Malaysia’s Policy Responses to the Panic of 1997: An Islamic Perspective MAZATUL AINI SHAHAR A thesis submitted in partial fulfilment of the requirements of the University of East London for the degree of Doctor of Philosophy School of Business and Law April 2021 Abstract This thesis explores the rationale behind the decisions of the Malaysian policymakers in response to the Panic of 1997, as Malaysia is the only country that had rejected the Washington Consensus while the rest of the crisis-affected countries pursued the orthodox policies. The thesis is to investigate whether the reasons behind the policy responses were due to adhering to the underlying principles of Shariah or mere political pragmatism. Identified by the World Bank as a newly industrialising economy (NIE), Malaysia symbolises a developing country with an impressive growth rate in the last thirty years prior to the Panic of 1997. The transformation to a rapid economic growth in the 1980s and 1990s resulted from a change of policies regarding social and economic development. It was a widespread perception that the reason for Malaysia’s rejection of IMF’s involvement was primarily due to prevent any intervention in its existing social affirmative action policy known as the New Economic Policy (NEP). Concurrently, Prime Minister Mahathir’s strong advocation towards the Islamisation policy had also made a significant impact in the development of Malaysia’s policy framework. The Washington Consensus via the IMF delegitimised the prevailing economic system in Southeast Asia by blaming the structural deficiencies in the financial and corporate sectors of the countries as the root cause of the Panic of 1997. The IMF believed that the Washington Consensus presents a model for institutional transformation. However, Malaysia had adopted the unorthodox capital control policy as a policy response, while the rest of the crisis-affected countries had accepted the Washington Consensus. The thesis adopts a historical institutional analysis in explaining the significance of the Islamisation policy and the importance of upholding the NEP and the likely impact of its reversal or revocation. Keywords: Asian Financial Crisis, IMF, NEP, Capital Control, Policy responses, Islamisation. ii Table of Contents Abstract ............................................................................................................................ ii List of Tables, Figures and Appendices ...................................................................... vii Abbreviations ............................................................................................................... viii Arabic and Malay terms and its meaning in English .................................................. x Acknowledgements ....................................................................................................... xiii Dedication ..................................................................................................................... xiv CHAPTER 1: INTRODUCTION ............................................................................... 15 1. Overview ...................................................................................................... 15 1.1 Background and objective of research ......................................................... 16 1.2 Research Design and Methodology ............................................................. 18 1.2.1. Path Dependence, Timing and Sequence ..................................................... 20 1.3 Research Questions ...................................................................................... 25 1.4 Significant contribution of the Research ...................................................... 25 1.5 Outline of Thesis .......................................................................................... 26 CHAPTER 2: MALAYSIA’S GLOBALISATION .................................................. 29 2. Introduction .................................................................................................. 29 2.1 East Asian Miracle ....................................................................................... 32 2.2 The Globalisation Experience in Southeast Asia ......................................... 34 2.2.1. First Phase: Initial Liberalisation (1970 to mid-1980s) ............................... 35 2.2.2. Second Phase: Rapid Globalisation (1980s onwards) .................................. 36 2.3 Malaysia's Globalisation Experience ........................................................... 43 2.4 The Impact of Neoliberalism........................................................................ 45 2.5 The Malay Dilemma..................................................................................... 46 iii 2.6 Mahathir and Middle Power ......................................................................... 51 2.7 Debating the IMF response .......................................................................... 53 2.8 Globalisation to the Ummah ......................................................................... 57 2.9 Conclusion .................................................................................................... 59 CHAPTER 3: ISLAMISATION IN MALAYSIA ...................................................... 60 3. Introduction .................................................................................................. 60 3.1 The Quran ..................................................................................................... 62 and early Islamic Economy .................................... 63 ﷺ Prophet Muhammad 3.2 3.3 Understanding the “Islamic Economy” ........................................................ 64 3.4 Sources of Shariah ........................................................................................ 65 3.4.1. Schools of Islamic jurisprudence ................................................................. 66 3.4.2. Relevant principles from the Quran and Hadith........................................... 68 3.4.3. The underlying principles of Islamic banking and finance .......................... 69 3.4.4. The religious ban on Riba ............................................................................ 71 3.4.5. Interest free banking (Riba-free banking) .................................................... 72 3.4.6. Conceptual differences between Islamic and conventional banking ........... 74 3.5 Islam in the world today ............................................................................... 76 3.6 Malaysia: Islamisation Policy ...................................................................... 77 3.7 BNM: The Dual Banking System ................................................................ 79 3.7.1. Phase One (1963 -1982): The Pilgrimage Fund ........................................... 81 3.7.2. Phase two (1983-1992): Development phase .............................................. 85 3.7.3. Phase Three (1993 - 2002): Take-off Phase ................................................. 90 3.7.4. Phase Four (post- 2004): The liberalisation of Islamic banks ...................... 92 3.8 Conclusion .................................................................................................... 93 CHAPTER 4: THE NEW ECONOMIC POLICY (NEP) ......................................... 94 4. Introduction .................................................................................................. 94 4.1 Malaysia’s social structure ........................................................................... 95 iv 4.2 The NEP ....................................................................................................... 98 4.2.1. Prologue to the NEP ..................................................................................... 98 4.2.2. The Colonial Rule (1786-1957) ................................................................. 100 4.2.3. Post-Colonial Development (1957-1969) .................................................. 102 4.2.4. Legitimising the NEP ................................................................................. 103 4.2.5. The Second Malaysian Plan (“2MP”) ........................................................ 104 4.2.6. The Third Malaysian Plan (“3MP”) ........................................................... 105 4.2.7. The Fourth Malaysian Plan (“4MP”) ......................................................... 106 4.3 The Fifth Malaysia Plan (“5MP”) .............................................................. 106 4.4 Legacies of the NEP ................................................................................... 107 4.5 Liberalisation of Malaysian policies .......................................................... 108 4.5.1. Financial Liberalisation .............................................................................. 110 4.6 Conclusion .................................................................................................. 114 CHAPTER 5: RESTRUCTURING OF FINANCIAL SYSTEM .......................... 117 5. Introduction ................................................................................................ 117 5.1 Malaysia’s financial market performance prior to the Panic of 1997 ........ 119 5.2 Management of Debt in Islam .................................................................... 121 5.3 The Policy Response – Maintain Financial Stability ................................. 123 5.3.1. The AMC Continuum................................................................................