Malaysian Crisis 1985

This contribution outlines the economic crisis that affected Malaysia from 1985 through 1986 and its effects on the country's economic growth, terms of trade, and balance of payments. After highlighting the macroeconomic dimension of the recession as it materialized during 1985 as a decline in nominal GDP, and a worsening of the country's terms of trade, it offers an interpretation of Malaysia's crisis as a long‐term effect of both the impact of the second energy crisis of 1979 on world commodity prices and of newly appointed President of the U.S. Federal Reserve Board Paul Volcker's decision in late 1979 to raise interest rates to unprecedented high levels to curb the skyrocketing inflation of the 1970s, which triggered a recession in the Western world and a collapse in world commodity prices. After depicting this broad global macroeconomic picture, this contribution stresses that Malaysia's economy was deeply affected by both the second energy crisis and its impact on world commodity prices and soaring interest rates as it was a commodity‐exporting country (tin and palm oil) but also an exporter of instrumental goods due to rapid industrialization since the very start of the decade. The world economic recession of the early 1980s and the fall‐off in world prices hit the Malaysian economy hard on either side of its export trajectory. After providing this broad picture, this piece of work details how at the beginning of the decade the country undertook a process of state‐subsidized industrialization, based on increased foreign indebtedness and public debt, in the heavy industry as a way to reorganize the structure of the national economy to prevent the implications of the second energy crisis in terms of declining commodity export from further ravaging the national economy's growth rate. The crisis of 1985–86 reversed this trend: during the crisis a fall‐off in public sector spending and investments war registered. The chapter highlights how the government's policies to cope with it, based on extensive privatization of state‐owned industries and promotion of private sector investments, combined with reduced foreign borrowings and improved world commodity prices, led to the beginning of economic recovery since late 1986, and the decline in the country's foreign debt, paired with improved confidence by foreign investors by 1987. Finally, this contribution stresses that the authorities enforced prudential regulations.