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Chapter

The Malaysian Economy:

Crisis & Recession
Rajah Rasiah

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Learning Objectives

Causes, Effects of the Asian Financial Crisis (1997

1998)

Causes, Effects of the Global Financial Crisis (2008)

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Causes of financial crisis

From the early 1990s up until 1997, Asia attracted

almost half of the total capital inflow into
developing countries.

High interest rates: The economies of Southeast

Asia in particular maintained high interest rates
attractive to foreign investors looking for a high rate of
return.

Inflow of money: As a result the region's economies

received a large inflow of money and experienced a
dramatic run-up in asset prices.

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Causes of financial crisis

Economies of Thailand, Malaysia, Indonesia,

Singapore, and South Korea experienced high growth
rates of 812% in the late 1980s and early 1990s.

In 1994, noted economist Paul Krugman argued that

East Asia's economic growth had historically been
the result of increasing the level of investment in
capital. However, total factor productivity had
increased only marginally or not at all.

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Causes of financial crisis

Thailand's economy developed into a bubble fueled by

"hot money.

The South east Asian economies were :

1.

Dependent upon exports: Indonesia, Philippines and

Thailand had seen their exports to GDP ratio grow
from average 35% in 1996 to over 55% in 1998

2.

Susceptible to currency movements: Huge

dependence upon trade made these countries
vulnerable to currency movements.

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Causes of financial crisis

From 1985 to 1996, Thailand's economy grew at

an average of over 9% per year, the highest
economic growth rate of any country at the
time.

Inflation was kept within the low range of 3.4

5.7%.

The baht was pegged at 25 to the US dollar.

Countries attempting to maintain a peg can run

into problems of either having persistent
surpluses or shortages

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Causes of financial crisis

Why did Bank of Thailand peg the Baht?

1.

Pegging gave certainty to Thai exporter to the to the

United States

2.

It protected Thai firms that had taken out dollar

loans.

The pegged exchange rate was 25.19 baht to the

dollar, or about $0.04 to the baht.

By 1997, this exchange rate was well above the

market equilibrium exchange rate of 35 baht to the
dollar, or about $0.03 to the baht.

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Causes of financial crisis

$0.04

0.03

The figure represents

the situation in the
1990s when the
government of
Thailand pegged the
exchange rate
between the dollar
and the baht above
the equilibrium
exchange rate as
determined by
demand and supply

A currency pegged at a value above the market equilibrium exchange

rate is said to be overvalued.
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Causes of financial crisis

The

result was a surplus of baht on the

foreign exchange market.

To

keep the exchange rate at the pegged

level, the Thai central bank, the Bank of
Thailand, had to buy these baht with
dollars.

In

buying baht with dollars, the Bank of

Thailand gradually used up its holdings
of dollars, or its dollar reserves.

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Causes of financial crisis

To continue supporting the pegged exchange rate, the

Bank of Thailand had to:

1.

borrow additional dollar reserves from the

International Monetary Fund (IMF)

2.

raise interest rates to attract more foreign

investors to investments in Thailand, thereby
increasing the demand for the baht.

The Bank of Thailand took these actions even though

allowing the value of the baht to decline against the
dollar would have helped Thai firms exporting to the
US by reducing the dollar prices of their goods

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Causes of financial crisis

The Thai government was afraid of the negative

consequences of abandoning the peg even though
it had led to the baht being overvalued.

Higher domestic interest rates helped attract

foreign investors, but it made it more difficult for
Thai firms and households to borrow the funds they
needed to finance their spending.

As a consequence, domestic investment and

consumption declined, pushing the Thai economy
into recession.

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Causes of financial crisis

International investors realized that there were limits:

1.

to how high the Bank of Thailand would be willing

to push interest rates

2.

to how many dollar loans the IMF would be willing

to extend to Thailand.

They began to speculate against the baht by

exchanging baht for dollars at the official, pegged
exchange rate.

If, as they expected, Thailand was forced to abandon

the peg, they would be able to buy back the baht at a
much lower exchange rate, making a substantial profit.

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Causes of financial crisis

Figure 30-4 shows the
results of this
destabilizing speculation.
The decreased demand
for baht shifted the
demand curve for
baht from D1 to D2
increasing the quantity of
baht the Bank of
Thailand needed to buy
in exchange for dollars.
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Causes of financial crisis

Because these actions by investors make it more

difficult to maintain a fixed exchange rate, they are
referred to as destabilizing speculation.

Foreign investors also began to sell off their

investments in Thailand and exchange the baht they
received for dollars.

Thailand abandoned its pegged exchange rate

against the dollar and allowed the baht to float.

Thai firms that had borrowed dollars were now

faced with interest payments that were much higher
than they had planned.

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Causes of financial crisis

Many firms were forced into bankruptcy, and the Thai

economy plunged into a deep recession.

Many currency traders became convinced that other

East Asian countries, such as South Korea,
Indonesia, and Malaysia, would have to follow
Thailand and abandon their pegged exchange rates.

The result was a wave of speculative selling of these

countries' currencies

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Causes of financial crisis

May 14, 1997

Thailand, with the intervention of Singapore, spends billions of dollars of its foreign
reserves to defend the Thai baht against speculative attacks
July 2, 1997
Thailand devalues the baht. News of the devaluation drops the value of the baht by as
much as 20%--a record low. The Thai government requests "technical assistance" from
the International Monetary Fund (IMF).
July 8, 1997
Malaysia's central bank intervenes to defend its currency, the ringgit
July 11, 1997
The Philippine peso is devalued. Indonesia widens its trading band for the rupiah in a
move to discourage speculators.
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Causes of financial crisis

U.S. economy recovers from a recession in the early

1990s

1.

The U.S. Federal Reserve Bank began to raise U.S.

interest rates to reduce inflation.

2.

US a more attractive investment destination relative to

Southeast Asia

For the Southeast Asian nations which had currencies

pegged to the U.S. dollar, the higher U.S. dollar caused
their own exports to become more expensive and less
competitive in the global markets.

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Effects on the Malaysian

economy

In July 1997 the Malaysian ringgit was "attacked" by

speculators. The overnight rate jumped from under 8%
to over 40%.

This led to rating downgrades and a general sell off

on the stock and currency markets. By end of 1997,
ratings had fallen many notches from investment grade
to junk.

The KLSE had lost more than 50% from above 1,200
to under 600. (Jan 23, 1998).

The ringgit had lost 50% of its value to the dollar, falling
from above 2.50 to under 4.57 on (Jan 23, 1998).

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Effects on the Malaysian

economy

High interest rates, credit crunch and falling demand

for goods and services many firms were rendered
bankrupt.

In 1998, the output of the real economy declined plunging

the country into its first recession for many years.

1998
construction manufacturing agriculture Over
sector
shrunk
sector
GDP
Fell 23.5%

Shrunk 9%

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Fell 5.9%.

Ringgit and the KLSE.

Fell 6.2% Below 4.7 % & 270

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Remedial steps taken by the

government of Malaysia
1.

The offshore Ringgit market was eliminated and

currency speculator no longer had access to Ringgit
funds. This was done by freezing the external
Ringgit accounts of the non-residents in
Malaysia. They were not allowed to sell or lend
the Ringgit to another non-resident but could
invest their fund freely in Malaysia. Thus the
currency traders were unable to short-sell the Ringgit
and change its exchange rate. Only the government
could determine the exchange rate.

2.

The government fixed the exchange rate at RM3.80

to the US dollar.

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Remedial steps taken by the

government of Malaysia
3. A twelve-month rule was imposed prohibiting the
repatriation of portfolio funds for twelve months. This
rule was necessary given the prevailing instability of
the financial market. When the situation stabilized, six
months down the road, this twelve-month rule was
replaced (for new funds) with a levy and subsequently
even this levy was diluted further to apply only to
dividends repatriated. The twelve-month rule expired
in September 1999.

4. Government conducted an expansionary fiscal policy.

This was possible when the exchange rate was fixed
and capital control were implemented.
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Remedial steps taken by the

government of Malaysia
5. The rationales for the establishment of Danamodal
Nasional Berhad:

To ensure that the banking sector re-capitalization process

is commercially driven and that investment decisions are
made according to market-based principles.

Delays in addressing re-capitalization and non-performing

loans issues will have a drag effect on the financial system
and economic recovery.

Direct capital injection by the government into banking

institutions is not desirable and would lead to conflict of
interest.

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Remedial steps taken by the

government of Malaysia

Malaysia refused economic aid packages from the

International Monetary Fund (IMF) and the World
Bank
There was massive government spending made
Malaysia to continuously recorded budget deficits in
the years that followed

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Causes of global financial

crisis - US

Causes of global financial crisis USA

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Causes of the global

financial crisis 2008

Inflows of money from abroad -- along with low

interest rates -- enabled more United States
consumers and businesses to obtain easy credit.

US economy experienced:

1.

Easy credit.

2.

Assumption that house prices would continue to rise.

3.

Mortgage lenders were led to approve loans without

due regard to ability to pay, and borrowers to took
out larger loans than they could afford.

Optimism about prices led to a boom in which more

houses were built than people were willing to buy.

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Causes of the global

financial crisis 2008
US

economy began to cool in 2007.

Subprime borrowers were unable to repay their
loans.

So

that prices fell and borrowers - with houses

worth less than they expected and
payments they could not afford - began to
default

Banks

were consequently left with large

amounts of unsaleable assets, and many
failed to meet their financial obligations.

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Effects of the financial crisis

2008

Economic consequences

The real economy was seriously damaged as a result of

attempts by banks holding toxic mortgage-based
securities, to deleverage their balance sheets.

Business and personal loans were restricted, creating a

credit crunch e.g. even major firms such as AT&T found it
impossible to borrow money.

Prospective householders were also affected as

mortgage approvals plummetted.

The immediate consequence was severe economic

downturn that was to develop.

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Effects on the Malaysian

economy
1.

Malaysia is highly dependent on its major trading

partners which will see a global slowdown and is
expected to trigger a deeper and harder recession.

2.

Slumping commodities prices on the concern of

global recession saw:

i.

Crude oil fall more than 50 percent from its high

in July 2008 to about US$ 73 per barrel

ii.

Crude palm oil is now trading at a low of Ringgit

1760 from a high of Ringgit 4300 dropping more
than 60 percent.

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Effects on the Malaysian

economy

Throw out the financial budget as it was drawn up

based on now outdated prices of these commodities of
which Malaysia is highly dependent on.

Demand for made-in-Asia exports weakened as

growth in the region's biggest markets in the US,
Europe and Japan slowed amid a global financial
crisis.

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