From Asiaweek 8th September 2000

By ASSIF SHAMEEN

Last weekend marked the second anniversary of capital controls in Malaysia. To the government's credit, the nationalistic rhetoric was more muted than last year, when quasi-government media used the occasion to launch another tirade against nasty foreigners who want to colonize Malaysia. Part of the reason was that the architect of capital controls, Prime Minister Mahathir Mohamad, was in the U.S. drumming up support for new Foreign Direct Investments in Malaysia. The irony of this wasn't lost on many.

Two years after capital controls were introduced, Malaysia's economy is chugging along nicely, thank you. But behind the headlines statistics, a new crisis is simmering. An investment draught threatens not only to derail recovery but also leave Malaysia behind as its nearest competitors move to reinforce their positions in the New Economy. Malaysia's recovery in the past two years has had little to do with the capital controls. Nearly all crisis-hit countries in Asia have seen their economies bounce back. The best performers have been those like Korea, which took the IMF medicine seriously and instituted real reforms, or Hong Kong, which has completely reinvented itself as more of a New Economy player.

Among the factors that have sustained the recovery in Malaysia are its huge electronics exports ‹ and the surging increase in demand for electronics components by Japanese and US companies selling the latest gadgets and gear to American and European consumers. In other words, the very people whom Malaysian leaders blame for their economic problems have been buying loads of goods from Malaysia and helping it recover. For a substantial oil and gas exporter like Malaysia, the record high oil and gas prices in the past year have also helped, though energy is fairly small part of total exports. However, higher government oil revenues however have helped keep fiscal spending up and that has kept the wheels of the economy turning slightly faster.

Because of its investment-friendly policies of the 1970s, 1980s and early 1990s, Malaysia is now the fourth-largest exporter of semiconductors and sixth-largest manufacturer of electronics components in the world. In some low-end categories, such as hard disk drives, it now leads the world.

Much of this can be tied to the investments that poured in from U.S. and Japanese electronics companies before capital controls were introduced. The problem now is that even the Malaysian government's own statistics show that new foreign direct investments (FDIs) especially in the high-tech sector, just aren't coming in at all. FDIs in the first six months of this year were drastically down more than 20% on the same period last year. FDIs in electronics manufacturing dropped even more sharply. What's more worrying is that most competitor nations particularly the likes of Thailand, China and a few others are seeing FDIs in electronics manufacturing soaring. U.S. and Japanese electronics companies, which considered Malaysia their best investment destination in 1996, now don't even count it as among the top-five destinations.Though capital controls do not apply to multinationals in the electronics sector (who are by law exempt) they have adversely affected decisions to relocate factories to Malaysia or set up new plants. An undervalued ringgit scares away investors who need to buy huge equipment today, fearing that at some point down the road the Malaysian government can arbitrarily change the exchange rate. The little new investments that is coming in is by companies who already have a plant in Malaysia and need to expand or upgrade.

One problem with electronics manufacturing is that product cycles are getting smaller. New companies are peddling new components for ever-sleeker gadgets all the time. Even existing plants need to retool far more quickly today than they did five or 10 years ago. A country that has just a few dozen top-notch multinationals with electronics plants can rely on those plants to keep shipping out products for a few years only unless there is massive new investment, reinvestment and retooling.

Clearly, that is not happening in Malaysia and its leaders are worried. On a recent trip to Seoul, I wandered into hotel ballroom after a lunch interview to find Malaysian Trade and Industry Minister Rafidah Aziz addressing Korean businessmen. She seemed irritated at the questions they were throwing at her about political stability, corporate governance, transparency and above all capital controls. "Why can't you just invest in Malaysia and see for yourself," she said. If only it were that simple.

Malaysia's new inward-looking policies, its inability to meet the globalization challenges, its backtracking on AFTA (ASEAN Free Trade Area) deadline for sectors such as autos do not instill confidence in long-term foreign direct investors.

SG Securities Asia in a recent report said that falling FDIs in Malaysia will lead to other more worrying trends such as the loss in technology transfers, best practice management techniques and integration into global trends. "This is an obstacle to the development of a productivity-based growth model," the report said.Over the past two decades Malaysia has drawn foreign investment in high-tech industries. It will be a shame to see the skills that have been developed now wasted on old machinery and obsolete technology in heavily protected industries, instead of being deployed to catapult the country into a manufacturing force in the New Economy.