Did Capital Controls Save Malaysia?

By Gombak Rock @ Embrace Malaysiana

The economies of the Asian “miracle” countries were damaged and ruined by the financial crisis in 1997-98. In the late 1980’s and early 1990’s the whole world was in awe of these countries economic performance and growth. Asian economic miracle countries were experiencing high growth rates and 8-12% increase in their GDP, thus the dub “Asian economic miracle countries”. However the East Asian economic miracle turned into a financial debacle in July 1997(the beginning of the Asian financial crisis).

South Korea, Thailand and Indonesia were the worst affected countries. As a result they were forced to impose IMF designed programs and measures to manage the financial crisis. These countries committed to float their exchange rates, raise interest rates, tighten fiscal policy (at least initially), open up their financial markets to foreigners, close troubled banks and financial institutions, and undertake a range of other structural reforms in return for the financial assistance from the IMF.

The same cannot be said about Malaysia. Malaysia took a completely opposite approach in dealing with the financial crisis. The Malaysian authorities imposed sweeping controls on capital-account transactions, fixed the exchange rate at RM3.80 per US$ (a rate that represented a 10 percent appreciation relative to the level at which the ringgit had been trading immediately before the controls), cut interest rates, and embarked on a policy of reflation.

This marked the beginning of the debate whether capital controls or the orthodox Keynesian method (capital liberalisation) is better in addressing financial crises. Apart from that the question lingering in the mind of every economist is “did capital control save Malaysia?” In answering both of these question economists compared the recovery of Malaysia (capital controls) with Thailand and South Korea (IMF measures). The fact that South Korea and Thailand recovered simultaneously imply that capital controls does not play a significant role in Malaysia recovery. In addition the financial crisis worsens in Malaysia in the middle of 1998 whereas it has significantly mellowed down in Thailand and South Korea. However, according to Ethan Kaplan and Dani Rodrik in their paper “Did the Malaysian Capital Controls Work?” suggests the opposite. Their research shows that Malaysian policies produced faster economic recovery, smaller declines in employment and real wages and more rapid turnaround in the stock market compared to the countries who implements the IMF plan.

According to Jomo K.S in his article “Malaysia’s September 1998 Controls: Background, Context, Impacts, Comparisons, Implications, Lessons” capital controls did not cause the recovery in Malaysia to be slower than in the other crisis countries. The 1998 collapse was less deep in Malaysia than in Thailand and Indonesia, while the recovery in Malaysia has been faster after early 1999. However this is because the pre-crisis problems in Malaysia were less serious to begin with owing to strengthened prudential regulations after the late 1980s’ banking crisis (when non-performing loans went up to 30 per cent of total loans). There were strict controls on Malaysian private borrowing from abroad with borrowers generally required to demonstrate likely foreign exchange earnings from the proposed investments to be financed with foreign credit unlike South Korea, Thailand and Indonesia.

Chandra Athukorala in his book “Crisis and Recovery in Malaysia” suggests that carefully designed capital control measures were successful in providing Malaysian policy makers with a viable setting for undertaking Keynesian reflationary policies without adverse backwash effects on FDI. Controls also assisted banking and corporate restructuring by facilitating the mobilization of domestic resources.

In conclusion, capital controls did save Malaysia and played a very significant role in her economic recovery. This is because Malaysia can afford to implement capital control measures as Malaysia crisis was not as deep as Thailand and Indonesia. We will never know whether capital controls measures will have the same profound effect on other countries. Jomo K.S suggestion of caution in making gross generalizations and instead urges greater attention to context and detail should be observed this is because as he argued the actual significance of the Malaysian controls is emphasized, before some policy lessons are drawn.