Global Trends by Martin Khor                        

Monday 10 September 2018

Be prepared, as global financial crisis spreads

As the emerging financial crisis has forced Indonesia to take more drastic measures, Malaysia should also prepare now to deal with any contagion effects.


The financial crisis affecting developing countries arrived in full-scale fashion in our region last week when the Indonesian economy experienced shocks reminiscent of the Asian crisis 20 years ago.

With the crisis coming so close to home, it’s time to consider scenarios of developments in the near future and list measures to respond to each scenario, so we are not taken by surprise.

The agreement reached with Singapore to postpone construction of the Kuala Lumpur-Singapore high-speed rail till end-May 2020 (with Malaysia paying only S$15 mil in cost) was an achievement.   It allows us two years’ delay before meeting large expenses for the mega project.  

The next couple of years will be crucial, as the country will be in the midst of managing the “perfect storm” of servicing the huge trillion-ringgit government debt, preventing the government deficit from ballooning, while also meeting the challenges of the emerging global financial crisis.

In this tight situation, every billion ringgit counts, indeed every single ringgit counts. As more discoveries are made of missing money, whether due to the 1MDB scandal, or unpaid tax refunds, there is increasing pressure to save money and cut costs to avoid wider deficits.  

So a two-year deferment helps a lot.  It may be like kicking the can down the street, but hopefully the situation will improve by the end of the two years to allow the can to be picked up, especially if during the period, ways are found to cut the overall cost of the project.

Other projects too have to be scrutinised.  Besides the mega East Coast Rail Link (ECRL) and the Trans Sabah gas pipeline projects, there are many other projects whose costs have to be examined, and whose implementation could be postponed or cancelled.  Besides the scandal-laced concerns of overpricing and kickbacks, there is the over-riding concern that a financial crisis has to be averted.    

Indonesia’s Energy Minister last week announced that energy projects worth US$25 billion and representing half of President Joko Widodo’s grand electricity programme would be postponed or restructured, to save US8-10 billion in the cost of imports to be used in the projects.

Indonesia is also raising tariffs to 10% on over 1,000 goods in a move to reduce the import bill. 

These are some measures the country is forced to take as its economy enters full crisis mode.  It could even face a meltdown of the 1998-99 scale.  The rupiah fell to almost 15,000 per US dollar, the lowest point since the 1998 crisis. 


Indonesia is vulnerable to a financial crisis due to its dual deficits in the current account and government budget, large external debt and high foreign ownership of equity and government bonds.

Indonesia is caught in a vicious cycle, which is typical when financially liberalised countries follow orthodox fire-fighting policies. When the markets perceive that the external reserves could be insufficient to pay for imports, service debts and absorb potential capital outflows, the currency depreciates. 

The perception sparks a self-fulfilling prophecy.  The fall in currency makes it more difficult for the government and companies to service foreign loans, and also prompts investors to pull out their money.

In such a situation, the government raises the interest rate to incentivise investors to retain their money in the country (Indonesian interest rates have risen by 1.25 percentage points since May). 

However the side effect is that home buyers and companies find it more difficult to service their mortgage and business loans.  Credit slows down, and so does the economy.  This in turn causes the currency to drop further.  That prompts further interest rate increases, causing loan defaults and bankruptcies.  The economy goes into recession, leading to more capital outflows, including by local people.  The currency drops again, recession deepens, and the cycle continues.

Indonesia is still at the start of this cycle.  Hopefully it will find the policy tools, including unorthodox ones that work, to avoid moving further down the spiral. 

But Indonesia is by no means alone.  Argentina and Turkey are deep in their crises, and more and more countries are suffering the contagion effect, including South Africa, India, Iran, and the Philippines.

Following the 2008-9 global financial crisis that especially hit the United States and Europe, many hundreds of billions of dollars rushed to emerging markets including Malaysia in search of higher yield.  The liquidity was created by quantitative easing (government pumping money into the banking system) and low interest rates in the US and Europe.

Now the funds are leaving the emerging economies and returning to the US.  This is due to the US policy reversing to quantitative tightening, its rise in interest rates, fears of an emerging market crisis and of a worsening trade war.

Developing countries vulnerable to currency decline, a pull-out of funds and a crisis are those with significant current account deficit, government budget deficit and debt; low foreign reserves; large external debt; and high foreign ownership of local bonds and equities.           

Malaysia is so far safe but it is wise not to be complacent.  It is not easy to escape contagion once it spreads.  A few warning signs have appeared, such as a narrowing of the current account surplus and significant portfolio investment outflows, both in the second quarter, and a weakening of the ringgit, besides the larger than previously reported government debt and the need to prevent the budget deficit from increasing.

The old Boy Scout motto “Be Prepared” comes in handy at times like this.  It is good to prepare now for any eventuality, so as to avoid being caught by surprise.