Economic and Social Survey of Asia and the Pacific, 1998

During 1996-1997, the world economy continued the steady pae of growth that had begun after the 1991-1993 recession, a slight slowdown in 1995 notwithstanding. World trade growth, on the other hand, eased substantially during 1996 but picked up again in 1997. Further progress was made with fiscal consolidation in most countries. Interest rates remained low and stable in the developed economies, and inflation declined in both developed and developing economies. After softening during 1996, overall commodity prices tended to decline further during 1997, but the decline in oil prices was much sharper. Amongst the developed countries, excluding the United States, the current account situation improved slightly. The main indicators of global economic developments are summarized in table I.1.

These generally positive features had an uneven impact on the chronically high levels of unemployment in several industrial economies. In France, Germany, Italy and Japan, unemployment increased or remained unchanged during 1996-1997, whereas in the United States and the United Kingdom it declined substantially.

In the developing economies as a group, growth picked up from 4.6 per cent in 1995 to 5.7 per cent in 1996 and again in 1997 as stronger performance in Latin America and West Asia offset a slowdown in East and South-East Asia. During the second half of 1997, a number of economies in the region experienced major shocks in exchange rates and financial sectors. These twin factors impinged negatively on the economic performance of these economies during 1997.

In the advanced countries, the favourable conjuncture of trends in the real economy has been associated, in the financial market arena, rather perversely, with somewhat higher levels of stock market and exchange rate volatility, especially in the latter half of 1997. In part, this was caused by the financial turbulence in Asia. Although most advanced country stock markets, with the exception of Japan, moved steadily upwards and some even reached record levels during 1997, this was accompanied by higher levels of volatility. Volatility was witnessed also in the foreign exchange markets, with many currencies experiencing sharp fluctuations in their exchange rates during 1997.

Some degree of fluctuation is part and parcel of both the stock and foreign exchange markets, as the perceptions and psychology of market participants are apt to change virtually on a day-to-day basis. However, excessive volatility can, over time, breed investor uncertainty and have an adverse impact on international capital flows. There was some concern during the last few months of 1997 that gyrations in the financial markets were, indeed, becoming excessive as international investors sought to minimize exposures to emerging markets and their currencies, generating huge movements into and out of different markets and instruments.

The developing countries have all along depended on the developed countries for trade, finance and technology to meet their development needs. In the past, they had exercised only marginal influence on the industrial countries, whether in terms of growth of the real economy or of movements in financial sector variables. That situation has altered somewhat in recent years with the increasing participation of the developing countries in the globalization process of production, trade and financial activities. During the 1990s, interdependence has been growing between the developed and the developing countries and within each of the two groups. The developing ESCAP economies, for example, now account for an appreciable share of world trade, both among themselves and with the developed countries. They have also emerged as destinations for a major portion of international financial resources. As such, their impact on the world economy has grown over the past few years.

Such participation entails some cost. In a world economy in which investor perceptions and sentiment, sometimes unrelated to fundamentals, are instantly transmitted around the globe, economies that have become more integrated internationallyalso become acutely vulnerable to changes in market sentiment. Financial market volatility in particular manifests itself, with considerable severity, in fluctuations in exchange rates and stock markets. Several economies in the ESCAP region fell victim to major turbulence in 1997. The 1997 ESCAP Survey had already drawn attention to such a possibility: “Greater freedom has been given to domestic commercial banks to establish credit lines abroad and to domestic non-bank borrowers to participate in foreign capital markets; at the same time, foreign investors have been allowed greater freedom to participate in the domestic capital market. Such openings make the domestic financial and capital markets more sensitive to changes in international interest rates, the perception of credit risks by foreign financial institutions and other creditors, and the speculative moves that market players can trigger¹ . Although such dangers were conceivable in early 1997, it could hardly have been foreseen that in less than a year so many of the best performing economies in the region would swiftly fall prey to a series of financial crises with such widespread contagion in the South-East and East Asian subregions.

Against the above background, this chapter explores in some detail the global economic developments over the last couple of years and their implications for the ESCAP region. The impact of global developments on the region and vice versa will no doubt be significantly influenced by the instability in the financial and currency markets of South-East and East Asian economies. This instability is still evolving at the time of writing this chapter. The analysis of implications is therefore admittedly tentative.

¹ Economic and Social Survey of Asia and the Pacific 1997, p. 16. The Survey also identified several policy actions required to pre-empt or mitigate the adverse consequences of volatility of short-term capital flows; see pp. 173-176.

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