What does economic recovery mean and how is it different from mere “stabilisation?” It is the equivalent of the patient on the one hand getting back his/her vital signs but still remaining essentially horizontal, and on the other wandering around the ward. There is a clear difference! In economic terms, recovery means that real economic indicators such as retail sales, industrial output, imports and so forth are no longer contracting, but actually rising, first year- on-year (due to basing effects compared with the previous, depressed year) and then month-on-month. Indeed, the first sign of economic stabilisation in Asia was that the pace of contraction in imports began to slow. Equally, the first sign of recovery at the theoretical level was that imports actually began to rise. More practically, at street level, recovery was - and is - evidenced by more people out on the streets, shopping and driving around - the streets of Seoul seemed deserted of cars for man months in 1998, while individuals sold their personal gold in the national effort to raise money for the country. In comparison, the return of the Korean shopper and motorist was one of the first practical signs of economic recovery. On a trip to Seoul I made in October 1999, the shops were jammed full, while at key times so were the main highways - lamentably so for anyone trying to get somewhere at the time! Clearly, one should not exaggerate this analogy. Traffic jams do not of necessity mean economic recovery. Indeed, they can suggest decidedly negative aspects of the economy, not least lack of adequate infrastructure. That said, the combination of increased retail demand for goods, whether of clothes or cars, is a clear, cyclical sign that things are on the mend. You do not go out and buy a car or luxury goods if you are afraid you might lose your job tomorrow. The elimination of corporate de-stocking which had hitherto been a drag on growth, coupled with lower interest rates and looser fiscal policy which provide support for weak domestic demand, help boost economic growth. Corporate re-stocking of inventories gives a further lift to the growth take off.
In terms of trade balance, inventory re-stocking accelerates the recovery in imports, in turn accelerating the pullback in monthly recorded trade surpluses. However, by this time, capital flows have begun to offset and then to exceed trade flows once more as investment returns to the region. This was the key driving force for the Asian currency strength in the second quarter of 1999. Indeed, it is my contention that but for the specific concerns over Y2K which emerged in the third quarter of that year, Asian currencies would at the least have remained stable in the third quarter and more likely have continued their strengthening process. Two further factors conspired to hurt them in that period. Firstly, there were in truth specific fundamental concerns at the microeconomic level. In Korea, the necessary restructuring of Daewoo caused significant volatility in Korean asset markets, encouraging an accelerated sell-off in local stocks and bonds and not only of Daewoo paper. In Thailand, the health of the domestic financial system was put in question as banking sector non-performing loans remained at a high 47 of the total despite increasing signs of economic recovery. More specifically, the health - or rather the ill-health - of state-owned Krung Thai Bank was put under the spotlight, for many an appropriate reflection of the inadequacy of the Thai financial sector reform up until that point. Meanwhile, in Indonesia, the scandal of Bank Bali first soured local market sentiment - and then offshore market sentiment as the Indonesian government refused to allow the publication of the full report from auditors PWC - only for the East Timor issue to take centre stage, the Indonesian armed forces’ inability or unwillingness to deal with the massacring of East Timorese by pro-Jakarta militias obliging the multilateral organisations such as the IMF and World Bank to cease further disbursement of loans from their respective aid programmes.
In addition to these specific concerns, at the global level the U.S. Federal Reserve changed the rules of the game. At its June 30 meeting of the Federal Open Market Committee, the U.S. central bank raised interest rates for the first time since its March 25, 1997 meeting. The Fed hiked the Fed funds’ target rate by 25 basis points to 5.00% from
4750 however it was not so much the degree of the move as what
that move itself signified - the end of monetary easing. To recap, the Fed had cut interest rates three times from September-November 1998, and by 25 basis points each time in order to provide emergency liquidity to a market that was verging on a global meltdown. The message at the June 30, 1999 FOMC meeting was that the market conditions no longer warranted such extraordinary, emergency monetary easing and that those rate cuts would gradually be unwound. Whether or not one likes it, the Federal Reserve remains the de facto Central bank of the world, the provider of global liquidity. Fed tightening of necessity means less favourable conditions for global markets, both of the emerging and the emerged variety. Indeed, this was the start of a major reversal in Asian currencies and asset markets, in line with a generally more defensive line in global emerging markets across the board. Gradually, through a number of Fed official comments and through testimony by Fed Chairman Alan Greenspan, it became clear that the Fed was seeking an orderly and gradual reversal of those three fate cuts. At its August 24 FOMC, the Fed again hiked its Fed funds’ target rate by 25 bps, bringing its benchmark interest rate to within 25 bps of the 5.50 level from which the monetary easing had begun.
Candidly, the problem with any economic model is that it does not, and cannot take account of what we call “event risk”. That is to say, it cannot by definition allow for events which occur unexpectedly and which can potentially - and often do - cause temporary or even extended reversals in market sentiment. The classic emerging market currency crisis model is no different in this. Its aim is to provide a framework for tracking various emerging market economies according to the specific phase in which they find themselves and thus anticipating how their respective currencies might perform, all other factors being equal, based on the developments of that phase. Of course, in reality, in many instances, all factors are most certainly not equal and event risk plays a major part in distorting price action. In the specific case above however, a model which is aimed at targeting the various phases of emerging market currency crisis cannot include such external factors such as Fed policy since the latter does not of necessity track events in the emerging markets, indeed the rate cuts of last year were a very rare exception to the rule. As we said at the start of this examination, the model provides a useful framework for market and economic analysis, albeit with caveats., the best one can hope for with any model. Despite those caveats, it provides an accurate reflection of what happened during the various stages of most of the emerging market currency crises in the 1990s.
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