John Hicklin, David Robinson, and Anoop Singh*
The papers in this volume were prepared as background for a conference on the major macroeconomic issues facing the member countries of the Association of South East Asian Nations (ASEAN), held in Jakarta, Indonesia, on November 7-8, 1996. The conference aimed to review the macroeconomic record of the ASEAN countries, examine the factors that have contributed to the region's economic success, and identify the policy agenda for sustaining this success into the twenty-first century. The background papers review the major policy issues and add to the empirical evidence in key areas such as saving, investment, and the current account; monetary policy, financial liberalization, and capital market development; and the medium-term outlook.
This overview section provides some background on the region, summarizes the papers, and conveys briefly the main points of the discussion at the conference.
The ASEAN countries--Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore, Thailand, and Vietnam--stand at the center of the most dynamic economic region of the world, and their performance has been part of the Asian "miracle" that has been well studied by economists and policymakers the world over. The region accounts for about 7 1/2 percent of the world's population and a rapidly growing share of world output.
The economic achievements of the countries in this region over the past quarter century have little parallel. As a result of strong, sustained economic growth since 1970, Singapore has now joined the ranks of the rich industrial countries, while Indonesia, Malaysia, and Thailand have seen their real per capita incomes rise more than threefold over this period (Table 1). More recently, the Philippines, too, has seen its growth rate rise closer to that of the other countries in the region.
In much of the region, this rapid growth has also been accompanied by dramatic reductions in poverty. Thus, Malaysia has been able to virtually eliminate the incidence of poverty, while Indonesia and Thailand have also made substantial progress in this key area (Figure 1).
An outstanding feature of the region's economic success has been exceptionally high saving and investment rates that have shown increasing disparity with the rest of the world. The strong and rising saving performance has reflected contributions from both the private and the public sector. In addition, these countries have been able to tap successfully additional foreign savings to complement their already formidable domestic effort.
Although countries varied considerably with respect to starting conditions, natural endowments, and individual experiences, there is broad acceptance of the key policy settings that have contributed to the region's strong economic fundamentals:
In recent years, in the wake of the globalization of international financial markets, the ASEAN countries have faced major new challenges. The nature of these challenges and their impact on macroeconomic performance in the region were some of the issues considered in Indonesian Finance Minister Mar'ie Muhammad's opening remarks at the conference, as well as in IMF Managing Director Michel Camdessus' address (Chapters 2 and 3).
As a result of these challenges, especially the interaction of large capital inflows with strong domestic demand, external current account deficits have risen in the region well above the average of previous years, and pressures on private sector credit and domestic prices have also mounted (Table 2). Greater attention has been given to the increased risks associated with rising external deficits, especially in the context of the openness of the economies in the region and the mobility of international capital. Although many of the region's traditionally strong underlying economic fundamentals--such as the fiscal position and domestic saving--have generally remained intact, there has been some erosion in other indicators and greater volatility in exchange markets. For example, the recent slowdown in exports has raised concerns over exchange rate policy and competitiveness in some countries, and high rates of credit growth together with property market developments have put pressure on financial systems.
Thus, the macroeconomic policy mix in the ASEAN countries has come under increased scrutiny, and the search for a strategy to reduce risks and sustain the region's exemplary performance has intensified. Mr. Camdessus' address points to a number of ingredients of such a strategy, including increasing domestic saving rates, reducing the burden on monetary policy through the adoption of an ambitious approach to fiscal consolidation, increasing flexibility in exchange rate policy, strengthening banking systems, promoting greater transparency, and fostering good governance in the affairs of the state. These issues were major themes of the background papers as well as of the discussion at the conference.
Savings, Investment, and the Current Account
Jonathan Ostry's paper on current account imbalances in ASEAN countries assesses the sustainability of the widening current account deficits in the region in the 1990s. Using a consumption-smoothing model, Ostry examines whether current account deficits (through 1994) have reflected excessive external borrowing for consumption, that is, whether foreign saving has been used to finance consumption beyond what would be warranted by transitory fluctuations in domestic income. His conclusion is that this has not been the experience of the ASEAN region and that the deficits have primarily reflected high levels of investment rather than excessive private consumption. Nevertheless, Ostry stresses that reducing current account deficits over time will minimize risks from other factors that bear on the assessment of sustainability by financial markets.
Papers by Geoffrey Bascand and Assaf Razin, on Indonesia's fiscal position, and by Philip Gerson and David Nellor, on the Philippines' fiscal policy, develop a number of criteria for assessing fiscal sustainability in these countries, analogous to the sustainability criteria for external current account deficits. The papers conclude that fiscal positions are sustainable in both these countries; for Indonesia, Bascand and Razin reach their conclusion after adjusting for the exhaustibility of oil reserves and with reference to an assessment of government net worth. However, the papers find that additional fiscal consolidation would be prudent to strengthen external sustainability in both countries, as well as to reduce their vulnerability to external shocks.
The paper comparing saving performance in Southeast Asia and Latin America, by Anuradha Dayal-Gulati and Christian Thimann, reinforces the conclusion of the other papers, namely, that fiscal policy plays a key role in determining national saving rates given that public saving in the region only partially crowds out private saving. Their paper also provides extensive empirical evidence of the strong contribution that macroeconomic policies have made to the high levels of private saving in the ASEAN region. However, Dayal-Gulati and Thimann also caution that policy measures to raise private saving typically work over the long term, hence providing additional justification for a larger contribution from public saving in the near term.
The Philippines' Gabriel Singson, in his lead presentation at the conference, focused on many of these issues, in particular, the sustainability of external deficits in the ASEAN region, the appropriate balance between fiscal and monetary policies, and the scope for fiscal policy to make a larger contribution toward reducing these deficits. Singson, drawing on the Philippines' experience, emphasized the linkages between fiscal and monetary policies and saw dangers in a policy mix that relied too heavily on monetary policy for current account reduction. He pointed to the importance that tax reform had played in the Philippines in lending credibility to the overall macroeconomic adjustment process, highlighting that this had required strong political leadership.
During the discussion, Indonesia's Robby Djohan emphasized the considerable importance that financial markets attached to current account sustainability. Djohan viewed export growth, the composition of import growth, the structure of capital inflows, the credibility of the exchange rate, and the level of reserves as being important factors governing the risks associated with external deficits in the region. He emphasized that policymakers could contribute to sustainability by ensuring that policies were transparent, implementation was consistent, the private sector was given a dominant role, and trade and investment policies fostered openness.
Both Thailand's Somchai Richupan and Indonesia's Dono Iskandar focused on the importance of fiscal policy in the mix of measures to reduce current account deficits. Iskandar noted that fiscal adjustment in Indonesia also had to contend with the declining importance of oil revenues and that this had required tax reform efforts, the strict prioritization of expenditures, and the provision of a greater role to the private sector in infrastructure development. Richupan pointed, in addition, to reforms designed to improve revenue collections at the state and local levels in Thailand.
The IMF's David Robinson provided additional background on the determinants of private saving in the region, noting that, in the short term, dependency ratios would continue to fall in a number of countries in the region, which should help boost private savings. He said that a supportive macroeconomic environment, the maintenance of competitive returns on financial saving instruments, and the development of fully funded pension schemes were promising avenues for increasing private saving in the region. However, because their effects were likely to be felt only with relatively long lags, Robinson saw fiscal policy as the most effective tool for raising national saving and reducing current account deficits in the near term.
The discussion focused on both tax and expenditure policies as ways to increase public saving. Many speakers judged that improvements in tax administration and tax collection systems could make a strong contribution. Some speakers pointed to the still low ratio of tax revenue to GDP in the region--considerably below that in many other countries--and saw revenue increases through expanding tax bases and more efficient tax administration as important channels for raising public saving. With respect to government expenditure, there was agreement that policymakers would have to carefully weigh important competing claims for additional spending on physical and human infrastructure rather than on other activities. Speakers also saw a role for developing stricter criteria to evaluate the returns on public sector investment and for developing a more supportive environment for private sector participation.
Monetary Policy, Financial Liberalization, and Capital Market Development
Two of the background papers examine the substantial changes that have taken place in financial and capital markets in the ASEAN region since the early 1980s and their implications for the financing of economic activity and the conduct of monetary policy.
Robert Dekle and Mahmood Pradhan's paper on financial liberalization and money demand in ASEAN countries reviews empirical evidence that points to continuing instability in the relationship between money growth, economic activity, and inflation. Their analysis suggests that policymakers need to look beyond the behavior of monetary aggregates--to a wider set of monetary and real sector indicators--to assess monetary conditions. Their paper reviews the feasibility of alternative policy frameworks, such as nominal income targets and inflation targets, and suggests that policy credibility would be enhanced by greater transparency in the making of monetary policy decisions.
Tim Callen and Patricia Reynolds, in their paper on capital market development and financial deregulation, look at these issues from the additional perspective of the financing of economic activity in Malaysia and Thailand. They find that rapid investment and growth have been associated with a shift in corporate financing from internally generated to externally generated funds, consistent with trends elsewhere in the world. Callen and Reynolds underscore the need for close monitoring of future developments and trends affecting corporate leverage ratios, the growth of domestic bond markets, and changes in the composition of bank loan portfolios, as part of effective monetary management.
John Montgomery's paper examines the impact of financial liberalization on Indonesia's financial system. It reviews the general experience of financial liberalization in other countries and points to the potential for such liberalization to result in the increased risk of poor lending decisions by domestic banks. Montgomery identifies key policy issues that should provide the focus for further improvement of the performance of financial markets and institutions in Indonesia. These include the need to resolve rapidly the problem of undercapitalized banks, improve the supervision and regulation of banking and securities markets, and deepen and expand the competitive structure and domestic investor base of these markets.
The recent surge in capital flows to many developing countries, particularly in Asia and Latin America, has been associated with widening current account deficits and concerns about exchange rate appreciations. Peter Montiel's paper on exchange rate policy and macroeconomic management in ASEAN countries examines the impact of the large-scale capital inflows on the real effective exchange rate in the region. Montiel finds that, unlike in Latin America, the recent capital-inflow episode did not result in an appreciation of the long-run real effective exchange rate in the ASEAN countries. The equilibrium rate appreciated in Singapore after about 1987 and in the Philippines after 1990, but stabilized or continued to depreciate in Indonesia, Malaysia, and Thailand. Montiel does not find evidence of misalignment in the real exchange rates of any of the countries in the sample at the end of 1994. He therefore concludes that the performance of the real effective exchange rate in these countries can be interpreted as broadly consistent with long-run equilibrium over the period reviewed.
Many of these themes were discussed extensively at the conference, especially the implications of structural changes in the financial environment of the ASEAN countries (including for monetary and exchange rate policy), and the impact on domestic financial systems. Indonesia's Soedradjad Djiwandono, in his lead presentation, pointed to instabilities in the relationship between money growth, economic activity, and inflation, caused by structural changes, that resulted in monetary policy in Indonesia being conducted with reference to a broader range of financial variables. The Philippines' Amando Tetangco said that the same instabilities had stimulated the development of a form of inflation targeting in the Philippines, which had incorporated flexibility with respect to capital inflows and indicators of financial deepening. Tetangco said that the regime had worked well so far, with generally low inflation, less variable and declining interest rates, and a stable exchange rate.
With respect to the exchange rate, Soedradjad noted that the increased mobility and size of international capital flows had also complicated the conduct of policy. He pointed to the recent greater flexibility in Indonesia's exchange rate--a crawling exchange rate band--as an attempt to address some of the difficulties posed by capital inflows and give greater control to monetary policy. Malaysia's Zeti Akhtar Aziz focused on the impact of increased short-term capital flows on monetary policy and emphasized that an independent monetary policy required flexibility in the exchange rate regime. However, Zeti pointed out that the level of the exchange rate was also important, with policymakers facing the dilemma of allowing the exchange rate to adjust partly or fully to short-term flows. She pointed to the risk of overshooting in this process, noting that the exchange rate was more volatile than was desirable. Moreover, given the costs of, and limits to, sterilized intervention, Zeti observed that administrative controls on short-term capital flows remained a temporary option in certain circumstances.
The discussion placed considerable emphasis on the importance of sound domestic banking systems, with Soedradjad stressing that weaknesses in financial institutions translated into additional constraints on monetary policy. A number of speakers echoed this point, with Thailand's Bandid Nijathaworn discussing the range of policies needed to safeguard financial systems in a rapidly changing environment. Nijathaworn emphasized, in particular, the strict enforcement of capital adequacy requirements, close monitoring and continuous assessments of banking system vulnerability to capital flows (both inflows and outflows), and the potential need for measures designed to discourage the banking system from extending excessive credit, as well as the importance of a strong fiscal position as an anchor in a volatile financial environment. Based on the region's experience, Nijathaworn also stressed that financial liberalization should be undertaken gradually and cautiously to give the monetary authority and financial institutions time to adjust.
Picking up on this theme, the IMF's John Hicklin also discussed the increased risks to the banking system as a result of financial liberalization and capital market development and agreed with Nijathaworn that steps should be taken to minimize these risks. Hicklin emphasized the importance of greater exchange rate flexibility and the need to deal quickly with emerging nonperforming loans. In this context, country authorities needed to demonstrate a greater willingness to close failed banking institutions in the context of improved prudential regulation and to work toward more transparency in indicators in line with the strength of financial systems. Hicklin noted that supervisors would need to focus increasingly on the ability of banks to assess market risks, including those associated with derivative positions.
The background papers for the final session of the conference, the medium-term outlook, deal with ASEAN in a regional perspective, as well as with future growth and productivity trends. The paper by Jeffrey Frankel and Shang-Jin Wei reviews regional aspects of ASEAN performance, including the role of trade and foreign investment in fostering the region's remarkable record of economic growth and the prospects for sustaining its rates of growth of trade above the world average. Frankel and Wei find that these prospects will be helped by a number of factors, including continuing rapid productivity growth--which will be spurred in part by further trade liberalization as well as by the full integration of the transition economies of Southeast Asia with the rest of the world.
The high degree of external openness of the ASEAN economies is also considered, among other influences, in the paper by Flemming Larsen and Jahangir Aziz, in the context of comparing the ASEAN business cycle with that of the industrial countries as well as looking at the future growth convergence of the ASEAN countries. The paper finds some evidence of a decoupling of the business cycle in the ASEAN countries from that in the industrial world, attributable in part to the growing dynamism of intraregional trade and other economic interactions. Regarding convergence, a significant degree of "catching up" by the ASEAN group with the industrial world has already taken place--although with considerable diversity in experience among ASEAN countries. On the basis of current trends, the paper concludes that the average income level in the ASEAN countries will reach Japan's 1995 per capita income level by the year 2010.
Michael Sarel's paper on growth and productivity reviews the sources of growth in the ASEAN economies, in particular the role played by total factor productivity, taking as background some recent studies that have concluded that growth rates of total factor productivity in Asian economies have not been nearly as spectacular as their growth rates of output. Using an alternative methodology and database, Sarel finds that total factor productivity growth has indeed been impressive in several ASEAN countries and that the proportion of output growth per person attributable to such growth is not systematically different in the ASEAN economies and the United States.
The final session of the conference, featuring a roundtable of speakers from the ASEAN region and the IMF, focused on the medium-term economic outlook. There was widespread agreement that the outlook for ASEAN countries would continue to be positive provided that macroeconomic management remained flexible and prudent, economic policies remained market oriented, and recent pressures on financial systems were addressed swiftly. In addition, sustaining the growth of total factor productivity over the medium term will require increased investment in infrastructure and education, with a greater role for the private sector in these areas.
The IMF's Jack Boorman reviewed the basic paradigm for growth, distilled from the experience of the ASEAN economies, as well as the new challenges in a more globalized world. Both Boorman and Malaysia's Tan Sri Datuk Clifford Herbert cautioned against complacency, noting that international acceptance of the basic paradigm was relatively recent.
Tan Sri Datuk Herbert stressed, in particular, that balanced budgets needed to be complemented through an acceleration of privatization programs, especially in new areas, such as health and education. Provided that sufficient regulatory safeguards are in place, the private sector can play a much bigger role in these areas. At the same time, to sustain high-quality growth, government expenditure should be directed more toward human resource development, research and development spending, and the social needs of the poor. In the area of governance too, there should be more private sector participation in the decision-making process. This would help promote efficiency and professionalism in the public sector and instill confidence in the system of governance by limiting corruption. In this context, Boorman also pointed to the need to eliminate off-budget outlays and increase the transparency of fiscal policies; improve data dissemination; strengthen banking supervision standards; and eliminate institutional mechanisms such as indexation that may entrench inflation and inflation expectations. In many of these areas, Boorman said that the IMF was prepared to play an important role through technical assistance and increased surveillance efforts.
Boorman also urged policymakers in the region to disseminate their experience to other developing countries, noting that there remained some reluctance in parts of the world to accept the ASEAN region's basic paradigm. He noted that the ASEAN countries could provide valuable policy advice and technical assistance, especially to countries in Africa, on macroeconomic management and on how to limit the distortionary effects of state intervention. Within ASEAN, this paradigm was also under attack in some quarters, but for the wrong reasons. Insufficient attention to strengthening institutional capabilities, especially in the area of tax administration, had created new problems, such as crime and money laundering, that needed to be addressed.
The growing demands for finance for infrastructure development had not, according to Japan's Yukio Yoshimura, received sufficient attention. Given the constraints on public finances, there was an expectation in the region that the private sector would increasingly fund infrastructure projects, but thus far domestic saving had not been channeled toward infrastructure development. Promoting the development of bond and equity markets in the region would help increase private sector funding for infrastructure and lessen the fiscal burden. Private finance would also bolster efficiency, and foreign financing would speed up the transfer of technology from industrial countries. However, governments will need to guard against the adverse effects of large private capital inflows on exchange rates and on monetary policy and maintain a competitive pricing and regulatory environment to ensure that projects are funded on the basis of market criteria. Yoshimura emphasized the necessity for cooperation in the international community and, in this regard, appreciated the IMF's role in monitoring macroeconomic developments.
Singapore's Teh Kok Peng emphasized the longer-term requirements of sustaining growth in the ASEAN countries, particularly those related to maintaining the quality of factor inputs. Although much of the recent debate on East Asian growth has centered on the growth of total factor productivity, in particular on the Krugman claim that its growth had been negligible (and, in some cases, such as Singapore, negative), Teh suggested that policymakers should not be overly concerned about growth that was driven largely by factor accumulation. Rather, the challenge ahead was to ensure that adequate funds were devoted to human resource development. The ASEAN countries compared well with the newly industrializing economies with respect to the percentage of the population enrolling for primary education, but lagged considerably behind with regard to secondary and tertiary education. Currently, a number of countries in the region, such as Indonesia and Malaysia, are experiencing skill shortages in key sectors, especially in engineering and computing, in part reflecting the lower levels of enrollment in higher education compared with Japan and the newly industrializing economies.
The sustained improvement in economic performance in Vietnam over the past ten years has been helped by its membership in ASEAN and by its greater integration with the region. Vietnam's Le Dang Doanh reviewed recent economic reforms in Vietnam, emphasizing that, while much remained to be done--especially maintaining the momentum in the transition toward a market economy--prudent macroeconomic management had helped reduce inflation and boost exports and overall economic growth. Saving in Vietnam remained lower than in other ASEAN countries, and this would limit the pace of infrastructure development and spending on education and health. The government was eager, however, to encourage a greater role for the private sector in these areas. Le Dang Doanh was confident that the continuing efforts to reform the legal framework and promote the development of financial markets would further enhance economic performance over the medium term.
The IMF's Flemming Larsen emphasized the growing importance of ASEAN in the world economy and the changing nature of trade and financial linkages between those countries and the industrial countries, key themes in his background paper. Whereas during the 1970s and 1980s business cycles in ASEAN countries moved closely with those in the industrial countries, since the late 1980s, growth in the ASEAN region has been less influenced by fluctuations in economic activity in North America and Europe. Larsen cited a number of factors that had led to the decoupling of business cycles between ASEAN and the industrial world, including the sustained increase in trade, both intraregional and with other developing country regions, and the countercyclical nature of capital inflows from industrial countries. Moreover, current trends in per capita income growth in the ASEAN countries suggested that--like Japan and, more recently, the Republic of Korea--the ASEAN countries were making rapid progress in converging toward industrial country living standards.
*Note: John Hicklin is Assistant Director, David Robinson is Division Chief, and Anoop Singh is Deputy Director in the IMF's Asia and Pacific Department.