FreeMalaysia, Aug 26 <http://www.freemalaysia.com/ipi.htm>
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It's the age-old question of whether the glass is half full or half empty. The Mahathir regime would have us believe that Malaysia's economy, while still wrestling with the aftermath of the crisis, is nonetheless recovering smartly -- i.e., the glass is half full and filling. Critics counter that the economy remains wobbly -- i.e., the glass is half full and leaking.

There's no doubt a recovery is underway. Equally, there's no doubt that Malaysia is paying a high price for Prime Minister Mahathir Mohamad's paranoid ravings about foreigners, his poorly conceived capital controls and the lack of true corporate restructuring. That price is evident in both the slow pace and frailty of the recovery, compared with the rebounds in regional neighbours.

The "Mahathir tax" on Malaysia's economy can be measured by how slowly foreign capital is returning, by the lackluster domestic investment and lending and by how far Malaysia has fallen behind other Asian crisis countries on the growth curve. Compare Malaysia's second-quarter GDP growth of 4.1% to South Korea's 9% growth, Singapore's 6.7% and Thailand's
estimated 6%.Remember that both Korea and Thailand went into the crisis with much sicker economies and crushing foreign debt loads.

Even local stock punters, prepped by official leaks to the local media, weren't impressed by either the leaks or the actual figure. The KL stock market weakened in anticipation of the announcement Wednesday and slid further the morning after.

freeMalaysia doesn't relish a slow or aborted recovery in Malaysia. We have all had enough economic turmoil to last us a lifetime or two. But when we're presented with the government's latest evidence of economic recuperation, we can't help but worry. Some critical economic indicators still betray unnerving weakness, and others just gloss over the real picture. So, despite the best efforts of the spinmeisters at Bank Negara and the Treasury, fM's BS meter continues to register deep doo-doo. Let's take a look at some of the reasons for real concern.

There's a killer on the road Of course, the biggest threat is not that the recovery will die, but that it will be killed. How? Well, start with greedy, harebrained schemes, the coercive bank mergers that sap investor confidence, and then move on to the intact preservation of the same depredated crony companies that dragged Malaysia into this financial quagmire (think TRI and the Renong group). With government-backed bailouts and bullet-repayment loan workouts, these zombie conglomerates must become lean and efficient if they are to avoid spectacularly expensive ends in the not-too-distant future. Instead, they're helmed by the same dimwits and set to task as bloated patronage machines all over again.

Little wonder, then that rumors of late have run hot and heavy about a snap election as early as the first two weeks of September. This makes some sense. For fM doesn't think the signs of economic recovery necessarily are as encouraging as Mahathir and his fustian finance minister Daim Zainuddin would have us believe. So, why not get the election over with before more bleak economic factors emerge and before the bank mergers generate more political discontent than they already have?

Indeed, if an election comes soon, freeMalaysia would consider it a bad omen for the nation's economic prospects. That is, unless Dr. M is toying with the idea of sidestepping the Constitution altogether and declaring a national emergency, thus shredding all remnants of democracy. Even that wouldn't be a real surprise. Dr. M's regime already has made a mockery of
the nation's founding document with dozens of amendments of the years.

As noted earlier, the pending, Moonies-style shotgun wedding of Malaysia's financial institutions is the most troubling signal that Dr. M is having little success in reviving the private sector - at least that part of it that isn't exporting to economically healthier points on the globe.

No, there's something deeply suspicious and disturbing about any government that fires off a midnight edict that calls for the near-immediate merger of 58 financial institutions, including all 21 of Malaysia's domestic commercial banks, into half a dozen financial groups.

The official rationale behind the Mahathir regime's command is mystifying enough. Other than being told that bigness will translate into some strength in meeting a globally open financial market by the year 2003, nothing of sense or truthfulness has been uttered officially about the plan nor about who will end up controlling the resulting ÜberBanks. Apart from the obvious motives of greed and an iron grip on bank lending, there's reason to believe that Mahathir and Daim are nervous about bad loans left in the banking system even after Danaharta purged some of the more rotten credit.

Plenty to fear They certainly should have good reason to be nervous.

The nation's total loans outstanding still amount to one and a half times Malaysia's entire gross domestic product. (In comparison, even troubled Brazil's ratio stands only at about 40%.) Yes, we know the official answer: The loan-to-GDP ratio isn't as dire as it sounds. Why? Because the bulk of the credit came from domestic lenders, who will be more understanding and cooperative in working out problem loans than their foreign counterparts.

But this scenario risks a credit logjam like that in Japan, where bankers are more and more reluctant to lend because they, of all people, are keenly aware of the shaky arrangements that are holding together their current loan portfolio. Call it the new Look East policy.

Is this really a risk in Malaysia? According to official data, bad loans (after deducting provisions made for them) have held steady at 7.9% of total loans from March through June. That's not much higher than the 7.5% level at the end of December. So, what's the worry?

The worry is that the official data are becoming more opaque. First, the headline non-performing loan (NPL) figures have been based since late last year on loans that have been unserviced for six months, not on the global norm of three months, which was previously used. Next, you have the exclusion of all the debt of companies before the Corporate Debt Restructuring Committee (count Renong's RM8.5 billion among the excluded RM25 billion, which is fully 25% of bad loans, by the way).

And then recently, Bank Negara stopped reporting three-month bad loan numbers altogether. With a recovery allegedly well under way, that seems odd, to say the least. By now, the reporting of important financial data should be returning to more transparent normalcy. Instead, Bank Negara is blocking the view.
 

The HSBC, StanChart experience Perhaps the experience of HSBC Malaysia and Standard Chartered provides some insight. The two banks, which have to comply with stricter international standards when they publish their financial figures, both reported a significant deterioration in their bad loans in the first half of 1999.

"In Malaysia, the deterioration in credit quality experienced in the second half of 1998 continued [to June 1999]; provisions for bad debts were at similarly unsatisfactory levels," the parent HSBC Holdings laments in its latest interim report. Unsatisfactory indeed. HSBC's bad loans in Malaysia jumped to US$950 million (RM3.6 billion) at the end of June 1999, up 37%
from the end of 1998. HSBC goes on to note that "approximately 50% of the [group's] bad and doubtful debt charge in the rest of Asia-Pacific related to Malaysia."

Standard Chartered, more concentrated in the safer consumer loans and mortgages, didn't fare quite as badly. Still, its bad loans bulged to RM1.55 billion by June, 23% increased from December 1998 and more than double the June 1998 level. Looking at these two banks' experience, it's little wonder that bank lending hardly grew at all in the first half of the year.

These are premier, safe banks. Both are specialists in doing business in Asia and have several hundred years of rich banking history between them. Both have a reputation for financial solidity and for prudent risk-management and exposure policies. Indeed, Malaysians flocked to them in droves to safeguard their money at the peak of the financial crisis.

But Bank Negara would have us believe that, somehow, they fared much worse than the Malaysian banking sector as a whole this year, which has apparently shown no rise in bad loans. That's hard to swallow. Even harder when you consider that the rest of the banking sector includes some quintessentially reckless lenders, such as Sime Bank and Bank Bumiputra.

Sure, it's not inconceivable that either foreign bank could have made mistakes - even some lending decisions bad enough to severely affect their non-performing loan figures during the six months in question. But both of them? In the same period? Not likely.

So, then, what does it mean if the official NPLs don't offer a true picture? For one thing, it tends to confirm that the recovery so far has been quite narrow, failing to benefit big segments of the economy. It also makes freeMalaysia worry about the banks that have rolled over bad debt into new loans and about the loans that have been repackaged into other forms of deferred credits. Could the true measure of bad loans be twice as high as the official statistics indicate?
 

A state of banking catatonia If so, that would explain why Malaysia's financial institutions are practically in a state of catatonia. With industry still facing burdensome overcapacity and an unrelenting property glut, many banks are finding it impossible to lend money to decent borrowers. There is, however, no shortage of big-time, irresponsible borrowers, many clamoring for yet more funds to roll over their bad loans. So, bankers could boost lending, as long as they don't mind increasing their NPLs by the same amount.

And then, there's the sudden and surprising departure of Mohamad Daud Dol Moin as managing director of Danamodal Nasional Bhd., the government agency established to recapitalize Malaysia's creaking, over-stretched banking system. As Mohamad Daud heads back from whence he came, Bank Negara, he will be replaced by another central bank official, Mohamed Ibrahim.

fM figures that Mohamad Daud has accomplished about as much as he could with the billions of ringgit in government-allocated funds and state-ordered private-sector cash calls to shore up the banks' depleted capital bases. With the Mahathir regime already running a growing, crony-feeding budget deficit, which will extend out for many years to come, finding the money to repair new holes in banks' balance sheets will be a major strain.

And if this isn't hair-raising enough, check out the predictions by the National Economic Action Council after they surveyed a sample of foreign fund managers investing in Malaysia. The NEAC warned that Malaysia is facing the outward stampede of US$5-7 billion (RM19-26.6 billion) when the corral gates are opened on 1 Sep for the penalty-free repatriation of
investment funds locked in the country tax for a long, ugly year.

No problem, says Bank Negara, with RM120 billion in foreign reserves, Malaysia can handle the outflow. This is a little like saying that a family of moderate means can afford an expensive house if they eat Maggi mee and cut down on education expenses.

Net inflows of new portfolio funds, mainly for stock investment, has only amounted to RM3.6 billion since Feb 15, when the government started clawing back its capital controls. So, Malaysia faces a net outflow for the whole year of as much as RM23 billion. The real question is why does this have to be, when all Malaysia's neighbors in the region are experiencing large net inflows of portfolio money? How have capital controls helped defend Malaysia's economy?
 

The note in Mahathir's political suicide All this adds a new dimension to Mahathir's bank-merger mania and helps explain his obstinacy and unresponsiveness in the face of the Malaysian Chinese community's outrage. For the merger scheme will use the small to mid-sized Chinese banks, and their relatively healthy balance sheets, to shore up those big, crony-loving political banks' own financial positions. Of course, it would take a lot of these smaller institutions to plug a few Renong-sized holes. In point of fact, it will take all of them.

Why would NPLs remain intractably high? We can think of several contributing factors, including the rollover of bad debt to politically influential borrowers. (Issuing new loans to pay off bad loans is known as evergreening. In this case, that's green as in the color of mould.) But the underlying problem is the sluggish economy. In a "V"-shaped recovery, the fast growth in the rebound phase revives borrowers' businesses and let's them start servicing loans again.

This doesn't appear to be the case in Malaysia, at least judging by the less-than-sizzling pace of the nation's industrial production index (IPI). For the past few months, Bank Negara has been keen to highlight how much industrial production is growing compared to its level a year ago. But that's largely a result of how rapidly it was shrinking a year ago.

For a more sensitive indication of the current trend, economists usually consider how production is faring from month to month. On a month-by-month basis from April through June, the index appears to be sputtering and most certainly isn't keeping abreast of the healthier production figures being recorded by some other hard-hit Asian nations, such as South Korea, Taiwan,
Singapore and Thailand.

Month-to-month figures can be volatile, but by averaging the last three months' growth on a running basis, a so-called running average can be built to demonstrate a less volatile, but still sensitive, trend for industrial production (see chart at <http://www.freemalaysia.com/ipi.htm>).
 

The recovery is lacking a certain something The resulting trend is still generally higher for the past few months, but it demonstrates recent weakness as well. It's hardly the hale recovery that has been trumpeted by the Mahathir regime as it bears down on a general election deadline.

Again, the figures demonstrate the fundamental narrowness of the economic recovery. Most of the economic growth has been driven by electronics exports, rising palm oil production, car sales and government spending. The first of these sectors has a substantial foreign component. Motorola and Intel may be happy, but that doesn't translate into much growth for a Johor
tile maker or the full range of domestic-oriented industries.

Meanwhile, the construction and services sectors remain moribund. Extrapolating from the 62% vacancy rate for Penang retail space and 50% rate for Selangor in 1998, it's hard to see a fast turnaround. Office space in these two states is about 32% empty, according to the government's own property market report.

It will take years and years just to eat through the property oversupply at the reduced rate of economic growth imposed by Mahathir's foreigner-bashing and crony-coddling policies. And with that economic growth dependent to such an extent on cyclical external demand for semiconductors and commodities, the narrowness of the current recovery puts Malaysia at
greater risk. All the more so because so many bailed-out crony companies, like Renong, whose subsidiaries continue to default on billions of ringgit in debt, will need continued solid growth to be able to meet their restructured obligations. Otherwise, the fallout could create another chain reaction in the financial system.

freeMalaysia doesn't wish to sound overly pessimistic. We hope the economic rebound gets stronger and deeper. We also hope the country doesn't drift into a period of stifled, sub-par growth and fall further and further behind its neighbors. But with the reading still high on our BS meter, fM thinks now is not the time to abandon our skepticism.
 

26 August 1999