THE 1997-98 FINANCIAL CRISIS IN MALAYSIA: CAUSES, RESPONSE, AND RESULTS†
ZUBAIR HASAN∗ This paper argues that the 1997-98 financial crisis did not hit Malaysia because the economic fundamentals of the country were weak. It was the result of massive unpredictable flight of short-term portfolio investment from the region including Malaysia. The paper assembles evidence, and employs econometric tools to support the contention. It maintains that the choice of the country to impose selective capital controls for remedying the situation was efficacious, and proved fairly rewarding. It also makes a few observations from an Islamic angle that may help forestall the occurrence of such crises in future. 1. INTRODUCTION The 1997-98 Asian financial crisis originating from Thailand struck one country after another in almost no time, Malaysia being among the later victims. The literature has since been full of books and articles on the subject. However, much has not been written exclusively about the Malaysian experience. The position of the country has largely been examined in comparative discussions on the subject. Such discussions, though useful, often tend to generalize the analysis beyond reasonable limits. Economic structures, social environment, political settings, and international relations of the countries that were caught in the turmoil have been much diverse to allow meaningful comparisons between them on the causes of the crisis, their response to it, or the results they obtained. Furthermore, the studies dealing with the crisis have mostly relied on the yearly or at best the quarterly data that was available for required variables from different sources. At times, it was perhaps the nature and periodicity of the data one could lay hands on that dictated the model form, or the issues one selected for discussion. However, the crisis being essentially a short-term phenomenon even the use of
† This paper is a substantially revised of an earlier draft presented on July 5, 2001 at the 76 Annual Conference of WEAI, San Francisco. The author is grateful to his colleague Mr. Mansur H. Ibrahim and Prof. Rodney Wilson of Durham University, UK who went through an earlier draft of the paper, and made valuable suggestions for improvement. However the usual disclaimer applies. ∗ Professor of Economics, International Islamic University, Kuala Lumpur, Malaysia (E-mail: firstname.lastname@example.org).
Islamic Economic Studies, Vol. 9, No. 2
monthly data could rarely capture the genesis or the abruptness of the event the authors sought to explain. Also, the difference in the quality, coverage, and periodicity of the data available for various countries detracted much from the utility of making comparisons. For the above reasons, the material one comes across in the current literature discussing the causes of the crisis in Malaysia, her policy response to it, and the results she obtained carries little conviction and is at times misleading. The present study essentially is specific to the country. It uses weekly data for the selected variables: stock market indices, interest rates, and foreign exchange ratios. The main source for the data has been the Business section of the New Strait Times, Kuala Lumpur, and comprises of the closing quotation for each Tuesday.1 If the Tuesday quotation was not available for any reason, the closing quotation of the day nearest to it was taken. Thus, the work has important distinctive features. The main objectives of this paper are to investigate (i) if the primary cause of the crisis in Malaysia was the flight of foreign capital from the country, or her weak economic fundamentals, (ii) if the imposition of exchange controls was an efficacious response to the malady, and (iii) if the results of the controls have really been rewarding for the country. The paper consists of seven sections including the present one. Section 2 discusses briefly the background