In the year of 1997 witnessed a new strain of financial crisis where by the Asian financial crisis. What began as a localized currency crisis rapidly turned into a financial and economic crisis. Beginning in mid-May 1997 with a speculation attack on the Thai bath, the Philippine peso and Indonesian rupiah and the Singapore dollar came repeated attack of selling pressure. Then the pressure on currencies quickly spread outside South-East Asia. The Korean won, Hong Kong dollar and Taiwan dollar soon came under pressure as well.
The crisis was unique in term of the damages of the contagion effects and the speed which the crisis spread across the region. The economies in Indonesia, Thailand, and Korea contracted by -13.7%, -9.4% and -5.8% respectively in 1998. As adverse developments in some of the region economies, the financial market reacted to the changed economic and financial situation, leading to the perception that existed in common set of high risk in the region. This encourages a massive reversal of capital flow from the region.
According to an estimate by the International Monetary Fund (IMF), net private capital inflows into Asia in 1997 fell sharply to US$34.2 billion from US$101.2 in 1996, due mainly to a decline in net portfolio investment and debt-related investment, which included short term and long term lending. Despite its relatively sound economic fundamental prior to the financial crisis, Malaysia was also not separated. Following the sharp decline of the Thai bath on 2 July 1997, the ringgit also seen to began to experience the waves of speculation pressure from financial crisis.
At the end of August 1998, the ringgit had decrease by 40% against the United States dollar relatively to its level at the end of June 1997. The market was also affected because of the speculation.. The Kuala Lumpur Stock Exchange Composite Index (KLSE CI) decrease by 79.3% from a high of 1,2171.57 points in the month of February in 1997. The effects then spread through the banking and corporate sector. When the second quarter GDP figure was announced in August 1998, it became evident that Malaysia was facing a recession for the first time in 13 years.
Malaysia experience
Refer to the Bank Negara Malaysia (BNM), the Malaysian economy can be view strong just prior to the start of the crisis. In the first two quarters of 1997, real GDP for the country continue to increase at about 8%. Therefore government continued to record fiscal surplus and the most important part is the level of external debt was low at 43.2% of GNP. The account deficit was decrease from 10% in 1995 to 5% of GNP in 1996 and was expected to improve further. Inflation had moderate to its lowest level, 2.1% in July 1997. The calculation to reduce the pace of bank lending were directed towards making domestic demand more compatible with the level of output, and to contain the development of any asset bubble. Therefore at the end of June 1997, the fundamental economy had strengthened further in order to reduce the pressure in the economy. Economic growth can be achieved against a background of lower inflation and improved balance of payment position for economy environment.
In the banking sector, the structural reform that had been undertaken since the mid 1980 had strengthened the banking system. At the end of June 1997, before the start of financial crisis in Malaysia, the average risk-weighted capital ratio of the banking system was only about 12% higher than the internationally recommended minimum level of 8% as laid down in the Basle Accord. Net non-performing loans (NPLs) were only 2.2% of total loans. At the same time same time, the approval process for external loan was strict more toward corporation and banks, therefore they did not have unhedged exposures to foreign currency borrowing.
There are significant differences in the economic structure and management of Malaysia and the other crisis affected countries. Malaysia did not have problems such as high short term debt and relatively fixed exchange rate. Ringgit rates have been floating since 1973. Just prior to the crisis, the ringgit actually appreciated to rm2.47 to the US dollar in the first quarter of 1997 from rm2.53 at the beginning of the year. Group behavior however led market participant to view Malaysia as having the common problems as those faced by her neighboring countries in East Asia region, despite Malaysia stronger economic fundamental.
The ringgit came under speculative attack as currency traders began placing bets on the depreciation of the ringgit. The relatively stable trend in interest rate was disrupted in May and again in July due to operations. The overnight rate shot up to 18.75% in mid-May. However a second round of speculative activity on the ringgit occurred in July soon after the depreciation of the Thai bath. BNM initially intervened in the foreign exchange market and interbank rates rose even more sharply. On 10 July, the overnight rate rose to 40% from 7.5% the day before.BNM placed emphasis on preserving its international reserves and restoring stability in the domestic financial market.
Malaysia response to the crisis
In Malaysia, measures had already been put in place before something happen in the future. The government maintained significant fiscal policy surpluses for five successive years, in addition to policies that encouraged high rate of saving from private sector. More importantly, Malaysia external debt exposure was very low at about 40% GNP. The policy measure to address the current account deficit and high credit growth had been effective in containing inflation and scaling back new bank lending less productive sectors. But the policy reacts not sufficient to reverse the financial panic and speculative pressure that blaze. By the end of 1997, the ringgit had depreciated by 35% and stock prices had fallen dramatically. It became evident that a recovery programmed had to be put in place to prevent further slump in the economy.
Macroeconomic policies also being used by the government to reduced the financial crisis. The major key using this is to containing inflation and excess domestic demand (manifested through high credit growth) and decreasing the current account deficit for the country. Beside that, maintaining the standard of living and export competitiveness toward the global entirely. Policies were directed to strengthen the financial sector so as to avoid systematic risks. From these objectives, the policy of the monetary restraint in place before the crisis continued. High interest rate to contain speculation against the ringgit was implemented only for a short period of time. When it show ineffective result, interest rates were keep remain unchanged to pre-crisis level soon after and were maintained until September 1997.
A credit plan was being introduced by the government in September 1997 to have amoderate loan growth. The target loan growth rate was set at 25% by end 1997 (from 29% at the end September 1997), 20% by end of the first quarter of 1998 and 15% by the end of 1998. In addition more strict regulation was introduced on purchase loan for non-commercial passenger vehicles. In the early 1998, shift deposits among banking institution resulted in inefficiencies and distort in the market. As continue pressure on the currency did not allow loose of monetary policy. In early 1998, sharp increase in volatility in both foreign exchange and stock market continue. During this time, shift in deposits among banking institution resulted in inefficiency in the local market. As result did not allow monetary policy several measure were taken to reduce the cost of funds to banks.
With respect to fiscal policy, the government reduces its expenditure and deferred implementation of selected infrastructure projects. However the government ensured the budget allocation with respect to health, education, and other basic amenities were maintained. In early 1998, IMF advice against Malaysia plan to reserve fiscal policy to a deficit position to arrest emerging sign of economic contraction. In April-May 1998, when it was clear that the economy was contracting, Malaysia unilaterally allocated additional fiscal expenditure amounting to rm3 billion.
Change in policy direction
The combination of tight monetary policy and fiscal policy restraint adopted in an environment of weakening external demand caused aggregate demand to fall more sharply than anticipated. The measure while succeeding in containing price pressure and exacerbated the cash flow problem of business already affected by the ringgit depreciation, the fall in share prices and weak external demand. As a result, these policies contribute to a rapid contraction of the Malaysian economy. Under these, government adopted more comprehensive and forward looking approach. Policies were formulated taking into account the likely development and the associated risk. The approach was just to adjust policy direction to changing economic circumstances.
Beginning mid-1998 the policy focus shifted towards reviving the economy, from this view, government eased its monetary and fiscal policies. The National Economic Action Council (NEAC) was established on 7 January 1998 to make concrete recommendations to the government to arrest the worsening economic situation and revive the economy back. On 23 July 1998, the NEAC launched the National Economic Recovery Plan (NERP) to provide a comprehensive framework for economic recovery and to counter the negative impact of the ringgit depreciation and the decline of the stock market.
The NERP had six objectives which include the short term focus of stabilizing the ringgit, restoring market confidence, and maintaining financial market stability. These were complemented with structural reform objective of strengthen economic fundamental, continuing the socio-economic agenda and restoring adversely affected sectors. It’s also contained 40 courses of action and more than 580 detailed recommendations. The recommendations were included wide range proposal for economic and structural reform while addressing socio-economy and sector affected by the financial crisis.
The importance of the efficient functioning of the intermediation role of the banking institution came to the frontline during the crisis period. In an environment uncertainty, banking institution had become excessively cautious in their lending decision causing a sharp slowdown in credit. To avoid a credit crunch situation, banking institution with sufficient capacity were encouraged to achieve the minimum loan growth rate of 8% for 1998. The motivation to 8% credit floor was to free to banking institution from self imposed credit freeze. Prudential consideration, however were not being used as bank were required to exercise financial discipline in making lending decision.
Apart from government effort to lower the funds of banks, they also recognized the adverse implication of excess high interest rates on small business. Reserves of funds were established and existing fund expanded so that the banking institution could give credit to priority sectors at reasonable rates without give any more pressure. Government set these funds included the fund for food (rm1 billion), fund for small and medium industries (rm1.5 billion), export credit refinancing facility (rm3 billion) and special scheme for low and medium cost houses (rm2 billion).
Pre-emptive measure was also implemented to avoid systemic risk and to ensure the continued efficient functioning of the banking sector toward the consumer in Malaysia and promote market stability in the face of economic condition. The establishment of Danaharta by the government of Malaysia.NPL issue was based on the following principle. Firstly the banking sector restructuring plan must contain a comprehensive set of policies and should be implemented soon once banking problems were detected. Secondly, the use of public money must be kept to a minimum particularly to prevent future moral hazard problem and lastly some form of operational restructuring would be required.
The result of the policy measures has been positive. Recovery can now be seen across the various sector of the economy. Of importance is that this recovery has been achieved at very minimal cost in term of social and economic cost. Recovery was achieved without massive fiscal cost going into massive debt, thus reducing the burden to future generation. The cost of financial restructuring was also contained. In additions, Malaysia also did not face high rate of inflation. Finally the nation did not suffer massive unemployment or social dislocation.
For the conclusion of the topic of financial crisis in Malaysia, there many factor that will influence the economy in the country. To have more security in term of financial Malaysia government and central bank (BNM) play the main role because with the major decision being implementing will affect the future economy. Therefore central bank should govern strict policies on the interest rate for the country and the investor from foreign. Beside that government should be balance the economic condition with not too high inflation or deflation because crisis might be happen again like in the year of 1998 if the government miss look this issue seriously. Other thing that government can do is, should reduce the quantity of import and increase the export to foreign market by imposing more subsidies or help for companies going for export. And yet attract the investment from foreign country to our country. By using this method, our currency will be much stronger and the reserve of our national bank will be increase and for sure we also can be a red dot nation as Singapore which by they were among the most competitive country in the world.
