IMPLICATIONS FOR THE ESCAP REGION

Trade

The patterns of world trade were reviewed at some length earlier in this chapter. The decline in the value and volume of trade flows was evident in 1998 and persisted into the early part of the following year; the downward trend appears to have been halted towards the middle of 1999. The recent increase in world trade in value terms embodies a sharp rise in oil prices, aided by an upturn in the export unit values of several categories of commodities. It was also underpinned by a measurable trade expansion fuelled by the recovery of exports from the crisis countries of Asia. Within the ESCAP region as a whole, for example, exports rose in both volume and value terms during the first half of 1999, compared to the levels prevailing in the first half of 1998 with this trend persisting into the second half of 1999.

The United States economy continues to provide much of the demand for exports from the region. EU and Japan, while showing welcome strength, are unlikely to add appreciably to the overall earnings through exports from Asia, as discussed previously. Indeed, the pace of economic recovery within EU is expected to be modest and could easily falter as a result of the recent increase in interest rates; at the same time, the depreciation of the euro could dampen the demand for imports. The appreciation of the yen, on the other hand, has generated some buoyancy in imports into Japan independently of the strength of the economic recovery; but the continuing weakness of consumer demand could be an offsetting factor. Intraregional trade, the engine of growth in the early 1990s, has remained sluggish thus far, although it should expand considerably with a broader and deeper recovery in the crisis economies.

On the supply side, higher prices for oil, if they persist, may increase production costs in oil-importing countries, which constitute the overwhelming majority of ESCAP countries. Higher prices of non-oil commodities should translate into higher earnings of a sizeable number of ESCAP economies, even with unchanged export volumes, especially given the relatively price-inelastic nature of short-run demand for such commodities. The greatest buoyancy currently visible on the supply side is in manufacturing, though. Several of the regional suppliers of electronic goods and other manufactured products within the crisis countries have been able to boost their production and exports significantly. This upswing is largely attributable to their enhanced competitiveness though crisis-induced currency depreciation and the persistence of strong United States demand for electronics goods in general, and for computers in particular. The strong cash flows so garnered have combined with lower domestic interest rates to attenuate somewhat the financing problems associated with the credit crunch in these countries.

Another element of the silver lining is manifested in concerted efforts made by many regional manufacturers, especially those in the crisis countries, to improve their efficiency and flexibility, including in capital mobilization and utilization and in ensuring leaner inventories and payrolls.¹⁶ All these have contributed to enhancing productivity and export competitiveness. The present buoyancy in manufacturing and trade should continue well into the year 2000 on the basis of current demand and supply-side parameters. Once the initial stages of economic recovery and the associated trade expansion have been successfully completed, however, any broader-based increases in output capacity and exports will require much greater support from the domestic financial system within the crisis economies. It is in this connection that various caveats apply. In particular, the persistent constraints on bank lending cannot be relaxed without a satisfactory resolution of the bad loan problems, widespread corporate insolvency and high levels of corporate indebtedness.

Another set of qualifications relates to widened market access for export from the developing economies of the region, the least developed countries especially. Despite the success of the Uruguay Round, market access has not been increased for developing countries' exports in line with initial expectations. Export penetration from those countries is still hampered by persisting restrictions on market access, especially those concerning tariff peaks and tariff escalation on products of major interest to them, as well as the reinforced non-tariff barriers. This is particularly true in the case of agricultural commodities, processed primary products and labour-intensive low-technology manufactured goods. The non-tariff barriers may involve linking market access to importing countries' environmental regulations unilaterally applied at the level of both products and processes as well to labour standards. Developing countries of the region, as elsewhere, will have to remain fully engaged in global trade negotiations in order to ensure that their access to export markets is not restrained by international agreements.

Capital inflows

A recovery is under way in aggregate flows of private finance to emerging market economies, as already noted earlier in this chapter. However, the flows in 1999 are unlikely to have surpassed the level of the previous year by any significant margin and will remain much lower than the corresponding volume in 1997 (table I.3). Remarkably, the volume of private financial flows to Asia in the first eight months of 1999 exceeded the amount channelled to the region for the whole of 1998 despite a reduction in loan commitments. Furthermore, the share of Asia in external private capital flows appears to be gradually increasing, albeit out of a drastically reduced total. However, only a relatively small number of Asian economies have been the destination of such flows; this characteristic geographical concentration seems to have become stronger in the post-crisis months.

When the extended period of relatively easy access to private capital came to an abrupt end among the crisis economies in 1997, the financing gap was largely bridged by official flows (from the IMF-led rescue packages). Within the subsequent 18 months, most of these economies were able to convert large deficits in their external current accounts into surpluses. Market sentiment concerning the crisis economies, and Asia more generally, showed a marked improvement following the build-up of external reserves, the containment of inflation, the resumption of export and GDP growth and, in the case of Indonesia, the improvement in the political situation. These were some of the factors leading to the revival of private capital flows into the region.

The spreads on international bond issues have begun to narrow for the crisis economies and for Asia as a whole. The risk premium declined from an unserviceable peak of 800 basis points in the third quarter of 1998 to 400 basis points by the first quarter of 1999. By and large, this downward trend continued as the year unfolded, even though the premiums involved were still much higher than those of the pre-crisis years. This positive development notwithstanding, access to such cheaper capital is now even more concentrated than before; it is available only to the highest-rated borrowers. Such enhanced concentration reflects lenders' fears of being forced to roll over existing lines of credit, or to provide new ones, should external financing problems arise again in the near future.¹⁷

The reduction in risk premium provides access to much less expensive funds as a means of restructuring the existing portfolio of external liabilities and lowering the overall cost of future debt servicing. While initially this option may apply only to the best borrowing entities, there could be positive spillover for others. But the easier access on improved terms should not lull policy makers into any sense of complacency. Although the events of 1997 and the hardships suffered in the aftermath are too recent to be forgotten, it is useful to remind policy makers that they have to keep perpetual vigil on the volume, terms and use of external private capital.

In the above context, it is also necessary to take note of the volatility that has been observable in the financial markets of the ESCAP region, including those in the crisis economies. There was a steady appreciation in exchange rates and rise in stock market indices up to the middle of 1999. Thereafter, both of these rising trends experienced a period of weakness, although a degree of financial stability was returning to most regional markets towards the latter part of the year. These changes in market sentiments did not appear closely related to movements in the so-called macroeconomic fundamentals; they tended to reflect the heightened volatility that has become a hallmark of global financial markets of late. In particular, the closer integration of international capital markets means greater correlation between selling and buying orders over different markets; and these orders may have little or limited relevance to the state of developments in individual markets of emerging economies. Given the considerable impact that sudden or frequent changes in foreign investor sentiment can have on exchange rates and stock prices, on the cost and availability of financing, and on overall financial and economic stability of individual countries, the vital importance of continually monitoring the domestic and international financial markets and of fine-tuning policy instruments to deal with any destabilizing developments cannot be overemphasized.

The comparative resilience of FDI flows into the region has been already noted, but there are some issues lurking behind the aggregate numbers. The recent patterns of Japanese FDI may serve to highlight some of the issues. The overall level of investment outflows from Japan declined by 7 per cent to $24 billion in 1998, or to approximately half of the corresponding volume during the early 1990s. Indeed, even the figure actually recorded as FDI from Japan during 1998 could contain a large element of intra-company loans (extended by the parent corporations in Japan to their foreign subsidiaries or affiliates). The principal rationale for such loan transactions was to stabilize the operations of the subsidiaries or affiliates in the aftermath of the crisis; the very low interest rates prevailing in Japan and the steep depreciation in the exchange rates of the crisis economies were other facilitating factors. At some stage, these subsidiaries or affiliates will require fresh equity support. It thus remains to be seen whether the loans from transnational corporations in Japan will be converted into additional equity investment. Given the (domestic) financial pressures on Japanese transnational corporations the prospects for any significantly enlarged FDI flows in the form of new equity from Japan to Asia are not very promising in the immediate future. Similar observations may hold true for FDI flows from other sources.

A significant part of FDI flows into the region has been through mergers and acquisitions. Such FDI may have a beneficial effect on the host economy in terms of increased efficiency in production, technology transfer, and so on, but does not create new capacity. To that extent, the developmental impact of FDI is likely to be less than in the past.

It is clear that the process of recovery has been under way among the crisis economies of the ESCAP developing region from the early part of 1999. The region should see further improvement in its performance during 2000, given respectable growth in the major global economies, the ongoing restoration of some economic strength in Japan and the absence of heightened financial turmoil and corrections. From the preliminary indications available, output growth from the developing countries as a whole should accelerate from 1.2 per cent in 1998 to about 3.3 per cent in 1999, and further to 5.1 per cent in 2000. The overall rate of growth of developing countries within the ESCAP region should exceed that exhibited by the developing countries as a group. However, major uncertainties lie ahead in the realm of domestic reforms and the international environment, as discussed earlier.

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