Today, the clash threatens to send Malaysia into upheaval. Anwar, a central player in the old patronage system, has now emerged as a hero of the swelling reformasi movement, which advocates a more open society and economy. He goes on trial Nov. 2 on 10 charges of sodomy and corruption. A conviction could turn the protests into an ugly confrontation.
How did the two men end up so militantly opposed to each other? Over the past month, BUSINESS WEEK interviewed dozens of Malaysians from both camps, including Anwar prior to his arrest, prominent pro-Mahathir businessmen, informed academics, and Anwar associates. Together, they draw portraits of the one-time allies and their battle to control the future of Malaysia Inc., an economic model that uses patronage to speed economic development.
HEIR APPARENT. It is a tragic spectacle. Just a few years ago, Mahathir was poised to retire from politics as the prickly but nonetheless brilliant and erudite architect of a model developing nation. And Anwar, the anointed successor, would smoothly take the helm of the ruling United Malays National Organization (UMNO) and lead a modern, politically stable 21st-century economy. Former Islamic radical Anwar, 51, was the more Western-friendly of the two, often quoting Shakespeare and hobnobbing with the moguls of international finance. Mahathir, 72, has long taken a confrontational stance toward the West. But like Anwar, he viewed foreign investment as key to Malaysia's economy and advocated freer trade within Asia.
Both also were savvy politicians who steered choice deals to their allies in the business community. Just last year, foreign investors criticized the government's handling of insider deals by Malaysia Resources Corp., a media and infrastructure company controlled by Anwar allies.
Still, Anwar had a reform agenda. In recent years, he increasingly advocated the rule of law and more transparency. But until the crisis erupted, he was willing to bide his time until it was his turn to run the country. ''He was that close to power,'' says Anwar's wife, Azizah Ismail, holding her thumb and forefinger close together. ''He was tolerating a lot.''
Perhaps the key difference between the two leaders was their outlook on the world. Anwar quickly realized that the meltdowns of Thailand and Indonesia were caused by excessive borrowing, overbuilding, and big trade imbalances--and that Malaysia's situation was similar. Malaysia didn't yet need an IMF bailout, but he feared its economy would implode without swift action. While this surely would hurt his business allies, Anwar was willing to have Malaysia absorb economic pain first and rebuild for the future.
Mahathir looked at it differently. Unlike the ascendant Anwar, he was in the twilight of his career--and feared for his legacy. While Anwar hinted he wanted to end patronage, Mahathir genuinely thought the system he proudly calls ''Malaysia Incorporated'' was a legitimate model for developing nations. A handful of wealthy businessmen are singled out for privileges and given the role of creating jobs, implementing big projects, and keeping the economy and the ruling party humming. Then wealth trickles down from Mahathir's chosen few to the many. ''We view Malaysia as a corporation, and the shareholders in the government are companies,'' says Mustapha Mohamed, the new No.2 at the Finance Ministry. ''To the extent you help the bigger guys, the smaller guys benefit.'' When Western agencies attacked his system as institutionalized corruption, Mahathir ''was quite angry,'' says Francis Yeoh, managing director of YTL Corp. and a longtime Mahathir ally. ''He found it incredibly hypocritical and unfair.'' Mahathir declined to be interviewed.
When Malaysia was growing 8% to 10% annually, the uneasy alliance worked. But the crisis in Malaysia's financial markets provoked a fury in Mahathir toward the outside world. The feud broke out two days after Mahathir returned from a two-month globe-trotting sabbatical in July, 1997, just as the crisis hit. He began blasting foreigners--and he kept it up for months. He blamed ''international manipulators'' such as financier George Soros and Jewish traders for trying to undo the success of the Muslim Malaysians.
Malaysian officials grew weary of the Mahathir effect on the currency and stock markets. The central Bank Negara tracked the plunges in the ringgit every time Mahathir lashed out, and officials showed him the data. If Mahathir would tone it down, they suggested, the ringgit might stabilize. For a while, he complied.
Meanwhile, Anwar tightened up on money and began urging Mahathir to suspend big infrastructure projects. When Mahathir agreed on Sept. 5 to postpone the $5.3 billion Bakun Dam, a new airport, and plans to build the world's longest building, the market enjoyed the largest one-day surge in over three years. But it fizzled as the crisis deepened.
Mahathir's patience ran out. On Nov. 21, he set up the National Economic Action Council to devise remedies. It included Mahathir, Anwar, economic adviser Daim Zainuddin, and prominent economists and business leaders. Council members quickly squared off over the best cure for the crisis: the IMF's austerity medicine or the easy money and massive government spending Mahathir preferred. ''We argued back and forth, back and forth,'' recalls Zainal Aznam Yusof, deputy director of the Institute for Strategic & International Studies, a government think tank. But as the months wore on, ''we became convinced that you cannot go on with tightening monetary policy. You might push the economy over the edge.''
Then came a move that rocked market confidence and drove a deeper wedge between Anwar and Mahathir: the bailout of big infrastructure developer Renong. Headed by longtime Mahathir associate Halim Saad, it was precisely the sort of company Mahathir was determined to save. Renong had built some of Malaysia's biggest projects but was choking under a pile of debt. In a complex transaction that left minority shareholders in the cold, Renong subsidiary United Engineers Malaysia (UEM) paid a stiff premium to buy out the parent company. Analysts suspected that Mahathir allies benefited, a charge Renong denied.
Anwar, miffed at the way the bailout was handled, ordered regulators to investigate. UEM was found to have broken disclosure rules, but the punishment was light. ''Within two weeks of the Renong-UEM deal being announced, it was all over'' for Malaysia's stock market, says a local securities trader.
Five days after the Renong bailout came the meeting on Langkawi. Anwar, having just met with IMF Managing Director Michel Camdessus and acting on the advice of his central bank governor, Ahmad Don, had concluded that the IMF formula of tight monetary policy and government austerity was right. The Cabinet agreed. When Mahathir arrived, the virtual IMF program was a fait accompli.
''MORAL OBJECTION.'' But local business leaders were growing unhappy with the effects of Anwar's policies. So was Mahathir. ''The intensity of business collapses and bank collapses was like tenpins falling every day,'' says YTL's Yeoh. ''He couldn't stand it.'' Adds another prominent businessman: ''He doesn't believe in bankruptcies. He has a moral objection to them.''
The attempts to get around Anwar's IMF-style budget grew. According to Anwar associates, Daim called the CEO of Bank Bumiputra, Abdul Aziz Othman, and asked him to lend $20 million to a company in trouble. After checking with Anwar, these sources say, Aziz told Daim no. Tensions between Daim and Anwar rose. Daim declines to comment on the allegation or other matters related to Anwar. Bank Bumi did not respond to requests for comment.
By February, Mahathir was pushing for more bailouts. Anwar aides contend that the Prime Minister had broached the idea of using Petroliam Nasional (Petronas) to bail out his son Mirzan Mahathir's shipping company, Konsortium Perkapalan, which had trouble servicing its $490 million debt. Both Mirzan and Petronas deny the Prime Minister had anything to do with the $220 million purchase of KP's assets by a Petronas unit. ''I didn't ask him to intervene. I just told him that any businessman faced with this situation will have to sell and pay down the debt,'' says Mirzan, who holds a Wharton MBA. ''We believe we are a viable company.''
But the deal reminded many Malaysians of Indonesia's Suharto, who fell partly because of his family's greed. In 1994, opposition politicians criticized the stakes Mahathir's sons had in over 200 companies. Now, those concerns were resurfacing. Comparisons with Suharto ''must have upset Dr. Mahathir, even though there are important differences between the two,'' says University of Malaya economist K.S. Jomo.
In April, the Anwar-Mahathir rift grew wider. Speaking in New York at the elite Council on Foreign Relations, Anwar lauded the virtues of ''creative destruction.'' Mahathir would deride that term time and again in speeches months later. Anwar later told Mahathir he was trying to push Malaysia's agenda by calling for reform of the international monetary system. But he did not mince his words in New York about what was going on back home. ''What are meant to be mere crutches often become permanent appendages, spawning a dependency mentality and rendering the public purse a rich feeding ground for all kinds of parasites,'' he said to applause.
Yet while he was away, Anwar got wind of another attempted bailout, this time for Daim pal Tajudin Ramli at Malaysia Airlines. ''The moment my back is turned, they push through this nonsense,'' he told his aides. ''How am I supposed to explain this over here?'' Mahathir denied he was involved. Anwar suggested the Finance Ministry would veto the deal, and it was never done.
Shortly after Anwar returned home, Suharto fell. Mahathir had met with the aging strongman in Cairo on May 14 at the G-15 summit. Mahathir left the meeting speaking of ''foreign parties trying to unseat us both.'' The new Indonesian President, B.J. Habibie, was a friend of Anwar.
ESPIONAGE CHARGES. So was Indonesian newspaper editor Nasir Tamara, who caused a flap on June 2 when he addressed Malaysian scholars, businessmen, and social activists assembled by Anwar's think tank. While he didn't mention Malaysia, Nasir spoke of cronyism and explained how the reformasi movement toppled Suharto. An Anwar aide says Mahathir questioned his deputy about the speech.
By the time the UMNO General Assembly meeting began on June 20, Mahathir had decided to get rid of Anwar--and the open battle began. Information packets given to the 1,900 conference attendees all contained a book alleging homosexual and heterosexual affairs by Anwar. The book, Fifty Reasons Why Anwar Cannot Be Prime Minister, also charged him with spying for a foreign power. Diplomats and other sources say the book could not have been distributed without Mahathir's knowledge.
Anwar's camp returned fire. The leader of the UMNO Youth league, Ahmad Zahid Hamidi, criticized the government for ''corruption, collusion, and nepotism.'' Mahathir blasted back the next day, saying that everyone, including Anwar and his allies, had benefited from the state's largesse. Days later, Mahathir announced that Daim would take over management of the economy. Anwar's role was sharply curtailed. At a mention of Daim during an interview with BUSINESS WEEK on June 30, Anwar crossed his arms and visibly stiffened.
By the end of August, Malaysian stocks were down 80% from the previous year. On Sept. 1, Mahathir shocked the world by imposing currency controls. He told Anwar to resign by 5:30 p.m. the following day ''or I'll humiliate you tomorrow,'' according to former Anwar aides. He refused. ''I told him, 'If you resign it's like an admission of guilt,''' Anwar's wife Azizah recalls saying the next day over a lunch where the food went uneaten. Anwar then went to his Finance Ministry office. At 5:30, the power went off at his official residence. At 7, Anwar received a letter from Mahathir saying he had been dismissed.
''I tried to work within the system,'' Anwar told BUSINESS WEEK three days after his ouster. But now, Anwar acted like the outsider. He organized the biggest protest in Malaysia's history on Sept. 20, attended by up to 50,000 people, to call for reform. That day, Britain's Queen Elizabeth II was in town for the Commonwealth Games. Mahathir ordered Anwar's arrest that night. A week later, Anwar appeared in court, bruised from what he said was a police beating.
Whatever the verdict in Anwar's trial, it is unlikely to end the momentum for reform kindled by his ouster. Clearly Malaysia's reform movement has legs, although no one wants a repeat of the violence that devastated Indonesia during Suharto's fall. It looks like the transition won't be easy. Mahathir seems intent on staying in power to safeguard the economic structure he spent 17 years building. But even if Anwar vanishes from power, the questions he posed in this turbulent year will haunt his stern mentor for years to come. Business Week
By Sheri Prasso and Mark Clifford in Kuala Lumpur, with Joyce Barnathan in Hong Kong