ASEAN market shadow over WTO financial talks

Talks at the World Trade Organisation to liberalise the financial services sectors will have to be concluded by mid-December. The current currency crisis faced by the ASEAN countries is a grim reminder of the dangers of such liberalisation and if Southern countries cave in to the continuing pressure of the US and European Union to open up their financial markets, they will be courting disaster.

by Chakravarthi Raghavan

THE turmoil in the ASEAN and Far Eastern currency and stock markets cast a shadow on the World Trade Organisation negotiations to liberalise the financial services sectors when talks resumed on 15 September after the July recess.

As there was no breakthrough after four days of talks, the talks have been postponed to 17 October. Since the talks recessed in July, the WTO has received some 19 offers from 32 countries.

The entire negotiations will have to be finalised, and new or revised schedules filed, by mid-December.

Since the July talks, the EC and the US have launched a coordinated campaign to pry open developing country financial markets, and particularly the Asian ones.

WTO officials are also indirectly pressuring and persuading the developing countries to do more to liberalise and make the talks a success - presenting it in terms of maintaining the role of the WTO as a multilateral system and enabling developing countries to be on the fast track and benefit from globalisation.

Senior trade and finance officials of the US and the EU have travelled to Asian capitals specifically for this issue in August. They have also held bilateral talks on the sidelines by taking advantage of their presence in the region for other reasons, and have pressed the Asian countries to open up their financial services markets.

In offering to open its market on a Most-Favoured Nation (MFN) basis, the US has said that, while it does not expect developing countries to match it, it does expect developing countries to commit themselves to achieve liberalised financial services and markets over a 3-5 year period, and schedule such a commitment at the WTO.

The United States officials in particular have been quoted in the media as saying that a solution to the crises of Asian countries on their exchange and stock markets lies in further liberalisation of their markets, and committing themselves to it through the WTO - so as to attract foreign capital flows.

According to them, the problems faced by these countries can be best resolved through strengthened prudential regulations and supervision, and more transparency in making public their data.

To the public and authorities of these countries, still reeling from the inherently unstable and speculative stock and exchange markets, with a large foreign presence, this advice is the equivalent of an advice to an alcoholic that a cure lies in imbibing more alcohol.

Since the outbreak of the crisis, first in Thailand, and then spreading across ASEAN and the Far East, hitting both their exchange markets and currencies and stock markets, the entire analysis of the policies of these countries has been on how their macroeconomic fundamentals have been at fault.

That the very same countries were being praised by international institutions, and fund managers and their 'economists', just a few weeks earlier as successful emerging economies has been quickly and easily forgotten.

There undoubtedly have been some fundamental problems with these economies. Even UNCTAD, which has held up the East Asia economic model, has warned in its Trade and Development Report last year that these countries (and specifically Thailand and Malaysia with their substantial current account deficits which were being and financed by capital inflows), may not be able to sustain their growth and export momentum unless they adopted the kind of policies that South Korea and Taiwan had done. UNCTAD had warned that these countries, Thailand more than Malaysia, would be vulnerable.

Domestic origins

The crisis has been associated with a slow-down of exports and has been linked to the fundamentals of their economy as well as to the link of their currencies to the US dollar.

Unlike in the Mexican peso crisis of 1994, where a loss of confidence of outsiders in the economy led to sharp outflows, triggering a crisis that spread to the domestic sector, in the case of Thailand, it began the other way round - a crisis in the domestic financial institutions in Thailand, having a contagion effect and spreading across its economy, with its currency, exchange and stock markets having a ripple effect and spreading to the ASEAN and the Far East.

But whether they originate in the external and spread to the internal sector or vice versa, the effect on the countries is the same. And a study of the recent crises shows that speculation is not based on any serious assessment of fundamentals. When the French franc came under attack earlier this decade, it had one of the strongest fundamentals in Europe.

As Yilmaz Akyuz (who heads UNCTAD's division on macro-economics and global interdependence) has pointed out in his introduction in Finance and the Real Economy (a UNU/Wider publication), the instability in short-term capital flows combined with inherent volatility of investment in company equity exposes the economy of developing countries to even greater risks. Since opening up domestic capital markets requires some form of currency convertibility for non-resident equity investors, a close link can develop between stock and currency markets even in countries where capital account is not fully open. The links between the inherently unstable stock and exchange markets can be further strengthened by dollarisation of economy. When that occurs, it increases the potential for emergence of foreign exchange and/or stock market crises.

Since returns on investment to the foreign investor depend largely on the movement of the exchange rate, a serious shock, e.g., terms of trade deterioration, that makes a devaluation appear inevitable can trigger both a sharp decline in equity prices and outflow of capital. Similarly the mood in equity markets can exert a strong influence on the exchange markets - a bullish expectation can trigger inflows, leading to currency appreciation, while a bearish mood in the capital market and/or massive profit-taking in dollars by non-residents will not only result in the pricking of the speculative bubble in the stock market but also to a currency crisis.

Written in August 1993, with an eye on Latin America, this could easily have relevance now to Asia or elsewhere in the future.

But Akyuz believes that Asian fundamentals are still better than those of Latin America, and as many fund managers and their economists have forecast, that with the exception of Thailand, while there will be some reduction in growth prospects, it will not be too much.

A particular blame for the current ASEAN crises, in retrospect, is being attached to the policies of the ASEAN countries in keeping their exchange rates steady, and linking to the dollar, instead of allowing them to freely float.

But no one, no foreign investor or operator on the stock and foreign exchange markets, talks of or withdraws funds on the ground that the currencies of Germany and Japan, for example, have depreciated even more sharply against the dollar over this period.

Foreign presence

It is not the currency depreciation vis-a-vis the dollar that has brought about the Asian crisis, but the kind of and extent of foreign presence on these markets, and these countries'reliance on foreign capital flows (short- and medium-term) to meet current account deficits to finance vast infrastructure projects.

A forthcoming UNCTAD discussion paper, by Andrew Cornford, brings out clearly the difference between the stock and exchange markets of these emerging economies, and those of the USA, Japan and the OECD countries.

The ratio of stock-market capitalisation of OECD countries in 1980 has been in the range of 3-10%, with a similar range of figures for the Asian countries, except for Singapore and Hong Kong which had percentages of 177 and 138 respectively.

While since the 1980s, the trends in market capitalisation has been upward in both the OECD and these emerging Asian countries, thanks to their 'liberalisation' policies, the percentages in some of the Asian countries are now in double or even triple digits: Hong Kong 206%, Malaysia 195%, Singapore 172%, Taiwan 65%, Thailand 58%, Korea 41%, the Philippines 37%, India 28%, Pakistan 18%, and Indonesia 12%.

However, as Cornford points out, in all these developing country markets, despite the increase in capitalisation and the number of firms with shares listed on these markets, financing through such markets has remained fairly small in relation to capital formation.

But although the contribution of stock-exchange financing to capital formation has remained limited, the large increase in turn-over of shares accompanying the growth in stock market's capitalisation generated a corresponding expansion of revenue for securities firms from commissions.

This development of asset and fund management in the countries studied has been closely connected to financial liberalisation and growth of domestic securities markets.

Liberalisation of these markets has however significantly increased access of foreign firms in the 10 Asian countries to several different financial services.

Entry into commercial and investment banking and stockbroking can take place through various types of legal entities. In many developing countries, foreign investment banks act through brokers and dealers (since they themselves can't be members of the stock-exchange) and these brokers and dealers get commissions.

International securities issues

A particularly profitable segment of investment banking for foreign firms in Asia is participation in large international securities issues - open in principle to banks with no commercial presence in the country issuing the securities. But such a presence, Cornford notes, enhances the probability of being awarded mandates, and in some countries it is virtually indispensable to get the business.

The estimates of shares of turnover in 1996 generated by foreign transactions, cited by Cornford (based on estimates from sources in the securities industry) are: Hong Kong 80%, India 37%, Indonesia 71%, Korea 12%, Taiwan 1.5 to 5%, and Thailand 26%.

A large foreign presence in the developing country markets, where domestic capital is small and shallow, means whether the problems starts at the stock market or in the exchange markets, they will quickly spread to the other.

Operators in stock and exchange markets are highly active speculators. They make money, and dealers are paid proportionately to their activities. This is the nature of their business.

While in all the world's markets the distinctions between various markets and operators are being smudged, the links between currency and stock markets in developing countries are stronger than in the industrial countries, and the speculative elements in both, greater.

The negotiations at the WTO on financial services are not directly about capital account liberalisation (which the International Monetary Fund is pushing), with many countries announcing their intentions on capital account convertibility as a target over the next 4-5 years.

Though the WTO processes relate to the current account transactions, they have an indirect bearing on capital account transactions.

When a country undertakes liberalisation and schedules its commitment (in terms of commercial presence, national treatment etc), a foreign investment banker going in and establishing a business - stock exchange or investment banking - will try to sell financial instruments, (whether stocks or shares) of investments funds or entities located in Europe or the US or Japan.

The earnings, profits, commissions etc will be to repatriated (thus affecting the balance of payments) or reinvested on the stock markets or exchanges, which may relieve the BOP, but seeds future problems.

Experience shows that very little of this type of investments goes into investments that add to production, bring in new technologies and raise productivity, and thus hopefully increase exports and earning.

Rather, they are either confined to the stock and exchange markets or in buying up financial assets.

Even if foreigners do not withdraw their assets (because of the fear of being forced to sell at a lower price) their failure to bring in new money would still make the whole thing a ponzi scheme (as Prof Jan Kregel has pointed out in the UNCTAD Review of 1995). In such a climate, developing countries which yield to the pressures of the US and EC and further liberalise their financial markets and services would be courting trouble.

Several observers have thus cautioned that they would be much better off trying to write or rewrite some international rules on such activities, with home countries undertaking some obligations to police the activities of their firms abroad by withdrawing tax and other incentives which would reward such speculative activities when the funds are brought back home.

It may or may not be easy to criminalise speculators and manipulators, but such a system at least weaken the incentives for speculation. (TWR No. 86, October 1997)

The above article first apeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.