Indochina braces for economic turbulence
Indochina braces for economic turbulence
By Nick J Freeman
The financial turmoil in Southeast Asia will soon affect trade and investments of the Indochina countries, which should resist any temptation to backtrack on economic reform.
THE economic downturn currently facing Southeast Asia is the first of its kind since the transitional countries of the region -- Cambodia, Laos, Myanmar and Vietnam (which we can collectively term "Indochina") -- embarked upon their economic reform programs in the late 1980s.
Consequently, the leaderships of these countries are on a steep learning curve, as they attempt to comprehend fully the recent sequence of events in the region's financial markets, and work to limit the likely impact on their own economies in 1998.
As the recent financial turmoil begins to ripple through into the real economies of most Southeast Asian countries, the adverse affects will rapidly become apparent in the scale and profile of both Indochina's external trade flows and foreign investment inflows, the bulk of which is conducted with business partners from the surrounding Asia Pacific region.
For example, of the cumulative stock of overseas venture capital in each of the Indochina countries, ASEAN-sourced investment alone accounts for 71 percent in Cambodia (where Malaysia dominates), 52 percent in Laos (where Thailand dominates), 49 percent in Myanmar (where Singapore leads) and 27 percent in Vietnam (where Singapore also leads).
The admirable economic reform and transition programs enacted in the four Indochina countries over the last decade have been supported by a regional platform of high economic growth and intra-regional investment flows.
Even though the full extent of the regional economic fallout is not yet quantifiable, it is clear that this platform will be far less sturdy in 1998, and Indochina's external environment has thus become much more challenging.
In spite of the fact that all four countries of Indochina have non-convertible currencies, they have not been spared from the financial market turbulence that is currently rocking the region.
Although some domestic factors -- such as the political conflict in Phnom Penh in July, or the June enforcement of a decree banning the use of foreign exchange in domestic transactions in Laos -- have undoubtedly contributed to the weakening in the local currencies of Indochina during 1997, external factors have also played a significant part in the marked depreciations witnessed during the second half of last year.
The Cambodian riel lost about 25 percent of its value in the latter half of 1997, whilst the Lao kip plummeted from around 960 to 2,130 against the U.S. dollar in 1997, and similarly, the market exchange rate for Myanmar's kyat witnessed a decline against the US dollar from 165 to 390 kyats.
In the case of Vietnam, two widenings in the permitted trading band for the interbank market resulted in a roughly 10 percent depreciation of the dong against the U.S. dollar in 1997, but external observers tend to concur that the dong is still markedly over-valued, and this could have an adverse impact on elements of the country's export performance in 1998.
Prior to the recent bout of currency depreciations in the region, a key competitive advantage of Vietnam as a host location for export-oriented foreign investment had been its low labor costs in relation to most of the region.
However, this competitive advantage may now be in some jeopardy, as a consequence of the marked depreciations in Thailand, Malaysia and Indonesia, among others.
Failure to counter this potential peril could portend a decline in new pledges of foreign investment, as well as future hard currency earnings for Vietnam.
With regard to trade, Thailand has tended to be a dominant force in border trade with Cambodia, Laos and Myanmar (in the case of Laos, official figures alone suggest that Thailand is the source of around 60 percent of the country's total imports, even before smuggling). Much of this vigorous border trading activity was, until 1997, largely transacted in Thai baht.
However, the sharp depreciation in the baht has led many traders to switch to U.S. dollars as the preferred form of payment, and with new foreign exchange restrictions now being enforced in Thailand, this has led to an avid search to access greenbacks in the Indochina countries.
This, in turn, has placed added downward pressure on the riel, the kip and the kyat. And of course, as these local currencies weaken, Indochina citizens have sought to hedge their savings by converting them into convertible currencies (or gold and some commodities), which compounds the downward trend even further.
Crucially, however, the local currency depreciations in Indochina are likely to have far less impact on the scale of these countries' cumulative foreign currency debt exposure, as their relatively youthful domestic corporate sectors were unable to access the very substantial levels of U.S. dollar credit which their counterparts in most other Southeast Asian countries could.
This will make the burden of the recent local currency depreciations in Indochina significantly easier to bear for each of the countries in terms of their cumulative debt obligations.
Given the anticipated downturn in Asia Pacific's economic growth during 1998, it seems likely that the Indochina countries will now seek to increase their relatively limited exposure to the U.S. and European markets, as both alternative sources of foreign investment and recipients of exports.
Cambodia and Laos will be aided in this regard by recent progress with both the U.S. and EU on various trade pacts. Cambodia already has most favored nation (MFN) status and Laos is expected to follow shortly. And since August 1997, both countries also enjoy GSP privileges.
Vietnam too has seen its trade quotas and privileges with the EU expand, although a major trade pact with the U.S. may not be imminent. However, it will be far harder for Myanmar to re- orientate its external trade relations and overseas venture capital inflows, without Yangon making significant concessions in the political arena.
It is not inconceivable that the initial, "knee-jerk" reaction by the four Indochina leaderships to the recent financial market turmoil across the region will be to back-step on their economic reform programs.
However, this would be a wholly erroneous reaction.
Indeed, there is now an even greater need to push ahead with economic reform, as these transitional countries will not be able to rely on as much support from the surrounding region, and will therefore need to better harness and mobilize domestic sources of capital and entrepreneurial spirit.
Therefore, Indochina's leaders might be well advised to consider propelling a second tranche of pro-business initiatives with renewed vigor.
The difficult task of rationalizing the large state sectors should be given high priority, as should measures to ensure that Indochina's banking sectors do not replicate the errors made in some neighboring countries.
And in a bid to better utilize Indochina's own capital resources, moves should also be made to deepen their fledgling capital markets, as the current banking sectors are clearly incapable of providing the scale of long-term credit required to adequately finance industrial development in these economies.
Will the Indochina leaderships rise to the increased challenges that now face them, as the result of a tougher external environment?
That remains extremely hard to tell at this early stage, particularly in the case of Vietnam, where a two-year process of generational transition within the dual party and state leaderships has only just been completed (although initial indications seem quite favorable).
But there is some scope for optimism. In the case of Myanmar, some observers have speculated that the recent changes in the structure of the leadership suggest that Yangon is seeking to embrace economic reforms with greater zeal, as evidenced by the recent announcement of a new privatization program.
And perhaps recent events will provide a degree of support for the Indochina leaderships in this regard, as the regional economic downturn provides a convenient "fig leaf" under which they can enact reforms that might normally expect to be met with opposition from various domestic constituencies during more prosperous times.
Far from allowing the regional turmoil to deter economic reform in Indochina, this is the time for these countries to push ahead with their economic transition programs.
Indochina is not exempt from the fact that those economies most likely to come out of the regional financial market turmoil (and resulting regional economic downturn) first, will be those most fit and able to compete in the changed business environment that will emerge in 1998.
Dr Nick J Freeman is Head of Indochina Research at ING Barings, based in Bangkok.