Singapore Government Press Release
Media Division, Ministry of Information and The Arts
36th Storey, PSA Building, 460 Alexandra Road, Singapore 119963.
Tel: 3757794/5
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SPEECH BY SENIOR MINISTER MR LEE KUAN YEW AT THE EUROPE-ASIA FORUM 1998 ON 20 FEBRUARY 1998 AT SHANGRI-LA HOTEL, SINGAPORE
ROOTS OF THE CRISIS
The currency turmoil engulfed East Asia from 2 July 1997. Currency values fell by 75% in Indonesia, and 30-50% in the other ASEAN countries and Korea. Even the Singapore and the New Taiwan dollar lost 15% of their value against the US dollar, despite strong economic fundamentals. Stock market indices in Thailand, Indonesia, Malaysia and the Philippines have fallen by one-third to one-half. Thailand called in the IMF to help in August, followed by Indonesia in October, and South Korea in November.
What went wrong? For over 15 years, these economies enjoyed high growth of between 7% to 9% per annum, during a period when America and Europe had sluggish growth. The World Bank, IMF, Asian Development Bank and financial writers lauded East Asia's "economic miracle". By the early 1990s, several of the regional economies were already operating at full capacity and so much of the new investments were channelled into properties and projects of doubtful value. Still no international organisation and no ratings agency raised the red flag. Mr Wolfensohn, President, World Bank, admitted recently that the World Bank had been too sanguine in its assessment of Indonesia. Fitch IBCA, one of the top three international ratings agencies, admitted recently that it had been overly optimistic on East Asia.
While the euphoria lasted, everyone overlooked the institutional and structural weaknesses in these economies. The corporate sector in Thailand, Indonesia, and South Korea borrowed heavily, even recklessly. Banks and investors in the US, Europe and Japan were also reckless to lend and invest in order to get higher returns than in their own economies.
Thailand, Indonesia, Malaysia and the Philippines had their currencies closely linked to the US dollar. Their governments did not fully appreciate the moral hazard problem of such a policy at a time when they no longer had restrictions on capital flows. Interest rates on the US dollar were much lower than domestic interest rates. Private corporations in these countries interpreted the fixed exchange rates as government guarantee that there would be no currency exchange risk. So they borrowed in US dollars, on the assumption that their exchange rates would remain more or less the same when the time came to repay. If these countries had floating exchange rates, borrowers would have had to carry the risk of a possible depreciation as against the benefit of a lower interest rate. And foreign lenders would not have been so confident about the borrowers' ability to repay if there were sudden changes in exchange rates.
For many years, this cheap credit fuelled high economic growth in East Asia. Governments had liberalised their financial markets without adequately strengthening the regulatory and supervisory systems. Easy credit that poured into the region, led to asset bubbles and overbuilt property markets. To compound the problem, local banks in these countries extended loans based not on feasibility of projects, but on personal relations or political connections.
The lenders were aware of the problem but accepted it as a way of business. Some even saw the presence of politically connected business partners as implicit government guarantees for the loans. They went along with the game.
THE CRISIS NOW
In 1996, an export slowdown and widening current account deficits in these countries spooked financial markets. Both creditors and investors became nervous. Speculators saw glaring weaknesses in Thailand's economic situation and started attacking the Thai baht from mid-1996. After a costly over US$20 billion defence of their currency, Thailand floated the baht on 2 July 1997 which fell immediately by 15%, with similar losses on the stock market.
Fund managers with billions of dollars in assets started selling to get out of other ASEAN countries, which they lumped in their minds together with Thailand as "emerging markets". At the same time, domestic corporations with foreign currency exposure rushed to hedge their positions. This massive selling brought down the stock markets and the exchange rates in all the ASEAN countries.
Ratings agencies like Moody's and S&P, which had been overly optimistic in the past, rushed to downgrade ratings. When the sovereign debts of Indonesia, Thailand and Korea were downgraded to junk bond status, many portfolio managers in the US and Europe had to sell out, as their investment mandate did not allow them to hold non-investment grade bonds. International banks scrambled to minimise their exposure and reduce or cut their credit lines to domestic banks in these countries. As credit dried up, and interest rates rose, the debt burden on East Asian companies became unsustainable. Fears of corporate defaults and financial distress caused currencies and stock markets to plunge further. Both spiralled downwards in a crisis of confidence.
Although the basic causes of each country's crisis were different, the collapse of foreign confidence infected the whole region, aggravating the problems. What had begun as a classic market mania as funds flowed exuberantly into East Asia to enjoy higher rates of return, became a classic market panic as foreign investors stampeded towards the door to get out with their money.
WHAT IS TO BE DONE NOW?
On hindsight, both borrowers and lenders did not take sufficient notice of the institutional and structural weaknesses of the economies, especially of the financial system. After an initial period of denial, the governments of the affected countries are now coming to terms with the disaster that has overtaken them.
East Asian governments have to undertake painful reforms.
Firstly, they have to restore confidence by implementing policies which will convince both their own peoples as well as international fund managers that their economies are being put on a sounder basis and will be on the mend. In spite of criticisms, there is no viable alternative to the IMF for now. Countries already on IMF programs must demonstrate their determination to achieve the targets agreed upon. This is the benchmark against which markets will judge a government's commitment to reform.
East Asia needs to strengthen their institutions of government and improve corporate governance. Their institutions have not developed to keep pace with the changes that came with rapid economic growth and the globalisation of financial markets. These ASEAN countries took less than ten years to double their per capita incomes, something the US took all of 30 years, from 1960, to do. A country needs a professional civil service, a competent and effective central bank, and good corporate governance, ie, soundly managed banks and companies. Relationships among businessmen, ministers and civil servants must not degenerate into cronyism where favours determine the outcome of a deal.
International investors can do their part to help Asia reform. Corrupt governments demand bribes, because they know corporations will pay them. In December 1997, OECD members and five developing countries signed an OECD Convention, to combat bribery of foreign public officials in international business transactions. This convention would criminalise the bribe-givers, and not just the bribe-receivers. This is a step in the right direction. Investors cannot have it both ways: turn a blind eye to corruption when the going was good, and blame corruption for their troubles when things go wrong.
Secondly, East Asian countries must improve information flow and disclosure, and be more transparent. The best way to avoid market reactions based on rumours is to make the relevant information (including the bad news) readily available to market players. The IMF and the World Bank can help, by asking the right questions, and providing the technical assistance to enable Asian countries to compile and disseminate the data the market needs.
Through such published data foreign investors and bankers should be able to distinguish between East Asian economies. Had such data been available foreign investors could have seen the problems ahead. In Thailand, hasty financial liberalisation in the early 1990s fuelled over-borrowing and excesses in the property sector. In Indonesia, hasty liberalisation led to a fragmented and poorly-supervised banking sector. High domestic interest rates, reflecting exchange and credit risk, encouraged corporations to borrow in US dollars abroad at much lower interest rates. Malaysia had less external debt than either Thailand or Indonesia; but it had one of the highest domestic credit to GDP ratios in ASEAN - one and a half times of GDP. In Korea, it was the system of chaebols and directed bank lending that led to excessive foreign borrowing and investment.
Thirdly, East Asian countries must continue to open up their economies. They should open up sectors that were previously protected, to encourage capital inflow. They have to give foreign investors management control over their investments. Europe can seize this opportunity to take a permanent stake in these temporarily devastated economies. It is too simplistic for European banks and companies to eschew "risky" East Asia altogether. They have to manage risk astutely, not shun the region. With currencies and stock markets at a fraction of their previous values, a discerning investor will find good value. East Asia has not lost its many strengths: pragmatic and pro-business governments, enterprising peoples who value education and are willing to work hard, save and invest for future gain and make sacrifices for their nations. European companies and banks should position themselves before East Asia prospers again.
Finally, East Asian countries must provide political continuity to assure foreign investors that present and future governments will stay committed to reforms. The currency crisis has erupted at a politically difficult time in Indonesia.
THE CRISIS CANNOT BE ALLOWED TO FESTER
The repercussions of an East Asian meltdown will not be confined to Asia. The industrial countries must contribute to the solution of the crisis that they abetted. International banks that have lent to, and multinationals that have invested in East Asia, have a vital interest in the region's recovery. The world economy, its trade and investments, and its financial markets are interlinked.
Just before the crisis, East Asia, excluding Japan, accounted for about 16% of European exports (excluding intra-EU trade). This is a modest, but growing share, compared to 6% in 1980. As of end 1996, European banks had an exposure of US$320 billion to East Asia, of which US$83 billion was direct lending to Korea, Thailand, Indonesia and Malaysia. As a group, EU banks are more exposed to East Asia than Japanese banks (US$260 billion) and US banks (US$46 billion). An S&P report in February 1998 estimated the potential losses for European banks with exposure to Asia at well over US$15 billion. It is in their interest to contain the crisis, and see Asia recover as soon as possible if they are to recover any part of their loans and benefit from Asia's economic potential.
Till now, China has been insulated from the turmoil because it has not opened its capital account. However, its competitiveness has been reduced by the large currency devaluations in its neighbours. It also has major structural problems, including those of the state-owned enterprises. If China were to devalue its currency, the Hong Kong dollar peg would be in jeopardy because some 50% of Hong Kong's GDP is derived from China-related activities. Moreover, it will be a grave loss of confidence to have Hong Kong break its peg so soon after its reversion to China. China must find other ways to stay competitive.
As the largest economy in East Asia, Japan can provide the impetus for an export and investment surge. Japan can do much more to stimulate its own economy by reducing taxes, like the recent cuts in personal income tax, and by increasing public spending. The sooner Japan takes such decisive steps the sooner it can help the troubled countries in East Asia. The country's banking sector needs an injection of public funds to restore bank capital ratios to international levels. Only then can Japanese banks resume lending and get its economy humming.
Japan cannot do this alone. Japan has contributed directly to the IMF package for Thailand, Indonesia and South Korea. The US and Europe must support Japan's effort. The US contributed to the IMF packages in Indonesia and Korea, issued calming statements on Indonesia, and spearheaded the Korean debt rescheduling talks. The US must continue to reassure Southeast Asia, in words and in action, that it is committed to helping the region out of its present crisis. The US President has already asked Congress for extra funding to the IMF. He has said that the cost to the US of doing less for Asia could be even higher.
Europe must take a more pro-active role in this crisis of confidence. It missed out on earlier opportunities to show concern for Thailand and Indonesia. It came in late to help Korea by contributing directly to the supplementary financing IMF package. However, Europe did not make any direct contribution to the IMF packages for Thailand and Indonesia except through its membership of the IMF.
Chancellor Kohl has publicly expressed his support for President Soeharto. Besides this, the perception in Asia is that the EU has been passive in this crisis. If it is to play a global role, the EU must be more active in helping to restore confidence in Asia's currencies and financial markets.
Our economies are interdependent and the gains from co-operation are great. If there is the will to implement painful reforms, East Asian countries can be back on track within a few years. East Asia, Europe and the US must work together to quell this panic and reassure investors. When capital flows back to East Asia, the economies will revive and all will benefit.
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