|
||
|
Asia:
The causes of the crises GENEVA: The crisis in East Asia, and the dramatic turnaround in the economic fortunes of these economies do not stem from the "East Asia model" or the resistance of these countries to a globalizing world and the discipline of market forces. Rather, says UNCTAD's Trade and Development Report (TDR), the crisis occurred because governments failed to manage integration into global capital markets with the same prudence and skill they had earlier shown in managing trade liberalization. Throwing caution to the wind, the voices of orthodoxy ordained even larger doses of financial liberalization, and wrong assessments of the roots of the crisis and the remedies put forward on this basis have been responsible for worsening the crisis, the report brings out. From the beginning, says Yilmaz Akyuz, the author of the report, "our assessment of the crisis and causes [was] different from those of orthodox assessments which concentrated on certain institutional and socio-economic characteristics of the regions, including the weaknesses of the Asian model." This ignores the fact that the crisis in Asia does not differ in essential features from other crises that have occurred in industrial and developing countries, which have different social characteristics. In what it calls a common-sense view, the report says that a few lessons are evident. First, the worst time to "reform" a financial system is in the middle of a crisis. Second, when currency turmoil is associated with financial difficulties, raising interest rates may simply worsen the situation by bringing about widespread corporate and bank insolvencies. Finally, currencies should not be left to sink while funds are used to bail out the international creditors. Looking back on the crisis and its handling, says Akyuz, it is clear it was not well-handled. The orthodox policy measures advocated by the international community aggravated the financial difficulties. Market confidence was further undermined by the initial allegations of corruption and cronyism. And closing down the banks to reform the financial system in the midst of the crisis undermined confidence. Instead of supporting the currencies of the affected countries, the international community was seeking free capital flows and bailing out the lenders. These are the main factors that aggravated the situation. Potential backlash The events of the past year, says the TDR, should serve to underline the warning in last year's TDR of a potential backlash against the contradictions of a globalizing world. Asks the TDR: "When a colossal global market failure and measures taken to bail out creditors are paid for at the expense of the living standards of ordinary people, and of stability and development in the debtor developing countries concerned, who is to say that justice has been served?" In East Asia, the trend of decades of rising incomes has been reversed, and unemployment, underemployment and poverty are reaching alarming levels. Many of the lost jobs have been in sectors that had helped to reduce poverty by absorbing low- skilled workers from the countryside. Rising food prices and falling social expenditures have further aggravated social conditions and contributed to growing poverty. Even on conservative estimates, the proportion of the Indonesian population living on incomes below the poverty line in 1998 is expected to be at least 50% greater than in 1996. Similarly, poverty in Thailand can be expected to increase by at least one-third. "As the crisis drags on, it will be increasingly difficult for the new poor to recover from deprivation and return to their previous occupations and living standards. Moreover, the social harm could persist long after economic recovery is achieved. Judging from the mounting evidence of growing child malnutrition and declining primary school enrolments, the impact of the crisis on human resources will spill over into future generations." "Safety net measures can act as palliatives to cushion the impact of the crisis on poor and vulnerable groups, but they are in no way a lasting solution. Only the resumption of rapid and sustained growth can bring unemployment and poverty levels back down to pre-crisis levels. Policy should turn from deflation to reflation, supporting the unemployed by lowering interest rates, expanding liquidity and raising public expenditure, thus breaking out of a vicious circle that could do incalculable harm." Challenging orthodox views on the origins of the crisis, the TDR points out that the East Asian crisis is only the latest in a string of financial crises which have disrupted the global economy since the breakdown of the Bretton Woods system. Such crises have been occurring with increasing frequency in both industrial and developing countries. In industrial countries, the episodes of financial instability have involved either banking or currency crises; but in developing countries, they have typically been a combination of the two, and have been accompanied by difficulties over external debt service. These differences reflect divergences in net external indebtedness as well as the increasing dollarization of the economies of developing countries. Common characteristics of crises A greater understanding of the causes and nature of financial crises is essential for their better management as well as for designing policies to reduce their likelihood. While each episode of financial instability has had its own special characteristics, a number of common features stand out, says the TDR: * They have typically been preceded by financial deregulation and - where there was currency instability - by liberalization of capital transactions; * Banking crises have been associated with excessive lending on certain categories of assets such as property and stocks, and with speculative bubbles, frequently following a large movement by banks into certain types of financing for the first time. Such lending has often, but not always, taken place in the context of weak financial regulation and supervision; * Currency crises have typically been preceded by periods of sharply increased capital inflows attracted by a combination of an interest rate differential and relatively stable exchange rates. These act as an incentive to borrow abroad, but at the same time they increase exposure to currency risk; * There is no known case in any country, developed or developing, of a large increase in liquidity in the banking sector resulting from capital inflows that did not lead to an over-extension of lending, a decline in the quality of assets and increased laxity in risk assessment; * The inflows generate tendencies to currency appreciation and deterioration of the balance on the current account. When there are excessive capital inflows, the worsening of external balances and the weakening of the financial sector are often two sides of the same coin; * of the impetus for the increased capital flows is related to the crisis of commercial banking in the major industrial countries. The pressure on banks to find alternative sources of business to increase returns, and the greater competition in the financial sector brought about by deregulation, have been an important cause of increased international financial instability; * Reversals of capital flows are often associated with a deterioration of macroeconomic conditions resulting from the effects of the inflows, rather than with shifts in policies. But almost all major episodes of capital outflows and debt crisis in developing countries have been associated with rising international interest rates. The consequent currency depreciation leads to capital losses among those with unhedged exposures, and may become a force transforming the depreciation into a free fall owing to the rush for foreign exchange. Other features of currency crises have varied. They have occurred under rather diverse conditions with respect to types of financial flows, borrowers and lenders. For example, they have been preceded by borrowing by the private and public sectors in different proportions. Likewise, the most important form of capital flows in many recent crises (including that in East Asia) was international bank lending, but in the Mexican crisis, a large share consisted of portfolio investment in equities and in the paper of the Mexican Government. Liberalization, interest rate differentials and nominal exchange rate stability have been the main factors attracting capital inflows; and rapid liberalization often gives rise to expectations of improvements in economic fundamentals and large capital gains as well as perceptions of reduced risks. The existence of massive arbitrage flows taking advantage of large international interest rate differentials appears to be an important element in each currency crisis in the post-Bretton Woods period. And while in traditional concept, arbitrage opportunities are not permanent and eventually get eliminated, international interest rate arbitrage flows tend to be self- reinforcing rather than self-eliminating, thus making it more difficult to sustain domestic policies. And in the absence of controls, capital inflows generally result in an unfavourable combination of appreciating real exchange rate, rising foreign deficit and rising fiscal deficit. Constant factor of volatility Analyzing the various types of flows - FDI, portfolio investments, bank lending - and the maturity of the flows and so on, the report challenges the view that one particular form is better than the other or prevents crises. The likes of Asia, Latin America and elsewhere have in their experiences gone through a full circle of bank loans, bonds, FDI and portfolio flows. But "there is one constant factor, namely extreme volatility of flows in periods of crisis." "The divergences in the form of the flows received by a country do not seem to have made a substantial difference to the impact of these flows on domestic conditions and their subsequent reversal." Nor is the distinction between private and public borrowing borne out. The experience of the post-Bretton Woods system shows that the nature of the borrower does not significantly alter the probability of a crisis. And financial sector competition, caused by deregulation, is as much a cause of increased financial instability as anything else. Large capital flows lead to an overextension in bank lending that is exposed when flows are reversed, resulting in instability or collapse of the banking system, says the TDR. The TDR notes there is now a tendency to relate these to inappropriate domestic regulation or lax supervision, and to emphasize the importance of sequencing liberalization with an effective system of prudential regulations. This is a welcome but delayed response, says the TDR, which points out that among the ten lessons drawn by the World Bank on the tenth anniversary of the Latin American debt crisis, there was no mention of sequencing or prudential regulations, and that "there is also a limit to what prudential regulations can achieve." Outlining what it calls a "typical post-Bretton Woods crisis", the TDR says that such a crisis involves increased interest rate differentials, often associated with tight monetary policy aimed at attaining or maintaining price stability. Financial market deregulation and capital account liberalization are introduced alongside currency regimes maintaining nominal exchange rate stability. These combine to produce arbitrage margins large enough to attract liquid and short-term capital and reinforce the stability of the exchange rate peg. Liberalized and deregulated banks are free to expand into new areas of business internally, and domestic firms are free to borrow abroad, avoiding higher domestic interest rates and building up foreign currency exposures. The combination of success in controlling inflation and exchange rate stability tends to cause a real appreciation of the currency, and weakens the foreign balance. Attempts to sterilize the impact of these capital flows on domestic credit expansion lead to greater pressures on interest rates. And since domestic bonds are issued to finance sterilization of inflows held as reserves in foreign currency at lower interest rates, the fiscal position deteriorates. Eventually, either the foreign balance or fiscal balance gets out of control, domestic financial conditions deteriorate and there is extreme vulnerability to changes in perception, rise in foreign rates and rapid outflows, breaking the exchange rate peg, leading to capital losses for banks and firms carrying unhedged foreign currency exposure. Such a process can occur under varying conditions, and starts not with unsustainable policies but with those designed to maintain macroeconomic stability and integrate the economy into the global system to take advantage of global market opportunities. And in the absence of effective controls, the impact of capital flows distorts the effect of policies, making it very difficult to attain the objectives. (Third World Economics No. 193, 16-30 September 1998) Chakravarthi Raghavan is the Chief Editor of the South-North Development Monitor (SUNS)from which the above article first appeared.
|
||
