Mr. Graeme Lawless
Managing Director
Export Finance and Insurance Corporation
Australia
There has been much to astonish us in East Asia this past two and a half years.
First the currency crashes, banking collapses, and deep recessions. Seemingly, out of nowhere.
And now the remarkable bounceback, the V-shaped recovery. An earlier, faster, recovery than most expected.
That unpredictability and volatility is reflected in the business that I manage - Australia's official export credit agency.
But it's a mirror image. In tough times, our business increases, EFIC's role is to step in as the commercial market moves back.
From late 1997, the contraction of trade finance across Asia saw a sharp increase in the insurance EFIC provides against the risk of non-payment by importers or their banks. As we stepped up to help keep trade running.
In Korea, for example, our insurance grew from a tiny A$50 million or so pre-crisis, to around A$2 billion over the two following years.
Overall, through 1998 and early 1999, Asia grew from 25% to 40% of our insurance business.
Now, as risk is improving, and bank finance is restored, we are seeing payment protection insurance for Asian markets recede quite quickly to pre-crisis levels.
So from what I see of the perspective of Australian exporters and banks, their answer on sustainability of growth in the region is already pretty clear - Australian companies are taking a very positive view; they believe it is sustainable; and they are backing that view with trade flows and investment.
So what might happen next?
The volatility experienced since mid-97 should be enough to make anyone pause before venturing into forecasting. But anyway, let's start by having at what seems unlikely to happen.
A repeat of 1997 is unlikely.
None of the crisis economies should succumb again to the sort of crisis they fell into 1997.
These crises were triggered by withdrawal of short term foreign capital far in excess of available foreign exchange reserves. And they were at least in part caused by pegged exchange rates that had to be defended.
These conditions no longer prevail.
Short term foreign debt has been cut.
Foreign exchange reserves have been built up.
And most exchange rates have been made more flexible.
So, in other words, we shouldn't be like general wanting to fight the last war.
We need to be on the lookout for new threats. The next crisis will be different from the preceding one.
Cyclical recoveries end...
So what else can we say with confidence?
Next would be that cyclical recoveries don't go on forever
The V-shaped recoveries will, sooner or later, end ... because they are a product of the preceding deep slumps.
Once crisis economies get back to square one, growth will be harder to achieve, because it will no longer be just a matter of soaking up idle labor and capacity.
Resuming trend growth...
Economies will then need to resume trend growth. To expand capacity by saving and investing. To keep demand up so that production is bought, rather than building as unwanted inventory.
Equally, these economies will need to beware letting demand run too quickly ahead of production capacity, lest the seeds of another financial problem be sown.
Attracting adequate finance...
One precondition for resuming trend growth will be attracting adequate finance - both domestic and foreign. And it is here that I now want to concentrate ... for two reasons.
First, this is where my focus has been for this past 2 ½ years as head of an agency charged with complementing and supplementing the supply of private credit available to finance Australian exports, including to Asia.
My second reason for focussing on whether sustained growth can be financed is that, up till now, recovery in the real economy has been outstripping by far the growth of credit.
Recovery without credit expansion...
GDP outpaces credit...
[Figure]
In the aftermath of the crisis, firms have been increasingly balancing cash flows without resort to credit. They have been doing this by:
- Cutting costs
- Selling non-core assets
- Restructuring debts (and in some cases 'strategically defaulting)
- Running down inventory
And that has been helping them to deleverage.
Certainly this is a phenomenon we have been witnessing in EFIC over the past two years. Many Asian clients of Australian exporters have found the means to pay cash in advance, or on delivery, where before the crisis they would have demanded - and gained - credit.
Yet growth without credit expansion won't be able to go on forever. At some point, lending will need to pick up. Or the recovery will run into a financial constraint.
But unfortunately, I don't believe we can take for granted that the credit will be forthcoming to allow the cyclical recovery to shade into high and sustained growth.
Two possible obstacles are:
- Continued weakness in domestic banking systems
- And wary foreign investors
Weakened banks ...
Just how weakened and just how unable to lend banks are is debatable.
It is true that domestic credit growth has been low recently. But that might be because of subdued demand for credit from firms to keep to deleverage. When the demand revives, the supply might be forthcoming.
I understand Korean banks have recently started to expand their lending to SMEs quite briskly - though chaebols are apparently continuing to deleverage.
The reports I have heard suggest the Korean, Malaysian and Philippine banking systems have restored their capital adequacy ratios to quite high levels. Philippine banks, for instance, are reported to have an average capital adequacy ration of 15%.
And yet there are also reports that Thai and Indonesian banks are still labouring under enormous bad loans, and have little capacity to make new loans.
I guess I'm just making the point others have made in a different way - Korea and Malaysia look best placed to resume trend growth, followed by Thailand, then Indonesia.
Or equivalently, Indonesia followed by Thailand look most vulnerable to lapsing into sluggish growth - to merely limping along as Japan has been doing since its asset bubbles burst in 1990.
Attracting foreign capital ...
Another possible growth constraint is the supply of foreign capital.
With crisis economies now running hefty current account surpluses, their external financing needs are small. Yet as the surpluses erode this year with further recovery, the demand for external capital will rise as economies revert to their more normal state of being net capital importers
We are already seeking some evidence of this in EFIC with a revival in demand of our structured trade and project finance.
Attracting this capital will be the big challenge for 2001.
A lot will depend upon confidence. Confidence:
- About political stability
- About bank and corporate restructuring
- About reform of the legal and regulatory framework (eg bankruptcy/foreclosure laws)
- About relaxation of FDI restrictions
- About fiscal consolidation.
- One each of these the record has been at best mixed.
- Political uncertainty seems to be falling gradually in Indonesia.
- Bank restructuring in Korea and Malaysia is going well.
- Corporate restructuring is lagging everywhere.
- And too few bankrupt companies are being forced into liquidation in all the crisis economies.
I suspect that it is because of this mixed record that capital inflow to East Asia has been so far only gradually reviving. By extension, it seems reasonable to speculate that it could be some years before capital inflow returns to previous peaks.
Lower trend growth in future?
Which I think raises another interesting question.
If capital inflow were to be lower in future than in the past, countries would need to correspondingly curtail their investment and capital accumulation - unless they raise their already high savings rates.
The World Bank assumes investment in East Asia up to 2007 will shift back from its high 1990s level, to a still-brisk 1980s level of 25-30% of GDP. If that turns out to be right, growth is likely to fall.
But even then, it remains robust by industrial country standards. Better still, to the extent that the overborrowing syndrome of the 1990's has been eliminated, it will be better quality growth, growth less likely to be vulnerable to periodic crisis.
Falling trend growth?
% pa growth
1991 - 97 1998-00f
Asian newly industrialising economies 6.8 4.2
East Asia and the Pacific 9.9 5.8
All of this analysis has implicit in it the assumption that these economies aren't hit by powerful external shocks.
The rising tide of cyclical recovery has lifted many corporate boats. But many companies still have little net worth, and thin operating margins. Their capacity to withstand setbacks is small.
So a lift in world interest rates, say, or a sharper-than-expected slowdown in the US, could easily result in a macroeconomic reversal.
When you think of the uncertainties in the world economy at present, that's pretty big qualification.
Summary
Let me now conclude by summarising the points I have been making about the sustainability of growth in Asia.
1. A repeat of 1997 is unlikely. Important lessons have been learnt. Recent history is unlikely to be repeated.
2. Don't extrapolate too far into the future from the present V-shaped recovery.
It's cyclical. It must come to an end. Still, it probably has another 18 months or so to run.
3. Growth without credit expansion won't be able to go on forever. At some point, lending will need to pick up.
Lack of finance is unlikely to be a drag on growth for at least 18 months; each of the crisis economies is running a large current account surplus that is only slowly eroding.
Bank reform remains vital. Restructuring has still a long way to go.
4. There will come a point - probably in 2001 - when lack of finance - both domestic and external - could pose a threat to continue growth
This risk is highest in Indonesia, then Thailand. Lowest in Korea and Malaysia.
5. When there is a return to trend growth, sustainable growth rates may be lower than in the peak pre-crisis years. For that to be wrong, there would need to be a strong resumption of capital inflow.
6. And finally, implicit in everything I have said is that the world economy continues to grow or near its historic trend. If another slowdown occurs all bets would be off.