Between 1983 and 1986, Malaysia embarked on a structural adjustment program to control its fiscal and balance of payments deficits. In reaction to the shock of sharply declining commodity prices, the Malaysian government drastically cut back on public spending and allowed the exchange rate to depreciate freely. A sharp decline in export income, combined with rising costs and reduced public spending, caused severe disinflation. This culminated in the failure of 24 deposit-taking cooperatives in mid 1986 and required the central bank to inject substantial fresh capital to aid three commercial banks. Losses to ailing financial institutions between 1985 and 1986 amounted to as much as 4.7 percent of 1986's GNP. The Malaysian authorities adopted several rescue packages and bank restructuring exercises to protect depositors. Malaysia's experience shows that structural adjustment to shocks emanating from changes in the external environment have pervasive microeconomic effects, particularly in the financial sector. Effectively tackling financial distress requires both macroeconomic policy adjustments and timely changes in banking legislation to address the problems of fraud and poor bank management that typically emerge in times of financial distress.
