Financial crisis in Malaysia: did FDI flows contribute to vulnerability?

Abstract

AbstractTo date there has been greater awareness that the sudden interruption and reversal of capital flows can cause financial crisis. However for the most part it is thought that the volatility of capital flows applies predominantly to short‐term flows and not longer‐term capital flows such as FDI. The Malaysian experience of financial crisis challenges the conventional wisdom and has profound implications for other developing countries seeking to attract FDI flows as a source of long‐term stable financing. Malaysia succumbed to crisis in spite of the fact that FDI flows accounted for the bulk of financial flows on average. This paper argues that FDI flows in Malaysia contributed to vulnerability to crisis by causing chronic current account deficits and was associated with a slowdown in export growth prior to the crisis. This suggests that when assessing a country's vulnerability to financial crisis, emphasis should not only be placed on the reversibility of flows but also on the macroeconomic impact of these flows. Copyright © 2007 John Wiley & Sons, Ltd.