Foreign capital inflows (FCI) are supposed to bring positive effects by augmenting investible funds, domestic savings and foreign exchange earnings, thus closing the savings and foreign exchange gaps. FCI may also have undesirable effects on the domestic savings rate as well as on the recipient’s balance of payments position. This study examines both sets of influences on Malaysia between 1966 and 1996, i.e. before the 1997-98 financial crisis.

Historically, Malaysia has relied heavily on foreign capital, especially foreign direct investment, rather than long-term borrowings. While FCI augmented domestic investment funds to accelerate the growth rate, they had negative influences on the savings rate as well as on the balance of payments. The findings also suggest that domestically raised funds, from savings and self-generated export earnings, are better than external funding. Hence, to sustain economic growth, greater efforts should be directed to better mobilising domestic savings, rather than relying heavily on foreign capital.