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Paris, Tuesday, September 26, 2000

Asian Economies Should Ride Out the Fuel Price Storm

By Philip Bowring International Herald Tribune
HONG KONG - The strong dollar and high oil price are creating neurosis in weak currency countries. This could be more damaging to the global economy than the reality of energy and currency prices.

In Asia there is loose talk that currencies falling sharply against the dollar could provoke another crisis, or at least an oil-caused stall in economic recovery. Europeans are fretting that a weak euro is a sign of institutional failure, forgetting that they are not alone in seeing their currency on the skids against the dollar, and that the euro is still far from plumbing the depths reached by the Deutsche mark during the 1985 dollar bull run.

Drawing the wrong conclusions about the causes of what is happening will surely lead to the wrong responses. In fact the almost universal strength of the dollar is at least in part explained by the oil price itself, as well as by the surge in global trade. Oil trade is entirely dollar-denominated and about half of trade generally is conducted in dollars so there has been a big increase in demand for dollars. This is independent of considerations of whether the U.S. currency is a good long term investment, given that the U.S. current account deficit is heading for 5 percent of gross domestic product, or whether U.S. technology is worth the prices Europeans have been paying during their trans-Atlantic corporate buying binge.

Oil prices will only seriously hurt Asia if policy makers are stampeded by the strong dollar into interest rate hikes and fiscal caution to stabilize local currencies and counter oil-based inflation. Benign neglect of currency values is the wisest choice right now.

Export growth will slow as global growth subsides, but as almost every country in Asia has a very large current account surplus the impact of oil on the balance of payments will simply be to slow the accumulation of reserves or the repayment of dollar debts.

China produces most of its energy needs, so the oil price rise will have only a slight effect. South Korea is very dependent on oil imports, as is Taiwan, but both have very strong trading positions. The recovery of domestic demand in South Korea has been so strong that the dampening impact of the oil price might even be beneficial. Significantly, the Korean won has been following the yen and remaining roughly stable against the dollar while others have been in retreat.

Thailand is more problematic. A falling baht has weakened corporate balance sheets and slower global growth will hurt exports, the main driver of recovery. However, the central bank has so far been determined to keep interest rates low and not try to hold the baht at any particular level against the dollar. Reserves are high and some capital controls in place, so another baht crisis is improbable. There is a reasonable hope that strong exports and a falling currency will more than offset higher oil prices and push up money growth and consumer demand.

As for inflation, that is the last of Thailand's worries, as it is of most countries in the region. Domestic inflationary pressures are nonexistent. The return of modest inflation of 2 percent to 3 percent, resulting from oil prices and currency declines, should benefit economies bogged down by the deflationary psychology of the post-crisis period.

Most of East Asia and Southeast Asia needs some inflation to spur consumer demand, reduce real interest rates and spark a revival in asset prices, which would ease banking sector problems and reduce the real cost of bank rescues funded by government borrowing. Even Japan may find that despite the firm yen, the oil price rise will help reverse the asset price deflation that is at the root of its problems.

Meanwhile the firm yen is on balance a help to the rest of Asia. The economies still pegged to the dollar, China and Hong Kong, are not suffering so badly from currency strength, and the weaker economies of Southeast Asia are seeing their competitive positions improve vis--vis stronger economies to the north.

The overall situation is indeed the reverse of that which helped generate the 1997 crisis, when the yen was weak and the other currencies were pegged at overvalued rates to a strong dollar. What the region still needs is stronger domestic demand which means keeping monetary and fiscal policy loose regardless of oil and dollar values.

Provided it does not forget the lessons of 1997, or follow Japan's catastrophic fiscal tightening in 1997, Asia should be able to take in its stride a period of expensive oil and a strong dollar. Meanwhile the oil price is a blessing for the one Asian country most in need of a change in its luck - Indonesia.