Malaysia is on the brink of bankruptcy. Its central bank, Bank Negara, has been forced to boost money supply to bail out the country's financial system. By cutting the amount of cash that the commercial banks are required to keep with the central bank, the government has released money into the economy equivalent to nearly 20% of GDP. As a result of this and what's to come, Malaysia's currency, the ringgit, will be debased.

Special Report

The roots of Malaysia's economic crisis are similar to those in other Asian countries. The cure its leader seeks is not. The crisis is based on a huge overhang of domestic debt. Bank credit now is equal to more than 160% of GDP. In September, Prime Minister Mahathir Mohamad imposed controls on capital flows to unhook Malaysia from the world economy and the currency speculators he loathes. But in wielding powers reminiscent of a Soviet-style master planner, he is merely adding to the country's debt and deficit woes.

Malaysia's super-high savings rates were squandered by a financial system prone to political interference on behalf of prestigious mega-projects and unproductive real-estate deals. International bankers signed on, shoveling in their depositors' money. Such practices have now ended nearly everywhere in Asia, leaving empty buildings, bankrupt banks and deserted shopping malls to litter the post-bubble landscape. They are ugly, but they signify the painful adjustment that, handled right, should put Asia back on a growth track in a few years. Market mechanisms are being allowed to destroy the excesses of the Asian economic "miracle."

Not, however, in Malaysia. There, by prime-ministerial command, the party must go on. Unfortunately Mahathir's policies are not working. Capital isolationism has not stabilized the economy. While industrial production has virtually stopped falling in Thailand and is even rising in South Korea, the drop in Malaysia is accelerating and has reached double-digit levels. Applications to set up new manufacturing projects are down 50%.

PAGE 1  |  2

R E L A T E D S T O R I E S : SPECIAL REPORT Links to all of TIME Asia's Malaysia coverage, including cover stories, polls and trial updates