EuropeanApr 2 2012

Can past crises help Europe?

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The European sovereign debt crisis has already lasted almost two years following the first bailout of Greece in May 2010.

In view of that, what lessons can be learned from other sovereign debt crises in Asia and Latin America and how the countries affected have returned to growth?

The Asian crisis started with a currency crisis in Thailand in May 1997, which then spread to the Philippines, Indonesia, Hong Kong, Malaysia and South Korea, and ended in a more general banking and sovereign debt crisis. The eurozone crisis, by contrast, began as a sovereign debt crisis in Greece, spread to the banking sector and ended up as a crisis of the single currency.

In their paper ‘The Asian Financial Crisis and the Role of the IMF’, Elaine Hutson, a lecturer at University College Dublin, and Colm Kearney, a professor at Trinity College Dublin, note: “The real economies of Hong Kong SAR, Indonesia, Malaysia, the Philippines, Singapore, South Korea and Thailand collectively turned around from an average growth rate of 6.8 per cent in 1996 to 5.1 in 1997 to minus 4.4 per cent in 1998.”

Frances Hudson, investment director, global thematic strategist, multi-asset investing at SLI, says: “If you look in terms of the current account balance as a percentage of nominal GDP, what was happening in Asia in 1996 and Europe in 2008 is that Thailand was effectively what Greece is now.

“Thailand had a current account balance of minus 8 per cent, Malaysia was at minus 6 per cent, Indonesia was at minus 3.5 per cent and South Korea was at minus 3 per cent. If you look at the eurozone you’ve got Portugal at minus 12 per cent, Greece at minus 15 per cent and Spain at minus 10 per cent, so there are definitely similarities in the pattern.”

Policy responses

However, she points out one of the biggest differences has been the policy responses, partly because the Asian countries had their own currencies. The currency crisis in Thailand was catalysed by the fact that the Thai currency was pegged to the dollar, but it was theoretically easier for Thailand to escape the peg than for individual countries to leave the euro.

“One of the things that they were able to do pretty well immediately was close things down. They instituted capital controls to give themselves time to put their houses in order. The IMF came in and said strict austerity and so on, and the difference between Asia and Europe is that Asia did it.”

In addition, Ms Hudson says government debt as a percentage of GDP wasn’t as bad in Asia as it is in Europe. For example Thailand’s debt to GDP ratio rose from less than 20 per cent to almost 60 per cent in 1999, which more or less persisted until 2003. By 2007, it had decreased to less than 40 per cent.

In comparison, Greece started with debt of slightly less than 100 per cent of GDP and is currently at approximately 140 per cent.

Ms Hudson argues: “If a very flexible economy like Thailand took several years for that to work itself out, then, if you think about a country like Greece where flexible is not one of the things you would describe it as, it’s going to be, in all likelihood, more protracted.”

Negative sentiment about emerging markets during the Asian crisis also had a knock-on effect on Latin America, providing a second point of comparison with the euro today. The ‘tequila crisis’ of 1994-95, which led to Mexico abandoning its currency’s peg to the dollar, combined with a knock-on effect from the Asian crisis, with investors less favourable to emerging markets, meant a prolonged period of recession in Argentina and ultimately led to the ‘convertibility crisis’ where it too abandoned the peg to the dollar and the country effectively defaulted.

Ms Hudson points out that in relation to Latin America, the default of Argentina was partly a knock on from crises elsewhere, including the Asian crisis and Russia’s default in 1998, but that there had already been attempts to reduce the debt in the region with the introduction of ‘Brady bonds’ in the 1980s, or dollar denominated debt with US Treasury zero-coupon bonds as collateral, with maturities of up to 30 years.

“Whereas if you look at Europe, what’s happened is that there is a three-year long-term refinancing operation, which perhaps doesn’t give them time to work it out given that in Asia it took more than three years to get back on an even keel,” she adds.

“So maybe Europe as a bloc hasn’t done enough longer-term thinking. It’s very reactive but also it’s reactive without considering how long things might take to work, so the chances of a policy error are huge, because you could still be going one way when things have actually started to turn but you don’t know about it.”

Adjustment

Ted Scott, director of global strategy at F&C, suggests there are also lessons to be learnt in terms of what it means to default, using Argentina as an example.

“Argentina is in some ways similar to Greece and other peripheral countries, in that it was pegged to the dollar and eventually had to remove that peg and default. The lesson from that is that initially it is a very difficult period of adjustment.

“You get a big devaluation in the new currency that tends to lead to higher inflation, you get a loss of confidence in the economy and there’s a risk you might be shunned in financial markets and that would make it more difficult for the government to raise debt in international bond markets as well.

“But the more medium and long-term lesson is that after that initial difficult period of adjustment it can actually benefit the country. Argentina did return to growth reasonably quickly.”

According to Mr Scott, one thing eurozone politicians fear is that if Greece did leave the eurozone and default on its debts, after a difficult period of adjustment like Argentina it might actually prosper quite well, which would be a lesson for other countries in the eurozone which are having problems like Portugal and Spain.

He adds: “They might say well Greece has defaulted and is actually benefiting from being out of the eurozone rather than being tied into this overvalued currency, so we might as well leave.

“They don’t want to create that precedent, but the lesson is that by defaulting it can actually benefit the country as well.”

Nyree Stewart is deputy features editor at Investment Adviser