The Pergau Dam ‘Arms for Aid’ Scandal

Introduction

In October 1993, a controversy erupted in London over whether the Thatcher government had used UK aid subsidies as a sweetener to help UK defense firms secure export orders worth more than GBP 1 billion from the Malaysian military. The subsidies in question helped finance a 600-megawatt hydroelectric dam built in the early 1990s by a consortium of UK construction firms on the Pergau River in Malaysia’s Kelantan province. While the primary focus of the controversy was on the quid pro quo of linking “arms for aid” in violation of the government’s own policies, the Pergau Dam scandal also raised questions of profiteering and bribery that were largely overshadowed.

Key Facts

Buyer: Malaysia

Sellers: BAe, GEC (Marconi and Yarrow Shipbuilding) (United Kingdom)

Year of Deals: 1990-1992

Equipment Sold:

• 28 BAe Hawk trainer and ground-attack combat aircraft variants
• 2 Lekiu-class/FS-2000 frigates
• 2 GEC-Marconi Air Search Radars
• 504 Starburst portable surface-to-air missiles
• Other smaller arms deals

Value of Deals: approximately GBP 1.3 billion

Sum Involved in Corruption Allegations: Unknown

Dramatis Personae

Mohamed Mahathir – Malaysian Prime Minister (1981-2003, 2018- ); final Malaysian decision-maker on both the Pergau Dam and arms deal.

Margaret Thatcher – UK Prime Minister (1979-1990); final UK decision-maker on the initial arms-for-aid linkage.

George Younger – UK Defence Minister (1986-1989); leading proponent of the arms deal within the UK cabinet.

A.P. Arumugam – director of GEC (Malaysia); advisor to Prime Minister Mahathir.

John Lippitt – international director at GEC; leading proponent of the Malaysian arms deal within the UK defense industry.

The Arms (and Aid) Deals

During the 1980s, Margaret Thatcher and Mohamed Mahathir, prime ministers of the United Kingdom and Malaysia, began to develop a positive relationship and explore potential arms and othertrade deals. In March 1988, the UK defence secretary, George Younger, negotiated a non-binding defense Protocol of Understanding in which he provisionally committed the government to provide non-military aid for Malaysian projects up to a value of 20% of a pending arms deal. Younger signed the protocol despite explicit prior instructions from both Thatcher and Chief Secretary to the Treasury John Major, that a defense deal should not be connected to financial support from the UK government. Younger argued that the arms deal was critical and that the Malaysians were unwilling to reach agreement without a link to an aid package. Neither the foreign secretary, Geoffrey Howe, nor the minister in charge of the UK’s aid programs, Chris Patten, were consulted before the protocol was signed, and both registered their protests afterward.

The UK government attempted to de-link aid from arms by sending letters to separate Malaysian government departments at once stating that no explicit promise of aid could be included in the arms deal, and that aid would be forthcoming nonetheless. Thatcher and Mahathir signed a Memorandum of Understanding without the aid promise in September 1988; nonetheless, the Malaysian side continued to act as if the aid linkage existed. As envisioned in the two 1988 state-to-state agreements, the arms deal would involve Panavia Tornado jets, as well as frigates and an air search radar. While the Tornado combat aircraft would eventually be replaced by British Aerospace Hawk trainers, the value of arms deals signed between the two sides total eventually around GBP 1.3 billion. GEC’s representative in Malaysia, A.P. Arumugam, was also Mahathir’s advisor on defense procurement, creating a stark conflict of interest.

To satisfy the Malaysian request for UK non-military aid, the UK’s aid agency, at that time known as the Overseas Development Administration (ODA), was pressured and rushed by government ministers into supporting the construction of the Pergau Dam. The dam, according to ODA permanent secretary Tim Lankester, was inappropriate for Malaysia’s energy market conditions. Lankester and ODA experts argued that other options for fulfilling Malaysia’s energy needs were more economical—by as much as GBP 56 million according to Lankester’s calculations— and that therefore the Pergau project did not represent the best use of ODA funds.

Corruption Allegations

The controversy over the Pergau Dam, which intensified in 1993 with the release of a UK National Audit Office report and the beginning of hearings in two parliamentary committees, was centered on the Thatcher (and later, Major) governments’ violation of their own policies on fire-walling aid from arms deals. As such, the scandal was framed as an incidence of cynical public policy, with UK tax-payers’ monies being used to support an interventionist program of government aid to arms manufacturers. While the scandal did result in a court case (discussed below), the terms of the debate were primarily political, not criminal.

Nonetheless, the scandal did spawn serious allegations of corruption, most of which remain uninvestigated. Labour MP Ann Clwyd, Malaysian opposition leader Lim Kit Siang, and anti-corruption advocate Jeremy Carver have all made allegations at separate times that the Pergau Dam deal involved side-payments to Malaysian parties, either paid directly by the British construction consortium or through siphoning-off of the ODA aid package. Clwyd’s informant appears to have been an employee of Balfour Beatty, one of the British firms involved in the dam’s construction. Carver claimed that a consortium executive boasted to him of handing over a Pergau-related pay-off to a Malaysian government minister.

The Sunday Times alleged in March 1994 that many Malaysian elites had profited from the partial privatization of Tenaga Nasional Berhad (TNB), the Malaysian electricity utility. Because the size of the UK aid commitment to the Pergau project had ballooned over the course of negotiations, ODA chose to deliver its aid in the form of loan subsidies. A syndicate led by the bank J. Henry Schroder Wagg extended a GBP 306 million commercial loan for the program, while ODA offered GBP 234 million over the life of the loan to cover most of the interest. Notably, the loan was taken out by TNB, not the Malaysian government. This arrangement ran contrary to ODA’s policies that subsidized loans be borrowed by the government directly. In May 1992, the government sold a 23% stake in TNB, mostly at a fixed price, and the company listed on the stock exchange. After the first day of trading, shares gained 94% in value, eventually quadrupling in price through 1994. This suggested that the shares had been severely underpriced by TNB’s advisors—which included the same bank, J. Henry Schroder Wagg. Energy Minister Samy Vellu and other TNB executives and employees thus profited from this sale at the expense of the Malaysian and UK treasuries.

The Pergau deal also involved a number of lesser irregularities that suggested both a cozy relationship between the British arms firms and the Thatcher government, and a deep desire to secure the arms deal whatever the cost. Notably, the Memorandum of Understanding contained a UK government ranked list of recommended arms firms, which may have led Yarrow Shipbuilders, a subsidiary of GEC, to win the contract for frigates over Swan Hunter, a competitor which had built similar frigates for the UK government. Swan Hunter was ready to offer to build the frigates at a price of GBP 400 million, whereas the final cost to Malaysia was double that amount—a price hike which itself represents a significant corruption red flag.

Investigations and Outcomes

The Pergau Dam affair and the associated arms deal were never investigated in Malaysia. Mohamed Mahathir stepped down as prime minister in 2003, but returned to power in 2018. His two successors were each senior officials who held significant cabinet postings in the 1990s; Abdullah Ahmad Badawi served as foreign minister, and Najib Razak as defense minister. The continuity in one-party rule was only broken in 2018 when Mahathir returned from retirement to lead the opposition parties against his own political heirs.

In the United Kingdom, the Pergau Dam project and the “arms for aid” linkage were investigated, in turn, by the National Audit Office, the Public Accounts Committee of the House of Commons, and the Foreign Affairs Committee (FAC) of the House of Commons. The FAC was the only body which had the remit to question broader government policy and also benefitted from the revelation, on Jan. 25, 1994, of the existence of the defense Protocol of Understanding that drew an explicit link between arms and aid, later struck out in the September 1988 Memorandum of Understanding. The officials who testified before the FAC struck a common note: the arms deal would have been lost if it were not for the Pergau Dam aid promise. The FAC agreed, but criticized ministers for driving themselves into such a dead-end. The FAC also criticized the construction consortium for low-balling their initial estimate of the dam’s cost, before Thatcher made an official offer to Mahathir.

Later in 1994, a court case was brought by the NGO World Development Movement (WDM) against ODA, arguing that the decision to support the Pergau Dam was unlawful. The court, in a surprising decision, agreed. It endorsed WDM’s argument that, in complying with a Treasury rule that public expenditures be incurred with regard to “prudent and economical administration, efficiency and effectiveness,” ministers had to rely on expert opinions and not only their own good-faith best judgment in arguing that this standard had been met.

No bribery case was ever brought against the companies involved in the deal, likely because this form of corruption was permitted by UK law up until the adoption of a limited anti-bribery clause in 2001’s Anti-Terrorism, Crime and Security Act.

Banner Image Credit

Image Caption: Protestors in front of the Royal Courts of Justice, London, the United Kingdom, unknown date.
Image Source: Flickr/Creative Commons, Global Justice Now.