The following is the speech by Bank Negara Malaysia (BNM) Governor Ali Abul Hassan Sulaiman on the Malaysian experience in the Asian financial turmoil at the Malaysia-Japan Economic Association 21st Joint Conference at Seri Kembangan in Kuala Lumpur on 10 March 1999. BNM is Malaysia's central bank.

First of all, I would like to thank the organisers for inviting me to speak at this conference on "Asian Financial Turmoil and Its Implications - The Malaysian Experience So Far". It is already nearly two years since the outbreak of the Asian financial crisis in mid-1997. While we are seeing signs of recovery in crisis countries, the global financial market remains unstable with continuing exchange rate volatility which makes business decisions difficult.

Most countries in the region have basically adopted the IMF-type policy approach or its variants in managing the adverse effects. Malaysia did the same initially, but subsequently, chose a different route. Malaysia’s approach was undoubtedly unorthodox and is still subject to much debate by the international community. In responding to the crisis, Malaysia did not follow conventional wisdom. We decided to change our policy direction very early in the crisis, but never losing sight of our ultimate objective of ensuring sustainable growth with price stability. The exchange controls were a necessary part of our efforts to stabilise domestic financial markets to ensure that the prospect for an economic recovery would not be jeopardised by external developments, which still posed a risk, and erode the gains made from macroeconomic adjustment policies.

Today, I would like to take this opportunity to present the Malaysian case in coping with the adverse effects of the financial crisis, and to provide a broad perspective of policy issues and responses to the financial crisis. In the latter part of my address, I would like to share some policy lessons from the Malaysian experience. I would also like to touch on the role of Japan in restoring recovery in the Asian region, and the need for reform of the international financial architecture.

The Effects of the Financial Crisis and Policy Responses

Let me first begin with a quick flashback on the state of the Malaysian economy and the financial system prior to the financial turmoil in the region. The economic fundamentals of the Malaysian economy were strong. At the end of 1996, real GDP was growing at about 8%. The Government was enjoying a fiscal surplus. The external debt was generally low, at about 40% of GNP. The current account of the balance of payments had narrowed from a deficit of 10% to 5% of GNP, and was expected to improve further. Inflation was at its lowest, at 2.1%. On the financial front, the banking system was also strong and sound as reflected in the strong capitalisation and the high asset quality. The average risk-weighted capital ratio (RWCR) of the banking system was more than 10%. Non-performing loans, using the three month classification rule, were only 3.6% of total loans outstanding, and the ratio of loan provisions to non-performing loans was close to 100%. The banking system was already subject to strict international prudential standards. Almost all the 25 Core Principles for Effective Banking Supervision recommended by the Bank for International Settlements (BIS) have been adopted.

When the crisis hit Thailand, these strong economic fundamentals were ignored by market participants. Indeed, it was the failure on their part to recognise the important differences that existed among the regional economies, that caused the contagion to spread rapidly. The "herd" instinct was strong. No economy, no matter how strong its economic fundamentals had a fighting chance in the face of such sudden and widespread change in market sentiments. Despite stronger fundamentals, the waves of speculation on the ringgit exchange rate caused it to depreciate to as low as RM4.88 per USD in January 1998. Consequently, the capital outflows prompted stock market prices to fall by as much as 70%.

As the regional crisis deepened and spread, the international debate continued on the causes and the appropriate policy responses. To date, there is no consensus on the remedy to the East Asian problem or ways to avoid a recurrence of the crisis. One view laid the blame entirely on inapt governments and their policies, coupled with cronyism and corruption! Standard prescriptions were dispensed by the IMF involving a combination of tight monetary and fiscal policies: raising interest rates to defend exchange rates, strengthening the banking system through stricter prudential standards, and cutting down public expenditure to improve the current account balance. The rationale for these IMF policy packages are well appreciated. The problem lay in the administration of the policies. It was not dynamic enough. Policy changes to the prescriptions were not made as circumstances in Asia changed during the course of the crisis.

I wish to digress a bit here to state that Malaysia was not under an IMF programme. Contrary to perception, we did not refuse to adopt a programme because we were unprepared to take the pain. Malaysia simply did not qualify for IMF assistance. Throughout the crisis, the external reserves level remained well above 3 months of retained imports. Of course, the reserves level is now sufficient to finance more than 6 months of retained imports. Although not under the Stand-by Programme, we did listen initially to the advice of IMF on how to handle the external shocks on an economy. In the initial stage of the crisis, we adopted an approach containing elements of the IMF prescription for other regional economies. When the ringgit was first attacked in early July, inter-bank interest rates were raised significantly. However, the high level of interest rates together with heavy intervention by Bank Negara Malaysia in the foreign exchange market failed to stave off the speculative pressure. This brief experience taught us that this policy approach could not be sustainable. Under normal circumstances of isolated and limited currency pressure, raising interest rates would be an effective measure to defend a currency. However, when the pressure emanates from large and incessant speculative activities, it would be naive and imprudent for a Central Bank to utilise its limited foreign exchange reserves to defend a country’s currency against such attacks. Thus, Malaysia allowed the ringgit to adjust downwards and interest rates were brought down to the level prior to the currency attack. Malaysia had greater flexibility to do this, because our external debt was low and short-term debt was less than half of external reserves.

The success of an IMF policy programme requires the existence of stable market conditions and demands rational behaviour of market participants. The policy package is formulated based on the assumption that free flows of funds under a perfect market system would lead to an efficient allocation of resources. The system is assumed to be self-equilibrating, that the economy and the financial system would respond to shocks in a predictable manner and would soon reach a new stable equilibrium. The fact of the matter, however, was that these pre-conditions were not present in the region nor the global economy. It was apparent that the financial markets during the period were very unstable and market participants were behaving irrationally. The market mechanism was not functioning as it should. Portfolio decisions were not based on economic fundamentals, but were based on herd-instinct, acting more on rumours rather than facts. It is, therefore, not surprising that the IMF policy package did not succeed in restoring financial stability in the East Asian economies. Markets became more stable only after the LTCM failure, as banks reduced their lending exposure to such large institutional players, thereby curtailing their leverage activities. Even now, we believe that financial markets under the current framework are inherently unstable.

Under these circumstances, in managing the economy, amidst the financial turmoil, the Malaysian Government adopted a comprehensive and forward-looking policy approach. As in the past, policies were formulated, taking into account the likely developments, and the upside and downside risks. The approach was one of pragmatism. As the crisis became more severe and prolonged, policy direction in Malaysia was changed to adjust to the changing circumstances. The objectives, however, remained unchanged, to achieve domestic and external stability. The initial policy of monetary and fiscal restraint, while contributing to restoring external balance and moderating inflation, also aggravated the decline in aggregate demand. Consequently, the downside risk that emerged was the prospect of a sharp deterioration in economic activities with ensuing implications on the soundness of the banking system. In particular, a worsening of economic conditions would translate quickly into widespread cash flow difficulties in the business sector that could lead to rising non-performing loans, that in turn could lead to an erosion in bank capital. Steps were, therefore, taken to deal with potential banking sector problems to contain its severity and ensure market confidence. Fiscal policy was relaxed in early 1998 to avoid further contraction of the economy. External conditions did not allow an easing of monetary policy. However, aggressive measures through lowering the statutory reserve requirement (SRR) were taken to reduce the cost of funds to bring lending rates down. Measures were also taken to remove distortions in loan intermediation so that the banking system continue to function and play its role in the economy, and does not suffer a breakdown that could jeopardise the prospects for economic recovery. This objective was also met through a pre-emptive four-pronged strategy to address the non-performing loans (NPLs) problem and emerging weakness in some banking institutions. The strategy involved the merger programmes for finance companies, the setting-up of an asset management company, Danaharta, the setting up of a special purpose vehicle, Danamodal, and the establishment of a joint public and private Committee, the Corporate Debt Restructuring Committee (CDRC), to deal with the expected deterioration in asset quality and capital as the economic situation worsened.

Allow me to elaborate our Malaysia’s approach to reform of the banking sector. The merger programme was announced in early January 1998. The aim was to rationalise the finance companies to increase their resilience in coping with the implications of a slowdown in economic activities. The merger programme is entirely a market-driven process. All negotiations between parties involved are market determined. To date, nine finance companies are already absorbed by their respective parent commercial banks. Our aim is to reduce the number of finance companies to a smaller group of large and strong institutions. We envisage that the number of finance companies would be reduced from 39 as at the end of 1997 to less than half by the end of 1999.

Danaharta, on the other hand, was established in June 1998. Its role is to acquire and manage non-performing loans from banking institutions. The aim is to ensure that the level of non-performing loans of banking institutions remain manageable at all times, so that banking institutions will be able to concentrate on their lending activities rather than focus on measures to protect the quality of their assets. It is important that the intermediation process continue to function and that economic activities are not deprived of financing. To complement the role of Danaharta, Danamodal was established in August 1998. Its function is to spearhead the re-capitalisation exercise of the banking sector as well as to act as a catalyst to rationalise the sector. The establishment of CDRC, on the other hand, complements the roles of Danaharta and Danamodal by assisting viable businesses that face temporary cash flow problems by providing a platform for creditors and borrowers to meet and discuss solutions through voluntary debt work-outs.

Although Malaysia and other countries undertook stabilisation measures, regional financial markets remained volatile. As we have observed, the crisis began to spread to other regions. It initially spread to Russia and subsequently as far as the Latin American economies. The magnitude of the crisis has grown larger and more widespread, and uncertainty remains on the horizon. The prolonged regional financial crisis caused all economies in South East Asia and Korea to contract significantly, with massive unemployment. In Malaysia, real GDP contracted by 2.8%, 6.8% and 8.6% in the first, second and third quarters of 1998 respectively. The ringgit depreciated by about 40% against the US dollar from July 1997 to August 1998. The Kuala Lumpur Composite Index (KLCI) declined by 70% over the same period. The banking system and the corporate sector had come under tremendous pressure. Faced with growing non-performing loans, banking institutions became very cautious in granting loans and even started to recall credit lines and began to concentrate on managing their bad assets. This was reflected in the sharp decline in the annual growth of loans from nearly 30% in July 1997 to only 7.5% in August 1998.

On the external front, the ringgit was under tremendous speculative pressures. Unlike other currencies of the regional economies, the ringgit was internationalised. The substantial onshore-offshore interest rate differentials, which was as large as 30%, began to attract ringgit funds abroad. This trend affected the ability of Malaysia to conduct an independent monetary policy based on domestic considerations. It limited the ability of monetary policy to be eased further to avoid a more severe economic contraction. At a time when it was necessary to inject liquidity into the banking system through lower interest rates, any rapid easing of monetary stance to lower cost of funds would only be met by further depreciation in the ringgit exchange rate. External pressures dictated that interest rates have to remain high to support the exchange rate. This dilemma confronting Malaysia of a trade-off between an easier monetary policy to avoid a contraction in the economy, and the need to check further deterioration in the ringgit exchange rate, threatened to destroy the social fabric of society and erode the gains of higher incomes achieved over the last decade.

The accumulation of ringgit funds abroad, which was a source for another round of currency attack, was indeed a great concern to the Government. The openness of the Malaysian economy, with trade in goods and services at about 200% of GDP meant that this development, if left unchecked, would cause fundamental damage to the real economy. As in the past, the Government has always been pro-active in policy responses. After careful consideration, the Government decided to introduce selective exchange control measures, which were aimed at eliminating the manipulation of the ringgit exchange rate and promoting a stable environment for restoring investor and consumer confidence to revive the economy. While our exchange control measures have been explained on many occasions, I cannot pass this opportunity to explain the motivation and scope of our exchange control measures. Given the large business interest between Malaysia and Japan, we should ensure a correct understanding of these measures.

Our exchange control measures are designed and implemented to achieve specific objectives. Measures are, therefore, selective and not totally restrictive, and they are temporary in nature. The controls are aimed specifically at eliminating access to ringgit by speculators by reducing the offshore market in ringgit and limiting the supply of ringgit to speculators. In addition, given the instability in the financial markets, the measures are also aimed at stabilising short-term capital flows. They are carefully designed to have minimal impact on economic activities. Thus, rules that govern trade transactions and foreign direct investment are left unchanged. Profits, interest, dividends and capital gains are freely allowed to be repatriated. Current account convertibility continues to be maintained. The only requirement is for trade settlements to be carried out in foreign currencies. This measure is in line with the objective to curb the internationalisation of the ringgit. As such, the exchange controls are only targeted at containing the free flow of non-trade related funds. These are mainly ringgit-denominated onshore-offshore transactions. Medium and long-term flows of foreign funds into the country continue to be welcome. What we do not welcome are short-term speculative inflows that could cause instability to the domestic financial markets. That is why the Government imposed a requirement for those funds to remain in the country for at least one year. Even then, these funds are freely allowed to be invested in any kind of ringgit-denominated assets.

The Malaysian Government has been pragmatic in imposing the exchange controls. In responding to the crisis, we have not worked alone. We encouraged and listened to ideas and suggestions from the investors, domestic and foreign, the manufacturers, other economic agents and multilateral institutions. We had received many representations on the 12-month rule. We had expected this when formulating the rule. At the same time, it was recognised that this measure was necessary to provide stability. As conditions have stabilised and improved, these views were incorporated in the modification to the selective controls. On 4 February 1999, Bank Negara Malaysia amended the 12-month requirement for foreign funds to be invested in ringgit assets. A "repatriation levy" has replaced the 12-month rule. For funds brought in after 15 February this year, the principal is allowed to be repatriated without any levy. A levy is imposed on profits made from their investment in shares, bonds and other financial instruments. Levies are not imposed on interest earned.

In amending the rules, Malaysia has been consistent in its objectives. The main objective is to encourage long-term capital inflows. Therefore, profits from foreign direct investment (FDI) are not subject to the levy. This is because the previous 12-month rule introduced on 1 September 1998 did not apply to FDI. It has and will always be the Government’s policy to protect long-term investment. Consistent with the objective to encourage long-term flows, for new portfolio funds entering Malaysia on or after 15 February, a higher levy of 30% will be imposed on profit realised if it were to be repatriated within a period of up to 12 months from the date of investment. The levy is reduced to only 10% if the profit is repatriated after 12 months. The aim continues to encourage investors to take a longer-term view of their investment in Malaysia, while at the same time, discourage destabilising short-term flows.

We continue to monitor the impact of the selective controls, and do not rule out further modifications to relax the rules as circumstances permit. While stability in the domestic markets is important, equally important is creating a conducive environment to promote new business opportunities.

As intended, following the imposition of the exchange controls, stability was quickly restored in the domestic financial system. On the day of the imposition of the controls, the ringgit-US dollar exchange rate appreciated from about RM4.20 per US dollar to settle at RM3.80 per US dollar. On the following day, the Government decided to fix the rate at this level. This level was more or less the average rate of the ringgit exchange rate between late February and June 1998. The subsequent depreciation of the ringgit to exceed RM4.00 in July and August was due to the depreciation of the yen to US dollar to a level exceeding ¥140. The fixing of the rate has benefited businesses. Trade is conducted in a more stable and orderly environment. At the same time, the KLCI, the main index that reflect stock market prices, also recovered significantly from a low of 263 points on 1 September to 400 points by the end of the month. The KLCI improved further to around 600 points, and is now in the region of 520 points.

Stability in the domestic financial market has also enabled the Government to press ahead with the planned banking restructuring programme. Achievements on this front have exceeded targets. Let me provide you some of the progress made so far. In 1998, Danaharta has acquired and managed RM19.2 billion of non-performing loans from the financial system. This exercise has led to a decline in the net non-performing loans ratio of the banking system, based on the 6-month classification, to 8.0% as at the end of December 1998, compared with 9.0% as at the end of November 1998. As non-performing loans are at a manageable level, the bank will be able to focus on lending to support economic activities. This is critical both in preserving ongoing business concerns as well as financing new activities, so that prospects of economic revival are assured.

At the same time, Danaharta is helping to resolve access to financing problems faced by viable companies. Danaharta will bear the risk of loans to these companies by agent banks. The sales of non-performing loans to Danaharta at a discount have, of course, weakened the capitalisation of the banking institutions concerned. This is where Danamodal plays its role to inject capital and strengthen these banking institutions, and ensure that they would continue to play their intermediary role without disruption. To date, Danamodal has injected new capital of about RM4.6 billion into 9 banking institutions. This exercise has resulted in an increase in the Risk-weighted Capital Ratio of the banking system from 11% to 12%. Meanwhile, Bank Negara will play a key role in restructuring the banks that have been recapitalised. As the economy continues to recover, the level of non-performing loans and the Risk Weighted Capital Ratio would improve further. The restructuring programme is also being accelerated. Danaharta will soon complete its acquisition process. All banking institutions whose shareholders are not able to inject new capital will be re-capitalised by Danamodal by the end of June this year, six months ahead of target. Danaharta will soon begin its asset management phase where it will maximise the value of the assets acquired through various techniques before the disposal of the assets.

Much progress has also been made by CDRC. Currently, CDRC is trying to resolve and restructure loans amounting to RM22 billion from 43 applicants. The package of measures are comprehensive and coherent and would contribute to ensure that the banking system will continue to function smoothly and viable businesses would continue to receive necessary financing from banking institutions. Restructuring of banking sector and large corporations, such as Renong, have shown that the use of Government funds have been minimised. Shareholders have borne the brunt of their past decisions.

Meanwhile, measures to ensure economic recovery will continue to be implemented. Export performance has improved over the last three months, but the external sector outlook remains uncertain. Therefore, growth will be domestic-driven, mainly through the fiscal stimulus. A better than expected export performance will result in higher growth than estimated for 1999. The monetary policy stance has been eased significantly. The statutory reserve requirement of the banking institutions has been lowered in stages from a high of 13.5% to 4%. The BNM 3-month intervention rate, the interest rate that reflects our monetary stance, has been lowered substantially. With the release of RM38 billion of liquidity into the banking system, the average Base Lending Rate (BLR) of commercial banks is now well below levels prevailing prior to the crisis. Focus of attention is to encourage banking institutions to break their self-imposed credit freeze mentality, which is a common phenomenon during an economic downturn, as banks try to avoid increasing non-performing loans. It is important, therefore, to ensure that while restructuring is being undertaken, banking institutions, which have the capacity to lend, continue to extend credit.

In this regard, Bank Negara is working together with banks to ensure that credit will remain available to viable activities so that financing constraints would not thwart economic recovery. In these efforts, however, the high standard of prudence will continue to be maintained. Only banking institutions with capacity are encouraged to lend. In addition, financial discipline has to be observed at all times without compromising prudential standards. Furthermore, although the default period for classifying a loan as non-performing loans has been lengthened from 3 to 6 months, it does not undermine prudential standards. This is because banking institutions are required to claw back all interest previously recognised but not collected to the first day of default when a loan turns non-performing. The classification period of bad loans is still retained at 12 months. Banking institutions are also still required to set aside 20% specific provision on the uncollaterised portion of their substandard loans if the overall loan loss provisions are inadequate. Off balance sheet items continue to be incorporated in the provisioning system. The adoption of a six-month classification period was designed to provide some breathing space for borrowers to regularise their accounts in unusually difficult conditions. Overall, these prudential rules remain relatively stringent compared with international standards.

Efforts are now being directed at improving the institutional and infrastructure of domestic banking institutions. Measures will be put into place to strengthen the supervisory process. Among others, this would include empowering Bank Negara to take pre-emptive measures where operations of the banking institutions have the potential to affect their future solvency and hence, the safety of their deposits. The capital adequacy framework will be further refined to impose minimum capital adequacy ratios depending on the risk profile of individual banking institution’s assets, including risk concentrations in terms of exposure to single customers and economic sectors. The appropriateness of setting-up of a deposit insurance scheme will also be studied.

On the fiscal side, the Government has adopted a policy of targeted fiscal expansion. As early as the second quarter of last year, the Government had already initiated an early fiscal stimulus. An additional RM7 billion was provided for specific priority projects. A total of RM5 billion Infrastructure Development Fund was also established. Allocation for existing special funds was also increased. In 1999, the Government will press ahead with its fiscal expansion programme, particularly on infrastructure and social projects. The bulk of the expenditure is targeted for the economic and social sector and not for consumption. The single largest allocation is for education, which amounts to RM14.5 billion or 22% of the Budget allocation.

There are, nonetheless, some concerns on the financing of the fiscal deficit and the financial restructuring programme. There are concerns that the Malaysian Government will embark on a monetisation programme that would fuel inflation. Let me reiterate here that the Government will remain prudent and disciplined in its financing. Monetisation of the deficit will never be an option. For 1999, financing of the operating expenditure will be fully financed by revenue, while financing of development expenditure will be sourced from non-inflationary sources. Apart from USD300 million loans from the World Bank, the Government had already benefited from the so-called Sumitomo-Nomura USD635 million loans, and will be benefiting from the Miyazawa Initiative. Japan and Malaysia have recently exchanged notes for loans amounting to about USD1 billion. JEXIM and Bank Industri of Malaysia have also signed a two-step untied loan amounting to USD300 million. Meanwhile, discussions are being conducted with the Japanese authorities for additional loans. Financing of the economic recovery will also be sourced from domestic non-inflationary sources, through the issuance of bonds and securities to provident, pension and insurance funds.

Funds for Danaharta and Danamodal will be raised through the issuance of ringgit bonds, the bulk of which will be subscribed by banking institutions. The high rate of savings in Malaysia, which continues to hover around 40% of GNP, the ample liquidity situation in the banking system and the likely continuing current account surplus would be more than enough to meet the financing requirements. To date, Danaharta and Danamodal have already issued bonds totalling RM14.7 billion to banking institutions. This exercise, instead of crowding out the private sector, has actually restored the ability of banking institutions to provide financing to the private sector. When business confidence and sentiment improve, the banking institutions would be ready and able to finance private investment expenditure.

Major indicators continue to indicate that consumer and investor sentiments are improving. These indicators, to my reading, show that the economy is already on the road to recovery. In terms of preceding change, real GDP has already registered a positive growth of 2.3% in the third quarter of 1998. Indicators also show that contraction in the fourth quarter would be more moderate. With improving consumer and business sentiments, coupled with prudence in financing the fiscal expansion, the prospects for sustainable growth in 1999 and 2000 are bright. Market analysts now forecast an expansion of economic activities in the region of 2-3% in 1999. Bank Negara Malaysia will be announcing its assessment of the economic outlook in conjunction with the release of its 1998 Annual Report at the end of this month.

Lessons from the Malaysian Experience

There are, at least, three lessons that we can learn from the Malaysian experience. The first lesson is that in formulating policy measures to deal with financial crisis, it is important to make an assessment on whether conditions are present to ensure success of policies. As I elaborated earlier, necessary conditions for the IMF conventional policy approach to work in Asia were far from present. Instead, the policy response in Asia should have been tailor-made to suit each country’s economic structure and circumstance. Most importantly, the response should have aimed at ensuring that the underlying strength of the real economy can be preserved, so that it can return to the path of recovery.

The second and related lesson is that policy prescriptions that work for one problem cannot be replicated as a recipe for success in other situations, particularly where the economies have become more integrated in a globalised world. The IMF policy prescriptions have, indeed, worked quite well in dealing with the Mexican financial crisis. However, the Asian crisis was a regional crisis and not a one-country crisis. Thus, the solution should be addressed at the regional level. In fact, the current financial crisis has quickly became a global problem that requires a global solution. Our view remains that correct policies and a more focussed international support as in the case of Mexico, could have contained the contagion.

The third lesson from our experience is that policy prescriptions cannot be rigid and inflexible. They have to adapt and change in accordance with changing dynamics, as long as the longer-term objectives are not undermined. Malaysia relaxed fiscal policy earlier than other countries, changed its monetary stance and complemented these with selective capital controls. This policy change has steered the Malaysian economy away from a more prolonged recession. Malaysia, which has always had a relatively liberal exchange control regime and a very open economy, took the bold step to introduce the selective exchange controls. We expected the shock and uproar our measures would elicit, but we had our national interest to protect. It was a necessary option and it was implemented only when conditions in the economy had developed to ensure its success. The stability engendered by these measures has enabled trade to continue uninterrupted and the payments system to function without disruption. We have not disengaged ourselves from the market. We continue to work with multilateral institutions, welcome foreign fund managers, and encourage foreign direct investment. Overall, our pragmatism in formulating short-term strategies, while remaining focused with single-mindedness on our long-term objectives, and looking beyond textbook economic prescriptions have served us well in managing the crisis.

Japanese Initiatives in Asian Economic Recovery

It is undeniable that Japan has a crucial role in facilitating the recovery of the Asian economies. With many sharing the belief that Japan has 'bottomed out' more or less at this point of time, this portends significant upside potential for the recovery of the world's third largest economy. We welcome the efforts of the Japanese Government to take proactive measures to speed up the recovery process. Among others, the implementation of the largest fiscal stimulus of ¥24 trillion outlined in November 1998, signifies a serious commitment on the part of the authorities to reverse the prolonged recession. While analysts have questioned the viability of certain parts of the package such as the ¥700 billion vouchers to teenagers and senior citizens, it is noted that the measure was taken as the demography of the country has given rise to weak consumption spending. I also welcome the creativity in the latest fiscal stimulus, especially to channel funds to social infrastructure with an emphasis on information technology, the environment, welfare and education. With respect to taxation, the MITI estimated that the planned tax cuts would lift Japan's nominal GDP by 2.3 percentage points for the fiscal year 1999. Further measures, I believe, will contribute to sustaining the recovery for both Japan and the rest of the Asian economies.

While some may relate the fiscal stimulus to the current debate on bond yields, many tend to ignore the need for the right combination of fiscal policy and monetary policy, especially when the economy is in distress. The Japanese Government, notably the Ministry of Finance's Trust Fund Bureau, has taken quick action to mitigate the impact of the rise in bond yields, and has effectively confined yields to below the 2% range, far below the peak of 2.44% in January 1999. The Bank of Japan has also taken steps to ensure sufficient liquidity in the financial system. These combined measures have allowed the yen to depreciate against the US dollar.

I do recognise that the yen depreciation will improve the export competitiveness of the Japanese economy and contribute to a recovery in Japan. This will indirectly help the Asian economies, which look to Japan as the anchor economy. However, it would not be inappropriate to question whether this mode of recovery in Japan could disadvantage external competitiveness of other Asian countries and dampen export growth in crisis countries. While a depreciation of yen would lead to an improvement in Japanese export competitiveness, it is also likely to result in a bigger trade deficit in Asian economies. In 1998, Malaysia’s trade deficit against Japan stood at RM15 billion. This is likely to increase further with the depreciation of yen. Thus, while we welcome the depreciation of yen as an indirect way of helping the recovery in Asia, there is also a risk of it being offset by the decline in export competitiveness of the rest of Asia against Japan, particularly if access to Japanese markets remain difficult to penetrate. Japan could contribute more effectively to recovery in Asia by opening up its markets to the cheaper imports from South East Asia. Mexico recovered from the crisis very quickly because it could realise the full benefit from the depreciation of the peso, by increasing exports to the more open US and Canadian markets. Similarly, Japan by moving towards greater economic liberalisation would contribute more effectively to recovery in Asia. The Asian economies have registered a large trade surplus in 1998 and are now expected to register an even larger surplus in 1999. The US and some European countries cannot absorb the growing balance of payment surpluses developing in Asia in a sustainable manner. Japan, as the world’s third biggest economy, must play a more supportive role to restore stability to the global economy. While the Miyazawa Initiative provides financing for recovery, a more liberal trade and economic regime in Japan will ensure that these funds contribute to long-term sustainable growth in Asian economies.

International Financial Architecture

Late as it may be, the new financial architecture has finally been included in the work programme of various international groupings. As Malaysia had suggested during the recent 1999 World Economic Forum in Davos, Switzerland, there are at least four key elements that should be included in the effort to reform the international financial system. Firstly, there should be a more balanced approach to the issue of transparency and disclosure by both the public and private sector. On the part of the Governments, there should be a mechanism for regular information-sharing among central banks and other national and international regulatory agencies. This mechanism should include, in particular, an early warning system to alert countries of any large and unusual movements in financial markets, so that an early and appropriate policy response can be formulated. The transparency of the Government alone is not sufficient. It must be complemented by a mechanism to strengthen surveillance and transparency of private sector market participants that are of systemic importance. In particular, greater disclosure by offshore financial centres and other large market players is important.

Secondly, however, mere disclosure of information is not a guarantee that the destructive volatility of international capital flows would not happen again. There should, therefore, be a global regulatory authority to supervise the international financial market. In a similar capacity of domestic regulatory bodies, its function should be directed at ensuring an orderly functioning of the international capital markets and at monitoring movements of short-term capital flows. Recent experience had clearly shown that currency manipulators, with their huge leverage funds, were easily able to manipulate and corner financial markets in Asian countries. Thus, measures to inhibit cross-border manipulative activities in financial markets, rules against the cornering of financial markets and appropriate international standards for financial institutions with respect to exposure to hedge funds and other leveraged financial institutions need to be considered and formulated.

Thirdly, there should be a mechanism for making rating agencies accountable for their actions, particularly when their ratings have a significant adverse impact on a country, more than had been warranted by economic fundamentals. Recent experience strongly suggest that rating agencies have failed to make objective assessments, despite being provided with comprehensive and timely information. Their failure to base their rating on accurate economic and financial situation had exacerbated the crisis by continually downgrading the credit standing of the affected Asian economies. Their actions had precipitated panic selling by investors and contributed to the destructive volatility of international capital flows.

Fourthly, there should be a more comprehensive framework for the orderly liberalisation of the capital account, with appropriate criteria to serve as guideposts for countries, particularly, emerging market countries. In particular, due consideration should be given to the state of development of the domestic economic and financial sector in relation to the openness and size of the economy before embarking on such liberalisation. The IMF, therefore, should exercise greater caution on efforts to amend its Articles of Agreement to accelerate capital account liberalisation. Its technical expertise should now be directed at helping countries to develop and deepen their own domestic financial markets, as well as criteria and safeguards for capital account liberalisation. The approach should focus on creating incentives for countries to liberalise market instead of using legal powers to promote liberalisation.

Conclusion

I have attempted to present the Malaysian experience in managing its economy from the adverse effects of the financial crisis. Our approach was unconventional and different from the traditional approach of relying on the market to re-equilibrate the system. The results of our policy strategies, which are comprehensive and forward-looking in nature, have been positive. We, nevertheless, continue to remain vigilant. Short-term measures will not jeopardise long-term prospects. I am confident that the recovery in Malaysia will be gradual but sustainable. Soon, we should be able to enjoy growth in line with the economy’s potential output.

Wednesday, 10 March 1999

The speech was sourced from Bank Negara Malaysia, Malaysia's central bank.

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