Download Chapter 1 Understanding Asia`s Economy

Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Chapter 1
Understanding Asia’s Economies
Asian economies, both individually and in aggregate, have been growing and developing
impressively during most of the post-war era. Asian economies have taken turns to achieve high
economic growth rates: first Japan; then South Korea, Hong Kong, Taiwan, and Singapore,
followed by Indonesia, Malaysia, Philippines, and Thailand; China and India are now powering
ahead; with Vietnam, Cambodia, Laos, and other Asian countries seemingly poised to participate
in the Asian economic growth story as well.
At times, such high levels of economic growth seem unstoppable. As shown in Figure
1.1, for the period from 1980 to 2006, the average real gross domestic product (GDP hereafter)
growth rate for China, India, Japan, and “other Asian economies” (the Asian export economies as
indicated in Figure 1.1) were respectively 9.8, 5.9, 2.4, and 5.7 per cent. If we exclude the impact
of the 1997-1998 Asian financial crisis, real GDP growth rates would be even higher, especially
for “other Asian economies”.
Figure 1.1 Real GDP Growth in Asia: 1980 – 2006
Numbers in brackets are average real GDP growth rates 1980- 2006
Percent
20
China (9.78%)
India (5.91%)
Japan (2.38%)
Others* (5.73%)
15
10
5
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
-5
-10
* Others include Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand.
Source : IMF; authors’ calculations.
This remarkable success has given rise to two opposing views about Asian development
model (s).1 One is that all is well – indeed, in some ways things may be even better than they look
and with some minor policy adjustments, there is no reason that the party cannot continue
indefinitely. Asian economies are fondly referred to as the “miracle” economies and they
epitomize the virtues of the capitalist system, although this capitalist system differs in many
aspects from that in the western world. Openness to trade, high domestic savings and investment,
1
We focus on the common features of different Asian economic stories in this book. By no means does it
suggest that there is only one Asian model of economic development, although economists, policy makers,
and analysts from the academic and professional worlds often refer to the term “Asian economic model”
and have delved into how the model has been working across Asia and over time at length.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
emphasis on human capital development, a disciplined work force, relatively cheap labour, and
economic-development-oriented macroeconomic and political policies have all been pointed out
as the building blocks of the Asian model. The believers and followers of the Asian miracles are
even committed to the view that the destiny of the world economy lies with Asia.
The other view is that the economic boom in Asia is built on an inefficient institutional
infrastructure and could come crashing down any minute. Systematic limitations such as underdeveloped financial systems, poor corporate governance, lack of sound legal frameworks and
effective law enforcement, corrupt governments, and exchange rate management are time bombs
haunting the Asian economies. The Asian crisis was a wake-up call for the region and brought to
the surface these systematic limitations. Even in academic research, many authors believe that the
so called “Asian model” – a common denominator that underlies the Asian success stories – does
not stand the statistical evidence. Studying total factor productivity (TFP) in Asian countries,
Kim and Lau (1994) and Young (1995) illustrated that the economic growth in Asia was mainly
driven by input growth or factor accumulation, not through high rates of efficiency growth
measured by TFP. To proponents of this view, the Asian model of development is no different
from previously successful ones (for example, the growth of the former Soviet Union and the
Warsaw Pact nations) – the secret, if any, is their extraordinary mobilization of resources and
willingness to sacrifice current satisfaction for future gain (Krugman 1994).
We take a middle road in this book. Instead of either defending or disputing the “Asian
Model”, we acknowledge the difficulties of placing the very heterogeneous economies of Asia
under one big umbrella – the Asian Model. Asia comprises more than 4 billion people (60 per
cent of the world population) in 46 different nation-states. Asia demonstrates a huge disparity in
economic development – while Japan and China are respectively the second and fourth largest
economies in the world (measured by nominal GDP in 2006), Mongolia, Maldives, Bhutan, and
Timor-Leste remain among the smallest. Due to its vast size (44 million km2 in area), a huge
range of cultures 2 , environments, historical ties and government systems, Asia, including its
economies, can hardly be described by using one single model.
Despite this diversity, there are still some common features underneath the successful
Asian economic stories. In this chapter, we offer evidence to highlight these common features.
While we discuss how these common features work together to power forward the Asian
economies, we also pinpoint the systematic limitations inherent in the Asian economies and their
implications for Asia’s future.
1.1 Snapshots of the Asian economies in the past one hundred years
1.1.1 The Pre-Modern Period in Asia
Asia was rich until quite recently and had been in the forefront of world development for at
least two thousand years until the eighteenth or possibly even the early nineteenth century.
Maddison (2001) estimated that Asia accounted for 70 per cent of global GDP for the year 1000
A.D., vis-à-vis only 9 per cent for Europe. China and India alternated in being the largest
economy in the world from 1 A.D. to about 1800 A.D. Columbus, in his search for the fantasy
land – India – accidentally discovered the Americas; the Silk Road had long been the main EastWest trading route.
Asia had since suffered a deeply felt eclipse. Even worse, prior to World War II, most
Asia countries were under colonial rule and only relatively few managed to stay independent (for
2
For example, there are more 600 languages spoken in Indonesia. More than 415 languages are spoken in
India and more than 100 languages are spoken in Philippines.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
example, Japan and Thailand). Due to the Meiji Restoration in 1868, Japan experienced massive
institutional changes and development, and managed to develop its economy. Japan was the only
Asian country that had kept pace with the industrial revolution in the West in the nineteenth
century. The Japanese economy continued to grow well in the first half of the 20th century. Along
the way, the fast growing Japanese economy created various shortages of resources essential to
economic growth. To secure strategic resources, Japan started its aggressive expansion, beginning
with neighbouring Korea and China and then moving into Southeast Asia.
In a stark contrast, China’s economic performance was lacklustre during the same period.
In the year 1800, per capita income in China, based on Bairoch’s (1993) estimate, was on par
with that of Western countries. However, by the end of World War II, per capita income in
Western industrialized countries was already a multiple of 6 of the average per capita income in
China. China, once the largest economy in the world, was even overtaken by Japan in terms of
per capita income as early as 1820.
At the same time, Southeast Asia was prospering due to trade and the introduction of
various new technologies of that time. The trade volume continued to increase with the opening
of the Suez Canal in the 1860s. Singapore, founded in 1819, rose to prominence as trade between
the east and the west increased. Malaysia, as a British colony, was the world’s largest producer of
tin and rubber. Indonesia, a Dutch colony at the time, was known for its spice production.
In 1908, crude oil was first discovered in Persia (now Iran). Afterwards, many oil fields
were discovered and it was learnt later that the Middle East possesses the world’s largest oil
supplies. This made the rulers of the Arab nations very rich, although the socioeconomic
development in that region lagged behind.
In 1937, Japan invaded China; in 1941, Japan invaded Malaya and began World War II in
Asia. The war had an incredibly destructive impact across the region, destroying established trade
networks; interrupting both physical and human capital development in Asia; and dragging the
region into a series of geopolitical and ideological problems that were later proven to be
detrimental to economic development.
1.1.2 The Post-War Period to the Asian Financial Crisis: 1945-19973
The post-war era eye witnessed new Asian success stories. The GDP growth rate and
income per capita in Japan and subsequently in a group of newly industrialized economies
(especially the four East Asian tigers – South Korea, Hong Kong, Singapore, and Taiwan) began
rising significantly faster than those in the mature Western industrial economies. From 1955 to
1973, Japan maintained an unprecedented 10 per cent of GDP growth rate per annum. Between
1966 and 1990, the Singaporean economy grew a remarkable 8.5 per cent per annum. Taiwan,
Hong Kong, and South Korea also achieved similar economic growth rates.
Why Japan and the Four Asian Tigers grew so fast has drawn intense attention from the
academic and professional worlds. Numerous reasons were suggested; the exact answers remain a
heated debate. Obviously, the post-war geopolitical environment favoured Japan and other Asian
economies. The United States supported Japan’s rapid economic growth because it was seen as a
bulwark to stop the spread of communism (Das 2005). Hong Kong, South Korea, Singapore, and
Taiwan also benefited from this geopolitical environment. The favourable environment opened up
the US market and allowed Japan and the four tigers to develop labour-intensive, resourceintensive, and capital intensive industries (exactly in that order).
3
There is a library of literature discussing the Asian economies during this period. We will discuss at
length the hows and whys in Chapter 1.2. Here we only offer a quick summary.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Japan and the Asian tigers grasped this opportunity and grew through a mobilization of
resources. In the case of Singapore, the employed share of the population surged from 27 to 51
per cent from 1966 to 1990. The financial system channelled high savings to high investment – as
we will show slightly later (Chapter 1.2); investment as a share of GDP rose to 30-40 per cent
during most of economic take-off era. The educational standards of the work force also increased
dramatically – the literacy rate increased; college graduates as a share of total population rose;
and more and more workers completed secondary education. To a certain extent, the economic
success in Japan and the four Asian tigers can be largely accounted for by increases in measured
inputs – such as resources, physical capital and participation of labour forces (Krugman 1994;
Young 1995). On top of the dramatic factor input growth, sound macroeconomic policies
especially the pervasive adoption of the export-led economic development strategy, a benign
demographic structure, and eve-improving labour productivity did play their roles along the way.
The success of Japan and the four Asian tigers provided a model, which other Asian
economies consciously tried to emulate. Economies such as Malaysia, Thailand, Philippines and
Indonesia followed the same development mode – resource mobilization and export-led strategy
combined with sound macroeconomic policies – and achieved impressive growth.
Until late 1970s, China adopted a state-led, central ownership and control economic
model similar to that used by the former Soviet Union. While China was able to mobilize huge
amounts of resources to develop heavy and chemical industries and had also achieved moderate
success, economic development from time to time was disrupted by political turmoil. China’s
lacklustre performance was even dimmer when compared to its smaller neighbours, especially in
terms of per capita income. When China kicked off its reform policy in the late 1970s, its GDP
per capita was only several per cent of that of its closest neighbours, Hong Kong and South
Korea. China formally launched the “reform” and “open door” policy in 1978. Many components
of the “Asian model” have been gradually introduced – attracting foreign direct investment,
promoting export-oriented industries and so on. By 1990, China had become an energetic part of
the rapidly growing and globalising Asia. Now, China is moving toward becoming the engine of
Asian economic growth.
India adopted socialist policies in most of the post-war era, which limited its economic
growth (the so-called “Hindu rate of growth”). Beginning 1990, India started to liberalize the
economy. Such efforts quickly made India one of the fast-growing economies in the region.
Wars driven by the Cold War and ideological conflicts, notably in Vietnam, Cambodia,
Laos, and Afghanistan, wrecked the economies of these respective nations. But now it seems that
at least Vietnam is back in the race for economic development – the strategies in Vietnam now
strongly resemble those adopted in the Asian tigers. Vietnam’s economy has been opened up and
exports are driving its growth. Shortly after the United States and Vietnam restored economic and
political ties, the Vietnam economy started to grow in 1995. Now it is poised to surge as a new
economic tiger in Asia.
When the Soviet Union collapsed in 1990-1991, many central Asian states announced
independence and were forced to adapt to pressure for democratic and economic change. Those
economies still heavily rely on natural resources and they are still in the process of searching for
appropriate economic development models.
Economically speaking, 1945-1997 was a golden time for an ever increasing percentage
of Asia. More than forty years’ rapid economic growth surely impressed the world. To take the
highest profile example at the moment, if the growth rate of the past quarter century were to
continue, China would overtake the United States as the largest economy in the world somewhere
in 2020s. If we measure the size of an economy by GDP computed at the purchasing power parity
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
(PPP), conservative estimates show that China is already the second largest economy in the world
and will overtake the United States. to become No.1 in 10 years.
It is tempting to seriously take such trend projections to forecast the future. However, as
we will show in this Chapter and throughout this book, rapid Asian economic development does
not come without costs. The rapid growth in most Asian economies has been built upon relatively
weak institutional infrastructure. In order to maintain a high level of investment, labour force
participation, and other inputs for economic growth, Asian governments have adopted a series of
distorted policies which eventually lead to different types of imbalance in the economies. These
risks loom large in Asia and from time to time trigger unfavourable dynamics between the real
economic sectors and the financial sectors. The outbreak of Asian financial crisis in 1997
epitomized fully those imbalances. In some way, 1997 signalled the end of the fairy tales about
the Asian economies – finally Asia was back to “real”.
1.1.3 The Asian economy today
2007 marked the tenth anniversary of the Asian financial crisis, an event (together with
the aftermath of the bursting of the earlier Japanese bubble economy) that since overshadowed
Asia. Yet 10 years since the crisis, doubts about Asia and its economies still linger. Have Asian
firms and regulators made enough progress to prevent another meltdown? What are the
implications of the underlying changes for the Asian economies? With the rapid ascent of China
and India as new engines of Asian development, can Asia’s economies be the pillars of the world
economy? Is there such a thing as the “Asian model”? To overcome the boom and bust cycles
inherent in Asian economies, what improvements should be made? The list of questions goes on
and on.
Figure 1.2 Asia’s Size in the World Economy, 2005
Global GDP in 2005 = $ 44 trillion
Rest of world
19%
31%
Japan 10%
5%
China
7%
28%
Other Asia
US
Source : IMF; authors’ estimations.
5
EU
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Although about 60 per cent of the world’s population lives in Asia, the Asian economies
as a whole only accounted for slightly over 22 per cent of global GDP in 2005. As a continent,
Asia still lags behind Europe and North America in terms of the size of its economy (Figure 1.2).
Moreover, the level of Asian economic development remains highly uneven – Japan and China
together, as shown in Figure 1.2, have more than two thirds of Asia’s output, with the other fortyfour states accounting for the rest of one third. While GDP per capita (at current prices) reached
the level of US$ 33,403 in Japan and US$ 27,483 in Hong Kong in 2006, Asia also includes some
of the poorest nations in the world: GDP per capita is only a few hundred US dollars in
Bangladesh, Myanmar, Nepal, Cambodia, Bhutan, Timor-Leste, and Mongolia.
When the media and investors all around the world talk about booming Asia, they likely
are only pointing to slightly more than ten Asian economies, which are mostly located in East
Asia and Southeast Asia – the majority of Asian states are consciously left out.
This is the true state of Asia’s economy. From Tables 1.1 to 1.11, we provide summary
reports of economic, socioeconomic, and financial facts for eleven Asian economies: China,
Hong Kong, India, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, and
Thailand.4 We focus on various aspects of these Asian economies and provide a bird’s view of
the state of Asia’s economy. All data are from 2006 unless otherwise specified.
Facts should speak louder…
4
We note that we are making the same conceptual mistake as most media and global investors do – taking
Asia as a continent consisting of the eleven economies and leaving out a large part of action in the region.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.1 China
Macroeconomics
GDP ($ billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP)
FDI outflow ($bn/% of GDP)
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/ATO accession date
2,765
2,104
7,600
1,062/38
853/31
69.0/2.5
57.2/2.1
1,066/39
323/12
1,180/43
EU, US, Japan
20
11-Dec-2001
Socioeconomics
Population (million)
Number of Households (million) (2005)
Mobile phones per 100 people
Internet subscribers per 100 people
Literacy rate, % (aged over 15) (2002)
Gini Index (2002)
% of population above 65 years old
1,314
407
33
9
90.9
44
7.7
Capital Markets & Banking Sector
Number of listed firms
1,421
Equity market capitalization ($bn /% of GDP)
1,121/41
Trading volume ($bn /% of market cap)
1,639/123
Life insurance Premium Volume / GDP (%)*
1.8
Non-Life insurance premium Volume / GDP (%)*
0.9
Private bond market capitalization / GDP (%)*
10.4
Public bond market capitalization / GDP (%)*
15.2
Private credit by deposit money banks and
135.3
other financial institutions / GDP (%)**
Financial system deposits / GDP (%)**
164.8
Financial derivative traded on exchanges**
NO
Ratio of non-performing loans (%)**
15.6
Number of ATMs per 100,000 people**
3.8
Number of branches per 100,000 people**
1.3
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.2 Hong Kong
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP) *
FDI outflow ($bn/% of GDP) *
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
190
27,483
36,500
390/205
368/194
34/18
27/14
133/70
513/270
41/22
Japan, China, EU
0
23-Apr-1986
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people (2005)
Internet subscribers per 100 people (2005)
Literacy rate , % (2002)
Gini Index (2001)
% of population above 65 years old
6.9
2.2
126
71
93.5
52.3
12.8
Capital Markets & Banking Sector
Number of listed firms
975
Equity market capitalization ($bn /% of GDP)
1,704/897
Trading volume ($bn /% of market cap)
1,072/63
Life Insurance Premium Volume / GDP (%)*
8.6
Non-Life Insurance Premium Volume / GDP (%)*
1.3
Private Bond Market Capitalization / GDP (%)*
17.8
Public Bond Market Capitalization / GDP (%)*
9.1
Private credit by deposit money banks and
other financial institutions / GDP* (%)
141.9
Financial system deposits / GDP* (%)
242.3
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%)**
2.2
Number of ATMs per 100,000 people**
n.a.
Number of branches per 100,000 people**
n.a.
All data are in 2006 unless otherwise specified.* Data in 2005; ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.3 India
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP)
FDI outflow ($bn/% of GDP)
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
924
843
3,700
212/23
238/26
11/1.2
n.a.
177/19
142/15
264/35
US, EU, China
6
1-Jan-1995
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people
Internet subscribers per 100 people (2005)
Literacy rate, %, (2003)
Gini Index (2000)
% of population above 65 years old
1,096
n.a.
6.3
5.5
59.5
32.5
4.9
Capital Markets & Banking Sector
Number of listed firms
4,796
Equity market capitalization ($bn /% of GDP)
1,579/171
Trading volume ($bn /% of market cap)
647/41
Life Insurance Premium Volume / GDP (%)*
2.6
Non-Life Insurance Premium Volume / GDP (%)*
0.6
Private Bond Market Capitalization / GDP (%)*
1.0
Public Bond Market Capitalization / GDP (%)*
32.9
Private credit by deposit money banks and
other financial institutions / GDP (%)*
36.8
Financial system deposits / GDP (%)*
52.2
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%)**
6.6
Number of ATMs per 100,000 people**
n.a.
Number of branches per 100,000 people**
6.3
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.4 Indonesia
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP)
FDI outflow ($bn/% of GDP)
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
370
1,510
3,800
114/31
96/26
16/4.3
n.a.
43/12
125/34
91/25
Japan, Singapore, US
0
1-Jan-1995
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people
Internet subscribers per 100 people*
Literacy rate, % (2002)
Gini Index (2004)
% of population above 65 years old
245
60
19.1
6.5
87.9
34.8
5.4
Capital Markets & Banking Sector
Number of listed firms
344
Equity market capitalization ($bn /% of GDP)
138/37
Trading volume ($bn /% of market cap)
50/36
Life Insurance Premium Volume / GDP (%)*
0.8
Non-Life Insurance Premium Volume / GDP (%)*
0.7
Private Bond Market Capitalization / GDP (%)*
2.4
Public Bond Market Capitalization / GDP (%)*
16.6
Private credit by deposit money banks and
other financial institutions / GDP (%)*
21.8
Financial system deposits / GDP (%)*
36.2
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%)**
13.4
Number of ATMs per 100,000 people**
4.8
Number of branches per 100,000 people**
8.4
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.5 Japan
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP) (2004)
FDI outflow ($bn/% of GDP) (2004)
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
4,269
33,403
33,100
687/16
634/15
34/0.8
32/0.7
880/21
1,513/35
1,028/24
US, China, EU
70
10-Sep-1955
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people (2005)
Internet subscribers per 100 people (2005)
Literacy rate, %, (2002)
Gini Index(2002)
% of population above 65 years old
128
n.a.
74.0
67.4
99
38.1
20.0
Capital Markets & Banking Sector
Number of listed firms
2,811
Equity market capitalization ($bn /% of GDP)
4,591/108
Trading volume ($bn /% of market cap)
5,912/129
Life Insurance Premium Volume / GDP (%)*
8.3
Non-Life Insurance Premium Volume / GDP (%)*
2.2
Private Bond Market Capitalization / GDP (%)*
42.4
Public Bond Market Capitalization / GDP (%)*
150.2
Private credit by deposit money banks and
other financial institutions / GDP (%)*
98
Financial system deposits / GDP (%)*
123.2
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%)**
2.9
Number of ATMs per 100,000 people**
113.7
Number of branches per 100,000 people**
10.0
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.6 South Korea
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP)
FDI outflow ($bn/% of GDP)
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
912
18,882
24,200
394/43
384/42
11/1.2
18/2.0
239/26
263/29
272/30
China, EU, Japan
12
14-Apr-1967
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people (2005)
Internet subscribers per 100 people (2005)
Literacy rate, % (2002)
Gini Index(2000)
% of population above 65 years old
48
18
79.9
70.6
97.9
35.8
9.2
Capital Markets & Banking Sector
Number of listed firms
731
Equity market capitalization ($bn /% of GDP)
758/83
Trading volume ($bn /% of market cap)
913/120
Life Insurance Premium Volume / GDP (%)*
7.5
Non-Life Insurance Premium Volume / GDP (%)*
3.1
Private Bond Market Capitalization / GDP (%)*
52.8
Public Bond Market Capitalization / GDP (%)*
25.3
Private credit by deposit money banks and
other financial institutions / GDP (%)*
79.9
Financial system deposits / GDP (%)*
43.8
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%)**
1.9
Number of ATMs per 100,000 people**
90.0
Number of branches per 100,000 people**
13.4
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
12
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.7 Malaysia
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP) ***
FDI outflow ($bn/% of GDP) ***
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
161
6,059
12,700
189/117
153/95
5/3.1
2/1.2
78/49
52/32
31/20
US, Singapore, EU
1
24-Oct-1957
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people (2005)
Internet subscribers per100 people (2005)
Literacy rate, %, (2002)
Gini Index(2002)
% of population above 65 years old
27
n.a.
72.4
40.8
88.7
46.1
4.7
Capital Markets & Banking Sector
Number of listed firms
1,027
Equity market capitalization ($bn /% of GDP)
239/148
Trading volume ($bn /% of market cap)
78/33
Life Insurance Premium Volume / GDP (%)*
3.7
Non-Life Insurance Premium Volume / GDP (%)*
1.9
Private Bond Market Capitalization / GDP (%)*
52.2
Public Bond Market Capitalization / GDP (%)*
38.2
Private credit by deposit money banks and
other financial institutions / GDP (%)*
117.8
Financial system deposits / GDP (%)*
105.9
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%)**
11.8
Number of ATMs per 100,000 people**
16.4
Number of branches per 100,000 people**
9.8
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
*** FDI for Malaysia is referred to as equity investment in the CEIC database.
13
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.8 Philippines
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP)
FDI outflow ($bn/% of GDP) ***
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
123
1,382
5,000
57/46
59/48
2/2
0.7/0.6
23/18.7
53/43
18/15
US, Japan, China
0
27-Dec-1979
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people (2005)
Internet subscribers per 100 people (2005)
Literacy rate, % (2002)
Gini Index (2003)
% of population above 65 years old
89
n.a.
36.9
8.8
92.6
46.1
4.1
Capital Markets & Banking Sector
Number of listed firms
240
Equity market capitalization ($bn /% of GDP)
146/119
Trading volume ($bn /% of market cap)
12/8
Life Insurance Premium Volume / GDP (%)*
0.9
Non-Life Insurance Premium Volume / GDP (%)*
0.6
Private Bond Market Capitalization / GDP (%)*
0.3
Public Bond Market Capitalization / GDP (%)*
38.4
Private credit by deposit money banks and
other financial institutions / GDP (%)*
30.6
Financial system deposits / GDP ( %)*
50.2
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%) **
24.7
Number of ATMs per 100,000 people**
5.3
Number of branches per 100,000 people**
7.8
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
*** FDI for Philippines is referred to as equity investment in the CEIC database.
14
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.9 Singapore
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP) ***
FDI outflow ($bn/% of GDP)
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
137
30,430
30,900
346/252
302/221
5/3.6
n.a.
136/99
0/0
26/19
Malaysia, EU, US
1
20-Aug-1973
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people (2005)
Internet subscribers per 100 people (2005)
Literacy rate, % (2002)
Gini Index (1998)
% of population above 65 years old
4.5
n.a.
97.4
53.8
92.5
42.5
8.3
Capital Markets & Banking Sector
Number of listed firms
539
Equity market capitalization ($bn /% of GDP)
378/276
Trading volume ($bn /% of market cap)
183/48
Life Insurance Premium Volume / GDP (%)*
6.1
Non-Life Insurance Premium Volume / GDP (%)*
2.6
Private Bond Market Capitalization / GDP (%)*
18.8
Public Bond Market Capitalization / GDP (%)*
39.2
Private credit by deposit money banks and
other financial institutions / GDP (%)*
109
Financial system deposits / GDP (%)*
105.4
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%)**
2.9
Number of ATMs per 100,000 people**
37.9
Number of branches per 100,000 people**
9.1
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
*** FDI for Singapore is referred to as foreign net investment commitment in the CEIC database.
15
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.10 Taiwan
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP)
FDI outflow ($bn/% of GDP)
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date (Chinese Taipei)
365
16,000
29,000
255/70
235/64
14/3.8
4/1.1
266/73
86/24
72/20
China, Japan, US
3
1-Jan-2002
Socioeconomics
Population (million)
Number of Households (million)
Mobile phones per 100 people (2005)
Internet subscribers/100 people (2005)
Literacy rate, %, (2003)
Gini Index
% of population above 65 years old
23
n.a.
96.4
57.4
96.1
n.a.
9.8
Capital Markets & Banking Sector
Number of listed firms
688
Equity market capitalization ($bn /% of GDP)
596/163
Trading volume ($bn /% of market cap)
735/123
Life Insurance Premium Volume / GDP (%)*
11.2
Non-Life Insurance Premium Volume / GDP (%)*
2.9
Private Bond Market Capitalization / GDP (%)*
28.1
Public Bond Market Capitalization / GDP (%)*
27.8
Private credit by deposit money banks and
other financial institutions / GDP (%)*
n.a.
Financial system deposits / GDP (%)*
n.a.
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%) **
n.a.
Number of ATMs per 100,000 people**
n.a.
Number of branches per 100,000 people**
n.a.
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
16
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.11 Thailand
Macroeconomics
GDP ($billion)
GDP per capita ($)
PPP GDP per capita ($)
Exports ($bn/% of GDP)
Imports ($bn/% of GDP)
FDI inflow ($bn/% of GDP) ***
FDI outflow ($bn/% of GDP) ***
Foreign currency reserves ($bn/% of GDP)
External debts ($bn/% of GDP)
investment ($bn/% of GDP)
Top 3 trading partners
Number of firms in Global Top 500
GATT/WTO accession date
218
3,354
9,100
161/74
152/70
7/3.2
0.8/0.4
67/31
60/28
61/28
Japan, EU, US
1
20-Nov-1982
Socioeconomics
Population (million)
Number of Households (million) (2004)
Mobile phones per 100 people (2005)
Internet subscribers per 100 people (2005)
Literacy rate, %, (2002)
Gini Index(2002)
% of population above 65 years old
65
19
42.1
13.0
92.6
51.1
8.0
Capital Markets & Banking Sector
Number of listed firms
476
Equity market capitalization ($bn /% of GDP)
142/65
Trading volume ($bn /% of market cap)
95/67
Life Insurance Premium Volume / GDP (%)*
2.0
Non-Life Insurance Premium Volume / GDP (%)*
1.6
Private Bond Market Capitalization / GDP (%)*
20.2
Public Bond Market Capitalization / GDP (%)*
21.1
Private credit by deposit money banks and
other financial institutions / GDP (%)*
93.3
Financial system deposits / GDP (%)*
90
Financial derivative traded on exchanges**
YES
Ratio of non-performing loans (%)**
11.9
Number of ATMs per 100,000 people**
17.0
Number of branches per 100,000 people**
7.2
All data are in 2006 unless otherwise specified.* Data in 2005. ** Data in 2004.
Source: CEIC; CIA World Factbook; IMF; Fortune Magazine; authors’ calculations.
*** FDI for Thailand is referred to as foreign equity investment in the CEIC database.
17
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
1.2 The common threads underneath the Asian success stories
Identifying the common denominator of Asian success stories turns out to be not so
outrageous. A careful examination of the driving forces behind rapid economic growth in Japan,
the four East Asian tigers, surging smaller tigers, China, and India in recent years immediately
yields several common threads – higher rates of savings and investment, export-led growth
strategies, large pools of surplus labour, sound and relatively stable macroeconomic policies and
benign external environments, and continuous improvements in productivity.
1.2.1 Investment! It has always been investment
One of the most prominent features in Asia, from a real economic perspective, is that the
rate of investment has always hovered at higher levels and thereby drives the economic
development in different Asian economies. Critics of Asian economic miracles –the most notable
being Paul Krugman and Alwyn Young – often argue that Asian economic development was
nothing more than large amounts of measured inputs, especially the input of physical capital.
Thanks to high savings and the Asian culture of sacrificing current for future satisfaction, Asian
economies such as Japan, Singapore, South Korea, and China are able to mobilize resources
(physical, human, and financial resources) and put them into economic development. This feature
underpins the economic development of most Asian economies.
In some sense, Krugman and Young are right – Asian economic stories have always been
investment stories. As shown in Figure 1.3, the average savings rates in China, Japan, India, and
the Asian export economies including Hong Kong, Indonesia, Korea, Malaysia, Philippines,
Singapore, Taiwan, and Thailand for the period from 1970 to 2004 were respectively 35.4, 32.1,
21.2 and 29.9 per cent. Although the savings rate in India has been lower than other Asian
economies, it is still significantly higher than the levels in the United States and most European
countries. More importantly, Figure 1.3 shows that it is roughly going through an upward trend
over time.
High savings fuel higher investment. It is worth pointing out that focusing too much on a
higher level of investment might be misleading in the sense that it downplays the important
contribution of technological advancement in Asia. Productivity level increases along with
economic growth – Japan was the first of this trend, and it has been repeatedly observed in other
parts of Asia too.
Still, the Asian economic story is largely an investment story. Fixed asset investment,
especially capital expenditures on infrastructure and construction, has been driving economic
growth. Figure 1.4 shows the fixed asset investment as a share of GDP in Asia for the period
from 1980 to 2006. A first read of the figure leads to the conclusion that Asian economies invest
a lot! Take Japan as the example. Although its fixed asset investment as a share of GDP has been
steadily declining over the examined time period, it remains within the range of 24-34 per cent.
The Asian export economies, including Hong Kong, Indonesia, Philippines, South Korea,
Singapore, Taiwan, and Thailand, have fixed asset investment as high as 20-35 per cent of their
respective GDPs.
Likewise, China has maintained a spectacular investment record throughout the past quarter
century. Even though the Chinese economy is still volatile and continuously goes through boombust cycles, fixed asset investment has been fixed at higher levels and has been driving the
economy forward: in the past five years, investment as a share of GDP even exceeded 40 per
cent. India started with relatively lower levels of fixed asset investment in the early 1980s, but its
investment has since started to pick up, especially after India liberalized the economy in early
18
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
1990s. In the past two or three years, the fixed asset investment in India has exceeded most of the
Asia export economies and is approaching the level of 35 per cent.
Figure 1.3 Gross National Savings as a Share of GDP Figure in Asia
China (35.4%)
India (21.2%)
45
Japan (32.1%)
Others (29.9%)
40
35
30
25
20
15
10
5
0
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
* Others include Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand.
Source : World Bank Development Data; authors’ calculations.
Looking only at investment data clearly is not enough. Another consideration is
consumption and the role of the Asian consumer. Some observers claim that Asia is expecting a
pending consumer “take-off” because of the economic development and changes in Asian
people’s life styles (especially the increase in their propensities to consume). Domestic
consumption thus is believed to be replacing fixed asset investment and exports to become the
major driver of Asia’s economy (for research disputing this view, see Anderson 2006).
This view challenges the traditional viewpoint about Asian economic development that
exports and fixed asset investment are the major drivers of economic growth in Asia. If it is true,
it will have many implications on our understanding of the Asian economies. However, as shown
in Figure 1.5, it is not happening. We do not see an obvious upward trend in Asian people’s
consumption. For Japan and Asian export economies (“others” in Figure 1.5), consumption as a
share of GDP has been quite stable during 1980-2006. Domestic demand does has not yet taken
off. For China and India, the two fast-growing economies now labeled new engines of the world
economy, the share of consumption in GDP actually declines steadily. Such a pattern is more
pronounced for India – in the past quarter century, the share of consumption decreased from 80
per cent to below 60 per cent. Although the Indian economy has many distinct features, it has one
thing in common with other Asian economies – saving more, and investing more.
19
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Figure 1.4 Investment/GDP in Asia: 1980 – 2006
China
50%
Asian Financial Crisis
India
Japan
45%
Others*
40%
35%
30%
25%
20%
15%
10%
5%
0%
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2000
2002
2006
* Others include Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand.
Source : CEIC; authors’ estimations.
Figure 1.5 Consumption/GDP in Asia: 1980 – 2006
China
85%
India
80%
Japan
Others*
75%
70%
65%
60%
55%
50%
45%
40%
35%
30%
25%
20%
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
* Others include Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand.
Source : CEIC; authors’ estimations.
20
2004
2006
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Box 1.1 GDP Accounting
In a given open economy, the total output in a given time period (normally a year or a
quarter) can be measured by gross domestic product (GDP). GDP consists of four components:
GDP = C +I +G + X- IM,
(1.1)
where C is consumption (some call it private consumption), I stands for investment (nonresidential and residential included), G is the government spending (some call it government
consumption), X stands for export, and IM is import. X-IM is also called net exports or the trade
balance. That is, if exports exceed imports, we say that the country has a trade surplus. If exports
are smaller than imports, then a country is said to run a trade deficit.
One quick takeaway from Equation (1.1) is that GDP growth could be driven by any of the
aforementioned four components – consumption, investment, export, or government spending,
although in real economy the four components are always work together to drive the GDP
growth.
Implications. First, Asian economic development is still investment-driven. Revisiting
Figure 1.4 demonstrates this point well from a different angle – the sharp drop in fixed asset
investment after the Asian financial crisis (more than 5 percentage points for Asia export
economies) led to the so-called Asian malaise, which affected Asia for almost ten years since
1997. Second, since investment plays such an important a role in Asian economic development,
key things to watch out about the Asian economies include: 5 (1) Can fixed asset investment
maintain at such high a level? (2) How efficient is the investment? (3) From where do the funds
for investment come?
1.2.2 Export-led growth
Trade has always been one of the most important aspects of Asia’s economies. All of the
11 economies we mentioned earlier are members of the World Trade Organization (WTO) (see
Tables 1-11). Most Asian countries have been, and are still, very export-oriented. Figure 1.6
shows the ratio of exports to GDP – a common measure of an economy’s external exposure – for
the Asian economies over 1980-2006.
We start with the relative smaller economics (“others” in Figure 1.6). We see a clear and
upward trend in the ratio of exports to GDP. Despite a slight decline in export/GDP after the
Asian financial crisis, these export-led economies have gradually recovered and the level of
export/GDP has gone back and even exceeded its pre-crisis level. Figure 1.7A shows that except
for a few years, exports in those export-led economies have grown more than 10 per cent on a
year to year basis.
In early stages of Japan’s economic development, its economy had largely relied on
exports. Now, the Japanese economy has become large enough to rely on domestic spending to
drive its growth. However, given its size, a more than 15 per cent of export/GDP ratio still
suggests that the external exposures of the Japanese economy are large and its economy is very
5
We will elaborate on the three things in Chapter 1.3.
21
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
sensitive to the changes in the global markets. Japan’s exports recovered in recent years too – the
year to year export growth rate has been increased to 13.7 per cent in 2006 (Figure 1.7B).
Figure 1.6 Export/GDP in Asia: 1980 – 2006
70%
China
65%
India
60%
Japan
Others*
55%
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
* Others include Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand.
Source : CEIC; authors’ estimations.
Both China and India are large, fast-growing, domestic-led and insulated from the global
cycle. In terms of the ratio of export to GDP, the levels in China and India are not comparable to
those in export-led Asian economies such as Hong Kong, Singapore and Taiwan. But we do
observe an upward trend in export/GDP for both nations (Figure 1.6). In early 1980s, the Chinese
economy was relatively closed from the outside world. Exports however started to take off since
mid-1980s, thanks to the reform and open door policies adopted by the Chinese government and a
large amount of foreign capital swarmed into the export-oriented sectors. As shown in Figure
1.7C, since 1987, China has managed to maintain a year to year export growth rate close to 20 per
cent except for 1989 (political instability), 1993 (credit tightening), 1998, 1999 (aftermath of the
Asian financial crisis), and 2001 (burst of IT and telecommunication bubbles). In 2006, according
to the estimates of the CEIC database, the total exports in China amounted to US$ 1,062 billion,
which accounted for 38 per cent of China’s GDP. While it is naive to argue that exports are the
sole driver of China’s economic development, its important role is undeniable.
After following the stagnant decade of the 1980s, India’s exports gradually picked up and
really took off in recent years. In 2006, exports had accounted for 23 per cent of India’s GDP,
indicating that India is becoming an important participant of global trade. The trend demonstrated
in India seems to suggest that India is emulating its Asian neighbours (at least partially) in the
selection of economic development strategy. As shown in Figure 1.7D, the year to year growth
rates of exports in India even dwarf those in China since 1990.
[Insert Figure 1.7 ABCD here]
It is not the end of the story. More and more Asian states have adopted export-oriented
economic policies. The continued rise of low-end economies actually implies more export-led
22
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
growth to come – Vietnam has been lined up for next round of explosion of exports and economic
growth, likely followed by Cambodia, Lao, Bangladesh, etc.
Implications. First, the reliance on exports leaves the Asian economies vulnerable. Asia was,
still is and will be in the foreseeable future, sensitive to economic changes in the United States
and the European Union, especially for smaller Asian economies. This might not apply to China
and India as their economies are still largely insulated from the US and EU and they both have
sizeable domestic markets. But their reliance on exports and linkage to the global markets is
creasing over time. As a result, they will be less and less immune to changes in the global markets
too. Second, Japan remains the largest economy in Asia, as well as the largest buyer in this
region, suggesting (1) Japan’s economic recovery is important for Asia’s economies; and (2)
promoting intra-regional trade is important for the stable development – although China and India
remain the fastest growing economies in the world, they are still relatively domestic-demandoriented and cannot drive Asia.6 Third, the export-led growth leads to a quick accumulation of
foreign exchange reserves, which brings external pressures from the US and EU and greatly
limits the spectrum of monetary and exchange rate policy instruments the Asian governments can
use to fine tune their economies. In one word, Asian economies and financial markets are not
sufficiently mature enough to generate their dynamics inside. They are still exposed to volatilities
in the global markets and are not able to provide a counterbalance to US or EU on a global scale.
1.2.3 Sound fiscal, monetary and exchange rate policies
A stable macroeconomic and policy environment is imperative for the implementation of
the investment-driven and export-oriented growth strategies. In most of the post-war era, Asian
governments have been prudent in designing and implementing their fiscal, monetary, and
exchange rate policies.
For developing economies, which include most of the Asian economies, governments are
heavily involved in economic activities – besides running state-owned enterprises by themselves,
governments also spend on education, infrastructure, pensions system, and so on. In the
developing economies, tax revenues and the amount of capital the government can mobilize
through financial system are normally limited. Governments thus are constantly attempted to run
high levels of budget deficits. To meet the fiscal deficits, the governments have strong incentives
to force their central banks to print more money or to borrow foreign debts. We have observed
this type of governmental behaviour repeatedly in Latin American economies and African
economies. However, it has been relatively rare in Asia due to various reasons to which we will
come below.
Asian governments in general have been quite restrained in their spending, especially
compared to governments in most other developing economies. Figure 1.8 shows the budget
balance as a share of GDP for the Asian economies vis-à-vis the United States. Due to a decent
fiscal network and high levels of savings rate mobilized through more developed banking system,
budget deficits in Asia are even below those of the United States.
Inflation in Asia has also been quite low. Figure 1.9 presents the inflation for the Asian
economies vis-à-vis United States since 1980. The inflation rate in Asia has been kept at one-digit
6
Economists believe that the trade data for China are misleading. For example, over half of mainland
Chinese imports are for processing and re-export to third countries. Once the processing trade is taken away
and re-assigned to their eventual financial destination market, China is not buying that much from their
smaller neighbors (Anderson 2006).
23
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
level for most of 1980-2006. The average inflation rate for Asia export economies (“others” in
Figure 1.9), measured based on the consumer product index (CPI), is about 8 per cent for the
same time period. Although it is 3-5 percentage points higher than that of the developed
economies such as the US and EU, it is significantly lower than the inflation rate seen in Latin
American countries. Even Asia’s high inflation relative to the United States can be justified by
economics theory. In fast-growing economies, productivity improves faster in labour-intensive
manufacturing sectors and export sectors, which however also pushes up prices for agriculture,
services, and other industries as wages and incomes rise. Therefore, the average inflation in a
fast-growing economy should be high enough to avoid outright deflation in the areas where
productivity is rising most rapidly. This is called the “Balassa-Samuelson effect”, which points to
relative productivity growth differentials as a driver of inflation.
Figure 1.8 Budge Balance As a Share of GDP: Asia vs. US
China
India
Japan
Budget Balance/GDP (percent)
4
Others*
United States
2
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
-2
-4
-6
-8
-10
* Others include Hong Kong, Indonesia, South Korea, Malaysia, Philippines, Taiwan, and Tailand. We do not include Singapore as its
budge balances were consistently positive for majority of our sample period, which makes it an obvously outlier.
Source : CEIC; authors’ calculations.
Taking into account the fast-growing and export-led nature of the Asian economies,
Asia’s inflation has been within a reasonable range and it is even comparable to that of the
developed economies. This provides Asia with a relatively stable macroeconomic and policy
environment to pursue its economic goals.
As most Asian economies adopt the “export-oriented” strategy, managing exchange rate
is an integral part of Asian economies’ portfolios of macroeconomic policy instruments. In most
of the post-war era, Asian governments have been reasonably successful with their exchange rate
management. We discuss this point by beginning with the Asia growth model. In order to growth,
Asia needs to expand rapidly into labour-intensive manufacturing exports. Exports contribute
significantly to Asia’s economic growth (this even applies to China and India now). The
developed countries such as the United States and the EU are naturally the destination of the
exported goods from Asia. To facilitate the exports, the Asian governments have incentives to
peg their exchange rates to the US dollar at an undervalued level. Thus, they can keep the wages
low at home and maximize the competitiveness of their products in the global markets. At times,
Asian countries used this strategy. It results in current account surplus (deficit of current account
24
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
for the US). However, as long as the governments control private capital flows, the net export
proceeds go directly into the central bank’s official foreign exchange reserves.
Figure 1.9 Inflation Based on CPI: Asia vs. US
Numbers in brackets are average inflation from 1980 to 2006
30
China (5.96%)
India (8.03%)
Japan (1.29%)
25
Others* (5.66%)
United States (3.89%)
20
15
10
5
0
1980
1982
1984
1986
1988
1990
1992
-5
1994
1996
1998
2000
2002
2004
2006
Year
* Others include Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand.
Source : IMF; authors’ estimations.
This type of “imbalance” in exports and imports works pretty well in Asia. As long as
Asian economies can export more and the developed economies are willing to import their goods
and services, the imbalance does not matter much. However, as we will discuss in Section 1.3,
this strategy does lead to some fundamental problems and from time to time, Asian countries are
facing huge amount of pressure from the developed countries to re-valuate their currencies: the
case of Japan in the 1980s and China in recent years, with the US and EU today pressuring China
for a sharp and fast appreciation of China’s currency, the yuan.
1.2.4 Abundant supply of low-cost labour
Asia’s demographic structure – more than 60 per cent of world population and relatively
smaller fraction of population aged over 65 years old (Tables 1.1-1.11) – provides Asia with a
huge supply of low-cost workers to become home of the world’s manufacturing workshop
supplying everything from textiles to toys to computers. Although having 60 per cent of the world
population, Asia only accounts for slightly over 20 per cent of global output. If we exclude Japan
from the statistics for Asia, the share of global GDP contributed by Asia immediately drops to
less than 15 per cent, which indicates that most Asian countries are low income or middle-income
nations. The abundance of low-cost workers allows Asian countries to support economic growth
by focusing on manufacturing exports.
A research report issued by the consulting firm McKinsey & Company compares the
hourly compensation for manufacturing workers in selected countries (Farrell, Puron and Remes
2005). In 2003, the average hourly compensation for manufacturing workers in United States,
Canada and Mexico was respectively US$ 21.3, 18 and 2.1, while in China, Philippines, and India
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
the number was US$ 0.7, 0.7 and 0.4 respectively. That is, even Mexico’s labour cost is three
times that of China. In Asia, besides China and India, there are many countries with labour costs
even lower or at least comparable to that of China’s, including Indonesia (227 million),
Bangladesh (133 million), and Vietnam (81 million).7 From the point of view of demographic
structure, and taking Asia as a whole, the Asian model of development seems sustainable. Of
course, no place can remain the world’s low-cost producer for ever – while we are seeing the
“Made in China” stamp on almost everything now, we might be seeing the “Made in Vietnam” or
“Made in Indonesia” stamps everywhere ten years from today.
The education level of the Asian population is also improving over time, which allows
some economies to gradually transform their industrial focus from low-cost manufacturing to
services or high-end manufacturing sectors. For example, in 2003 China had roughly 9.6 million
young professional graduates with up to seven years’ work experience and an additional 97
million people that would qualify for support-staff positions. China has about 1.6 million young
engineers. About one third of university students in China study engineering, compared with 20
per cent in Germany. The talent pool is large. Since the heterogeneity in the economies and
income disparity among people are both large in Asia, the trend described as a series of economic
events has been repeatedly observed in the region – an economy started out in the simple, labourintensive parts of an industry but over time hone its skills and capabilities to compete in more
profitable areas such as services sectors and high-end components of the value chain for a given
sector – marketing, product design, research and development (R&D), and distribution.
1.2.5 Improvement in productivity?
We have not discussed this factor until now as it is likely the most controversial factor
about Asia’s economies. The conventional wisdom on the Asian economies, especially the East
Asian newly industrialized countries (NICs), says that the productivity growth in these
economies, especially in their manufacturing sectors, has been extraordinarily high. This seems to
be consistent with experiences of Japan, the NICs and China. In his study of labour productivity
in different countries, Lewis (2003) reports that Japan definitely has two faces – while some
sectors in the Japanese economy has labour productivity significantly lower than that of the
United States (e.g., retail, housing construction, food processing), sectors such as steel,
automotive parts, metalworking, cars, and consumer electronics have higher labour productivity
levels. It is interesting to note that the sectors in which Japan boasts higher labour productivities
are also the sectors Japan has a competitive edge over the US, which indicates strongly that
improvement in productivity matters a lot for economic development, and some Asian economies
(at a minimum, Japan) has partially achieved that goal. South Korea, Hong Kong, Singapore, and
Taiwan, China, India, and some other Asian economies have also made a stride in improving their
levels of labour productivity, which significantly contributes to the growth in those economies.
What accounts for the improvement in productivity? Many factors have been identified in
empirical studies or suggested in theoretical research. It is a long list including benign
fiscal/macroeconomic environment, reasonable input factor prices, appropriate income level and
distribution, well-enforced labour rules and unionism, availability of skilled workers, welldesigned incentive mechanism, culture, product market competition and regulations, barriers to
trade, capital intensity of the industry, operation efficiency, and etc. (see Lewis 2003). Among the
numerous factors named above, educational attainment is particularly important. Young (1995)
provides the educational attainment of the working population for the four East Asian tigers from
1966 to 1991 (Table 1.12). Obviously, from 1966 to 1991, during which the four economies had
7
Numbers in brackets are the population.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
achieved astoundingly high economic growth, the education attainment of their working
population improved significantly as well. In South Korea for example, the percentage of
working population without any education dropped from 31 to 6.4 per cent, while about 75 per
cent of the working population has finished secondary education or even more. The human
capital accumulation directly explains a fraction of labour productivity improvement.
Table 1.12 Educational attainment of the working population (%)
Hong Kong
1966
1991
None
19.2
5.6
Primary
53.6
Secondary +
27.2
Singapore
1966
South Korea
Taiwan
1991
1966
1991
1966
1991
55.1
nil.
31.1
6.4
17.0
4.5
22.9
28.2
33.7
42.4
18.5
57.2
28.0
71.4
15.8
66.3
26.5
75.0
25.8
67.6
Note: Self-taught included under primary. All percentages are calculated net of those reported as
unknown.
Source: Young (1995)
The critics of Asian economic miracles believe that improvement in productivity is a
misperception. The research by Young (1995) provided detailed analyses to identify a striking
finding he believed that had been buried in statistics about Asia – while the growth of output and
manufacturing exports in the four East Asian tigers (Hong Kong, Singapore, South Korea, and
Singapore) is virtually unprecedented, the growth of total factor productivity (a common measure
of productivity) in these economies is not. Specifically, over the period from 1966 to 1991,
productivity growth in the aggregate non-agricultural economy of the four NICs ranges from a
low of 0.2 per cent in Singapore to a high of 2.3 per cent in Hong Kong, which is not impressive
at all since France, the United Kingdom and Italy had achieved similar productivity growth
during the same time period. In a recent academic article, Young (2003) applies similar analysis
to China and claims that the Chinese model of development is no different from that of the NICs.
When it comes to productivity – especially productivity measured by total factor productivity –
the performance of Asia’s economies is not that spectacular.
The debate is still on-going. Recent works, for example Hotz (2005), point out that
results in Young (1995, 2003) are based on databases that need cleaning up. After correcting the
data problems, many conclusions will no longer be valid. The debate will always go on as long as
Asia’s economies continue to grow and attract attention from economists, practitioners and
policymakers. The bottom line is that when it comes to the sustainability of Asian economic
development, productivity matters a lot and it is likely one of the most fundamental drivers going
forward.
1.3 The potential holes in the Asian model of development
The Asian model of development, as we characterize in Section 1.2, has helped one after
another Asian economies to unleash rapid growth. But the model does not come without costs.
The success and sustainability of this model largely hinges on the following assumptions:
•
There exists an effective financial intermediation, which continuously channels the scarce
capital to the most wanted and most profitable sectors in an economy.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
•
The reliance on foreign markets, especially the US and EU markets, can be taken as a
pre-condition for economic development without worrying about the collapse of foreign
markets, protectionism, and weak domestic consumption.
•
The trend of higher levels of savings rate will continue in Asia; meanwhile, Asia will
continue to provide a large number of low-income workers.
•
The costs and welfare loss associated with the accumulation of international reserves can
be managed at a sustainable level. The particular approach to macroeconomic and
structural policies that have been adopted by the Asian governments can deliver high
growth along with a reasonable degree of macroeconomic stability.
•
The regional competition, especially the competition for cheaper factor inputs (e.g.,
labour), will not generate imbalances and become a source of instability.
•
…
That list obviously can go on and on.
The key point is that not all of the above assumptions can hold in reality for all countries in
all time. The weak or missing links in a certain Asian economy could easily trigger unfavourable
economic dynamics, which, in the context of globalization, could spread to other Asian
economies and have serious adverse repercussions on growth and welfare.
1.3.1
Costly financial intermediation
As mentioned earlier, the Asian economies can largely be characterized by higher levels
of fixed asset investment. Asia’s economy would grow even faster and in a much healthier way if
the financial system in Asia can improve its efficiency and channel savings into more productive
areas. Although Asia’s economies have grown at a very high rate, most economies’ financial
systems are still under-developed. Using the ratio of the market capitalization of bonds and
equities plus the market value of private credits extended by deposit taking and other financial
intermediaries to GDP as a measure of the level of financial development, as shown in Figure
1.10, most Asian economies are less financially developed.
On the face of it, Asia’s financial systems are better at allocating capital than are their
counterparts in many other emerging markets economies. It has some high-performing private
and foreign banks, and its stock of nonperforming loans, has been declining since the Asian
financial crisis. It has relatively well-run equity markets. However, the most productive part of
the economy is not the main recipient of funding from the financial system, causing significant
social welfare loss and eventually endangering the stability of the economies. We use China and
India, the two fastest-growing economies in Asia, as the examples.
China
China’s striking economic growth in the past quarter century has been largely driven by
fixed asset investments. Three distinct features characterize the fixed asset investments during
China’s reform period. First, due to a high gross domestic savings rate and success in attracting
FDI, the rate of China's fixed asset investments has hovered at a high level, which from time to
time raises the concern that China might have invested too much and the economy is overheating. Second, more than 50 percent of fixed asset investment concentrates in the state or quasistate sectors (Table 1.13), where productivity and investment efficiency are believed to be
considerably low. Third, because the capital markets in China, including both the equity markets
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
and corporate bond markets, are poorly developed, bank lending has been the main funding
source of China's investment boom. The excessive amount of capital allocated to the state sector
causes widespread inefficiency among SOEs, reduces overall productivity of the economy and
results in a large amount of non-performing loans. Prior literature has identified several sources
of inefficiency in corporate investment, and attributes them to insufficient institutions and a low
level of financial development. The foremost one is a state-dominated financial system that
systematically allocates capital away from more productive sectors/regions towards less effective
sectors/regions (see, e.g., Brandt and Li, 2003; Cull and Xu, 2003; Liu and Siu 2007, and
Boyreau-Debray and Wei, 2005). Legally and financially, inefficient SOEs are favoured at the
expense of more efficient non-state sectors (Huang, 2003).
Figure 1.10 Financial Deepening vs. GDP Per Capita*, 2004
600%
Financially
developed
500%
United States
Switzerland
400%
Financial deepening
South Africa
Malaysia
Denmark
Netherland
300%
200%
Korea
Less financially
developed
Chile
China
100%
India
Thailand
Spain
France
Japan
Ireland
Germany
Norway
Italy
Brazil
Philippines
Indonesia
Columbia
0%
1,000
Belgium
Singapore
UK
Australia
Sweden
Russia
Poland
Mexico Argentina
10,000
100,000
Log GDP per capita (at PPP), 2004
* Degree of financial deepening is defined as the ratio of the sum of equity, bond and private credits (all in market values) to the PPP-based GDP.
** Hong Kong is an outlier with the degree of financial deepening at 694%, and GDP per capita measured at $34,200.
Source : International Monetary Fund; CIA World Fact book; authors’ estimations.
Despite numerous anecdotes and sound economic intuitions, it remains empirically
difficult to map out the dynamic relations between corporate investment behaviour and
institutions and financial development. Liu and Siu (2007) propose an innovative approach to
quantify the investment efficiency across different sectors in China. They estimate structural
investment models that characterize the Chinese firms’ investment behaviour to derive the
effective discount rate perceived by firm managers in deciding investment spending. The
“implied” cost of capital is similar to the managerial hurdle rate, and is potentially a function of
variables measuring institutions and financial development. They thus infer the return on invested
capital (ROIC) from firms’ actual capital expenditures. They document robust evidence that
ownership is the primary institutional factor affecting the firm-level return on invested capital in
China, and that return on invested capital for a non-state firm is approximately 10 percentage
points higher than that of an otherwise similar state firm.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Table 1.13 Fixed asset investment by corporate ownership 2000-2005 in China
Fixed Asset Investment
2000
2001
2002
2003
2004
2005
SOE
1650.4
50.14%
1760.7
47.31%
1887.7
43.40%
2166.1
38.98%
2502.8
35.51%
2966.7
33.42%
Collective
489.6
14.87%
537.3
14.44%
612.6
14.08%
819.8
14.75%
1018.3
14.45%
1219.9
13.74%
Mixed
406.2
12.34%
566.4
15.22%
832.9
19.15%
1273.4
22.92%
1769.8
25.11%
2353.6
26.51%
Private
470.9
14.31%
542.9
14.59%
651.9
14.99%
772.0
13.89%
988.1
14.02%
1389.1
15.65%
HK/TW
129.3
3.93%
158.3
4.25%
176.5
4.06%
237.5
4.27%
311.4
4.42%
376.7
4.24%
Foreign
131.3
3.99%
141.5
3.80%
168.5
3.87%
253.4
4.56%
385.4
5.47%
465.7
5.25%
19.8
0.46%
4349.9
100%
34.6
0.62%
5556.7
100%
72.1
1.02%
7047.7
100%
105.7
1.19%
8877.4
100%
Others
13.9
14.2
0.42%
0.38%
Total
3291.8
3721.3
100%
100%
Source: China Statistical Yearbook
Unit: RMB billion
The least productive part of the economy (the state sector) obtains the most financing and
makes most investment. This causes widespread inefficiency in the financial system and the
economy. Figure 1.11 illustrates the deadweight loss in the bank lending market for SOEs. By
the end of 2005, the total value of financial assets in the Chinese banking sector is RMB 34.14
trillion, 35 percent of which have been allocated to the SOEs, while SOEs only contribute to 25
percent of industrial output in China (sources: PBOC; and Farrell et al. 2006). Since the interest
rates have been regulated throughout China's reform era, let assume that the interest rate applied
to SOEs is set to be at r, which is lower than market rate, r*. Instead of accepting the market rate,
the state sector can borrow money at r, which has been intentionally designated to them at a lower
level. Their excess demand for bank lending by the state sector thus is given by K*-K. The
deadweight loss is given by area A in Figure 1.11, which can be computed as: deadweight loss=
1/2(K*-K) (r*-r).
Using the above approach, Liu and Siu (2007) compute the size of deadweight loss. They
find that the deadweight loss in the banking market for SOEs due to the mis-allocation of capital
to be RMB 186.4 billion in 2005. The total deadweight loss in the financial system amounts to 4
percent of China’s GDP in 2005, which might have been greatly underestimated since it does not
account for the financial distortion in the service sectors and opportunity costs.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Figure 1.11 The Welfare Loss Due to Distorted Lending Decision in China’s State Sector
Price, r
r*
A
Deadweight
Loss
r
K
K*
Quantity, K
India
The situation in India is similar to that in China. The private corporate sector, as the most
productive part of the economy, is not receiving financial support from India’s financial system
due to various institutional deficiencies. Most of the funding goes to the government and to
investments it designates as priorities. Private corporations receive just 43 percent of the
country’s total commercial credit and that level has not increased since 1999 (Farrell and Lund,
2005). The rest goes to SOEs, agriculture, and the tiny businesses in the unorganized sector. This
pattern of capital allocation impedes growth because SOEs in India, as China’s, are, on average,
only half as productive as private ones and require twice as much investment to achieve the same
additional output. Productivity in the agricultural and unorganized sectors is only one-tenth as
high as it is in India’s modern private sector, and their investment efficiency is commensurately
low.
The Indian government’s tight control of the financial system explains its poor allocation
of capital. Regulations oblige banks and other intermediaries to direct a high proportion of their
funding to the government and its priority investments. Banks must hold 25 percent of their assets
in government bonds. Government policies require banks to direct 36 percent of their loans to
agriculture, household businesses, and other priority sectors, Directed loans have relatively high
default rates and are costly to administer because of their small size. Besides diverting credit from
the more productive private sector, these policies reduce the overall level of lending, since the
unprofitable directed loans of banks must expand in proportion to their discretionary loans. Banks
therefore lend just 60 percent of their deposits, compared with 83 percent for Thai, 90 percent for
South Korean, and 130 percent for Chinese banks (also shown in Figure 1.9). Similar policies
require 90 percent of the assets of provident funds (essentially pension funds) and 50 percent of
all life insurance assets to be held in government bonds and related securities. As a result, these
policies have allowed India’s government and SOEs to absorb 70 percent of the savings that
Indian households and foreign investors have channeled into the financial system since 2000
(Farrell and Lund, 2005).
The government’s tight control of the financial system lowers its efficiency and raises the
cost of financial intermediation. India now has one of the highest levels of state ownership of
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
banks in any major economies. The prevalence of state-owned banks means that they experience
little competitive pressure to improve the way they operate, which leads to lower profitability,
less sophisticated business models, and potentials for higher levels of NPLs. Based on
McKinsey’s estimates, an integrated program to reform the financial system could substantially
raise India’s growth rate. If the system improved its allocation of capital, captured more savings,
and reduced its operating inefficiencies, India’s real GDP could expand by 9.4 percent a year
(Farrell and Lund, 2005).
1.3.2 Adverse changes in the demographics/savings dynamics
Asia’s development model, as mentioned earlier, is largely based on two important pillars
– high savings rate and availability of a large number of low-income young workers. Although
Japan and the four East Asian tigers have successfully transformed their economies and are
gradually migrating to high profit-margin products and services, a large part of Asia still relies on
labour-intensive export manufacturing sectors. Even for economies like China and India, which
are less export-dependent, labour-intensive manufacturing or services sectors are still their pillar
industries.
Figure 1.12 The Aging Asia
% of population above 60
US$ billion
2000
2005
2050
30.2
22.6
20.5
20.0
13.0
11.2
7.2
East Asia
Southeast Asia
18.0
11.5
11.0
7.1
7.0
South Central
Asia
West Asia
Source : United Nations.
Throughout Asia, the demand for labour comes from every front – from the large foreignowned companies and joint ventures to domestic firms of all sizes. However, demographics might
not be in Asia’s favour anymore – Asian’s population is aging and gets grayer. The problem is
pressing now in Japan as the percentage of population aged above 65 has exceeded 20 percent. In
other parts of Asia, aging is also becoming an issue, even though it might not be as urgent as that
in Japan. The United Nations estimated the aging situation in Asia (Figure 1.12). As to 2005, the
percentage of population over 60 in East Asia has reached 20.5 percent. 8 The percentage is a bit
lower in Southeast Asia (13 percent), South Central Asia (11.5 percent), and West Asia (11
percent). However, the estimates show that by 2050 the percentage of population over 60 years in
8
The official retirement age in most Asian economies is 60 years old.
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
East Asia, Southeast Asia, South Central Asia, and West Asia will be respectively 30.2, 22.6, 20,
and 18 percent. The implication is obvious – Asia will be short of workers if it continues to focus
on labour-intensive sectors.
Aging will also bring lots of other social problems, which are beyond the scope of this
book. But one consequence that is particularly relevant in Asia is that an aging society might
undermine another pillar of Asian model of development – high savings rate.
Due to improvements in health care and living conditions, average life expectancy has
increased dramatically around the world. As the elderly come to make up a larger share of the
population, as we are seeing in most of the developed countries and will see in majority of Asian
economies in the future, the total amount of savings available for investment and wealth
accumulation will dwindle – for an average person, the prime earning years are roughly from age
30 to 50; thereafter savings rate falls. In Asia, the issue becomes more complicated as the younger
generation do not save as much as their parents and grandparents did – due to a tendency to rely
more on inheritance; the good fortune to avoid the economic hardships that prompted earlier
generations to be more frugal; and the availability of consumer credit and mortgages. As a
consequence, the household financial wealth will decline as the population gets older. Once the
financial wealth declines or fails to growth as fast as they used to be, the high-investment driven
Asian economies will be seriously challenged especially given that financial intermediation in
Asia has always been inefficient.
However, how to fill the coming gap between investment and availability of financial
wealth remains an uneasy task. Potentially a few approaches are available to solve the problem:
(1) increasing birth rate; (2) increasing immigration, which may solve the problem in a small
economy but not the problem in a larger economy like Japan or China; (3) increasing the
retirement age by 5 to 10 year, which may delay the outburst of the aging problem but cannot
solve it; and (4) increasing savings by current young generation.
All these approaches only have limit impact. The best approach, as suggested in Farrell,
Ghai, and Shavers (2005), is to boost the appreciation of financial assets, in other words, to
improve the average rate of financial asset return. To make this approach work requires an
economy’s financial system to be sophisticated enough – providing a wide range of financial
products; greater skills in managing risks involved; mobilizing resources and handling all types
of mismatches (e.g., quantity, maturity, risk profiles) through better financial innovations.
Does Asia have an answer?
1.3.3 Unfavourable changes in macroeconomic and policy environment
Asian governments have been adopting a set of fiscal, monetary and exchange rate
policies that promote exports and investment. As discussed in Chapter 1.2, these policies have
been quite successful in terms of providing a stable and favourable environment to develop
economies. However, the good times have led to a build-up of imbalances as well. The build-up
of those imbalances may eventually make certain major adjustments – note that we are quite
careful and do not use the term “crisis” here – inevitable.
Trade imbalance
The exports-led strategy promotes trade imbalance, which increases Asian countries’
reliance on the US economy or the European economies. As old saying goes, “When the US
sneezes, Asian catches a cold!” As the Asian economies become more complex and integrated
with the world trade and financial system, they become more exposed to shocks, which may
33
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
come from many sources – a collapse of external demand, U.S. trade sanctions, competition for
cheap input factors, regional political tensions over sensitive political issues (e.g., Iran, North
Korea, Taiwan, etc.). Internally, over-reliance on trade could lead to some internal imbalances as
well. Since the financial system in most Asian economies in still in poor shape and has distorted
domestic demand, the patterns of investment financing could lead to the surge of nonperforming
loans (NPLs) by fuelling a build-up of excess capacity in some industries especially the exports
industries.
Another potential problem associated with the strategy of promoting the exports sectors
and piling up trade surplus is that it may repress other sectors in the economy. In many Asian
economies, even including China, export sectors are largely driven by foreign direct investment,
which are attracted by preferential policies such as tax breaks, free land use rights, easy and cheap
access to financing, and so on. Those policies however do not necessarily apply to domestic
firms. It is believed that over-reliance on exports sectors represses the domestic firms and nonexports sectors (see Huang 2003 for study on China). It may constrain the development of
financial system as well. The financial system in the export-led economies can make easy and
safe profits by over-allocating financing to the exports sectors, which limits the access to capital
by other sectors in the economies. In addition, the financial intermediaries in those economies
lack incentives to develop a wide range of financial products/services to enlarge their reach.
Quick accumulation of foreign exchange reserves
Figure 1.13 Accumulation of Foreign Reserves in Asia
Unit: US$ billion
China
1200
India
Japan
Others*
1000
800
600
400
200
0
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
* Others include Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand (Indonesia, Malaysia and
Philippines start in 2000 as previous years’ data are missing).
Source : CEIC; authors’ calculations.
One prominent change in the Asian economies in recent years is that Asia has seen an
unprecedented flood of foreign exchange liquidity rushing into domestic economies through
official foreign exchange reserve accumulation, thanks to recovering exports on the part of Asia
and relatively weak domestic demand. As shown in Figure 1.13, foreign exchange reserves in
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Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
China, Japan, and other parts of Asia started to take off since the beginning of this decade. China
over-took Japan sometime in 2005 to become the country with the largest foreign exchange
reserves in the world. The total amount of foreign exchange reserves, by the end of 2005, had
reached US$ 1 trillion in China. For the same period, Japan and other Asian economies (Taiwan,
Singapore, Hong Kong, South Korea, Thailand, Indonesia and Philippines) continue to
accumulate large amounts of foreign exchange reserves. Notably, India, which used to be
economically inward, is piling up its foreign exchange reserves as well. The cumulative official
holdings of foreign exchange reached US$ 3 trillion in Asia as of December 2006, two thirds of
which were accumulated since 2000.
One direct consequence of the rush of foreign exchange inflows is that the government
has to interfere in the foreign exchange markets – central banks have to buy them from
commercial banks. When the central banks do so, they create an offsetting amount of domestic
liquidity, which is credited to commercial banks’ reserve accounts, as a result of the transaction.
For example, for every US dollar the People’ s Bank of China (PBOC, China’s central bank)
purchases from commercial banks such as the Bank of China, PBOC places about RMB 7.7 Yuan
to Bank of China’s reserve account with PBOC. Bank of China then will have additional based
money (RMB 7.8 Yuan) to lend, which eventually lead to more money supply in the economy.
That is, when central banks buy dollars they also automatically print money at home.
Thus, when Asian central banks have bought up unprecedented amounts of foreign
exchange, they have also been creating domestic liquidity in equally unprecedented amounts –
reserve accumulation has been a very large part of existing money stock in Asia. For countries
that run a fixed exchange rate system, they essentially give up control of domestic monetary
policy (e.g., the case of Hong Kong). And if the currency is undervalued such as China’s currency
Renminbi, high liquidity inflows may lead to low real interest rates, strong credit growth, higher
inflation and finally asset bubbles.
To deal with the above problems, the governments have to aggressively sterilize (see Box
1.2), just like what Taiwan, Malaysia, Singapore, Korea, China and India are doing now.
However, there are costs associated with central banks’ sterilization. When central banks issue
short-term debt instruments to the commercial banks, they generally have to pay a market rate of
interest to attract the funds. In fact, the only method that does not involve a market cost for the
central banks is hiking reserve requirements to tighten credits. Of course, central banks can also
making money by sterilizing because they can invest their large amounts of foreign exchange
reserves in the global financial markets. As a matter a fact, almost every single central bank in
Asia is earning a positive return on total foreign exchange operations – either because the costs of
sterilization are low, or else because banks do not engage in sterilization in those cases (e.g.,
Indonesia and Philippines) where interest rates are high.
Box 1.2 Sterilization
Sterilization means the monetary authorities attempt to sterilize the capital inflows through
offsetting borrowing operations to reduce liquidity. For example, central banks can sell
government bonds, issue their own bonds, lock up the money in time deposit, or simply freeze
liquidity through administrative measures such as reserve requirements. The purpose of
sterilization is to sterilize the effect of foreign exchange purchases on domestic base money by
effectively borrowing back the funds.
The implications of quick accumulation of foreign exchange reserves and central banks’
sterilizations on the Asian economies are not always favorable. First, Asian economies lose
corporate, national, even regional autonomy due to over-reliance on exports and large amounts of
35
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
foreign exchange reserves. For countries practicing pegged exchange rate or quasi-pegged
exchange rate systems, it implies the outright loss of the independence of monetary policies or
greater limitation in the spectrum of monetary policy instruments the government can adopt.
Second, the accumulation of foreign exchange reserves also indicates welfare loss. Due to
inefficient financial intermediation, especially lack of alternative investment venues, majority of
foreign exchange reserves in Asia flows outside the region again – they are re-directed to the US
financial markets or European financial markets – and are not servicing the Asian economies.
Third, the accumulation of foreign exchange reserves may also lead to excessive liquidity
in domestic economies when sterilizations fail or when the costs of sterilizing outweigh the
benefits. As mentioned earlier, excess domestic liquidity may lead to lower real interest rates,
strong credit growth, higher inflation and finally asset bubbles. Although the inflationary
pressures have not been felt in Asia now mainly because for most Asian economies the domestic
demands are still weak and have not fully recovered from the Asian financial crisis, the long term
risks are high. Without effective financial intermediation, lower real interest rates and strong
credit growth cause over-heating economies, especially over-investment in certain sectors in an
economy. Without effective financial intermediation, there is a lack of alternative investments.
Excessive liquidity will swarm into available assets such as real estate and equities, leading to
asset bubbles, for example, the real estate bubbles in Japan and Hong Kong back in 1990s and
arguably the on-going stock market bubble in mainland China.
To sum up, the macroeconomic environment and policies that have supported the growth
of Asia so far are also constraining the flexibility and potency of macroeconomic tools Asian
government can choose to deal with negative shocks that hit the economies.
1.4 Asian Financial Crisis
The cause and ensuing contagion of the 1997-1998 Asian financial crisis has been a
subject of much debate. Most explanations have focused on macroeconomic factors including
underlying vulnerabilities in financial sector and inconsistent macroeconomic policies. In our
view, the root causes of the crisis were at the micro-level – Asian companies’ excess leverage and
low profitability. Weak policies and loose corporate governance practice related to inadequate
bank supervision and implicit guarantees, led to poor credit decisions, and consequent
misallocation of resources. 9 The crisis thus epitomized how the holes in the Asian model of
development, when encountering a series of exogenous shocks, failed to generate virtuous
dynamics between the real economic sector and the financial sector. We discuss the build up of
Asian financial crisis and the lessons leaned. We focus on Thailand because the origin of the Thai
crisis and the ways it unfolded were surprisingly similar to those of ensuing crises in other parts
of Asia including Korea, Malaysia, and Indonesia. Unless otherwise specified, the structure
factors we discuss about the Thai crisis can be directly applied to other Asian economies that
were contagious in 1997-1998.
1.4.1 Overview of the financial crisis in Thailand
The events in 1997 did not happen in a vacuum. They were the culmination of years of
lax monetary policies, loose corporate governance, and sluggish corporate sector performance.
The Thai crisis began to unfold in 1997 when currency speculators launched a concerted attack
on its currency, the Baht. It was triggered when the Thai central bank’s reserves proved
9
Economist Paul Krugman has used the term “crony capitalism” to describe this type of practice.
36
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
inadequate to protect the Baht, forcing Thailand to give up the fixed exchange rate system and to
float its currency. The ability of the banking sector to service debts, especially debts denominated
in foreign currencies, declined as foreign reserves fell.
It however started with problems in real sectors. After the runaway investment in the real
estate in earlier 1990s, the asset-bubble bust in late 1996. The bust of the asset bubble greatly
weakened the health of the financial intermediaries as a large fraction of lending were directed to
the property and related sectors. For example, Finance One, Thailand’s leading finance company
was under serious threat of default. In February 1997, Thailand’s prominent property company,
Samprasong Land, missed payments due on its foreign debt, kicking offer another round of
dramatic fall in the property sector. In the next six months, the Bank of Thailand (BOT,
Thailand’s central bank) lent money to distressed financial intermediaries through its Financial
Institutions Development Fund (FIDF). The BOT had committed almost all of its liquid foreign
exchange reserves to forward contracts. The concerns continued to mount. The speculators thus
correctly guessed that the combination of slow export growth (which implied slow accumulation
of foreign reserves) and financial distress would ultimately require a devaluation of the Baht.
In May 1997, international speculators launched the second attack on the Baht. In June
1997, the Thai Government reneged on promise to buy $3.9 billion pf bad debt from Finance
One, announcing that creditors (including foreign creditors) would incur losses, contrary to
previous announcements and market expectations. The shock accelerated the withdrawal of
foreign funds and prompted the currency depreciation of nearly 50 percent by late 1997. In turn,
the Thai Baht devaluation triggered capital outflows from the rest of East Asia. In June 1997,
domestic real interest rate in Thailand further increased. The Thai government started to impose
currency control. Foreign investors’ concerns over Thai financial intermediaries’ ability to serve
foreign debts continued to grow. By July, Baht was allowed to float…
The effect of the crisis on the Thai economy was devastating. Interest rates, which had
been approximately 5 percent, rose to nearly 10 percent in 1998. This was done in order to
stabilize the currency and to control inflation, but the result was a plummeting of the economy as
GDP contracted 8 percent in 1998 according to IMF’ estimate. The un-employment rate increased
by about 5 percent from 1997 to 1999. The economic decline led to a severe erosion of the asset
quality of banks. The ratio of NPLs jumped to somewhere between 50 –75 percent of banking
assets. The nationalized banks, in particular, appeared to suffer from a high level of “strategic
NPLs” – borrowers who stopped payments after the government signaled that it would intervene
to bail out the banks. These strategic NPLs were made possible by Thailand’s hitherto ineffective
bankruptcy laws. 56 finance companies were closed and foreign banks took a controlling share of
several domestic banks. The average return on equity (ROEs) for the Thai banks in 1997 was
negative 160 percent. The Thai baht lost as much as 55 percent of its value by early 1998, and
foreign funding stopped flowing into Thailand.
1.4.2 How did the financial crisis build up?
One particularly aspect of the Thai financial crisis was on its over-reliance on foreign
bank funding to maintain the integrity of its financial system. The conventional wisdom holds
that portfolio investment, held by foreign “speculators,” is particularly volatile, and that these
speculators tend to pull their money out at the first sign of trouble. Bank funding, it is often
assumed, is more stable. However, the Thai financial crisis showed that it was not the case. The
financial crisis in Thailand was driven in large part by the foreign bank funding. Deregulation
and liberalization of the financial markets and intermediaries generated a credit boom. Foreign
capital flowed into Thailand to grasp booming opportunities in the Thai economy. A large part of
foreign funds flowed to riskier sectors, in particular the real estate market. Over time, the banking
37
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
system and the entire integrity of the financial system became reliant on the maintenance of real
estate prices.
The large inflow of foreign funding, primarily from Japanese banks, meant that more and
more funds were chasing fewer and fewer good investments, which fanned the flames of
corporate value destruction. Additionally, the government policy of pegging the exchange rate
contributed to an overvaluation of the baht. It also led to a currency mismatch. All of these
factors led to situation in which the entire Thai financial system was ripe for a major crisis.
To understand how financial crisis unfolded in Thailand. We study the build-up of the
crisis by beginning with the dynamics of funds taken and directed to real sectors by financial
intermediates in Thailand.10
I. Funds dynamics
The Thai government gradually deregulated and liberalized the financial sector in 1990s
– first, the interest rate ceilings were lifted, followed by the lifting of exchange control; the
government then allowed the establishment of offshore banking facilities. Financial deregulation
and liberalization fueled a credit boom from 1990 to 1997, with bank liquidity increasing through
offshore borrowing. It also led to the emergence of other largely unregulated non-bank
intermediaries such as finance companies, which were allowed considerable latitude to borrow
from abroad. Finance companies and banks took advantage of extremely low-interest yendenominated loans, borrowing heavily from overseas financial intermediaries (especially, from
Japan). As a result, the net foreign liabilities of financial intermediaries rose from 6 percent of
domestic deposit liabilities in 1990 to 33 percent by 1996, and net foreign liabilities ballooned
from $22 billion in 1993 to $78 billion in 1996 (source: Bank of Thailand).
The large inflow of foreign funds drove the credit boom in 1990s. The Bangkok
International Banking Facility (BIBF) was a major reason for the inflow of foreign funds. Its
design and its special incentives actively encouraged the increase in external debt of the financial
intermediaries which in turn shifted the money into the real economy. The overabundance of
funds flowing into the country from foreign sources meant that money ultimately was going to
fuel more and more speculative investment, particularly in real estate sector. By the end of 1996,
the banking system’s exposure to the property sector and related equities stood at 41 percent of
total loans, compared with 23 percent for manufacturing. As a result, the health of the banking
system became increasingly dependent on the maintenance of property prices, a critical factor in
the emergence of the banking crisis.
There was a lack of prudent regulations in Thailand as well. Financial policies are
designed by entrenched groups in the business sectors, with direct credit granted to politically
favored firms and industries and questionable lending allowed within conglomerates. Banks were
owned by politically well-connected individuals, who used them to finance the operations of
affiliated companies. This “crony capitalism” led to poor credit decisions in the banking system
and to the misallocation of resources from potentially high return investments to those with
significant risk and relatively low returns.
These weaknesses in the financial system were exacerbated by structural weaknesses
which were reflected in the following aspects:
10
•
Poorly regulated and unsupervised banks protected from international competition
•
Lack of prudential regulation and supervision of financial intermediaries
For a more detailed recount of the financial crisis in Thailand, see Barton, Newell, and Wilson (2003).
38
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
•
Loose disclosure requirements
•
Lack of transparency of public and private financial intermediaries; inadequacy of
bankruptcy law and procedures
•
Bank capital requirements were low or not met in practice
•
Immature capital markets
As a result, the lack of relative balance in the development of the financial markets led to
a dependence on the banking sector – Thailand’s financial system was overwhelmingly driven by
banks and by bank-funded or controlled finance companies. Outstanding bank loans to non-banks
accounted for 89 percent of Thailand’s private sector liabilities in 1997. In comparison, equity
market capitalization accounted for only 15 percent of GDP in 1997. Clearly – Thailand followed
a “high-debt” growth model before 1997.
II. The dynamics in corporate sectors
There is a strong link between the financial system and the underlying economy. The
capital inflows financed increases in investment activities over 1990-1997. Meanwhile, the
pegged currency contributed to the overvaluation of the Baht and thus led to a growing current
account deficit. The large capital inflows challenged the economy’s ability to productively deploy
them and resulted in the buildup of excess capacity. The investment spending spree contributed to
erosion of profit margins and poor financial performance as reflected by declining return on
invested capital (ROIC). Thus, credit quality in the private sector eroded, manifested by a fall in
interest coverage from 4.6 times in 1992 to 1.9 times in 1996. As shown in Table 1.14, from 1992
to 1996, debt as a percent of equity increased from 71 percent to a high 155 percent. And
Thailand was not alone. Similar growth was also evident in Korea, Malaysia, and Indonesia.
Leverage ratios for Asian Firms were significantly higher than firms in developed economies.
Such a high leverage ratio left the corporate sector vulnerable to shocks.
Figure 1.14 Corporate Investment Efficiency: the 1992 –1996 average
Return on Capital
Employed (RCOE)
Hong Kong
20
Indonesia
U.S.
3
16
8
Thailand
Japan
-2
9
7
Singapore
-9
9
11
Philippines
Germany
12
20
8
Malaysia
Economic Value Added*
8
11
Korea
France
Lending interest rate
-9
6
2
7
16
5
-8
8
4
-3
12
5
4
11
-8
1
7
4
* Economic value added (EVA) is defined as (ROCE – Cost of Capital) multiplied by invested capital. In this figure, we only report
the gap between ROCE and lending interest rate.
Source : World Bank; World Development Indicators, 1998; authors’ calculations.
39
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
Lower levels of return on invested capital led to value destruction in most sectors in the
economies. Poor corporate governance and the fact that much of the economy was dominated by
family-owned conglomerates allowed this value destruction to continue (see Chang (2003) for the
cases in South Korea). These conglomerates lacked independent directors and often channeled
investment funds into related companies, taking advantage of institutional deficiencies. They also
leveraged government and corporate relationships to protect their portfolios to enter new business
sectors, to overcome regulatory barriers, and access the advantage credit line. Often, these
conglomerates owned their own banks or at least held shares in banks, which allowed them easy
access to credit.
As a consequence, economic value added (EVA) – a concept defined as the gap between
return on invested capital and cost of capital multiplied by total invested capital – was negative
for many Asian firms, especially Thai firms. Negative EVA – the fact that the return on
investment is smaller than the average cost of raising capital – suggests that firms should have
forgone the investment because it destroys value. However, institutional deficiencies such as lack
of financial discipline and poor corporate governance encouraged firms’ spending spree. The
various Asian economies, especially Thailand, thus witnessed lower levels of investment
efficiency. Figure 1.14 presents the average return on capital employed (ROCE), lending
interesting rate, and their difference for 11 economies in the world during 1992 – 1996, among
which seven are in Asia and four of them (Indonesia, Korea, Malaysia, and Thailand) were badly
hit during the crisis. The average gap between return on capital and cost of capital, as shown in
the last column of Figure 1.14, was -8 percent for Thailand, -9 percent for Indonesia, -2 percent
for Korea, and 3 percent for Malaysia. The widespread of investment inefficiency eventually will
comprise the integrity of financial intermediaries – as more and more corporates would have
difficulty repaying the debts, and non-performing assets therefore pile up among the financial
intermediaries.
Table 1.14 The corporate leverage ratio (%) *
Total debt/equity
Hong Kong
Indonesia
Korea
Malaysia
Philippines
Singapore
Taiwan
Thailand
Latin America
France
Germany
Japan
U.S.
12/31/92
26
59
123
31
81
37
71
71
31
141
61
136
106
12/31/93
23
54
129
29
78
34
73
81
35
133
67
139
102
12/31/94
33
58
127
38
50
33
71
103
34
117
61
139
97
12/31/95
36
81
132
45
49
45
67
135
33
112
59
135
94
12/31/96
39
92
n.a.
62
69
58
65
155
31
111
58
138
90
* We do not include China and India as they were relatively insulated during the 1997 Asian
crisis.
Source: Pomerleano (1998); World Bank.
The government’s policy of pegging the exchange rate reduced the perceived
currency risk, leading to an overvaluation of the Baht and encouraging cheaper foreign
40
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
borrowing. When cheap capital meets lousy investment decisions, it is not hard to guess what will
happen – the underlying economy in Thailand experienced sharp declines in real output. GDP
growth fell from 8.9 percent in 1994 to -0.4 percent in 1997.
III. Mis-conducted macroeconomic policies
The pegged currency adopted by the Thai government before 1997 was also questionable
because it led to over-valued baht. The overvaluation of Baht reduced Thai companies’
competitiveness in the global markets, resulted in current account deficits (exports were smaller
than imports) and accumulation of foreign debts in the form of short-term foreign currency. The
economic growth in Thailand had been largely financed by a rise in the current-account deficit
(then the inflows of foreign capital). When the economy was doing well and the firms could make
profits, they would not have problem repaying the debts (remember that Thai firms were heavily
levered before the crisis, the average debt/equity ratio was 155 percent in 1996). However, by
1996, there was a significant drop in economic activity – import growth slowed from 3 percent in
1995 to just 2 percent in 1996; and even worse, exports actually declined in 1996. As a result, the
percent of short-term debts to foreign reserves moved up to 99.7 percent in 1996. In the event of a
liquidity crisis, with banks no longer willing to roll over short-term loans, foreign reserves would
be insufficient to cover short-term liabilities.
IV. Foreign funding dynamic
The foreign funding dynamic played a central part in the buildup of imbalances in the
Thai economy. Besides leading to current-account deficits by providing access to credit to fund
imports, it also supported exchange rate overvaluation. Access to foreign liabilities, backed by
domestic assets, also created a currency mismatch. Finally, the credit boom – driven as it was by
large amounts of foreign money without adequate underwriting guidelines – encouraged
overinvestment both by banks and private corporations in marginal projects. These investments
fueled the destruction of corporate value, eventually causing bank loans to default and
undermining the banking system itself.
V. Asset price bubble
Speculative investment in real estate and equity created an asset bubble by 1992, which
led to the collapse of the domestic financial system in 1997. Speculative overinvestment in land
and real estate was evident in their relationship to stock market prices, which rose more rapidly in
the property sector than in the other sectors over 1990-96. When the stock market collapsed in
1997, the percentage drop was much larger in the property sector than in the overall market.
Between 1990 and 1993, the Thai stock market rose by 175 percent, compared with 395 percent
for the property sector, but then lost 51 percent of its value between 1993 and the end of 1996,
compared with 73 percent for the property sector.
Because of the above five structural factors, by 1997, Thailand was fully ready for a
major crisis to break out. The attack on the Thai currency by international speculators just
ensured that it did happen.
1.4.3 Lessons learned
The financial crisis in 1997, originating in Thailand and spreading to South Korea and
other parts of Asia, yielded many takeaways as follows:
41
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
•
Regulating non-bank finance companies. As the Thai government discovered, non-bank
finance company problems can infect the banking sector as well. A potential rule of
financial regulation should be that all institutions that take deposits and make loans,
regardless of what they are called, should be regulated as banks. The challenge for
regulatory authorities will be to ensure that financial intermediation, wherever it occurs,
is well regulated, but not overregulated. With an improved regulatory environment,
governments can realistically expect that financial intermediation will be more likely to
absorb, rather than magnify, shocks.
•
Reducing the incentives for excessive borrowing. One of the root causes of the Thai crisis
and the crisis in other parts of Asia was that credit boom led to poorly managed
investment, which in turn caused the pile up of non-performing assets. How to remove
the incentives to over-borrow and over-investment remains a challenge as it involves
deeper institutional development.
•
Improving governance in the financial corporate sectors. Reducing the governmentdirected credits, increasing capital adequacy ratios, and strengthening regulation of
financial intermediation as well as improving bankruptcy laws, accounting and auditing,
and disclosure requirements can play important roles in ensuring that capital will be well
invested.
•
Improving corporate governance in corporate sectors. Banks need to develop an arms’length relationship with corporations. Stricter enforcement of limits on lending to
connected firms and insiders, the violation of which has contributed to the recent
financial crisis and poor intermediation. In those cases where banks and firms are
effectively controlled by the same shareholders, increased transparency is required, which
could take the form of more disclosure or requirement of a formal ownership relationship,
such as through a holding company; the financial intermediaries and agents involved in
disciplining firms should be encouraged to enhance their roles.
•
Developing capital markets. Developed corporate bond markets herald more balanced
financial systems that rely less on bank financing, diversify risk, and improve corporate
monitoring.
•
Strengthening regulations. In crisis, the distinction between private and public debt easily
blurs. Private external bank debt tends to become socialized to prevent collapse of the
banking systems and thus constitutes a huge and implicit public contingent liability.
Governments should monitor short-term debt and establish tight prudential regulations
limiting exposure of financial institutions to prevent excessive buildup of short-term
liabilities. Better disclosure of information would reduce one source of speculation
affecting investors’ outlook.
•
Improving bankruptcy laws and mechanisms for restructuring. Without credible laws and
procedures, banks and corporate owners may delay recognizing their losses to prevent
losing control of assets to creditors or new investors, causing the financial and
operational restructuring to drag on for years. As the crisis has become systemic, the
scale of the problems has shown the need to establish a rapid and voluntary mechanism
for creditors and potentially viable companies to restructure as an alternative to court
ordered bankruptcy and liquidation of assets.
First Draft: June 24, 2007
42
Finance in Asia: Institutions, Market, and Regulation (Qiao Liu, Douglas Arner, and Paul Lejot)
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