| Provisional Translation |
| Introduction |
The currency and financial crisisthat started with the plunge in the value of theThai baht in July 1997 spread rapidly to manycountries in the Asian region, pushing many into asharp recession in 1998. In 1999, however, theAsian economy generally staged a rapid recovery,reflected in a return to positive growth in allcountries.
We are seeing the emergence ofdisparities between countries in the pace of theireconomic recoveries. Problems such as those ofnon-performing loans ("NPLs") in thefinancial and corporate sectors, and the fiscalburden these are imposing, continue to act as aheavy burden on economic management in numerouscountries. In addition, these currency andfinancial crises have had an enormous economic andsocial impact, manifested in such forms asincreased numbers of unemployed and sharp declinesin living standards.
To ensure that the presentrecovery trend is put on a solid basis, and toensure Asia's stability and prosperity in the 21stcentury, it is necessary to build stable economicand financial systems that can support sustainableeconomic growth. Based upon this understanding,the Subcouncil identified, considered andpresented the various measures that it will benecessary for Asian countries to implement for thesake of the revival of Asian economy and financialsystems in the 21st century.
The report of the Subcouncil onAsian Financial and Capital Markets released inMay 1998, entitled "Lessons from the AsianCurrency Crises - Risks Related to Short-TermCapital Movement and the "21stCentury-Type" Currency Crisis - ",reported on matters such as the causes andcharacteristics of the Asian currency crises, andthe issues that the Asian currency and economiccrises have raised toward emerging marketeconomies, international financial institutions,and Japan. Based upon subsequent economic trendsand the state of structural reform in Asiancountries, and the discussions that have takenplace about the new international financialarchitecture, this report further develops thediscussion in the previous report, focusing inparticular on regional cooperation within theAsian region.
As a result of the deepening ofthe interdependence of Asian economies, regionalcooperation will be essential to supplementdomestic and global approaches in order to buildstable economic and financial systems that cansupport sustainable economic growth,
In order to reflect the views ofAsian countries in its deliberations, members frominstitutions such as universities and researchinstitutes from nine Asian economies (China, theHong Kong Special Administrative Region (HongKong), Indonesia, the Republic of Korea, Malaysia,the Philippines, Singapore, Thailand, and Vietnam)were invited to participate in the deliberationsas special members of the Subcouncil. To promoteregional cooperation within Asia it is essentialto strengthen policy dialogue with Asian countriesat various levels, and we believe that the Councilon Foreign Exchange and Other Transactions shouldcontinue this kind of involvement of foreignmembers in the future in accordance with the themeof its deliberations.
| Note: | As in the May 1998 report, in this report "Asia" refers primarily to the East Asian region along the Pacific coast from the Republic of Korea in the north to Indonesia in the south. Also of note is that this report discusses the economic and financial revival principally of countries in the East Asian region that have already reached "takeoff" (countries, which have successfully achieved acceleration of their economic growth with a low-income level); a discussion of countries of the region that have not yet reached the takeoff stage will need to be conducted separately. |
1.Current Situation of the Asian Economy
(1) Rapid recovery of the Asianeconomy
(a) Macroeconomic trends
The Asian currency and financialcrisis dealt a heavy blow to the Asian economy,illustrated by the fact that numerous countriessuffered severe recessions in 1998. In 1999,however, the real growth rate turned positive inall countries of the region, although there weredisparities in the pace of recovery, which variedfrom 10.7% in the Republic of Korea to 0.3% inIndonesia.
Accompanying drops in exchangerates in 1998, consumer price index increased by77.6% in Indonesia, 9.8% in the Philippines, 8.1%in Thailand, and 7.5% in the Republic of Korea,but these inflation rates fell in 1999, turningnegative in some countries.
Exchange rate movements weregenerally subdued in 1999, and equity pricesshowed a general rise from September 1998. Thisyear, however, has seen downtrends in bothexchange rates and equity prices in manycountries.
The economic recovery has broughtabout a recovery in confidence in the householdsector. Private consumption has been positive inthe Republic of Korea since the first quarter of1999, since the second quarter in Thailand andMalaysia, and since the third quarter inIndonesia. Of particular note is that in theRepublic of Korea, in part as a result of thewealth effect due to the recovery by the stockmarket, private consumption increased by 10.3%year-on-year in 1999. Private capital investmentwas still negative in many countries in 1999,owing to factors such as excessive investmentprior to the crisis, but the extent of the falldeclined. There were turnarounds in Thailand inthe second quarter, and in Malaysia in the thirdquarter. In the Republic of Korea, improvements ineconomic activity and corporate earnings causedcapital investment to turn positive in the firstquarter of 1999, and in the year as a whole therewas a 38.0% increase from the previous year.
The current accounts of Asiancountries in 1998 recorded substantial surplusesas a result of the contraction of economicactivity, and they remained in surplus in 1999,although the extent of the surpluses generallynarrowed. As a result, Asian countries' officialreserves increased substantially, and there was astrong improvement in such indicators as the ratioof short-term external liabilities to officialreserves, showing a marked reduction in thesecountries' external vulnerability.
(b) Factors behind the economicrecovery
The factors behind the economicrecovery include the growth of exports, theimplementation of appropriate fiscal and monetarypolicies, and progress in the reform of thefinancial and corporate sectors. In the case ofthe Republic of Korea in particular, which hasachieved a very rapid economic recovery, factorsthat can be identified include the early switch toexpansionary fiscal and monetary policies, thatthe reform of the financial and corporate sectorswas pursued vigorously, and that to counter theoccurrence of a credit crunch, measures (such asbond markets, and policy-based finance) were takento supplement bank lending.
Since mid-1999 the exports ofAsian countries have grown sharply, and thatgrowth has been contributing to thefaster-than-expected recovery of the Asianeconomy. The growth in exports is partlyattributable to a virtuous circle from the factthat the global expansion of IT investment hasincreased demand for the electronics industry, andthe fact that the interdependence of the Asianeconomies (discussed below) has deepened aseconomic activity has expanded in tandem withgrowth in intraregional trade. An examination ofthe year-on-year rates of export growth in nineAsian economies (4 ASEAN countries [Indonesia,Malaysia, the Philippines, Thailand], the NIEs[Hong Kong, the Republic of Korea, Singapore,Taiwan Province of China (Taiwan)], and China) inthe second half of 1999, broken down by region,shows that exports grew by 24.6% to Japan, 19.6%to Asia, 11.5% to the United States, and 8.8% toEurope, demonstrating that intraregional trade isacting as the locomotive of the export activity ofAsian countries. Exports to Japan showed aparticularly large increase.
A look at import-export trendsbetween Japan and these nine Asian economies (4ASEAN countries, the NIEs, China) reveals that inthe second quarter of 1999 Japan's imports fromthese countries started to increase more rapidlythan that from other regions, a factor that had apositive impact on Asia's economic recovery;Japan's exports to Asia started to increase morerapidly than to other regions in the thirdquarter. The occurrence of this favorable cyclesuggests that the interdependence of the Japaneseand Asian economies is accelerating economicrecovery on both sides.
Support from Japan under the NewMiyazawa Initiative has also been playing a majorrole as Asian countries have implemented economicstimulus measures and structural reforms, and hasreceived high praise from those Asian nations.
| Note: | The New Miyazawa Initiative, announced in October 1998, is a package of support measures totaling US$30 billion to assist Asian countries affected by the currency crisis to overcome their economic difficulties, by providing US$15 billion in medium and long-term facilities for the recovery of Asian countries' real economies, and another US$15 billion to satisfy short-term capital needs that during the process of implementating economic reforms by those countries. So far, US$13.5 billion in medium and long-term facilities and US$7.5 billion in short-term funds, totaling US$21 billion, have been committed. |
It has been pointed out thatintermediate goods account for a large proportionof intraregional trade in Asia, while countriesoutside the region, particularly the UnitedStates, account for a large proportion of exportsof final goods. Accordingly, the view has beenexpressed that the impact on the Asian economy offactors such as any future slowing of the U.S.economy must be monitored closely.
(2) Progress in financial andcorporate sectors' reform
In order to stabilize theirfinancial systems, Asian countries have beencreating and improving legal systems and assetmanagement institutions for the purpose ofdisposing of NPLs, and have been implementingmeasures such as expediting capital injectioninto, and the reorganization of, financialinstitutions, and closing or nationalizing banksthat are non-viable. In addition they arereinforcing the regulation and supervision offinancial institutions, including through thesequenced strengthening of prudential regulations.As a result they have largely halted the uptrendin NPLs, and in many countries these have begun totrend downwards.
Nevertheless, in many countriesthe stock of outstanding loans of financialinstitutions is continuing to decline, and this isone of the factors which is impeding the recoveryof production. An essential prerequisite for thereturn onto a stable growth track by the Asianeconomy is the restoration of the financialintermediation functions of financialinstitutions.
The cost of financialreconstruction is being financed principally bythe issuance of government bonds (orgovernment-guaranteed bonds), and this is imposinga heavy fiscal burden on their governments.Furthermore, in cases in which the institutionspurchasing NPLs are unable to sell off thoseclaims and are unable recover sufficient funds,the final fiscal burden may be increased. There isa possibility that the pledges of the governmentsof the Republic of Korea and Thailand to cover thedeterioration of the assets of the private bankswill increase the fiscal burden in the future.
(a) Resolution ofnon-performing loans ("NPLs")
In Malaysia Danaharta, theinstitution established in 1998 to purchase NPLs,has been carrying out that task, with the resultthat the NPL ratio of the domestic banking sectorhad declined to 17.1% by the end of January 2000,down from a peak of 20.4% in November 1998.
In the Republic of Korea the KoreaAsset Management Corporation is buying up NPLs.The NPL ratio declined to 6.6% in September 1999,down from a peak of 8.5% in March 1999. (However,the ratio rose at the end of 1999 as a result ofthe stricter definition of NPL categories.)
In Indonesia the Asset ManagementUnit (AMU) established within the Indonesian BankRestructuring Agency (IBRA) is conducting thistask, and as of March 2000 NPLs totaling some 220trillion rupiah in value had been transferred tothe AMU. (The NPL ratio declined from 58.7% at theend of March 1999, to 33.3% at the end of January2000.)
In China the four majorstate-owned commercial banks have each establishedan asset-management company, and these aredisposing of NPLs. The strategy of theseasset-management companies for disposal of debtsis the conversion of NPLs into equity.
In Thailand the banks have set upasset-management companies to dispose of NPLs,whereas no government institution has beenestablished. The NPL ratio had declined to 42.3%at the end of January 2000, down from a peak of52.3% in March 1999.
(b) Capital injections
In Indonesia the total amount ofpublic funds necessary for the revival of thefinancial sector was said to be 550 trillionrupiah in March 1999, and by March 2000 a total ofsome 300 trillion rupiah of capital (approx. 25%of GDP) had been injected.
In the Republic of Korea, 64trillion won (approx. 13% of GDP) of public fundshave been injected, of which capital injections bythe Korea Deposit Insurance Corporation total 18.6trillion won (approx. 4% of GDP).
In Malaysia, Danamodal, thecapital-injection institution established inSeptember 1998, had injected 6.2 billion ringgits(approx. 2% of GDP) into 10 banks by the end ofJune 1999.
China issued 270.0 billionrenminbi (approx. 3% of GDP) of special governmentbonds in August 1998, to augment the capital ofthe four major state-owned commercial banks.
In Thailand, in opposition to thedemand for management responsibility whichaccompanies the injection of public funds, onlyone commercial bank accepted such an injection(32.5 billion baht; approx. 0.7% of GDP).
(c) Restructuring of financialinstitutions
In the Republic of Korea, twocommercial banks experiencing operatingdifficulties were nationalized in January 1998,and steps have been taken to improve theirmanagement and then privatize them, and theFinancial Supervisory Commission, established inApril 1998, is undertaking the restructuring offinancial institutions. With regard to 12commercial banks with capital adequacy ratios of8% or less, it was decided that five were unableto achieve reconstruction through their ownefforts and should be merged with other banks, andthat the other seven could remain in existencesubject to management improvements. This triggeredbank reorganization, resulting in the reduction inthe number of commercial banks from 26 to 17.
In Malaysia the central bankapproved a merger plan designed to reorganizefinancial institutions into 10 groups. The end of2000 is the deadline for mergers, and banks arenow taking the necessary steps.
In Indonesia the Indonesian BankRestructuring Agency, established in January 1998,announced in March 1999 the closure of 38 banks,the nationalization of seven, and participation incapital reorganization plans by nine.
In Thailand, seven commercialbanks have been nationalized.
With respect to the acceptance offoreign capital by financial institutions, theRepublic of Korea and Thailand are taking activesteps to introduce foreign capital. In theRepublic of Korea one major commercial bank beingrestructured under government guidance has beensold to foreign capital, and the investment offoreign capital in financial institutions isincreasing. In Thailand, four banks had been soldto foreign capital by the end of 1999.
(d) Strengthening of regulationand supervision of financial institutions
In many Asian countries thefinancial supervisory agencies are being reformed,and prudential regulations are being strengthened.The latter include the strengthening ofregulations governing capital adequacy ratios, andthe introduction of stricter definitions of NPLcategories.
With regard to NPL criteria in theRepublic of Korea, for example, the end of 1999saw the introduction of criteria for categorizingasset soundness that take future capacity to repaydebt into consideration. As a result, NPLcategorization is more stringent. In four ASEANcountries provisioning requirements have beenraised. In Thailand and Indonesia the independenceof the central banks has been reinforced.
(e) Corporate debtrestructuring
To expedite the restructuring ofcorporate debt, Asian countries have createdcorporate debt restructuring frameworks.
Thailand, Indonesia, Malaysia, andthe Republic of Korea have established mechanismsto facilitate negotiations directly betweencreditors and debtors; these are based on theprinciple that dealing with debt is to be betweenthe parties concerned, and are designed to assistthis process. In this way the most desirablemethods of resolving these problems from thestandpoints of creditors and debtors are beingsought.
In the Republic of Korea, inJanuary 1998 agreement on reforms, including theimprovement of debt structure, was reached betweenthe government and five chaebol.
However, it is said that there aremany cases in which companies that are actuallyable to make debt repayments are not repaying themfor strategic and other reasons. For theseproblems to be improved, a number of steps shouldbe taken, including developing accounting systemsand other measures to assure the transparency ofcorporate debt, ensuring the effectiveness ofbankruptcy laws, and reinforcing the soundness ofbanks - the principal debtors.
(f) Reform of state-ownedenterprises (SOEs) in China
State-owned enterprises (SOEs) inChina remain in very poor condition: burdened withthe legacy of excessive employment, excessivecapacity of plant and equipment, and excessivedebt; lagging behind in responding to the shift toa market economy; and carrying out socialfunctions such as providing education and healthcare. In 1998, 41% of SOEs made losses, and thatnumber is gradually rising. Furthermore, many ofthe loans of the state-owned commercial banks areto SOEs, and therefore the operating difficultiesof those SOEs is giving rise to an increase inNPLs.
In order to address the problem ofSOEs we believe it is important to find aresolution based on market principles. That is, topermit SOEs and companies that are not state-ownedto compete on equal terms in the market, and inthat way to bring about the reallocation ofresources from the low-productivity state sectorto the high-productivity non-state sector.
The progressive reform of SOEs isresulting in the bankruptcy of corporationsexperiencing operating difficulties, and in theelimination of excess production capacity. Theconsequences of these include reductions inemployment, causing large-scale unemployment andlaid-off workers. In 1999 the number of peoplelaid off by SOEs increased by 5.64 million. (Thetotal number of employees of SOEs stood at approx.90 million at the end of 1998.) This increase inthe number of people laid off may placedeflationary pressure on the Chinese economy inthe short term. However, the reform of SOEs is aprerequisite for China's sustainable growth, andit is essential that it be pursued vigorously,while implementing measures to assist the peopleaffected, such as ensuring the provision ofadequate economic safety nets, and helping to findalternative employment.
(3) The social impact of thecurrency and financial crisis
(a) Increase in poverty
The Asian economy is recoveringrapidly, as described above, but the Asiancurrency and financial crises have had an enormousnegative social impact on Asian countries.Although the degree differs according to country,province, sector, and group, the blow dealt to thepeople of Asia has yet to disappear. Incomedistribution as measured by the Gini coefficientis not deteriorating markedly, but there has beena marked increase in the number of people belowthe poverty line, and there has been aparticularly large increase in the number of urbanpoor in all countries.
(b) Trends in the labor market
The substantial fall in demand forlabor that accompanied the Asian currency andfinancial crisis has led to the movement of laborforces from cities to regional areas, from themanufacturing sector to the agricultural sector,and from the formal sector to the informal sector,causing declines in real wages in the labormarket, and increased unemployment. The impact onunskilled workers in the formal sector in urbanareas has been particularly large. Therefore, theimpact of this has been the greatest in theRepublic of Korea, where the movement of labor tothe informal sector has been more limited than inother countries, and urbanization is the mostadvanced. In Thailand there had been an outflow oflarge numbers of workers from the cities to therural areas, and rises in prices of agriculturalgoods were relatively small, which resulted inthat the crisis had an acute impact mainly inrural areas. The economic recovery in Asiancountries is bringing about increases in realwages and substantial declines in unemploymentrates, but the levels of unemployment remainhigher than before the crisis.
(c) Response of households andgovernments
In the Republic of Korea andMalaysia there were rises in the saving ratios inresponse to the substantial fall in income duringthe crisis, whereas in Indonesia there was a largefall in the ratio. In Indonesia the access by poorhouseholds to education and health care declined,and this decline was particularly marked in urbanareas.
In many countries public spendingon education and health (as a proportion of GDP)was reduced, but it increased in Thailand, wheregovernment programs mitigated the adverse effectsof the crisis by preventing a decline in theschool attendance ratio and access to healthservices. Though there were countries that madesubstantial increases in public spending for asafety net, it has been pointed out that theeffects of these were limited, owing to factorssuch as the lack of development of safety nets inpre-crisis days, tardiness in responding to thecrisis, institutional problems, and the low levelof spending relative to the seriousness ofpoverty.
The causes of, and background to,the Asian currency and financial crises and thelessons to be learned from them have already beendiscussed in detail in the report of theSubcouncil on Asian Financial and Capital Markets.In this report we wish to recapitulate the mainpoints after considering subsequent economicmovements, the spillover of the currency crises onother emerging market economies, and the progressof the discussion about a new internationalfinancial architecture.
(1) Causes of the Asiancurrency and financial crisis
As was pointed out in theaforementioned report, the causes of, andbackground to the Asian currency and financialcrises differ from country to country. Basically,however, there were composite factors comprisingmacroeconomic factors - relating to internationalfinance (abrupt and large-scale internationalcapital movements)-and microeconomic factors -domestic structural factors (the vulnerability ofthe financial and corporate sectors), meaning thatthe crises were "twin crises that were acombination of rapid liquidity crises throughcapital accounts, and crisis" in domesticfinancial systems. However, in addition, thefollowing factors have also been identified asthose that may have acted in a composite manner.
| (a) | One of the macroeconomic factors relating to international finance is the fact that as the economies of individual countries (particularly as regards financial transactions) have become globalized, all countries have become exposed to abrupt and large-scale international capital movements. In every country, for several years prior to the crises there were inflows of large amounts of capital into the domestic financial and corporate sectors, resulting in particular in an increase in short-term external indebtedness. These flowed out in a moment when market perceptions changed, leading to an international liquidity crisis. When that occurred, the increases in foreign-currency-denominated debt burdens resulting from falls in currency values caused the balance sheets of financial institutions and companies to deteriorate, in turn making the currency and financial crises even more serious. Other factors that have been identified include those of self-fulfilling prophecies and the herding behavior of foreign financial institutions upon the outbreak of the crises. |
| (b) | Unease in financial systems was fermented by the structural vulnerability of financial and corporate sectors (e.g. excessive investment in real estate sectors, excessive capital investment that ignored demand forecasts, companies' high debt-equity ratios and low return on equity, and increases in financial institutions' NPLs), while outflows of capital and currency crises caused the balance sheets of financial institutions and companies to deteriorate, further amplifying the unease in financial systems. Furthermore, a vicious cycle arose as the currency and financial crisis grew more acute, as the NPL problems arising in the financial and corporate sectors had a mutual effect on each other and led to a credit crunch, and that depressed economic activity substantially further. |
| (c) | With the appreciation of the U.S. dollar from the spring of 1995, exchange rate regimes that virtually pegged to the dollar caused Asian currencies to appreciate in real terms. This was one of the factors behind the sharp fall in export growth in 1996. In addition, de-facto dollar-peg systems weakened borrowers' perceptions of foreign exchange risk, bringing about the inflow of large amounts of short-term foreign-currency funds. In countries such as Thailand in particular, where interest rates were raised in order to ease the domestic economies overheating, this led to further capital inflows. It could be concluded that the sequencing of capital liberalization was also wrong, in which capital liberalization was preceded before development of domestic financial systems. |
| (d) | Macroeconomic austerity measures adopted during the crisis as the conditionality of the IMF placed pressure on the management of financial institutions and companies, amplifying unease in financial systems, and through the deterioration in economic conditions this had the unintended adverse effect of worsening market confidence in the relevant country. In Indonesia in particular, the resolution of very widespread structural problems was made the pillar of the rehabilitation program, and the markets focused their attention on this issue. When it became clear that the Indonesian government was not prepared for a swift resolution of the structural problems, market confidence evaporated on the contrary. |
| (e) | Greater economic interdependence generated by trade and investment within the East Asian region and financial globalization gave rise to linkages (or expectation of linkages) between different countries' markets, spreading the crisis like a contagion from one country to another, and as economic crises grew deeper, mutual economic activity contracted exponentially. This was a case of a vicious circle in which countries hit by currency crises led to the contraction of the economies of East Asian countries through sharp reductions in imports, and this reduction in imports also brought about the further contraction of the economies of the crisis-hit countries. |
| (f) | Because of factors such as delays in changing its industrial structure, in Thailand - the starting-point of the currency crisis - it became impossible to sustain the imbalance in macroeconomic conditions. In addition, the excessive optimism about the Asian economy, combined with the above-mentioned large-scale international capital inflows and the vulnerability of the financial sector, led to economic bubbles in Thailand and other countries. |
Asian countries formulated avariety of economic measures in the course oftheir pursuit of growth, but it has been pointedout that as a result of changes in the environmentboth internationally and domestically, thesemeasures became unsustainable.
(2) Lessons from the Asiancurrency and financial crisis
From the above analysis of thecauses of the Asian currency and financial crisis,it is possible to draw the following lessons forthe revival of Asian economy and financial system.
| (a) | The currency and financial crisis that occurred in Thailand spread rapidly to many Asian countries, and over the following year spilled over into other emerging market economies. Its effects also caused the global plunge in equity prices that started in Hong Kong, and the collapse of the U.S. hedge fund LTCM. The rapid, worldwide spread of its effects suggests that the crisis did not arise only because of problems of individual emerging market economies, but that there are aspects of the international financial system itself that should be improved. Accordingly, to assure the sustainable and stable growth by Asian countries, global efforts must continue to be made to strengthen the international financial system. |
| (b) | The Asian currency and financial crisis has revealed the vulnerability of the financial and corporate sectors in Asian countries. It is necessary to reform the financial and corporate sectors of Asian countries in order to build stable economic and financial systems that can support sustainable economic growth. |
| (c) | Exchange rate regimes that were virtually pegged to the dollar had been a cause of the worsening of the current-account situation when the dollar was in a strong phase, and of abrupt and large-scale short-term fund inflows. Studies must be made on the exchange rate regime that is appropriate for Asian countries. |
| (d) | It is essential to ensure that a kind of safety net to enable any future currency and financial crises to be dealt with swiftly and appropriately be put in place in advance. Taking various factors into consideration, in particular the enormous impact that this currency and financial crisis has had on the social sector, Asian countries must consider appropriate forms of social safety net. |
| (e) | When the IMF imposes conditionality upon providing liquidity, the conditionality must increase the credibility of the policies of the countries receiving assistance. The reasons/ways in which the credibility of countries receiving assistance has been lost vary from country to country, and thus conditionality will also vary according to each country's macroeconomic situation and the history of its policies to date. In the event that tightening macroeconomic measures are implemented, their impact on structural vulnerability at the micro level and on the socially disadvantaged must be taken fully into consideration. With respect to structural policies it will also be vital to ascertain the content and procedures necessary to regain market confidence, taking into consideration the history of the relevant countries' economic policies, and its social systems and restrictions. |
| (f) | Taking into consideration factors such as the increase in interdependence in the Asian region, and the possibility of contagion by currency and financial crises within the region, if Asian countries are to build stable economy and financial systems that can support sustainable economic growth, it is vital that, in addition to efforts domestically by individual countries and global efforts, efforts also be made on a regional basis. |