The Political Economy of Financial Development in Malaysia

From the Asian Crisis to 1MDB

Lena Rethel

• Publisher: Routledge
• Year: 2020
• ISBN:
  9780429647383
• Edition: 1
• Topic: Economics
• Subtopic: Development Economics
• Index: Economics

Current inquiries into the political economy of financial policymaking in Malaysia tend to focus on the high-level drama of crisis politics or simply point to the limited impact of post-crisis financial reforms, given that politico-business relations have remained close. In so doing, pundits ignore a number of intriguing questions: what is the relationship between financial development and financialisation and how has it played out in the Malaysian context? And more generally: how can a country like Malaysia become significantly more financially developed, yet fail to emancipate the financial system from political control; a core element of the financial development discourse?

To unravel the complexities of this puzzle, this book subjects the history and contemporary practices of financial policymaking in Malaysia to scrutiny. It argues that to understand financial development in Malaysia, its progress and reversals, it is important to conceptualise it as a political, rather than a merely technical process. In so doing, the book echoes a more profound concern in the political economy literature, namely the evolving relationship between states and markets, and the supposed retreat or reassertion of the state at a time of increasing (financial) globalisation. The book can generate further insights into the evolving role of the state with regard to broader processes of development and marketisation, as they relate specifically to finance.

1Introduction

As the 1MDB scandal gained international traction in 2015, it took many commentators and financial analysts by surprise. From the outside, Malaysia had looked very stable. Control of the political system had remained firmly in the hands of the United Malays National Organisation-led Barisan Nasional coalition, most recently reconfirmed in the 2013 general election. The Malaysian economy had seemed to prosper, getting close to achieving the government’s target of reaching advanced industrialised country status by the year 2020. The financial bureaucracy was seen as competent and managing the economy prudently, perhaps much more so than its US and UK counterparts, whose failures to rein in the financial sector had been so drastically exposed during the global financial crisis of 2008–2009. Indeed, Malaysia had had a relatively smooth run in the early 2010s. International investors had returned to the country after a decade-long hiatus in the wake of the Asian financial crisis of 1997–1998, during which Malaysia had imposed capital controls. Capital outflows during the ‘taper tantrum’ of 2013 had been much more muted than in neighbouring Indonesia. In particular, its support for the growing Islamic finance sector had given Malaysia an international reputation for being among the most innovative jurisdictions when it came to emerging market financial policymaking.

At the time of writing, former Prime Minister Najib Razak, 1MDB and the intricate financial webs they wove are under investigation in several countries. This includes in Malaysia itself, after the short-lived Pakatan Harapan government now under the administration of Perikatan Nasional, but also, perhaps most prominently, in the USA. Allegations have been well documented in investigative media reports.¹ They include the use of manipulative bond issuances – deeply implicating US investment bank Goldman Sachs; money laundering through various offshore firms and transactions; and a slate of other charges.² Moreover, investigators have expanded their nets and looked into a greater number of actors and their involvement in the scandal and its concealment.³ Ultimately, it will be down to the courts in Malaysia and elsewhere to establish the extent of 1MDB’s wrongdoings and to mete out justice for those involved. Nevertheless, the 1MDB scandal also cast a shadow on Malaysia’s, by many accounts highly successful, track record of financial reform in the wake of the 1997–1998 financial crisis.

This book examines how these two narratives can be reconciled. On the one hand, there is the success story of Malaysia as an innovative and quite effective financial reformer. In this guise, it has been applauded by the international financial community and seen as a role model for other emerging markets to emulate. On the other hand, there is the persistent, if not growing, influence of the government on the economy. Close ties between government and business then serve as the backdrop to the scandalous narrative of Malaysia as a country that struggles to escape money politics and is periodically prone to financial crises and recurring scandals.⁴ Of course, both these narratives embrace a certain hyperbole. Nevertheless, they leave us with an important question: how is it that a country can become significantly more financially developed, but associated expectations that this would lessen the influence of the state and result in less political control are far from being met?

To unravel this puzzle, this book critically examines the political economy of financial development in Malaysia. Financial development, in this context, and as I will elaborate in more detail in the next chapter, is understood as a process that involves government and market actors, although the distinction between the two is often not as clear cut as it seems at first glance. I will examine the political economy of financial development along a number of dimensions that are typically considered to be largely technical matters: i) the politics of financial modernisation, in particular efforts to consolidate the Malaysian banking sector in the aftermath of the 1997–1998 crisis and their implications, ii) the politics of financial deepening, with a focus on capital market development, and last but not least iii) the politics of financial inclusion, which will be explored through the lens of the country’s rapidly growing Islamic finance sector.

A significant correlate of financial development has been the increasing financialisation of Malaysian capitalism. By this, I mean that the reach of finance has become progressively more pervasive not just in the economy, but also in both polity and society. The financialisation of Malaysian capitalism has thrived on a combination of deeply entrenched state capitalism and selective pro-market reforms. The Malaysian experience clearly demonstrates that financialisation is not just a derivative of market idea(l)s, but that the state plays a constitutive role in shaping financialisation dynamics.

Argument in brief

Financial development, rather than being the predominantly technical issue which it is portrayed as in the mainstream economics and policy literatures, has to be understood as a political process. As such, it represents an amalgamation of competing understandings of good economic management and material preferences of the actors involved. This holds true for Malaysia as it does for many other countries. The state is a crucial agent in the financial development process as it can adjudicate between different ideas and interests. Financial development therefore is not only underpinned by changes in the global economy – or market shifts – but deeply enmeshed with domestic politics and the continuation and contestation of prevalent economic paradigms.

In this sense, the key to unpacking Malaysia’s complex financial history is to better understand the ambiguities of financial development and its political nature. Malaysia presents a very intriguing case in that its financial markets are considered to be mature, but political control of the financial system and the economy is nevertheless firmly entrenched. Thus, what we see is neither pervasive state capture, given the technocratic strength and moral authority of the financial authorities, specifically the central bank – Bank Negara Malaysia (BNM) – and the Securities Commission (SC). Nor is it a fully autonomous financial bureaucracy that serves the national interest over particular interests as policymakers have to navigate a complex political-economic terrain. Indeed, the very notion of what constitutes the national interest is subject to fierce contestation in Malaysia. This then results in an increasingly professional and internationally networked financial bureaucracy that nevertheless can be quite powerless in the context of financial scandal and patronage politics.

In the two decades since the Asian crisis of 1997–1998, the Malaysian financial system has undergone significant changes. On the market side, the banking system was consolidated and capital markets have taken on a much more substantial role. Moreover, Islamic finance, still a niche phenomenon in the Malaysian financial system of the mid-1990s, catering largely to the rural population, has become ubiquitous and a major preoccupation for the urban financial elites. On the policy front, financial policymakers have pursued an ambitious agenda of reform aimed at widening and deepening domestic financial markets. The institutional standing of the financial bureaucracy has been strengthened with the granting of statutory independence to Bank Negara Malaysia, consolidated by the Central Bank of Malaysia Act 2009. Likewise, the statutory powers of the Securities Commission were enhanced by the Capital Markets & Services Act 2007. However, in light of recurrent financial scandals and crises, these substantial developments have been eclipsed by a focus on the nexus between politics and business in the Malaysian political economy.

While emerging trends of the financialisation of Malaysian capitalism could already be discerned on the eve of the regional crisis, in its aftermath this accelerated and intensified, on both economic and political grounds. Indeed, the fallout from the Asian crisis, at least temporarily, made more egregious forms of rent-seeking politically difficult to sustain. This led to a push among the widespread web of beneficiaries and institutions, created over successive phases of Malaysian capitalism as detailed in Chapter 3, to reassert their influence in novel ways. Along these lines, close cooperation between the notionally public and private sectors, in the context of deep domestic pools of capital, is perhaps best understood as a form of state-permeated market economy (Nölke et al. 2015, 543–545). So-called government-linked companies (GLCs) and government-linked investment companies (GLICs) have played an important role in this regard, as will be shown.

Until the early 2000s, the acronym GLC would have been more familiar in Singapore than in Malaysia. Indeed, the term was used in Singapore for state enterprises with a commercial bottom line (Ramirez and Tan 2003). In the wake of the Asian crisis, this terminology was increasingly embraced in Malaysia, culminating in the GLC Transformation programme announced in 2004 as I will discuss in more detail in Chapter 3. However, as part of the reconceptualisation of state enterprises as GLCs, another acronym would rise to prominence – that of the GLIC. In this context, GLIC refers to a range of state-linked investors, including pension funds, the national unit trust company and the country’s sovereign wealth fund (for more details, see Gomez 2017, 6–9). These GLICs have refashioned themselves as major shareholders of GLCs and institutional investors in the Malaysian political economy, a phenomenon for which Wang (2015), in the context of the Chinese political economy, has coined the notion of the ‘shareholding state’. Financialisation thus brings into close alignment state-permeated capitalism and the shareholding state.

In the course of financial development, Malaysian capitalism has moved from an interventionist variety of state capitalism geared towards industrialisation and economic restructuring along ethnic lines to a more marketised form of shareholder state capitalism that embraces financialisation dynamics. This has important analytical implications. Rather than continuing to juxtapose interventionist and liberal policymaking, in this inquiry into the Malaysian political economy, I propose a more open-ended approach that focuses on the interplay of state-interventionist and market-liberal tendencies in shaping the Malaysian financial system (Rethel 2010b; see also Gomez and Lafaye de Micheaux 2017). Ultimately, these dynamics have to be understood as a renegotiation of the relationship between an ethnically stratified state and market, as financial principles have become increasingly imbued within the state apparatus, with political control, rather than economic efficiency being the primary purpose.

Such an approach, then, highlights the dynamic nature of the webs of relationships that underpin financial development, all within Malaysia’s distinctive ethnic political economy setting. Moreover, it clearly points to the political nature of financial development in both its internal and external relations. In so doing, it brings the political and socio-economic implications of financial development and its relationship with the financialisation of Malaysian capitalism to the fore. At the same time, as later chapters will show, this shift has been a fundamental means of shoring up political control of the financial system. As a result, in Malaysia, the increasingly professional and internationally well-networked financial bureaucracy has to navigate a complex terrain of interests – of political elites, GLICs and GLCs and private actors – and wider national developmental and ethnicity-inflected socio-economic priorities. In this regard, financialisation dynamics are part and parcel of wider forces of state transformation.

In subjecting the history, practices and politics of financial development in Malaysia to scrutiny, the analysis presented in this book echoes a more profound concern in the political economy literature, namely to better understand the evolving relationship between states and markets. The fact that Malaysia is still a developing nation, although in close reach of graduating to being a high-income country, makes its experience especially intriguing. Indeed, the experience of Malaysia casts a light on the evolving role of the state with regard to broader processes of development and marketisation as they relate specifically to the financial system. In so doing, it challenges the rather simplistic notion that as financial globalisation proceeds, the state recedes and market actors step in to dominate processes and outcomes.

In fact, the Malaysian experience demonstrates how the lines between state and market have become increasingly blurred, with the state incorporating market principles, whilst being a substantial shareholder in some of the country’s biggest banks. As such, the relationship between financial globalisation and the state is far from straightforward and is shaped by a range of contextual factors. It is by better understanding the Malaysian story that we can gain valuable insights into other developing countries facing divergent interests between a political class, an emerging or consolidating corporate sector, and social cleavages within the wider public (whether these are ethnic/religious, class or geographical) in a period of extreme financial globalisation.⁵

Outline of the book

In exploring the nexus of financial development and financialisation, this book offers fresh insights into the nature of state-permeated capitalism in Malaysia. The next two chapters provide the conceptual and historical background of this study. Chapter 2 examines key debates surrounding the notion of financial development to illustrate both the ambiguous and political nature of the concept, before it is applied to the context of Malaysia. It will suggest that financial development is best conceptualised as a relational category, constituted through both external and internal relationships. After examining financial development in relation to policy autonomy and the real economy, the chapter moves on to critically interrogating major thrusts of financial reform, from banking sector modernisation to capital market deepening to financial inclusion. Chapter 3 provides an overview of the evolution of the Malaysian political economy, illustrating the impact of different phases on financial policymaking. It briefly introduces key actors in the Malaysian financial policymaking process and sets out the major frameworks within which they operate.

The empirical discussion in Chapters 4 and 5 focuses on financial market reforms specifically, and how they intersect with financialisation dynamics. Chapter 4 examines the banking system as a key constituent of the process. Following a period of bank consolidations in the wake of the Asian crisis, rationalised by the need to make Malaysian banks more competitive, government control over the banking sector actually increased. Through its GLICs, the state is a major shareholder in the banking system. This then has important implications for the incentive structure within which banks operate. However, at the same time, there has been growing interest in so-called value-based intermediation, in which the Islamic banks are to take a leading role. Chapter 5 looks at capital market reforms, including efforts to develop the bond market. Once more, the state can be characterised as an important market actor, ...