THE HINDU ONLINE Friday, February 12, 1999
THE DARK SIDE OF GLOBALISATION - I
By Prem Shankar Jha
THE collapse of the South-East Asian economies has touched off a huge debate on its causes and remedies that is not structured on north-south lines but has cut across them. The debate is over the respective roles of state and market in the age of globalisation. On one side are those who believe the collapse was the fault of the economies themselves and, therefore, one must leave it to the market to impose discipline on them. On the other are those - a much smaller minority - who believe that it was caused by a failure of the market and the state must reassert its autonomy to protect its people. The first view is held by the International Monetary Fund, backed by the United States Treasury and the ``Wall Street'' global financial community. But the other is not a theoretical position held by left leaning academics. It is being put into practice by one state, and one alone - Malaysia. On the outcome of the debate will depend the shape of the future world order.
The IMF has placed its entire faith in the market's capacity for self-correction. Its immediate prescription was an increase in interest rates to stem the flight of capital; a drastic cut in government spending to reduce imports and the closure of the most insolvent financial institutions. These moves had exactly the opposite of the desired result.
The sudden increase in interest rates made even investments that previously looked sound, unviable. Spending cuts of 18.5 per cent in Thailand played havoc with demand. Since the bulk of the cuts was concentrated in construction projects, the effect on employment and land values was disastrous. Furthermore, as neither government felt capable of reducing the size of the bureaucracy in order to cut expenditures, the axe fell on health, education and, above all, investment. The overall impact was a sharp fall in consumer demand. This triggered the next round of bankruptcies.
Even the purpose of stabilising the external sector was not achieved. The closure of 16 banks in Indonesia and 58 finance companies in Thailand was supposed to send the message that those that remained open were sound, but the message the public received was the exact opposite. No one knew when his bank was going to be closed, so all rushed to take their deposits out. The bottom dropped out of the foreign exchange market and the IMF had to grudgingly admit its mistake. The IMF's longer-term goal is to ``restructure'' insolvent companies and banks as soon as possible so that they can become creditworthy once again. The faster it is done, the quicker can new liquidity be released into the bloodstream of the economy and the cancerous spread of bankruptcy be stopped. In this strategy, therefore, the role of the government is to remove all hurdles to restructuring. Insolvent companies have to be declared bankrupt and their assets sold to pay their creditors. Banks have to use the resources freed by these foreclosures to pay back foreign creditors and reschedule the rest of their debt.
Those that are beyond redemption by various yardsticks such as their capital adequacy ratio and their ``non-performing loans'' (bad debt) have to be closed down and their assets, which include the loans they have given, sold at a depreciated price. But 18 months after the crisis the crucial foreclosures and sales have still not materialised. The magnitude of failure is reflected by the fact that the Indonesian Debt Restructuring Agency held its first-ever sale of foreclosed assets not in November 1997 but November 1998! This sale consisted of 34 automobiles and 41 motorcycles!
The strategy has failed for the simple reason that no one foresaw. Bankruptcy, foreclosure and restructuring are all micro- economic solutions. They are well suited for dealing with isolated banking or corporate failures within a nation-state. When those happen, other stronger companies and banks buy out the weaker ones. But restructuring is not a panacea for a macro- economic, indeed systemic failure. When most of the banks and large manufacturing companies become, or threaten to become, insolvent at the same time, who is left to buy the bad debt or take over the bankrupt company?
The answer is ``foreign companies''. The purpose of the IMF's reforms is to remove all hurdles that can prevent such sales and thereby promote the return of foreign capital (and of indigenous capital that fled abroad) to the local capital markets. Once this return flow starts, the currencies will stabilise and start appreciating towards their natural exchange rate. Inflation will taper off, imported goods will become cheaper and real incomes will rise once more. Domestic interest rates will fall once more towards international levels (plus the risk premium) and investment will revive.
This is where the IMF has hit its first hurdle. For, the CEO of every insolvent or near-insolvent company has the strongest vested interest in delaying foreclosure and sale. Each, taking decisions in isolation from his peers, sees advantages in delay for, each believes that sooner or later the government's deflationary policies will stabilise the currency and bring down interest rates, thereby bringing the enterprise back closer to viability. This will push up the value of his assets, so that he can sell less of his assets to meet his liabilities. He might therefore still be able to hang on to his best companies. The fact that the currencies of all the East Asian countries have recovered more than half of the value they lost between July 1997 and January 1998 has vindicated their strategy.
The second hurdle the IMF has hit is nationalism. There is a growing realisation that the burden of readjustment will not be shared equally, but will fall most heavily on one segment of industry - the locally-owned businesses and conglomerates. Foreign companies have long since absorbed the losses sustained by their Indonesian and Thai subsidiaries into their global profits and are therefore fully solvent. Their main concern now is the collapse of the domestic and regional demand. But locally- owned and still largely family-held enterprises such as the Salim group in Indonesia, the Prachai group in Thailand and Renong Berhad in Malaysia borrowed for short-term abroad to invest in long-term projects at home and lost out. The realisation that these are the companies and banks, along with their land, that will have to be sold to foreigners is feeding a stream of intellectual resistance in both Thailand and Indonesia that has reinforced the resistance of the debt-ridden entrepreneurs who are fighting for their very lives.
In Thailand, the Government is still trying to get 11 bills through Parliament which will greatly tighten the bankruptcy and foreclosure laws to prevent those who default on payments from delaying court proceedings. Parliamentarians and senators have not rejected these bills. In sharp contrast to the empty and confused rhetoric on economic sovereignty that one hears in India, Thai legislators are approaching the challenge in a pragmatic frame of mind, scrutinising each clause of each bill.
But few are hiding their distaste for, and wariness of, the bills. For apart from bankruptcy and foreclosure, both of which offend the Thai cultural sensibilities, the bills are intended to permit foreign investors to buy agricultural land and acquire a majority shareholding in all companies, and not only in those located outside the large cities or more than 150 km off Bangkok; allow foreign nationals to buy land and own apartments in condominiums, and reduce the number of occupations reserved for locals from 69 to 30.
The full implications of these bills have only now begun to sink in. The head of Bangkok's premier economic research institute remarked wryly after a lengthy discussion of the 11 bills, ``Welcome to the bargain basement sale of Thailand''.
Despite the failure of the IMF programme to unclog the South-East Asian economies, it is most unlikely that the Governments of Thailand and Indonesia will deviate from it. All that they have insisted upon so far is to ease the budgetary constraints imposed on them so that they do not starve the rest of the economy of liquidity until the restructuring is completed. The IMF has reluctantly agreed.
Today, no one outside the offices of the IMF believes that the worst is over, the economies have bottomed out and recovery is round the corner. Thailand is being held up as a shining example of the success of the IMF's policies, but in a speech delivered in Bangkok at the beginning of December, the head of the Shinowatra group (one of Thailand's most powerful conglomerates) said that he did not expect that the decline in the gross domestic product (GDP) would be reversed till 2,000-2,001. In the same vein, on November 29, Ms. Marie Phangistu, one of Indonesia's most respected economists, predicted at a Jakarta conference that between the credit log-jam and political uncertainty, she did not expect Indonesia to recover its pre- crisis level of the GDP in less than eight years.
THE DARK SIDE OF GLOBALISATION - II
By Prem Shankar Jha
The Hindu Online Saturday, February 13, 1999
Malaysia started down the IMF road but changed tack within a matter of days. After pouring more than $5 billion into a futile defence of the ringgit, the Malaysian National Bank gave up the attempt and raised interest rates from 7.5 to 30 per cent. To cut expenditure, it also cancelled a number of very large construction projects. This stemmed the slide in the value of the ringgit, but within a week the Government realised that the social cost of the bankruptcies that would follow was one that it could not afford. So the Government allowed the interest rate to fall back to the pre- crisis levels and instead announced a temporary closure of the money market.
The unprecedented move sent shock waves through the world financial markets. In offshore markets, the value of the ringgit plummeted. Malaysia, therefore, reopened the money market but placed a large number of restrictions on the inflow and outflow of foreign exchange on the capital account. By January 1998, short-term capital had to stay in the country for a minimum of 12 months. The import and export of ringgit by private individuals and Malaysian investment abroad required prior approval. But the ringgit continued to fall till January 1998 when it touched 4.8 to the dollar against the pre-crisis level of 2.5. The main cause was a buildup of the ringgit abroad. Although Malaysia had not formally allowed offshore trading of the ringgit, in practice it had always been traded freely in Singapore. Singapore traders had begun to sell the ringgit short (anticipating some devaluation) in June 1997, even before the crisis began.
But after the partial imposition of capital account controls, this trade picked up rapidly. Currency speculators, anticipating a flight of the ringgit to the dollar the moment the controls were lifted, began to stock up with offshore ringgit by offering 20 to 40 per cent interest rates against the 11 per cent that the investor could get in Malaysia. Malaysians began, therefore, to take suitcases full of ringgits across the Johore Straits to Singapore.
The buildup of offshore ringgits thus opened Malaysia to exactly the kind of attacks in the forward markets that had brought down the baht. In January 1998, Malaysia was still reluctant to go further down the road to controls. It thus had two options. The first was to use its excellent credit rating to raise a large loan of around $15 billion, in New York and bolster its reserves. This would send a message that the attacks on the ringgit would fail, or impose controls intended to destroy all offshore trading in the currency. The former suggestion was made by the Rating Agency of Malaysia, whose President, Dato Rajendran, pointed out to the Prime Minister that although Malaysia's overall debt was $42 billion, sovereign borrowing was low at $16 billion. This was finally accepted after a long delay in June 1998. As part of the money raising exercise, the Government asked the main rating agencies, Moody's and Standard and Poor's, to make a fresh appraisal. To their horror, while S&P downgraded them by one level, Moody's downgraded them by three steps from a stable to a near- junk bond status. Moody's rating came just two days before Malaysia was to launch the roadshow for the loan and effectively destroyed the option. On September 1, therefore, Malaysia chose the alternative and announced that in 30 days it would cease to honour any trade in ringgits carried out beyond the shores of the country that did not have its approval. It also pegged the exchange rate at 3.75 to the dollar. Some weeks later, noticing that foreign companies were repatriating amounts equal to several years of profits, it also put a limit on the annual repatriation of dividends at the average of the previous three years' performance. Today, Malaysia's foreign exchange regime differs from India's only to the extent that Malaysians can still use their credit cards abroad.
Malaysia's policy seems to be working. The GDP was 8.6 per cent below the pre-crisis level in July to September 1998, far better than the figures for Indonesia but not significantly different from Thailand. However, there are indications such as a pick-up in construction and car loans, that the slide may have been halted in the last quarter. The main difference between the two economies is qualitative. Unlike Thailand, Malaysia's economy is not log-jammed by bad debt. In contrast to the other two countries, Malaysia has decided not to let its banks and corporations sink. Instead, it has created two asset management companies, Danamodal and Danaharta (Dan comes from the Sanskrit Dhana), with a mandate to restructure the defaulting companies and banks, and offer them the capital they need. To provide the seed capital in a non-inflationary way, it has reduced the statutory liquidity ratio by two per cent and allowed banks to invest the money in government bonds. Instead of going to the banks, however, the interest on these additional bonds is going to the two corporations to provide the seed capital for reconstruction.
Danamodal and Danaharta are proving as severe in their assessments of the defaulting companies and banks as the market might have been. Proof of this is that the board of Renong Berhad, for long the pride of Malay (as distinct from the Chinese-owned) industry and packed with the Prime Minister's friends, has been all but divested of control by the banks that it owed money to. But in keeping with the local (crony) tradition, they prefer to let unviable companies and banks be taken over by the viable ones to their being brought under the hammer.
Free marketeers in Kuala Lumpur, not to mention the rest of the financial world, shake their heads and warn that this will only end up making the strong company sick. But that is a static view of the economy. In practice, the fate of the merged and weakened company depends on the state of the macro-economy. If Malaysia begins to grow once more in a reasonably short period of time, both companies will prosper. Otherwise, both will fail.
Thus, what Dr. Mahathir Mohamad has done is to concentrate on getting the financial log-jam cleared as soon as possible and place all his bets on growth. The second reason for an early turnaround is simplicity itself. By pegging the exchange rate, the Government has at last put a floor under entrepreneurs' calculations. This may not be of much importance to the very large globalised part of the Malaysian economy which both imports and exports, but it has made an enormous difference to the small and medium, indigenous, more often than not Malay, entrepreneurs who import but cater mostly for the home market. The question on everyone's mind in Kuala Lumpur today is, `what will happen when the exchange controls, which were imposed for 12 months, are lifted?' Most financial experts think that the ringgit will immediately fall to between 5 and 6 to the dollar. Malaysia has, thus, postponed its day of reckoning. But everything will depend on the state of the world economy and the Malaysian economy when that is done. If both look good, the ringgit could as easily appreciate after being let off the leash. Malaysia's own performance is astoundingly good. Its exports are booming and imports have dropped, giving it a very large trade surplus. This has encouraged Dr. Mahathir to demand that the banks increase their lending to pump prime the economy. A large number of construction projects have, as a result, restarted. But since the recovery has not yet taken place and the world economy is not looking rosy at the moment, the controls are likely to remain in place for some more time.
Malaysia is likely to find, as many countries have found in the past, that it is easier to impose controls than to take them off. Far more hangs on Malaysia's success or failure than simply the final value of the ringgit or the position Malaysia occupies on the table of industrialised nations. Malaysia has already shown that a government that is not afraid of bucking the market can significantly reduce the rigours of a downturn on the population of a small nation in the short-run. If it is able to rejoin the global community fully in the coming years, without having to pay too high a price, then it will have proved an immensely important point, that globalisation does not do away with, but strengthens the need for strong governance. Contrary to what the neo- liberals of London and Washington claim, a truly global economy will not emerge until all barriers to the movement of people in search of work are removed and the world becomes a single market for both capital and labour. Nor will it emerge until all currencies are unified and backed by a single Global Reserve of foreign exchange.
Not only are we nowhere near this utopia but the shortsightedness and avarice of man make its arrival extremely unlikely in the foreseeable future. Until that happens all markets will remain imperfect, and susceptible to manipulation by the strong for their advantage. So until that utopia arrives there will always be need for a strong state that is capable of shielding its people against the dark side of globalisation so that they can benefit from its boundless energy.
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