Implications of the Malaysian Experience on Future International Financial Arrangements

Abstract

I. Introduction In responding to the East Asian crisis, Malaysia took a different route from the other affected countries. At the onset of the crisis, Malaysia adopted policies similar to the other crisis-hit economies, namely tight monetary and fiscal policies and floating of the exchange rate. Despite these remedies, the economy continued to deteriorate and the exchange rate remained volatile, thus pushing the Malaysian Government to look for alternative measures. From the First Quarter of 1998, response to the crisis was directed towards the easing of monetary policy and introduction of fiscal stimulus but these measures were implemented in the middle of 1998. To stabilize the sinking exchange rate, Malaysia implemented selective capital controls in September 1998, pegged the ringgit to the U.S. dollar and restricted short-term capital flows. Initially, Malaysia's action was condemned but international opinion has changed somewhat during this recovery period. The debate is whether the Malaysian experience can provide a lesson for other small open economies (which are overwhelmed by huge short-term capital flows) or it is a just case of one country defying the global trend. This article is organized as follows. Section II summarizes the impact of capital inflow on Malaysia. Section III details the selective capital controls measures taken, and Section IV discusses the offshore market for Malaysian securities as well as the offshore ringgit market. Section V analyses the result of the recovery measures taken by Malaysia. Section VI draws some lessons from the Malaysian experience. II. The Impact of Capital Flows on the Malaysian Economy From 1992 to the period just before the East Asian crisis, Malaysia had enjoyed a large inflow of foreign capital, both long and short term. Long-term private capital (foreign direct investment) had always been the most reliable source of external financing for Malaysia since it started to open its doors to private capital flows. Table 1 shows that the long-term private capital flow had increased steadily over the years and the flow was especially strong in the 1990s. In 1990, about US$2.3 billion of the private long-term capital came into Malaysia and this had more than doubled in 1997 (US$5.1 billion). During the 1990-97 period, the cumulative FDI inflow was US$34.8 billion. A comparison of FDI flow in 1998 in U.S. dollar terms is problematic due to the large volatility of the exchange rate. However, in ringgit terms, the FDI flow in 1998 (RM 13.1 billion) was higher than that of 1997 (RM 11.5 billion) (Ministry of Finance, Malaysia 1999). TABLE 1 Net Balance of Payments of Malaysia (In US$ millions) Item 1990 1991 1992 Merchandise f.o.b. 2,627.04 526.91 3,376.08 Balance on services -3,601.11 -4,798.18 -5,712.94 Balance on goods and services -974.07 -4,271.27 -2,336.86 Unrequited transfers 54.44 37.09 132.16 Balance on current account -919.63 -4,234.18 -2,204.71 Official long-term capital -1,050.37 -241.82 -1,127.84 Federal Government -291.48 38.55 -1,243.14 Market loans 364.07 118.91 -1,121.18 Project loans 134.81 -20.00 -72.16 Suppliers' credit -62.22 -60.36 -49.80 Non-financial Public Enterprises -764.44 -269.09 152.55 Other assets and liabilities 5.56 11.27 -37.25 Private long-term capital 2,336.67 3,998.55 5,178.04 Balance on long-term capital 1,286.30 3,756.73 4,050.20 Basic balance 366.67 -477.45 1,845. …