<Asia-Economics> A Glimmer of Hope (Prof.Jeffrey Sachs-Harvard)
Ratan and all:
Here is article (almost brilliant and simple to read) by Prof.Sachs on the Asian crisis,its causes,impact,solutions etc.A must read I think if anyone is interested in this sort of thing.
Glimmers of Hope
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By Jeffrey Sachs
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November 5, 1998
T he economic collapse in Asia this past year was startling in its speed and depth. So many politicians, analysts and business people were caught off guard that the mood has swung from unguarded optimism before 1997 to extreme pessimism in recent months. Let me try to inject a measure of cautious optimism into the debate over Asia's economic prospects in 1999. The economic collapse is moderating throughout the region, and in several countries--including Japan, South Korea and Thailand--it is arguably reaching the bottom of the economic cycle.
During 1996, the five hardest hit countries of East Asia--Indonesia, South Korea, Malaysia, the Philippines and Thailand--had received net capital inflows of around $95 billion. In 1997, these inflows suddenly turned to outflows, of around $12 billion. Most of the reversal came in the second half of the year, following the devaluation of the Thai baht. In 1998, net outflows may reach $30 billion-40 billion.
Looking back, we can see that the inflows themselves were a bit overoptimistic. They were predicated on the continued strong growth of East Asian exports, a good bet given the historical record up to 1996. But from that year, the region's exports weakened for at least four reasons: The currencies became overvalued when the U.S. dollar strengthened relative to the yen; there was overinvestment in some export sectors, such as basic memory chips; East Asian exports to the U.S. faced tougher competition from other parts of the world, such as Mexico; and the Japanese economy continued to post weak growth, providing a soft market for East Asian exports.
These export problems would have led to a reduced flow of capital in any event. But as the capital flows weakened, the underregulated financial sectors in East Asia also revealed unexpected stresses. Banking problems in South Korea and Thailand, in particular, undermined investor confidence in the first half of 1997. Then, when the Thai baht was devalued in July 1997, investor concerns turned into investor panic.
The result was a wild, and thoroughly unnecessary, overshooting of every aspect of the macroeconomy. Investors stopped looking at East Asia's fundamental strengths, which remain important even to this day. The panic was based on one basic fact: The five hardest-hit countries owed about $175 billion in short-term debt to international banks as of mid-1997, but had only about $100 billion in foreign-exchange reserves. Once the panic started, the onset of nonpayments became a mathematical certainty.
The IMF, in principle, might have helped to moderate the panic by calming the market's nerves and providing some emergency liquidity. But rather than defending Asia, the IMF immediately demanded closures of banks and finance companies through the region, sending international investors further into panic. The IMF's macroeconomic advice of crushingly high interest rates further deepened the gloom.
Panics come to an end, however. Just as they are fuelled by the sudden withdrawal of short-term funds, they reach their nadir as the short-term withdrawals of capital cease. This happens for three main reasons: Part of the short-term debt is repaid; part is formally rescheduled; and part goes into default. After one year of intense capital withdrawals, the process is winding down. That is the fundamental reason why Asian currencies have begun to strengthen, and why interest rates have begun to fall.
What are the reform priorities in South Korea and Thailand? First, and most importantly, both countries should aggressively recapitalize their banking sectors, using public money as needed. The governments' resulting claims on the banks should, however, be sold off in the private markets as quickly as possible.
Second, the governments should help to facilitate a satisfactory solution to the problem of bad corporate debts. Foreign creditors cannot expect to be fully repaid, but governments should make clear to the debtor companies that they can't simply walk away from obligations. Clearly, we need a process that mixes debt reduction, debt stretchouts and conversions of debt to equity as part of the solution.
Third, macroeconomic policies should be expansionary. With current-account surpluses of 10% of GDP, and inflation at single-digit levels, the balance of effort should be on the side of macroeconomic expansion. Exchange rates should remain flexible, to accommodate the monetary expansion by modest currency depreciation, if necessary.
Financial crises are tragic and largely unnecessary short-run phenomena. It bears emphasizing that East Asia's challenges will not end with the end of the financial crisis. In fact, the true hard work will begin again. This will require considerable openness to foreign direct investment, improvements in education and greater attention to fostering research and development in the academic and business communities.
Jeffrey Sachs is a professor of economics at Harvard University and director of the Harvard International Institute for Development.
Source:Far Eastern Economic Review |
