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The ECONOMIC FORUM

Dear Anwar...

These must indeed be very challenging times for you. October 17th is being watched very closely by both Malaysians and foreigners alike. The situation you face is dire - the ringgit is in apparent free-fall; the Current Account deficit is looming large and threatens to overshoot official forecasts; foreign capital inflows, wary of the country's economic prospects, are scant; the direction of previous credit has gone into economically unproductive channels; the KLSE is not wont to recover; whereas economic growth threatens to slump to levels unheard of in a decade. No doubt, in the run-up to October 17th, you will be in consultation with some of the country's most respectable and able economists, who will be advising you of the necessary steps you should take in order set our house in order. If I may, Anwar, I'd like to offer you whatever little advice I am capable of. I present them below.

OBJECTIVE OF BUDGET


The objective of your presentation on October 17th should be three-fold:

1) to restore confidence in Malaysia's economic fundamentals.
2) to commit the Government to a sustainable and balanced development.
3) to foster productivity-driven growth.

RESTORING CONFIDENCE

THE FUNDAMENTALS

The phrase 'strong economic fundamentals' is a term much abused these days. So much so that it has taken on a vague meaning. People are prone to asking: If indeed our fundamentals are so strong, how come the economy seems to be in such a bad shape? I propose, that you spell out these (strong) fundamentals in your budget. What are Malaysia's sound economic fundamentals that have contributed to her strong economic growth ever since 1960? They are:
a) a Government committed to an open and liberal economy that is receptive to foreign capital and ideas.
b) a good education system that commits itself to ensuring universal basic skills (first), before venturing into more advanced levels of education.
c) a high savings rate, augmented by the Government's commitment to a budget surplus.
d) low inflation.
e) economic growth that is export-led, and not consumption-led.
f) relatively free and flexible markets which ensure that any necessary economic adjustments occur relatively quickly.

I am sure you will agree with me when I say that many of these have not changed despite the present economic situation and as such there does not seem to be a reason why Malaysia's positive economic prospects should all of a sudden vanish. Spell these out clearly in the budget, so that investors are once again reminded of this fact.

Nevertheless, some mistakes have been made. The unchecked credit boom threatens to undermine our low inflation record and a waif of administrative measures and threats to raise import tariffs in order to improve the country's external balance calls into question the Government's previous commitment to an open and liberalised economy. Your budget therefore should aim to allay these fears.

POLICIES

FRAMEWORK OF POLICY. Anwar, in order to restore confidence in our economy, we have to appear to be credible. I therefore propose that the Government, including Bank Negara Malaysia (BNM), commits itself to a pre-announced target and/or policy. No doubt, many of these targets already exist, only that they are not religiously implemented. Perhaps this is in part due to the fact that information with respect to these targets are not widely disseminated. Therefore, I also propose that the pre-announced target or policy should be widely publicised. In doing this, you are staking your reputation as well as BNM's. This should prove a powerful disciplining factor not only for yourself and the present BNM Governor but also upon all future Ministers of Finance and BNM Governors. After all, nobody likes a boy who cries wolf, and so we are all constrained to keep our word on the target or policy. In restoring confidence, even small measures may help. For example, fix in advance dates for the publication of economic statistics, as most industrialised nations do. This would minimise the uncertainty amongst investors and also rids the possibility of their suspecting a government that is taking its time to 'massage the figures'. Consistent reporting on economic data may also help reassure investors that nothing is being hidden from them - official data are sometimes not comparable across years and this reduces the ability of investors to get a true picture of the economy.

MONETARY POLICY. Anwar, I have earlier mentioned the need to set a target. I now turn my attention to this. At present, money supply is expanding too rapidly. At 8% economic growth, the M3 money supply measure should only be expanding at about 10.5% per annum, and not the above-twenty figures we are accustomed to hearing these days. No doubt money-supply expansions lead to lower interest rates and that they may seem like a good way to bolster ailing investment. But those lower rates can only be a temporary phenomenon. Money supply expansions lead to instabilities in output, a lower ringgit and ultimately higher inflation. Higher inflation in turn compromises economic growth. Therefore, measures must be taken to reign in domestic credit creation, which has in recent years consistently been the foremost contributor to money-supply expansions. I propose that this be done in stages: set long-term targets for reductions in domestic credit creation so that ultimately their growth fluctuates around 2.5% such that the net long-run expansion or contraction amounts to zero. Long-run money supply changes will therefore only reflect capital inflows in and out of the country.

Anwar, the reason that domestic credit creation is able to soar is because interest rates are too low. However, I appreciate that BNM may have problems in knowing what the 'correct' interest rate is at a particular point in time and so it seems that credit expansions are an inevitable feature of a capitalist economy. This is a problem that all central banks face and the reason is simple. Ensuring that interest rates are at the 'correct' level all the time necessitates knowing at the beginning of a month or year what would happen at the end of it. Of course, this is impossible. Therefore, the solution seems to lie in not fixing the rate of interest in advance of the ex-post rate of return upon capital. There are already several methods of financing investment that is consistent with this and I urge their further development. I therefore propose that there be a commitment to encourage equity financing and profit-sharing schemes, as opposed to debt financing. Equity finance and profit-sharing would not only achieve this end, it would also internalise the high cost of capital usually associated with long-term projects. These financing methods would also help reduce the gearing of the economy. Meanwhile, the nation's savings should be increased to compensate for past money-supply expansions. This you have already hinted you would do and I commend you for it.

Page 2: Government, Speculation & FOREX

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