Global Trends by Martin Khor

Monday 1 September 2008

Plan now to face global economic crisis

As the global financial crisis turns into recession in developed countries, Asian countries should anticipate the effects and prepare policy measures to counter them, according to a regional workshop held in Penang last week.


The global financial turmoil has yet to affect Asian developing countries severely, but it is best to anticipate adverse effects and examine policy options to counter them before the crisis hits.

This was the conclusion of a workshop last week held in Penang by the Consumers’ Association of Penang and the Third World Network.

Several experts from international agencies warned that Asian countries face vulnerabilities, especially to the vagaries of capital flows. Though the region is better prepared than during the financial crisis a decade ago, some countries have weaknesses which in ways are different from the old ones but can nevertheless cause problems.

The workshop on the Global Financial Turmoil, Capital Flows and Policy Responses    was attended by 50 policy makers, researchers and civil society representatives.

Two routes by which the global crisis may affect Asia are through volatility in financial flows and reduced trade caused by recession, said Dr. Yilmaz Akyuz, former Chief Economist of the UN Conference on Trade and Development (UNCTAD).

He added that Asian countries are even more integrated to the global financial system than a decade ago, making them more vulnerable to shocks.  In some countries, there have also been massive increases in the outflows of capital by residents, who press their governments to enable them to diversify their investments abroad.

If the global crisis leads to less inflows (or a high outflow) of foreign funds, the government may want the local funds to return, but it is not easy to achieve this, warned Akyuz.

China and Malaysia are two countries with large trade surpluses and big increases in foreign reserves.  It is not easy to get good returns on the reserves, while there are also costs for the governments in “sterilisation”. 

This refers to the sale of bonds by the Central Banks to banks to mop up excess liquidity caused by capital inflows.  The governments incur a loss since they usually have to pay higher interest for the loans they obtain than the interest they earn on their foreign reserves.  

Akyuz estimated that Asian developing countries together lose US$50 billion a year from the cost of holding foreign reserves that are “borrowed.”

He suggested that Malaysia take measures to increase investment in the country (which at 22% of GNP is much lower than savings, which comprise 38% of GNP), while China should increase wages so that growth can be boosted by higher domestic consumption rather than just by exports.

Several other speakers, including Indian economist C.P. Chandrasekhar and Yu Yongding of the Chinese Academy of Social Sciences, and Filipino academic Joseph Lim warned that their countries had become more vulnerable to the volatility of capital flows because of recent financial deregulation and liberalization.

Chandrasekhar said India has a large and growing trade deficit, which is covered by capital inflows. If these are reversed, India could face significant weakening of its balance of payments.   Deregulation has also increased banking fragility, including fears of India’s own domestic sub-prime crisis, besides exposure of local institutions to losses due to their investments abroad (including a US$2 billion loss in the US sub-prime crisis).

Yu said that China had previously been sheltered by capital controls but due to liberalization the country has been inundated by a flood of hot money coming in, which is a serious threat to economic stability.  He suggested several measures to tighten control over capital inflows.

Dr. Rizal Ramli, former Coordinating Minister of the Economy of Indonesia, traced the adverse effects of IMF policies on Indonesia and said the country had failed to learn the lessons of the crisis.   Continued liberalization has led to the inflow of hot money, driving up stock market and property prices.

“The more hot money flows into Indonesia, the more vulnerable the economy becomes,” he said, urging the policy makers to learn from the recent policies of other countries like China and Thailand.              

Datuk Seri Andrew Sheng, former head of the Hong Kong Monetary Authority, said it was now even clearer that reform of the global financial system is needed, as recent events showed that the central countries can also face financial crisis and thus the world requires the changes. 

However the international financial institutions are not designed to cope with crisis occurring in the central countries.  Asian developing countries should get their act together for regional cooperation to increase their global voice, but it may take a new threat through a global financial crisis to lead them to a common view and approach.

In a final session, the prospects of Asian regional financial cooperation were discussed.  Heiner Flassbeck of UNCTAD, and a former German Finance Vice Minister, spoke on how Europe achieved monetary cooperation (including the present common currency) through steps taken over many decades.

“Political will was key, there were strong leaders who pushed this forward,” he said, adding Asia could learn from this and start monetary cooperation now as it will take many years to achieve.

Chandrasekhar said regional cooperation was needed in three areas – to prevent financial crises, to manage them if they occur, and to provide financing for growth, as was being attempted by the Bank in the South in South America.

President of the Philippine Institute for Development Studies, Josef Yap, summarized the various Asian regional cooperation measures, such as the Chiang Mai initiative, the Asian Bond Fund, and discussions on exchange rate coordination.

However, some of the more recent efforts appear to have stalled, he said.  Participants of the workshop concluded that attempts towards regional monetary cooperation must be accelerated, in view of the need to counter the impending effects of the global crisis.