Economic policies in crisis: Eurozone versus East Asia (Part 1 of 2)
Anwar Nasution, Seoul | Opinion | Tue, December 04 2012, 10:15 AM
Klipping The Jakarta Post
Paper Edition | Page: 7
Except in Greece, the causes of the present economic crisis in the periphery of the eurozone are similar to those behind the Asian financial crisis of 1997-1998: a current accounts crisis.
In contrast, the Greece crisis is closer to the Latin American model of financing of budget deficits by selling sovereign bonds to attract short-term capital inflows. At that time Asian countries had adopted fixed exchange rates.
Robust domestic growth and large interest rate differentials attracted huge short-term capital inflows, mainly channeled through weakly regulated and weakly supervised banking systems.
Banks in turn invested the short-term foreign borrowings in long-term investments, mainly in the unproductive non-traded sector of the economy. This led to a surge in investment and in the prices of land-based assets and caused double currency and maturity mismatches.
By joining a monetary union, the member nations of the eurozone abandoned their nominal exchange rates and monetary policies.
The monetary union rapidly integrated the financial systems of the eurozone and brought about a convergence in nominal interest rates through the free movement of capital across the eurozone and through cross-border credit.
Capital mainly moved from the core countries with high saving rates in the northern part of the
eurozone to the periphery countries in the south, which have traditionally been characterized by low savings rates.
In contrast, savings in Asia were invested in international financial markets and were recycled back into the region through non-regional financial institutions and in non-regional currencies.
Price levels in these nations rose more than in the core against a backdrop of excessive credit expansion with very low interest rates, thus fuelling domestic demand and eroding their international competitiveness.
The property boom during the first 10 years of the eurozone monetary union generated windfall revenue for the central and local governments in the periphery.
Combined with cheap credit after joining the euro, this provided extra resources for all tiers of government for building infrastructure projects and for the expansion of generous social programs.
The eurozone has no fiscal union and no unified debt strategy. Meanwhile, the fiscal and debt rules of the Stability and Growth Pact (SGP) of the Maastrictht Treaty of 1991 have been continuously violated by all member countries. The European Union (EU) budget is small and not intended for counter-cyclical purposes.
The banking crisis in the eurozone began in Ireland in 2008 and escalated with increasing concern about the health of public finances in the periphery countries.
The haircut taken by the lenders owed Greece’s private debt raised doubts about the ability of the other crisis countries to service their sovereign debt. Debt reduction requires a primary surplus that can be attained only if the growth rate of the economy is higher than that of interest rates.
Debt forgiveness eroded the ability of the European banks to lend after the decline in the market value of sovereign bonds that they used as collateral on wholesale funding.
It also raised yields on the sovereign bonds of the periphery nations and their spread over the same securities issued by the core nations.
The increased cross-border dispersion of interest rates and worries about a euro break-up have encouraged intra-euro capital flight and reversed the financial integration of the eurozone.
In the process, savers and depositors transferred their savings from the periphery nations to perceived safe nations.
Economic agents in the periphery nations have to pay higher interest rates than in the core, and often banks just do not want to lend
at all. The fragmentation of the single financial market has disrupted the bank lending channel of monetary policy.
To provide liquidity to the banking system in the eurozone, the European Central Bank (ECB) provides long-term refinancing facilities (LTR) and buys sovereign debt in secondary markets to drive interest rates down to smooth market fluctuations.
The independent ECB, however, has no mandate to act as a lender of last resort. The EU has no banking union for the whole eurozone with a common supervisory and macroprudential framework, a deposit insurance scheme and bank resolution authority. As in Asia prior to the crisis in 1997, prudential regulation of financial institutions in the eurozone has been weak.
Controlled by political parties, the cajas, the local saving banks in Spain, for example, borrowed excessively from the core nations to lend to real estate developers, to financing white elephant projects and to make contributions to political parties.
The European Financial Stabilization Fund (EFSF) and the European Stability Mechanism (ESM) provide emergency lending to stabilize troubled banks. The funds, however, are only made available through the national governments and are channeled to ailing banks.
This financing mechanism only transforms banking liabilities into sovereign liabilities, thus raising borrowing costs of sovereign nations that could lead to fiscal crises.
The writer is a professor of monetary economics at University of Indonesia and a former senior deputy governor of Bank Indonesia.
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