COMPREHENSIVE POLICY MEASURES: Better financial and monetary
regulation, exchange rate flexibility and more liberal capital flow regime help stabilise economy
The International Monetary Fund has named Malaysia as one of the
three countries that has been successful in increasing its resilience against swings in capital flows.
The other two countries are Chile and the Czech Republic.
The fund, in its latest World Economic Outlook, said while all three countries took different paths, their greater resilience can be linked to a mix of policy measures.
These measures included better prudential regulation and financial supervision, more counter-cyclical fiscal and monetary policy, greater exchange rate flexibility and a more liberal regime for capital outflows.
“Overall, the success of these countries has been based on embracing these reforms in a comprehensive manner.”
In the case of Malaysia, which faced capital inflows and capital flight during the previous regional financial crisis, it closed its financial account and fixed its exchange rate.
Over the following decade, it carefully built financial sector
resilience, moved to a flexible exchange rate regime and
gradually relaxed restrictions on capital flows.
“The improvements in resilience have been such that, despite more open capital markets, highly volatile gross inflows during the global financial crisis did not lead to a sudden stop in net flows or domestic financial instability.”
To avoid a haemorrhaging of foreign capital, prevent an even larger depreciation of the currency and allow for monetary and fiscal easing, Malaysia introduced capital controls and fixed the exchange rate with respect to the US dollar on September 2 1998.
The economy rebounded quickly, returning to healthy growth rates by the end of 1999.
The IMF noted that following the Asian financial crisis,
Malaysia embarked on a process of reforms that involved
strengthening the domestic financial sector and reopening
the financial account.
From enhancing the capacity and capability of existing banks and the liberalisation of the sector, Malaysia promoted international
integration by allowing new players into the domestic economy and supporting investment abroad.
Another important step that increased the resilience of the financial sector was to foster the development of equity and bond markets, which expanded financing beyond bank lending.
Finally, it said the Malaysian authorities also took steps to improve financial regulation and supervision by adopting risk-based capital requirements, stress testing, peer group comparisons, and horizontal reviews.
Apart from strengthening the financial sector, restrictions on capital flows and exchange rate transactions were eased to increase efficiency and reduce the costs of conducting business internationally.
This led Malaysia to accumulate a substantial gross international asset position.
"While international liabilities stayed relatively constant as a proportion of gross domestic product (GDP), Malaysia more than doubled its gross foreign holdings between 1997 and 2012, leading to a large correction in the net foreign asset position, which turned positive."
The proportion of official reserves in total private and official outflows fell from more than 50 per cent during 2002-2005 to less than 20 per cent during the 2006-2009 period.
This increase in private capital outflows was characterised by strong growth of foreign direct investment by Malaysian companies overseas.
The IMF noted that the reduced capital inflows during the Great Recession was largely offset by the sales of foreign reserves and the repatriation of domestic capital invested abroad.
"In particular, large sales of domestic bonds by foreign investors were absorbed with minimal impacts on yields by the Employees Provident Fund and other deep-pocketed domestic institutional investors."
Another reason for the increased resilience is the significant change in the dynamics of public spending.
While government spending was positively correlated with GDP fluctuations during the 1990s, it has become much more counter-cyclical during the 2000s, especially by providing fiscal stimulus during downturns.