rajah rasiah 2

7/26/2019 Rajah Rasiah 2

1/21

l\'Ionetary

Economics

,&

@

I

nere were

some

signs of

an overvalued

ru rrency.

Rapid credit

expa

nsion

and increased

exposure

to

the

property

sector

were

getting

worrisome.

when

it

was at

a

level

of

2.79,

to

2.43

in August

1995.

This

was

a

gain

of

almost 15

percent in

its value.

One

might

arbitrarily

take

the value

of the

ringgit

in

the

period of earlv

7994

to

early

7995

as a

benchmark

value.

It

is worthwhile

to

point out

that

the

Malaysian

economy

registered

a

substantial

current

account

deficit of

RM21.6

billion

(US$8.6

billion),

or

L0.4 percent

of

nominal

GNP

in

1995.

That

year, the balance on long-term

capital

(RM16.6

billion)

was

insufficient

to

finance the

current

account

deficit

and

the basic

balance registered

a

deficit

of

RM5.0

billion. Net private

short-term

capital amounted

to

only

RM2.5

billion and the

overall

balance

was in deficit

by RM4.4 biltion. Despite

the

overall

balance

being

in

deficit for

two

straig-ht

years

and

the fears br-

analysts

of

a

current

account blow-out, the

ringgit actually

strengthened

against

the U.S.

dollar

by

the

end

of 1995

(2.54)

compared to

year-end

1993

(2.70).

Flence,

the

ringgit

appeared

overvalued

when

the

crisis

unfolded.

5. State

of the

Banking

Sector

Despite

the

high

loans

growth

over

the

preceding few

years,

the health

of

the

banking

system

appeared to

be excellent.

At

the

end of

June

7997,

the

month

before

the

attack

on the

currency

started, the net

NPL ratio of

the

banking

system

was at

2.2

percent. The risk-weighted

capital

ratio

(RWCR)

was

12

percent, significantly

above the

minimum

requirement

of eight

percent.

Notwithstanding

the

favourable

indicators

above,

there

was

rapid

credit expansion

and

increased

exposure to the property

sector.

With

the

economy being

so

highly leveraged, it was

made more vulnerable

to

a

speculative

attack

on

its

currency

as

the

central

bank will

be

constrained

in

the

use

of the interest

rate

instrument

to defend the

exchange rate.

Also,

when

there

is

rapid

credit growth

over a short

span

of time,

especially

in

view

of

an increasing

exposure

to the

property

r"itor,

it may

not

be

prudent

as some

of the

borrowers

could be less

creditworthy. Declining

asset prices

in

an

economic

downturn would

also

pose

high risks

to banks

with loans

secured

using

property

and

shares as

collateral.

The

central bank

was

slow

in

responding

to this

uneasy

trend,

taking

corrective action

only

in

early

7997,just

months

before the

first

attack

on the

ringgit.

The

sluggishness in

policy

response

probably

contributed

to investors'

nervousness.

The

worries

over excessive

credit

expansion

through

the

banking

system

and its

implications

on

potential

bad debt

was

also

prompted

by

concerns

that

the

business

sector

is

linked

to

the

government

with

a

certain

amount

of tonnected lending'

not

necessarily

based

on

commercial

criteria.@

Athukorala

(1998a)

also

oplned that

the

reiilience

of

the

banking

system to

a

crisis may

have

been

'weakened

over the

years because

of

the

growing

dominance

of

local,

relative

to

foreign,

banks'.

Presumably,

he

was

alluding

to

the

perception

that

the

foreign

banks were less

susceptible

to

any pressure from

the

government

to influence

lending activities

@

S"" Athukoral

a

(7998a,

p.

93). Gomez,

et al.

(7997)

observed that influencing

bank

lending

activities

has been

part

of the New

Economic

Policy

(NEP)

strategy

of

restructuring

business

ownership. Athukorala

(1998a)

also

mentioned

that the

stock market has

been a

'key

instrument

used ...

to achieve the

political

goals

of

restructuring

wealth

ownership in

the economy'.

Rasiah

(2000)

argued

that the NEP

cultivated

cronyism

that was driven

by patronage

rather than

performance.

\_


2/21

The Use of Monetary

Policy

in

Crisis

Management

compared to local banks

and, thus, had a lower risk

profile.

This

perception

seemed to be also prevalent among

depositors

at the end

of

7997 and

early

1998 when

smaller

(domestic)

financial

institutions

faced

withdrawals

from

concerned depositors

and experienced some problems

with

their

liquidity.o

Apart from

the risks

associated

with

the

banking

system,

the

question

of

the independence

of

the central bank

(and

the related issue

of

credibility) was brought

to the

fore. Athukorala

(7998a),

for

example,

observed

the

'long

silence

of

BNM'

on

the

issue

of

rapid

credit

expansion

until

just

months

before

the

onset

of

the

first

attack

on

the

ringgit in mid-

1997.

The indications

are that

the central bank had been

guilty of

a lax

monetary

policy

in

the

period

prior

to the

crisis.

6.

Build-up

of

External

Debt

External

debt

exposure

of the

economy was

not

very high

at

the onset of

the

crisis.

Total

external debt

outstanding amounted

to RM101.2

billion

at

the

end of

March

1997

(38.8"h

of

GNP;

140.3%

of

net

international

reserves),

of

which

71.5

percent was

medium

and

long-term

deb|

the

remaining

28.5

percent

being short-term

debt.

However, it is

noted that

there was a

steady

build-up

of external

debt

ffi

by the

private sector

and the

non-financial

public enterprises

(NFPEs)

starting

from

7992. Private

sector

medium

and

long-term

external debt

rose

from

RM5.4

billion in

March

7997

loRM37.7

billion

in

June

1997,

an increase

of almost

seven-fold. The

NFPEs

started accumulating external

debt

from

1993

onwards-medium

and long-term debt

rising from RM12.0

billion

in

March

1993

to

RM32.5 billion

in

June

7997;

an increase

of

2.7

times. As

for

short-term external

debt

exposure, the

banking

sector's debt rose

from

RM11.3 billion

in

December

1995 to RM27.B billion

in

June

7997;

an

increase

of almost

2.5 times

over

a

short period of

L8 months.

The rapid build-up in

external debt

in

the

years

preceding

the

crisis

in

7997

was

probably facilitated by

a

very

stable exchange rate

of

the

ringgit

against the

U.S.

dollar.

During

this period,

domestic interest

rates

were

not

very high;

otherwise

there

would

have

been added incentive to borrow

more

from abroad.@

G*

WW

ONSET OF

THE

CRISIS

From

the

earlier section,

it

was clear

that

there were several signs of

vulnerability in

the

Malaysian

economy

prior

to the

currency

crisis

in7997.

0

To a significant extent, this perception that

the

foreign-owned

banks are less exposed

to risks may have been

justified

if

one looked at the list

of

banks which

sold NPLs

to Danaharta

(the

asset

management

company

set

up to

help in

cleaning up bank

balance sheets)

-

most of the foreign banks

did not have to do so. For a

couple

of

foreign banks which did

so, the

value

of the

loan

rights acquired amounted to only

0.15

percent of the total for the

period

June-December

1998.

(Source:

Danaharta,

^

Operations

Report: 20

June

7998-Sl December 1998)

@

1o*o

(7gggb,

p.

183) noted that much

of

the foreign

debt was dollar-denominated,

short

term and unhedged'.

There was

a

steady

build-up

of

external debt b'i'

.

the

private

sector

and the

NFPEs.


3/21

l,lcneiar\.

Economics

The crisis

in Thailand

threatens

to spill

over as

investors

got

nervous.

x/

The

ringgit

plunged

to an all-

time

low against

the

U.S.

dollar in

early

1998.

Together

with

the

ringgit

depreciation,

the

stock

market

plunged.

*

Following

the Thai

baht

tumble,

this

caused

serious

concerns

for investors'

particulaily

portfolio

investors.

This

was

no doubt

influenced

by

the

facr

that

most

of the

international

financial

community

had

failed

to

perceive

the

very

real

risks

in

some of

the

crisis-hit

economies.

Ouattara

(1995

remarked

that

'in

hindsight, it

is

clear

that most

of

these

(capital)

inflo\\-'

(to

East

Asian

economies)

did not

show

sufficient

concern

for

the

potentia,

risks'.

Thus, once

the

Thai crisis

started

to

become

full-blown,

the

prospecl:

for

self-fulfilling

panics were

rife.

As

Dornbusch

(1998) so

aptly put

it:

,vulnerability

is

in part

an objective

fact

but,

just

as

in

the

case

cr

bank

runs,

in part,

it

is

in

the

eyes

of

the

beholder.'

,Safety

first

is

the

motto of

investors

when

they

smell

a

rat.

Thus, one

vulnerable

economy

after

another

tumbles.'

Ringgit

Fell Under

Pressure

Since

March

7997, the

ringgit

fell

against

the

u.s.

dollar

and

most

of

the

major currencies.

From

a level

of

2.48

against

the

U.s.

dollar

in

March

speculative

attacks

on

the ringgit

saw

it depreciating

to

an

average

tf

Z.SZ

inJuly.

By the end of

that

year,

the

ringgit's

exchange

rate against

the

greenback

had

plunged

to an astonishing3.77.

The

worst

had yet

to

come

In early

January

1998,

the

ringgit

sank to

an

all-time

low

of

4.88

agains:

the

U.S.

dollar.

This

triggered

the

panic

button in

the

business

sector

as

well

as

among

policymakers.

In

August,

the ringgit

was

at

an

average

c:

4.20

against

the

greenback.

This

was

prior

to the

announcement

o{

the

capitaicontrol

mJasures

on

1 September

and

the

subsequent

fixing

of

the

"*"hutlg"

rate at

3.80

to

the U.S.

dollar

the

next

day'

Stock

Market

Plunged

with

confidence

on

the ringgit

shattered,

investors

in the

stock

market

began

mass

selling

on the

KLSE,

causing the

market

to

tumble.

The

KLSE

Colnposite

Index

IKLSE

CI),

which

stood

at

1,,216.7

points

at

the

end

of

lanuiry

1997, ended

the

year at

894.4

points.

In

August

1998,

the

month

tefore

the

imposition

of

the capital

control

measules,

the

KLSE

CI

was

just

302.9

points.

Average

daily

turnover

had plunged

from

about

RM2-3

tiliior"r

in

the first

three

months

of

1997

to

just

RM193

million

in

August

1998.

The

market

capitalisation

of

the

KLSE,

at

RM826

billion

in

Januarr-

7997,had

shrunk

to

RM200

billion

in

August

1998.

Most

would

agree

that

the

ringgit

had

fallen

way

beyond

what

one

might

term

aS

reflective

of

economic

'fundamentals'.

The

circumstances

in which

the

regional

currency

turmoil

occurred

and

the

resulting

sentiments

that

uppeaied

to

influenie

fund

managers

and

currency

traders

were

indeed

r-iq.t".

with

the

seed

of

the crisis

sown

in

the

dramatic

fall of

the

Thai

baht

andihe

Korean

won

following

closely,

stock

market investors and currencr-

traders

wele

shocked

at the

apparent

lack

of

prudential

supervision

on the

part

of

the

authorities.

Added

to

this,

there

were

instances

pointing

to poor

'r11unug"*"r1t

of

the

economy

and

allegations

of

lack

of

transparency.

To

be

fair,

sJme

of

these

allegations

were

well grounded

in

some

countries.

This,

coupled

with

an obvious

lack of

ability

to

differentiate

the

circumstances

between

the

various

economies

in

the

region,

resulted

in

market

players


4/21

I

The Use

of

Monetary

Policy

in

Crisis

seeking

to

highlight

similarities

with

the

Thai

and

Korean cases.

The

result

was a

massive

sell-down

of stocks

and the

dumping

of

domestic

currencies.

Both these

developments

fed on

each

other.

It was a

typical

demonstration

of

herd

behaviour

by fund

managers

and curlency

tradels

alike.

To

a

certain

extent,

there

were

probably

self-fulfilling

prophecies.

These

were

augmented

by

imperfect

knowledge

of country-specific

circumstances

and

unlavourable

sentiments

partially

fed

by

the

inappropriate

handling

of

the crisis

by

some

governments

at

the

initial

stage.

The

vulnerabilities

in

the

Malaysian

economy

highlighted

in

the

earlier

section

caused

investors

to become

nervous over

potential

problems

in

the

economy,

following

the

Tha

i baht

debacle.@

The falling

ringgit

and the

stock

market

collapse

reinforced

each

other's

downward

momentum

and

had

a

profound

impact

on

businesses.

The

financial

system,

in turn,

was

hit by

the

rising

number

of

business

failures

or

company

closures.

The much

weaker

ringgit

also

inflated

the

size

of

foreign

debt

obligations.

Dannpened

Business

Confidence

and

Gonsumer

$entiments

What

started

out

as an

exchange

rate

problem

that some

initially

thought

to

be

transitory

quickly

exerted

a

negative

impact

on

the

real

sector.

Following

the onset of

the

crisis

in

mid-1997,

beginning

from

the

third

quarter

o]

thut

year

up until

the

first

quarter

of

7998,

business

confidence

oJ

manufacturers,

as

gauged

by

the

Malaysian

Institute

of

Economic

Research's

(MIER)

Business

Conditions

Index

(BCI), dipped

sharply

for

three

consecutive

quarters.

Likewise,

the

impact

on

consumer

confidence

was

telling.

The

MIER

Consumer

Sentiments

Index

(CSf

plunged

for

four

conseiutive

quarters

beginning

in

the

third

quarter

of

1997

until

the

second

quarter

otlggl.

The

index

reached

an

all-time

low

in

2Q:98

and

the

quarterly

drop

in

the

previous

quarter

was the steepest

recorded

since

the

inception

of the survey.

?e

..

Busi

ness

confidence

as

.

well as

consumer

sentiments

took

a

bie

hit.

W

rNrrrAL

PoLrcY

REsPoNsE

The

initial

policy

lesponse

was

one

of

stabilisation

measules,

in particular

to

address

the

current

account

deficit,

contain

inflationary

pressures

resulting

from

the ringgit

depreciation,

stabilise

the

exchange

rate

and

prevent

large

outflow

of

short-term

capital.

@

1o1no

(1998b)

mentioned

sending

out tonfusing

signals"

giving

the

impression

of the

,authorities,

wiliingness

to change

the rules

in'mid-game'

and,'bending

of the

rules'

in

the uEM-Renong

case,

as examples

of

undermining

confidence

and

ad-"ersely

affecting

sentiments

at

valious stages

of

the crisis.

In the

UEM-Renong

case, cash-

rich

UEM

(United

Engineers

Malaysia,

a favourite

KlSElisted

comPany

among

foreign

fund managers

up

till then)

was

allowed

to execute

a

reverse-take-over

of its

heavily-indebted

parent

firm,

Renong,

in a

move that

was seen

as

detrimental

to the

interests

of

its minority

(foreign)

shareholders.

It attracted

much bad

publicity-see

for

example,

Fox

(1998).


5/21

lonetary Economics

:

lnitial

policy

response by

central bank

was to slabilise

exchange rate,

contain inflation

and

ensure

soundness of the

:

banking system.

l

Monetary Policy

Response

In response

to

the currency crisis and

its

impact on the real

sector,

the

central

bank

implemented

several measures designed to stabilise

the

exchange

rate,

control

inflation

and

ensure

the

soundness

of

the

banking

system.

It

is noted

that

from

the very beginning

of

the crisis,

monetar)-

policy was

not

as tight as that recommended by the International Monetarl'

Fund

(IMF).

At

the onset of the crisis, the central bank's stance

in monetary

policy

has been

to keep interest

rates

at

a

relatively high level to contain

any

inflationary

pressures

arising

from

the

ringgit

depreciation.

This

was

to

maintain

positive

real interest

rates to

encourage

saving and

to

prevent capital outflow.

BNM

was

of

the opinion that

raising

interest

rates excessively

would not be

effective

in

supporting the

exchange

rate,

given the strong external

factors, and was mindful

of

the

need

to provide

sufficient

liquidity

to

finance

economic

activities. However, beginning

September

7997, when the ringgit

breached

the

3.00

level against

the U.S.

dollar

beyond

most

expectations,

the central bank

acted

to

raise interest

rates

gradually.

The benchmark 3-month interbank rate, BNM's policv

rate, was

raised

from 7.55

percent

in

mid-September

to 8.7 percent by

the

end o{

1997.

Negative sentiments {ollowing

external developments

such

as

the

deprecration

oi

the

l(orean

won

in

December

199?

and

the

ream

collapse

of

the

Indonesian

rupiah

in

early

1998 exerted

a powerful

impact

on

the

ringgit.

In 1998,

following

the

shock

decline of

the ringgit

to

4.88

against

the

U.S.

dollar on

7

January,

the

3-month

rate

rose

to ten

percent

and

further

to 11

percent in

February.

Interest

rates

were

raised

to

stem

inflationary

pressures

arising

from

the

higher

cost

of imports

and

also

to

prevent

outflow

of

short-term

capital.

In

April

7997, concerned

with the strong

growth

in bank

lending

to the

'less

productive'

sectors

and the sharp

rise

in

asset prices,

BNM imposed

quantitative

restrictions

on

loans to the

property

sector

and

for the purchase

of stocks

and shares.

Following

speculative

attacks on

the ringgit since

July

7997,banks

were

also subjected

to

limits

on

outstanding

non-commercial

ringgit

offer-side

swap

transactions

with

foreign

customers effective

4

August 7997.

However, transactions

for trade and direct

investment

were

not

subjected

to

the restriction.

The objective

was

to

reduce

the

supply

of

offshore

ringgit

used to

mount

speculative

attacks on the currency.

In

view

of the

continued

strong

credit

and

money supply

growth and

the

further weakening

of

the ringgit,

BNM enforced

further

measures

in

October

7997.

Financing on

hire-purchase

loans for the purchase

of

non-

commercial

vehicles

was

reduced

to

70

percent of

the purchase

price.

The

repayment period

was shortened

to

not more than

five

years.

Banks

were

also

advised

to prioritise

lending to

activities

such

as the export-oriented

manufacturing

sector.

Additional

lending

guidelines

were announced

in

December

1997

stating

that

credit should

not be

extended

to property

projects

which

have

not

started

construction.

As

for

on-going

property

projects,

strict selectivity

and viability

assessment

were

advised'

In

order

to

detect problem

loans early,

the

classification

of

non-

performing

loans

(NPLs)

for

banking

institutions

was

reduced from

6-months

arrears

to

3-months

arrears effective

1

january

1998. The

disclosure

requirements

for the

financial statements

of

banking

institutions

were

increased to

include

more

information.

This

was to

improve

the level

of

transparency.

re1

to

efj

thr

m(

rer

fi

uI

a\'

J-

ea

P(

re

le

P(

CI

r

bi

1

I

I

I


6/21

The Use

of Monetary

Policy in Crisrs

Management

The central

bank

was also

determined

to ensure

that

the cost of

funds

reflects supply-demand

conditions

and that credit

be

made

available

to productive

economic

activities.

To remove

distortions

and enhance

efficiency

in

the money

market

so

that interest

rates

would better

reflect

the market's

liquidity

conditions,

BNM announced

a

number

of

monetary

measures

in

February 1998.

The

statutory

reserve

requirement

(SRR)

was

reduced from

13.5

percent

to

10.0

percent

on

16

February

7998,

to

provide

financial institutions

greater

access

to funds

that were previously locked

up

with the central

bank.

However, as a

form

of compensatory

measure to

avert

any undue easing

of

monetary

policy

due to the SRR

reduction,

BNM's

3-month

intervention

rate was raised by

100 basis

points

to

11 percent

earlier

on 6

February.

The central

bank

also

reiterated

that

tight monetary

policy

will

be

maintained

in

order

to contain

inflationary

Pressures

as a

result of

the weaker

ringgit. Following

these

measures adopted

by

BNM,

lending

rates

fell from

as

high

as

22percent in early

February

to

about 16

percent

at

the end of

February.@

Beginning

late

March

1998,

in

a move

to

enhance

transparency

and

to

enable

better supervision of

the

banking

sector,

banking

institutions

were

required

to

publish

data

to

indicate

financial

soundness

on

a quarterly

basis. These

included NPLs and capital

adequacy

daia.

They

were

also

required to

maintain, on

a quarterly

basis,

a

minimum 8.0

percent

risk-

weighted

capital

ratio.

To

further

reduce distortions

in

the

financial

system

and

improve

liquidity

managemenf

the central bank

introduced

new

features

in

its

money market

operations.

Effective

1

May

1998, the band on

the

required

balances

to

meet the

SRR

requirement

was

widened

to 2.0 percent

from

the

previous

0.5

percent.

This was to provide

banks

greater

flexibility

in

their liquidity

management.

BNM

also

mentioned that

it will

maintain

real deposit

rates at

pre-crisis

levels

to prevent

outflow

of funds, increase

savings

and stabilise

the exchange

rate.

The

first hint

of

a

change

in

the

stance

of

monetary policy

was on

1

JuIy

7998,

when

the central

bank

further

reduced

the SRR to

eight

percent.

Unlike

the

SRR

reduction

in

February,

which

was

done

to

improve

the

liquidity

situation

of some

banks,

this

was done

to reduce the cost

of

funds.

Gosrdlna&ed

FXseal

Policy

Respomse

Malaysia

had

six

years

of

fiscal surpluses up

tlII 7997.

When the crisis

unfolded

in

mid-7997

and

escalated

as

the year progressed,

the

concerns

that policymakers

had was

one of

maintaining

macroeconomic

stability

through

containing

inflationary

pressures

and

addressing the

current

account

deficit,

as well as

maintaining

investor

confidence.

Even

by the

third

quarter

of

1997,

Malaysia

was

still

experiencing

healthy economic

growth.

Thus,

the

government

budget

for

calendar year

1998,

proposed

in October

7997, showed

fiscal

restraint,

not unlike

that

prescribed

by

the

IMF

for the

other crisis-hit

countries.

In

line

with

the

anticipation

that government

revenue

will be

affected

by an

economic

slowdown,

the

Finance

Minister proposed

a

scaling

down

of

public

expenditure

through

@

Bnnk Negarn

Malnysia

Annunl Report

1998, p. 92.

lnitial fiscal

policy

response

was

one

of restraint,

consistent

with

ll\4F

prescription

for

other crisis-hit

economies.


7/21

Llonetarv Economics

Despite the early

monetary and

fiscal measures,

the ringgit

continued its

slide.

restraining

consumption

spending

and

deferring

projects that u.er.

deemed

as non-critical,

as

well

as privatising

government activities.

-{

fiscal

surplus

of

two

percent

of GNP

was

proposed

in

Budget

1998. Then

by

December,

this fiscal restraint

was tightened further

by

implementin:

an austerity drive which

saw expenditures reduced by ten

percent across

the board

and

a further

cutback of eight percent

on

a

selective basis.

By the

end

of

March

1998,

it

was evident

to

the authorities

that

the

economy

is

slowing down

faster

than

anticipated.

Real GDP

had

contractei

in

the

first

quarter of

1998

by

1.8 percent

compared

to

a year ago

(this

u'as

later revised to

a

contraction

of

2.87').

Although

the government

reducei

the

fiscal

surplus

to

just

0.5 percent

of GNP,

it

allocated an

additional

R\11

billion

for

socio-economic

projects to benefit the more vulnerable

groups

in

society.

The

tight fiscal policy

maintained

at the beginning

stages

of

the

crisis, to a certain

extent,

may

have

been

dictated to by financial market

expectations.o

The

economic slowdown would have caused government

revenue

to

fall

and,

hence,

there certainly was

merit

in containing public

sector expenditure. Nevertheless, given

the

fact

that

the

economy

\\,as

going

into a

steep

downturn and the poor investment

climate

even then,

the

likelihood of crowding-out from

running

a

budget

deficit was much

less.

Thus,

fiscal

policy

could have played

a

more

stimulating

role

even

at

that early

stage, in

view

of

the

government's strong

fiscal

record of

the

past.@

lmpact

sf

lnitial

Poliey

Stance

Despite the

earlier

fiscal and monetary

measures,

the ringgit's exchange

rate

continued

to

be affected

by

external

factors beyond the

control

oi

policymakers. After hitting an all-time

low

of

4.88 against

the

greenback

in

early

January

1998, the

ringgit

was still

weak in

August,

when

it

was

at

4.20. The

riots

in Indonesia in May,

the weakening of

the

japanese

yen

in

june

and

the devaluation of

the Russian

ruble

all

exerted negative

impact

on sentiments on the

ringgit.

The

tight

monetary

and

fiscal

policies

allowed the current

account

deficit

in

the balance of payments

to be

contained

(subsequently

registering

a

huge surplus

for

the year due

to

a

slump

in

demand for imports)

and

also helped to

contain

inflationary

pressures

at

reasonable levels. Flowever,

@

Garnaut

(1998,p.19)

noted that there

'seemed

to

be

discordance between good policy,

on

the

one

hand, and international

market perceptions of good policy, on the other'.

iomo

(1998b,

p. 190) pointed out

that

'it

is not as

if

the government

did

not respond

at all, but

rather

that

it did not respond in the manner desired by

"the

market", i.e.

mainlv the Western financial communitv'.

@

th"

.rle of

u more

stimulating

fiscal

poli.y

*u.

noted

in

mid-1998

by

Ariff,

et

nt.

(1998a):

'...in

the

event

of

a

significant

slowdown

in

the

economy,

fiscal

policy

may

have to be more

stimulating.

The cash-strapped

private

sector

is not in

a

position to

stimulate a flagging economy. Thus, the public sector

will have to play this role. The

surplus budgets that we

had in

the past

few

years

were appropriate in light

of

the

robust

economic growth.

However,

if

the

economy

slows down significantly, then

a

mild

expansionary

fiscal policy r) /a Keynesian economics may be

in

order. ...

A

balanced

or even

a

small

deficit budget is clearly more

appropriate

than a surplus

budget under the present circumstances.'


8/21

The

Use

of Monetary

Policy

in Crtsis

llanagement

179

Detlatronarl

impact

was felt

stronglv

in the

real

economv.

"

Short

term

capital

outflows

were

registered

in

the

balance

of

payments.

&....

wThe

stock

market

continued

to

plunge.

w

4i

:'

*

-

together

with

the effect

of

a

massive

depreciation

in

the

exchange

rate and

th

negative

wealth

effect

of the stock

market

plunge,

this

was

achieved

at

the

coJt

of exacerbating

the

fall

in

aggregate

demand.

if

left

unchecked,

the

recession

would

have

become

deeper

and

the

banking

sector

saddled

with

higher

bad

debts.

That

would

have

prevented

it from

continuing

to

play

its

,ol"

us

financial

intermediary

and severely

ieopardised

economic

recovery

prospects.

-

in"

current

account

balance

turned around sharply in

the

first quartel

of

7998,

registering

a surplus

of

RM6.5

billion

compared

to

a

deficit of

RM1.9

billion

in

the

pr"rrions

quarter.

This

was

achieved

through

ihe

improvement

in

the

merchandise

balance

which

more

than

offset

the

deficit

in

the

services

balance.

However,

the

adjustment

in

the current

account

balance

was not

well

reflected

in

the

net

international

reserve

position

of

the country.

This

was due

to

the

large outflow

of,short-term

iapital

in

the

first

q.tuit"t

of

7998.

Net

private

short-term

capital

registered

a

deficit

of

RM9.2

billior-t

that

quarter.In

4Q:97,

there

was

a huge

outflow

of

RM9

billion

which

was

unaccounted

for

and

placed

under

'errors

and

omissions'.

This

item

may

well

reflect

short-term

capital

flows

(or

capital

flight)

that

were

not

captured.

Net

international

reserves

in

the

first

quarter

of

7998

declined by

RM1.9

billion.

In

the

second

quarter

of

1998,

although

the current

account

balance

showed

a larger

surplus

amounting

to

RM8.5

billion,

private

short-term

capital

again

iecorded

u

d"ficit

of

RM4.6

billion.

Nevertheless,

the

large

cuirent

account

surplus

and the

positive

net inflow

of

long-term

capital

were

still

not

well

captured

in the

net

international

reserve

position.

There

was

a

huge

negative

amount

that

was

unaccounted

for

that

quarter,

with

,errors

and

omissions'

recording

a deficit

of

RM6.3

billion.

This

may

again

indicate

a

large

net

outflow

of

short-term

capital

or

tapital

flight'.

The

outflow

of

short-term

capital

from

the

financial

system

was

linked

to

the

liquidation

by

foreign

portfolio

investors

in the

KLSE

as

confidence

wus

dampened

and

uncerlainties

increased.O

The

Co-posite

Index

of the

KLSE

plunged

from

745.4

points

in

February

1998

to

455.6

points

by

end-

|une.

However,

the

ringgit

outflow

was

also

triggered

by very

attractive

offshore

rates

of

between

20-40

percent,

which

provided

a

hefty premium

over

domestic

rates

of

about

11

percent

at

that

time.@

The

large

outflows

of

portfolio

investment

were especially

evident

in the

second

and

third

quarters

of

1998.

Due to

the

high

domestic

debt

level

in the

economy,

the

sharp

rise

in

interest

rates

by

the

central

bank

in

response

to

the

depreciating

currency

had

an

adverse

impact

on

the

business

sector

and

consumers.

Firms

that

borrowed

from

banks

had

higher

debt

obligations.

The

sharp

rise

in the

cost

of

imported

input

due

to

the

ringgit's

depreciation

also

contributed

to

the business

sectols

difficulties.

Infrastructure

projects

with

high

import

content

were

deferred.

As

the business

climate

deteriorated,

consumels

became

more

cautious

and

spent

less.

This

was worsened

by

the negative

.

.

r

1l

.,

,.i

''

.

9

Dornb.rsch

(1998) termed

this

type of

phenomenon

as

a

'liquidation

scramble'.

@

Ia i, unclear

why

such

high offshore

rates wete

offered

for ringgit

deposits

at

that

time. one

possibility

waslhat

speculators

who had

sold

the

ringgit short

(and

drove

its exchange

rate

dor.r,n)

wanted

to cover

their

forward

contract

obligations

and thus

bid

high

for

the

ringgit

but

still

made

huge profits

from

the

plunging

exchange

rate.


9/21

lrTonetarv Economlcs

Business and

co n5u m

er

confidence

were

badly affected.

Credit

growth

reversed and bad

loans increased.

Liquidity

crunch

had

a

telling

effect on

the real

economy.

;.:

wealth

effect

following the

collapse

of

the KLSE.

|ob

losses as

companies

downsized

or

closed

also added

to

the

negative consumer

sentiments.

On top

of

all

this, the

much hoped for export

sector-led

recovery never

materialised

as

external

demand was

hampered due to

the widespread

crisis

in

East

Asia.

Japan,

which

many

crisis-affected

countries

had

hoped

to

depend on as a

growth

pole

to

puII out

of

the recession,

continued

to

be

mired

in

its

own

economic

and

financial

problems.

Following

the

economic

downturn which

affected demand

for

loans

and coupled

with the

caution

of

the banks

in

extending

further

credit,

loans

by

the

banking

system

fell sharply

in

1998

to

a contraction

of

1.8 percent or

RM7.6 billion

in

quantum

(7997:

growth

of

26.5'/"). As

more

companies

and

individuals

were affected

by the economic crisis

and encountered

problems

with

servicing

their

loans,

the

number

of

non-performing

loans

increased

The net NPL

ratio

of the

banking

system

rose from

4.1

percent

of

total

loans

outstanding

at

the

end

ol

1997

to nine

percent

as at the end of

1998.

This,

together

with

the

erosion

of

the

capital

base

of

some

banks,

restricted

the

capacity

of

some

banks

to

lend.

For

banks which

were

in

a

better position

to

lend,

their

focus on

maintaining their

asset

quality

caused

them to adopt

a

very cautious attitude.

As bank credit

became

more

difficult

to obtain,

this

affected

even

well-run

companies, especially

small

and

medium-sized

ones.

Reflecting

the

decline in economic

activities and

loans growth,

the

monetary

aggregates

continued

its downward

trend. Narrow

rnoney,

M7,

contracted by

16.0

percent

(year-on-year)

by

August

7998, while

growth

in broad

money

M2 and

M3

had

weakened

significantly

to 7.2 percent

and

4.3

percent,

respectively.

Hence,

there

was declining

liquidity in the

economy.

The

impact of

the credit and liquidity

crunch on

the real sector

of

the

economy

was

telling.

The

industrial

production index

dropped

by

77.6

percent

(year-on-year)

in August

that year

while

manufacturing

production

declined

by

14.5

percent.

The economy

started

to

contract

in

the

first quarter

of

1998.

Real

GDP

declined by

2.8

percent

compared

to

the corresponding

quarter

of

1997.

This

contraction

became

more pronounced

in

the

second

quarter

when

GDP

dipped by

6.8 percent

(year-on-year).

For the year

as a whole,

real GDP declined

by 6.7

percent.

Private

consumption

dipped

by

72.4

percent while

private

investment

slumped

by

a

phenomenal

57.8

percent.

On

the supply-side,

the

worst

hit

sector

was construction,

which

dipped

by 24.5

percent, while

manufacturing

contracted

by 70.2

percent.

In the external

sector, exports

declined

marginally

by

0.7 percent

while imports

dropped sharply

by 18.3 percent,

reflecting

the adjustment

to

a weaker

ringgit

and especially

the

dip in

private

investment.

W

cHANGE

rN

PoLrcY

srANcE

By mid-1998,

it

became clear

that the

initial

policy

response

had

perhaps

outlived

its

use.

The

changing

conditions,

especially

the

sharper than

anticipated

economic contraction

caused

by

both

depressed

domestic

demand

and sluggish export

growth,

together with concerns

of declining


10/21

-

-

.

:EJ

J

bank

asset

quality,

suggested

an

urgent

re-thinking

of

policy.response'

Stability

ir-r

tne

io-"iil.

financiai

market

was

not

obtained

through

the

current

policy

stance

and

the

exchange

rate

continued

to

be

volatile

whilethestockmarketremaineddepressed.Continuedpursuanceofthe

fr"r"r,t

course

of

monetary

and

fisial

policies

would

most

likely

have

iu.rr"d

a

steeper

decline

in

economic

growth

and

destabilised

the

situation

further.

At

this

stage,

both

monetaly

and

fiscal

policies

needed

to

be

more

expansionary.

This

is

to

enable some

reflation of

the

economy

to provide

staUltity

for

consolidation

and

reforms

to

be

carried

out'

In

an

environment

of

extremely

volatile

exchange

rates

and

with

an

open

capital

account,

the

conduct

of

monetary

pol1cy

threatened

to

become

g',iato.t."a'Thecentralbankgrappledwitllthedilemmaoftwopossible

Sptions:

either

maintaining

hlgh

interest

rates

to

support

the

exchange

.ut"

1b.rt

without

ur-ty

urr.rrld

siccess)

and,

in

the

proc,ess'

further

choking

u.y

prorp"cts

of

economic

recovery;

or

aggressively

.easing

monetary

conditions

to

boost

aggregate

demand'

(complemented

by

a

fiscal

boost)'

b.rt

rur-t

the

very

r"ut

tlt"k

oT

seeing

the

exchange

rate

plunge'

given

the

very

negative

external

sentiments

prevailing

at

that time'

"

Choosirlg

either

option

could

prove

to

be

disastrous

as

each

was

fraught

witilextreme

.isks

that couid

lead

to

adverse

consequences.

Had

ihe

luthorities

picked

the

firsl

option,

the

economy

would

likely

have

contracted

further

and

faster

as

debts

rise

and

company

closures

cause

further

unemployment.

There

would

have

been

more

firms

and

individuals

Jefaultir-tg

orrbank

loans,

thus

causing

the

banking

system

to

deteriorate

further.

An

economy

sinking

deeper

into

recession

and

with

banks

,.r""1"g

into

difficulties

woulJhavelaced

a

daunting

task

of

stabilising

its

e"chun[e

rate

(even

with

higher

interest

rates)

as

the

risk

premium

would

rise

treinendously.

Also,

raising

interest

rates

aggressively

would

attract

mostlyshort-termcapital,theverytypeoffundsthatarenotsoughtafter

at

that

stage

due

to

its

volatile

nature'

Choos"ing

the

second

policy

option

would

probably

have

meant

more

capital

outflfw

(due

to

lower

interest

rates

and

expectations

of

further

..irr"'r.y

depreciation)

and

the ringgit,s value

falling

further. This

would

have

added

to the

cost

of

imported

i"t-tllutiot-,.

Companies

with

high

external

J"U,

"*por.rre

will

see

their

debt

obligations

rise

further.

Importers

and

"*port"i,

would

have

had

to

tolerate

increasing

exchange

rate

volatility.

The

stock

market

would

have

taken

a

further

battering

through

massive

selling

by

foreign

investors

(probably

local

ones

as

well)'

This

would

put

even

more

downward

pr",,t'i"

on

ttre

ringgit'

Importers

paying

in

foreign

currency

would

have

hedged

their

positi,ons

in

anticipation

of

further

J"pr".iutior-,

of

the

ringgitjhereby

contributing

further

to,the

fall

in

the

domestic

currency.

Opting

to proceed

along

this

path

would

have

meant

a

strong

possibility

of

u

-ulot

capital

flight,

depleting

much

needed

foreign

."r"ti"r.

A

much

*eakei

"*thutlg"

rate

(and a

very

likely

downgrade

in

sovereign

rating)

would

have been

very

costly

as

it

would

9ele"rely

hamper

the

gov?rnmeni;s

ability

to

raise

any-

external

funds

needed

for

the

fiscal

stim"ulus

and

implement

reforms

in

the

financial

sector'

Analysingtheoptionswiththeirriskfactorsintheabovepolicy-setting

environment,

it

was

obvious

that

policymakers

must

first

break

the link

between

domestic

interest

rates

and

the

exchange

rate

before

any

measures

can

be

taken

to stimulate

aggregate

demand

and

stop

the

economy

from

Tne:;"4:--

caliec

':'

:

'.-

think

of

tr.

)

polic_r' respc

r

se

"

i\4aintaining

high

interest

rates

will

choke

off

economic

activities,

but

easing

off

will see

the

exchange

rate

plunge.


11/21

t82

X4onetary

Economrcs

Faced

with

the dilemma,

p

o

licyma kers

decided

to

break

the link

between

interest

rate

and

exchange

rate by

implementing

capital

controls.

This

enabled

the

nursuit of

expa

nsiona

ry

monetary

and

fiscal

policies

to

boost

aggregate

d,emand.

The capital

control

measures

did

not affect

foreign

direct

i

nvestment.

x

going

into

a deeper

recession.o

This can

be

done

through

capital

controls

ind

pegging

the

ringgit

exchange

rate

to

a

major

international

currencr-

such

as

the

U.S.

dollar.

The

Malaysian

authorities

decided

on this

option

on

1

Septemb

er

1998,

when

the capital

control

measures

wele

announced

and

enforced.

The

next

day,

the

ringgit

was pegged

to

the

U.S.

dollar

at

3.80.@

This

policy

option

was

chosen

so

as to

insulate

the

economy

from

the

continu"d

udt

"ir"

external

situation

and

to

regain

some

measure

of

monetary

autonomy

which

will

enable

policymakers

to

better

address

problemi

in the

economy

and

facilitate

its

recovery.

Of

particular

concern

io

policymakers

was

the

disruptive

nature

of

short-term

speculative

capital

flows

on

financial

markets

and

economic

activity.

The

capital

control

measures

did

not

disrupt

trade

and

FDI

flows,

and

the

current

account

remained

fuliy

convertible.

The September

measures

enabled

the

pursuit

of

an

expansionary

monetary

policy

and

a

complementary

fiscal stimulus

to

boost

aggregate

demand.

7;

It

is important

to

note

that

the capital

control

measures

affected

onh-

short-term

iapital

flows.

Transactions

for

trade

in

goods

and

services

were

not

affected;

neither

were capital

movements

pertaining

to

foreign

direct

investment

(FDI).

Foreign

long-term

investors

were

free to

repatriate

profits,

interest and dividenaJ.

fne

government

had

also reiterated

on

several

occasions

that

the

measules

wele

temporary

and

would

be removed

when

its

objectives

were

achieved.

indicating

that

the

measures

introduced

har-e

not

dampened

long-term

foreign

investors,

net

FDI

inflows

in

the

first

four

months

ottssg

rose

sharply

to

RM8

billion

compared

to RM9

billion

for

the

whole

of

1998.

In fact,

the

government

actually

liberalised

foreign

equitl'

investment

guidelines

in

the

manufacturing

industry,

telecommunications

and

financial

sectors

to encourage

further

FDI it-tflo*t'o

Monetary

PolicY

Further

Relaxed

As

inflationary

pressules

showed

signs

of

moderating,

monetaly

policl'

started

to

be

eased

in

August

1998.

The

steep

decline

in

loans

growth

had

to

be arrested

to

resuscitate

economic

activities.

Otherwise

a

credit

crunch

situation

will

deepen

and prolong

the

recession.

9

rni,

poinr

was

raised

by Krugman

(1998a)

and discussed

by

Athukorala

(1998b).

@

attho.rgll

capital

controls

cun

be enforced

without

fixing

the

exchange

rate,

in

this

case,

it was ob,riont

that

the

increased

certainty

from pegging

the

ringgit

at 3'80 to

US$1

was

needed

judging from

the continued

Volatility

in

the currency

markets.

Implementing

the

capital

controls

without

pegging

the exchange

rate

would

not have

sewed

the

ultimate

objective

of

providing

the

necessary

stability.

Also, given

the

severe

outflow

of short-term

capital

and the

very

high

off-shore

interest

rates

offered

for

ringgit

deposits,

the

RM

had to

be

made

non-legal

tender

overseas.

whatever

trading

in

cuirencies

will

then

be

done

only

domesticalty.

If

the authorities

did

not

fix the

exchange

rate against

the U.S.

dollar,

the tendency

for

hoarding

foreign

currency

and a

black

market

to develop

will

be great.

@

L-r

th"

manufacturing

sector,

100

percent

ownership

by

foreigners

was allowed

for

applications

received

between

31

July

1998

and

31

December

2000. The

share of

foreign

equity

investment

in the

telecommunications

sector

was

raised

to 49 percent

1or-,

u

.ur"-by-case

basls,

this can

go

up to

61 percent

for a

period

of

5 years);

in the

insurance

industry,

it was

raised

to

51 percent;

and

49 percent

in the

stockbroking

sector.


12/21

With

the cover provided

by the capital

control measures,

monetary

policy

was

further relaxed

through lowering

interest

rates.

This

was

achieved

through

progressive

reduction

of the

statutory

reserve

requirement

(SRR)

and

the

intervention

rate

of

the

central

bank

in

the domestic

money market.

The

easing

of

monetary

policy

complemented

expansionary

fiscal

policy

in

resuscitating

the economy.

Bank Negara

reduced

its intervention

rate

rapidly

The

central

bank

reduced

its

3-month intervention

rate

three times

in

the

month

of

August

1998,

from

11

percent to 9.5 percent.

After

the

1

September

capital

control

measures,

the


rate

was

lowered

more

aggressively

by BNM. From

eight

percent

in

September

1998,

it was reduced

to

six percent

in

early

ll/ay

7999.

The

Statutory Reserve

Requirement

was

also slashed

from

eight percent

to six percent

on 1

September

1998 and further

down

to

four

percent

on

16

September.

The liquid

asset

requirement

of

the

commercial

banks was also

reduced

by

200 basis

points in

early September.

BLR

framework

revised

The

formula

for

computation

of the

base lending

rate

(BLR)

was

revised

on

1

September 7998.Instead

of being

based

on the

3-month Kuala

Lumpur

interbank

offer rate

(KLIBOR),

it

was then

based

on the 3-month

intervention

rate

of

Bank

Negara Malaysia.

This

ensured

a more

speedy

transmission

of

changes

in monetary

policy via

the interest

rate

tool

to the

lending

rate

of

banks.

The flat administrative

margin

of 2.5

percent

was

also reduced

by

25

basis points.

The

maximum

margin

over

the quoted

BLR

was

lowered

by 150

basis

points, from

four

percent

to

2.5

percent.

Loans

growth

target

set

for

banking

institutions

The

central

bank

also

enforced

a

loans

growth

target

of

eight percent

to

be met

by

the

banking institutions by

year-end

1998.

Subsequently,

when

it

became

clear

that

in view

of

the

sluggish

loans

growth

in

the first

three

quarters

of

the

year,

the target

cannot

be

met,

BNM

changed

its

stance

to

that

of

encouraging

banking

institutions

which

have

the

capacity

to

meet

this

target

to do

so. The

iarget

date for

the

eight

percent loans

growth

was

then

more realistically

set

at

year-end

1999.

This

was

also

an industry

target and

BNM

reiterated

that

it

did

not intend

to

irnpose

the

target

on

each and

every

single bank.

Relaxation

of credit

terms for

purchasing

property

The

construction

sector

was

perhaps

the

worst

hit by the

crisis.

To boost

the

sector, BNM

relaxed

the

credit

ceilings

imposed

earlier

on the broad

property

sector.

With

effect

from

7

September

1998,

lending

for

the

construction

or

purchase

of

residential

properties

costing

up

to

RM25e000

were

exempted

from

the

20

percent

loan

limit

for

the

broad

property

sector.

From

5

october onwards,

the

60

percent

maximum

margin

of financing

was

lifted

for

the purchase

of non-owner

occupied

residential

propertiei

costing

RM150,000

and above,

as

well

as

the

purchase

of

shophouses

costing

RM300,000

and

above

which

were

not

used

for

doing

one,s

own

business,

and

also

for

the

purchase

of land.

The

Use of Monetary Policy in

Crisis

Management

183

Nlonelar\

pcl

(,

llas furtner

t::.

through lor,

er'

'':

of interest

rates

and

other

ad

min istratir

e

measu res


13/21

Monetary

Economics

Relaxation

of

credit limits

for

the purchase

of

shares

To

boost

the

stock

markef

the

credit

limit

on loans

for

buying

shares

and

unit

trust

funds

was increased

from 15

percent to 20

percent

of total

outstanding

loans

for

commercial

banks

and

finance

companies

on 23 septemb

er

1998.

The merchant

banks'limit

of 30 percent

remained

unchanged.

Easier

financing

for purchasing

cars

The

car

industry

was

also

badly

affected

by the

economic

downturn,

with

sales

of

passenger

cars

plummeting

by

about

60-70

percent in

the

first

three

quarters

of

1998.

To help

sales

pick

up,

the

margin

of financing

for

all

passenger

cars was

increased

from

70

percent

to 85

percent

effective

from

23

April

1998.

This

was

further

boosted

by

another

measure

on 28

July,

when

the

restriction

on the

maximum

repayment

period

was

removed.

Then

on

21

November,

the

margin

of

financing

of

85 percent

was abolished.

Banks

could then

fix

the

percentage

of financing

given

to its

customers based

on

their

own credit

assessment.

Assisting

smaller industries

and

the lower-income

groups

To

assist the

small and

medium-scale

industries which

are

more

vulnerable

to

the

crisis,

BNM

cut the

maximum

lending

rate

under

the Fund

for

small

and

Medium

Industries

from

ten

percent

to

8.5

percent. To

alleviate

the

burden

of

the lower

income

groups, the

same

was

done

for

the

Special

Scheme

for

Low

and

Medium

Cost Houses,

lowering

the

funding

rate

from

eight

percent

to six percent.

Easier

credit

terms

for

credit

card holders

To

boost

private

consumption,

the

central

bank reduced

the

minimum

monthly

repayment

on

credit

cards

by

a

whole

10

percentage

points,

from

15

percent to five

percent

effective 20

November

1998.

with

effect

from

30

December

1998,

the

maximum

finance

charge

per month

cannot

exceed 1.5

percent

(or

18%

per

annum).

Curbing

finance

on certain

types

of new

property

development

Due

to

the

glut

in

certain

segments

of the property

market,

there

was

a

need

to

clear the

backlog

of properties.

From

5

Janu

ary 1999,bank

financing

was

not

allowed in

the development

of

new

residential

properties

and

shophouses

which

cost

more

than

RM250,000

each.

Financing

was

also

curbed

in

the development

of hotels,

office

buildings,

resorts,

clubs,

shopping

complexes and

golf

courses.

Liquidity

improved

and

interest

rates

declined

The

benchmark

3-month

interbank

rate,

which

peaked

at

11.3

percent

in

May-]uly

1998,

ended the year

at an

average

of 6.48

percent

in

December.

It

stood

at

around

3.2-3.3

percent

inJuly

1999.

One-week

money

and

overnight

money/

which

soared

to

a

height

of

35

percent

and S0

percent

inluly

1997

(when

BNM

unsuccessfully

tried

to

defend

the

ringgit

against

speculative

attacks),

declined

to an

average

of

5.85

percent

and

5.41 percent

respectively

in

December

7998.

The


rate

of BNM,

at a

peak

of 11

percent for

much

of 7998,

stood

at 6.0

percent in

June

1999. This

lowered

the

b

1

tt

ir

T

I

rl

5

t

e

tr

a

a

i:

a

a

t

-I

t

c

c

:q

e

1

I


14/21

''

,

-,

i'

r-"

-

-

_

.l

The Use of

Monetary

Policy

in

Crisis

\{anagement

185

base

lending

rate

(BLR)

of commercial

banks

to

8.04 percent

in

December

1998,

from

a

height of

72.27 percent

in

june.

This

lowering

of

interest rates

:

-;

::--ncnic

reco\rery would not have been possible

had

it

not

been

:,-: ine

capital

conttols

and

the

fixrng

of

the

ringgit

exchange

rate.

3

"d

Financial

Sector

Restructuring

Tne

capital

control

measures and

pegging

of the exchange

rate

were

done

:. rt to merely bolster the

economy

by pursuing

a

high

growth

policy

per

:r,

Following this route

would

have been

a

mistake

as

there

will

come

a

.ime when the

authorities

may need to

lift the capital

controls

and float

the

erchange

rate again.

If efforts

to

improve

economic

efficiency

and

reforms

,o

clean

up

and

strengthen

the financial

sector

were not

done

promptly

and

effectively,

then

the breathing

space that

the September

1998 measures

accorded

Malaysia

would have gone

to waste.

Hence,

the government

put

rn

place

a

comprehensive

programme

to

reform

its banking sector

and

accelerate

progress

in

the

implementation

of these

reforms.

Although

the

bankingsystem

entered

the crisis

in what

appeared

to be

a

strong

position,

with a

low

NPL

ratio and

adequately

capitalised

(above

the

minimum

required

level),

it

was

in

a

position

of

some

vulnerability.

This was made

more evident

when the currency

crisis

dragged

on and

the

economy

worsened.

The lax

monetary policy in

the

years

before the

crisis

had

allowed

high

loans

growth

to continue

unabated.

It

was not

until

early

1997,

months before

the

first

speculative

attack on

the

ringgit,

that the

central

bank

acted

to

curb excessive

credit

expansion

to

certain

vulnerable

sectors such

as the broad property

sector,

loans

for

the purchase

of stocks

and

consumption

credit.

Thus,

by

7997

the banking

system

had

a high

loan

exposure.

Bank loans also

constituted

a

large

portion

of

the

financing

requirement

of

the economy.

The increased cost

of capital

and

higher cost of

imports

(particularly

imported

input for

the business sector)

steadily

took

its toll on companies.

The

deflationary impact

exerted

itself

on

the

asset

quality

of

the

banking

system. By end-June

1998,

the NPL ratio of

the

banking

system

had

risen

to

8.9

percent of

total

loans.

Banks became

concerned

with

their

balance

sheets

and

huge bad debts

for some

banking

institutions

had begun to

cause

worries about

their

capital

adequacy.

Resulting

from

this,

bank

loans

growth

began

to slow

down

rapidly and

even

sound

companies

then

ran

the

risk

of being

unable

to

obtain much needed credit.

These problems

had

to be addressed

quickly.

Together

with an

appropriate

macroeconomic

policy, a programme

for

restructuring

the

financial

system

was

absolutely

crucial

in

the recovery

process.

This was

done through

establishing

an asset

management

company

(Pengurusan

Danaharta

Nasional

Berhad),

a

special

purpose

vehicle for

recapitalising

ailing banks

(Danamodal

Nasional

Berhad), and

the Corporate

Debt Restructuiing

Committee

(CDRC).@

A programme

of

bank

mergers was

also announced,

in

order to

create

bigger

and

stronger

banking entities

better

able to

face

shocks.

The

functions

of

Danaharta,

Danamodal

and the CDRC

are briefly

discussed

as

follows.

@

See

Rasiah

(2001).

A comprehensive

reform

programme

for

the banking

sector

was

needed.

An asset

management

company

and

a

special

purpose

vehicle for

recapitalising

ailing

banks

were

set

u

p.


15/21

Monetary

Economics

Danaharta

Pengurusan

Danaharta

Nasional

Berhad (or

Danaharta)

was

established

on

20

June

1998; lts

function

being

to

purchase

non-performing

loans

(NpLs)

from

banking

institutions

so

that they

can

be

free

to

concentrate

on

their

lending

activities

in order

to facilitate

the

economic

recovery.

Danaharta

also

aimed

to

maximise

the

recovery

value

of

these

loans.

Danaharta

was

given

statutory

backing

to

perform

its

functions.

In

its

operations,

it

adopted

a

market-based approach

and published details of

its

acquisitions,

including

the

amount

of NPLs

acquired

from

individual

financial

institutions

and the

average

discounts

apphea.

In

its acquisitions,

Danaharta

gave

priority

to

the

weaker

financial

institutions.

This

included

those

seeking

recapitalisation

from

Danamodal

Nasional Berhad

(or

Danamodal).

It

also

managed

loans

of selected

financial

instituti.ons

on behalf

of

BNM

or the

government.

This

was

done

to facilitate

mergers

between

identified

financial

institutions

by

preserving

the

strength

of the

acquiring

institution.

Danaharta

did

not

purchase

ai

the

NPLs

of

the banking

institutions

but

the remaining

poition

was

at

manageable

levels.

However,

banking

institutions

with

a

gross

NpL

ratio

exceeding

ten

percent

had

to

sell all

their

eligible

NpLs

to

Danaharta.

otherwise,

the value

of

these

loans

would

have

to be

written

down

and

restructured.

Banks

which required

recapitalisation

from Danamodal

also

had

to sell

their

eligible

NPLs to Danaharta.

In

acquiring

NPLs

from

the banking

institutions,

Danaharta

also

performed

its

other

role

of assisting

in

corporate

sector

restructuring.

This

was

because it

had the

power

to

impose

conditions

on borrowers,

for

eximple

in

matters

pertaining

to

restructuring

of assets

and

improving

cash

flows.

It was

also

vested

with

the authority

to

appoint

'special

administrators'

into

viable

companies

facing

temporary

cash

flow

problems.

It

has

to

be

stressed

that Danaharta

purchased

NpLs at

fair

market

value,

which

often

meant

that

banking

institutions

selling

their

eligible

NPLs

incurred

losses.

As

payment

for

NPLs

acquired

from

the financial

institutions,

Danaharta

paid

cash and/or

issues

zero-coupon

tradable

bonds

which

were

government-guar

rajah rasiah 2

Documents