Asia: Back to the Future: Creating Long Term Growth

Asia: Back to the Future: Creating Long Term Growth

Moeen Qureshi _*

Ninth Annual Corporate Conference
Hong Kong, May 8, 1998

Speeches and Transcripts: 1998

I feel very privileged to have been invited to speak at the Conference on the subject of creating long-term growth in the Asian countries. These countries have been in the throes of one of the gravest financial crises of modern times.

I will not dwell much on the question of what caused the crisis or how it has been managed—these issues were discussed at length by various speakers yesterday. Nor will I dwell on the role of the IMF, although I am reminded of the Asian political leader who asked an oriental sage as to whether he should, or should not have a program with the IMF. The answer in true Socratic fashion was, “Whatever you do, you will repent it.”

The focus of my remarks will be on the long-term strategy of rebuilding these economies, making sure that one does not throw out those virtuous policies that served them so well in the past, but at the same time strengthening those aspects which made them vulnerable to the crisis.

The formulation and implementation of such a strategy will require a great deal of wisdom and vision, not only on the part of the Governments that have been affected by the crisis but also on the part of multilateral institutions and major governments that have a stake in Asia. It will be necessary to look at both the economic and political implications of the steps to be taken. The two are closely related and both are pivotal to re-establishing stability and prosperity in Asia in the 21st Century.

In my view, there were five key ingredients of the spectacular economic performance of the Asia–Pacific region over the last quarter century:

An environment of relative political stability over an extended period; Extraordinarily high rates of savings which, for the most part, were channeled into productive investments; An impressive record of macro-economic management and financial stability; An investor friendly environment both for domestic and foreign private investment; And, finally, the commitment to economic and social development as the overriding objective of government policy.

These policies will be just as necessary in the future as they were in the past except that they will be harder to follow in the future.

Indonesia and Thailand have been so buffeted by the financial crisis that restoring fiscal, monetary and exchange stability now seems a formidable task. The loss of public confidence in the currency and domestic financial institutions has also undermined the ability of governments to take strong and decisive measures to correct the situation.

Aside from re-establishing the right policy framework, there are two areas that will require continuing attention for sustainable recovery and growth: the Reform of the Financial Systems, and Infrastructure Development.

There is ample evidence that although weaknesses in the financial system were not the cause of the financial crisis in the Asian countries, they certainly contributed to its severity.

Insufficient capitalization, inadequate supervision and regulation, and a lack of transparency and disclosure in the relationships between banks and their clients—official and private—all encouraged excessive risk taking and poor loan decisions. In these circumstances, the reform of financial institutions, is partly an exercise in confidence building—and partly an attempt to create a more viable financial infrastructure for the future.

Capital markets in the emerging economies are in no position to deal with the massive flows of funds that are typical of today’s free global financial markets. These capital flows can cause serious volatility in large markets—in the tiny markets of Asia, they can be devastating.

The answer, however, is not to go back to a system of capital and currency controls which would be tantamount to giving up the source from which the Asian countries have achieved many of their economic gains over the last quarter century. The only solution, in my view, is to strengthen and build up their capital markets—to strengthen their regulatory framework and to promote measures that will allow broader public participation in security markets.

Let me now turn to the importance of infrastructure.

Government and people throughout the world are beginning to recognize the fundamental linkage between the adequacy of infrastructure and a sustained process of economic growth.

This realization is fairly new.

In the past, infrastructure in most countries—but especially in the developing world—has been the domain of the public sector. In periods of financial crisis, when government budgets have had to be trimmed, it is expenditures on infrastructure that have been slashed.

Over the last decade, Asian countries have begun to recognize the need to greatly increase infrastructure investments. Before the crisis, the plans of governments in Asia and the Pacific region called for an increase in infrastructure investments from 4% GDP at the beginning of the 1990’s to 7% of the GDP by the end of the century. An important and growing role for Private Sector participation in Infrastructure Development was envisioned in this strategy.

The Asian financial crisis has greatly exacerbated the pressures on government budgets and a dramatic increase in recourse to the private sector for infrastructure development seems unavoidable. However, to attract a much larger volume of private investment—and especially foreign investment—into infrastructure and improvements in existing policies and procedures governing foreign investment.

The multilateral institutions—especially the World Bank and the Regional Development Banks—as well as Export Financing Agencies have an important role to play in supporting the flow of direct foreign investment into the Emerging Markets.

The World Bank and Regional Banks have announced an expansion of their guarantee programs to cover certain types of sovereign and political risks. However, the cases where actual guarantees have been provided are few and far between. These should become a mainstream—not a marginal—operating of these institutions.

Does all this mean that if developing countries were to undertake these structural reforms—follow the right macro-economic policies, reform their financial system and develop their infrastructure—they would then be impervious to crisis in the future?

The answer is clearly no!

The truth is that we live in a world of global finance in which more financial transactions are done outside the framework of national regulatory standards than within.

And it is also frustratingly true that one doesn’t really know the exact conjuncture of forces that can trigger these larger movements of “hot” money or the best defenses to protect against them.

Based on the experience of the three financial crises that we have had in the 1990’s—the ERM crisis of 1992–93, the Mexican crisis of 1994–95 and the recent Asian crisis—we do know that typically, foreign exchange crises occur not when economic fundamentals suddenly change, but when for one reason or another, currencies suddenly look vulnerable.

Small countries are particularly vulnerable to this type of disruption. The capital flows today are so large, and the “contagion” effects can be so rapid and overwhelming that countries with a long track record of sound policies can still see much of their good work undone.

The developing countries face a special dilemma. As someone said, when they are successful they create a trade problem; when they are unsuccessful they create a banking problem.

I am convinced, therefore, that it is now critically important to begin an international dialogue on how to bring about a better balance between the risks and opportunities of global finance.

Already, there is a severe backlash in some countries—a questioning of the benefits for the smaller economies of policies of liberalization and integration with the global community.

In this connection, it would be wrong to dismiss the political import of the economic devastation that has been wrought in countries such as Indonesia—which for many years was held up as a paragon of sound economic management.

I do not think that the current crisis in Indonesia was triggered by the misdemeanors of the government, as it is so often alleged. Weaknesses do exist in the Indonesian systems—as they do also in many other countries—but they were blithely ignored by financial markets for almost 30 years. The crisis occurred, in the main, because following the Thai devaluation, the forces unleashed by “contagion” and the herdlike behavior of domestic and external investors overwhelmed a financial system that was completely open. By contrast, other countries in Asia which maintain capital controls, but have weaker economies than Indonesia, have been much less affected by the crisis.

Therefore, in my view, there is now an urgent need to initiate an architecture—to examine more systematically, than has been the case so far, the challenges and risks posed by financial market globalization, especially for emerging markets, and the possibility of reducing volatility. Working through the International Monetary Fund, and ITO where appropriate, we should begin to evolve international standards and norms of behavior for banks and financial institutions that operate in the international arena.

This is essential if we are to maintain uninterrupted progress towards free and fair globalized financial markets.

I also believe strongly that there is a lot of untapped potential for regional cooperation in this area. With the benefit of hindsight, it is clear that much of the financial panic that ensued in the Region following the crisis in Thailand, might have been averted if there had been a concerted and massive effort by Regional Central Banks, supported by the IMF, to shore up the currency defense in Indonesia and Malaysia.

The financial crisis that has descended on much of Asia provides a unique opportunity for three countries which have a pivotal position in the Region—China, Japan and the United States—to join hands and take the lead in organizing a major new effort aimed at pulling Asia out of its current crisis and putting it on the path of renewed growth.

A major instrument to this end would be the establishment of an Asian Recovery and Development Fund. Fund resources should be used to assist in debt-restructuring, to promote private investment, especially in infrastructure, to finance social safety nets in association with IMF structural adjustment programs and to provide support for human resource development and environmental preservation.

These are all areas that are now being neglected because of the budget stringency that has come in the wake of the financial crisis. A similar neglect in Latin America during the debt crisis of the 1980’s still constrains Latin American growth rates.

There is a great deal of rhetoric these days about the serious implications of the Asian financial crisis, but precious little assistance and support to the affected countries from those that have the capacity to provide it. The multilateral institutions are performing an extremely valuable role but it is not enough. Their resources are neither sufficient, nor are they sufficiently adaptable, to deal with the size and scope of the problems that Asian countries have to contend with.

It is, therefore, now time for a bolder collective effort, and this effort should begin with the Asian countries themselves.

The objective should be to establish a $200 billion fund for Asian Recovery and Development. It should be structured on sound business lines—it should not be a give away. Resources should be made available on the basis of strict conditionality and performance criteria.

Japan, as the largest source of capital and technology within Asia, is best suited to take the lead in organizing such a Fund, but China, Taiwan and Singapore also have the financial capacity to play key roles in putting together such a scheme. Japan did propose the establishment of a $100 billion Fund last year, but the proposal was not clearly formulated and was widely misunderstood and misinterpreted.

The United States is unlikely to be a significant financial contributor to such a program but its involvement, and that of the Bretton Woods institutions, and the Asian Development Bank, could have a strong catalytic effect. If the United States were prepared to actively support the establishment of such a Fund, it could then be fitted into an organization such as APEC. That would give APEC a new vitality and a clearer sense of purpose.

If the Asian countries do not move boldly to forge new instruments for mutual support and cooperation, the recovery in Asia could be painfully slow.

Obviously, the establishment of an Asian Recovery and Development Fund will not, by itself, assure economic recovery and renewed growth in the crisis-ridden countries but it can provide that badly needed extra push, which can jump start the process of recovery.

It is a sad fact of our times that despite all the technological advances that we have achieved, we still live in the dark ages when it comes to collaboration among nations. As James Michener noted, “Our age is called dark not because the light fails to shine, but because people refuse to see it.”

One of the great challenges that the financial crisis presents to the political leaders of Asia and the Pacific is to see that light and seize the opportunity to build a more solid architecture of mutual support and cooperation for the future.

*: Moeen Qureshi is Chairman and Managing Partner of the Emerging Markets Corporation and is the former Prime Minister of Pakistan. Back.