Proceedings of the Standing Senate Committee on
Issue 3 - Evidence
OTTAWA, Wednesday, November 5, 1997
The Standing Senate Committee on Foreign Affairs met this day at 4:45 p.m. to
examine and report on the growing importance of the Asia-Pacific region for
Canada (recent disruptions in currency and stock markets in Asia).
Senator John B. Stewart (Chairman) in the Chair.
The Chairman: Honourable Senators, I call the meeting to order.
Please proceed, Mr. Rayfuse.
Mr. Bruce Rayfuse, Acting Director, International Finance and Economic Analysis
Division, Department of Finance: I was asked to provide a brief chronology of
events. I will attempt to do that, glossing over many of the specific events. I
will give you a general idea of what happened, with the proviso of course that
events are continuing to evolve as is the interpretation of the events.
The current period of instability originated in Thailand wherein, during the
decade up to about 1993, the Thailand authorities had established a record of
sound macro economic management that had paid off for them in near double-digit
growth rates. One element of this macro economic package was the exchange rate
regime. Thailand was operating with a pegged exchange rate regime whereby the
baht was pegged or tied to a basket of currencies whose weights in the basket
were secret but, empirically, observers were able to determine that the U.S.
dollar accounted for about 85 per cent of this weight. In effect, the Thailand
baht was tied to the U.S. dollar.
From the mid-1980s to the early 1990s, that exchange rate regime was a major
contributor to Thailand's growth performance. For most of the period after
1985, the American dollar was falling against the Japanese yen, ergo the baht
was falling against the Japanese yen and Thailand became a very attractive
sight for Japanese investment. Thailand was caught up in a near explosion of
investment in emerging market economies. This reflected a number of factors; low
interest rates in industrialized countries which led people to search for
higher yields elsewhere; high stock market values in industrialized countries
which led to a quest for portfolio diversification and so on; and technological
factors such as developments in computer aided investment technology and so on.
This was the situation up to about 1993.
Beginning in about 1993 or shortly after, imbalances begin to appear in the
Thailand economy. Growth and demand were excessive. We began to see a rise in
inflation pressures and a growing current account deficit. Moreover, some of
the growth was unbalanced in the sense that these massive capital flows tended
to be intermediated by the banking system which was, in retrospect one could
say, too loosely regulated or supervised so that much of this money ended up
being invested in the real estate sector, so there was a real estate boom in
Bangkok in particular.
As well, with the fixed exchange rate system, much of the borrowing that went on
was unhedged. People borrowed in U.S. dollars. Their revenue streams were in
baht. People were not too concerned about that. They believed in the government
guarantee of, in effect, a fixed exchange rate.
The Thailand authorities did recognize the problem with demand pressures and
moved with a tightening monetary policy in 1995-96 to try to reign them in.
However, when you are operating with a fixed exchange rate, attempting to
change monetary policy or to reign in inflation pressures with monetary
policies is problematical. It involved of course a rise in interest rates that
served to attract even more capital, particularly short-term capital which, as
you probably know -- and it certainly seemed to be the case in Mexico -- is
particularly volatile and subject to reversal.
As well, the rise in interest rates created problems in the real estate sector
which then translated into problems for the banking sector.
In 1995-96, the economy was subject to a number of external shocks. I mentioned
earlier how the Thailand economy had benefited from a falling dollar against
the yen. That situation reversed in the spring of 1995 and the dollar and the
baht began to rise against the yen. As well there was a slow down in the market
for some of Thailand's export products such as microprocessors and so on.
The vulnerabilities were becoming increasingly apparent to market participants,
and as a result, from July 1996 on, there was a series of speculative attacks
against the baht which the Thailand authorities managed to hold off until July
2 of this year when the baht was floated and, within a few days of the float,
the baht fell 20 per cent.
The Thailand authorities' problems were not over with the decision to float the
baht. They still had need of money to help the financial sector because many
people had borrowed in dollars and their revenues were in baht, so when the
baht fell against the dollar, all of a sudden there was a massive deterioration
in their balance sheets. Their debts, in effect, increased.
The Thailand authorities initially approached the Japanese banks for assistance,
since they are the largest investors in the area. They were told that, to be
eligible for assistance from Japan, they would first have to get an IMF
package. Therefore, in late July, early August they approached the IMF and on
August 20 an IMF package was agreed to.
I refer to it as an IMF package, but in fact it involves a number of actors,
including the World Bank, the Asian Development Bank and eight regional
economies. The package comes to about $17.2 billion and is to be used to bring
Thailand's international reserves up to the levels targeted in the IMF
agreement, and to assist in the restructuring of the Thailand financial sector.
In return for receiving the package, Thailand authorities agreed to a financial
restructuring package or agreed to do a restructuring of their financial sector
which began with a closing of 58 of 91 finance companies which were then
operating in Thailand. These were near bank institutions who would raise money
in capital markets, including international capital markets, and lend in
Thailand. Much of this lending was in the property sector. That was the weakest
part of the Thailand financial sector.
In addition, as part of this IMF package, the Thailand authorities agreed to
fiscal restraint measures to raise national savings and help to reduce the
current account deficit. As well they agreed to continue with a floating
exchange rate policy and to monetary restraint.
The implementation of the package depends on the Thailand authorities. So far,
the record is mixed in part because of the political instability in Thailand.
The Thailand authorities are now on their third finance minister in the last 10
months. Only the day before yesterday the Thailand Prime Minister announced he
was resigning. Elections are due early next year, so the near-term prognosis for
the Thailand authorities carrying out all of the reforms mandated is somewhat
mixed, although IMF Managing Director Michel Camdessus has expressed confidence
and has said that the program so far is on track. The IMF will be revisiting
the program. Under the terms of the program it will be reviewed quarterly, so
it will be reviewed later this month.
What has made this crisis more than a national concern is the fact that it has
spread throughout the Southeast Asian region. Contagion in these instances
generally works through two channels.
One is a trade linkages channel. These countries are major trading partners with
each other and competitors with each other, so a drop in income in one country,
an exchange rate change, will naturally affect the economic prospects of the
other countries, in this case less favourably so.
As well, there tends to be in these instances a macro economic similarity effect
where investors take a look at the Thailand economy, which has suffered this
shock, and then they look at other economies that seem to be in a similar
position, for example, with large current account deficits, strong investment
property, and they think to themselves, "Is this guy next?" They then
begin to pull out of economies that exhibit those characteristics.
Both of those channels appear to be operating in this case. Very quickly after
the Thailand float, other currencies in the region came under downward
pressures. The Philippine peso was among the first, and the Philippines very
quickly sought aid from the IMF, and were granted it.
Other countries attempted a number of measures to maintain their managed
exchange rate regimes to no avail.
Now, with the exception of the Hong Kong dollar, all the currencies in the
region are floating. All are down. The big four in terms of currency
depreciation are Thailand, Indonesia, Malaysia and Philippines. Thailand is
down almost 40 per cent, and the others are down about 25 per cent since July
The Indonesian currency came under particular pressure in October for reasons
that are not terribly well understood. In many respects, Indonesia appeared to
be the economy that was in the best shape in terms of having the smallest
current account deficit, the largest supply of international reserves, and so
on. In any event, they approached the IMF for a package and, on October 30,
agreement was reached, although the package is to be submitted to the IMF
executive board today. The package again is a multi-part package with
participation from the IMF, the World Bank, the Asian Development Bank in the
first line of defence, and then a number of countries, mostly Asian, but
including the United States, participating in the second line of defence. In
other words, they have not put money up yet, but they have indicated that
should the need arise, they would be prepared to help out.
I will stop there and deal with questions.
Mr. Subodh Kumar, Managing Director, Securities, CIBC Wood Gundy: From our point
of view, which is a markets perspective, I would like to give you some feedback
on how we see the markets.
Overall we do not think that the Southeast Asian crisis per se is a major factor
for the equity or bond markets, or the currency markets for that matter.
Currency markets trade about $1.2 trillion a day. To put that in perspective,
that is the equivalent of two times the GDP of Canada per day, trading in the
global currency markets. Therefore, the maintenance of confidence is very
important in the markets. People are constantly looking to find the weak links
in the market so they can exploit them.
If we summarize what has been taking place in Asia and what the implications for
Canada and other countries will be, basically the markets or the participants
in the markets went for those countries first where the political and economic
structures were the weakest. For example, consider Thailand, and to some extent
Indonesia and Malaysia, where the checks and balances are weak in terms of
politics and economics, and the interlinkages between the two. For example, in
Thailand you have extensive business ownership within government. Therefore,
there are competing interests within by politicians. Where it existed, the
markets exploited that weakness.
Investors then went on to try to exploit weakness in Latin America. It did not
work to the same extent. The final piece of the puzzle was that people thought
that there was weakness to be exploited in Hong Kong, but Hong Kong, having a
comparatively strong financial system, responded in a traditional way which was
to maintain their exchange rate, and make it very expensive to speculate by
raising interest rates. In fact, Hong Kong has ended up with lower interest
rates, although they are not yet to pre-crisis levels, and their reserves are
back to where they were before this crisis started.
This is a crisis in specific countries in Southeast Asia. Northern Asia, which
includes China and Taiwan, is in fairly good shape.
We must also consider whether the focus on Asia is shifting to the bigger
countries, that is to say, what happens to growth rates in India, China and
Japan is key now, as opposed to Southeast Asia which has been the focus of much
attention because it is growing fast. There is also a change of political
dynamics going on in Asia which will effect the economies of the region. The
economies of those larger countries I mentioned are in good shape and their
influence should increase.
The Canadian markets and the U.S. markets are looking for better balance. The
better balance is that stock and bond markets have been volatile throughout
most of this summer and a lot of good news is already incorporated in the
markets, so when there is some sign of uncertainty, for example this situation
in Southeast Asia, markets have reacted quite violently. However, that is more a
function of how much good news was already in the markets as opposed to
Southeast Asia having a substantial effect on the overall markets in North
There is uncertainty about Southeast Asia, but their GNP is about $600 billion.
That compares to Latin America of $1.5 trillion. Therefore, proportionally,
this is a much smaller crisis than was the Latin American crisis two years ago.
The rate of increase in interest rates in recent months has been much less in
the developed countries than was the case pre-Latin American crisis of 1994-95.
In 1994 during the Latin American crisis, the U.S. was the only major economy
that was in recovery. Currently, the European recovery is in shape but Japan is
a little vulnerable. However, overall, I think that strong growth in North
America, recovery in Europe and some bottoming out in Japan will more than
offset weakness in Southeast Asia. That is assuming that the Chinese and the
Indians maintain fairly good economies in Asia, and the Latin American
economies remain in good shape. Overall, we have seen increased volatility in
the markets, but this is not something to be particularly worried about. The
Southeast Asian countries will have trouble getting new investment for some time
but, from a global investment perspective, we do not think it is a major
Ms Laurette Gauthier Glasgow, Director, International Economic Relations,
Department of Foreign Affairs and International Trade: I would like to focus on
a broader question which is: How does the international economic financial
monetary system respond to this sort of situation? Do we have the tools in
place to deal with such a crisis? I agree with the comments made to date and I
recognize that we must put this particular crisis in some context.
Southeast Asia has been experiencing unprecedented economic growth. At
conferences we talk to representatives of other countries about how to do it
right, yet their growth rates are twice our growth rates. We certainly have
some things to learn from them. The growth rate in that region has been
The current situation is nowhere near as severe as what occurred in Mexico in
1994-95 and it does not present a deterioration in the region's fundamental
longer term growth prospects. Growth in the region will continue in spite of
In addressing the main point of whether the international system is equipped to
handle this sort of situation, I would refer to the 1995 G-7 Summit in Halifax
where the Prime Minister launched major initiatives and major reforms to revamp
the capacity of the international system to prevent crises through improved
diagnostic tools, better surveillance, and, where prevention fails, to improve
the financing sources and the mechanisms so that they can move in very quickly.
Compared to the Mexican situation, we have seen a prompt and adequate reply to
the needs by the international system. Progress has been made as a result of
the reforms launched in Halifax, and there is further work underway through the
International Monetary Fund and the World Bank.
At the annual meeting held in September of this year in Hong Kong, agreement was
reached on an increase in the IMF quota and special drawing rights. There was
also consolidation of the new arrangements to borrow. There is more work
underway in another area which is improving and strengthening financial systems
internationally, as well as within countries. That is where the main challenge
remains. There must also be prudential supervision, particularly in emerging
If the international system is up to the challenge, why do we still have crises?
Do we have the right diagnostic tools? Diagnosis was not a problem in this
instance. This crisis was foreseen. You could have read about it in The
Economist or The Financial Times. There were clear warnings in the
International Monetary Fund's Economic Outlook last year which is a public
Was the problem timely policy advice about what steps to take to deal with it?
Again, the IMF certainly provided timely advice in all of these situations,
particularly in Thailand, including the need to move to flexible exchange
Was the problem speculators? That may have aggravated some of the volatility in
the market. Of course, one person's loss is somebody else's gain in the market.
Was the problem, then, something more fundamental, that is, whether or not some
of the existing policies were no longer sustainable? Good advice is only as
good as those who are willing to take it.
There is a clear need to strengthen the financial sectors in this region and to
implement and enforce prudential surveillance of regulatory arrangements. It is
important to increase the transparency of the kinds of economic and financial
policies that exist in these economies, and to address some of the corruption
Does the international system need bolstering? The best system in the world can
always be improved upon. Our sense is that the Asian crisis has been a good
test of the system's ability to respond promptly and effectively, but
improvements are always possible. I am sure you have read the various ideas
that have surfaced. Some say that the IMF should issue public warnings. Perhaps,
if the advice is public, it will compel those who are receiving it to heed the
Sovereign nations want to retain their sovereignty. They do not want to
participate in compulsory programs unless they receive money in exchange for
their participation. That is how the word "conditionality" is applied
at the IMF. There is a trade-off between publicity and candour. Therefore, it
is not clear that that is the best approach.
Some believe that we need to increase the economic and monetary cooperation in
the region and worldwide. That is something the G-7 countries currently strive
for currently. Others believe that the IMF's capacity must be strengthened to
respond to crises. The question is: How can we provide technical assistance and
advice to assist some of these countries to develop the institutions that they
need and to strengthen their existing financial institutions? That is not always
There has been a lot of discussion about whether you need a separate fund. Is
the IMF enough? Should we have an Asian monetary fund? There is no clear,
unique proposal before us. Those of you who read The Globe and Mail this
morning read about the "moral hazard". Clearly, if every country will
be bailed out of every situation that may not encourage countries to put in
place the right kinds of policies or to change their policies as quickly as
they might. We want to avoid that. That is why we continue to believe that the
International Monetary Fund remains, and should remain, the principal
international authority to provide that kind of advice and to assist countries
in making those adjustments.
Finally, this is the year of Asia-Pacific in Canada. We will be hosting the APEC
leaders' meeting towards the end of November and that agenda is currently being
sketched out. Trade and investment facilitation and liberalization is very much
part of the agenda, as are major initiatives on infrastructure. However, it is
clear that leaders will discuss their concerns, and several Asian leaders have
already indicated, some publicly, that they would like to discuss what is
occurring in their economies. Therefore, that may well be on the agenda,
whether the discussions are formal or informal. However, this is a good
opportunity to be able to discuss the importance of putting in place some macro
economic policies, and of having in place solid financial systems and
institutions to be sure they do not close their borders to investment. It may
not be the countries with whom we have the highest export potential who might
close their borders to our goods and services and our investment, but we must
encourage them to deregulate their economies prudently. Those are some of the
keys of long-term sustainable economic growth.
Ms Ingrid Hall, Director General, South Asia and Southeast Asia Division,
Department of Foreign Affairs and International Trade: I will broaden the
discussion by giving you some information as to what our posts are reporting in
Asia. There are lower growth rates; a fragility in the banking sector; rising
interest rates; falling investment; sagging consumer demand resulting from
reduced purchasing power; slowing business expansion; escalating costs of
imports; and government austerity measures to raise revenue and cut spending
through the deferral of infrastructure projects. This definitely resulted in
reductions in Canadian exports in the last two quarters of this year only.
There was growth in previous quarters in many of the markets, and that is likely
to be the case next year as well.
What has not been discussed very much in the last three months is a number of
other converging issues which cloud the Asian picture temporarily for us. These
include such issues as the mismatch of infrastructure requirements with
available trained labour; underemployment and unemployment; the rapid growth of
urban populations; and the limited percentage of the population receiving
secondary and post secondary education in the newly emerging economies of East
There is also a group of newer issues that are having a negative impact on the
economies of Southeast Asia: The forest fires in Indonesia and the impact of
smog and industrial pollution have blanketed the region causing aircraft and
ship collisions, as well as the closure of airports. This has also reduced
factory output. INCO had to close down its operations for lack of water for its
turbines. There has also been devastation of the areas immediately affected by
the fires. We know that the health risks from constant exposure to the
particulants in the air runs high.
However we -- and this is a global "we" because this is a first -- do
not know what the short- and medium-term impact will be. There has already been
a very dramatic decrease in tourism to all areas of Southeast Asia impacted by
the forest fires.
The media is reporting on the consequences of El Nino. There has been an
unexpected drought in some regions, as well as unusually massive flooding in
southern Thailand, and both have had an impact in that food production,
particularly as it relates to rice, is expected to be a problem. Both China and
Indonesia will have to increase food imports significantly. Famine is occurring
in not only North Korea, but also in Eastern Indonesia. It is particularly
noticeable in Irian Jaya. Thus, for the moment, agriculture is a wild card.
There has been a growing number of demonstrations in Indonesia in the last year.
There have been demonstrations in Thailand for the last month and the current
government will step down by the end of the week. In Malaysia the situation is
quite the reverse. There have been arranged demonstrations in support of Prime
Minister Mahathir. There is a growing sense of unease amongst the populations
most affected. This is all the more so when we are entering into political
succession equations in a number of countries, Indonesia being the most
Is this what could be termed "a crisis"?Has the sky fallen in? The
answer is most definitely not. What we see is continuing growth, but at a
When we look at the six key economies of ASEAN, their GDP weight in Asia-Pacific
is less than 5 per cent. This is indeed small. The growth momentum in the area
is determined by the U.S. and Japan. That accounts for about 80 per cent of
GDP. The other developed countries, namely, ourselves, Australia and New
Zealand, have relatively good growth momentum. Japan's is questionable. We see
Southeast Asia being pulled along with the rest, especially now because of its
considerably cheaper exports.
Our current assessment is that the most serious issue in Asia may not be
directly related to Southeast Asia at all, but whether the largest economy,
Japan, will be able to emerge from its prolonged period of slow growth. We see
a period of slower growth in most Asian countries for the median term, and by
that we mean two years, with a more prolonged period, three years, in Thailand.
How will Canadian exports be affected by slowing rates of growth in Asia? We
predict, over the next two years, some stalling in exports, but growth
thereafter. However, the key factor we must bear in mind is that the huge
majority of Canadian exports go primarily to the U.S. We are talking about only
9 per cent of our exports in 1995; and 8.5 per cent in 1996.
I will now walk you through what we have seen in the last weeks in a number of
the Asian countries. The worst affected was Thailand. It is a very mixed
review. Canadian commercial ventures are likely to be reduced in size and
quantity, postponed or cancelled. This will involve, primarily, deferrals in
infrastructure projects. The Globe and Mail reported this morning on a firm in
Nova Scotia that was involved in training of offshore oil rig workers in health
hazards, fires, evacuations, helicopter crashes and other disasters which are
normally very high priority training elements. All of that training has been
At the same time, quite a number of Canadian firms are currently prospecting in
Thailand to purchase Thai firms because they see this as a likely period in
which market entry costs will be the lowest they will see for the next five to
ten years. In October, 20 Canadian firms participated in a trade mission in
Northern Thailand. They are looking for opportunities and they are finding them.
The review on Indonesia is also mixed because of the convergence of various
elements, not only the currency but the other economic factors I outlined. In
general, we do see an impact on engineering services, oil and gas and
telecommunications ventures. Canadian wheat exports may be affected by the
break up of the Indonesian wheat monopoly. That was part and parcel of the IMF
package. Mining contracts of work in which Canadian firms are dominant could
also be affected.
However, we are already seeing a change in business strategies. Firms are
telling our posts that what they are looking at now is investment in joint
ventures in the transfer of technology rather than at straight exporting.
I will now deal with some of those that are less hard hit. We have all heard
about the deferral of large projects in Malaysia. At the same time, it
continues to encourage investment, inward investment, particularly in the
multimedia super corridor. We are strong in IT and the Malaysians, at the end of
this month will come to Eastern Canada to actively cultivate these firms. We
expect that the number of Malaysian students coming to Canada, both government
sponsored and private, will decline because of higher taxes, higher visa exit
rates in Malaysia, and less money. Canadian academic institutions must
establish sites in Malaysia, and some have already started to do so.
As to the Philippines, we do not have quite as clear a fix on that situation as
Mr. Kumar seems to have on it. Our messages are mixed. It is a more difficult
read for us. Currency and stock markets are down, but Canadian exports have
increased approximately 94 per cent and we do know that there will be a
significant number of commercial signings when President Ramos visits at the end
In a number of countries there has been a minimal impact, namely, Singapore,
Brunei and Vietnam. That economy is buffeted by ODA.
Another group of countries we are starting to talk about are becoming known as "the
Asian traders", and those are the larger economies in the north, including
Japan. Exposure to losses on the Hong Kong Stock Exchange could result in some
losses to banks. We see slower domestic growth due to reduced demand for
Japanese exports in Southeast Asia. Lower profits will dampen imports. We will
see decreased export opportunities for Canadian firms, and there will be less
cooperation between Canadian and Japanese firms in Southeast Asian
infrastructure projects. At the same time, there is the concept of more secure
investment, and the possibility of diversifying investment to Canada and the
Our general view of South Korea is that its problems are huge and they are
primarily home grown. Certainly, its exports to Southeast Asia will be
affected, but its problems are primarily domestic. It is considered to be the
weakest economy among the larger Northeast Asian economies.
There has been a certain amount of discussion about Australia in the media
because, in the last seven years, there has been a dramatic increase in
Australian-Asian exports. However, Australia's country of concentration is
Japan, and only a relatively small portion of their exports go to Southeast
There will be no impact on New Zealand unless the Japanese economy falters.
We have also considered Greater China. China participated in the Thailand and
Indonesia IMF packages, and we are spending some time trying to interpret what
this means. It is a closed economy and the renminbi is not convertible, so it
has been sheltered. The lesson learned is that it is very unlikely that it will
be terribly keen on moving to convertibility to foreign funds. What we are
watching more closely now is how the depressed Hong Kong market may lead to
declining investment in China and slower commercialization of its state-owned
industries, and the initial public offerings of so-called "red chip"
stocks on the Hong Kong Stock Exchange.
Another element we are closely monitoring is the increased competitiveness of
Southeast Asian exports in textiles. In 1994 when the Chinese devalued, they
grabbed market share from Southeast Asia. In the next few months we expect to
see Southeast Asian exports taking over this market share again, and we will
then assess the impact on China.
Hong Kong has a very similar reading today around this table. The dollar peg
remains. There is continuing volatility in the stock market. Property prices
are likely to fall. Earnings of the financial sector have been severely hit.
There was no visible interference from Beijing when those very dramatic
corrections in the market occurred. The impact on Canadian exports will be on
food, luxury goods and construction materials. There will be less tourism to
Canada, and fewer Hong Kong students will study in Canada. There may be, and
this is an uncertainty, an increase in immigration and FDI, foreign direct
investment, into Canada.
Taiwan was, essentially, marginally affected.
What has not appeared in the press -- and I think we should all be spending a
little time thinking about this -- is what the impact has already been in South
Asia. Our posts report that India, Pakistan and Bangladesh will all lose market
share in low end market products because Southeast Asian products in these
areas are of higher quality, and their currencies have devalued. The slow down
in the Southeast Asian economies is likely to lead to large repatriation of
foreign workers. They will leave Thailand and Malaysia and return to Bangladesh
and India. That, in turn, will mean lower remittances for those countries. The
same will happen in Indonesia and the Philippines.
Pakistan is the country we are monitoring most closely in South Asia because it
will find it considerably more difficult to meet its debt repayments on foreign
currency denominated loans, including those from CIDA and the EDC.
Today we saw in the press the results of the 1996 census figures. The face of
Canada has been changing dramatically. I was struck this morning, not only by
the figure of 17.4 per cent of our population being foreign-born, but the
source of our new immigrants was particularly intriguing. There is only one
country that tops that figure, and that is Australia where 22 per cent of its
population is foreign-born. However, our numbers are rising. Of the top eight
source countries, all Asian except Poland. In descending order, they were Hong
Kong, China, India, the Philippines, Sri Lanka, Taiwan and Vietnam. Only after
that were the source countries the U.S. and the U.K. Our Canadians of Asian
origin will continue to have an interest in Asia. They are us and we are they.
This will ensure that our foreign policy, short term, medium term and long-term
will continue to have an Asian focus. We fall into the school that believes
that the economic prospects for Asia remain very solid.
Senator Stollery: Being involved in these bail outs essentially means that the
Canadian taxpayer is paying part of the bill. I find myself increasingly
resenting these bail outs when I know that, in Toronto this winter, 7,000
people will be sleeping in the streets.
In its June report, the IMF stated that the industrialized world has three new
countries: Taiwan, Hong Kong and South Korea. The group of seven is now,
according to the IMF, the group of 10 or 11. I find that hard to believe.
That report also stated that there was no indication that Southeast Asian
currencies would collapse and that we would have to bail them out. However, I
am sure you remember that there was no indication a few years ago that the
Mexican currency would collapse and that we would have to bail them out.
Your testimony was of a factual nature, Ms Hall. Surely I am not the only person
who finds this situation to be somewhat more than outrageous. There is a total
lack of ability to predict these crises. We all know there will be another one
although, with all the intelligence at our disposal, we are unable to predict
when and where it will occur, and then our tax dollars will be used to bail out
the area in crisis.
While my tax dollars are being spent in that way, I trip over some of these
7,000 homeless people on my way to the St. Lawrence Market on Saturdays. I
would rather that money be used to assist those people than those who, as far
as I can make out, are very often the authors of their own misfortune.
Mr. Rayfuse: You are absolutely right that part of the risk of the bail out
package is ultimately borne by the taxpayer. That is why, when we do enter into
these agreements, it is with strict "conditionality" to see that the
necessary reforms are undertaken.
The purpose of these bail out packages is not to give banks or investors a free
ride. It is a recognition that a country has a temporary balance of payments
problem and that, given the proper policy changes and reforms, it can get
recover. The purpose of the IMF "conditionality" is to ensure that the
reforms are undertaken. We are helping these countries over a rough stretch,
but we certainly do not want them to become permanent wards of the IMF or other
You mentioned predictability. As my colleague pointed out, the Thailand case in
particular was predicted. The Thailand authorities were warned that their
balance of payments situation was becoming unsustainable. They did not heed the
warning. This is, perhaps, a gap in the current system: The IMF can warn, but
it cannot force countries to change policies unless the countries come to the
IMF for assistance. In considering the international system and what we can do
to predict these things and, having predicted them, we must determine how we
can encourage countries to accept required policy changes. It is still an open
issue. It will be considered, and it is being considered now in various
Mr. Kumar: Basically, we run into these financial problems when the government
and the financial institutions are both not strong enough to withstand
pressures from private interest. These factors are consistent across countries.
What is taking place in Asia used to happen often in Europe, where there was
speculation from currency to currency, until a more stable currency band was put
in place. However, that is the weakness in the Asian financial system and it
will remain. No country can affect the politics of another country. Until the
political and economical links in Asia evolve, currency volatility remains a
My main concern is not so much Asia, but Russia because they have a weak
political system. There you find many conflicting pressure groups in terms of
the economy. The institutions should be watching, what happens in Russia.
Ms Glasgow: Far be it from me to take exception with the Department of Finance,
but inasmuch as we use the words "bail out", we must be careful in
the use of the word. Bail out suggests that it is a handout. However, our
subscriptions to the monetary fund are viewed as assets not expenditures.
Canada has benefited from the IMF in the past. It is not a handout. The money
comes back into the system. It helps countries to get over a particular stage
of crisis and to bolster confidence. I would suggest that there might be more
people in the St. Lawrence Market if more economies fell apart because Canada
is a trade dependent country. As such, we have a vested interest to ensure that
does not happen.
On the question of predictability and warnings, I come back to the question: Do
you go public? As you know, markets operate on rumour as much as they do on
facts. If the IMF says something too dramatic about a economy, it could result
in a self-fulfilling prophecy. There is a trade-off between that and private
advice. How do we improve our leverage and how do we improve the capacity of
these countries to swallow the medicine and take the advice?
Senator Stollery: I would like to leave you with the advice of Benjamin Graham,
who wrote the book Security Analysis. In one of the criteria that he uses for
investment, he talks about foreign bonds and equities and he says, "Leave
that to others." I think that is good advice. I believe I have the 7th
edition and the advice has not changed.
Senator Bolduc: Two or three years ago there was the Mexican crisis. That too
was predictable, but it happened. What has changed since the Mexican situation?
Apparently we have not improved the system of international surveillance. You
said that, although the Thailand crisis could be predicted it, nonetheless,
happened. I do not understand that.
I agree with my colleague on the wisdom of bailing these countries out. My
concern is that, the more money we put in, the wilder they may become.
What can you do when you have bad economic policy and bad people in charge of
that policy? You have no power to change them. What can you do? In a democracy
the accountability of politicians comes through the markets. However, in a
situation where there is no democracy, it is more uncertain because we do not
know who will replace those politicians. The newcomers may be worse than those
who have left office. Do you have any views on that?
Ms Glasgow: Since Halifax, where the attention was very much focused on this
type of situation because of the Mexican crisis, there have been several
specific improvements. We could forward some of that information to you, Mr.
Chairman. There have been improvements in surveillance, in transparency, in
being able to provide prompt advice, in the ability to mobilize resources more
quickly and to make sure that the International Monetary Fund is as strong as it
can be in order to give good advice.
The pending crisis in Thailand was a lot more open than what occurred in Mexico.
That, in part, was due to our surveillance. After Mexico, many revisionists
told us they had predicted the crisis 18 months ago. The surveillance had
improved by the time of Thailand. It has been on record for over a year now,
including in the media, so the surveillance is very much improved.
The techniques of working with countries to help them avoid a crisis and to
prevent a crisis have improved. When it does happen, the response rate has been
a lot faster and the resources have been put forward so as to prevent a
deterioration in the situation to the extent where you get a whirlpool effect.
Now, two years later, I would suggest that you take a look at the performance of
the Mexican economy.
I agree with you, senator, that the market is the best discipline. However, it
may be that we are bailing out private investors, and that is a problem. That
is a question which must be raised.
In the Mexican case, they swallowed incredibly harsh medicine. Even those of us
who are used to seeing IMF programs were surprised at just how tough they were.
We have seen a huge recovery in performance within two years, so something is
working well in the system.
Mr. Rayfuse: To address your specific question as to what was done post-Mexico,
I would say that a number of measures were taken. One was an attempt to make
economies more transparent with the development of a data dissemination system
within the IMF that would improve both the quality of statistics and the
distribution of statistics in an attempt to make economies more transparent. As
a result of the Halifax Summit, increased resources were given to the IMF. Ms
Glasgow has already referred to that when she mentioned the quota expansion of
the IMF and the new arrangements to borrow. As well, an emergency funding
mechanism was put in place at the IMF to allow them to react faster. Those were
the specific measures that were put in place in an attempt to forestall these
crises, and, in the event of a crisis, to allow the IMF to react faster.
As to why it keeps happening, the IMF may be in a position to predict these
things, but there is no way -- unless the country comes to it for assistance --
that it can force a country to change.
Senator Bolduc: You have the beginnings of a collective warning system. For
example, Western Europeans keep open lines of communication about these
matters. Of course, there are bad policies and speculation in that area also.
However, it is a fairly tight group and they discuss these issues. I expect the
dialogue between the French and the Germans is quite tough. There is no such
discussion group in the Asian countries. In many countries, dictators may talk
among themselves, but they do nothing unless and until they can reach a
consensus, and that rarely happens. I am not sure the situation in South
America has improved. Can you comment on the value of these open discussions?
Mr. Kumar: In terms of currency crises, the Italians behaved in that manner for
years after the Second World War. However, once they were forced into the
European monetary union, the political policies had to change, the governments
changed, and the way the Central Bank operated changed. The deciding line for
more stability is when a country is forced into a structure.
The French and the Germans have been talking closely since the end of the war
but, as I said, the Italians did their own thing until they were faced with the
reality of being in Europe or outside. The same thing happened in Spain and
Portugal. The key seems to be that once a country is forced into a structure,
it forces people to talk and cooperate. However, without that structure, they do
Ms Glasgow: Asian economies have not been keen on the peer review that OECD
perform. Peer review is a good way to pressure your neighbour into better
behaviour. The world is so interdependent, that individual behaviour affects
everybody. Over the last few years, as a result of the dialogue within the
Asia-Pacific Economic Cooperation group, we are seeing a gradual shift towards
wanting to enter into discussions about policy.
For example, this year, for the third year in a row, there will be issued an
agreed upon paper on economic and technical cooperation. This involves more
than the Asian economies. It also includes Canada, the United States and some
Latin American countries. That is a movement in the direction you are
suggesting, and it is important. However, if you want to find silver linings to
crises, then, as a result of this most recent one, politicians in Asia are
making public statements to the effect that there must be closer economic and
monetary cooperation in the region. That is a significant development.
Senator Bolduc: Are you optimistic about the fact that we are engaged with them
in a group and there will be a process of exchange, and that, more and more,
they will accept the European or the North American way of doing things
Ms Glasgow: That or a new way.
Mr. Rayfuse: Currently there is a mechanism in place for a type of review within
the IMF. Under the Article 4 hearings IMF can give them a very blunt
assessment. It is discussed among the executive directors of the IMF, one of
whom is a Canadian. I also accept your point that closer, more regular
consultative mechanisms would probably be useful in this case. We will probably
see something like that come out of this crisis. I cannot venture to speculate
on the exact institutional changes that will come out of this, but certainly in
many of the public pronouncements that I have seen by politicians from the
region, as well as from American and Japanese authorities, there does have to be
more peer review in the future, some sort of regional or group consultative
mechanism. I think we will see something along the lines that you suggest.
Mr. Kumar: We certainly have a U.S. dollar zone. Now we have the makings of the
Deutschmark zone, in the "European Monetary Union zone". Until the
Japanese become strong enough to establish a yen zone, Asian countries will be
unstable. The key difference between Europe and Asia, is that in Europe the
Bundesbank and others have come together.
Senator Bolduc: The influence of the Chinese is such in Southeast Asia, that the
Japanese are obliged to play the game smoothly, a little like the Italians used
to do in Europe.
We did not speak about the influence of that little turmoil, and perhaps it is
not over. The real estate situation is such in those countries is such that
someday what happened in Japan will happen there. I am not sure that their
financial institution will be strong enough to carry the ball.
I have noticed that the Canadian dollar has been going down for a few weeks and
that the Bank of Canada has tried to counterbalance the situation. I have heard
figures mentioned in the area of half a billion in the last two weeks. Do you
have any figures in that regard?
Mr. Rayfuse: I do not have those figures.
Senator Bolduc: Would $440 million seem appropriate?
Mr. Rayfuse: I could not say. I do not have those numbers.
The Chairman: Is there a connection between this and the downward pressure on
the Canadian dollar?
Senator Bolduc: It may be, if there is some impact on our foreign trade
Mr. Rayfuse: I would not think so that is the case, given that the impact on our
foreign trade is likely to be so small. These four countries only make up less
than 1 per cent of our trade.
Senator Bolduc: What about the United States.
Mr. Rayfuse: In the United States, the affect on GDP works out to be quite
similar. A greater share of their trade is with that region, but trade is a
much smaller part of their economy. In terms of economic growth, you are
talking about 1 to .02 percentage points at most, so it should not have a major
impact As well, I mentioned another channel of contagion, the macro economic
similarity. In the Mexican crisis, people began to look for countries where
government spending seemed to be out of control. At that time our deficit was
very large and we paid a price for that, and that was higher interest rates.
That is not the case this time. The fundamentals appear very sound. Our fiscal
position is the best in the G-7, so we did not see any move in Canadian
interest rates. In fact, Canadian long-term rates declined slightly in the
immediate aftermath of the crisis.
The Canadian dollar has been recovering in the last couple days. Trying to
predict currency fluctuations is next to impossible, but I can safely say that
the events in Southeast Asia have had no impact on the Canadian dollar. It is
not that major a crisis.
Senator Bolduc: However, the $500 million we pay for the financial institution
will go up next year to $600 million.
Mr. Rayfuse: That will be our quota increase, yes. That is an off-budget item.
Mr. Kumar: The Australian dollar also weakened during this crisis. The
international investor is becoming more cautious, and if they can get good
interest rates in the U.S. dollar, which is still the strongest currency, there
will be a shift of liquidity into that area. There is no question that Canada
must be careful about the fact that our interest rates are lower than those of
the U.S., so in these periods where there is volatility, it is important to
maintain confidence. That will not change.
Senator Whelan: I do not think the IMF is very capable. It has mismanaged many
situations. In the field of agriculture, for instance, people who know nothing
about agriculture go into a country like Russia or the Ukraine, make decisions
and demand compliance before money is handed over. They have a system in the
Ukraine -- and CIDA is going right along with it -- based on farming small
plots of land, and that is causing poverty. Same thing in Canada we are getting
rid of small plots of land. Our farms are becoming bigger. This was an
opportunity to make the Ukraine one of the greatest agricultural producers in
the world. I think they are sabotaging the Ukraine by not going in and helping
to them organize. If developed properly, it could be the richest agriculture
country in the world, but that will not happen by giving people 10 hectares of
land and expecting them to survive. Some stupid person in the IMF makes that
kind of decision.
We went to the Ukraine and made recommendations. As a former Minister of
Agriculture and farmer, I spent seven weeks there. CIDA told us we knew nothing
about agriculture and they did not accept our report. I find it hard to believe
that these people are telling them that they must form a democracy; that they
must have a free market system working and, yet, they do not go in and work
with these people. They give advice from a distance. They come in, lay down the
law, and live in the best hotel in Kiev. The World Bank representatives do the
same thing. We stayed in low class apartments when we were there. The fellow I
was with was a former Dean of Business at the University of Windsor. He had
left the Ukraine when he was nine years of age. One of the people from the
World Bank who was telling us what to do in the Ukraine used to teach economics
at the university in Hungary. Here was this economic wizard telling them how to
privatize. He has a place in Washington; a place in Florida; and a place in
Budapest. He was telling us how agriculture should be run. To me, food is the
most important commodity.
The Globe and Mail says the Asian economic flu will spread to Canada. Low price
imports will find their way into Canada.
The other day I saw a fellow by the name of Trump being interviewed on TV. There
is an old Canadian card game called "Euchre". When you trump, you win
the game. Trump trumped them. He told his bankers that he owed $8 billion and
that he needed $600 million or $800 million. They not only gave him the money,
but they put him on an income of $450,000 a month plus living costs. Now he is
richer than he ever was because the financial institutions were so deep in debt
to him they had to go along with what he said, otherwise they would have lost
billions of dollars. The banks put him in that position in the first place.
When we had high interest rates, the biggest economic losses were not in
Indonesia or Asia, they were suffered in the United States of America. Canadian
investors lost billions of dollars in the United States in real estate and
other investment. In just one venture in Texas, Canadian Tire lost $600
million. They followed the same path as the banks. I should tell you that banks
are my pet project. I was responsible for the tenth largest lending institution
in Canada, the Farm Credit Corporation. Where did Canadian Tire recoup their
losses? Here in Canada.
Mr. Kumar did not mention how much the CIBC has invested in Asia and how much
they lost. You did not tell us how much they lost in Mexico. They lost millions
of dollars in Mexico, but now they are in a profit position by very quickly
rearranging their service charges. They have recouped most of their money from
us poor Canadian citizens. When Mr. Flood, the head of the CIBC, was the bank
manager in the Town of Essex, he would not lend money to me.
I am concerned that our markets will be flooded with these cheap imports from
Global trade is not new. Marco Polo brought back spaghetti from China when he
was looking for gold. He was financed by the traders who paid him to bring
slaves into their countries. Those slaves now work in Malaysia, Indonesia and
the Philippines and the products are shipped to Canada. Global trade is not
Ms Hall you talked earlier about the fact that these products will inundate our
The IMF is financed with our money. I remember I went to the prime minister
because I wanted to do more for Mexico. He said that he admired my compassion
for the Mexican people but, he told me that that country was so crooked that he
did not believe anybody could ever help them. You mentioned their great
comeback. Banks were investing $600 million here, another $300 million there.
Many of these countries, for instance, Indonesia, have very corrupt political
and banking systems, and nepotism is widespread.
Senator Andreychuk: About four years ago the Canadian government said that we
must broaden our trade base and that we must be global traders if we are to
survive. There was great activity in all of the departments, all looking for
new markets, and Asia became a very strong market. Recently we have seen these
Team Canada visits.
I remember visiting Malaysia more than a year ago and being told that there was
too much real estate activity and that Canada was contributing to the problem.
The well-known twin towers stand there, vacant or occupied, I do not know. We
were very bullish on Asia. We have encouraged the Canadian government to
consider Asia as a long-term investment. While it may only be 8 per cent -- and
you said it is not significant to make changes in our economy -- a lot of
businessmen have invested time and energy in developing that market. What is
your strategy now? What do we say to all these businesses that are gearing
themselves to markets in Asia? Should we encourage them to keep going, and to
not make any changes? What advice are we offering businesses as they go into
We knew some of the risk factors, but I do not think we identified them to
businesses. I do not fault the IMF. What lessons will we take out of this for
our future investment into Asia?
Ms Hall: Markets go up and down and we have a pretty positive view on the
fundamentals of the Asian economies, and a very positive view of the future of
Asia, with growing possibilities for exports. Our share of the export market in
Asia has been declining. There is a two fold response to that. There has been a
dramatic growth in intra-Asian trade. Also our competitors have been doing more
than we have. At the same time, the economies in North America have been
becoming more and more integrated, particularly Canada and the U.S. so our
trade is growing with the U.S.
We encourage those businesses that are already established in Asia to stay, but
to change their business strategies. This is probably not the time for small-
and medium-sized enterprise to enter into the markets of key countries that
have been affected for the very first time because imports are prohibitive.
However, for those that are already there, it could provide very attractive
opportunities of a different type. Not straight exports but outright purchases
Mr. Kumar: I know the stock and bond markets best. In those markets, you always
hedge your bets. You can never be that sure that you will be right. Typically,
companies should not bet on one region. If they do want to go outside Canada,
they should think about Europe and Asia, and try to balance what they can do.
They should decide whether they are big enough to be able to do that. To bet on
one region is the equivalent of buying one stock and saying I assuming you will
get rich. Diversification is very important.
On the long-term demographics, there are a lot of young people in Asia now. By
that I mean those less than 20 years old. In 15 years, this group will be the
productive group as they will be in the 35 years-of-age groupand will generate
a lot of income and engage in a lot of spending. That demographic move in Asia
from the youth stage now to the spending and investing stage in 10 or 15 years
remains intact. Longer term based companies are taking that into consideration,
and that outlook remains unchanged.
As happens in the markets, people who cannot hang on for the long-term get wiped
out in the short-term. Before people go outside Canada, they must think about
whether they can stay for the long-term which is 10, 15 years down the road.
Senator Bolduc: The smaller companies can do contract work also with the bigger
ones who are out in front.
Mr. Kumar: Yes. That is being done very successfully in the auto parts industry.
They go as subcontractors to some major company, so they come under the wings
of a major company.
Mr. Rayfuse: I would stress the importance of taking the long-term view. You
have a region that, over the past two decades, has had the greatest rise in
living standards in the shortest space of time that the world has ever seen.
That reflects a number of substantial strengths in the economy. This currency
crisis has pointed out some weakness in the financial sector, but this should
not be a long-term discouraging factor to growth. This is a crisis that they
will get over. There have been financial crises in Southeast Asia in the past
20 years. They get over them. The fundamental strengths are still there. There
are other potential limitations on Asian growth, and Ms Hall referred to them,
environmental infrastructure, bottle necks and so on, but those represent
opportunities to Canadian business. I stress the importance of taking a
long-term view here.
Ms Glasgow: What can the Canadian government do to assist the Canadian
exporters? The government can create a facilitating environment. In fact, that
is what we do, but we also have a responsibility to ensure that the policies in
these countries are sound so that their growth continues, and to make sure that
they do not close their borders to trade and to investment. That fits in with
the longer term. That is very much what we do through the IMF "conditionality";
through the discussions that we have formally and informally with these
countries. We try to ensure the right conditions for our exports as well as our
Clearly, the private sector does what the private sector wants to do. I think
they have stopped listening to government advice.
The Chairman: To what extent are situations such as that which developed in
Thailand screened by having a pegged exchange rate? Setting aside Hong Kong,
should investors be wary when the currency of a country into which they are
putting capital is pegged?
Mr. Rayfuse: Pegged currency can work, and in fact many countries find it a good
system to adopt when they are trying to gain credibility. If it is a country
with a tradition of high inflation that wants to gain instant market
credibility, it will peg its currency to a low inflation country. In that sense,
it can be good.
Where you get into a problem with a pegged exchange rate is when it becomes
misaligned and when it has created conditions where outflows of money will
never be matched by inflows, in essence, whether that be a current account
deficit that is not willingly financed by international capital markets or
If you are a businessman considering making an investment in a country with a
pegged exchange rate, there are certainly indicators of brewing trouble. One of
them is a prolonged current account deficit, particularly a current account
deficit that is incurred primarily to sponsor consumption rather than
productive investment. Where a country is losing foreign exchange reserves at an
unsustainable pace, as Mexico was in 1994-95, that is a sure sign of trouble on
the horizon. Where the country, despite the fixed exchange rate is running a
higher inflation rate than its major trading partners, that is what economists
refer to as a real exchange rate appreciation, but that is another indicator of
impending competitive pressures or excessive monetary creation.
The composition of a country's debt is another possible indicator of trouble. A
country that is borrowing primarily short-term; a country that has large
unhedged assets, as Thailand did, is another potential indicator of trouble. A
pegged exchange rate becomes untenable when the balance of payments position of
a country is in a long-term, untenable situation.
The Chairman: Thank you very much. I have a draft report for you to consider.
As you know, Honourable Senators, the reference on which we operate now relates
to APEC, but other questions have been raised, and we need an additional
reference to accommodate those matters. I would suggest that we go to the
Senate and ask for authorization to examine and report on the consequences to
Canada of the emerging European monetary union and on other related trade and
Is this agreeable, honourable senators? I see Senator Bolduc nodding.
Senator Corbin: What prompted this proposal?
The Chairman: It was raised at our initial meeting. There were questions
concerning whether or not the committee was keeping up to date with what is
happening in Europe relative to the expansion, and relative to the achievement
of the monetary union. There were questions concerning the multilateral
Senator Bolduc: And Latin America.
The Chairman: The Latin America fallout. There were proposals which we could not
accommodate within the APEC reference. This would enable us to do that.
Senator Andreychuk: My concern related to the phrase: "...and on other
related trade and investment matters" which I thought may restrict us to
dealing only with the emerging European monetary union. However, our chairman
advises me that he is taking the interpretation that "...and on other
related trade and investment matters" means that we can revisit our study
on Latin America. That is important to me.
Senator Bolduc: The use of the word "on" the second time makes that
Senator Andreychuk: As long as the interpretation includes Latin America I would
The Chairman: Senator Bolduc is an expert in English and he is telling us that
the repetition of the word "on" clarifies the situation.
Senator Andreychuk: In court, that would be only one acceptable interpretation.
That is why we have prosecutors and defence counsel.
The Chairman: If my interpretation is challenged I will defend it in court.
Senator Andreychuk: It is a question of whether we as a committee know what we
will be permitted to study.
The Chairman: I think we all agree.
Senator Andreychuk: Senators can continue to debate the interpretation.
The Chairman: We will continue in camera.
The committee continued in camera.