Hoover Daily Report

Asia's Dramatic Recovery

Monday, June 5, 2000

East Asia's recovery in 1999 and 2000 has been no less dramatic, though much less publicized, than its economic reversals in 1997 and 1998.

Triggered by the collapse of Thailand's baht in July 1997, four economies that had high positive GDP growth in 1996 experienced negative growth (between 5 and 12 percent) in 1997 and 1998. Asset values in these "crisis" countries—Thailand, Korea, Malaysia, and Indonesia—plummeted by about 75 percent owing to currency depreciation, deflated equity, and property valuations. Averaging over the four economies, an asset worth $100 in June 1997 was worth only $25 a year later.

The turnaround of the East Asian economies by the second quarter of 2000 was extraordinary. Korea, Thailand, and Malaysia currently have growth rates equal to or above those of 1996. Indonesia's growth—about 5 percent annually—is surprisingly high as well as shaky because of civil and military unrest in Timor, Atjeh, and Ambon and the ambiguous position of Indonesia's military establishment.

Other indicators of the recovery's strength abound. Capital inflows have resumed, in the form of direct investment rather than debt. Korea, for example, which was almost closed to foreign direct investment before the turmoil of 1997, received $15.5 billion in FDI in 1999, five times the level in 1996. The current accounts of the four economies are now positive, their foreign exchange reserves are above those held in 1996 (except Indonesia), and their currencies, whose exchange rates are now flexible rather than artificially pegged, have regained 50 percent or more of their precrisis values.

The recovery is all the more impressive because the Japanese economy—long viewed by many as the essential engine for East Asia's recovery—continues to stagnate.

Although the East Asian economic picture is rosy, serious soft spots still exist in addition to Indonesia's problems. Korea's large and amorphous chaebols still require reform, as well as explicit nonpreferment in access to credit or other benefactions. One-third of Thailand's bank loans are "nonperforming." Malaysia's Mahathir has perhaps only temporarily backed away from his belief in tightly regulated capital markets.

Nevertheless, the upward trajectory of the Asian economies is likely to endure because of five lessons—four tactical and one strategic—that appear to have been learned from the debacles of 1997–98. (1) As a form of foreign capital inflow, direct investment is far preferable to debt. (2) When borrowing abroad, the repayment period should not be shorter than the yield from the uses to which loans are put . (3) Don't borrow in foreign (hard) currency for purposes whose yields do not generate foreign currency, (at least not without ample foreign exchange reserves). (4) Don't peg domestic currency to the U.S. dollar (unless fiscal and monetary policies and institutions are strong enough to support the peg). (5) In charting development strategy, eschew the so-called Japan development model, which predicated resource allocations not on the basis of market criteria of costs and returns but on nonmarket-based preferment for particular firms or industries.