THE ASIAN CRISIS: LESSONS AND RESPONSES
Introduction: Asia Recovers
I want to thank CARI for giving me this opportunity to share my thoughts on the Asian financial crisis.
It is now two years since the financial crisis erupted in Thailand. Fortunately, the economic outlook for Asian economies is beginning to look brighter. Low global interest rates have helped. So have the buoyant US economy and the gravity-defying Dow Jones index.
The Japanese yen has steadied while the Japanese economy shows signs of stabilising. Output in the four crisis-hit economies of South Korea, Thailand, Malaysia, and Indonesia has risen. Their current account surpluses and foreign exchange reserves have grown. Net capital inflows have recently turned positive in South Korea, Thailand and Malaysia.
Forecasts for growth in 1999 for the crisis-economies have been revised upwards, ranging from zero to 4 percent. This is a sharp improvement from the contractions of 2.8% to 13.7% seen in 1998. Consumption and export growth are supporting the recovery, while private investment has only improved marginally.
Recovering at Different Rates
There are, however, differences between countries in the speed of recovery. South Korea leads, with Malaysia and Thailand right behind, while Indonesia lags.
South Korea and Thailand, with IMF guidance, have undertaken the most comprehensive reforms. They have made substantial progress in financial and corporate restructuring. They have also been the most aggressive in liberalising foreign ownership rules and encouraging foreign participation in the financial sectors. As a result, both South Korea and Thailand have regained investor confidence and have attracted significant capital inflows.
Malaysia refused to call in the IMF. Instead, it self-medicated through capital controls. This unorthodox method also appears to have worked. Malaysia has adopted a softer approach in its banking reform, choosing to merge bad banks with strong banks rather than shut them down. Controls on portfolio capital have been relaxed. A graduated foreign capital gains tax has replaced quantitative restrictions on capital withdrawals. The government welcomes foreign investment, but such interests are evaluated on a case-by-case basis for its strategic sectors. Its fixed exchange rate is competitive at current level.
Indonesia's recovery is the most precarious because the country is still in the grips of political transition. Indonesians and foreign investors alike are anxious over the country's political stability after the June 7 election. Nevertheless, Indonesia has done better than many people expected. The Indonesian currency, rupiah, has stabilised and inflation has not run away. Indonesia is, however, the slowest in addressing banking and corporate reforms.
Singapore was also affected by the spillover effects of the financial crisis. Our economy still grew by 1.5 percent last year but this was a sharp decline from the 8.0 percent in 1997. We expect positive growth again this year, possibly reaching 2 percent.
Singapore countered the crisis by cutting taxes, rentals, wages and other costs to improve our competitiveness. We are liberalizing Singapore's already open financial sector further, to consolidate our status as the region's leading financial centre.
Lessons and Responses
I believe the Asian crisis holds lessons which are universal. The rapid spread of the Asian crisis to Russia and Brazil shows that this is a global virus, not purely an Asian strain.
Responses By Individual Governments
Let me now deal with the national responses required of governments. First, governments must strengthen their financial system. They should improve their supervision and regulation of banks. Government-directed lending must be curbed. Lending operations must be based on market principles. Weak banks should be closed or restructured.
Second, governments must adopt and enforce internationally accepted laws, proper disclosure and accounting standards, and good corporate governance practices.
Third, countries should refrain from over-investment, particularly in massive capital projects, office buildings and other real estate development. Such over-investment, which leads to huge excess capacity and creates white elephants, is like consumption. If financed by external borrowings, these investments will be a drain on the balance of payments.
Fourth, governments should encourage long-term foreign direct investment (FDI) rather than short-term capital flows. FDI is more stable and less susceptible to sudden withdrawals. At the very least, governments must guard against the private sector financing long-term projects with short-term capital flows.
Fifth, countries that have not opened their capital accounts should do so only cautiously. The pace of liberalisation must match the strength of the banking system and the pace of banking reforms. Unless the banking system is strong and resilient to volatile short-term capital flows, it is better not to open the capital account prematurely.
Sixth, economies should develop their domestic bond markets to reduce their reliance on the banking system. Bonds tend to have longer maturity than bank credits, which are more vulnerable to a credit crunch.
Multilateral Responses
These are responses required of individual countries. In addition, multilateral responses are also needed.
Today, we live in a global village. The Asian crisis drove home dramatically the reality of inter-dependence in a global economy.
When the crisis first broke in Thailand, no one anticipated how it would reverberate across continents and oceans.
For a moment, after Russia defaulted on its domestic debts and Brazil's financial situation became very wobbly, there was a strong fear of a global recession.
Fortunately, a concerted effort by the G7 and multilateral financial institutions managed to restore calm to financial markets. But the G7 was clearly only willing to work within the existing international framework. They were very cautious about moving beyond it. Yet it is precisely this framework which needs to be looked at. This framework was not designed for a world in which capital sweeps across political boundaries at electronic speed.
Changing the International Financial System
A number of ideas designed to ultimately create a new international financial architecture have been mooted. These are still being discussed.
The major economies seem reluctant to do a revamp of the existing international financial system. They have good reasons because the system has worked well so far, despite the latest financial crisis. Also, the international financial system is not just about finance. The system reflects and sustains a particular configuration of global power. It is only natural that countries which believe that they have benefitted from the status quo do not want it to change.
But financial crises are likely to recur as globalization intensifies. Many developing countries do not yet have the capacity, efficiency and resilience to deal with huge and rapid movements of money. Even efficient but small economies can be damaged by the speculative and volatile flows of large sums of money.
In seeking to prevent another financial crisis, the major economies have demanded that the affected Asian economies put their houses in order. There should be prudent macro-economic policies. A proper system of financial regulation and supervision, with internationally recognised standards, must be in place.
But these domestic changes are painful and politically difficult. They will be more acceptable politically if they are made in the context of changes to the international economic and financial system. Then domestic and international reforms are seen to proceed in tandem and to reinforce one another.
Turning Away From Free Markets
The challenge of change goes beyond the financial architecture. There is also the intellectual and political dimension. The Asian crisis has focussed attention on the risks of globalization. Free markets have created unprecedented prosperity. But not every economy can be opened overnight. Even if that is possible, the economy cannot compete successfully in the free market system.
It is precisely because East Asian economies were so successful for so long that any turning away by them from the free market system would have a powerful demonstration effect. If they do, countries that did not open up will feel vindicated. Both the East Asian economies that tried orthodox IMF measures and those that resorted to unorthodox capital controls are seen to be doing equally well. The result is a growing temptation to resist the IMF solutions in future.
In fact, respected economists in the US and Europe are debating issues such as loss of macro-economic control and undue influence of foreigners over national policies. Such debates did not arise only because of the Asian financial crisis. They were prominent in the last two US presidential elections. It is also a feature of the European political scene.
Protectionism is not dead. The danger is always there. Should there be a widespread retreat from free markets, it will damage long-term growth prospects for everyone.
Undermining Global Peace and Stability
The impact will not just be economic. The prosperity that open markets create is also the foundation of global peace and stability. History teaches us that economic rivalries almost invariably have political and military consequences if not confined within an agreed framework.
Historical experiences have shown that even a global recession can be dealt with or ridden out. But if the usefulness of an open global economy is questioned and challenged, then we will have a more intractable problem. If the accepted intellectual and political paradigm in which economic solutions are sought is abandoned, the risk to global peace and stability will be substantial.
The post Cold War order seems to have resulted in a unipolar world. Many countries are uncomfortable with this because they see a latent instability. A return to global tensions cannot be ruled out if faith in a free-market global economy falters. To ensure that this does not happen must be a matter of design and not left to chance.
This is a subtle challenge. Cold War divisions were clear. Post Cold War distinctions between friends, friendly critics and honest disagreements are less sharply defined. Persuading those disoriented by globalization and technological changes will require skilful diplomacy and artful balance of the competing interests. Pushing an ideological agenda is not the best way to reach consensus on the reform needed for a sound international economic and financial system.
Some commentators view the Asian financial crisis as proof that western models of capitalism and democratic values are superior to Asian systems. I do not wish to stir up another "clash of civilisations" debate. I just want to make the point that any smugness will only feed the anti-western reflexes that lurk below the surface.
For example, in early May, some western countries sparked a confrontation with China and India at a recent Asian Development Bank (ADB) meeting. They had demanded that ADB accept western development mores and make its lending conditional upon acceptance of such standards.
Overall, however, there is a better understanding that while there is no alternative to the free market, there is room to improve its workings through closer monitoring and response. At the minimum, such monitoring could give an early warning of looming dangers. The IMF and the World Bank have also begun a process of self-examination and renewal. This is healthy. The new Financial Stability Forum to discuss global financial issues and vulnerabilities is another step in the right direction.
Strengthening Links and Cooperation
To be sure, a new international financial architecture will not be erected overnight. It is an evolutionary process that will take many years. Progress will be uneven. It will be contingent on the development of a domestic consensus within the major economies and dialogue and compromise within the G7 and between the G7 and other economies.
In the meantime, supplementary non-economic structures can be designed to bring about a stable international order. Global markets do not of themselves create cohesion among nations. One of the features of the post Cold War order is the resurgence of ethnic conflicts and political fragmentation as groups try to preserve their sense of tribal identity. A sense of global cohesiveness, of interconnections between regions, must be encouraged.
Several such multilateral structures are already in place. APEC has linked both shores of the Pacific for a decade. Trans-Atlantic links between Europe and North America are even better established. North and South America have the Organization of American States (OAS) and deeper interdependencies will be built by the Free Trade Area of the Americas (FTAA). Four years ago, I drew attention to the need to bridge the gap between Asia and Europe. The first Asia-Europe meeting (ASEM) was held in Bangkok the following year. Since then, ASEM members have met at different levels every year.
The missing link is now between Asia and Latin America. In a global economy, such a gap inhibits relations. It is for this reason that I proposed the formation of an East Asia-Latin America Forum (EALAF) last year.
Recent developments have clearly shown how closely financial markets have bound Asia and Latin America, making geographical distance irrelevant. But some of the psychological barriers of a different era still linger. I conceived the EALAF as a multi-dimensional dialogue. It was to help break down barriers and encourage the evolution of more concrete links. This proposal has been canvassed. I am happy to say that support for the EALAF in both Asia and Latin America has been very encouraging. It convinces me that such a forum is long overdue.
Singapore will host a meeting of senior officials from East Asia and Latin America this year to advance the Forum. Our wish is to catalyse this obvious need for more cooperation and interactions between two very important regions of the world into a concrete form.
Hopefully, over time, the EALAF will lead to increased trade between Asia and Latin America. East Asia exports only 0.2 percent of its total exports to Argentina, an amazingly small amount. Its exports to Argentina, Brazil, Chile and Mexico combined only adds up to 1.7 percent of its total exports. Asia, in turn, absorbs only slightly above 4 percent of Latin American exports. In the last two decades, the relative participation of Latin American in the Asian market increased by only 0.5 percent. There is clearly a vast empty space to be filled.
Conclusion
Technological improvements in transport and communications have reduced the barriers created by distance and time zones. The scope for trade between geographically separate countries has never been greater. We have not yet fully taken advantage of the new possibilities. Diversifying trading markets can help cushion volatility in the economic fortunes of specific trade partners, reducing reliance on any one country or region. This will make for greater overall stability.
Let me conclude by conceding that I have raised far more questions than answers. I do not claim to have answers to the issues that I have highlighted. But until we recognise the problems, we will not even begin to overcome them.
The Asian financial crisis has thrown up important lessons for all of us in the global economy. The sooner we respond substantively, the more likely we are going to be able to deal with another similar crisis, in Asia or anywhere else in this global village.
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