Mr. George gives a central banker's response to the Asian crisis  (Central Bank Articles and Speeches, 28 May 98)
Central bank: boe | Type: speech | Date: 1998-05-28

Mr. George gives a central banker's response to the Asian crisis Speech by the Governor of the Bank of England, Mr. E.A.J.

George, at the Foreign and Colonial Emerging Ma Conference, in London, on 28/5/98.Thank you, Mr Chairman.

I'm delighted to participate in this Emerging Mark Conference, sharing the platform with such distinguished company.

I am particularly pleas joined in this session by Guillermo Ortiz - my colleague from the Bank of Mexico.The particular examination question which you set me is: 'How did an OECD cent banker respond to the Asian crisis?'.

I have to confess that it's a somewhat embarrassing q I'm brutally honest I have to acknowledge that I didn't see it coming; I played a mode helping to contain its immediate impact on global financial stability; and I'm still s understand its implications, in terms both of its economic after-effects, and of the less all learn to reduce the risks in the future.

I would only plead in mitigation, your honour, no means alone in all of that; and I beg leave to join in my defence all my centra colleagues, governments and Finance Ministry officials, in Asia and elsewhere, the inte financial institutions, and the world's financial markets.The storm last year in Asia struck essentially the ASEAN four - Thailand Philippines, Malaysia and Indonesia - spreading subsequently to South Korea and intermi battering Hong Kong and elsewhere.It is still not wholly clear - to me at least - quite why the storm struck sud it did.

Most crises of this sort have their origins in some evident macro-economic policy least in hindsight there are usually fairly clear tell-tale signs of expanding fiscal def monetary policies, classically accompanied by evidence of imbalance in the form of acce inflation or a rapidly deteriorating balance of payments.

There were such signs, perhaps mo in Thailand; but they were not for the most part particularly pronounced in Asia.

Some perhaps understand better than I do why the initial infection proved to be so contagious. all your money!In fact through the first half of the 1990's, and in some cases for much lon countries in question had been remarkably successful.

They attracted, by their very succ inflows of capital from the rest of the world, where yields had fallen, in the hope of ach returns.There is no question that this capital inflow made a very big contribution remarkable economic expansion in Asia and hence to the global economy; but with the bene hindsight, the accelerating scale of the inflow, and particularly the forms that it too important part of the problem.

It was not all in the end productively employed.

Th over-investment in some sectors; much went into ambitious property development; and much into financial assets, including short-term foreign currency claims, rather than into rea hoped-for higher returns could not be maintained.Again with the benefit of hindsight, it is possible to identify a number of weaknesses in the mechanisms for financial resource allocation in the recipient countries. for example, a general lack of reliable financial information, and a lack of transparency i the financial position, of both public and private sectors.

Complex and opaque links government, financial institutions and non-financial companies made it difficult for ou understand the real nature of their exposures.

Financial markets were not well developed, l system heavily dependent upon the banks.

There was inadequate regulatory or supervisory oveThere was widespread, often informal, government influence over financial flows, which impo also contributed to a perception that much of the borrowing was implicitly under-writte government.

The list could go on.The problem was compounded by the absence of any real perception of exchange ra risk.

Borrowers were evidently confident that governments would maintain their exchange ra against the dollar, even when the dollar itself began to strengthen, so that unhedged fore debt, much of it at short-term, appeared to be a cheap alternative to domestic currency The result was a build-up of short-term foreign currency liabilities, by banks and non-ba was not fully appreciated, and which left the Asian economies especially vulnerable to a capital in the event of a change in sentiment.

The particular problem is that while nationa can create their domestic currency, if they choose to do so, even if it leads to inflatio simply create foreign currencies in the same way.So, once the run started, it was violent and contagious.

For a time around th last year there was a significant possibility of a chain of default emanating from Asia tha reverberated right through the global financial system.

The immediate task was to contain tEssentially there are two broad options for dealing with a foreign currency cri is simply to allow financial markets - exchange markets, interest rates, and stock and bond take the strain, and to seek to restore confidence, and to moderate the impact of market m by restrictive macro-economic policy adjustment in the affected country.

The second is to t the financial market impact and the extent of the associated macro-economic adjustme providing or arranging alternative external financing.

In practice these options are not mutually exclusive and the real question is the appropriate balance between them.Where a country has transparently been pursuing an unsustainable macro-econom policy, most people find it easy to accept that that country should bear the burden and ad though that may be.

Many people find this harder to accept where, as in the presen conventional macro-economic policies had, for the most part, been relatively responsibl were certainly adjustments to macro-economic policy that needed to be made - a more fl exchange rate regime in some cases, for example, or a somewhat tighter overall macro-ec stance, with perhaps some adjustment between fiscal and monetary policy.

And, once the outflow had started, macro-economic adjustment had to be harsher than might otherwise hav necessary, in order to re-establish confidence.

But there are real dangers in extre movements or in excessively severe macro-economic adjustment to contain them.

The politic social consequences are all too apparent in parts of Asia; but even without that there is vicious circle of domestic default and systemic financial weakness in the affected country could have seriously adverse implications - in terms of both financial and economic knock-o - for the global economy.That, essentially, is why it may be in the self-interest of the international to attempt to mitigate the market and macro-economic adjustment pressures by providing fi support.

It is why the international community responded to the crisis in Asia by promptl very large amounts of official assistance - $17 billion in the case of Thailand, $43 Indonesia and $57 billion for South Korea.

This kind of official assistance of course is es the international financial institutions and for governments - though central banks ar channel for bilateral financing, as the Bank of England is, for example, in the case o contribution to the bilateral support for Korea.But such official financial help cannot be unlimited and it cannot be provided strings.

It, too, has real dangers.

If it were too readily forthcoming it could encouhazard', especially by encouraging commercial lenders - particularly foreign currency cred the belief that they will be bailed out if things go wrong.

That would be likely to add to of potentially volatile capital inflows next time around.

Not surprisingly, too, there is resistance in many countries, including notably the United States, to the idea that public money should be used to bail out private creditors, especially foreign creditors.External financing need not come solely from the public sector.

Private f would serve the same purpose, and in many situations market price adjustments may be suffi stem the capital outflow.

But, given the extent of the loss of confidence in the Asian case private financial support meant in practice persuading existing creditors that their asse better protected if they were prepared to leave them in place, especially if other ma creditors agreed to do the same, and if official support were made available in parallel case, too, difficult judgements have to be made.

There is a danger that, if private cred effect to be coerced into staying put, they will immediately cut their positions elsewhere still could, thereby adding to the international contagion.In fact, in the critically important case - because of its size - of Korea, th massive official support failed to restore market confidence.

And when it became apparent official bilateral financing was in practice available only as the very last resort we central banks as the immediate intermediaries - had to turn to the commercial bank lende major creditor countries and persuade them to extend the maturity of their loans.

Like mos it was a dangerous moment.

But the banks' constructive response went a long way to stabili immediate situation in relation to Korea - and thereby to the region as a whole.

The cred are also now in negotiation with Indonesia's bank and commercial non-bank debtors.I can't pretend that we are completely out of the wood in terms of the e financial crisis in Asia, but there is now at least a good deal more light between the treeInternational attention is now extending to managing the economic fall-out fro year's financial disturbances, against the background of the longer-standing financial and fragility in Japan - which is of course the largest economy in the Asian region.

The concer part to the implications for global economic activity; but it relates importantly, prospective external payments imbalances within the global economy which will need to be h very carefully if they are not to lead to trade frictions and/or exchange rate volatility.But attention has also turned to an intensive reappraisal, in all sorts of i fora, of more effective means of preventing, and managing, such situations in the future.It would have been understandable in the light of the Asian experience if th been some turning back from the path towards greater freedom of international capital mov and there has been some suggestion of this.

But on the whole the international debate central banks as well as governments are actively involved - continues to recognise the benefits of free capital movements and the contribution that they can make to global e prosperity.

The mood is to continue cautiously down that path, but to emphasise the need, for sound macro-economic policies, which everyone accepts as a sine qua non , but also for steps to accompany capital account liberalisation designed to reduce the risks of volatility.These relate in part to the process of capital account liberalisation, wher now a good deal more stress on 'sequencing' - that is on liberalising potentially mo longer-term, capital inflows initially, rather than short-term borrowing denominated i currency.But they relate particularly to three key conditions for living with fre movements.The first is 'transparency'.

In a broad sense a need for greater transpa recognised in relation to public policy, to the relationship between the public and privat corporate governance, accounting standards, and so on.

In a narrower sense there is seen to for more reliable, and greater and more timely disclosure of, financial information gener level of individual borrowing entities, but especially also in relation to countries' exchange short-term asset and liability positions.

This is especially important in rel foreign currency liquidity position of the monetary authorities and of the banking sys general point is that we cannot reasonably expect markets to make a proper assessment of of their investments, including particularly their short-term lending if they do not ha information in accessible form, so that we need to provide appropriate incentives for co provide such information.

The corollary is that where they do have adequate information, market participants can be expected to accept the penalty if their judgements prove ill-f indeed they largely do already in respect of many forms of overseas investment.The second condition for more stable capital flows is stronger financial syste includes for example the broadening of capital markets so that the allocation of capi concentrated on local banking systems.

It includes robust financial infrastructure - f payments and settlements systems.

And it includes crucially more effective financial regul supervision.

A key feature of future arrangements for me in this area is the encouragemen of more published information about the short-term foreign currency assets, relative to li the public sector and the banking system, but more positive management of the country's currency liquidity position, taking account of the nature of the exchange rate regim weaknesses in this area, above all, in my view that turned the Asian financial problem intoThese various steps - which need a great deal of elaboration and refinemen themselves represent a huge agenda for the future.

But however much we try to prevent accid need nevertheless to be prepared for them to happen.

The third condition for living with f capital movements, therefore, is a more consistent view of how, when a crisis does break, t might be expected to be shared in future between official and private sector financing.In this context, one thing seems clear: given the evidence of public resist cannot assume that massive official financing packages will in fact be deliverable in th bail out private foreign currency creditors.

Various ideas have been put forward for involv foreign currency lenders in an extension of maturities in case of a serious foreign excha perhaps within a framework of insolvency principles or some other form of code of practic ideas, too, need to be developed and refined; and we need to establish suitable incen conditions to ensure that the financing burden is in fact shared between official and pr creditors.

The general point here is that it may help to discourage excessive, potentia short-term foreign currency lending in future if the lenders clearly understand from the they will indeed be expected to carry a substantial part of the load.Mr Chairman, the debate on all these issues is still at a relatively early st being carried forward seemingly whenever two or more monetary officials, or indeed private analysts or commentators, are gathered together in one place.

It is a key part of t international monetary agenda, and as the debate crystallises into policy consensus, it wil important element in the environment in which you take your decisions on investment emerging markets.

I have no doubt that massive capital flows to the emerging markets wi continuing feature of the financial landscape - it is in the long-term interests ofcountries, the investing community, and the world economy that they should.

The task is introduce greater stability into the process.