Malaysia's introduction of exchange controls has increased the anxiety of international agencies and the rich countries: they worry that this is the start of a trend by developing nations to curb the freedom of financial institutions. These rich economies are now pushing hard for new global laws that would guarantee the right of international speculators and investors to move their funds as they wish. If approved, the new rules would prevent governments from regulating foreign speculators and investments. Thus, the current moves in the IMF, the OECD and the WTO should be watched carefully.

By Martin Khor

Ever since Malaysia introduced exchange controls to deny speculators the opportunity to profit from fluctuations in the ringgit, there has been a growing debate about the pros and cons of "capital controls".

Some economists and commentators have praised the move as a bold measure to break the cycle of financial instability and recession.

Others, perhaps the majority, have criticised Malaysia for committing sacrilege, warning that the country would be cut off from foreign financial flows.

The debate is sure to continue, and everyone is watching how the Malaysian economy performs.

Should it succeed in recovering faster or at less cost than other countries affected by recession, then the public and policy makers in these other countries will be tempted to also go the Malaysian way.

Indeed, there were reports from Jakarta some weeks ago that quoted a few Ministers as saying Indonesia would also impose some capital controls.

This was subsequently denied by a senior economics Minister. And in the next "letter of intent" signed by Indonesia and addressed to the International Monetary Fund, a new condition for getting more funds from the IMF was that the country would not impose capital controls.

The IMF and the powerful financial authorities of the industrial nations are worried that other countries might want to follow the Malaysian example.

If more countries were to impose some kinds of controls over their currencies and over capital flows, this would begin to alter the international financial system which is presently based on freer and freer flows of funds across borders.

Such freedom of capital flows has been advocated by international financial institutions such as commercial and investment banks, hedge funds, mutual funds and brokerage houses because they can take advantage of a financially borderless world to make more money through investment and speculation.

In order to facilitate and defend the interests of these international financial institutions, players and speculators, governments of most Northern or industrial countries have been advocating that all countries increasingly liberalise their external financial operations.

The benefits of financial opening have been stressed and over- exaggerated whilst the risks and costs have been downplayed or not mentioned.

Following this advice, many East Asian countries liberalised their currency trade and financial sectors, allowing funds to flow freely, and this liberalisation is now recognised as a major cause of the East Asian (and now global) crisis.

There is a growing clamour for international regulation of financial institutions such as hedge funds, other investment funds, and banks, to prevent the kind of excessive flow of short term funds that is now wreaking havoc across the world.

The recent APEC summit was the latest international event where the need for such regulation was discussed. Due to strong resistance from the rich countries, there was no decision on regulation, but an agreement to set up a task force to come up with proposals to review hedge funds, investment banks and rating agencies, for the Group of 22 countries to consider.

Meanwhile, as the discussions surrounding APEC showed, there is greater interest now to consider the benefits for those countries that have opened up too much to reimpose some capital controls, so as to regain national control over economic policies.

Despite (or maybe because of) the emerging view that it is wise for regulation of capital flows, the governments of developed countries are going ahead with plans to introduce new international laws or rules that protect the freedom and rights of international investors and speculators.

This is being done by preventing governments from introducing or having policies that hinder the free flow of short term and long term funds and investments by foreigners.

Through the proposed new global rules, governments would in future be forbidden to regulate foreign funds and investments from entering and operating in their countries.

These moves are taking place at three different fora:

** In the IMF there is a strong push by the Secretariat (backed by the US and other G7 countries) to expand the IMF's powers to include disciplining developing countries to open up their capital account (ie allow free flow of funds into and out of the country that are unrelated to trade or direct investment).

At present IMF has jurisdiction over the current account only (ie over the flow of funds to finance imports and exports). The Secretariat and rich country member are attempting to amend its articles of agreement to extend the jurisdiction to capital account convertibility (ie the free flow of funds for non-trade purposes).

This would make it difficult or impossible in future for countries to take measures to prevent or discourage the inflow or outflow of speculative funds.

The IMF secretariat says it would be careful to ensure only "progressive and orderly liberalisation," but in fact the main principle would be that countries would not be allowed to "backtrack" but can only "go forward" in liberalisation.

In other words, a country that has liberalised to a certain degree will be persuaded to liberalise more, and will not be permitted to reimpose some of the controls it formerly had in place.

** In the OECD (the grouping of 28 rich nations), a multilateral agreement on investment (MAI) is being negotiated that would prevent states from regulating the inflow of foreign investment (defined as FDI plus portfolio investment, bonds, loans and also intellectual property rights).

Foreign investors must be allowed the right and freedom to enter and establish themselves in the countries under the agreement.

Foreign investors must given the same rights as locals (national treatment) and there should be no or minimal regulation on their operations. They are to be given freedom to bring funds in and out of the host countries.

Breaking the agreement would mean having to pay heavy compensation to foreign companies which can sue states. The OECD wants non-OECD countries (ie the developing nations) to also join the agreement.

** In the World Trade Organisation, there is a working group on trade and investment. Presently its terms of reference involves only a "study" of the relation between trade and investment with no mandate to negotiate an investment agreement.

The European Union, Canada and other rich countries are now pushing to convert the working group into a negotiating group for an investment agreement similar to the OECD's multilateral agreement on investment.

This push is getting very strong because of the failure of the OECD countries to reach an agreement. There is now a decision among the OECD countries to move their MAI agreement to the WTO for negotiation.

This is even more dangerous for developing countries as they are members of the WTO, whereas they are not OECD members and do not have to join an OECD agreement. Such a MAI-type agreement in the WTO will be part of the EU's idea of a new Millennium Round of negotiations in the WTO.

It is crucial that some developing countries unite among themselves and strongly oppose any move to convert the Working Group into a negotiating group, for this will lead to very strong pressures for a MAI-type investment agreement in a few years. They should push that the Working Group continue to study the issue for another two or three years.

The events taking place in the IMF, the OECD and the WTO should be of great interest to Malaysians and to people in other countries who are concerned about the negative consequences of free capital flows and about retaining the right of governments to regulate foreign financial speculators and institutions.

They have only a little time to organise themselves to oppose the moves in the IMF and the WTO.

If the IMF amendment goes through and the WTO starts an MAI negotiation, developing countries will face very great pressures to further liberalise their financial operations and to allow foreign companies to buy up local firms and control key economic sectors.

Action on the negotiating and diplomatic front is therefore urgently needed, if Malaysia is to defend its right to maintain exchange controls and capital flows, and its right to deny speculators the free space to manipulate the currency and financial markets. - (November 1998)

(Martin Khor is the Director of Third World Network.)