(This article appeared in Southeast Asian Affairs, 1998)

In 1997, while the Association of Southeast Asian Nations (ASEAN) proudly looked back at its past thirty years of accomplishment in forging regional peace and security, vibrant economic growth, and higher levels of social welfare, a new issue – economic security – confronted the grouping’s economies. Rapid growth of over 7 per cent per annum achieved during the past decade, which made ASEAN one of the fastest-growing regions in the world, came to a crashing end because of the financial crisis that hit the region in the second half of the year. ASEAN’s economic growth in 1998 is predicted to be the lowest in the last three decades.

However, the factors that contributed to rapid economic expansion in ASEAN countries remain strong, and have the potential to return the region’s economies back to a sustainable growth path. ASEAN continues to enjoy, for example, high levels of saving, a strong work ethic, low underlying inflation rates, and a dynamic and entrepreneurial private sector.

In previous instances of economic slow-downs in the 1980s and 1990s, each ASEAN’ country was able to come out relatively unscathed after the restructuring of their industrial sectors. Since then, the region’s rapid economic growth, particularly in the real sector, has resulted in strong demand for capital to finance economic development. This led to large inflows of both long and short-term capital into the region. The development of strong financial institutions both at the regional level and for each ASEAN member country is of crucial importance in order to cope with such large inflows. The adjustment to the present crisis will therefore be different from previous ones. The crisis is a region-wide phenomenon and calls for a regional solution. It also involves private debts for which the role of the private sector would be crucial.

ASEAN Economies Up to the 1990s: An Overview

To understand the financial turmoil it is necessary to begin by looking at macroeconomic developments in the region up to the middle of 1997. The sound macroeconomic fundamentals of ASEAN countries defied any suspicion of the dramatic collapse of exchange rates that began in July 1997.

Over the past twenty-five years, ASEAN has been one of the fastest-growing regions in the world. Between the1970s and 1995, the gross domestic product (GDP) of ASEAN countries grew at an average annual rate of 6.6 per cent. This is a remarkable achievement since other developing countries grew by only about 3 per cent during the same period. More remarkable was the fact that the high rates of growth were sustained in the face of major upheavals in the world economy, including the collapse of the Bretton Woods system and the global recession of the early 1980s and early 1990s. Growth actually accelerated in the early 1990s before it peaked in 1994-95 with Malaysia, Singapore, and Thailand enjoying growth rates in the range of 8-10 per cent. Even the Philippines, which had been bypassed by the East Asian Miracle, had begun its economic recovery sustained by a decade-long process of reform and liberalization (Table 1).

During this period, ASEAN countries dramatically transformed and consolidated production structures. Agriculture’s share of GDP fell from about 40 per cent in 1960 to 14 per cent in 1993. In 1960, industry accounted for only about 20 per cent of the GDP; by 1993, this figure had more than doubled. Today, industrial growth in ASEAN has begun to show the hallmarks of modernization and rapid industrialization, with electrical appliances, machinery, chemicals, and other manufacturers becoming as important as the cultivation and processing of food, raw materials, and textile goods. The force for this transition was enhanced by ASEAN’s export-orientation, supplemented by liberalization both within the region and internationally.

The acceleration of growth in the 1990s was generally achieved without generating inflationary pressure. With the exception of the Philippines, inflation in the five ASEAN countries considered in this article remained within single digits. Given the GDP growth of about 7 per cent during this period and the boom in the export sector, maintaining a low level of inflation was quite an achievement (Table 2).

TABLE 1
GDP Growth Rates, 1991-96
(Percentages)

Country

1991

1992

1993

1994

1995

1996

Brunei Darussalam

4

-1.1

0.5

1.8

2

3.5

Indonesia

8.9

7.2

7.3

7.5

8.1

7.8

Laos

n.a.

7

5.9

8.1

7

7

Malaysia

8.6

7.8

8.3

9.2

9.5

8.6

Myanmar

n.a.

n.a.

n.a.

9.2

6.9

5.8

Philippines

0

0.3

2.1

4.4

4.8

5.7

Singapore

7.3

6.2

10.4

10.5

8.8

7

Thailand

8.5

8.1

8.3

8.8

8.6

6.6

Vietnam

n.a.

8.6

8.8

8.8

9.5

9.4

SOURCE: ASEAN Macroeconomic Outlook, 1997-1998 (Jakarta: ASEAN Academic Press, ASEAN Secretariat, 1998).

TABLE 2
CPI inflation Rates, 1991-96
(Percentages)

Country

1991

1992

1993

1994

1995

1996

Indonesia

9.5

4.9

9.8

9.2

8.6

6.5

Malaysia

4.4

4.7

3.6

3.7

3.4

3.5

Philippines

18.7

8.9

7.6

9

8.1

8.4

Singapore

3.4

2.3

2.3

3.1

1.7

1.4

Thailand

5.7

4.1

3.3

5

5.8

5.9

SOURCE: ASEAN Macroeconomic Outlook, 1997-1998 (Jakarta: ASEAN Academic Press, ASEAN Secretariat, 1998).

The clearest sign of macroeconomic stability was that almost all countries ran budgetary surpluses through the 1990s. Singapore had traditionally run budgetary surpluses even though it had a low-tax regime. Thailand ran budgetary surpluses for nearly a decade from the mid-1980s. Only the Philippines struggled to bring its fiscal house in order, but in 1996 it managed to run a surplus in the consolidated public sector as a result of the passage of important tax measures between 1993 and 1996 and administrative improvements in tax collection (Table 3).

The engine of growth for the ASEAN countries was exports. Their exports grew more than fifty-fold, from US$6.3 billion in 1970 to US$340 billion in 1996, making it the fourth largest trading region in the world, lagging behind only the European Union, the United States, and Japan. Export growth was strong for most countries until 1996, with Malaysia, Singapore, and Thailand showing exceptional strength. Singapore’s exports more than doubled from US$58.4 billion in 1991 to US$122.5 billion in 1996 (Table 4).

TABLE 3
Fiscal Position (Percentage of GDP), 1991-96

Country

1991

1992

1993

1994

1995

1996

Indonesia

0.5

-0.5

0.9

n.a.

0.5

n.a.

Malaysia

1.8

-2.6

-2.2

3.5

3.2

3.7

Philippines

-2.1

-1.2

-1.5

-1

-0.6

0.3

Singapore

4.7

4.9

5.9

7.4

6.1

5.9

Thailand

4.9

3.1

2.2

1.8

2.7

2.2

SOURCE: ASEAN Macroeconomic Outlook, 1997-1998 (Jakarta: ASEAN Academic Press, ASEAN Secretariat, 1998).

TABLE 4
Export Growth, 1991-96
(Percentages)

Country

1991

1992

1993

1994

1995

1996

Indonesia

19.9

14.7

6.6

9

4.3

6.5

Malaysia

14.1

6.2

17.2

22.5

17.6

7.2

Philippines

0.1

4.3

6.2

19.8

12

20.3

Singapore

n.a.

9.6

17.3

26.5

21.6

6.1

Thailand

23.5

13.2

13

21.3

23.6

-0.2

SOURCE: ASEAN Macroeconomic Outlook, 1997-1998 (Jakarta: ASEAN Academic Press, ASEAN Secretariat, 1998).

The major concern with the macroeconomic picture in ASEAN was the relatively high current account deficits, especially for Malaysia and Thailand. By 1995 the deficits had grown to 8.1 per cent of GDP in the case of Thailand and 10 per cent of GDP for Malaysia. For the most part, the deficits were associated with lumpy investment expenditures and were therefore short term in nature and did not reflect a structural imbalance. Nevertheless, by 1996 most countries were engineering a soft landing for their economies from the perhaps unsustainable boom years of 1994-95. With the exception of Thailand, current account deficits had been reduced to more sustainable levels by the end of 1996 (Table 5).

TABLE 5
Current Account Deficit as a Percentage of GDP, 1991-96

Country

1991

1992

1993

1994

1995

1996

Indonesia

-3.4

-2.2

-1.5

-1.7

-3.4

-3.4

Malaysia

-8.8

-3.8

-4.8

-7.8

-10

-4.9

Philippines

-1.9

-1.6

-5.5

-4.6

-4.4

-4.5

Singapore

11.2

11.3

7.5

17.1

16.9

15

Thailand

-7

-5.7

-5.1

-5.6

-8.1

-7.9

SOURCE: ASEAN Macroeconomic Outlook, 1997-1998 (Jakarta: ASEAN Academic Press, ASEAN Secretariat, 1998).

The current account deficit by itself is not necessarily a sign of structural weakness, since creditors who provide the financing must be convinced by the positive prospects of adequate returns on their investments.

In short, the macroeconomic evidence gave very little hint of the coming crisis. This suggests that the financial meltdown of the region had roots substantially different from past financial crises within and outside the region. In Latin America, lack of public sector discipline and unsustainable and unproductive financing of public projects through sovereign debt were the root cause of economic upheavals.

Causes of the Financial Crisis

The causes of the financial crisis continue to be hotly debated. Given the intellectual and political passion expended on the issue, it is likely to be some time before a consensus on this issue emerges. The following looks first at events leading up to the crisis, then provides a synthesis of the debate on its causes.

Most ASEAN countries maintained an exchange rate pegged to the U.S. dollar for many years. This provided a sense of security to the business community. However, when the U.S. dollar started to strengthen in 1995 and throughout 1996, particularly vis-a-vis the yen, ASEAN currencies also became stronger. The stronger ASEAN currencies partly explain the decline in exports of ASEAN in 1996, which grew by only about 8 per cent compared with 14 per cent in 1995. For Thailand, export growth was essentially nil in 1996. The decline in exports could also be partly explained by the loss of ASEAN countries’ export competitiveness, particularly in electrical goods, which constituted more than half of ASEAN exports. The decrease in exports worsened the trade deficit, increasing the current account deficit.

The rapid economic expansion in the region had increased the demand for foreign borrowing. In an environment of stable exchange rates and high interest rates in ASEAN countries, foreign capital inflows increased. Statistics from the Bank for International Settlements show that by the end of June 1997, cross-border claims in all currencies and local claims in non-local currencies for eight ASEAN countries (excluding Singapore) reached a total of US$173 billion. It is interesting to note that about 60 per cent of these claims were from the non-bank private sector. This was stimulated by the opening of the capital accounts in ASEAN countries. In Indonesia, Malaysia, and Thailand, the non-bank private sector shares were as high as 67 per cent, 57 per cent, and 59 per cent, respectively (Table 6).

The increase in the availability of capital enabled the expansion of loans for private spending particularly in real estate and motor cars, creating a price bubble for these sectors. When the bubble collapsed, the entire financial system was severely affected. In Thailand, the Bank of Thailand initially attempted to support financial institutions in difficulty. Its failure to salvage the biggest of the finance companies, Finance One, in early 1997, attracted international attention particularly from foreign lenders, triggering fears of loan defaults and worsening creditworthiness. Short-term loan creditors started to withdraw their funds from these institutions.

In addition, expectations of a Japanese recovery in early May 1997 led to a sharp appreciation of the yen and a sudden rise in Japanese short-term interest rates. Investors started to withdraw their funds from Southeast Asian markets to take advantage of the higher interest rates in Japan.

The withdrawal of short-term credit placed considerable pressure on the reserves and exchange rates, making the baht vulnerable. The Bank of Thailand virtually lost all its reserves while attempting to defend the baht, and was forced to float the currency on 2 July 1997. By the end of that month, Thailand had requested assistance from the International Monetary Fund (IMF); by then the contagion effect had spread to the Philippines, Malaysia, and Indonesia, which then floated their exchange rates.

TABLE 6
Cross-Border Claims in All Currencies and
Local Claims in Non-Local Currencies, End June 1997
(US$ million)

Claims
vis-à-vis
Total Bank Non-Bank Unallocated
Public Sector Private Sector

Brunei

151

22
(14.57)

1
(0.66)

128
(84.77)

-
(0.00)

Cambodia

21

6
(28.57)

-
(0.00)

15
(71.43)

-
(0.00)

Indonesia

58,726

12,393
(21.10)

6,506
(11.08)

39,742
(67.67)

85
(0.14)

Laos

20

8
(40.00)

-
(0.00)

12
(60.00)

-
(0.00)

Malaysia

28,820

10,486
(36.38)

11,851
(6.42)

16,460
(57.11)

23
(0.08)

Myanmar

82

15
(18.29)

-
(0.00)

67
(81.71)

-
(0.00)

Philippines

149115

51485
(38.86)

1,855
(13.14)

6,772
(47.98)

3
(0.02)

Thailand

69,382

26,069
(37.57)

1,968
(2.84)

41,262
(59.47)

83
(0.12)

Vietnam

1,456

579
(39.77)

112
(7.69)

756
(51.92)

9
(0.62)

Total

173,573

55,298
(31.86)

12,327
(7.10)

105,744
(60.92)

203
(0.12)

NOTE: Singapore is an Offshore Banking Country, and hence, not included here. Figures within parentheses are percentage shares for each country.
SOURCE: Bank for International Settlements, Monetary and Economic Department, “The Maturity, Sectoral and Nationality Distribution of International Bank Lending, First Half 1997″ (Basle, Switzerland, January 1998), table 1.

At its most basic, the debate over the causes of the crisis centres on whether the cause was (i) weakness in the fundamentals of the ASEAN economies or (ii) risk factors associated with open capital and financial markets. However, one cannot discount the fact that different factors played a role at different times and in different countries in the progressive worsening of the crisis. As such, to identify one basic cause of the crisis would be too simplistic.

Weaknesses in Macroeconomic Fundamentals

This thesis explains the financial turmoil as a predictable consequence of structural weaknesses in the region’s economies. These weaknesses are argued to be: first, low productivity and declining competitiveness, especially vis-a-vis other regions of the world; second, weakness in the financial sector, particularly inadequate supervision of financial institutions and lack of adequate disclosure; and third, poor governance.

Krugman has argued that there has been no East Asian Miracle and that the high growth rates achieved by the region had come about mainly from increases in the utilization of the factors of production (labour and capital) rather than from an increase in the productivity of these factors.’ While the empirical basis of that argument has continued to be debated, a recent paper by Tan Kong Yam, using data compiled by the World Economic Forum to measure competitiveness, claims to find evidence of loss of competitiveness among the ASEAN ecoiiomies.2 This occurred even as growth had resumed in Latin America and while new low-cost competitors such as China and India had arisen. The result has been the erosion of ASEAN’s share in export markets and more competition for scarce foreign direct investment.

A number of important features in the financial systems of the region have been widely cited as contributing to the current crisis. Foremost among analysts’ concerns has been poor regulation of financial systems. The rapid expansion of credit and the resultant accumulation of assets of poor quality have been taken as important confirmation of the region’s poor regulation of financial institutions.

The policy of fixing the exchange rate of the local currency to the dollar also aggravated the problem. Interest rates in the ASEAN countries have typically been higher than international rates. With the exchange rate risk absorbed by the central bank, the interest rate differential induced the inflow of both long-term and short-term investments. Domestic companies found it cheaper to borrow from offshore markets rather than from the domestic financial system. As a result, there was an unsustainable accumulation of short term foreign indebtedness.

Implicit guarantees that some banks or financial institutions were too big to fail also contributed to moral hazard. Financial institutions tended to take more risks than would have been justified without the guarantee. This was a result of rapid but poorly managed liberalization of the financial sectors in the region.

However, it would be unrealistic to focus attention on regional banks alone. Statistics indicate that a large proportion of private debt in the region had been channelled directly through foreign banks, particularly in Thailand, Malaysia, and Indonesia. The moral hazard proposition can therefore be extended to the international financial sectors. Perhaps a lack of a clear international legal framework for financial institutions contributed to the over-extension of loans to the private sectors in the region.

While the degree of compliance with international norms of financial reporting varies in the region, there is a general feeling that it is less than optimal. Siamwalla has pointed out that the accounts kept by many “finance” companies in Thailand that went bankrupt were unreliable.’ Without reliable and adequate financial accounts in these institutions, it is difficult for regulators to monitor properly the level of risk incurred by these companies.

As a consequence of these weaknesses, the financial system in the region was unable to perform its proper functions of allocating savings to those sectors with the highest social returns, and sorting good from bad credit risks.

Lack of good governance has been a code word used for the presumed region wide practice of using non-transparent processes as a basis for awarding lucrative commercial deals, usually based on political or family connections. This is supposed to have encouraged lending to companies connected to the powers that be regardless of the intrinsic viability of those companies and their projects.

While anecdotal evidence of such practices may be found, it is difficult to gauge their true extent in the region. Even more important, it is difficult to determine whether the economic consequences of these practices differ significantly from the pork-barrel politics practised in other parts of the world. In countries which lack appropriate market and legal institutions within which adequate information can be obtained and legal contracts can be properly enforced, implicit and informal arrangements may be an efficient, albeit transitional, means for regulating economic activity.

Also, pundits have argued in more general terms that the overall lack of transparency, cronyism and so forth in the conduct of economic activities in some of the ASEAN countries is one of the main causes of the crisis. Examples cited are often unrelated to economic sectors or companies which have capitalization in the stock markets or to the financial sectors of the economy. Arguments for informal arrangements aside, how these have any direct impact on the exchange rate depreciation or on the financial turmoil is unclear. Such “politicized” arguments should be best left aside.

Openness of the Capital Account

In contrast to the structural weakness thesis, the other explanation stresses the inherent risks associated with financial markets and liberalization. According to this explanation, moral hazard, bubbles, and the herd instinct are natural features of financial markets. Hence, under some circumstances, it is possible to turn a local instability into a global one.

Stiglitz has likened the ASEAN financial turmoil to a small boat out in the open sea. One can make the boat as seaworthy as possible but in the end, a huge storm can tip the boat over, no matter how well it was made. However, if the boat leaks, it will sink by itself.

In this view, financial markets are intrinsically different from markets for commodities. In the market for grain, the price of corn quoted on the Chicago Board of Trade tells the buyer and seller all that they need to know about the product. As the price goes up, quantities demanded and supplied move in predictable directions. On the other hand, the price of a financial contract does not contain all the necessary information needed by the buyer and seller. This market is characterized by information asymmetries and hence the price may be a misleading indicator of the quality of the financial product. Hence it is possible that as the interest rate that a borrower is willing to pay increases, the lender may be justified in actually turning away the borrower since it may indicate the underlying riskiness of the borrower. Furthermore, financial markets are subject to bubbles and to self-fulfilling prophecies. The massive short-term private capital inflows into developing countries have long been studied, and economists have warned of the consequences. Given the “openness” of the international financial markets together with market imperfections and investor irrationality, the impact of any sudden outflows would be unjustifiably damaging.

McKinnon and Pill have described how the opening up of the capital account can aggravate inherent problems of moral hazard on the part of domestic financial institutions. Opening up the capital account leads to overborrowing by the domestic financial system, which exacerbates the eventual crisis.

The associated pitfalls with opening up the capital account are not mere theoretical constructs. Previous episodes have occurred in Chile in 1981 and Mexico in 1995. In fact, Chile’s experience led it subsequently to apply direct controls on foreign capital flows, although it has long been held as a paragon of laissez faire policies. James Tobin had in fact proposed the idea of a tax on foreign capital flows to reduce any destablizing effects of sudden inflows or outflows (“Tobin Tax”). In the case of the present ASEAN turmoil, Montes has argued that in Thailand and Indonesia, the openness of the capital account led to an increase in foreign borrowing by financial institutions, especially the commercial banks. And, as shown in Table 6, borrowing by the non-bank private sector expanded even faster.

The inflow of short-term funds can quickly create an asset bubble. Then, it is only a matter of time before animal spirits, or exuberance, lead to bad investment choices. Once foreign capital inflows accumulate in the domestic financial system, small perturbations or shocks can quickly lead to a massive withdrawal of finance with a consequent deflation of asset prices, loss of investor confidence, increasing domestic bankruptcies and a decrease in real activity.

The region did see a massive run-up in stock market and real estate values in the 1994-96 period at the height of the market mania. While good and poor investment choices were certainly made, the overall quality of investments made with the funds would have declined. Then a flurry of bad news such as the export slow-down in the region – began to affect investor confidence. This precipitated speculative attacks against regional currencies, and once the baht was devalued the process quickly unravelled.

Clearly, a sober response to the financial crisis must require policy-makers to consider all possible explanations of the crisis and not prematurely discount one explanation or the other. Each of these explanations must be weighed carefully for they are likely to contain kernels of truth that would help the region ultimately break free of the consequences of the turmoil.

Impact of the Crisis

The financial crisis has had a significant impact on ASEAN countries, the effects of which are likely to be felt beyond the immediate and medium terms. Chronologically, what started out as an exchange rate crisis swiftly became a banking and financial crisis. By late 1997 it had infected the real sectors due to rising interest rates, higher costs of imports, credit crunches in the banking sector, and the resultant bankruptcies of firms which had become insolvent.

The financial crisis has directly affected four ASEAN member countries: Thailand, Indonesia, Malaysia, and the Philippines. Panic in the financial markets caused the exchange rates for these countries to weaken and destabilize. The depreciation of these currencies placed pressure on Singapore, the regional trade Centre, to follow suit. Brunei Darussalam earns petrodollars from its exports of oil and gas, and major imports of food come from ASEAN countries with devalued currencies; but the Brunei dollar was also devalued since it is tied to the Singapore dollar. The new members of ASEAN, Vietnam, Laos, and Myanmar – and the remaining future member, Cambodia – were also affected, as most of their foreign direct investments come from the older member countries of ASEAN.

Weaker, Unstable Exchange Rates and Weakened Financial Institutions

The impact was first felt in the foreign exchange markets, with ASEAN currencies being devalued in a dramatic fashion, and within a very short period of time. At its worst during the first weeks of January 1998, the baht had fallen by 40 per cent, the rupiah by 80 per cent, the ringgit by 40 per cent, and the peso by 30 per cent against the dollar from their values on I July 1997.

Because of the high exposure of the domestic banking and financial systems in unhedged foreign debts, the fall in local currencies immediately bloated the liabilities of these institutions, rendering many of them technically insolvent. As a result Indonesia was forced to close sixteen banks while Thailand suspended the operations of fifty-six finance companies, then eventually closed fifty-four.

Higher Interest Rates

To moderate the continuing pressure on the local currency, policy-makers across the region had to raise domestic interest rates. This made tile situation worse for the financial institutions, since the cost of funds rose even as they struggled with their foreign exchange liabilities. And the higher interest rates made it difficult for companies to obtain funds for investment, for working capital, and in some cases, even trade financing. The high interest rate regime led to a slow-down in manufacturing and industrial activity in the region. The difficulties were compounded by the higher cost of imported raw materials because of the depreciation as well as the credit crunch on banks to give out loans to companies. As a result many companies have had to shelve expansion plans, bring down inventory levels, and lay off workers.

Unemployment

Although there is no thorough study on the level of unemployment generated by the financial crisis, recent statistics on the closure of business operations show that it will be quite large. Habito has indicated that since the financial crisis started in July, over 430 companies in the Philippines have closed down and about 40,000 workers laid off.’ The closure of these companies will in turn lead to a subsequent round of consolidation in employment in all companies. The International Labour Organization (ILO) has estimated an increase in unemployment of 3 million in Indonesia, 1.5 million in Thailand, and about 150,000 in Malaysia.

Social Impact

One of the worrying aspects of the crisis is the prospect of long-term damage to the economic and social fabric of the region. In Latin America the debt crisis of the 1980s resulted in a “lost decade”, with the region taking nearly a decade to recover to pre-crisis levels of per capita incomes. The Latin American experience suggests the most affected group is likely to be the middle-income categories, especially those workers with fixed incomes in the urban areas. With the decrease in their incomes and the increase in the price of imported goods, the effect will be particularly felt in areas such as reduced levels of health care, food and nutrition (notably imported food items such as milk for infants and children), and education.

In most ASEAN countries essential medical products are imported. The devaluation will increase the costs of health care. At the same time the reduction of government budgets will eat into public health care programmes. Such factors, together with the decrease in household incomes, will undoubtedly reduce health care, especially for the poor.

One of the tragic coincidences of the financial crisis is that it occurred at a time when some countries in the region were going through their worst drought in decades as a result of the El Nino phenomenon. The currency devaluation aggravated this by increasing the domestic price of all tradable commodities, including food. For the urban poor, this increase in the price of food will have an impact on the quality and quantity of nutrition. In the Latin American experience, the rural population was least affected by the debt crisis since this group of people was self-sufficient in food. In the case of Indonesia and some areas in other ASEAN countries, the rural poor will not have that luxury due to the devastating effects of the El Nino.

In some cases, children will have to leave school because of the increased cost of schooling and the need for them to work to contribute to the income of the family. This will have a long-term impact on the quality of the labour force in the region.

The crisis may also lead to a deterioration of the environment in the region. As governments cut spending to maintain fiscal balance, environmental protection may rank low in priority. The decrease in household incomes may also force the poor to exploit natural resources more intensively, leading to problems such as over-grazing and over-fishing. Such increase in the use of natural resources may, in turn, affect the sustainability of the environment.

Regional and Global Economies

The financial crisis will have significant international repercussions. The ASEANT countries collectively represent the fourth largest trading region in the world market. In 1996, ASEAN exported about US$650 billion and imported approximately US$700 billion.

Since the exchange rates of most currencies in ASEAN have been reduced at similar rates, there has been limited change in the cross exchange rates among these countries. This may not induce much change in the pattern of intra-regional trade. Imports from ASEAN countries may have become relatively cheaper while exports to non-ASEAN countries may be more attractive, resulting in an increase in the trade imbalance regionally among ASEAN countries. However, the increase in imports may be checked by the decrease in incomes in each country in the region.

The change in exchange rates, particularly vis-a-vis major trading partners – the United States, the European Union, Japan – will reduce extra-regional imports and increase extra-regional exports. The decrease in exchange rates will make ASEAN exports cheaper internationally. Increasing exports is the key to recovery in ASEAN. This requires the market for major export destinations to remain open. ASEAN imports will diminish because of the reduction in purchasing power brought about by the depreciation of currencies and the reduction of income. An increase in the trade surplus is expected.

The resultant increased competitiveness of ASEAN products in export markets, and the reduction in imports by ASEAN countries, would induce a reduction in global economic growth. The World Bank has reduced its estimate of world growth in 1998 from 3 per cent to about 1.5 per cent. The World Trade Organization also expects growth of world exports to fall from 9.5 per cent in 1997 to 6.5-7.5 per cent in 1998. If the response to these pressures by the developed countries results in their slowing down imports, the crisis in ASEAN will be deepened and the recovery process will become more difficult.

Solutions

A range of solutions must be considered to remedy the crisis. At least six areas should be addressed: stabilization of exchange rates in the region; cushioning the social impact; strengthening financial institutions; greater involvement of the domestic private sector; adjustment of industrial structures; and reforming international financial markets.

Stabilizing the Exchange Rate and Debt Management

Currencies in the region are now free-floating. The prevailing market exchange rates are higher than what is believed to be the real exchange rate, which reflects the true value of each currency. There is a need for the rate to come quickly to the real exchange rate. This process can start when all the currencies are stable and major debt problems have been resolved. To resolve the debt problem, Akyuz proposes the following steps:

  • debt stand-still – this will stop the withdrawal of foreign lending and debt-run;
  • roll-over and rescheduling of the loans – this will allow the servicing of the debt through export earnings and not through increased external borrowing (which generally incurs penalizing interest rates);
  • provision of working capital to keep business activities going; and
  • an accommodating monetary policy designed to allow debtors to restructure their balance sheets and to maintain growth in demand.

Some ASEAN countries – notably Thailand – succeeded in managing their debt problems and have found that their currencies stabilized. Unfortunately, these successes were not intrinsic to the IMF programmes. On the contrary, some of the conditionalities imposed by the IMF may even work against debt 1-nanagei-nent. For example, tight fiscal and monetary policy imposed by the IMF is unnecessarily contractionary and reduces the availability of credit in the system. Various segments of the private sector, particularly in Indonesia, have complained about the shortage of credit to finance trade transactions. The contractionary policies also squeeze domestic demand and reduce the consumption of goods. This will aggravate the crisis.

Dealing with the Social Impact

The most urgent issue is to prevent the short-term negative social impact induced by the crisis from having a long-term impact with non-reversible consequences. The availability of food at an affordable price for the poorer population, especially those in the urban areas, is an urgent issue and needs to be addressed immediately. This would not have been a major problem for ASEAN if not for the drought caused by the El Nino in some ASEAN countries. The ASEAN Food Security Reserve, which provides for emergency rice reserves for member countries, could be used for this purpose.

With tight fiscal policies, there will be a reduction in the health budgets of most ASEAN countries. Aside from this, the devaluation will make imported pharmaceutical products more expensive. Suppliers of health care products should be given priority in import credits, if possible at concessionary interest rates.

The problem of poor students dropping out of school because of the crisis could have severe long-term repercussions. Given tight budgets, private organizations should play a more active role here. Activities such as school lunch programmes and the donation of books will help to cushion the negative impact of the crisis on future levels of human resource development.

Strengthening the Financial Sector

In most ASEAN countries, the crisis has pried open the financial sectors. With increased foreign ownership in this sector it is hoped that better discipline will be put in place. At the same time, there must be some assurance that foreign capital will not leave the country at the first sign of trouble. Prudential supervision and regulation of new financial institutions in ASEAN countries will be a different ball game compared with the past. There will be a need for increased disclosure and transparency requirements to keep the public informed of the performance of this sector.

There is a need for funding to facilitate adjustments for recovery. This is to reduce the cost of industrial restructuring between companies in declining industries and those in “winning” industries. While some funds can be generated abroad, it is important to mobilize savings in the country. One option is to develop further financial instruments and the market in areas such as the bond market.

The Private Sector and the Individual Citizen

In addition to the governments, the key players in the recovery of the ASEAN economies are the private sectors and individual citizens (that is, households). While the standard approach to recovery in these kinds of situations is to increase exports, recovery will be undermined by decreases in government expenditure, private investment, and consumption. It is important to prevent substantial declines in these three areas, and additional sources of growth must be identified.

Government expenditure will decrease, partly induced by the reduction in government revenue and, in some countries, the maintenance of budget surplus required by the IMF. This constrains the function of a government budget as an automatic stabilizer for growth in an economy, particularly for the next ,few years.

Once the economic conditions stabilize, ASEAN will again be attractive to investors, particularly foreign investors, who will find it cheaper to invest in the region. However, this may be limited by the slow-down in domestic consumption. For local companies, the difficulty of obtaining credit and the high interest rates would have a slow-down effect on domestic investments.

One possible source of growth could come from the stock of wealth in a country, the existence of which has been evident in campaigns to donate U.S. dollars and gold from citizens in South Korea, Thailand, and Indonesia. This wealth could be applied to domestic investment and consumption. It could also be applied in financing domestic investment, particularly from large multinationals or from the upper-middle to higher income classes. This is because large and important investment projects within the region such as those in information technology, rail, and road currently require large amounts of financing.

Adjustment of Industrial Structures

The shock from the exchange rate changes will affect the trade and industrial structures in each country. This transition process will be quite painful for some firms. In order to ease the pain, governments could assist the companies in various ways, such as increasing access to new technology, reducing income taxes, and facilitating the financing of investments. At the regional level, firms should look at business opportunities in the region, and take advantage of an integrated ASEAN market in their restructuring process.

Funding could be sought to facilitate restructuring, particularly to ease the pain of exit from or the cost of entry into a new industry. The establishment of such a fund through the contribution of various ASEAN Dialogue Partners would assist ASEAN countries to speed up their recovery. Such a fund could be project-oriented with a private sector focus, its management carried out by an independent institution. Examples of such institutions are the European Bank for Reconstruction and Development for the European Union and the Corporacion Andina de Fomento for the Andean Group. This fund could complement efforts by the Asian Development Bank (ADB) and the World Bank.

International Capital and Financial Markets

This crisis shows, once again, that there are inherent weaknesses in the international financial markets. The rapid development of international capital markets facilitated through improved telecommunications technology makes it possible to mobilize large amounts of funds across borders in a split second. The opening up of the capital markets exposes small economies to large flows of capital. The liberalization of the financial markets in ASEAN countries, especially in Thailand and Indonesia, as mandated by IMF conditionalities, has exposed these countries even more to the international capital market. Prudential regulations and sound financial structures in these countries would not be enough to prevent the collapse of their financial systems. It may be necessary to regulate or control the flow of capital into these countries.

At the regional level, the question is what can ASEAN countries do to reap the highest benefits in the light of the changed environment within which countries in the region are operating, and what role should ASEAN be playing as a group to shape the international capital market?

Financial institutions in ASEAN will change very rapidly with the increased presence of foreign players. To prevent any quick withdrawal of funds from national economies there should be regulations governing disinvestment in these sectors on the part of foreign players. A system of closer monitoring and control will have to be put in place to enforce these regulations. At the regional level, a mutual surveillance system would be an important tool to monitor the movement of capital.

One of the fundamental elements in the development of a regional capital market is the availability of trained financial experts. In order to forge a common understanding of and adherence to the same standards of practice, an ASEAN network of training institutes on finance should be established. The exchange of trainers and ideas, co-operative research, and the alignment of curriculums would improve the level of human resource development in this discipline for the region.

There is also a need to assess the performance of the IMF. Strong reservations have been expressed by mainstream economists J. Sachs, M. Feldstein, P. Krugman) and even by the World Bank on the programmes that the IMF prescribed for Indonesia and Thailand. At its core, the disagreement stems from the inappropriateness of the programme, which seems more suited to imbalances caused by fiscal imprudence and runaway monetary policies than to the financial and banking crises faced by the ASEAN countries. The conditionalities imposed by the IMF on these countries would not necessarily assist a country out of the financial crisis. Some pundits have alleged that these conditionalities merely serve the specific interests of creditor nations.

ASEAN Co-operation

The financial crisis has made one thing clear, and it is that ASEAN countries are more closely linked to one another than previously perceived. Investors have clearly considered ASEAN as an integrated region.

Also, it is clear that each ASEAN country by itself is too small to address the crisis. The size of funds that flow across borders in financial markets dwarfs the size of each country and can render ineffective any policies imposed by them. Hence, each ASEAN country should not only consider the impact of the crisis on their own economy but on that of the region as a whole. This implies the crucial need for regional strategies and regional action. The cost of doing otherwise would be too large. In addition to national-level reforms and remedies, there is substantial value-added from regional co-operation. Recognizing this, ASEAN has pulled together a number of regional initiatives to address the crisis.

Debt Management

Dealing with debt in ASEAN countries should be the first step to remedy the crisis. The size of the corporate foreign debt in ASEANT is quite large. While some proportion of these debts are intra-firm debt, a large proportion will have to be settled promptly before the squeeze on working capital and insolvency hampers the operations and continued existence of these companies. Large repayment commitments can further damage both debtors and creditors, potentially spreading to the rest of the economy and the region as a whole. To deal with this more effectively, debtors in ASEAN countries may have to negotiate with creditors collectively to reschedule their debts.

Many ASEAN countries are now revising or putting in place bankruptcy laws. It would be desirable for them to ensure that bankruptcy laws are efficient, and based on similar principles. This would greatly enhance the environment within which businesses operate in the future.

Revitalizing the Financial Market

In order to monitor closely the financial markets in ASEAN as a way of preventing a recurrence of the crisis, the Second ASEAN Finance Ministers Meeting held in Jakarta on 28 February 1998 agreed to establish a “mutual monitoring system” with a permanent secretariat. This monitoring system will be developed with technical assistance from the ADB and initially housed at the ADB premises in Manila, Philippines, before transferring to the ASEAN Secretariat in two years.

The ASEAN mutual monitoring mechanism will act as an early warning system for the financial crisis. It would provide an opportunity for the ASEAN Finance Ministers to exchange views on the status of financial and exchange markets in each country.

As ASEAN currencies do not fluctuate much against each other, the use of ASEAN currencies in regional trade would greatly reduce the uncertainties caused by exchange rate volatility. This idea was broached at the Second Informal ASEAN Summit in Kuala Lumpur in 1997 and finalized at the Second ASEAN Finance Ministers Meeting in Jakarta on 28 February 1998 through the creation of a framework for Bilateral Payments Arrangement (BPA), a mechanism for the use of ASEAN currencies for ASEAN trade. The details necessary to operationalize this are currently being worked out by both the private sector, particularly the ASEAN Bankers Association, and the Central Banks, based on existing arrangements. The BPA would lower the transactions cost for imports and exports among ASEAN countries.

The fact that ASEAN currencies have not fluctuated much against each other since they were floated in July 1997 (with the exception of the rupiah, which is expected to join other currencies once the current skirmish is resolved) suggests the possibility that ASEAN currencies can be systematically related to each other. This could lead to the formation of a system of cross rates among ASEAN currencies, pegged to an external currency or a basket of currencies, greatly enhancing the stability of ASEAN currencies.

If this proposed ASEAN exchange rate system were established, the mutual monitoring mechanism could be used as a tool to monitor the fluctuations of currencies and recommend appropriate courses of action to ensure continued stability.

A mechanism to assist one another in times of a currency crisis already exists in ASEAN. The ASEAN Swap Arrangement was established in 1977. However, the total amount of funds earmarked is US$200 million, with the maximum withdrawal per country of US$80 million. This sum is too small to address the current crisis. The First ASEAN Finance Ministers in Phuket on 1 March 1997 agreed that the Swap Arrangement should be expanded, taking into consideration the New Arrangement for Borrow/General Arrangement for Borrow (NAB/GAB) of the IMF.

The size of the Swap Arrangement would certainly have to be enlarged for it to be effective. This could be achieved by inviting non-ASEAN countries to participate in the arrangement. With a mechanism that is in consonance with the NAB/GAB of the IMF, the enlarged ASEAN Swap Arrangement could reduce the burden of the IMF, where its limited resources constrain its ability to pay close attention to some ASEAN countries. The information from the mutual monitoring system could be used as an input to trigger off the use of an extended ASEAN Swap Arrangement.

While ASEAN countries should try to solve the problem confronting them now, they should also look ahead and take advantage of new financial tools or technologies. A bond market would be an important tool to generate long-term capital and mobilize funds within the region. At a meeting between the ASEAN Finance Ministers and China, Japan, Korea, Hong Kong, and the United States in Kuala Lumpur on 2 December 1997, Hong Kong proposed that an Asian bond market be established to generate capital to ameliorate the financial crisis. The technical aspects of this bond are being studied.

ASEAN should consider issuing bonds to be floated both within the region and outside to raise funds to finance the restructuring of the debt, and for capital and infrastructure investment.

Revitalizing the ASEAN Economies

A regional undertaking as a means out of the crisis is important. Current reform programmes at the regional and national levels should be accelerated. The momentum for great regional economic integration should be enhanced, to increase ASEAN’s economic resilience internationally. The Second Informal ASEAN Summit in Kuala Lumpur in December 1997 agreed that ASEAN should accelerate the implementation of the ASEAN Free Trade Area so as to increase intra-ASEAN trade and further encourage investments in ASEAN. It also supported the liberalization in services and the formation of the ASEAN Investment Area. These agreements indicate ASEAN’s continued commitment to global trade without resorting to protectionist tendencies as a response to the crisis.

The free movement of goods, services, and investments in ASEAN countries are important for its recovery process. The expected global slow-down would mean that exports from ASEAN in 1998 cannot grow as fast as in 1997. ASEAN countries need to consider one another’s markets as a potential destination.

A freer trading environment is critical to the recovery process in ASEAN. The depreciation of ASEAN currencies also makes goods and services from other ASEAN countries relatively cheaper. To take advantage of this, there is a need for various private sector groupings to meet and discuss the possible courses of action to seek opportunities and niches regionally. Industry Clubs in ASEAN should come forward with action plans for their respective industries. At a private sector roundtable held at the ASEAN Secretariat in March 1998 in Jakarta, private sector organizations agreed to work more closely among themselves and with governments in determining possible courses of action for enabling ASEAN countries to recover quickly from the crisis.

Conclusion

The financial crisis poses a new challenge for ASEAN. It has grown to become a regional economic crisis with implications for a slow-down in global economic growth in 1998/99. The longer the crisis drags on, the impact will be deeper and recovery will take longer. The resultant stagflationary situation in which countries will face the twin problems of increased inflation and worsening unemployment – will lead to misery and social unrest. Such a situation calls for strengthened ASEAN solidarity and commitment to the regional cause. An economically integrated ASEAN would create a large market which would enhance the competitiveness of ASEAN’s exports and lower production costs through economies of scale. A cohesive ASEAN would increase the group’s international bargaining power and help facilitate negotiations for greater market access for its products and services to export markets. A more integrated ASEAN would also increase the region’s economic and financial clout, as individually the countries are dwarfed by the size of the international capital market.

Scope exists for greater private-public sector collaboration. The inter-play of macroeconomic and macroeconomic factors during this crisis calls for greater involvement of the private sector in policy decision-making, both at the regional and national levels. Large companies which have massive debts should play a more pro-active role in providing inputs to governments and minimizing the negative impact of their debt positions on the rest of the economy. Their joint actions could help ASEAN countries overcome the current crisis, and restructure their economies in the medium and long terms.

Requirements for good governance of financial institutions are also necessary. Strengthened prudential regulation and supervision would be required, along with greater disclosure and transparency obligations on the part of banks and companies.

NOTES

  1. P. Krugman, “The Myth of Asia’s Miracle”, Foreign Affairs 73, no. 6 (November/ December 1994): 62-78.

  2. Tan Kong Yam, “The Regional Economic Crisis: Looking at the Lessons” (Paper presented at the Eighth Southeast Asia Forum, 14-17 March 1998, Kuala Lumpur, Malaysia).

  3. Ammar Siamwalla (Presentation at the Conference on East Asia: The Unfinished Agenda, organized by Asian Development Forum, 6-9 March 1998, Manila, Philippines).

  4. Joseph Stiglitz (Presentation at the Conference on East Asia: The Unfinished Agenda, organized by Asian Development Forum, 6-9 March 1998, Manila, Philippines).

  5. R. McKinnon and Pill Huw, “Credible Economic Liberalisations and Overborrowing”, American Economic Review 87, no. 2 (May 1997): 189-93.

  6. M.S. Montes, The Currency Crisis in Southeast Asia (Updated Edition) (Singapore: Institute of Southeast Asian Studies, 1998).

  7. Celito Habito, “The East Asian Crisis: Social And Environmental Impacts” (Keynote Address at the Conference on East Asia: The Unfinished Agenda, organized by Asian Development Forum, 6-9 March 1998, Manila, Philippines).

  8. Yilman Akyuz, “Financial Crisis in ASEAN: Causes, Policy Response and Consequences” (Paper presented at the Private Sector Roundtable on the Impact and Response to the Financial Crisis in ASEAN, 26-27 March 1998, Jakarta).