"Investment Opportunities in New Asia"

Asian Economic Crisis: The Long View

Date: 14 Sep 1998

INTRODUCTION

1   I am pleased to address this seminar hosted by J P Morgan. This is not an obvious time for fund managers to gather in Asia. The region is engulfed in a severe economic crisis. Funds which poured into the region during the boom have fled. But it is the responsibility of fund managers to add value by discerning hidden dangers when times are good, and spotting opportunities when the market is down. You have to track and understand what is going on, and anticipate where and when a turnaround will happen.

2   The crisis started last year as an Asian problem. This engendered much soul searching and criticism: Was the Asian miracle a mirage? Was the Asian model of economic growth fatally flawed? What about Asian values? Did this crisis prove the correctness, even the supremacy, of the American and European versions of free market economics and democratic transparency?

3   Now, the so-called "Asian" problem has crossed geographical boundaries. It has spread to Latin America, Eastern Europe and Russia. Even US and European equity markets have not been spared, as nervous investors scramble to reduce their exposure to risky assets. Purely Asian explanations for the crisis have gone out of fashion.

4   The contagion has spread further and faster than anyone expected. The risk of a global deflation has increased, although the odds are still against it. This global contagion has stirred up panic and gloom. Articles in reputable journals question the efficacy of unfettered global markets. Some pessimists even predict an era of global deflation, or maybe a replay of the Great Depression of the 1930s.

5   But extremes of gloom and euphoria are both unjustified. As Federal Reserve Chairman Alan Greenspan said in his recent speech at the University of California at Berkeley: "we have relearned in recent weeks that just as a bull stock market feels unending and secure as an economy and stock market move forward, so it can feel when markets contract that recovery is inconceivable. Both of course are wrong. But because of the difficulty imagining a turnabout when such emotions take hold, periods of euphoria or distress tend to feed on themselves."

A FRAGILE WORLD SYSTEM

6   The backdrop to Asia's problems is a fragile world economy. The US has thus far been less affected by the Asian crisis. Its economy is operating at full capacity, sustained by strong consumer spending. But it is nonetheless vulnerable to shocks, for example a negative wealth effect on consumer spending from a further decline in the stock market.\

7   The EU is achieving steady economic recovery, but its economies still have significant structural weaknesses. Unemployment continues to be a serious problem, with the jobless rate above 10% for most of the continent. This has dampened consumer spending and the recovery in domestic demand.

8   Japan remains mired in economic stagnation and political gridlock over fiscal and banking reforms. The Japanese economy is not likely to collapse, but its problems are still deepening. This has hampered economic recovery in East Asia, since Japan is a major importer and an important source of foreign direct investment and bank loans for this region.

9   China's economy continues to grow, but it is decelerating, and will not reach the 8% growth China was hoping for this year. Any devaluation of the yuan or of the Hong Kong dollar will trigger a renewed round of currency depreciation in the region. But the Chinese authorities have made a credible commitment not to devalue, and continue to reaffirm this consistently. China's external position remains strong. They have foreign reserves of US$140 bn and large current account surpluses. In addition, they maintain strict controls over the capital account, and so are less vulnerable to speculative attacks.

THE LONG VIEW

10   Asia's economies are very diverse. Thailand, South Korea, Indonesia, Malaysia, Hong Kong and Singapore are all different. Their problems are not uniform, nor is there a consensus on the correct approach to tackling them. Each country is seeking its own path to recovery. Economists propound a wide range of analyses and solutions, while governments follow very different policies and formulas. This makes it a fascinating and challenging period for a sharpeyed observer, and even more an investor, to track where problems are receding, which formulas work best, and where opportunities are emerging.

Thailand and South Korea

11   Thailand and South Korea are the two countries following IMF prescriptions most closely. They are currently restructuring their banking and corporate sectors, and unwinding the excesses and weaknesses in their economies. Their efforts have paid off to a certain extent. Domestic interest rates have declined sharply, current accounts have improved, and exchange rates have stabilised. Capital is starting to flow back again.

12   But the reform and restructuring process is gradual and painful. Thailand has made reasonable progress in restructuring. The Thai government has closed down insolvent financial institutions. It has also opened the financial sector to foreign equity participation, and pushed ahead with bank recapitalisation.

13   However, like the rest of the region, Thailand faces a serious downturn in its real economy. Exports are weak while consumption and investment have collapsed. Unemployment is at a record high. Poverty is a pressing problem. The Thai government is now working to strengthen the social safety net, to alleviate the social impact of the crisis.

14   Korea has successfully rescheduled its short-term external debt and achieved an impressive turnaround in its current account. It has bought itself time to reform and restructure its banks and chaebols. But its task of reform will be herculean. Major surgery has been prescribed, on which there is by no means consensus in Korea, among political leaders, the chaebols themselves, and the militant unions.

15   To take just one illustration, the new Korean government passed a controversial law permitting retrenchments in February this year. This was a historic achievement in a country where workers have been guaranteed life-time employment. But implementation will not be easy. Hyundai was the first chaebol to attempt to lay off 1,500 workers. This led to a 6-week strike costing Hyundai and its subcontractors US$1.2 billion¹ in lost production and exports. Finally Hyundai agreed to reduce the number of layoffs to just 270 employees, of whom two-thirds were female cafeteria workers. Unless the pace of restructuring speeds up, the process will take a very long time.

Indonesia

16   When the crisis first struck Indonesia last year, its Government called in the IMF, as Thailand and Korea did. However, the former Indonesian Government did not follow through its agreements with the IMF, to implement them in the way that the financial markets and investors expected. As a result, the situation deteriorated. President Suharto resigned in May, to be succeeded by President B J Habibie.

17   As Singapore's Prime Minister Mr Goh Chok Tong said recently, President Habibie has the toughest job in the world. Indonesia's economy is in deep recession. GDP is expected to contract by 15% this year. Half the total population of 200 million Indonesians will be living below the poverty line by the end of this year. Indonesia faces pressing problems of hunger, economic deprivation and political and social discord. These basic issues must be settled before confidence can return and the economy can stabilise.

18   The international community can assist with humanitarian aid, but only Indonesians themselves can settle the social and political issues. These issues are beyond the competence of the IMF and the World Bank, which can now only play supporting roles in Indonesia's recovery. As Stanley Fisher, the Deputy Managing Director of IMF, recently said in an interview on CNN, while Thailand and Korea are beginning to respond to IMF programmes, Indonesia is a different and more complicated case.

Malaysia

19   Malaysia's situation contrasts with that of other countries. Malaysian companies have not borrowed excessively abroad, unlike Thai, Korean or Indonesian companies. Nevertheless, Malaysian share prices and the ringgit exchange rate have fallen sharply, and many companies and financial institutions are in distress.

20   The reasons are controversial. Many foreign analysts ascribe it to a loss of confidence, the result of excessive borrowing by companies, as well as statements and actions by the Malaysian government as the crisis progressed. But Malaysian leaders, especially Prime Minister Dr Mahathir, have strongly argued that Malaysian companies were fundamentally sound, but speculators and hedge funds deliberately brought down the ringgit and stock market in order to profit by selling them short, thus undermining the companies and bringing a catastrophe upon the nation.

21   Initially Malaysia followed relatively orthodox market-oriented policies, raising interest rates to defend the exchange rate, reducing credit expansion, and cutting back on spending, especially on large infrastructure projects. But even then Prime Minister Mahathir had voiced his dissatisfaction with this approach of fiscal austerity and monetary restraint, at the expense of what in his view were sound companies. In recent weeks the Malaysian government has decisively rejected this orthodox prescription, especially after Prime Minister Mahathir dismissed Deputy Prime Minister Anwar Ibrahim and took over responsibility for the economy.

22   Dr Mahathir has declared that Malaysia will not follow the IMF approach, because he is convinced that it is wrong. In an article he published in Time magazine (14 Sep), Dr Mahathir asked: "How long before we reject the infallibility of the free market dogmas? Malaysia cannot wait. Malaysia has chosen to become a heretic, a pariah if you like."

23   The Malaysian government has acted in accordance with Prime Minister Dr Mahathir's convictions. Bank Negara, the central bank, imposed stringent exchange controls to prevent speculative attacks, block capital flight and shield the economy from the volatility of global capital markets. It followed up with cuts to interest rates, lower bank reserve requirements, and looser classification of non-performing loans. It removed restrictions on lending to the property market, and told banks that they should expand their lending by 8% this year, or else explain why they have not done so. Malaysia has set out to prove to the world that it will succeed in restoring its economy on its own, and in its own way.

Hong Kong and Singapore

24   Hong Kong and Singapore are the two economies with the freest markets in the Asian region. Traditionally Hong Kong has been the one closer to an ideal laissez faire system. Both have been comparatively less affected by the Asian crisis than their neighbours, chiefly because they have sound and robust financial systems, and corporate sectors which are not over-leveraged.

25   Nevertheless, neither Hong Kong nor Singapore has escaped unscathed. Hong Kong, because its currency peg to the US dollar has left the Hong Kong dollar out of line with other regional currencies, making its economy uncompetitive. And Singapore, because our economy is closely inter-twined, through trade and investment, with Malaysia, Indonesia, and the other economies affected by the crisis.

26   Because their problems are different, the two economies have responded to the crisis in different ways. Hong Kong is strenuously defending the currency peg, and letting the necessary adjustments to its costs be made through interest rates, wages and prices. The Hong Kong authorities, however, recently surprised everyone by making an unprecedented intervention in their stock market, to force up share prices and thus the Hang Seng index. They explained that it was to punish speculators who were manipulating the currency and share markets, and not to support share prices, and that it in no way changed their long-standing policy of non-intervention in financial markets. They must have anticipated that not all market observers would accept this explanation. Milton Friedman called it a "ghastly mistake". That they decided to act despite the likely flak is a measure of their determination to defend the peg at all costs.

27   In Singapore, we have taken a number of measures to cushion the impact of the crisis on the economy and to enhance our productive capacity and prepare for the eventual recovery in the region. Firstly, we are managing our exchange rate more flexibly, consistent with economic fundamentals, in order to maintain confidence in the Singapore dollar while maintaining our external competitiveness. Secondly, the government has also used fiscal measures to reduce business costs and enhance productive capacity. It implemented one package of cost cutting and pump-priming measures in June. The Committee on Singapore's Competitiveness, under the Minister for Trade and Industry, is now studying comprehensive measures to reduce business costs decisively, including the possibility of reducing employers' CPF contributions. The overriding imperative is to strengthen our overall competitive position, especially against those countries which are our major competitors in third markets. The Committee will report before end of the year.

28   Thirdly, Singapore is carrying out economic restructuring and strategic planning, to enhance our attractiveness as a regional and international business hub. This includes investments in infrastructure and education, training and retraining of workers, especially older or retrenched workers, and the ongoing financial sector reforms. These measures will not yield immediate dividends, but they will strengthen our competitive advantage and position us for the longer term when the region recovers.

29   Our fundamental approach continues to be to rely on market forces, allow free capital flows, encourage foreign investments, and plug ourselves into the global economy. This has not prevented our economy from slowing down sharply, or our stock market from falling together with other markets in the region. But we believe that Singapore's different approach will be noted by analysts and investors, and be reflected in credit ratings and risk assessments. It will provide a long term basis for confidence in Singapore's predictability, rationality and stability. As one recent analyst's report by Credit Lyonnais Securities stated, after a particularly eventful week in the region: "It is only a matter of time before the radically different approach to the crisis adopted in Singapore to that applied in other markets will be forcibly brought home to investors and the premium that is paid for Singapore investment will widen and widen dramatically. Relatively, Singapore has become much more attractive in Asia in the past week."

CONCLUSION

30   This financial crisis, severe as it is, is not the end of the global economy. Historically, financial crises have been an inherent feature of capitalism and the business cycle, in every economy. The fundamentals which supported two decades of high growth in Asia before this crisis have not disappeared - a sturdy work ethic, skilled and disciplined workforces, and an entrepreneurial culture. In time, these strengths, together with the ongoing economic reforms, will enable the countries to grow and progress again.

31   The diversity of conditions and policy approaches makes the Asian economies today a fascinating and rewarding study. Nobody can tell for sure yet which approaches will work, and which countries will recover more quickly. But those who watch closely developments in the region stand the best chance of spotting the turn before others, and being rewarded for their perception. Singapore offers itself as a base from which analysts and fund managers can follow the region dispassionately, with neither euphoria nor panic. They will be well positioned to detect the turnabout, and grasp the opportunities that will surely come when the storm clouds disperse and the sun shines again.

¹ Figure from the Labour Ministry