Malaysia needs to maintain tools for capital controls


chartsProposed measures in the new Trans-Pacific trade pact that the Malaysian government is negotiating this week could restrict Pacific nations from preventing and mitigating financial crises. Beginning March 1, the so-called Trans-Pacific Partnership agreement (TPP)--a proposed treaty by the United States, Australia, Brunei, Chile, Malaysia, New Zealand, Singapore, and Vietnam—is being negotiated in Australia.

United States President Barak Obama has pledged that this will be a “21st Century” trade deal that discards many of the harsh conditions of past trade pacts. In the wake of the global financial crisis and with the memory of the Asian crisis still in our minds, any 21st Century trade deal should leave Pacific nations with all the tools necessary to prevent and mitigate financial crises.

Under the proposed deal, nations would not be permitted to regulate speculative capital flows to protect their economies from financial crises.

As we know, during the Asian Financial Crisis Malaysia initially adopted IMF policy measures such as raising interest rates and reducing public spending to counteract the economic downturn. This exacerbated the problems. Raising interest rates did not stem massive capital flight and only contracted the economy.

In a change of course, in September of 1998, the government started to introduce several capital control measures that included banning the trading of off-shore ringgit which was contributing to outflow of funds due to higher off-shore interest rates. It also pegged the ringgit at 3.80 to US$1 and imposed a one-year moratorium on repatriation of proceeds from share sale from purchase date of shares to discourage short-term trading of local shares. Other measures included halting of ringgit loans to non-residents, control of transfer of ringgit funds, and conversion of ringgit to other currencies except for the purposes of trade and long-term investments.

These measures were gradually loosened and capital now flows freely to and from Malaysia. But we must remember that they allowed the country to have breathing space to pursue more independent and effective monetary policies. Together with other counter-cyclical fiscal policies and pro-active debt restructuring measures, Malaysia recovered more quickly from the Asian Financial Crisis (indeed, this has been confirmed by US government sponsored research as well). Let us hope that the nation, or any other nation for that matter, does not experience such a situation again. But if the time does come, we will need all the possible tools at our disposal.

Malaysia has been careful to be sure that it maintains that breathing room in most of its other trade treaties. A recent study by the Washington-based Institute for Policy Studies shows that most free trade agreements (FTAs) among other TPP nations provide temporary safeguards on capital inflows and outflows to prevent or mitigate financial crises, or defer that matter to the host country’s legislation. Indeed, Article 17 of the Malaysia-New Zealand treaty and Article 88 of the Malaysia-Japan treaty have such a safeguard.

However, the TPP would disallow Malaysia these policy options. According to US proposals all forms of capital--including derivatives, stocks, bonds, and currency speculation—must be permitted to move “freely and without delay” among TPPA countries. Moreover, rather than having the enforcement of these provisions be conducted by nation-states, the treaty would allow private firms to directly file claims against governments who have used them.

The experience of Malaysia and that of other countries demonstrate that judicious use of capital regulations is an important tool that countries should have in managing their economy. Indeed, there is a new consensus on capital regulations and crises. A 2010 IMF report showed that such measures not only work but "were associated with avoiding some of the worst growth outcomes" of the current economic crisis. The paper concludes that the "use of capital controls – in addition to both prudential and macroeconomic policy – is justified as part of the policy toolkit."

Indeed, many of these other countries, such as Chile and Peru that are also in TPP negotiations, have used regulation to stem capital inflows to prevent crises from happening in the first place.

Citing this evidence, over 100 economists from TPPA nations (including ourselves) sent a letter to their negotiators this week urging them to safeguard the agreement with the flexibility of using capital account regulations to prevent and mitigate financial crises.

Malaysian treaties have been careful to maintain the flexibility to regulate capital flows in many of its other trade treaties. It would be highly prudent to maintain that flexibility in a trade deal with the United States—the source of both much of the world’s volatile capital flows and the world’s largest financial crisis since the Great Depression.

Dr. Lim Mah Hui is a Visiting Senior Fellow at Penang Institute and a former international banker. Dr. Kevin Gallagher is an economics professor at Boston University.


* This article was first published in The Edge weekly March 3, 2012 and reproduced with permission.