The beginning of the Asian financial crisis can be traced back to 2 July 1997. That was the day the Thai Government announced a managed float of the Baht and called on the International Monetary Fund (IMF) for ‘technical assistance’. That day the Baht fell around 20 per cent against the $US. This became the trigger for the Asian currency crisis. Within the week the Philippines and Malaysian Governments were heavily intervening to defend their currencies.
While Indonesia intervened and also allowed the currency to move in a widened trading range a sort of a float but with a floor below which the monetary authority acts to defend the currency against further falls. By the end of the month there was a ‘currency meltdown’ during which the Malaysian Prime Minister Mahathir attacked ‘rogue speculators’ and named the notorious speculator and hedge fund manager, George Soros, as being personally responsible for the fall in value of the ringgit.
Soon other East Asian economies became involved, Taiwan, Hong Kong, Singapore and others to varying degrees. Stock and property markets were also feeling the pressure though the declines in stock prices tended to show a less volatile but nevertheless downward trend over most of 1997. By 27 October the crisis had had a world wide impact, on that day provoking a massive response on Wall Street with the Dow Jones industrial average falling by 554. 26 or 7. 18 per cent, its biggest point fall in history, causing stock exchange officials to suspend trading.
Countries such as Thailand, Indonesia, Malaysia and the Philippines have embraced an unusual policy combination of liberalisation of controls on flows of financial capital on the one hand, and quasi-fixed/ heavily managed exchange rate systems on the other. These exchange rate systems have been operated largely through linkages with the United States (US) dollar as their anchor. (1) Such external policy mixes are only sustainable in the longer term if there is close harmonisation of economic/ financial policies and conditions with those of the anchor country (in this case, the United States).
Otherwise, establishing capital flows will inevitably undermine the exchange rate. Rather than harmonisation, there seems to have actually been increased economic and financial divergence with the US, especially in terms of current account deficits, inflation and interest rates. These increasing disparities have prompted global (and local) financial interests to speculate against the administered exchange rate linkages, i. e. speculative pressure mounted that the monetary authorities in these countries would not be able to hold their exchange rate links.
In most cases, such financial speculation has been of sufficient magnitude to actually provoke the collapse of the administered exchange rate links, in the manner of ‘self fulfilling’ prophecies. Defence of the exchange rate through the use of foreign exchange reserves and higher interest rates proved to be insufficient. (2) The result has been large devaluation’s of the exchange rates of these countries, especially against the US dollar.
Large interest rate increases to support the exchange rates at their new lower levels (to prevent wholesale over reaction and collapse in foreign exchange markets and to help contain the strong inflationary forces set in motion); and extra restrictions in fiscal policy. Designed to rise national saving, contain domestic spending and reassure foreign investors and international institutions such as the International Monetary Fund (IMF). Figure 1 shows the magnitude of this devaluation’s.
The IMF had arranged conditional financial support packages for Thailand and Indonesia. (3) Financial support is provided in exchange for (on condition of) economic policy reforms which, it is argued, will encourage economic recovery and help prevent a recurrence of the turmoil these countries are now experiencing. In the case of Australia, help to Thailand has taken the form of a ‘currency swap’ where Australia’s US dollar assets of up to $1 billion were exchanged for Thai Baht, with an agreement that the reverse exchange would occur at a future point in time.
These financial crises have also provoked substantial falls in the stock markets of these countries and in other parts of Asia. (They also contributed to stock market falls around the world). Foreign investor funds would have been initially withdrawn as exchange rate speculation mounted, and this would have partly taken the form of a sell off of foreign-owned stock. As well, much higher interest rates (both before and after the currency devaluation’s) encourage flows of funds out of shares and into loan/ debt-type assets.
In turn, higher interest rates and lower exchange rates have substantially increased the rate of collapse/ bankruptcy of businesses operating in highly leveraged sectors (especially where loan contracts were written in foreign currency), and this would have further undermined confidence in the stock markets throughout Asia. Figure 2 shows the recent stock market price falls in these countries. Overall, reductions in the growth of spending, production and employment in the region are likely to be prominent consequences of these financial crises.
Both as the direct result of the financial disruptions and also as the result of consequent contraction in economic policy changes that have been, and will be, implemented. Loss of general economic and financial confidence will reduce the growth in spending and output and the related tightening of fiscal and monetary policy will reinforce these effects. (5) Economic growth in these countries in the next couple of years will probably be substantially lower, and countries such as Thailand may actually tip over into recession, i. its absolute level of output may fall. This downturn is likely to continue until the inflationary forces unleashed by the large exchange rate devaluation’s have been tamed. Foreign exchange markets stabilise at their new lower prices, and the enhanced international trade competitiveness of these countries (arising largely from the currency devaluation’s) allows them to better implement export led growth strategies. Such strategies have traditionally been the most successful and effective means of encouraging growth in Asia.
Thailand and Indonesia seem to have been the worst affected by the economic and financial crisis of the last several months; Malaysia and the Philippines seem to be in somewhat better economic and financial shape, at least compared with Thailand and Indonesia. Singapore appears in turn to be much better placed than the rest of the region and is likely to have the least economic and financial problems. This is because of the latter’s more advanced economic structure, more sophisticated financial system, more flexible exchange rate system and substantial current account surpluses (in contrast to the deficits elsewhere in the region). ) Further Economic and Financial Problems Enhanced trade competitiveness will also help these countries better deal with their longer-term problems of repositioning their economies in a region where trade competition has intensified and where domestic policy directions have often been counter-productive. Competition from China and other developing countries in standardised products that make intensive use of low-skilled/ semiskilled labour have reduced export growth in Southeast Asia at the same time as imports of capital goods in the region have continued to grow strongly.
China has also been much assisted by earlier large exchange rate devaluation’s). These trends have contributed to large and increasing trade and current account deficits in the region, and this seems to have been one of the fundamental reasons why speculators and other financial interests began to move against many of the currencies of Southeast Asia. While much of the high rates of investment in these countries have been directed towards efficient and productive uses, a substantial part has gone into industries unsuited to the economic conditions of these countries.
Such as ‘national car’ projects), or into sectors (such as commercial property) where asset price inflation has distorted investment priorities and taken capital away from more efficient uses. Thus, the productivity of such investment has been lower than expected and has not contributed much to the ability of these countries to fund their capital imports. The bursting of asset price inflation bubbles, fuelled and then undermined by speculative activity, has also contributed to the economic and financial crisis (especially in countries such as Thailand).
This in turn has rapidly increased the amount of bad/non-performing loans in the banking systems of these countries (and for foreign lenders such as the Japanese banks) and has forced the closure or consolidation/ merger of a number of lending institutions. Thus, the crisis has enveloped the financial systems in the region, and has been accentuated by high rates of borrowing. Its resolution will also require structural reform of financial institutions. (7) The prudential regulation of financial institutions will probably also have to be drastically upgraded in these financial systems.
Asset price deflation, rising bad debts and failing banks provide a very dangerous mixture for national economic performance and may require several years of adjustment before they can be fully overcome. The case of Japan is both instructive and rather frightening. After rapid Japanese asset price inflation in the 1980s (especially in property and shares), the early 1990s there saw asset price crashes, escalating bad debts (since these were often secured against the now vastly devalued assets) and banks teetering on collapse.
Japan has seen very low economic growth in the last six years as it has attempted (ineffectively) to cope with such deep-seated financial problems. It is now clear that the Japanese financial sector has not been rationalised in the thorough way needed for strong economic recovery. Insolvent institutions beyond hope of trading their way out of trouble have not been closed but have been allowed to linger on. Bad loans beyond any genuine hope of payment have not been written off against shareholder capital and/or government funds but have remained hidden in the ‘nether regions’ of institutions’ balance sheets. ) However, more resolute action by Japanese financial regulators may now be forthcoming. It can only be hoped that the countries of Southeast Asia fare better but this will require rapid, concerted responses to the problems confronting them. The policy responses so far announced have been reasonably encouraging but much more needs to be done. (9) Affect to New Zealand New Zealand’s rapidly growing export markets in Southeast Asia will probably be cut back substantially in the next couple of years.
This is both because slower growth in the region will reduce the growth in demand for New Zealand exports, and also because the much lower real (inflation-adjusted) exchange rates of Southeast Asian countries will further reduce their imports by favouring domestic production the latter effect will also favour their exports. Further ‘second round’ adverse effects on our major trading partners such as Japan and South Korea will be important to New Zealand.
Similarly, New Zealand exports to Asia can be expected to eventually recover when exports from these Southeast Asian countries themselves accelerate under the influence of their devalued exchange rates. The latter export expansion will then help to generate broader recoveries in economic growth in the region. The strong ‘economic fundamentals’ of high rates of investment, saving, technological transfer, and expansion in education and training throughout Asia all point to the region recovering to robust economic growth once the current set of problems have been dealt with.
The crucial proviso is probably that financial sector problems in the region be effectively resolved). Thus, the medium to longer term prospects for New Zealand exports to Asia remain strong so long as our producers continue to be competitive in terms of price and quality. Estimates of reductions in New Zealand economic growth resulting from this negative external shock currently range from 0. 2 to 1. 0 percentage point falls in the next year or two. (13) Initial estimates were at the low end of the range, but more recent forecasts have generally been higher, as more adverse information has been received.
Falling growth in New Zealand exports is likely to be reinforced by cuts to investment and consumption plans). These estimates pose serious problems for the New Zealand economy and New Zealand economic policymakers. Most importantly, they imply that New Zealand economic recovery in the growth of output and employment, which according to many forecasters already looks to be only quite moderate and gradual, could be substantially nullified by the external economic shock emanating from Southeast Asia, and its flow-on effects on Northeast Asia. (14)
Difficult dilemmas for the current setting of New Zealand monetary and fiscal policy are thus created. For example, disturbances to New Zealand financial markets caused by the crisis alleviate against any current relaxation of monetary policy arising from consideration of the need to counter the external economic shock proactively. This is especially so in the case of the recent fall in the New Zealand dollar; this acts to encourage net exports and helps to counter the external shock (but also adds to domestic inflationary pressures, mainly through higher import prices).
However, this devaluation could prove to be substantially the result of financial market over-reaction and thus could be quite temporary in nature. Unfortunately, this may not become clear until end of 1999, by which time a further reduction in official interest rates might be rather late in terms of dampening the external shock. The enduring currency devaluation may be insufficient in itself to dampen the external shock substantially. On the other hand, even if monetary policy is relaxed now this will do little to nullify the shock’s effect on New Zealand spending and growth.
This is because of the substantial time lags involved in the impact of such monetary policy changes on the economy. However, such a policy relaxation could help to bolster growth after next calendar year, if the effects of the crisis on New Zealand are expected to last that long. Monetary policymakers also seem to be restrained at the present time by uncertainty about the magnitude and duration of the economic effects of the Asian crisis on New Zealand, and its effects upon the future course of New Zealand inflation in particular. 5) This also comes at a time when official forecasts already see inflation rising back into its target range, in 2000, of 2-3% underlying inflation. (16) Fiscal/ budgetary policy might also help to dampen the shock by temporarily moving to a more expansionary/less restrictive stance. It is an attractive policy tool since it has shorter lags of impact on the economy than monetary policy and is less likely to generate exchange rate devaluation (and consequent intensified inflation pressures) than monetary policy.
This might allow stronger growth while also allowing the inflation target to continue to be met. However, fiscal policy is currently in a contraction stance at the national level, being preoccupied with budget deficit reduction to boost levels of national saving and help contain current account deficits. Indeed, New Zealand’s current account deficit is highly likely to increase as a result of the negative external shock arising from Asia, and this mitigates against any move to fiscal policy expansion.