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Date 26 February 2007
Press Release No. L/05/2007

Note: This press release is embargoed until 12:00 Bangkok/05:00 GMT, Monday, 26 February 2007.

Keynote Address by Mr. Kim Hak-Su
Under-Secretary-General of the United Nations and
Executive Secretary of the Economic and Social Commission for Asia and the Pacific
at the Conference on Ten Years after the Asian Financial Crisis: Vulnerabilities of East Asia
Bangkok, 26 February 2007

Excellencies,
Distinguished Guests and Participants,
Ladies and Gentlemen,

It is my great pleasure to be with you at this important and timely conference. The financial crisis of ten years ago was a harrowing experience for many countries in the Asia-Pacific region. Growth plunged and unemployment and poverty increased dramatically after years of remarkable progress. However, the worst is finally behind us. Our objective now is to apply the lessons learned from the experience in evaluating the current situation of our economies and future scenarios in order to ensure that such a crisis does not occur again.

Those Southeast Asian countries affected and the Republic of Korea have made great progress in reviving the strength of their economies. Growth in the crisis-affected nations has been impressive in recent years. Between 1999 and 2005 average per capita income in these countries grew by more than 8 per cent. Enormous strides were made in reducing the poverty and unemployment which had resulted from the events of 1997.

More recently, the crisis-affected countries displayed robust GDP growth of more than 5 per cent in 2006, driven by strong international demand for manufactured goods such as electronics. A similar rate of growth is expected this year.

Those countries have taken significant macroeconomic policy measures to improve their resilience to shocks. Inflation, although rising recently because of higher oil prices, is generally below pre-crisis levels and close to central bank targets. Inflation in the crisis-affected countries was a benign 4.3 per cent in 2006 and is expected to decline further to around 3.6 per cent this year. Countries have also taken the crucial step of adopting more flexible exchange rates. Crisis-affected countries such as the Republic of Korea, Thailand, Philippines and Indonesia, now officially target inflation rather than a currency peg.

Another positive development is the improvement in the current account of these countries. They have consistently recorded current account surpluses that have averaged around 5 per cent of GDP since 1999, compared with the deficit of 2 per cent of GDP before the onset of the crisis. Current account performance has been driven by impressive export growth in recent years. In 2006 alone, the crisis-affected economies saw their exports grow by 14 per cent.

These countries today depend less on portfolio inflows as a financing source. The contribution of foreign direct investment has risen compared to a decade ago. Foreign direct investment grew at an average rate of 18 per cent between 1999 and 2005. The proportion of financing through foreign debt is lower, as is its short-term component.

The region has now established remarkable foreign currency reserves. Foreign currency reserves for developing countries in the Asia-Pacific region have reached an unprecedented US$2.5 trillion dollars. Crisis-affected countries account for 20 per cent of this total. Reserves have been accumulated partly as a reaction to the 1997 financial crisis. They have also been a result of continuing efforts to put downward pressure on the region’s currencies through official intervention.

The region can now lay claim to much-improved banking sectors after years of tough financial sector reforms. In the aftermath of the crisis, weak financial institutions were closed and the remaining banks were recapitalized. Banks are required to adopt strict prudential measures in order to satisfy international standards. Profitability of banks has been increasing over recent years. Capital adequacy ratios are generally rising across Asia and are mostly well above the 8 per cent recommended international minimum, reflecting better prudential regulation and improved risk management. There is a reduced prevalence of currency and maturity mismatches in borrowing. Non-performing loans have been reduced in most countries. Their ratio to total loans, which exceeded 25 per cent in the Republic of Korea and Malaysia and 40 per cent in Indonesia and Thailand around the year 2000, stands at less than 10 per cent today.

Finally, Southeast and East Asia has displayed progress in regional cooperation to increase self-reliance in crisis prevention and recovery. The ASEAN+3 economies are sharing information about portfolio flows, collaborating in regulatory activities, and have established a financial support mechanism against disruptive capital movements through the Chiang Mai currency swap initiative.

The other aspect of regional cooperation has been to reduce the dependence of countries on bank financing. Local bond markets, both in domestic and foreign currencies, have been encouraged through the Asian Bond Market Initiative of ASEAN+3 and the Asian Bond Fund project of EMEAP.

However, the region cannot afford to rest on its laurels. Globalization, along with its many benefits, exposes economies to quick and harsh risks from the constantly shifting international environment. We saw a recent example of such a rapid reversal of fortune in May and June of last year. An unexpected rise in interest rates in the United States in early May saw Asia-Pacific equity markets recording their biggest losses since September 2002. There was also financial market instability in the region later in the year due to the political situation in the Middle East and its impact on oil prices.

There are currently three potential risks which must be addressed by Southeast and East Asian economies. In fact, these risks share some common characteristics with those in the run-up to the 1997 crisis.

• The first risk is that Southeast and East Asia are witnessing the effects of a global liquidity bonanza. This is because of a dramatic increase in hedge fund activity and credit-financed capital inflows in recent years. Financial derivatives now grew to a US$370 trillion industry, eight times greater than global GDP. Credit-financed international flows have been encouraged by the so-called “carry trade”. This involves borrowing in cheap foreign currencies, especially the yen, to buy international assets.
  
  The rapid growth of these financial instruments increases uncertainty and heightens the possibility of contagion and “herd behaviour” in response to any adverse event in the region. ESCAP analysis shows that, after five years of declining economic vulnerability, most of the crisis-affected economies saw moderate increase in vulnerability in 2006. This was due, in part, to the appreciation of their real exchange rates through short-term capital inflows.
  
• The second, and related, risk is that Southeast and East Asia are again witnessing some worrying incidences of inflated asset values. International liquidity has flowed to Asian equities and other financial products. Asia-Pacific equity markets rose 29 per cent in 2006. Indonesia, for example, saw a 55 per cent rise for the year. Some countries have also seen large housing price rises over recent years, fuelled by growing household debt. One example is the housing market in the Republic of Korea. Apartment prices in Seoul rose by more than 24 per cent in 2006, and house prices rose nationally by more than 11 per cent.
  
• The third risk is that in recent months Southeast and East Asian economies have seen tremendous speculative pressures on their currencies. Compared to a decade ago, the nature of speculation is fundamentally different as currencies are now undervalued as opposed to the overvalued currencies in the run up to the crisis. Again, currency management is at the centre of the policy agenda of monetary authorities. Despite interventions to keep currencies down, nominal exchange rates appreciated significantly against the United States dollar in 2006. This appreciation is expected to continue in 2007 as the United States dollar depreciates further.
  
  As you know, monetary authorities can choose a combination of any two of the following three policy options: monetary policy autonomy; exchange rate targeting; and open capital accounts -- but not all three. Having two potentially conflicting nominal targets for monetary policy -- inflation and the exchange rate -- creates an opportunity for speculation. Past experience suggests that when financial markets see an opportunity for gain, they move fast. Attempts to delay adjustment of the real exchange rate provide markets with the opportunity to gain at the expense of the central banks in the region, both in financial terms and in terms of their credibility.

What should Southeast and East Asian Governments do to address these pressing policy challenges?

One policy action is to ensure that exchange rates are more flexible. Greater flexibility would help take away the "one-way bet" that encourages even more capital inflows than would otherwise take place, since markets would quickly realize that the currency could move in either direction.

Central banks should be clear about their objectives for price stability and their exchange rate policy. Since most central banks have committed to an inflation target, allowing their exchange rates to adjust would be in keeping with that policy. In those economies where the central banks have not made such a commitment, they could continue to manage their nominal exchange rates.

However, much more is required of Governments in terms of policy measures. The overarching goal should be to build strong and flexible economies that can weather global shocks and adapt to new realities. In this endeavour, I propose a four-track approach for consideration:

• First, countries must ensure solid macroeconomic fundamentals to maintain investor confidence and sustain economic growth. Key elements are moderate and stable inflation; sound fiscal policies that ensure low budget deficits and sustainable debt burdens; and more flexible exchange rates regimes that can absorb external shocks and reduce currency mismatches in borrowing.
  
• Second, countries must develop healthy financial sectors to build confidence and benefit from capital inflows. This requires well-developed regulatory structures to be in place to prevent bad debts. Independence and a competitive environment for banks to ensure efficient credit allocation and pricing are also necessary. Authorities must keep pace with the great diversity of complex new products that are being used in regional financial markets. Knowledge and risk management systems should be updated to ensure early warning of any adverse flows.
  
• Third, countries must have robust microeconomic foundations to ensure the efficiency of the economic system. A basic requirement is clear property rights, overseen by a strong judiciary. This will allow companies and institutions to operate effectively and transparently. The labour market should be flexible enough to adjust to economic downturns. Social safety nets have to be developed further to prevent people falling into hardship during such periods. Key areas to address are unemployment insurance, healthcare and pensions.
  
• Fourth, countries must improve regional cooperation to lessen the impact of financial market volatility. As I mentioned earlier, there have already been positive moves in this direction. However, the regional funds currently available for financial support are not sufficient as a primary means of response compared to the scale of possible need. Existing regional mechanisms on surveillance of domestic policies need to be improved. It is also important to extend cooperation in these areas to other countries in the region.

I believe that the deliberations of this conference will serve as valuable “early-warning” inputs to this region’s policymakers in ensuring that their economies do not fall into the pitfalls of the past and are best prepared for the uncertainties of the future.

I wish the conference all success.

Thank you.

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