The End of a "Miracle": Speculation, Foreign Capital Dependence and the Collapse of the Southeast Asian Economies

by Walden Bello

Environmentalists received an early Christmas gift when the Malaysian government announced in early December that it was suspending plans to build the controversial Bakun Dam in Sarawak. Constructing the dam would have resulted in the clearcutting of 70,000 hectares of forestland in an area that is already experiencing one of the world's highest rates of deforestation and in the displacement of approximately 9,500 indigenous people. What years of international and local pressure on and lobbying of the Malaysian government could not do was achieved by the one message that the country's strong-willed leader Mohammed Mahathir could understand: no more dollars. Expected to cost $5 billion, the Bakun Dam -- like Mahathir's other vision of building a two kilometer-long "Linear City" that would have been the world's longest building -- fell victim to the financial crisis that is presently wracking Southeast Asia.

In the past several months, the Philippines and Southeast Asia have been gripped by an economic downturn that has yet to hit bottom. The Philippine peso, the Thai baht, the Malaysian ringgit and the Indonesian rupiah have collapsed, falling in value by as much as 80 percent in the case of the rupiah. Stock markets from Jakarta to Manila have hit record lows, dragging down via a curious "contagion effect" Hong Kong and even Wall Street, at least momentarily.

Governments throughout the region were paralyzed by the crisis. In Thailand, the ruling coalition has lost its last ounce of credibility as people look toward the curious combination of the King and the International Monetary Fund (IMF) for salvation in these frightening times. In the Philippines, the administration of President Fidel Ramos is reduced to telling people to count their blessings because the crisis is worse in Thailand, Malaysia and Indonesia. In Kuala Lumpur, Mahathir rails angrily against what he sees as a conspiracy to debauch Southeast Asia's currencies led by speculator George Soros, also hinting darkly at a Jewish plot against Islamic Malaysia.

Once proud of their freedom from IMF stabilization and structural adjustment programs, the Thai and Indonesian governments have run to the Fund, which has assembled multi-billion dollar bailout funds in return for draconian programs that pull the plug from banks and finance companies, mandate deep spending cuts and accelerate liberalization and deregulation in economies marked by significant state intervention. The Philippines never left IMF management, and it is now likely to postpone its "exit." True to form, Malaysia's Mahathir refused to go to an institution that he sees as part of the problem rather than the solution.

Crisis of a Model

Many informed analysts, while dismissing Mahathir's conspiracy theories, have pinned part of the blame for the crisis on the uncontrolled flow of trillions of dollars across borders owing to the globalization of financial markets over the last few years. Increasingly, some assert, capital movements have become irrational and motivated by no more than a herdlike mentality, where one follows the movement of "lead" fund managers like Soros, without really knowing about the "economic fundamentals" of regions they are coming to or withdrawing from. Surprisingly, Stanley Fischer, the deputy managing director of the IMF, lent support to this interpretation about irrational markets, telling the recent World Bank annual meeting in Hong Kong that "markets are not always right. Sometimes inflows are excessive, and sometimes they may be sustained too long. Markets tend to react late, but then they tend to react fast, sometimes excessively."

The merits of this analysis notwithstanding, it fails to grapple with a more fundamental issue: the pattern of development that has rendered the region so vulnerable to such variations in foreign capital inflows and outflows. To a considerable extent, the current downspin of the region's economies should be seen as the inevitable result of the region's closer integration into the global economy and heavy reliance on foreign capital.

More than in the case of the original newly industrializing countries (NICs) of Northeast Asia, the Southeast Asian NICs have been dependent for their economic growth on foreign capital inflows. The first phase of this process of foreign capital-dependent growth occurred between the mid-eighties and the early 1990s, when a massive inflow of capital from Japan occurred, lifting the region out of recession and triggering a decade of high 7 to 10 percent growth rates that were the envy of the rest of the world.

Central to this development was the Plaza Accord of 1985, which drastically revalued the yen relative to the dollar, leading Japanese corporations to seek out low-cost production sites outside of Japan so they could remain globally competitive. Some $15 billion in Japanese direct investment flowed into the region between 1986 and 1990. This infusion brought with it not only billions more in Japanese aid and bank capital but also an ancillary flow of capital from the first generation NICs of Taiwan, Korea and Hong Kong.

By providing an alternative access to tremendous sums of capital, Japanese investment had another important result: it enabled Southeast Asian countries to slow down the efforts of the IMF and World Bank to carry out the wide-ranging "structural adjustment" of their economies in the direction of greater trade liberalization, deregulation and privatization -- something the Fund and Bank were successfully imposing on Latin America and Africa at the time.

By the early 1990s, however, Japanese direct investment inflows were leveling off or, as in the case of Thailand, falling. By that time, the Southeast Asian countries had become addicted to foreign capital. The challenge confronting the political and economic elites of Southeast Asia was how to bridge the massive gap between the limited saving and investments of the Southeast Asian countries and the massive investments they needed for their strategy of "fast track capitalism."

But happily for them, a second source of foreign capital opened up in the early 1990s: the vast amounts of personal savings, pension funds, corporate savings and other funds -- largely from the United States -- that were deposited in mutual funds and other investment institutions that sought the highest returns available anywhere in the world.

These funds were not, however, going to come in automatically, without a congenial investment climate. To attract the funds, government financial officials throughout Southeast Asia devised come-hither strategies that had three central elements:

• Financial liberalization or the elimination of foreign exchange and other restrictions on the inflow and outflow of capital, fully opening up stock exchanges to the participation of foreign portfolio investors, allowing foreign banks to participate more fully in domestic banking operations and opening up other financial sectors, like the insurance industry, to foreign players.
  
  
• Maintaining high domestic interest rates relative to interest rates in the United States and other world financial centers in order to suck in speculative capital that would seek to capture the enormous difference from the spread between, say, interest rates of 5 to 6 percent in New York and 12 or 15 percent in Manila or Bangkok.
  
• Fixing the exchange rate between the local currency and the dollar to eliminate or reduce risks for foreign investors stemming from fluctuations in the value of the region's currencies. This guarantee was needed if investors were going to come in, change their dollars into pesos, baht or rupiah, play the stock market or buy high-yielding government or corporate bonds, and then transform their capital and their profits back into dollars and move on to other markets where more attractive opportunities awaited them.

The policy was wildly successful in achieving its objective of attracting foreign portfolio investment and bank capital. U.S. mutual funds led the way, supplying new capital to the region on the order of $4 billion to $5 billion a year for the past few years.

Thailand's Record Rise and Fall

A close look at two countries -- Thailand and the Philippines -- reveals the dynamic of the rise and unravelling of foreign capital-driven "fast track capitalism."

In the case of Thailand, net portfolio investment or speculative capital inflow came to around $24 billion in the last three to four years, while another $50 billion came in the forms of loans via the innovative Bangkok International Banking Facility (BIBF), which allowed foreign and local banks to make dollar loans to local enterprises at much lower rates of interest than those in baht terms. With the wide spread -- 6 or 7 percent -- between U.S. interest rates and interest rates on baht loans, local commercial banks could borrow abroad and still make a mean profit relending the dollars to local customers at lower rates than those charged for baht loans. Thai banks and finance companies had no trouble borrowing abroad. With the ultimate collateral being an economy that was growing at an average rate of 10 percent a year -- the fastest in the world in the decade from 1985 to 1995 -- Bangkok became a debtors' market.

Contrary to current IMF and World Bank attempts to rewrite history, the massive inflow of foreign capital did not alarm the Fund or the Bank, even as short-term debt came to $41 billion of Thailand's $83 billion foreign debt by 1995. In fact, the Bank and the IMF were not greatly bothered by a conjunction of a skyrocketing foreign debt and a burgeoning current account deficit (a deficit in the country's trade in goods and services) which came to 6 to 8 percent of gross domestic product in the mid 1990s. At the height of the borrowing spree in 1994, the official line of the World Bank on Thailand was: "Thailand provides an excellent example of the dividends to be obtained through outward orientation, receptivity to foreign investment and a market-friendly philosophy backed by conservative macro-economic management and cautious external borrowing policies."

Indeed, as late as 1996, while expressing some concern with the huge capital flows, the IMF was still praising Thai authorities for their "consistent record of sound macroeconomic management policies." While the Fund recommended "a greater degree of exchange rate flexibility," there was certainly no advice to let the baht float freely.

The complacency of the IMF and World Bank when it came to Thailand -- and their failure to fully appreciate the danger signals -- is traced by some analysts to the fact that the debt was not incurred and financed by the government but by the private sector. Indeed, the high current account deficits of the early 1990s coincided with government budget surpluses. In the Fund/Bank view, since the financial flows were conducted by private actors, there was no need to worry, as they would be subject to the self-correcting mechanisms of the market. That, at least, was the theory.

Siam's Twin

Turning to the Philippines, Manila's technocrats were in the early 1990s very hungry for foreign capital since the country had been, for reasons of political instability, skirted by the massive inflow of Japanese investment into the Southeast Asian region in the late 1980s. Eager to join the front ranks of the Asian tigers, the Philippine technocrats saw Thailand as a worthy example to follow and in the next few years, in matters of macroeconomic strategy, the Philippines became Siam's twin. Cloned by Manila, the formula of financial liberalization, high interest rates and a virtually fixed exchange rate attracted some $19.4 billion of net portfolio investment to the Philippines between 1993 and 1997. And dollar loans via the Foreign Currency Deposit Units -- Manila's equivalent of the Bangkok International Banking Facility -- rose from $2 billion at the end of 1993 to $11.6 billion in March 1997. As one investment house put it, with the peso "padlocked" at 26.2 to 26.3 to the dollar since September 1995, "they [Filipino banks] are not fools in Manila. They were offered U.S. dollars at 600 basis points cheaper than the peso rates along with currency protection from the BSP [the central bank]. They took it."

Real Events Versus the Real Economy

Had these foreign capital inflows gone into the truly productive sectors of the economy, like manufacturing and agriculture, the story might have been different. But they went instead principally to fuel asset-inflation in the stock market and real estate, which were seen as the most attractive in terms of providing high yield with a quick turnaround time. Indeed, the promise of easy profits via speculation subverted the real economy as manufacturers in Thailand and the Philippines, instead of plowing their profits into upgrading their technology or skills of their workforce, gambled much of them in real estate and the stock market. The inflow of foreign portfolio investment and foreign loans into real estate led to a construction frenzy that has resulted in a situation of massive oversupply of residential and commercial properties from Bangkok to Jakarta. By the end of 1996, an estimated $20 billion worth of the residential and commercial property in Bangkok remained unsold. Monuments of the property folly were everywhere evident, such as Bangkok Land Company's massive but virtually deserted residential complex near the Don Muang International Airport and the sleek but near empty 30-story towers in the Bangna-Trat area. Yet developers were still rushing new highrises to completion as late as mid-1997.

In Manila, the question by the beginning of 1997 was no longer if there would be a glut in real estate. The question was how big it would ultimately be, with one investment analyst projecting that by the year 2000, the supply of highrise residential units would exceed demand by 211 percent while the supply of commercial units would outpace demand by 142 percent. In their efforts to cut their losses in the developing glut, real estate developers refrained from major new investments in office space and condos, pouring billions of pesos instead into tourist resorts and golf courses.

Oversupply also overtook property development in Kuala Lumpur and Jakarta.

This all spelled bad news for commercial banks and finance companies in all four countries, since their real estate loan exposure was heavy. As a percentage of commercial banks' total exposure, real estate or real estate-related loans came to 15 to 25 percent in the case of the Philippines and 20 to 25 percent in the case of Malaysia and Indonesia. In Thailand, where the exposure in real estate was grossly underestimated by official figures and calculated by some to come to as high as 40 percent of total bank loans, half of the loans made to property developers were said to be "non-performing" by early 1997.

Unchecked by any significant controls by governments that had internalized the IMF and World Bank theory about the self-correcting mechanisms of the financial market, the frenzied flow of capital had led to the creation of a giant speculative bubble over the real economy that would explode in a highly destabilizing fashion.

Stampede and Speculation

It was the massive oversupply in the real estate sector that underlined to foreign investors and creditors that, despite creative accounting techniques, many of the country's finance companies that had borrowed heavily, floated bonds or sold equities to them were saddled with billions of dollars worth of bad loans. This led them to reassess their position in Thailand in the beginning of 1997. They began to panic when they saw the real estate glut in the context of the country's deteriorating macroeconomic indicators, like a large current account deficit, an export growth rate of near zero in 1996 and a burgeoning foreign debt of $89 billion, half of which was due in a few months time. Of these figures, the current account deficit loomed largest in foreign investors' consciousness, because it was thought to indicate that Thailand would not be able to earn enough foreign exchange in order to service its foreign debt. Nevertheless, during the boom years, investment analysts shrugged off deficits that came to 8 to 11 percent of gross domestic product (GDP) and continued to give Thailand A to AA+ credit ratings on the strength of its high growth rate. However, the combination of the massive buildup of private debt and the real estate glut put the country's "macroeconomic fundamentals," to borrow investors' jargon, in a new, and to many, scary light in 1997. Thailand's deficit in 1996 came to 8.2 percent of GDP, and this was now emphasized as roughly the same figure as that of Mexico when that economy suffered its financial meltdown in December 1994.

It was time to get out, first, and with over $20 billion jostling around in Bangkok, parked in speculative investment in Thai companies or nestled in nonresident bank accounts, the stampede was potentially catastrophic. It meant the unloading of hundreds of billions of baht for dollars. The result was tremendous downward pressure on the value of the baht, making it difficult to maintain the now-sacrosanct one-dollar-to-25-baht rate.

The scent of panic attracted speculators who sought to make profits from the well-timed purchases and unloading of baht and dollars by gambling on the baht's eventual devaluation. The Bank of Thailand, the country's central monetary authority, tried to defend the baht at around 25 baht to one dollar by dumping its dollar reserves on the market. But the foreign investors' stampede that speculators rode on was simply too strong, with the result that the central bank lost $9 billion of its $39 billion reserves before it threw in the towel and let the baht float "to seek its own value" in July.

Speculators spotted the same skittish foreign investor behavior in Manila, Kuala Lumpur and Jakarta, where the same conjunction of overexposure in the property sector, weak export growth and widening current account deficits was stoking fears of a devaluation of the currency. Speculators rode on the exit of foreign investors, which accelerated tremendously after the effective devaluation of the baht on July 2. Central bank authorities attempted the same strategy of dumping their dollar reserves to defend the value of their currencies, with the only result being the massive rundown of their reserves. By the end of August, the "fixing" of the dollar value of the Malaysian ringgit, Indonesian rupiah and the Philippine peso that had been one of the ingredients of the Southeast Asian "miracle" had been abandoned by all the region's central banks, as the currencies were let go to seek their own value in the brave new world of the free float.

The Future

Seldom in economic history has a region fallen so fast from economic grace. From being one of the world's hottest economic zones, Southeast Asia now faces a bleak future marked by the following likely developments:

First, despite statements made by some Southeast Asian governments (as well as by professional Asian miracle boosters like Harvard's Jeffrey Sachs) that the crisis is a short-term one -- a phase in the normal ebb and flow of capital -- there is a strategic withdrawal of finance capital from the Southeast Asian region. Capital movements may indeed be dictated by a mixture of rationality and irrationality. But one thing is certain: foreign capital is not so irrational as to return to Southeast Asia anytime soon. For in most investors' minds, the most likely scenario is one of prolonged crisis. The current instability will last from seven to 12 months, if the earlier experiences of Mexico, Finland and Sweden were any indication, says the chair of Salomon Brothers Asia Pacific, during which there will be weak domestic demand and "severe contraction in GDP in some of them."

A second likely development is that foreign investors will follow the lead of the banks and portfolio investors and significantly decrease their commitments to the region.

General Motors is now said to be regretting its 1996 decision to set up a major assembly plant in Thailand to churn out cars for what was then seen as the infinitely growing Southeast Asian market.

How Japanese direct investors who dominate the region will react is, however, the decisive question. Some analysts say that new investment flows from Japan are not likely to be reduced much since the Japanese are continuing to pursue a strategic plan of making Southeast Asia an integrated production base. More than 1,100 Japanese companies are ensconced in Thailand alone, they point out.

However, there are new wrinkles that make the situation different than the early 1990s. Japanese investment strategies in the last few years have targeted Southeast Asia not just as an export platform but increasingly as prosperous middle-class markets to be exploited themselves -- and these markets are expected to contract severely. Diverting production from Southeast Asian markets to Japan will be difficult since Japan's recession, instead of giving way to recovery, is becoming even deeper. And redirecting production to the United States is going to be very difficult, unless the Japanese want to provoke the wrath of Washington.

The upshot of all this is that Japan is likely to be burdened with significant overcapacity in its Southeast Asian manufacturing network, and this will trigger a significant plunge in the level of fresh commitments of capital to the region. Already, nearly all of the Japanese vehicle manufacturers -- Toyota, Mitsubishi and Isuzu -- have either shut down or reduced operations in Thailand.

A third likely development that will lengthen the shadow of gloom in the region is that the United States and the IMF are likely to take advantage of the crisis to press for further liberalization of the ASEAN economies. While many Asian economic managers are now coming around to the position that the weak controls on the flow of international capital has been a major cause of the currency crisis, U.S. officials and economists are taking exactly the opposite position: that it was incomplete liberalization that was one of the key causes of the crisis. The fixing of the exchange rate has been been identified as the major culprit by Northern analysts, conveniently forgetting that it was the Northern fund managers who had emphasized the stability that fixed rates brought to the local investment scene and not even the IMF had advocated a truly free float for Third World currencies owing to its fears of the inflationary pressures and other forms of economic instability this might generate.

But the agenda of U.S. economic authorities goes beyond the currency question to include the accelerated deregulation, privatization and liberalization of trade in goods and services.

Formerly, the economic clout of the Southeast Asian countries enabled them to successfully resist Washington's demands for faster trade liberalization. Indeed, they were able to derail Washington's rush to transform the Asia-Pacific Economic Cooperation (APEC) into a free trade area. But with the changed situation, the capacity to resist has been drastically reduced and there is virtually no way to prevent Washington and the IMF from completing the liberalization or structural adjustment of the economies where the process was aborted (with the significant exception of financial liberalization) in the late eighties owing to the cornucopia of Japanese investment.

Indeed, as part of the package of reforms agreed with the IMF, Thai authorities have removed all limitations on foreign ownership of Thai financial firms and are pushing ahead with even more liberal foreign investment legislation to allow foreigners to own land. Even before it sought the help of the IMF, Jakarta abolished a 49 percent limit for foreign investors to buy the initial public offering (IPO) shares in publicly listed companies.

Because of depressive effects of severe spending cuts, currency depreciation and the channeling of national financial resources to service the foreign debt, structural adjustment programs in Latin America and Africa brought a decade of zero or minimal growth in the 1980s. It is likely that with the resumption of structural adjustment that was aborted in the mid-eighties by the cornucopia of Japanese investment, Southeast Asia's economies will see the recession induced by the current crisis turn into a longer period of economic stagnation, possibly leading to political instability.

Flotsam and Jetsam

All this has translated into a pervasive feeling throughout the region that an era has passed, that the so-called "Southeast Asian miracle" has come to an end. Increasingly, some say that the miracle was a mirage, that high growth rates for a long time put a lid on what was actually a strip-mine type of growth that saw the development of the financial and services sector at the expense of agriculture and industry, intensified inequalities and disrupted the environment, probably irretrievably. In Thailand, where the crisis in the real economy is spreading most quickly, with unemployment rates fast approaching double digits, the balance of costs and benefits of the last decade of fast-track growth is painfully evident. The legacy of this process is an industry whose technology is antiquated, a countryside marked by continuing deep poverty and a distribution of income worse than it was more than two decades ago. Indeed, inequality has reached Latin American (or U.S.) levels, with the income going to the top 20 percent of households rising from 50 percent in 1975 to 53 percent in 1994, while the income of the bottom 40 percent declined from 15 to 14 percent.

As the World Bank admitted in a recent study, this pattern of growing inequality has marked most of the other "tiger" economies.

But it is probably the rapid rundown of natural capital and the massive environmental destabilization that will serve as an enduring legacy of the miracle that has vanished.

In Indonesia, deforestation has accelerated to 2.4 million hectares a year, one of the highest levels in the world. Industrial pollution is pervasive in urban centers like Jakarta and Surabaya, with about 73 percent of water samples taken in Jakarta discovered to be highly contaminated by chemical pollutants. In the East Malaysian state of Sarawak, 30 percent of the forest disappeared in 23 years, while in peninsular Malaysia, only 27 percent of 116 rivers surveyed by authorities were said to be pollution free, the rest being ranked either "biologically dead" or "dying."

In this dimension, too, Thailand is the paradigm. According to government statistics, only 17 percent of the country's land area remains covered by forest, and this is probably an overestimate. The great Chao Phraya River that runs through Bangkok is biologically dead to its lower reaches. Only 50,000 of the 3.5 million metric tons of hazardous waste produced in the country each year are treated, the rest being disposed of in ways that gravely threaten public health, like being dumped in shallow underground pits where seepage can contaminate aquifers. So unhealthy is Bangkok's air that, a few years ago, a University of Hawaii team measuring air pollution reportedly refused to return to the city.

"I ask myself constantly what we have been left with that is positive," Professor Nikhom Chandravithun, one of the country's most respected civic leaders, recently told a public meeting. "And, honestly, I can't think of anything."

Walden Bello is professor of sociology and public administration at the University of the Philippines and co-director of Focus on the Global South, a research program at Chulalongkorn University in Bangkok, Thailand. He is author of the forthcoming A Siamese Tragedy: Development and Disaster in Modern-Day Thailand.