EconSouth (Third Quarter 1999)

Is the International
Economic Crisis Over?

Although countries in Southeast Asia and Latin America continue to grapple with economic reform measures, the general outlook for these regions appears to have stabilized somewhat. But have these countries turned the corner, and will they return to economic growth?

wo years after the onset of the Asian financial crisis in July 1997, some anxiety still looms over the global financial markets. What was first perceived as a localized currency and financial crisis in Thailand soon spread — to Malaysia, Indonesia and the Philippines and eventually much of the rest of Southeast Asia. In 1998 Russia and Latin America were affected by the contagion, and international stock markets plummeted as investor confidence was shaken by the spreading crisis.

While these regions continue to sort through many serious economic and social issues, most of the individual countries have begun to work through their respective economic difficulties and appear to be moving toward a recovery.

Asian economies on the mend
In Asia, there are mounting signs that economic and financial conditions are improving. Economic activity is rebounding in most of the region, and financial markets are recovering from some of the heavy losses experienced over the last two years.

In 1998 analysts speculated about how quickly Asia would recover from the crisis. Forecasters now expect a sharp recovery, at least in 1999. As Chart 1 shows, economic growth in the developing Asian economies appears to be following the distinct V-shaped path of a sharp, short recession instead of an L-shaped track that would indicate a sharp downturn with little or no recovery for some time. The current and projected economic recovery is most impressive in South Korea while Indonesia remains behind the curve. (The forecasts used in this analysis represent a consensus of a number of private economists and are not predictions by the Federal Reserve Bank of Atlanta.)

Four general factors may be contributing to Asia's projected recovery.

First, the economic policies pursued by Asian authorities have contributed greatly to the recovery. Central banks in these countries have significantly eased credit conditions, so interest rates have declined substantially. Lower interest rates have had two positive effects — they have made debt repayments more manageable and reduced borrowing costs. In addition, government spending in these countries has increased.

Second, Asian economies have remained open during this tumultuous period. No government has cut its ties to the global economy, although Malaysia did impose some controls on the flow of money into and out of their country. Open trade and investment strategies allowed Asian economies to rely on exports to propel economic activity during the crisis when domestic conditions were so poor. And when international investors felt that a total economic collapse would not materialize, Asia's open economies allowed funds to return.

The Asian turmoil appeared to reveal a tendency among investors to treat emerging markets as an asset class.

Third, all the affected countries of Asia are moving to restructure their economies. Some are moving more quickly than others, but all are making the necessary adjustments to remedy the kind of structural problems that played a part in igniting the crisis. This process will take time, especially in the area of financial system reform, but these countries currently appear to be moving in the right direction. Unfortunately, the early signs of rapid recoveries in the Asian economies may tempt policymakers there to curtail their reform efforts in the mistaken belief that with their economies on the mend the need to pursue restructuring has somehow lessened.

Finally, the strength of the U.S. economy has contributed to Asia's recovery. As the Asian countries used exports to earn money for their wounded economies, the United States has been a major customer. This increase in imports of Asian goods into the United States has led to a widening trade deficit here, but recovering Asian economies are now beginning to import more U.S. goods as well.

The worst of the economic and financial crisis in Asia seems to be over. All Asian economies appear to be recovering, some more rapidly than others.


Latin America making progress
In Latin America, while international and global factors are important in driving the economic outlook, domestic political and economic issues are having increasing influence.

When the Asian economic problems started in the summer of 1997, the potential impact on Latin America was uncertain. Some analysts even predicted that the crisis could benefit Latin America in that investment and capital would stop flowing to Asia and be redirected to Latin America. These predictions did not come to pass. In fact, Asia's troubles had serious negative repercussions for Latin America and for much of the rest of the world.

Both trade and financial markets spread the contagion from Asia to Latin America.

Some of the Latin American economies send a significant portion of their exports to Asia. Chile (34 percent in 1997) and Peru (23 percent) are most dependent on Asia for export earnings. Both countries are heavy exporters of minerals, and Asian economies, particularly South Korea and Japan, are significant copper importers. As the Asian countries experienced recessions, they naturally imported less from everywhere, including Chile and Peru.

However, other economies in Latin America are less trade-dependent on Asia, sending less than 15 percent of their exports to that region. Overall, Latin America actually depends a good deal more on the United States and Europe as export markets.

In 1998, as the Asian economies were declining, international commodity prices also dropped significantly. This development was related to weaker Asian demand but was also a function of other factors, including weather patterns. Weak commodity prices in 1998 affected virtually all Latin American economies, which depend heavily on primary exports such as oil, copper and agricultural products. For example, oil prices reached an all-time low last year in real terms, with serious repercussions for oil-dependent countries like Ecuador and Venezuela. So diminished Asian demand, in conjunction with declining commodity prices, contributed to a significant deceleration of economic activity throughout Latin America last year.

CHART 1: Asia Real GDP

Chart 1

Source: JP Morgan, Consensus Forecasts

For better or for worse, the Asian crisis prompted investors to reassess investments in all emerging markets. If any redirecting of financial flows occurred, it was not toward Latin America but rather out of emerging markets and to safer havens such as the United States. The Asian turmoil appeared to reveal a tendency among investors to treat emerging markets as an asset class, whether the markets are in Asia, the former Soviet republics or Latin America.

This lumping together of emerging economies in investors' minds became a point of controversy. Some observers believe that Latin America was unfairly tainted by Asia's troubles while others argue that the crisis in Asia exposed pre-existing economic imbalances in other regions.

Perhaps the first time the Asian crisis started being considered an emerging markets problem rather than a regional situation was when Latin stock markets tumbled in late October 1997 after strong returns during the first 10 months of that year. The contagion in equity markets began when it appeared that Hong Kong's currency board regime was coming under pressure, raising concerns over the maintenance of Argentina's currency convertibility regime, which is similar to a currency board. Ultimately, neither country altered its exchange rate system.

Nonetheless, the losses in Latin American stocks continued through the first half of 1998 and were aggravated by the Russian debt default in late summer of 1998. The U.S. equity markets also experienced losses in the fall of 1998. But unlike the U.S. markets, Latin markets did not rebound significantly and showed weak performance throughout 1998.

Other financial markets — not just equities — were also affected by the Asian and Russian crises. Debt issues, sovereign as well as corporate, fell significantly in Latin America during the fourth quarter of 1997 and all of 1998, and credit lines to financial institutions in the region became harder to come by. In addition, higher interest rates throughout the region also curtailed economic activity.

Given all the economic and financial turmoil, how is the region expected to perform in 1999? After growing by about 5 percent in 1997 and 2 percent last year, the region's real gross domestic product (GDP) is expected to contract by 0.5 percent in 1999 (see Chart 2); available data for the first half of the year are largely in line with expectations.

CHART 2: Latin America Real GDP

Chart 2

    Source: InterAmerican Development Bank,
     Consensus Forecasts

CHART 3: Real GDP Levels

Chart 3

    Source: DRI data and forecasts, indexed by the
     Federal Reserve Bank of Atlanta

Is much of the region still in recession or decelerating because of a continued drag from Asia? On the surface, the answer is no. The recession in Asia appears to have bottomed out, and the economies there are recovering. So the direct effects of trade and the indirect effects of financial markets are receding.

In a policy sense, though, the Asian crisis is still having an impact in Latin America. When the crisis was in full force in 1997 and 1998 and Latin America began experiencing capital flight, policymakers in the region raised domestic interest rates to try to attract investments and thus help keep capital in their countries. Rates were especially high last year in several countries, like Brazil and Chile. Some countries also implemented severe budget cuts at the time. Since these countries were experiencing hard times, tax collection was down, government revenue was declining, and these countries were getting less for their exports. All these factors compelled policymakers to cut budgets.

Even though rates are starting to decline, the impact of this sustained period of high interest rates has endured into this year. This lingering effect is part of the reason that much of Latin America is entering a recession just as the international outlook is improving. Economic growth in Latin America is expected to follow a V-shaped path similar to Asia's recovery, but lagging behind, with a contraction in 1999 followed by recovery in 2000 and beyond.

While this pattern for Latin America's overall economic recovery seems fairly clear, the particulars of each country's ups and downs continue to evolve. The most recent report from Latin American Consensus Forecasts shows an improvement in Brazil's 1999 outlook but downgrades for many other economies. Brazil's real GDP is now expected to contract by only 0.5 percent this year compared to the 3.9 percent decline forecast in February and the 2.9 percent decline predicted in April. The outlook in Brazil has improved faster than expected; after the currency devaluation in January 1999, conditions in Brazil stabilized much faster than many people had thought possible, and inflation has been much lower than anticipated.

In contrast, the current-year outlooks for Argentina, Colombia, Ecuador and Venezuela continue to deteriorate as the August Consensus Forecasts predicted deeper-than-expected recessions in these countries. Chile's economic growth forecast was also cut to –0.1 percent in August from 0.6 percent in June and 1.7 percent in April.

The Mexican and Peruvian outlooks were little changed, with forecasters maintaining output expectations in the 3 percent range for these economies.

For the countries whose 1999 GDP forecasts have been downgraded, their current economic difficulties appear to be largely homegrown rather than the result of global crisis. So even if the region as a whole is experiencing a recession that can be at least partially attributed to the aftereffects of the international crisis, this stress is being either augmented or diminished by domestic factors within the individual economies.

Is the crisis over?
In one sense, the international crisis appears to be over because the Asian economies are recovering and are no longer constituting a significant drag on Latin America, at least in terms of trade flows and financial market effects.

But in another sense, the crisis appears to be ongoing in that the Latin American economies still face some serious challenges in the domestic economic and political arena. In a way, however, this fact is somewhat encouraging. Over the last two years, international economic forces that often seemed beyond the region's control have buffeted Latin America. Although serious challenges remain, at least these are challenges that policymakers in the region can address directly.

While the Asian and Latin American economies appear to be on the rebound, there are serious social costs to the international crisis.

The social effects of the crisis
While the Asian and Latin American economies appear to be on the rebound, there are serious social costs to the international crisis that may take longer to work through in these regions.

In each country in these areas, a significant segment of the population is living in poverty — in many cases, extreme poverty. Put simply, the international financial crisis has made some of the rich less rich, has pushed many of the middle class into poverty and has made the poor in these countries poorer. It may take years for this situation to greatly improve. As Chart 3 shows, while Korea and Brazil are expected to recover to their pre-crisis levels of GDP next year, Indonesia is not expected to return to a pre-crisis level for some time. (The chart refers only to the size of the economy and does not account for the uneven income distribution in these countries.)

Going forward
Economic and financial indicators point to an end to the international crisis in Asia and to a lesser extent in Latin America, although in the latter region domestic developments appear to be the source of current weakness in many countries. Social indicators reveal that the effects of the international crisis will be felt for some time. If policymakers in both regions continue to restructure and reform their economies, the longer-term economic, financial and social outlooks should remain positive.

This article was researched and written by analysts in the Atlanta Fed's Latin America Research Group.

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