A Sound Example for the West Indies

Quote:Malaysian Alternative Strategy

During the crisis in 1998 as financial and economic situation deteriorated

Malaysian government decided to adopt a different strategy then IMF advised. Development of this strategy is usually attributed to The Prime Minister of Malaysia at that time, Dr. Mahathir Mohamad (by the way he is a doctor, not of nonsense "Economics", but doctor of medicine).

This new strategy was not adopted all at once, but stage by stage and part by part as developments unfolded.

Firstly, on the institutional side, a National Economic Action Council (NEAC) was formed in January 1998 to take overall charge of economic crisis management. Previously the Finance Ministry took the lead in managing the crisis, and now the decision-making centre shifted to the Prime Minister’s Department which hosted the NEAC. The Council was chaired by the Prime Minister and comprised several Federal Ministers, the Chief Ministers of the state governments, several government agencies, and representatives of industry. It had an executive committee led by the Prime Minister and included the Deputy Prime Minister, Finance Minister, Executive Director of the NEAC Secretariat and some key economics-related officials (including the Central Bank Governor, the Director General of the Economic Planning Unit and the Secretary General of the Treasury) and a few individuals. A new NEAC Secretariat was established in the Prime Minister’s Department, with an Executive Director and full-time staff drawn initially from the Economic Planning Unit (the country’s main planning agency), and it was also serviced by a Working Group of five individuals drawn from business and academia.

The establishment of this high-powered Council with almost over-riding authority to deal with the economic crisis on an emergency basis, was a central and structural aspect of the Malaysian model of crisis management. Eventually it was the NEAC that drew up an alternative medium-term strategy to deal with the crisis. But it also intensely monitored all aspects of the economy and made decisions on a day-to-day basis. The NEAC executive committee chaired by the Prime Minister met every day for several hours to receive feedback on the implementation and effects of policy decisions and to make decisions on new measures. The NEAC was also able to cut through the usual territorial compartmentalisation of the various Ministries and agencies, and take decisions in a coordinated way.

A National Economic Recovery Plan was then formulated and launched on 23 July 1998. Its objectives were to stabilize the currency, restore market confidence, maintain financial market stability, strengthen economic fundamentals, continue the equity and socio-economic agenda, and revitalize affected sectors.

On 1 September 1998, measures were announced by the then Prime Minister Dr Mahathir Mohamad relating to the currency and to mobility of capital flows. They were aimed at stabilizing the level of the local currency (through fixing of the exchange rate to the US Dollar); preventing overseas speculation on the value of the local currency and local shares (by banning the overseas trade in these); and reducing capital outflows (through selective capital controls). This set of measures was a watershed as until then it had been almost taboo for economists let alone governments to even discuss capital controls. By coincidence, a week earlier the American economist Paul Krugman had broken the intellectual taboo by advocating that Asian countries should adopt exchange controls, in an article in Fortune magazine.

The Malaysian move involved measures to regulate the international trade in its local currency and regulate movements of foreign exchange, aimed at reducing the country's exposure to financial speculators and the growing global financial turmoil. The policy package included officially fixing the Ringgit to the US Dollar, deinternationalising the trade in the Ringgit, a one-year moratorium on the outward transfer of foreign-owned funds invested in the local stock market, and strict limitations on the transfer of funds abroad by local residents.

The rationale for the move was explained by Dr Mahathir in a television interview on the day the measures were announced. Asked whether the exchange control measures were regressive, he said they were not so, but instead it was the present situation, where currency instability and manipulation was prevalent, which was regressive. He said that when the world moved away from the Bretton Woods fixed‑exchange system, it thought the floating rate system was a better way to evaluate currencies. "But the market is now abused by currency traders who regard currencies as commodities which they trade in. They buy and sell currencies according to their own system and make profits from it but they cause poverty and damage to whole nations. That is very regressive and the world is not moving ahead but backwards." He added the Malaysian measures were a last resort. "We had asked the international agencies to regulate currency trading but they did not care, so we ourselves have to regulate our own currency. If the international community agrees to regulate currency trading and limit the range of currency fluctuations and enables countries to grow again, then we can return to the floating exchange rate system. But now we can see the damage this system has done throughout the world. It has destroyed the hard work of countries to cater to the interests of speculators as if their interests are so important that millions of people must suffer. This is regressive."

Dr. Mahathir added the Malaysian measures were aimed at putting a spanner in the works of speculators, and taking speculators out of currency trade. He said: “The period of highest economic growth was during the Bretton Woods fixed exchange system. But the free market system that followed the Bretton Woods system has failed because of abuses. There are signs that people are now losing faith in this free market system, but some countries benefit from the abuses, their people make more money, so they don't see why the abuses should be curbed."

The elements of the Malaysian strategy included:

* Selective Capital Controls

It should also be noted that the ruling, in existence before the outbreak of the crisis, prohibiting local companies from obtaining foreign-currency-denominated loans from abroad unless these were for activities that earned foreign exchange, remained in force.

The capital controls were selective in that they covered movements of funds in the capital account. In the case of foreigners, they covered mainly some aspects of portfolio investment. In general, the Ringgit was still to be freely (or at least easily) convertible to foreign currencies for trade (export receipts and import payments), inward foreign direct investment (FDI), and repatriation of FDI-related capital and dividends by non-residents. In the case of local residents, the capital controls covered a wider range of activities, and in fact the aim of preventing the flight of local-owned capital was to be just as important (if not more) than the controls imposed on foreign-owned funds. However, there was no control on currency convertibility by local residents for purposes of trade. Convertibility up to a certain limit was also allowed for certain other purposes, such as the financing of children's education abroad. But convertibility for autonomous capital movements for several purposes not directly related to trade was to be prohibited or limited.

* Stabilizing the Currency and fixing the exchange rate.

Stabilizing the exchange rate became about the most important objective. The NEAC studied the experiences of many countries. It was decided to adopt a fixed exchange rate system, i.e., fixing the Ringgit to the US Dollar. This would NOT be done through a Currency Board system (as adopted by some other countries) because in this system the country’s money supply would be linked to the level of the country’s foreign reserves. In the Malaysian system, this linkage is not made. The exchange rate chosen was RM3.80 to US$1, which was about the rate at the time the then Prime Minister announced the adoption of a fixed exchange rate system in September 1998. The Central Bank uses this rate to exchange Dollars with Ringgit in its dealings with the commercial banks and other authorized financial institutions, and they in turn are required to use this rate in their currency dealings with the public. The Ringgit-Dollar rate has remained the same ever since. The government has announced several times its intention to stick to the same rate for as long as possible (i.e., if this does not cause the Ringgit to be too over-valued or too under-valued, especially in relation to concerns for export competitiveness) so that there will be a high degree of predictability. Up to now, there has not been any “black market” or parallel trade with a different rate. The predictions especially by international analysts (voiced when the Malaysian system was introduced) that a fixed exchange rate system would result in misalignment and a black market have not been borne out, at least till now.

The fixing of the exchange rate has been important for stabilizing the financial situation. Perhaps its most important role, however, is that it allows the government to take monetary and fiscal policies on the basis of their own merit without being constrained by fears of a fall in the value of the currency if the funds analysts do not approve of the measures. The exchange rate fixing also reduces the opportunity for speculation.

As stated by the then Prime Minister when introducing the measures in September 1998: “With the introduction of exchange controls, it would be possible to cut the link between interest rate and the exchange rate. We can reduce interest rates without speculators devaluing our currency. Our companies can revive.” He added the country would not be affected so much by external developments such as the crisis in Russia." (Sic! - Malaysian PM said this in 1998. Now Russia is repeating same monetary policy mistakes in 2014 as in 1998. Why? Because, it was and it is a man-made crisis and people in the Government who were responsible for crisis and Government debt default then and still in charge now! )

Let me summarize the above mentioned measures in simple words :

If someone would like to have a comfortable temperature say between 20 and 22C in his home while winter is coming and its getting cold outside, what usually one does? One switch on heating system inside the house, once there is no inflow of warm air from outside and no sun light anymore penetrating through the windows and gently warming the rooms, while closing previously opened widows and insulating them from leaking valuable warm air. Winter is coming to Russia and no mantras will help to keep the place comfortable for its residents, but heating the house inside and insulating from the cold will.

Malaysia was able to manage the "climate control" very successfully since 1998. Can Russia navigate crisis now better then 1998? Who knows? Only time will tell us.