KUALA LUMPUR — Impressed with what she saw for herself during a state visit to Malaysia in August 2001, President Gloria Macapagal-Arroyo went home pondering the possibility of duplicating Prime Minister Mahathir Mohamad’s controls on the financial system as a way of curbing speculative activity on the Philippine peso and stabilizing the economy.
At the end of that visit, Mrs. Macapagal-Arroyo publicly expressed admiration for her host and said she was not ruling out Mahathir-style capital controls to protect the peso. At the time active trading on the foreign-exchange market saw a steady erosion in the value of the peso against most currencies.
She said then that was just might adopt a fixed exchange rate and capital controls as a strategy for striking back at currency speculators whom she accused of being behind the peso’s sharp decline in the currency markets in recent weeks.
Mrs. Macapagal-Arroyo never actually pursued her threat. Perhaps it was because the Bangko Sentral ng Pilipinas, the country’s central monetary authority, was able to quell the speculation with its own initiatives. Or perhaps the flow of dollars from Filipino workers abroad proved to be a strong force against the speculators.
But was Mrs. Macapagal correct in looking at that option? It must be noted that apart from the high cost of defending a currency peg, any country implementing that policy also risks isolation from the rest of the world financial community.
Malaysia’s capital controls, it will be remembered, did not prove effective enough to prevent a contraction of seven percent in the country’s economy during the fixed-currency regime’s first year. It was also noted later that nervous investors still managed to get their money out despite the controls.
Today, however, there is a lot of respect being shown for Mahathir’s scheme. The economy is again growing at a steady rate and the currency, the Malaysian ringgit, is one of the strongest in the region, if not the world.
Mrs. Macapagal-Arroyo was due to arrive in Kuala Lumpur on Feb. 23 to attend the 13th Summit of the Non-Aligned Movement, a grouping of 116 developing countries that seek a fairer treatment from their former colonizers in the West. If she would take up the topic of capital controls in her brief tete-a-tete with Dr. Mahathir, Mrs. Macapagal-Arroyo might find out that the Philippines cannot possibly be in a position to adopt the same strategy.
The Malaysian prime minister, in a new book The Malaysian Currency Crisis: How and Why It Happened, puts the blame on “rogue currency traders” and “big capitalist powers” for severe financial and economic turmoil that his country suffered in 1997-98.
Malaysia’s currency went on a rapid decline and its stock market weakened dramatically shortly after its neighbor Thailand let go of its defense of its own currency, the baht. At the time, analysts said the sudden downturn in Malaysia was due to “bad governance and the contagion effect of the fall of the Thai baht.”
The fall in the value of the ringgit and stock-market capitalization looked likely to be continuous and could not be arrested, Mahathir recalls in his new book. Malaysians, he says, were “bewildered as they found themselves suddenly impoverished.”
The country and the government were completely unprepared to deal with the seriously deteriorating economy, Mahathir writes. Not because Malaysians were not competent enough to cope with the problem, but mainly because they were confident that the economy was doing well before the crisis came.
Indeed, for 10 consecutive years, Malaysia grew by more than eight percent annually. There’s more: the country had always been politically stable and economically resilient. The ringgit, Mahathir argues, was strong and the nation’s international debts were well within accepted limits. Indeed, Malaysia was able to “prepay loans repeatedly.”
These qualities should be assessed more carefully by Philippine officials if they are serious in adopting the Mahathir formula. Even now, after being proclaimed as the least affected of Asian countries during the worst of the Asian crisis, the Philippines is also heavily indebted. Trade remains weak. So are investments.
And while Malaysia boasts a strong government that is in control, the Philippines continues to grope for a way to becoming a “strong republic.” Witness the extreme difficulty that the administration goes through in securing legislation needed to support important economic initiatives.
Malaysia appears strong enough to cope with any adverse impact of imposing the September 1998 capital controls. A look at the situation the Malaysian economy was in during that difficult period could also show that the Philippines may not have achieved the same result if it did the same. Not now, for that matter.
Mahathir’s government was so confident that the economy was strong that it even pledged a $1-billion loan to Thailand when its neighbor started to suffer from a weakening currency. This is how Mahathir describes the Malaysian fundamentals when the crisis erupted:
The ringgit’s exchange rate was generally stable not only against the US dollar but also against the regional currencies. Against the currencies of two of Malaysia’s neighbors, Thailand and the Philippines, the ringgit was stable at 1 ringgit to 10 Thai baht and 1 ringgit to 10 Philippine pesos.
The ringgit did appreciate against the Indonesian rupiah but this was due to the rupiah’s weakness against most currencies, including the ringgit.
The Thai baht, unlike the ringgit, was fixed by the Thai government at about 25 baht against the US dollar. Mahathir says that since the baht rate against the ringgit was steady at 10, “there was a wrong perception among some” that the ringgit was also pegged against the US dollar at 2.50.
On the back of the currency stability (at 2.50 against the US dollar) Malaysia was doing very well. At the end of 1996, real gross domestic product grew at almost 8.5 percent per annum for 10 consecutive years and it looked like this rate of growth was going to continue for many more years.
By 1997 total external trade reached more than $158 billion, making Malaysia, according to the World Trade Organization, the 18th biggest exporting nation and the 17th biggest importing nation in the world.
The government was enjoying a fiscal surplus. The external debt was generally low, at 40 percent of gross national product. The current account of the balance of payments had narrowed from a deficit of 10 percent to five percent of GNP, and was expected to improve further. Inflation was down to its lowest at 2.1 percent.
Mahathir adds: On the financial front, the banking system was sound, as reflected in the strong capitalization and the high asset quality. The average risk-weighted capital ratio (RWCR) of the banking system was more than 10 percent, compared to the minimum international standard of eight percent.
Non-performing loans (NPLs), even using the stringent three-month classification, was only 3.6 percent of total loans outstanding. The banking system was already subject to international prudential standards. Almost all the 25 Core Principles for Effective Banking Supervision recommended by the Bank for International Settlements (BIS) had been adopted.
Malaysia’s savings rate, at 38 percent of GDP, was one of the highest in the world. The national savings was sufficient to finance 95 percent of total investment outlays.
Perhaps the Philippines should first find ways to achieve this same level of stability before it considers copying the Mahathir solution to the 1997 Asian crisis. There lies the Philippines’ real problem.