Phase III: Transition from the NEP to the National Development Policy (NDP), 1987 to 1997

The new policy orientation involved gradual easing of the strictures of the NEP, with the government declaring the NEP to be “in abeyance.” The Promotion of Investment Act of 1986 introduced fresh, more generous incentives for private investors, and some of the ethnic requirements of the NEP were relaxed. The NEP was subsequently replaced (in 1990) with the National Development Policy (NDP). The NDP eased the remaining strictures of the NEP, with a view to putting the creation of wealth ahead of redistributing it. The policy thrust of the NDP was to redress racial imbalance in a more overt fashion through various initiatives geared to entrepreneurship, managerial expertise and skills development within the Malay community.

The reforms since the mid-1980s have also involved a gradual process of privatization and restructuring of state-owned enterprises. By the early 1990s, state-ownership in manufacturing was limited to some politically sensitive ventures in automobile manufacturing, petrochemical, iron and steel and cement industries. Even though tariff protection had always been low relative to other developing countries (with the exception of automobiles), it was further reduced over time. The average effective rate of manufacturing protection, which increased from about 25% in the early 1960s to 70% in the early 1970s, declined continuously to fall below 30% by the late 1980s (Alavi, 1996).

By the mid-1990s, only 3% of all import tariff lines were subject to licensing requirements, and the import-value weighted average nominal tariff was as low as 15%. Unlike many other developing countries, Malaysia does not have a history of relying heavily on quantitative restrictions and other non-tariff barriers (NTBs) to protect its domestic industry. The Pacific Economic Cooperation Council (PECC, 1995) study noted that the only industry in which the frequency ratio of core NTBs was high in 1993 was ISIC 12 “Forestry and logging”—not uncommon in such an environmentally sensitive industry.

The market-oriented policy reforms were accompanied by a strong focus on restoring and maintaining macroeconomic stability, maintaining a realistic real exchange rate and meeting the infrastructure needs of a rapidly expanding economy. The Fifth (1986-90) and Sixth (1991-95) Malaysia Plans saw a significant reduction in overall government expenditure and a shift in government spending away from public sector enterprises and towards infrastructure projects designed to enhance private sector development. Although this reduced the fiscal burden, the Malaysian car project, Proton, continued to be a significant drain on resources.

The approach that the government had adopted towards increasing Malay participation in the economy also changed. The commitment to the 30% equity participation target became less dogged, with the government placing more emphasis on entrepreneurship, managerial expertise and skill development within the Malay community (Ariff, 1991). These changes reflected a switch in the government’s approach towards support for the Malay community. The support now came in the form of assisting the Malay community to compete more confidently with the other communities, without being too dependent on the government.

The government also relaxed regulations on foreign equity participation in Malaysia, and parts of the Industrial Coordination Act were liberalized. Up to 100% foreign equity ownership of export-oriented companies was allowed, and work permit requirements for foreign employees of companies with foreign paid-up capital of US$2 million or more were eased. In addition, guidelines for the approval of new investment projects were relaxed (Athukorala and Menon, 1996).

The ballooning fiscal deficits of the mid-1980s were reversed in the 1990s. In 1993, and for the first time in Malaysian history, the federal government achieved a balanced budget. The fiscal position continued to improve leading up to the 1997 crisis. There are a number of reasons for the turnaround in fiscal performance during this period. The first was the growth dividend, with higher tax revenue collections as a result of sustained strong economic growth. Fiscal reforms to broaden the tax base and improvements in the efficiency of tax collections also contributed to the public coffers. Furthermore, non-finance public enterprises as a group recorded a current surplus from the early 1990s, increasing the consolidated public sector current surplus from 5.2% to 7.7% of GDP between 1990 and 1996 (Athukorala, 2001).

Although the fiscal position leading up to the crisis appeared rosy, there were other signs of vulnerability emerging in the economy. Following capital market liberalization initiatives in the early 1990s, designed to promote Kuala Lumpur as an international financial center, Malaysia had started attracting large amounts of short-term capital, chasing high-yielding money and share markets. The real exchange rate also started to appreciate, affecting the competitiveness of the tradeable goods sector (Athukorala and Warr, 2002). In an attempt to stem the appreciation of the ringgit, BNM again imposed controls on short-term capital inflows in 1994, and kept them in place until mid-1995. Banks were prohibited from conducting swaps and forward transactions which were unrelated to trade, investment or inventory. BNM also set a ceiling on domestic banks’ net external liabilities; raised and extended reserve requirements on all deposits from abroad, including the vostro accounts of foreign banks with Malaysian banks; and prohibited residents from selling short-term financial instruments to foreigners in January and February 1994.

Although these restrictions stemmed the surge in short-term capital inflows, they quickly regained lost momentum when the controls were lifted in mid-1995. By 1996, short-term flows again constituted more than half of total inflows. Share market capitalization as a percentage of GDP was hovering around 250%, the highest in the Asia-Pacific region. Signs of vulnerability to a speculative attack, in the form of a quick and large reversal of these short-term flows, were clearly present.

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