The Asain Finacial
The beginning of the Asian financial crisis
can be traced back to 2 July 1997. That was the day the Thai Government
announced a managed float of the Baht and called on the International Monetary
Fund (IMF) for ‘technical assistance’. That day the Baht fell around 20
per cent against the $US. This became the trigger for the Asian currency
crisis. Within the week the Philippines and Malaysian Governments were
heavily intervening to defend their currencies. While Indonesia intervened
and also allowed the currency to move in a widened trading range a sort
of a float but with a floor below which the monetary authority acts to
defend the currency against further falls. By the end of the month there
was a ‘currency meltdown’ during which the Malaysian Prime Minister Mahathir
attacked ‘rogue speculators’ and named the notorious speculator and hedge
fund manager, George Soros, as being personally responsible for the fall
in value of the ringgit. Soon other East Asian economies became involved,
Taiwan, Hong Kong, Singapore and others to varying degrees. Stock and property
markets were also feeling the pressure though the declines in stock prices
tended to show a less volatile but nevertheless downward trend over most
of 1997. By 27 October the crisis had had a world wide impact, on that
day provoking a massive response on Wall Street with the Dow Jones industrial
average 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 combination
of liberalisation of controls on flows of financial capital on the one
hand, and quasi-fixed/ heavily managed exchange rate systems on the other.
These exchange rate systems have been operated largely through linkages
with the United States (US) dollar as their anchor. (1) Such external policy
mixes are only sustainable in the longer term if there is close harmonisation
of economic/ financial policies and conditions with those of the anchor
country (in this case, the United States). Otherwise, establishing capital
flows will inevitably undermine the exchange rate.
Rather than harmonisation, there seems
to have actually been increased economic and financial divergence with
the US, especially in terms of current account deficits, inflation and
interest rates. These increasing disparities have prompted global (and
local) financial interests to speculate against the administered exchange
rate linkages, i.e. speculative pressure mounted that the monetary authorities
in these countries would not be able to hold their exchange rate links.
In most cases, such financial speculation has been of sufficient magnitude
to actually provoke the collapse of the administered exchange rate links,
in the manner of ‘self fulfilling’ prophecies. Defence of the exchange
rate through the use of foreign exchange reserves and higher interest rates
proved to be insufficient. (2)
The result has been large devaluation’s
of the exchange rates of these countries, especially against the US dollar.
Large interest rate increases to support the exchange rates at their new
lower levels (to prevent wholesale over reaction and collapse in foreign
exchange markets and to help contain the strong inflationary forces set
in motion); and extra restrictions in fiscal policy. Designed to rise national
saving, contain domestic spending and reassure foreign investors and international
institutions such as the International Monetary Fund (IMF). Figure 1 shows
the magnitude of this devaluation’s.
The IMF had arranged conditional financial
support packages for Thailand and Indonesia. (3) Financial support is provided
in exchange for (on condition of) economic policy reforms which, it is
argued, will encourage economic recovery and help prevent a recurrence
of 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’s
US dollar assets of up to $1 billion were exchanged for Thai Baht, with
an agreement that the reverse exchange would occur at a future point in
These financial crises have also provoked
substantial falls in the stock markets of these countries and in other
parts of Asia. (They also contributed to stock market falls around the
world). Foreign investor funds would have been initially withdrawn as exchange
rate speculation mounted, and this would have partly taken the form of
a sell off of foreign-owned stock. As well, much higher interest rates
(both before and after the currency devaluation’s) encourage flows of funds
out of shares and into loan/ debt-type assets. In turn, higher interest
rates and lower exchange rates have substantially increased the rate of
collapse/ bankruptcy of businesses operating in highly leveraged sectors
(especially where loan contracts were written in foreign currency), and
this would have further undermined confidence in the stock markets throughout
Asia. 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 consequences
of these financial crises. Both as the direct result of the financial disruptions
and also as the result of consequent contraction in economic policy changes
that have been, and will be, implemented. Loss of general economic and
financial confidence will reduce the growth in spending and output and
the related tightening of fiscal and monetary policy will reinforce these
effects. (5) Economic growth in these countries in the next couple of years
will probably be substantially lower, and countries such as Thailand may
actually tip over into recession, i.e. its absolute level of output may
This downturn is likely to continue until
the inflationary forces unleashed by the large exchange rate devaluation’s
have been tamed. Foreign exchange markets stabilise at their new lower
prices, and the enhanced international trade competitiveness of these countries
(arising largely from the currency devaluation’s) allows them to better
implement export led growth strategies. Such strategies have traditionally
been the most successful and effective means of encouraging growth in Asia.
Thailand and Indonesia seem to have been
the worst affected by the economic and financial crisis of the last several
months; Malaysia and the Philippines seem to be in somewhat better economic
and financial shape, at least compared with Thailand and Indonesia. Singapore
appears in turn to be much better placed than the rest of the region and
is likely to have the least economic and financial problems. This is because
of the latter’s more advanced economic structure, more sophisticated financial
system, more flexible exchange rate system and substantial current account
surpluses (in contrast to the deficits elsewhere in the region). (6)
Further Economic and Financial Problems
Enhanced trade competitiveness will also
help these countries better deal with their longer-term problems of repositioning
their economies in a region where trade competition has intensified and
where domestic policy directions have often been counter-productive. Competition
from China and other developing countries in standardised products that
make intensive use of low-skilled/ semiskilled labour have reduced export
growth in Southeast Asia at the same time as imports of capital goods in
the region have continued to grow strongly. (China has also been much assisted
by earlier large exchange rate devaluation’s). These trends have contributed
to large and increasing trade and current account deficits in the region,
and this seems to have been one of the fundamental reasons why speculators
and other financial interests began to move against many of the currencies
of Southeast Asia.
While much of the high rates of investment
in these countries have been directed towards efficient and productive
uses, a substantial part has gone into industries unsuited to the economic
conditions of these countries. (Such as ‘national car’ projects), or into
sectors (such as commercial property) where asset price inflation has distorted
investment priorities and taken capital away from more efficient uses.
Thus, the productivity of such investment has been lower than expected
and has not contributed much to the ability of these countries to fund
their capital imports.
The bursting of asset price inflation
bubbles, fuelled and then undermined by speculative activity, has also
contributed to the economic and financial crisis (especially in countries
such as Thailand). This in turn has rapidly increased the amount of bad/non-performing
loans in the banking systems of these countries (and for foreign lenders
such as the Japanese banks) and has forced the closure or consolidation/
merger of a number of lending institutions. Thus, the crisis has enveloped
the financial systems in the region, and has been accentuated by high rates
of borrowing. Its resolution will also require structural reform of financial
institutions. (7) The prudential regulation of financial institutions will
probably also have to be drastically upgraded in these financial systems.
Asset price deflation, rising bad debts
and failing banks provide a very dangerous mixture for national economic
performance and may require several years of adjustment before they can
be fully overcome. The case of Japan is both instructive and rather frightening.
After rapid Japanese asset price inflation in the 1980s (especially in
property and shares), the early 1990s there saw asset price crashes, escalating
bad debts (since these were often secured against the now vastly devalued
assets) and banks teetering on collapse. Japan has seen very low economic
growth in the last six years as it has attempted (ineffectively) to cope
with such deep-seated financial problems.
It is now clear that the Japanese financial
sector has not been rationalised in the thorough way needed for strong
economic recovery. Insolvent institutions beyond hope of trading their
way out of trouble have not been closed but have been allowed to linger
on. Bad loans beyond any genuine hope of payment have not been written
off against shareholder capital and/or government funds but have remained
hidden 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 countries
of Southeast Asia fare better but this will require rapid, concerted responses
to the problems confronting them. The policy responses so far announced
have been reasonably encouraging but much more needs to be done. (9)
Affect to New Zealand
New Zealand’s rapidly growing export markets
in Southeast Asia will probably be cut back substantially in the next couple
of years. This is both because slower growth in the region will reduce
the growth in demand for New Zealand exports, and also because the much
lower real (inflation-adjusted) exchange rates of Southeast Asian countries
will further reduce their imports by favouring domestic production the
latter effect will also favour their exports. Further ‘second round’ adverse
effects on our major trading partners such as Japan and South Korea will
be important to New Zealand.
Similarly, New Zealand exports to Asia
can be expected to eventually recover when exports from these Southeast
Asian countries themselves accelerate under the influence of their devalued
exchange rates. The latter export expansion will then help to generate
broader recoveries in economic growth in the region.
The strong ‘economic fundamentals’ of
high rates of investment, saving, technological transfer, and expansion
in education and training throughout Asia all point to the region recovering
to robust economic growth once the current set of problems have been dealt
with. (The crucial proviso is probably that financial sector problems in
the region be effectively resolved). Thus, the medium to longer term prospects
for New Zealand exports to Asia remain strong so long as our producers
continue to be competitive in terms of price and quality.
Estimates of reductions in New Zealand
economic growth resulting from this negative external shock currently range
from 0.2 to 1.0 percentage point falls in the next year or two. (13) Initial
estimates were at the low end of the range, but more recent forecasts have
generally been higher, as more adverse information has been received. (Falling
growth in New Zealand exports is likely to be reinforced by cuts to investment
and consumption plans).
These estimates pose serious problems
for the New Zealand economy and New Zealand economic policymakers. Most
importantly, they imply that New Zealand economic recovery in the growth
of output and employment, which according to many forecasters already looks
to be only quite moderate and gradual, could be substantially nullified
by the external economic shock emanating from Southeast Asia, and its flow-on
effects on Northeast Asia. (14)
Difficult dilemmas for the current setting
of New Zealand monetary and fiscal policy are thus created. For example,
disturbances to New Zealand financial markets caused by the crisis alleviate
against any current relaxation of monetary policy arising from consideration
of the need to counter the external economic shock proactively.
This is especially so in the case of the
recent fall in the New Zealand dollar; this acts to encourage net exports
and helps to counter the external shock (but also adds to domestic inflationary
pressures, mainly through higher import prices). However, this devaluation
could prove to be substantially the result of financial market over-reaction
and thus could be quite temporary in nature. Unfortunately, this may not
become clear until end of 1999, by which time a further reduction in official
interest rates might be rather late in terms of dampening the external
shock. The enduring currency devaluation may be insufficient in itself
to dampen the external shock substantially.
On the other hand, even if monetary policy
is relaxed now this will do little to nullify the shock’s effect on New
Zealand spending and growth. This is because of the substantial time lags
involved in the impact of such monetary policy changes on the economy.
However, such a policy relaxation could help to bolster growth after next
calendar year, if the effects of the crisis on New Zealand are expected
to last that long.
Monetary policymakers also seem to be
restrained at the present time by uncertainty about the magnitude and duration
of the economic effects of the Asian crisis on New Zealand, and its effects
upon the future course of New Zealand inflation in particular. (15) This
also comes at a time when official forecasts already see inflation rising
back into its target range, in 2000, of 2-3% underlying inflation. (16)
Fiscal/ budgetary policy might also help
to dampen the shock by temporarily moving to a more expansionary/less restrictive
stance. It is an attractive policy tool since it has shorter lags of impact
on the economy than monetary policy and is less likely to generate exchange
rate devaluation (and consequent intensified inflation pressures) than
monetary policy. This might allow stronger growth while also allowing the
inflation target to continue to be met.
However, fiscal policy is currently in
a contraction stance at the national level, being preoccupied with budget
deficit reduction to boost levels of national saving and help contain current
account deficits. Indeed, New Zealand’s current account deficit is highly
likely to increase as a result of the negative external shock arising from
Asia, and this mitigates against any move to fiscal policy expansion.
1.International Monetary Fund, World
Economic Outlook, October 1997, Table 16.
2.The Asian Financial Review July
1998, pp. 37-39.
3.’The IMF and Indonesia: Baleful
Bonanza’, The Economist, 8 November 1997, p. 95.
4.Commonwealth of Australia, JOURNAL
No. 90, 11 August 1997, and No. 116, 1 November 1997.
5.For a critical perspective on
such policy changes, see: Greg Earl, ‘IMF Solution Follows Wrong Track:
Economists’, Australian Financial Review, 19 November 1997, p. 13.
6.Economist Intelligence Unit, Country
Report: Singapore, London, 3rd quarter, 1997, pp. 23-26.
7.Simon Davies and John Ridding,
‘Crisis into Catastrophe?’ Financial Times (London), 31 October 1997, p.
8.Max Walsh, ‘Aid Parcels to Japanese
Banks’, The New Zealand Herald, 18 November 1998, pp. 25-26; Max Walsh,
‘Time for Japan to Save the World’, The New Zealand Herald, 21 November
1998, pp. 29-30.
9.John McBeth, ‘Big is Best: Indonesia’s
Rescue 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 Review
10.Charles Lee, ‘The Next Domino?’
Far Eastern Economic Review, 20 November 1997, pp. 14-16.
11.Eric Ellis, ‘Kim Inspects Mouth
of IMF Gift Horse’, Australian Financial Review, 24 November 1997, p. 12.
12.Teresa Wyszomierski and Christopher
Lingle, “Fortress Japan Under Siege’, Australian Financial Review, 19 November
1997, p. 20.
13.Ian MacFarlane, Forbes Magazine
Business 1998, pp24-27.
14. Forecasts Lowered’, The New
Zealand 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 Smith
As published in NZBUSINESS, August 1998, PP 5-12.