Yen/Dollar
--The Strong Wind of Appreciation
By
Scott B. MacDonald
A
major adjustment is underway in the global economy -- the yen
is on track for a gradual appreciation vis-à-vis the US
dollar. This is a trend that is likely to continue into next
year and has clear implications for helping the United States
deal with one of its major problems -- a large current account
balance of payments deficit that is expected to come in a little
over 5% of GDP in 2003. 
Although there are arguments to be made
as to why the yen will not be allowed to appreciate, the arguments
for such a development loom far larger. Some of the factors for
yen appreciation are economic and some are political.
The September 2003 Dubai G-7 summit focused on foreign exchange,
with the United States and the European Union looking at China
(not part of the G-7) and Japan as well as other Asian countries
to appreciate their currencies. The concern is that if global
economic recovery is going to take place (and that means having
sustainable growth in the U.S. and Europe), a number of Asian
countries need to let their currencies adjust to market conditions – i.e.
undergo an appreciation due to their relatively strong economic
performance, much of it based on export expansion. This in
theory should make trade competition fairer for various industrial
sectors
in the United States and Europe.
Over the last few years, the U.S. economy has been the mainstay
of the global economy, willing and able -- though helped by a
heavy dose of borrowing -- to buy a tsunami wave of foreign goods
from China, Japan, Korea and Taiwan. While helping to keep the
global economy afloat during tough times, this support of foreign
exporters has come at a cost of employment in the United States
(at least this is one of the popular arguments). Job loss in
the United States is now a major political issue, in particular,
the 2.7 million lost in the manufacturing sector over the last
three years. Consequently, the Bush administration prefers a
weaker dollar and a stronger yen and yuan due to (1) the pressing
need to correct the massive current account deficit; (2) the
need to reduce unemployment which could be helped by a potential
boost to the export sector; and (3) the need to show that President
Bush is tough in dealing with issues central to the common working
man as in protecting job losses through currency devaluation
(as well as protectionism). Bush increasingly faces potential
voter discontent, which could complicate his bid for re-election
in November 2004.
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All
of the above puts considerable pressure on the yen to appreciate.
We see the natural progression from yen 115/dollar to yen
110 and eventually in 2004, to 100. But economics is not
without
politics. If the yen goes too quickly to 100 to the dollar,
it would be a major negative for Japan’s export sector,
in particular, autos and heavy machinery. Thus far in 2003,
the
Bank of Japan has spent over $80 billion to slow any major
appreciation of the yen. Y115 was for many months the benchmark
around which
the Bank of Japan intervened and today it has broken the
110 mark. G-7 pressure at Dubai as well as an improving Japanese
economy changed this.
What is significant in Japan is that the domestic economy
is now looking stronger and the dependence on the export
sector
has lessened. Real GDP growth for 2003 is well above last
year’s
torpid pace and possibly could come in around 2%. Consequently,
it is easier for Japan to let the yen appreciate – to a
point. The last thing Prime Minister Junichiro Koizumi wants
to see is a disorderly and volatile appreciation of the yen.
This could choke off the economy’s recovery and spook
investors, especially as he plans on calling an election
for the lower house
sometime in November of this year. In addition, a rapidly
strengthening yen could only give deflationary pressures
a further push.
However, for all the efforts of the Bank of Japan to slow appreciation,
there is considerable pressure for appreciation. As the perception
of a Japanese economic recovery becomes more widespread, we expect
that foreign investment will continue to be attracted to the
Nikkei. Despite the recent slump the index remains far higher
than the lows seen earlier this year. Indeed, according to the
Tokyo Stock Exchange, net purchases of Japanese equities by foreign
investors in the fiscal first half of the year came to Y6.02
trillion, the largest amount on record for any fiscal half. This
was driven by growing expectations of an end to structural problems
and hopes for stronger growth.
Another pressure for appreciation is Japan’s trade and
current account surpluses. As long as Japan’s export
companies continue to be so competitive, they will continue
to suck dollars
into the economy. More dollars means more pressure on the
yen.
Taking all the various factors into consideration, in the short
term we see the Bank of Japan struggling to keep the yen in a
110-112 range to the dollar, with a dose of tough talking, followed
by intervention as the trend strengthens below the 110 mark.
However, as the Japanese economy is likely to further signal
a recovery, we expect that the yen could go to 105-7 by year-end.
The bottom line in all of this is that Japan has a little more
flexibility in terms of growth to give back a little to help
deal with the U.S. current account deficit.
The excesses of the 1990s will require further adjustment
in the 2000s. Foreign currencies will play a central role
in that
process and Japan’s appreciation of the yen is part of
the picture. An eventual appreciation of China’s yuan would
be another. By Japan moving first, it can now sit more comfortably
in the chorus calling for an appreciation of the yuan. However,
we do not see China’s jumping on to the appreciation band
wagon any time soon nor do we think that it would be smart policy
move on the part of Beijing, considering the massive challenges
that continue to dog that country’s banking sector. These
include huge bad loans and troubled state-owned enterprises.
Instead, the yen will be further squeezed as the global economy
moves into 2004. Ironically, Washington and Europe’s
push for Asian currency appreciation has fallen much more
on Japan,
not China, the country where many of the lost 2.7 million
manufacturing jobs have migrated.
Do
Economic Statistics Adequately Reflect the Size of the
Asian Economies?
By
Marc Faber
Officially,
the US has a GDP of about US$11 trillion, while China’s
GDP amounts to US$1.1 trillion and India’s to about
US$500 billion. Moreover, whereas the world’s GDP
stands at about US$32 trillion and the advanced economies
have a combined GDP of US$25 trillion (G7: US$21 trillion),
the emerging Asian economies (including China and India,
but excluding Hong Kong, Japan, Singapore, South Korea,
and Taiwan - countries that are classified as advanced
economies) have a GDP of just US$2.2 trillion. However,
if we look at some production figures, it becomes obvious
that the US economy is nowhere near ten times as large
as the Chinese economy or more than 20 times the size
of India’s GDP. Neither do the G7 countries have
a GDP ten times larger than the emerging Asian countries.
According
to The Economist’s World in Figures 2003
directory, China ranks as the world’s largest producer
of cereals, meat, fruits, vegetables, rice, zinc, tin,
and cotton. It is the world’s second-largest producer
of wheat, coarse grains, tea, lead, raw wool, major oil
seeds, and coal, the world third-largest producer of
aluminum and energy (measured in million tons of coal
equivalent), and ranks between fourth and sixth in the
production of sugar, copper, precious metals, and rubber.
India ranks among the top three producers of cereals,
fruits, vegetables, wheat, rice, sugar, tea (number one
for the latter two), and cotton. Indonesia ranks among
the top four producers of rice, coffee, cocoa, copper,
tin, and rubber; while Thailand is the world’s
largest producer of rubber, and Vietnam the world’s
second-largest producer of coffee.
“So what?” some readers may think, since these
are just commodities and thus are irrelevant in post-industrialized
societies! However, if we consider that China is already the
world’s largest manufacturer of textiles, garments, footwear,
steel, refrigerators, TVs, radios, toys, office products, and
motorcycles, just to mention a few product lines, and if we
then add the industrial production of Japan, Taiwan, South
Korea, and India, we get a totally different picture of the
size of the Asian economies than is suggested by statistics
based purely on nominal GDP figures, which don’t
take into account the difference in the price level between
different
countries.
In
fact, statisticians, in order to account for the fact
that in some countries the price level is far lower
than in the Western industrialized countries (such as is
the case for most emerging economies), have calculated
the GDP
level based on purchasing power parities (PPP). And while
I have some doubts about the methodology of PPP-adjusted
GDP
figures, it is nevertheless interesting to see how large
the emerging economies are when based on this measurement.
Asia (including China, Japan, India, South Korea, Indonesia,
Taiwan, Thailand, the Philippines, Pakistan, Bangladesh,
Malaysia, Hong Kong, and Vietnam) has a PPP-adjusted GDP
of US$14 trillion,
which is 50% larger than the US’s PPP-adjusted GDP of
US$9.6 trillion. In fact, by this measurement, Asia, in which
we should probably also include Central Asia, Australia and
New Zealand, as well as parts of Far East Russia, would be
by far the world’s largest economic bloc. And while,
as just mentioned, I have some reservations about PPP adjustments,
in general I think that it is fair to say that the PPP-adjusted
figures reflect a far more realistic picture of the size and
importance of the Asian economic bloc with its 3.6 billion
people (61% of the world’s population) than do the nominal
GDP figures, which suggest that the US has a GDP ten times
that of China.
One of the reasons why I have chosen to discuss the size
of the Asian economies, their impact on commodity prices
and on
resource-based countries and basic companies aside is that
if we compare the true size of Asia with the extremely low
weighting some Asian countries have within the MSCI World
Free Index, it becomes obvious that some big changes are
likely
to take place in future. The combined weighting of the entire
Asian region with 3.6 billion people and the world’s
largest economic bloc is just 3.4% excluding Japan and 12.1%
including Japan!
This
low weighting of Asia compared to the US raises two important
questions. Is Asia ex-Japan really
worth around 5% of the world’s entire market capitalization
(5% would include shares, which at present cannot be bought
by foreigners), and is the US worth 11 times the Asian market
capitalization ex-Japan? I, for one, doubt it! This particularly
because of the low price level in Asia compared to the US and
also because of Asia’s bulging foreign exchange reserves,
which are approaching $ 2 trillion. Should the day come when
Asians have more confidence in their own economic bloc (which
I think will happen in the next few years), we could see a
massive shift of assets from the US to Asia, with Asian financial
assets and Asian currencies rising very strongly relative to
US financial assets and the dollar. In other words, I think
it is only a matter of time before Asian currencies and Asian
assets, including real estate and stocks - will appreciate
relative to US financial assets and US properties.
There is one further point worth mentioning. If an individual
or a financial institution asked a traditional fund manager
(who inevitably follows the index weighting quite closely)
to invest their funds that have been allocated to equities,
they would end up having more than 50% of their money in
the US and just 11% in Asia including Japan, a region which,
as
I have explained above, is already the world’s largest
economic bloc with 3.6 billion people and the world’s
most favorable growth prospects (moreover, they would have
a maximum of 5% of their money in Asia ex-Japan, with 3.5 billion
people and which includes the world’s fastest-growing
economies - China India, and Vietnam). He would also end up
with less than 1% of his assets in combined China, India, Indonesia
(the latter a country with the world’s fourth-largest
population), Bangladesh (eighth-largest country), Pakistan
(sixth-largest country), Thailand, and the Philippines. Somehow,
I think that such an asset allocation, which implies that the
index-benchmarked investor would own just 1% of a region that
is inhabited by half the world’s population, simply doesn’t
make any sense at all and exposes the absurdity of indexing
as it is practiced today.
In fact, I believe that investors should allocate at least
50% of the money they invest in equities to Asia where valuations
are far lower and growth prospects more favorable than in
the US.
But, while I am very positive about Asia from a number of
points of view (the size of the economy, growth potential,
low valuations,
and low weighting within the MSCI Index), I also have to
admit that near term I am far less optimistic. I simply feel
very
uncomfortable about the US economy and the entire financial
system, and feel that the US stock market has at best entered
a sharp correction phase or may at worst, experience a crash
- if not now, then following another brief bout of strength.
And since the recent strength in the Asian markets has been
driven largely by foreign buyers, a US stock market correction
or, in the worst case, a crash would almost certainly spill
over into Asia and lead to some pronounced weakness but not
likely to new lows.
It
is for this reason that I have turned more cautious on
Asia from a near term point of view. In the
US, I am particularly concerned that rising interest rates
will have a negative impact on the housing market and on
financial stocks, which make up more than 20% of the
S&P 500. Housing
stocks, which have been formidable performers since 2000 (up
fivefold), should from now on under-perform, as the decline
in refinancing activity will slow down the industry. Moreover,
the Philadelphia Bank Indexappears
to be tracing out a head and shoulders formation and
financial shares such as Fannie
Mae look poised to decline sharply. I may add that while
financial stocks look likely to weaken in the US, in
Asia financial shares
appear to be strengthening.
In
sum, I like Asian assets including real estate and equities
and I remain of the view that investors
should avoid the US. Thus, you might consider hedging
your Asian bets by shorting the US!.
Long Live the Asian Bond Market!
Asians tend to save for the future while Americans borrow
from the future. The irony of the situation is that
America, the only superpower left in the world, is
financing its standard of living with excessive borrowing
from the world, in particular Asia. This is due to
the status of the US dollar as the world’s reserve
currency and the lack of alternatives in the existence
of a deep, liquid and well governed and functioning
Asian Bond Market.
If Asian countries were to substantially reduce their holdings
of US Treasury bonds, they would remove a key source of finance
for the US investment and the war on terror spending. President
Bush is recklessly turning the United States more heavily into
debt and the need for a local alternative to the US bond market
is suddenly becoming an issue again.
China is under intense US political pressure to revalue its
currency and in order to pave the way for the inevitable full
convertibility of the Renminbi, China is hosting the 1st Annual
Asian Bond Market Forum in Beijing this coming November.
President Bush and the Us Federal Reserve is making clear the
degree to which they are willing to bet the integrity of the
global financial system in its determination to keep the game
going. Spend and not save, consumption vs. production and borrowing
from the future. The US Federal Reserve Bank controls its own
balance sheet. It can print as much money as it likes but if
it is liquidated by the American commercial banking system
and credit contracts then deflation will surely follow. This
is not just theory.
Like gold or any commodity, US dollars have value only to the
extent that they are strictly limited in supply. But the US
government has a printing press that allows it to produce as
many US dollars as it wishes at essentially no cost. By increasing
the number of US dollars in circulation, or even by credibly
threatening to do so, the US government can also reduce the
value of a dollar in terms of goods and services which is equivalent
to raising the prices in dollars of those goods and services.
Under a paper money system, a determined government can always
generate higher spending and hence positive inflation. Domestic
monetization and deliberate depreciation of the dollar are
major policy alternatives available to the American government
to fight deflation. This is obviously a real issue for America,
the world’s largest debtor nation and its foreign creditors
many of which are in Asia.
It is quite realistic to assume that the US dollar standard
will become obsolete by the end of this decade, while at the
same time I expect the Renminbi to become fully convertible
and Asia to have its own fully developed bond market. All of
this will have huge implications for Asia, financial and geopolitical,
given the massive foreign exchange reserves accumulated by
the region and the huge percentage of them held in US dollars.
Renewed efforts are now under way to set up an Asian bond market
whose purpose it is to lessen the dependence on the United
States and to better circulate local money within the region
and funnel it into a variety of Asian public and private sector
bonds.
The Asian bond market initiative is led by member countries
of the Association of South Asian Nations (ASEAN) plus Japan,
China and South Korea. These countries hope that by establishing
the market, the pool of savings will be used to buy new bonds
issued by private firms and governments within Asia. The plan
is to establish a system to enable institutional investors
in the region to purchase local currency-denominated bonds
issued by Asian governments and private sector firms.
If the Asian Bond Market becomes a reality, many fear that
Asian investors, who are the largest foreign owners of US Treasuries,
may cut their holdings of US government debt, withdrawing a
key source for America’s large current account deficit.
Continued weakness in the US dollar could make Asian investors
even less willing buyers of American debt. However, for the
time being many Asian central banks, institutional and private
investors do not have a choice. The US has captive buyers for
its debt due to the lack of an Asian bond market.
One of the key motivating factors behind the creation of the
Asian Bond Market was the 1997 Asian financial and currency
crisis that hit the region. The establishment of deep financial
and capital markets is one of the best measures to prevent
a repeat of the financial collapse that spread among the region.
A deep and well functioning bond market lessens a company’s
dependence on the often volatile equity market and improves
a companies capital structure. This is turn will make it easier
to withstand any financial storms. However the IMF spearheaded
by the United States strongly resisted any efforts to establish
an Asian Bond Market then.
At that time, the United States had a president who was more
global and farsighted in his thinking and the Clinton administration
favored a strong dollar. Now under President Bush, the focus
is more narrow and domestic in nature and the US has adopted
a weak dollar policy.
President Bush’s strategy seems to be to run the US even
more into debt and let the dollar fall. As a result of this,
foreigners who still buy US debt are net losers, and the US
can continue to live beyond its means.
The last time such an aggressive policy was attempted was not
the Reagan “star wars” program, as some commentators
have suggested, but the “guns and butter” policies
of another populist president, Lyndon Johnson, in the mid 1960s.
The exporting of the resulting US inflation lead to two Sterling
crises, the shattering of the gold standard and the explosive
growth of the eurobond markets, which attempted to recycle
the massive “petro-dollar” surpluses.
China and Asean's favorable response to the Asian Bond Market
is therefore significant because it reaffirms the effort to
design and build financial protection for Asia with a more
balanced financial infrastructure, thereby diversifying risk
of intermediation across a large number of institutions and
market players.
It would also offer an additional source of funds, instead
of being tied solely to borrowing from international financial
institutions and would help China to pave the way for full
convertibility of the Renminbi.
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To
develop a bond market, three essential components are
needed. Firstly, there must be a deep and liquid government
bond
market to serve as benchmark yield curve against which
corporate paper
can be priced. Secondly, there must be an adequate infrastructure,
both legal and operational, to support trade and transfer
of instruments and funds. Operational infrastructure
includes
efficient clearing and settlement systems, short and long-term
foreign exchange hedging instruments, risk management for
investors and bond rating agencies establishment, and
development of
secondary bond market and repurchasing market. Thirdly, there
must be collaboration among players in the bond market, namely,
the intermediaries, the end-users and the private sector.
Because it is an important far reaching initiative, many
areas will be addressed in Beijing: pension investors need
better
and more choices; banks need a disciplining competitor; both
investors and issuers need a live, market-priced benchmark – i.e.
an Asian yield curve – to price long-term investment
risk; infrastructure finance needs local currency finance
and local watchdogs; the local markets need proper credit-rating
agencies. The potential list is long.
The Asian Development Bank (ADB) has shown its willingness
to promote the supply side of the Asian Bond Market in APEC
economies in Asia and so far the mood toward materializing
the Asian Bond Market has never been better.
This is true especially now as Asian nations feel that they
need to lessen their dependence on the United States, especially
after US Treasury Secretary Snow is pushing for Asian currencies
to appreciate.
For some time, a happy equilibrium has existed between the
US and Asia. The US buys Asian exports, and Asian countries
use income from the sale of their exports to buy US assets
to help prevent their currencies from rising against the dollar,
and it keep exports competitively priced.
However, this equilibrium now seems to be breaking down as
the Bush administration (for domestic political purposes) is
putting pressure on Asian countries to revalue their currencies.
Traditionally, economic growth in many Asian countries hinges
on exports and generating foreign currency, but trade is largely
based on the US dollar. As the US dollar has entered a secular
bear market, more Asian countries feel the need to shift to
domestic demand as one of the key drivers of economic growth
and lessen their dependence on exports to the US.
What's becoming more apparent now is the way Asia has been
strengthening its financial infrastructures by combining market-based
rules with ingenuity to instigate economic and financial dynamism
for the region and to encourage better utilization of regional
resources.
The regional bond market development is tied into market-based
rules and a stable financial infrastructure, such as rating
agency standards, settlement systems and sound governance.
Central Banks in Asia alone buy more than 40 per cent of all
international purchases of US government debt.
Asian nations – foremost China - do more than Washington
appreciates to finance the growing US current deficit. More
than 90 per cent of the current account surpluses earned
by Asian nations through trading with the US, Europe and
Japan
are put on reserves in US Treasuries.
If Asia, led by China un-pegs its currencies and moves toward
floating ones, US bond yields will surge. Rising bond yields
would put a lot of pressure on the US economy and might derail
the recovery.
Seen from this perspective, it makes you wonder if Secretary
Snow truly understands the risks involved in demanding that
China and other Asian countries scrap their pegs to the US
dollar or whether it is pushing local politics too far. But
with a US election on the way, it's much easier to pick on
the currency policies of China and other Asian economies, instead
of dealing with structural problems at home for which there
is no easy solution.
If the White House isn't careful, though, its actions could
cause much bigger problems with far reaching consequences.
The Asian Bond Market gathering could set in motion momentous
changes with unpleasant outcomes for an America that has grown
used to relying on Asian buyers at its treasury auctions.
If the Asian Bond Market does find attention of the media
and regulators, it could become a regular event. It is in
the interest
of the global community to have a deep and liquid Asian bond
market with lots of participants – it does not matter
whether it will work from the beginning, what’s important
is that it is started and the right direction is taken.
Michael
R. Preiss serves as Chief Investment Strategist at CFC Securities.
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India’s
Role in Central Asia
By
Kumar Amitav Chaliha
India
has launched a number of new policy initiatives in the Central
Asian states and their vicinity. The economic and strategic
initiatives now being implemented are shaped by several factors,
including India’s vision of playing a broader Asian role
commensurate with its rising economic and military power. The
strategies are also meant to extirpate Islamic terrorism from
South Asia, Afghanistan and Central Asia; to checkmate Pakistan
and restrain China’s growing power and influence; to
prevent India from falling into energy dependency on any one
source; and to have access to new trading opportunities.
India has joined the “New Great Game” being played
in the Central Asian region where competition for economic
and strategic positioning is intensifying. The ensuing conflict
of interest in the area between India’s longtime ally,
Russia, its newfound strategic partner, America, nuclear rival
China, and Iran, is fuelling New Delhi’s “forward” Central
Asian policy. Since India is unable to insulate Central Asia
from such power politics, it has decided to become a part of
it. Its size, military and nuclear capability makes it a significant
part of the complex jigsaw.
Pakistan, as part of its ongoing challenge to India in Kashmir
and South Asia generally, has consistently tried to establish
strategic depth in Central Asia. It tried to implement its
agenda from the 1990s by supporting the Taliban, and through
them the myriad extremist and terrorist groups that have destabilized
Kashmir and Central Asia. The events of September 11 and especially
the attack on India’s Parliament in December, 2001, has
awoken India to the urgent need of devising a comprehensive
strategy to stabilize Central Asia and prevent it from becoming
a haven for terrorism and a strategic platform from which Pakistan
could threaten Indian interests.
As a strategic measure, India in May,2002 established its first
military facility outside its territory at Farkhor in Tajikistan.
A bilateral agreement was also signed in April to train Tajik
defense personnel, and service and retrofit their Soviet and
Russian military equipment similar to that of the Indian armed
forces. A similar pact between India and Kazakhstan is expected
to be signed soon.
Tajikistan, Kazakhstan, Uzbekistan and Kyrgyzstan, besides
Russia, have supported India’s case for entry into the
Shanghai Cooperation Organization. The six-nation organization,
which also includes China, was set up six years ago to deal
with border issues, combat ethnic and religious tensions in
member countries and to safeguard against the spread of Islamic
terrorism. While Beijing has been silent on the issue of India’s
entry and encouraging Pakistan’s membership, security
officials feel China would not oppose India’s case as
part of its long-term policy of “keeping its friends
close, but its enemies closer.”
Indian officials and entrepreneurs have been looking to explore
the immense possibilities that lie with increased interaction
with the five Central Asian republics. Most of these countries
have enormous oil and natural gas deposits. Indian which has
so far been over-dependent on oil from the Persian Gulf states,
is keen to tap into the Central Asian energy reserves. There
is also a huge market in this region for Indian pharmaceuticals,
heavy machinery, tea, and information technology.
To achieve these objectives, India has launched a regional “people-to-people” initiative
by inviting diplomats, parliamentarians and opinion makers
from Central Asia to visit its industrial and technological
centers and also to interact with politicians, officials and
businessmen.
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New
Delhi’s efforts are already paying dividends. Its
supply of pharmaceuticals to Central Asia has increased to
30 percent of the region’s requirements. During an industrial
meet at Almaty recently, Indian companies got orders for consumer
goods worth $28 million. And, Kazakhstan has sought India’s
IT expertise to develop software parks and start joint ventures.
The shortest route from India to Central Asia is by land through
Pakistan and Afghanistan. But, New Delhi cannot use this route
given its troubled relations with Islamabad. So, India has
joined Russia and Iran to build a North-South corridor, which
will not only strengthen Iran and Russia, but also enhance
access to energy and trade from these countries and Central
Asia. Linking India’s commercial capital, Mumbai, with
the Iranian port of Bandar Abbas by maritime transport, the
North-South corridor will subsequently rely on existing road
and rail networks that are being upgraded, to link with Central
Asia, as also with Russia and western Europe.
This corridor holds promise for New Delhi for it will “enable
India to bypass Pakistan while reaching out to Central Asia, “ says
an Indian External Affairs Ministry official. “We do
not have to wait for India-Pakistan relations to normalize
to tap into Central Asia, “ he said.
But, there are obstacles in the implementation of this corridor.
The potential of the transport corridor will be determined
by the funds available to upgrade the rail and road networks
and other related infrastructure. "“None of the
signatories to the North-South Corridor Agreement -- Russia,
Iran and India -- have that kind of money,” says the
Confederation of Indian Industry.
There is also the question of security. The corridor runs through
the unstable Caucasus region. Few will be willing to send cargo
through conflict-ridden Chechnya or Dageshstan.
Finding a route bypassing Pakistan is also important for India
due to its increasing involvement with another country in the
region -- Afghanistan. Since a land route via Pakistan is not
possible in the immediate future because of hostile India-Pakistan
relations, links like the North-South corridor are vital.
India has already opened a front by setting up the military
base at Farkhor in Tajikistan. The base is being used to provide
relief assistance that India pledged to Afghanistan after the
Taliban’s ouster.
India’s relations with Afghanistan had been much circumscribed
so long as a Soviet-style regime ruled Kabul and had been non-existent
during Taliban rule. The Pakistan-backed Taliban’s staunch
anti-India position prompted India to fully back the Northern
Alliance. With the Taliban’s ouster by the Northern Alliance
and American forces, India was given the chance to establish
itself firmly in Afghanistan. This time, it appears focused
on not missing the opportunities -- both strategic and economic
-- that Kabul offers.
The setting up of the Farkhor base is a step in this direction.
India has also reopened its embassy in Kabul and has decided
to establish consulates in Heart, Jalalabad, Kandahar and Mazar-e-Sharif.
Again, it has given an immediate assistance of $100 million,
resumed the India-Afghanistan air link, and revived the Indira
Gandhi Hospital in Kabul where Indian doctors are fitting artificial
limbs to the large number of war-disabled Afghans.
Besides, India is also seeking to be a major player in the
reconstruction of Afghanistan for which $20-$30 billion is
expected to be spent by international donors in the next decade.
Unless the political situation in Afghanistan prevents implementing
such a long-term plan, India expects to get a substantial share
of the reconstruction contracts ranging from road construction
to restoration of health care facilities.
Visits by Afghan President Hamid Karzai, Defense Minister Mohammed
Fahim and Foreign Minister Abdullah Abdullah to India have
helped foster this growing relationship with Afghanistan. In
the process, India is seeking to establish itself as a major
stakeholder in Afghan affairs.
There is no doubt that India will continue to support the Northern
Alliance leaders in the Afghan administration. These leaders
are locked in a power struggle with President Karzai and it
is no secret that they are now calling the shots. While the
linkages between India and the Tajik-dominated Northern Alliance
have been beneficial to both, New Delhi cannot ignore the opportunities
that are now available to revive the centuries-old relations
with the Pashtuns who oppose the Alliance. The Pashtuns formed
the Taliban with Islamabad’s help and have been anti-India
since the 1980s. Strategists say New Delhi should be careful
of Pakistan’s efforts to foment Pashtun discontent by
propagating the view that they have been inadequately represented
in the Kabul power structure. Recent Indian gains in Afghanistan
would be stymied if Pakistan and remnants of the Taliban foist
a new Pashtun leadership in Kabul.
India’s new policy initiatives in Afghanistan and Central
Asia have involved improving relations with America, Russia,
China and Iran, mainly due to mutuality of economic and strategic
interests. The question is how are these relationships going
to develop?
Despite the current bonhomie, there still exists a lot of mistrust
between India and Iran. The Iranian leadership is still wary
of a strong Hindu-dominated India, while New Delhi views an
influential Islamic Iran as a potential adversary in the long
run.
India’s growing strategic relations with the United States
are also likely to put New Delhi in an awkward situation if
it did join the Shanghai Cooperation Organization or is heavily
involved in the North-South corridor process. Moscow and Beijing
anticipate an eventual clash with Washington in the region
awash with oil and gas deposits. And, India is not anxious
to convey to America that it is willing even to consider a
Moscow-Delhi-Beijing triangle to ensure a multi-polar world,
while simultaneously enhancing relations with Russia and China.
New Delhi does not want to jeopardize its long friendship with
Russia. And with China, it is finding ways to cooperate despite
officially unstated but visible goals on the part of both countries
to restrain and rival each other’s growth of power and
influence in Asia. India’s eagerness to keep its options
open has been prompted by fears that despite warming India-U.S.
relations, Washington is going to depend more on Islamabad
to safeguard American interests in Central Asia and would not
change its policy on Pakistan in the foreseeable future to
accommodate India.
Since this is the beginning of the implementation process of
India’s economic and strategic initiatives, it is difficult
to forecast the ramifications. But, what is certain is that
they will be profound and long-lasting and have great significance
for the future.
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BUSINESS
When
Free Trade Went on Siesta: The WTO Cancun Trade Talks
By
Jean-Marc F. Blanchard, Ph.D.
Senior Consultant, KWR International
On September 15, global trade talks in Cancun, Mexico ended
without an agreement. The breakdown of talks does
not bode well for the future of the Doha Round, the
latest series of World Trade Organization (WTO) talks
designed to produce a greater liberalization of the
global economy. Many worry that the lack of a trade
deal is hindering economic growth and reducing confidence.
In a pique, U.S. Trade Representative Robert Zoellick
opined “some countries will now need to decide
whether they want to make a point or whether they
want to make progress.”
According to various news reports, two issues sank the negotiations.
First, the developed world, particularly European Union countries,
would not compromise on the issue of agricultural subsidies.
They simply could not bring themselves to make significant
reductions in subsidies now running an incredible $300 billion
per year. Second, the developed world called for a liberalization
of foreign investment rules to improve transparency, reduce
red tape, and open government procurement. Developing countries,
led by Brazil, China, and India, were unwilling to move forward
without meaningful cuts in agricultural subsidies. Moreover,
they never warmed to the idea of new foreign investment rules
because of the potential adverse consequences of such rules
for their domestic industries.
For cynics, the talks produced one agreement, a concurrence
on the merits of protectionism! In truth, the meeting had
one noteworthy accomplishment. Specifically, there was an
agreement authorizing developing countries to import generic
versions of vital drugs—e.g., those needed to deal
with epidemics like HIV/AIDS—without contravening WTO
intellectual property protections, provided that importers
meet certain conditions and sellers take measures to prevent
exports to developed countries.
WTO delegates will be meeting again in Geneva in December,
but it is hard to imagine how they will achieve the goal
of a new global trade deal by the end of 2004. In fact, it
is possible that free trade has gone on an enduring siesta.
One reason is that the U.S. seems to have abandoned the leadership
role it has played in the past. Another reason is that the
democratization of foreign economic policy has made it more
and more difficult to advance the agenda of an open international
economy. A third reason is the changed geopolitical environment.
This makes economic tradeoffs in the name of national security
less likely.
Ever since the establishment of an open international economic
order in 1945, the United States has played a lead role in
promoting it. It has cajoled, threatened, and bribed other
states to get them to reduce tariffs, to eliminate non-tariff
trade barriers, and to accept new items on the global free
trade agenda. The U.S., however, no longer seems willing
to assume such a role. The weakness of the last three American
Presidents has made them wary of alienating constituencies
that might provide the crucial margin of victory in close
Presidential elections. This dynamic is shown vividly in
President George W. Bush’s decision in March 2002 to
dramatically increase tariffs on foreign steel. Moreover,
the U.S. continues its heavy subsidization of large farms.
Frustrated by the lack of progress at the global level, U.S.
policymakers have increasingly turned to bilateral and regional
negotiations, arenas where the consensus of 146 WTO members
is not required and the U.S. can use its political and economic
power to strike favorable deals. The evidence indicates the
U.S. will maintain such a strategy. Such arrangements, though,
are not as beneficial for world trade as global deals and
have the potential to produce a series of closed trade blocs.
Compounding the problem, global trade negotiations have become
much more democratic. The democratization of globe trade
has occurred because of internal changes within countries,
the activism of non-governmental organizations, and the structure
of WTO negotiations whereby a complete consensus is required
for the conclusion of trade deals. This development increases
the number of players who can veto trade deals, injects time,
organizational, and material burdens into the trade negotiation
process, and restricts secret side-payments. The democratization
of global trade clearly is positive from a procedural standpoint,
but not necessarily for the future of free trade and investment.
The last factor that bodes poorly for an open international
economy is the changed geopolitical situation. Many forget
the Bretton Woods system came into being not only because
the U.S. and its allies wanted to promote capitalism, but
also because they wanted to avoid the protectionist mistakes
of the 1930s, mistakes they believed fueled the Great Depression
and World War II. Beyond this, open trade benefited from
the willingness of the U.S. to tolerate European and Japanese
protectionism if it facilitated the containment of the Soviet
Union. Such geopolitical imperatives no longer exist. Hence,
there is a reduced inclination on the part of the U.S. and
others to accept disadvantageous trade structures.
In total, the prospects do not look good for a further opening
of the international economic system. How might companies
respond to this changed setting? Clearly, it will be critical
to exploit whatever leverage one’s home government
has to gain access to other markets. Furthermore, it will
be essential to draw upon knowledgeable individuals who can
facilitate access to foreign markets. Finally, it will be
advisable to direct attention to those countries that actively
embrace the liberal trading order.
Part II - “Zaibatsu” and “Keiretsu” -
Understanding Japanese Enterprise Groups
By
Andrew H. Thorson
This
Article is Part II of a series that explains the
origins of the Japanese corporate complexes that
have characterized Japan’s modern economy.
Part I explained the origins of pre-WWII zaibatsu.
This part discusses the dissolution of the zaibatsu and
origins of the current company groups known as
the keiretsu.
Zaibatsu Dissolution: As explained in the previous article,
by 1945 the zaibatsu had grown to control a significant
portion of Japanese trade and industry. During the Allied
occupation, the zaibatsu were liquidated in order to “democratize” Japan’s
economy. In addition, for the purpose of controlling concentrations
of economic power, special provisions were included in
Japan’s Antimonopoly Act for the specific purpose
of forbidding holding companies and limiting the acquisition
by financial enterprises of stock of other companies. In
hindsight these provisions might appear to have been ineffective
barriers to the creation of excessive economic control
and equally ineffective as measures to ensure competition
in Japan’s economy. These arguments were made when
Japan enacted the Act for partial Amendment of the Antimonopoly
Act in 1997 by which act Japan finally eliminated the 50-year
old ban on holding companies.
The zaibatsu were dismantled by (i) destruction of pyramid
control structures via liquidations, (ii) public dispositions
of zaibatsu-owned shareholdings, (iii) reorganization of
large existing monopolies, and (iv) strengthening of the
legal prohibitions on monopolies and unfair competition.
The Imperial Order of 1946 Concerning the Restriction,
etc., of Securities Holdings by Companies also forbids
certain interlocking relationships among former zaibatsu members via personnel, shareholding, loans, and contractual
ties. In all, 1200 companies and 56 individual members
of zaibatsu families had their assets frozen and transferred
to what was known as the Holding Company Liquidation Commission.
Political Overtones of Dissolution: While the Allied presence
influenced the dissolution of the zaibatsu, there are also
suggestions that bureaucrats in Japan desired to liquidate
the zaibatsu for political reasons of domestic politics,
including perhaps for the purpose of strengthening the
Ministry of Finance’s (MOF) control over Japan’s
economy. From the late 1930’s, powerful Japanese
stockholders were also under public attack for emphasizing
private profit interests over what were perceived to be
public interests and the interests of labor. On the domestic
level, zaibatsu became targets of social resentment, and
managers of leading zaibatsu were sometimes even subject
to terrorist attacks. The theory that zaibatsu dissolution
implicated a power coup between the MOF and the zaibatsu
rather than a real desire to eliminate concentrations of
economic power is arguably consistent with the circumstances
which followed dissolution, namely, the emergence of new
and powerful corporate groupings in Japan.
New Corporate Groups – Emergence of Keiretsu: Within
years of dismantling the zaibatsu, changes on both the
domestic and international fronts are thought to have led
to a relaxation of regulations upon the concentration of
economic power in Japan. On the latter front, following
the establishment of communist China, U.S. foreign policy
toward Japan could be seen shifting to one supporting a
shoring up of Japan’s economic power. Secondly, industrial
growth and increased production capacity in Japan supported
the U.S. need for supplies during the Korean War. Domestically,
legislation in 1949 and subsequently in 1953 relaxed restrictions
under the Antimonopoly Act. By 1953, financial companies
were permitted to own up to 10% of the outstanding shares
of non-financial companies and the prohibition upon holding
the stock of competing companies was eliminated.
Government policies in support of economic and industrial
growth also tended to promote a new pooling of resources
and grouping of enterprises during this period. When the
Korean War ended and some large industrial companies faced
over capacity problems, governmental policies supported
greater cooperative efforts among enterprises. For example,
in 1953 the Ministry of International Trade and Industry’s
(MITI, now known as METI) Industrial Rationalization Counsel
called for the grouping of trading and manufacturing companies
to concentrate scarce capital in the domestic economy.
Antimonopoly restrictions were also relaxed during this
period. In this environment the currently existing corporate
groups began to crystallize.
By the 1960’s six “quasi-zaibatsu” had
emerged, including the following groups: Mitsui; Mitsubishi;
Sumitomo; Fuyo; Sanwa; and Dai-Ichi Kangyo. Of these six,
Mitsui, Mitsubishi and Sumitomo have been called the most
direct successors of the pre-war zaibatsu. In contrast
to actual zaibatsu, however, large financial institutions,
under the influence of MOF, have been said to play a central
role in corporate governance. The current groups are arguably
so substantively different from original zaibatsu that
it could be misleading to refer to them as “quasi”-zaibatsu.
As will be explained in Part III of this series, the current
company groups that we often loosely lump together and
refer to as keiretsu¸ include horizontal and vertical
company relationships, and sometimes business ties that
are held together not by capital but by mere transactional
relationships among enterprises. The central role of main
banks in corporate governance greatly distinguishes these
groups from the zaibatsu.
The views of the author are not necessarily the views
of the firm of Dorsey & Whitney
LLP, and the author is solely and individually responsible for the content above.
China: the “New Japan” of Trade Policy?
By
Russell L. Smith and Caroline G. Cooper, Willkie
Farr & Gallagher, LLP
In
the 1980s and 90s, Japan was the scapegoat that
was blamed for plant closings and job losses in
the U.S. manufacturing industry. These days, that
label is more and more being conferred on China.
In the past few months, many U.S. manufacturing
sectors have united around the claim that their
high production costs render them unable to compete
with low-priced Chinese imports. They assert that
their problems would be solved if the Bush Administration
and Congress take immediate steps to force China
to allow the yuan to float, or to impose tariffs
that will offset China’s claimed exchange
rate advantage.
So far, the Administration has reacted to these industry
pressure tactics by encouraging China to free float the
yuan, but not insisting on immediate action. Officials,
at least those from the Treasury Department, recognize
it will take time for China to adopt a market-based exchange
rate so as not to precipitate an implosion of what is,
for its massive bulk, a quite fragile Chinese economy.
In a move more directly responsive to industry and Congressional
pressure, the Administration has also encouraged major
trading partners, especially those in Asia, to support
flexible exchange rates. At the recent G-7 Finance Ministers
meeting, Treasury Secretary Snow successfully convinced
Ministers to include in the final communiqué a
mild statement that endorsed more exchange rate market
flexibility. Even this rather reserved action has caused
temporary turmoil in exchange markets, driving up the
value of the yen quite significantly.
Members of Congress are significantly less sophisticated
in their approach to this issue, and are acting mainly
in response to 2004 election prospects, which are expected
to be strongly influenced by employment levels. In the
past month, a number of resolutions were introduced in
Congress demanding action on China’s alleged currency
manipulation, and one urging (but not requiring) new
initiatives by the President has passed the Senate. While
more aggressive legislation may never be enacted into
law, the message to policymakers and U.S. trading partners
is clear--continuing exchange rate problems are heightening
trade tensions and therefore the prospects for imposing
trade remedies.
Addressing the China Problem: China’s alleged currency
manipulation became a priority issue for Congress last
May as a result of a hearing convened by House Commerce-Justice-State
Appropriations Subcommittee Chairman Frank Wolf (R-VA).
Agricultural producers joined furniture and pharmaceutical
manufacturers in testifying that the Chinese government
supported a monetary policy that kept the yuan pegged
at an artificially low exchange rate relative to the
dollar. They considered China’s undervalued currency
to be a subsidy, warranting action under U.S. trade remedy
law.
The issue continues to warrant attention because legislators
claim they can quantify the extent to which China can
manipulate the yuan and the impact this has on the U.S.
economy. Legislators say that China can intervene in
the exchange rate market at any time because it has large
foreign exchange reserve holdings. They also claim that
China’s currency manipulation has given rise to
a soaring U.S. merchandise trade deficit. The latest
Census Bureau data shows the U.S. merchandise trade deficit
with China through the first seven months of 2003 comprised
nearly 21% of the overall U.S. merchandise trade deficit.
U.S. imports from China in July 2003 reached a record
monthly high of $13.4 billion, with no diminution in
sight as the year-end holiday selling season approaches.
At a September 9th Senate Foreign Relations Committee
hearing on U.S.–China relations, Republican and
Democratic Senators charged that actions by the Chinese
government to manipulate the yuan violated WTO rules.
They expressed concern about statements by Treasury Secretary
Snow following his trip to China that the Administration
would do little in the near future to pressure China
to float the yuan. Administration witnesses offered assurances
that the United States would ensure that China complies
fully with all of its WTO commitments. They cautioned,
however, against thinking that the “structural
problems” in the Chinese economy that are driving
China’s leaders to control the value of the yuan
could be resolved overnight. These include billions of
dollars in doubtful loans, problems with state-owned
industries, high unemployment, and potential instabilities
resulting from burgeoning foreign investment flows.
It is also noteworthy that some major U.S. industrial
sectors, particularly the U.S. auto industry, do not
support these initiatives. They have substantial investments
in China, which would be adversely affected by a stronger
yuan. While they have not publicly opposed the business
community’s efforts regarding China, when asked
they argue that for them, Japan’s intervention
in currency markets is more detrimental that China’s
refusal to float the yuan.
This caution seems to have had little impact either on
the affected U.S. industries or the Members of Congress
who support them. Since September there has been a continuing
flow of legislative proposals threatening trade restrictions
against China, and justifying such threats by asserting
that currency manipulation violates U.S. trade remedy
laws and WTO subsidy rules. S. 1586, introduced on September
5 by Senators Schumer (D-NY), Bunning (R-KY), Dole (R-NC),
Durbin (D-IL), and Graham (R-SC) authorizes the Treasury
Department to enter into negotiations with China to float
the yuan and to certify to Congress that the Chinese
government is no longer intervening in the exchange rate
market. If the Chinese government fails to value base
the yuan on an acceptable market rate within a specified
period of time, the Administration would be authorized
to impose an across-the-board tariff on all Chinese exports
to the United States of 27.5%--an amount equal to the
claimed average percentage rate by which China has devalued
its currency.
The House companion bill, H.R. 3058, would also require
the Treasury Secretary to report annually to Congress
on how China has manipulated its currency. The legislation
authorizes the Administration to impose a tariff, and
in some cases an additional tariff, on all imports from
China at a percentage rate “equal to the rate of
manipulation.” Although these bills will most likely
never become law, the extreme approach they take invite
use of existing trade remedy laws, such as dumping and
safeguards. These appear moderate by comparison although
in reality are just as exclusionary.
The proposals that have received favorable attention
on Capitol Hill and in the White House are those that
are WTO-consistent and encourage, rather than threaten,
affected countries. Some of these bills broaden the countries
of concern by including Korea, Japan, and Taiwan, as
well as China as alleged currency manipulators. Some
also include potential calls for “unfair trade
practice” actions under Section 301 of the Trade
Act of 1974. This long-dormant provision permits the
United States to investigate and negotiate with other
countries on unfair trade practices, but any action to
restrict trade could only come as a result of a successful
WTO dispute resolution case. That, in turn, is highly
unlikely, since it is unclear whether the WTO rules would
permit such a case, whether exchange rates are a valid
basis alleging WTO inconsistency, and whether the Administration
would be willing to bring such a case.
Next Steps: Given the current “jobless recovery” in
the United States, these trade-related political pressures
are no surprise. The next step for legislators and manufacturers
is getting the Administration to do more to press China
to float the yuan. For now, President Bush wants limited
pressure on China. The most that legislators can probably
expect from the Administration in coming months is that
the annual Treasury Department report to Congress on
foreign exchange rates will include a lengthy section
on China. If the White House decides to put more pressure
on China, it is difficult to know how that will manifest
itself. It is entirely possible, if not probable, that
future cases seeking special safeguards against Chinese
imports will be more successful than those brought in
the past. This would be the type of “signal” that
the Bush Administration could be expected to send to
China. This would express that China is free to act as
and when it wishes on exchange rates, but that as long
as the perceived currency manipulation persists, the
Administration will respond to political pressures with
the tools over which it has discretion. These include
trade remedy laws, which allow affected U.S. industries
to protect themselves, at least temporarily, from Chinese
imports.
Emerging
Market Briefs
By
Scott B. MacDonald
 Better
in the Bahamas: The Bahamas have one of the higher
rankings for a sovereign in the universe of Emerging
Market credits,
having received an A3 rating from Moody’s. On September
29, 2003, Moody’s affirmed the rating and maintained
a stable outlook. As the rating agency noted: “The
stable ratings outlook is based on a relatively strong
external position, although the economy faces challenges
posed by the negative effects on the tourism sector of
terrorism and geopolitical uncertainties.” Moody’s
also made note that while the negative impact of 9/11
on tourism appears to be bottoming out, the country has
as of yet to revert back to more favorable budgetary
trends. In addition, The Bahamas has embarked upon constructive
legislative and regulatory actions, which prompted its
removal from a blacklist of jurisdictions prone to money
laundering. The Caribbean nation has also been removed
from the list of non-cooperating tax havens by the Organisation
of Economic Cooperation and Development because of the
local authorities commitment to exchange information
on a bilateral, non-discriminatory basis with other governments.
The Bahamas is not rated by either Fitch or Standard & Poor’s.
Dominican Republic – Mounting Problems: Standard & Poor’s
on October 1, cut the Dominican Republic’s ratings two
notches due to growing concerns that the island-state will default
on $1 billion of debt coming due in 2004. The country has been
hard hit by a major banking scandal, which has badly damaged
investor confidence, forcing the government to turn to the IMF
for assistance. The situation has only been made more complicated
by looming presidential elections. Standard & Poor’s
took the Dominican Republic’s ratings from B+ to B-, with
a negative outlook. Depending on what the government can do to
repair the economy, we see ratings pressure mount for an external
debt default.
Indonesia – Moody’s
Upgrade: In September, Moody’s upgraded Indonesia from
B3 to B2, which places it on a par with Brazil and Ukraine. However,
the B2 rating is well below Indonesia’s ratings prior to
the 1997-98 Asian financial crisis – Baa3/BBB. Key points
that pushed the upgrade were improved foreign exchange reserves,
a fall in external debt, corporate restructuring and relatively
prudent fiscal policies. The rating agency also admitted that “there
remain considerable risks to Indonesia’s economic and financial
outlook, particularly in 2004 and 2005”. Those risks encompass
a major presidential and parliamentary election, a shift away
from direct IMF support, and dealing with the ongoing insurrection
in Aceh, northern Sumatra.
Pemex – Mexico’s Oil Company Under the Moody’s
Gun: In early October Moody’s placed Pemex, Mexico’s
state-owned oil company on review for a possible downgrade. Although
the rating was affirmed in September, Moody’s suddenly
appears to have been alarmed by many of the same things that
it noticed earlier, but now have it concerned. The rating agency
is now concerned over the oil producer’s rising debt obligations
and other liabilities as it needs to make investments to boost
its oil and gas production. Another newly-reconsidered fear is
the company’s high tax burden.
Ironically, many of the
concerns that Moody’s is fingering are being addressed.
The company has a new CEO who is expected to be smoother in dealing
with the unions, government and board; foreign companies are
being allowed to do some of the costly exploration and infrastructure
development -- something that has a big price tag and is not
Pemex’s forte); and prospects for an improving economy
in 2004 could take some of the government pressure for upstreaming
Pemex revenues to the government in the form of taxes. It appears
that Moody’s has more concerns with having Pemex sit one
notch above the sovereign Baa2 rating and attending to housekeeping
as opposed to any new development.
Philippines – Cloudy Skies
Ahead: On September 30, 2003, Moody’s changed its outlook
for the Philippines from stable to negative. The country is rated
Ba1. The key reasons for the change entail “political uncertainties” stemming
from the failed July coup attempt and the upcoming presidential
elections. As the rating agency stated: “Recent political
developments, including the brief coup attempt and legal maneuverings
against senior officials in the central bank, reflect deep political
tensions.” Sadly, the political uncertainty comes at a
time when the administration of President Gloria Arroyo is making
headway in narrowing the budget deficit. The government projects
the gap in its finances will narrow to 202 billion pesos this
year from a record 211 billion pesos in 2002. This year’s
deficit was 113.6 billion pesos at the end of August, well ahead
of economists’ forecasts after the government spent more
than planned for a second month. Standard & Poor’s
earlier in 2003 downgraded the Philippines BB+ rating to BB,
due to concerns over the fiscal deficit.
Thailand – Heading Back Up the Ratings Ladder: In early
October Moody’s indicated it was considering upgrading
Thailand’s Baa3 rating, probably to Baa2. The key reasons
for this change are strong economic growth (6.4% real GDP expected
for 2003), stronger revenues, robust foreign exchange reserves,
and low inflation. Factors that remain of concern include the
government’s overall fiscal situation and bad debt in the
banking system – which remain from the 1997-98 financial
crisis. Bad debt in the banks are reported to be as high as 16%
of all loans as of June 2003. Standard & Poor’s rates
Thailand BBB-.
Book
Reviews
 Gillian
Tett, Saving the Sun: A Wall Street Gamble to Rescue
Japan from Its Trillion-Dollar Meltdown (New York:
Harper Collins, 2003). $26.95 337 pages.
Reviewed
by Scott B. MacDonald
 Click
here to purchase "Saving
the Sun: A Wall Street Gamble to Rescue Japan from Its Trillion-Dollar
Meltdown"
directly from Amazon.com
Gillian
Tett, the former bureau chief for the Financial Times
in Tokyo, has written an excellent book about the rise
and fall of Long Term Credit Bank and its attempted rebirth
as Shinsei, owned by a group of American investors. In
many regards, the fundamental thrust of Saving the Sun
is that in Japan there has been reluctance to taking
the tough measures needed to deal with the massive piling
up of bad bank debt and that the solution could be with
what Shinsei has done – a painful, yet committed
effort to cut down on bad debt, even if it incurs the
wrath of the government and vested interest groups. As
she states: “…what this LTCB-Shinsei saga
does do is to offer a general moral about structural
reform: namely, that if a country continually tries to
avoid short-term pain by clinging to outworn institutions,
and refusing to adapt to a changing world with ‘creative
destruction’ – in Schumpeter’s famous
phrase – this can carry a terrible long-term cost,
not just in terms of lost growth but also shattered lives.”
The LTCB saga has its roots in the Meiji era, though its
formal start was in 1952, when the bank was created to provide
long-term credit to priority industrial sectors in the postwar
period. The Japanese government had a strong preference for
putting the raising of capital for key industries, such as
steel and shipping, in the hands of the banks, rather than
in the hands of capital markets, which could be volatile.
Consequently, LTCB and other long-term credit banks played
a major role in the Japanese economic miracle during the
1950s and 1960s. By the 1970s, conditions had changed, with
large successful Japanese companies no longer needing long-term
credit banks and instead having the option of going to international
credit markets. This meant that LTCB was forced to come to
terms with the need for change. If not a long-term credit
bank, what then? By the early 1980s the answer was to become
an investment bank. Yet, as Tett notes, this was a revolutionary
idea and LTCB has “the wrong staff to run an investment
bank.”
In addition, the reformers within LTCB (regarded as the internationalists)
faced considerable resistance to changing the bank. Tett
captures the constitution of the domestic wing of LTCB: “The
other was the ‘domestic’ tribe, or men who had
forged their whole career inside Japan, making loans to Japanese
corporations in the traditional way – over endless
cups of green tea, building complex relationships of trust,
recording it all on piles of handwritten paper, and occasionally
skirmishing with the yakuza, Japan’s ubiquitous groups
of gangsters.” The domestic tribe was initially successful
in blocking meaningful reform. However, during the mid-1980s
the landscape changed and with Japan’s economic boom
the bank made advances into the world of investment banking.
At the same time, LTCB got into the real estate market, a
development that was to prove its undoing. When the bubble
burst in the early 1990s, LTCB struggled with an ever-rising
amount of bad loans. Finally in 1998, the bank was nationalized
by the Japanese government.
The rest of Tett’s book focuses on the adventures of
the Ripplewood Group, lead by Timothy Collins, who had a
vision that the Japanese bank could be turned around if Western
management was implemented. Although the Japanese government
was to allow the foreign firm (which enlisted the help of
the U.S. government, Vernon Jordan and Paul Volker) to assume
control of Shinsei (the new name), the saga that followed
was one of a substantial cultural clash on many levels. Shinsei,
though led by Masamoto Yashiro, was soon regarded as not
behaving as Japanese as it refused to supply new loans to
dead-beat companies and instead preferred to put the bad
loans (as under its agreement with the government) back to
the government. Although this created all kinds of tensions
with the government, Shinsei eventually showed a profit and
a cleaner balance sheet than many of its Japanese rivals.
Tett has produced a well-written, easy-to-understand book,
dealing with a major international issue – Japan’s
bad loan problem. The final message is that the solution
is going to be a painful adjustment in which Japanese banks
find a way to assimilate some of the harsh lessons of Anglo-Saxon
capitalism, while maintaining some of the traditional Japanese
ways of allowing face and form. Change must come. The parable
of Shinsei is that the bank “had only succeeded in
cleaning up its bad loan book because it had a clear sense
of leadership. Moreover, this leadership was willing to endure
bitter controversy and short-term pain – and squarely
face up the problem.” To this she adds: “Thus
far, however, these qualities were still in woefully short
supply in Japan…”
What is at stake in all of this is the future of Japan. As
Shinsei’s CEO Yashiro proclaimed:
"If we don’t change here in Japan, we will just
keep slowly declining as a nation. We have to change our
ways
of thinking if we want a better future. By avoiding shorter-term
pain we just keep creating a longer-term cost. The way we
have been dealing with the problems of the last ten years
in this country will lead to a continuous decline of this
country, not only economically but also politically."
Clearly these are major concerns for Japan in the 21st century.
For anyone interested in Japan, Tett’s book is a must-read.
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2003 KWR
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