By JON OGDEN

Malaysian Prime Minister Mahathir Mohamad may just find out this year  that in the unforgiving world of economics there is no such thing as a free lunch.

Mr Mahathir looked like he was getting the best of everything with his neat trick of exchange controls to stave off the worst of the Asian crisis in 1998.

By pegging the ringgit at 3.80 to the US dollar at the same time as he clamped down on capital flows, he was able to lower interest rates to revive domestic demand without punching further holes in the currency.

Two years later, amid a sharp slowdown in global growth, the pegged-ringgit policy may be getting to the end of its use-by date, according to some economists.

Guarded by the fortress ringgit, Malaysia's economic growth has revved  up from 5.8 per cent in 1999 to an estimated 8.5 per cent for last year, according to Deutsche Bank.

But the first cracks are appearing. Foreign currency reserves, after falling as low as US$13 billion in 1998, peaked at US$34 billion in February last year and have since declined to US$30 billion.

Behind that fall has been the steady trickle of US$200 million in capital out of Malaysia each month. Some of the outflow is chasing higher interest rates, particularly in the United States. Bank Negara Malaysia's key rate is just 3 per cent, well below the US Fed Funds rate of 6 per cent even after last week's cut.

The problem of falling foreign currency reserves is also being caused by rapidly rising imports, sucked in by the growth Mr Mahathir's government engineered in 1998 to help the country expand out of the corporate and financial troubles it was in.

Exports grew faster than imports in 1999 16.8 per cent to 12.7 per cent, according to SG Securities. The situation reversed last year as imports surged 28.9 per cent against 15.8 per cent growth for exports. While the trade balance has stayed in surplus, the balance of payments is in the red.

Adding to the agony has been the ringgit - rock-like while neighbouring currencies have melted before it and the US dollar.

The Philippine peso plunged 25 per cent against the ringgit last year, the baht lost 18 per cent and even the Singapore dollar fell 7 per cent,  adding to the purchasing power of Malaysia's re-invigorated consumers.

"Objectively they have a problem. With a fixed exchange rate and a balance of payments deficit something has to give. To adjust policy to be consistent with the exchange rate they need to tighten fiscal policy,"  said Michael Spencer, regional chief economist for Deutsche Bank.

Rates might also have to go higher to slow growth and bring things into line.  "The longer they stick with the fixed exchange rate the more the  adjustment is going to come through domestic income and prices to correct that balance of payments deficit," Mr Spencer said.

There is another solution - but it may be emotive one particularly for  Mr Mahathir: let the ringgit go. That would involve the dread "D" word: devaluation.

But growth is another economic sacred cow. The mandate of Mr Mahathir's United National Malays Organisation relies in some measure on its  ability to deliver consistent growth to voters.

Mr Mahathir has already lowered the official estimate for growth this  year to 5.8 per cent from the 7 per cent to which Malaysians have grown accustomed.

Many private sector economists think even the new target is going to be tough to meet. Mr Spencer is projecting between 4.5 per cent and 5.5  per cent after growth of up to 9 per cent last year. Goldman Sachs projects 4.9 per cent growth this year, while Morgan Stanley Dean Witter is reducing  its number from 6 per cent to about 4 per cent.

"I think the incentive for them to move to a more flexible exchange  rate mechanism will grow," said Mr Spencer.

Goldman Sachs economist Adam Le Mesurier played down the dilemma  sparked by the slow erosion of reserves. But he saw devaluing the ringgit as a  good move to aid Malaysian exports, which will become an increasingly tough  sell as global growth slows.

"Would it be more desirable if the government were to adopt a more  flexible policy now? I would argue yes," he said.

"Whether they are really likely to do it in the next six months. I  would be very surprised."

Trade is the key for Malaysia, agreed Morgan Stanley's head of regional economics, Andy Xie.

"It is very dependent on exports and the value added is pretty low. There are no other sources of growth. Growth is going to come down," he said.

Ominous for Malaysia is that US capital spending on technology was  expected to be flat this year after growing 20.37 per cent to US$130 billion  last year.

With electronic components making up the lion's share, Malaysia's  exports might suffer a couple of quarters of negative growth, Mr Xie said.

"The issue is what is their fiscal response?" he asked.

The option of devaluation was not likely to be considered politically palatable by Mr Mahathir, Mr Xie said.

Some economists believe the worries about the ringgit and an export slowdown are overplayed. Malaysia came in third behind Hong Kong and Singapore in a survey by SG Securities into regional economies'  resilience in the face of a US slowdown.

"I don't see any reason why they should re-peg the ringgit," said SG economist Khatina Nawawi, who was "quite happy" to stick with her  forecast of 7 per cent economic growth for Malaysia this year even though her  peers and Mr Mahathir have been busying cutting their forecasts.

Besides, Mr Le Mesurier said, many foreign investors had grown to like  the assurance of knowing exactly how many US dollars they would be getting  for their ringgit when it was time to take money out of the country.
 
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