Asia's Crisis: A Market Perspective

• Author: John Lipsky
• Position: Chief Economist and Director of Research at Chase Manhattan Bank, New York

Recent events in Asia have posed a particular challenge for international capital markets. How can net private capital flows best be restored?

ASIA'S CURRENCY CRISIS-the opening act of which was the July 2, 1997 devaluation of the Thai baht-dampened significantly the prospects for global growth while unsettling financial markets. Even today, the fragile situation in Asia constitutes a potential systemic threat, despite the progress that has been wrought through the unprecedented efforts of the past months. In less than one year, Asia has been transformed from the world's fastest-growing into its slowest-growing region. At the same time, the region previously considered by many investors to offer the most attractive business opportunities was converted almost overnight into a net capital exporter.

The Asian crisis has attracted a wide range of commentary. Reviewing key aspects of the crisis remains worthwhile, however, since many of the conclusions reached by observers of recent events warrant closer examination. In particular:

* Clear-cut warning signals of a potential Thai crisis were recognized widely, but the specific policy actions that precipitated the baht's collapse-and critical data-were hidden from public view.

* The virulence of the crisis, and the speed with which it spread throughout the region, was unanticipated, indicating that the importance of preexisting regional linkages was not adequately recognized.

* The economic damage and financial disorder resulting from the crisis were not inevitable and were exacerbated by policy errors that sapped investor confidence.

* The role of fixed or pegged exchange rate policies in precipitating the currency crisis has been exaggerated. The critical failure in the crisis countries was in following inconsistent policies-albeit in difficult circumstances-that progressively lost credibility.

* The catalytic role of external capital flows in triggering the crisis has been overestimated-in essence, treating symptoms of deeper problems as if they were the problems themselves. At the same time, the critical importance of capital flight from the crisis countries has been underestimated.

* The reluctance of the crisis countries to tighten their monetary policies to stem capital flight-and their attempts to shield domestic firms and wealth holders from the impact of market discipline-proved to be self-defeating. Stabilization efforts did not gain credibility until policies were tightened-although this occurred in most cases only after a lengthy delay, and at a substantially greater cost.

* Asia's financial turmoil in large part has been tamed for the time being, but the risks of renewed problems remain substantial. Asia's 1998 economic growth outlook appears more subdued today than consensus views indicated previously, even at the peak of the crisis in late October-early November.

* The economic and financial challenges differ substantially from country to country. The Japanese economy's stagnation throughout the 1990s, the Chinese economy's transformation, and the maturing of the Association of Southeast Asian Nations (ASEAN) economies all represent distinct-although linked-issues, requiring individually tailored approaches.

* Much of the criticism leveled at the official responses to the unfolding crisis seems misguided. The international financial institutions are not dealing with the crisis countries in a "one size fits all" fashion-a claim repeated widely-nor are stabilization programs "causing" the economic downturns now afflicting the crisis countries. At the same time, international officials did not always anticipate accurately financial market problems.

* Any solution to the ongoing crisis necessarily will rely on private funding. Thus, restoring investor confidence is a paramount challenge. Recurring, large-scale provision of public funding simply is not a practical alternative to capital market stabilization-while strengthening the crisis countries' financial markets will contribute substantially to rebuilding confidence.

* The securitization of international finance will accelerate as the crisis abates. The Mexican peso crisis of 1994-95 and the 1997-98 Asian currency crisis underscore that the current international financial system does not provide clear delineation of responsibility for liquidity and solvency in a world increasingly dominated by securitized cross-border...