The Malaysian Financial Crisis: Economic Impact and Recovery Prospects

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The Developing Economies, XXXVII-4 (December 1999): 417–38

THE MALAYSIAN FINANCIAL CRISIS: ECONOMIC IMPACT AND RECOVERY PROSPECTS MOHAMED ARIFF SYARISA YANTI ABUBAKAR

I. INTRODUCTION to the crisis, Malaysia had been dubbed as one of the miracle economies in East Asia owing to its maintenance of high growth rates averaging 8.9 per cent during the period 1988–96 in addition to low inflation rate of about 3–4 per cent per year. Moreover, the increasing emphasis on manufacturing, and electronics in particular, ensured high employment rates for the country. From July 1997 however, Malaysia began attracting more international attention not for its extraordinary economic performance, but for its entanglement in a major regional economic crisis. At the outset, for the more pessimistic observers it was already doubtful whether Malaysia’s target to become a developed country by the year 2020 would still be achievable. After all, for the first time in years, the external value of Malaysia’s currency, the ringgit, shrank by nearly 50 per cent while the stock market contracted by even more at about 60 per cent. The ringgit fell from an average of 2.42 to the U.S. dollar in April 1997 to an all-time low of 4.88 to the U.S. dollar in January 1998. The composite index (CI) of the Kuala Lumpur Stock Exchange (KLSE) which had been 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. Between July 1997 and mid-January 1998, approximately U.S.$225 billion of share values were wiped off. Before long, the impact of the financial crisis was being felt in the real sector as evidenced by business closures, retrenchments leading to high unemployment, and increasing inflation levels. For the first time since 1985, the Malaysian economy experienced a recession, contracting by 6.7 per cent in 1998. By nearly all accounts, the current downturn is worse than that experienced by the country in 1985. The recession experienced in 1985 lasted for only one year with a mild 10 per cent contraction. Two years after the onset of the current crisis, the main problem is whether a similar recovery is will occur for Malaysia this time, or whether the crisis will last beyond 1999. Obviously, some positive signs suggest that the worst is over for the Malaysian economy, although this does not necessarily guarantee that Ma-

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THE DEVELOPING ECONOMIES

laysia is out of danger yet. In the past two years the Malaysian government has resorted to different tactics to withstand the negative effects of the crisis. While some of the strategies employed have been successful, some others have failed. The aim of this paper, as the title suggests, is to examine the various impacts of the Asian economic crisis on the Malaysian economy, to analyze Malaysia’s recovery prospects in the future, as well as to highlight some of the key challenges facing Malaysia on the road to sustained recovery. The paper begins by describing the genesis of the financial crisis in Malaysia and then proceeds to outline the various policy responses of the Malaysian government. In the subsequent section, a snapshot of the crisis’ impact on the economy is provided. Malaysia’s prospects for recovery and the challenges associated with ensuring sustainable future growth are dealt with in the final section. II. THE FINANCIAL CRISIS IN MALAYSIA

In mid-May 1997, the Thai baht came under severe pressure from speculative attacks. The ringgit was also not spared, and came under severe selling pressure. Bank Negara Malaysia’s (the central bank of Malaysia) immediate response was to intervene in the foreign exchange market to uphold the value of the ringgit. Bank Negara valiantly upheld the value of the ringgit for about a week before it finally was forced to float the ringgit on July 14. By that time, the bank had already lost close to U.S.$1.5 billion in the effort to prop up the...
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