Misunderstood Malaysia
Capital controls are unorthodox, but the Finance Minister says they're working
By DAIM ZAINUDDIN
Dealing with the Asian economic crisis is no easy task. One would like to believe that standard prescriptions exist, but after trying various cures, the crisis-hit countries are still not out of the woods. Malaysia initially adopted a textbook response for dealing with its problems. Public expenditure was slashed and monetary policy tightened to contain the exchange-rate depreciation. As a result, the high cost of capital and the credit squeeze choked businesses. Cutting public expenditure only intensified the contraction of an economy caught in a regional contagion.
So we tried a new approach. In July 1998 we adopted the National Economic Recovery Plan, which relaxed monetary policy and increased fiscal spending. Selective capital-control measures were imposed on Sept. 1, not on ideological grounds but to tame capital flows and stop the internationalization of the ringgit. The changes aim to contain ringgit speculation and minimize the impact of the kinds of short-term capital outflows that precipitated the problems we now face. As a small country, Malaysia can ill-afford the costs associated with internationalizing the ringgit. The high offshore interest rate for the currency at the height of the crisis was 30% to 40%, compared with 11% at home, prompting the outflow of funds. The offshore ringgit was used to short the domestic ringgit. This prolonged the exchange-rate volatility and nullified our attempts at recovery.
Some observers concluded that Malaysia had decided to use capital controls to isolate itself. Why would we want to do that? Our international trade is more than twice the size of our GNP, and exports have long driven our economic growth. The new controls continue to guarantee the general convertibility of current-account transactions and the free flow of direct foreign investment. They should not affect the normal conduct of business or long-term investment.
Malaysia is not under any illusion that capital controls are the cure for its troubles or a substitute for appropriate policies. To provide any benefit, they must be accompanied by the right mix of macroeconomic policies, and restructuring efforts must continue. Contrary to what critics say, Malaysia did not resort to capital-control measures to rev up the economy to an imprudent level. Moreover, we did not print money to fund the budget deficit so as to avoid the pains of financial and corporate restructuring.
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