|Politik und Gesellschaft Online
International Politics and Society 2/1998
Diverging Ills - Diverging Remedies
Vorläufige Fassung / Preliminary version
Between 1991-92 and the beginning of 1997, most Asian countries
have experienced a real appreciation of their currencies, vis-à-vis
the US dollar or vis-à-vis a trade weighted basket of the
currencies of trading partners, as shown below in Table 1.
Real appreciation is not systematically linked to currency
In most cases, real parities have fluctuated quite wildly from
1992-93 onwards. Countries can be classified into several groups:
China is a case apart because of the unification of exchange
rates in 1993. This led to a very sharp devaluation and boosted
competitiveness substantially. Since that point in time, the exchange
rate has experienced a real appreciation.
Among the 10 countries, only China and Hong Kong have not experienced
a visible depreciation against the dollar since the summer of
1997. The 7 other countries have seen their currencies depreciate
massively against the dollar since the end of the first half of
1997. Note that the depreciation has been automatic in Singapore
since the Singapore dollar is pegged to a basket of currencies
weighted in terms of exports. It therefore includes neighbouring
countries whose currencies have been attacked.
If the analysis is restricted to the 6 countries whose currencies
have come under attack (Malaysia, Thailand, Philippines, Indonesia,
South Korea and Taiwan), it is noteworthy that the last two had
not been subject to real appreciation. Another point of interest
is that the real appreciation in Hong Kong and Singapore has not
resulted in the currency dropping below the level desired by the
authorities. If real appreciation is a frequent occurrence, there
is no systematic link between an excessively strong currency and
the breakout of exchange rate crises.
Except in the case of South-Korea, external deficits are consistent
with the trends in competitiveness
When analyzing the evolution of the external deficits, one can
again devide the countries into three groups :
Is there a link between a country's competitive position and its
current-account balance? Countries having suffered from a sharp
drop in competitiveness (Philippines and Hong Kong) have substantial
trade deficits (in 1996, 14% of GDP in the Philippines, 10% of
GDP in Hong Kong) even though their current-account balances are
far smaller. Countries with a moderate deterioration in competitiveness
(Malaysia, Thailand, Indonesia and Singapore) all have trade deficits,
although Singapore's is masked by capital income. Countries with
steady or sound competitiveness (Taiwan and China) enjoy trade
surpluses. Only South Korea displays an "abnormal configuration:
trade deficits but favourable competitiveness, as has been seen
above. We will later link this situation to trends in domestic
In nearly all cases, the expected link between competitiveness
(real exchange rate) and trade balance is found: deficits in the
event of real appreciation, surpluses in the event of favourable
Capital inflows account for the accumulation of foreign reserves
Let us begin with countries suffering from a persistent current-account
deficit. In Malaysia, foreign reserves grew markedly until
end-1993 before ebbing at virtually the same pace as the current-account
deficit. In Thailand, despite very high deficits, reserves
increased until mid-1996 before plummeting. In the Philippines,
despite the deficits, reserves have been rising slowly. In Indonesia,
despite the worsening current-account deficit from 1995 onwards,
foreign reserves have ballooned. South Korea's current-account
deficits in 1994-96 (a cumulative USD 37 bn) grew even as foreign
reserves rose by USD 15 bn.
Let us now look at countries with surpluses: Singapore's foreign
reserves have grown at the same pace as its current-account surpluses,
Hong Kong's twice as fast. Taiwan has accumulated fewer reserves
than cumulative current-account surpluses (USD 30 bn against USD
59 bn from 1990 to 1996). China's foreign reserves have risen
dramatically since 1994, up by USD 105 bn, whereas its cumulative
current-account surplus was only USD 26 bn. The most blatant anomalies
therefore concern Thailand, the Philippines, Indonesia and South
Korea - where current-account deficits have been recorded even
as foreign reserves grew - and Hong Kong and China, where the
rise in foreign reserves has outstripped the current-account surplus
significantly. The situations of Malaysia, Singapore and even
Taiwan are far more normal.
In a high number of cases (Thailand, Philippines, Indonesia and
Hong Kong), the fact that capital inflows enabled foreign reserves
to rise even at a time of current-account deficit is due to the
pegging of the nominal exchange rate to the dollar: In China,
the nominal exchange rate can be said to have been fixed since
mid-1994, and this coincides with a surge in foreign reserves.
In South Korea, the nominal exchange rate has not been fixed but
foreign reserves have nevertheless grown very rapidly.
When the balances on capital flows are examined (Tables 2 and
3), it can be seen that this is due to direct investments in China,
which have been substantial since 1993. In the case of South Korea,
this is due in particular to financial inflows from the banking
sector. When one looks at the other countries with an "abnormal
accumulation of foreign reserves (Thailand, Philippines and Indonesia),
it can be seen that direct investment has been low and financial
capital inflows very high (notably in Thailand).
Countries which have accumulated foreign reserves despite current-account
deficits are countries that have received substantial financial
capital inflows while direct investment has been weak.
What is the link between capital flows and the level of interest
rates? Most of the countries (Philippines, Indonesia, Thailand,
South Korea and China) have experienced, during the 1990's, short
term interest rates well above the level of US rates : around
10% in the Philippines and in Thailand, 15% in Indonesia, 9% in
Korea, 11% in China, but China's case is different since there
is no convertibility.
Not surprisingly, Thailand, Philippines, Indonesia and South Korea
have had large financial capital inflows, drawn by high returns.
In all these countries, the nominal exchange rate has remained
virtually pegged to the dollar (in South Korea only until early
1995). When the nominal rate is pegged and interest rates are
high in relation to US rates, financial capital is attracted as
the country's currency is deemed similar to the dollar but with
a higher return. In Singapore and Malaysia, conversely, interest
rates have been low and speculative capital inflows have not appeared.
On the contrary, capital outflows have been recorded in Singapore.
Investment and growth: very rapid increase has been the rule
A distinction can be drawn between countries in which a substantial
investment drive has promoted very rapid growth and the others.
Malaysia, Thailand, Indonesia, Singapore, South Korea and China
are in the former group, with average growth of 8-11% and investment
often exceeding 10% per year.
In the Philippines (average growth of 2.9% p.a.), Hong Kong (5.1%)
and Taiwan (6.3%), real growth has been more reasonable with investment
rising by what could be called a mere 5-10% p.a.
Note that rapid growth does not always entail the appearance of
a trade deficit; this has not occurred in China and Indonesia.
Conversely, moderate growth can coincide with trade deficits,
as in the Philippines and Hong Kong. In the Philippines, however,
growth and investment have accelerated since economic reforms
were implemented in 1994.
Although China is in the high-growth group, its export capacity
has prevented any deficit from appearing. In cases where deficits
occur despite modest growth, real appreciation in the exchange
rate is the main cause.
Real overvaluation as a way to finance unbalanced growth
Table 4 summarizes the results we have obtained. What does it
show about the origin of the currency crisis and the role of real
China, Singapore and Hong Kong are the only countries so far to
have been spared a currency depreciation. China displays none
of the worrisome characteristics of the other countries. Even
though growth is rapid, there is no trade deficit and capital
inflows are direct investments. In Singapore, there is both real
overvaluation and a trade deficit, but no current-account deficit
thanks to capital income. There is no sign of unstable external
financing - quite the contrary in fact.
The situation is slightly more worrisome in Hong Kong as its
currency is highly overvalued and its trade deficit is substantial
but it has not run up a current-account deficit. The authorities'
strategy seems to be to try to curb the deficit by discouraging
capital imports in driving down prices of assets (stock market
and real estate). The authorities also undeniably enjoy great
Some of the countries show most of the possible unfavourable
characteristics: overvalued currency, external deficit, financing
by short-term or speculative capital attracted by high returns
and very rapid growth. This applies especially to Thailand, the
Philippines and Indonesia.
* not in the current account balance.
** in relation to the cumulative current-account balance.
*** since 1995.
In these countries, the economy has been financed by short-term
or speculative capital. The strategy to attract this type of capital
has been quite straightforward: propose an attractive return with
high interest rates and peg the currency nominally. Real overvaluation
was therefore a prerequisite for them to attract indispensable
external financing of growth. In the long term, the strategy proved
to be disastrous since it hurt foreign trade and triggered a pullout
of foreign investors.
In South Korea, there has been no real appreciation, at least
in recent years, thanks to the exchange rate's relative flexibility.
Nevertheless, after two years of very robust growth (1994 and
1995), a substantial trade deficit appeared along with huge financial
capital inflows. Apparently, foreign lenders were sufficiently
confident to obviate the need to let the currency appreciate in
real terms, unlike what occurred in other Southeast Asian countries.
Lastly, Malaysia and Taiwan seem to have suffered more from contagion
effects than pronounced macroeconomic imbalances. Malaysia's external
deficit is entirely covered by direct investments and Taiwan has
avoided currency overvaluation, deficits and an influx of capital.
There is therefore no systematic link between real appreciation
and currency crisis. Some countries were affected by contagion,
others can cope with real appreciation thanks to other sources
of income. Conversely, the financing structure can be unbalanced,
like in South Korea, without entailing overvaluation of the currency.
However, stability in the nominal exchange rate against the dollar
has enabled several Asian countries to attract the capital required
to underpin robust growth when domestic savings were insufficient.
Overvaluation permitted an unstable financing of excessively robust
Diverging paths out of the crisis
The analysis implies that, in a medium-term perspective, the
situations of the different Asian countries will probably diverge:
© Friedrich Ebert Stiftung | technical support | net edition bb&ola | April 1998