Asia will survive with realistic economic policies
Asia will survive with realistic economic policies
International Monetary Fund chief Michel Camdessus spoke to
Southeast Asian business leaders in Kuala Lumpur last week. The
following article is based on his speech. This is the first of
two articles.
KUALA LUMPUR: The crisis that began in Thailand has now shaken
a number of other economies in the region, and its aftershocks
have been felt as far away as Latin America and Eastern Europe.
Countries that have been accustomed to, in some cases, decades
of high growth now face the prospect of a marked slowdown in
economic activity. This has prompted some observers to suggest
that perhaps the so-called "Asian miracle" was only a "mirage". I
do not hold that view.
In my opinion, the region's economic success over the last
couple of decades can be described in many ways as outstanding,
superlative, and certainly admirable. But it was no "miracle".
Rather, it was the result of good policies that fostered
saving and investment, including in human development; encouraged
innovation and entrepreneurship and a quick response to market
signals; and promoted trade.
Recent developments have not wiped out past achievements. On
the contrary, the region's longer-term fundamentals -- including
its high domestic savings rates, strong fiscal positions, dynamic
private sectors and competitiveness -- remain favorable.
Moreover, most Asian countries still have a long way to go to
catch up with advanced economies.
Thus, to all the prophets of doom and gloom I would reply that
with a lucid diagnosis of the problems, without complacency and
with appropriate economic adjustments now and sound policies in
the future, they will be able to rekindle -- in a more
sustainable way -- high rates of growth in the coming years.
In a situation like the current one that is evolving quickly,
it is difficult to step back and take a longer view. But indeed
that is what is required to get to the root of the region's
problems and find appropriate solutions. In this spirit, I would
like to talk very candidly about the causes of the current crisis
and what they suggest about the requirements for rebuilding
confidence in this dynamic region.
How could events in Southeast Asia unfold this way after so
many years of outstanding economic performance? In the case of
Thailand, the answer is fairly clear. To begin with, standard
economic indicators revealed large macroeconomic imbalances: the
real exchange rate had appreciated considerably; export growth
had slowed markedly; the current account deficit was persistently
large and was financed increasingly by short-term inflows; and
external debt was rising quickly.
These problems, in turn, exposed other weaknesses in the
economy, including substantial unhedged foreign borrowing by the
private sector, an inflated property market, and a weak and over-
exposed banking system.
Markets pointed to the unsustainability of Thailand's
policies: equity prices declined and the exchange rate came under
increasing pressure. The IMF stressed these problems and pressed
for urgent action in a continuous dialogue with the Thai
authorities during the 18 months leading up to the floating of
the baht last July.
But after so many years of outstanding macroeconomic
performance, it was difficult for the authorities in Thailand --
as in other countries -- to recognize that severe underlying
problems could seriously jeopardize their track record. And this
"denial syndrome" contributed to the delay in taking corrective
measures. Finally, in the absence of convincing action, the
crisis broke.
The more vexing question is why the crisis spread to other
countries, such as Indonesia, Malaysia, the Philippines and
Korea.
Developments in Thailand prompted market participants --
especially those who had initially underestimated the problems in
Thailand -- to take a much closer look at the risks in other
countries. And what they saw to different degrees in different
economies were many of the same problems affecting the Thai
economy, including overvalued real estate markets, weak and over-
extended banking sectors, poor prudential supervision and
substantial private short-term borrowing in foreign currency.
Moreover, after Thailand, markets began to look more
critically at weaknesses they had previously considered minor, or
at least manageable, given time. In other words, markets became
less forgiving.
Market doubts were compounded by a general lack of
transparency -- about the extent of government and central bank
liabilities; about the underlying health of the financial
sectors; and about the links between banks, industry and
government and their possible impact on economic policy.
In the absence of adequate information, markets tended to fear
the worst and to doubt the capacity of governments to take timely
corrective action. The imposition of controls on market activity
-- and the threat of future controls -- not only made investments
riskier, but tended to reinforce the view that governments were
addressing the symptoms, rather than the causes, of their
problems. This sent investors fleeing to safe havens and set back
other efforts to restore confidence.
But perhaps the most important factor in the depreciation of
exchange rates was the rush by domestic corporations to buy
foreign exchange. Expecting that exchange rates would remain
stable indefinitely, and in the context of inefficient banking
systems, domestic firms had borrowed heavily in foreign
currencies in order to take advantage of lower interest rates
available in other markets. Once they recognized that the peg
might not hold and that their debt service costs might rise,
perhaps dramatically, they hastened to sell domestic currency,
extending the currency slide.
Finally, in some cases, the contagion can be traced in part to
the "denial syndrome" that I referred to earlier -- to the
conviction that "it couldn't happen to us".
Questions have also arisen about the role of hedge funds. The
IMF has been looking into this question, talking to market
participants and central banks about how hedge funds are set up
and regulated, and what role they may have played in the crisis.
But from what we know so far, it would be a mistake to blame
hedge funds or other market participants for the turmoil in Asia.
Turbulence in the market is only a symptom of more serious
underlying problems which are now being addressed seriously in
many countries.
It remains the case that there are things that can be done to
promote a more orderly working of the markets. For instance,
consideration could be given to strengthening large-trader
reporting requirements, limiting position-taking by requiring
bankers and brokers to raise collateral and margin requirements
so as to limit the use of leverage by hedge funds and other large
investors, and discouraging herd behavior and avoiding one-way
bets.
This could be done by providing better information to markets
on government policies and the condition of domestic financial
institutions to encourage investors to trade on fundamentals
rather than to run with the herd.
So what does all of this imply about the way in which
governments should manage their economies and approach the
markets?
The first implication is the most obvious one: the necessity
to take early action to correct macroeconomic imbalances before
they precipitate a crisis. This did not happen in Thailand
despite timely and vigorous warnings. Instead, policymakers
attacked the symptom of the crisis -- the pressure on the baht --
and accumulated large reserve losses and forward foreign exchange
liabilities in the process.
This, together with delays in addressing Thailand's severe
financial sector problems and lingering political uncertainties,
clearly contributed to a deepening of the crisis and its spread
to other economies in the region.
Second, countries may find that they are more vulnerable to
crises in other markets than their own economic fundamentals
would suggest. Consequently, they may need to take preemptive
action to strengthen their policies. Several suggestions come to
mind as to where such action might be needed.
* Maintaining an appropriate exchange rate and exchange rate
regime. Clearly, there is no single "right" choice, but more
flexible exchange rates can help provide early and visible
signals of the need for policy adjustments and are less likely to
invite reckless behavior on the part of borrowers and lenders;
* Maintaining an appropriate macroeconomic policy mix to
ensure that fiscal positions do not lead to unduly high domestic
interest rates, which, in many cases, have contributed to
excessive amounts of short-term capital inflows;
* Strengthening structural policies -- especially the
policies and institutions, such as prudential supervision, needed
to underpin a sound financial system. In particular, it is
important that fragilities in the financial system are not
allowed to become so acute that the authorities are unwilling to
use the interest rate instrument in times of international
financial instability;
* Carrying out other supporting reforms -- what we call
"second generation" reforms -- to promote domestic competition,
increase transparency and accountability, improve governance,
help ensure that the benefits of future growth are widely shared,
and otherwise strengthen the foundations for future growth.
-- The Business Times