Mahathir Is Taking a Big Risk With the Malaysian Economy
International Herald Tribune
September 21, 1998
David G. Brown and Douglas H. Paal 

The latest and most loyal of three designated heirs to Prime Minister Mahathir bin Mohamad of Malaysia has been arrested following his dismissal by the prime minister.

Mr. Mahathir said he had ousted Anwar Ibrahim, the deputy prime minister and finance minister, because of Mr. Anwar's moral character. Mr. Anwar was investigated for allegations of homosexuality, procuring sex, and sodomy as well as leaking state secrets. Mr. Anwar has denied all of the allegations.

The charges are not believable. The reality is that Mr. Mahathir has long been maneuvering to check Mr. Anwar for a combination of policy and political reasons. In May, he perceived that Mr. Anwar's supporters were plotting against him at the assembly of the governing United Malays National Organization, using accusations of corruption and cronyism similar to those that had led to the downfall of President Suharto of Indonesia.

What prompted the final falling out was Mr. Mahathir's determination to avoid Mr. Suharto's fate. He was willing to sacrifice Malaysia's carefully nurtured succession mechanism and its market orientation to do so.

The decisive moment came on Aug. 27, when the central bank announced that the economy had shrunk an unprecedented 6.8 percent in the second quarter and when a downgrading of Malaysia's sovereign debt by Moody's rating agency forced Mr. Anwar to withdraw a $2 billion bond flotation

Mr. Mahathir saw his economic accomplishments going down the drain and Mr. Anwar's tight money policy and general adherence to policies advocated by the International Monetary Fund failing. Characteristically, the prime minister acted ruthlessly.

On Sept. 1, Mr. Mahathir announced sweeping new capital controls. The next day, after Mr. Anwar declined to resign, Mr. Mahathir's office announced that he had been dismissed from government posts. The following day, Mr. Anwar was ousted from the government party.

Interest rates were lowered and other policy changes followed. Mr. Mahathir appointed himself finance minister and named loyalists to key positions in the ministry and the central bank.

Mr. Mahathir has made a huge gamble with Malaysia's prosperity. He seems to believe that growth can be restored by insulating the economy from short-term capital movements, pegging the Malaysian currency, the ringgit, at a fixed rate of 3.8 to the dollar and loosening credit dramatically. The current turmoil in international markets and doubts about the IMF's methods have created some sympathy for his move to insulate Malaysia.

The new deputy governor of the central bank, Zeti Akhtiar Aziz, expects the economy to rebound in the fourth quarter and achieve 1.0 percent growth in 1999. She said that inflation was lower than expected and that domestic demand would spur the economy.

Most importantly, Mr. Mahathir has the nation's public resources at his disposal to lubricate the political gears of the governing party and reinforce his continued control before a worsening economy threatens his grip on power even more.

As expected, his policies have had an initial positive impact. Lower interest rates, increased liquidity, purchases by government-run funds, and the reported return of large amounts of ringgit from abroad have pushed stock prices up, particularly those of companies connected to the government.

Mr. Mahathir is betting that the improvement can be sustained and converted into real growth next year, permitting an easing of the new policies. This is unlikely to happen. The positive effects will fade as the problems with Mr. Mahathir's policies accumulate.

The easy credit that has created the current stock market bubble will spill into the real economy and rekindle inflation. The growth drive is pushing frail banks to expand lending to favored companies, while recent transparency reforms promoted by Mr. Anwar are being relaxed to mask their weakening balance sheets.

Worse financial problems lie ahead. However much Mr. Mahathir tries to reassure foreign investors, overseas capital will dry up, hurting exports and competitiveness.

Mr. Mahathir wants to depend primarily on domestic investment to reflate the economy and recapitalize banks. But Malaysia will need external resources. The downgrading of Malaysia's debt ratings to near junk status reflects the difficulty the country will face in obtaining any foreign funds.

Moreover, recent official threats against foreign banks that do not increase their lending will only frighten potential investors away. With investors alienated by policies they believe are bound to fail and its politics in turmoil, Malaysia faces difficult times.

Mr. Brown is a senior associate and Mr. Paal is president of the Asia Pacific Policy Center in Washington. They contributed this comment to the International Herald Tribune.

Copyright © 2006 the International Herald Tribune