in August 1998 and after the Russian ruble collapsed. (See George Soros)

The fixed exchange rate was abandoned on July 21, 2005 in favour of a managed floating system within an hour of China announcing the same move. In the same week, the ringgit strengthened a percent against various major currencies and was expected to appreciate further. As of December 2005, however, expectations of further appreciation were muted as capital flight exceeded USD 10 billion. According to Bank Negara's published figures, Malaysia's foreign exchange reserves increased steadily since the initial capital flight, from USD75.2 billion as at 15 July 2005 (just before the peg was removed) to peak at USD125.7 billion as at 31 July 2008, a few months before the global credit crisis that started in September 2008. As at 29 May 2009, the reserves stood at USD88.3 billion. In spite of the large positive current account surplus, foreign reserves have started to fall at a rapid rate. Official statistics released in March 2006, confirmed capital flight of more than US$10 billion. However, as of the 4th fiscal year, a surge of FDI has pushed the KLSE above 1200 points, and is expected to strengthen to pre 1997 levels.

In March 2005, the United Nations Conference on Trade and Development (UNCTAD) published a paper on the sources and pace of Malaysia's recovery, written by Jomo K.S. of the applied economics department, University of Malaya, Kuala Lumpur. The paper concluded that the controls imposed by Malaysia's government neither hurt nor helped recovery. The chief factor was an increase in electronics components exports, which was caused by a large increase in the demand for components in the United States, which was caused, in turn, by a fear of the effects of the arrival of the year 2000 (Y2K) upon older computers and other digital devices.

In September 2005, Sir Howard J. Davies, director of the London School of Economics, at a meeting in Kuala Lumpur, cautioned Malaysian officials that if they want a flexible capital market, they will have to lift the ban on short-selling put into effect during the crisis. In March 2006, Malaysia removed the ban on short selling. It is interesting to note that some of the measures taken by the Malaysian government in response to the Asian crisis, such as the ban on short selling, were swiftly adopted by the very countries that had previously been critical of the Malaysian response.

Regardless of cause and effect claims, rejuvenation of the economy also coincided with massive government spending and budget deficits in the years that followed the crisis. Later, Malaysia enjoyed faster economic recovery compared to its neighbours. The country has recovered to the levels of the pre-crisis era – as an example, the KLCI Composite Index hit an all time high of 1,386 on 20 June 2007 which is approximately 100 points higher than the pre-crisis record of 1,275 in 1993. While the pace of development today is not as rapid, it is seen to be more sustainable. Although the controls and economic housekeeping may or may not have been the principal reasons for recovery, there is no doubt that the banking sector has become more resilient to external shocks. The current account has also settled into a structural surplus, providing a cushion to capital flight. Asset prices are generally back to their pre-crisis heights, despite the effects of the global financial crisis. As of 21 May 2007, the Ringgit touched a nine-year high record at 3.39 against the US dollar. Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz says the Ringgit moves up on its own merit and in line with the Malaysian economy and not in tandem with the Chinese Yuan. Malaysia has shown the ability to absorb the crude oil price increases and most economies have shown high resilience in absorbing higher energy prices. Malaysia is the world's largest Islamic banking and financial centre.