Thanong Khanthong looks at the possibility of Malaysia lifting its capital controls soon.

MALAYSIA is increasingly being isolated over its capital-control policy, with regional leaders believing that it will soon have to scrap the draconian regulations to prevent the country, already facing a looming political crisis, from experiencing a meltdown.

Thai officials, who will participate in the upcoming Asia-Pacific Economic Cooperation summit next week, said the impression they had got from the regional leaders was that Malaysia's capital-control policy was a big mistake, for it had created uncertainty and also done nothing to change the fundamentals of the Malaysian economy.

''There is a possibility that Dr Mahathir [Mohamad, the Malaysian prime minister] will have to jump off the tiger's back soon,'' one official said.

Although Japanese officials said, with a diplomatic overtone, that Malaysia's capital controls were not completely illogical, they privately believed that the controls were no answer to helping the country climb out of the economic crisis. Singapore is also upset with Malaysia's capital controls, saying privately that these will not work.

Apart from a political reason to oust Anwar Ibrahim, the former deputy prime minister and finance minister, Mahathir's decision to impose capital controls since Sept 1 this year also grew out of fear of speculative attacks on the ringgit. Before the capital controls were imposed, financial sources said, Malaysia was appalled to find out that there was as much as US$10 billion in offshore ringgit, held largely by Malaysian corporates in Singapore.

Malaysia is facing the same problem as Indonesia: its ethnic Chinese moved money out of the country as the financial crisis hit. Most of the money was deposited in Singapore, where the offshore interest rates were higher than the onshore rates. There were fears that the $10 billion in offshore ringgit, which had largely not been converted into other hard currencies, would be used as a stockpile to attack the currency.

The situation was similar to the one Thailand witnessed before the economic crisis. Liberalisation of Thailand's capital account since the early 1990s had led to a build-up of a huge offshore baht trading in Singapore. A Bank of Thailand official said a Singaporean study had found that offshore baht trading in Singapore had hit a daily volume of more than US$10 billion, more than the onshore trading of US$2-3 billion.

The offshore baht was tapped by the hedge funds and currency speculators, who relied on it to further speculate against the Thai currency by selling it short.

Thai officials said Mahathir's move to tackle the offshore ringgit at source was understandable but he should not have gone further by imposing other controls such as prohibiting foreign investors from remitting their money from selling local stocks. Moreover, there is no clear evidence that Malaysia has used the opportunity to seriously reform the economy, because all the countries in the region are not only facing a cyclical downturn but also structural problems.

Thailand has gone ahead of its crisis-hit neighbours in instituting economic reforms, and it is likely to be the first country to benefit from a return of capital inflow. It has been able to bring down interest rates, from 24.5 per cent in January this year to the present level of 4.5 per cent, stabilise the currency, bring inflation under control and institute wide-ranging reforms, including measures to restructure the banking system. Thailand's interest rate is now lower than Malaysia's.