TREASURY UNDER SECRETARY ADAMS' VISIT TO MALAYSIA:

C O N F I D E N T I A L SECTION 01 OF 04 KUALA LUMPUR 000613 SIPDIS SIPDIS TREASURY FOR OASIA AND IRS STATE FOR USTR - WEISEL AND JENSEN STATE FOR FEDERAL RESERVE AND EXIMBANK STATE FOR FEDERAL RESERVE SAN FRANCISCO - TCURRAN USDOC FOR 4430/MAC/EAP/JBAKER GENEVA FOR USTR E.O. 12958: DECL: 04/04/2016 TAGS: ECON EFIN ETRD EINV MY SUBJECT: TREASURY UNDER SECRETARY ADAMS' VISIT TO MALAYSIA: FRANK CONVERSATION ABOUT THE RINGGIT Classified By: Ambassador Christopher J. LaFleur, for reasons: 1.4 (B) and (D) Summary -------------- ¶1. (C) In meetings with the government of Malaysia's financial leadership, Treasury Under Secretary Tim Adams sparked a frank discussion about Malaysia's exchange rate and foreign reserve policies, including a 90 minute dialogue with Bank Negara Malaysia Governor Zeti Aziz. Adams also discussed global imbalances, protectionist trends in the U.S. Congress, and the crisis the world economic system would face if the U.S. economy were to rebalance too abruptly. Adams asked Zeti to pass these messages to her colleagues in China and told her that he would do the same. Zeti emphasized her concerns over rapid movement of funds due to speculation and the risks this posed for a small, highly open economy such as Malaysia's. ¶2. (C) Comment: Zeti's policy mindset is dominated by her experience of the 1997 financial crisis. She clearly is not prepared to introduce a fully floating exchange rate. She views ringgit stability as being important for Malaysia's export-led economy. Zeti did agree that the current global imbalances, in particular the United States' current account deficit, cannot be sustained and that adjustment will happen, whether abrupt or soft. Although she recognizes the danger this poses to Malaysia, she does not seem inclined to change course in any fundamental way. With United States-Malaysia Free Trade Negotiations beginning this summer, post recommends Treasury continue this useful, behind-the-scenes dialogue as the best vehicle for influencing Malaysia's currency and financial policies. End Comment. Bank Negara: Stability In Defense of Social Goals -------------- ¶3. (SBU) Bank Negara Governor Zeti Aziz emphasized the need for stability in her discussion with Under Secretary Adams. She cautioned that Malaysia is small, open economy and cannot afford to risk too much volatility. She argued that if exchange rates were to move too fast, it could be destabilizing. Without Bank Negara's actions to smooth the transition from the peg, the rate could have depreciated to RM 3.90 or RM 4.00 to the dollar. Conversely, the ringgit could have appreciated to RM 3.00. Zeti asserted that a 3.00 to 4.00 shift is too large for a small country. Her experience during the 1997 financial crisis has made her wary of too much volatility. Referring to that experience, she noted: "There were individual transactions of $300 million and $500 million each. It overwhelmed the system and the currency depreciated by 40%. The bank managed reserves carefully to face this speculative onslaught. Lots of banks were making lots of large orders. The stock market fell by 70%. Bank Negara had to restore stability." ¶4. (SBU) Zeti acknowledged that Malaysia communicated with China when it depegged the ringgit from the U.S. dollar. She said Bank Negara was forced to act to prevent huge speculative flows once China moved, as there were large levels of funds held in deposits, treasury bills, and short-term paper instruments waiting for the exchange rate to change. On July 21, 2005, there was an orderly transition in Malaysia's exchange rate regime and reserves stood at approximately $80 billion. In an August report to the GOM, Bank Negara identified calls on reserves and how flows might go the other way. As short-term speculative funds flowed out of Malaysia during the last half of the year, Bank Negara's reserves dropped by $12 billion in three months. Zeti said that the rate bounced from RM 3.8 per U.S. dollar to RM 3.74 and then back to RM 3.79. (Note: the rate now stands at approximately RM 3.70 to the U.S. dollar). The outflows subsided by December and the currency has appreciated gradually in recent months. Financial Sector Obligations -------------- ¶5. (SBU) Zeti highlighted Malaysia's multi-ethnic character KUALA LUMP 00000613 002 OF 004 and linked economic stability to political stability. She related how Malaysian banks since the earliest days have had little town branches. "Obviously, this is less profitable for the banks and they don't like it. But there is a need for a formal system to give access to little towns so that there is job creation and no unemployment or crime. I have been challenged or criticized on this issue. But I tell the banks that you have a stable social environment for growth and benefit from that positive environment," Zeti said. ¶6. (U) Zeti then launched into a critique of Citibank and its for-profit style, relating how it had posted a profit in 1997 when the rest of the nation was undergoing a crisis. (Comment: Zeti mentions Citibank's actions during the crisis in every meeting with U.S. officials. She obviously feels very strongly that foreign banks, such as Citibank, are not to be trusted entirely because they put profit motive and their responsibilities to their shareholders ahead of the Malaysian socio-economic agenda. End Comment.) She explained that foreign companies in Malaysia deliver high returns for their parent companies and shareholders. In 2005, Zeti continued, Citibank's after-tax profits exceeded its capital in Malaysia, in part due to tax concessions. ¶7. (SBU) Zeti described Malaysia's Financial Services Master Plan (FSMP),which she said follows a Swedish model. In 1997, Malaysia had 71 banks; now there are 29. As of 2006, Bank Negara has relaxed most of the capital requirements and completed a round of mandated bank mergers. A new waive of mergers is taking place today with the recent consolidation of Bank Bumiputra and CIMB into Bumiputra Commerce and Bumiputra Commerce's very recent hostile take over of Southern Bank. Bank Negara also is interested in capacity building, adoption of best practices, and risk management, often based on the performance of foreign banks operating in Malaysia. Zeti maintained Bank Negara is pursuing liberalization at a measured pace, pushing some reforms ahead of the 2007 deadline for full liberalizations. (Comment: The FSMP never actually specifies dates for full liberalization nor exact benchmarks for what that liberalization might mean for international players. Most local observers assume that Bank Negara will a ctually slide the date from 2007 to a later implementation date. End comment.) A Global Problem and Treasury's Role -------------- - ¶8. (U) Under Secretary Adams lauded Bank Negara's move to depeg and adopt a new exchange rate mechanism on July 21. He said that it was difficult for Americans to understand the scarring effect of 1997. He then described some of the economic challenges that the U.S. faces: huge global imbalances and a U.S. current account deficit of 6.5-7%. He explained that he is trying to figure out how the system can sustain itself, and believes that it is obvious that there will be an adjustment. He made clear his preference to let the markets work and to use government policy to help the markets' imperfections. ¶9. (C) Acknowledging that the United States must raise national savings, raise household savings, and reduce the deficit, Adams called for flexibility in exchange rates globally. Adams explained that other nations -- Japan, Europe, and China -- have been saying that it is the United States' job to balance the global economy, but if only the U.S. adjusts it would produce a serious contraction in the global economy. Adams noted that it has been estimated that the U.S. would have to contract 6% to balance the external account by 2010, which would be the biggest contraction since the Great Depression. The United States does not want to see such a sharp adjustment. Other nations need to "look at what it would do to your economies. This has to be a shared job," related Adams. Don't Single Out Malaysia -------------- ¶10. (SBU) Zeti, while acknowledging Adams' comments, countered that, although the U.S. has a current account deficit and Malaysia a current account surplus, one must look at Malaysian outflows in terms of profits and dividends KUALA LUMP 00000613 003 OF 004 flowing out from Malaysia to the U.S. United States companies in Malaysia have been sending profits out. They create jobs and there is a multiplier effect but capital is still flowing out. Adams, in turn, asked why was there so much Malaysian investment flowing into the U.S. ¶11. (SBU) Zeti said Malaysia is trying to adjust in two ways: there is more domestic and regional consumption and it has floated its exchange rate. She explained that Malaysia has seen increasing domestic demand. With a larger middle class market in Malaysia and regionally, too, the middle class is buying more and more of Malaysia's goods and services. Still, the region must integrate better. Malaysia has also floated its exchange rate. Zeti asserted her displeasure that Malaysia was singled out as a possible currency manipulator and Singapore was not. She related that Singapore operates in the same way as Malaysia but, due to good public relations, they were not criticized by the U.S. Zeti found this criticism very unfair. Adams promised that Malaysia would not be singled out in the upcoming Treasury exchange rate report. Tell Your Friends In China -------------- ¶12. (C) Adams asked Zeti to "tell your friends in China that we need to see more movement. We are going to lose the policy battle and disrupt vital trade relations and bi-lateral relations." He urged changes in three components of Chinese policy - exchange rates, domestic demand, and modernization of financial services - but noted that the exchange rate has become symbolic in Washington of what is seen as an unfair relationship. Zeti responded, "China is going to move. Because Malaysia's financial liberalization is so institutionalized, Malaysia was more confident. China needs time to become confident." Meeting with New Ministers -------------- ¶13. (U) Adams also met with Effendi Norwawi, Minister in the Prime Minister's Officer in charge of economic planning and Awang Adek, Deputy Minister of Finance, focusing on the upcoming FTA negotiations in both meetings. Minister Effendi explained that his biggest fear would be the FTAs impact on local firms. He explained that the Prime Minister and the government are behind the FTA. All agree that it is a critical step to take, but there are sensitivities. Effendi asserted that there may be synergy between FTA negotiations and 9th Malaysia Plan initiatives -- for example, in technical education. Effendi would like to see the U.S. and Malaysia focus on these synergies during negotiations. ¶14. (U) Deputy Finance Minister Awang Adek mirrored Governor Zeti's concern with stability, and similarly drew a connection between economic and political stability. In addition to exchange rate stability, he said that Malaysia hopes to see more oil price stability, even if that means lower prices for Malaysian's energy exports. He expressed concern that Malaysia is not as competitive for foreign investment as in the past. "What used to come easily to us is not coming as easily as before. We are not at the center of growth," he said. He also noted the government's efforts to control inflation, suggesting that Bank Negara would start to be more proactive in raising interest rates. He discounted, however, a suggestion from Under Secretary Adams that ringgit appreciation might help with inflation, adding that this had not been a consideration in the decision to move away from a fixed exchange rate. Comment -------------- ¶15. (SBU) Zeti's views on capital flows and the danger of speculation due to a volatile exchange rate were formed during the 1997-98 Asian financial crisis. In her conversation with Under Secretary Adams, she was visibly uncomfortable with the idea of allowing the ringgit to experience short-term fluctuations. In addition, Zeti is also wary of foreign financial institutions because their choices and actions are governed by profit motive and KUALA LUMP 00000613 004 OF 004 responsibility to shareholders rather than Malaysia's development agenda. When asked to pick between allowing the market to operate freely and Malaysia's development goals, Zeti will always pick the latter (or someone above her will pick it for her). ¶16. (SBU) Under Secretary Adams' visit sparked a small amount of public discussion about the value of the ringgit, with reporters questioning Zeti, Minister of Finance (II) Nor Yakcop and, even, Prime Minister Abdullah. Even if Malaysia does not take action in the way that the United States would wish, Adams sent a clear message to the financial leadership about our concern with Malaysia's policy stance. Further, whether Zeti agrees with Adams' proposed actions to solve global imbalances is unknown, it is clear that she recognizes the danger an abrupt adjustment holds for Malaysia's economy. ¶17. (SBU) Zeti clearly was miffed at the mention of Malaysia in November's Foreign Exchange Report and will expect that Malaysia not "be singled out" again. Maintaining a quiet dialogue between Treasury and Bank Negara officials is likely to have greater influence on Malaysia's policies than public "jaw boning." End Comment. ¶18. (U) Under Secretary Adams cleared this cable. LAFLEUR