Prasarn Trairatvorakul: Post-crisis recovery - Asian lessons for Europe
Speech by Dr Prasarn Trairatvorakul, Governor of the Bank of Thailand, at the OMFIF
Golden Series Lecture, London, 12 September 2012.
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Distinguished guests,
Ladies and Gentlemen,
I am honored and delighted to be part of the Golden Series Lecture and would like to
thank OMFIF for the kind invitation. Events such as these provide an opportunity for us
to exchange views on topical issues that are at the center of international finance and I am
keen to learn from the perspective of our audience.
Fifteen years ago the Asian crisis forced us to go through painful adjustments and far
reaching economic and financial reforms. We had to embrace legal, regulatory and
governance reforms, while our business sector had to deleverage and our bankers
became much more prudent and risk conscious. Today, the world is witnessing another
crisis not dissimilar to ours and I have been asked to share with you some lessons from
the Asian financial crisis. This is somewhat ironic as we in Asia look to Europe as a role
model and a benchmark in our integration efforts. Individually we are all small states and
find it difficult to compete for foreign investment without the attraction of size and economy
of scale. So my talk today will be a modest contribution to the current debate on the
challenge of post crisis recovery.
I will start with a brief recap of the Asian crisis, drawing some lessons and comparison with
the European debt crisis. I would briefly discuss the economic setting and policy reform that
brought Asia out of the crisis and end with some thoughts and reflections on the post
crisis recovery period.
Ladies and gentlemen,
As a well-known American author, Mark Twain puts it, "history doesn't repeat itself, but it
does rhyme". So despite the differences in the context and details of both the Asian and the
European crises, the underlying root causes are not dissimilar.
First, both crises, like most others in the recent economic history of the world, are often
associated with the mispricing of risk and distorted incentives structures.
In the case of Asia, our problem was both a currency and a banking crisis. We had to
abandon the pegged exchange rate system which led to massive devaluation of our
currency. With the corporate sector largely overleveraged and loaded with foreign debt, the
sharp depreciation of the currency technically bankrupted firms overnight. Banks NPLs
shot up and brought on with it the banking crisis. It was clear that the region's "original sin"
was well beyond redemption. We borrowed in foreign currencies and used it to finance
projects that did not generate foreign exchange earning to service such a debt.
In the case of Thailand, the amount of private external debt was over three times the level of
international reserves. Given the healthy public finances in Thailand (with 9 years of
fiscal surplus prior to 1997), the expanding foreign private sector debt was interpreted as
a sign of euphoria and confidence in the emergence of a new tiger of Asia.
In Europe, a similar story of mispricing occurred when some peripheral nations were
able to access financing at a much cheaper rate than the country's underlying credit
rating would have allowed them to do so - and this was made possible out of sheer
membership of the Euro zone. A single currency and a convergence in risk rating, like our
fixed exchange rate, gave the market a false sense of security that encouraged borrowing
beyond our means and without proper risk management.
Second, both crises occurred as a result of a failure to fulfill the necessary "pre-conditions".
In Asia, they were preconditions for liberalization, and in Europe they were preconditions for
integration.
A number of Asian countries embarked on ambitious liberalization programs with insufficient
safeguards, appropriate infrastructure and policy tools. Liberalizing capital flows while still
maintaining a fixed exchange rate system eventually ran up against the impossible trinity.
The country must give up control over monetary policy. Recourse to macroprudential
policies to stem the excessive bank credit expansion and asset price inflation, was not
well-known then.
Along the same line, the currency union proceeded without the necessary preconditions for
integration. Countries entered the union with large diversities both in terms of economic
development and competitiveness, and in the absence of fiscal, and banking union.
On the whole, these countries were victims of their own success. The "reckless optimism"
prior to both episodes of crisis had ultimately led the countries to face similar
consequences of severe market stress and capital flight, albeit with different symptoms:
for Asia, losses incurred in the private sector's balance sheet, for Europe, public sector
balance sheet was impaired.
Ladies and gentlemen,
Let's now look at how Asia got out of the crisis and whether such conditions are
available for Europe.
At the onset of the Asian crisis, Indonesia, Korea, and Thailand built up large private short
term external debt while high private credit growth fueled the bubble in the stock and
property markets. Once the crisis hit, these countries faced sharp capital reversal of up to
10% and 12.5%1 of GDP in 1998 for Korea and Thailand respectively and a massive
devaluation of the currency soon followed. Some of us were forced to seek international
assistance (IMF) or, in the case of Malaysia2, to undertake rigorous self-reform and an
eventual unorthodox measure on exchange and capital flows.
Notwithstanding the different approaches, these steps were all painful yet critical for
economic recovery. By 1998, the current account balance of the four countries became
positive, helping to improve the national account and restore consumer confidence. GDP
growth subsequently returned to positive territory by the second quarter of 1999.
Two differences stand out between Asia and Europe.
The first is policy flexibility. The devaluation of the exchange rate helped restore export
competitiveness of the Asian economies. However, this freedom of flexibility might not be
practical for Europe given its single currency setting and political complexities.
The second is the supportive global economy, which provided the necessary market for
Asia and allowed Asia to export our way out of the crisis. Global GDP registered a
4.7% growth in 2000 with advanced economies, the world's largest consumer, growing at
4.1%. In contrast, the global setting of the current European sovereign debt crisis is not
as favorable. Global and advanced economies growth turned to a negative territory of
0.6% and 3.4% respectively in 2009. Emerging and developing economies, increasingly
feeling the pinch of the global slowdown, witnessed the continued slowdown of their GDP
growth from 8.7% in 2007 to just 2.8% in 2009.
I believe that there may be other success factors for the European story. But, we have to
bear in mind that some of the success factors are not without costs that remain to be
addressed. In the case of Asia, the sharp devaluation and swift recovery in exports led the
Asian economies to become addicted to large volume of export at low prices. And, in the
case of Thailand, with little incentive to invest in research and development to raise the
products' value and enhance human capital, the average growth of labor productivity3
had trended down from the 1990s to 2000s.
Ladies and gentlemen,
This brings me to my third part on the lessons from the Asian financial crisis. I would like
to offer three reflections that may not necessarily pertain to Europe but may provide
food for thought for policymakers.
First, conventional policy prescriptions may not be appropriate for unusual circumstances
and there is no one-size-fits-all solution. Asia was a case in point of ill-timed austerity
measures. Public sector debt in Thailand then was less than 15% of GDP; yet the
policy prescription for Thailand was to tighten fiscal policy and maintain tight monetary
policy, resulting in (interbank) interest rate rising from 10% at the beginning of 1997 to over
20% at the end of 1997. With large private external debt beyond the ability of the country to
service, a way out should have been debt restructuring with international creditors to give the
country a breathing space and avoid the painful shock from the sharp reversal in capital.
This was made possible only in the case of Korea which has helped the country recover
from the crisis and was able to bring down interest rate much faster than other crisis
countries.
The case of Indonesia further led the IMF to reform towards more careful and focused
policy prescription. The abrupt close-down of Indonesian commercial banks under the IMF
program added to a sense of panic, which led to a broad-based bank run. Moreover, the
conditionalities did not focus on the more critical macroeconomic adjustments which
were directly related to the problems of the crisis but also included unrelated changes
such as requirement to abolish import restrictions on all new and used ships.
Secondly, policymakers must be ready to take away the punch bowl. In the past we used
to talk about monetary policy being on the alert to take away the punch bowl. This crisis
has proven that public policy in general need to observe this principle as well. Fiscal policy
must guard against falling into the populist trap. Financial supervisors also need to be vigilant
and watch out for signs of excessive credit creation, and act pre-emptively for the cost of
cleaning up the crisis far outweigh the brief euphoria and exuberance of the moment.
Central bank must maintain independence and credibility in order to voice and conduct
appropriate policies that may not be favored politically. Going forward, I view that there is
a need for international institution that oversees all finance-related conducts to ensure
strict compliance of rule, implementation of ethical codes and avoid double standard across
nations.
Lastly, continuous and collective reforms are vital. Crisis is a recurring phenomenon and
no lessons from previous crisis will ever fully prevent the next one. But through the
process of reform after each crisis, the market grows and becomes more efficient.
Crises provide a window or "political feasibility" to undertake needed structural changes that
may be hard to sell to the public in normal circumstances, so one should not waste a
good crisis. I am pleased to see numerous improvements in key areas of finance and
supervision such as the use of macroprudential measures to complement traditional monetary
policy tools. It is also more acceptable to require banks to provision in good times against
losses in bad times, for after all most bad loans are made in good times.
In addition to structural reforms, change in "mindset" is probably the most important. In order
to keep up with the dynamic global environment, we may need to challenge and correct
some of our old beliefs. Let me name a few - 1) sovereign is no longer risk-free, 2) we are
taught to value economies of scale but are now confronted with the too-big-to-exist problem
and 3) banks should no longer be only international in life but also in death as crises are
more and more systemic given the growing interconnectedness. Spillover and contagion
were witnessed in 1997 where the turbulence spread from Thailand to South East Asia
and to Russia, China and Brazil, as it was a decade later in 2007 where the crisis widened
from US and EU to the rest of the world. Imagine the pace of the spread of crisis in the next
10 years in 2017 - where crises would grow in size and speed beyond the management
capacity of a single nation, real collective action is called for.
Most importantly, we have to be forward-looking and well prepared. As crises are prone to
occur more frequently with larger spillover, reform must be continued during normal times. It
is imperative that the public is on board and support the reform effort to raise the
competitiveness of the country, and minimize vulnerabilities or imbalances that may be
triggered by external factors through no fault of their own.
Ladies and gentlemen,
Let me conclude by offering an observation that in 2002, five years after 1997 crisis,
Asian economies had fully recovered, in particular, Thailand was able to repay the IMF
package some two years ahead of the schedule. Today, four years after the Lehman
crisis, more work remains ahead of us. At this critical juncture, it might come down to
policy action, which entails clarity, commitment and credibility, to progress onwards.
Indeed, there are always benefits from looking back to the do's and don'ts in the rear
mirror but it is of greater importance to be looking forward in the windshield. As such,
for Asia and other non- crisis country, in this era of growing uncertainties, complacency is
a luxury we can ill afford.
Thank you.