Capital controls breed fear

Business Asia, Sept 21, 1998

The resurrection of the exchange control debate has added a new twist to Asia's financial crisis, with long-term fears being held for the Malaysian economy following Prime Minister Mahathir Mohamed's decision to impose capital controls.

Coupled with the dismissal of Deputy Prime Minister Mr Anwar Ibrahim, the implementation of exchange controls takes Malaysia into murky waters.

Dr Mahathir has taken over the finance portfolio from Mr Anwar, who denies charges of sexual misconduct and obstruction of justice.

Meantime, economic analysts are hotly debating the merit of exchange controls. Most oppose the move, while acknowledging possible short-term benefits.

The Kuala Lumpur Stock Exchange's blue chip index recently surged 35 per cent, while the ringgit also strengthened after the controls were announced. The ringgit has been pegged at 3.80 per US dollar.

Noted US economist Dr Paul Krugman, of the Massachusetts Institute of Technology in the United States, caused controversy by supporting in the September 7 edition of Fortune magazine the imposition of controls on capital movements in and out of Asian economies.

He described the move as "the obvious alternative".

However, even Dr Krugman sees risks in Malaysia's strategy.

Dr Krugman said controls must serve as an aid to reform, not as an alternative.

"It should not be used in an attempt to prove points about the soundness of the pre-crisis economy, or about the wickedness of hedge funds, or anything else," he said in reference to Dr Mahathir's defensive reflexes.

Dr Hugh Patrick, the R.D. Calkins professor at the Columbia Business School in the United States, believes the time has passed for Asian economies to clutch at the exchange control option.

"I think it's too late to impose exchange controls because we are really talking about trying to prevent capital flight from countries, and I think the only real country where the capital flight issue is a major one is Indonesia," he said.

However, Dr Patrick understood the logic of Dr Krugman's pro-control sentiments.

"As a practical matter it's too late. As a structural matter of what sort of architecture you want as an international financial centre, I think it would be a backward step. (Krugman) is addressing, however, what is a very real dilemma, which is the danger to a country which has a lot of sharp short-term borrowings."

Will the exchange control measures be effective in Malaysia?

Some think they will.

"It's easy to be negative, but this might just work," said Mr SongSeng Wun, regional economist at G.K. Goh Research in Singapore.

Most economists warn that while the controls could insulate Malaysia from financial turbulence for a short time, they could be counterproductive unless accompanied by reforms.

Rating agency Fitch IBCA said capital controls would depress banks' foreign exchange earnings and hurt their stockbroking units. -- Business Asia and wire agencies

What are exchange controls?

* Under exchange controls, a country sets the value of its currency artificially.

* Exporters are usually paid in foreign currency. With controls, they must sell those foreign exchange earnings to the central bank at the official rate. That currency is then sold at the same rate for approved payments to foreigners (eg. for imports).

THE BENEFITS

* Controls could allow Asian countries to stabilise their currencies.

* Interest rates can be cut without causing the currency to drop dramatically, while stimulating consumption.

* Currency rates can be set for political reasons. An artificially low rate can spur exports, while a high rate can be used by leaders to engender the impression of a strong nation.

THE DISADVANTAGES

* Governments need large bureaucracies to monitor the system. This is expensive. Exporters can conceal foreign exchange receipts.

* Black market currency trade flourishes.

* Countries imposing controls have found them impossible to manage over a long period.