Q How is Kuala Lumpur positioning itself as a financial centre?
A The blueprint for the development of our financial sector is outlined in our Financial Sector Masterplan. When as deputy governor I started work on the Financial Sector Master Plan in 1999, we looked at where we wanted our economy to be in 10 years, and at what kind of financial system we would need to facilitate this economic transformation.
Malaysia regards its financial system as an enabler and facilitator of economic growth and development. We don’t aspire to be an international financial centre, where an important strategy would be to liberalise very rapidly and open up the system. But our agenda is that we want to have a financial system that best serves our economy and that contributes towards the process of growth and economic transformation.
Q What is the role of Islamic finance in Malaysia?
A Islamic assets currently represent 10% of the banking system and this is expected to increase to 20% in the next 10 years. While Islamic finance operates side by side with conventional banking, it is expected to become an increasingly important component of the system.
I was told by one of the large banks that half of the clients for Islamic financial services are non-Muslims – including multinational companies – because they are competitive.
Malaysia has more than two decades of experience in Islamic finance. We have developed an Islamic financial system supported by a strong legal and supervisory framework. This year we will introduce deposit insurance for Islamic deposits, the first country in the world to do so. We are also able to conduct monetary policy using Islamic-based papers to perform open market operations to manage the liquidity in the system.
Q What role should foreign banks play in Malaysia? Will any new banking licences be issued?
A Foreign banks bring to our system linkages to the global financial system as well as new products and services. There are 13 foreign banks that are 100% foreign owned and we have 10 banks that are domestic-owned in Malaysia. The foreign banks have about a 30% share of the market.
Some of the early foreign banks in Malaysia have a wide branch network but the foreign banks are mainly focused on the urban areas and the best clients. They are not interested in having branches in the smaller towns.
In Malaysia we want balanced growth and social stability and therefore we want the outreach of banking services to be extensive. No new licences have been issued to either domestic or foreign banks. No new licences have been issued for some time now because we are overbanked but the situation will be reviewed from time to time.
We will, however, issue up to three licences to foreign players with experience in Islamic banking in the very near term, as part of the effort to develop Islamic finance.
Q Malaysia may not aspire to be a Hong Kong or a London but all the same, it has liberalised its financial sector.
A While we do not aspire to be an international financial centre, it doesn’t mean we are going to operate in isolation. As we have developed our financial system and our capital markets, we have progressively liberalised our system. In March this year, we liberalised our exchange controls so that non-residents, including multinationals, can raise funds in our domestic capital markets.
The aim is to broaden and deepen our capital markets so that the raising of funds will be more efficient. We also don’t want to be overdependent on the banking system for raising funds. We want a diversified system that includes not only banking but capital markets, venture capital and micro-finance.
Large corporations now mainly access financing from the bond and equity markets, while an increasing volume of the business loans extended by the banking sector are to small and medium-sized enterprises and to consumers.
Q Will Malaysia keep the currency peg to the dollar?
A Investors tell us that they like it because it represents stability. We are a very open economy and the objective of our exchange rate policy is stability.
Stability, however, doesn’t mean rigidity. Stability means predictability and reflecting the underlying trends. The volume of Malaysia’s trade is equal to two times the size of our economy, which is very large, and if we have wide swings in our exchange rate, it is very difficult to conduct business in such an environment.
We saw this take place over a period of one and half years [during the Asian financial crisis in 1997-98], when there was no sign that the currency would settle down. [This led to the fixing of the exchange rate.] It has functioned well for six years now and is well supported by our fundamentals.
Q Other countries have had similar experiences even though many international economists argue in favour of floating rates. Do you think you are winning the intellectual argument?
A It’s really an illusion to believe that having more flexible exchange rates will solve the problem of global imbalances. I don’t think it will. The exchange rate would have to move very significantly to achieve that.
If you look at wage levels in Asia compared with the developed countries, our rates are about one-fifth of theirs. Therefore the comparative advantage that we have is not from the exchange rate, it’s from other, lower costs.
Stability can be achieved when trade flows are what determine exchange rates but now it is financial flows determining exchange rates, and financial flows are based on other developments.
In Malaysia, we have always had a liberalised capital account and since 1992 the financial flows became more significant. If you have a system where financial flows are determining the exchange rate, you experience a great deal of volatility. You get significant inflows of short-term money, then when portfolio investors don’t like you for one reason or another the money flows out. This happens even to the major currencies.
When it breaches certain critical levels, significant concern is expressed, such as when the euro was low against the dollar and when it didn’t reflect the underlying fundamentals. For countries where trade is not so significant in relation to the total economy, they are not so adversely affected but for us, where trade is twice the size of our economy, we were very adversely affected by the exchange rate instability – more so than any other country in the region.
Q How is Malaysia’s trade structure evolving? And how important is China?
A While Malaysia’s strategy has been to diversify its export markets, the large economies such as the US and China will always be important trading partners to us. Our trade with the US is now 16%-17% of our total trade. It used to be more than 20%. There has been a greater integration with the Asian region. Our trade now with ASEAN (Association of South East Asian Nations) alone, where there is a population of 500 million, is about 25%. Trade relations with China, Japan and South Korea are also important. In particular, our trade with China has gone up by about 48%.
Q Will Malaysia’s economic fortunes be affected by China’s economic health?
A While we will indeed be affected by developments in our major trading partners, Malaysia has quite a diversified export market throughout the world. In addition, we are positive about the region and China.
Looking forward, the Asian regional economy will be increasingly self-reinforcing because of the promotion of the domestic economy and the demographic structure. As living standards improve, aggregate demand in the region will become increasingly more important.
Asia has for a long time had a high rate of savings. In Malaysia it was 42% of GNP, now it’s about 35%. As it declines to about 30%, domestic consumption is promoted considerably. We can more than adequately finance our investment with that level of savings.
The same trend can be seen in Asia. The domestic demand in Asia will therefore increase significantly over time and represents an important market for goods and services produced in Asia.
In the April issue of The Banker, Dr Zeti was described as our Central Banker of the Year for 2003. It should have been 2004. Apologies.
