SUNS  4297 Thursday 8 October 1998



ASIA: NEEDS QUICK RESTORATION OF GROWTH, SAYS GERMAN BANK

Geneva, 6 Oct (Chakravarthi Raghavan) -- Unless economic growth is restored quickly, and at a significant rate, the debt crisis in Asia will only get worse.

And without debt relief, by write-down, growth cannot be sustained, says the Deutsche Bank Research bulletin, which makes clear that the views reflect the views of Deutsche Securities Limited and of the holding company Deutsche Bank AG.

The publication though has no specific solutions, but in effect supports the idea of governmental and other interventions to force debt reductions, on all creditors.

The publication notes that the use of the term "debt crisis" is being strenuously avoided in discussions, with preference to the general but less fatal "Asia crisis" as if the dynamic is unique to that region.

Analytically, says an article in the publication, "Will the Asian Phoenix Rise again?", by three staffers, the Asian crisis is best viewed as a debt crisis, and in many respects worse than the debt
crisis which had such devastating impact on Latin America in the 1980s.

"The resolution of the external debt overhand and the banking crisis is critical for Asia to avoid the same severity of economic collapse."

While the current value of the debt overhand is still manageable, resolution is becoming increasingly costly and difficult to implement.
And unless economic growth is restored quickly and at a significant rate, the debt crisis will get worse. As expensive as it may to tackle the debt overhang, without resolution and a simultaneous return to economic growth, domestic asset quality and repayment prospects for external debt will deteriorate further.

And as credit risk worsens, it is increasingly unlikely that foreign private capital will return. The current policy of prioritising currency stability will be increasingly difficult to achieve without
imposing even greater losses on domestic asset prices.

The article also questions the tendency to separate the external and domestic debt of these countries.

Drawing on the Latin American experience, the article notes that progress on debt relief in Latin America was possible only after the countries were seen to be insolvent.
The delay in resolving that crisis was due to the protracted set of negotiations among debtors and creditors, and their respective governments. Creditor banks wanted the debtor governments to take on the debts, and have this financed by their own governments and or international financial institutions.

But there was "unexpected intransigence" of creditor-country governments who refused to take over the loans - that the banks had only made in the first instance because the governments were reluctant to recycle petro-dollars themselves.

If Asia is to avoid the prolonged period of decline that proved to be devastating in Latin America, participants in external debt negotiations must move to the stage of debt reduction and scheduling
quickly, says the article.

A second lesson from the Latin American experience, the article says, is that debtors and creditors alike will attempt to have the private debt taken over by the official sector. This pattern is already clear in Asia, it adds.

And the Latin American experience also showed that debt rescheduling alone provided little relief. When the debt burden is excessive, only very large debt reductions have a significant impact on repayment ability.

Private creditors, it points out, will not voluntarily accept a large amount of losses. Commercial banks will not relieve debtors of their legal obligations, even if the bank has set aside provisions against whole amount of the debt. As long as there is a possibility of redemption, banks will continue to press their claims.

The Asian debt crisis, and the solutions so far, are evolving along a familiar and predictable path. The relative weight of external debt, one year into the crisis, has growth rather than being reduced. Private creditors are not voluntarily writing off their claims.

Resolution of the overhang of debt requires both debt reduction and economic growth, and in the short run these objectives conflict.

Since the onset of the crisis, economic policy - with the exception of Malaysia - has largely followed the IMF course of restoring exchange rate stability and addressing structural issues.

Currency stability has been achieved, despite persistent volatility, but reforms to enhance confidence and stabilisation has "comprehensively failed."

One year after the crisis, there has been a trade and current account surplus, but this has been through import compression. As in the case of Latin America in the 1980s, Asia's trade surpluses have been due to a collapse in import volume. The modest growth in export volumes have been offset by falling unit prices, and prospects for a strong export revival are poor.

Lasting balance-of-payments stability requires return of private capital. But the region has received a financial shock in the form of net resource transfer from Asia to the rest of the world of 10% of GDP.

While some direct investment equity flows are expected to improve modestly in Korea, the Philippians and Thailand, the more significant bank loans are expected to remain negative.

The worsening credit outlook, and accumulation of arrears, suggest banks will be loathe to increase, or even maintain their exposure.

And while the IMF-led policy has achieved currency stability, it has failed to prevent an extreme economic recession - with domestic demand falling by 20% in some countries. With such a severe recession asset quality in banking sector and fiscal accounts will deteriorate further. This is in spite of the IMF relaxing fiscal targets and allowing some increase in fiscal expenditure.

Relying on a gradual reduction in interest rates to restart growth assumes that the banking crisis will not hinder the credit process. But experience suggests that the banking sector will be exposed to several distortions. Even if the banking system is recapitalized, the difficulty in discriminating credit risks may still lead to risk aversion. From a borrowers perspective, high lending rates will
discourage low risk clients, as the projects typically have lower returns or alternative sources of funding will be available.

The resolution of the financial crisis will need large build-up in public sector debt. Their current fiscal stance is not sustainable as long as governments pursue bank recapitalization aggressively.

Governments can raise taxes, but this is a kind of threat that may lead to capital flight or make it more difficult for governments to progressively roll over the debt.

In such a situation governments may be inclined to seek rescheduling of their domestic debt or even impose one on investors if negotiated agreements fail.