Malaysian government should not view capital control measures as a substitute for the necessary reforms in the long run, said a foreign senior economist today.

Dr Prema Chandra Athukorala said although the measure has proved conducive for speeding up the recovery, it may backfire on the country's economy in future.

"Capital controls were instrumental in achieving economic recovery with minimum disruption and related social cost but it could also be a road to disaster," he warned at a seminar organised by Malaysian Institute of Economic Research (MIER) in Kuala Lumpur, today.

Prema has written numerous books and research papers on trade, development and macro-economic policy, the most recent of which is Crisis and Recovery in Malaysia: The Role of Capital Controls .

The senior fellow with the economics division at the Australian National University said capital control measures could discourage new foreign direct investment (FDI) and portfolio investments which Malaysia had relied on thus far.

In October 1998, the government imposed a series of capital control measures to regulate the capital outflow from this country.

Amid dire expectations that the control measures will send the country's economy into a tailspin, the Finance Ministry had reported an annual growth of 7.5 percent last year in sharp contrast to the -7.4 percent of year 1998.

Locking the stable door

However, Prema refuted criticisms that capital control measures made little difference to the recovery process.

Sceptics had argued that the capital had left the country and that the measures were merely "locking the stable door after the horse was stolen".

Since the financial crisis hit this region in1997, Prime Minister Dr Mahathir Mohamad had stressed repeatedly that it was caused by Western currency speculators and therefore rejected an International Monetary Fund (IMF) loan.

Prema disagreed that Malaysia was an innocent victim of wild capital market.

"There were fundamental weaknesses in the pre-crisis Malaysian economy, such as inadequate reserves and a fragile financial sector, which made it vulnerable to the Thai baht contagion," he said.

He also said the bank and corporate restructuring (by Danaharta and Danamodal) is vital to ensure that Malaysia's economy recovers and becomes better immune to future crises.

Exports still competitive

Prema predicted that the government may adopt a more flexible peg of the ringgit to the US dollar in the near future.

He said the present fixed exchange rate may need a revision now but the government is unlikely to lift the measure.

Most of the measures have been gradually lifted, among others the ban on ringgit trading outside Malaysia and the ruling that portfolio investment must remain in this country for at least a year. However, the peg of ringgit to the US dollar at RM3.80 still stands.

In recent months, many analysts have speculated a re-peg of the ringgit, causing uneasy market sentiments and an unstable performance of the stock exchange.

Despite the weakening of regional currencies, Prime Minister Dr Mahathir Mohamad insisted that the ringgit is not overvalued and a re-peg is not necessary for now as the country is still competitive in exports.