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The 1997‐1998 Asian financial crises underscored the dangers of open capital accounts in developing nations that have weak macroeconomic policies or poorly regulated…
The 1997‐1998 Asian financial crises underscored the dangers of open capital accounts in developing nations that have weak macroeconomic policies or poorly regulated financial systems. Most developing Asian countries responded to the crisis by adopting the orthodox remedies prescribed by the International Monetary Fund. These included liberalised capital accounts, floating exchange rates and tighter fiscal and monetary policies designed to restore investor confidence. Malaysia departed from this orthodoxy. In September 1998 it imposed controls on capital account transactions, pegged its currency to the US dollar, cut interest rates and reflated its economy. The literature suggests that even temporary capital account controls entail serious economic risks for developing countries. However, the undue hardships imposed by the IMF regimen suggest that it is time to re‐evaluate the role of currency controls in mitigating the destabilising effects of unfettered capital flows in developing countries that have poorly regulated financial systems. This article analyses the effectiveness of Malaysia’s 1998 capital controls by evaluating Malaysia’s post‐1998 economic progress. Its goal is to inform the debate concerning the benefit‐risk tradeoffs of currency controls in developing countries.