Annual Report on the Asian Economies 1999(SUMMARY)


  • Chapter1 Asian Economies-Overview-
  • Chapter2 Asian Economies after the Crisis
    • Part 1 Causes of the Asian Currency and Financial Crises
    • Part 2 Present Situation of Asian Economies and Their Road to Recovery
    • Part 3 Potential Economic Growth of East Asian Countries in the Medium- and Long-Run
  • Chapter3 Economic Development of Individual Countries and Regions in Asia and Oceania (omitted)


  1. This report focuses mainly on East Asia and South Asia.

    Smaller regions defined in this report, are groups of the following countries and regions:

    Asian NIEs(Asian Newly Industrializing Economies)
    Korea, Taiwan, Hong Kong, and Singapore
    ASEAN 4
    Indonesia, Thailand, Malaysia, and the Philippines,
    East Asia
    Asian NIEs, ASEAN4, and China
    South Asia
    India, Pakistan, Bangladesh, Sri Lanka, Nepal, Bhutan
    The Pacific regions
    Australia, New Zealand
  2. The economic forecasts of individual countries are based on the forecasts by the IMF, ADB, and PECC.

Chapter 1 Asian Economies -Overview

[Summary of Chapter 1]

Asian Economy in 1998

Asian economies in general experienced a harsh recession in 1998, as the currency and financial crises exerted a greater influence on them than expected. The growth rate of East Asia as a whole declined sharply to 2.6% in 1998. China maintained a comparatively high growth rate of 7.8%. But Asian NIEs recorded a negative growth rate of - 1.4%, among which Korea and Hong Kong shrank most. The growth rate of the ASEAN countries as a whole declined to - 6.9%, as Thailand registered its consecutive year of negative growth, and Indonesia and Malaysia also recorded negative growth rates. Inflation accelerated especially in the first half of 1998 among the countries hit harshly by the crisis. But in the second half it was subdued in general. Current account deficits turned into surplus in many countries due to substantial decrease in imports. East Asia as a whole recorded a surplus ( Table 1-1-1 , Figure 1-1-6 ).

Employment Situation

In East Asian countries, the employment situation has significantly worsened since the end of 1997. In Asian NIEs, unemployment rates surged partly due to the restructuring of financial institutions in Korea, increased bankruptcies in retail sectors in Hong Kong, and other factor. The number of unemployed also increased in ASEAN countries due to corporate bankruptcies and business downsizing. In China the reform of state-owned enterprises now in progress gave rise to a rapid increase in unemployment ( Figure 1-1-7 ).

Prospects for Asian Economies in 1999

At the beginning of 1999, the Asian economies started to show bright signs such as the continued decline in interest rates made possible by currency stabilization, an increase in stock price indices, and recovery of production. The Asian economies as a whole are expected to recover gradually and to grow by 4.4% in 1999. But if we take a closer look, expected performance is different from country to country; the Korean economy has already bottomed out and is expected to register positive growth in 1999, while politically and socially unstable conditions in Indonesia make it very difficult to know when its economy will recover. The current account surplus in Asia is expected to be maintained in 1999, though at a lower level.

International Trade and Investment

Both exports and imports in dollar terms by Asian countries as a whole decreased in 1998. The growth rate of exports from Asia declined in general in 1997. In 1998 exports decreased in many countries, and even China registered a decrease in the latter half of the year. Exports in real terms from the countries that experienced a large currency depreciation registered a comparatively high growth. The downturn of domestic demand resulted in a large decline in imports, which improved the trade balance in most countries. But in 1999 imports to some Asian countries started to increase as production bottomed out.

The growth rate of foreign direct investment (FDI) into Asia declined due to the financial crisis. Asian countries are trying to enhance the inflow of FDI, recognizing anew the importance of it; FDI is rather stable and contributes to economic development ( Figure 1-2-1 ).

Development of Regional Cooperation Within and With Asia

Asian regional cooperation has been invigorated recently, and has been backed by rapid economic growth in this area. Many have recognized that cooperation bestows mutual benefits within the Asian economies, and promotes cooperation with other regions. But this development might have reached a turning point, as many Asian economies have been in severe economic conditions due to the crisis. Asian countries must respond correctly to the crisis and are pursuing stable growth paths, maintaining cooperation among countries mired in difficulties by the crisis.

Chapter 2 Asian Economies after the Crisis

[Summary of Chapter 2]

Causes of the Asian Crisis

Comparing the pre-crisis situation of each East Asian economy with its crisis index, which represents how seriously the economy was affected by the crisis, we see that there is no strong causal relationship between macroeconomic fundamentals and the index. In this sense, the Asian crisis showed us a dangerous aspect of free global capital movement. But it was also confirmed that the weakness of the financial systems and corporate financial structures was an important cause of the crisis.

Present Situation of Asian Economies and Their Road to Recovery

East Asian economies in general are bottoming out and moving toward a recovery. But this movement is supported largely by public spending, and has not yet led to a full-fledged recovery.

Development of export growth is a key to future recovery. But export volume from the region is expected to grow gradually rather than rapidly, primarily because world trade volume is not expected to make a rapid recovery.

Another external factor crucial for the recovery is capital inflow from abroad. After the crisis, bank lending from the U.S., Japan, and other countries decreased significantly. But foreign direct investment (FDI) has been increasing in some countries such as Korea and Thailand, which are making progress on economic structural reforms. The current environment surrounding Japanese firms operating in Asian markets is severe. But the firms regard those countries as important investment destinations from a longer-term viewpoint. Thus further progress of economic structural reforms in Asia, with financial assistance from Japan, is expected to improve the business climate for investment.

Turning to domestic factors, the malfunctioning of financial intermediation and the credit crunch are major obstacles to economic recovery in East Asian countries. The malfunctioning of financial intermediation is caused by mounting non-performing loans and large-scale capital outflows. The governments of East Asian countries are trying hard to build stronger financial systems. Although the stance and speed of financial reforms are divergent across the region, basic schemes of financial restructuring have been put in place in most countries. Further developments in the implementation of the legal and institutional frameworks constituting these schemes require close attention.

Besides financial systems, there also exist economic structural problems such as industrial policy which restricts competition and overly diversified business activities of chaebols.

Economic structural reforms such as financial system reform may have a negative influence on the economy in the short-term. However, to utilize the high economic potential of East Asia, it is necessary to implement these reforms without hesitation, and thereby to improve economic efficiency and to attract long-term foreign capital.

Potential Economic Growth of East Asian Countries in the Medium- and Long-Run

Estimating the potential economic growth of East Asian countries, it is pointed out that before the crisis actual GDP was higher than potential GDP in most countries, and these economies seemed to have been overheating. It is also pointed out that potential growth rates in some countries had been declining before the crisis. Based on the past trend, medium- and long-run potential economic growth rates of East Asian countries until the year 2010 were estimated. Due to the slowdown of growth rates of capital as well as of labor, potential economic growth rates are expected to fall to 5-7% annually, which is below the pre-crisis rates. However, if on-going reforms of financial system, corporate sector and others are completed successfully, total factor productivity could surpass a trend line, and the growth rates could be higher than our estimation.

The Asian currency and financial crisis since the middle of 1997 was a very important event to be recorded in the history books of the world economy as well as of the Asian economies. Recognizing that large-scale capital inflows and outflows caused the crisis, a fundamental question has been raised with respect to what the desired international currency and financial system ought to be. At the same time, this crisis has brought various problems inherent in the Asian economies to the surface.

Part 1 of Chapter 2 analyzes the causes of the crisis. Part 2 discusses the current situation of the Asian economies and prospects for future recovery. This is followed by Part 3, which estimates the potential growth of Asian economies from a longer-term perspective. Throughout Chapter 2, the importance of structural reform, including stabilization and strengthening of the financial sector, is emphasized.

Part 1 Causes of the Asian Currency and Financial Crisis

Comparing the pre-crisis macroeconomic fundamentals and the seriousness of the crisis in each East Asian country, we could not find a strong causal relationship between them. That is, many crisis countries recorded fiscal surpluses and one-digit inflation rates before the crisis. Moreover, if we look at the relationship between the crisis index (a weighted average of currency appreciation rates and growth rates of net international reserves) and macroeconomic variables such as real exchange rate appreciation against the dollar and the current account deficits, though we cannot deny that a correlation between the index and these variables indeed exists, it is doubtful whether current accounts deficits were worsened to such an extent as to cause such a large-scale crisis except in Thailand. And time-series data show that, before the crisis, capital was flowing into Asian countries backed by de facto fixed exchange rates against the dollar, high interest rates, deregulation on capital mobility, and high economic growth expectations irrespective of macroeconomic fundamentals. This capital inflow was reversed with little precaution in July 1997. In this sense, the Asian crisis taught us a dangerous aspect of global capital mobility under de facto pegged exchange rates.

This, however, does not directly imply that Asian countries had no problems at all before the crisis, not that international capital mobility was the only cause of the crisis. Instead, it is possible to point out that crisis countries had weaknesses in terms of their financial systems and corporate finance structures.

For example, a country with more dependence on indirect finance from banks before the crisis tended to be hit more seriously by the crisis (see Figure2-1-6 ). Similarly, the lower "operating profit to interest payment ratio" in its manufacturing sector, or the larger the amount of external debt of its private sector, the more seriously a country was hit by the crisis. From these observation, we learn the following: When we judge an economy’s soundness, we should pay attention not only to basic macroeconomic variables but also to other structural features like its financial system, corporate finance, and other factors.

Part 2 Present Situation of Asian Economies and Their Road to Recovery

(1) Development of exports and economic recovery

In East Asian countries that experienced large currency depreciation, economic recovery led by the increase in exports was expected. But exports in dollar terms from many East Asian countries actually decreased in 1998 mostly due to the decline of dollar-denominated exports prices and the contagious spread of the crisis throughout the whole region.

Crisis countries such as Korea, Thailand, and Indonesia registered comparatively high real export growth due to real effective exchange rate depreciation. But these real export growth rates were much lower than those during the Mexico crisis, which started at the end of 1994 (see Figure 2-2-6 ).

As for the future prospects of exports from East Asia, positive factors include freed bottlenecks in trade financing and expected growth of semiconductor export prices. These factors, however, may be offset by weak world demand growth and appreciation of real effective exchange rates. Thus, exports from Asia are not expected to increase rapidly. It is difficult to expect an export-led V-shape recovery.

(2) Development of capital inflow and Japanese firms in Asia

Development of foreign direct and indirect investment into Asia is another important external factor that will shape the future Asian economies. Net external financing of Asia dramatically changed from an inflow of $102.3 billion in 1996 to an outflow of $27.6 billion in 1998 ( Table 2-2-12 ). The current environment surrounding Japanese firms operating in Asian markets is severe. But these firms highly evaluate those markets as important investment destinations from a longer-term perspective. Thus further progress of economic reforms in Asia, with financial assistance from Japan, is expected to improve the business climate for investment.

(3) Malfunctioning of financial intermediation and efforts to build stronger financial systems

1) Cautious lending attitude by commercial banks and dependence of Asian economies on indirect financing

Comparing growth rates of both deposits and lending, the plots of these rates became diverged in 1998 from the trend line until 1996 in most East Asian countries. That is, the growth in lending is low relative to the growth in deposits in 1998, particularly in the second half, compared with the trend line ( Figure2-2-26 ). Based on these observations, banks seem to be reluctant to make loans to the private sector and to increase government bond holdings. There seems to be a credit crunch in these countries. The credit crunch is having a great impact on the real economies of East Asia, which are highly dependent on indirect financing.

2) Increase in bad loans and sharp decrease in capital inflows from abroad

Bad loan problems are one of the main reasons for the cautious lending attitude of banks in East Asia. Non-performing loan ratio of the banking sector in most East Asian countries increased from the end of June 1997 to the end of December 1998 ( Table2-2-30 ).

3) Efforts to build more stable and stronger financial systems

The turmoil after the crisis has almost come to an end in the East Asian economies. But it is necessary to stabilize the financial systems for their full-fledged recovery. In particular, a solution to the bad loan problem of the banking sector is indispensable. The measures to solve the bad loan problem in most East Asian countries primarily consist of :

  • Improving the capital base of financial institutions by injecting public funds.
  • Establishing special agencies for disposal of non-performing loans.
  • Restructuring and consolidating financial institutions.

Moreover, the governments of East Asian countries have been making progress in amending corporate reorganization laws and bankruptcy laws. These steps will contribute to hasten the disposal of non-performing loans. Although the stance and speed of financial reforms are divergent across the region, the basic schemes of financial restructuring have been put in place. Further developments in the implementation of the legal and institutional frameworks that constitute these schemes require close attention.

4) External debt profiles and economic recovery..... omitted

(4) Progress in economic structural reforms

The structural problems of Asia are not confined to problems of financial systems. For example, industrial policies that restricted competition were also a major structural problem.

(Promotion of Privatization)

After the crisis, each nation in Asia has been promoting the revision of competition-restrictive policies. In particular, each nation has been trying to privatize state-operated companies to improve economic efficiency. But progress in this area has not necessarily been satisfactory due to relatively low stock prices and labor market rigidities.

(Inefficiency of the Economic System and Structural Reforms)

The competition-restrictive industrial policies discussed above have been continuously conducted, together with subsidies, supports in terms of tax cuts and financing, and credit allocation by the government, so that various inefficiencies have been embedded in the economic system of the East Asian countries. Here, we take Korea as an example.

In Korea, chaebols (or conglomerates), reacting to policies provided by the government, conducted overly diversified business activities, and as a result the economic system came to involve inefficiencies such as over-investment and over-borrowing. As a matter of fact, in Korea capital efficiency deteriorated rapidly in 1996 and some chaebols have gone bankrupt since 1997 (See Figure 2-2-39 ).

So, the new administration decided to promote its "Big Deal" policies, limiting the scope of the chaebols' business activities. Moreover, since labor market flexibility is a prerequisite for companies to execute restructuring, the government legislated the firing law, making such means as lay-offs or flexible adjustment of wage levels possible, at least legally.

Of course, implementation of the reforms may be painful in the short-term, because it may reduce employment and production. But, in the medium- or long-term, Asian countries will be on the right track of continuous growth again after successful completion of those reforms.

How quickly these reforms will be implemented will depend on the overall system of a country, not only economic, but also political, because the Asian Crisis was not a simple external shock from demand side, but a shock with a more fundamental systemic nature. To get over it, many important systemic changes will be necessary.

(5) Conclusion-Road to the Recovery

Most East Asian economies are bottoming out and beginning to recover. For their full-fledged recovery, domestic private demand needs to pick up. And structural reforms such as financial system reform, privatization, business sector reform, and labor market reform are important. On the other hand, the international community, especially developed countries, must do three things: expand imports, give financial assistance to East Asia, and stabilize the international currency and financial systems.

Part3 Potential Economic Growth of East Asian Countries in the Medium- and Long-Run

Comparing actual GDP of East Asian countries with their estimated potential GDP, it was found that actual GDP was substantially higher than potential GDP in all countries except Korea in the 1990s (until mid-1997). (Potential GDP: GDP obtainable with full utilization of capital and labor forces) This indicates that their economies were overheating at that time. (See Figure 2-3-3 ) Therefore, even without the economic crisis, it is highly possible that their economic growth would have slowed down. Moreover, due to decrease of labor input, potential economic growth rates slowed down in Thailand, Korea, the Philippines and Singapore. It is thus probable that their economic growth rate would have decelerated in the medium- and long-run, even without the economic crisis.

We estimated potential economic growth of East Asian countries until the year of 2010. The amount of investment, which determines the growth of capital stock, depends very much on domestic savings rates. Prospective savings rates fall slightly with aging population in NIEs, such as in Korea and Singapore, and thus growth of investment is expected to slow. In ASEAN 4 countries, savings rates are expected to rise continuously because of the fall in youth dependency ratio. However, the rise in savings rates is expected to be smaller than before, and thus growth of investment is expected to slow. Growth of labor input is basically determined by the growth of the labor force population. The labor force population is then determined by working-age populations (population of age between 15 and 64) and labor force participation ratio (labor force population between age of 15 and 64 / working-age population). Due to the fall in birthrate, population growth will slow down. Because of the decrease in younger population, the growth rate of working-age population until the year of 2010 will halve, except in the Philippines and Malaysia. Also, labor force participation rate (labor force population / total population) is expected to continue to rise, albeit at a lower rate, especially among women and older population. As a result, the labor force population is expected to continue growing, albeit at a lower rate. As for total factor productivity, the growth rate of technical progress through "catch-up" will decline in the long-term. However, continuing expansion of production frontiers is expected by technology transfer via direct investment and accumulation of imported capital goods, original technical development, improved human capital, and a spill-over effect of the fruits of developed countries’ research and development. We assumed that the growth rate of total factor productivity for each country is equal to the average growth rate from the 1970s. (Note: average growth rates of TFP for the Philippines were negative in the past, so we assumed a 0% growth rate for the low case, and the average of the other five countries for the high case) Based on these assumptions, potential economic growth rates are estimated at 5-7 % annually, primarily due to the slowing of labor force population growth and a decrease in the growth of investment. (See Figure 2-3-9 )

However, if on-going reforms of inefficient financial systems and of industrial structures are completed successfully, total factor productivity might surpass the past trend line, and the growth rate might be higher than our estimation.