Comparing the Asian and Eurozone Crises: A Perspective from Asia

Policy Brief Series Issue 5, Dec 2011

Comparing the Asian and Eurozone Crises: A Perspective from Asia Ramkishen S. Rajan and Sasidaran Gopalan1

Key Points •

This policy brief compares the current crisis in Europe with the Asian crisis of 1997-98, and tries to identify the common elements as well as differences in both crises.

•

This brief argues that the Eurozone crisis should put an end to suggestions that Asia should consider having any sort of exchange rate coordination for the foreseeable future.

Ramkishen Rajan is currently a Visiting Professor at the Lee Kuan Yew School of Public Policy, National University of Singapore and Professor of International Economic Policy and Public Policy, George Mason University, USA. E-mail: rrajan1@gmu.edu. Sasidaran Gopalan is a research scholar at the School of Public Policy, George Mason University, USA. E-mail: sasi.daran@gmail.com. All errors are our own.

This brief builds upon remarks made by the first author at the EU Center in Singapore on “Leadership and Governance in a Post-Crisis Landscape – The EU and East Asia,” November 22, 2011.

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Introduction The ongoing Eurozone crisis is being watched by Asian policymakers and scholars with a combination of detachment and a degree of trepidation. While there remains a feeling that ‘Asia is different’ and that the problems currently evident are of Europe’s own making (primarily a premature and hasty monetary union), there are genuine concerns that the crisis could turn global if not dealt with decisively. Moreover, given that the endgame stemming from the Eurozone crisis remains hazy, making clear predictions on its actual impact on Asia is particularly difficult. 2 However, the short-lived but unexpectedly sharp negative consequences faced by Asia following the collapse of Lehman Brothers in the summer of 2008 remains fresh on the minds of Asian policymakers as they watch the proceedings in Europe and monitor the global financial market repercussions. In particular, apart from a deep recession in Europe and a marked depreciation of the euro having an impact on Asian exports and investments, Asian financial and asset markets which experienced a massive surge in capital flows in 2009-2010 could be badly disrupted should the foreign investors liquidate their positions suddenly. 3 Indeed, in early November 2011, the International Monetary Fund’s Managing Director Christine Lagarde raised the spectre of contagion when she warned that the world runs ‘the risk of a downward spiral of uncertainty [and] financial instability.’ 4 This said, a precise quantification of the potential impacts of such a dynamic is made particularly difficult by the increasing complexity of financial institutions’ balance sheets and a lack of clarity in terms of policy responses. 5 Nonetheless, the structural changes Asia has undergone since the financial crisis of 1997-98 as well as the experience in implementing corrective counter-cyclical policies during the global financial crisis offers

2

For instance, see Nomura Global Economics (2011), Europe Special Report: Endgame, November 2011.

For two recent analyses of the impact of the Eurozone crisis on Asia, see Morgan Stanley (2011), Asia-Pacific CrossAsset Research: Asia Insight – The Challenge to Asia of European Deleveraging, November 13 and IMF (2011), Regional Economic Outlook Asia and Pacific: Navigating an Uncertain Global Environment While Building Inclusive Growth, IMF, October, available online:

3

http://www.imf.org/external/pubs/ft/reo/2011/apd/eng/areo1011.htm, accessed November 30, 2011.

4

Channel News Asia (2011), ‘IMF Chief Warns World Economy Risks “Downward Spiral”’, available online: http://www.channelnewsasia.com/stories/afp_asiapacific_business/view/1164282/1/.html, accessed November 30, 2011.

5 Coordinated intervention by six central banks (European Central Bank, U.S. Federal Reserve, and the central banks of England, Canada, Japan and Switzerland) on November 30, 2011 helped ease liquidity concerns in the global financial system for the time being.

Page |3 some room for optimism about the region’s relative resilience in the event of an Eurozone-induced global financial disruption or some other type of tail risk (that is, large negative shock with low probability). 6 This said, it is curious that Asian academics/scholars have been notably silent on the Eurozone crisis and its consequences on Asia. This policy brief is a response to that silence, comparing the ongoing crisis in Europe with the Asian crisis of 1997-98, drawing out the similarities as well as differences between the two episodes, and distilling some lessons for Asian monetary regionalism from the European experiment.

Comparison between the Asian Crisis and the Eurozone Crisis More than a dozen years have passed since the Asian crisis. While the crisis did have region-wide repercussions, the four countries that stood out in terms of being the worst-hit were Malaysia, Indonesia, Thailand and South Korea (Asian 4). Similarly, while the Eurozone crisis has already produced a fallout in all the countries in the region, including France and Germany where yields have risen and demand for government bonds fallen accordingly, it has thus far been heavily concentrated in Greece, Ireland, Italy, Portugal and Spain (European 5). 7 Though there are obviously important differences between individual countries within these groups and generalisations across countries are always fraught with dangers, it is nonetheless useful to undertake a broad-brush comparison of both sets of economies during the run-up to their respective crises, i.e.1996 in Asia and 2008 in Europe.

Let’s start with some notable commonalities.

1) Prior to their respective crises, both sets of countries were running current account deficits (the Asian 4 averaging nearly 5 per cent and the European 5 , averaging about 9 per cent of their respective gross domestic product (GDP)), though there were some variations between countries in both groups (Figure 1). While Thailand stood out in the Asian 4, with a current account deficit of 8 per cent of GDP in 1996, Greece in the European 5 had a current account deficit of 15 percent of GDP in 2008.

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Most countries in Asia, due to their holdings of reserves and high growth rates, also have relatively more space than their developed counterparts to use expansionary monetary and fiscal policies if needed. This said, risks vary considerably across the region. India is more vulnerable to funding squeezes while net creditor countries such as Singapore are more affected by slowing global growth.

7 The credit standing of 15 Eurozone economies (including Germany and France) is under review by Standard and Poor’s. For more details, see Steinhauser and Keller (2011), ‘S & P puts 15 Eurozone Countries on Credit Watch’, available online: http://www.businessweek.com/ap/financialnews/D9REJNB01.htm, accessed December 5, 2011.

Page |4 Figure 1: Current Account Balance (% of GDP) - Asian 4 (1996) and European 5 (2008) 0

0 -1

Malaysia

Indonesia

Thailand

South Korea

-2

-2

Portugal

Ireland

Italy

Greece

Spain

-4

-3

-6

-4 -5

-8

-6

-10

-7

-12

-8

-14

-9

-16

Source: Compiled from IMF International Financial Statistics Database.

2) Both sets of countries had very open capital accounts coupled with fixed exchange rate regimes (soft US dollar pegs in the case of the Asian 4, and the euro in the case of the European 5).

3) Both groups were facing some degree of declining price competitiveness (the exception being South Korea), as reflected in appreciating real effective exchange rates (REERs) (Figure 2). 8 Figure 2: Index of Real Effective Exchange Rate - Asian 4 (1991-96) and European 5 (2003-08) 115

120

Portugal

113

115

Ireland

111

110

Italy

109

105

107

100

105

95

103

Greece Spain

101

90 85

Malaysia

Indonesia

99

Thailand

South Korea

97

80

95 1991

1992

1993

1994

1995

1996

2003

2004

2005

2006

2007

2008

Note: 1997=100 for Asian 4; 2005=100 for European 5. Source: Compiled from EIU World Investment Services and IMF International Financial Statistics Databases.

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Two caveats are in order. First in fast-growing economies real exchange rate appreciation may not necessarily imply loss of competitiveness (so-called Balassa-Samuelson effect). Second, real exchange rate trends might vary depending on the indices used in their computation.

Page |5 4) Both sets of countries were afflicted by the “original sin” problem in that much of their external liabilities was in foreign currencies – primarily US dollars in the case of the Asian 4 and euros in the case of the European 5 9, with a sizable share of their total debt being short-term in nature (maturing within a year) in both cases.

5) Both sets of countries faced sharp credit growth before their respective crises and the financial systems and households in both sets of countries were fairly heavily exposed to the property sector.

This was particularly so in the case of Thailand and Malaysia in Asia, and Ireland and Spain in Europe where the percentage of private credit to GDP doubled in the pre-crisis years (1991-96 in Asia and 2003-08 in Europe) (Figure 3).

Figure 3: Domestic Credit to Private Sector (% of GDP): Asian 4 (1991-96) and European 5 (2003-08) 160

Malaysia Thailand

Indonesia South Korea

240

Portugal Ireland Spain

140 190

120 100

Italy Greece

140

80 90 60 40

40 1991

1992

1993

1994

1995

1996

2003

2004

2005

2006

2007

2008

Source: Compiled from the World Bank Database. See http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS

While similarities between the two crises extended to policy paralysis and crisis-induced political fluidity, there were also significant differences, some of which are noted below.

1) In the Asian 4 economies, the current account deficits were driven largely by rising domestic investments – most notably in Thailand and Malaysia. In contrast, in the European 5 economies notably Greece, the current account deficits were more caused by rising consumption and declining national savings (Figure 4). The average savings and investment rates as a percentage of GDP stood 9

We say “foreign currency” for the European 5 countries in the sense that if any of them choose to revert to their own national currency and depreciate, their external liabilities which remain in Euros will skyrocket.

Page |6 at 33 per cent and 38 per cent respectively in 1996 for the Asian 4 countries, and 14 per cent and 24 per cent for the European 5 countries respectively in 2008.

Figure 4: Gross National Savings and Gross Domestic Capital Formation (% of GDP) – Asian 4 (1996) and European 5 (2008) Gross National Savings (% of GDP)

45

Gross Domestic Capital Formation (% of GDP)

40

30

Gross National Savings (% of GDP) Gross Domestic Capital Formation (% of GDP)

25

35 30

20

25 15

20 15

10

10 5

5 0 Malaysia

Indonesia

Thailand

South Korea

0 Portugal

Ireland

Italy

Greece

Spain

Source: Asian 4 - compiled from Asian Development Outlook Database; European 5 compiled from Annual Macro-Economic (AMECO) database, European Commission.

2) In the Asian crisis, the Asian 4 maintained a fairly high degree of fiscal discipline ensuring there were no obvious concerns about fiscal sustainability. In the case of Europe, , the most afflicted countries mostly ran fiscal deficits – structural in the case of Greece but driven more by the collapse of the property markets in the cases of Ireland and Spain (Figure 5). 10

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Ireland and Spain ran fiscal surpluses of about 3 per cent and 2 per cent of their GDP, respectively in 2006. However, insofar as the property prices in both cases, the underlying cyclically-adjusted budget balances were a likely cause for concern.

Page |7 Figure 5: Fiscal Balance (% of GDP) - Asian 4 (1996) and European 5 (2008) 2.5

0

2

-2

1.5

-4

1

-6

0.5

-8

Portugal Ireland

Italy

Greece

Spain

-10

0 Malaysia Indonesia Thailand

South Korea

-12

Source: Asian Development Outlook Database; European Central Bank Database.

3) While both sets of countries had accumulated large external debt positions, the problems in the European 5 countries were mainly due to excessive borrowings by their respective private sectors compared to the sovereign (public) debt crises in Asia (Figure 6). 11 The debt positions were also much greater in Europe.

Figure 6: Gross External Debt (% of GDP) - Asian 4 (1996) and European 5 (2008)

South Korea

Spain

Thailand

Greece

Indonesia

Italy

Malaysia Portugal 0

20

40

60

80 0

50

100

150

200

250

Source: Asian 4 - data from Asian Development Outlook Database; European 5 - data (excluding Ireland) - adapted from Gros, D. (2010). ‘Adjustment Difficulties in the PIGS Club,’ CEPS Working Document, 326/March 2010, accessible at http://www.feelingeurope.eu/Pages/Adjustment%20difficulties%20in%20the%20Gypsy%20club%20Gros%20march%202010. pdf, last accessed November 30, 2011.

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Positions worsened much sharply in 2009 and 2010 as growth slowed, interest payments rose and contingent liabilities swelled.

Page |8 4) While the Asian 4 were growing very rapidly up until the Asian crisis, averaging about 8.5 per cent of GDP growth as a group between 1991 and 1996, the growth in the European 5 averaged 2.5 per cent between 2003 and 2008 (Figure 7).

Figure 7: Real GDP Growth (%) - Asian 4 (1991-96) and European 5 (2003-08) 12 10 8

Average (199196)

4.5 3.5 3

6

2.5

4

2

2

1.5

0

Average‌

4

1 0.5 0 Portugal Ireland

Italy

Greece

Spain

Source: Compiled from EIU World Investment Services and IMF International Financial Statistics Databases.

5) During the Asian crisis, the external environment was favourable as the US economy and the rest of the developed world was robust. This is not the case now. The average real GDP growth in the US between 1996 and 1999 was above 4 per cent, but less than 1.5 per cent between 2006 and 2009. 12

6) The Asian 4 governments allowed their currencies to depreciate in nominal terms to regain external competitiveness, while the European 5 have been constrained due to a common regional currency – the euro, implying the need for painful and drawn out adjustments via cuts in domestic wages and other costs. 13

7) While both crises have had widespread regional spillover effects, the global financial linkages of the European banks are much greater today than those of their Asian counterparts in the late 1990s.

12

Data based on EIU World Investment Services database. In addition, commodity prices were not elevated in the late 1990s unlike today.

13 Two caveats are in order. First, Hong Kong chose to remain committed to the US dollar and experienced severe domestic deflation, including in the property sector. More relevant to the European crisis may be the experience of the Baltic states such as Latvia which chose to remain pegged to the euro and successfully adjusted via internal devaluation.

Two, while Malaysia did fix its currency to the US dollar in September 1998, prior to that the ringgit fell sharply from 2.4 ringgit to 1 US dollar in January 1997 to a trough of 3.8 ringgit to 1 US dollar by September 1998. Malaysia ended its dollar peg in July 2005.

Page |9 Thus, the Eurozone crisis is threatening to have much wider and deeper global funding stresses - and hence adverse feedback loops - than was the case during the Asian crisis. 14

8) While the IMF played an important role in both crises, there are substantial differences in the speed with which the IMF responded to the two crises, the terms of loan access (somewhat easier conditionalities in Eurozone compared to Asia), and the quantum of financing offered. 15

Monetary Regionalism in Asia Going Forward Regardless of the nature and potential outcomes of the Eurozone crisis, the advent of the euro itself has had a major impact on policy and academic thinking in Asia on monetary regionalism. Looking back to the Asian crisis and its immediate aftermath (1997-2001) when Asian currencies and economies were in freefall, there was a lack of any kind of regional leadership or cohesion in Asia to deal with the crisis (including the failed attempt by Japan at creating an Asian Monetary Fund) and a deep sense of vulnerability and helplessness.

On the other hand, with the seemingly benign leadership of Germany and France, the euro was successfully introduced in January 1999 and widely circulated by January 2002. Interest rates in many of the Eurozone economies started converging rapidly towards German rates (convergence was largely achieved by 1998-99 before sharply diverging with the Eurozone crisis), 16 and there seemed to be a general sense of euphoria in Europe with respect to medium- and long-term prospects. While the euro did depreciate from 0.86 euros per US dollar in January 1999 to a low of 1.1 euros per US dollar in June 2001 it bounced back after that (averaging 0.8 euros per US dollar since 2003). Over time, policy makers as well as investors were proclaiming the inevitability of the euro becoming an international currency to rival the US dollar. 17

14

For a comprehensive discussion of the funding risks emanating from the Eurozone crisis, see “ The Impact of Sovereign Credit Risk on Bank Funding Conditions,” CGFS Papers No.43, Committee on the Global Financial System, Bank for International Settlements, July.

15 The IMF provided a total of US$35 billion of financial support for adjustment and reform programs in Indonesia, Thailand and South Korea.

For more details on the role of the IMF, see http://www.imf.org/external/np/exr/ib/2000/062300.htm , accessed November 30, 2011,. For a breakdown of financial support from different sources including the IMF see Table 1 in http://www.fas.org/man/crs/crs-asia2.htm , accessed November 30, 2011. In contrast, the IMF agreed to give 30 billion euros (roughly US$ 40 billion spread over three years) to Greece alone as part of a joint EU-IMF 110 billion euro financing package. While many in Asia might view this as IMF having double-standards, one could just as easily argue that there has been substantial learning by the Fund over the last decade or so which may account for the difference in support.

16 Of course, this in turn fuelled a spending spree in some of the peripheral members like Greece.

17 For instance, see Bergsten, C.F. (2004), ‘The Euro and the Dollar: Toward a “Finance G-2”’?, A. Posen (ed.), The Euro at Five: Ready for a Global Role?, Peterson Institute, pp.27-45.

P a g e | 10 Not too surprisingly, seen in this light, many policymakers and scholars looked fondly at the European experiment in the late 1990s and started using that as a possible model for Asia. How fast times have changed. The Eurozone is now in an existential crisis and the current turmoil has made apparent a number of glaring institutional and governance deficiencies that need to be tackled for the region to survive a possible breakup. The crisis should also put an end to suggestions that Asia should consider having any sort of exchange rate coordination. In the absence of a high degree of de facto intra-regional factor mobility, such exchange rate coordination cannot take place without monetary coordination, which in turn cannot take place without a high degree of fiscal coordination – if not fiscal union – which effectively implies forsaking even more political sovereignty (especially for smaller countries). 18 Countries in Asia with widely differing levels and stages of development, and differing economic structures and policies are unlikely to forsake such a high degree of sovereignty. Moreover, whether the benefits are worth the sacrifice are not demonstrably clear. 19 This said, Asian governments should persevere with weaker and medium forms of monetary and financial cooperation. While there are ongoing steps to develop and harmonise regional bond and equity markets, at the macro-level, the major initiative already underway in Asia has been the Chiang Mai Initiative Multilateralization (CMIM), formally put in place in March 2010. Much has been said elsewhere about the CMIM and its limitations. 20 Suffice it to note here that the CMIM involves the 13 Association of Southeast Asian Nations plus Three (APT) economies and Hong Kong committing US$120 billion to the regional facility.

As with the IMF, members have been allotted certain quotas and they can draw on the facility in various proportions of their quota in times of distress. The CMIM is not exactly a centralised reserve pool as the monies dedicated by each member to the pool are held in their individual national accounts. Thus, as economists from the Peterson Institute in Washington D.C. have observed ‘(t)he CMIM can thus be understood as an agreement on joint decision-making to disburse from the national accounts

18

In the recent EU summit (December 9, 2011) the members (with the notable exception of the UK) have stopped short of creating a federalist ‘fiscal union’. What is on the cards, however, is a new treaty to impose much greater budgetary discipline with penalties for countries that exceed agreed upon budget targets. It is not clear how different this so-called “fiscal stability union” will be from the ineffective Stability and Growth Pact that was to limit government debts but failed. There is also no clear indication of whether the ECB will act as a lender-of-last resort for the member economies at times of acute stress.

19

There is obviously a different set of calculus when a country/region has not entered a monetary union (Asia) as opposed to a situation when the country is already in one (Eurozone economies).

20 See Henning, C.R. and M.S. Khan (2011), ‘Asia and Global Financial Governance,’ Working Paper No. 11-16, Peterson Institute, October and Sussangkarn, C. (2011), ‘Institution Building for Macroeconomic and Financial Cooperation in East Asia,’ mimeo, Thailand Development Research Institute, June.

P a g e | 11 simultaneously.’ 21 The relatively small size of the CMIM (US$120 billion compared to the region’s overall reserves of well over US$ 6,000 billion) and the fact that 80 per cent of lending is linked explicitly to an IMF lending program, will likely render the facility irrelevant in the event of a near-term crisis. 22 In addition, any such pooling arrangement would only work if complemented by a strong and credible regional surveillance mechanism that analyses and reports economic and financial conditions in the member economies.

The creation of the APT Macroeconomic Research Office (AMRO) office in Singapore in April 2011 is of pertinence. Its mandate is to ‘monitor and analyze regional economies, which contributes to the early detection of risks, swift implementation of remedial actions, and effective decision-making of the CMIM.’ 23 The extent of resources that member economies commit to developing the AMRO will offer an indication as to how serious they are in pursuing regional monetary cooperation as a credible mechanism for crisismanagement to supplement what is available at both the country and global levels (i.e. national reserves and IMF assistance). If the Asian economies nurture the AMRO by ensuring that it deepens its technical capacity and broadens its membership (possibly to include Australia, New Zealand and India), over time it could be a platform for the region to develop common positions on major issues in the arena of global financial governance, be it the G20, IMF or the Financial Stability Board (FSB)

21

See Henning and Khan (2011), op cit, p.14.

The issue of size, source of funding and role of a regional liquidity facility remains hotly debated in the EU as are plans to create a European Stability Mechanism which combines the existing arrangements.

23 See http://www.asean.org/26280.htm, accessed November 30, 2011.

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The Lee Kuan Yew School’s Briefing Room Series is edited by Toby Carroll, Senior Research Fellow at the Centre on Asia and Globalisation, and Claire Leow, Senior Manager for Research and Dissemination at the Research Support Unit.

Feedback should be sent to: research.lkyschool@nus.edu.sg