World Bank traces Mahathir’s banking solutions that saved MalaysiaDecember 19, 2017
One of the immediate reform measures undertaken by the authorities in 1998 was to consolidate the highly-fragmented banking system.
Prior to 1997, there were more than 77 banks and the authorities decided to consolidate the sector.
At that time, existing institutions did not have the resources to compete with their regional peers or provide a wide array of products and services.
To enable commercial banks to unload their non-performing loans and foreclosed assets, the Government passed the Pengurusan Danaharta National Berhad Act in August 1998.
A second institution, Danamodal Nasional Berhad (Danamodal), was established as a special purpose vehicle under BNM to facilitate the recapitalization of viable banking institutions.
As a result, Malaysia emerged from the AFC with a significantly stronger banking sector.
The country emerged from the crisis with no bank closures, with a high recovery rate on non-performing loans, and stronger banking institutions.
The government also implemented currency controls, amid talks by critics that there would be negative expectations regarding the impact of the controls were not fulfilled.
Instead, the controls enabled BNM to reduce interest rates to a level that would have been impossible without their imposition.
The reduced interest rates alleviated the credit crunch, affecting both strong and weak firms alike.
As a result, fewer firms went bankrupt and the subsequent costs of restructuring and recapitalizing the financial sector were smaller.
In addition, after the initial stimulus package, the combination of policies allowed the economy to recover with less reliance on fiscal expansion.
Finally, there is little evidence to suggest that the introduction of the capital controls affected investors’ decisions as to whether to mobilize capital to Malaysia.
The World Bank also recalled how the Government initially responded to the Crisis by taking steps consistent with conventional economic wisdom at the time.
The objective of these measures was to restore investor confidence in the Malaysian economy and to restrain the capital outflows.
However, Malaysia’s implementation of these measures did not produce the intended results.
In particular, the increased interest rates resulted in a credit crunch that particularly affected small and medium-sized firms and that generally sapped the strength of Malaysia’s private sector.
This undermined the prospects of a recovery, including in export-orientated businesses.
As a result, the economy contracted by 7.4 percent in real terms, with a sharp decline in investment and private consumption.
With the tightening of public expenditure, the Government announced a three percent surplus in the 1998 budget.
The stock market lost 60 percent of its value and the ringgit depreciated sharply as a result of market speculation.
By the beginning of 1998, it had become clear that far from facilitating recovery, the adopted policies were hurting the economy.
Confidence continued to decline and the credit crunch exacted a heavy toll on the private sector, resulting in loss of employment and a fall in living standards.
It became clear that a new approach was needed.
The establishment of new coordinating institutions helped ensure streamlined decision making and timely policy responses as the crisis evolved, allowing for course corrections once it became clear that the initial response was not working.
in July 1998, the National Economic Recovery Plan was announced.
This plan was intended to restore market confidence, to facilitate the restructuring of corporate debt, to recapitalize and restructure the banking sector, to stabilize the ringgit and to stimulate the economy through counter-cyclical scale and monetary policies.
To stimulate an economic recovery, BNM changed its approach and implemented a series of expansionary measures.
First, the BNM gradually reduced interest rates, with these rates going down from 11 percent in July 1998 to 5.5 percent in August 1999.
Second, the monetary authorities reduced reserve requirements to increase liquidity in the financial system, with the reserve requirement being reduced from 13.5 percent in February 1998 to four percent by September of that year.
Also, to revitalize the credit market, BNM established targets for banks to achieve a minimum loan growth rate of eight percent for 1998.
Finally, to increase the banking sector’s flexibility to operate in the stressed market, BNM reversed the decision it had initially made related to the definition of non-performing loans when it had reduced the number of months for a loan to be in arrears to be classified as non-performing from six months to three months.
To support economic recovery, the Government also implemented an expansionary fiscal policy, synchronized with the accommodative monetary policy stance.
In order to revitalize the economy and to restore confidence, the Government implemented a counter-cyclical fiscal policy that included both tax incentives and investments in infrastructure.
In July 1998, the Government launched a fiscal stimulus package that implied a reduction in the fiscal balance by 4.2 percentage points, going from a surplus of 2.4 percent of GDP in 1997 to a de cit of 1.8 percent in 1998.
By 1999, with the economic situation demanding increased efforts from the treasury, the fiscal budget was increased to 3.2 percent of GDP.
In short, Malaysia adopted a much more aggressive fiscal response to the crisis than did the other crisis-affected countries.
The World Bank said this edition of the Malaysia Economic Monitor takes stock of the macro-financial policies adopted during and after the crisis.
With Malaysia at the centre, the analysis aims to explain what happened, what responses were adopted, and how they differed from those employed by other affected countries.
A key aim is to highlight how Malaysia’s experience helped leverage reforms and achieve transformation, a process that might be appropriate for other small, open, developing economies during a period of financial turmoil.
The analysis also assesses Malaysia’s comparative resilience to future economic shocks, especially now that the economy is larger and more interconnected than in the past.
Today, Malaysia enjoys an overall sound banking sector with one of the more sophisticated capital markets in the region.
The financial system supports a significantly larger and more interconnected economy than 20 years ago, and the authorities remain committed to financial stability.
Malaysia’s experience and lessons learned could be very relevant for economies of similar characteristics, in particular, small and open developing economies.
In Malaysia, the process of capital account liberalization was not as fast as in other countries, thus allowing the economy to better manage and absorb shocks. In particular, domestic companies were allowed to contract foreign loans only with the approval of BNM.
Approval was only granted if BNM determined that the project would yield sufficient revenues to repay the loan, even if the exchange rate were to depreciate.
Thus, the Malaysian economy was less vulnerable and had a lower level of external debt than did Thailand, Indonesia or the Republic of Korea.
However, the nature of the AFC was that the contagion spread to Malaysia regardless of the differing fundamentals.