Lessons from Malaysia.
Valuable lessons are to be learned from the collapse in confidence in the South-East Asian region, which only last year had attracted over $56bn in net private capital inflows.
The recent market turbulence in Asian tiger economies could be disinflationary for the global economy, in particular the economies of developing countries, and it shows the real powers of hedge fund gurus like George Soros to adversely influence the medium-term economic prospects of developing countries.
In essence, when any currency suffers from a prolonged and steep depreciation, as was the case of the South African rand in 1996, or the Malaysian ringgit since July of this year, the nation's monetary wealth, as measured in major currency terms, also diminishes rapidly. Thus the central banks are compelled to increase interest rates to defend their exchange rates against further speculative attacks. In Indonesia, short-term rates are currently 30.5% higher than those of most African countries. Rising interest rates hit domestic demand hard, leading to falls in both consumption and investment. A grossly devalued currency augments the costs of imports and external debt-servicing, which in turn exacerbates problems in balance of payments.
In some respects, Dr Mahathir Mohammad, Prime Minister of Malaysia, is justified in arguing that speculative trading is immoral and should be stopped. Liquidity-rich hedge funds or speculators benefit from aggressively selling a currency short. With vastly increased real purchasing powers, speculators can acquire long positions in local capital markets at highly undervalued prices. But the real economy suffers from sustained currency weakness if inflation creeps into the system, hence the real earnings growth of both companies and their workforces will diminish.
Therefore, amid conditions of extreme market volatility, some regulations on the short-selling of financial instruments, including currency options, may be acceptable. A total ban on forex trading is however inadvisable, because emerging markets depend heavily on steady inflows of foreign capital to finance both current account deficits and some long term projects.
Turmoil in Asia
Turmoil in SE Asian markets, if it continues, will lead to a reduction in outward foreign direct investment (FDI) from the region. Malaysia is a major source of FDI in sub-Saharan Africa, and a major trading partner.
More importantly, the fall-out from the Asian currency devaluations has some conceptual implications for the African region.
It serves to illustrate that when governments pursue unsound economic policies, thus failing to tackle on-going structural problems, currency and wider financial crises are inevitable, and sooner rather than later. Constraints which hinder sustained economic growth arise from unsustainable large current account and fiscal deficits (the latter due mainly to massive but unproductive government spending), rising interest and real exchange rates, heavy short-term capital inflows, for example hot-money as opposed to more desirable FDI, and chronic banking sector problems. As Mr Eddie George, governor of the Bank of England puts it: "It is unusual for markets to develop a crisis out of a clear blue economic sky."
Thus the responsibility for averting a financial crises ultimately rests with government. Policy makers should maintain fiscal discipline, for sustained periods of low interest rates and inflation are dependent on a prudent fiscal policy. Exchange rate stability, by reducing forex risk on crossborder investment, promotes economic growth and attracts inward portfolio investment.
However, as the experience of USS devaluation in the early 1990s shows, rebound in exports stimulates economic activity. Many Asian economies which had maintained overvalued currencies (partially pegged to the dollar) should take South Africa's example. Its manufactured exports are benefiting this year from a competitive rand.
Fund managers are now reducing their SE Asia portfolio weighting in favour of other regions, including Africa. South Africa remains an attractive outlet, where enormous capital gains are likely next year as interest rates are projected to fall by at least 23%. Foreign investors this year remain overweight in SA financial assets. Net foreign investment in bonds and equity have totalled R20bn in 1997 so far.
The dollar is a safe haven amid Asian financial fragility. The greenback's bull market remains largely intact, and strong institutional demand indicates prospects of further appreciation on a 6-12 month view. The US economic cycle is still more advanced than that of either Japan or continental Europe.
The recent G-7 meeting in September expressed overall satisfaction with forex markets, but stressed the importance of avoiding large external imbalances. Thus expect the dollar to trade in the near-term within a range of Yen118-123, and DM1.75-1.80. Whilst rates in Japan and Germany are on hold until the end of 1997, the futures markets have undergone a reassessment of the outlook for US interest rates amid signs of inflation-free economic growth.
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|Date:||Nov 1, 1997|
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