Asian Financial Crisis Redux?: Is Malaysia Set To Introduce Capital Controls, Currency Peg?

In July 1997, during the dawn of the Asian Financial Crisis, the Malaysian ringgit was heavily traded by speculators. The overnight rate jumped from under 8 percent to over 40 percent. This led to rating downgrades and a broad selloff of its stock and currency markets.

By the end of 1997, Malaysia’s ratings had fallen many notches from investment grade to junk, the Kuala Lumpur Stock Exchange (KLSE) had plunged over 50 percent from above 1,200 to under 600, and the ringgit had lost 50 percent of its value, falling from above 2.50 to under 4.57 to the dollar on January 23, 1998.

At the time, Mahathir bin Mohammad, Prime Minister of Malaysia from July 1981 to October 2003, imposed strict capital controls and introduced a currency peg of 3.80 against the U.S. dollar.

Mahathir blamed foreign investors, particularly George Soros, for the demise of the ringgit and for the Asian Financial Crisis.

George Soros at the World Economic Forum (WEF) annual meeting in 2011. Photo courtesy of Wikipedia.

According to Mahathir, Soros — as the hedge fund chief of Quantum — may have been partially responsible for the economic crash in 1997 of East Asian markets when Thailand relinquished its currency peg to the U.S. dollar.

According to Mahathir, in the three years leading up to the crash, Soros invested in short-term speculative investment in East Asian stock markets and real estate, then divested with “indecent haste” at the first signs of currency devaluations. Soros responded, saying that Mahathir was using him “as a scapegoat for his own mistakes”, that Mahathir’s promises to ban currency trading (which Malaysian finance officials hastily retracted) were “a recipe for disaster” and that Mahathir “is a menace to his own country”.

The two continued to traded angry barbs against each other in various newspapers and broadcast interviews over the next nine years.

Fast forward to present-day and Malaysia’s Ringgit is at the lowest level since 1998, and its foreign-exchange reserves have tumbled 17 percent this year to $96.7 billion as of the end of July, which is the first time its reserves have fallen under $100 billion since 2010.

The Malaysian Ringgit. Photo courtesy of Flickr/Stardex

The ringgit has fallen in each of the last eight weeks, dropping 3.8 percent against the dollar last week, and slid to a 17-year low of 4.1225 per dollar on Friday.

Malaysia’s currency has fallen nearly 14 percent so far this year and has led losses in Asia over the past year with a 22 percent plunge as it has been battered by a political scandal, a devaluation of the Chinese yuan, falling oil prices, in addition to a likely hike in U.S. interest rates by the Fed.

The exchange traded fund (ETF) that tracks Malaysian equities, the iShares MSCI Malaysia Index Fund ETF has tumbled 23 percent this year and has plunged over 35 percent over the past 12 months.

Investors are saying that the risk of such a repeat that we saw in 1997 is fueling an exodus of money from Malaysia.

The iShares MSCI Malaysia Index Fund ETF

That being said, could Malaysia take a page out of its playbook from the 1997 Asian Financial Crisis and impose such measures today?

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There is a “fear in the market that they would impose macro-prudential measures to limit outflows,” Anthony Chan, Asian sovereign strategist at AllianceBernstein, told Bloomberg in an interview on Friday.

“The fallout is reviving memories of hedge-fund attacks in the 1997-1998 crisis,” Chua Hak Bin, an economist at Bank of America Merrill Lynch in Singapore, told Bloomberg in an interview on Friday. “We don’t think capital controls are likely, but cannot rule out the risk given the rapid depletion of foreign reserves.”

“There are similarities to the 1997-1998 crisis,” Gerald Ambrose, Managing Director of Aberdeen Asset Management in Kuala Lumpur, told Bloomberg in an interview. “There’s a certain amount of emotions involved, a certain amount of panic but I think not so much from the equity market. The real worry is Malaysian government securities, where foreign ownership levels are much higher.”

China’s decision to devalue its currency has sparked fears of a global currency war as U.S. lawmakers said that Beijing was unfairly supporting its exporters.  The decision will also set the stage for what will likely be testy talks when Chinese President Xi Jinping visits Washington next month.

Following China’s initial move to devalue its currency, global stocks, currencies, and commodities were sent plunging and emerging market stocks fell into a bear market.

But as China continued to devalue its currency for a third straight day last Thursday, fears continued to grow that other regional Central Banks could follow suit with their own currency devaluations, as such countries are attempting to maintain their own competitiveness against China.

As China Devalues For Third Day In A Row, A Global Currency War Appears To Be Intensifying http://t.co/0MqjrJRyrO pic.twitter.com/A6mFnBNqnn

— EMerging Equity (@EMequity) August 13, 2015

“It was inevitable that China would join the currency war at some point. The key will be the response of other central banks,” Nick Lawson, Managing Director at Deutsche Bank in London, told Reuters.

And as such concerns grew, Vietnam became the first to follow in China’s footsteps as it widened its currency trading band last Wednesday to allow for its currency to weaken.

Vietnam’s currency can now trade as much as 2 percent on either side of a fixing set by the monetary authority, from 1 percent previously.

The Central Bank of Malaysia’s headquarters in Kuala Lumpur. Photo courtesy of Wikipedia

Malaysia’s Central Bank Governor Zeti Akhtar said last Thursday that although foreign-exchange reserves need to be replenished, Malaysia is not planning to introducing a currency peg or capital controls.

“I think there is a concerted effort to test Bank Negara Malaysia’s reserves,” Mixo Das, an equities strategist at Nomura Holdings, told Bloomberg. “Sentiment is bad, which is why the central bank needs to break the cycle.”

For Malaysia, the pressure is mounting as Prime Minister Najib Razak faces a probe of fund transfers into his personal bank accounts, alongside a depletion of reserves, falling oil prices, growth and devaluation concerns in China, and a likely Fed rate hike on the horizon.

As a perfect storm brews in Malaysia — could we be upon an Asian Financial Crisis Redux?

One thing is for sure — a growing number of investors are not sticking around to find out.