Macroeconomics. A Study on Economy Events and their Impact on Malaysia and Australia

Table of Content

Introduction

1. Malaysia
1.1 Economic Performances
1.2 Asian Financial Crisis (1997-1998)
1.2.1 Investors’ confidence
1.2.2 Capital outflow
1.2.3 Stock market
1.2.4 External Debt
1.2.5 Correcting problems

2. Australia
2.1 Foreign Direct Investment (FDI)
2.2 Monetary Exchange Policy
2.3 Balance of Payment (BOP)

3. Conclusion

4. Bibliography

5. Appendices
Appendix A
Appendix B

Introduction

This report is made as required for the completion of the macroeconomic subject. It investigates economy events for the last decade and its impacts to Malaysia and Australia economy performances.

Asian Financial Crisis event is chosen merely because this event is arguably the most influencing global economy event during the last decade.

Analysis will start from both countries economy performances and conditions during the crisis (1997-1998). Sources of information are mostly gathered from internet researches and other relevant materials such as economic journals and books. Data collected are analyzed and hypotheses drawn are based on my understanding of macroeconomic subject.

1. Malaysia

1.1 Economy Performances

Malaysia economy in 1990’s was focused on former Prime Minister Mahathir as the main architect. Structural changes in the economy since political independence in 1957 have made the Malaysian economy increasingly outward-looking. Malaysia’s total value of exports and imports is twice as large the country’s national income. Much of the Malaysia’s manufactured exports are associated with the foreign direct investment (FDI) activities. Japan, Singapore and US have been the major sources of FDI for manufacturing electronics, chemicals, textiles and wood product in Malaysia.^[1]

Before crisis, Malaysia’s real output growth averaged 8½ percent a year and unemployment was below 3 percent. In fact, the economy had experienced labor shortage, it can be said that Malaysia was experiencing an over full employment. The presence of about 2 million foreign workers has kept wages low, therefore maintaining the competitiveness of Malaysian exports. But foreign workers can also provide negative sides, let us assume that each foreign worker sends home RM400 a month, 2 million of them would created RM9.600.000.000 of capital outflow a year.

Despite healthy economy performance, there were also signs of economic overheating as there was a growing deficit about 6% of its GDP in the current account of the country’s Balance of Payment (BOP). Malaysia actually has trade surpluses but there was a huge deficit in the service sectors as Malaysia made a lot of payments to foreigners for freight and insurance, education, travel and investment income which includes profits on investment and interest on debt. Fortunately, the overall balance has been in Malaysia’s favor due to the large FDI inflows.^[2]

The openness of Malaysia’s economy has made the economy become vulnerable to external fluctuation because FDI not only bring positive effects but negative effects as well. Economist noted that there was a large of current account deficit caused by outflows of funds resulting from the boom in foreign investments. FDI comes in as capital inflow and export earnings and comes out as capital outflow for payment of machinery and intermediate goods payment, payment and fees and repatriation of profits. These outflows overall can be heavier than the inflows so, it can be said that FDI can also have a negative effect on Malaysia’s balance of payment.^[3]

1.2 Asia Financial Crisis (1997-1998)

1.2.1 Investors’ Confidence

Asia crisis which started from the depreciation of Thai’s bath and then spread to its neighbor’s countries began to affect Ringgit (RM). Malaysia which is in the same region was perceived to have similar weaknesses with those countries because of the country’s huge amount of current account deficit, so currency traders believed that RM would also lose its value to USD. The fact that FDI inflows into country in the first 6 months of 1997 has declined by about 45 per cent have strengthened this belief. This led to fears about Malaysia’s ability to finance the deficits. The loss in investors’ confidence was the root of large capital outflows, declined in reserves, stock market collapses and large currency depreciations.^[4]

1.2.2 Capital Outflow

During the crisis, because of panic, massive capital outflows took place and resulted in more capital account deficit. Both currency traders and speculators should be blamed because they took speculative positions in the offshore RM market in anticipation of a large devaluation of RM. The offshore RM interest rate which was higher than the domestic rates also triggered capital outflow. RM was under great pressure and declined drastically.

The massive capital outflow resulted in shortage of money supply and pressured the interest rate to increase. See appendix A

The Malaysian corporate sector experienced significant loss of wealth as a result of sharp falls in the value of real estate and equities used as bank collateral. Corporate incomes and cash flows also declined, leaving some corporations unable to service their debt.^[5]

1.2.3 Stock Market declined

Malaysia stock market also declined sharply during the period. See appendix B. According to Urby Garay, an Assistant Professor of Finance at the Instituto de Estudios Superiores de Administración (IESA) in Caracas, Venezuela “currency devaluations have traditionally been accompanied by declining stock markets in the developing world because they have usually taken place in the middle of a financial crisis and uncertainty about the future course of economic policies and outcomes.” Others authors; Bailey, Chan and Chung (2001), also found a close relationship between exchange rate depreciations and stock returns during a crisis is consistent.^[6]

1.2.4 External Debt

There was an increase of foreign borrowing as Malaysia began many ambitious projects such as the multi-media corridor project and in 1998; the Federal Government's external debts amounted to RM11.3 billion. If the same amount of external debts were calculated on the basis of the exchange rate before the depreciation, they would only amount to RM8.6 billion. In other words, the RM depreciation increased the Federal Government's foreign debt repayment by RM2.7 billion or 31.4 percent.^[7]

1.2.5 Correcting Problems

Beginning efforts to overcome these problems were made, following the IMF’s method, by increasing interest rate and tightening fiscal policy, Malaysia was hoping for capital inflow. However, the expected result went another way. High interest was not attractive enough for investors as mistrust and fear overcome it. Increased interest rate which meant to reduce capital outflow mainly to Singapore, had negative impacts to the country’s economy performances, it halted the economic growth. When the government increased its interest rate, there was a decrease of induced investment on its agriculture, manufacture and construction sector and it all culminated on the GDP decreased. See appendix A

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^[1] http://www.iuj.ac.jp/research/wpap003.cfm

^[2] ibid

^[3] http://www.sunsonline.org/trade/process/followup/1996/01220196.htm

^[4] http://www.imf.org/external/np/exr/ib/2000/062300.htm

^[5] http://www.imf.org/external/pubs/nft/op/207/#overview

^[6] http://www.westga.edu/~bquest/2003/asian.htm

^[7] http://www2.sjsu.edu/faculty/watkins/econ202/malay2.htm#table