Dr Mahathir Mohamad, the Malaysian prime minister, may have been too hasty with his decision on exchange controls, Thanong Khanthong  says.

US President Bill Clinton's pledge to work with Japan, Europe and other nations to revitalise the global economy and push for a drastic cutback of exposure by hedge funds in emerging markets cause the drastic exchange control move by Malaysian Prime Minister Mahathir Mohamad to backfire.

However, at the time Mahathir announced his order for Malaysia to adopt exchange controls two weeks ago, there had not been the slightest evidence to suggest that the superpower countries would take any initiative to stem the global financial turmoil. Thus, he went ahead with the exchange controls to ensure Malaysia's survival, although the move was also highly political.

Mahathir's logic was that since capital was not flowing back into Malaysia, he could at least try, thorugh exchange controls, to protect Malaysia's foreign exchange reserves of US$20 billion from flowing out. By doing so he hoped to shield Malaysia from the volatility of the financial markets. Interest rates had to be kept high to defend the ringgit, but if the exchange controls were put in place, speculation against the ringgit would be impossible, hence making it possible to bring down interest rates to spur domestic economic growth.

Mahathir had a legitimate concern over speculative attacks on the ringgit. A market source from Singapore said he knew that at least one hedge fund had been holding a huge short position against the ringgit at about 15 per cent of Malaysia's gross domestic product. The hedge funds were simply aiming to slam Malaysia into pieces.

Malaysians had also been withdrawing their deposits from local banks and shifting them to Singapore, where interest rates were more attractive. This provided the ringgit supply for the hedge-fund operators to further leverage their speculative attacks. At the same time, local banks, which in the four months leading to the announcement of the exchange controls had lost about US$1.5 billion in deposits, were becoming more vulnerable to failure.

With the turmoils in Russia and Latin America, hedge funds have been drastically cutting back their exposure in emerging markets, sparing them from speculative attacks.

As it now appears with the two important events -- a potentially emerging policy coordination from the economic superpowers to relieve Asia from the crippling debt burden and retreat by the hedge funds -- Malaysia's exchange controls are far less attractive than they initially seemed to be. With the country's economy contracting by about 6 per cent in the first half of this year, Mahathir aims to go for massive printing of new money and rigorous expansion of fiscal spending to spur the country out of recession.

The problem is that if Malaysia really opts for an expansionary fiscal and monetary policy, the ringgit -- pegged at 3.80 to the US dollar -- will certainly crumble. With exchange controls imposed on a relatively open economy like Malaysia, there will be leaks everywhere, particularly in the trade accounts. Exports and importers will under-report or over-report their proceeds to profit from the foreign exchange gains.

But there is a chance that Malaysia can recover if the stimulus plan works. Since Malaysia's external debts amount to about US$20 billion, it has much less debt burden than Thailand when implementing domestic economic reform. Once Mahathir regains his grip on his political party next year, and if there happens to be the slightest sign of economic recovery, he can proceed to abolish exchange controls and declare victory.