An UNCTAD View
The Financial Crisis in East
Asia
This is perhaps the most serious
financial crisis since the breakdown of the Bretton Woods
system in the early 1970s, in terms of both its scope and
its effects. Its impact is much more global than that of
the financial crises we have seen in the past two or
three decades, including those in Latin America. Today,
global financial integration is much more pervasive, and
the East Asian countries have a much higher share of
world trade and production. For the first time, a
financial crisis in the South has had a profound impact
on capital markets in the North. It is also expected to
cause a significant drop in global growth.
What are the roots of the crisis?
Although different influences have been at play
in different countries in the region, a common feature is
that the crisis has its origin in the private sector and
has taken the form of a major market failure. One can
describe it either as excessive borrowing abroad by the
private sector, or as excessive lending by international
financial markets.
In any case, as pointed out by Alan Greenspan,
Chairman of the US Federal Reserve Board, it is clear
that more investment monies flowed into these economies
than could be profitably employed at modest risk. Hence,
there is a failure of free financial markets to produce
an optimal global allocation of capital. There was a
similar episode in the Southern Cone of Latin America in
the late 1970s and early 1980s. The private sector was
allowed unrestricted access to external finance in the
belief that, for private firms, the difference between
domestic and external debt was not significant, since
they were expected to assess carefully the costs and
benefits on which their survival depended. The result was
private over borrowing and a debt crisis, necessitating
subsidized debt servicing via preferential exchange rates
and eventually the nationalization of private external
debt and a de facto socialization of the banking system.
What is the role of governments in the crisis?
Perhaps one could fault governments for failing
to prevent market failure. But what they might have done
is a complex question. According to one view, the problem
is not liberalization as such but the absence of
effective prudential regulation and supervision of the
banking system. There can be little doubt that prudential
limits on bank lending, capital adequacy requirements and
currency matching conditions for assets and liabilities
that are properly enforced can help prevent excessive
risk-taking by banks, thus containing the adverse effects
of widespread defaults. However, it is not easy to
prevent domestic credit expansion when capital inflows
lead to a rapid liquidity expansion. As long as capital
inflows and liquidity expansion remain unchecked, lending
will eventually spill over from the financing of safe and
productive investments to risky and speculative assets.
This in turn raises the collateral values of the assets
financed by such lending, thereby encouraging belief in
the appropriateness of these values. Such a process was
experienced not only in Asia but also in Mexico in the
early 1990s and in the US in the 1980s.
In this process, as the investment boom continues,
growth remains strong and the external balance
deteriorates. But eventually loans become non-performing
and banks are weakened. Thus, deterioration of the
external balance and weakening of the financial sector
are two sides of the same process of excessive capital
inflows. The basic problem is the absence of instruments
to restrict capital inflows and contain their impact on
macro economic and monetary conditions. It is difficult
to check this process solely through prudential banking
regulations. In any case, such regulations cannot prevent
excessive non-bank private borrowing abroad. This is not
always appreciated, even though in East Asia an important
part of private borrowing from international banks is by
non-bank firms: one-third in the Republic of Korea,
around 60 per cent in Malaysia and Thailand, and even
more in Indonesia. Nor do international financial markets
impose the right kind of discipline over private
borrowers in developing countries. All too often they
manifest herd-like, pro-cyclical behaviour in both giving
and cutting back loans. The global reverberations of this
boom-bust character of finance are further enhanced by
greater integration of markets and increased mobility of
capital. This is why governments need to be prepared to
use a broad range of policy instruments, including but
not restricted to prudential regulations.
What is the role of external factors?
Quite apart from the overreaction of financial
markets in lending and calling back loans, two external
factors seem to have played a major role. First, the
appreciation of the dollar led to the appreciation of the
currencies in the region, as they were pegged to the
dollar. The regional division of labour in East Asia (in
the context of the so-called flying geese process)
presupposes a stable pattern of exchange rates, and this
may be an important reason why individual countries were
not willing to devalue vis-a-vis the dollar and hence
vis-a-vis each other.
Second, a glut has emerged in markets for a number of
manufactures produced in the region, such as electronics,
leading to sharp declines in their prices. Attention has
focused on over-investment in some areas, but such
over-investment also reflects sluggish global demand - a
phenomenon that UNCTAD has been constantly warning about
in recent years in opposition to the widespread
complacency regarding growth in the world economy. In any
case, less than 10 years ago there was much talk about a
shortage of savings in the global economy. Now, however,
the refrain has changed, and the new culprit is excessive
global investment at a time when unemployment in the
North is on the rise and poverty in the South remains
unabated.
Could the crisis have been anticipated?
Financial instability has become a systemic
feature of the global economy and has been occurring with
considerable frequency since the beginning of the past
decade. Accordingly, such instability is a recurring
theme of our annual Trade and Development Report (TDR).
In 1990 we argued that the hands-off approach to finance
was putting serious strains on international
debtor-creditor relations and on the international
payments and exchange rate arrangements. We warned that
although disruptions in financial markets had until then
been contained, 'as long as the international monetary
and financial system remained structurally vulnerable,
the potential for an extremely costly crisis would
remain'. Since then the world economy has witnessed
further bouts of financial instability, including debt
deflation in some major industrial countries, a currency
crisis in Europe, a financial crisis in Latin America,
and now the East Asian crisis. In the early 1990s, the
UNCTAD secretariat was among the minority of forecasters
that persistently expressed doubts as to the
sustainability of Mexico's external financial position.
On South East Asia, the TDR 1996 sounded a clear warning,
noting that growth in the region relied excessively on
foreign resources, and that these economies could suffer
from loss of competitiveness and were highly vulnerable
to interruptions of capital inflows. We shall return to
this theme in our TDR 1998, to be released in September,
with a detailed analysis of the causes and effects of the
crisis, the policy response and its global implications,
and actions needed at the national and global levels to
avert such crises.
How should the international policy response
be assessed?
Handling a crisis of this kind poses a complex
policy challenge. Indeed, a major disagreement has
emerged among mainstream economists over the
appropriateness of the standard policy package
comprising, inter alia, fiscal austerity and tight money.
A main concern is that these could drive the economies
into deep recession. Confidence and stability in currency
markets have so far proved difficult to restore. A way
still has to be found to prevent the undermining of a
positive response to recent shifts in exchange rates by
the effects of high interest rates on the banking sectors
and companies' capacity to meet their financial
obligations. The credit crunch seems to be so deep that,
despite favourable exchange rates, firms are unable to
export, as their access to trade credit has been
curtailed. Thus, an important part of the improvement in
the current account balances of the Republic of Korean
and Thailand so far seems to have been due to import cuts
rather than export expansion. Over a longer horizon,
however, increased exports should account for a major
share of the required external adjustment.
What is to be done?
A positive adjustment to the crisis should
include a number of components. First, loans should be
rolled over and rescheduled to allow the countries
concerned to service them from future export earnings and
not through increased external borrowing at penalizing
rates. This should be combined with the provision of
external liquidity to support the exchange rate and
enable a more accommodating monetary policy to be pursued
while restructuring of the financial sector is under way.
In this respect, there are important lessons to be
learned from the policy response of the US Federal
Researce Board to the debt deflation of the early 1990s -
a response which played a major role in bringing about
one of the country's longest recoveries following one of
its deepest post-war recessions. Finally, it is necessary
to raise global growth to provide markets in which Asian
countries can earn the foreign exchange needed to pay off
their foreign currency debt. Thus, an important component
of the solution is to remove the deflationary bias in the
macroeconomic policies in those areas of the developed
world running large trade surpluses. Until the surplus
countries initiate domestic demand-led growth and reduce
their external surpluses, the global economy will
continue to be vulnerable to the risk of financial
instability and recession, and the crisis in South East
Asia will continue to contribute to the decline in global
growth and to trade frictions.
Will the Asian financial crisis dampen world
economic growth?
On the eve of the crisis, there was already a
major imbalance in the world economy: virtually all major
industrial countries except the US were expecting faster
growth on the basis of increased exports. The surplus
countries (Europe and Japan) were employing restrictive
fiscal policies and attempting to increase their export
surpluses to preserve growth. With the notable exceptions
of China and Taiwan Province of China, the fast-growing
economies of East Asia were major contributors to global
demand, running large deficits financed by private
capital inflows.
Perhaps the single positive contribution of the East
Asian crisis is that it has halted the tendency towards
monetary restriction and higher interest rates in the US
and Europe, and hence prevented the global deflationary
gap from deepening further. It has eased the concern of
central bankers over the risk of inflation, leading Alan
Greenspan, Chairman of the US Federal Reserve Board, to
talk of deflation. Japan has also been spurred to take
steps to reflate its economy, while alleviating the drag
on activity resulting from the weakness of its banking
sector. However, the crisis in East Asia will still mean
slower growth of global demand and output. This is
recognized by the IMF and by the OECD, which have revised
(downward) their growth estimates.
Will the Asian crisis affect the launching of the
European Monetary Union (EMU)?
The East Asian crisis may pose an additional challenge
for the EMU. It has been pointed out by several observers
that desynchronization of cycles among the participating
countries, together with restrictions on individual
countries' budgetary policies and the absence of a strong
fiscal centre a la US, can cause frictions regarding
common interest rate and exchange rate policies,
particularly since initial conditions with respect to
external payments and labour markets differ widely. Such
frictions are also possible when the EMU community
receives asymmetric external shocks which require
different monetary policy response for the different
participants. In that respect, the coincidence of the
Asian crisis with the launching of the EMU could be a
major cause for concern.
How will the crisis affect other developing
regions?
There are three channels of influence. First,
contagion and capital flight: we have not seen much of it
so far, but it cannot be ruled out. Second, the crisis is
expected to influence policies in other developing
countries with large external deficits. They may be
inclined to cut their imports and external deficits to
reduce their vulnerability to an interruption of capital
flows. This happened after the Mexican crisis when, for
instance, Brazil tried to reduce its external deficits
despite continuing capital inflows. This would certainly
be deflationary for the countries concerned and for the
global economy. Finally, other developing regions will be
adversely affected by changes in exchange rates. Given
their sensitivity to inflationary pressures, Latin
American and Central and Eastern European countries may
not be able to adjust their exchange rates to restore
their competitiveness in world markets.
Is there a danger of competitive devaluations?
This was a major concern for the architects of
the Bretton Woods system, and that concern increased
after the collapse of the system in the early 1970s.
However, it receded when inflation became a major
problem. Because of the implications for price stability,
countries were unwilling to use their exchange rates to
export unemployment. The threat of competitive
devaluations is much more serious now than at any time
since then, because the danger now is deflation, not
inflation, as we already pointed out in TDR 1995. There
were some signs of it during the currency crisis in
Europe a few years ago when some countries pulled out of
the EMS and devalued to import some demand. If the crisis
deepens global deflation, there may be more action of
this kind. This is why it is important to have
expansionary policies in the countries with external
surpluses.
Is this a situation which might tempt
industrialized countries to protect their markets?
UNCTAD has always maintained that international monetary
and financial instability is the principal enemy of free
trade. Certainly, increased trade imbalances and reduced
growth will provide humus to protectionist sentiments and
such pressures may intensify, as much in countries with
slow growth and high unemployment as in those with large
trade deficits. Moreover, these pressures could succeed
in attaining their goals if surplus countries do not
pursue expansionary macroeconomic policies as developing
countries start cutting their trade deficits.
Is the crisis a setback for the process of
globalization.
There are some positive sides to it. It has long
been maintained by many observers that it is not possible
to speak of a 'system' of international money and finance
in the way we refer to the trading system. There is
indeed a vacuum regarding global governance of finance.
The East Asian financial crisis has increased awareness
of the need for greater management of international money
and finance so as to prevent the recurrence of similar
crises. Indeed, the international community will
undoubtedly be forced to think about whether or not
existing arrangements regarding international payments
and finance are compatible with stability and growth.
What are the issues?
The main problem is that, even though financial
markets are much more integrated than product markets and
capital is much more mobile than other factors of
production, there is no global governance of
international financial transactions analogous to that
found in the area of trade. Moreover, the present
international arrangements are not only inadequate but
also asymmetrical; they are designed to discipline
borrowers rather than regulate lenders. This stands in
sharp contrast with the way national financial systems
are designed. Moreover, international arrangements are
designed to manage rather than to prevent crises. And the
measures to starve off international banking crises tend
to be at the expense of living standards, stability and
development in debtor developing countries.
Second, with greater financial integration, the global
impact of interest-and exchange-rate policies has become
much more important. This is true not only for the major
industrial countries but also for many developing
countries where policies are seem to have had serious
regional or global repercussions. There is no effective
surveillance in these areas and there is no way of
preventing 'beggar thy neighbour' policies affecting key
monetary and financial variables.
Moreover, there is no mechanism for dispute settlement
regarding macroeconomic and financial policies, such as
exists for trade policies. If a country puts up its
tariffs on imports of cars from its neighbour, the latter
can go to the WTO and complain, but no forum exists where
a country can make analogous representations about a rise
in a major country's interest rates and a consequent
increase in its debt burden, or about a devaluation which
has the same effect on its exports as higher tariffs.
Third, there are no effective, rule-based and
adequately funded arrangements for the provision of
liquidity by an international lender of last resort.
Finally, there is a need for a system of orderly
work-outs based on rules and bankruptcy procedures
governing international debtor creditor relations.
Several proposals to fill these gaps are worth
considering. The international community needs to turn
its attention to these issues as part of efforts to
improve the governance of international finance.
- South Letter
Point of View
‘War’
or ‘Peace’
by
Citizen-D
A multi-faceted campaign for so-called
‘peace’ has been launched by diverse
organisations including the government. On the one hand,
government laments that young people are no longer
enlisting in the forces. On the other, the government
itself (ably assisted by the NGO lobby) conducts a
vigorous anti-war effort through the ‘Sudu
Nelum’ and other organisations. This ambiguity is
obvious to those who watch Rupavahini. There are those
colourful advertisements exhorting our youth to join the
forces and defend one's country. It stirs up a dormant
nationalism in the young mind. Rambo like commandos are
shown doing spine-chilling manoeuvres in jungles and
swamps, in trees and astride trail-bikes. Which young man
can resist such bravado? So, they collect their
certificates, pack a bag and are ready to be first in the
enlistment queue, come dawn.
Alas, the next message on the
screen is a "Sudu Nelum" damp squib. A little
girl with a pottu cries for her mother while bombs
explode in the background. Ambulance sirens scream while
refugees stare forlornly into space in a refugee camp.
The message is loud and clear. Do not join this
"dirty war" ("kuriru yuddhya"), a war
that costs thousands of lives and billions of rupees. Do
you want ‘war’ or ‘Peace’? Comes the
final question. The confused young man, who moments ago
packed his bag to enlist, unpacks and goes to bed. The
‘National Peace Council’ has won the day. A few
more enlistments have been prevented. The ‘peace
-mongers’ have achieved what their foreign masters
want them to achieve and they are amply rewarded. More
dollars flow into their bank accounts while the Tiger
celebrates the event. The Army Commander forlornly shakes
his head and laments. No one is joining up and 15,000
have deserted, he cries. How on earth can I win this war?
he says. He does have a problem. But it is really with
the ambiguity of his masters. One can hardly blame our
youth.
Strategy
The ‘peace’ strategy is quite sinister and
is well financed by the World Tamil Movement and the
World Council of Churches. Their local lackeys are well
paid, each group given a special task to perform. Some
conduct seminars on ‘peace’. Others take VIPs
abroad, give them 5-star treatment and get them to sign
‘peace treaties’. Yet others write weekly
columns, painfully playing the ‘peace’ record
over and over. These ‘conflict’ resolutionists
bogus attempts at objectivity is painfully obvious.
There are the university dons who
have launched themselves on a pseudo-interlectual voyage
of discovery. They have suddenly discovered that there
are no people called the Sinhalese. This is Dravidian
land and was never a unitary state, the
‘package-historians’ tell us. Some even trudge
to Ibbankatuwa and Ambalantota looking for Dravidian
artefacts and burial sites under a broiling hot sun.
The more vociferous types do an
occasional picketing campaign opposite Fort station.
There, after a few shots of good whiskey at their
favourite ‘watering hole’, they ‘lightly
refract’ under the watchful eyes of those trousered
‘Women of Peace’. Then, there are those
pseudo-intellectuals who write paper after research
paper. One need not read between the lines to realise
these ‘papers’ are nothing but toilet paper.
While all these antics progress,
the Hindu Council, AGOTIC, the TULF, Thondaman, the
redoubtable Kumar P., not to mention the sundry
‘peaceful’ terrorists (EPRLF, EPDP, etc.) are
all busy issuing their own statements from Colombo 7.
Some are quite direct, like those demands for the north
and east to be handed over to Prabakaran on a platter for
five years. The President, not to be outdone, has upped
this to ten years.
Recently, I watched the TNL TV
programme for young people called YA-TV. On Wednesday,
they have introduced a so-called ‘peace’
programme called ‘Sathi’, obviously another
dubious ‘Piece-mongering’ effort. In one
programme, their well known ‘piece’ boys and
girls appeared, playing the same old ‘peace’
(piece) record. One is mystified as to how these
‘piece-mongers’ (who aim to dismember our
country into pieces — it being their
‘solution’ to a so-called ‘ethnic’
conflict) spend so much money on such trashy programmes.
A once interesting YA-TV programme — A view to
Tel"" has now been proselytized and bastardized
by the ‘piece’ dollar.
Subtlety
In all these programmes and campaigns, the subtle
message is quite clear. The government and the Sinhalese
are the prime culprits. The Tamils have a genuine
grievance, viz., their ‘aspiration’ for their
‘homeland’. This aspiration is genuine and the
hard-line Sinhalese with the ‘Mahawamsa
mentality’ would recognize this genuine aspiration
of the Tamils and hand over the north and east and if
necessary, the entire island (after all this was
originally Dravida land) to the Tamils, whose sole leader
today is Prabakaran. If we hand over one-third of the
country peacefully, an already divided country will
unite. If not, beware folks, the country will
disintegrate. Prabakaran will, in any case win the war.
So why not give in right now and avoid the dire
consequences of Prabakaran's wrath.
According to these ‘conflict
resolu-tionists’, so-called ‘piece’ is
worth any price. It is worth sacrificing even your
country or your birthright. But of course, one must keep
in mind that these traitors are well paid and well bribed
to say what they say and do what they do. Some are
prepared to sell their own mothers for the ‘Yankee
dollah’.
Ploy
Another ploy of these ‘piece-mongers’ is to
say that only the poor boys are enlisting (and dying),
while the rich boys stay at home. Unfortunately, the
President too, expressed the same view and threatened to
conscript the rich boys. We hope she will start with
those supper-rich in Colombo International schools. But
then, who were Kobbekaduwa, Wimalaratne and those
hundreds of Airforce pilots, Naval offices and other
officers who bravely died in action. Weren't they from
the upper class? Some were from the big schools and in
fact from the Deputy Defence Minister's own alma mater.
It is well known that over 80% of
Sri Lankans are from the poorer classes of society. In
any profession therefore, over 80% will be from these
poorer segment of society and the forces are no
exception. It logically follows therefore, that the
majority of casualties will be from the poorer classes.
One does not have to be a brilliant mathematician to
figure this out. It is not necessary to labour the
obvious, unless the motive is to cast aspersions against
the Sinhalese people, in general. And this, we know, is
the NGO agenda.
Cost
The cost of the ‘war’ is another point
highlighted by the ‘piece-mongers’ in their
dubious attempt at balkanising the country. Well known
economist and banker, N. U. Jayawardena, factually
refuted the Marga claim that the money spent on the
‘war’ is colossal and all this money can be
diverted for development once fighting is over. NUJ
demonstrated how almost a similar amount of funds (as
being spent now) will have to continue to be diverted for
maintaining the forces even in peace time, as well as for
rehabilitation and for upgrading the forces into a modern
outfit. Even tiny and peaceful countries such as
Singapore and Switzerland spend over 20% of their budget
on maintaining their defence capabilities. Thus, all this
talk of saving billions once the ‘war’ is over,
is a lot of rubbish. Many do not know that quite a large
chunk of the 40 odd billion rupees of our defence budget
goes for wages and for the police force as well. This
budget includes the Defence Ministry votes, too.
It appears quite unfortunate that
our bunch of conflict revolutionary
‘peace-mongers’ were not around during the
second World War. International Alert, National Peace
Council, Women for Peace, MARGA, MIRJE and other such
sundry ‘piece’ groups could have persuaded the
British and other Europeans to simply hand over their
countries to Hitler. Such a move would have saved
millions of lives and trillions in terms of money. The
war would have been over even before it started.
Similarly, USA and Asia could have been persuaded to hand
over to Hirohito's Japan. What a peaceful world it would
have been. Then again, all those millions of unfortunate
Jews should have been persuaded to ‘peacefully’
commit suicide. It would have saved so much expense on
constructing all those expensive gas-chambers and
concentration camps.
Desertions
Today, thanks to the ‘peace’ efforts of
these ‘peace-mongers’ our boys are refusing to
enlist. More are deserting and Prabakaran is happy. And
these ‘peace-mongers’ too are a happy lot.
Their bank balances are getting fatter all the time. Once
the country is balkanised and handed over to the Tiger,
this lot of traitors will probably fly to darkest Africa,
where many more opportunities await their expertise.
Rwanda, Burundi, Somalia, Sudan and many other African
nations need their services and await balkanisation.
So, while the Sinhala modayas are
kept busy figuring out the cost and etics of
‘war’ and ‘peace’ these
‘peace-mongering’ balkanisers’ are
covertly busy and the Tiger creeps in slowly but surely.
It is time to wake up from our
infighting and slumber and identify the traitors within.
The solution lies in our own hands. Are we going to stand
up and fight for our country or do we want to
‘peacefully’ commit suicide? Does
‘conflict resolution’ mean giving into
terrorism and to terrorists? Are we to allow a set of
traitors to balkanize our country and fatten themselves
in the process?
These are the questions everyone of
us must think about. Wake up Sri Lanka. There isn't much
time.
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