ASEAN Beyond the Regional Crisis: Challenges and Initiatives

6. Financial and Macroeconomic Co-operation in ASEAN: Issues and Policy Initiatives

126 Ramkishen S. Rajan© 2001 Institute of Southeast Asian Studies, Singapore 126 Introduction While the intellectual debate about the exact causes of the crisis in East Asia in 1997–98 and the appropriateness of various remedies rages on, one thing is clear: the boom-bust cycle in East Asia was caused by foreign bank lending. Indeed, the major part of the net US$130 billion outflow of capital from the four crisis-hit ASEAN economies (Indonesia, Thailand, Philippines, and Malaysia) and South Korea between 1996 and 1998 was due to reversals in net short-term lending by commercial banks. Reversals in portfolio equity investments roughly averaged about US$9 billion during this period (Table 6.1). Such large-scale capital withdrawals, curtailment in lending, and consequent sharp currency devaluations inevitably created major collateral damage and dislocations to the domestic financial sectors. Indeed, the closure of troubled financial institutions was a key element of the International Monetary Fund (IMF) programmes for the crisis-hit economies (Lane and Associates 1999). Table 6.2 provides some evidence of the dominance of banks (and “near-banks”) relative to the bond and equity markets in East Asia. It is this heavy regional dependence on bank intermediation that contributed to the breadth, depth, and longevity of the crisis. 6 Financial and Macroeconomic Co-operation in ASEAN: Issues and Policy Initiatives RAMKISHEN S. RAJAN ISEAS DOCUMENT DELIVERY SERVICE. No reproduction without permission of the publisher: Institute of Southeast Asian Studies, 30 Heng Mui Keng Terrace, SINGAPORE 119614. FAX: (65)7756259; TEL: (65) 8702447; E-MAIL: publish@iseas.edu.sg Financial and Macroeconomic Co-operation in ASEAN 127© 2001 Institute of Southeast Asian Studies, Singapore TABLE 6.1 Net Capital Flows to East Asia (Indonesia, Malaysia, South Korea, Thailand and Philippines), 1995–99 (In US$ billion) Type of Capital Flow 1995 1996 1997 1998c 1999d Current account balance –40.6 –54.8 –26.1 69.2 44.6 External financing 83.0 99.0 28.3 –4.2 7.8 Private flows 80.4 102.3 0.2 –27.6 0.3 Equity investment 15.3 18.6 4.4 13.7 18.5 Direct 4.2 4.7 5.9 9.5 12.5 Portfolio 11.0 13.9 –1.5 4.3 6.0 Private creditors 65.1 83.7 –4.2 –41.3 –18.2 Commercial banks 53.2 62.7 –21.2 –36.1 –16.0 Non-banks 12.0 21.0 17.1 –5.3 –2.3 Official flows 2.6 –35.3 28.1 23.4 7.6 Resident lending/othersa –28.3 –27.3 –33.7 –22.9 –21.0 Reserves (exc. gold)a,b –14.1 –16.9 31.5 –42.1 –31.4 NOTES: a minus denotes increase b including resident net lending, monetary gold and errors and omissions c estimates d forecast SOURCE: IIF (1999). TABLE 6.2 Selected Indicators of Financial Sector Development in East Asia, 1994–96 (% of GDP) Credit of Bank Bank Share in Stock Bond Banking Assets Financial Market Market System (1994) Intermediation Capitalization Capitalization (1995) (1994)a (1996) (1996) Indonesia 50 57 91 10 6 S. Korea 70 75 38 43 24 Malaysia 132 100 64 33 56 Philippines 63 54 n.a. n.a. 39 Thailand 137 110 75 4 14 NOTES: a Assets of banks as a percentage of the assets of banks and non-bank financial institutions SOURCES: Rajan (1999b). 128 Ramkishen S. Rajan© 2001 Institute of Southeast Asian Studies, Singapore This being said, the aim of this chapter is not to revisit the origin and consequences of the crisis.1 Rather, the focus here is threefold. First, the issue of “regional contagion” is briefly discussed. This provides the context within which the scope — if not the type — of regional co-operation in the financial and macroeconomic spheres may be considered. Secondly, the main policy initiatives in ASEAN in these areas are highlighted. Finally, concrete policy initiatives for regional co-operation in ASEAN and the larger East Asian region are tabled. Rationale for Regional Co-operation in the Macroeconomic and Financial Spheres2 The currency crises of the 1990s, and particularly the one that hit ASEAN and the larger East Asian region in 1997–98, seem to be strongly suggestive of the relevance and pervasiveness of contagion or negative spillover effects that are largely regional in scope (thus, also referred to as “neighbourhood effects”). Following Masson (1998), we may...