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Web-only Exclusives
November 30, 2000

From Our Correspondent: Hirohito and the War
A conversation with biographer Herbert Bix

From Our Correspondent: A Rough Road Ahead
Bad news for the Philippines - and some others

From Our Correspondent: Making Enemies
Indonesia needs friends. So why is it picking fights?

Asiaweek Time Asia Now Asiaweek story

TAKE THE HARD WAY

Soft options will hurt Asia more


FINANCIAL MARKETS HAVE SO far been unimpressed by most of the prescriptions Asian nations have written to cure their economic woes. But David Roche says those who take the bitter medicine first will recover the fastest. Roche, who built an enviable reputation as global strategist at U.S. investment house Morgan Stanley before forming London-based investment consultancy Independent Strategy in 1994, spoke to Asiaweek's Ricardo Saludo, Cesar Bacani and Jonathan Sprague last week.

Why the regional economic crisis?

The dollar-bloc arrangements had outlived their usefulness and were flooding these economies at the peak of the cycle with too much liquidity. The results were two-fold. One was a lot of bad investments made using rates of interest to calculate profitability that were artificially low and not sustainable. The other was excessive external deficits financed by capital inflows. The way out is very tricky -- if you pursue lax monetary policy to get over the problem, then you devalue your currency all the time. That will import inflation and hit foreign direct investors, who will stop investing. But you need the capital inflows to cover the current-account deficit, so you start trying to attract short-term money with higher real interest rates, which is no solution for the economy. You end up going on an enormously circuitous route to get back to the same problem. How you get out of this is to tighten fiscal policy, tighten monetary policy, clean up the financial system, and deregulate the economy.

Is Asia taking the necessary steps to resolve the crisis?

It's going to sort itself out, but it's not going to sort itself out as a bloc. Indonesia has a massive foreign debt problem while Malaysia doesn't, and countries with external constraints are more likely to follow the sorts of policies financial markets impose because they have real problems actually servicing debts. These policies are different from those of countries like Malaysia which decide they cannot afford to slow down growth. Now the ones which take hard options will come out first and better, and the ones that take soft options will in the long run suffer more -- you can go the long route or the short route. I think countries like Indonesia are likely to go the short route. I have greater faith in the Philippines doing that.

But not Malaysia?

Not at the moment. The budget was a small step in the right direction, but too small a step. The real issue is to cut investment rates. Malaysia's savings rate is 35%-36% of GDP, but its investment rate is 43% of GDP. You don't need to invest 43% of GDP to grow by 8%, there's something wrong. Plus add another 6% of GDP of foreign direct investment inflows. So the efficiency of investment is lacking. You need to move to a bigger budget surplus by cutting government expenditure across the board, and you need to see bigger deregulation of the economy. But most importantly, you need to see a much tighter monetary policy framework.

How do you see Thailand?

Thailand is going so slowly it's almost stopped. They know what to do, the International Monetary Fund has told them what to do, but their problem is credibility and implementation. The problem is not the recipe, the problem is the cooks. Unless you can get leaders that people can believe in, the bottom is anywhere you want to put the pin in the map. You've got a real political problem about selling the idea that the Thai economy is not going to grow by 1% this year or next year -- it's going to shrink by about 5% between now and the next 12 months. At some point somebody has to stand up and say, "We have to swallow the medicine."

Hong Kong seems to be shaky. You've been a bear on this market all along. Why?

It has to do with whether you can be a part of China and also have U.S. interest rates. My argument is, no you can't. The second argument is, if everybody in Asia devalues their currencies and you don't devalue yours, then there are long-term consequences for the real economy. The peg [linking the Hong Kong and U.S. dollars] has had its useful day and is necessary to maintain political confidence, but it's going to take higher interest rates to actually maintain and those higher rates are deleterious for the Hong Kong economy and market. If you got rid of the peg tomorrow, the political cost would be enormous. But if you get rid of the peg sometime in the next three to five years, the cost would not be enormous because the transition to being a more integrated part of China will be more complete. And you would no longer need a political symbol to keep money in Hong Kong. There's a 30% to 40% chance there will be a crisis [before then] that will knock [the peg] out of the water, but do I want to bet on that? No. I'd bet on falling stock prices, not on an immediate end to the peg. I see the Hang Seng Index going to about 10,000 points -- that's the top end of my forecast. The bottom is 6,000.

So what is the Asian investor to do?

It's very difficult to make a bull case for long-term financial assets in the short term if you think global interest rates are going to go up and Asia's are going to stay up. For the next six months or so, I wouldn't rush to try to be really smart about Asian equity markets. The answer is to diversify. Asia's not disappearing. Asia will come back and grow again, but the problem is that the transition between how we've lived over the last 10 years and how we're going to live over the next 10 years is not being well managed. I'm going to wait and see that it's better managed before I buy into it.


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