Masaru Yoshitomi

English

Research Papers in Economics

POLICY PRESCRIPTIONS FOR EAST ASIA
Masaru Yoshitomi*
At the Asian Development Bank Institute in Tokyo, we recently
produced policy recommendations about how to avoid another ﬁnancial
crisis and, if we should have a crisis, how to mitigate that crisis. These
policy recommendations were disseminated at the time of the Asian
Development Bank’s annual meeting in Chiang Mai, Thailand, early this
May.
Understanding the nature of crises should provide us with new
policy prescriptions. If the International Monetary Fund (IMF) ﬁnds
evidence of a new type of crisis, I am sure it will develop a new policy
prescription. So, the identiﬁcation of the nature of each crisis becomes
very important.
THE CAPITAL ACCOUNT CRISIS
We call the East Asian crisis a “capital account crisis,” as distinct
from the conventional “current account crisis.” The conventional current
account crisis often is caused by poor macroeconomic fundamentals,
according to conventional measures: inﬂation, a budget deﬁcit, and low
domestic savings rates. But in the case of Asia, as you know, such
fundamentals were near perfect and yet we faced large current account
deﬁcits. However, the current account balance was driven by the capital
account, rather than the other way around. Even before the crisis, when
capital was ﬂowing in, the current account deﬁcits of East Asian emerg-
ing economies tended to widen, because of the absorption effect of the
domestic monetary and credit expansion resulting from the massive
*Dean, Asian Development Bank Institute in Tokyo.capital inﬂows. It is so clear now, after the crisis, that when the capital
ﬂows reversed, then the current account had to change from deﬁcit to
surplus quickly.
A major feature of the capital account crisis is, ﬁrst of all, massive
capital inﬂows, dominated by short-term loans and followed by a sudden
reversal of such capital ﬂows. And, in a sense, we can say that the “secret
corrupter” in the 1990s, in most of those Asian economies, was the use of
short-term, foreign-currency-denominated loans as a source of ﬁnancing,
which resulted in both a maturity mismatch and a currency mismatch.
This had an enormously large balance sheet effect, as compared with the
case of a conventional current account crisis. Therefore, an exchange rate
depreciation did not help the Asian economies, but only worsened the
balance sheet. The nature of the crisis required quite different policy
prescriptions.
FOREIGN EXCHANGE RATES AND CAPITAL MARKETS
So, what sort of policy recommendations do we make? First of all, we
focus upon two features of this capital account crisis: the massive capital
inﬂows and then the sudden reversals. What would be the appropriate
foreign exchange rate regime? A ﬁxed regime is considered unworkable
in this dysfunctional and globalized ﬁnancial market, yet at the same time
we cannot advocate drastic solutions. Hong Kong has a currency board,
but Hong Kong is an exception in Asia. In the case of the currency board
in Argentina, the national currency ﬁrst experienced the loss of a
domestic anchor, that is, Argentina experienced high inﬂation at home.
Therefore, the currency board provides the country with an international
anchor for ﬁghting its domestic inﬂation. There was not a similar need in
other Asian economies because, as I said, conventional macroeconomic
fundamentals remained quite excellent.
On the other hand, the free-ﬂoating exchange rate regime, exercised
by advanced economies, may not ﬁt the emerging economies well.
Short-term volatility of the exchange rate tends to cause very high
volatility in domestic assets as well. Therefore, under capital account
convertibility, residents tend to make investments abroad, where they
can ﬁnd stable, less volatile ﬁnancial assets. So, when talking about the
developmental issues of an emerging economy, short-run volatility of the
exchange rate and, hence, volatility in domestic markets make it difﬁcult
for emerging economies to establish and promote a strong and sound
capital market.
By the way, when we say capital market, the bond market and the
equity market are two totally different animals. In the Asian economies,
because of the good macroeconomic performance, there have been no
budget deﬁcits and hence no need to issue government bonds. Only over
the past few years have we been talking about how to establish a
POLICY PRESCRIPTIONS FOR EAST ASIA 233yardstick for the yield curve by issuing national bonds; the maturity of a
national bond in East Asia now is less than ﬁve years. We are just starting
in the government bond market. The corporate bond market is even more
difﬁcult to establish. Even in the United States, 94 percent of the
outstanding corporate bonds are traded only once a year. So liquidity
tends to be very shallow, even in the U.S. markets. No wonder emerging
economies have such shallow corporate bond markets.
At any rate, because of the double mismatch of currency and
maturity, the balance sheet factor worsens the crisis. Then, how to
establish a sound capital market? A ﬂoating exchange rate regime may
not promote a sound capital market. Also, over the medium run, a capital
market’s soundness will depend upon the extent to which capital ﬂows
are endogenously or exogenously determined, in emerging economies. If
capital persistently ﬂows into the emerging economies, it is possible that
the exchange rate will become misaligned over the medium run, resulting
in misallocation of domestic resources between tradables and nontrad-
ables, as happened in many countries. For those reasons, we propose an
exchange rate policy that lies between the currency board and the pure
ﬂoating regime.
I should stress that this in-between exchange rate regime is going to
work alone, but that our recommendations should be taken as a compre-
hensive policy package. So we also suggest that, if necessary, Chilean-
type capital controls over short-term loans and short-term ﬂows also be
introduced. Many researchers suggest that the composition of capital
ﬂows could be inﬂuenced by such Chilean capital controls, but this would
not necessarily inﬂuence total volume of capital inﬂows.The composition
could be changed toward longer maturities, which certainly would help
to at least mitigate a crisis caused by massive short-term capital inﬂow.
MATURITY MISMATCH
The third policy recommendation concerns how to mitigate the
maturity mismatch. The currency mismatch, that is, the exposure of
domestic intermediaries to foreign-currency-denominated liabilities, was
not their only problem. In many cases, their excessive lending to the real
estate sector using short-term lending was an important cause of the
crises, too. So, a cap on lending to such areas should be introduced to
avoid serious maturity mismatch. Many people, even Asian economists,
are saying that banks are no longer functional because of the overreliance
on short-term borrowing to ﬁnance long-term projects of investment and,
therefore, capital markets should be utilized more. But these markets are
not there yet in emerging countries, as I have said. A sound and deep
capital market is very difﬁcult to establish, in the short term.
234 Masaru YoshitomiCORPORATE GOVERNANCE
We also need to consider corporate governance. When talking about
corporate governance in Asia after the crisis, in particular bank-based
corporate governance, one should note that the banks in Asia are very
different from the banks in Germany or even banks in Japan. And we
should talk not about the governance of corporations featured by
dispersed ownership in Asia, but instead about the corporate governance
of family businesses, featured by concentrated ownership. Also, the
powers of banks in Asia are very different from those in Japan or
Germany. Most of the banks in the Asian economies are located in a lower
position in the control chain of the overall industrial organization,
whereas they are in a higher position in Japan and Germany. Therefore,
when we address the issues of how prudential regulation and the
strengthening of the banking system would improve these economies, we
should not forget the feature of family businesses. Given these consider-
ations, we did reach the conclusion that banks should be strengthened.
CURRENCY RESTRICTIONS
On the sudden reversal of capital ﬂows, we have another set of
recommendations. One is related to the currency attack on the Malaysian
ringgit in the ﬁrst half of 1998, which resulted in the introduction of
capital controls by Malaysian authorities on September ﬁrst of that year.
It was interesting to observe that such a currency attack took place a year
after the Thai crisis in July 1997. We wondered whether such different
timing of the crisis might reﬂect the different nature of the crisis from
those in Thailand, Korea, and Indonesia. In the Malaysian case, nonres-
idents accumulated Malaysian ringgits in the Singapore offshore market,
resulting in a very high interest rate on the ringgit in that offshore market,
about 35 percent from April to July. This compared to about 12 percent or
so on the onshore home market in Malaysia. This was a pure currency
attack on the Malaysian ringgit through selling the accumulated Malay-
sian currency by nonresidents in the offshore market. Therefore, why not
restrict the nonresident holdings of domestic currencies of emerging
economies? Exactly that has been done by the Singapore authorities over
the past three decades, in sharp contrast to the fact that Singapore has
liberalized capital account convertibility. This restriction is one of the
policy recommendations regarding reversal of foreign capital ﬂows.
LENDER OF LAST RESORT
The last policy recommendation concerning sudden reversals of
capital ﬂows relates to the international and/or regional lender of last
resort and the international liquidity crisis as an important aspect of
POLICY PRESCRIPTIONS FOR EAST ASIA 235capital account crisis. To take care of large currency depreciations, which
tend to aggravate the problems associated with the aforementioned
balance sheet mismatch, we may need an international and/or regional
lender of last resort. If the IMF is ready to provide a timely and massive
amount of international liquidity to economies undergoing a capital
account crisis, as in the case of the East Asian economies, then we
welcome such provision of international liquidity. If the IMF is not ready
for that, then an Asian monetary fund-type of arrangement should be
established to supplement the activity of the IMF.
I have been discussing all these policy recommendations with
various ﬁnancial ministers in Asia. However, we have to admit that we
might be ﬁghting the old war instead of discussing how to avoid a new
crisis. My major concern today is what we should do in Asia if the U.S.
stock market crashes. The nature of the next crisis may be very different,
we may need a very different policy prescription in Asia. The U.S. stock
market is one of the major concerns Asian policymakers now have in
mind.
236 Masaru Yoshitomi

Policy prescriptions for East Asia

http://www.bostonfed.org/economic/conf/conf44/cf44_20.pdf

Policy prescriptions for East Asia

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