Malaysia beat a currency attack by invalidating offshore ringgit, then taxed exits by time

By mid-1998 the Asian crisis was still deepening in Malaysia even as it eased in Korea and Thailand: the ringgit was under speculative attack from the offshore ringgit market in Singapore, where traders borrowed ringgit assets that onshore rules made impossible to obtain. The textbook options were ruinous — hike interest rates to defend the currency and crush the banking system, or devalue and import inflation. On September 1, 1998 the government took a third road: sweeping capital controls that focused entirely on the transmission channel of the attack.

The controls had two blades. Non-residents lost access to ringgit credit, and all ringgit held abroad had to be brought home and was no longer recognized offshore — the market speculators drew on simply ceased to exist, and shorts had to repurchase into a closed market. Repatriation of non-resident portfolio capital was frozen for twelve months and residents' outflows restricted; trade and long-term foreign investment were untouched. Currency and financial policy then worked together: the ringgit was fixed at 3.80 to the dollar, interest rates were cut, and banks were pushed to lend.

The refinement came on February 15, 1999: instead of holding portfolio funds hostage for a fixed year, Malaysia substituted a graduated exit tax on the invested amount for pre-September money and a tax on profits for funds entering after that date and leaving within a year. Money could now leave early at a price — a speed bump instead of a wall. The design signaled that the controls were transitional and gave the government a dial for pacing liberalization.

Did it work? Malaysia's GDP swung from −7.4% in 1998 to +5.8% in 1999, but controls-free Korea swung from −6.7% to +10.9%, so skeptics read the recoveries as regional export demand. Kaplan and Rodrik's answer was to time-shift the comparison: Malaysia's crisis was still worsening in mid-1998 while peers had already turned, so the right benchmark is where each economy was at its own trough. Measured that way, Malaysian policies produced faster recovery, smaller employment and wage losses, and a quicker stock-market turnaround than IMF-program comparators.

Kill the offshore market, then price the exit by duration

The attack was being financed offshore; invalidating offshore ringgit removed the ammunition directly instead of raising the price of defending the currency economy-wide.

Segregating the market let Malaysia cut interest rates and peg at a defensible level simultaneously — the opposite of the rate-hike defenses that deepened banking crises elsewhere.

Trade and FDI exemptions kept the real economy running, so the controls targeted portfolio flows without strangling commerce.

Converting the freeze into a graduated exit levy gave investors a way out and the government a throttle, reducing the incentive to circumvent the system.

The peg plus rate cuts plus bank lending formed a coherent stimulus package that controls alone could not deliver.

When capital flight runs through one market, close that market instead of tightening policy for everyone. And price the exit: a graduated levy keeps a bridge from becoming a cage.

The February 1999 levy turned the controls from a freeze into a dial Malaysia could turn as stability returned. The episode now stands, alongside Chile's inflow reserve requirement, as one of the two canonical 1990s capital-control experiments — the San Francisco Fed reviewed both together when the debate reopened. Kaplan and Rodrik's time-shifted method became part of the evidence that temporary outflow controls need not trap a country: measured from each economy's own trough, Malaysia's policies beat IMF-program comparators on output, jobs, wages and stock-market recovery.