by Walden Bello*

“Turmoil” has been the operative word used to describe the economic situation in Southeast Asia since the de facto devaluation of the Thai baht on July 2, 1997. By late October, when this report was finished, the Philippine peso had lost close to 30 per cent of its dollar value, the Thai baht about 47 per cent, the Malaysian ringgit 32 per cent, and the Indonesian rupiah 54 per cent. Even the mighty Singapore dollar was not unscathed in the currency shakedown.

Of Currencies and Conspiracies

Malaysian Prime Minister Mohammad Mahathir angrily attributed the debauching of the region’s currencies to speculators, singling out the controversial American currency trader George Soros, whom he described as a “moron.” At the World Bank-IMF annual meeting held in Hong Kong in the third week of September, Mahathir branded currency trading as immoral, demanded that it be criminalized, and advocated capital controls. Soros also took the podium at the same conference and called Mahathir a “menace” to his own country, asserting that Malaysia’s currency problems were of its own making. Probably the only clear signal that came out of this highly publicized debate was that everytime Mahathir opened his mouth and demanded curbs on capital, foreign capital would scamper out of Malaysia and Southeast Asia, forcing down the value of the ringgit and its sister currencies.

Informed observers refused to be drawn into the Mahathir-Soros debate on whether the currency crisis had been provoked by “internal” factors or “external” agents. The speculative activities of Soros vis a vis the Thai baht are well known, and there is evidence that his traders also targetted the Philippine peso. However, as an editorial in The Nation in Bangkok pointed out, Mahathir was on less than firm ground when he targetted outside speculators as the problem for three reasons. First, many of the speculators were Southeast Asian in nationality. Second, the Bank Negara, Malaysia’s central bank, had acquired a reputation of trying to profit from speculative activities, including betting on the pound sterling and the US dollar. Third, and most important, “[T]o blame Soros for the crises sweeping through the currency markets of Southeast Asia is not addressing the real issue.” And the real issue was that

When Southeast Asia jumped on the global bandwagon, it should have

prepared for the downs as well as the ups. Instead, many have allowed the

region’s spectacular economic growth to lull them into a false sense of

invincibility and security.

By pegging its currencies, Southeast Asian economies have ensured a

certain degree of stability to help lure foreign funds. But such easy money

is too often splurged on non-productive property markets and wasteful

mega-projects. To add to the woes, billions are squandered through

unmitigated corruption. Such excesses are now being ruthlessly punished

by the currency market.

Crisis of a Model

The reason that the current conjuncture in the regional economy is so momentous stems from the sense that the crisis ushers in the end of an era, that it marks the unravelling of a model of development that brought a certain kind of success but also carried within it the seeds of its own downfall. This model was one of high-speed growth fueled, not principally by domestic savings and investment, as in the case of Taiwan and Korea, the classical NICs or “newly industrializing countries,” but mainly by huge infusions of foreign capital. The mechanism to achieve this was to liberalize the capital account as fully as possible, achieving very considerable integration between the domestic financial market and global financial markets. The illusion that propelled the advocates of this model was that countries could, as one commentary put it, “leapfrog the normally long and arduous course to advanced country status simply by maximizing their access to foreign capital inflows.”

This model “worked” for a time because it promoted the interests of three very influential actors: foreign direct investors seeking low-wage production sites; portfolio investors seeking high yields on their investment with a quick turnaround time; and technocratic and economic elites in Southeast Asia that saw in high-speed growth or “fast- track capitalism a strategy that brought about the happy union of prosperity for them, development for all, and political stability. It was a formula that, in their view, finally gave them a way out of meeting the challenge that had haunted the region for much of the post-war era: that of taxing the wealthy to acquire investment capital and carrying out a significant measure of asset and income distribution both to create a viable market to sustain industrialization and ensure political stability.

The First Wave: Japanese Direct Investment

The Southeast Asian version of the East Asian “economic miracle” had its origins in the mid-eighties, and to more fully understand its dynamics, it would be useful to briefly revisit the region in the mid-eighties. At that time, the conjunction of high levels of foreign debt, record low prices of commodity exports, and the skyrocketing price of oil threatened to drag the Southeast Asian countries toward the same dire fate as that which was engulfing other highly indebted countries of the South.

All the key countries in the region were undergoing structural adjustment. Thailand and Indonesia were under World Bank and International Monetary Fund (IMF)-imposed programs, while Malaysia chose to manage its own austerity program. The Philippines, caught in the vice of recession and political turmoil, was practically under receivership and micromanaged by the IMF and the Bank.

By the late eighties, however, a surge of prosperity was sweeping the region and structural adjustment had stalled in Malaysia, Indonesia, and Thailand. In these countries, economic technocrats worked with the Bank and the Fund to bring about a greater export orientation and to substantially liberalize the capital account and financial sector, but they resisted the greater liberalization of trade, deregulation, and privatization of state enterprises demanded by the Bretton Woods insititutions.

What retrieved the region from recession and spun it into prosperity–and enabled a number of governments to limit structural adjustment–was a veritable deus ex machina: the massive inflow of Japanese direct investment. And the trigger of this momentous movement of capital was the Plaza Accord of 1985, which forced the Japanese government to allow the value of the yen to drastically appreciate relative to the dollar in order to relieve the US trade deficit with Japan by “cheapening” US exports to that country and making imports from Japan more expensive in dollar terms to American consumers.

With production costs in Japan rendered prohibitive by the yen revaluation, Japanese firms moved the more labor-intensive phases of their production processes to cheap-labor sites in East Asia. And within the region, Southeast Asia–with the notable exception of the Philippines, which was plagued with the political instability accompanying the post-Marcos transition–became the key recipient of Japanese direct investment.

What occurred was one of the largest and swiftest movements of capital to the developing world in recent history. Between 1985 and 1990, some $15 billion worth of Japanese direct investment flowed into Southeast Asia. In the case of Thailand, for instance, the Japanese investment that flowed into the country in 1987 exceeded the cumulative Japanese investment for the preceding 20 years.

By 1996, about $48 billion worth of Japanese direct investment was concentrated in the core ASEAN countries of Indonesia, Singapore, Malaysia, Thailand, and the Philippines. In FY 1995, the ASEAN countries received 10.6 per cent of Japan’s total foreign direct investment, in contrast to only 7 per cent in FY 1990. Moreover, Japanese investment had also triggered an ancillary flow of billions of dollars in foreign direct investment from the first generation newly industrializing economies of Taiwan, Hong Kong, and South Korea. Though the flows from some of these economies at times outstripped Japanese investment, they were not as prized by local recipients, who regarded Japanese capital as having a “strategic,” long-term commitment that NIC capital did not have, given the latter’s propensity to pull out once wage rates began to rise.

Formerly focussed mainly on raw material extraction, Japanese investment in the late eighties and early 1990’s was aimed at turning ASEAN into an integrated production base for Japanese conglomerates that assembled manufactures for export to the US, Europe, and Japan itself. And as economic growth spawned a middle class in the ASEAN countries, the region itself became an important consumer of Japanese products.

The critical importance of Japanese investment to ASEAN was underlined in a recent report of the Japan Economic Institute: By virtually any measure, it noted,

corporate Japan’s presence in Southeast Asia is massive. Japanese affiliates employed an estimated 800,000 people across ASEAN economies in 1994. In a number of key industries Japanese firms have

staked out a commanding regional position, with Matsushita Electrical

Co., Ltd.’s operations alone said to account for between 4 per cent

and 5 per cent of Malaysia’s gross domestic product. Japanese

manufacturers currently control about 90 per cent of the automotive market

in most ASEAN countries.”

The significance of Japanese investment for Southeast Asian technocrats was not only that it had rescued Southeast Asia from recession and promoted prosperity. It also filled the gap between the relatively limited investments of the Southeast Asian economies and the large investments needed for sustained high-speed economic growth. But there was a downside to this industrial process Japanese investment had spawned: it was heavily dependent on the decisions of Japanese conglomerates and on Japanese technology inputs, and it created enclave industries “with only weak backward and forward linkages to domestic firms.”

The ambivalence of Southeast Asian technocrats toward Japanese investment was heightened in the early 1990’s, when direct foreign investment inflows into some countries in the the region began to level off. In the case of Thailand, Japanese direct investment dropped by over 50 per cent, from $2.4 billion in 1990 to $578 million in 1993. While total foreign direct investment inflows into Malaysia continued to rise, Japanese direct investment fell from $880 million in 1991 to $742 million in 1994. Indonesia continued to be a favored Japanese destination, but the Philippines, owing to uncertainties about its political stability, continued to be skirted by Japanese investors, with the annual inflow averaging only $207 million in the period 1990-94. This levelling off of Japanese investment inflows posed both and an opportunity for diversification, in the view of many Southeast Asian economic managers.

The Second Wave: Finance Capital

By the early nineties, in fact, these financial technocrats were eyeing new sources of capital to sustain their growth. These were the vast amounts of personal savings, pension funds, government funds, corporate savings, and other funds that were deposited in mutual funds and other investment mechanisms that were designed to maximize their value. These funds were often placed under the management of big international banks or investment houses and they were played as portfolio investments by fund managers that were experienced in spotting investment opportunities that combined high yields with a quick turnaround time. In the early 1990’s, noted an Asian Development Bank report, “the declining returns in the stock markets of industrial countries and the low real interest rates compelled investors to seek higher returns on their capital elsewhere.”

But beyond differentials in yields, the global economy had undergone major structural changes by the early 1990’s which drove these funds to scout “emerging markets” like Southeast Asia:

First, the death of communism has hastened the development of privatization and

free markets. There are now more things to buy. Second, there is more cash to

buy things with. The apparent death of inflation has led to easy monetary policies

in the world’s chief economies; and with Wall Street at unnerving heights, the

flood is lapping on remoter shores. Third, the globalization of world markets

prompts portfolio investors, like corporations, to seek to capture growth in

developing economies.

The Magic Bullet

To attract these funds to their markets, financial managers in the different Southeast Asian countries evolved strategies that had essentially the same three key elements: financial liberalization, the maintenance of high interest rates, and the “pegging” of the local currency to the dollar.

Maintaining high interest rates to suck in foreign capital was a technique that the Asians learned quickly from other countries in the early 1990’s, when interest rates in New York and other Northern financial centers were comparatively low. Mexico’s technocrats had discovered the efficacy of this technique fairly early, and US investors responded quite eagerly. As William Greider has noted:

By borrowing in New York’s money market where interest rates were then

comparatively low, an investor could buy Mexican stocks or short-term government

notes and capture the spread between returns of 5 to 6 per cent in America and 12 to

14 per cent in Mexico.

Imitating the Mexicans, who in the early 1990’s were impressing the world with their ability to draw portfolio investments inspite of low economic growth, central banks in Southeast Asia manipulated a variety of policy tools to maintain relatively high interest rates to provide high yields on speculative capital.

Fixing the rate of exchange between the local currency and the dollar was the second element of the strategy to bring in dollars. The idea was to eliminate or reduce risks for foreign investors stemming from fluctuations in the value of “soft currencies.” This guarantee was needed if investors were going to come in, change their money into pesos, baht, or ringgit, and play the local stock market. This was not simply a clever idea of Asian financial technocrats; it was often demanded by key foreign investors as a condition for their coming in. As the economist Jeffrey Sachs has pointed out, in both Asia and Mexico, financial authorities “fell under the influence of money managers who championed the cause of pegged exchange rates,” arguing that “only a stable exchange rate could underpin the confidence needed for large capital inflows.”

A pegged exchange rate was, of course, also needed by local banks and corporations raising money in global capital markets: they needed assurance that they would not be blindsided by devaluations which would significantly raise the costs of repaying dollar-denominated loans. Fixing the rate was not formal policy, but one that was done through “market friendly” means. This was the so-called “dirty float,” wherein the local currency was allowed to float within a narrow band, say, $1: 25.25–25.75 baht; movement beyond the upper and lower limits would be countered by the central bank selling or buying dollars to keep the exchange rate within the band.

Financial liberalization was the third key element of the strategy. Among these measures were the elimination of foreign exchange and other restrictions on the inflow and outflow of capital, opening up stock exchanges to foreign portfolio investors, allowing banks to participate fully or partly in domestic banking operations, and opening up other financial sectors, like the insurance industry, to some foreign participation. Here, it is worth noting that while the Southeast Asian countries, generally, were reluctant to liberalize their trade, in their desire to attract foreign capital they did go a long way toward meeting the World Bank’s and International Monetary Fund’s (IMF) demand to deregulate their financial markets.

Early Warning Ignored

This three-pronged strategy was wildly successful in attracting a new infusion of foreign capital. In contrast to the late 1980’s, when capital flows were dominated by foreign direct investments from Japan and the NICs, the new capital flowing in in the early 1990’s were dominated by American funds. US funds were estimated to have contributed more than 50 per cent of net foreign equity investments in Asia-Pacific developing countries, and the vast majority of bonds was denominated in dollars, “reflecting,” as one report noted, “the strong interest of US investors in these countries.” To Southeast Asia’s financial managers, this was positive as it helped them lessen their heavy dependence on Japanese capital inflows.

There were, however, voices of caution who warned that, unlike Japanese direct investment, which had a “strategic” quality to it, portfolio capital could just as easily flow out as flow in, and a mad stampede to leave could not be underestimated given foreign investors’ volatile moods. Lending credence to these fears was the Mexican financial crisis in December 1994, which was largely created by massive capital flight from an “emerging market” that had been highly rated by portfolio investors. But while this event did dampen stock market activity and bring down stock prices in Southeast Asia, the markets soon recovered and lending and investment flows to the region reached even higher levels after the brief scare. From early 1995 to late 1996, foreign capital came into the region at a dizzying pace, before it began to flow out, at an equally rapid pace, early in1997.

Of course, the mix of financial liberalization, interest rate policy, and exchange rate policy was different in the various countries, and it was greatly nuanced by the varying appreciation of other factors, such as inflation and recession, in the different governments, but the thrust in the manipulation of these policy tools was in the same general direction.

Thailand–Back to the Third World?

A close look at the interaction of foreign capital, goverment policy, and domestic economic interests in the different countries reveals the superficial successes and very real perils of a model of economic development driven by foreign capital. The following account and analysis focusses on the Thailand and the Philippines, followed by a shorter discussion of developments in Malaysia and Indonesia.

Thailand was, initially, the country that most successfully attracted other forms of capital inflow aside from foreign direct investment. The strategy of the Thai technocrats was, in the description of one prominent investment firm, quite simple but also quite effective in its results, at least in the short and medium term:

Since 1987 the Thai authorities have kept their currency locked to the

US dollar in a band of B[aht]25-26 while maintaining domestic rates

400-500 basis points higher than US rates and keeping their borders

open to capital flows. Thai borrowers naturally gravitated towards US

dollar borrowings and the commercial banks accommodated them, with the result

that the Thai banks now have a net foreign liability position equivalent to

20 per cent of GNP. The borrowers converted to baht with the Bank of Thailand

the ultimate purchaser of their foreign currency. Fuelled by cheap easy money

the Thai economy grew rapidly, inflation rose, and the current account deficit


The Deluge

Net portfolio investment, which averaged only $646 million in the period 1985-89, came to $927 million in 1992 and skyrocketed to $5.5 billion in 1993 after key reforms were carried out in the Stock Exchange of Thailand (SET). But this was just the beginning. Initially cautious, foreign portfolio investors came in in force beginning in 1994, influenced by the continuing high growth rates and the World Bank’s and Bank of Thailand’s optimistic projections that the economy in the coming years would barrel along the path of high growth, low inflation, and financial and monetary stability. You couldn’t seem to lose with Thai equities. By 1995, foreign investors had become net buyers and Thai investors net sellers of equities at the SET, with the former snapping up 427 billion baht while selling off 379 billion baht.

Issues of stocks and bonds by private entities were, however, not the only, or even primary, channel of capital flowing into Thailand. Loans to Thai private financial institutions were gladly advanced by international banks. The country’s external debt more than doubled, from $21 billion in 1988 to $$55 billion in 1994, with private debt climbing from 14 per cent of the total to over 25 per cent. With the establishment in 1993 of the Bangkok International Banking Facility (BIBF), a system which allowed foreign banks to establish subsidiairies to engage in dollar-denominated loans to local entities, the already significant flow of funds escalated, with loans channelled through it coming to about $50 billion in just three years’ time.

Indeed, so attractive was Bangkok as a destination of capital that, as one 1995 account described it,

[W]ith the country’s positive outlook, competition to lend to Thai banks and

finance companies has been intense. This had become even more pronounced with

the recent migration of banks to the Asian market to chase the relatively few number

of good credit risks, thus driving down the cost of funds. Not only are the margins

narrowing; to win business, banks are reducing fees and extending their maturity


This frenzied activity made Bangkok a debtors’ instead of creditors’ market, and the foreign debt rose by over 60 per cent in just three years to $89 billion, with private debt making up $66.2 billion of this figure.

The Myth of a Worried IMF

It might be useful to pause here and ask how the Bretton Woods institutions, which are supposed to monitor the external accounts of different countries, reacted to this rapid financial buildup. This is not to imply that the IMF and the Bank, two institutions with a checkered history in the Third World, should be serving as the guardians of the finances of Southern governments. It is merely to set the record straight on this particular issue; and the record is that contrary to recent reports, the onrush of portfolio investment and private loans did not alarm the World Bank and the IMF, though short-term debt came to about $41 billion of Thailand’s $83 billion foreign debt by 1995. In fact, the Bank and Fund were not greatly bothered by the conjunction of skyrocketing foreign debt and a burgeoning current account deficit, which came to 6-8 per cent of GDP in the mid-1990’s.

While other countries marked by massive capital inflows, large current account deficits, and a virtually fixed exchange rate would have received stern admonitons, Thailand elicited praise and hardly any urgent warnings from the World Bank, even when its current account deficit hit a high of 11.4 per cent in the period July 1990-January 1991. As late as 1994, the official line on Thailand from the Bank was:

Thailand provides an excellent example of the dividends to be obtained through

outward orientation, receptivity to foreign investment, and a market-friendly

philosophy backed up by conservative macro-economic management and

cautious external borrowing policies.

Indeed, as late as 1996, while expressing some concern with the huge capital flows, the IMF was still praising Thai authorities for their “consistent record of sound macroeconomic management policies.” While the IMF “recommended a greater degree of exchange rate flexibility,” there was certainly no advice to let the baht float freely.

The complacency of the Bretton Woods institutions when it came to Thailand–indeed, their failure to fully appreciate the danger signals–is traced by some analysts to the fact that it was not incurred and financed by government but by the private sector. Indeed, the high current account deficits of the early 1990’s coincided with the government running budget surpluses. As a group of perceptive Indian analysts noted, “[p]art of the reason for this silence was the perception that an external account deficit is acceptable so long as it does not reflect a deficit on the government’s budget but ‘merely’ an excess of private investment over private domestic savings.” In this view, countries with significant budget deficits, such as India in 1991, were regarded as profligate even when their current account deficit was lower than Thailand’s. The latter’s deficit, because it was not incurred by government and not financed by public expenditures was simply reflecting “the appropriate environment for foreign private investment rather than public or private profligacy.”

Financiers and Realtors–Bonnie and Clyde in Bangkok

Had the IMF and World Bank looked carefully at Thailand’s finance companies, they would have found cause to worry.

The finance companies were institutions which financed purchases of property, cars, and other consumer durables. They were also key recipients of inward capital flows. Traditionally plagued by problems of capital shortage, the finance companies found that it was easier to raise money by borrowing from abroad or by selling stocks and bonds to portfolio investors than through their usual route of issuing promissory notes to Thai investors. In fact, the creditors’ market that Bangkok was in the early 1990’s facilitated this, since, as one account put it, “as a result of the stiff competition [to lend to Thai institutions], pricing levels in some cases are not premised entirely on the financial fundamentals of the borrowers. Many banks in Asia are anxious to develop good relations with their Thai counterparts, and are increasingly willing to lend to build relationship rather than to make money.”

Taking advantage of the enormous spreads between the relatively low rates at which they borrowed dollars from foreign and big Thai banks and the relatively high local interest rates, finance companies relent money in baht to local enterprises and individuals, with the expectation of huge profits. The foreign banks and big Thai banks were not unhappy: raising dollars in the major financial centers where interest rates were at a low 6-8 per cent, the Thai banks and finance companies captured the enormous spread between those rates and the 14 to 20 per cent interest rates which they charged clients for real estate- and consumer-financing or for loans in the local market.

Flush with cash, the finance companies and banks channelled their borrowed money to activities that would be moneymakers in the short term, and primary among this was real estate. Investing in the truly productive sectors of the economy like manufacturing required huge blocks of capital, a strategic commitment to a company, a willingness to forego high returns in the short term owing to a long gestation period of the invested capital. Real estate, however, offered in the early 1990’s the prospect of high profits with a quick turnaround time.

In fact, the finance companies not only lent to property developers, but they themselves, like the high-flying Finance One, diversified into real estate speculation. And here they were joined by many of the country’s manufacturers, who were seduced into plowing their profits into real estate rather than into upgrading their technology and their workers’ skills.

Thus, property development was the hottest sector of the economy in the early 1990’s. Highrise after highrise rose in Bangkok and its environs. Looking down from the top floor of any one of Bangkok’s buildings, one could see hundreds of building cranes alongside rising structures dotting the city for miles around. They were the preeminent sign of the great Thai boom. And boom the real estate sector did, “with property development in all its aspects–construction, building materials, mortgages, loans, legal fees and all manner of other financial services–[contributing] 30 to 50 per cent of annual GDP growth.” Property-related investment, according to some calculations, came to 50 per cent of total investment, which made official Bank of Thailand figures that real estate loans came to only 10 per cent of the exposure of Thai banks and 20 per cent of that of finance companies gross underestimates.

In any event, by 1995, runaway construction had resulted in a glut of residential and commercial units, with the stock of vacant units in Bangkok coming to an estimated $20 billion. By the beginning of 1997, half of the loans made to property developers were “non-performing,” with the total value of these loans estimated at between $3.1 billion abnd $3.8 billion. But the finance companies and banks could not afford to declare their real estate borrowers insolvent since their own financial standing could be seriously damaged by the acknowledgment that so many of their borrowers were technically bankrupt.

Thus a game of pretend ensued. Finance companies and banks did not press their borrowers too hard on regular debt servicing, instead employing creative accounting techniques to hide the latter’s actual financial status. But the parlous state of Thailand’s financial firms and developers could not be indefinitely concealed from Thailand’s international creditors, and reality hit home in early 1997 when two prominent institutions that were heavily dependent on foreign loans, Finance One, the country’s premier finance company, and Somprasong Land Company, one of its largest developers, both defaulted on interest payments to foreign borrowers. By then, it was estimated that non-performing loans came to 25 per cent of total loans and to 33 per cent of GDP.

Apres Moi…

With the bust in the real estate market, the national accounts for 1996 that came out early in 1997 were now seen as extremely worrisome. The foreign debt stood at $89 billion, almost 80 per cent of which was private debt and slightly under half of which was short-term debt. The net foreign liabilities of Thailand’s banks now came to 20 per cent of GNP. A massive debt crisis was in the offing, but unlike the Third World debt crisis in the 1980’s, this one was brought about not by government borrowing but by private borrowing that “governments have ceased to try and direct because of their commitment to neo-liberal market-friendly policies.”

The current account balance was a particular focus of foreign investors and creditors. The current account balance, which sums up a country’s external trade in goods and services, is a very sensitive measure to creditors since it indicates if a country will be able to earn the foreign exchange that will enable it to service its debt over the long term. Thailand’s traditionally high current account deficit now looked worrisome in the wake of the developing crisis in the domestic economy, and many investment analysts reminded their clients that its ratio to the GDP was the same as Mexico’s when the latter experienced economic meltdown in December 1994. The current account deficit was especially a cause for alarm if one took into account the fact that the vaunted Thai export machine came to a standstill, registering zero growth in 1996, compared to the 21 per cent and 24 per cent growth respectively in 1994 and 1995. This was not unrelated to the centrality of the property sector in driving the Thai economy, since, as one Bangkok Bank analyst asserted, “the manufacturers failed to keep their products competitive in world markets by investing in research and development and upgrading workers’ skills. Instead, they gambled their profits in real estate.” Or in the pithy words of a prominent investment specialist, “in the normal course of events,” manufacturers would have,

gradually moved upmarket to more sophisticated products. In Thailand for

the last several years many of them have put their manufacturing businesses

on the backburner and devoted all the money into property instead. Now they

are starting to come back to manufacturing but the pots and pans shop is

still a pots and pans shop and the money it needs has vanished into property.

Looking at the worrisome figures, many investors figured it was time to go. By the end of 1996, it was estimated that there was around $24 billion of “hot money” sloshing around in Bangkok in portfolio inflows and non-resident deposits that might try to move out. And move it did. Stocks plunged to record lows as foreign portfolio investors stampeded to get sell off their investments, with share prices plunging in late May 1997 by 65 per cent from their value during the balmy days of early 1994. The rush to convert baht into dollars and move out created tremendous pressure to devalue the baht. This placed the Bank of Thailand, the country’s central financial manager, in an unenviable dilemma that was aptly captured by the following report:

The central bank has little latitude in these uncomfortable circumstances…

The baht is under pressure, and the Bank of Thailand legally has to keep it in

a narrow band. The central bank can’t raise interest rates to support the

currency without triggering further damage to its wounded property and

finance firms. And, if it cuts interest rates to ease the burden of repayment,

it would trigger even worse capital flight.

Sensing a grand opportunity to make profit from this outward movement of capital, speculators moved in, betting on the eventual devaluation, intent on making a killing on well-timed purchases and sales of the dollar and baht. With some $39 billion in reserves at the beginning of 1997, the Bank of Thailand tried to defend the value of the baht. The Bank’s sale of massive quantities of dollars stabilized the baht in two spectacular battles with speculators in late January and in early May, when other Southeast Asian banks came to its rescue. However, the cost was high, with the Bank’s reserves dropping by $9 billion in seven months. By the time of a renewed attack in late June, the Bank threw in the towel and allowed the baht to “float” beyond the margins of the narrow band in which it had tried to restrict its fluctuations in value relative to the dollar.

The baht went on to lose close to 20 per cent of its value in just a few days. The Thai finance minister flew to Japan, reportedly to ask for a $20 billion loan. The Japanese government officials told him to go to the IMF first, and in early August, the Fund announced a $17.2 billion emergency loan for Bangkok. The quid pro quo was the closing down of 58 of the country’s 92 financial companies, a rise in the value-added tax from 7 to 10 per cent, significant cuts in government spending, a balanced budget, and an increase in utility prices. Fear gripped Bangkok, with panic withdrawals hitting many smaller banks and the finance companies and people muttering that soon they might be left with no choice but to leave their savings under their mattresses.

In early September, the finance minister announced that as many as one million Thais would lose their jobs in three months’ time. For many Thais, who had little memory of the years of recession in the mid-eighties, before the spectacular 11-year boom, a world had come to an end.

What concerned many was that if suffering was going to descend on the country, the pain should be equitably shared by everybody, including foreign investors that had taken the risk of trying to make money in Thailand and should now receive their just reward from the market for making the wrong decision. As one editorial put it:

The penalties imposed on foreign creditor banks which have lent to

the Thai private sector must be precise and applied equally…Thailand

and Thai companies may bear the brunt of the financial crisis but foreign

banks must also share part of the cost because of some imprudent lending.

It would be irresponsible to lay the blame entirely on Thailand.

Despite such sentiments, however, Prime Minister Chaovalit Yongchaiyudh asssured foreign and local creditors that the loans they had made to the bankrupt finance companies would be guaranteed by the government, on the grounds that not compensating the creditors would provoke more capital flight and further reduce Thailand’s attractiveness as an investment site. This was, as the logicians would say, the reductio ad absurdum of the thinking that had dominated Thai economic policymaking for more than a decade.

The Philippines: Siam’s Twin

Unlike its neighbors, the Philippines was skirted by Japanese capital in the late 1980’s owing to the instability of the post-Marcos transition. Thus it did not have the leverage to blunt the structural adjustment program pushed on it by the IMF and the World Bank, as Thailand, Malaysia, and Indonesia were able to, despite the fact that all three were under formal structural adjustment programs. The Philippines desperately needed the IMF-World Bank seal of approval, and so, between 1980 and the early 1990’s, successive governments proceeded to move towards comprehensive liberalization, deregulation, and privatization.

Adjustment and Approval

The first phase, from 1980 to 1984, focussed on trade liberalization. The average rate of protection was brought down by a third or more, and import restrictions were lifted on two-thirds of some 3000 items targetted before the combination of deep economic crisis and political crisis of the last years of the Marcos dictatorship forced a suspension of the six-year program.

The second phase, which extended from the downfall of the Marcos dictatorship to the final years of the Aquino goverment, was marked by a scaling down of government expenditures and subsidies, not only to get the state of out production in line with free-market doctrine, but also to refocus government funds on repaying the country’s $26 billion debt. Over 40 per cent of the government budget was devoted to servicing the foreign debt, leaving very little, after the financing of government operations, for capital expenditures and producer and consumer subsidies. This so-called “model debtor strategy,” wherein the country’s financial resources were devoted mainly to servicing the foreign debt instead of financing development, produced the not unexpected result of keeping the growth rate down to an average of 1.4 per cent per annum between 1980 and 1993, compared to 8.2 per cent for Thailand, 5.8 per cent for Indonesia, and 6.2 per cent for Malaysia.

The third phase of structural adjustment, which began with President Fidel Ramos’ assumption of office in 1992, was marked by the acceleration of deregulation, trade and investment liberalization, and privatization. Profitable government enterprises like the oil-refining and marketing firm Petron, considered the crown jewel of the state sector, were handed over to the private sector, as were some vital services like managing the water supply. Using Chile as a model, the government has been in the process of reducing tariffs on all products (except on sensitive agricultural commodities like rice) to a uniform five per cent by 2004 for all trading partners. Nationality restrictions on foreign investment have been loosened up considerably, with 100 per cent foreign equity allowed in all but a few sectors on a short “negative list” and the government determined to open up even the retail trade sector–long a sacred cow–to foreign firms. This was a far more liberal foreign investment code than that of most of the Philippines’ neighbors.

Together with financial liberalization, these measures elicited the much desired seal of approval from the IMF and allowed the Philippines to reenter world capital markets in the early 1990’s. With the country starved of capital in the years of draconian structural adjustment in the 1980’s, the aim of the Filipino financial managers was to attract significant amounts of foreign capital to drive a high level of GDP growth that would allow the Philippines to join the ranks of the “tigers”– to “become a NIC by the year 2000,” as the slogan of new Ramos administration put it.

Copying the Thais

Thai financial policies, which were then attracting large amounts of investment, served as a model for the technocrats of the new Ramos administration, and they moved swiftly to implement the three key elements of the Thai strategy: financial liberalization, high interest rates, and a stable exchange rate.

In the area of financial liberalization, the government moved to create one of the most foreign capital-friendly systems in the region. The capital account was fully liberalized, with most foreign exchange restrictions lifted, making the peso virtually fully convertible; full and immediate repatriation of profits, dividends, and capital; and the free utilization of foreign currency accounts. After being closed for 50 years, the insurance sector was opened up to 100 per cent-foreign owned companies in 1994. But especially critical in facilitating capital flows was the liberalization of the banking system by Republic Act 7721, which opened up the banking system to foreign banks, resulting in 12 of them setting up operations by September 1996.

Like the Bank of Thailand, the policy of the Bangko Sentral ng Pilipinas (BSP) was to keep local interest rates high–some 12 to 15 per cent–in order to suck in foreign capital. Prime lending rates in the Philippines in the last few years were kept about six percentage points above US rates, on average. This policy transformed the view of high interest rates in financial circles; as one analyst has written, “[b]eing ‘endowed with high interest rates turned out to be a ‘virtue’ that attracted external capital whereas it was once nothing but a brake upon economic activity as it served as a barrier for businesses to acquire capital.”

And like the Thais, the Ramos administration pegged the peso to the dollar at a stable rate of exchange, so that in the whole of 1996, for instance, there was only a two per cent fluctuation in the peso-dollar rate. The consequent inflow of dollars caused the peso to appreciate relative to the dollar, and the Bangko Sentral intervened in the foreign exchange by buying or selling dollars to keep the peso wthin a certain band.

Finance Capital’s Vote of Confidence

The country reentered the international bond market in 1993 and was able to successfully float about $1.3 billion that first year. Portfolio investors were attracted to Philippine Treasury bills and their relatively high yields. Foreign exchange liberalization also drew them to the reorganized Philippine Stock Exchange, where publicly listed local firms sought to sell equities as a means of raising capital. In 1993, the first year of the Ramos presidency, the stock price index in the Philippine Stock Exchange rose by 154 per cent–the highest among all major stock exchanges in Asia and the third best in the world.

The Philippines was on the way to becoming a darling of foreign portfolio investors, and between 1993 and 1997, some $19.4 billion worth of net portfolio investment flowed into the country. These flows dwarfed the foreign direct investment inflows, with estimates of their size ranging from 75 to 90 per cent of total investment.

Foreign capital also flowed in in the form of loans made abroad by the private sector or as capital raised by local banks through the issuance of debt instruments like floating rate certificates of deposit (FRCDs). Contracted at relatively low interest rates, these funds were registered as time deposits at the banks, then relent via foreign currency deposit units (FCDU’s), a facility dating back to the Marcos era that enabled local and foreign banks to extend dollar loans to local borrowers. With the wide spread–some six hundred basis points–between US interest rates and interest rates on peso loans in the local markets–local banks could borrow abroad and still make a clean profit relending to local custmers at lower rates than those charged to peso loans. In 1996, the average interest rate for FCDU loans came to 7.41 per cent compared 12.8 per cent for peso loans.

Financial liberalization brought more foreign banks into the local scene by late 1993 and brought about a greater competition for customers. This translated into a rapid buildup in FCDU deposits and loans over the last few years, with deposits coming to $14.4 billion by the end of 1996 and loans coming to $9 billion, according to Central Bank data. In 1996 alone, new foreign currency loans totalled $4.9 billion.

Other estimates showed an even sharper increase, with the respected investment analyst Deutsche Morgan Grenfell (DMG) asserting that dollar loans had risen to $11.6 billion as of March 1997–or almost five times the level of $2 billion in December 1993. Another reliable investment house calculated that as of mid-year 1997, FCDU assets that were out not only as loans and advances but also as investments, placements in the interbank market, and other assets came to $22.9 billion, or 17.3 per cent of GDP.

In other words, the FCDU facility played the same role as the Bangkok International Banking Facility of providing cheap dollar loans to domestic customers. As the latest HG Asia puts it, with the exchange rate “padlocked” for two years at 26.2 to 26.3 pesos to the dollar, “They are not fools in Manila. They were offered US dollars at 600 basis points cheaper than the peso rates along with currency protection from the BSP. They took it.”

For the most part, this inflow of foreign investment and foreign capital was hailed as a vote of confidence in the management of the “new Philippine economy.” That it could be inflationary in its consequences was seen as a minor consideration. That it could be volatile, with the possibility that it could leave just as fast as it had come in, was underestimated. That it could be the Achilles Heel of the new economic order was not even entertained, grateful as the authorities well for any sign that confidence in the Philippines was returning in international financial circles.

Overheating and Overbuilding

By late 1996, however, worried looks began to be cast by investment houses as the Philippine banks’ net foreign liability reached close to $14.6 billion or close to 35 per cent of the Philippines’ foreign debt of $42 billion. The private debt was equivalent to 13 per cent of GNP and rising–a position which bore comparison with that of their models, the Thai banks, whose net foreign liability position at the end of 1996 was equivalent to 20 per cent of GNP. This picture led one investment analyst to warn:

The Philippines has not yet had to pay its reckoning for copying Thai practices.

It adopted them much later than Thailand. But its reckoning is likely to come

earlier than Thailand’s. The BSP does not have the resources of the Bank of

Thailand and the game is heating up faster than it did in the early stages in


The Philippine banks had gone on a borrowing spree, but this would not have been that worrisome had the money gone to the right places. Unfortunately, much of the lending of banks had gone, not into the really productive sectors of the economy but into the speculative areas, like the financing of consumption and property development. A clear indication of lending going to the wrong sectors was that while construction has been booming, industrial growth dropped from a 17 per cent annual rate in mid-1997 to -2.3 per cent in mid-1997.

Manufacturing and agriculture were not attractive sectors to lend to because they would demand strategic commitments of large chunks of capital that would only bear fruit in terms of decent returns over the medium and long term. Moreover, their future was uncertain since the radical liberalization of trade and investment that paralleled financial liberalization was making production less and less profitable for domestic producers. Duty free shops were flooding the country with cheap imported manufactures, and cheap rice and corn imports were coming in in volumes that far outstripped the minimum access volumes committed by the country under the GATT-WTO Agreement.

In any event, in the wake of the much-publicized real estate problems in Bangkok and the suspected high exposure of Philippine banks to the real estate sector, rumors about the imminent collapse of a highly indebted developer, Megaworld, early in 1997, forced people to look more closely at the Philippine real estate sector. The result was a consensus that a glut would emerge in 1998, though analysts differed on how big it would be. All Asia, one local investment house, predicted that, owing to overbuilding, by the year 2000, supply of high-rise residential units would exceed demand by 211 per cent, while supply of commercial developments would outpace demand by 142 per cent. In any event, fears of a coming glut were so widespread that the property index of the Philippine Stock Exchange fell by 40 per cent on fears that developers would be saddled with unsold condominiums.

Overbuilding was forcing developers, according to one account, to “become creative in search of new markets.” More and more companies, it noted, apparently without irony, “are spending billions of pesos to develop resorts, golf courses, and other special projects.”

Stats Wars

To calm public worries about bank exposure in the real estate sector, the BSP, in mid-1997, declared that no more than 20 per cent of the total exposure of commercial banks should be in property loans. But as a DMG study found, this tightening, which paralleled similar moves by other Asian central banks, was “probably too late.” The BSP announced that lending to the property sector in mid-1996 amounted to only 9.2 per cent of the exposure of banks, going up to about 11 per cent by December. BSP officials in that same survey admitted, however, that the property loan exposures of individual banks ranged from ‘negligible’ to as high as 28.6 per cent.

Under pressure from a skeptical public, Finance Secretary de Ocampo upped the figure of the banks’ real-estate-related exposure to 14 per cent in September 1997. But even this figure was considered low by foreign analysts, some of whom saw the real exposure of the banks at around 15-25 per cent. These analysts felt that the higher estimate would take into account property-related loans that could be classified under other categories such as services, hotel, construction, and even manufacturing. Indeed, if property used as a collateral were to be used as a criterion, then some estimates would place real-estate related loans as coming to 60 per cent of the total exposure of Philippine banks.

The huge capital inflows and the banks’ real estate exposure did begin to worry BSP officials, but this was at a rather late stage in the game. In May 1997, one BSP official warned that funds could be easily moved globally “at the tap of a finger” and the possibility of facing “abrupt reversals of capital flow.” And it was only in early June, shortly before the July 11 de facto devaluation of the peso, that the BSP issued “preemptive measures…aimed at curbing the growth in foreign currency lending.”

Foreign investors took much earlier notice of the massive debt buildup of local banks and the crisis of the real estate sector, and they saw these in the context of serious structural flaws that were glossed over by the growth rates of 5 to 6 per cent GDP per annum growth rates that the Philippines registered from 1994 to 1997. For them, the two most sensitive indicators became the trade deficit and the current account deficit, which, among other things, indicate if a country would have the capability in the long term to pay for its imports and service its foreign debt obligations. The trade deficit in 1996 stood at $12.8 billion, or a doubling in just three years! And a key reason for this was that even as exports continued to rise, imports rose even faster owing to the high-cost of imported components that went into the Philippines’ prime export, electronic products, the import content of which was 70-80 per cent.

Moreover, traditional Philippine mainstays had a lackluster performance, with garment exports, for instance, falling by 27 per cent in 1996, contributing to foreign investors’ perception that despite its 24 per cent export growth rate that year, the Philippines was facing the same difficulties of declining export capacity as Malaysia and Thailand, which registered no export growth, and Indonesia, which registered only 7 per cent. To many foreign investors, the export slowdown indicated, not a temporary blip, but the ending of the export-led “Southeast Asian Miracle” and dampened their enthusiasm to commit new funds. Many began, in fact, to consider shifting their investments to China, whose low-wage-based export machine was going into high gear, displacing higher-cost Southeast Asian exports in many key markets, including that of the United States.

But not to worry, said Philippine government analysts, and please don’t compare us to our neighbors. For instance, they claimed that the country’s current account balance, which brought to bear on the positive side of the ledger the remittances from the Philippines’ vast army of overseas workers, was manageable; and the current account was, more than the trade deficit, what foreign investors, analysts, and speculators allegedly looked at in asssessing the strength of the peso. But even if one were to grant this argument, things looked shaky. In 1996, according to estimates based on official figures, the current account deficit of $3.5 billion stood at 4 per cent of GNP. Worrisome but not alarming, said some.

However, when one tightened up the methodology for calculating the figure to account for unexplained errors and omissions in the balance of payments (which now add up to almost 6 per cent of GNP), as one prescient investment house study did last year, one comes up with realization that the real current account deficit is around 7 per cent of GNP–or uncomfortably close to the eight per cent deficit experienced by Mexico and Thailand before their economic meltdowns began. With a deficit of that size, investors speculated, the pressure would increase on the Philippine financial authorties to close the deficit by devaluing the currency, a move which would allow the country’s exports to remain competitive.

Uneasiness on the part of foreign investors over the possibility of a peso devaluation and to the parallels between Thailand and the Philippines led them by the beginning of 1997 to significantly scale down their commitments, with foreign equity inflows to banks dropping by 97 per cent in the first quarter of the year relative to the first quarter of 1996. With the jitters over property, a possible devaluation, and the massive private debt buildup, the stock market begun its downward plunge–not surprising since 70 per cent of the trading activity was accounted for by foreign investors. Indeed, instead of being parked in peso-denominated paper, awaiting new opportunities in the domestic market, foreign investors began to demand dollars for their pesos and move out, adding to pressures for depreciation of the peso.

“Stampede Tramples Tiger Cub”

It was this escalating exit of foreign investment in response to the strong possibility of a devaluation that would reduce the value of their peso holdings that attracted the attention of speculators looking for opportunities to cash in on large-scale foreign capital movements through the well-timed sale and purchase of dollars and pesos. In June and early July, the BSP worked mightily to contain the stampede of foreign investors to change their pesos to dollars and leave. It intervened in the foreign exchange market to maintain the peso at roughly 26:50 to the dollar, but, after spending almost $1.6 billion of its $11.3 billion reserves, it gave up the fight and let the peso float freely against the dollar.

To stem the outflow of dollars, the Bangko Sentral moved to raise local interest rates to stabilize the peso and continue to make investment in the country attractive to foreign investors. Interest rates doubled, from 15 to about 30 per cent, but capital continued to flow out. The expected fall to P29:$1 was rapidly breached, and exporters, who had initially felt that devaluation would serve their interests, started to get worried as it pushed past the P30:$1 mark since this could signficantly raise the value of their imported inputs that would more than wipe out any gains from the devaluation.

The impact on the local economy of the expected inflation owing to higher peso import prices, higher interest rates, and the sudden rise in the peso cost of servicing dollar obligations by local borrowers was expected to lead to an economic downturn and a string of bankruptcies, but Philippine officials continued to characterize the crisis as an external event, “a storm passing through,” as Finance Secretary de Ocampo put it. Manila’s “economic fundamentals” were sound, in contrast to Bangkok’s, and investors would see that.

But the IMF was unconvinced, and in its Capital Markets Report released during the IMF-World Bank Annual Conference in Hong Kong in the third week of September, the Fund said that “commercial banks in the Philippines have a high exposure in the property sector.” The big credit rating agencies concurred, with Standard and Poor’s Corporation downgrading its outlook for the Philippine economy from “positive” to “stable” and warning that “aggressive” lending by banks “has exposed the banking system to potential asset-quality problems.” It estimated the total exposure of Philippine banks to the real estate sector at 20 per cent. And, with the onset of the currency crisis, the “asset quality” problems of loans to this sector had most likely intensified. As a top executive of one of the bigger developers admitted, “Before there had been an abundance of property developers, many of them small in size. The recent developments have severely tested all developers. Those that were not fundamentally strong folded up. Many projects were discontinued.” It seemed only a matter of time before such heavily indebted firms would surface in newspaper reports.

Perhaps the most alarming analysis came from the investment specialist DMG, which stated in a mid-September report that there was “clearly a present danger” presented by non-performing loans, which it estimated as “rising to 2.3 per cent of loans in 1998 and 2.7 per cent in 1999 from 1.9 per cent in 1996 because of problems in dollar and real estate lending plus initial cracks in consumer finance.”

Rumors began to circulate in Manila that the creditworthiness of a number of banks had been damaged by loans to the real estate sector, including Westmont Bank, Banco de Oro, Traders’ Royal Bank, Urban Bank, China Banking Corporation, and International Exchange Bank. To quell the rumors and avoid a bank run, the BSP director threatened to unleash the National Bureau of Investigation on people making those claims. But the threat dissipated when a member of the Monetary Board that governs the policies of the BSP admitted that five banks had indeed overshot the cap of on real estate loans to 20 per cent of the banks’ total exposure. Moreover, threats could not conceal the surfacing of a succession of victims of the weaker peso and higher interest rates seeking government protection from their creditors. Among them were Vitarich, a major food processor, the big milling company Victorias Milling Company, and the EYCO Group of Companies, which had started as an appliance maker but diversified into real estate with dollar-denominated loans as well as peso loans from 22 banks.

Meanwhile, the value of the local currency went down to 35 pesos to the dollar in early October–a figure unimaginable just a few months earlier–and with that 35 per cent plunge in its value went the Philippines’ last hopes of becoming one of Southeast Asia’s tiger economies.

…Meanwhile, in Malaysia and Indonesia

A detailed analysis of the unfolding of the crisis in Malaysia and Indonesia will not be attempted but a few words of comparison are in order.

In the last few years, foreign direct investment flows into these countries have outstripped those to Thailand, and speculative and other foreign capital flows have been equally dynamic. Indonesia has, of course, been known for being ahead of its neighbors in terms of financial liberalization. The capital account was substantially liberalized back in the 1970’s, and in the late 1980’s a package of reforms eliminated remaining substantial obstacles between the domestic financial market and global markets.

Rhetoric, Reality, and Crisis in Kuala Lumpur

In the case of Malaysia, foreign investors have long known that Prime Minister Mohamad Mahathir has created a very friendly atmosphere for foreign investors that belie his occasional rhetorical sallies against “imperialism.” In fact, by 1995, Malaysia was rated the number one pick of Asia’s economies by key investment houses, with Standard and Poor’s giving it a sovereign credit rating of AA+–above Thailand (A+) and Indonesia (BBB). Indeed, Kuala Lumpur was so sold on globalization that it built up Southeast Asia’s largest and best performing stockmarket, and launched a big drive to make Kuala Lumpur a regional financial center rivalling Singapore and Hong Kong.

The same formula of financial liberalization, high interest rates, and elimination of foreign currency risk via a stable exchange rate that marked macroeconomic policy in Thailand and the Philippines were also broadly followed by the central banks of Indonesia and Malaysia, though some observers claimed that the Malaysian Bank Negara was more cautious about consistent high interest rates than its neighbors and the Bank Indonesia practised more flexibility when it came to the exchange rate. These differences, however, were marginal in the face of their common seduction by the vision of development driven by massive capital inflows.

Determined to maintain an economic growth rate of 8 per cent plus a year, Malaysia attracted a massive net inflow of private capital that reached $11.9 billion in 1995. Much of this flow went into unproductive activities like stock market speculation, financing of consumer spending, and, most worrisome, property development. While it was largely domestic funding that drove the real estate boom, foreign funding did have a significant role. With property loans growing faster than the overall loan growth rate, real estate loans made up, by 1997, about 25 per cent of the total exposure of both banks and finance companies. By 1997, Malaysia had the highest property loan exposure in the region–that is, if Bank of Thailand statistics on the real estate loan exposure of Thai financial institutions were be taken at face value. With about 2 million square meters of office space scheduled to go on the market in 1997, vacancy rates were expected to shoot up, in some estimates by 15 per cent. A ruling early in 1997 to limit the banks’ exposure to real estate lending to not more than 20 per cent of their loan portfolio came a little too late to ward off the developing glut.

Foreign capital was assiduously courted to finance the mega-projects that Prime Minister Mahathir labelled as top priority in line with his drive to make Malaysia a developed country by the year 2000. These projects included the 88-story Petronas Towers, the world’s tallest building, the completion of which was pushed through in spite of the softening of the property market and widespread fears about the emergence of chronic oversupply in office space. Other big ticket items included the controversial Bakun Hydroelectric Dam in Sarawak (expected cost: $5 billion), the Multimedia Super Corridor that would house more than 300 high-tech and information technlogy companies ($6.8 billion), the new Kuala Lumpur International Airport ($3 billion), and the 2 km-long “Linear City” that Malaysian planners envisioned as the world’s longest building.

As in Thailand, the danger signs in real estate caused foreign investors to take a second look at the so-called “fundamentals” of Southeast Asia’s hottest economy and they became uncomfortable at what they saw: a $5.6 billion current account deficit that the came to 5.5 per cent of GNP in 1996 and, more worrisome, zero export growth. Worried about a real estate bust, the cooling down of an overheated economy, and the capacity of the country to earn foreign exchange to service its growing foreign debt, investors started to move out, leading to the downspin of the stock market. As in Thailand and the Philippines, this movement outwards attracted foreign exchange speculators to bet on the devaluation of the ringgit.

The currency was finally forced to float freely early in August, but its freefall and that of the stockmarket had apparently just begun. Capital flight and further depreciation of the ringgit were exacerbated by Mahathir’s bitter denunciations of currency traders as “immoral,” and the Malaysian authorities’ moves to restrict the activities of foreign investors in the stock market, like preventing them from short-selling, accelerated its downspin, leading to a loss of 40 per cent of its market capitalization in about six months–a sum of M$ 250 billion (or twice the size of the domestic product in 1996).

By mid-September, the most promising tiger before the currency crisis was being rated as the one in the worst shape next to Thailand, and Mahathir had been forced to suspend, owing to lack of prospective funders, some of his cherished mega-projects, including the Bakun Dam and the Linear City.

This was, however, the least of his problems. By October, the problem was how to avoid a massive Thai-style crash. Malaysia, one analyst told his investor clients, brought together the elements for such a outcome, among them,”huge leverage a la Thailand (180 per cent of GDP); low (6%) and declining capital to asset ratio, large exposure to property and stock markets; asset prices falling sharply, [with] a property sector glut imminent…[great dependence] on short-term capital inflows; fiscal deterioration…[and] very high dependence on foreign trade.” In short, policywise, the country’s financial managers were caught between a rock and a hard place, and they had very little room for policy error:

As capital inflows slow down, and indeed reverse themselves, the Malaysians

have elected to let the ringgit fall, knowing full well that currency volatility

for a country where trade accounts for almost 200 per cent of GDP

must be doing some damage to the real economy. Malaysia, however,

cannot afford to defend the currency by raising interest rates because that

might precipitate an even larger problem. The country is, therefore, caught

in a difficult dilemma….

Volatile Brew in Jakarta

Turning to Indonesia, foreign capital had been expected to desert the country in the wake of the massive street demonstrations in Jakarta in July 1996. That it largely stayed on was interpreted by the business press as a huge vote of confidence in the political and economic leadership of Indonesia.

Jakarta’s business community lapsed into business-as-usual, and it was business-as- usual this that led to its unravelling in 1997. For the three elements of the Southeast Asian success–financial liberalization, high interest rates, and a stable dollar exchange rate–became unstuck in a fashion that was only slightly less spectacular than in Thailand. With interest rates in Jakarta at 16-18 per cent per annum compared to interest rates for offshore loans that came to less than 10 per cent, Indonesian enterprises went on a borrowing spree abroad that drove private foreign debt to $55.5 billion–an amount equal to 25 per cent of the gross domestic product. At the same time, speculative capital flooded in, especially since the beginning of 1996, attracted by an interest rate differential that, in the words of one observer, assured a “huge arbitrage opportunity” to “any offshore punter who borrowed in US dollars and parked his money in rupiah-denominated paper…” These movements of capital appeared to entail little foreign currency risk to the players involved since in the Bank Indonesia’s “managed float system,” the rupiah had not been allowed to depreciate by more than five per cent in any year.”

Much of the foreign money found its way to real estate, as did a very significant amount of domestic credit. Indeed, some 25 per cent of the banking system’s outstanding loans was to the property sector, and a large segment of this exposure was expected to go sour owing to dangerous levels of oversupply, especially in office space. In fact, reckless lending to developers reached “alarmingly high” levels for many of the country’s 239 banks and posed the threat of a “small bank bust.”

As in Malaysia and the Philippines, the real estate crisis and the currency crisis in neighboring Thailand forced investors early in 1997 to look at the macroeconomic fundamentals of Indonesia, and some of the figures struck them not only as worrisome but alarming. Principal among these was the fact that almost two-thirds of the country’s huge private external debt burden of $55.5 billion was due within a year. If one added to the brew a current account deficit that escalated from $2.9 billion in 1994 to $7.2 billion in 1995, owing to the conjunction of anemic export growth and rapidly rising imports of goods and services; the unresolved political succession problem; and continuing mass unrest that often resulted in the torching of churches, then one had the perfect recipe for capital flight.

Speculators, as in the other Southeast Asian countries, rode on the stampede of foreign investors to get out of Jakarta, and their frenzied activiites put the rupiah on a downward curve that became steeper when local banks and enterprises, fearing further depreciation, fulfilled their own dire prophecies by dumping the rupiah to hoard dollars to cut their losses in servicing their dollar-denominated debt or financing their imports. By October, the coming crunch in Indonesia was expected to be only slightly less harsh than that in Thailand. “There is little doubt,” an investment analyst told its clients, “that some Indonesian banks will have to be liquidated in the aftermath of the recent currency turmoil.” This was shaping up, however, to be one of the less destabilizing probable developments, for with the political situation being so volatile, there were likely to be consequences that would be far more momentous.

The Shape of Things to Come

It might be useful at this point to draw out some of the implications of the financial earthquake of the last few months.

Strategic Withdrawal

First, despite statements made by some Southeast Asian governments that the crisis is a short term one–a phase in the normal ebb and flow of global capital–there is a strategic withdrawal of finance capital from the Southeast Asian region. The new darlings of the fund managers are Latin American markets, which rose almost 40 per cent on average this year as Asian markets fell. As the Financial Times points out, Brazilian equities, which have risen 70 per cent since the end of the year, look very good to fund managers. So do Russian equities, which have more than doubled since the start of this year, and Chinese “red chips,” which have gone up by 90 per cent.

Capital movements are, contrary to the doctrinaire free market views, dictated by a mixture of rationality and irrationality. As the deputy managing director of the IMF recently admitted during the World Bank-IMF annual meeting in Hong Kong, “markets are not always right. Sometimes inflows are excessive, and sometimes they may be sustained too long. Markets tend to react late; but then they tend to reacty fast, sometimes excessively.” But one thing is certain, foreign capital is not so irrational as to return to Southeast Asia anytime soon.

Most likely is the scenario of prolonged crisis layed out by the chairman of a key player in the Asian investment scene, Salomon Brothers Asia Pacific. US mutual funds, he said, which had been supplying net new capital to the region of $4 to $5 billion a year, were now pulling out owing to the bleak investment outlook. The currency instability would last from seven to 12 months, if the earlier experiences of Mexico, Finland, and Sweden were any indication, during which there would be weak domestic demand and “severe contraction in GDP in some of them.”

Will FDI also Fly?

A second consideration is the question: Will foreign direct investors follow the lead of the banks and portfolio investors and pull their capital out of the region? With the slow growth in the region’s exports and the spread of deflationary tendencies, new foreign investors are likely to be deterred from making significant commitments, and Ford and GM, for one, are now probably regretting their 1996 decision to set up major automobile assembly plants in Thailand to churn out cars for what was then seen as an infinitely growing Southeast Asian market.

It is not clear, however, how Japanese direct investors will react. Some analysts say that new investment flows from Japan are not likely to be reduced that much since the Japanese are continuing to pursue a strategic plan of making Southeast Asia an integrated production base. In Thailand alone, it is pointed out, more than 1,100 Japanese companies are ensconced and only a massive economic downturn can reverse the momentum that has built up. As one Japanese executive asserted, “It [Japanese investment] is a long-term strategy where investments are increased on a year-to-year basis, so I don’t think a 10 to 20 per cent devaluation will force Japanese investors to change their investment strategies for Thailand.”

However, there is a new wrinkle to the situation that makes the situation different from the early 1990’s. First of all, Japanese investment strategies in the last few years have targetted Southeast Asia not just as an export platform for third-country markets but increasingly as prosperous middle-class markets to be themselves exploited–and these markets are expected to contract severely.

Second, diverting production from Southeast Asian markets to Japan will be difficult since Japan’s recession, instead of giving way to recovery, as expected earlier this year, is becoming even deeper, with an astounding 11 per cent decline in GDP on an annualized basis recorded in the second quarter!

Finally, redirecting production to the US is going to be very difficult, unless the Japanese want to provoke the wrath of Washington, which is already warning Japan not to “export its way out of its recession” and is increasingly responsive to claims from US manufacturers that the Southeast Asian economies’ trade surpluses with the United States are really mainly trade surpluses registered by Japanese companies that have relocated to the region–implying that they must be added to Japan’s official trade surplus with the United States.

The upshot of all this is that Japan could be burdened with significant overcapacity in its Southeast Asian manufacturing network, which could trigger a significant plunge in the level of fresh commitments of capital. This only deepen and prolong the regional recession.

Liberalization–Advancing or Retreating?

A third key consideration relates to the question of whether the crisis will result in an advance or in a retreat of economic liberalization. While many Asian economic managers are now coming around to the position that the weak controls on the flow of international capital has been a major cause of the currency crisis, US officials and economists are taking exactly the opposite position: that it was incomplete liberalization that was one of key causes of the crisis. The fixing of the exchange rate has been identified as the major culprit by Northern analysts, conveniently forgetting that many portfolio investors had emphasized the stability that fixed rates brought to the local investment scene and not even the IMF had advocated a truly free float for Third World currencies owing to its fears of the inflationary pressures and other forms of economic instability this might generate.

But the agenda of the US has been bigger than advocacy of the freely floating currency, and this includes the accelerated deregulation, privatization, and liberalization of trade in goods and services in a part of the world which many American corporations regard as one of the world’s most protectionist and government-managed in economic orientation. Formerly, the economic clout of the Southeast Asian countries enabled them to successfully resist Washington’s demands for faster trade liberalization. Indeed, they were able to derail Washington’s push to transform the Asia-Pacific Economic Cooperation (APEC) into a free trade area. But with the changed situation, this may no longer be possible, and Washington may work via the IMF to complete the liberalization or structural adjustment of the economies where the process was aborted (with the significant exception of financial liberalization) in the late eighties owing to the cornucopia of Japanese investment. Indeed, even without prodding from Washington, in their desperate desire to keep foreign capital in the country, Thai authorities are pushing ahead with even more liberal foreign investment legislation to allow foreigners to own land and Jakarta has abolished a 49 per cent limit for foreign investors to buy IPO shares in publicly listed companies.

Under IMF tutelage, the Philippines is already the most structurally adjusted country in East Asia, and Thailand is now in the process of being radically liberalized by the IMF. If the crises in Indonesia and Malaysia deepen, then those countries will likewise be forced to go to the Fund, whose agenda is no longer simply stabilization but trade liberalization, deregulation, and privatization. In which case, Southeast Asia may be on the threshold of an era of minimal or low and fluctuating growth such as that which characterized Latin America and the Philippines in the period 1980-1993, when they underwent fairly comprehensive and thorough adjustment programs at the hands of the World Bank and the Fund.

Crisis and Opportunity

A final consideration is perhaps the most important one, and this is that the current crisis may in fact translate into opportunity for the progressive movement. For it opens up the space for people to once again entertain alternative paths to development, to strategies whose consideration has been blocked by the hold on the popular imagination of the illusion of permanently high growth rates, leading to the gradual amelioration of poverty and inequality, promoted by the model of foreign-capital-fueled fast track growth model within the context of accelerated integration of the local economy into the global economy.

o Controls on capital flows are the first step in any strategy, a defensive move that is a sine qua non for the success of an alternative development strategy. For as Singapore’s Business Times, a paper which is not exactly noted for radicalism has pointed out, “Short-term capital inflows are of highy dubious benefit when all they do is to finance asset inflation (stocks and real estate) and a nation is arguably better off without them.”

The so-called “Tobin Tax” (named after its proponent, the US economist Jame Tobin), a transactions tax imposed on all cross-border flows of capital that are not clearly earmarked as direct investment would help slow down the frenzied and increasingly irrational movements of finance capital. A slowing down of the movements of speculative capital would also be accomplished by a measure used by the Chileans and advocated by University of the Philippines Professor Solita Monsod: require portfolio investors to make an interest-free deposit of an amount equal to 30 per cent of their investment that they would not be able to withdraw for one or more years. This would make them think twice before pulling out at the scent of higher yields elsewhere.

The aim is not to discourage foreign direct investment. Such measures would create a strong disincentive for speculative capital to arbitrarily enter and exit, with all the destabilizing consequences of this movements, but would not penalize direct investors that are making more strategic commitments of their capital. Or as William Greider puts it, mechanisms like these “would not destroy globalized markets, but should greatly reduce the unproductive daily turnovers in currencies and other assets, thus increasing stability in money values.”

Foreign direct investment, of course, brings with it its own problems, and it must be managed by a related system of incentives based on, among other considerations, the strategic objective of acquiring technology. As with portfolio investment, it would pay to be critical, for as the Singapore business paper cited above warns:

Long-term flows can be of greater benefit but it is questionable whether allof the money that goes into so-called foreign direct investment (FDI) inmanufacturing and service industries is as long-term as it purports to be.The moment one country is perceived to be becoming less competitive than an emergent neighbor, FDI ca prove to be highly footloose and fancy free, as some ASEAN nations have already found. And the benefits it confers by way of technology transfer and productivity gains can be exaggerated. Such measures, however, would be just the beginning. Enacting and implementing progressive tax legislation is a medium-term measure that must be seriously undertaken, for as the same commentary underlines,

“The lesson that emerges with increasing clarity form all this is that developing nations, especially those that aspire to rapid development, must give priority to domestic resource mobilization. This means developing efficient (and honest) tax collection systems as well as promoting long-term savings (through provident funds and the like) to support a domesticbond market.”

Such measures must, in turn, be part of a larger program of asset and income reform, including effective land reform, that is part of a strategy of enlarging the domestic market to serve as the main engine of growth–something absolutely necessary now that chasing after export markets is being shown as a strategy with no exit except draconian efforts to cheapen wages and living standards in a race to the bottom that benefits only international investors.

There is in this, of course, the unfinished social justice agenda of the left, but it is one that is now impelled by the added logic of economic sustainability. Achieving conomic sustainability based on a viable and dynamic domestic markets can no longer be divorced from measures that promote equity. The post-Keynesian illusion of economic growth based on the formula of opening up export markets and beggaring one’s labor force must be banished once and for all, and this is the time to do it.

o There are many other elements to a development strategy, and this is not the place to make a detailed listing and analysis of these. But one cannot leave out of this brief discussion the principle of ecological sustainability. For the now discredited model of foreign capital-fueled high-speed growth is leaving behind little that is of positive value and much that is negative. As any visitor to Bangkok these days would testify, 12 years of fast-track capitalism is leaving behind few traces except industrial plant that will be antiquated in a few more years, hundreds of unoccupied highrises, a horrendous traffic problem that is only slightly mitigated by the repossession of thousands of late-model cars from bankrupt owners, a rapid rundown in the country’s natural capital, and an environment that has been irretrievably, if not mortally, impaired, to the detriment of future generations. Ecological sustainability, like equity, must be central to any alternative strategy of development that rises on the ruins of the old.

Of course, this program cannot become be credible unless it is materialized in a social and political movement driven by necessity, vision, and passion. But how such a movement is to be built is the subject of another paper by another, more qualified writer.

*Dr. Walden Bello is professor of sociology and public administration at the University of the Philippines, co-director of Focus on the Global South, a progam of policy research of Chulalongkorn University in Bangkok. He is the author of Dragons in Distress: Asia’s Miracle Economies in Crisis (London: Penguin Books, 1991) and several other books on Asian economic and political developments.