(Reprinted from HKCER Letters, Vol. 49, March 1998)
The Asian Economic Outlook:
An Assessment in World Models
Lawrence R. Klein
Some Background Facts
Those of us who try to forecast the World economy at very regular intervals (several times each year) had a rude shock in 1997, as far as the Asia prognosis is concerned. The typical forecast featured the following points:
Developing economy growth is stronger than industrial economy growth. Among developing economies, Asia (particularly East Asia) still stands out as the strongest, for broadly defined regions. Inflation is being brought under control in most areas. Unemployment is receding, but Europe continues to be an exception. World trade activity remains strong but not as high as in 1994 and 1995. Many of the transition economies are recovering, but Russia and some states of the former Soviet Union are lagging behind. Latin America has overcome the shock of the Mexican crisis of December 1994. In Asia, Japan remains stagnant, but China and India are both expanding nicely.By year-end 1997 we find two major forecast presentations, covering the point enumerated above, made in both cases in spring and in autumn, so seriously off base in numerical terms that significant revisions had to be released as early as December, largely on account of the Asian crisis. Not only were they revised in December, but the forecasters (IMF-World Economic Outlook and UN Projections and Perspective Studies Branch - Project LINK) regarded the December revisions as tentative and in need of additional revision as soon as they were released. The only motivation behind these special forecasts of December was to try to take account of the Asian financial crises, both for their Asian effects and for their global effects. As soon as the Mexican crisis occurred, there was a considerable body of analysis that questioned whether such a crisis could appear in Asia. One of the more perceptive analyses was by Lawrence Lau of Stanford, who presented the accompanying table at a Project LINK meeting in Pretoria.
There were special reasons to believe that the Philippines were an exceptional case. The next most vulnerable country was Thailand, and the conclusion was drawn that a Mexican-type failure probably would not occur, but if it did happen, Thailand would be the victim.
During 1996, it became apparent that the East Asian expansion was shifting toward a slower rate of growth, but only by one or two percentage points and without bankruptcy or currency depreciation. It looked, on paper, more like a sustainable down shifting.When a crisis erupted in Thailand, there was much attention paid to analogies with Mexico, but in many respects, it was similar to the Japanese stagnation that followed the bursting of the bubble in land, construction, and equity markets. It is worth pointing out, however, that Thailand was not the initial crack in the Asian facade. The Thai crisis became known in early 1997 and erupted on a large public scale when the baht was floated last July. In 1996, however, in Korea there was already a great deal of economic pessimism and poor industrial performance stemming from poor judgment about production of semiconductors as well as significant bankruptcies in large enterprises. In this period, the Thai baht was being held to its then steady exchange value, but the Korean won was gradually depreciating. One other characteristic of the Asian crisis, after the floating of the baht in July, was its contagious spread to other Asian economies. In Latin America, there was very limited spread associated with the depreciation of the peso and the collapse of prices on the Bolsa. Argentina felt the Mexican crisis and went into a year's recession, but the effects on other stock markets were very short lived.
Mexico had a short but sharp recession in 1995 and started to recover in 1996. It was a one-year recession; whereas the reaction to the LDC debt crisis of 1982-83 lasted as a recession in Mexico for two years. Japan, after the bubble, has had sluggish economic performance for almost a decade, interrupted by some feeble attempts at recovery. Argentina felt side effects for one year and then recovered, with a very steady currency, controlled by a currency board. What can we expect in Asia? Will the pattern be like those in Mexico, Argentina, or Japan? Of course, Asia is highly varied, and it is more likely that recovery will have many special individualistic features. Except for Thailand, the changes in projected growth rates are small. The IMF-December forecast marks Thailand's growth down to 0.6% in 1997 and zero in 1998. The LINK projection in December estimated 1.2% and zero for the same two years but also presented a figure of 3.3% for 1999, indicating a slow recovery after two years of recession. The Korean rates fall from 6.1% in 1997 to 3.3% and 4.8% in 1998 and 1999. Although the Korean drop is not to zero or negative growth, the bare figures give no idea about the effects of teetering near the edge of bankruptcy or default, with severe effects on households and firms. All in all, the area is expected to experience about 3 percentage points fewer in growth during 1998-99, and this is worse than a slight decline of 1 or 2 percentage points that had been expected during the early part of 1997. Malaysia and Indonesia are estimated to expand by less than 3 or 4% in 1998, but the UN-LINK estimates are both above 4% in 1999, suggesting the possibility of some recovery getting underway in 1998 or earlier. The IMF places Chinese growth at 8.8% in 1997 and 7.5% in 1998, while LINK has an even higher value, at 9%, for 1999. This gives the appearance of a minor adjustment for China, but some concern has been expressed during the past few weeks about the extent to which China can insulate itself against overall Asian economic setbacks. The Philippines are interesting because they are "late bloomers" in Asia, that is to say, the Philippines were left out of the earlier good performance in Asean countries, and in Asia as a whole, but after Ramos took over, there has been a decided turn for the better, and the Philippines appear to be giving up only a small amount so far in this present crisis period. Hong Kong is a typical case of very modest adjustment difficulties, losing just 1 percentage point. India had envied many of the countries in East Asia, especially those in Southeast Asia and did reach levels higher than 7 percent expansion in recent years. They appeared to be settling down to long run expansion at a high equilibrium rate of about 7%, but 1997 turned out to be disappointing, not so much on account of Southeast Asian troubles but because of domestic political instability. The growth rate in 1997 is estimated to be only 5.8% by the IMF and under 7% in the LINK-UN forecast. It is becoming doubtful now, given the slowdown in Asian neighbors and the lack of unified political leadership, that the aspiration for long run growth at 7% can be attained in the near term. While there is no doubt that high growth rates of the past decade or more are not likely to be maintained, in Asia, there are other economic considerations for the recovery. These include the outlook for exchange rates, inflation, capital inflows, and income distribution. There are, broadly speaking, two exchange rate patterns in Asia:
Asian Forecasts, 1998 and 1999
(1) Economies with strong currencies backed by good reserves and a fairly narrow range of foreign exchange fluctuation. These are China, Japan, Hong Kong. Their exchange rates have had only intermittent fluctuation or movement in a very narrow band. Australia has undergone a depreciation against the US dollar by about 15 percent, but it can hold the rate steady under pressure. Japan had a highly over valued yen at 80-/$ in 1995 and depreciated by a wide margin to 130-/$, but both cases involved a degree of overshooting, and the yen is likely to come back towards a trading range of 110-120-/$. Both Hong Kong and China have stated their resolve to hold dollar rates where they are.
(2) The other pattern is one of severe depreciation or devaluation by switching from an unsustainable rate to international floating (or near floating) in the face of financial crises, in terms of debt service and large adverse balances. Thailand, South Korea, the Philippines, Malaysia, Indonesia, Vietnam, are in this grouping. It is probably the case that these currencies have overshot their present temporary equilibria, and their exchange rates (per dollar) already show signs of retreating. They must get their economies into the situation of maintaining better macroeconomic balance, and then decide on a strategy of exchange rate determination-pegged to one or more major currencies, pegged to a basket, fixed by a currency board, or eventually managed by a regional economic system. Regardless of the ultimate choice, these countries will be moving soon to some degree of appreciation as they restructure their economies and work their way out of imbalance.Singapore, Taiwan, India, and Pakistan experienced depreciation during the last few months, but the deterioration was by less than 30 percent, and the extent of overshooting was not serious.
When the Asian economies went into crisis situations requiring re-structuring they were not showing accelerating inflation or other unusual macroeconomic characteristics, except in rising current account deficits. They generally had modest inflation, well under 10 percent. It was only in 1990 and 1991, in the Philippines struggle for political democracy, that inflation began to appear.Also, China experienced double-digit inflation in the over-heating period, 1993-95, but brought price rises under control in early 1996, and have held to that position. In 1997, with strong exchange depreciation and high capital costs some moderate inflationary pressures have appeared. This can be seen in Indonesia and Thailand. Interest rate have also gone up in Indonesia, Thailand, Hong Kong and the Philippines. Generally speaking, credit is being restrained throughout Asia, while the crises are being monitored by each individual economy. Among the various early warning signals now being investigated for clues to be used in monitoring future onset of crisis situations are the current accounts of individual countries. These were pointed out, in directional terms (increasing deficits) by Professor Lau in his 1995 LINK presentation. In Thailand and Korea large amounts were projected in the spring of 1997. They were already large in 1996 (-$14.7 bn for Thailand and -$23.1 bn for Korea). By the end of 1997 they were already brought down to much more manageable values and are now projected to be quite small in 1998. Throughout East Asia, efforts and policies have been directed towards import restraint and export promotion to such an extent that unfavorable current balances are rapidly diminishing. Japan is even increasing their large surplus, and Taiwan is holding their surplus steady, in the neighborhood of $4 bn. China is expected to maintain a surplus of $20 to $30 bn. And the monthly trade reports of South Korea already show three monthly net export surpluses for October, November, and December, 1997. In this respect, the Asian economies are following Mexico's path, where there has been a strong turnaround from a deficit of $30 bn in 1994 to less than $2 bn in 1995 and 1996. In Mexico's case, the turnabout seems to have been made in these two years after the crisis, and a relaxed feeling prevails while the current account gets a bit larger in 1997 and 1998, which is what a vigorous emerging market needs for growth. A vigorously growing economy needs foreign capital inflows to cover current account deficits. It is possible for some individual economies to work hard, save much, and provide financial capital for their own development. The usual pattern, however, is to find prudent current account deficits, covered by foreign capital inflow. Prudence means having enough reserves for several months' basic imports, having long term financial capital that does not move about with very short notice, and having capital for productivity-enhancing capital formation. There are many aspects of capital flows in the 1970s, 1980s, and 1990s that were not prudent or healthy. Now, the most needy cases in East Asia (Indonesia, South Korea, and Thailand) are getting official capital in order to avoid default, and trying to get obligations and current balances into manageable sums. Mexico has done this and is now able to attract capital inflows again. They formerly felt neglected when so much of the world's pool of financial capital was going to Asia. Now, they can show Asian economies how to recover and became attractive again as emerging markets for international investors.
Professor Lawrence R. Klein, Nobel Laureate in economic Science, 1980 is now Benjamin Franklin Professor, emeritus, at the University of Pennsylvania. Professor Klein is a well-known econometrician and has constructed several statistical models of the United States and various other countries. He was a principal investigator of Project LINK which combined models from countries throughout the world for studying international trade, payments, and global economic activity. The above is the script of his luncheon talk jointly held by the Better Hong Kong Foundation and the APEC Study Centre, the University of Hong Kong on 23 February, 1998.
Is There a Next Mexico in East Asia?
Lawrence J. Lau, and Jung-Soo Park, Department of Economics, Stanford University, Stanford, CA 14305-6072, USA
1. Falling Real Exchange Rate 6. High Real Rate of Interest 2. Low or Lowered Rate of Growth of Real DGP 7. Low Domestic Saving Rate 3. High Relative Rate of Inflation 8. Large Negative Trade Balance 4. High Interest Rate Differential 9. Large Negative Current Account Balance 5. Rising Interest Rate Differential 10. High Ratio of Foreign Portfolio to Foreign Direct Investment
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Mexico X X X X X X X X X X China X Hong Kong Indonesia X X X X South Korea X X X X X Malaysia X X X X Philippines X X X X X X X X Singapore X X Taiwan Thailand X X X X X X
Table 1 Revisions to World Economic Outlook Projections
for Selected Asian Countries
(Annual percent change unless otherwise noted)
Real GDP Growth Current Account (in $ billions) Projection year and WEO date Projection year and WEO date 1997 1998 1997 1998 May Oct. Dec. May Oct. Dec. May Oct. Dec. May Oct. Dec.
Thailand 6.8 2.5 0.6 7.0 3.5 0.0 -14.8 -9.0 -6.4 -14.9 -5.3 -2.5 Indonesia 8.0 7.0 5.0 7.5 6.2 2.0 -9.9 -8.8 -6.3 -11.1 -8.8 -4.1 Malaysia 8.0 7.5 7.0 7.9 6.5 2.5 -5.4 -6.4 -5.9 -6.8 -5.4 -1.5 Philippines 6.3 5.3 4.3 6.4 5.0 3.8 -4.1 -3.8 -3.9 -4.1 -3.4 -3.6 Hong Kong SAR 5.0 5.3 5.3 5.0 5.0 4.1 2.0 -1.8 -2.6 3.7 0.3 -0.3 Japan 2.2 1.1 1.0 2.9 2.1 1.1 77.7 98.9 94.9 90.0 98.1 98.9 Korea 5.6 6.0 6.00 6.3 6.0 2.5 -20.0 -16.9 -13.8 -17.2 -13.0 -2.3
Source: IMF World Economic Outlook, December, 1997.