Southeast Asia: The politics of economic disarray

LONDON: More than two months after the Thai government bowed to the inevitable and allowed the baht to float free of its fixed exchange rate, Southeast Asia's currency markets and stock- exchanges remain in considerable disarray. The threat to free- market policies throughout the region has grown.

With no end in sight to a vicious cycle of declining currencies, rising domestic interest rates, weakening growth prospects and collapsing stock-markets, longer-term political and strategic consequences are certain to manifest. Already, some effects are discernible:

* rising social tension;

* political instability;

* a growing recognition of Japan's economic strength; and

* closer financial cooperation among South-east Asian nations.

Indonesia, Malaysia and the Philippines were all forced to follow Thailand's lead and allow their currencies to depreciate sharply against the U.S. dollar. Even the Singapore and Hong Kong dollars, backed by huge foreign-exchange reserves, came under attack. Consequently, the economic 'golden age' that began with the 1985 New York 'Plaza Accord' ended.

The Plaza Accord led to a sharp appreciation of the Japanese yen against the U.S. dollar. For Southeast Asian countries, whose currencies were all pegged to the dollar, this provided a strong impetus to export-led growth. Japanese investment poured into regional states, and cheap exports flowed out. The wave of speculative currency selling began after the U.S. dollar climbed sharply against the yen, causing export growth to slow considerably.

Linking regional currencies to the U.S. dollar, however, has served many purposes besides keeping export prices down. In some countries -- notably Thailand -- it has acted almost as a national monetary policy, with interest rates set at a level sufficient to protect the currency's value.

As financial markets liberalized, premium interest levels led to the availability of vast amounts of cheap capital. Because investors believed that they were incurring no exchange risks, they could borrow U.S. dollars to put into local currency- generating projects at virtually negative interest rates.

It is still possible that the region is experiencing a one-off currency realignment. If this proves to be the case, then once the financial markets have settled down, central banks will revert to their old habit of intervening and setting interest rates to maintain a stable value against the U.S. dollar.

More likely, however, is a fairly long period of volatility, until a new system emerges that is less dominated by the dollar. The consequences will probably include tight monetary and fiscal policies, much higher interest levels, and hence slower economic- growth rates.

This in turn has considerable political implications which will be felt most acutely in Thailand, where years of imprudent borrowing and poorly placed investment culminated in high levels of non-performing loans. Confidence began to erode after the failure of a medium-sized commercial bank in May 1996.

In 1997, 58 finance companies have been closed, the stock- market has lost two-thirds of its value and the baht has been devalued by 30 percent.

To forestall a balance-of-payments crisis in the short-run, the Thai government asked the International Monetary Fund (IMF) on July 28, 1997 for a US$17 billion loans package to bolster its foreign-exchange reserves. Increasingly, it looks as if this rescue package will not be enough to meet Thailand's foreign- exchange needs.

Furthermore, the government of Prime Minister Chaovalit Yongchaiyut appears too weak to implement to IMF's reform demands -- severe budgetary cuts, tax rises and the recognition of corporate bankruptcy in the finance sector -- thereby deepening the economic and political crisis.

Bangkok optimistically claims that economic growth can be maintained at around 3 percent per annum in 1997 and 1998. Even if this forecast were achieved, it would still constitute a disaster for a country that has averaged 8 percent annual development for the past decade.

The reasons why Southeast Asia is so dependent on increasing economic-development rates are demographic, social and political. Between 1965 and 1990, the annual growth rate of Southeast Asia's economically active population was 2.9 percent, the fastest in the world. Indeed, increased labor input, together with high savings and investment levels, are commonly credited with playing a large part in the region's economic miracle. The corollary is that rising growth needs to be maintained to keep all of these new workers employed.

Rapid economic development has both created and masked social tensions. Despite enormous achievements in alleviating poverty, Southeast Asia is widely considered by its residents to be a deeply unequal place. There is widespread resentment of a perceived 'wealth gap' between the plutocratic few who have made fortunes and the disadvantaged many who have not.

To some extent, the fact that everybody was getting richer eased these tensions. But fear of explosions of popular anger has led to a priority being placed on high growth rates at the expense, sometimes, of economic rationality. For more than a year, Indonesia has experienced riots, which often take the form of ethnic or religious pogroms, but whose roots lie more in social inequity. Thailand, which is by most measures the region's most unequal country, now faces the possibility of protests by thousands of workers who will lose their jobs in the recession.

Significantly, labor unrest is on the increase both in Thailand and Indonesia. Strikes in Indonesia, for example, involved 150,000 workers in 1994 compared to 1,000 in 1989. In both countries, pressure to create independent trade unions is likely to grow.

The risk of political instability is also greatest in Thailand. Financial collapse has coincided with Constitutional reform efforts to eradicate corruption which is widely -- and accurately -- seen as a central reason for the economic malaise.

Some members of the ruling elite can be expected to resist amendments to protect their vested interests. Thousands of village leaders, for example, have said that they will protest against the reforms. Bangkok's middle classes, who demonstrated against political manipulation by the army in 1992, are still angry and demanding change.

Indonesia, Malaysia and the Philippines are also in various stages of political transition. Indonesia's 1998 presidential 'election' is likely to result in 76-year-old President Soeharto continuing to hold office. His monopoly of power and failure to identify an heir apparent, however, make the eventual succession process highly prone to disruption. If economic growth slows, there is no shortage of potential rioters willing to take to the streets.

In the Philippines too, the prospect of presidential elections in 1998 dominates domestic politics. President Fidel Ramos will be obliged to stand down. While the business community would like someone in Ramos' mold to take over, the indications are that the electorate would prefer a more populist figure who might support a policy of economic nationalism. Soeharto's eventual successor might also pursue this option.

Even in Malaysia, a succession process is under way. Prime Minister Mahathir Mohamad has still not indicated when he will hand over power to his deputy, Anwar Ibrahim. The danger is that 71-year-old Mahathir, who is conscious of securing his place in history, will insist on finishing too many of the 'mega-projects' that he instigated. Mahathir seems to see these programs as a symbol of his legacy, despite the fact that they dangerously over-extend the country's economic capacity.

It was Mahathir who most fiercely blamed Southeast Asia's currency turmoil on the West. But all nine of the Association of Southeast Asian Nations (ASEAN) foreign ministers signed a communique on July 25, 1997 accusing Western speculators of 'well-coordinated efforts to destabilize ASEAN currencies for self-serving purposes'.

Although this rhetoric is partly directed at domestic audiences, it does highlight a common sense of vulnerability to the power of global markets. Since Southeast Asia has become dependent on foreign investment to finance large current-account deficits, protectionist measures -- such as capital controls -- are not really a long-term option. Closer cooperation among regional governments, however, is likely to emerge.

Currency-protection schemes introduced in 1995 following the collapse of the Mexican peso have been inadequate. Southeast Asian central banks signed a series of bilateral deals with each other, as well as with Australia, China, Hong Kong and Japan. The agreements, however, offered only very limited assistance -- liquid reserves were granted against the security of central banks' holdings of U.S. government bonds.

Central banks are working on more substantive forms of mutual assistance, such as a regional currency-defense fund. Such efforts will always be inhibited by the wealthier institutions' reluctance to commit their reserves to supporting a currency that is maintained at an indefensible level, as in Thailand. At the very least, however, closer coordination of currency management -- and hence of economic policy -- has become a pressing need.

In 1995, bullish Southeast Asian nations could highlight many reasons why their economies were not like Mexico's: high savings rates; fiscal surpluses; and soaring economic growth. Pessimists, however, could point to another: the absence of an overwhelmingly powerful financial actor that would rescue the region, as the U.S. did for Mexico in February 1995.

Thailand's efforts to persuade Japan to assume this role were rebuffed, despite Tokyo's huge financial stake in the country. Japan insisted that its support would have to be under IMF auspices. Nevertheless, Tokyo pledged $4 billion to the IMF's assistance package.

Japan's offer is no more than a recognition of economic reality. But it is also a sign of the relative decline of U.S. economic, political and even strategic influence in the region. Washington has not contributed to the rescue package.

In fact, to the outsider, ASEAN appears increasingly like an anti-U.S. forum, given the frequent clashes with Washington over human-rights issues, trade developments and now currency speculation. Although this is an illusion, the market turmoil has given a boost to leaders such as Mahathir who want greater economic cohesion between Southeast Asia and its Northeast Asian neighbors -- China, Japan and South Korea -- as a defense against U.S. and European pressure.

Successor regimes to those of Mahathir, President Soeharto and President Ramos may adopt a more nationalist stance in economics and politics unless the vulnerability of their economies to global pressures is addressed.

-- IISS