to balance sheets in the region and what will be required to remedy that. financial sector adjustments what has been highlighted by the asian crash is the extent to which asian growth has been debt fuelled and has proceeded on structures that were inherently risky. assumptions were made about the ability of asian governments to shelter entrepreneurs from those risks. those assumptions proved ill - founded. deals that involved borrowing in low - interest foreign currency terms to invest in rapidly inflating domestic property assets, for example, were premised on exchange rates remaining fixed, and property prices continuing to inflate. other investments in manufacturing capacity were based around assumptions of continued rapid growth in demand, continued access to loan funding, plus stable interest and exchange rates. it was a good formula while it lasted, but it could not last. estimates of the extent of balance sheet damage done in the asian collapse carry wide margins of error, largely because asset prices remain uncertain and accounting and auditing conventions do not always provide reliable guidance as to the health of entities. however, even in accepting those wide margins of error, it seems plausible that, within the region ’ s financial sectors alone, losses have been incurred which are equivalent to something of the order of 25 to 50 percent of gdp. even for japan, non - performing assets of the banking system ( not all of which will become ‘ losses ’ ) are estimated by one of the credit rating agencies at 30 percent of gdp. the usa treasury estimates for total non - performing assets of japan ’ s banks run to a more modest 20 percent of gdp. by comparison, the usa savings and loan problems of the early 1990 ’ s involved losses of around 3 percent of usa gdp, and the scandinavian financial sector collapses of the same period ran closer to 6 to 8 percent of gdp. to find anything comparable to what has happened to asia, we have to look to the argentinian crisis of the early 1980 ’ s which led to loan losses of the order of 50 percent of gdp. it is difficult to see how robust growth can resume in asia before these equity holes are filled. the obvious question is how to achieve that. specifically, where will the money come from? first, we need to recognise that not all such losses need to be ‘ replaced ’. the financial sectors in much of asia were almost certainly rather larger than needed and therefore don ’ t need to be fully ‘ replaced ’. indonesia, for example, had something like 240 banks servicing an economy which, at its peak, was little more than

three times the size of new zealand ’ s. as in other parts of the region, most of those banks are insolvent. but it will not be necessary to rebuild the capital base of each to bis standards. without wishing to diminish the magnitude of the task, many, if not most, of those banks can probably be allowed to disappear, through mergers or closures, without impairing the effective functioning of the economy. indeed, the priority throughout the region is to quickly resurrect functioning and trustworthy financial systems around a small core of robust institutions. even that will require enormous equity injections. where will that equity be found? the options are reasonably clear cut : • • • • • shareholders of banks creditors ( i. e. depositors ) of banks the public purse domestic investors foreign investors but those options are somewhat constrained. in essence, existing shareholders have, to use the vernacular, ‘ lost their shirts ’. some private shareholders may be able to contribute additional capital, but most will not. for the most part, the depositors of banks in the region have already received public guarantees on their deposits. there seems little prospect that they will be obliged or allowed to share directly in the losses accrued. the public purse is the mostly likely source of substantial, and early, new equity. most countries in the region went into this crash with relatively light public debt loads. most could probably absorb an additional debt burden of, say, 10 to 20 percent of gdp equivalent in order to recapitalise banks and deal, at least in part, with the bad debts. in so doing, they would, in effect, socialise the losses, and spread the impact of the economic collapse over the next decade or two. of course, as conditions improve, and perceptions grow that the worst of the shock is over, private investors will be increasingly willing and able to reinvest, enabling the governments to withdraw from direct ownership and retire at least some of that debt. whatever view one takes of the desirability of public investment in financial institutions, it is difficult to see how this particular option can be avoided given the magnitude of the problems that have emerged, and the profound lack of confidence on the part of private investors which now exists. indeed, this process of public capital injections is already well under way in korea, thailand and indonesia. japan, it seems, is still struggling with the concept. asia ’ s domestic private investors, for the most part,