Crisis Threatens a Region, but Not the System
International Herald Tribune
October 24, 1997
Alan Friedman

Nearly four months after Thailand's currency crumbled, East Asia's financial crisis has now moved decisively into an even more contagious phase, one that has put the Hong Kong dollar, long a haven of Asian wealth, under siege amid a flight of investment capital from the region.

The real danger now, specialists say, is not so much a threat to the world financial system as it is the risk of increasingly severe economic hardship and banking woes in a number of individual countries in East Asia.

Jean-Michel Severino, the World Bank's vice-president for East Asia and the Pacific, said that despite a collateral impact on European stock prices, he did not believe the Asian crisis would degenerate into a threat to the global financial system.

"I would be a bit surprised if the crisis were to spread all over the world because East Asia does not represent a significant enough share of the global economy to cause a systemic risk, meaning to jeopardize the profits of major companies around the world or to affect world economic growth or the world banking system," Mr. Severino said.

But Mr. Severino and other officials agreed that the Asian crisis could cause more economic hardship for individual

countries in the region. He warned that "the only way to avoid more hardship was for East Asian economies to react very quickly and to deepen efforts at financial-sector reform."

The World Bank official said the competitive devaluations of other currencies in the region had "put pressure on Hong Kong's competitiveness," helping to explain why the Hong Kong dollar was under pressure. He added that for China, "the devaluation of other currencies in the region is a problem because it could hurt Chinese exports, which are driving the economy's strong growth rate."

Japan, meanwhile, which has significant investments, bank lending, and exports to East Asia, "could be affected."

Phase one of the Asian crisis began last summer, when Thailand was forced to devalue its currency and had to ask the International Monetary Fund for a $17.2 billion bailout. Between July and early this month the currencies and equity markets of the "tiger economies" of Thailand, Malaysia, Indonesia and the Philippines slumped repeatedly. The Philippines and, more recently, Indonesia both turned to the IMF for help, while well-managed economies such as Hong Kong's and Taiwan's seemed to be havens for investors.

In the last couple of days, more things changed. Investors became frightened by Thailand's political crisis, and speculators began taking aim at the Hong Kong dollar, whose value has been pegged to the U.S. dollar for the past 14 years.

Now, phase two of the crisis has begun, with heavy selling hitting stockmarkets from Japan to Australia. The Hong Kong stock index fell 16 percent in just 48 hours.

In Europe, stock-exchange indexes also dropped, for two reasons. Some investors fear the Asian crisis will affect European exports and are unloading the shares of companies that either export to East Asia or have big investments there. Also, the psychological impact of the sell-off across Asia has had a contagious effect in Europe.

Finance officials around the world are increasingly concerned about the Asian crisis, which they say is being driven mainly by a loss of investor confidence in Thailand and by a negative mood swing in general market sentiment that tends to lump together all of the economies in the region, be they well managed or poorly managed.

On Thursday, France's finance minister, Dominique Strauss-Kahn, said the IMF should become involved in calming the crisis. "The risk of instability is very great," he said. This point of view was echoed by the newspaper Le Monde, which carried a front-page article Thursday warning that the crash of Asian markets could threaten economic growth in Europe and destabilize the world financial system.

A senior international financial official, speaking on condition that he not be named, on Thursday termed the Asian market crisis "a significant and yet unwarranted contagion" that stemmed from the Thai crisis and would continue "until investors become convinced that the countries hardest hit are doing what needs to be done to reform their economies."

Andrew Freris, an economist at the Hong Kong branch of Bank of America, said that "what is really driving market sentiment is an inability to differentiate between problems in different countries." This, said Mr. Freris, meant that "you have an aggregation of the Thai problem into a broader pan-Asian problem, and in Hong Kong a disbelief that a pegged currency can actually stay pegged."

Mr. Freris and some other economists predicted that the Hong Kong authorities would keep interest rates high as a way of attracting funds into Hong Kong to prop up the currency. But he also admitted that high interest rates in Hong Kong and elsewhere could have "a definite impact on consumption and on economic growth" in the region.

He also pointed out that despite the assurances given by Hong Kong officials that they would defend the Hong Kong dollar's link to the U.S. dollar "this is now a political and not an economic decision because if they let the peg go now it would make China look bad in the eyes of the world."

Mr. Freris said it was "hard to imagine the Chinese throwing the peg out the window without a fight after 14 years of it having been successfully pegged by the British."

Mr. Severino said that among the reasons for the new phase in the crisis was the fact "that some Asian countries under fire have not been successful or fast enough in fixing their problems."

Thailand and Indonesia "have been a bit slow," Mr. Severino said in a telephone interview from Washington on Thursday. "Malaysia is a stronger economy but the ringgit was clearly overvalued and Prime Minister Mahathir's rhetoric has not been helpful. The Philippines has been more discreet and has taken the right steps, but investors may be concerned about the political situation there."

The speed with which some East Asian economies have been taking steps to clean up their financial systems, especially in countries where bank lending to real estate and other risky ventures has been bloated, is at the heart of a political problem that lies behind the financial crisis.

In some countries the authorities appear unwilling to do what international financial officials are recommending, namely to let a number of finance companies and banks go bankrupt or be merged quickly, in part because they do not want to hurt their political cronies or financial backers who control these institutions.

Copyright © 2006 the International Herald Tribune