Financial Liberalization and Its Impact on Domestic Stabilization Policies: Singapore and Malaysia

Full convertibility on the capital account brings with it the danger of real appreciation of the domestic currency as a consequence of additional net capital imports. The real appreciation, in its turn, does not favour exports. At the end of the 1970s, Singapore and Malaysia had liberalized almost completely their international capital flows. Both countries experienced approximately the same growth and inflation rate. During the first held of the 1980s, both currencies went through a considerable appreciation of their real effective exchange rates, since at that particular period both pegged their currencies to the U.S. dollar. In 1985, both were "an island of recession" when industrialized Asian and other developing countries passed through an economic boom. The recession was an outcome of their domestic stabilization policies. Singapore, which developed towards an international financial centre, had to assure the "quality" of its domestic currency in order to overcome the regulatory and fiscal advantages of Asian dollar deposits. The Singapore dollar became misaligned since financial priorities overruled commercial considerations. In contrast, Malaysia's real effective appreciation was the outcome of its huge government expenditures since it fell into the trap of the Dutch disease after the commodity price boom of 1979/80.