This I thought will help you a lot in understanding the implications and consequences of ASEAN contagion.. oneof the finest I have read..
Asian Crisis: An Interview with Nouriel Roubini
Dateline: 1/27/98
Nouriel Roubini has generously agreed to answer a few questions about
the causes and consequences of the on-going Asian currency and
economic crisis. He also shares some thoughts on the implications for
policy and for the analysis of currency markets.
Roubini is an Associate Professor of Economics
and International Business at the Stern School of
Business, New York University. He is the author
most recently of Political Cycles and the
Macroeconomy as well as numerous academic
papers. Some of his recent work has focused on
the causes and consequences of the Asian
currency crisis. He received his Ph.D. from
Harvard in 1988 and was previously an Assistant
and Associate Professor in the Economics
Department at Yale University. Roubini is also a
research fellow at the National Bureau of
Economic Research and the Center for European
Policy Research; and is a visiting Economist at the
IMF and consultant to the World Bank.
Impact of the Crisis
Q:
Is the currency crisis likely to impact the long-run performance
of the Asian economies? Is this the end of the Asian miracle?
The Asian miracle might have been over even without the crisis. These
countries could not possibly grow forever at 8-10% per year rates, as
diminishing returns at some point kick in. Also, the evidence in Young,
popularized by Krugman, suggests that the role of total factor productivity
growth was limited in Asian growth; a lot of growth was due to inputs
growth (labor and capital especially). Rate of investment of 40% of GDP
per year are not sustainable forever and savings rate are bound to fall over
time.
So, even if these countries whether the crisis, the growth rate might not
return to the high levels pre-crisis; 4-5% per year may be more
reasonable.
Mexico was back to growth in 1996 after the 1995 recession following the
1994 collapse of the Peso. A recession might be deeper and persist for
much longer in Asia for several reasons:
1.The Tequila effect did not spread so dramatically from Mexico to
the rest of Latin America while in Asia as Argentina's and Brazil's
pegs resisted; however in Asia one after the other most currencies
collapsed with the ensuing recession that is going to follow being
exacerbated by the recession in the neighboring countries.
2.The US was in a strong cyclical upswing in 1994-95, something that
helped Mexico and the rest of Latin America while growth in Japan,
the main regional economy, has been stagnating close to zero since
1991.
3.The US had cleaned up its banking problem (the S&L crisis) by
1994 while the Japanese banking problems are still unsolved and
Japan is heavily exposed in Asia.
4.The game of competitive devaluation that has been observed in Asia
was largely avoided in Latin American following the Peso collapse;
most currencies in L.A. resisted and this presented a recessionary
competitive devaluation game (as the one currently observed in Asia
that is similar to that in the 1930s depression).
5.There was a lot of over investment and capacity glut in Asia; for
example, Korea overbuilt in low-tech semiconductor (DRAM)
plants whose profitability is going to be very low in the medium
term; same thing for shipping, steel and other traded goods. Also,
the glut of non-traded goods, especially real estate will lead to low
returns in these sector for a long time.
So it is not clear whether Asia will look ex-post more like Mexico that had
a one-year severe recession and then resumed growth or more like Japan
whose economic model has stalled and whose growth has stalled since
1991.
Q:
How much of an impact will the Asian currency crisis have on
the economies of the US and other western economies? How
long will it take before this impact will be felt?
Growth in US and Europe will be reduced by about a 1/2% point in 1998
unless Japan, who is already stagnating, plunges in a deeper recession.
Causes
Q:
In your paper What Caused the Asian Currency and Financial
Crisis, you point to the moral hazard problem as being one of the
main contributors to the crisis - is this feature stronger in the
Asian crisis versus other past crises? If so why?
Most episodes of Balance of Payment crisis in emerging economies are
episodes of Twin Crises where a balance of payments crisis is associated
with a Banking crisis (see the evidence in Kaminsky and Reinhard (1996).
And most of these banking crises are caused over borrowing and over
lending due to poor regulation poor supervision following financial
liberalization and the presence of a moral hazard problem deriving form
implicit and/or explicit government promises of a bail-out in case things go
wrong. So moral hazard is important but is only a part of the story.
The crisis is not just a debt crisis, it is also a currency crisis. By 1997 most
of the regional currencies were overvlalued and fixed rate regimes and
excessive short-term capital inflows led to significant real appreciation. The
current account deficits were very large and driven both by the
overvaluation and the (moral hazard driven) overinvestment. So, we are
talking of a currency AND debt crisis where moral hazard was one factor,
among several other fundamental problems and policy mistakes.
Q:
Your paper describes the "investment boom" as "excessive and
often in the wrong sectors of the economy". You also conclude
that a significant portion of the borrowing was used for
speculation rather than real productive investment in capital
goods. Should lenders be more careful about specifying and
monitoring the uses of their loans?
Of course, they should be, but moral hazard at various level led to the lack
of monitoring.
International creditors did not monitor and overlent to domestic banks and
financial intermediaries under the implicit or explicit promise that they
would be bail-out, either by the governments and/or via IMF supported
packages. Domestic banks and financial intermediaries did not monitor for
many reasons, mostly related to the implicit promise of a government
bail-out in case things went wrong:
1.Their risk capital was usually small and owners of banks risked
relatively little (by lending to excessively risky projects) if the banks
went bankrupt;
2.Several banks were public or controlled indirectly by the
government that was directing credit to politically favored firms,
sectors and investment projects;
3.Depositors of the banks were offered implicit or explicit deposit
insurance and therefore did not monitor the lending decisions of
banks;
4.The banks themselves were given implicit guarantees of a
government bail-out if their financial conditions went sour because of
excessive foreign borrowing.
The outcome of all this was twofold: first, banks borrowed too much from
abroad and lent too much for investment projects that were too risky;
second, because of these implicit public guarantees of bail-out, the interest
rate at which domestic banks could borrow abroad and lend at home was
low (relative to the riskiness of the projects being financed) so that
domestic firms invested too much in projects that were marginal if not
outright not profitable. Once these investment projects turned out not to be
profitable, the firms (and the banks that lent them large sum) found
themselves with a huge amount of foreign debt (mostly in foreign
currencies) that could not be repaid. The exchange rate crisis that ensued
made things only worse as the currency depreciation dramatically
increased real burden in domestic currencies of the debt that was
denominated in foreign currencies.
In summary, fixed exchange rates regimes, capital inflows and moral
hazard jointly led to real appreciation, an investment boom in wrong
sectors, an asset price bubble and large current account deficits that led to
accumulation of a large stock of short-term foreign liabilities. Such deficits
were financed mostly through banking system intermediation (given the
lack of developed securities markets in the region): banks borrowed
abroad in foreign currency and their borrowings were mostly short-term.
These large currency positions were mostly unhedged as firms and banks
expected the fixed exchange rates to be maintained and/or to be bailed-out
if things went wrong.
Once the firms' investment projects turned out not to be very profitable,
the firms and the banks found themselves with a huge amount of
currency-denominated foreign debt that could not be repaid. The exchange
rate crisis that followed made things only worse as the currency
depreciation increased the real burden of the foreign-currency
denominated debt. The behavior of weak and not very credible
governments that were not committed to structural reforms exacerbated
the policy uncertainty and the financial panic that followed.
Policy
Q:
You argue that, in conjunction with other factors, large current
account imbalances coupled with fixed exchange rates lead to a
overvaluation of several Asian currencies. Should we have seen
speculative attacks and a crisis coming? Could it have been
prevented?
If you looked carefully at the fundamentals you should have seen that a
currency crisis had to occur. For example Thailand and Malaysia had all
the symptoms of Mexico by early 1997: huge current account deficits
(close to 10% of GDP for a decade), real appreciation, asset bubble,
overinvestment in wrong projects, weak and fragile banking systems.
As in the case of Mexico, by the time we got close to the crisis it was very
hard to prevent it. Policies should have been different several years earlier:
i.e. avoid excessive capital inflows via controls on hot money inflows; a
more flexible exchange regime aimed at maintaining a stable real exchange
rate; greater supervision and regulation of the financial system; policies to
avoid short term foreign debt borrowing by banks and firms; development
of securities markets (debt and equity) to prevent that most of the capital
inflows be intermediated through the short-term channels of the banking
system.
Q:
There has been some debate over the role of the IMF in
providing stabilization funds for currency crisis. Bailing out
failing organizations obviously contributes to the moral hazard
problem mentioned above. Is there some balance we can strike
between legitimate stabilization programs and generating the
moral hazard problems? (i.e. can the time consistency problem
be addressed in a useful way?)
There is some tradeoff: repeated bailouts signal to creditors that they can
take risky gambles and pay no cost, a huge incentive to repeat the same
mistakes over and over again. On the other side, the IMF should have a
role of lender of last resort. Unfortunately, the bailouts in Asia suggest that
no country seems to be too small (not too big) to be allowed to default.
That's a bad signal for the future; the IMF might have lost some credibility
in the process.
Probably, the only way to avoid future mistakes is to make sure that
international creditors pay some costs for their risky decisions: they should
not be fully bailed out. For example, Korea, Indoenesia and the other
countries should not give new public guarantees for the debt of private
companies; also, for the debt of the banks, any rescheduling agreement
should imply some losses for the international creditors. Unless the US,
Japanese and European banks get burned with fire, they will play with fire
again.
Analysis
Q:
The volume of media coverage and analysis (probably primed by
the Mexican crisis) has been extraordinary. Are there any
common misperceptions about the causes and consequences of
the crisis?
One misconception about the causes is that it was all due to irrational
speculation and irrational contagion. Fundamentals were quite weak in the
region and these fundamentals triggered the crisis. Of course, there has
been a certain amount of overshooting once financial panic ensued. The
rupiah had to devalue, but a 15,000 rate to the US dollar is pure folly and
not justified, even when you weigh in the important role of policy and
political uncertainty. So there has been an overreaction of asset markets
but based on bad fundamentals to begin with: a strong wind can collapse a
big tree only if its roots are rotten.
Q:
You also suggest that traditional models of currency crisis are
inadequate to the extent that they do not emphasize the moral
hazard or the multi-country "contagion" effects. What do you
think will be the main policy implications of a "third generation"
of models.
'Third generation' models are still work in progress as many of us are
working on these ideas. The systemic multi-country nature of the problems
and the twin-crisis phenomenon suggest several policy implications:
1.There should be more credible monetary policy cooperation
and coordination. In the case of the ERM in 1992-93 there
was a breakdown of cooperation (as the recent monograph
by Buiter, Corsetti and Pesenti (1998) suggests). In Asia
cooperation was harder as these countries has unilateral pegs
to the US dollar and were not tied in a formal cooperative
exchange rate regime like the ERM.
2.Excessively volatile capital flows are a serious problems and
can exacerbate a crisis. Controls on excessive short-term
inflows, such as those imposed in Chile look more and more
appealing; short-term borrowing by banks and governments
should be avoided. More extreme solutions such as a Tobin
tax on capital flows should be considered more seriously.
3.Moral hazard problems should be avoided via prudential
regulation and supervision and avoidance of government
bail-out promises. Opening domestic financial system to
foreign banks, as done in Argentina and Mexico, can only
help.
4.Fixed rate regimes are fragile, even more so when many
regionally integrated economies have a formal or informal
system of pegged rate. As the 1990s crises (ERM in
1992-93, Mexico and Tequila in 1994-95 and Asia in
1997-98) suggest some degree of exchange rate flexibility is
beneficial. If countries really like fixed rates, then they should
go to the extreme: give up a domestic currency and form a
monetary union. Even currency boards, a strong form of fixed
rates, are fragile: if the currency board in Hong Kong
collapses, quite likely now that all the regional currencies have
devalued, Argentina could go under too. Also, currency
boards are likely to be phased out in East Europe, especially
Lithuania and Estonia as they have led to severe
overvaluation.
5.Fixed rate regimes may be useful in early stages of a
stabilization program when, starting from high inflation, they
focus expectations on a low inflation equilibrium. After that, it
is better to switch to a more flexible regime.
WHAT EVER HAPPENED TO THE ASIAN MIRACLE?
Two years ago a wave of financial jitters swept Latin America after the devaluation of the Mexican
peso. Now a similar case of financial contagion has spread across Asia following Thailand's currency
crisis. First the Thai baht, then the Philippine peso, then the Malaysian ringgit, then the Indonesian
rupiah; what's next?
Actually, that's the wrong question. Almost every economy in Asia will feel the ripples from this
summer's wave of devaluations: higher interest costs because international markets fear further
devaluations, lower export prices because the devaluations will intensify competition, reduced capital
inflows because once ebullient foreign investors have become suddenly wary, and maybe a growth
slowdown. The real question is whether and how fast the region's economies will bounce back. Is
this just a blip, a temporary setback--or is it the end of the Asian miracle?
Or was there any miracle in the first place?
A little background here: Three years ago I published an article in Foreign Affairs that made me
enemies all over Asia (and among American pundits who preached the gospel of Asian superiority).
The article summarized research by Alwyn Young of Boston University and Larry Lau of Stanford,
who suggested that Asian growth, impressive as it was, could mostly be explained by such
bread-and-butter economic forces as high savings rates, good education, and the movement of
underemployed peasants into the modern sector. What they found was that once you took account
of the growth in these measurable inputs, you could explain most, and in some cases all, of the
growth in output. What Young and Lau found was, if you like, that Asian growth has so far been
mainly a matter of perspiration rather than inspiration--of working harder, not smarter. These results
were and are controversial--partly because many people don't want to believe them and are eager to
accept contrary calculations--but their basic message has held up quite well under repeated
challenges.
Why does this matter? After all, nobody is questioning the awesome reality of Asia's growth over the
past 20 years. But the "perspiration theory" of Asian growth upsets two cherished beliefs held by
both Asian leaders and their admirers. First, if there is one thing that believers in an "Asian system"
really admire, it's the way Asian governments promote specific industries and technologies; this is
supposed to explain their economies' soaring efficiency. But if you conclude that it's mainly
perspiration--that efficiency isn't soaring--then the brilliance of Asian industrial policies becomes a lot
less obvious.
The other unwelcome implication of the perspiration theory was that the pace of Asia's growth was
likely to slow. You can get a lot of economic growth by increasing labor force participation, giving
everyone a basic education, and tripling the investment share of GDP, but these are one-time,
unrepeatable changes. So the perspiration theory suggested that sooner or later Asia's growth would
slow down--sooner in the case of the original Asian tigers like Singapore, which is already investing
half its GDP; later in low-wage countries like China that still have vast reserves of underemployed
rural labor to exploit.
And sure enough, Asia is in trouble. In Thailand, a financial bubble has burst, leaving behind plunging
stock and real-estate markets and a banking system in shambles. In South Korea, high-profile
bankruptcies have highlighted the runaway debts of many corporate empires--and the shakiness of
the banks that own those debts. And international capital markets have suddenly noticed that
countries throughout the region have been running world-class trade deficits--bigger relative to their
economies than Mexico's was just before the big peso collapse.
Is this the slowdown the perspiration theory predicted? The perspiration theory predicts a gradual
loss of momentum, not a crash. The recent news from Asia has been so bad that in a way it's good:
the size and suddenness of the slump shows we're dealing with financial snafus that don't tell us much
about Asia's long-term prospects. But sometimes a slump reveals deep problems that were papered
over by a boom. Japan is the classic case: It's now clear that growth in Japan's potential output (the
output it can produce on average over the business cycle) began declining more than a decade ago,
just when Western pundits became convinced Japan had all the answers. That slowdown was
masked by the "bubble economy" of the late 1980s, when runaway stock and land
prices--Remember when the grounds of the Imperial Palace were supposed to be worth more than
the whole state of California?--created an unsustainable boom. Then the bubble burst, revealing a
dreary reality.
Growth rates in the rest of Asia, by contrast, have stayed pretty high, even in the countries that are
having a hard time. By last year it became clear that South Korea's and Thailand's torrid growth
rates of the first half of the 1990s had to end--wages were rising faster than productivity; overheated
domestic markets were spilling over into imports, creating massive trade deficits. To perspiration
theorists, these troubles were an early sign of the diminishing returns that will force a gradual
slowdown in growth.
The biggest lesson from Asia's troubles isn't about economics; it's about governments. When Asian
economies delivered nothing but good news, it was possible to convince yourself that the alleged
planners of those economies knew what they were doing. Now the truth is revealed: They don't have
a clue. Even during the glory days, a visit to one of those planning agencies--say, Japan's
all-powerful Ministry of Finance--was enough to inspire a few doubts. I visited the MOF in 1985
and saw what looked less like the Pentagon's War Room than like the Department of Motor
Vehicles: dusty hallways, broken furniture, guys padding around in their socks, centerfolds taped to
the dirty glass partitions. But maybe, I thought, appearances were deceiving. Then things started to
go wrong, and the MOF proved itself as hapless in action as it was in appearance. It's easy to look
competent in a prosperous economy (ask Bill Clinton), but the true test is whether you can cope with
adversity. So much for the legendary managers of Japan Inc.
Officials in many other Asian countries are no better. We now know that the financial problems of
South Korea and Thailand have been obvious to policymakers for a long time, but government
officials, like their Japanese counterparts, temporized. When the crash came in Thailand, officials
dithered in classic fashion--declaring they would never devalue, but failing to make any convincing
policy moves that would support the baht, and finally doing exactly what they had promised they
wouldn't. The list goes on. Malaysia has not yet had a crash, but its policies--from grandiose plans
for a new capital to attempts to banish its trade deficit by imposing import restrictions--sound like the
kinds of things that ended Brazil's economic miracle in the 1960s. Then there's Indonesia, whose
idea of a farsighted industrial strategy is to promote an inefficient auto industry with special tax and
regulatory breaks.
Asia's growth will probably resume, driven, as before, by education, savings, and growing labor
force participation. It probably won't be as fast as it was: some Asian economies have already
pushed savings, education, and labor participation as far as they can. But there are still a lot of
peasants in China waiting to be pulled into the modern world, and there are even more in other
places where the process of joining the modern world has barely begun. No doubt Asia will
eventually account for most of gross world product--but only because most human beings are, after
all, Asian.
Q:
Do you see currency crisis as a permanent fixture on the
economic landscape or will we eventually learn how to
effectively stabilize international financial markets?
A cocktail of greater international capital mobility, financial liberalization,
short-term-oriented trigger-happy and sleep-deprived fund managers and
currency traders, and fixed exchange rates can be deadly. Some broad
international effort to stabilize markets, enforce prudential regulation and
supervision of otherwise unsupervised offshore financial institutions and
poorly supervised onshore ones should be considered. |
