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«Financial Crisis of 1997/1998 in Malaysia: Causes, Impacts and Recovery Plans Zaherawati Zakaria (Corresponding author) Department of Administrative ...»

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Zaherawati Zakaria, Zaliha Hj. Hussin, Nazni Noordin & Mohd Zoolhilmie Mohamed Sawal / Voice of Academia Vol.5 No.1 2010

Financial Crisis of 1997/1998 in Malaysia: Causes,

Impacts and Recovery Plans

Zaherawati Zakaria (Corresponding author)

Department of Administrative Science & Policy Studies, University of MARA Technology

PO Box 187, 08400 Merbok, Kedah Malaysia

Tel: +604- 4562565 Email: zaherawati@kedah.uitm.edu.my

Prof. Dr. Zaliha Hj Hussin

Department of Administrative Science & Policy Studies, Universiti Teknologi MARA, P. O Box 187, 08400 Merbok, Kedah. Malaysia Tel: +604- 4562222 Email: drzaliha@kedah.uitm.edu.my Nazni Bin Noordin Department of Administrative Science & Policy Studies, University of MARA Technology PO Box 187, 08400 Merbok, Kedah Malaysia Tel: 04- 4562519 Email: nazni@kedah.uitm.edu.my Mohd Zool Hilmie Bin Mohamed Sawal Department of Information Management, University of MARA Technology PO Box 187, 08400 Merbok, Kedah Malaysia Tel: 04- 4562519 Email: zoolhilmie@kedah.uitm.edu.my

ABSTRACT

A speculative attack was the cause for the Asian financial crisis in 1997, in which Malaysia itself was caught in this crisis. Asian countries suffered heavily as a result of the financial crisis in which none of them managed to completely evade from the crisis. Later, severe economic problems; a number of the multinational companies and enterprises had gone bankrupt and this increased the unemployment rate. In order to overcome this problem, the Malaysian government had taken several steps which involved the usage of internal and external resources in order to overcome this financial crisis and bring the economy back to its normal value. The financial crisis was worsened due to wrong policy responses, anti-market rhetoric, panic, and excessive risk-taking which damaged the balance sheets of banks and corporate sectors.

The financial crisis affected the economy, society and politics in Malaysia, which made it hard to recover from the slump in just a few years. A few recovery plans were implemented by the Malaysian government; reengineering the financial systems, corporate sectors, capital controls as well as short to medium term outlook. Ten years after the financial crisis of 1997-1998, Malaysia’s economy was at its strongest, and had greater economic flexibility that enabled the shift to new areas of growth and thus sustained the developmental momentum. This scenario showed that the recovery plans geared towards battling the crisis was successful, as Malaysia stands strong in the eyes of the world Keywords: Financial Crisis, Speculative, Financial System, Financial Institution

1. Introduction The financial crisis was first felt in Thailand on July 2, 1997, in which later spread to Malaysia, Indonesia, Philippine and Singapore; not forgetting Hong Kong, Taiwan, Korea, Japan and China. None of the countries in East Asia were spared from the impact of the financial crisis. A year later, the financial crisis had spread its wrath to Russia and Latin America, in which it causing a sharp depreciation in their currency values and collapsing the stock market.

This had caused a decline in exports, and resulted in a slowdown of economic growth, as well as an alarming rate of unemployment. Moreover, the East Asian region itself was also suffering from internal economic problems which caused a lot of companies and enterprises to file the bankruptcy. The governments concerned had no effective means of mitigating the impact of the financial crisis (Yu & Xu, 2000) The Malaysian government had resorted to public borrowing, which means the government had to find economic sources from borrowing or public debt, essentially through internal or external sources of money, capital, manpower, expertise and so forth. The internal sources of the Malaysian government in public borrowing were from the Central Bank as well as Financial and Commercial Banks. Moreover, the Malaysian government had introduced Danaharta, Danamodal, Merger of Financial Institutions, Corporate Debt Restructuring Committee, and Bond Market in order to overcome the financial crisis internally. However, the internal sources were not enough to overcome the impact of financial crisis and this forced the Malaysian government to resort to external borrowing.

1.1 The Causes of the Asian Financial Crisis 1997/1998

According to Zubair Hadan (2003), the Malaysian economy had largely been in a good condition since independence. In recent years, it had enjoyed full employment, considerable stability in the price level, and high growth, with the average rate being 8.7 % during the time period of 1990-1997. Malaysia, even with its small mass, was ranked as the 35th top country in 1997 with Zaherawati Zakaria, Zaliha Hj. Hussin, Nazni Noordin & Mohd Zoolhilmie Mohamed Sawal / Voice of Academia Vol.5 No.1 2010 reference to the size of both the aggregate and per capita GNP. It essentially was a trading country, in which exports and imports played a major role in the progress of the economy. Thus, the economy was highly open, and was much susceptible to external disturbances. The foreign capital had continuously supplemented domestic savings in order to sustain high investment rates, to bring forward growth. Malaysia wanted to retain the advantage of its achievements in economic stability, but it was no easy task, especially because of the international economic policies had assumed political overtones. The high performance of the Malaysian economy that was maintained over the decades, without markets or technology or even the core capital being local, cannot be undermined. However, in 1997 the financial crisis came to light, and essentially being a short-term phenomenon, it caused the crash of the Malaysian economy.





Among the factors that caused the financial crisis in Malaysia were speculative attacks, deficiencies in risk management, form of corporate governance and equity markets, and the legal infrastructure (Colin & Fancis, 2003).

The Malaysian economic was vulnerable due to the unsustainable pace of economic growth and over-valued exchange rates. The relationship between firms, government and banks in Malaysia in the financial crisis period cannot be describe as good compared to other Asian countries. There was no clear policy on directed lending to big firms, and to that extent one cannot say that the financial constraints on big firms were weak. The government came out with a high growth policy based on a high ratio of investments to gross domestic product complemented with the promotion and support of certain mega projects, which led to implicit assumptions by lenders that the government would not let those projects fail, which was helped by lending decisions by bankers based on not only a project’s cash flow but also on collateral and implied government support. The over-investment was fueled by an aggregated demand to outstrip aggregated supply, with a consequently persistent external deficit. Moreover, it had also led to a poorer cash flow and more problems of loans.

Later on, the deficiencies in risk management caused by the financial crisis had also affected the Asian region, including Malaysia; with huge mismatches between the asset and liabilities of enterprises, leading them to assume excessive liquidity, interest rate and currency risks. The currency mismatches had also happened in Malaysia, with the exchange control regime requiring approvals for foreign currency borrowing. Several prominent corporations were allowed to raise foreign currency loans, although they only had ringgit cash flows. Due to the sharp ringgit depreciation, these corporations were faced with massive foreign exchange losses or insolvencies because of their currency mismatches and inabilities to hedge exposures. Moreover, the banking system in Malaysia was very risky and this caused bad macroeconomics.

It was an explosive mix for any corporate entity which had over-borrowed and assumed too much maturity period or currency mismatches. The high risk nature of banking in distinction to fund management had risen from its high gearing and massive asset liability mismatches, and in particular, from its tendency to borrow for a short period and lend for even longer. The overdependence on banks in Asia was caused by their over-protection, as well as by the over-regulation of capital markets, and had also affected the Malaysian financial system. This had caused the under-development of non-banking financial institutions, capital markets, and risk management products, risk intermediaries, trading and market-making, which had functioned under inconsistent macroeconomic policies (Colin & Fancis, 2003).

The form of corporate governance and equity market was another factor that caused the financial crisis to occur in the Asian region. Asia was characterized by a concentrated shareholdings system. Non-competitive product markets and weak legal protection as well as governance by large shareholders rather than managers had reduced opportunities for managements to specialize, poor diversification of investments, and increased risks of expropriation of outside shareholders by insiders. The concentrated shareholding had resulted in a less-developed equity market. In Malaysia, the equity market was very sizeable (Colin & Fancis, 2003). The news of the outbreak of the regional crisis of corporate governance breakdowns, and the weak responses to these regulators had led to a huge stock market sell-down. The problem was compounded by new rules on scrip delivery which was imposed to check the sell-down, even though these rules were scrapped later on. However, the initiatives taken to facilitate the development of suitable mechanisms for improved corporate governance were taken only much later, and doubts persisted on issues related to enforcement.

Lastly, the legal infrastructure system in Asia, and more specifically Malaysia, was plagued by inadequate reliance on markets due to its weak infrastructure in private contracting, which in turn was attributed to poor laws or weak enforcement of those laws. The investment decisions were based on the relationship model rather than on market prices, whereas contracts need not manage the supply of capital relative to investment opportunities, which were limited. In order to protect their interest, foreign lenders to Asian corporations and banks invariably made short-term loans; relying on the threat of not rolling over the loans to ensure borrowers serviced the latter. When the Asian economic crisis occurred, a majority of the lenders took back their loans and this caused the capital to outflow without any control. This was considered to be a rational response by the lenders in taking their time and going to courts to enforce their rights; given the poor laws and weak enforcement (Colin & Fancis, 2003).

Zaherawati Zakaria, Zaliha Hj. Hussin, Nazni Noordin & Mohd Zoolhilmie Mohamed Sawal / Voice of Academia Vol.5 No.1 2010

2. Impact on the economic, society and politics Malaysia faced the financial crisis on July 1997, and several impacts or consequences were observed, especially on the economic, social, and political aspects in Malaysia, and these are explained below.

2.1 Impact on the Economic The financial crisis had an impact on the economy of Malaysia. During the financial crisis, the value of the ringgit had declined. Previously, in April 1997, the ringgit was equivalent to 2.42 of the U.S. dollar, whereas later on the value of the ringgit against the dollar depreciated by almost 50 per cent, hitting a high of RM 4.88 to the U.S. dollar on January 7, 1998 (Mohamed Ariff & Syarisa Yanti, 1999). Besides that, the composite index (CI) of the Kuala Lumpur Stock Exchange (KLSE), which was the third largest stock exchange in the region after Tokyo and Hong Kong, fell precipitously from 1,077.3 points in June 1997 to 262.7 points on September 1, 1997 (Syarisa Yanti, 2002). Between July 1997 and mid-January 1998, approximately U.S.

$225 billion of share values were wiped off and between July 1, 1997 and September 1, 1998, market capitalization in the KLSE fell by about 76 per cent to RM 181.5 billion. In the end, Malaysia experienced the biggest stock market plunge among the Asian countries amid the crisis. The financial crisis had also caused the real sector of the economy to feel the negative effects of the crisis. Weak stock prices, the property market slump, and the net contraction impact of the ringgit depreciation together led to a negative wealth effect, which resulted in a general contraction of domestic demand. Consequently, domestic-oriented industries, such as the construction and services sectors, were severely hit by the economic crisis. Meanwhile, the increase in nonperforming loans (NPLs) of the financial sector was reflected in a sharp downturn in borrowing and financing, bringing about tight liquidity (Syarisa Yanti, 2002).

Other than that, in the foreign direct investment (FDI) levels, as measured by the value of applications received in the manufacturing sector and applications for investment incentives from the hotel, tourism, and agriculture sectors by the Malaysian Industrial Authority (MIDA), it displayed a declining trend over the period January until December 1998.

Thus, it can be concluded from the information above that the investors tried to reduce their investment in order to avoid any lost during the time of crisis.

The public sector itself had its share of impacts from the financial crisis. In the public sector, a decrease in both expenditure and investment was initially expected, following the government’s intention of reducing the budget for operating expenses by 18 per cent, as well as cancelling or postponing several mega-projects (Syarisa Yanti, 2002). Other than that, the ministers accepted a 10 percent pay cut, while the salaries of senior civil servants were slashed by 10 percent in order to reduce the government’s expenditure. Salary increases for higher categories of civil servants were also frozen (Ching, 1999). This was part of the government’s effort to reduce the government’s expenditure in order to stabilize the economy.

Another impact from the crisis was the declining of imports of luxury goods, as domestic demand slowed due to the depreciation of the ringgit.



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