Malaysia Capital Controls Boost Stocks

Once one of Asia’s tigers, a mauled Malaysia has withdrawn into an economic shell.

But so far, local investors think that’s the best way to cope with the region’s economic crisis.

After standing by for 14 months while Asia’s financial collapse pummeled the economy, Prime Minister Mahathir Mohamad last week imposed capital controls that mark a dramatic U-turn in policy.

Basically, Malaysia’s currency will no longer be freely convertible into other currencies. Thus, money invested in Malaysia may not be able to freely exit. The government has fixed the value of the currency, the ringgit, at 3.8 to the U.S. dollar, and declared that any ringgit abroad not repatriated by Oct. 1 will become worthless.

The immensity of Asia’s crisis was a huge factor in the decision. Malaysia, which built its stunning growth of the past decade on open markets, has all but turned its back on financial freedom.

“Malaysia’s destiny is now firmly in its hands,” said market consulting firm MMS.

The verdict is still out on whether the measures will work. What is indisputable is that the stakes, both for Mahathir and his nation, are huge.

Since the outbreak of the crisis, Mahathir has been able to point a finger of blame at others--speculators, the International Monetary Fund, the central bank.

His former finance minister, Anwar Ibrahim, was sacked last week and faces possible arrest over alleged sexual misconduct and obstruction of justice.

Mahathir’s personal commitment to the controls was symbolized by his decision to add insult to Anwar’s injuries and take on the finance ministry portfolio himself.

Will the controls work? Many think so. “It’s easy to be negative, but this might just work,” said Song Seng Wun, economist at G.K. Goh Research in Singapore.

Columnist A. Kadir Jasin wrote in the New Sunday Times that the “shocking measures have shown promising signs of working out.”

Indeed, the Malaysian stock market has soared since the measures were announced. The main share index rocketed 38% between Sept. 1 and last Friday.

Early today the index zoomed another 16%, to 420.35.

That is still well below its level of about 750 early this year. And one analyst on Sunday termed the market “totally artificial now.”

Even so, analysts say local investors, heartened by expectations that currency controls will protect the market from attacks by speculators--and by the government’s concurrent decision to cut interest rates--are buying frantically.

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Yet most economists warned that while the controls could insulate Malaysia from financial turbulence for a short time, they could lead to distortions over time and prove counterproductive unless accompanied by reforms.

“Capital controls are all very well, but not if they’re a replacement for financial and economic reform,” said Callum Henderson, an emerging markets analyst at Citibank in London.

Rating agency Fitch IBCA said controls would depress banks’ foreign exchange earnings and hurt their stockbroking units, but lower interest rates would be beneficial in the short term by reducing the risk of default by borrowers.

But in the longer term, reduced capital inflow could dampen economic growth, it said.

Standard & Poor’s--one of Mahathir’s favorite targets--said the new policies would likely discourage foreign investor interest, at least in the short term.The rating agency said banks would have to rely more on government or state agencies for capital.

Economist Paul Krugman of the Massachusetts Institute of Technology, whose recent qualified support for capital controls was widely noted in Malaysia, said there were risks.

Krugman said controls must serve as an aid to reform, not an alternative. “It should not be used in an attempt to prove points about the soundness of the pre-crisis economy, or about the wickedness of hedge funds, or anything else,” he said in a clear reference to Mahathir’s defensive reflexes.

The very fact that the measures coincided with Anwar’s humiliation lent a disturbing political note.

“We’ve been raising our risk ratings,” said Bruce Gale of Political and Economic Risk Consultancy. “The risk is that we might find more unorthodox economic measures being introduced by the government at very short notice that could impact very negatively on the business environment.”

Many analysts expressed worry that the government would use the controls as a shield for propping up politically powerful businessmen at the expense of banks’ balance sheets.

“Outside investors are going to be very wary of going into Malaysia,” said Ronald Stride, analyst at Booz, Allen & Hamilton.