Mahathir looks east. Abe doesn’t look him back.

 

Just one month after his surprise victory against the scandal-ridden and increasingly-authoritarian incumbent Nazib Razak in May, the new Malaysian Prime Minister Dr.Mahathir bin Mohamad landed in Tokyo for his first foreign visit, where he chatted with Japanese Prime Minister Shinzo Abe. Since then, Mahathir has aggressively courted Japan for investment, aid, and loans, visiting Japan once more in August before even announcing the dates for his much-anticipated first official visit to Beijing. Mahathir calls this Japan-focused approach as part of the New Look East policy, situating it as an attempt to revive the close Japan-Malay relations during the original Look East policy, which Mahathir pursued in his previous 22-year stint as prime minister from 1981 to 2003.

One of the critical priorities of the New Look East policy is to secure Japanese soft loans — preferential credits denominated in yen offered at exceptionally low interest rates and extended maturity periods — to retire higher interest rate loans ballooning the national debt, which has reached 65% of the Malaysian GDP. Reducing the national debt — which far exceeded Nazib administration’s self-imposed debt-ceiling — will go a long way to achieve Mahathir’s top priority of stabilizing the country’s finances.

Unfortunately for Mahathir, Japan doesn’t share Malaysia’s enthusiasm for new soft loans. Dr.Mahathir claims Abe agreed to “study the request” for financial support during their June bilateral summit. On the other hand, Japan’s Ministry of Foreign Affairs in their press release refrained from acknowledging that any discussions of a Japan-backed soft loan took place in the same meeting. A similar discrepancy was seen in the contrasting accounts of the July meeting in Malaysia between the two country’s foreign minister — while the Malaysian foreign ministry press statement said the two ministers discussed “soft credit assistance,” its Japanese counterpart issued a report that did not include such details.

Perhaps sensing Japanese hesitation to commit to concrete aid packages, Mahathir in late July adjusted expectations for Japanese credit assistance, saying he was unsure whether Japan will offer soft loans with low interest rates, but said he was still interested in taking Japanese loans even at higher rates to refinance maturing debt.

With Malaysian national debt ballooning to 65% of GDP, access to Japanese soft loans is key to Mahathir’s goal that aims to lower debt burden by switching existing debt with lower-interest rate loans while simultaneously expanding populist deficit spending to shore up domestic support. Easy Japanese credit also plays a role in the prime minister’s plan to phase out China-backed debt — which funds joint infrastructure projects — out of geopolitical concerns about the nation’s over-reliance on China in its capital accumulations: a Japanese cash infusion will provide funds that could be used to return the principles of Chinese loans.

Thus, Japan’s reluctance to finance soft-loans for Malaysia has severe domestic and geopolitical consequences. Without Japanese cash Mahathir will face difficult choices between enforcing unpopular austerity measures and taking on more debt to finance deficit spending, contradicting his promise to the electorate either way.

Japan’s reluctance may be puzzling from Mahathir’s perspective which appears unchanged from the days of his old Look East policy: why will Japan hesitate to offer soft loans now although it willingly provided them before, as Mahathir repeatedly stresses? In reality, however, what he asks now under his revived Look East policy is entirely different from what he obtained under the original Look East policy in nature and economic magnitude, explaining the divergence in Japanese response between then and now.

First, the purpose of the soft loans Japan offered under Malaysia’s original Look East policy was fundamentally different from that of the loans Malaysia recently seeks. Malaysia obtained development finance during Mahathir’s first tenure; in direct contrast, what Mahathir is requesting Japan today is effectively a bailout loan, since the Japanese funds acquired will be used to make early repayment of loans with higher interest rates and shorter maturity period rather than development projects.

In 1990 and 2000 Japan provided 40-year loans with exceptionally low interest rate (0.75%) in order to fund development projects to build the nation’s economic and social foundations.  Specifically, such loans were used to enhance the nation’s education, public infrastructure, and small businesses — not as refinancing for its debt. Even in the aftermath of Asian financial crisis of 1997, Japan opted to provide Malaysian with liquidity as the funding source of its economic restructuring, not public debt.

 

While Mahathir says that Malaysia is requesting the loans with the similar terms and conditions as those Japan once willingly extended twenty years ago, applying interest rate on development assistance loans to bail-out loans is not relevant due to the completely different nature and risk profile of these two types of the loans.

Second, Malaysia’s economic profile essentially changed from the day of its original Look East Policy.  Malaysia in 2008 ascended to middle-income country status according to the Japanese foreign ministry, disqualifying the country as a recipient of significant amounts of soft loan as financial aid. Reflecting its enhanced fund-raising capacity, Malaysia actually has not requested any soft loans since 2012: the country today is too developed for Japan to provide subsidized credit within the framework of developmental assistance.  Accordingly, Japan will have to create a new scheme in order to provides bilateral bail-out loans for a middle-income country like Malaysia; otherwise, using tax payers’ money for such loans is considered moral hazard.

Even if Abe wishes to meet Mahathir’s request by providing low-interest bailout loans under the new scheme, justifications of such loans would be the significant challenge both economically and politically.

The first obstacle is economic burden. The cumulative amount of Japan’s soft loans to Malaysia stood at about ¥976 billion ($8 billion as of 2015,) compared to Malaysia’s total debt of 1 trillion riggit ($251 billion as of May 25, 2018).  If Japan were to expand its debt to Malaysia to have meaningful influence as a major lender, additional funding will most likely far exceed its bilateral ODA disbursement to any single country, considering the fact that Japan’s total 2018 ODA annual budget amounts to ¥500 billion ($4.5 billion as of August 18, 2018.)  The Japanese government will face considerable difficulty getting political consensus to mobilize such a larger fund especially because Japan itself has been under significant pressure to reduce its large debt that now represents 251% of GDP.

Diplomatic and political disincentives for providing such loans also hinder Japan’s willingness to actively get involved in Malaysia’s debt finance.  As Japan strives to pursue a more cooperative approach with China in South East Asia, it prefer not to openly move into a vacuum left by Mahathir’s rebuff of Beijing by gaining lending share from China in Malaysia’s debt. Abe will face the risk to lose the public support by potentially abetting China’s and Malaysia’s risk-avert project finance as their financial supporter.  Also, unlike during the late 1990s when ensuring Malaysia’s economic stability was in Japan’s financial interest, it is unclear what economic benefits Japan could gain if they were to provide financial support to Malaysia.

These factors make it abundantly clear that Japan is not in a realistic position to provide the soft loans Mahathir asks. Then why does Tokyo refuse to openly rebuff Malaysia’s request, instead opting for a mysterious absence of all soft loan discussions from official communications?

Mahathir, a seasoned politician with decades of experience working with Japanese counterparts, should know his soft loan request is particularly challenging for Japan to supply. And yet, he pushes forward perhaps because he is aware that rejecting the loan request is just as tricky for Tokyo as accepting it because it is a unique geopolitical opportunity to counter China’s financial reach in South East Asia.

Make no mistake: a Japanese bailout package for Malaysia, if it materializes, will be fundamentally different in character from most bail outs —its purpose will not be to shore-up a nearly-bankrupt country to prevent a financial crisis. With Moody’s credit rating for Malaysia holding steady at the investment-grade A3 and the country’s treasury bond rates well-within historical bounds, Malaysia is a relatively healthy country financially speaking that should not require a multi-billion-dollar bail-out. That Malaysia is seeking Japanese funds anyways is indicative of Mahathir’s intention to diversify the country’s lender profile by adding Japanese loans as he moves to reduce Chinese debt.

Presented with a rare opportunity to earn influence and dilute China’s power in a country that until recently appeared to be sliding into Beijing sphere, Tokyo may not feel comfortable openly rebuffing the Malaysian request — explaining their reserved response.

The story of Sri Lanka, which fell prey to a Chinese debt trap that forced them to sign with China a 99-year port lease in exchange for debt relief, is fresh in Japanese decision makers’ minds, raising concerns if Malaysia could be next if their debt continues to grow. Moreover, despite Mahathir’s skepticism of China, he appears eager to maintain a working economic relationship with them — Malaysia has other countries it can turn to if Japan hesitates, adding to Tokyo’s insecurity.

As is often is the case in these sorts of stories, the debtors actually have the upper hand over the creditors.

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