| Straits Times July 2, 2007
INTERNATIONAL capital markets are the super highways of the global economy. Developing countries should connect themselves to these highways. They should open slipways so funds zipping along on the highways can flow in and out of them freely. Failure to do so would mean consigning themselves to the boondocks. That at any rate was the consensus - the so-called 'Washington consensus' - before July 2 1997, exactly 10 years ago today, when the Asian Financial Crisis began with the Thai baht plunging by 15 per cent against the US dollar. Less than a year later, by May 21 1998, when then-Indonesian president Suharto was forced to step down, it was obvious there was something terribly wrong with the consensus. The Indonesian rupiah had plunged by 86 per cent against the US dollar and Jakarta had exploded in violence - leaving about 1,200 people dead and 5,000 buildings burnt. It was clear that simply connecting developing countries to those super highways was not necessarily a benign short cut to prosperity. What were the lessons of the Asian financial crisis - and has the
world learnt those lessons? Lesson No 1: Connecting to super highways is all well and good, but it would be prudent to have speed bumps. It was not an accident that the two Asian countries least affected by the crisis, China and India, were also the ones that had not liberalised their capital markets. And among the countries that had liberalised, it was not an accident that the country that weathered the storm best, Singapore, was also the one with the best-developed regulatory systems. The absence of speed bumps had led many Asian economies to rely too much on an extraordinarily volatile form of external finance - namely, short-term loans. By the end of 1996, Europeans bank had lent US$318 billion (S$487 billion), and Japanese and American banks, US$260 billion and US$46 billion, respectively, to East Asian countries, much of it in the form of short-term instruments. In the five crisis countries - Indonesia, Malaysia, the Philippines, South Korea and Thailand - foreign borrowing in 1995-1996 reached an annual rate of US$43 billion, with two-thirds having maturity dates of less than a year. According to the International Monetary Fund (IMF), short-term loans to Thailand soared to an astonishing 7-10 per cent of GDP in the three years preceding 1997, while foreign direct investment languished at 1 per cent of GDP. When the crisis hit, these short-term funds disappeared as
rapidly as they had materialised. They had boomed the boom on the
way in and had busted the bust on the way out. There were no speed
bumps to retard their flight in either direction. Lesson No 2: Government matters, regulatory oversight is essential, the rule of law is crucial. Just as one would not connect small towns to super highways without first equipping them with proper traffic systems and enough traffic cops to see to it that drivers obey the rules, it would be foolhardy to connect developing countries to global capital markets without first ensuring they are equipped with proper regulatory systems and incorruptible regulators. Loosely supervised banking systems in the years preceding 1997 had led to an excessive expansion of credit in the crisis countries. This in turn had fuelled over-investment in some sectors. Excessive credit growth had also led to wasteful boondoggles. These fed delusions of grandeur ('the world's tallest building', for example), but did not make sense otherwise. Worse still, excessive credit had fed a real estate bubble, which in turn led to a further expansion of credit, as banks lent more as the value of their collateral rose. The result was that when the bubble burst, banks were dangerously exposed, and their non-performing loans shot up. Poorly supervised banking systems had also allowed banks to
function with inadequate capital or liquid asset ratios. Bank for
International Settlements (BIS) figures for 1997 show that these
ratios were significantly higher than the minimum international
standard only in the Philippines (17 per cent), Hong Kong (18 per
cent) and Singapore (19 per cent). Lesson No 3: Unusual flows of capital - a surge of traffic on super highways - can produce virulent boombust cycles. Governments of emerging economies cannot do much to stem these tides, for the sources of global financial imbalances are not within their direct purview. The Asian crisis was not due solely to the fecklessness of Asians. The fiscal budgets of most Asian economies were either balanced or in surplus, and there was no inflation. The crisis was caused in large part by changes in the pattern of international financial intermediation. Firstly, the remarkable expansion of global liquidity in the 1990s increased competition in the financial services industry worldwide. Financial managers were thus predisposed to seek higher yields through risky investments, to offset declining rates of return on high-quality assets. Secondly, the macroeconomic policies of major economic powers contributed significantly to the expansion of global liquidity. In the United States, for example, declining budget deficits and higher productivity led to low inflation rates - and thus low interest rates. It was not surprising that capital inflows into Asia surged as a result. Asian rates of returns seemed higher. And Asians found it cheaper to borrow in dollar- or yen-denominated instruments rather than in their own local currencies. But such imbalances could not last. The surge of funds led to upward pressures on exchange rates, which in turn worsened trade deficits. And when markets forced currency depreciations, the downward pressures were worsened by the sudden outflow of short-term funds. Greed turned into fear; events took on the classic dimensions of a 'bank run'; markets panicked and overshot; trade credit dried up. Can the same happen again? Yes, of course it can. There was much talk during the crisis of reforming the 'global financial architecture'. Apart from some modest steps, that 'architecture' has remained largely unchanged. Those super highways still lack speed bumps. As for regulatory structures, these have been much improved since 1997. Thanks largely to strong growth, Asian banks are now on a firmer footing. Their capital ratios have improved and their non-performing loans have fallen. General quality of governance, however, has not improved. A recent Asian Development Bank study, reported The Economist, has found that the quality of governance in four of the five crisis countries - Indonesia, Malaysia, the Philippines and Thailand - has in fact deteriorated since 1997 on six measures of governance: accountability, political stability, government effectiveness, regulatory quality, the rule of law and control of corruption. As for those super highways, there is a global surfeit of liquidity again. The cause is different this time - Asian reserves have grown from US$250 billion in 1997 to US$2.5 trillion this year, chiefly due to China. Capital flows to Asian emerging markets are now averaging 6 to 7 per cent of GDPs, the same levels they were prior to the 1997-98 financial crisis. Unlike in the 1990s, though, the current inflow consists mostly of portfolio investment and foreign direct investment, not short-term funds. Still, as Second Finance Minister Tharman Shanmugaratnam, among others, has pointed out, a long period of low interest rates has led to bubbles developing in stock markets, real estate, commodity markets and private equity. And as Prime Minister Lee Hsien Loong has warned, if global financial imbalances are not unwound 'in a coordinated and orderly way...the whole global economy will be affected'. There is no present or future, said the playwright Eugene O'Neill; there is only the past, repeating itself over and over again. That is probably an exaggeration. It would perhaps be more accurate to say that history repeats itself - but with a difference. Prudent governments will try to figure out what that 'difference' might consist of and take precautionary measures. The tragedy is prudent governments and peoples are always in
short supply. One can therefore be certain that history will repeat
itself - somehow.
|