(FORTUNE Magazine) – It's no secret that international investors, whom Malaysian Prime Minister Mahathir Mohamad has derided as "criminals" and "morons" for making a run on his currency, would draw deep satisfaction from seeing him fail. The irony: Mahathir may be helping them get their wish. In the midst of modern East Asia's most serious financial crisis, he has chosen not to heed the market's forceful demand for structural reform but is instead making a huge bet on the status quo. If the bet goes wrong--and the odds are that it will--the now relatively calm Malaysian economy will by next spring be plunged into chaos of Thai-like proportions, with even worse political turmoil.

Mahathir is in a position to take his reckless gamble because, after Singapore, Malaysia has Southeast Asia's strongest banks. Balance sheets are firm, nonperforming loans are low, and the quality of banking supervision is at least a notch above the regional norm. None of these virtues can be boasted by the financial systems of Thailand, Indonesia, or the Philippines, all of which have already been driven to accept the strict discipline of the IMF. Mahathir would, as one opposition politician puts it, "rather shoot himself than go to the IMF," and he is relying on the financial might of Malaysia's banks to make sure he has to do neither.

At first glance, Mahathir is not badly positioned to make his escape. Unlike Thailand and Indonesia, Malaysia has no overwhelming foreign-debt problem. Its total foreign-bank debt is a relatively modest $27 billion: As a share of GDP, that's less than half as big as Thailand's foreign-bank debt.

But Malaysia does have a bad and worsening problem with domestic debt. Loans as a share of GDP will reach at least 140% by the end of this year, the biggest such percentage in Asia. There is nothing wrong with debt, of course, provided the loans go for things that will eventually produce a stream of income to pay them off. But it is never a good sign when so much government money is going to build the "world's tallest" building or the "world's biggest" dam. Moreover, a lot of credit has been extended for speculative investments. Analysts at Jardine Fleming in Singapore estimate that half Malaysia's domestic bank loans in 1995-97 went for property, consumption, and equity investment, with only 16% going into manufacturing.

A more prudent government might react by squeezing its budget, tightening liquidity, and deregulating industry. Malaysia will have none of that. Although some white-elephant monuments such as the Bakun Dam have been postponed, the mid-October budget was only mildly contractive; GDP growth in 1998 is projected to fall to a "mere" 7% from more than 8% last year. Real interest rates remain at zero or below.

This is where those robust banks come in. Malaysia can put off its day of reckoning by provisionally shoving every failure onto the books of the financial system. The country's 61 brokerages had, as of late September, made very few margin calls, even though they're sitting on around $2.5 billion in margin losses. Nor do commercial banks seem to be calling in loans. Thanks to such flimflam, Jardine Fleming reckons that nonperforming loans as a share of all loans in Malaysia will quadruple and that the country will be left with a higher share of bad debts relative to GDP than even Thailand.

For his bet to succeed, Mahathir is banking on four things: that exports will rise, that consumer spending will rise, that the stock market will recover, and that the currency will stop falling. Some combination of these might mount a successful rescue. Overall, this economic strategy represents a wild throw of the dice. Like everywhere else in Asia, Malaysia needs deep reforms. Unlike everywhere else in Asia, Malaysia denies it.

--Jim Rohwer