The Autralian Financial Review Saturday, November 14, 1998


No quick cures in sight for
Asia's economic ills

By Steve Burrell and Hans van Leeuwen

The Asian economic crisis will grind on for another five years of low growth and financial instability, despite a moderate recovery next year, according to leading international economist, Dr Paul Krugman.

But he described the way that Australia has ridden out the Asian crisis so far as "nearly miraculous" and tipped that the US Federal Reserve will cut official rates again next week.

Speaking yesterday at the Credit Suisse First Boston economics conference in Sydney, Dr Krugman said the massive debt overhang in crisis-hit Asian economies like Thailand, South Korea and Indonesia, the incapacity of local companies to generate enough cash flow to restructure themselves and crippled domestic demand would see a prolonged period of economic stagnation in the region.

"There is no full-scale recovery in prospect," he said in a briefing with The Australian Financial Review.

"The acute phase of the crisis may be ending -- output will be better and we may see some return to growth next year -- but a little bit of growth does not end the whole crisis. The hot crisis may be over but now the cold crisis begins."

At the same conference, Reserve Bank deputy governor, Dr Stephen Grenville, advocated a wider role for capital controls in the wake of the Asian financial crisis, even if they reduced international capital flows.

"The problems come from excessive inflows, so if the net result of more rigorous 'rules of the game' is smaller inflows in the boom times, then that will be a plus," he said.

Dr Grenville said there may be a role for the kinds of controls used in Chile, which include a tax on capital inflows and other restrictions.

In a major crisis, he said, "you should reach further down the list of possible policy instruments", beyond the less controversial proposals such as stand-fast and work-out arrangements for private debt."

Mr Grenville also backed some variant of the Tobin tax, a uniform tax of 1 per cent on all spot conversions of one currency into another.

Dr Krugman paralleled the current situation in Asia with the Mexican crisis of the early 1980s, when there was a short, sharp economic collapse, followed by a partial recovery and then more than five years of stop-start growth and financial fragility.

He held out little hope of Japan leading the rest of Asia out of its slump, saying it was caught in a "classic liquidity trap" which left it unable to use interest rate cuts as a way to lift it out of recession and suffering from chronic "under-consumption" because of high savings rates and demographic changes.

He said the US Federal Reserve was likely to again cut interest rates after its Federal Open Markets Committee meeting next Tuesday because of the risk of further financial instability if it disappointed market expectations.

"Purely on grounds of fear, the Fed will deliver the cut the market expects," he said.

The two recent cuts in rates were a response to the intense fears which swept suddenly through markets of a major credit crunch in the wake of the near-collapse of the Long-Term Capital Management hedge fund, he said.

"The people in the Fed were as frightened as I have ever seen them post-LTCM -- they thought they were walking on solid ground and suddenly they found themselves walking on cardboard over an abyss," he said

"The Fed dodged a bullet [with the interest rate cuts] but they're not sure why and they don't know if the sniper is still out there."

Also speaking at the conference, International Monetary Fund assistant director for Asia, Mr David Nellor, said Chilean-style capital controls could create distortions in decision making.

He said Chile's rules had led to a lot of large Chilean companies shifting to the New York stock exchange, at great cost to Chile's small and medium-sized enterprises.

"There's a real question over whether you can effectively control capital in many of these [Asian] countries," he said.

Dr Krugman supported greater controls on "hot money" flows.

He said temporary capital controls may have a role in giving countries gripped by currency crisis some breathing space to reflate their economies and rekindle the growth necessary to recover.