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The specter of a new Asian financial
crisis
By Alan Boyd
SYDNEY -
Hot money inflows. Weak banking sectors. Inflexible
exchange systems. Regulatory shortcomings. When these
and other structural deficiencies converged in 1997,
laid bare by a calamity in offshore loan repayments and
domestic capital accounts, Asia went into a financial
meltdown that would ultimately erase a decade of growth
from the young tiger economies of the East.
Incomes are now moving back to pre-crisis
levels, and Asia is likely to record the world's best
economic performance this year. Long-term poverty
remains high, but is steadily falling as wealth spreads
into more remote regions.
Yet the red flags are
again being hoisted as regulators dither over a mass of
policy challenges that should sound familiar: how to
reduce the unhealthy reliance on export revenues;
provide more cheap, local funding for business; and
shield exchange regimes from external hiccups.
The Asian Development Bank (ADB) suggested in
its annual Asian Development Outlook this week that a
failure to loosen fixed exchange rates and astutely
manage burgeoning offshore reserves had heightened the
risks of another financial crisis.
"While
originally the accumulation of reserves reflected the
prudent behavior of policymakers, increasingly, however,
it appears to be fueled by speculative market behavior
stemming from rigidities in many of the region's
exchange rates," the bank said.
Similar warnings
have been issued in recent weeks by the International
Monetary Fund (IMF) and the World Bank, which put rescue
packages together for the beleaguered Indonesian, Thai
and South Korean economies in 1997, and led later reform
efforts.
The research arm of Lehman Brothers
noted in a separate report that an upsurge in capital
flows had bloated international reserves to the point
where resurgent inflation would impact on interest
rates.
Six years ago, an accumulation of
offshore reserves, which underwrite a country's ability
to service its overseas debt and pay for imports, would
have been considered prudent economic management, as
they provide a cushion against sudden external shocks
such as oil-price rises.
But economists are
worried about the excessive weighting of dollars and
treasury bills in these standby funds, especially at a
time when strengthening regional currencies are
undermining export competitiveness and interest rates
are under siege from tightening US monetary policies.
According to the ADB, foreign reserves in Asia -
excluding Japan - rose by 18 percent to US$1.3 trillion
in 2003, largely because of dollar purchases that were
used to prevent local currencies from appreciating too
far. East Asia saw an increase of 35 percent.
Banks have absorbed excess domestic liquidity by
selling bonds and treasury bills, triggering a credit
boom that is feeding inflation and evoking fears of
another wave of bad loans as the dollar depreciates.
"The resulting expansion in money supply could
create asset bubbles, which in turn could create
conditions for another financial crisis," ADB chief
economist Ifzal Ali said in a statement.
Stock-market indices have reached their highest
point since the mid-1990s, when values were inflated by
a massive real-estate splurge and over-investment in
capital-intensive industries, such as petrochemicals and
steel. A sudden capital flight would have a dire effect
on exchange markets.
In 1996-97 the exchange
trend followed a similar pattern in the export-driven
East Asian economies, though for different reasons.
Major currencies in the region began to
appreciate in the first half of 1996, as an upsurge of
portfolio flows into Wall Street launched an equities
boom in the United States and revitalized the slumbering
dollar. East Asia was especially affected because 90
percent of trade was conducted in US dollars, and almost
all currencies were fixed to the greenback.
Offshore confidence was dented by the failure of
regulators to take effective remedial measures, and
doubts that reserves, which were mostly around the $20
billion mark, were adequate to cover higher repayment
costs on foreign debt and compensate for the lower
export revenues.
Another handicap was the
conflicting signals put out by political leaders, who
had scant understanding of the requirement for
independent monetary and fiscal policies, and in some
cases were liable to use state budgets as an extension
of their private business dealings.
Many of
these underlying structural flaws still exist.
Banks are mired in billions of dollars of
non-performing loans from loan defaults, and have not
overhauled their accounting and risk systems to global
standards, dampening credit ratings and keeping funding
costs high.
Corporate transparency and
governance are low, deterring foreign investors that
fear they will have limited say in how their joint
ventures are run. Disclosure rules for listed firms
often are not enforced.
A failure to develop
strong domestic supplier networks has left manufacturers
dependent upon imported parts, materials and
intermediate goods that are highly susceptible to
exchange movements.
Political systems are still
at a transitional stage from the 1997-98 upheaval, which
forced leadership changes in Indonesia, Thailand and the
Philippines. There are again political uncertainties in
the same countries, as well as in India, Taiwan,
Malaysia, South Korea, Sri Lanka, Pakistan, Hong Kong
and Nepal.
But should these challenges be read
as the early signs of another crisis, or merely as
teething problems? The answer probably lies in how Asian
economic planners respond, and how much say the global
community has in the matter.
One critical
difference from 1997 is that all leading economies other
than Malaysia, China and India have severed their direct
linkages with the US dollar, thus providing more scope
for exchange adjustments. And the three holdouts are
also moving to reduce their dollar exposure.
While there are signs that some countries are
wavering and may move back to fixed regimes to improve
their attractiveness to foreign investors, it appears
that they will embrace hybrid systems rather than the
rigid linkages of the 1990s.
China, which
inevitably attracts the most attention because of its
importance to the regional economy and investment
markets, announced last week that it was diversifying
some of its $440 billion reserve into European and Asian
bonds.
Chief foreign-exchange regulator Guo
Shuqing told the domestic media that China was moving
toward a floating currency system that would link the
yuan to a basket of currencies. Beijing has been under
intense pressure from its major trading partners to
untether the yuan and allow market conditions to reign.
India's central bank also is considering a full
flotation, but has to contend with more domestic
political pressure to keep shipment costs low. The rupee
is linked to a basket comprising the dollar, euro,
sterling and yen, but the euro is being given a bigger
weighting.
South Korea has set up an agency to
diversify its currency holdings, and Thailand has been
progressively building its euro exposure for several
years. The Thais are also reportedly bringing in more
regional currencies.
Another structural
improvement that has lengthened the odds on a recurrence
of the 1997 currency strains is a sharp drop in the
proportion of short-term overseas debt, which will
quench some of the heat being caused by speculative
stock market inflows.
Combined short-term debt
and portfolio inflows comprised 60-70 percent of all
loan obligations in the worst-hit economies in 1997, but
are now down to a more manageable 20-30 percent, while
reserves have in some cases doubled.
Even
Indonesia, viewed by many economists as the most
vulnerable to external pressures, is believed to have a
fairly modest exposure of $11 billion to $13 billion
from loan repayments and "hot" stock-market investments,
compared with at least $35 billion in 1997. Its reserves
have risen from $24 billion to an estimated $35 billion
to $37 billion in the same period.
The credit
bubble has again exposed the fragility of banking
systems in Indonesia, China, Thailand, Malaysia, South
Korea and the Philippines, and the need for tighter
scrutiny of lending activity.
There is
particular concern over liberal lending policies in
China, with the IMF noting a 65 percent surge in factory
and infrastructure loans during the first two months of
the year.
Yet the World Bank reported that loan
oversight had greatly improved in East Asia since 1997,
with a requirement for higher risk reserves that will
offer a buffer against short-term capital flight.
Monetary chiefs are pursuing regional
integration as a collective form of exchange security
for banks and the wider economy.
Thirteen
bilateral currency-swap arrangements, involving $33
billion, have been negotiated by East Asian countries
under the Chiang Mai Initiative, which will in effect
set aside reserves for the use of countries that come
under speculative attacks.
The Association of
Southeast Asian Nations (ASEAN) and its dialogue
partners are developing an Asian bonds market that
should help balance exchange pressures. Less
practically, there are hopes for a regional currency
that will probably be unrealized because of a lack of
policy coordination.
Lehman Brothers ranked
Thailand as the country least at risk from a recurrent
financial crisis in its quarterly Damocles Financial
Crisis report. The Philippines was given the lowest
score.
Significantly, the index rated Asia as
the "least vulnerable" among emerging markets globally,
noting that the global community could have a
substantial influence on efforts to prevent another
currency crisis.
"Pressure from the developed
world for greater exchange-rate flexibility in Asia is
bound to build and will ultimately prove irresistible.
This conclusion extends to China," the report said.
(Copyright 2004 Asia Times Online Co, Ltd. All
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