Alternative Policy Measures

This section discusses various policies to manage capital flows. Some may be more effective than others depending on the state of the economy and the financial sector.

First, fiscal policy may be useful in controlling capital inflows. By running a budget surplus, inflation pressure and appreciation of the real exchange rate can be lowered. A reduction in government expenditure has the same effect as a decrease in demand for loanable funds because it can lower interest rates. However, this policy has to be balanced with the development responsibility of the government. Moreover, fiscal policy has long lags. Thus, it may not be effective in managing short-term speculative capital inflows.

There is some indication that Malaysia is trying to use the above measure in conjunction with sterilization to handle surges in foreign capital (Ministry of Finance Malaysia, 2007). To mitigate lower government expenditure on infrastructure, a private financing initiative was strongly encouraged. The progress was slow, however, given current financial volatility.

Policies aimed at strengthening domestic consumption and investment may be useful in lowering dependency on the volatile external sector. The high level of national savings could be directed to productive investment activities as well as encouraging more consumption. However, prudential regulations should be employed to prevent an unsustainable boom in consumption and investment.

Private investment, which grew by 7.0% in 2006, is expected to remain on an upward trend, accelerating by 10.0% in 2008 and 11.4% in 2009 (Figure 22 [ PDF 16.5KB | 1 page ]). To attain 6.0% in GDP growth over the Ninth Malaysia Plan (9MP) period from 2006 to 2010, higher private investment growth of 11.2% per year would be needed.

There are three measures to encourage faster private investment growth in Malaysia. First is the reduction in the corporate tax rate from 27% in 2007 to 26% in 2008. By lowering the corporate tax rate, the level of competitiveness in Malaysia is enhanced. Corporate earnings will be higher and in turn, this may lead to higher reinvestments by local economic agents. Moreover, a lower corporate tax rate may also encourage more inflows of direct investment into strategic industries in Malaysia.

The second measure entails a revamped public delivery system to ease the cost of doing business in Malaysia. Although there were some improvements in expediting the public sector delivery procedure, more measures may be required to ensure faster implementation of public projects under the 9MP.

The first two drivers seek to address concerns raised by Guimaraes and Unteroberdoerster (2006), while the third measure centers on industry clusters to raise the rate of private investment. Recently, the government launched five regional economic corridors in Malaysia (Table 18 [ PDF 14.9KB | 1 page ]). These economic corridors are expected to target a combined sum of around USD 343.8 billion investment over the period 2006 to 2030.

When domestic policies are not effective in dealing with massive capital flows, troubled countries may seek regional assistance from the Chiang Mai Initiative (Ariff, 2007). Although the available funding is small, it may be better than having been subject to tough IMF conditions.

Finally, with little progress in the international financial system, Asian economies have continued to amass foreign reserves. Large reserves may be useful in the face of large capital reversal. With high import covers and low exposure to foreign debts, Asian countries have been able to weather the recent financial contagion without much difficulty.

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