1

The East Asian Crisis and its Implications for India

Joseph E. Stiglitz

Senior Vice President and Chief Economist,

Development Economics

The World Bank

May 19, 1998

2

Outline of the Talk

1. Introduction: India in Context

2. The East Asian Crisis

3. Financial Systems and Growth

4. Responding to International Capital Flows

3

Progress in India

0

1000

2000

3000

4000

5000

6000

7000

1960 1966 1972 1978 1984 1990 1996

GN

P p

er c

apit

a (c

onst

ant

Rp

s)

1960 1996GNP percapita(Constant Rps)

2,715 5,892

LifeExpectancy

45(1962)

63

Under-5Mortality(per 1000 births)

242 85

PrimarySchoolEnrollment(% of gross)

61 100

Access to safewater (% of pop)

17(1970)

81(1994)

SOURCE: World Development Indicators 1998

4

Kerala vs. India

Kerala India

Female74.4 59.4

Life Expectancy atBirth, 1990-2.

Male68.8 59

Total Fertility Rate, 19911.8 3.6

Death Rate for 0-4 age group, 19914.3 26.5

Female98 52

Rural LiteracyRate in 10-14 agegroup Male

98 73

SOURCE: Dreze and Sen (1995).

5

Growth with Equity

In 88 growth spells:

•77 benefit the poorest fifth of the population

•changes in inequality were modest (roughly half small positive and half small negative).

Savings rates are uncorrelated with income or inequality. -50

-40

-30

-20

-10

0

10

20

30

40

50

60

0 20 40 60 80 100

Gini Index (c.1992)

Gro

ss d

omes

tic

savi

ngs

(% o

f GD

P, 1

992)

SOURCE: World Development Indicators 1998

6

Figure 1

Periods During Which Output per Person Doubled

0 10 20 30 40 50 60 70

United Kingdom, 1780-1838

United States, 1839-86

India, 1960-95

Japan, 1885-1919

Turkey, 1857-77

Brazil, 1961-79

S. Korea, 1966-77

China, 1977-87

Years

SOURCE: World Development Report 1991 and calculations from World Development Indicators 1998.

7

Figure 2

Per-capita Income:Korea vs. India

0

2,000

4,000

6,000

8,000

10,000

12,000

1956 1966 1976 1986 1996

PP

P-A

dju

sted

US$

, 199

6

India Korea

SOURCE: Penn World Tables, WDI 1998, and author’s calculations

8

Fis

cal C

osts

of

Sel

ecte

d B

ank

ing

Cri

ses

(per

cen

tage

of

GD

P)

Cou

ntry

(D

ate)

Cos

t (p

erce

ntag

e of

GD

P)

Arg

entin

a (1

980-

82)

55.3

Chi

le (

1981

-83)

41.2

Uru

guay

(19

81-8

4)31

.2Is

real

(19

77-8

3)30

.0C

ote

d’Iv

oire

(19

88-9

1)25

.0S

eneg

al (

1988

-91)

17.0

S

pain

(19

77-8

5)16

.8B

ulga

ria

(199

0s)

14.0

Mex

ico

(199

5)13

.5H

unga

ry (

1991

-95)

10.0

Fin

land

(19

91-9

3)8.

0S

wed

en (

1991

)6.

4S

ri L

anka

(19

89-9

3)5.

0M

alay

sia

(198

5-88

)4.

7N

orw

ay (

1987

-89)

4.0

Uni

ted

Sta

tes

(198

4-91

)3.

2

Sou

rce:

Cap

rio

and

Kli

ngeb

iel 1

996.

9

Figure 3

GDP Growth Before and After Banking Crises, 1975-1994

0

0.5

1

1.5

2

2.5

3

3.5

OECD crisis countries Non-OECD crisiscountries

Non-crisis countries

Five years before crisis

Five years after crisis

Mea

n G

DP

gro

wth

(an

nual

per

cent

)

SOURCE: Caprio 1997

10

Key Aspects of the East Asian Crisis

1. Not public sector profligacy, but private sector borrowing.

2. Not overall indebtedness, but the type of borrowing and use of funds.

3. Not just borrowers, but also lenders.

11

Figure 4

Public Sector Balances: Latin America versus East Asia

-6

-5

-4

-3

-2

-1

0

1

2

3

Arg

enti

na

Bra

zil

Ch

ile

Co

lom

bia

Ve

ne

zuel

a

Ind

on

esia

Ko

rea

, R

ep.

Ma

lay

sia

Ph

ilip

pin

es

Th

ail

an

d

Latin America (1982) East Asia (1996)

Percent of GDP

SOURCE: World Development Indicators, 1998

12

Figure 5

Inflation: Latin America versus East Asia

0

100

200

300

400

500

600

1980 1982 1984 1986 1988 1990 1992 1994 1996

Latin America

East Asia

Average inflation (GDP deflator)

SOURCE: author’s calculations based on World Development Report 1998

13

Figure 6

Total External Debt-Exports Ratio in 1996

0

50

100

150

200

250

300

EAPECA

LACM

NASAS

SSAIn

dia

Indo

nesia

Mala

ysia

Philip

pines

Thaila

nd

Percent

SOURCE: Global Development Finance 1998

14

Figure 7

Office Vacancy Rates, 1996(% of space vacant)

-1

4

9

14

19

24

Bangkok Jakarta Kuala Lumpur Manila Hong Kong Tokyo

SOURCE: JP Morgan Data and Estimates

1996

1997-99 (projected)

15

Figure 8

Short-term Debt-Exports Ratio in 1996

0

20

40

60

Arg

ent

ina

Bra

zil

Me

xico

Ind

on

esia

Th

aila

nd

Ph

ilipp

ine

s

Ko

rea

Ma

lays

ia

Percent

SOURCE: BIS, World Development Indicators 1998, and author’s calculations.

16

Figure 9

Non-Performing Loans (as a % of total loans)

0

5

10

15

20

Uni

ted

Sta

tes

Indo

nesi

a

Tha

ilan

d

Mal

aysi

a

Phi

lippi

nes

Percent

17

Table 4

Foreign Currency Debt Ratings

Country

June

1996

June

1997

March

1998

Indonesia BBB BBB B

Korea AA- AA- BB+

Malaysia A+ A+ A+

Philippines BB BB+ BB+

Thailand A A BBB-

SOURCE: Standard and Poor’s

18

Importance of Financial Markets

Collecting and aggregating savings

Brain of the Economy:Allocating capital, selecting investment projectsMonitoring

Other Functions:Reducing riskIncreasing liquidityConveying information

19

Figure 10

Average Growth in Selected Countries, 1976-1993

0

0.5

1

1.5

2

2.5

3

3.5

Low High Low High

Ave

rage

Gro

wth

Initial Conditions

Stock Market Liquidity Financial Depth

Calculations by Ross Levine, World Bank

20

Why the Financial Sector is Different

• Financial sectors are essentially concerned with information

• General Theorem: Whenever information is imperfect, markets are not constrained Pareto optimal

• Two Information Problems:•Selection•Monitoring

• Information is Like a Public GoodFree rider problems

21

Principles of Reform

1. Rules contracts, bankruptcy, disclosure. protections for shareholders in securities

2. Information

3. Regulation ensuring safety and soundness promoting competition consumer protection promoting access to underserved groups

4. Incentives eg. enhance franchise value in banks

22

Development Banks

The Role of Development BanksLong-term lendingProjects private sector would not supply

Past failuresPolitical lending decisionsUnprofessional management

Looking to the futureCorporatizationMarket’s new lending demands (e.g. infrastructure)

Market’s new instruments demands:guaranteessecuritiesratings

23

Figure 11

Long-term Capital Flows to Developing Countries

0

50

100

150

200

250

300

1980 1985 1990 1995

Bil

lion

s of

US

$

PrivateOfficial

1997

SOURCE: Global Development Finance 1998

24

Figure 12

Private Capital Flows to India

0

1

2

3

4

5

6

7

8

1980 1996

Bil

lion

s of

US

$

Private debtPortfolioFDI

SOURCE: Global Development Finance 1998

25

Evidence on Capital Account Liberalization

• Increases risks

• No discernable benefit for growth or investment

• Short-term flows: volatilitycosts of sterilization

26

Figure 13

Economic Growth, Investment, and Capital Account Liberalization

-8

-6

-4

-2

0

2

4

6

8

-1 -0.5 0 0.5 1 1.5

Degree of Capital Account Liberalization

GD

P G

row

th 1

978-

1989

-15

-10

-5

0

5

10

15

-1 -0.5 0 0.5 1 1.5

Degree of Capital Account Liberalization

Inve

stm

ent/

GD

P 1

978-

1989

SOURCE: Dani Rodrik (forthcoming). These are the residual growth and investment/GDP that are not explained by per-capita income, secondary education, quality of government institutions, and regional dummies for East Asia, Latin America and Caribbean, and Sub-Saharan Africa.

27

Policies to Reduce Vulnerability to Capital Volatility

• Traditional policies:Good macroeconomic management.Sound financial regulation and oversight.Transparency.

• Policies to affect composition of capital flows

Eliminate distortions favoring short-term flows.Prudential regulations to restrict currency exposure.Possibly inhibitions on short-term flows (Chile).

28

Managing Crises

• Expected return = promised return X probability of repayment.

• Additional considerations: Risk adjustment. Insiders vs. outsiders. Adverse selection and credit rationing. General equilibrium credit crunch.