MAIN PAGE | SPEECHES & EDITORIALS | 1999 | RESTORING ASIA TO GROWTH
PACIFIC BASIN ECONOMIC COUNCIL
MAIN PAGE | SPEECHES & EDITORIALS | 1999 | RESTORING ASIA TO GROWTH
Restoring Asia to GrowthJulian F. SchweitzerDirector, Strategy and Operations, East Asia and Pacific Region, The World Bank The Asian Financial Crisis: A Focus on Solutions Los Angeles, California Monday, October 19, 1998 The crisis in Asia has now become a full-fledged global problem, affecting Russia, Brazil and other emerging markets as well as threatening financial stability around the world. The Asian crisis ranks in seriousness with the LA debt crisis of the 1980s and the ECA transition crisis of the 1990s. World output is expected to decline by 1-1.5% in 1998, mainly due to the recession East Asia. The crisis is threatening the hard-fought economic and social achievements of the "crisis" countries. Prior to the crisis, Korea, Malaysia, and Thailand had virtually eliminated absolute poverty, and Indonesia was within reach. The crisis now risks dismantling one of the single most successful anti-poverty performances in history. So, we need to keep in mind that this is as much a human crisis as it is a financial crisis, with major impacts on the poor and vulnerable groups of society. These countries are now in a deep recession and are caught in a vicious cycle of falling credit and output. Exports will help break this downward spiral, but the regional nature of this recession will slow the recovery. Output in the crisis countries will likely stabilize over the next 6-12 months, but a sustained return to potential growth may take some years. The roots of the current turmoil in East Asia lie in the private sector. Most of the afflicted countries have run budget surpluses or minimal budget deficits in recent years; while private borrowing, especially short-term external borrowing has increased remarkably. The current turmoil is more the consequence of misallocation of investment, (most notably to overbuilding in the real estate sector) rather than overconsumption. The East Asian countries have among the highest savings rates in the world. In many ways, the crisis in East Asia brings to the fore some of the structural and institutional challenges posed by globalization. In terms of capital flows alone, the reversal in capital flows since late 1997, has been punishing. According to the Institute of International Finance, net private capital flows to Indonesia, Korea, Malaysia, the Philippines and Thailand, which had increased from $41 billion in 1994 to $93 billion in 1996, collapsed to an estimated negative $12 billion in 1997 — a reversal of $105 billion. Commercial bank credits which had risen to $56 billion in 1996, turned a negative $21 billion in 1997. Government policies clearly helped create incentives that led to the excessive short-term borrowing and misuse of these funds. For example, rigid exchange rate regimes encouraged foreign borrowing and led to increased foreign exchange risk in both the financial and corporate sectors. Interest rate ceilings, government-directed lending, insider relationships between banks and borrowers, corruption, and cronyism, all contributed to the misallocation of resources. However, the main causes of the crisis were fundamental weaknesses in the financial sector, and associated corporate indebtedness. Deep flaws afflict the financial system. These include excessive leverage, and a banking system based on directed lending, connected lending and other collusive relationships. Also, Asian corporations had a tendency to focus in the direction of empire- building, that is, maximizing market share, rather than profit maximization or maximizing the price of the company's stock. Shareholders and consumers often lost out. The rapid outflow of foreign capital, the deterioration in income, the high cost of social adjustment and financial and corporate restructuring has put the East Asian crisis countries in a serious recession. Each crisis country, in effect, is exporting its recession to its neighbors, with no obvious engine of growth to pull the region out. Aggregate GDP for Asia (excluding Japan) will probably fall by 2% this year, compared to trend growth rates of 6-7%. In the crisis countries, real GDP for 1998 is expected to fall by almost 15% in Indonesia, and by about 5% in Thailand, Malaysia, and Korea. Many regional banks are faced with acute systemic risk as a function of Asia's deep recession, and are burdened with excessively high levels of nonperforming loans. This, in turn, is contributing to a collapse in domestic demand amid a lingering credit crunch caused by the reluctance of risk-averse banks to lend domestically. The economic policy implications from the regional recession are significant. Crucially, East Asian governments are being forced to support their banking systems, and the cost of these bail-outs are high. Funding the ever- widening budget deficits is an increasingly important issue, which will require significant international support. With the stock markets depressed and unreceptive to new issues, few banks can raise new capital. Both good and bad corporations are affected by the decline in voluntary new lending. As aggregate output has shrunk, the share of NPL has increased, forcing banks to call in more good loans to rebuild capital, and the downward spiral of economic activity has worsened. As a result, the recession in crisis countries has deepened. Exports contribute more than a quarter of GDP in the crisis countries; 25-40% of the exports of crisis countries are within the East Asia region; 45-50% when including Japan. Japan represents over 60% of the region's GDP. But as the Japanese economy slumps, and as recession spreads throughout the region, there is little likelihood that exports alone can pull the countries out of recession. Japan's economic problems are well known. One effect has been the reduction of lending by Japanese banks, adding to the credit squeeze in the region. Trade outside the region, on the other hand, can continue to increase, as dong as world trade continues to grow. But the contribution of exports to GDP growth is not enough to offset the collapse in domestic demand. The path to recovery in East Asia can be divided into two overlapping phases. In the first phase, which is likely to last another 6-12 months, governments are trying to stop output (and credit) from falling further. In this phase, bank recapitalization, offloading of bad loans and expansionary fiscal and monetary policy, within the constraints of maintaining confidence in the exchange rates, play the main role. The second phase, which is likely to last several years, requires structural reforms. These include restructuring of firms/corporations, introducing changes in ownership, debt-equity conversions, overhaul of the legal framework, corporate governance reforms, etc. to return the crisis countries to their potential growth path. In both phases, governance and issues of transparency, accountability and reducing corruption, will be high on the agenda. These are key elements in achieving sustainable growth. The sustainability of the reform effort depends heavily on real progress being achieved on the social front. With unemployment rising and growth slowing, poverty is increasing at an alarming rate, and the present crisis jeopardizes the hard-won results of East Asia's development record and threatens to return to poverty the millions of people who have rescued themselves over the past three decades. Indonesia, which had an impressive record of poverty reduction, faces the likelihood that the proportion of the population under the poverty line ( 11 percent) could double this year, nearing 50 million people. Investing in social services — including ensuring food and medicine supplies, keeping children in school, and protecting women's health — will be vital. In addition, the crisis has been exacerbated by severe droughts, in societies with little or no social safety net. There is little yet, but hard data reports suggest that rising levels of poverty stemming from unemployment have now taken on a gender dimension. Women are often the first to be laid off. There has also been some erosion of workers' rights, lower working standards, and reduced access to social services from governments and NGOs alike. Violence and crime are reportedly also on the rise. Although this is a rather gloomy assessment of the crisis in East Asia, there is no question that the East Asian economies will recover. Some would argue that we are already seeing light at the end of the tunnel with lower interest rates in Thailand and Korea, and currencies which have stabilized, albeit at much lower levels. The questions are essentially:
The World Bank is supporting the crisis countries to accelerate the pace of recovery, to ensure its sustainability and to address the social implications, using a variety of lending instruments (liquidity support, project lending) and mobilizing the support of partners throughout the world (e.g. ASEM). We are working closely with partner institutions (IMF, ADB, ASEAN, PVOs etc.). We are supporting domestic demand through:
We are helping to restructure and develop the microeconomy through:
We are assisting governments improve the sustainability of reforms by:
The scale of our lending in East Asia has increased dramatically — from about $4 billion in FY97 to $9 billion in FY98, and we expect lending of a similar magnitude in FY99. Much of this lending has been in the form of liquidity support, but the conditionalities attached have been addressed to structural reforms. In the coming year we will increasingly turn our attention to issues of public sector efficiency and governance. We have also greatly increased our advisory services and have recently issued an important paper "The Road to Recovery" which attempts to detail the options available to the East Asian countries.
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