ASIA: Asia Economies - Asia shaken but still standing.

ASIA: Asia Economies - Asia shaken but still standing. - The 'crisis' has hit some of the countries in the region harder than others. But the fundamentals which were a year ago suggesting that the economies had strong growth potential are still there.

by David Smith.
Last Updated: 31 Aug 2010

The 'crisis' has hit some of the countries in the region harder than others. But the fundamentals which were a year ago suggesting that the economies had strong growth potential are still there.

The Asian businessman, addressing a seminar on the subject of information technology, had a good line. It was a considerable relief, he said, to be talking about Asia, without the word 'crisis' attached to it. His relief, however, was short-lived - soon the questions were coming in thick and fast about the impact of Asia's deep financial and economic woes on investment, pricing, research and development spending and the opportunity for new business partnerships.

Asia's transformation from miracle to crisis region has been brutally fast, a demonstration of the speed with which global financial markets can react and bring about real, and far-reaching, economic consequences.

The journey from last summer's collapse of the Thai baht to the winter's $57 billion (£34.8 billion) International Monetary Fund (IMF) rescue package for South Korea, the largest in the IMF's history, was a short one in time but epic in terms of its implications for Asia. The IMF has also put together packages worth $43 billion for Indonesia and $18 billion for Thailand.

This financial version of the old domino theory, in which currency and stock-market collapse in one country was followed, inevitably, by a similar process in a near neighbour, acquired a grim internal logic of its own.

If the Thai currency and stock market have fallen, then Indonesia, the Philippines and Malaysia begin to look expensive, and their stock markets overvalued. And, as in all speculative rushes, when the process results in many panic sellers and no buyers, the direction can be only one way.

The businessman mentioned above was from one of the crisis-hit Asian economies.

It is important, however, to distinguish between severely affected and relatively unaffected countries in the region. For some in Asia, the word crisis has been inappropriate.

'The storm mainly struck the ASEAN-4 (Thailand, the Philippines, Malaysia and Indonesia), spreading subsequently to South Korea, and intermittently battering Hong Kong and elsewhere,' noted Eddie George, the Bank of England governor, in a recent speech. But this left, even in his list, economies that have proved at the time of writing relatively immune to this virulent form of Asian flu.

Thus, Singapore, Taiwan and, crucially, China remain upright dominoes. So too, in spite of its bruising encounters with these powerful and destructive forces, does Hong Kong.

Even so, after any disaster or crisis, the question 'why?' is the one most frequently asked, and usually least satisfactorily answered. Gavyn Davies, chief international economist at Goldman Sachs in London has come up with a more complete answer than most. In a detailed analysis, Causes, Cures and Consequences of the Asian Economic Crisis, Davies says: 'Traditional models of currency crises do not satisfactorily explain the onset of the Asian crisis. There was little or no sign of fiscal and monetary profligacy on the part of governments prior to the crisis, and current account deficits were more than offset by private-sector capital inflows, so official reserves rose sharply. Real exchange rates also went up for several years before the crisis broke.'

So why, if conventional explanations do not work, did it happen? 'The crisis was caused by an extreme build-up of private sector capital inflows, channelled primarily into short-term banking instruments,' says Davies.

'These inflows were fuelled partly by a perception that implicit government guarantees supported the banks. This led to asset price bubbles, over-investment and a severe misallocation of investment into dubious projects.

The trigger for the crisis was a combination of chance events - a rising dollar, a collapse in global demand for computer parts, a declining yen and the expectation of tighter monetary policy in the G7 - which would cut export growth and threaten the supply of the huge inward capital flows which were by now needed to finance burgeoning current account deficits.'

The crisis was, therefore, not necessarily an accident waiting to happen.

Rather it was the product of a particular combination of circumstances.

But, now that it has happened, putting back in place the factors that made Asia attractive to foreign investors won't be easy. And with this, the danger is that the second phase of the crisis - the first being collapsing financial markets - will be prolonged. Although several Asian countries are now beneficiaries of highly competitive exchange rates, they have also faced a sharp rise in the cost of capital and face, at least in the short term, a big increase in inflation alongside economic stagnation - stagflation.

In some countries, too, a reluctance to abandon the systems that were associated with earlier economic success - breaking up the great chaebols of South Korea, reducing the 'crony' influence of the Suharto family on the Indonesian economy - has slowed the process of economic rehabilitation. In the case of Indonesia, the pet policy of the Suharto government, establishing a currency board in which the rupiah would be backed by hard currencies, fell foul of the prescription favoured by Group of Seven governments but this did not mean, initially at least, that the policy was scrapped.

Not that the traditional response to the crisis favoured by the IMF has escaped criticism. Jeffrey Sachs, the prominent Harvard economist, has attacked the IMF for trying to impose the wrong solution on Asian economies.

Because these countries did not have problems with big budget deficits or excessive money supply growth prior to the crisis, it has been a mistake, he argues, to try to force the standard IMF corrective policies of tighter fiscal and monetary policy - sharply higher interest rates - upon them.

The problem, he argues, lay with private capital flows, and their abrupt reversal. This is likely to be exacerbated - not assisted - by the IMF programmes.

The point is put even more strongly by the AFL-CIO, America's trade union grouping. 'The clout and leverage exercised by the IMF must serve a broader set of social and economic goals,' it says. 'Currently, the IMF defines its mission narrowly, as protecting the interests of international capital.

It requires debtor governments to raise interest rates, cut public spending, deregulate financial markets, and weaken labour laws to facilitate massive lay-offs and deep wage cuts. These terms may solve some short-term credibility problems with foreign investors, but will necessarily exacerbate the tensions, inequality and instability of the global economy. Such policies are short-sighted and must be fundamentally altered.'

Nobody would deny that the IMF, in trying to cope with the Asian financial hurricane, has made mistakes. The abrupt closure of a string of Indonesian banks last November, as a first strike against the crony capitalism it believed to be rife within the country, merely added to the mood of panic.

Much of the criticism appears, however, to be misplaced. The first requirement in these countries, as Stanley Fischer of the IMF has argued, was to re-establish confidence in their currencies, otherwise the risk would be of ongoing crisis and hyper-inflation. And fiscal and monetary orthodoxy, harsh as they sometimes can seem, have to be part of any package aimed at restoring international confidence. There is also the 'moral hazard' argument - any crisis has to involve pain as part of the solution otherwise other governments may be tempted to follow mistaken policies in the future. Some argue that the Mexican rescue which was so successful three years ago, creating relatively few losers, led directly to the problems in Asia.

There is now a general acceptance that the crisis will reduce global economic growth by about 1% this year, with the effects disproportionately concentrated upon Japan, the rest of Asia, and Australia and New Zealand. Europe and America will see growth between 0.5 and 0.75 percentage points below what otherwise would have been the case. But what happens next year and beyond?

The biggest risk is of an outbreak of protectionism, particularly in America, against the threat of a flood of cheap imports from Asia. The AFL-CIO analysis talks of a widening of $100 billion in the US trade deficit this year as a direct result of events in Asia, resulting in a loss of about one million US jobs, 'most of them in the better paying manufacturing sector'. John Makin, an economist at the American Enterprise Institute in Washington, says that, in this context, continued strong economic growth in America becomes vital. 'If growth slows down, the American market for Asian exports will not be rising and the ability of Asian producers to expand exports, even at sharply reduced currency values, will be limited,' he says. 'Beyond that, the tendency of American producers to complain about the dumping of Asian products, especially in view of the IMF subsidies to Asian producers, will grow and Congressional protests will increase if US growth slows.'

Assuming the protectionist threat can be avoided, how long will it be before the crisis-hit Asian economies turn the corner? Financier George Soros suggests around 18 months. Other analysts look for a longer period of convalescence and recovery, perhaps three or four years. Nobody believes, however, that the crisis should be regarded as an opportunity to write off Asia as a powerhouse region of the world economy. Even if one is pessimistic about its structural problems, and assumes that Asia grows by just 2% in 1998, followed by five years of below trend growth of 4% before finally accelerating to 6%, the region will then only have to wait for a marginally longer period, to 2020-2025, before becoming a larger economy than Europe, North America and Japan combined.

The Asian crisis, in other words, has had painful consequences and required plenty of hard decisions. But the economic fundamentals that were suggesting a year ago that these economies had potential for strong growth stretching for years ahead remain in place. Asia has wobbled badly. But it has not fallen.

David Smith is economics editor of the Sunday Times.


Currency Stock market *Exports

(% change/$) (% change) (% of GDP)

Brunei -6.3 n/a n/a

China +0.4 +6.1 20.3

Hong Kong -0.2 -23.6 193.0

Indonesia -67.7 -8.3 27.6

Japan -6.0 -2.3 17.4

Malaysia -20.2 -14.8 152.0

Philippines -14.3 +3.3 51.0

Singapore -5.8 -18.7 132.9

South Korea -42.6 -13.8 44.7

Thailand -18.0 -4.9 58.0

Vietnam -9.6 n/a n/a

Source: Datastream/ICV Notes: figures are for period 10/10/97 to

10/3/98; *latest figures.

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