Malaysia marks 50 years of independence this year, but 2007 is also remarkable for another anniversary: it is 10 years since the financial crisis that wiped out the value of stocks and currencies throughout south-east Asia. The then prime minister Dr Mahathir bin Mohamad largely blamed the crisis on currency speculators, and took recovery steps that flew in the face of the advice of the World Bank and the International Finance Corporation. But, realising that letting the ringgit “find its own level” would be disastrous for his country’s economy, he pegged his currency to the dollar and introduced foreign exchange controls.

Malaysia’s response was ultimately vindicated, when it bounced back faster than some others in the region, and without the social and political upheaval that dogged Indonesia. The World Bank, by contrast, was forced to take stock of its standard prescription package.

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Crisis resolution

Abu Hassan, director of communications at Bank Negara Malaysia, the central bank, says that both government and bank can be proud of the way they handled the crisis. Three mechanisms were instrumental to the country’s ability to weather the storm, he says. First was establishing a capitalisation agency, enhancing the capital of some of the country’s worst affected banks. Since then, all subordinated debt has been repaid.

Second was to establish a central asset management company enabling the banks to “cough out” their non-performing loans, and thus resume lending. This gave a vital lifeline to businesses that were fundamentally sound but required access to capital to remain solvent in a difficult climate. In a similar vein, the establishment of a corporate debt recovery committee meant that “banks were able to sit down with borrowers and work out solutions, instead of pulling the rug. This enhanced the viability of companies with short-term liquidity issues and kept some momentum in the economy,” says Mr Hassan.

Perhaps the most controversial action – from the perspective of the World Bank and the collective wisdom of neo-liberal economic theorists generally – was the decision not to let the ringgit free-float. Instead, Dr Mahathir pegged the Malaysian currency to the dollar and imposed a number of forex controls to prevent a repeat of the speculation that he believed bore much of the blame for the initial collapse in the value of south-east Asian currencies.

To date, few of those measures still apply – although the ringgit can still not be traded offshore, as a guard against speculation. The dollar peg was lifted in 2005 and the ringgit’s exchange rate is now managed against a basket of currencies. Mr Hassan would not reveal which currencies are in the basket but says: “It includes those of our main trading partners. Anyone interested could make a fairly educated guess.”

As a result of the financial crisis, the central bank called for consolidation of the unwieldy financial industry, whittling down the number of banks from 71 to about 10. Although that figure has since doubled as a result of the boom in Islamic banking, it makes for a more manageable, robust sector than existed a decade ago.

Financial stability

Given Malaysia’s stage of continuing economic development, the central bank understands its role involves more than merely pulling at the various monetary tools at its disposal, says Mr Hassan. “We are primarily concerned with financial stability but we also get involved in development areas, with the creation of the right kinds of financial infrastructure and taking steps to boost the fortunes of small and medium-sized enterprises,” he says. The bank is responsible not just for setting policy, but also for regulating the financial services sector, he adds.

The central bank has a comparatively light hand on the monetary tiller, says Mr Hassan. For example, it does not set an inflation target, but looks at the balance of risk between growth and price stability. In the past few years, inflation has remained low: it was 3.6% in 2006, despite predictions of 6% economic growth in 2007.

For the year as a whole, the bank expects growth to be driven by the service sector and finance and business services, with a buoyant construction sector being underpinned by both the Ninth Malaysia Plan and increased activity in the non-residential segment.

As a sub-sector, finance, insurance, real estate and business services is reported to have seen remarkable growth in the first quarter of 2007, at 17.6%. On the finance side, the bank has reported higher lending activities, both in Islamic and non-Islamic banking, in part driven by the introduction of a slew of new products and the opening of a new Islamic bank.

The central bank is keen for capital markets in Malaysia to continue expanding. Traditionally, underdeveloped capital markets have represented something of a constraint on the growth of business. “With the growth of the bond market, we are seeing higher levels of capital market activities and we are creating a breadth and depth of instruments to cater for business needs. We are also looking at how to develop a market for private securities,” says Mr Hassan.

In the last quarter, total net funds raised by the public and private sectors amounted to RM9.4bn ($2.7bn), up from RM7.5bn in the last quarter of 2006. Key indicators in the capital markets sector included about RM795m raised in the equity market (most of which was through 12 initial public offerings totalling more than RM572m). And for the first time, an Islamic plantation real estate investment trust was introduced to the market in January.

Development role

But highlighting the central bank’s development role, Mr Hassan is keen to underscore the efforts it is making to accelerate the small and medium-sized enterprises (SME) sector, which he says is a significant component of the Malaysian economy. “We want to see balanced growth and this means taking steps such as encouraging microfinancing, asking mainstream lenders to become involved so that we can ensure that everyone has access [to growth opportunities].” The strategy seems to be working. Mr Hassan says that of the number of loans made, about 40% are made to the SME sector.

The Malaysian economy has made great strides since the region seemed to be coming to a standstill a decade ago, but policy makers are still keenly aware of some of the challenges that remain. The economy is massively dependent on exports and had a trade account surplus of about RM21.3bn in the last quarter of 2007 (which showed some narrowing, by about RM9bn, on the previous quarter).

Competitive edge

The question of maintaining an edge in an extremely competitive region is a key one. The answer has to lie in providing intellectual and technical skills that outshine those of competitors. But the government – and the central bank, too – is all too aware that highly skilled Malaysians are in demand elsewhere. “We face acute talent shortages as a result of salaries in the Middle East and Europe, but we want to get them back,” says Mr Hassan.

It is these kinds of issues that Malaysia’s development plans set out to address: by taking an overarching, time-structured approach to growth, the country hopes to focus on areas of concern and remain resilient in the face of a fast-changing global economy.

CONSOLIDATION

The Malaysian banking industry underwent two phases of consolidation in the wake of the Asian crisis. In an initial wave of change, the intention was that non-performing banks would be swept out. (Some critics of that phase have argued that the unintended consequences of the consolidation were that successful, smaller private banks disappeared, while larger public banks were bailed out.)

A second phase was driven by the market, and culminated in 10 main domestic financial institutions dominating the industry, and market concentration is now significantly higher than it was pre-crisis – a process which, observers predict, is almost certain to continue (although, the number of banks has increased since a central bank diktat that banks would have to form separate entities if they wanted to enter the Islamic finance industry).

The Malaysian market is now one of the most sophisticated in the region and one of the deepest debt markets. The central bank reports that in the most recent quarter the market has “continued to show strong resilience”, with a high level of capitalisation, improved profitability and continuing improvements in the system generally. This is reflected in a continuing decline in non-performing loans (NPLs) – the net NPL ratio has declined to 4.6% of loans, down from 4.8% in the final quarter of 2006.

Domestic banks, including Maybank, CIMB, RHB Bank and Hong Leon Bank, dominate the pack, but international brand names, including HSBC, Citibank, and Standard Chartered, also play a vigorous role in the industry. Malaysian banks themselves are also nurturing regional ambitions in nearby markets such as Singapore, Cambodia, Thailand and Vietnam.