The traumatic economic downturn of South-east Asia holds lessons for India, though many might wish for the problems of the Asean-4 (Thailand, Indonesia, the Philippines and Malaysia) in return for their higher wealth. Preceded by prescient, falling stockmarkets for the past year, the downturn was caused by two previously unforeseen problems: too much investment, especially in residential and commercial property, and a consumer boom that began with the nineties and has suddenly gone bust. New investment now looks likely to fall by a sharp 15 per cent or more in each of these countries this year and consumer demand will match it. The latest reports from Thailand, for example, indicate that automakers there plan to cut output by more than 50 per cent for the rest of the year. Kuala Lumpur alone is estimated to have 2 million square feet of unoccupied office space.
At the heart of their linked problems of over-investment and not enough demand is a 10-year history of cheap capital. Back in the mid-eighties, when a booming US economy created a mountain of cheap capital, policymakers in South-east Asia decided that the best way to develop their economies was to attract foreign investors by offering them an open, export-oriented economy in which they could manufacture cheap consumer goods for export. Fixing the exchange rate or linking it to a basket removed foreigners main concern, that of exchange rate risk. The price for fixing the exchange rate appeared to be small: a domestic interest rate that was higher than international rates. Foreign investment flowed in and the South-east Asian miracle took off, compressing over the five years to 1990 what the Asian tigers-- Hong Kong, Singapore, Korea and Taiwan -- had achieved over two decades.
A key switchover from producing goods for export to producing goods for the home market occurred in the early nineties due to a slowdown in demand in the western economies. This is where policymakers made what, in hindsight, looks like a big mistake. Until that point, total foreign debt was low and had been used largely to manufacture exportable goods. However, in order to keep the economy moving in the face of declining export growth, domestic banks were allowed to finance consumer purchases from their dollar borrowings. A domestic consumer now found that he could get a mortgage at single digit rates compared with the high double digit rates that he was used to earlier. He responded to the incentive, creating in the process an impressive real estate and consumer products boom.
For a while, it did not matter as property values kept soaring, so that the collateral of the banks looked secure. But the seeds of self-destruction were sown in the increasing unwillingness of the consumer to keep on borrowing at a pace unrelated to his income and, therefore, unrelated to his ability to service more debt.
When the consumer started cutting back on his purchases, the bubble burst on asset values. Banks and companies had huge dollar commitments of foreign debt that they could not service. The governments of these countries, forced by foreign debt that they could not repay, let the currencies float. Now these economies must go through a period of adjustment, slowing down until demand catches up with existing capacity. It might take a year or more for that to happen. Governments, meanwhile, have blamed everybody but themselves for the problem, including George Soros, the IMF and the rising dollar. The last factor, a rising dollar, certainly helped prick the bubble a little earlier than it might otherwise have burst because exchange rates were linked to the dollar hurting exports to Japan and Europe.
What lessons can India learn? An important one is that rising incomes that are caused mostly by capital investment can easily reverse course. In the Asean, it seemed that their economies could effortlessly achieve 7 per cent plus growth rates (only the Philippines, a more recent entrant to the growth game, had lower growth rates). But much of that growth was investment-driven in anticipation of future demand that never occurred. It took the form of offices, homes and factories to make TVs and other consumer goods. Not enough went into irrigation, roads, education, health care -- the sort of investment that is driven by government policy and does not respond on its own to market signals, but is crucial to raising productivity. It, therefore, turned out to be an unsustainable investment programme.
The second lesson is that a nation should produce where it has a comparative advantage. Thailand lost its advantage in exports after the government decided that electronics production for exports should be encouraged by cheap loans and after the real wage for textile workers was raised by fiat. The government hoped that investment would shift from low value-added textiles to higher value-added electronic components. The actual result has been that Thailands exports consist of low-tech electronics items such as computer monitors, which have become a low value-added commodity whose prices have been falling due to world over-capacity. Meanwhile, it has lost its cost-advantage its textiles. The hoped for investment in high-tech hardware such as chip fabrication plants never materialised because the population lacked the educational capacity to produce such items. What the government should have done, if anything, was help textile makers move up the value-added curve by producing better textiles with better machinery and designs.
Similarly, India has a comparative advantage in contract software writing and there are more software companies listed on the Indian stock exchanges than in all of Asia, excluding Japan, combined. But it also has natural strengths in textiles and the government ought not to promote one over the other.
The third lesson is that cheap capital can be a mixed blessing. If the cost of capital is high because of the governments past profligacies, as has been the case for some years in India, then there may well be a case for encouraging larger, well-capitalised corporations to raise capital offshore at their own risk. However, costly capital has helped India avoid its neighbours worst excesses while keeping the debt burden under control.
On the whole, this is not to say that there are no positive lessons that India can learn from its Asean neighbours; there is a lot to learn, especially in the field of regulation: property laws and administered pricing mechanisms being two examples where these countries have positive lessons to offer India. The recent experience of these countries, though, has some negative lessons and Indias bureaucrats would do well to sharpen their pencils and note these as well.
(Rafiq Dossani is a California-based investment banker.)
