Nouriel Roubini has generously agreed to answer a few questions about
the causes and consequences of the on-going Asian currency and economic
crisis. He also shares some thoughts on the implications for policy and
for the analysis of currency markets.
|Roubini is an Associate Professor of Economics and International Business|
at the Stern School of Business, New York University. He is the author
most recently of Political Cycles and
the Macroeconomy as well as numerous academic papers. Some of his recent
work has focused on the causes and consequences of the Asian currency crisis.
He received his Ph.D. from Harvard in 1988 and was previously an Assistant
and Associate Professor in the Economics Department at Yale University.
Roubini is also a research fellow at the National Bureau of Economic Research
and the Center for European Policy Research; and is a visiting Economist
at the IMF and consultant to the World Bank.
Impact of the Crisis
|Is the currency crisis likely to impact the long-run performance|
of the Asian economies? Is this the end of the Asian miracle?
The Asian miracle might have been over even without the crisis. These
countries could not possibly grow forever at 8-10% per year rates, as diminishing
returns at some point kick in. Also, the evidence in Young, popularized
by Krugman, suggests that the role of total factor productivity growth
was limited in Asian growth; a lot of growth was due to inputs growth (labor
and capital especially). Rate of investment of 40% of GDP per year are
not sustainable forever and savings rate are bound to fall over time.
So, even if these countries whether the crisis, the growth rate might
not return to the high levels pre-crisis; 4-5% per year may be more reasonable.
Mexico was back to growth in 1996 after the 1995 recession following
the 1994 collapse of the Peso. A recession might be deeper and persist
for much longer in Asia for several reasons:
The Tequila effect did not spread so dramatically from Mexico to the rest
of Latin America while in Asia as Argentina’s and Brazil’s pegs resisted;
however in Asia one after the other most currencies collapsed with the
ensuing recession that is going to follow being exacerbated by the recession
in the neighboring countries.
The US was in a strong cyclical upswing in 1994-95, something that helped
Mexico and the rest of Latin America while growth in Japan, the main regional
economy, has been stagnating close to zero since 1991.
The US had cleaned up its banking problem (the S&L crisis) by 1994
while the Japanese banking problems are still unsolved and Japan is heavily
exposed in Asia.
The game of competitive devaluation that has been observed in Asia was
largely avoided in Latin American following the Peso collapse; most currencies
in L.A. resisted and this presented a recessionary competitive devaluation
game (as the one currently observed in Asia that is similar to that in
the 1930s depression).
There was a lot of over investment and capacity glut in Asia; for example,
Korea overbuilt in low-tech semiconductor (DRAM) plants whose profitability
is going to be very low in the medium term; same thing for shipping, steel
and other traded goods. Also, the glut of non-traded goods, especially
real estate will lead to low returns in these sector for a long time.
So it is not clear whether Asia will look ex-post more like Mexico that
had a one-year severe recession and then resumed growth or more like Japan
whose economic model has stalled and whose growth has stalled since
|How much of an impact will the Asian currency crisis have on the|
economies of the US and other western economies? How long will it take
before this impact will be felt?
Growth in US and Europe will be reduced by about a 1/2% point in 1998
unless Japan, who is already stagnating, plunges in a deeper recession.
Most episodes of Balance of Payment crisis in emerging economies are
episodes of Twin Crises where a balance of payments crisis is associated
with a Banking crisis (see the evidence in Kaminsky
and Reinhard (1996)
. And most of these banking crises are caused over
borrowing and over lending due to poor regulation poor supervision following
financial liberalization and the presence of a moral hazard problem deriving
form implicit and/or explicit government promises of a bail-out in case
things go wrong. So moral hazard is important but is only a part of the
The crisis is not just a debt crisis, it is also a currency crisis.
By 1997 most of the regional currencies were overvlalued and fixed rate
regimes and excessive short-term capital inflows led to significant real
appreciation. The current account deficits were very large and driven both
by the overvaluation and the (moral hazard driven) overinvestment. So,
we are talking of a currency AND debt crisis where moral hazard was one
factor, among several other fundamental problems and policy mistakes.
|Your paper describes the “investment boom” as “excessive and often|
in the wrong sectors of the economy”. You also conclude that a significant
portion of the borrowing was used for speculation rather than real productive
investment in capital goods. Should lenders be more careful about specifying
and monitoring the uses of their loans?
Of course, they should be, but moral hazard at various level led to
the lack of monitoring.
International creditors did not monitor and overlent to domestic banks
and financial intermediaries under the implicit or explicit promise that
they would be bail-out, either by the governments and/or via IMF supported
packages. Domestic banks and financial intermediaries did not monitor for
many reasons, mostly related to the implicit promise of a government bail-out
in case things went wrong:
Their risk capital was usually small and owners of banks risked relatively
little (by lending to excessively risky projects) if the banks went bankrupt;
Several banks were public or controlled indirectly by the government that
was directing credit to politically favored firms, sectors and investment
Depositors of the banks were offered implicit or explicit deposit insurance
and therefore did not monitor the lending decisions of banks;
The banks themselves were given implicit guarantees of a government bail-out
if their financial conditions went sour because of excessive foreign borrowing.
The outcome of all this was twofold: first, banks borrowed too much from
abroad and lent too much for investment projects that were too risky; second,
because of these implicit public guarantees of bail-out, the interest rate
at which domestic banks could borrow abroad and lend at home was low (relative
to the riskiness of the projects being financed) so that domestic firms
invested too much in projects that were marginal if not outright not profitable.
Once these investment projects turned out not to be profitable, the firms
(and the banks that lent them large sum) found themselves with a huge amount
of foreign debt (mostly in foreign currencies) that could not be repaid.
The exchange rate crisis that ensued made things only worse as the currency
depreciation dramatically increased real burden in domestic currencies
of the debt that was denominated in foreign currencies.
In summary, fixed exchange rates regimes, capital inflows and
moral hazard jointly led to real appreciation, an investment boom in wrong
sectors, an asset price bubble and large current account deficits that
led to accumulation of a large stock of short-term foreign liabilities.
Such deficits were financed mostly through banking system intermediation
(given the lack of developed securities markets in the region): banks borrowed
abroad in foreign currency and their borrowings were mostly short-term.
These large currency positions were mostly unhedged as firms and banks
expected the fixed exchange rates to be maintained and/or to be bailed-out
if things went wrong.
Once the firms’ investment projects turned out not to be very profitable,
the firms and the banks found themselves with a huge amount of currency-denominated
foreign debt that could not be repaid. The exchange rate crisis that followed
made things only worse as the currency depreciation increased the real
burden of the foreign-currency denominated debt. The behavior of weak and
not very credible governments that were not committed to structural reforms
exacerbated the policy uncertainty and the financial panic that followed.
|You argue that, in conjunction with other factors, large current|
account imbalances coupled with fixed exchange rates lead to a overvaluation
of several Asian currencies. Should we have seen speculative attacks and
a crisis coming? Could it have been prevented?
If you looked carefully at the fundamentals you should have seen that
a currency crisis had to occur. For example Thailand and Malaysia had all
the symptoms of Mexico by early 1997: huge current account deficits (close
to 10% of GDP for a decade), real appreciation, asset bubble, overinvestment
in wrong projects, weak and fragile banking systems.
As in the case of Mexico, by the time we got close to the crisis it
was very hard to prevent it. Policies should have been different several
years earlier: i.e. avoid excessive capital inflows via controls on hot
money inflows; a more flexible exchange regime aimed at maintaining a stable
real exchange rate; greater supervision and regulation of the financial
system; policies to avoid short term foreign debt borrowing by banks and
firms; development of securities markets (debt and equity) to prevent that
most of the capital inflows be intermediated through the short-term channels
of the banking system.
|There has been some debate over the role of the IMF in providing|
stabilization funds for currency crisis. Bailing out failing organizations
obviously contributes to the moral hazard problem mentioned above. Is there
some balance we can strike between legitimate stabilization programs and
generating the moral hazard problems? (i.e. can the time consistency problem
be addressed in a useful way?)
There is some tradeoff: repeated bailouts signal to creditors that
they can take risky gambles and pay no cost, a huge incentive to repeat
the same mistakes over and over again. On the other side, the IMF should
have a role of lender of last resort. Unfortunately, the bailouts in Asia
suggest that no country seems to be too small (not too big) to be allowed
to default. That’s a bad signal for the future; the IMF might have lost
some credibility in the process.
Probably, the only way to avoid future mistakes is to make sure that
international creditors pay some costs for their risky decisions: they
should not be fully bailed out. For example, Korea, Indoenesia and the
other countries should not give new public guarantees for the debt of private
companies; also, for the debt of the banks, any rescheduling agreement
should imply some losses for the international creditors. Unless the US,
Japanese and European banks get burned with fire, they will play with fire
|The volume of media coverage and analysis (probably primed by the|
Mexican crisis) has been extraordinary. Are there any common misperceptions
about the causes and consequences of the crisis?
One misconception about the causes is that it was all due to irrational
speculation and irrational contagion. Fundamentals were quite weak in the
region and these fundamentals triggered the crisis. Of course, there has
been a certain amount of overshooting once financial panic ensued. The
rupiah had to devalue, but a 15,000 rate to the US dollar is pure folly
and not justified, even when you weigh in the important role of policy
and political uncertainty. So there has been an overreaction of asset markets
but based on bad fundamentals to begin with: a strong wind can collapse
a big tree only if its roots are rotten.
|You also suggest that traditional models of currency crisis are|
inadequate to the extent that they do not emphasize the moral hazard or
the multi-country “contagion” effects. What do you think will be the main
policy implications of a “third generation” of models.
‘Third generation’ models are still work in progress as many of us
are working on these ideas. The systemic multi-country nature of the problems
and the twin-crisis phenomenon suggest several policy implications:
There should be more credible monetary policy cooperation and coordination.
In the case of the ERM in 1992-93 there was a breakdown of cooperation
(as the recent monograph by Buiter,
Corsetti and Pesenti (1998) suggests). In Asia cooperation was harder
as these countries has unilateral pegs to the US dollar and were not tied
in a formal cooperative exchange rate regime like the ERM.
Excessively volatile capital flows are a serious problems and can exacerbate
a crisis. Controls on excessive short-term inflows, such as those imposed
in Chile look more and more appealing; short-term borrowing by banks and
governments should be avoided. More extreme solutions such as a Tobin tax
on capital flows should be considered more seriously.
Moral hazard problems should be avoided via prudential regulation and supervision
and avoidance of government bail-out promises. Opening domestic financial
system to foreign banks, as done in Argentina and Mexico, can only help.
Fixed rate regimes are fragile, even more so when many regionally integrated
economies have a formal or informal system of pegged rate. As the 1990s
crises (ERM in 1992-93, Mexico and Tequila in 1994-95 and Asia in 1997-98)
suggest some degree of exchange rate flexibility is beneficial. If countries
really like fixed rates, then they should go to the extreme: give up a
domestic currency and form a monetary union. Even currency boards, a strong
form of fixed rates, are fragile: if the currency board in Hong Kong collapses,
quite likely now that all the regional currencies have devalued, Argentina
could go under too. Also, currency boards are likely to be phased out in
East Europe, especially Lithuania and Estonia as they have led to severe
Fixed rate regimes may be useful in early stages of a stabilization program
when, starting from high inflation, they focus expectations on a low inflation
equilibrium. After that, it is better to switch to a more flexible regime.
|Do you see currency crisis as a permanent fixture on the economic|
landscape or will we eventually learn how to effectively stabilize international
A cocktail of greater international capital mobility, financial liberalization,
short-term-oriented trigger-happy and sleep-deprived fund managers and
currency traders, and fixed exchange rates can be deadly. Some broad
international effort to stabilize markets, enforce prudential regulation
and supervision of otherwise unsupervised offshore financial institutions
and poorly supervised onshore ones should be considered.
Filed under: International