Ten Years After

Sta. Ana coordinates Action for Economic Reforms.  This article was published in the Opinion Section, Yellow Pad Column of BusinessWorld, July 31, 2007  edition, page S1/5.

It was 10 years ago—in July 2007—that the Asian financial crisis shook the world.

The conflagration, as it were, began in Thailand. Financial investors panicked and like a herd, rushed towards the exit.  The capital flight led to the precipitous fall of the once stable but overvalued Thai baht. The wild fire immediately spread to the neighboring region—Korea, Indonesia. Malaysia, and the Philippines.  Within the same year, the Asian contagion reached other parts of the world, especially Brazil and Russia.  Not only did their currencies plunge; their economies crashed.

The crisis also had deep political repercussions.  In Indonesia, what the activists could not accomplish, the financial crisis did—end the long reign of the dictator Suharto. In Malaysia, Prime Minister Mahatir Mohamad was initially weakened but managed to survive. He instituted capital controls to stem the hemorrhage and provoked nationalist sentiments by blaming the International Monetary Fund (IMF)  for the crisis.   And in the Philippines, Fidel Ramos took a beating from popular opinion.  His much-ballyhooed vision—“Philippines 2000,”which was a fantastic leap to industrialization in a short period—was blown to smithereens.

Furthermore, the crisis marked the decline of the Washington Consensus (WC) agenda of liberalization and deeper economic integration.  In the pre-crisis period, the ideologues of the WC sounded arrogant and triumphant.  But the depth of the crisis, in no small measure resulting from the policies emanating the WC, gave the critics ammunition.  The WC henceforth took an intellectual and political retreat.  The power and prestige of the IMF likewise diminished.

Those among the believers of the WC who were intellectually honest acknowledged the mistakes.  For example, Kenneth Rogoff, who later became the IMF’s Economic Counsellor,  wrote that “there seems to be a good case for keeping an open mind on the issue of capital controls and debt—especially when debating ways to better immunize the global financial system against crises in the twenty-first century.” (See the IMF’s Finance and Development magazine, December 2002, Volume 39, Number 4.)

In hindsight, the prevailing view among mainstream economists was that the liberalization of capital accounts was premature in countries that were hit by the crisis. A liberalized capital account makes it easy for short-term capital flows to enter and exit a country, thus creating volatility.  Further, a heavy inflow of foreign capital exerts pressure on the domestic currency to become overvalued, with adverse effects on the tradeable sectors.

Ten years after the Asian (or global) financial crisis, prominent scholars, economists and non-economists, have revisited the issue.   Lessons learned have been reiterated and new insights have been offered in light of similarities between then and now.

The world is again upbeat on the economic front.  Large amounts of capital are returning to the emerging markets.

Thailand, where the 1997 crisis started, is enjoying modest growth, but the economic managers are worried over the inflow of short-term capital.  They attempted to tax stock market transactions, but this was immediately withdrawn after a wild reaction from the financial markets.

China, insulated from the 1997 financial crisis thanks to its capital controls, could become the source of a new global crisis.  While its high growth has been sustained through two decades, its dizzying pace has produced bubbles that can burst in the near future. The problem with economic crises is that no one can anticipate when they will erupt.

Here in the Philippines, short-term flows are again on the rise as the stock market booms.  The peso has appreciated and is in fact already overvalued, according to the IMF’s latest estimate of the real effective exchange rate (REER).

These developments, among others, make the lessons of the 1997 crisis all the more relevant.

Emerging markets, especially in East Asia, have built huge foreign-exchange reserves.  The reserves in East Asian countries are estimated to add up to $2.3 trillion. China alone has reserves amounting to $1.33 trillion.  The Philippines has likewise steadily beefed up its reserves.  The Philippine reserves however look paltry (US$26.3 billion) compared to those of other East Asian countries.

But accumulating reserves has a huge opportunity cost; such amount could have been used to fuel growth or to finance human development.  Nevertheless building the international reserves is a prudent approach to fend off financial crises.

From a global perspective, Joseph Stiglitz argues that “the two most important lessons of the crisis have not been absorbed.”  The first lesson is that “capital market liberalization—opening up developing countries’ financial markets to surges in short-term ‘hot money’—is dangerous.”  The second lesson, says Mr. Stiglitz,” is that “there is a need for a credible international financial institution to design the rules of the road in ways that enhance global stability and promote economic growth.”

But what about the Philippines?  It may look messy for the Philippines to reverse the course of financial liberalization.  Yet some measures can be taken without losing credibility.

The strategy is to encourage productive long-term flows but discourage hot money. Several tools, including “market-friendly ones,” are available—a tax on short-term flows, for one.  It is a strategy that will not upset the IMF.

Further, Josef Yap of the Philippine Institute for Development Studies argues in his paper (“Ten Years After: Financial Crisis Redux or Constructive Regional Financial and Monetary Cooperation?,” 2007) about the need to rethink the exchange-rate policy.

An overvalued currency is a telltale sign of the likelihood of a financial crisis.  Those countries struck by the 1997 crisis, as well as countries in previous and later episodes, had overvalued currencies.

The Bangko Sentral ng Pilipinas has attempted to slow down the peso appreciation though prepayment of foreign debt and the purchase of US dollars.  Yet, the peso continues to appreciate.  Much more has to be done.

Crises are inherent in the global economy. .  The question is can we either avoid or weather such crises?

Reforms at the country level are undoubtedly crucial.  But the problem is likewise global, requiring internationally coordinated solutions.

There’s a British blues band, a favorite of mine, called Ten Years After.  And the title of its hit song can serve as an ending for this essay about ten years after the financial crisis:  “I’d love to change the world.”

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