Financial policy and management of capital flows: the case of Malaysia

Financial policy and management of capital flows: the case of Malaysia

Capital flows, the exchange rate and related issues in Malaysia

Malaysia had a relatively open financial system, when the financial crisis struck in 1997. This openness contributed to the conditions for the crisis, especially the inflow of foreign portfolio investment, the internationalisation of the currency, the overseas trade in the domestic stock market’s counters, and the inadequate regulation of foreigners’ borrowing of domestic assets (enabling currency speculation).

This paper reviews the evolution of Malaysian financial policy, focusing especially on policies regarding various types of capital flows, and related issues including management of the exchange rate, and macro-economic policies are also examined.

Since the crisis, there has been the deregulation and liberalisation of various categories of capital flows. One major aspect of the liberalisation process has been the deregulation of capital outflows by residents. Certain policies have been retained, especially the non-internationalisation of the currency, aimed at preventing the overseas or offshore speculation on the ringgit. However, the currency system itself has changed from having a fixed rate (with the US dollar) to a managed float. On capital flows, the restrictions on capital flows by foreigners have been largely lifted, on both the outflow and inflow aspects. The lifting or relaxation of restrictions on residents is very significant. There are no limits on locals using their own funds to invest in foreign currency assets, thus enabling the free flow of capital to abroad.

A weakening trade surplus combined with continued high outflows on the financial account would cause the overall balance of payments to weaken and even move into deficit. With these weaknesses and the growing global financial crisis and recession, the author argues that the following policy measures should be considered:

  • the increasing deregulation and liberalisation of the capital account regime should be urgently reviewed, as the volatility of many types of capital flows has been heightened in the financial turmoil 
    regulation of the foreign loans by domestic companies and financial institutions should be an important component in the treatment of inflows 
  • measures to re-regulate the outflows should be considered, especially at the present period when foreign reserves are declining rapidly 
  • Investment opportunities and conditions within the country for local investors are not attractive enough and should be improved as a matter of urgency 
  • a review should be made on the large and increasing placements of the assets of resident banks deposited or invested abroad 
  • the deregulating of the types of foreign portfolio investment in which Malaysian investors are allowed to participate should also be re-considered 
  • the financial authorities should not introduce complex financial instruments such as credit derivatives and collateralised debt obligations in the domestic market, due to the high risks associated with them, as exposed in the global financial turmoil 
  • a review of the policies linked to the liberalisation strategy is urgently required