How Effective is Malaysian Capital Control Policy in Handling 1997-1998 Financial Crisis?

Financial crisis in Asia during 1997-1998 have created a huge economic downturn for South East Asian economy, particularly in Thailand, Indonesia, and Malaysia. Thailand and Indonesia were forced to follow IMF policies to handle the financial crisis in return for IMF’s financial assistance. These countries were obliged to float their exchange rates, increase interest rates, tighten their fiscal policy, shut down troubled banks and liberalize their capital account (Stiglitz, 2002).  However, Malaysia took a very different path in handling the financial crisis. Instead of relying on IMF financial assistance, Mahathir Mohammad, Malaysia’s prime minister at that time reduced interest rate, imposed strict capital controls, and fixed the exchange rate at RM 3.80 against the US dollar. Malaysian economic policies were seen as “radical” and many economists at that time criticize Malaysia’s decision to abandon IMF measures. On the contrary, Malaysia’s choice to impose capital control have able the country to recover faster and stronger compare to Indonesia and Thailand.    

Stiglitz (2002) argues that imposing capital controls was an effective way to stabilize the economy at that time and he criticizes the IMF decision to interfere with Thailand’s economic policy. He argues that the interventions of IMF in the Thailand economy that force it to liberalize its capital account have dampened the economic recovery process in the country.  IMF utilized similar measures that they have done in Latin America to improve Thailand and Indonesia economic condition, but the situation is not exactly the same. Most of IMF measures have negative effect for targeting countries. For example, IMF has forced Thailand and Indonesia to increase their interest rate. Alas, increasing these countries’ interest rate has dampened the consumption demand in these countries and makes matters worse. High interest rates implementation have put many firms and businesses to be in high levels" of indebtedness because the cost to borrow money has become more expensive. This has led to reduce in investment in most of the major driver of economy in the country.

Malaysia’s decision that was very contrary with Thailand and Indonesia, which is to reduce interest rate instead of increasing it and to suspend capital account, have revived the domestic demand in the country. Malaysia’s capital control policy put an end to speculative activities in the currency and stops the investment rush to exit the country. Due to the effective capital control policy in handling 1997-1198 Asian financial crisis, Malaysia was able to recover faster and stronger compare to other Asian crisis economies such as Indonesia and Thailand. Malaysia has accumulated large surpluses from the external current account allowing an accumulation of international reserves. Unemployment in the country has steadily declined, and inflation remained low (Meesook, et al., 2001). The econometric analysis presented by Kaplan and Rodrik (2001) that compare the control of capital in Malaysia with the International Monetary Fund’s policies in other countries are consistent with the conclusion that control of capital was the best response to the crisis at that time.  

Bibliography

Kaplan, E., & Rodrik, D. (2001). Did the Malaysian Capital Controls Work? NBER Working Paper, No. w8142.

Meesook, K., Lee, I. H., Liu, O., Khatri, Y., Tamirisa, N., Moore, M., et al. (2001). Malaysia: From Crisis to Recovery. International Monetary Fund.

Stiglitz, J. E. (2002). The East Asia crisis: how IMF policies brought the world to the verge of a global meltdown. In J. E. Stiglitz, Globalization and its Discontents (pp. 89-132). New York : Norton.