States & National Interest & Asia's Currency Crisis: The Malaysian Case

I. A Brief Background

Within two weeks after affecting Thailand, the Asian financial "bug" hit Malaysia as the latter's currency (i.e., the ringgit) began to depreciate. More than just a currency depreciation, it essentially signaled the end of Malaysia's impressive decade-long growth record. Indeed, the slippage in the Thai bath that began on July 2, 1997 almost immediately raised serious concerns about the resilience of the currencies in Southeast Asia.

Whether driven by the success and profits associated with the speculation of the Thai baht or troubled by what they perceived were fundamental economic problems in the region, currency traders next focused their attention on the other regional currencies. Speculation on the Filipino peso increased after July 11, while Indonesia allowed the rupiah to fall sharply on July 21. 

Initially, the Malaysian government tried to defend the ringgit from dropping in value, but this strategy was not sustainable and proved costly. On July 14, the ringgit was allowed to depreciate. From RM2.50 to US$1, the ringgit slipped to RM2.61 (July 14) and gradually to RM2.83 (August 12), before reaching RM3.00 on September 2. Eventually, it sank to a low of RM4.88 on January 7, 1998, before recovering along with the regional stock market rally in February 1998. By this time, however, the crisis had become too critical. As the word got out that a number of high profile local companies were not on sound financial ground, the ringgit weakened again and reached RM4.16 on 8 July 1998.

Before the Crisis

As a developing nation, the Malaysian economy enjoyed a number of favorable features prior to the crisis in 1997. During the first half of the 1990s its real GDP growth averaged 8.7 per cent per annum, inflation also appeared under control around 3.7 per cent, and the unemployment rate for 1996 was only 2.5 per cent.

Unlike some other East Asian economies with high external debt, Malaysia has managed to keep its external debt relatively low. Just prior to the crisis, it was at US$45.2 billion or about 40 per cent of GDP. Further, the nation's saving rate at 38.5 per cent in 1996 was one of the highest in the world.

These encouraging statistics can sometimes mask certain inefficiencies that were apparent in the region albeit not as severe in the Malaysian case. Some have argued the nervousness of the market over some issues in countries such as Thailand, Indonesia and South Korea led to the contagion effect that brought the currency crisis to Malaysia.

Nevertheless, some disturbing signs were there before the crisis:

1. Loss of Efficiency in the Economy. Experts noted that there were also signs of excessive investments in capital-intensive projects where there was little potential for these projects to add to the efficiency of the overall economy in the short or medium term.

2. Rising Current Account Deficit. The deficit in the current account corresponds to the saving-investment gap. Despite having one of the highest savings rate in the world, Malaysia ran into current account deficit problems because of its high investment rate (fueled in part by various capital-intensive projects). This investment boom led to a current account deficit, which along with the declining efficiency, contributed to the anxiety about Malaysia.

3. Excessive Credit Expansion. Along with the above concerns, Malaysia's economic expansion during the early 90s had also created a situation where credit was easily available. Hence, total loans had grown at a rapid pace which by 1997 became a serious point of concern.

III. Responding to The Crisis

For bringing Malaysia out of its dire economic straits, one faction in the government favored the approach endorsed by the International Monetary Fund (IMF). This approach basically called for tightening the country's monetary policy and implementing some austerity measures. Typically, this involves raising interest rates so that borrowing (and "excessive" spending) slows down. This in turn would also help slow down the risk of runaway inflation. Other common austerity measures include cutting the "fat" from the government's budget. Here, IMF and other experts often call on governments to at least temporarily halt spending on elaborate or major infrastructure projects. The concern typically centers on the assumption that these major projects would only add to the concerns about inefficient use of resources. This in turn can undermine investor confidence in the economy and unduly dry up the already fast evaporating capital. In the case of Malaysia, there clearly was a strong sentiment among many experts that the country would be better able to rebound from the crisis if its political leaders would only adopt such confidence building measures associated with the IMF's recommendations.

The prime minister, Dr. Mahathir Mohamad, and his close advisors on the other hand adopted a nationalist outlook about the crisis coupled with a strong anti-IMF stance. These influential leaders believed the way out of the predicament was to "stimulate" the economy by loosening monetary policy: lowering interest rates and expanding the money supply. Along with blaming "foreign" currency speculators for triggering the economic crisis, Mahathir was defiant of what he regarded as IMF meddling in the economic affairs of Malaysia. Hence, according to the prime minister and his close allies, greedy and unscrupulous foreign speculators were largely to blame for Malaysia's economic woes. "Greed. An incessant greed for money and instant material gain has impoverished Asia" (Mahathir, 1999: 7).

Steering the country's economic policy to reflect his nationalistic fervor, Mahathir unveiled wide-ranging new measures that went against IMF admonition and commonly held free-market economic theory. Most significant of these was the decision in September 1998 by the central bank (Bank Negara) to institute currency controls to curb capital flows and intervene to stabilize the ringgit. This move - which limits the role of the market - was an attempt by the government to gain control over the ringgit from what it regarded as unconscionable speculators. In this instance, the currency control measure was intended to "stabilize" interest rates at a reasonable level so that consumers and local businesses can continue to borrow. The government also regarded this move necessary to prevent further devaluation of the ringgit. This response by Mahathir's government put the country on a collision course with major foreign investors and the IMF.

A key provision of the capital-control measures was to limit the amount of Malaysian currency that can be carried into or out of the country. Beginning in October 1998, the government required:

a) that foreign travelers will be allowed no more than 1,000 ringgit (about $250);

b) local residents will be prohibited from taking abroad more than the equivalent of 10,000 ringgit in foreign currency;

c) official approval will be required for any transfer or withdrawal of funds involving external ringgit accounts, and

d) profits from the sale of Malaysian stocks purchased with foreign funds cannot be transferred out of the country for a year.

IV. Economic Nationalism and Political Change

The fallout from the Asian financial crisis included some major political changes in Southeast Asia. Most evident was the downfall of then Indonesia's President Suharto. Malaysia too experienced significant political unrest. As we noted above, the prime minister turned on blaming institutions like the IMF and international financial companies for undermining the region economically and acting in an arrogant, paternalistic manner. Clearly an attempt to deflect blame and to also consolidate his own power domestically at a time of uncertainty, Mahathir's nationalistic rhetoric isolated him from key actors and institutions in the world economy. In his view, taking the above measures was in the nation's best interest and this had to be of utmost priority. Some observers noted that Mahathir was turning his back on the very international market system that was a big part of Malaysia's economic prosperity before the crisis hit. However, the Malaysian government insisted that the IMF's prescriptions would not be in the nation's best interest. Apparently referring to the situation in neighboring Thailand and Indonesia, the Malaysian prime minister noted:

For the affected nations, the combination of stock-market collapses, sharp [currency] devaluations, high interest rates and IMF-inspired austerity programmes has not alleviated the situation. On the contrary, it has led to a further deterioration of living standards (Mohamad, 1999: 100).

Domestically, the Malaysian government's apparent "anti-free market" maneuver added to the bubbling rift between Mahathir and his deputy at the time, Anwar Ibrahim. His deputy who did not share his anti-market nor anti-Western political rhetoric was summarily dismissed from office on September 2, 1998.

It is important to note that the prime minister's response to the financial crisis in Malaysia encompassed a set of interrelated economic and political measures. Consolidating his political power and silencing his opponents domestically further enabled Mahathir to more effectively galvanize public opinion against what he labeled the "economic colonialism" of the IMF and foreign investors (Mohamad, 1999: 62). These "culprits" provided temporary political cover for the prime minister. In turn, Mahathir appeared defiant and in a classic nationalistic tone, argued that instead of "revitalizing troubled economies, the IMF has been digging graves, both for itself and for the countries where it has been most massively involved" (Mohamad, 1999: 105).

Although Mahathir eventually agreed to a number of the IMF's conditions for economic assistance, as we have seen he was defiant and highly critical. It is sometimes tempting to characterize this controversy between the IMF and the Malaysian government as a classic case of the clash between "pro-market" and "anti-market" forces. Upon closer examination, it becomes evident that the Malaysian government's response to the crisis had its antecedents in, and was quite in line with its approach to economic development over the past 20 years. The government's outlook was not "anti-market" as much as it was a strong believe in "managing" market forces to suit its national interests (see below). Such an outlook and approach to the market is one of the distinguishing aspects of economic nationalism (see Balaam and Veseth, 1996: 26-34).

V. The Market and National Interest

Malaysia's high growth rate before the economic crisis was carefully shaped and guided by strategic five-year development master plans. Among other things, these plans have essentially reflected the government's targeted goals for investments, trade, and employment. A few years before the crisis, the government had undertaken a major plan - Vision 2020 - that established some specific goals and objectives for the long-term development of the nation. 

This plan attempts to establish Malaysia as a developed society by 2020. A major part of this agenda is the highly coordinated masterplan to make Malaysia a central player in the increasingly information based global economy by building what has become known as the Multimedia Super Corridor (MSC) outside the nation's capital.

The government hopes that by attracting major global companies, the Multimedia Super Corridor would become a major international information technology center and promote Malaysia's entry into the Information Age.

The MSC is being promoted as an innovative venture to create a state of the art integrated global multimedia environment. Along with this information technology hub, the government is also promoting other high profile projects that it hopes will propel the country's reputation as a major economic force in the region. It has embarked on developing the world's first "Smart Cities" along the MSC. Putrajaya, which is to become the nation's new administrative capital, will highlight the concept of "electronic government" and Cyberjaya will host major multinational corporations, research and development facilities, multimedia industries, and a Multimedia University. In essence, the MSC will provide an array of opportunities for high-tech investments, research ventures, and business.

This ambitious, government initiated venture will obviously depend on a great deal of financial and technological input from private investors and multinational corporations. As Mahathir himself notes, "we have been trying to lure many foreign companies to...the MSC with tax breaks and other incentives. We are often offering foreign corporations special privileges and more favourable starting conditions than our own local corporations" (1999: 124).

VI. An Assessment

Hence, although it may be "obvious" that the government's response to the financial crisis in 1997 was incompatible with the free market idea, it is important to put the actions into context. Taken in isolation, the government's response was not seen favorably by the market nor the IMF. However, it would also be misleading to label the Malaysian government as "anti-market." Initiatives like building the MSC and the "Smart Cities" (to mention just a couple of examples) demonstrate a stronger propensity toward pursuing what the government regards are key national interests and priorities. Steps that the government believes, rightly or wrongly, will strengthen its economic base. Indeed, as noted above these goals are being pursued by appealing to international investors and developers. This would seem quite contrary to what one might expect from a government that was presumably hostile to foreign investors in the wake of a major financial crisis. It is important, therefore, to recognize that Malaysia's response to the financial crisis - albeit controversial - can be better understood by recognizing the relevance of economic nationalism and the role it plays in shaping how nations may act in our highly integrated world economy.


Mark Landler, "Malaysia Wins it Economic Gamble." New York Times, September 4, 1999.

Balaam, David N. And Michael Veseth. 1996. Introduction to International Political Economy. New York: Prentice-Hall.

Mohamad, Mahathir. 1999. A New Deal For Asia. Kuala Lumpur: Pelanduk.

Prepared by Professor Sunil Kukreja.