Malaysia’s capital control (cepo) success – a journey beginning in Buenos Aires

Malaysia’s successful model of capital controls during the 1997–1998 Asian financial crisis has long been studied by economists and economics students around the world, particularly because Malaysia was the only country choosing not to take any loans from the International Monetary Fund (IMF).

However, few know that this success story actually began at the Alvear Palace Hotel in Buenos Aires in 1997!

Background

The Asian financial crisis of 1997–1998 was a watershed moment for many East and Southeast Asian economies. Triggered by the collapse of the Thai baht in July 1997, the crisis quickly spread across the region, leading to massive currency depreciations, plunging stock markets and severe economic contractions. While many countries turned to the IMF for assistance and adopted its prescribed structural reforms, Malaysia chose a different path, one that was unconventional and, in hindsight, remarkably effective.

I vividly remember that period, as I was freshly graduated and working as a junior trader at one of stockbroking firms in Malaysia. I witnessed firsthand the dramatic decline of the Kuala Lumpur Stock Exchange (now known as Bursa Malaysia), plunging from around 1,200 points to as low as 262 points.

Crisis unfolds

By mid-1997, Malaysia was experiencing severe economic turmoil. The Malaysian ringgit had depreciated significantly against the US dollar, the stock market had lost nearly half its value and investor confidence was in free fall. The country’s open capital account made it vulnerable to volatile short-term capital flows, exacerbating the economic shock.

In September, 1997, the Malaysian prime minister at the time, Tun Dr. Mahathir Mohamad (who turns 100 in July), was on a working visit to several Latin American countries, including Cuba, Chile and Argentina. During this period, the Malaysian ringgit was under immense pressure and urgent action was needed to devise a strategy to stabilise the economy.

Recognising the gravity of the situation, Dr. Mahathir instructed his officials to urgently contact one of Malaysia’s leading economists and foreign exchange experts, Tan Sri Nor Mohamed Yakcop, requesting that he meet the prime minister in Buenos Aires, where Dr. Mahathir was scheduled to arrive on October 2, 1997.

Nor Mohamed was advised to reach the capital a day earlier. Fortunately, at that time, Malaysia Airlines operated a direct flight twice a week from Kuala Lumpur to Buenos Aires via Johannesburg and Cape Town. Thanks to this, Nor Mohamed successfully arrived in Argentina on October 1, 1997, just one day ahead of the Prime Minister.

During the working visit to Argentina, the Prime Minister and the Malaysian delegation stayed at the Alvear Palace Hotel. Upon his arrival at the hotel, Dr. Mahathir requested Nor Mohamed to meet him in his suite.

At the meeting, Dr. Mahathir asked Nor Mohamed to explain the root causes of the financial crisis and how the foreign exchange market actually works. Nor Mohamed proceeded to brief the Prime Minister on the mechanics of the global foreign exchange system and the interrelationship between the forex and equity markets.

The meeting in the suite lasted about two hours, during which Dr. Mahathir spoke very little, asking only one or two questions, and listened intently throughout. The discussion ended when the prime minister had to prepare for an official dinner with Argentina’s then-president Carlos Menem.

Before departing, he asked Nor Mohamed about his plans for the evening. When Nor Mohamed replied that he, too, had been invited to the dinner, Dr. Mahathir requested that he skip it and instead spend the evening writing down all the key points discussed during their two-hour meeting, as he wished to review them further over breakfast the following day.

Nor Mohamed then spent the entire evening preparing the report and submitted it to the Prime Minister later that night. The next morning, Dr. Mahathir mentioned that he had read the report and now clearly understood what was happening in the financial markets. They then proceeded to discuss various options and strategies to address the crisis, including the potential implementation of capital controls.

Implementation of capital controls

Upon returning from Buenos Aires, both Dr. Mahathir and Nor Mohamed held regular meetings in Kuala Lumpur. Recognising the need for swift and coordinated action to address the escalating financial crisis, the Prime Minister believed it was crucial to establish a special committee to monitor and respond to the situation effectively.

On November 20, 1997, Dr. Mahathir announced the formation of the National Economic Action Council (NEAC), a special committee tasked specifically with monitoring the developments of the financial crisis and formulating strategic responses to safeguard the nation’s economy.

Then, on September 1, 1998, the Malaysian government took a bold and decisive step by imposing capital controls.

The key components of Malaysia’s capital control strategy were as follows:

1. Fixing the exchange rate
The Malaysian ringgit was pegged at RM3.80 per dollar to provide immediate stability and predictability in the currency’s value. This move eliminated speculative attacks on the ringgit and helped restore investor and business confidence.

2. Macro-economic stimulus
In contrast to the austerity measures prescribed by the IMF in other affected countries, Malaysia lowered interest rates to encourage domestic borrowing and stimulate investment.

3. Blocking offshore ringgit trading
Offshore trading of the ringgit was banned to curb currency speculation in unregulated markets. All ringgit held outside Malaysia had to be repatriated within a specified timeframe.

4. Restrictions on capital outflows
Controls were imposed on portfolio capital, including an initial one-year holding period on capital repatriation. This was later replaced by a more flexible exit levy system to ensure a smoother and more managed transition.

5. Freedom for current account transactions
Trade-related payments and foreign direct investment (FDI) were exempt from restrictions. This ensured that Malaysia’s external trade and economic activities continued uninterrupted, minimising disruption to the real economy.

Successful strategy

1. Stabilised the ringgit and economy
The fixed exchange rate brought currency stability, eliminating uncertainty for investors and businesses. It allowed the central bank to regain full control over monetary policy.

2. Preserved sovereignty and avoided IMF austerity
One of the reasons Malaysia rejected the IMF rescue package was the government’s desire to maintain full control over its economic policy and avoid the painful austerity measures that had exacerbated crises in neighbouring countries. Unlike the typical IMF approach, which often involves raising interest rates, the Malaysian government chose to lower interest rates. This unorthodox decision proved to be highly effective, as it stimulated domestic economic activity and supported recovery in key sectors such as manufacturing and construction. As a result, Malaysia managed to avoid a prolonged recession. While gross domestic product contracted by 7.4 percent in 1998, the economy rebounded strongly with 6.1 percent growth in 1999, a clear testament to the success of its alternative strategy.

3. Prevented capital flight and speculation
By halting offshore ringgit trading and imposing capital restrictions, Malaysia effectively blocked all channels that had previously enabled rapid capital outflows. This allowed the country to stabilise its financial system and rebuild its foreign reserves.

4. Maintained trade and FDI flows
By allowing trade-related and FDI flows to continue, Malaysia kept its productive sectors active, ensuring export earnings and job retention.

5. Strong economic fundamentals
Another key factor behind the success of Malaysia’s strategy was the country’s strong economic fundamentals.

For the record, in late 1996, prior to the onset of the crisis, Malaysia’s foreign reserves stood at approximately US$27 billion, equivalent to about 6.7 months of import cover, reflecting a relatively strong position. However, as the crisis deepened, reserves came under intense pressure.

By the time capital controls were imposed on September 1, 1998, reserves had fallen to around US$20.2 billion, covering only 3.8 months of imports. Following the implementation of capital controls and the pegging of the ringgit at 3.80 to the US dollar, reserves began to recover.

By October 15, 1998, they had risen to US$22.6 billion (4.3 months of import cover), marking a US$2.4-billion increase from August. This recovery was largely driven by reduced capital outflows and improved trade performance.

By the end of 1998, reserves had climbed to approximately US$26.2 billion, as the controls had stabilised the economy and export revenues strengthened.

In terms of inflation, the crisis triggered a sharp increase, with the rate rising to 5.3 percent in 1998, up from 2.7 percent in 1997. However, the situation stabilised quickly. Inflation fell back to 2.7 percent in 1999 and further declined to 1.6 percent in 2000.

These economic indicators clearly demonstrate that Malaysia’s capital control strategy was not only effective but also instrumental in ensuring the resilience and recovery of the national economy during one of the most severe financial crises in modern history.

Conclusion

In my view, capital controls are not inherently good or bad, but they are tools that can be highly effective when used correctly and wisely.

When Malaysia imposed capital controls on September 1, 1998, the decision drew heavy criticism. I still remember reading an article in an international magazine that described Malaysia as having entered “uncharted territory, taking an unprecedented path that challenged the norms of the global financial architecture.” Critics warned that Malaysia’s unorthodox response could trigger economic catastrophe, not just for Malaysia but for the entire region.

However, history proved otherwise. The bold measures not only enabled Malaysia to regain control of its economy but also contributed to a swift recovery with positive spill-over effects across the region.

In fact, Malaysia gradually eased the controls starting in 1999, replacing the 12-month holding rule with a graduated exit levy (e.g., 30 percent for funds held less than a year, reduced to 10 percent by 2000). Full liberalisation was finally achieved by 2005.

Malaysia’s success highlights the importance of policy credibility, clarity of purpose and exit strategy in the use of capital controls. It demonstrated that under exceptional circumstances, capital controls can be part of a pragmatic policy mix that includes monetary easing, fiscal stimulus, and institutional coordination. Malaysia succeeded not by rejecting globalisation but by temporarily pausing its vulnerabilities, giving the country the space to recalibrate and recover on its own terms.

Furthermore, Malaysia’s experience also contributed to a broader reassessment of IMF policies and a growing acceptance of capital flow management measures by institutions such as the IMF and World Bank in subsequent years.

From a wider perspective, Malaysia and Argentina share more than just historical ties. Not only were our iconic Petronas Twin Towers designed by Tucumán-born architect César Pelli but the story of Malaysia’s successful navigation through the financial crisis also carries a unique Argentine connection.

After all, the bold journey began in Buenos Aires!

* Nur Azman Rahim is the Ambassador of Malaysia to Argentina, Paraguay and Uruguay. He is also a Chevening scholar (2003–2004) and an alumnus of the Foreign Service Programme at the University of Oxford (Lincoln College)