Lessons from the Southeast Asian currency crisis

Lessons from the Southeast Asian currency crisis

The financial turmoil sweeping Southeast Asia may scare off
western investors, but not the Japanese. And as Walden Bello
writes in this Inter Press Service commentary, the crisis may
serve to strengthen the already dominant position of Japanese
capital in the region.

MANILA: Does the currency crisis in Thailand, Malaysia,
Indonesia, and the Philippines spell the end of the Southeast
Asian model of development?

In contrast to the path followed by the "newly industrializing
countries" (NICs) in Northeast Asia, development in Southeast
Asia was financed to a great extent by huge inflows of foreign
investment instead of domestic savings.

The countries of the region were headed for the same fate as
the other highly indebted countries of the South in the mid-
eighties when they were retrieved from recession and spun into
prosperity by the massive inflow of Japanese direct investment.

The reason for this was the Plaza Accord of 1985, which
imposed a drastic appreciation of the yen relative to the dollar
owing to pressure from the U.S., which sought to reduce its
gaping trade deficit with Japan by "cheapening" its exports to
that country and making its imports from Japan more expensive to
U.S. consumers.

With production costs rendered prohibitive by the yen
revaluation, Japanese firms moved the more labor-intensive
production to cheap-labor sites, mainly in Southeast Asia. The
result was one of the largest and swiftest movements of capital
to the developing world in recent history -- $15 billion between
1985 and 1990, according to one conservative estimate.

By 1996 about $48 billion worth of Japanese direct investment
was concentrated in the core ASEAN countries of Indonesia,
Singapore, Thailand, Malaysia, and the Philippines.

The prosperity triggered by Japanese investment was critical
in turning Southeast Asia into a prime destination for global
financial flows in the early 1990s. Especially attracted were the
mutual and hedge funds that tapped into the vast pool of savings
and pension funds in the North and ploughed them into profitable
short-term investments.

With interest rates and stock prices low in the U.S., Japan,
and other industrial markets, these funds, many of them American,
were steered into "emerging markets" in search of higher returns.
And with their high growth rates fueled by Japanese investment,
East and Southeast Asian countries became key magnets for
speculative capital.

In varying degrees, most Southeast Asian governments adopted
policies to attract portfolio investment, or what is termed as
"hot capital". Three measures in particular were put in place.
First, foreign exchange restrictions were abolished or eased,
stock exchanges were opened to foreign investors, and foreign
banks were attracted with more liberal lending rules, including
allowing dollar loans to be made to local borrowers.

Second, interest rates were kept high -- relative to
benchmarks like U.S. rates -- in order to suck in foreign
capital. Third, the local currency, while not formally fixed to a
particular rate of exchange, was informally pegged to a stable
rate of exchange to the dollar via periodic interventions in the
foreign exchange market by the central monetary authority, to
eliminate or reduce currency risk for both foreign investors and
local borrowers.

Net portfolio investment in the region rose from an annual
average of $1.0 billion in 1985-1989 to $4 billion in 1993,
according to the Asian Development bank. The figure had risen
considerably higher by 1996.

In soon became clear, however, that portfolio investment was a
mixed blessing. To begin with, it was extremely volatile in its
search of higher returns wherever they were to be found.
Moreover, those funds zeroed in on those parts of the domestic
economy that promised a high rate of return with a quick
turnaround time. Invariably this was the real estate sector,
which soon became overheated in Bangkok, Manila, and Kuala
Lumpur.

By 1995 the inevitable glut hit Bangkok, setting off a domino
effect of developers dragging their financiers into bankruptcy
with their non-performing loans. With similar gluts expected to
develop in Manila, Kuala Lumpur, and elsewhere, portfolio
investors began to grow skittish and withdraw their capital from
these markets. The result was a plunge in stock market indicators
throughout the region.

It was this growing lack of confidence among foreign investors
that created the climate for the recent speculative attacks on
the Thai, Philippine, Malaysian, and Indonesian currencies. A
currency is only as strong as the "fundamentals" of the economy,
as investors say, and with their widening current accounts
deficits, anemic local manufacturing sectors, troubled or
stagnant agricultural sectors, and overheated real estate
sectors, the fundamentals of most of the ASEAN countries are
starting to look bad.

Portfolio investment inflows into Thailand are drying up, and
though probably not as drastically, inflows into Malaysia, the
Philippines, and Indonesia are also expected to decline. Will
foreign direct investors now follow portfolio investors in
drawing down their presence in the region? With the slow growth
in the region's exports and the spread of deflationary
tendencies, new foreign investors are likely to be deterred from
making significant commitments.

However, while these conditions may scare off prospective
American and European investors, they are likely to have much
less impact on the Japanese, who are far ahead of their American
competitors in making the region an integrated production base.
In Thailand alone more than 1,100 Japanese companies are well
established, and only a massive economic downturn could reverse
the momentum that has built up.

Indeed with most of their production aimed at other markets, a
decline in local demand owing to an economic downturn will not
have too big on an impact on the profitability of Japanese firms.
In fact, it may well work to their advantage by dampening the
pressures for wage raises.

At the same time, with the assets of many Thai companies being
downgraded by devaluation and debt, Japanese investors may take
advantage of the crisis to buy a controlling interest in local
firms and extend their reach into the local manufacturing sector.
In sum, the financial crisis sweeping ASEAN may well mark the end
of the Southeast Asian miracle, and its principal legacy may be a
strengthening of the already dominant position of Japanese
capital in the region.

Dr. Walden Bello is professor of sociology and public
administration at the University of the Philippines, co-director
of Forum on the Global South, a program of policy research of
Chulalongkorn University in Bangkok.

-- IPS