IMPLICATIONS FOR THE ESCAP REGION

In the immediate future, it is the crisis in Asia, together with its eventual resolution, that is likely to have the biggest and most direct impact on growth and stability in the region and, indeed, on the global economy as a whole, rather than events elsewhere. At the same time, it is as well to be aware that the speed and ease with which the crisis can be resolved will be partially determined by developments in the global economy.

Export prospects

Economies in the ESCAP region that together account for around one fifth of global output are in recession. As a result, demand for imports has been severely constrained in 1998. Table I.3 gives a broad overview of trends in merchandise exports from major ESCAP economies up to the middle of 1998 (the latest information available at the time of writing). Commodity price declines have lowered the value of exports. Declines in the real effective exchange rates of some of these economies from pre-crisis levels imply significant improvements in competitiveness, but the data in table I.3 do not indicate any major supply response because of the constraints noted earlier. Besides, to what extent trade flows are responsive to exchange rate movements cannot be considered separately from the demand side. Thus, for example, slowing world demand for imports may stifle an export-led recovery of output. In particular, should the United States economy slow down significantly or reduce import growth over the coming months, the chances of such a recovery in the Asian region would inevitably recede further into the future. Doubts have been expressed about the sustainability of United States imports, one of the main props of global trade growth in 1998. These rose by more than 10 per cent year-on-year in the first three-quarters of 1998, more than twice the world average. It is obvious that some slowdown in United States import growth will occur in 1999.

More generally, it is important that the difficult external environment does not lead to defensive exchange rate and trade-restricting actions by individual countries with negative consequences that would threaten other countries' overall growth prospects. Thus far, there is little direct evidence of such actions. But complaints to WTO of unfair trading practices, such as dumping, have risen considerably.

The following paragraphs examine the prospects for the ESCAP region in the light of probable developments in Japan and the other developed economies during 1999 and whether, on balance, an externally generated revival of activity is likely.

The Japanese economy, weighed down by persistent problems in the financial sector and a collapse of consumer confidence, continues to remain weak and almost certainly incapable of increasing imports significantly from the ESCAP region during 1999. The Economic Planning Agency's most recent forecast indicates that the economy will shrink by 2.2 per cent during the fiscal year 1998. A boost to GDP growth from net exports will be more than offset by a major fall in consumption, leading to falls in industrial output and capital spending and a further reduction in imports. Fears have been expressed in various quarters of a deflationary spiral, in which price falls lead to cuts in output, increased unemployment and reduced household spending, prompting still more price cuts.

These fears are in the nature of a worst-case scenario, but so intractable are the problems of the Japanese economy that even a worst-case scenario is not entirely inconceivable. Whether the fears embodied in it actually materialize are contingent upon the success or failure of the banking reform plan and on the impact of large stimulus packages approved by the Japanese parliament.

However, even on the most optimistic assumptions, the Japanese financial system cannot be expected to recover within a single year and thus remove fears of a credit crunch affecting recovery in 1999. Another concern lies in the strong propensity to save that Japanese consumers have displayed over the previous 12 months, thereby rendering virtually ineffective the tax cuts provided in the stimulus packages. The Japanese economy is likely to experience a further, albeit marginal, decline in output and some further rise in unemployment during 1999.⁽⁹⁾ It is therefore unlikely that Japan will be able to provide any major stimulus for exports from developing countries in the region. ⁽¹⁰⁾

The United States economy has continued to display remarkable strength. In trying to determine its likely course during 1999 a number of different variables need to be kept in view. With corporate profits coming under pressure, capital spending has slowed substantially and manufacturing employment growth has shown signs of flattening out. Most business surveys indicate that capital spending is likely to remain sluggish during 1999 for both external and domestic reasons. Export growth is tending to taper off and the current account deficit has begun to widen. The current account deficit is now forecast to expand from 2.75 per cent of GDP in 1998 to over 3.00 per cent in 1999. With the weaker world economy, the United States is likely to experience a significant slowdown; the growth rate in 1999 may be slightly above one half of the 3.9 per cent rate achieved in 1997. This does not augur well for the region as the United States remains a major market for exports from the region.

The EU appears to be comparatively better situated than either the United States or Japan. Even though the economy of the United Kingdom is expected to experience a significant slowdown in growth during 1999, the other large EU economies should continue, by and large, to maintain their present momentum of growth with the likelihood of some gentle easing because of the impact of the Asian crisis and its global repercussions.

However, the Asian financial crisis, the debt freeze in the Russian Federation and the ensuing stock market volatility have collectively produced a significant adverse effect on consumer and investor confidence in the EU. Meanwhile, weakness in the dollar exchange rate has reduced EU competitiveness and cut demand for EU exports, especially in non-EU markets. It is unlikely therefore that the EU economies will be in a position to provide a significant boost for exports from the region during 1999. There are implications, too, of the introduction of the euro for non-euro exports (see box I.1).

The upshot of the analysis in the above paragraphs is that developed country markets will not be a source of strong demand for exports from the region. Of late, exports to other developing economies in the ESCAP region have emerged as an important locomotive for growth of the exports of a number of countries. This locomotive has already lost much of its steam owing to the recent crisis and will remain weak for some time to come.

Capital inflows

A major imponderable is the behaviour of capital flows. The extent to which confidence has been undermined during 1997 and 1998 and the general risk aversion evident in the developed countries do not suggest that private capital is likely to start flowing into the region soon on any substantial scale. Non-FDI financial flows, that is, debt-creating flows such as short-term and long-term bank loans and bond issues have been the principal victims of the crisis in the region and have received further knocks from the debt freeze in the Russian Federation and new uncertainties in Latin America.

There are two distinct but interrelated aspects of the problem with regard to financial flows. On one side, even though benchmark interest rates are on a declining trend, spreads for all developing countries have, on average, widened to levels not seen since early 1995 in the immediate aftermath of the Mexican crisis. On the other side of the coin, even at these higher costs, liquidity appears to have dried up for all but the most creditworthy borrowers. All in all, net private debt flows to developing countries are estimated to have declined in 1998 to their lowest level since 1990 and are expected to remain weak in 1999 with Asia continuing to bear the main brunt of the decline.⁽¹¹⁾

The real risk in the unfolding situation is that the flight-to-quality phenomenon could become self-reinforcing and prolonged as financial institutions become cautious about taking on new risks, as noted earlier. This phenomenon is currently evident in several of the economies of Asia affected by the crisis where even domestic financial institutions not dependent on external funds are displaying an unwillingness to extend credit to production enterprises in the real economy.

The countries worst affected by the crisis are currently seeing an outflow of capital in net terms. Previous high levels of investment activity were sustained, in part, by large inflows of foreign capital, so it is inevitable that capital expenditure will decline further in 1999, with adverse consequences for long-term growth.

With regard to non-debt-creating forms of capital flows to developing countries, such as portfolio and FDI flows, preliminary indications suggest that the former declined during 1997, reflecting the weakness in stock markets in the developing countries. FDI flows, on the other hand, continued to show resilience during 1997. Nevertheless, it is unlikely that FDI flows will have remained unaffected by the crisis and this rising trend will be maintained in the medium term. FDI flows have long lead times and decisions to delay, scale down or cancel investments do not normally show up at once. Nevertheless, tentative data for 1998 suggest that there has already been a reduction in the quantum of FDI flows to developing countries as a whole and particularly to emerging markets. It is likely that the ESCAP region has been affected in view of the particularly difficult economic situation prevailing in several economies. A number of countries in the region have experienced a significant decline in FDI approvals.

As a direct consequence of the crisis many transnational corporations from within the region are faced with severe financial difficulties, partly on account of the high levels of their indebtedness and partly on account of the downturn in the regional markets, which has constrained sales growth. Broadly speaking, two considerations apply: first, most TNCs from within the region are not in a strong enough financial position to contemplate an increase in their cross-border investments; second, there is likely to be some degree of hesitation in investing in new foreign facilities until the financial and economic uncertainty subsides. Intraregional FDI flows are therefore unlikely to retain their past momentum.

Such FDI flows as are occurring are often from outside the region and tend to be concentrated in acquisitions of existing assets, which have become available now as many corporations in the region have embarked on restructuring their balance sheets through divestment and some of the countries affected by the crisis have further liberalized their policy regimes with respect to acquisitions. Moreover, the cost of acquiring assets has fallen substantially in dollar terms. The acquisition of existing assets by foreign investors may be at the expense of investments to create new productive capacities, a phenomenon that may impact on long-term growth, though some benefits may be reaped in the form of better management, technological upgrading and enhanced access to markets.

All this makes it easier for TNCs to enter or expand their operations at the present time, if they are interested in taking a long-term view of the market prospects in the region or in producing primarily for export, rather than domestic or regional markets. There is evidence that some TNCs have availed themselves of the opportunity to invest in the crisis-affected countries by acquiring already operational assets, especially in the Republic of Korea and Thailand

Another factor in this context is that most affected Asian countries have seen an improvement in their international cost competitiveness as a result of their currency depreciations. This is especially relevant for export-oriented FDI and there are signs that some investors have begun to respond to the opportunities that this is providing.

At the same time, some consequences of the crisis will affect FDI adversely in the short and medium term. For TNCs focused on domestic or regional markets, reduced demand and slower growth can be expected to lead to some cancellation, scaling down or postponement of planned FDI in the affected countries. The automobile industry, in which TNCs figure prominently in the ESCAP region, is a good example of the impact of the crisis and the range of responses. A number of car-manufacturing TNCs have scaled down, postponed or even cancelled investment projects in some of these countries.

The implications of the financial crisis for inward FDI are also likely to extend to other, less seriously affected, developing countries in Asia. In addition to being affected by deceleration in intraregional FDI referred to earlier, some countries, especially those with close economic links to the countries most affected by the crisis, are likely to experience lower economic growth. Some countries may also lose export competitiveness vis-à-vis the countries that have experienced exchange rate depreciations. These factors could reduce their attractiveness as host countries, at least in the short run, but, in general terms, it is the climate of uncertainty that is likely to have the biggest negative influence on FDI into the region for some time to come.

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Table I.3. Merchandise exports: values and percentage shares by origin and destination, 1995 to mid-1998

(Value in millions of US dollars)

Footnotes:

^9. Bangkok Post, 23 December 1998.
^10. It should be stressed that, despite the economic difficulties, the Japanese authorities have taken a number of initiatives to counter the downturn in the ESCAP region. In October 1998, Japan announced a $30 billion aid package for the Asian economies in crisis to ease the credit crunch and provide guarantees for bond finance. This was followed by a joint $10 billion United States-Japan package announced at the APEC summit in November 1998 to provide trade finance and assistance with corporate restructuring; and in December 1998, at the ASEAN summit, the Japanese prime minister announced a further $5,150 million in concessional loans over the next three years for the ASEAN region.
^11. IMF, World Economic Outlook (Washington DC, October 1998), p. 3.