Malaysian Success Spawns New Thinking on Controls

By Claude Robinson, IPS, 15 September 1999

MEXICO CITY Sep 15 (IPS)—Malaysia’s apparent success in using capital controls to stabilize its financial crisis had forced new thinking in international financial institutions about the use of controls as policy instruments, the World Bank said Wednesday.

Five years ago the conventional wisdom was that controls are always bad. If you impose them, there will be capital flight. Now, there is a little bit of doubt about that position said William Dillinger, one of the authors of the Bank’s World Development Report 1999-2000, released worldwide.

While noting it was too early to tell if controls are necessarily bad or not he added that experiences in the financial crises in Latin American and Asia suggested that in some instances, they had played a positive role.

Dillinger stopped short of endorsing general use of capital controls, saying that the World Bank’s preferred position was for developing countries to rely less on short-term foreign capital inflows and go for longer-term investment capital which was less volatile.

His comments came at a news conference here to launch the World Bank’s annual report on world economic development, which focused on the challenges of globalization and localization in the 21st century.

Ignoring warnings from the World Bank, the International Monetary Fund and private international bankers, the Malaysian government of Prime Minister Mahathir Mohamad imposed controls on capital movements more than 12 months ago.

At the time, Malaysian officials blamed money speculators for the crash of its currency, the ringit, which sank in the midst of panic by investors scared by the financial meltdown in Asia and Russia. The control measures included a decree preventing foreign investors from pulling their money out of the stock market for one year.

Experts predicted an economic collapse, but this did not happen and, when the controls were lifted September 1, there was no flight of capital.

A report on the region issued by the Asian Development Bank last week predicted a 2 percent growth in the Malaysian economy this year, up from an earlier estimate of point seven (0.7) percent, while Malaysia itself reported a 4.1 per cent annualized growth in the April-June quarter.

In an endorsement of Malaysian financial policy, the influential benchmark index provider Morgan Stanley Capital International, announced that it would reverse a decision a year ago and re-admit Malaysia to its indexes next February.

Reports from Kuala Lumpur have predicted that the Malaysian stock market could attract some 20 billion dollars in foreign funds over the next year, bringing foreign holdings to some 30 billion dollars.

Perhaps the most surprising endorsement of capital controls came from the International Monetary Fund which had opposed the action last year.

IMF Board members broadly agreed that the regime of capital controls-which was intended by the authorities to be temporary- had produced more positive results than many observers had initially expected, according to a summary of a July board meeting released September 8.

Both the Bank and the IMF hold their annual meetings in Washington next week and the question of selective use of capital controls, to stem wild and destabilizing currency withdrawals from developing countries, likely will be a major issue.

Unless the major western economies heed Malaysia’s Mahathir call for a new global financial architecture that would protect developing countries from the volatility of short-term capital then many developing countries will have to look at the option of controls, as a sort of insurance policy, according to some observers.

Dillinger said the use and effectiveness of controls would vary from country to country as something which worked in one place at one time may fail in another place at another time.

He refused to be drawn into a discussion as to whether Mexico was on target to rehabilitate its banking sector reeling since the crash of 1994 or to speculate on whether there will be another crash after the 2000 presidential elections.

Dillinger emphasized that developing countries should seek to strengthen their financial institutions and create a framework for attracting long-term investment capital.

Such measures include steps to clearly define the rights and obligations of multinational investors, the report said. This sort of institutional reform is especially attractive to investors considering investing in countries plagued by political risk and corruption.

Privatization policies and commitment to World Trade Organization obligations that allow foreign firms access to certain domestic service markets were other measures to attract investors.

The report said that the many banking crises in developing countries over the past decade—with their deleterious consequences for poverty reduction, social stability and growth—illustrate the need for a sound regulatory framework and highlights Hungary’s successful experience.

Through a series of changes beginning with the collapse of the Soviet empire in 1989, the banking system moved from a state monopoly and in 1998, some 60 percent was under foreign ownership, 20 percent under Government ownership and the remainder under local private ownership.