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At the onset of the East Asian crisis, Malaysia adopted policies similar to the other crisis-hit economies, tightening monetary and fiscal policies and floating the exchange rate, but the situation continued to deteriorate. In September 1998, Malaysia implemented selective capital controls to peg the ringgit to the U.S. dollar and restrict short-term capital flows. The controls gave Malaysia monetary policy independence to reflate the economy, and the breathing space to drastically restructure the financial and corporate sectors. The cost of the capital controls is that Malaysia missed most of the international capital that returned to the region beginning 1998:4Q, as reflected by the steep recovery of the equity markets in other crisis-hit countries. Another cost comes from concerns that a similar policy could be reintroduced prior warning, hence resulting in a higher risk premium for Malaysian-issued Eurobonds.
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...