HARD LESSONS AND RADICAL REFORMS
2
Causation
Complexity, speed and ferocity distinguished the Asian financial crisis. With the perfect vision of hindsight, there were many warning signals that the ‘Asian Miracle' could not continue unchecked.
In the worst-affected countries, it was a combination of crony capitalism, private sector over-borrowing, inadequate bank regulation, poor risk management and tragic policy errors in the corporate and banking communities. Strong growth, fuelled by high capital inflows, created a big Asian bubble. When it burst, the fallout spread far and wide. The growth of derivatives and modern information technology accelerated the speed of the contagion.
Before the meltdown, few could deny the impressive record of strong growth, general price stability, high domestic savings, an educated and highly flexible labour force, fiscal prudence and openness to trade and investments that were the hallmarks of Asia for more than a decade. By promoting intra-regional trade and investments, the region enjoyed unprecedented growth and prosperity during that period. Just before the turmoil began, even authorities such as the International Monetary Fund (IMF) and World Bank testified to these strengths and successes.
Quite obviously, something else must have happened with the 'Asian problem'. Indeed, it was not isolated to Asia, but had a more international flavour. The former Chairman of the US Federal Reserve Board, Mr Paul Volcker, thinks it may well be systemic.
In the late 1980s and early 1990s, the private sectors of major emerging economies with strong growth potential became the target of financial institutions with the capacity and willingness to reach out for more exotic high-yielding investments. These economies converts to the basic philosophy of open markets for goods and capital welcomed the funds, which came in the form of loans, portfolio capital and in direct investment.
Funds flowed in very rapidly but little attention was paid to the fact that the money could flow out just as rapidly at short notice. The Bank for International Settlements (BIS) Annual Report showed that it was a combination of mutual and hedge funds pulling out of Asia, as well as the sharp reversal of bank lending, that did the true damage.
Net private capital flows to Other Asia (excluding China and Japan) reversed by US$108 billion in the second half of 1997, compared with an inflow of roughly the same order in the previous 12 months. It is difficult to expect the IMF, the World Bank or any other organisation that advised developing economies in distress to come up with an effective and appropriate package to withstand these kinds of capital flows. The important lesson is that small and open economies are inherently vulnerable to the volatility of global capital markets.
can move as
As long as the G-3 currencies the Dollar, Deutschmark and Yen much as 75 per cent from peak to trough, there is tremendous pressure put on the smaller trading economies. It may be fashionable to believe that flexible exchange rates are the answer to small volatilities but no one has yet discovered an effective way to deal with huge volatilities caused by competing devaluations or exchange rates in a free-fall that readily develop into economic catastrophes or the social upheavals that have pervaded East Asia.
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