SEMINARS

Training and education in international affairs:
Japan, Palestine and the Middle East (1999)

Asia and the Recent Economic Crisis

Skeptics claimed that the Asian economic mira­cle was exaggerated, saying that Asia was bound to run into problems eventually. They had raised warning flags a year or two before the Thai cri­sis, noting that the current balance deficits of South­east Asian countries were as high as or even higher than those of Latin America in 1994. They also argued that Asian economies were not im­mune to financial crises. The reality was more complex and more critical: collapses in domestic asset markets, widespread bank failures, bank­rupt­cies of many firms, and so on. The econo­mies of Indonesia, Malaysia, and Thailand in particu­lar were closely interrelated in terms of their vulnerability to crisis.

The recent Asian currency and financial crises highlight both the positive and negative effects of global integration on individual economies. The positive effects stem from the influence of foreign capital in the form of foreign direct in­vestment, which accelerates industrialization and export promotion. On the other hand, three nega­tive effects have been pointed out:

1)     Globalization might enlarge income inequal­ity.

2)     Quick capital outflow, in particular short-term portfolio capital, disturbs the individual econ­omy.

3)     A mismatch arises between global standards and domestic institutions and customs - an­other reason for capital outflow.

Broadly speaking, observers suggested two theo­ries for the currency crisis:

1)     Budget deficits financed by using a limited stock of reserves made it difficult to maintain pegged exchange rate systems. Therefore, when reserves fell to a critical level, a specu­lative attack on the currency was gen­erated.

2)     Defending parity is more costly (e.g., higher in­terest rates) if the market believes that such a defense will ultimately fail. For this reason, therefore, a pegged exchange rate might mean a trade-off between short-term stability and long-term development.

At the same time, the Asian financial crisis seems to have revealed several fundamental eco­nomic weaknesses, which are as follows:

·       Fragile fundamentals, such as budget deficits, monetary expansion and inflationary pres­sure;

·       No incentives to abandon fixed exchange rates, because unemployment was not sub­stantial in the early stage of the crisis;

·       A boom-bust cycle in the asset market, such as stock and land prices, preceded the cur­rency crisis; and

·       Financial intermediaries, such as non-bank financial institutions in Thailand, took out too many foreign short-term loans, often in US dollars, then lent that money to specula­tive in­vestors. These intermediaries’ liabili­ties were largely guaranteed by the govern­ment, which posed the serious problem of moral haz­ard. Similarly, these countries of­fered easy access to global capital investors, thus also in­ducing moral hazard. As a result, external short-term loans brought about an asset bub­ble, which in turn generated real ex­cess capi­tal accumulation.

Within these contexts, there are two plausible ex­pla­nations for the crisis mechanisms:

·       Speculative money attack (the ASEAN capi­tal movement in terms of short-term portfolio money inflow had been relatively small, ex­cept in Thailand, in the previous three years); and

·       A fundamental deterioration in terms of cur­rent balance deficits with respect to the ap­preciation of real effective exchange rates.

For these reasons, governments failed to correct money supply expansion by sticking to a fixed exchange rate level (intervention in foreign ex­change markets by buying US dollars pushed up high-powered money, which eventually ex­panded money supply). Moreover, the steriliza­tion policy was ineffective because of less func­tional open-market operation, and financial sys­tems suffered from institutional failures.

Impact on Japan and its Role

The Asian currency and financial crises exerted various influences on the Japanese economy, which has close ties with the Asian economy, in­cluding a decrease of exports and increase of im­ports, deteriorating profits for Japanese com­pa­nies that have advanced into the Asian region, and the decline of loans to Asia to a non-per­forming status. Besides this direct impact, be­cause of the drop in the expected growth rate of the Asian econ­omy, which until then had been leading the world economy as a growth center, Japanese com­panies came to perceive a decline in busi­ness opportunities, and so their propensity for capi­tal investment in Asia was adversely affected.

As the ripples from the Asian currency and fi­nancial crises began to broaden and deepen, the impact on the Japanese economy came not only directly from the Asian countries concerned but also indirectly from such new markets as Russia and Latin American countries, the developed nations that have close relations with them, and also through the international financial market.

Although the situation has calmed somewhat, it still does not warrant optimism, since the Asian countries concerned continue to face economic recession, and their financial markets remain in confusion. Against this background, Japanese companies continue to see their Asia-bound ex­ports decline, and there is still concern that loans to Asia are going to be rendered increasingly non-performing.

There are, however, some good signs. The ex­ports of Asian countries are beginning to re­cover, and the business sentiment and earnings of Japanese companies in those countries, espe­cially export-oriented enterprises, are showing signs of picking up. If the Asian economy moves toward an export-led recovery, this development would also be a factor in propping up the Japa­nese economy through an increase of exports to Asia.

Regarding the domestic economies in the Asian countries, while there are moves to eliminate ex­cessive government intervention, there are also moves to carry out reforms in the direction of fur­ther consolidating their market economy sys­tems, including financial system reforms. Re­garding capi­tal transactions, however, there are differ­ences in the responses of South Korea and Thai­land, which are seeking to deregulate, and Ma­laysia, which is moving to tighten regu­lations. Further discussion is necessary on the issue of capital transfer regulations. Whatever the case, if the re­covery led by external demand continues and or­derly capital inflows to the Asian countries are resumed, it will lead to an expansion of domestic demand, and the econo­mies of Asian countries will hopefully move toward recovery. In that case, hopefully the Japanese and Asian sides could form a mutually beneficial cycle, in which the re­covery of Japan’s economy would contribute to the re­covery of the Asian economy and vice versa.

Japan is expected to play a role especially through the expansion of imports following do­mestic eco­nomic recovery, the supply of funds for financial stability in the Asian countries, and human re­sources development via technical co­operation. Regarding funds for financial stabil­ity, the New Miyazawa Initiative is extending funds in a form that is different from the finan­cial cooperation of the International Monetary Fund (IMF).

State of Progress of the New Miyazawa Initia­tive

South Korea

In a meeting of the leaders of Japan and South Korea on 8 October 1998, Japan indicated untied loans through the Export-Import Bank of Japan (JEXIM) of the yen equivalent to approximately US$2.35 billion.

In a meeting of the finance ministries of Japan and South Korea on 15 January 1999, on the oc­casion of an Asia-Europe Finance Ministers’ Meet­ing, Japan announced its commitment to short-term financial support of up to US$5 bil­lion.

Malaysia

In a meeting of the leaders of Japan and Malay­sia on 15 December 1998, on the occasion of a Japan-ASEAN summit, Japan indicated financial support totaling approximately US$1.5 billion.

[Export industry support two-step loan - JEXIM): about US$500 million; seven yen credits (Over­seas Economic Cooperation Fund): about US$1 billion.]

Thailand

In a meeting of the leaders of Japan and Thai­land on 16 December 1998, on the occasion of a Japan-ASEAN summit, Japan indicated financial sup­port totaling the yen equivalent of US$1.85 billion.

[Loans for economic and financial structure re­forms (JEXIM, co-financing with the World Bank): up to the yen equivalent of about US$600 million; manufacturing industry support two-step loan (JEXIM): yen equivalent of about US$250 billion; agricultural sector program loan (OECF, co-financing with the Asian Develop­ment Bank): yen equivalent of about US$250 million.]

Philippines

In a meeting between the finance ministers of Japan and the Philippines on 15 January 1999, Japan indicated financial support totaling the yen equivalent of US$1.4 billion.

[Electric power sector reform program loan (JEXIM, co-financing with the ADB): yen equiva­lent of about US$300 million; banking system re­form project loan (JEXIM, co-financ­ing with the World Bank): yen equivalent of about US$300 million; private-sector develop­ment two-step loan through the Philippines De­velopment Bank (JEXIM): yen equivalent of about US$500 mil­lion; Metropolitan Manila air pollution improve­ment program loan (OECF, co-financing with the ADB): yen equivalent of about US$300 million.]

Indonesia

When the Japanese Deputy Minister of Finance for International Affairs visited Indonesia on 5 Feb­ruary 1999, he delivered a letter from Fi­nance Minister Miyazawa to the President in which Japan indicated financial support totaling the yen equivalent of about US$2.4 billion.

[Parallel loan with the IMF’s expanded credit meas­ure (JEXIM); co-financing with the ADB’s program loan (JEXIM); co-financing with the World Bank’s program loan (JEXIM): yen equivalent of about US$1.5 billion; commodity loans, etc. (OECF); health and nutrition sector development program loan (OECF, co-financing with the ADB); social safety net program loan (OECF, co-financing with the World Bank): yen equivalent of about US$900 million.]

IMF Recommendations and Lessons

of the Asian Crisis

In light of the crisis, the IMF recommended to these countries the following:

·       The tightening of monetary and fiscal poli­cies;

·       The establishment of market discipline; and

·       Financial and banking system reform.

The IMF has been criticized by some econo­mists, such as Martin Feldstein, who argued in Foreign Affairs (“Refocusing the IMF,” March/April 1998) as follows: “The IMF is now acting in Southeast Asia and Korea in much the same way as it did in Eastern Europe and the former Soviet Union - insisting on fundamental changes in eco­nomic and institutional structures as a condition for receiving IMF funds.” Addition­ally, Feldstein pointed out the following: “The IMF should eschew the temptation to use cur­rency crisis as an opportunity to force funda­mental structural and institutional reforms on countries, however use­ful they may be in the long term, unless they are absolutely necessary to gain access to interna­tional funds.” As a con­clusion, Feldstein asserted that the “IMF should work with countries that have not yet reached a currency crisis in order to prevent the larger cur­rent account deficits or the excess short-term debts that could later precipi­tate a crisis.”

In view of the above argument, we could draw the following lessons from the Asian crisis. First, regarding the sequence of liberalization of finan­cial markets, a country should liberalize its do­mestic financial system before opening up to foreign capital. Second, financial liberalization requires the strict market discipline of financial institutions. Third, a flexible exchange rate sys­tem is fundamentally important. Free capital move­ment and pegged rates are a dangerous mix. Fourth, financial markets need reliable in­forma­tion to work efficiently. Fifth, in promot­ing the global integration of capital, the estab­lishment of a resilient regional capital market is an urgent task so as to reduce the ‘capital flight shock’. Lastly, in creating an individual capital market in each country, the concept of a regional mone­tary fund (such as the ‘Asian Monetary Fund’ recently propounded by the Government of Japan) helps to reinforce the architecture of the global financial market. It is worth nothing that such a regional financial institution is ex­pected to function on a regional basis and with looser conditions than the IMF.

An equally important issue is when and how such a regional monetary fund will be estab­lished. Obviously, the setup would require fi­nancial sup­port from the developed countries.