Asian Economic Crisis
by Richard McMullen
International Risk Management Interview
Valore International Finance responds to questions covering the economic crisis in Asia from Jonathan Saul of the International Risk Management Magazine.
• Following the Asian crisis I would like to ask you whether there are any ways foreign investors/risk managers are able to predict instances of political instability?
• Political instability can be defined in many ways, and is often the result of economic crisis rather than its cause. Any direct link between political and economic instability is tenuous however, especially with the current problems being experienced in Asia.
The economic crisis in Asia defies a generalised explanation about its underlying causes. The crisis has affected both politically stable and unstable countries alike, while leaving others relatively unscathed.
That so many countries and territories were affected within a relatively short time period indicates a cascading crisis in confidence with respect to the region as a whole. The crisis came as a complete surprise to most every seasoned risk manager, just as it did for the region's political and economic leadership.
Each of the countries affected should be viewed according to their specific situation in order to draw any reasonable conclusions.
For risk managers to anticipate political and economic instability, they must have an honest and ongoing dialogue with colleagues stationed within the territory under consideration. This ensures that local criteria are applied to local issues, while the economic interrelationships with other countries are kept in perspective.
• Are the hedging of currencies and the use of credit derivatives viable options to avoid losses in the event of currency crises?
• The insolvency of many large financial institutions in Asia has been attributed to the excessive use of cross-currency derivatives as portfolio investments.
Financial institutions have often portrayed derivatives as portfolio investments rather than hedging instruments. This practice resulted in the excessive use of derivative contracts by treasury and portfolio managers who were trading for their own account.
Currency hedging programs which use forward contracts, options, and swaps were originally intended to reduce the impact of wide swings in the spot market on ongoing business activity.
Hedging contracts are most effective when applied to specific currency exposure risks such as transactions involving imported or exported goods and materials, direct investment in plant and equipment, and cross-currency monetary transfers.
• I would also like to know whether you believe any of the South East Asian Governments will introduce policies preventing future currency speculation?
• Currency speculation is a convenient scapegoat for Asian governments which are contending with domestic unrest. Reliance on simple solutions to complex problems is a common response by most governments around the world.
Most Asian economies have relatively thin currency markets, meaning that the volume of transactions involving their currency is small in comparison to the total market.
Free trading in their currencies provides greater market liquidity and makes it easier to transact trade and investment with other countries. By restricting speculative trading, the governments in question could reduce their ability to conduct international trade.
By improving spot market liquidity, speculative currency trading can also reduce the risk associated with long term direct investment, and help to prevent capital flight. In a region which has attracted significant foreign direct investment, the prospect of this investment being withdrawn should outweigh concerns about currency market speculation.
• What are your feelings about the future of the whole area? Will Governments introduce the requisite measures and policies necessary to allay investors' fears?
• Great faith has been placed on the ability of governments in the region to implement policies imposed by the international institutions which are coming to their assistance.
While implementing these policies will return the affected countries to good standing amongst the world economy, it is less clear whether these policies will be able to mitigate the economic hardship being experienced within their domestic economies.
Most of the affected countries had, prior to the recent crisis, relied upon exports to generate such impressive economic growth. Looking forward, such reliance is less secure and it will be necessary to adopt a posture aimed at stimulating local demand and inward investment in order to ensure long term growth.
The respective Asian governments have within their mandate the ability to shift their reliance on international trade and investment, towards local development and regional economic integration.
• Also, what of Japan? Will the new leadership prevent further destabilisation?
• Japan, being the most significant source of direct investment in the region, is likely to adopt policies which protect its existing investment.
Additional direct investment by Japanese businesses in other Asian markets is unlikely in the medium term, until Japanese domestic production levels approach full capacity.
The Japanese government recognizes that its business interests justify assistance to distressed governments in the region, though it is unlikely to go beyond short-term measures until its own recession begins to turn around.
• Turning to Europe, what are the implications of European Monetary Union? Will it create stability or will it lead to a wave of speculation and affect businesses the way that Exchange Rate Mechanism did in the early 1990s?
• Fiscal discipline imposed on constituent members by the European Monetary Union is likely to have a long-term beneficial impact on the European economy as a whole, as its recovery gathers strength.
By overcoming entrenched conservatism and resistance to change, the EMU has encouraged a wider view of European economic prospects and has made it easier for members to coordinate their stabilization policies.
The strength of the Euro could easily be greater than the sum of its combined components, as European investment instruments become more transparent across national markets. Transparency within EMU overcomes the limitations of the Exchange Rate Mechanism, which attempted to maintain subsidiarity in monetary policy among the member currencies.
The Euro's stability should be enhanced by its increased attractiveness as a reserve currency, becoming a significant alternative to the Dollar, Yen, and Pound Sterling in the settlement of international accounts.
