Ebook Financial Policy and Management of Capital Flows: The Case of Malaysia
THE management of capital flows and related issues such as the exchange rate and macroeconomic policies have become important to developing countries as they increasingly interact with the global economy, especially global finance. While finance has usually been seen as an important tool for economic development, in recent years it has also been an area of concern as the economies of many countries were destabilized because of problems or shocks originating from the financial sector.
This paper reviews the evolution of Malaysian financial policy, focusing especially on policies regarding various types of capital flows. Related issues such as management of the exchange rate and macroeconomic policies are also examined.
The paper describes the main features of the policies instituted by the Malaysian government in response to the financial crisis of 1997-99. An innovative mixture of policies relating to stabilizing the exchange rate, selective capital controls, counter cyclical macroeconomic policies, and the revival of financial institutions and corporations was adopted. This set of policies was unorthodox as they were contrary to the usual policy mix that the International Monetary Fund (IMF) has been prescribing.
The paper then discusses changes in policies since the mid-1990s crisis. In recent years, there has been a liberalization of the capital account, with increasing freedom given for both inflows and outflows of funds. As at 2008, the economy is more financially liberalized than at 1997, on the eve of the crisis. As a result, the economy has become more vulnerable to sudden and significant shifts in capital. In particular, there have been large outflows of funds by domestic banks and residents in the past few years, adding to the more traditional outflows of profits by foreign firms. While these capital outflows have been covered by the large trade surpluses of recent years, they could contribute to weaknesses in the balance of payments should the trade surplus decline as a result of adverse conditions in the global economy, and if this is also accompanied by outflows of foreign portfolio capital. The volatility of foreign portfolio flows became rather extreme in 2008 with the onset of the global financial crisis, with massive outflows in the second and third quarters following large inflows in the first quarter. Mainly as a result of these huge outflows, the overall balance of payments slipped into deficit in the second half of 2008.
CONTENTS
1. INTRODUCTION
2. THE 1997-99 CRISIS AND POLICY RESPONSE
- a. The financial and economic crisis
b. The Malaysian counter-crisis strategy
c. Lessons from the Malaysian policy response
3. EVOLUTION OF THE CAPITAL ACCOUNT REGIME SINCE 1998
- a. Introduction
b. The exchange rate regime
c. Liberalization of foreign exchange rules and foreign investment
4. RECENT DEVELOPMENTS RELATING TO CAPITAL FLOWS
- a. General
b. Flows of direct investment
c. External loans and external debt
d. Volatility in portfolio flows
e. “Other investments”: Outflows of banking deposits abroad
5. OVERVIEW OF THE EVOLUTION OF CAPITAL FLOWS 38
6. MANAGEMENT OF CAPITAL FLOWS AND THE EXCHANGE RATE
- a. Managing the effects of capital flows
b. Capital outflows as a means to lower the pressure of inflows
c. Managing the exchange rate and interest rates in a liberalized environment
d. Increasing buildup of foreign exchange reserves
e. Strengthening the surveillance and risk management system
7. VULNERABILITY TO EXTERNAL SHOCKS
- a. Vulnerability to global financial turmoil
b. Effects of capital flows on asset prices
c. Balancing the benefits and risks of capital liberalization 64
d. Capacity to keep regulatory pace with new financial instruments
8. SUMMARY AND RECOMMENDATIONS
ANNEX 1: Changes in Malaysia’s Foreign Exchange Regulations 76
ANNEX 2: Equity Regulations Relating to Foreign Direct Investment
ANNEX 3: Regulations on Foreign Purchase of Real Estate
BIBLIOGRAPHY
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