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But like the crowds at the Prime Minister's residence, signs of revival may be misleading. Many economists regard the recovery as shaky, noting that Malaysia has failed to use the breathing space capital controls provided to introduce badly needed reforms, especially in the unstable banking sector. Critics say the economy is still overextended, particularly in the property sector, and saturated with credit. Rather than prick the bubble, Mahathir has insisted that the money keep on flowing. "Things appear rosy because the government has changed a few definitions here and there," says Johor businessman Ahmad Muzni Mohamed, "but in reality it hasn't done much to tackle the structural problems."
Perhaps the most controversial aspect of Mahathir's growth-at-all-costs approach has been a shifting of risk from the bloated private sector to Malaysian taxpayers. The stock market is heavily supported by state-controlled companies and the government-managed Employees' Provident Fund. No less than $6.9 billion has been spent to liquidate nonperforming loans and recapitalize nine ailing banks, most of it funded by government-guaranteed bond issues. And while other Asian governments have been attempting to ensure more prudent bank-lending practices, Malaysia has slashed the central bank's reserve requirement from 13.5% of eligible liabilities to just 4%. By allowing indebted companies to stay afloat, this loose money is merely putting off the inevitable, painful restructuring. "It's like a free lunch for anybody to go out and borrow," says a Singapore economist. "The only thing the capital controls achieved was to create a fence around the economy."
More importantly, the controls have hurt Malaysia's reputation as an open investment environment, with stable, predictable rules of the game. Even if all the restrictions were lifted tomorrow, there's no telling how long it would take investors to get over the shock of last year's abrupt changes. Fund managers' newfound enthusiasm for Malaysian shares seems to be based mainly on government hints that foreigners may be allowed to take stock market assets out of the country inside of 12 months. Second Finance Minister Mustapa Mohamed said last week that the government was considering alternatives, such as an exit tax or preferential treatment for long-term investors. If the new rules are attractive, the reasoning goes, there could be a rush of portfolio investment-meaning quick gains for those who dive in early.
It's not hard to see why the Finance Ministry is trying to come up with a new arrangement. Under the current regime, as much as 90% of the estimated $7 billion to $10 billion in foreign portfolio funds now "trapped" in Malaysia might scramble for the exit on Sept. 1. Whatever transpires, few analysts expect the currency peg to be lifted any time soon, even though the ringgit is widely regarded as undervalued by perhaps 10%. In the face of continuing political uncertainty, floating the currency would carry the risk of rapid fluctuations. And the Brazilian crisis has provided Mahathir with fresh ammunition in his crusade against unfettered capital flows.
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