Manage Financial Flow

7.1 In 1998 and 1999 the U.S.  Federal Reserve is likely to raise its interest rate because of the following reasons.  Thus far, several economic data demonstrate that the U.S. economy is nearing the peak of its business cycle.  For instance, the unemployment rate dipped to the lowest level in two decades.  Elevating interest rates will certainly serve as a preemptive measure against inflation.  Even though it has been argued that various U.S. industrial sectors have already achieved considerable restructuring benefiting from advancement of technology, records in the past rarely indicate that incremental worker productivity outstripped inflationary pressure for a long period of time.  It is the pace of inflation, instead, that tends to persist if not subdued at its earliest.  Once the U.S. starts to hike its interest rate, the Asian financial crisis will deteriorate as the U.S. now serves as a vital export market for most emerging Asian countries.  Worse yet, higher interest rates will accelerate recycling of funds back to the U.S.

7.2 What is more threatening is the shifting of capital flows towards Europe mainly due to currency unification in 1999.  Under the new tightly linked Euro currency system, European business entities will receive better credit rating from international capital markets owing to firm currency commitments of credible monetary authorities, such as the Bundesbank and the newly established European Central Bank, regarding minimal exchange risks and sustainability of Euro.  Moreover, given that European corporate are inclined to hinge more upon commercial banks’ funding than their American rivals who typically lean towards debentures and securities issuances, international financial institutions will be tempted to feed more funds to European corporate than those elsewhere.  Unsurprisingly, the IMF believes that Middle East and Europe will represent the only continent which receives more net private capital inflows in 1998 (Table 3.)

7.3 Asia, in contrast, is suffering the loss of investor confidence after the financial crisis in 1997.  Its total net private capital inflows plunged from US$ 102.2 billion in 1996 to US$ 38.5 billion in 1997 and only US$ 1.5 billion in 1998.  Such drop was largely attributed to short-term net outflows, while sizable net portfolio outflows were also distressing.  The situation in 1998 is like the converse of 1996 except foreign direct investment which remains firm, reflecting promising long-term prospects as viewed by foreign direct investors.

7.4 Another factor which may aggravate the Asian balance sheet is that the Euro currency unification requires stringent fiscal and monetary policies on the part of 11 participating member governments.  Therefore, higher interest rates are expected in Europe, attracting or retrieving funds from Asia.  Meanwhile, in the midst of bleak status, the suffering Asian economies are not expected to raise their interest rates further, so they can hardly count upon interest rate differentials as a means to capture foreign capital.  Instead, they have to improve their economic fundamentals to a satisfactory and sustainable level; otherwise foreign investors can readily shift their funds elsewhere.

7.5 One notable feature in 1998 and 1999 is that the East Asian countries which are hard hit by the financial turmoil–Thailand, Indonesia, and Korea–will score current account surpluses as a result of imports declining more than exports.  What is questionable is whether these surpluses are adequate to compensate for net capital outflows.  If not, the consequential balance-of-payments deficits will exacerbate the prevailing financial distress as well as declining investor confidence.