Currency crisis triggered by inefficient investment<\/p>\n
By Vincent Lingga<\/p>\n
HONG KONG (JP): The thousands of economists, monetary pundits
\nand securities analysts who gathered here for the annual meeting
\nlast week of the International Monetary Fund and World Bank, and
\nthe dozens of seminars and panel discussions held before the
\nmeeting, came up with almost the same diagnosis of the disease
\nwhich led to the recent currency crisis in Southeast Asia.<\/p>\n
They cited a weak financial system, especially the banking
\nindustry, too heavy a dependence on foreign capital, notably
\nportfolio funds, widening current account deficit and a too-rigid
\nexchange rate regime.<\/p>\n
The solution obviously focuses on a cure for these ills, in
\naddition to the standard advice on sound macroeconomic policy.<\/p>\n
The same solution has also been central in the policy
\nrecommendations provided by the various reports issued by the IMF
\nand the World Bank, as well as its affiliate institutions.<\/p>\n
Several economists went deeper, by analyzing the capital
\nproductivity and profitability, or in the context of what
\nIndonesia's most senior economist Sumitro Djojohadikusumo usually
\ncalls the incremental capital output ratio (ICOR).<\/p>\n
Daniel Franklin, the editorial director of the Economic
\nIntelligence Unit -- the think tank of the Economist group in
\nLondon -- questioned the trumpeted praise of the high domestic
\nsavings rate in and large capital flows to the major emerging
\nmarkets in Southeast Asia.<\/p>\n
"It is the quality and not the quantity of investment that
\nshould attract analysts' attention," Franklin said in a seminar
\nthat discussed the myths of emerging markets and their hidden
\nrisks.<\/p>\n
David Roche, president of Independent Strategy research
\ninstitution, said in the South China Morning Post daily that it
\nwas an anomaly that the major economies in Southeast Asia which
\nhave massive domestic savings rates of up to 35 percent, still
\nused foreign capital of up to 6 percent and 9 percent of their
\ngross domestic product.<\/p>\n
Roche raised a puzzling question as to why the steadily big
\nimports of capital goods by the Southeast Asian economic tigers
\nhave no longer been able to generate sustainable growth and
\nsteady expansion of exports.<\/p>\n
His conclusion was that in the major economies in Southeast
\nAsia, the superior capital productivity and profitability -- the
\nequation of cheap labor combined with new machinery -- does not
\nhold any more.<\/p>\n
Roche estimated that in the past five years, it took US$4.60
\nof capital investment in Indonesia and Malaysia to produce just
\n$1 of output (an ICOR of 4-to-6).<\/p>\n
Roche's estimate is not much different from the incremental
\ncapital output ratio made last year by Sumitro for Indonesia.<\/p>\n
Sumitro has repeatedly called for more concerted efforts to
\nimprove the efficiency and productivity of investment in
\nIndonesia, to reduce the country's dependence on foreign capital
\n(official and private borrowings and private investments).<\/p>\n
In Thailand and the Philippines, according to Roche's study,
\nthe ICOR was even higher. It required $5.50 of capital to
\ngenerate $1 of output.<\/p>\n
Hence, the key problem, according to Roche, is that the
\nproductivity of investment in Southeast or East Asia in general
\nhas been worsening.<\/p>\n
He estimated that quite a portion of the large domestic
\nsavings in Southeast Asia had ended up in companies which
\nundertake real estate and property development financing.<\/p>\n
John Greenwood, chief economist at Chancellor LGT Asset
\nManagement, came to the same conclusion, saying that since 1993,
\nthe excessively high credit growth in Southeast Asian countries
\nhad partly been wasted through inefficient investment.<\/p>\n
Greenwood noted the annual credit growth in the ASEAN four
\n(Indonesia, Malaysia, Thailand and the Philippines) rose from 14
\npercent in 1993 to more than 30 percent in 1995.<\/p>\n
He said even the dynamic economies of these countries could
\nnot have absorbed such a massive credit expansion without
\noverheating: strong domestic demand growth, widening current
\naccount deficit and over-extended markets for equity and real
\nestate.<\/p>\n
So, their key advice is for Southeast Asian countries to
\nincrease the efficiency and productivity of their investment in
\norder to narrow the gap between domestic savings and investment,
\nwhich has been mainly responsible for their large current account
\ndeficit.<\/p>\n
Further down the road, less dependence on foreign capital
\nwould reduce their vulnerability to currency volatility. An added
\nbenefit is that more productive capital investment would reduce
\nthe inflationary risk of high growth.<\/p>\n
American financier George Soros, who also addressed one of the
\nseminars here, voiced similar advice.<\/p>\n
Soros, who has made tons of money from the international
\ncurrency market, said financial markets are inherently unstable
\nand international financial markets are even more so because
\ncapital flows are notorious for their boom-bust pattern.<\/p>\n
"So, the best way to achieve (currency) stability is to
\nmobilize domestic savings for domestic capital formation in an
\nefficient fashion," Soros said.<\/p>\n
Greenwood cited the promotion of many government-orchestrated
\nprojects of dubious commercial viability in Malaysia and
\nIndonesia as examples of grossly inefficient investment.<\/p>\n
Franklin noted that in several Southeast Asian countries where
\ndomestic savings have been abundant and capital flows
\nsignificant, the temptation for politicians to funnel investment
\ninto pet, large projects and even to pick industrial winners is
\ngreat.<\/p>\n
The bottom line of these economists' analytical observations
\nis that governments are making the mistake of plowing domestic
\nsavings into prestige projects when what is needed is increased
\ninvestment in education to overcome the shortage of skills badly
\nneeded to develop industries of higher value-added products.<\/p>\n
Sadly, though, the strong capital inflows from overseas so far
\nhad created an atmosphere of over-confidence, which resulted in
\nexcess investment in a variety of sectors, which now have to be
\ncut back after the currency turmoil.<\/p>",
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