Long-Term Strengths, but Sweat and Worries for Now
International Herald Tribune
December 19, 1997
Douglas H. Paal and David G. Brown 

Making tough decisions is never easy for democratic governments, particularly when past successful policies have created strong vested interests. However, the unavoidable need for action seems finally to be taking hold in East Asia.

In Japan on Wednesday, Prime Minister Ryutaro Hashimoto bowed to reality and accepted the need to stimulate the economy.

In South Korea, the continuing collapse of the won persuaded the three presidential candidates to agree formally last weekend to support an IMF loans-for-reform program. The government announced that five more merchant banks would be suspended, one major commercial bank sold to overseas interests, the currency allowed to float, the domestic interest ceiling raised, and rules for mergers and acquisitions eased.

Four months after its IMF package was announced, Thailand bit the bullet recently and closed 56 finance companies so that it would get the next installment of its IMF loan.

In Indonesia, the central bank governor, Sudradjad Djiwandono, acknowledged that the financial sector's problems were worse than expected and said the government would push ahead with reform and further consolidation in the financial sector.

Malaysia announced a tough austerity plan last week. It tightened credit, cut government spending and lowered growth targets. That amounts to an IMF program without the IMF.

Another indication of realism was the joint statement from an informal summit of the Association of South East Asian Nations in Kuala Lumpur this week. The ASEAN leaders did not blame outside forces or trumpet Asian values or models.

They made the necessary statements about the importance of sound economic fundamentals, financial transparency, multilateral cooperation and support for the IMF, and they appealed for greater help from the international community.

Malaysia's Prime Minister Mahathir bin Mohamad said he had learned to hold his tongue, the financial crisis could not just be blamed on speculators and ASEAN needed to get its own house in order.

This good news does not mean that East Asia is out of the woods. Far from it.

The poor health of Indonesia's President Suharto, made evident by his failure to attend the ASEAN summit, sent the rupiah and the Jakarta stock market into a further fall. Concern about the political succession in Jakarta will be a source of uncertainty in the run-up to a presidential election in March.

Now that the rupiah has fallen so much in value against the dollar, virtually every major Indonesian company is insolvent because of extensive foreign currency borrowings.

Succession concerns also bedevil the Philippines. No sooner had President Fidel Ramos anointed House Speaker José de Venecia as his party's candidate for the presidency in 1998 than former Defense Minister Renato de Villa quit the party to run separately. All this divides the governing party's base and leaves Vice President Joseph Estrada, a populist whose commitment to economic reforms is in question, still in the lead in early polls.

The outcome of South Korea's presidential election could provide a new jolt to the market, particularly if the winner does not immediately marshal a nationwide display of government, corporate and labor resolve to reassure markets of Korean commitment to implement the IMF package.

South Korea will face another test next week when the National Assembly meets to reconsider long-delayed financial reform bills, whose passage is a condition for receiving the next installment of IMF aid.

Korean legislators are still seriously considering revising the financial reform that makes bank account holders use their own names, not those of nominees. If the reform is gutted, this would be a step away from transparency and send another negative signal to markets.

So South Korea may be headed for another beating in the marketplace, and possible default, in the absence of an early show of determination to fix the system.

While markets have played the central role in the unfolding financial turmoil in East Asia, governments have not been the powerless bystanders that some feared. To be sure, the crisis has elicited more than the usual number of ill-considered and counterproductive statements. Xenophobic comments raised the specter of narrow, protectionist responses.

But despite divergent views and conflicting interests, most governments, working collectively and through multilateral institutions, have acted responsibly. Their actions have gone well beyond the three IMF rescue packages for Thailand, Indonesia and South Korea.

Markets have responded positively in the short term to the steps taken in Tokyo, Seoul and Kuala Lumpur. However, it is too early to say that the corner has been turned toward recovery. Some of Seoul's remedies smack of election eve tactics. A long process of pain, recovery and uncertainties lies ahead.

Still, currencies have been driven to levels where they appear undervalued. With barriers coming down as a result of domestic reform or IMF fiat, big new investment opportunities are opening. Some companies are moving to take advantage of these possibilities, but are looking first for the beginning of a restoration of confidence in the banking community.

In the long run, many economic fundamentals remain strong. These include generally conservative fiscal policies, openness to foreign investment, declining tariffs and trade barriers, well educated and hard working populations, high domestic savings rates, and strong entrepreneurial skills. These long-term strengths remain valid and should not be obscured by the financial problems that the region is experiencing and will in time overcome.

Meanwhile, however, the political costs of the economic adjustments have yet to be felt. The aftershocks of scheduled elections and parliamentary debates could be severe, affecting both the regional and the global economy.

Mr. Paal is president and Mr. Brown senior associate at the Asia Pacific Policy Center. Both are former senior U.S. officials who specialized in Asian affairs. They contributed this comment to the International Herald Tribune.

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