At last, the Malaysian Government has eased the controversial capital controls that the Prime Minister, Dr Mahathir Mohamad, imposed last September. Yesterday's announcement by the Finance Minister, Mr Daim Zainuddin, at a press conference closed to the foreign press, comes a week after Dr Mahathir hinted at the easing during the World Economic Forum in Davos. Making it easier for new capital to flow into Malaysia is a small step in the right direction, but the 30 per cent tax on money leaving Malaysia still masks the economic problems that only serious structural reforms can remedy.

The decision to ease capital controls is, of course, in accordance with Dr Mahathir's announcement five months ago that the controls were always a short-term measure, designed to prevent international speculators from attacking Malaysia's currency. By isolating Malaysia's financial system from the rest of the world, he sought to revive his country's recessed economy by cutting interest rates.

To be fair, Dr Mahathir's capital controls have not been as disastrous in the Malaysian context as many economists and financial analysts had predicted last September. After all, the ringgit has stabilised while interest rates have fallen. And the Malaysian stockmarket has boomed while exports in $US terms have strengthened, which in turn has boosted foreign reserves. All of which suggests that Malaysia is finding its feet.

Trouble is, so are Thailand and South Korea, both of which conformed to the letter and spirit of their predominantly free market agreements with the International Monetary Fund in 1997. Indeed, the Thai and South Korean economies, hard-hit casualties of the financial crisis, seem to be improving at a much better rate than Malaysia's. Seoul and Bangkok, unlike Kuala Lumpur, have not frightened away foreign investment.

Capital controls have also solidified the authoritarian power structure in Malaysia where the fortunes of Dr Mahathir's crony capitalist mates and relatives are secure. Another problem is that the controls have failed to boost industrial production. In a country in which such production accounts for one-third of economic growth, this is not an encouraging sign.

Nor is the fact that the draconian measures have not whetted the appetite of foreign investors. In the past, foreign investors played a direct role in transferring new technology and boosting productivity. Indeed, a common message they received when they invested in Malaysia was that the country was more stable than most of its neighbours. Today, however, thanks to Dr Mahathir's obsession to thumb his nose at the international community -- not to mention the controversy over his sacking of deputy Datuk Anwar Ibrahim last September -- such investment is no longer conceivable.

But there is still a major obstacle facing Kuala Lumpur: the process for easing the controls. Dr Mahathir was wrong to embrace capital controls to shelter Malaysia from the global economic turmoil five months ago, but yesterday's announcement to modify these controls into a more flexible "exit tax" on short-term capital is also a wrongheaded and inappropriate response to Malaysia's fiscal problems. Under the exit tax plan, foreign investors will be allowed to withdraw their money before the year-long limit of September 1 only  if they have paid a tax on their capital (30 per cent by March 31; 20 per cent by May 30; 10 per cent by August 31).

While the idea of an exit tax is preferable to the present policy of capital controls, the long-term cost could still isolate Malaysia from foreign investment. Any foreign company would still have limited incentive to put its money into a country that refuses to recognise its fiscal vulnerability.

Dr Mahathir should change course on economic policy. Heeding the wise words of the US Treasury Secretary, Mr Robert Rubin -- who argued last weekend that capital controls were no substitute for serious structural market reforms -- would be a start. "Only nations that take ownership of good policies and consistently follow them will be able to maintain their credibility and the confidence of markets," Mr Rubin said.

It is fitting that Dr Mahathir now appears to recognise that capital controls are not a long-term solution. But neither is his exit tax an appropriate method of dealing with fundamental economic imbalances in Malaysia.

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