Some suggested this could lead to the collapse of the only support left for domestic currencies, namely the huge trade surpluses that were being generated as a result of that collapse in demand which had in turn led to sharply lower imports. Others attributed this to year-on-year basing effects, dismissing any prospect of recovery in the near term and pointing instead to the protracted downturn in Latin America, Mexico and Japan after their respective financial crises in 1982, 1995 and 1991. Yet, to us, this slowdown in the pace of import contraction represented something quite different, the first, faint flickering of recovery. In medical terms, it would have been the first up-beat on a heart monitor which had been flat-lining, faint, but still there. Proof at least that the patient was not going to die.
Demand remained deeply depressed by standard consumption indicators, unemployment continued to rise and economies for the most part continued to contract on a quarterly basis. These were, however, lagging indicators, for the most part reflective of the past, substantial inventory reduction and corporate downsizing. Some were sceptical of the reasons behind a gathering slowdown in the pace of import contraction in the likes of Thailand and Korea in particular, attributing the move the to J-curve effects whereby the devaluation of local currencies exaggerated the dollar value of imported goods. Yet, this slowdown in import contraction appeared to be also happening in volume as well as value terms, seriously questioning such a view. For the full year of 1998, imports contracted by a stunning 35.5 year-on-year in Korea and by almost 340o in Thailand after a 13.4% contraction in 1997, yet the first sign of improvement in this key indicator was seen in the fourth quarter of that year. If the collapse in imports was slowing down, that meant that at the very least the fall in demand was slowing, positive news in a regional environment where all prevailing news was dire to moderately bad. That first sign of stabilisation in the IMF programme-countries such as Thailand and Korea were matched by the more efficient economies such as Singapore, which saw a GDP contraction in the fourth quarter of 1998 of -1.1% as against a contraction of -1.9 in the third quarter. While the feeling on the streets was one of utter misery as the full unemployment effects of the financial and economic crisis continued to be felt, particularly by those who had started off lower down on the ladder in any case, a gradual reduction in financial market pessimism took place in the final months of 1998 and the first quarter of 1999 as regards Asian economic prospects. Singapore actually saw positive growth in the first quarter of 1999 of +O.6 and other ASEAN countries saw their contractions continue to shrink. Suddenly, there was talk that since Thailand had been first into the Asian crisis, it would be the first out. Thai manufacturing production had clearly bottomed in May of 1998 (at a contraction rate of around - 1 5 year-on-year), however this was rightly attributed initially to Thai companies re-directing production towards export markets which were still buoyant, as well as basing effects from the financial and economic collapse in 1997. By February of 1999, however, the Thai manufacturing production was actually in positive territory on a year- on-year basis, a degree of revival which could not simply be explained by exports, particularly as exports were still falling (they fell 4 year-on-year in the first quarter of 1999). Simultaneous to that, albeit after a lag, imports started to come back in earnest. After falling 11.6 in the fourth quarter of 1998, import growth in volume terms (and thus not distorted by foreign exchange considerations) actually rose over 5 in the first two months of 1999. Simultaneous to this process, the collapse in credit growth bottomed out and money supply growth data also regained positive territory in early 1999, the result of the massive fiscal and monetary stimulus which the Thai and other ASEAN governments undertook from the second half of 1998 onwards.
วันอังคารที่ 3 สิงหาคม พ.ศ. 2553
CHAPTER 3 THE RECOVERY - SET TO CONTINUE?
If 1998 was a year of excruciating pain for most Asian economies - which undoubtedly it was - then 1999 has been altogether a different story, one which has repeatedly and publicly been dubbed the year of Asian recovery by the world’s media. Even those Asian economists who were reluctant to forecast a supposed “V-shaped” recovery from that dire year of 1998 were gradually forced to admit gathering signs of economic expansion. From early 1999, it looked as if we could see a revival due to the Keynes-ianist policies adopted in the wake of the IMF’s policy U-turn of allowing significant monetary and fiscal easing.
In truth, the first signs had appeared in the last quarter of 1998. In Fhailand and Korea, where the crisis had begun, exports had collapsed and imports were continuing to contract by some 3000 year- over-year through the end of the third quarter reflecting an equal collapse in domestic demand. In Indonesia, domestic prices were still rising, but elsewhere they were falling, further confirmation of that slide in demand. However, in the fourth quarter of 1998, we started to see a marked reduction in the year/year contraction of imports in Thailand, Korea, the Philippines and even Indonesia. If the first sign of financial market stabilisation was the collapse of imports and the consequent, dramatic turnaround in national trade accounts, the first sign of economic stabilisation was paradoxically almost the complete opposite, that is the slowdown in import contraction if not the actual revival in imports.
In truth, the first signs had appeared in the last quarter of 1998. In Fhailand and Korea, where the crisis had begun, exports had collapsed and imports were continuing to contract by some 3000 year- over-year through the end of the third quarter reflecting an equal collapse in domestic demand. In Indonesia, domestic prices were still rising, but elsewhere they were falling, further confirmation of that slide in demand. However, in the fourth quarter of 1998, we started to see a marked reduction in the year/year contraction of imports in Thailand, Korea, the Philippines and even Indonesia. If the first sign of financial market stabilisation was the collapse of imports and the consequent, dramatic turnaround in national trade accounts, the first sign of economic stabilisation was paradoxically almost the complete opposite, that is the slowdown in import contraction if not the actual revival in imports.
TINKERING WITH THE MICRO-ECONOMY
The last strategy response from the Asian countries which we will look at briefly - and subsequently in a later chapter in substantially more detail - is that of microeconomic reform and restructuring. In contrast to the Latin American debt crisis of 1995 which undoubtedly had major microeconomic effects, but whose roots were macroeconomic, the very root cause of the Asian crisis lay in the micro-economy. Consequently, a key strategy for dealing with the worst effects of the crisis and for reviving Asia’s shattered and bruised economies had to deal with microeconomic management and reform. Here, one has to say that the record in 199 7-98, while fine in theory, was poor in practice, in the implementation of that theory.
Some progress was made however. Since the onset of the Asian crisis, several Asian countries have sought to improve their regulatory frameworks for domestic financial institutions, forcing increases in bank CAR ratios and the improvement of standards on loan provisioning and loan classification.
In addition, the governments of Korea, Indonesia and Thailand sought to varying degrees to put in place an institutional and legal framework for the resolution of debt restructuring. Finally, all three countries increased foreign investor access to their markets, companies and banks through the raising of foreign investor ownership ceilings and the reduction or elimination of rules inhibiting such access. Korea, for example, fully liberalised foreign purchases of domestic Korean won bonds and abolished most ownership restrictions for foreign investors, key elements in the task of re-liquifying the Korean financial and economic system. In the financial sector, to recall, Thailand closed 56 finance companies, while Korea closed more than half of its merchant banks. In addition, it closed two commercial banks, re-capitalised them and sought to resell them to domestic and foreign investors. The governments of Korea and Thailand announced the issuance of domestic bonds worth up to 15 of the GDP, placing these with domestic financial institutions in order to put a floor under the balance sheet of their respective banking systems.
All sound measures and proof indicated that the efforts of the IMF and World Bank were not wasted and that progress was made at the micro-economic as well as the macroeconomic level. That said, one should not under-estimate the damage caused at the micro-economic level by the crisis and thus the remaining problem. The World Bank in its report East Asia: The Road to Recovery’, said that it was estimated that as a result of the crisis two-thirds of Indonesian firms suffered losses exceeding their equity, while for Korea this figure was two-fifths and for Thailand one quarter.5 Higher interest rates, plunging capital bases, a collapse in available domestic bank credit as banking systems sought first to repair their own balance sheets combined to produce a ruinous result for many Asian corporations. In the go-go days of Asian economic growth, the fundamental weaknesses of many of these companies, including small capital and equity bases and over-leverage on cheap, in many cases governmentinduced credit, had been hidden by strong top line growth in the P&L. Diminishing total returns was a warning prior to the crisis, a warning
which went unheeded at all levels.
High debt-equity ratios was however the natural product of the Asian growth model, itself founded on consensus and co-operative rather than competitive economics. Asian governments had sought to expand deliberately the strategic export sectors. In order to do so, they provided, directly or through their banking systems, cheap, directed credit, subsidised loans and tax breaks. Insufficiently deep Asian equity and bond markets required that the Asian corporates rely for most of their external funding on bank loans. In the early 1990s, many Asian governments removed or reduced borrowing limits, particularly on foreign currency borrowing, but failed simultaneously to strengthen banking, corporate regulation and supervision. When I arrived in Asia at the start of 1996, before I joined the banking sector, many of its markets and economies felt like a Gold rush precisely because there was insufficient control or supervision of bank lending or corporate borrowing. It was the ‘Wild East” in that just about anything went. Cheap credit was available and deals were done whatever it took. Corporate governance played a part also in that corporate borrowing was in many cases hugely excessive relative to its potential for driving the bottom line. As a result, a substantial part of corporate profit went into paying interest costs, thus making corporations especially vulnerable to domestic interest rate rises. For example, by 1997, according to the World Bank, more than two thirds of all profits of listed Thai companies went to cover the interest costs.
In addition, excessively cosy relationships between domestic bank loan officers and many corporations led to increased loans to firms with high debt leverage and low profitability. Political pressure from the top to make loans to favoured or strategic companies had an eventual cost and in 1997 and 1998 that cost was high - and remains high to this day. As stated in Asia Falling, it is all about incentive. Banks had little incentive for ensuring that their loans were creditworthy, while corporations had little incentive to ensure that their loans were needed in the first place since they would get them anyway. The market pricing mechanism was thus significantly distorted. What we have seen subsequently is not only the result of that but effectively an attempt by “the market” to achieve a greater degree of pricing mechanism equilibrium. In the 1960s and 1970s, many Asian countries privatised banks and corporations, however in many cases they retained a heavy hand in their financial running. As an economist, it is my profound view that the state is inherently inefficient from a profit perspective in running companies and banks, a condition brought about by the fact that profit is not the only or in some cases even the major motive. Interlocking relationships between the government, banks and corporations thus reduced the ability of the market mechanism to function, thus inexorably leading to ever diminishing returns and the consequent need for ever increasing credit just to maintain those returns. Cronyism” was a factor behind the Asian crisis. To anyone with any common sense, this is merely stating the obvious, but to some apparently it has to be said. Granted, that same cronyism or contact- or consensus- capitalism depending on how one terms it was also a key plank of the Asian growth story for at least two decades, but such practices, lacking the discipline of a free market which focuses only on the bottom line eventually led to major price distortion, such distortions inevitably being corrected, albeit after a substantial period of time and at the expense of a regional crash.
Inadequate domestic asset markets and more specifically the infrastructure of those asset markets, namely zealous and INDEPENDENT regulators and deep and broad institutional investor bases were also a key reason for the lack of true market discipline which pervaded in Asia in the 1990s. For instance, in 1996, the mutual fund industry represented under 1000 of the total Stock Exchange of Thailand (SET) trading. Outside of Singapore, many Asian countries had weak or minimal pension fund industries. Finally, the very organisational structure had a part to play in the eventual Asian crisis, characterised most commonly by a diversified conglomerate structure whose shares were closely held by a family. Given the lack of development of the Asian equity markets and the lack of minority shareholder rights, these owners again did not have sufficient incentive to make their corporations efficient. They simply did not have to.
The result of all this was that the crisis caused wholesale bankruptcy in countries which had these fundamental microeconomic flaws. Indonesia was easily the hardest hit, followed by Korea and Thailand. The extent of the damage reached systemic proportions in all IMF programme member countries. Solving this crisis at the microeconomic level always necessitated a comprehensive and cooperative strategy involving international creditors, domestic banks and corporations, domestic governments and the influence of multilateral organisations to prod proceedings along in the right direction. Using the incentive rule, such strategies oniy work if they have to, if they are forced to. This implies the breaking up of those cosy relationships between banks, corporations and governments. There is a key lesson from the Japan crisis (1991-and still counting) in this. Bank restructuring in particular works most effectively if it is enforced by the government, creditors or shareholders, rather than at the agreement of cosy agreements. This was a key reason why the Japanese government attempts at bank restructuring - however belated, however pitiful - have so far failed to achieve what most in the West see as the desired result - a profitable, healthy bank. Instead of this, Japan has gradually been nationalising its financial system, a strategy which is doomed to ever diminishing returns and ultimate failure. When faced with the painful choice between propping up institutions (and those cosy relationships) or biting the bullet and letting such institutions go or be forcibly restructured, no matter what the short term cost to prices or market confidence, Japan chose the easy way out.
It has yet to be confirmed that Thailand, Korea and Indonesia have avoided this route. If they have not, that will have dire consequences for the medium- and long-term growth prospects of their economies. The alternative to the approach of bank-led restructuring is theoretically and has been practically that of government-led restructuring. Under this model, the government creates an asset management company to reduce and restructure bank non- performing loans, taking over and restructuring bad debts and replacing these assets with bond issues, thus the banking system is re-capitalised. While governments may prefer voluntary negotiations between bank creditors and corporate debtors, without appropriate balancing mechanisms in order to avoid social structure damage, this is rarely the most appropriate way of achieving an efficient result. What seems clear is that there must be an element of enforceability of this restructuring by the authorities and equally a degree of submission to market pricing discipline. On the latter, this means, whatever price the market currently supports is the price you get for your distressed assets, not the price you or your government might want. However, those distressed assets need domestic as well as foreign buyers. More has to be done to democratise the Asian equity markets, increasing the rights of minority shareholders, developing strong mutual and pension fund industries which in turn can help enforce corporate and bank restructuring - or throw out directors and CEOs through the creation of emergency shareholder meetings - a source of much humour in Japan for some time and look at the cost of that. Disclosure and accounting standards have to be improved (or in some cases created). Remember, things don’t improve if they don’t have to improve. The message to Asia is a clear, if an uncomfortable one: the Asian capitalist model does not work anymore. It has passed its sell by date. This is not to say that Asia should necessarily and automatically adopt a U.S. version. It is to say that Asian governments and financial authorities should create true market places, which might or might not mimic their U.S. counterparts, but which focus on creating free and fair trade, strong regulatory and supervisory standards and the institutional investor structure to support deep and liquid asset markets. The pricing mechanism used must be the market rather than the relationship. Why? Not because that is the U.S. model (it is questionable whether or not it is in fact given trade subsidies which both the U.S. and Europe provide), but because it is the most efficient model, providing the soundest base for long-term sustainable growth. That, surely, must be the aim.
The emphasis on the market pricing mechanism must not be at the expense of ignoring the importance of creating a sufficient legal framework, a crucial element in any country’s infrastructure, as important as ports and roads, as electricity, housing and education. In the case of a debt and currency crisis, the first priority in this regard must be to provide an adequate bankruptcy law framework to encourage new investors to pick through the rubble of distressed assets. Only when this occurs will there be sufficient incentive not to become distressed in the first place. In the wake of what appears to be strong recoveries in Asia, this may no longer seem relevant, but it most assuredly is. Without sufficient microeconomic reform and restructuring, those recoveries will most assuredly prove fleeting, the result of temporary fiscal and monetary stimulus which when removed in order to avoid renewed inflation results in a sharp pullback in domestic demand. Generally speaking, there are three types of resolving bankruptcy or insolvency: liquidation, rescue or agreed restructuring or “work out” involving informal relationships outside of the court’s mandate. Both liquidation and rescue necessitate the presence and active involvement of the formal court procedure, the first leading most likely to a sale of assets to a third party (the company and the court being the first two parties), the second involving the administered rescue of a company as a viable and going concern through public infusion or in the private sector case most likely debt-equity swaps. The dependency in Thailand, Korea and Indonesia on the Asian model of consensus rather than market capitalism led to an initial emphasis on informal work outs after the crisis, despite the emphasis by the IMF on the strengthening of the institutional infrastructure framework. Issues such as “loss of face” and the necessity to maintain business and banking relationships have proved to be strong obstacles to the initial creation and then the enforcement of efficient bankruptcy laws. However, it is wrong to say that culture is an inevitable obstacle to this process. The Singapore bankruptcy code, shaped by the UK 1985 Insolvency Act is a case in point, involving supposed Western legal enforcement with an Asian emphasis on compromise and negotiation, a potential model for others in the region to follow. Extending that example, it is no coincidence whatsoever that Singapore has an exceptionally strong corporate legal framework and zealous and independent regulatory bodies, and at one and the same time its corporate and banking systems are relatively low geared - as befits PROFIT necessity - and have survived the Asian crisis for the most part healthy and intact. There are no doubt strong relationships between banks and corporations in Singapore, but they are not allowed to be the founding premise for debt creation.
Outside of Singapore, in crisis countries where the relationship became the essence of the pricing mechanism, rather than the market, is where the Asian model eventually broke down when it was forced to compete with the unfettered forces of the global freemarket system. The Asian model does not have to be scrapped wholesale, but the driving force and the incentive for economic growth have to be altered in favour of the market. Strong relationships can and should still exist. That need not change, but they cannot be the primary motivating force behind economic expansion. Not anymore. The alternative is to reject the global system and turn inwards, but that is not a realistic option for any but the foolhardy. The “emerged’ nations chose that alternative in the 1930s, in favour of trade and capital market protectionism. The Great depression was the result.
Going forward, Asia, now more than ever, will need access to great amounts of liquidity. In the short term it might get that from asset managers seeking short-term returns. However, to rely on those is to ignore many of the key lessons of the crisis, not least that over- reliance on short-term capital flows is a perilous policy choice - and that is exactly what is, a policy choice. There is an alternative, and that is to create a more viable platform for foreign direct investment in the cases of some, institutional infrastructure for others, recapitalising their financial systems not only with money but with the legal and supervisory framework to encourage investors to the view that the crisis will not re-occur.
So much for what has not happened at the level of microeconomic reform, what is needed, what is to come - or not. This is not to take anay from the fact that 1999 saw a dramatic recovery in Asian economies, one which surprised many. The length of that recovery will, as we have seen, depend crucially on the extent of microeconomic reforms which Asian countries attempt to achieve. That said, IF such reforms are imposed, it is a recovery which has some chance of continuing into 2001 and beyond, depending of course on how the external environment, not least in the U.S., pans out. The next chapter looks at this issue of Asian economic recovery, how it was created, the recovery’s first symptoms and why macroeconomic dynamics suggest it will continue at least in the short term.
Some progress was made however. Since the onset of the Asian crisis, several Asian countries have sought to improve their regulatory frameworks for domestic financial institutions, forcing increases in bank CAR ratios and the improvement of standards on loan provisioning and loan classification.
In addition, the governments of Korea, Indonesia and Thailand sought to varying degrees to put in place an institutional and legal framework for the resolution of debt restructuring. Finally, all three countries increased foreign investor access to their markets, companies and banks through the raising of foreign investor ownership ceilings and the reduction or elimination of rules inhibiting such access. Korea, for example, fully liberalised foreign purchases of domestic Korean won bonds and abolished most ownership restrictions for foreign investors, key elements in the task of re-liquifying the Korean financial and economic system. In the financial sector, to recall, Thailand closed 56 finance companies, while Korea closed more than half of its merchant banks. In addition, it closed two commercial banks, re-capitalised them and sought to resell them to domestic and foreign investors. The governments of Korea and Thailand announced the issuance of domestic bonds worth up to 15 of the GDP, placing these with domestic financial institutions in order to put a floor under the balance sheet of their respective banking systems.
All sound measures and proof indicated that the efforts of the IMF and World Bank were not wasted and that progress was made at the micro-economic as well as the macroeconomic level. That said, one should not under-estimate the damage caused at the micro-economic level by the crisis and thus the remaining problem. The World Bank in its report East Asia: The Road to Recovery’, said that it was estimated that as a result of the crisis two-thirds of Indonesian firms suffered losses exceeding their equity, while for Korea this figure was two-fifths and for Thailand one quarter.5 Higher interest rates, plunging capital bases, a collapse in available domestic bank credit as banking systems sought first to repair their own balance sheets combined to produce a ruinous result for many Asian corporations. In the go-go days of Asian economic growth, the fundamental weaknesses of many of these companies, including small capital and equity bases and over-leverage on cheap, in many cases governmentinduced credit, had been hidden by strong top line growth in the P&L. Diminishing total returns was a warning prior to the crisis, a warning
which went unheeded at all levels.
High debt-equity ratios was however the natural product of the Asian growth model, itself founded on consensus and co-operative rather than competitive economics. Asian governments had sought to expand deliberately the strategic export sectors. In order to do so, they provided, directly or through their banking systems, cheap, directed credit, subsidised loans and tax breaks. Insufficiently deep Asian equity and bond markets required that the Asian corporates rely for most of their external funding on bank loans. In the early 1990s, many Asian governments removed or reduced borrowing limits, particularly on foreign currency borrowing, but failed simultaneously to strengthen banking, corporate regulation and supervision. When I arrived in Asia at the start of 1996, before I joined the banking sector, many of its markets and economies felt like a Gold rush precisely because there was insufficient control or supervision of bank lending or corporate borrowing. It was the ‘Wild East” in that just about anything went. Cheap credit was available and deals were done whatever it took. Corporate governance played a part also in that corporate borrowing was in many cases hugely excessive relative to its potential for driving the bottom line. As a result, a substantial part of corporate profit went into paying interest costs, thus making corporations especially vulnerable to domestic interest rate rises. For example, by 1997, according to the World Bank, more than two thirds of all profits of listed Thai companies went to cover the interest costs.
In addition, excessively cosy relationships between domestic bank loan officers and many corporations led to increased loans to firms with high debt leverage and low profitability. Political pressure from the top to make loans to favoured or strategic companies had an eventual cost and in 1997 and 1998 that cost was high - and remains high to this day. As stated in Asia Falling, it is all about incentive. Banks had little incentive for ensuring that their loans were creditworthy, while corporations had little incentive to ensure that their loans were needed in the first place since they would get them anyway. The market pricing mechanism was thus significantly distorted. What we have seen subsequently is not only the result of that but effectively an attempt by “the market” to achieve a greater degree of pricing mechanism equilibrium. In the 1960s and 1970s, many Asian countries privatised banks and corporations, however in many cases they retained a heavy hand in their financial running. As an economist, it is my profound view that the state is inherently inefficient from a profit perspective in running companies and banks, a condition brought about by the fact that profit is not the only or in some cases even the major motive. Interlocking relationships between the government, banks and corporations thus reduced the ability of the market mechanism to function, thus inexorably leading to ever diminishing returns and the consequent need for ever increasing credit just to maintain those returns. Cronyism” was a factor behind the Asian crisis. To anyone with any common sense, this is merely stating the obvious, but to some apparently it has to be said. Granted, that same cronyism or contact- or consensus- capitalism depending on how one terms it was also a key plank of the Asian growth story for at least two decades, but such practices, lacking the discipline of a free market which focuses only on the bottom line eventually led to major price distortion, such distortions inevitably being corrected, albeit after a substantial period of time and at the expense of a regional crash.
Inadequate domestic asset markets and more specifically the infrastructure of those asset markets, namely zealous and INDEPENDENT regulators and deep and broad institutional investor bases were also a key reason for the lack of true market discipline which pervaded in Asia in the 1990s. For instance, in 1996, the mutual fund industry represented under 1000 of the total Stock Exchange of Thailand (SET) trading. Outside of Singapore, many Asian countries had weak or minimal pension fund industries. Finally, the very organisational structure had a part to play in the eventual Asian crisis, characterised most commonly by a diversified conglomerate structure whose shares were closely held by a family. Given the lack of development of the Asian equity markets and the lack of minority shareholder rights, these owners again did not have sufficient incentive to make their corporations efficient. They simply did not have to.
The result of all this was that the crisis caused wholesale bankruptcy in countries which had these fundamental microeconomic flaws. Indonesia was easily the hardest hit, followed by Korea and Thailand. The extent of the damage reached systemic proportions in all IMF programme member countries. Solving this crisis at the microeconomic level always necessitated a comprehensive and cooperative strategy involving international creditors, domestic banks and corporations, domestic governments and the influence of multilateral organisations to prod proceedings along in the right direction. Using the incentive rule, such strategies oniy work if they have to, if they are forced to. This implies the breaking up of those cosy relationships between banks, corporations and governments. There is a key lesson from the Japan crisis (1991-and still counting) in this. Bank restructuring in particular works most effectively if it is enforced by the government, creditors or shareholders, rather than at the agreement of cosy agreements. This was a key reason why the Japanese government attempts at bank restructuring - however belated, however pitiful - have so far failed to achieve what most in the West see as the desired result - a profitable, healthy bank. Instead of this, Japan has gradually been nationalising its financial system, a strategy which is doomed to ever diminishing returns and ultimate failure. When faced with the painful choice between propping up institutions (and those cosy relationships) or biting the bullet and letting such institutions go or be forcibly restructured, no matter what the short term cost to prices or market confidence, Japan chose the easy way out.
It has yet to be confirmed that Thailand, Korea and Indonesia have avoided this route. If they have not, that will have dire consequences for the medium- and long-term growth prospects of their economies. The alternative to the approach of bank-led restructuring is theoretically and has been practically that of government-led restructuring. Under this model, the government creates an asset management company to reduce and restructure bank non- performing loans, taking over and restructuring bad debts and replacing these assets with bond issues, thus the banking system is re-capitalised. While governments may prefer voluntary negotiations between bank creditors and corporate debtors, without appropriate balancing mechanisms in order to avoid social structure damage, this is rarely the most appropriate way of achieving an efficient result. What seems clear is that there must be an element of enforceability of this restructuring by the authorities and equally a degree of submission to market pricing discipline. On the latter, this means, whatever price the market currently supports is the price you get for your distressed assets, not the price you or your government might want. However, those distressed assets need domestic as well as foreign buyers. More has to be done to democratise the Asian equity markets, increasing the rights of minority shareholders, developing strong mutual and pension fund industries which in turn can help enforce corporate and bank restructuring - or throw out directors and CEOs through the creation of emergency shareholder meetings - a source of much humour in Japan for some time and look at the cost of that. Disclosure and accounting standards have to be improved (or in some cases created). Remember, things don’t improve if they don’t have to improve. The message to Asia is a clear, if an uncomfortable one: the Asian capitalist model does not work anymore. It has passed its sell by date. This is not to say that Asia should necessarily and automatically adopt a U.S. version. It is to say that Asian governments and financial authorities should create true market places, which might or might not mimic their U.S. counterparts, but which focus on creating free and fair trade, strong regulatory and supervisory standards and the institutional investor structure to support deep and liquid asset markets. The pricing mechanism used must be the market rather than the relationship. Why? Not because that is the U.S. model (it is questionable whether or not it is in fact given trade subsidies which both the U.S. and Europe provide), but because it is the most efficient model, providing the soundest base for long-term sustainable growth. That, surely, must be the aim.
The emphasis on the market pricing mechanism must not be at the expense of ignoring the importance of creating a sufficient legal framework, a crucial element in any country’s infrastructure, as important as ports and roads, as electricity, housing and education. In the case of a debt and currency crisis, the first priority in this regard must be to provide an adequate bankruptcy law framework to encourage new investors to pick through the rubble of distressed assets. Only when this occurs will there be sufficient incentive not to become distressed in the first place. In the wake of what appears to be strong recoveries in Asia, this may no longer seem relevant, but it most assuredly is. Without sufficient microeconomic reform and restructuring, those recoveries will most assuredly prove fleeting, the result of temporary fiscal and monetary stimulus which when removed in order to avoid renewed inflation results in a sharp pullback in domestic demand. Generally speaking, there are three types of resolving bankruptcy or insolvency: liquidation, rescue or agreed restructuring or “work out” involving informal relationships outside of the court’s mandate. Both liquidation and rescue necessitate the presence and active involvement of the formal court procedure, the first leading most likely to a sale of assets to a third party (the company and the court being the first two parties), the second involving the administered rescue of a company as a viable and going concern through public infusion or in the private sector case most likely debt-equity swaps. The dependency in Thailand, Korea and Indonesia on the Asian model of consensus rather than market capitalism led to an initial emphasis on informal work outs after the crisis, despite the emphasis by the IMF on the strengthening of the institutional infrastructure framework. Issues such as “loss of face” and the necessity to maintain business and banking relationships have proved to be strong obstacles to the initial creation and then the enforcement of efficient bankruptcy laws. However, it is wrong to say that culture is an inevitable obstacle to this process. The Singapore bankruptcy code, shaped by the UK 1985 Insolvency Act is a case in point, involving supposed Western legal enforcement with an Asian emphasis on compromise and negotiation, a potential model for others in the region to follow. Extending that example, it is no coincidence whatsoever that Singapore has an exceptionally strong corporate legal framework and zealous and independent regulatory bodies, and at one and the same time its corporate and banking systems are relatively low geared - as befits PROFIT necessity - and have survived the Asian crisis for the most part healthy and intact. There are no doubt strong relationships between banks and corporations in Singapore, but they are not allowed to be the founding premise for debt creation.
Outside of Singapore, in crisis countries where the relationship became the essence of the pricing mechanism, rather than the market, is where the Asian model eventually broke down when it was forced to compete with the unfettered forces of the global freemarket system. The Asian model does not have to be scrapped wholesale, but the driving force and the incentive for economic growth have to be altered in favour of the market. Strong relationships can and should still exist. That need not change, but they cannot be the primary motivating force behind economic expansion. Not anymore. The alternative is to reject the global system and turn inwards, but that is not a realistic option for any but the foolhardy. The “emerged’ nations chose that alternative in the 1930s, in favour of trade and capital market protectionism. The Great depression was the result.
Going forward, Asia, now more than ever, will need access to great amounts of liquidity. In the short term it might get that from asset managers seeking short-term returns. However, to rely on those is to ignore many of the key lessons of the crisis, not least that over- reliance on short-term capital flows is a perilous policy choice - and that is exactly what is, a policy choice. There is an alternative, and that is to create a more viable platform for foreign direct investment in the cases of some, institutional infrastructure for others, recapitalising their financial systems not only with money but with the legal and supervisory framework to encourage investors to the view that the crisis will not re-occur.
So much for what has not happened at the level of microeconomic reform, what is needed, what is to come - or not. This is not to take anay from the fact that 1999 saw a dramatic recovery in Asian economies, one which surprised many. The length of that recovery will, as we have seen, depend crucially on the extent of microeconomic reforms which Asian countries attempt to achieve. That said, IF such reforms are imposed, it is a recovery which has some chance of continuing into 2001 and beyond, depending of course on how the external environment, not least in the U.S., pans out. The next chapter looks at this issue of Asian economic recovery, how it was created, the recovery’s first symptoms and why macroeconomic dynamics suggest it will continue at least in the short term.
HONG KONG
While other Asian currencies were allowed to depreciate, to whatever degree, Hong Kong did not have that luxury, having adopted a currency board in October 1983 when the peg - for want of a better word, since it is not strictly speaking a currency “peg” - was fixed at
7.80 Hong Kong dollars to the U.S. dollar. What the Hong Kong authorities themselves call a linked exchange rate regime (i.e, a currency board) is designed to allow Hong Kong interest rates to adjust automatically to currency pressures via changes in domestic money supply, whereby the selling of Hong Kong dollars results in an equal reduction in the Hong Kong dollar money supply, thus causing interest rates to rise. Eventually, as the logic of the currency board system goes, domestic Hong Kong interest rates reach a level which attracts renewed investor interest in the Hong Kong dollar, causing purchases of that currency and subsequently an equal and opposite increase in the supply of Hong Kong dollars to the system, thus causing interest rates to fall back once more. In theory, the system is beautifully and elegantly simple. However, the practice of financial markets can be somewhat more violent. The date of October 23, 1997 was the first of several to be etched in the minds of those who watched the Hong Kong markets during the crisis. That day, the benchmark Hang Seng stock market index lost a stunning 1,211.47 points, at the time its largest one-day drop in history as speculators attacked both the currency and asset markets at the height of the first wave of the Asian crisis. As the Hong Kong dollar came under increasing attack, increasingly large amounts of Hong Kong dollars had to be withdrawn from the domestic money supply as required by the rules of the currency board. The Hong Kong Monetary Authority sat back and watched as the overnight borrowing rate skyrocketed to 3000o. The combination of soaring interest rates and heavy foreign exchange intervention caused USD-HKD to hit an intraday low of 7.4800, compared to usual trading levels at the time of around
7.7450, as the Hong Kong dollar screamed higher against the U.S. dollar in the wake of panicked speculators desperately trying to get out of their short Hong Kong dollar positions. October 23, 1997 was a day of high drama, a day when investors throughout the territory gazed up at public stock market screens in horror as the Hang Seng was smashed, a day when the speculators thought they were winning and ended up very badly burned as sky-high interest rates caused their funding costs to soar, a day the HKMA was tested and not found wanting. It was not to be the last time that the HKMA was tested however, far from it, though the bruising which the speculators took on that day caused many to take quite some time before they returned to have another go.
Basically, the options open to the Hong Kong authorities came down to two: hold the peg or let it go. The authorities chose to hold it at all costs, in the face of significant criticism from financial and economic commentators (mostly outside Hong Kong, and who were thus not exposed to the result of a de-peggingO and rightly so. As I argued at the time, a dc-pegging or an adjustment/devaluation of the Hong Kong dollar would have been catastrophic for Hong Kong. Many at the time said that Hong Kong needed to devalue in order for it to regain trade competitiveness lost to its major competitors in the wake of the ASEAN and North Asian currency devaluations during the Asian currency crisis. This logic is deeply flawed. Returning to the strict definition of the exchange rate regime in Hong Kong, the Hong Kong dollar is not pegged as several ASEAN currencies were pegged to the dollar at the time (only for those pegs to be blown apart), but is instead linked to the U.S. dollar via a currency board, whereby the HKMA, the monetary authority of Hong Kong in lieu of a standard central bank, guarantees to sell dollars at a rate of 7.80 Hong Kong dollars to the market, backing that guarantee with its own foreign exchange reserves from the Exchange Fund.
The currency board survived its test in October 1997, just as it had many before that (and subsequently), and by the end of the first quarter slightly more favourable liquidity conditions had allowed a relaxation in domestic Hong Kong interest rates, causing the spread between the 3-month HIBOR rate and the Fed funds’ target rate to finally dip back below pre-crisis levels. This was to be a temporary relief however for the Hong Kong markets and for the exchange rate system, which started to come under renewed attack in June and July of 1998. Local interest rates were forced sharply higher, while the stock market turned South, falling to a 1998 low of 6,544.79 from above 16,000 in 1997. At the time, speculators had discovered a way of “manipulating” the local markets as the HKMA would later charge, selling the Hang Seng futures, borrowing Hong Kong dollars and selling them short against the U.S. dollar, thus forcing interest rates higher. What they lost on their Hong Kong dollar borrowing, they more than made up for on their short Hang Seng futures’ and short Hong Kong dollar positions, seemingly free money. A large scale attack on the Hong Kong dollar and Hong Kong asset markets took place in early August of 1998. The Hong Kong authorities, not surprisingly took exception to this given that the economy remained mired in deep recession and higher interest rates would exacerbate that. Trading in Hang Seng stock index futures exploded in early August, with gross open interest in the front end contract rising to 92,000 contracts from 70,000 in June. Eventually, the Hong Kong authorities decided to do something about this, with the Financial Secretary and the HKMA Chief Executive Joseph Yam giving approval for the HKMA desk to intervene in the stock market with the specific aim of eliminating the speculative presence. From August 14-28, the HKMA bought cash stocks and Hang Seng futures, with a total worth of around HKD11O bin, causing the Hang Seng to rebound back above the 10,000 level. Incredibly, the HKMA had taken on the markets and won - again - but this did not come without a deluge of criticism, both from within Hong Kong this time and externally that the authorities, by intervening in the market had effectively abandoned their free- market principles.
The HKMA followed this up in September by introducing a number of measures to boost the overall market liquidity, when measured it caused the Hong Kong dollar to halve almost instantly, further burning the speculators. The package of measures contained two major provisions: a convertibility undertaking to demonstrate the authorities’ commitment to the currency board and a cushion of liquidity through a series of technical improvements to that currency board system. On the first, the HKMA provided a crystal clear undertaking to licensed banks to convert Hong Kong dollars in their clearing accounts into U.S. dollars at a fixed rate of HKD7.75 to the U.S. dollar. In addition, from April 1, 1999, that convertibility undertaking exchange rate of 7.7500 would change by 1 pip per
calendar day, taking 500 calendar days to complete the move to 7.80.
On the second provision, the HKMA made a commitment to increase
systemic liquidity reducing the ability of speculators to manipulate
the market, which was what the HKMA saw as levelling the playing
field. More specifically, the HKMA suggested 6 specific measures:
1. Removing the bid rate of the Liquidity Adjustment Facility (LAF)., thus
r keeping more interbank funds in the system.
2. Replacing the LAF with a discount window with the base rate of that
(formerly the LAF’s offer rate) to be determined occasionally by the
HKMA but in general by the market.
3. Removing the restriction on repeated borrowing of overnight Hong
Kong dollar liquidity through repo transactions using Exchange Fund
Bills and Notes.
4. New Exchange Fund paper to be issued only when there is an inflow of
funds, ensuring that all EF paper is fully backed by foreign exchange
reserves.
5. Introducing a schedule of discount rates applicable for different
percentage thresholds of holdings of Exchange Fund paper by the
licensed banks for the purpose of accessing the discount window.
6. Retaining the restriction on repeated borrowing in respect of repo
transactions involving debt securities other than Exchange Fund paper.
Joseph Yam, the HKMA Chief Executive, said: “These measures aim at strengthening Hong Kong’s currency board arrangements and achieving an even higher degree of transparency and disclosure. They will enhance the robustness of Hong Kong’s monetary arrangement, characterized by the linked exchange rate system. They should also help to reduce excessive volatility in interest rates.”4
The measures were aimed at significantly boosting systemic liquidity and at the same time increasing transparency of the currency board system, thus allowing the potential for the market itself to offset speculative interest. Despite further criticism of these measures and ongoing criticism of the stock market intervention, it is no exaggeration to say that this package of measures was brilliant. In addition to those stated aims, they eliminated much of the market concern regarding the HKMA’s previous apparent policy of stating a convertibility rate of 7.80 to the dollar while actively intervening in the foreign exchange market at 7.7500, thus allowing the potential for arbitrage and putting into question its commitment to the currency board - if the HKMA believed in the strength and efficacy of the currency board system, why did it need to intervene at all instead of letting the mechanism work.
The HKMA’s response to repeated attacks against the currency board system attracted praise from none other than the New York Fed President William McDonough for its steadfastness and resiliency in the face of the most trying of financial market conditions. Yet, while it seemed to have won a series of battles, the fundamental economic situation remained dire. After seeing its economy expand by an impressive 5.3 in 1997 - the height of the boom in local asset markets, in the run up to the Handover on July 1, 1997 - Hong Kong’s conomy contracted by 5.1 in 1998, a stunning reversal of lO.4 points. Unlike other Asian countries which saw their currency depreciate, deliberately or inadvertently as a result of the crisis, Hong Kong did not have that luxury given the currency board peg requirement. Equally, on the fiscal side, the HKSAR - Hong Kong Special Administrative Region of China - was restrained by the Basic Law from having significant fiscal deficits which would be deemed fundamentally imprudent. Hong Kong ran a budget deficit of -2.5 of the GDP in 1998 on the basis that this was an emergency situation, which is likely to have been followed by a deficit of -2.9 in 1999. Despite some degree of deficit spending and a cut in the national income tax, the main brunt of the adjustment fell on the three main pillars of the Hong Kong economy: property, financial services and tourism/retail trade. On the first issue, the government, which remains the sole owner of remaining plots of land due to the Colonial heritage of the place, ceased having new auctions to try and rebalance the supply/demand equation. The second issue, resulted in mass layoffs of bank staff as financial institutions sought to downsize to reflect greatly reduced demand for financial product, of whatever sort. On the third, tourism collapsed.
Fundamentally, this adjustment in the form of asset prices and demand was actually no bad thing, for Hong Kong by 1997 was an extremely expensive, un-competitive place, as reflected most clearly by house prices (which doubled from January-June 1997 alone). Hong Kong did not have the problems that Thailand, Indonesia and Korea had, namely of excessive short-term foreign currency debt and a shaky banking system. On the contrary, the HKMA was a very prudent and sound regulator of the banking system, ensuring the maintenance of bank capital adequacy ratios substantially in excess of the Bank of International Settlements (BIS) requirements. No, Hong Kong’s problem was one simply of loss of price competitiveness, a loss which was shown up and greatly exacerbated by the Asian currency devaluations against the Hong Kong dollar as well as the U.S. dollar in the wake of the crisis given Hong Kong’s need to maintain a fixed exchange rate commitment. The HKMA was right to maintain that commitment to the currency board system at the time, during the crisis given that the alternative would have courted a financial disaster potentially worse than Thailand given the proportion of the U.S. dollar and Hong Kong dollar assets in the system as a result of the currency board, and more specifically the fact that the domestic banking system’s capital base was in Hong Kong dollars. If the peg had been let go at any time during the crisis, the resulting devaluation of the Hong Kong dollar could not have been limited and would have caused a proportional devaluation of the banking system’s capital base. It would have caused the one thing it had not done to any degree up until that point, a loss of confidence in the domestic supervisory institutions and in the domestic banking system. There would have been mass panic, runs on banks. The banking system would have imploded, domestic interest rates would have skyrocketed rather than fallen as demand for Hong Kong dollars collapsed and the stock market and the economy would have gone into meltdown. It would have been the type and degree of financial catastrophe from which it would have taken Hong Kong decades to recover. During the crisis, there was absolutely no benefit to the HKMA in letting the peg go, and every reason to maintain it. Those who called for its abandonment were talking utter nonsense. This does not mean to say that a currency board cannot be eventually replaced by another form of exchange rate regime. It is to say that if the currency board system had been seen to be defeated, it would have caused disaster, and not just for Hong Kong. All other currency boards in the world would have been instantly targeted. Argentina has much to thank Hong Kong for, and vice versa.
Going forward, Hong Kong may decide that a policy change is necessary given more suitable conditions and fundamentals, however what it did in 199 7-98, maintaining the peg at all cost was exactly the right thing to do. Anything else would have been disgracefully irresponsible. The Hong Kong authorities also, justifiably, deserve much praise. What one can say however is that their policy response was not asymmetric. They intervened against what they saw as excessive and manipulative selling pressure against the Hong Kong dollar and its asset markets, but they were not so similarly zealous when those same asset markets were rallying excessively in 1996-97. Was this not also speculation? It is not a sufficient answer for the HKMA to say that they do not intervene in financial markets, since they plainly did do exactly that in August 1998. It would not have been beyond the remit of the monetary authority at the time to warn against the potential dangers of speculative gains, indeed it should have done so, though political factors ahead of the Handover might have made that somewhat difficult and a sensitive issue in practice.
7.80 Hong Kong dollars to the U.S. dollar. What the Hong Kong authorities themselves call a linked exchange rate regime (i.e, a currency board) is designed to allow Hong Kong interest rates to adjust automatically to currency pressures via changes in domestic money supply, whereby the selling of Hong Kong dollars results in an equal reduction in the Hong Kong dollar money supply, thus causing interest rates to rise. Eventually, as the logic of the currency board system goes, domestic Hong Kong interest rates reach a level which attracts renewed investor interest in the Hong Kong dollar, causing purchases of that currency and subsequently an equal and opposite increase in the supply of Hong Kong dollars to the system, thus causing interest rates to fall back once more. In theory, the system is beautifully and elegantly simple. However, the practice of financial markets can be somewhat more violent. The date of October 23, 1997 was the first of several to be etched in the minds of those who watched the Hong Kong markets during the crisis. That day, the benchmark Hang Seng stock market index lost a stunning 1,211.47 points, at the time its largest one-day drop in history as speculators attacked both the currency and asset markets at the height of the first wave of the Asian crisis. As the Hong Kong dollar came under increasing attack, increasingly large amounts of Hong Kong dollars had to be withdrawn from the domestic money supply as required by the rules of the currency board. The Hong Kong Monetary Authority sat back and watched as the overnight borrowing rate skyrocketed to 3000o. The combination of soaring interest rates and heavy foreign exchange intervention caused USD-HKD to hit an intraday low of 7.4800, compared to usual trading levels at the time of around
7.7450, as the Hong Kong dollar screamed higher against the U.S. dollar in the wake of panicked speculators desperately trying to get out of their short Hong Kong dollar positions. October 23, 1997 was a day of high drama, a day when investors throughout the territory gazed up at public stock market screens in horror as the Hang Seng was smashed, a day when the speculators thought they were winning and ended up very badly burned as sky-high interest rates caused their funding costs to soar, a day the HKMA was tested and not found wanting. It was not to be the last time that the HKMA was tested however, far from it, though the bruising which the speculators took on that day caused many to take quite some time before they returned to have another go.
Basically, the options open to the Hong Kong authorities came down to two: hold the peg or let it go. The authorities chose to hold it at all costs, in the face of significant criticism from financial and economic commentators (mostly outside Hong Kong, and who were thus not exposed to the result of a de-peggingO and rightly so. As I argued at the time, a dc-pegging or an adjustment/devaluation of the Hong Kong dollar would have been catastrophic for Hong Kong. Many at the time said that Hong Kong needed to devalue in order for it to regain trade competitiveness lost to its major competitors in the wake of the ASEAN and North Asian currency devaluations during the Asian currency crisis. This logic is deeply flawed. Returning to the strict definition of the exchange rate regime in Hong Kong, the Hong Kong dollar is not pegged as several ASEAN currencies were pegged to the dollar at the time (only for those pegs to be blown apart), but is instead linked to the U.S. dollar via a currency board, whereby the HKMA, the monetary authority of Hong Kong in lieu of a standard central bank, guarantees to sell dollars at a rate of 7.80 Hong Kong dollars to the market, backing that guarantee with its own foreign exchange reserves from the Exchange Fund.
The currency board survived its test in October 1997, just as it had many before that (and subsequently), and by the end of the first quarter slightly more favourable liquidity conditions had allowed a relaxation in domestic Hong Kong interest rates, causing the spread between the 3-month HIBOR rate and the Fed funds’ target rate to finally dip back below pre-crisis levels. This was to be a temporary relief however for the Hong Kong markets and for the exchange rate system, which started to come under renewed attack in June and July of 1998. Local interest rates were forced sharply higher, while the stock market turned South, falling to a 1998 low of 6,544.79 from above 16,000 in 1997. At the time, speculators had discovered a way of “manipulating” the local markets as the HKMA would later charge, selling the Hang Seng futures, borrowing Hong Kong dollars and selling them short against the U.S. dollar, thus forcing interest rates higher. What they lost on their Hong Kong dollar borrowing, they more than made up for on their short Hang Seng futures’ and short Hong Kong dollar positions, seemingly free money. A large scale attack on the Hong Kong dollar and Hong Kong asset markets took place in early August of 1998. The Hong Kong authorities, not surprisingly took exception to this given that the economy remained mired in deep recession and higher interest rates would exacerbate that. Trading in Hang Seng stock index futures exploded in early August, with gross open interest in the front end contract rising to 92,000 contracts from 70,000 in June. Eventually, the Hong Kong authorities decided to do something about this, with the Financial Secretary and the HKMA Chief Executive Joseph Yam giving approval for the HKMA desk to intervene in the stock market with the specific aim of eliminating the speculative presence. From August 14-28, the HKMA bought cash stocks and Hang Seng futures, with a total worth of around HKD11O bin, causing the Hang Seng to rebound back above the 10,000 level. Incredibly, the HKMA had taken on the markets and won - again - but this did not come without a deluge of criticism, both from within Hong Kong this time and externally that the authorities, by intervening in the market had effectively abandoned their free- market principles.
The HKMA followed this up in September by introducing a number of measures to boost the overall market liquidity, when measured it caused the Hong Kong dollar to halve almost instantly, further burning the speculators. The package of measures contained two major provisions: a convertibility undertaking to demonstrate the authorities’ commitment to the currency board and a cushion of liquidity through a series of technical improvements to that currency board system. On the first, the HKMA provided a crystal clear undertaking to licensed banks to convert Hong Kong dollars in their clearing accounts into U.S. dollars at a fixed rate of HKD7.75 to the U.S. dollar. In addition, from April 1, 1999, that convertibility undertaking exchange rate of 7.7500 would change by 1 pip per
calendar day, taking 500 calendar days to complete the move to 7.80.
On the second provision, the HKMA made a commitment to increase
systemic liquidity reducing the ability of speculators to manipulate
the market, which was what the HKMA saw as levelling the playing
field. More specifically, the HKMA suggested 6 specific measures:
1. Removing the bid rate of the Liquidity Adjustment Facility (LAF)., thus
r keeping more interbank funds in the system.
2. Replacing the LAF with a discount window with the base rate of that
(formerly the LAF’s offer rate) to be determined occasionally by the
HKMA but in general by the market.
3. Removing the restriction on repeated borrowing of overnight Hong
Kong dollar liquidity through repo transactions using Exchange Fund
Bills and Notes.
4. New Exchange Fund paper to be issued only when there is an inflow of
funds, ensuring that all EF paper is fully backed by foreign exchange
reserves.
5. Introducing a schedule of discount rates applicable for different
percentage thresholds of holdings of Exchange Fund paper by the
licensed banks for the purpose of accessing the discount window.
6. Retaining the restriction on repeated borrowing in respect of repo
transactions involving debt securities other than Exchange Fund paper.
Joseph Yam, the HKMA Chief Executive, said: “These measures aim at strengthening Hong Kong’s currency board arrangements and achieving an even higher degree of transparency and disclosure. They will enhance the robustness of Hong Kong’s monetary arrangement, characterized by the linked exchange rate system. They should also help to reduce excessive volatility in interest rates.”4
The measures were aimed at significantly boosting systemic liquidity and at the same time increasing transparency of the currency board system, thus allowing the potential for the market itself to offset speculative interest. Despite further criticism of these measures and ongoing criticism of the stock market intervention, it is no exaggeration to say that this package of measures was brilliant. In addition to those stated aims, they eliminated much of the market concern regarding the HKMA’s previous apparent policy of stating a convertibility rate of 7.80 to the dollar while actively intervening in the foreign exchange market at 7.7500, thus allowing the potential for arbitrage and putting into question its commitment to the currency board - if the HKMA believed in the strength and efficacy of the currency board system, why did it need to intervene at all instead of letting the mechanism work.
The HKMA’s response to repeated attacks against the currency board system attracted praise from none other than the New York Fed President William McDonough for its steadfastness and resiliency in the face of the most trying of financial market conditions. Yet, while it seemed to have won a series of battles, the fundamental economic situation remained dire. After seeing its economy expand by an impressive 5.3 in 1997 - the height of the boom in local asset markets, in the run up to the Handover on July 1, 1997 - Hong Kong’s conomy contracted by 5.1 in 1998, a stunning reversal of lO.4 points. Unlike other Asian countries which saw their currency depreciate, deliberately or inadvertently as a result of the crisis, Hong Kong did not have that luxury given the currency board peg requirement. Equally, on the fiscal side, the HKSAR - Hong Kong Special Administrative Region of China - was restrained by the Basic Law from having significant fiscal deficits which would be deemed fundamentally imprudent. Hong Kong ran a budget deficit of -2.5 of the GDP in 1998 on the basis that this was an emergency situation, which is likely to have been followed by a deficit of -2.9 in 1999. Despite some degree of deficit spending and a cut in the national income tax, the main brunt of the adjustment fell on the three main pillars of the Hong Kong economy: property, financial services and tourism/retail trade. On the first issue, the government, which remains the sole owner of remaining plots of land due to the Colonial heritage of the place, ceased having new auctions to try and rebalance the supply/demand equation. The second issue, resulted in mass layoffs of bank staff as financial institutions sought to downsize to reflect greatly reduced demand for financial product, of whatever sort. On the third, tourism collapsed.
Fundamentally, this adjustment in the form of asset prices and demand was actually no bad thing, for Hong Kong by 1997 was an extremely expensive, un-competitive place, as reflected most clearly by house prices (which doubled from January-June 1997 alone). Hong Kong did not have the problems that Thailand, Indonesia and Korea had, namely of excessive short-term foreign currency debt and a shaky banking system. On the contrary, the HKMA was a very prudent and sound regulator of the banking system, ensuring the maintenance of bank capital adequacy ratios substantially in excess of the Bank of International Settlements (BIS) requirements. No, Hong Kong’s problem was one simply of loss of price competitiveness, a loss which was shown up and greatly exacerbated by the Asian currency devaluations against the Hong Kong dollar as well as the U.S. dollar in the wake of the crisis given Hong Kong’s need to maintain a fixed exchange rate commitment. The HKMA was right to maintain that commitment to the currency board system at the time, during the crisis given that the alternative would have courted a financial disaster potentially worse than Thailand given the proportion of the U.S. dollar and Hong Kong dollar assets in the system as a result of the currency board, and more specifically the fact that the domestic banking system’s capital base was in Hong Kong dollars. If the peg had been let go at any time during the crisis, the resulting devaluation of the Hong Kong dollar could not have been limited and would have caused a proportional devaluation of the banking system’s capital base. It would have caused the one thing it had not done to any degree up until that point, a loss of confidence in the domestic supervisory institutions and in the domestic banking system. There would have been mass panic, runs on banks. The banking system would have imploded, domestic interest rates would have skyrocketed rather than fallen as demand for Hong Kong dollars collapsed and the stock market and the economy would have gone into meltdown. It would have been the type and degree of financial catastrophe from which it would have taken Hong Kong decades to recover. During the crisis, there was absolutely no benefit to the HKMA in letting the peg go, and every reason to maintain it. Those who called for its abandonment were talking utter nonsense. This does not mean to say that a currency board cannot be eventually replaced by another form of exchange rate regime. It is to say that if the currency board system had been seen to be defeated, it would have caused disaster, and not just for Hong Kong. All other currency boards in the world would have been instantly targeted. Argentina has much to thank Hong Kong for, and vice versa.
Going forward, Hong Kong may decide that a policy change is necessary given more suitable conditions and fundamentals, however what it did in 199 7-98, maintaining the peg at all cost was exactly the right thing to do. Anything else would have been disgracefully irresponsible. The Hong Kong authorities also, justifiably, deserve much praise. What one can say however is that their policy response was not asymmetric. They intervened against what they saw as excessive and manipulative selling pressure against the Hong Kong dollar and its asset markets, but they were not so similarly zealous when those same asset markets were rallying excessively in 1996-97. Was this not also speculation? It is not a sufficient answer for the HKMA to say that they do not intervene in financial markets, since they plainly did do exactly that in August 1998. It would not have been beyond the remit of the monetary authority at the time to warn against the potential dangers of speculative gains, indeed it should have done so, though political factors ahead of the Handover might have made that somewhat difficult and a sensitive issue in practice.
SINGAPORE
The case of Singapore concerns one of fundamentally superior economic managsment. One of the most open trading nations in Asia, it was especially vulnerable to the collapse in inter-Asian regional trade which resulted from the Asian regional crisis. Well aware that competitive devaluations by its trading partners could result in a loss of competitiveness, the Singaporean authorities set about restoring that competitiveness through a series of microeconomic and budgetary measures, most notably including a 15 point cut in the employer contribution to the CPF, the national provident (pension) fund compulsory for domestic workers. Prior to the crisis, Singapore was already running a current account surplus of over 1 5 of the GDP so it had a substantial cushion to limit the damage to its currency. As a result of the downturn in domestic demand, that current account surplus almost reached 21 in 1998 and is expected it to be just over 17 in 1999. Outside of China, Singapore and Taiwan were the only countries which did not see their economies contract in 1998 in the emerging Asian region which we follow. Singapore saw growth of +0.3 and on current form this is likely to be followed by a growth of
6.0 in 1999 and 8.0 in 2000. How did this happen? The Singaporean authorities allowed greater flexibility in tracking the Singapore dollar against its basket of trading currencies, thereby implying a modest depreciation, but they explicitly did not allow a devaluation of the currency for the purpose of maintaining or expanding trade competitiveness. Thus, while the Singapore dollar was allowed to weaken slightly at the height of the crisis, from a high against the dollar in May 1995 of 1.3830 to a crisis low of 1.8 160, the crisis-related depreciation of the Singapore dollar from 1997 through the end of 1998 was around 25%, comparing favourably with devaluations of 40-50 for the Thai baht and the Philippine peso, with the Indonesian rupiah losing an astounding 80% of its value at one point. The Singapore dollar could not but be swept along to an extent by the crisis, but the important point was that investor confidence in the handling of the economic and financial fundamentals of the country remained assured. While Singapore did not take the road of devaluation, it also avoided the policy U-turn by IMP programme countries which are now looking at budget deficits of around 6 of GDP for 1999. The Singaporean authorities allowed a budget deficit of just -0.3 of the GDP in 1998, followed by an estimated -1.5% in 1999 which is likely to be flat in the year 2000. Strong long-term fundamentals, a prudent policy mix and a clear focus on maintaining the overall cost competitiveness of the economy, through allowing the market mechanism for re-pricing the domestic property market and through cutting the employer cost base through the CPF contribution reduction, were the foundations for the city state’s rock solid economic performance. Without any sense of false flattery whatsoever, the Singaporean economic and financial authorities are among the most impressive anywhere in terms of their skill in running the economy.
6.0 in 1999 and 8.0 in 2000. How did this happen? The Singaporean authorities allowed greater flexibility in tracking the Singapore dollar against its basket of trading currencies, thereby implying a modest depreciation, but they explicitly did not allow a devaluation of the currency for the purpose of maintaining or expanding trade competitiveness. Thus, while the Singapore dollar was allowed to weaken slightly at the height of the crisis, from a high against the dollar in May 1995 of 1.3830 to a crisis low of 1.8 160, the crisis-related depreciation of the Singapore dollar from 1997 through the end of 1998 was around 25%, comparing favourably with devaluations of 40-50 for the Thai baht and the Philippine peso, with the Indonesian rupiah losing an astounding 80% of its value at one point. The Singapore dollar could not but be swept along to an extent by the crisis, but the important point was that investor confidence in the handling of the economic and financial fundamentals of the country remained assured. While Singapore did not take the road of devaluation, it also avoided the policy U-turn by IMP programme countries which are now looking at budget deficits of around 6 of GDP for 1999. The Singaporean authorities allowed a budget deficit of just -0.3 of the GDP in 1998, followed by an estimated -1.5% in 1999 which is likely to be flat in the year 2000. Strong long-term fundamentals, a prudent policy mix and a clear focus on maintaining the overall cost competitiveness of the economy, through allowing the market mechanism for re-pricing the domestic property market and through cutting the employer cost base through the CPF contribution reduction, were the foundations for the city state’s rock solid economic performance. Without any sense of false flattery whatsoever, the Singaporean economic and financial authorities are among the most impressive anywhere in terms of their skill in running the economy.
MALAYSIA
In the case of Malaysia, the government not only had to combat the full force of the crisis, it also had to deal with a growing policy quarrel between Prime Minister Dr. Mahathir Mohamed and Deputy Prime Minister Anwar Ibrahim, the former railing against the market, blaming Western currency speculators for impoverishing his country and the region as a whole and saying that currency trading should be banned, the latter championing the free market and supporting the IMF’s case of fiscal and monetary tightening. Mahathir fired his Deputy Anwar, who was subsequently arrested and convicted on several charges. The Governor and Deputy Governor of the central bank, Bank Negara Malaysia, resigned and the following week, on September 1998, Malaysia imposed capital and exchange controls, fixing the ringgit at 3.80 to the dollar and banning the offshore spot and forward ringgit markets. As a result of this, domestic liquidity increased, allowing interest rates to be lowered, thus reducing the debt service burden on the domestic corporate base and banking system, an important consideration given that Malaysia’s total debt to GDP at the time was around l6O Malaysia is currently undergoing a strong growth recovery and GDP growth is anticipated at 4.8 in 1999 and 5.0 in 2000 after a 7.5 contraction in 1998.
THE IMF’s U-TURN
Somewhere along the way, the IMF had a change of heart. Though the ideological spat with the World Bank’s Joseph Stiglitz is unlikely to have caused it directly, that did serve to cause the IMF to defend publicly their programme’s principal condition of fiscal austerity. In addition, the near collapse of Korea, a country which had only recently been elevated to the OECD - and thus presumably getting as close to an emerged status as a country can be while remaining emerging” - caused a realisation that the problems of first Thailand, then Indonesia and finally Korea were not isolated incidents, but part of a regional, if not a global crisis and that the private sector had to be more involved in the resolution of the debt crisis. In addition, there was the realisation, however belated, of the sheer catastrophic degree of damage done to the Asian economies as a result of the currency devaluations and consequent debt re-valuations, economic damage which had actually been exacerbated by the IMF’s own demands for fiscal austerity. Certainly, there was the realisation within the IMF that more effective procedures had to be created to involve the private sector in emerging market currency and debt crises. In addition, there was the belated recognition of the specific nature of private rather than public debt crises. Two IMF internal reports appeared to call into question the randomness of bank closures and the appropriateness of fiscal austerity.
Once Asian external gaps had been closed by the end of the first quarter of 1998 and currencies had been stabilised, the IMF finally started to listen to Asian government requests for flexibility in terms of the fiscal account given the extent of the pain being felt by their economies and populations. Indeed, the JMF went so far as to allow Thailand, Indonesia and Korea to run significant budget deficits for both 1998 and 1999 in return for further moves to open up their markets, reduce and restructure corporate debt and strengthen institutional infrastructure. From a budget surplus of +2.2 of GDP in 1996, Thailand ran a budget deficit of i.0 in 1997 (initially targeted at a surplus of + 1.000 by the IMF) followed by -2.3 in 1998 and -6.0 estimated in 1999. Korea is also expected to have recorded a budget deficit of -6.0 in 1999, after -2.9 in 1998, such was the extent of the IMF U-turn on fiscal policy. Credit where credit is due: this reflected the realisation that financial conditions had been stabilised and the priority going forward was to stabilise the economic situation and alleviate the suffering of domestic populations. The fact that the programme countries were now running trade and current account surpluses (because their economies had collapsed and thus imports had collapsed) provided a much needed funding cushion and in addition acted as a stabilising factor for Asian currencies, allowing them greater flexibility in this regard.
In particular, the IMF allowed for programme-member Asian countries to expand social spending to mitigate against the worst demand factors resulting from the effects of the crisis and the initial fiscal and monetary austerity which had been necessary in order to close external gaps and to stabilise currencies. In the case of Indonesia, the overall budget cost of social safety net programmes was initially put at 8 of the GDP per annum, a financial hole which the IMF helped plug. Up until the first quarter of 1998, the programme member fiscal targets remained contractionary, but after that they became expansionary as the IMF allowed the three programme members to increase social spending, seeking to reduce the worst of the burden on the poor. There was a condition however and that was that deficit spending had to be financed through viable borrowing rather than monetary creation in order to avoid the potential threat of further inflationary impulses. In addition, there was the deliberate attempt to avoid increased fiscal deficits resulting in higher domestic interest rates. Through the joint efforts of the World Bank, deficit spending was aimed to help the poor, and to provide the necessary funding for the cash-strapped corporate sector. Monetary policy was similarly allowed to be expansionary, in line with easier fiscal policy after currencies were stabilised.
This belated flexibility on the part of the IMF was welcome. There were however Asian countries which suffered similarly or even equally amidst the hurricane of the Asian crisis which did not go the way of the IMF. These were divided into two types: those who sought to go their own way, rejecting both the idea of IMF help and ultimately of exchange rate flexibility (Malaysia), and secondly those who did not seek IMF aid but used policies similar to those promoted by the IMF in seeking to deal with the crisis, through their own best efforts and superior economic management (Hong Kong and Singapore).
Once Asian external gaps had been closed by the end of the first quarter of 1998 and currencies had been stabilised, the IMF finally started to listen to Asian government requests for flexibility in terms of the fiscal account given the extent of the pain being felt by their economies and populations. Indeed, the JMF went so far as to allow Thailand, Indonesia and Korea to run significant budget deficits for both 1998 and 1999 in return for further moves to open up their markets, reduce and restructure corporate debt and strengthen institutional infrastructure. From a budget surplus of +2.2 of GDP in 1996, Thailand ran a budget deficit of i.0 in 1997 (initially targeted at a surplus of + 1.000 by the IMF) followed by -2.3 in 1998 and -6.0 estimated in 1999. Korea is also expected to have recorded a budget deficit of -6.0 in 1999, after -2.9 in 1998, such was the extent of the IMF U-turn on fiscal policy. Credit where credit is due: this reflected the realisation that financial conditions had been stabilised and the priority going forward was to stabilise the economic situation and alleviate the suffering of domestic populations. The fact that the programme countries were now running trade and current account surpluses (because their economies had collapsed and thus imports had collapsed) provided a much needed funding cushion and in addition acted as a stabilising factor for Asian currencies, allowing them greater flexibility in this regard.
In particular, the IMF allowed for programme-member Asian countries to expand social spending to mitigate against the worst demand factors resulting from the effects of the crisis and the initial fiscal and monetary austerity which had been necessary in order to close external gaps and to stabilise currencies. In the case of Indonesia, the overall budget cost of social safety net programmes was initially put at 8 of the GDP per annum, a financial hole which the IMF helped plug. Up until the first quarter of 1998, the programme member fiscal targets remained contractionary, but after that they became expansionary as the IMF allowed the three programme members to increase social spending, seeking to reduce the worst of the burden on the poor. There was a condition however and that was that deficit spending had to be financed through viable borrowing rather than monetary creation in order to avoid the potential threat of further inflationary impulses. In addition, there was the deliberate attempt to avoid increased fiscal deficits resulting in higher domestic interest rates. Through the joint efforts of the World Bank, deficit spending was aimed to help the poor, and to provide the necessary funding for the cash-strapped corporate sector. Monetary policy was similarly allowed to be expansionary, in line with easier fiscal policy after currencies were stabilised.
This belated flexibility on the part of the IMF was welcome. There were however Asian countries which suffered similarly or even equally amidst the hurricane of the Asian crisis which did not go the way of the IMF. These were divided into two types: those who sought to go their own way, rejecting both the idea of IMF help and ultimately of exchange rate flexibility (Malaysia), and secondly those who did not seek IMF aid but used policies similar to those promoted by the IMF in seeking to deal with the crisis, through their own best efforts and superior economic management (Hong Kong and Singapore).
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