Challenges and Opportunities of the Southeast Asia Crisis

Dr. Supachai Panitchpakdi

Discussion Paper Series

APEC Study Center ,Columbia University

April 1998

..Before I discuss the prospects of Asia coming out of this ongoing financial crisis, let me highlight seven important issues which will provide a clearer understanding of the present economic and political situation in Asia.

First, I would like to start by emphasizing that this is not going to be the end of Asia... A lot of people are talking about a meltdown from the Asian miracle and wondering how fast it will happen. But it has never been a miracle, and it is not going to be a meltdown. It has never been a miracle because many of the substantial economic and social achievements that Asia has posted over the past decades came as a result of blood, sweat and tears -- a lot of hard work, a lot of savings, large doses of the correct macroeconomic policy, openness, export-driven competition, fiscal and monetary discipline, deregulation, liberalization. All of these ingredients have gone into the right blend of economic policy that has made Asia a successful place. And I would like to assure you that all of these fundamental ingredients are not going to evaporate instantly just because we have to cope with some changes in the exchange rates.

We only have to realize that the Asia crisis did not arise because of the wholesale mismanagement of fiscal policy or the misdirection of the macroeconomy, but mainly because of the overenthusiasm of the private sector to expand. This lust to expand by the private sector was allowed to persist for too long by governments in Asia and is essentially at the heart of the Asia crisis at the moment. It was not because of overconsumption or budget deficits, but because of overinvestment, over and above a substantial rate of savings.

...Second, I think we should be worried about the quality of our early warning system. Problems such as this can occur time and time again in the future if we do not have the right kind of early warning system in place. Although there have been some early warning signals, such as rising rates of inflation in some parts of Asia... all of these signs have been witnessed before in the history of economic development in Thailand... so these warning signs were not significant enough in the eyes of policy makers to take drastic action.

The last straw... was the... de facto pegging of the baht to the US dollar.... We knew we should switch to a more neutral basket or unpeg the baht altogether from the basket of currencies, but the timing was never right... the ultimate error was in the delay of the unpegging of the currency.

Third, all of these problems came in 1996 at a down time in the Asian economic cycle, which was aggravated even further by the down cycle of the electronics industry... this, in combination with the increase in real exchange rates in Asia, created a severe loss of competitiveness for the Asian economies.

Fourth, we talk these days a lot about mismanagement, particularly in the financial sector, and the need for financial reforms... although it has absorbed a lot of funds from abroad at very low rates, many of those funds have actually been misallocated... less funds have gone into tradable sectors even though this type of investment could have helped to repay interest and principal on foreign borrowings...

Fifth, there seems to be an exaggeration of the fluctuation of currency changes that have taken place in Asia, in particular a gross overshooting of the rates in the countries that are now in the hands of the IMF -- Korea, Thailand and Indonesia.

Sixth, trade theory suggests that following significant devaluation and the resulting J-curve effect, we should see a return to a normal trade surplus because of expansion in exports and slowing down of imports. However, I can report that this time around the improvement on our current account will not be so much the result of export expansion as of the slowdown in imports due to deep deflationary trends in the Southeast Asia economies... As is feared by many countries throughout the world, it will be difficult for the Asian economies which have devalued their currencies at similar rates to increase their exports since gains in price level will be offset by competing countries' devaluations.

...Lastly, agricultural products and our agri-based industry fortunately will do exceptionally well this year. Agricultural prices have gone up in Thailand by between 40% and 100%, in part because of the baht devaluation and in part because of the drought in the rest of Asia. While we have profited from this pressure on agricultural prices, we have also had to bear the brunt of the resulting inflation as food prices went up.

...Of course, to survive this crisis, correct measures will have to be implemented. The key to the whole issue is gaining confidence by restoring financial stability. In this respect, I recommend the following strategies.

One is determined action for overhauling the financial system. In the case of Thailand, there has been a mix of liquidation of the financial institutions that are insolvent and takeovers by the government... we also have to open up the financial sector to full participation by foreign entities. Therefore, we have amended our laws to allow a 100% share of ownership by foreign financial institutions.

...A second strategy is continuing Thailand's efforts at trade and investment liberalization. I believe that even during difficult times there should be no backtracking of commitments on trade and investment liberalization.

...Third, I do not think we can be successful at regaining confidence and achieving financial stability by applying only austerity measures... In the case of Thailand and some of the other countries that have taken up the IMF measures, there was no choice. It was either let the country "go down the drain" by depleting all of its reserves or take up the IMF measures.

...To regain confidence and stability, we need to supplement austerity measures with efforts to restructure our industrial concerns, allowing them the opportunity to change from labor-based to more technology-based industry, to switch into subcontracting modes, and to create component and spare parts industries. We should also invest in enhancing our agricultural

productivity, since we will be able to absorb some of the rising prices because of the devalued currency. We also have to reduce state ownership in some of our key state-owned enterprises, such as the airlines, some of the energy concerns, and power providers, so that they depend less on government subsidies.

...Fourth, there is a need for clearcut policies to enhance our competitive position. Heavy investment is needed in human resources, in key infrastructure such as seaports and power plants, and in rationalization of customs evaluation and procedures. All of these ingredients for competitiveness will need to be enhanced in order to sustain a new round of growth.

...Fifth, and this is the key issue, we plan to maintain our fiscal discipline at all times. Although pressure to reduce interest rates in Thailand is strong, the government is resisting and will try to keep interest rates at a high level at least until the end of the year.

...Certainly the present crisis in Asia is not specific to Thailand, Indonesia or Korea. It is a region-wide problem that can easily become contagious to the rest of the world... therefore, I would not be surprised to see a sharp deterioration in the trade figures for the United States and Europe.

...Japanese automobile firms in Thailand, for example, have been haunted by the slowdown in the Thai economy, with sales dropping by some 40% last year alone... so we will be seeing from Thailand quite a substantial expansion in the export of automobile s to places such as Europe and Oceania.

...Of course, all of our efforts to revitalize the Asian economies will go to naught if we cannot mobilize adequate international cooperation. Any moves by foreign investors to resist export expansion from Asia will kill off any opportunity we might have to find permanent corrective measures for the problems in Asia. While we can reflate our domestic economies by allowing more foreign investment to come in... this will not be sufficient because for most countries in the region, foreign indebted!>ebs is quite exorbitant. This means we really have to export our way out of the difficulties. There is a real need for the World Trade Organization to be part of the package of international organizations assisting the countries in Asia so that we can move forward on the same track of trade-liberalization we won through the Uruguay Bound and thus prevent the recurrence of both tariff and nontariff barriers.

Thank you.