The Asain FinacialCrisisThe beginning of the Asian financial crisiscan be traced back to 2 July 1997. That was the day the Thai Governmentannounced a managed float of the Baht and called on the International MonetaryFund (IMF) for ‘technical assistance’. That day the Baht fell around 20per cent against the $US. This became the trigger for the Asian currencycrisis. Within the week the Philippines and Malaysian Governments wereheavily intervening to defend their currencies. While Indonesia intervenedand also allowed the currency to move in a widened trading range a sortof a float but with a floor below which the monetary authority acts todefend the currency against further falls.
By the end of the month therewas a ‘currency meltdown’ during which the Malaysian Prime Minister Mahathirattacked ‘rogue speculators’ and named the notorious speculator and hedgefund manager, George Soros, as being personally responsible for the fallin value of the ringgit. Soon other East Asian economies became involved,Taiwan, Hong Kong, Singapore and others to varying degrees. Stock and propertymarkets were also feeling the pressure though the declines in stock pricestended to show a less volatile but nevertheless downward trend over mostof 1997. By 27 October the crisis had had a world wide impact, on thatday provoking a massive response on Wall Street with the Dow Jones industrialaverage falling by 554.26 or 7.18 per cent, its biggest point fall in history,causing stock exchange officials to suspend trading.Countries such as Thailand, Indonesia,Malaysia and the Philippines have embraced an unusual policy combinationof liberalisation of controls on flows of financial capital on the onehand, and quasi-fixed/ heavily managed exchange rate systems on the other.
These exchange rate systems have been operated largely through linkageswith the United States (US) dollar as their anchor. (1) Such external policymixes are only sustainable in the longer term if there is close harmonisationof economic/ financial policies and conditions with those of the anchorcountry (in this case, the United States). Otherwise, establishing capitalflows will inevitably undermine the exchange rate.Rather than harmonisation, there seemsto have actually been increased economic and financial divergence withthe US, especially in terms of current account deficits, inflation andinterest rates.
These increasing disparities have prompted global (andlocal) financial interests to speculate against the administered exchangerate linkages, i.e. speculative pressure mounted that the monetary authoritiesin these countries would not be able to hold their exchange rate links.In most cases, such financial speculation has been of sufficient magnitudeto actually provoke the collapse of the administered exchange rate links,in the manner of ‘self fulfilling’ prophecies. Defence of the exchangerate through the use of foreign exchange reserves and higher interest ratesproved to be insufficient. (2)The result has been large devaluation’sof the exchange rates of these countries, especially against the US dollar.Large interest rate increases to support the exchange rates at their newlower levels (to prevent wholesale over reaction and collapse in foreignexchange markets and to help contain the strong inflationary forces setin motion); and extra restrictions in fiscal policy. Designed to rise nationalsaving, contain domestic spending and reassure foreign investors and internationalinstitutions such as the International Monetary Fund (IMF).
Figure 1 showsthe magnitude of this devaluation’s.The IMF had arranged conditional financialsupport packages for Thailand and Indonesia. (3) Financial support is providedin exchange for (on condition of) economic policy reforms which, it isargued, will encourage economic recovery and help prevent a recurrenceof the turmoil these countries are now experiencing.
In the case of Australia,help to Thailand has taken the form of a ‘currency swap’ where Australia’sUS dollar assets of up to $1 billion were exchanged for Thai Baht, withan agreement that the reverse exchange would occur at a future point intime.These financial crises have also provokedsubstantial falls in the stock markets of these countries and in otherparts of Asia. (They also contributed to stock market falls around theworld). Foreign investor funds would have been initially withdrawn as exchangerate speculation mounted, and this would have partly taken the form ofa sell off of foreign-owned stock. As well, much higher interest rates(both before and after the currency devaluation’s) encourage flows of fundsout of shares and into loan/ debt-type assets. In turn, higher interestrates and lower exchange rates have substantially increased the rate ofcollapse/ bankruptcy of businesses operating in highly leveraged sectors(especially where loan contracts were written in foreign currency), andthis would have further undermined confidence in the stock markets throughoutAsia. Figure 2 shows the recent stock market price falls in these countries.Overall, reductions in the growth of spending,production and employment in the region are likely to be prominent consequencesof these financial crises.
Both as the direct result of the financial disruptionsand also as the result of consequent contraction in economic policy changesthat have been, and will be, implemented. Loss of general economic andfinancial confidence will reduce the growth in spending and output andthe related tightening of fiscal and monetary policy will reinforce theseeffects. (5) Economic growth in these countries in the next couple of yearswill probably be substantially lower, and countries such as Thailand mayactually tip over into recession, i.e. its absolute level of output mayfall.This downturn is likely to continue untilthe inflationary forces unleashed by the large exchange rate devaluation’shave been tamed.
Foreign exchange markets stabilise at their new lowerprices, and the enhanced international trade competitiveness of these countries(arising largely from the currency devaluation’s) allows them to betterimplement export led growth strategies. Such strategies have traditionallybeen the most successful and effective means of encouraging growth in Asia.Thailand and Indonesia seem to have beenthe worst affected by the economic and financial crisis of the last severalmonths; Malaysia and the Philippines seem to be in somewhat better economicand financial shape, at least compared with Thailand and Indonesia. Singaporeappears in turn to be much better placed than the rest of the region andis likely to have the least economic and financial problems.
This is becauseof the latter’s more advanced economic structure, more sophisticated financialsystem, more flexible exchange rate system and substantial current accountsurpluses (in contrast to the deficits elsewhere in the region). (6)Further Economic and Financial ProblemsEnhanced trade competitiveness will alsohelp these countries better deal with their longer-term problems of repositioningtheir economies in a region where trade competition has intensified andwhere domestic policy directions have often been counter-productive. Competitionfrom China and other developing countries in standardised products thatmake intensive use of low-skilled/ semiskilled labour have reduced exportgrowth in Southeast Asia at the same time as imports of capital goods inthe region have continued to grow strongly. (China has also been much assistedby earlier large exchange rate devaluation’s). These trends have contributedto large and increasing trade and current account deficits in the region,and this seems to have been one of the fundamental reasons why speculatorsand other financial interests began to move against many of the currenciesof Southeast Asia.
While much of the high rates of investmentin these countries have been directed towards efficient and productiveuses, a substantial part has gone into industries unsuited to the economicconditions of these countries. (Such as ‘national car’ projects), or intosectors (such as commercial property) where asset price inflation has distortedinvestment priorities and taken capital away from more efficient uses.Thus, the productivity of such investment has been lower than expectedand has not contributed much to the ability of these countries to fundtheir capital imports.The bursting of asset price inflationbubbles, fuelled and then undermined by speculative activity, has alsocontributed to the economic and financial crisis (especially in countriessuch as Thailand). This in turn has rapidly increased the amount of bad/non-performingloans in the banking systems of these countries (and for foreign lenderssuch as the Japanese banks) and has forced the closure or consolidation/merger of a number of lending institutions. Thus, the crisis has envelopedthe financial systems in the region, and has been accentuated by high ratesof borrowing.
Its resolution will also require structural reform of financialinstitutions. (7) The prudential regulation of financial institutions willprobably also have to be drastically upgraded in these financial systems.Asset price deflation, rising bad debtsand failing banks provide a very dangerous mixture for national economicperformance and may require several years of adjustment before they canbe fully overcome. The case of Japan is both instructive and rather frightening.After rapid Japanese asset price inflation in the 1980s (especially inproperty and shares), the early 1990s there saw asset price crashes, escalatingbad debts (since these were often secured against the now vastly devaluedassets) and banks teetering on collapse. Japan has seen very low economicgrowth in the last six years as it has attempted (ineffectively) to copewith such deep-seated financial problems.
It is now clear that the Japanese financialsector has not been rationalised in the thorough way needed for strongeconomic recovery. Insolvent institutions beyond hope of trading theirway out of trouble have not been closed but have been allowed to lingeron. Bad loans beyond any genuine hope of payment have not been writtenoff against shareholder capital and/or government funds but have remainedhidden in the ‘nether regions’ of institutions’ balance sheets. (8) However,more resolute action by Japanese financial regulators may now be forthcoming.It can only be hoped that the countriesof Southeast Asia fare better but this will require rapid, concerted responsesto the problems confronting them. The policy responses so far announcedhave been reasonably encouraging but much more needs to be done. (9)Affect to New ZealandNew Zealand’s rapidly growing export marketsin Southeast Asia will probably be cut back substantially in the next coupleof years.
This is both because slower growth in the region will reducethe growth in demand for New Zealand exports, and also because the muchlower real (inflation-adjusted) exchange rates of Southeast Asian countrieswill further reduce their imports by favouring domestic production thelatter effect will also favour their exports. Further ‘second round’ adverseeffects on our major trading partners such as Japan and South Korea willbe important to New Zealand.Similarly, New Zealand exports to Asiacan be expected to eventually recover when exports from these SoutheastAsian countries themselves accelerate under the influence of their devaluedexchange rates. The latter export expansion will then help to generatebroader recoveries in economic growth in the region.The strong ‘economic fundamentals’ ofhigh rates of investment, saving, technological transfer, and expansionin education and training throughout Asia all point to the region recoveringto robust economic growth once the current set of problems have been dealtwith. (The crucial proviso is probably that financial sector problems inthe region be effectively resolved). Thus, the medium to longer term prospectsfor New Zealand exports to Asia remain strong so long as our producerscontinue to be competitive in terms of price and quality.
Estimates of reductions in New Zealandeconomic growth resulting from this negative external shock currently rangefrom 0.2 to 1.0 percentage point falls in the next year or two. (13) Initialestimates were at the low end of the range, but more recent forecasts havegenerally been higher, as more adverse information has been received. (Fallinggrowth in New Zealand exports is likely to be reinforced by cuts to investmentand consumption plans).These estimates pose serious problemsfor the New Zealand economy and New Zealand economic policymakers. Mostimportantly, they imply that New Zealand economic recovery in the growthof output and employment, which according to many forecasters already looksto be only quite moderate and gradual, could be substantially nullifiedby the external economic shock emanating from Southeast Asia, and its flow-oneffects on Northeast Asia. (14)Difficult dilemmas for the current settingof New Zealand monetary and fiscal policy are thus created.
For example,disturbances to New Zealand financial markets caused by the crisis alleviateagainst any current relaxation of monetary policy arising from considerationof the need to counter the external economic shock proactively.This is especially so in the case of therecent fall in the New Zealand dollar; this acts to encourage net exportsand helps to counter the external shock (but also adds to domestic inflationarypressures, mainly through higher import prices). However, this devaluationcould prove to be substantially the result of financial market over-reactionand thus could be quite temporary in nature.
Unfortunately, this may notbecome clear until end of 1999, by which time a further reduction in officialinterest rates might be rather late in terms of dampening the externalshock. The enduring currency devaluation may be insufficient in itselfto dampen the external shock substantially.On the other hand, even if monetary policyis relaxed now this will do little to nullify the shock’s effect on NewZealand spending and growth.
This is because of the substantial time lagsinvolved in the impact of such monetary policy changes on the economy.However, such a policy relaxation could help to bolster growth after nextcalendar year, if the effects of the crisis on New Zealand are expectedto last that long.Monetary policymakers also seem to berestrained at the present time by uncertainty about the magnitude and durationof the economic effects of the Asian crisis on New Zealand, and its effectsupon the future course of New Zealand inflation in particular. (15) Thisalso comes at a time when official forecasts already see inflation risingback into its target range, in 2000, of 2-3% underlying inflation. (16)Fiscal/ budgetary policy might also helpto dampen the shock by temporarily moving to a more expansionary/less restrictivestance. It is an attractive policy tool since it has shorter lags of impacton the economy than monetary policy and is less likely to generate exchangerate devaluation (and consequent intensified inflation pressures) thanmonetary policy. This might allow stronger growth while also allowing theinflation target to continue to be met.However, fiscal policy is currently ina contraction stance at the national level, being preoccupied with budgetdeficit reduction to boost levels of national saving and help contain currentaccount deficits.
Indeed, New Zealand’s current account deficit is highlylikely to increase as a result of the negative external shock arising fromAsia, and this mitigates against any move to fiscal policy expansion.Bibliography1.International Monetary Fund, WorldEconomic Outlook, October 1997, Table 16.
2.The Asian Financial Review July1998, pp. 37-39.3.’The IMF and Indonesia: BalefulBonanza’, The Economist, 8 November 1997, p. 95.4.
Commonwealth of Australia, JOURNALNo. 90, 11 August 1997, and No. 116, 1 November 1997.5.
For a critical perspective onsuch policy changes, see: Greg Earl, ‘IMF Solution Follows Wrong Track:Economists’, Australian Financial Review, 19 November 1997, p. 13.6.Economist Intelligence Unit, CountryReport: Singapore, London, 3rd quarter, 1997, pp. 23-26.
7.Simon Davies and John Ridding,’Crisis into Catastrophe?’ Financial Times (London), 31 October 1997, p.15.8.
Max Walsh, ‘Aid Parcels to JapaneseBanks’, The New Zealand Herald, 18 November 1998, pp. 25-26; Max Walsh,’Time for Japan to Save the World’, The New Zealand Herald, 21 November1998, pp. 29-30.9.John McBeth, ‘Big is Best: Indonesia’sRescue Package Draws on the Thai Experience’, Far Eastern Economic Review,13 November 1997, pp. 68-69; Greg Sheridan, ‘The Asian Malaise is Curable’,28 November 1997, p. 13. National Business Review10.
Charles Lee, ‘The Next Domino?’Far Eastern Economic Review, 20 November 1997, pp. 14-16.11.Eric Ellis, ‘Kim Inspects Mouthof IMF Gift Horse’, Australian Financial Review, 24 November 1997, p. 12.12.Teresa Wyszomierski and ChristopherLingle, “Fortress Japan Under Siege’, Australian Financial Review, 19 November1997, p.
20.13.Ian MacFarlane, Forbes MagazineBusiness 1998, pp24-27.14. Forecasts Lowered’, The NewZealand Herald, 20 November 1998, pp.
29-30.15.Reserve Bank of New Zealand,semi-annual Statement on Monetary Policy, November 1997, pp.
2-13.16 A New Revolution by Peter SmithAs published in NZBUSINESS, August 1998, PP 5-12.