Saturday, January 30, 2010

Financial Dire Straits

There has been a number of reports questioning why Malaysia experienced capital outflows in 2009 that were far larger than many countries, and it was deemed especially puzzling because Malaysia has a large current account surplus. Today’s The Star (pp SBW 20-21) highlighted this "Capital dilemma" concern, especially on this disquieting issue that if the country's capital outflows persist, it couold leave a dent in Malaysia's investment prospects.

Bank Negara governor Dr Zeti Akhtar Aziz responded like a true politician – she said a lot of things that actually did not tell us anything: “The strong reserves position, the well developed financial system and the resilience of the banking sector allowed Malaysia to absorb this volatility in our stride. At all times, liquidity remained ample… Given the uncertainty in the global financial markets, capital flows are likely to remain volatile. What is important is having the capacity to absorb this increased volatility without having disruptions to the domestic financial system”.

Zeti’s answers were standard responses that didn’t quite allay my fears nor put to rest my concerns. Firstly, I subscribe to this view that inflows must always be greater than outflows. But studying 3 countries' FDI flows (2006-2008) – Malaysia, Indonesia and Singapore, we will have the heebie-jeebies. Why? Just look at our outflows!!!!

Secondly, an important question comes to mind – whether the capital outflows represent capital flight or normal flows? I worry a lot if it is the former because that can mean that we are in financial trouble.

I located this report written sometime ago and I thought it is relevant in expanding our understanding of this issue of ‘capital flows’: “Capital flight is defined here as the outflow of resident capital from a country in response to economic and political risk in the domestic economy. The loss of capital through capital flight has implications for the future growth prospects of the country. Capital is already scarce in many of the countries which are believed to experience capital flight and, as a natural corollary, it is assumed that if the funds are held at home they can be utilized to reduce the level of external indebtedness and the inherent liquidity constraints in bridging the foreign-exchange gap. The loss of capital through capital flight also erodes the domestic tax base in developing countries and has adverse implications for the distribution of income. It is feared that the flight of capital from developing countries may send a signal to foreign private investors about the risks involved and lead to a decline in, or even cessation of, private capital flow.”
Zeti also provided the following information: "As at Jan 15, 2010 the international reserves of Bank Negara are at RM331.4bil (equivalent to US$96.7bil). This reserves position is sufficient to finance 9.5 months of retained imports and is 4.1 times of the short-term external debt. The reserves level is sufficient to deal with volatile capital flows" (p SBW21).

Duh! This does not mean anything. After all, it is generally accepted that central banks should avoid building up excessive international reserves, since overvaluation also causes capital to move out in anticipation of depreciation. Capital controls won’t work either, except perhaps for the short-term only. Besides, such a train of thought is unlikely to gain traction in today's more liberal environment. The only solution seems to be for the government to tackle the roots of economic and political instability. But we seemed to be caught in a time-warp.

A troubled ruling party, an untested opposition, a stalled economy, a politicized judiciary, a resort to racial discourse – Malaysia's polity is moving farther away from the progressive governance it needs, says Bridget Welsh (an assistant professor in Southeast Asian studies at Johns Hopkins University) in an article published on July 22, 2008 (Source: Webpage, accessed January 30, 2010).
Doesn’t this national predicament still holds true even today? We are trapped in this quagmire that we don’t seem to be able to escape from.
And the truth of the matter is that the government of the day will not act. This instability that is being referred to is due to corruption, economic mismanagement, political patronage and the list of national ills goes on. Our only hope is a change in government.

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