MALAYSIA: WAS IT DIFFERENT

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MALAYSIA WAS IT DIFFERENT?    
Rudi Dornbusch   June 2001 Massachusetts Inst
itute of Technology (MIT)       Then the unex
pected happened. The Asian miracle was shattered
almost overnight and suddenly once fawning
economists argued that all it really had been was
a bubble, over-inflated by corruption, cronyism
and bad loans. Asians were not only impoverished
but were blamed for impoverishing themselves.
  Mahathir Mohamad (1999, A New Deal for Asia,
p.47)
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FINANCIAL CRISIS AND MALAYSIAS REACTION
    ? In the Asian crisis of 1997-98, most coun
tries followed IMF prescriptions for
stabilization and recovery.   ? Malaysia went a
nother route, placing an emphasis on capital
controls.  
   -        Non-residents should hold their pr
incipal sum for portfolio investment for at least
12 months in Malaysia -        Prior approval for
transfer of funds between External Accounts
-        All payment for import and export
proceeds must be made in foreign currency
-        Prior approval for overseas investment
in excess of 10,000 ringgit -        Exchange rat
e was fixed
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External Capital Flows for Crisis Asia (billion
US)

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Malaysia Portfolio Flows
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HISTORY OF CAPITAL CONTROLS   ? In 1930s, Nazi
Germany invented capital controls.
-        Soon after, in an environment of capital
flight and competitive depreciation, much of
Europe moved to controls.   ? After 1958, Europ
e gradually and unevenly shifted to full
convertibility. -        France and Italy took ca
pital controls until the late 1980s.
-        England abolished exchange control only
during the Thatcher government.
-        Japan and neighboring countries took
capital controls even longer.
  ? In the late 1980s, opening the capital accou
nt became one of the major US financial
policies. -        Rubin-Summers US Treasury want
ed an agenda of financial services trade and
domestic financial deregulation.
- Repressed finances had to give way to an
opening of domestic finance and to more
substantial freedom for cross border flows.
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CLAIMS ON THE EFFECTS OF CAPITAL CONTROLS
  ? Malaysian authorities claim that capital con
trols were successful.   -        It worked out
to lower the cost of the crisis and fostered a
more rapid recovery. -        Without the
controls, the collapse would have been far
deeper, the recovery much harder, and the l
asting damage more profound.   ? However, it i
s different from general expectations.
  -        More efficient allocation of resources
can be achieved by competition, diversification,
opportunities, and equalization of risk-adjusted
returns. -        Restrictions to capital flows c
an create a hotbed of privilege and corruption
around exceptions and loopholes.
-        Open capital market will do a better job
at allocating capital resources than politicized
and corrupt local arrangement.
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• QUESTIONS TO BE ANSWERED
•  
• ? If Malaysias claim was correct,
  Malaysia should have performed
  
• much better than the other
  countries exposed to the same initial
  
• shocks but responding with
  orthodoxy rather than controls.
  
• ? With this idea in mind, following three
  questions might be answered.
  
•  
• (1)          On the eve of the crisis, was
  Malaysia appreciably different in its
  
• vulnerability from other crisis
  countries?
  
•  
• (2)          Did the policy measures make for a
  significantly better performance
  
• than in other economies?
• -  Higher growth, Less volatility, Less
  bankruptcy without offsetting
  
• large increases in public debt
•  
• (3)          Is there any indication of lasting
  costs or benefits?
  
• ? However, it is far too early to judge
  the impact.

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Events During Asian Crisis     May July 1997
Pessure on Thailand, Exchange control,
Devaluation   July Philippines go to a float, M
alaysia abandons support for th
e ringgit, Thailand goes to the IMF
  October Indonesia goes to
the IMF, Hong Kong dollar under attack
  November Korea abandons won support and goes to
the IMF   Jan. Aug. 1998 Asian IMF packages r
evised, Financial restructuring  
August
Russian crisis, Yen peaks  
Septemb
er LTCM crisis, Malaysia imposes capital
controls, Deputy
Prime Minister Anwar Ibrahim deposed
  Sept.
Nov. Fed cuts rates by 75 basis points
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VULNERABILITY   ? Favorable to Malaysia - Deb
t / Equity ratio of the corporate sector
-
Short-term External Debt / Reserves ratio
-
Non-performing Loans / Total Loans ratio
-
Cleanup Cost (? Public Debt / GDP ratio)
-
Bank Strength Rating   ? Neutral - Non-perf
orming Loans / GDP ratio
- Public Debt / GDP ratio
-
Short-term External Debt / Total Debt ratio
  ? Unfavorable to Malaysia - Stock Market Cap
italization / GDP ratio
- Private Bank Credit / GDP
ratio  ?               Malaysia was no more
vulnerable than other crisis countries.
? Malaysia should not have been doing wo
rse.
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Vulnerability Indicators 1996
Non-performing Loans and Increased Public Debt
1999
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PERFORMANCES   1. GDP   ? Star performance t
hrough 1996 ? Lower growth in 1997 ? Output de
cline in 1998 ? Recovery is underway in 1999 ?
GDP is back above pre-crisis levels in 2000
  ? Similar performance with other crisi
s countries   2. Real Exchange Rate   ? If
other things equal, a capital outflow crisis
country with controls should suffer a less ex
treme real depreciation.   ? No better
outcome
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Malaysia and Other Crisis Countries GDP Growth
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Real Exchange Rate (Jan 1970100)
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3. Stock Market and
Interest Rates   ? Sto
ck market recovery began in September 1998.
Short-term interest rates also began to fall from
that time.  
? It is tempting to see the imposition of
capital controls as the turning
point.
  ? However, at the tim
e capital controls were imposed, markets in Asia
had already settled. Interest rates had been
coming off and would soon do so everywhere.
  Why? -
Impact of Fed rates cuts (Sept. Nov. 1998)

- Reduction in jitters (calm down from the
shock)   Facts
- Korea and Thailand rates had fallen by
August to half
their June levels.
-
Malaysian offshore rates
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Malaysia Stock Market (Index Jan 94100)
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Malaysia Money Market and Lending Rates
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? A Closer Look at Malaysian Offshore Rates  
  ? Much of the pressure had subsided befor
e the September 1.   ? By August, the offs
hore rates had declined to around 10, far below
crisis levels.   ? Interestingly, it reach
ed 28 on September 1.     ? It was the
advent of capital controls that raised the
rates. ? The political interpretation f
or the controls deserves more attention.
18
Malaysian Offshore Daily Rates ( p.a.)
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CONCLUSION     ? There is no evidence of one w
ay or another no evidence of a better
performance and no evidence of any obvious
harmful effects. -        Malaysia had more favo
rable preconditions. -        Malaysia did not pe
rform appreciably better. -        The costs or b
enefits of capital controls are ambiguous.
  ? Capital controls were imposed after the cris
is was over. -        Interest rates in all Asian
crisis economies, including Malaysia, were
already declining rapidly. -        US interest r
ate cuts fostered a more stable environment.
  ? Dr. Mahathir might have imposed capital cont
rols for political reason, not for economic
reason. -        Political challenge by the deput
y prime minister, Anwar Ibrahim
? He was deposed right after capital
controls were imposed.