Foreign Investment and the Second Debt Crisis: Southeast Asia

The post-modern economy is largely a history of the unfettering of the market by means of floating currencies, open financial markets, and lower trade barriers. World monetary deregulation in 1971 was followed by financial deregulation in the 80s, and trade deregulation in the 90s.



With the lifting of capital controls and ceilings for interest rates during the Reagan-Thatcher-Kohl years, finance capital was free to flow across borders, seeking the highest rates of interest. Under the United States' Brady plan in 1989, the Latin debts held by major commercial banks were converted into bonds. International banks held some of these bonds; others were offered to the public through insurance companies, mutual funds, and pension funds. These new financial products were designed to prevent the exclusive exposure of banks to debt crises in developing nations by spreading the risk of global investment.

With the lifting of trade barriers during the Clinton-Major-Kohl years, developing countries increased exports and earnings. However, with their massive debt loads, even these increases in foreign exchange accumulation and domestic savings could not generate significant economic growth, leaving poor nations all the more dependent on foreign capital. As each developing nation embraced free market capitalism, it was absorbed more deeply into the global financial market. Developed nations, led by American investors increasingly eager to diversify their financial holdings, poured billions of dollars into overseas debt and equity markets.

  Foreign securities trading exploded. Almost overnight, investment prospects in emerging economies were upgraded from non-creditworthy to red-hot. Once-risky developing nations suddenly became exotic 'emerging economies'. In spite of minimal banking and legal safeguards in many poor countries, and the near-default on Mexican sovereign debt in 1994, total portfolio investment in developing nations increased to $94 billion.

From derivatives and options, commodities and futures contracts, to currencies, stocks, and bonds – financial instruments were all the rage in the 90s, and no place on earth seemed beyond consideration for investment.

Meanwhile, through foreign direct investment, large American, European, and Japanese companies could now become owners in the utilities, the energy plants, and the industrial factories of a developing country, not just its stocks and bonds. As a result, corporate objectives broadened. In the early 1980s, international corporations invested in developing countries to manufacture and market goods locally. By 2000, the situation had shifted: foreign companies were investing in developing countries to produce and sell goods globally.

From 1980 to 2000, foreign exchange trading and foreign corporate investment both increased fivefold. Developing nations became, in effect, capital sinks for the world's investment houses, and export platforms for the multinational corporations. With all the new overseas investment by financial institutions and corporations, and the new jobs and wage increases that resulted, many developing economies experienced a recovery for the first time in more than a decade. Investment in foreign assets and factories in the 90s seemed to fill the vacuum created by the collapse of bank lending in the 80s.

As the new century dawned, half of all American households, whether by direct or institutional investment, were stockholders in corporate enterprises, many with overseas holdings. Stocks accounted for 1/3 of total personal wealth in the United States. The number of European and Japanese investors also increased rapidly during the 90's. Through direct stock ownership or through institutional investment – insurance companies, pension funds, mutual funds, and hedge funds with large investments abroad – millions of Westerners became owners of stocks in developing countries.

The enthusiasm suddenly turned dark in 1997 as trouble spread in South Asia. When they spotted a currency depreciation looming in Thailand, emerging market investors cut their losses with the push of a button to bring their funds safely home. The shakeout wasn't confined to the devaluation of the Thai bhat. Suspicious of similar weaknesses in the region – shaky banks, indebted corporations, overvalued currencies, large budget deficits, inflated stock and property values, and weak legal protection – finance houses also trimmed holdings from neighboring countries to pay back nervous shareholders, draining the treasuries of several nations.  

In 1997-98, devaluation, followed by raging inflation, spread from Thailand to South Korea, Indonesia, Malaysia, and then to Russia and Brazil. The sell-out of the emerging economies in Asia produced not just soaring interest rates, but currency collapses in the Philippines, Malaysia, Taiwan, Indonesia, and South Korea. Capital dried up. Workers were let go. Stock prices collapsed all over Southeast Asia. World trade slowed. The IMF was called in to revitalize the comatose economies. These rescues involved some $230 billion in relief packages for Mexico, Thailand, Indonesia, South Korea, Russia and Brazil.

Rampaging international capital flows had struck, wreaking havoc again. Like the black hole created by the collapse of bank lending in the 80s, the flight of investor capital in the late 90s created a massive shortage of money in emerging economies. In 1999, they began to bounce back, but slowing global growth dashed initial hopes of recovery. South Korea, Russia and Mexico have revitalized, but Latin America is still experiencing weak exports, deteriorating terms of trade, and decreasing capital flows. Industrial production in Southeast Asia has also fallen off sharply, especially in high technology, because its major export customer – the US – is undergoing its own slump in consumer demand.

Japan has been experiencing severe recession and deflation for more than a decade. China's entry into the World Trade Organization in 2001 has forced it to restructure its banks and corporations, lower import tariffs, drop prices, and lay off workers, creating deflation both at home and elsewhere in Asia. At the same time, there is deep instability in Asian banking sectors. Japan and China both have large levels of non-performing loans.

  At the end of 2001, Southeast Asian nations also had more than $2 trillion in problem loans – 30% of their GDP. International banks continue to suffer losses in these countries because of delayed loan payments, as well as outstanding loans to hedge funds which lost heavily in the panic of 1997-98. Crippled by debt and perceived as investment risks, developing nations continue to experience the effects of a shortfall in liquidity.

The global situation now is more complex and more serious than two decades ago. In the Latin crisis, government debt threatened to bring down the international banks. In the Asian crisis, the debt owed to companies and banks threatened the world's stock markets, endangering millions of investors, large and small. In a third debt crisis, international banks, private investment houses, and the world's stock investors may all be exposed.

When financial markets are so closely fused, an economic malady in one nation can spread through the global neighborhood overnight, leaving devaluation and default in its wake. It is unlikely that the safety nets of the G-7 and IMF would be able to weather a major global credit collapse, due to the escalating level of debt saturation across all sectors of the developed world – household, corporate, and government. Financial instability affecting the unregulated derivatives market, now at $130 trillion, would also absorb major capital sources needed for global crisis intervention.

At the same time, there is no international framework for foreign exchange trading or foreign direct investment to spread the risk between debtors and creditors, and stabilize financial conditions in developing economies when foreign investors suffer losses from failed loans. After two major debt crises in twenty years, no source of public or private financial assurance appears willing or able to step up again to a new challenge. Next time a currency crisis hits, there may be no economic guarantor large enough to bail out the stricken nations.

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Members of the Independent Commission on International Development Issues (ICIDI)
Willy Brandt (Chair)
Abdlatif Y. Al-Hamad (Kuwait)
Rodrigo Botero Montoya (Columbia)
Antoine Kipsa Dakouré (Upper Volta)
Eduardo Frei Montalva (Chile)
Katherine Graham (USA)
Edward Heath (UK)
Amir H. Jamal (Tanzania)
Lakshmi Kant Jha (India)
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Haruki Mori (Japan)
Joe Morris (Canada)
Olof Palme (Sweden)
Peter G. Peterson (USA)
Edgard Pisani (France)
Shridath Ramphal (Guyana)
Layachi Yaker (Algeria)

Ex officio Members
Jan Pronk
Goran Ohlin
Dragoslav Avramovic

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