When the Thais floated the baht on 2 July last year, no one foresaw the chain of events that followed. Soon several countries were affected and called in the IMF to help - Thailand in August, Indonesia in October, and South Korea in November. (The Philippines was already under IMF supervision). Currency values went down by as much as 80% in Indonesia, and 40-60% in the other countries. The stock markets have been pulverised.

What triggered off this loss of confidence? The companies in these countries had borrowed in foreign currencies, primarily US dollar. The US currency then had low interest rates, their own currencies had higher interest rates. They wanted the cheap loans, not realising the serious risks they would run into, once their creditors wanted their money back. The creditors become worried when they saw that the current account deficits of these countries were ballooning. When the current account goes into deficit, it means a country earns less foreign exchange than it needs to pay for imports. In the case of Thailand, the deficit was 8% of their GDP.

What went wrong? East Asia’s economic miracle had its weaknesses. In going helter-skelter for economic growth, many governments did not strengthen their banking systems. Had there been adequate legislation and rigorous supervision, the excessive borrowings that went into real estate, stock market and unproductive industrial expansion, would have been noticed and checked before they ballooned out of control. Corruption and cronyism exacerbated these problems. Market excesses were overlooked, policy weaknesses and adverse developments in economic fundamentals were ignored.

The massive inflows of investments and credit had boosted growth, but they had also built up problems. Weaknesses in the banking systems made careless, even reckless investments, possible and this in turn led to unrealistic ballooning of asset values of properties and stocks. But at a time of rapidly expanding domestic credit the infusion of these funds generated an atmosphere of unending boom and prosperity.

When the problems came to a head, for several months political leaders and their officials in the finance and banking sectors refused to accept the market’s verdict. They did not accept that things had gone wrong and that their weak banking systems and loose credit policies had been at fault. Their refusal to accept the new realities made investors sell out and cut their losses.

This stampede deepened the crisis. Investors lost confidence not just in particular projects or countries but in the entire region; they disregarded the differences in economic and political conditions between countries in the region. When confidence is shattered, the markets no longer reflect real value. Good and bad projects, prudent and profligate financial institutions, were all abandoned.

Countries with inflexible exchange rates tied their currencies to the US dollar. This worked well when the US dollar was weakening against the Yen and the German Deutsche mark (DM) after the Plaza Accord in 1985. With the baht tied to a weakening dollar, Thai exports became cheaper and increased. However the Thais and others continued this link even after the US dollar began to strengthen against the Yen, the DM and all currencies in mid-1995. Thai exports decreased because they had become dearer.

Thai companies had assumed that their exchange rates would remain more or less the same when the time came to repay the US dollars which they had borrowed at interest rates much lower than Thai baht interest rates. If they had floating exchange rates, borrowers would have had to balance the risk of a possible depreciation against the benefit of a lower interest rate. Since the 1970s the Singapore dollar has been managed against a basket of currencies. It had steadily appreciated against the US dollar until the mid-1990s when the US dollar strengthened against the Sing dollar and all other currencies. Sing dollar interest rates, which freely floated were much lower than US dollar rates, and this made it unattractive for Singapore companies to borrow US dollars. So when the crisis struck, Singapore companies had little or no US dollar debts.

Two points are worth noting. First, the root of the problems was political. Ministers had not heeded the warning signals from the market because they were pre-occupied with political difficulties. The Thais had six governments in five years and none had the time to attend to the gaping current account deficits. The Malaysian Prime Minister Dr Mahathir condemned foreign speculators. And President Soeharto thought that he could ride out this crisis as he had ridden so many others in the past 30 years. During the Cold War, 1965-66, when Soeharto took charge of Indonesia after a failed communist coup, Indonesia had hyper inflation of over 700%. At that time, America helped with food and other support to bolster a precarious Indonesia against a communist take-over. But today, the US Congress is not eager to be involved in any rescue that would cost them money.

The second factor was that the leaders did not realise the implications of the globalised financial market of instant communications between the financial centres of the world and their representatives in the capitals of East Asia. The inflow of funds from the industrial countries brought both the benefits of high growth and also the risk of a sudden outflow of these funds. In every East Asian capital, Bangkok, Kuala Lumpur, Jakarta, Manila, Singapore and Seoul, there were hundreds of American, European and Japanese resident bankers, stock brokers and financial analysts, supported by local staff with roots in the community. Every move the governments in East Asia made was instantly analysed and reported back, around the clock, to the headquarters of these banks and financial houses in New York, London and Tokyo for instructions on what to do next. But governments in the region reacted as they did in the 1960s when financial markets were more segregated and reaction time tended to be much slower. Then there was a time lag of 8 to 12 hours, when Europe and America were asleep while trading was going on in East Asia.

No sentiment, goodwill, or personal obligations counted in the decision making of international fund managers and traders. Hard-headed calculations of the higher rates of return they could get in the region than in their home countries made them invest in East Asia. When they sensed that the East Asian markets would let them down, they decided to cut and run, making a collapse certain. However much each country in the region tried to differentiate itself from the economic conditions of its neighbours’, the head offices in New York, London or Tokyo classified them all as "emerging markets".

Confidence - The Political Factor

It is a crisis of confidence and confidence has not yet been restored. Until bankers, fund managers and stockbrokers and the region’s own people believe that the policies of their governments are realistic and will be implemented consistently, confidence will be low and the value of their currencies will not increase. The crucial ingredient is the political factor.

In South Korea a new president, Kim Dae Jung, has been elected. He has been a dissident all his life, a supporter of human rights and democracy, a Korean nationalist, a radical. But faced with a perilous situation, he is saying and doing all the right things even before he is installed as President. He invited George Soros to advise him, and has expressed support for all that the IMF wants South Korea to do: close weak banks, restructure the chaebols or conglomerates, open up the economy, their companies, banks and stock exchange to foreign investors. Because of his attitude, the US government is fully behind him and has got US bankers to roll over their debts. Bankers and fund managers, especially Americans, have adopted a positive attitude towards the Korean Won and their stock market. Both are stabilising and improving in value. But where the market is not convinced that the leader is doing what is necessary, they have withheld their vote of confidence and the currency is vulnerable.

Similarly, the new Thai government of Prime Minister Chuan Leekpai has also been saying and doing the right things and this has stabilised the baht.

Although President Soeharto has said and shown that he intended to carry out its terms after he signed the second IMF agreement, the Indonesian rupiah and the stock market have not stabilised like the Korean Won and the Thai baht. What is it that the Indonesian President did not get right? It is the political factor. The market was disturbed by his criteria for the Vice-President that required a mastery of science and technology, announced shortly after the second IMF agreement. They believed that this pointed to a Minister whom they associated with Indonesia’s high cost projects. If the market is uncomfortable with whoever is the eventual Vice-President, the rupiah would weaken again. Then prices of essential goods will again increase with higher inflation and more companies will go bankrupt, creating greater unemployment. The resulting social problems will be widespread.

When will the worst be over? The answer is not until after the Indonesian election of the President and the Vice-President in early March. If there are no upsets, the situation will stabilise and improve. If there are, currencies and stock markets in the region will be affected by another bout of nervousness and panic.

These matters are beyond our control, but where we can, we should help. Hence the Prime Minister has visited President Soeharto three times in the course of the last few weeks. It is vital to Indonesia that the Indonesian rupiah is stabilised and the stock market begins to recover. Otherwise the fallout would be bad for Indonesia and may again spread panic over the region.