Just when most commentators seem to suggest that the worst of the Asian crisis be behind us, some dire prognostications have recently been made about Malaysia.
At the very least they highlight the problems of making predictions about the impact of capital controls on an economy which for decades had been the most open in the region.
According to the much quoted analyst Mr David Roche, of the London-based consultancy Independent Strategy Ltd, Malaysia's combination of vast non-performing loans in its banking system and the lack of access to foreign capital caused by the capital controls imposed in September will lead to currency collapse, prolonged recession and high unemployment.
The contrary thesis is that a combination of lower interest rates and huge current account surpluses caused by the recession will gradually ease the banking sector's problems while providing a basis for currently stability. Meanwhile, government spending can begin to revive the economy without threatening rampant inflation.
These starkly opposing views interact with two other debates.
One is between supporters of the Prime Minister, Dr Mahathir Mohamad, and critics headed by his jailed former deputy, Anwar Ibrahim, whose fall was precipitated by the capital controls.
The other is whether policies ostensibly aimed at stablising the financial system are simply covers for bailouts of crony capitalists linked to the dominant faction of the ruling United Malays National Organisation (UMNO).
The weakest point in the Malaysian system is not its foreign debt but its domestic debt - and hence the banking system. Domestic debt is around 160 per cent of GDP, which puts it at the top of the Asian league along with Korea and Hong Kong.
A significant proportion of this went to ambitious property developments and to privatised road, rail, power and other capital-intensive infrastructure projects associated with politically well connected individual.
The depth of the crisis depend on whether one believes that non-performing loans (NPLs) in the system will hit 25, 30 or 40 per cent of the total. It is generally assumed that 50 per cent of non-performing loans will be uncollectable. Mr Roche argues the most pessimistic case, which would require injections of capital of 56 billion ringgit ($24 billion), or 22 per cent of GDP to restore the health of the banking system. That, he maintains, is too large that without huge amount of foreign capital the government would have to resort to the printing press and thus debase the currency.
Domestic sources of capital do exist but are under serious strain. Cash reserves of one traditional cash-cow, the oil monopoly Petronas, have been depleted by many appeals for help, and now by the fall in oil prices. Another cow, the Employees' Provident Fund, a forced savings system, has likewise seen more requests for help than it can afford. It has again become the main buyer of givernment bonds.
The Malaysian government had not added to public confidence in the banks by extending the period before the non-performing loans have to be acknowledged. To many, this change in the rules suggests a cover-up.
Other critics say the problem would be less threatening if banks stopped throwing good money after bad, liquidated the defaulters, and sold the assets. But that is said to be impossible because of their political connections.
The Government's defenders reasonably point to two officially funded institutions which are addressing bad debt and banking problems: Danaharta, which is buying bad non-performing loans at heavily discounted prices, and Danamodal, whish is providing new capital for the financial sector. The questions come down to: are these big enough and bold enough to address the problems?
On a more postive note, the government's measures to boost money supply and bring down interest rates could be seen as reasonable responses to severe recession. They may stimulate demand and at the very least will reduce the pressure on banks and their customers from high interest rates. Even now at 8 per cent, is probably now down to 3 per cent. The economy is still contracting - even the government is forecasting only fractionally positive growth this year and most private estimates are in the negative 1-3 per cent range.
Malaysia's tragedy is that it introduced capital controls and started trying to force-feed the economy just before international sentiment towards the US dollar, and to Asian risk, changed.
Thailand and Korea have been able to enjoy even more rapid interest rate cuts while attracting new foreign capital which has caused their currencies to strengthen.
It may not to late for Malaysia to turn the sentiment in its favour by dismantling the controls. But it may also have to make more credible efforts to end crony bailouts id de-control were to result in more capital flowing in than out.
The banking system and the large UMNO-linked corporates are the heart of the problem. Because public sector debt is low, the government itself can probably afford two years of large deficits to stimulate the economy. For 1999 it is budgeting a 16 billion ringgit shortfall, or 6 per cent of GDP. This is now viewed, even by the orthodox tenets of the IMF, as not excessive under the circumstances. It should enable some infrastructure projects to restart while accommodating an inevitable fall in tax revenues.
Nor is the current account any cause of concern. It is likely to end 1998 in surplus to the tune of 20 billion ringgit or 8 per cent of GDP. It should still be nearly half that in 1999, which would provide plenty of scope for reducing foreign debt or building reserves to help ensure a stable ringgit. In principle, Malaysia should be able to reduce interest rates further without sacrificing the ringgit. No country with such a current surplus should feel pressure to do anything get back to 2-3 per cent growth before the current account moves again into negative territory.
However, the difficulty with the balance of payments is not over size of the foreign debt or fear that a current account surplus will soon vanish. Short-term foerign debt is relatively low as most capital inflow has been direct investment or in the form of long-term loans. The trade position is tolerable despite the collapse of the oil prices and fierce competition in manufactured goods. (To some extent, these have been offset by a palm oil price boom).
Malaysia, which began the Asian crisis viewed as better run and less vulnerable than most in the region, now encounters widespread sceptism. The weakness of the US dollar and global decline in interest rates of the past three months have taken the pressure off Dr Mahathir and his Malaysian "solution" to global turmoil.
But Malaysia still needs to prove that its economy, its exchange rate and its banks can live without the exchange controls so hastily introduced in September. The longer the authorities wait to prove the likes of Mr Roche wrong, the more difficult it will be.~C.I.A.REFORMASI