New Measures Aim to Rekindle Foreign Investment : Malaysia Eases Fund Flows 
International Herald Tribune
February 5, 1999
Thomas Fuller

Malaysia said Thursday it would ease the tough controls it imposed last September on currency flows, edging its way back into the global financial markets in a bid to encourage the return of foreign investors.

While leaving in place the main components of its capital controls, Malaysia altered a key part by introducing an "exit tax" aimed at discouraging short-term investment and money flows. The new tax replaces the temporary rule introduced last September that had banned foreigners from repatriating their money for 12 months and that had trapped about $3 billion of foreign equity investment in the country.

The measure makes Malaysia the first East Asian country to introduce such a tax on foreign investment. Remaining in place are a freeze in the value of the ringgit against the dollar, a ban on trading of the Malaysian currency abroad and limits on how much foreign currency Malaysians can take abroad.

The move announced Thursday, which was made in consultation with two major Wall Street investment banks, is an effort to woo back "serious long-term investors," in the words of Prime Minister Mahathir bin Mohamad, and to avoid the type of market volatility seen during the early months of the current economic crisis.

Analysts generally applauded the announcement, but some voiced concern that the government was taxing only foreigners.

"It smacks to some degree of discrimination because it applies only to foreigners," said Mohammed Ariff, executive director of the Malaysian Institute of Economic Research. "If the idea is to penalize short-term portfolio investors because it creates volatility, then you must target short-term capital regardless of ownership — local or foreign."

"These new measures are aimed to encourage existing portfolio investors to take a longer-term view of their investments in Malaysia," Finance Minister Daim Zainuddin said in a statement. The moves, he added, would also help "attract new funds into the country, while at the same time discourage destabilizing short-term flows."

The government was relatively terse in explaining the measures, and foreign reporters were excluded from the press conference where Mr. Daim elaborated on the plan.

The purpose of the new measures is two-fold: to ensure that foreign money that had been trapped in the country since September was not taken out all at once, and to encourage new foreign investors to keep their money in the country for at least a year.

To regulate the outflow of foreign money, the government imposed graduated levies on that money, with the rate declining the longer the money stays in the country. For new foreign investment, a simple formula will apply: Profit taken out of the country less than a year after initial investment will be taxed at 30 percent, and profits repatriated thereafter will be taxed at 10 percent.

Attracting new foreign money is a key concern for Malaysia, which after imposing the capital controls found itself removed from a widely consulted benchmark index of world stock markets published by Morgan Stanley Capital International.

That move, analysts said, led many foreign investors to shy away from the stock market, cutting off a key source of funding for cash-strapped Malaysian companies.

"We think there could be some net foreign buying when Malaysia makes it back to the index," said Yeoh Keat Seng, head of research at Merrill Lynch in Kuala Lumpur .

"A lot of Malaysian companies need to recapitalize," Mr. Yeoh added. "And this may help these companies tap foreign money."

Malaysia's capital controls cut to the heart of a debate on what caused the massive outflow of money from Southeast Asian economies at the start of the region's economic crisis 18 months ago.

Mr. Mahathir and other officials contend that the primary cause of the dramatic drops in currencies and stock markets was trading by unregulated hedge funds and currency speculators. By slowing down the flow of capital, Malaysia believes it can avoid or lessen future shocks to its financial system.

Officials in Washington, however, blame the crisis on lax banking supervision and generally poor economic management. Stemming or slowing the flow of investment is not the answer, these officials say.

Although Malaysia's moves appear to run counter to Washington's vision of unfettered capital flows, two Wall Street investment banks — Salomon Smith Barney and Goldman, Sachs — were instrumental in formulating the policy. The two firms competed to provide a plan acceptable to policymakers, according to a government adviser.

Salomon, the Malaysian government's official financial adviser, is said to have favored the exit tax. Goldman, according to the adviser, argued for a system of "most favored investors," which would have allowed investors judged to have more long-term interests in the country more freedom to move money in and out.

The government adopted Salomon's proposal after the firm arranged for meetings between fund managers and Mr. Mahathir. Government officials also met informally with officials from the World Bank and International Monetary Fund at the Genting Highlands resort outside of Kuala Lumpur several weeks ago.

"It was a matter of getting more views as seeing whether there was anything we had overlooked," said a government representative who attended the Genting meetings.

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