IIAS | IIAS Newsletter Online | No.17 | Institutes
Views on the Asian Financial CrisisThe financial crisis in Southeast and East Asia has raised fundamental questions about Asia and the world economy. Was Asia's 'miracle' just a 'mirage'? Is a reassessment of the Bretton Woods approach to liberalization and deregulation now needed? Is there not a need for new institutions to supervise global finance? The European Institute for Asian Studies, a think-tank in Brussels sponsored by the European Union, has been at the cutting edge of the debate and analysis of these questions. Some insights were offered at recent meetings of the Institute in Brussels.
By Willem van der Geest
Contrary to what one may think reading the international press, there is not a great deal of disagreement amongst economic analysts about what has caused the Asian crisis. Dr Ngiam from the National University of Singapore, expressed this with singular clarity. In particular he stressed the appreciation of the real exchange rates, current account deficits, private capital inflows consisting largely of volatile portfolio investment, and imbalances in the private sector as the four causes of the slowdown in export and therewith of GDP growth.
The appreciation of real exchange rates was primarily the result of domestic inflation in Southeast Asia being well above the world average. However, the appreciation of the US dollar and the depreciation of the Japanese yen both taking place against the background of the devaluation of the Chinese yuan in 1994 provided an unstable environment. The 'pegged' currencies of Southeast Asia simply could not cope with these momentous changes.
The current account deficits were partly triggered off by the appreciation of the real exchange rates. They were compensated by foreign capital inflows, which often went to 'unproductive' investments, as real estate, generating little by way of exportable goods, while increasing costs in the economy. An asset price bubble evolved, with companies overvalued and simple apartments priced astronomically. The private capital inflows were mostly portfolio investment and transmitted via the banking sector rather than direct Greenfield investment. The inflows were caused by the perception of a huge growth potential of the Asian economies and an increased globalization of the capital markets.
A large amount of foreign capital went to corporations and banks as short-term US dollar and yen loans that the domestic banks in turn lent to local companies in long-term loans in domestic currencies. Implicit government guarantees led to a sharp deterioration in the quality of banks' loan portfolios and to investment and asset bubbles. In a context of decreasing foreign reserves, these guarantees became increasingly dubious. Without them, overvalued prices collapsed which led to loan defaults and losses for the banks. In short, the overvaluation of domestic currencies and the growing competition on exports and to attract direct investment, especially from China, led to a slowdown in export and GDP growth across Southeast Asia. Hence, at the heart of the crisis is a failure of financial governance of the Southeast and East Asian economies. It is also quite evident now that globalization means that contagion is also global.
Did nobody foresee the Crisis?
On 2 July, 1997, the Thai baht fell seventeen per cent as its peg with the dollar had to be dropped. The fall of the baht sparked off contagious responses engulfing most of the countries of Southeast and East Asia, in particular because Japanese banks panicked and halted lending across the region. Weaknesses in the economies of Thailand, the Philippines, Malaysia, and Indonesia had already been noted by the Asian Development Bank and the OECD. Nevertheless, the extent of the falls in their stock markets and of their exchange rates during the last quarter of 1997 came as a surprise to most analysts - a dream scenario turning into a nightmare. However, it is not fair to say nobody had seen the warning signs. Prof. Brian van Arkadie, speaking at the Institute in May 1997 before the eruption of the problems had noted that 'High levels of investments sustained growth in a year marked by a sharp decrease in export growth. The underlying justification for such investments was that it should lead to continuing export-led growth. It is clear that investors will not sign a blank cheque if export growth is not restored.'
Another leading analyst, Yilmaz Akyuz (UNCTAD, Geneva), had also predicted a slow-down of the South East Asian economies, a particular reason being the 'high degree of short term borrowing which had characterized South Korea and Thailand's expansion.' But, with the benefit of hindsight, we know that at the time these analysts were lone voices assumed to be overly pessimistic. It is now abundantly clear that they were fairly mild in their questioning and warnings and that there was a systemic reluctance to accept any bad news about Asia - from business, governments and international financial institutions alike.
In Dr Ngiam's opinion, the best way to cope with the crisis will be floating exchange rates. In such a context borrowers would have to balance the risk of possible depreciation against the benefit of lower US$ interest rates themselves. Currency boards seem questionable because they are not very flexible and require a strong banking sector plus a very strict monetary policy. Even Hong Kong, notwithstanding its restrictive monetary policy and massive financial reserves, has found it very difficult to cope with speculative attacks on its currency.
A review of several proposals noted that Chile's system of controlling short-term capital offered some opportunities as well as Soros' proposal for an International Credit Insurance Corporation. Controls on capital inflow would slow the investment boom as they would push up domestic interest rates. Another important task for the Asian economies is to strengthen their banking sectors and to improve the regulation and the supervision of the financial system. As short-term remedies, one has to look at the IMF bailout packages, stabilization funds, and regional surveillance. However for the longer term, Asian countries should try to hold more of each other's assets and increase the use of each other's currency for trade within the region - monetary integration such as the Euro may be part of the long-term solution.
A general lesson to be learnt from the crisis appears to be that countries have to build up strong macroeconomic fundamentals (such as current account surplus, high saving rates, and low external debt) and to adopt sound policies (e.g. sound banking supervision, transparency, and a neutral government). To avoid over-reliance on short-term capital inflows, it will be necessary to reduce the risk of capital outflows and the excesses in borrowing and lending. It is essential for a country to maintain a high growth rate and a healthy banking sector, to be able to withstand high interest rates in order to defend its currency against speculative attacks. As the IMF Director General Michel Camdessus said: 'I have never seen a speculative attack, when an economy is strong and government policies are sound.'
Any country with a pegged exchange rate system or a currency board system should be extremely careful to ensure that its economic fundamentals are consistent with the level of the exchange rate that it fixes. If discipline or credibility is lacking, it is better to maintain a more flexible exchange rate regime. By building a deep, liquid, and mature debt market, corporations will be able to borrow long-term in order to reduce maturity mismatches and Asian economies will have a wider range of instruments to invest.
What should be done about Bretton Woods?
Perhaps the most important lesson from the Asian crisis concerns the architecture of the global financial system. Mr Masaya Miyoshi, a former Director General of the Keidanren, the Japanese confederation of industries, said that the recent experiences in East Asia have fostered a growing discussion of functional limits to the ability of the IMF to prevent financial crises in the newly emerging economies. Two reasons are commonly given for this observation. Firstly, it is argued that the IMF arrives to help only after the foreign exchange market of the country in trouble has already collapsed. As such, it is incapable of preventing a financial crisis. Secondly, it is frequently argued that the IMF does not have the requisite flexibility to cope effectively with the unique features of the countries that it is trying to help. The IMF does not investigate the details of the political and economic structures of individual countries and is not well-versed in the special features of the crisis that it is trying to address. It has a single formula and a single programme, which it attempts to prescribe to all.
The time is now ripe to seriously consider how to rise above these limitations of the IMF. This is a shared challenge for all nations across the world. What one has to contend with is the enormous powers of the international financial markets which today are about twenty-six times larger than the size of the trade volume worldwide. What is more, these funds are not bound by the rules of time and space, which govern the movement of goods. In a matter of seconds, these funds can travel around the world. Given these realities, the question is how to prevent financial crises in the small and weak economies of the world, and how to minimize the scale of any crisis that may occur.
For the short term, there is a need to create an international organization charged with the surveillance and regulation of the huge capital movements mounted by international institutional investors. Mr George Soros, the financier and owner of a major hedge fund, proposed this at the World Economic Forum in Davos.
On October 1, the Institute organized a Round Table Discussion in the European Parliament in Brussels to review EU-Asia relations in times of crisis. Sir Leon Brittan, Vice President of the European Commission and the EU chief negotiator in the Uruguay Round of the World Trade Organization, was one of the speakers. He said that the European Union would concentrate on five areas of action: first, maintaining confidence in Europe by pursuing the credible launch of the Euro; second, keeping European markets open to Asian goods and services; third, providing direct assistance and advice in helping Asia to rebuild its financial system; fourth, intensifying our political and economic relations with China and Japan - the two lynchpins in the region and fifth, stimulating co-operation between the EU and the US on co-ordinated interest rate policies, and deepening the commitment to multilateralism, including reform of the IMF and the World Bank.
Share your views
The EIAS cyberforum website displays information about seminars and conferences organized by the Institute. Appositively, the full report of the Round Table on the Asian Crisis was put on the Internet the same day as the meeting took place in Brussels. An exciting and important debate regarding the various presentations made at the Round Table and the diverging views on desirable and adequate international responses is ensuing. Please visit the Institute's Cyberforum website and contribute to this important debate: http:// www.eias.org.
Dr Willem van der Geest is Research Director of the European Institute for Asian Studies.
IIAS | IIAS Newsletter Online | No.17 | Institutes