THE GREAT CURRENCY CLAMP-DOWN
The new exchange control policy in Malaysia may stabilize the ringgit. But it’s shaking up finance directors who have to live with the radical new system. 
By Sethuraman Dinakar

On September 1, corporate managers in Malaysia unexpectedly stepped into a time machine. On that day, Prime Minister Mahathir Mohamed announced that the government of Malaysia, heretofore one of the world’s most liberal foreign exchange regimes, was imposing strict capital controls on the movement of ringgit in and out of the country. At the heart of Mahathir’s plan: a radical decision to make the ringgit non-legal tender outside of Malaysia, thereby kneecapping any speculation in the Malaysian currency. A day later, officials at Bank Negara Malaysia, the country’s Central Bank, fixed the exchange rate for the ringgit at 3.8 to the US dollar.

While a return to 1944 and the dollar-pegged world of Bretton Woods may make life easier for Malaysia’s economic planners, it is an unwelcome detour for many CFOs in the country. For all practical purposes, capital controls make it mighty difficult for finance directors to manage cash flows, hedge exposures, and repatriate proceeds from asset sales. Worse, despite Mahathir’s assurances that foreign direct investors would not be hurt by the controls, the added burdens of doing business in Malaysia will undoubtedly have regional managers rethinking any plans of setting up shop in that country. Senior executives say Malaysia stands to lose billions in corporate investment to nearby rivals like the Philippines and Thailand - countries which offer freely convertible currencies. Notes Tan Boon Hui, Motorola Incorporated’s regional treasurer for the Asia-Pacific region, "Capital controls certainly make it less favorable to invest in Malaysia."

Tan knows a little something investing in Malaysia. Motorola, a global manufacturer of semi-conductors and electronic communications equipment, has poured over US$1 billion dollars into greenfield investments on the Malay peninsula since 1976. Now the second largest private sector employer in Malaysia, Motorola makes two-way radios at a factory in Penang and semi-conductors at facilities in Kuala Lumpur and Sembawang. The factories, which employ more than 10,000 workers, are 90 percent export-oriented and are net foreign exchange earners. Tan says one of the reasons Motorola invested in Malaysia in the first place was the low-cost of doing business in the country. But exchange controls have changed all that. By locking in the Malaysian currency at 3.8 to the US dollar - when the market rate was nearer 4.2 - the government has effectively raised the price of Malaysian exports by 15 to 20 percent. If the Thai baht or Philippine peso begin to depreciate once again, Malaysian exports will, by comparison, become even more expensive. Boon Hui says Motorola is already feeling the pinch. "Every cent counts," he says.

Lord of the Ringgit

So does stability. While capital controls have long been in place in China and India, the dramatic departure from Malaysia’s traditional free market policy has left many finance managers in the region wondering what will come next. "You want to do business in a country," says Tan. "But you are concerned that regulations could change suddenly." Apparently, officials at Moody’s have similar concerns. Following the implementation of the exchange controls, the US-based investors service lowered Malaysia’s sovereign debt rating to Baa3 and is considering a further downgrade (a Baa3 rating indicates a medium-grade obligation, or one that’s just slightly above junk-bond status). According to an analyst at Moody’s, "The control measures heightened uncertainty over the country’s external financial position over the medium term."

The short term may not be so hot, either. Economists say the exchange controls are certain to spark a dramatic run-up in consumer prices in Malaysia. The inflation rate for the country was a modest 2.7 percent last year. The official forecast for 1998 is 7 percent. That sort of jump will seriously threaten the competitiveness of Malaysian-based exports, particularly electronics, one of the country’s key industries. And some observers now say the inflation rate may actually break into double digits - thanks to a government plan to pump US$4.8 billion into the foundering Malaysian economy.

In truth, the last thing Malaysia needs right now is more ringgit in circulation. Since the September 1 announcement, over $11 billion worth of the Malaysian currency (US$2.8 billion) has been brought back into the country. Cross-border holders of the ringgit had no choice - as of October 1, any offshore Malaysian currency was about as valuable as Monopoly money. This, of course, has killed off speculation in the ringgit - a fact which no doubt pleases Mahathir. He has repeatedly stated that the switch to exchange controls was intended mostly to rescue the currency from the clutches of speculators, whom the Prime Minister angrily blames for dragging down the ringgit, and with it, the once high-flying Malaysian economy. Mahathir’s central bank deputy governor, Zeti Akhtar Aziz, defended the radical new policy in a recent interview. "This is directed at containing speculation on the ringgit and minimizing short-term capital flows," he reportedly said. "We want to prevent a meltdown."

Mahathir’s actions may have indeed prevented a meltdown - and torched foreign currency speculators - but finance managers have been burned in the process. Take James Riley, the group finance director at Cycle & Carriage Limited, a Singapore-based property and automotive distributor with revenues of $1.9 billion last year. Riley says the new regulations have him worrying about repatriating proceeds from asset sales in Malaysia. In the past, the repatriation of funds raised from disposing of an asset was a mere formality. Now, getting the money out of the country rests entirely on the discretion of officials at Bank Negara. What’s more, the new capital controls dictate that investors wait one year before repatriating the proceeds from a divestiture of ringgit assets [see box]. Such restrictions are particularly tough on finance managers at regional companies, some of whom are looking to restructure sagging operations by hiving off assets, then deploying the proceeds elsewhere. Riley says Cycle & Carriage, which derived 17 percent of its turnover last year from Malaysia, had an outstanding US$16 million from the sale of assets in Malaysia due in mid-November. The Cycle & Carriage finance director says he applied to the Central Bank for approval. As of press time, he hadn’t heard back. "We have no need for ringgit in Malaysia," says Riley. "But the approval process now could be more difficult."

Paying for products imported from Malaysia won’t be any less painful. With the Malaysian currency worthless outside the country’s border, companies that once settled transactions in ringgit now have to trade in a convertible currency like the US dollar. That means they have to pay more. Riley says Cycle & Carriage, which imports close to 680-700 Proton cars a year from its Cycle & Carriage Bintang subsidiary, might have to pony up an extra 10 percent for imports. The Singapore-based company also incurs transaction costs when converting the currencies.

What’s more, exchange controls rob CFOs of much of their ability to hedge against fluctuations in currencies. Of course, in theory, Malaysia’s fixed exchange rate should eliminate any currency fluctuations in the ringgit. In reality, some observers wonder when - not if - Bank Negara officials will step in and rejigger the current peg.

Tough to Figure

Mark Stevens prefers the ups-and-downs of the marketplace to the discretion of central bankers. Stevens, corporate vice president and controller at Dell Computers Asia Pacific, says that, six months into the Asia currency crisis, Dell did not have to change its computer prices whatsoever. "We had seen signals coming from Asian economies even before the crisis and hedged our exposures," he explains. (Dell’s hedging strategy in Asia has proven so successful, in fact, that CFO magazine, CFO Asia’s sister publication, recently awarded the company its Excellence Award for risk management.)

Dell has good reason to hedge its bets in Asia. A whopping 75 percent of the company’s procurement costs are tied in some way to the region. And Stevens notes that Dell transacts all regional sales in local currencies. The strategy appears to have given Dell a competitive edge - the company is now the seventh largest seller of computers in Asia, up from 32nd just a few years ago. But pricing locally also adds to currency risk. Stevens mitigates the risk by hedging his immediate trade exposures and future economic exposures in the forward market, as well as by taking out options. "We hedge every quarter and also beyond a year," he notes. The Dell controller has even figured out a way to hedge in the cloistered new world of Malaysian currency controls. Stevens says he has turned to an instrument called a non-deliverable forward contract, which is popular in countries that maintain currency controls. In a non-deliverable forward contract, the local currency does not physically leave the country. Settlements are made on the margins.

Of course, not all CFOs have access to a sophisticated treasury operation to smooth currency shocks. Finance managers at some smaller companies in Malaysia, in fact, insist that the new exchange controls have brought a sense of order to their daily routines. Richard Soo, group financial controller at the Carsem Group, a Malaysia-based company with revenues of US$240 million, says, in the past, managing Malaysian ringgit risk was a nightmare. Carsem, which is an assembly contractor for high-tech manufacturers like Hewlett-Packard, Toshiba, and Ericsson, sources about 30 percent of its raw materials from outside Malaysia. Soo says that, before exchange controls, he could never get a fix on the ringgit’s value. "It changed without any reason," he says. Not surprisingly, currency risk management has not exactly been the hallmark of the Carsem finance department. "We were totally unsuccessful in hedging," Soo says.

Carsem may be more successful in borrowing funds locally, however. The Malaysian government is currently putting together a program to help revive local banks. The package includes recapitalizating some ailing financial insitutions, as well as easing the amount of funds that banks must keep on deposit with Bank Negara. The message seems clear: Kuala Lumpur wants local banks to start lending again. While Soo says banks still seem somewhat reluctant to open their vaults, he notes that they are gradually becoming more receptive to companies with strong export prospects. As it stands now, Carsem carries very little debt. The company has only about $40 million in foreign currency borrowings, which Soo says will be retired soon. The company raised capital overseas, he explains, because interest rates were lower. But he insists that he prefers to borrow in ringgit - if rates are competitive.

They should be soon. Prior to the implementation of currency controls, officials in Kuala Lumpur had little choice but to prop up the ringgit by raising interest rates. Over the past year, those rates have gone as high as 17 percent. Since September 1, however, those rates have been cut nearly in half. As of press time, the overnight interbank rate had fallen to 7 percent, and economists say long-term interbank rates could fall even farther.

Cheaper local capital will help finance managers like Soo, who are still recovering from the nearly 40 percent drop in the value of the ringgit since last July. Despite added paperwork wrought by the new exchange controls, the Carsem finance director seems relieved that the management of foreign exchange risk is now in the hands of the central bank. Says Soo: "For us, what matters most is where the currency stays."

For now, at least, it stays in Malaysia.