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PERIOD OF 1996 - 2006





In 1968 Malaysia removed restrictions on payments and transfers for current international
transactions, accepting the obligations of the IMF’s Article VIII. Exchange and capital account
regulations were relaxed further in 1973, and Malaysia moved from a fixed to a floating
exchange rate. Subsequently the authorities gradually liberalized capital controls, particularly in

GDP and Interest Rate data from 1990 – 2007 can be seen on the table below:

Table 1. GDP-Interest Rate in Malaysia (1990-2007)

Year GDP (Million RM) Interest Rate (%)
1990 119,082 6.49
1991 135,123 7.57
1992 150,682 8.1
1993 172,194 7.21
1994 195,461 5.14
1995 222,473 6.76
1996 253,733 7.39
1997 281,795 8.70
1998 283,243 6,46
1999 300,764 2,66
2000 356,401 2,79
2001 352,579 2,79
2002 383,213 2,73
2003 418,769 2,74
2004 474,048 2,70
2005 522,445 2,72
2006 573,736 3,40
2007 641,864 3,50
Source: Asian Development Bank (ADB), 1990-2007

GDP data that can be seen from above showed us a bullish movement trendline from 1990-

2007. The main reason of this GDP bullish trend is come from the increasing internal trade and

strong external demand. And from supply side, the higher economic development that growing

sustainably mainly came from a strong industrial and manufacturing sector.

An interest rate level that patterned in the trendline has shown a very fluctuate movement.

Before a global financial crisis in 1997-1998, interest rate level always tried to reach a higher
level. This is just because the Malaysian government used a basic principle, which was a tight

money policy program. And this higher level of interest rate will influence and boost people to

save their money in the banks account, so that there was a lot of fund available for a new

investment proposal. Further, Malaysian government policy will develop an investment loans for

the real sector, mainly for small and medium enterprises. (look at Chart 1).

Chart 1. Interest Rate and GDP Combination.




1999 2000

Some of fiscal and monetary policy has taken by Federal Government from 1990-2007 (before

and after the global financial crisis) :


The Federal Government policies:

- An increasing interest rate has reach the top at 1992 which has caused increasing level of GDP.
From the IS-curve, the Federal Government has implemented an Expansionary Fiscal Policy,
with increasing government expenditure and other increasing import activities in order to
develop a national economics.
- Total borrowing by residents in foreign currency from domestic commercial and merchant banks
to finance imports of goods and services was restricted to the equivalent of RM 1 million
(previously there were no limits).




Y1 Y2

Eq. >> Y = C + I + G

- Borrowing under the Export Credit Refinance Facilities (both pre- and post-shipment financing)
by non-resident controlled companies would be considered domestic borrowing.
- Offshore guarantees obtained by residents to secure domestic borrowing, except offshore
guarantees (whether denominated in ringgit or foreign currency) without recourse to Malaysian
residents and obtained from the licensed offshore banks in Labuan to secure domestic
borrowing, were deemed as foreign borrowing. In cases where an offshore guarantee is
denominated in ringgit, it was subject to the condition that, in the event the guarantee is called
on, the licensed offshore banks in Labuan must make payments in foreign currency (with some
exceptions), not in ringgit.
- The guidelines on foreign equity capital ownership were liberalized. Companies exporting at
least 80 percent of their production were no longer subject to any equity requirements, whereas
companies exporting between 50 percent and 79 percent of their production were permitted to
hold 100 percent equity, provided that they have invested $50 million or more in fixed assets or
completed projects with at least 50 percent local value added and that the company's products
do not compete with those produced by domestic firms. These guidelines were not to apply to
sectors in which limits on foreign equity participation have been established.
- Residents and the offshore companies in Labuan were prohibited from transacting with the
residents of dealing in the currency of the FYR Yugoslavia (Serbia and Montenegro) without
specific prior approval from the Controller of Foreign Exchange.

The Federal Government policies:
- A ceiling was placed on the net external liability position of domestic banks (excluding trade-
related and direct investment inflows).
- Residents were prohibited to sell the following Malaysian securities to nonresidents: banker’s
acceptances; negotiable instruments of deposit; Bank Negara bills; treasury bills; government
securities (including Islamic securities) with a remaining maturity of one year or less.
- Residents were prohibited to sell to nonresidents all forms of private debt securities (including
commercial papers, but excluding securities convertible into ordinary shares) with a remaining
maturity of one year or less.
- The restriction on the sale of Malaysian securities to nonresidents was extended to both the
initial issue of the relevant security and the subsequent secondary market trade.
- Prohibition of forward transactions (on bid side) and nontrade-related swaps by commercial
banks with foreign customers to curtail the speculative activities of offshore agents seeking long
positions in ringgit (lifted on August 16, 1994).
- Residents were permitted to sell to nonresidents any Malaysian securities.





Y1 Y2

- Residents may borrow in foreign currency up to a total of the equivalent of RM 5 million from
nonresidents and from commercial and merchant banks in Malaysia.
- Nonresident-controlled companies were allowed to obtain credit facilities, including immovable
property loans, up to RM 10 million without specific approval, provided that at least 60 percent
of their total credit facilities from banking institutions were obtained from Malaysian-owned
financial institutions.
- Nonresidents with valid work permits may obtain domestic borrowing to finance up to 60 percent
of the purchase price of residential property for their own accommodation.
In the fall of 1997, the currency crisis that began in Thailand reached Malaysia. The ringgit, the
Malaysian currency, would lose nearly two-fifths of its value by August 1998. The stock market
fell even more severely, with the main Kuala Lumpur Stock Exchange composite index losing
three-quarters of its value over the same period. The net inflow of capital into Malaysia was cut
in half as net portfolio investment turned highly negative and remained negative through 1998.

The Malaysian economy slowed during the second half of 1997, then crashed in 1998,
contracting by 6.7 percent. Construction, real estate, and manufacturing were all hard hit.
Employment contracted across the economy and jobs for foreign workers disappeared. Still, all
told, the economic crisis did less damage in Malaysia than in either Thailand or Indonesia. And
unlike the Indonesian economy, which remained mired in crisis, the Malaysian economy began
to recover during 1999, growing 4.3 percent, about one-half the rate it had averaged over the
previous decade.

Jomo and Rajah Rasiah, a Malaysian economist who has written extensively about foreign
capital flows into Malaysia, establish that at the onset of the crisis Malaysia's "first order
macroeconomic conditions" were in good shape and were characterized by sustained rapid
growth, relatively mild inflation, and fiscal discipline. What plagued the Malaysian economy was
a persistent current account deficit dangerously financed by short-term capital flows.

Unlike Thailand and Indonesia, which relied on borrowing from foreign banks to cover much of
their current account deficits, Malaysia turned to the capital markets to finance its current
account deficit, for prudential regulation limited bank borrowing from abroad. When the crisis hit,
both types of short-term capital flows - foreign bank lending and stock buying - reversed
themselves with little regard for the actual strength of these economies. But, as Jomo and his
colleagues establish, Malaysia's closer regulation left its banking sector in better shape and
thereby muted the impact of the crisis in Malaysia.

Since the Asian financial crisis that began in 1997, the Government has maintained a fiscal
pump-priming policy to boost domestic demand, aimed at preventing recession and keeping
unemployment down, in the wake of volatility and uncertainty in the global economy. In 2001
and 2002, the Government continued its expansionary fiscal policies to stimulate investment
and production (Figure 4). Reflecting this, public consumption (accounting for about one fourth
of total consumption) grew by 17.6% and 13.8% in 2001 and 2002, respectively, while private
consumption increased by lower rates of 2.8% and 4.2% over the same period.
The Federal Government policies:
- The threshold for the completion of the statistical forms for each remittance to or receipt of
funds from, nonresidents was raised from amounts exceeding RM 50,000 to RM 100,000 or its
equivalent in foreign currency.
- Controls were imposed on banks to limit outstanding noncommercial-related ringgit offer-side
swap transactions (i.e., forward order/spot purchases of ringgit by foreign customers) to $2
million per foreign customer or its equivalent. Hedging requirements of foreigners for trade-
related and genuine portfolio and foreign direct investment investments were excluded.




Y1 Y2

- Residents are allowed to enter into non-commercial-related swap transactions up to a limit (no
limits previously).
- A ban on short-selling of the listed securities on KLSE was introduced to limit speculative
pressures on stock prices and exchange rates.

In this reassessment of capital controls, recent experience in Malaysia—which reimposed
capital controls in September 1998—has been central to the two main views on capital controls.
The more established view emphasizes macroeconomics. If a country faces a severe external
crisis, particularly one caused by pure panic, and if orthodox macroeconomic policies have
failed to restore confidence, Krugman (1998) argues that imposing capital controls may be an
effective way to stabilize the economy.

More generally, Bhagwati (1998a, 1998b) and Rodrik (2000) oppose the conventional wisdom
that free capital flows help countries benefit from trade liberalization and argue instead that
capital market liberalization invites speculative attacks. In this context, Malaysia’s experience
has been interpreted as demonstrating that capital controls can have positive macroeconomic
effects (Kaplan and Rodrik, 2001), but this claim is controversial and was forcefully opposed by
Dornbusch (2001).

The second view of capital controls puts greater emphasis on institutions (i.e., the rules,
practices, and organizations that govern an economy). Specifically, Rajan and Zingales (1998)
argue that capital controls are an essential part of the package of policies that allows
“relationship-based” capitalism to function. In this system, informal relationships between
politicians and banks channel lending toward approved firms, and this is easier to sustain when
a country is relatively isolated from international capital flows. If capital controls are relaxed, as
in some parts of Asia in the early 1990s, the result may be overborrowing and financial collapse
(Rajan and Zingales, 1998).

Theoretically, relaxing capital controls can lead to financial distress in at least three ways. First,
local financial institutions respond by taking on more risk. Second, local firms borrow directly
from international lenders who are either unable to assess risks appropriately or believe that
there is an implicit sovereign guarantee. Third, after they lose their monopolies, local banks are
less willing to bail out firms that encounter problems, as discussed in Petersen and Rajan

In this context, Rajan and Zingales (2003) suggest that reimposing capital controls may be
attractive if it enables politicians to support the financing of particular firms. If this view is correct,
we should expect capital controls to be associated with more resources for favored firms. In the
context of economic crises, there are two testable implications at the firm level. Firms with
stronger political connections should (1) suffer more when a macroeconomic shock reduces the
government’s ability to provide advantages, and (2) benefit more when the imposition of capital
controls allows a higher level of support for particular firms.

For the macroeconomic debate, the Malaysian experience is inconclusive. The capital controls
worked in the sense that they were not circumvented on a large scale. They also never came
under serious pressure, however, controls might have played a preventive role— that is, to
guard against risks to financial stability―but they were never tested in this role. At the same
time, there is no convincing evidence of adverse macroeconomic consequences from the

At the time of the Asian crisis, portfolio flows were generally free of restrictions. Domestic and
international credit transactions in foreign currency were carefully controlled, but international
trade and financial transactions denominated in ringgit were allowed and perhaps even
promoted. As a result, an active and largely unregulated offshore market in ringgit developed.

After Thailand devalued in July 1997, the Malaysian ringgit came under severe pressure.
Portfolio outflows intensified (Figure 1) and foreign exchange reserves plummeted (Figure 2). As
currency traders took speculative positions against the ringgit in the offshore market, offshore
ringgit interest rates rose markedly relative to onshore rates (Figure 3). This further intensified
the movement of ringgit funds offshore.

The initial response of the authorities was to tighten macroeconomic policies. The Malaysian
authorities intervened heavily in the foreign exchange market and sharply raised interest rates in
July 1997. These measures were abandoned after a few days. In August 1997, the authorities
introduced limits on ringgit swap transactions with nonresidents to stabilize the offshore market.
They also restricted trading in blue chip stocks on the Kuala Lumpur stock exchange. For more
details, see Meesook and others (2001).

Spending cuts were introduced in 1997, and the 1998 budget was drafted to target a surplus of
2½ percent of GDP. Base lending rates were allowed to rise somewhat in response to higher
interbank interest rates (Figure 4), and lending targets were adjusted to reduce growth of credit
for financing purchases of real estate and securities. These measures had little stabilizing
impact on financial markets as crisis continued to spread in the region. When the extent of the
output collapse became clearer, by early 1998, fiscal policy became more expansionary. The
target for the 1998 budget was relaxed to a surplus of ½ percent of GDP in March 1998. A
package of measures to strengthen the financial sector was also introduced at the same time.

In early September 1998, arguing that the measures and reforms that had been put in place by
all countries affected by the Asian crisis did not appear to be returning stability to financial
markets, the Malaysian authorities imposed capital controls and pegged the ringgit to the U.S.
dollar. To close the offshore market in ringgit and ringgit assets, investors were required to
repatriate all ringgit held offshore back to Malaysia, licensed offshore banks were prohibited
from trading in ringgit assets, and residents were prohibited from granting or receiving ringgit
credit vis-à-vis nonresidents. Among supporting measures, the authorities prohibited offshore
trading of ringgit assets and brought to a halt long-standing trading in Malaysian shares in
Singapore. In addition to controls on international transactions in the ringgit, the authorities
imposed controls on portfolio outflows, particularly a one-year holding period on nonresidents’
repatriating proceeds from the sale of Malaysian securities and a prior approval
requirement―above a certain limit―for residents to transfer capital abroad.
The controls were carefully designed to withstand pressure―i.e., to close all known channels
and loopholes for the supply of the ringgit to the offshore market and major portfolio
outflows―while attempting not to affect foreign direct investment and current account
convertibility. The authorities also stressed the temporary nature of controls. Furthermore, a
number of pre-conditions facilitated the implementation of capital controls—a history of using
some controls, effective state capacity, and generally strong bank supervision and regulation
(Meesook and others, 2001; Latifah, 2002).

The Federal Government policies:

- A requirement introduced to repatriate all ringgit held offshore (including ringgit deposits in
overseas banks) by October 1, 1998 (BNM approval thereafter).
- Approval requirement was imposed to transfer funds between external accounts (freely allowed
previously) and for the use of funds other than permitted purposes (i.e., purchase of RM
- Licensed offshore banks were prohibited to trade in ringgit assets (allowed up to permitted limits
- A limit was introduced on exports and imports of ringgit by residents and nonresident travelers,
effective September 1, 1998 (no limits existed previously).
- Residents were prohibited from granting ringgit credit facilities to nonresident corresponding
banks and stockbroking companies (subject to a limit previously). Residents were prohibited
from obtaining ringgit credit facilities from nonresidents (subject to a limit previously).
- All imports and exports were required to be settled in foreign currency.
- All purchases and sales of ringgit facilities can only be transacted through authorized depository
institutions. A 12-month waiting period for nonresidents to convert RM proceeds from the sale of
Malaysian securities held in external accounts (excluding FDI, repatriation of interest, dividends,
fees, commissions, and rental income from portfolio investment). No such restrictions
- A prior approval requirement beyond a certain limit for all residents to invest abroad in any form
(previously applied only to corporate residents with domestic borrowing).
- No restriction on conversion of ringgit funds in external accounts of nonresidents with work
permits, embassies, high commissions, central banks, international organizations, and missions
of foreign countries in Malaysia.
- Designated nonresident accounts for futures trading are allowed and exempt from the 12-month
holding period. LM2



Y1 Y2

The Federal Government policies:
- Funds arising from sale of securities purchased by nonresidents on the CLOB can be
repatriated without payment of exit levy.
- Nonresident controlled companies raising dom credit through private debt securities were
exempted from RM 19 million limit and the 50:50 requirement for issuance of private debt
securities on tender basis through the fully automated system for tendering, to develop
domestic bond market.
- Residents and nonresidents were no longer required to make a declaration in the traveler's
declaration form as long as they carry currency notes and/or travelers' checks within the
permissible limits. For nonresidents, the declaration was incorporated into the embarkation card
issued by the Immigration department.
- Licensed offshore banks in the Labuan international offshore fin center were allowed to invest in
RM assets and instruments in Malaysia for their own accounts only and not on behalf of clients.
The investments could not be financed by ringgit borrowing.
- Foreign-owned banks in Malaysia were allowed to extend up to 50 percent (previously 40
percent) of the total domestic credit facilities to nonresident controlled companies, in case of
credit facilities extended by resident banks. This is to fulfill Malaysia's commitment under the




Y1 Y2

- Licensed com banks were allowed to extend intraday overdraft facilities not exceeding RM 200
mil in aggregate and overnight facilities not exceeding RM 10 mil (previously 5 mil) to foreign
stockbroking companies and foreign global custodian banks.
- All controls on the trading of futures and options by nonresidents on the MDEX were eliminated.
The Commodity and Monetary Exchange of Malaysia and the KLSE were merged to form the
Figure 6. Role of Fiscal Priming
in GDP Growth, Malaysia, 1998-2002.

And from now on…

In addition to Fitch’s base‐case scenario for last year, 2008, of weaker global and Emerging
Asian growth, there are several risks to consider :
• A recession in the US – as opposed to a slowdown – could have much more significant
effects on Emerging Asian balance of payments positions.
• A pronounced decline of the US dollar – as opposed to more measured, gradual
weakness – could force Asian currencies higher, affecting regional competitiveness. This
would be all the more concerning if a much weaker dollar were accompanied by a much
weaker US economy.
• Inflation is rising in several Emerging Asian economies. If inflation continues to
accelerate and balance of payments inflows continue to apply upward pressure on
regional exchange rates, real appreciations could be inevitable. Raising policy interest
rates to curtail inflation may not appeal to regional central banks if economic growth is
slowing and higher rates attract capital inflows, adding to appreciation tendencies.
The effects of a slowdown in US growth on Emerging Asia could be greatly amplified by a US
recession. In a downturn, Asian exporters are likely to have options in terms of seeking
alternative export markets, adjusting prices to retain market share in the US, or temporarily
absorbing losses. These options may disappear in a recession scenario. A US recession,
especially if prolonged, would result in a much weaker export performance, with consequent
effects on Emerging Asian growth. The region could lose its relative attractiveness in terms of
international capital flows, possibly testing the resilience of external balance sheets. Fiscal
pressures would almost certainly be more pronounced.

Leading into 2009, one of the most important macroeconomic questions for Emerging Asia is
how the region might cope with a slowdown in US GDP growth, which is expected to be
accompanied by weaker growth across industrialized economies.

The Malaysian economy has been resilient in the first-half of 2008, but is not going to be
insulated from the global downturn. As the external sector worsened, GDP growth has subsided
to 4.7 per cent in 3Q08 after a strong 7.1 per cent gain in the first-half of '08 (revised upwards
from 6.7%), bringing growth to an average of 6.3 per cent in the first three quarters of '08.
Resilient private consumption, steady public investment and higher fiscal spending supported
the growth in 3Q08. Malaysia has no direct exposure to the US market but is increasingly
feeling the shock from the slowing global economy through trade and investment linkages.

Fearing a dismal global outlook that would hurt the domestic economy, the government
stretched its fiscal deficit to 4.8 per cent in '08, reversing a 7-year progressive deficit reduction.
A RM7 billion stimulus package, to be financed by savings from subsidy reduction, was unveiled
in Nov'08 as a measure to stimulate domestic demand. The deficit fiscal target for 2009 has
also been raised to 4.8 per cent of GDP, from 3.6 per cent previously. This may be justified as
difficult times call for drastic measures. However, there are concerns that government revenue
would be adversely affected by the falling commodity prices, which could subsequently enlarge
the deficit to even exceed 5.0 per cent of GDP, especially now that there is a possibility of an
additional stimulus package being introduced by mid-2009. There is also the longer-term worry
over the high dependency on oil revenue to finance fiscal spending. With most spending going
into construction projects, there are questions over the delivery speed and the potential
leakages from payments to foreign workers and the imports of construction materials, which
would blunt the multiplier effects.

Monthly indicators up to Nov'08 are losing momentum markedly. Industrial output has
contracted in three successive months, as the export-oriented sectors faced diminishing
demand. Total exports have declined for two months in a row, with imports showing steeper
declines, resulting in sustained trade surplus. With prices climbing down, export revenues from
commodities are growing at a slower pace. Thanks to reduction in domestic oil prices, inflation
has eased to 5.7 per cent in Nov'08, down from a peak of 8.5 per cent in Aug'08. Inflation will
likely subside further in tandem with the softening economy.


Bhagwati, J., 1998a, “The Capital Myth,” Foreign Affairs, May/June, pp. 7–12.

_____, 1998b, “Why Free Capital Mobility May Be Hazardous to Your Health: Lessons from the
Latest Financial Crisis?” paper presented at NBER Conference on Capital Controls, November

Dornbusch, R., 2001, “Malaysia: Was It Different?” NBER Working Paper No. 8325 (Cambridge,
Massachusetts: National Bureau of Economic Research).

Jomo, K.S., 2001, Malaysian Eclipse: Economic Crisis and Recovery (London and New York:
Zed Books).

Kaplan, E., and D. Rodrik, 2001, “Did the Malaysian Capital Controls Work?” NBER Working
Paper No. 8142 (Cambridge, Massachusetts: National Bureau of Economic Research).

Krugman, P., 1998, “Saving Asia: It’s Time to Get Radical?” Fortune, September 7.

Latifah, M.C., 2002, “Capital Flows and Capital Controls: The Malaysian Experience,” in
Globalization and the Asian Pacific Economy, ed. by Kyung Tae Lee (London and New York:

Meesook, K., and others, 2001, Malaysia: From Crisis to Recovery, IMF Occasional Paper No.
207 (Washington: International Monetary Fund).

Petersen, M., and R. Rajan, 1995, “The Effect of Credit Market Competition on Lending
Relationships,” Quarterly Journal of Economics, Vol. 110, pp. 407–43.

Rajan, R., L. Zingales, 1998, “Which Capitalism? Lessons from the East Asian Crisis,” Journal
of Applied Corporate Finance, Vol. 11, pp. 40–48.

_____, 2003, “The Great Reversals: the Politics of Financial Development in the 20 th Century,”
Journal of Financial Economics, Vol. 69, pp. 5–50.

Rodrik, D., 2000, “Exchange Rate Regimes and Institutional Arrangements in the Shadow of
Capital Flows” (unpublished; Cambridge, Massachusetts: Harvard University Working Paper).