NEWS ANALYSIS 

           Mahathir Is Cornered by His Currency Peg 

           Malaysia's ringgit appears overvalued, and the country's reserves are dwindling. Will the Prime Minister
           cave in and devalue? 

           Malaysian Prime Minister Mahathir Mohamad has rarely been at a loss for words about any perceived
           threat to his country's currency. In fact, he's infamous for his outrageous canards on the subject. In April,
           1998, for example, in a BusinessWeek interview, he blamed a "Jewish conspiracy" for supposedly
           undermining the ringgit. But when Malaysia's central bank announced on Apr. 16 that foreign reserves
           had fallen 9%, or $2.7 billion, during the first three months of 2001, Mahathir was conspicuously
           discreet. 

           The fall in reserves is an ominous sign because the currency, which Mahathir ordered pegged at 3.8 to
           the dollar in November, 1998, as part of a series of capital controls, is widely considered to be
           overvalued. Yet the closest thing to fire and brimstone he could muster was a bland remark to the local
           press the next day: "The ringgit is not overvalued at all. We are still able to compete." That's because
           this time the enemy is within. 

           THUMBING THEIR NOSES. 

           Bank Negara Malaysia's reserves are evaporating because the country's own manufacturers -- many of
           them in the electronics sector -- are illegally holding billions of dollars in export revenues offshore.
           They're thumbing their noses at a hard-to-enforce rule that requires them to repatriate their revenues from
           exports within six months and to convert that money into ringgit. 

           The reason? A growing expectation that Bank Negara won't be able to sustain the peg much longer.
           "There has been ongoing speculation in recent weeks of an imminent devaluation or a repegging of the
           ringgit, and this has encouraged people to convert to other currencies," concludes Jomo Sundaram,
           professor of economics at the University of Malaya in Kuala Lumpur. "We're not just talking about
           foreigners. We're talking about exporters not bringing their money back." 

           In the aftermath of the 1998 emerging-markets crisis, Mahathir's capital controls -- including the peg --
           won grudging praise because they buffered Malaysia's economy against the capital flight and currency
           collapses that flattened other Asian economies. Indeed, until a few months ago, investors and importers
           considered the ringgit to be about 20% undervalued. 

           DESPERATE EXPORTERS. 

           But economic conditions have changed. "The pendulum is swinging in the other direction," says
           Mohamed Ariff, executive director of the Malaysian Institute of Economic Research. Malaysian
           manufacturers now see the peg as a liability. Earlier this year, the Federation of Malaysian
           Manufacturers issued a public statement urging a ringgit devaluation in light of the weakening of other
           currencies across the region as Asia's lifeblood -- exports to the U.S. -- dries up. "Exporters are getting
           desperate," says a foreign investment adviser in Kuala Lumpur. 

           Bankers in Singapore say Malaysian companies are parking their funds in banks on the island and in
           other countries where they do business -- anywhere but at home. As a result, the pressure is mounting
           on the government. On Apr. 5, Standard & Poor's downgraded its Malaysian currency rating from
           "positive" to "stable," signaling concern that "increasing political and economic stress...could erode the
           government's financial position." On Apr. 17, the Malaysian Institute of Economic Research, an
           independent think tank, citing the lag effect of government stimulus efforts, lowered its forecast for growth
           of gross domestic product this year to 4%, from 5%. 

           The manufacturers have interests on both sides of the fence -- but they're rooting for a devaluation, by all
           accounts. It would hurt their ringgit holdings, but would be a big boon for their exports. In any case, by
           holding their revenues offshore in dollars, they're making a devaluation more likely. "Unless stopped, the
           declining trend in [foreign exchange] reserves will undermine the central bank's ability to sustain the
           ringgit peg," warns an economist in Singapore who asked not to be named. 

           DEVALUATION DENIALS. 

           The government has been scrambling to reassure manufacturers and investors alike that all is under
           control. In an interview on Malaysia's TV3 television network on Apr. 14, Bank Negara Governor Zeti
           Akhtar Aziz denied that a devaluation was in the cards. "If you look at the context of the current
           environment, it would certainly not be to our benefit to depreciate the currency," she said. An Apr. 14
           statement by the National Economic Action Council, a government agency that reports to Finance
           Minister Daim Zainuddin, said S&P's decision to downgrade Malaysia's currency rating was "not
           substantiated by economic data." 

           But the government's reassurances do not appear to have convinced business. Malaysian investors, who
           account for most of the trading on the local stock market, are already pricing such expectations -- and
           then some -- into the Kuala Lumpur Composite Index, wwhich has plunged 23% since Feb. 1, notes Chew
           Ping, an analyst at S&P in Singapore. 

           Devaluation would be a severe loss of political face for Mahathir, who swore to keep the peg until global
           restrictions on currency trading were imposed. "He painted himself into bit of a corner," says Bruce
           Gale, an independent political analyst in Singapore. "I think he'll hold the peg as long as he can." 

           MOUNTING PRESSURE. 

           Economists say the government will try to delay devaluing at least until midyear. Bank Negara's $27.2
           billion in reserves cover four months of imports. What's alarming is the trend, though. More than half the
           plunge in Bank Negara's foreign reserves in the first quarter of 2001 occurred in the second half of March,
           when $1.5 billion evaporated. This sugggests that the real pressure on the currency is only starting to
           mount. 

           The currency controls may have helped stem capital flight in 1998. But now Malaysia's problem is that it
           needs to lure capital back. Keeping an overvalued currency in the face of a global slowdown is hardly a
           solution. Clearly, no foreign demons are at work here. The question is whether the notoriously stubborn
           Mahathir will listen to his own country's businesspeople and adapt to changing circumstances. 
 

           By Michael Shari in Singapore