Changes in Malaysia: Capital Controls, Prime Ministers and Political Connections Heather Mitchell - RMIT University Saramma Joseph - Metropolitan College, Malaysia

RMIT University©2009 School of Economics, Finance and Marketing 2 On 1 st September 1998 Malaysia introduced capital controls On 2 nd September Anwar Ibrahim was arrested He was an outspoken opponent of capital controls Other countries had been hit earlier by crisis Thailand in late South Korea and Indonesia 1997 These countries reduced restrictions on the flow of capital to facilitate IMF loans

RMIT University©2009 School of Economics, Finance and Marketing 3 What were these controls? Fixed exchange rate of 3.8 ringgit to US dollar Ringgit no longer legal tender outside Malaysia Offshore trading in Malaysian shares was banned Repatriation of foreign owned investments banned for one year All trade settlement had to be make in foreign currency All ringgit assets held abroad had to be repatriated and the list goes on ……

RMIT University©2009 School of Economics, Finance and Marketing 4 Capital Controls: Good or Bad? Definitely no agreement! Krugman (1998) capital controls should be used even at the risk of increasing corruption IMF, Sinclair Davidson – capital controls bad Were they effective – still no agreement Rodrik and Kaplan (2001) – Malaysia did better than other SE Asian countries Dornbush (2000) found the evidence unclear

RMIT University©2009 School of Economics, Finance and Marketing 5 General Agreement Capital controls allow politicians to protect or favour their mates “cronies” Did this happen in Malaysia? Evidence strongly suggests it did Johnson & Mitton (2003) – compared firms allied with Mahathir to those allied with Anwar Firms with a crony connection to Mahathir increased in value by $5 billion in September % of that gain can be attributed to their connection to Mahathir

RMIT University©2009 School of Economics, Finance and Marketing 6 Our Questions Have politically favoured firms continued to benefit from the controls? Have they suffered as controls have been reduced? Do we find similar effects for firms with government investment or control? Have these effects been impacted by the change of prime ministership from Mahathir to Badawi?

RMIT University©2009 School of Economics, Finance and Marketing 7 Major Events Restructuring period 1/10/1998 to 30/9/2000 (J&M) Repatriation restrictions lessened Forced mergers of firms in finance industry Crony financial firms should do well but other crony firms will lose their advantages Consolidation period 1/10/2000 to 21/6/2002 Final repatriation restrictions removed No substantial differences in firms performance

RMIT University©2009 School of Economics, Finance and Marketing 8 Major Events Transition period – 22/6/2002 to 30/10/2003 Mahathir’s shock resignation, followed by a planned handover to Badawi All firms will be adversely affected, especially those with Mahathir connection, but those with Anwar, not as badly Resolution period – 31/10/2003 to 21/7/2005 Last of controls, including currency peg, removed Anticorruption measures introduced Crony firms should do worse, especially financials

RMIT University©2009 School of Economics, Finance and Marketing 9 Major Events Final Period – 22/7/2005 to 30/6/2006 Nothing much going on. Included for comparison purposes Mahathir seems to have lost influence No difference between crony firms and others

RMIT University©2009 School of Economics, Finance and Marketing 10 Classification of firms Crony firms – personal relationships with politicians – based on listing in J&M Government linked companies (GLC) – commercial objective, but government holds a direct controlling stake Khazanah firms – government holds an investment through its investment arm Khazanah Nasional Berhad Government can openly favour 2 nd two and connection is stable

RMIT University©2009 School of Economics, Finance and Marketing 11 Data Monthly returns data on 625 firms listed on KLSE main board Both returns and accounting data sourced from Datastream Firm specific control variables of size, industry type and leverage used instead of risk adjusted returns Beta values have been found to be highly variable during this period

RMIT University©2009 School of Economics, Finance and Marketing 12 Preliminary findings Raw data – table 1 Connected firms of all three types are substantially larger than those without that connection Significant differences exist between most of the other performance measures considered Controlling for size and profitability – table 2 Khazanhah firms are different, but cronies and GLCs are not different from other groups

RMIT University©2009 School of Economics, Finance and Marketing 13 Model RET – return during period JM, GLC & KNB – dummy variables for connected firms, also single variable for all connection types TA & LEV – controls for size and debt ratio ID – industry dummy variables Financial firms analysed separately

RMIT University©2009 School of Economics, Finance and Marketing 14 Results PeriodExpectation (Connections)Finding RestrictionFinancials up – others downNothing ConsolidationNothingFinancials – GLCs worse Others – only KNB better ResignationAll firms down Anwar firms less badly effected Other cronies worse First month only – all firms down GLCs worse Anwar financials better? Whole period – GLCs worse (only effect) TransitionCrony firms worseCrony financial firms worse FinalNothing

RMIT University©2009 School of Economics, Finance and Marketing 15 Conclusions Some evidence that crony firms suffered through withdrawal on capital controls – but only those in finance industry Weak evidence that “Anwar” finance firms were less concerned with Mahathir’s resignation Government controlled firms often underperformed Political connection no longer seems to have market value

RMIT University©2009 School of Economics, Finance and Marketing 16 The End For copy of full paper