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Global bonds require G-7 support

 

SINCE Plan A designed by the IMF to cure Thailand's financial crisis does not seem to work and Plan B adopted by Malaysia to shield itself from the external shocks is in serious doubt, it's time to consider Plan C.

Simply put, Plan C will involve securitised bank debt in the form of global bonds, similar to Brady Bonds. However, Plan C won't work without the participation of the US, the EU and Japan.

Let's face the facts. The underlying problem in Thailand and the emerging-market economies is the overwhelming indebtedness. The crisis of confidence has led to a stampede of capital outflow. Although Thailand has strictly followed the IMF-prescribed financial and economic reforms for over a year, it is still bleeding. Some US$85 billion in outstanding foreign debt is waiting to leave the country as Thailand's sovereign risks deteriorate due to the volatility on international financial markets.

Plan A bets on a return of foreign capital to lead the Thai economic recovery. However, the latest Russian rouble devaluation, the attack on the Hong Kong dollar and the looming crisis in Latin America are clear indications capital won't be flowing back to Thailand or the risky emerging markets. Even worse, Plan A serves the interest of foreign creditors, who are represented by the IMF. Under the IMF guidelines, Thailand is required to post a $9-billion current-account surplus this year, to have enough money to service its debt to creditors and to retain their confidence.

The IMF last year demanded the Thai National Assembly pass a law to guarantee all loans extended by foreign creditors to Thai banks and finance companies. However, the creditors are still recalling their loans, making it impossible for Thailand to make ends meet. Winning back the confidence of the creditors is almost an impossible task at a time when the economy is going to contract by 7-8 per cent this year. Next year the economy will be as bad as this year, or probably worse.

Regardless of external factors, some three million Thais will be facing unemployment. Growing unemployment will erode purchasing power in the domestic economy. Less domestic consumption will hit businesses and factories. Falling sales will lead to corporate bankruptcies, which will increase the non-performing loans of the banks. Rising NPLs will deter banks from lending because they need the capital to meet capital-adequacy regulations. Without liquidity and domestic consumption, businesses and factories will lay off their workers, hence intensifying the vicious cycle.

Plan A has been sharply criticised for its failure to provide enough firepower to turbo-charge the economy out of the severe recession. It is moving too cautiously to maintain broad macroeconomic stability at the expense of the domestic economy. Much worse, Plan A says if external shocks increase, Thailand will have to raise interest rates again to defend the baht.

Chatchai Parasuk of National Finance & Securities Plc suggested it was time the IMF and the Thai government pay less attention to external factors and focus more on creating jobs and stimulating the domestic economy. ''It's necessary that the government go for rigorous fiscal deficit spending, which should not amount to less than 10 per cent of the gross domestic product. This deficit spending must be directed at re-employing the three million Thais out of the workforce. In this enterprise, the government must create at least one million jobs to make sure that they help the remaining two million unemployed. At the same time, interest rates must be brought down to the symmetry level, which is equal to the rate of economic growth plus the rate of inflation. This is equal to 8-10 per cent,'' Chatchai said.

Professor Paul Krugman of the Massachusetts Institute of Technology wrote in a recent article in Fortune magazine that Plan A was not working so it was time to try something more radical. In radical Plan B, Krugman floats the idea of exchange controls. This draconian measure was revived in spite of its unpopularity as it deters foreign capital inflows, leads to inefficiencies and automatically creates a black market.

Krugman argues it is the only way for Southeast Asia to cut interest rates to jump-start the economies without having to worry about exchange-rate volatility. He cites the experience of China, whose exchange controls and inconvertibility of the yuan have helped it weather the regional financial crisis. China has been able to maintain a low interest-rate environment while all the other Asian countries have had to raise their interest rates to defend their currencies. High interest rates kill an economy quickly.

Last week Dr Mahathir Mohamad, the Malaysian prime minister, decided to adopt Plan B. It came as an anticlimax because when a country faces a crisis, the top leader must go. In the Malaysian case, the No. 2 man, Anwar Ibrahim, was forced out of his office instead. In any event, exchange controls had been on Mahathir's mind for quite some time. He continually expressed his frustration over the failure of the IMF and the international community to deal with hedge funds, which overnight robbed Asian nations of the wealth accumulated over decades of growth.

By adopting an inconvertible ringgit, Mahathir has openly defied the IMF's orthodoxy. The ringgit is repegged to the US dollar at a nominal rate of 3.80 and will be shielded from any speculative attacks because of the imposition of the exchange controls. After announcing the exchange-control package last week, the Malaysian authorities immediately lowered interest rates, hoping lax monetary and fiscal policies would arrest any further contraction in the economy and buy time for Malaysia to adjust to the volatility of the international financial markets.

Plan B might not be suitable for Thailand after all the painful adjustments it has gone through. It will be terribly painful for a country to adopt Plan B, which comes up only when a country really has no other choice and which requires immense sacrifice by its people. Plan B is in doubt because it raises the spectre of protectionism and openly challenges the IMF's orthodoxy. Former Indonesian president Suharto's plan to adopt a currency board to stabilise the rupiah failed to materialise earlier this year because not a single country came out to support him. So far nobody, except Krugman of course, has supported Mahathir. Without international support it will be very difficult for Malaysia to succeed. The commitment of Malaysia to reform its economy is also questionable, for the exchange controls might be looked upon as instruments to protect the interests of crony capitalism.

From this vantage point, neither Plan A nor Plan B address the problem of foreign debts. Both Thailand and Malaysia are too weak to recover on their own. In fact, they are drowning. Only further financing or some sort of debt guarantee from the superpowers can end the downward spiral. If Thailand is allowed more time to sort out its external debts, it will have a better chance of cleaning up its own house and recovering.

Since most of the IMF's money handed out to Thailand has been used to service capital outflow, the foreign exchange reserves of $26 billion are earned by the labour of Thai companies. Looking ahead, if export earnings are to be used to pay off the debt, Thailand will face another balance-of-payments crisis and will never be able to recover because it will continue to run short of liquidity. This is not an economic problem but a debt-restructuring problem.

Here comes Plan C. It will only work with an concerted intervention policy from the G-7 countries to short up the debts of the emerging countries. The attitudes of the US and the EU so far are that the crisis, which originated in Asia and is now spreading to Russia and other Latin American economies, is none of their direct business. Until recently, Robert Rubin, the US treasury secretary, emphasised the Asian crisis would have a limited impact on the US growth.

As a former bond trader at Goldman Sachs, Rubin made a fortune in investment banking. He now appears to enjoy walking a tightrope while taking on the global financial markets. His confidence lies in the fact that exports account for only 12 per cent of the US gross domestic product and the fact that two-thirds of the US economy is made up of domestic demand. The US, which is a safe haven, will not have to worry about its current-account deficit, because it is amassing so much wealth from the money game as evidenced in its massive capital account surplus.

However, the latest round of global financial turmoil has made the US think twice. The US is now as inclined to raise interest rates as to lower them. In his first comment on recent tumbling stock prices, Alan Greenspan, the US Federal Reserve Board chairman, said the Fed now saw risks facing the US economy, including deflationary pressure from the international crisis and domestic inflation.

''It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress,'' Greenspan was quoted as saying in a speech at the University of California in Berkeley.

Europe, whose growth is also internally driven, is too preoccupied with financial and economic integration to pay heed to the global financial crisis. Only after the Russian rouble collapsed did it begin to show some panic.

With the crisis threatening to blow up the global financial markets, it may be long overdue for the G-7 to react in a way similar to the advent of the Brady Plan of 1989, named after US treasury secretary Nicholas Brady. The Brady Bonds represent securitised bank debt. Loans made by the US and European banks to various countries, having becoming deteriorated credits, are restructured and exchanged for fixed-income securities. The debtor countries are obliged to repay the debt evidenced by the securities, and to date no defaults on these obligations have occurred. Now the Brady Bonds have become the largest and most liquid asset class of emerging markets.

Across the geographical divide, the US may take the firm initiative to back Russia, which is a special case, and the Latin American economies while the EU assists Eastern Europe and Japan helps out the rest of Asia. Japan agreed to prop up Asia by establishing a $100-billion rescue fund last year, but this initiative was shot down by the US out of its narrow geopolitical interests. Japan should be willing to support Plan C because its banks have the largest exposure in Thailand and the region.

Without G-7 action, the world risks being plunged into protectionism. There is growing negative sentiment in the region that the US is not doing anything because it stands to benefit from the Asia crisis through the money game. It is not too late to act on Plan C now and save the world from anarchy.

BY THANONG KHANTHONG

 

 

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