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Your Excellencies, distinguished guests, ladies and gentlemen, please firstly allow me to pass my thanks to the Thai Institute of Directors and The Nation group for the opportunity to share some of my thoughts with you today.

Ground zero, July 2nd, 1997

Bangkok in 2007 is a very different city to that of 10 years ago. In July of 1997 we had little idea of how traumatic conditions were to become for much of the Asian region, but the magnitude of July 2nd and the pan Asian crisis unfolded very quickly before our eyes.

The saddest part is that the entire crisis was largely avoidable.

Why a crisis

When being asked to look forward one is more often than not well advised to look to history for leading indicators of what lies ahead. The Asian crisis of 1997 had its seeds sewed in inappropriate policies pursued by governments, poor decisions by commercial banks and business, poor supervision by central banks, and poor investment planning by individuals many years earlier.

The environment of pegged exchange rates had the predictable effect of distortion of costs of capital, of inappropriate interest rates, the declawing of central bankers' ability to use interest rates as an inflation management tool, and of resultant investment expenditure focussed on sectors that could in no way provide appropriate returns for the risks being taken - primarily into short term property speculation - and was accompanied by excessive consumption, giving rise to what we term a "bubble economy".

Predictably the bubble burst.

The Berlin Wall effect

In addition to pegged exchange rates, the root cause of the crisis was embedded in the destruction of the Berlin Wall. This wall was constructed in 1961, and finally dismantled in November of 1989. With its destruction the opening of Eastern Europe began in earnest, as did a commensurate change by investors in their attitude to global investment destinations, and investment flows.

New investment opportunities and destinations were opened, and competition for global investment funds was eventually felt in Asia, which became benchmarked to other emerging economies.

Given the prevailing exchange rate environment, the implied inherent discouragement of investment into productive areas of Asian economies, the collapse in exports in 1996 due to declines in foreign demand for Asian goods and services, quickly led to current account deficits - which in Thailand amounted to 8% of GDP in 1996 - and pressure was applied on those pegged exchange rates.

The Berlin Wall Effect strode in and capital flew, desperately seeking a better life and opportunity in markets outside Asia.

Defending pegged exchange rates

Added to this pressure was the mistaken belief that central banks could defend such pressures, and their pursuit of ineffective, ill-advised exchange rate defence policies led to foreign reserves being wiped out, and the destruction of domestic economic growth.

The Asian region was cast into depression. Asia's over reliance on foreign funds inflows and their appetite for short term investment opportunities into the property sector exposed its greatest vulnerability - inadequate domestic demand, inadequate investment into productive sectors of its economies which could have encouraged and developed domestic demand, with the resultant destruction of domestic savings.

The consequent loss of control over their economies, the destruction of domestic confidence, and the ignominy of an IMF lording over domestic policy formulation drove the nail to the heart of most of the Asian region.

Gave rise to social costs

The social costs of these policy lapses were huge. Readily measurable consequences were the collapses in GDP growth, of which we have heard a lot, but more important was the collapse in nominal income levels in US dollar terms that took until 2004/05 to return to their July 1997 levels in Hong Kong, Indonesia, Malaysia, The Philippines, Singapore, Taiwan and Thailand. This destruction of income leaves long lasting memories, and materially alters attitudes to risk taking, to borrowing, to investment and to equity markets, at a personal, corporate and governmental level, making the return to prosperity all that more difficult.

So what were the lessons learned, and how will they provide us with leading indicators of what may lie ahead?

Lessons learned

Firstly, it is clear that floating exchange rates, which reduce value anomalies and malinvestment propensity, are an essential ingredient. A floating exchange rate environment allows investing capital to make more rational decisions, as capital knows the interest rate will reflect underlying inflationary expectations, and as such is an accurate measure of return. Capital has the assurances it will be subject to market conditions, and will be treated by the prevailing rules of such conditions, and can accordingly base its allocation on the underlying investment opportunity, and not be concerned with exploitation of inconsistencies that inevitably prevail when cross border flows are subject to artificial barriers.

Disintermediation of the banking sector is important for the corporate sector's ability to source capital at market rates that reflect the true cost of capital. When the banking sector constitutes such a proportion of market capitalisation as is the case in much of Asia, the competition for capital materially alters its price and crowds out other capital users, as does the banking sector's involvement in its allocation - history has demonstrated time and again that bankers do not make superior lending decisions to the ultimate user of capital, the corporate.

A mature bond market is similarly essential if capital is to be provided with interest rate indicators of real returns over time on offer in an economy, if central bankers are to have an effective interest rate management tool, if corporates are to have the availability of long term debt, and if savings are to have a home for long term asset: liability management.

Secondly, it is essential a country's rules and regulations, and more importantly its supervisors, ensure a robust financial services sector underpins its economy. As was evidenced post-crisis, a technically insolvent banking sector causes severe harm to an economy through the destruction of credit creation, from its inability to lend due to impaired balance sheets, and from the psychological inability to lend due to the destruction of confidence across its lending officers.

This sector also needs to incentive to create risk assets other than in the property sector - which was the source of much of Asia's financial services sector meltdown - in which role supervisors and regulators can play an important part.

Capital management disciplines and shareholder - management independence have historically been weak across Asian banks, and have not been supported by the market disciplines a flexible exchange rate system encourages through more accurate real interest rates and consequent return on investment.

Thirdly, an economy must ensure the highest possible defences against external disruptions through the exploitation of its inherent comparative advantages.

A recovery example

As Thailand demonstrated post-crisis, the Kingdom has a huge comparative advantage in its agricultural sector which had not been fully exploited. Through subsequent policies that enabled investment and production, like an efficient land titles system facilitating access to the formal banking sector and access to rural credit at non-usurious prices, rural economic activity surged. As one example, this had the desired effect of competency concentration through the OTOP programmes, linking specialisation to marketing to new markets, along with incorporation of the latent rural talent of its rural populace into the formal economy.

Another was the substitution of the formal banking sector for money lenders - this had the effect of lowering interest costs from a usurious 1% per day, to a normalised single digit % per annum - a huge saving to the rural sector and an enormous build up in savings to enable rural investment.

The next step in growing rural investment through the retention of value in rural Thailand is to encourage the producer from being a price taker to becoming a price maker through greater value add close to the farm gate, and facilitating marketing away from a single buyer.

Is it competitive or comparative advantage

And finally, all economies must strive for competitive advantage. Whilst comparative advantage will provide an edge, it is through the application of competitive advantage - being the low cost manufacturer and service 'low cost provider' - an economy fully exploits its potential and creates sustainable markets for its products and services. It is virtually impossible to create competitive advantage behind the skirt of a fixed exchange rate and government protection, as there is no internationally benchmarked set of disciplines imposed upon a producer or service provider.

I would like to turn now to a look at what has been done since the crisis, in an attempt to find clues that will show us a less turbulent path forwards.

What has been done

There has been an unquestionable enhancement in transparency and governance across much of the region. Reporting standards, disclosure, reform of shareholder registers, compliance with international capital adequacy standards, and so on.

The region's financial services sector has been revolutionised, internationalised and adequately capitalised, with a clear movement away from directed lending. Credit has been made available at the personal level, with an escape from the informal money lenders and their extortionate prices, and is enabling growth in personal debt-assisted consumption. Foreign financial intermediaries have been provided market access across much of Asia, bringing with it international best practice, competition, and the accumulation of domestic currency savings for on lending to their global client base in its domestic investment programmes. Central banks have clarified their charters and improved their supervisory capabilities.

But much remains to be done. In some instances the growth in empowerment of rural sectors is lagging, and the resultant consumption demand and investment opportunity has been left withering on the vine. Similarly, the independence of ownership and management has not yet fully matured, leaving residual propensity for non arm's length credit decision making, and the potential for impaired risk asset growth. Many Asian stock markets are inefficient, do not pursue best practise, and do not sufficiently champion good corporate governance.

Exchange rate policies have lapsed

Whilst pegs have largely disappeared, we continue to see attempts at exchange rate management in much of the region, either overt or covert, which, along with a heavy reliance on exports, has given rise to significant US dollar surpluses. This conscious policy of keeping currencies undervalued and building a domestic economy with an export reliance based on the competitive advantage of government supported prices, and not underlying efficiency, is as dangerous as the previous over valued currency policy.

This is a very important systemic issue for Asia, Southeast Asia in particular, as it runs at breakneck speed towards two massive new players on the block - China and India.

Enter China and India

The two and a half billion people these two heavyweights represent are making their presence on the world stage truly felt for the first time. Not only are they huge regional competitors the likes of which the region has not seen before, the very dynamic they bring to the world stage is forcing major changes in aspects from commodities demand to the export of deflation to a major shift in longstanding geopolitical alliances.

Economies that are not prepared for this changed dynamic are truly vulnerable to the effects of these two emerging superpowers.

Thailand's near neighbour, China, has the power to influence Thailand positively, or negatively - it is up to Thailand as to which option it chooses. Just as China has caused global dislocations in established supply and demand patterns, so it is up to Thailand to choose the extent to which is desires to participate in those changing patterns.

As an example take Vietnam

China has many options open to it, and China's trading partners similarly have many options. One has only to look at Vietnam to see how opportunity can be grasped - this communist country is displaying all the signs on a newborn baby reaching for the investment nipple as it enables investment across the full goods and services chain.

Vietnam is a competitor to Thailand for many of those goods and services that are being nurtured, with the latest standards of technology and efficiency, and with foreign capital confident in its ability to generate sensible returns from its Vietnamese investments. Vietnam is rapidly privatising many government owned assets, looking to the private sector to provide capital and management to these institutions, to meet their growth needs.

On the issue of social responsibility, one of the greatest challenges for government in this process is to ensure the transfer price of these assets is equitable to the country. The challenge is to open the door to opportunity smoothly and transparently, and not to tear the door off its hinges in the process.

Chinese opportunity

But China also offers opportunity. The reform process today of the Chinese banking system will lead to a dramatic increase in the availability of consumer credit and growth, offering enormous opportunities for Thailand. Tourism growth is one such sector, which is not being consciously developed at the speed required to create barriers to competitor nations.

Similarly food stuffs - although the key point is to bring as much of the processing and packaging to the farm gate as one can, to both gain a higher share of the value chain and to encourage investment into the rural sector.

Who knows, maybe there is even demand in China for Thai tuk-tuks!

Over reliance on the US

Notwithstanding the potential for increased trade with China to lower dependency on the US, today the United States of America, still the major export destination for much of Asia's exports, is itself on the brink of a possible sub-prime housing mortgage led economic crisis. The effects of Asia's, and Thailand's in particular, reliance on the US for those rapidly accumulating current account surpluses is particularly concerning.

We estimate the US housing sector constitutes a meaningful element of its domestic economy. Much of the strong growth in this sector over the past decade has been accompanied by a fall in credit quality as a result of lenders lowering minimal equity requirements for housing purchases.

These low-equity (or sub-prime as they are generally known) mortgage loans are subsequently bundled and collateralised as CMOs, CDOs and CLOs, and sold into long term savings pools. Prior to sale, the collateralised loans are rated by an oligarchy of rating agencies, which are not subject to regulatory supervision, and accordingly priced.

Defaults begin to emerge as mortgages mature and as the emergence gathers momentum, provisions are brought to account into the books of the financiers of the collateralised loans, and the seeds of the credit tightening cycle begin to bear fruit. This leads to a tightening of the consumer credit tap, and cascades into a fall in domestic demand, which in turn leads to a decline in the demand for Asian goods and services.

And credit rating agencies

Growth in current account surpluses is brought to a rapid and unpleasant halt, and no amount of intervention against the backdrop of a controlled exchange rate and unhealthy export-dependent domestic economy will prevent this external shock to one's economy.

It is only a matter of timing and magnitude - not if, but when - and for a leading indicator check the stock market price of those credit rating agencies. As it falls it is a sure indication investors are losing confidence in the voracity of ratings applied, and begin to question the voracity of future earnings of the agencies themselves.

Asian economies preparing for the changes the world will certainly deliver have to have their domestic houses in order if they wish to maintain the status quo and continue to enhance the living standards of their peoples.

Preparation includes internal - a sustained focus on their domestic economies to ensure solid underlying domestic consumption underpinning domestic demand and investment with the flexibility to efficiently move across different sectors, and external - shaping economies that can withstand the inevitable swings and roundabouts of varying trade patterns and preferences.

Internal economic focus

Dealing with the internal focus, creation of a confident domestic economy is a real challenge. Consumers' memories are fresh with the effects of the 1997 crisis. Attitudes to debt, to investment and the stock market are alive and well, and are a generational issue.

The private sector's willingness to take on debt is one of the clearest measures of the underlying lack of domestic confidence. Across most of Asia private sector bank credit as a percentage of GDP languishes behind levels prevailing in 1997.This is purely and simply an issue of lack of confidence in the future. Bank balance sheets have been repaired and banks are armed with a far stronger armoury of debt products than those of a decade ago, yet from a macro perspective consumers are voting with their pocket books and not borrowing, notwithstanding the growth in credit card debt.

No point in relying upon the credit cycle

The implication for policy makers is that the classical approach to post-crisis growth - an expansionary monetary policy through utilisation of the credit cycle to boost domestic demand - is not available as a stand alone tool. Deeper structural measures are required, and all rely on an environment of confidence.

Nor ineffectual leadership

Japan is an excellent example of how not to manage an economy. Market forces were not allowed to work by a bureaucracy and political leadership that were unable to enable required change, with the result being a Japan that has become growingly risk averse since 1991.

M1 as a percentage pf GDP has risen over this period from 25% to a staggering 77% today, compared to the US which has gone from 28% in 1959 to 10% today.

Given the Bank of Japan's 'zero interest rate policy', this seems paradoxical, until we equate apparent negative real interest rates with a lack of domestic confidence and risk appetite, giving rise to a vicious deflationary cycle - the failure to enable domestic structural reforms, including normalisation of interest rates, has further neutralised the exchange rate mechanism's effectiveness.

The implication is a residual fear of unemployment, lack of confidence in the wealth effect (asset price appreciation), aversion to risk, and fear the social security net is inadequate.

But don't forget the countryside

As Thailand demonstrated, engagement of the underperforming rural economy through structural changes in specialisation and the development of new products, the opening of new markets for those products, movement away from the informal economy through the availability of finance at non-usurious rates of interest, placing finance in the direct hands of rural users, and large scale projects with measurable effects on logistics and efficiency, had the effect of rapidly raising growth, and spreading economic benefits across the wider economy. The tax net widened dramatically, providing further evidence of the latent potential of the rural economy and potential for investment returns in this sector.

The challenge is to continue to provide the enabling infrastructure and confidence building tools, to keep that growth going.

As an example of what not to do, one had to look to Hong Kong, whose maintenance of a pegged exchange rate put its citizenry through a prolonged "death by a thousand cuts" as the challenges of living with deflation were experienced. One measure of the erosion of confidence is the erosion of private sector bank credit, which, as a percent of GDP, remains lower today than in 1997. Another is nominal housing prices which are still not back to their pre-crisis levels.

Or housing prices

House prices are a very important element in the domestic confidence equation. A source of savings, typically a family's single largest asset and store of wealth, rising house prices elicit confidence across a range of decisions, from attitudes to debt, to saving, to investment and even family sizes, as a result of the wealth effect, and the general level of confidence this illicits. When house prices are smashed, as in much of Asia post the crisis, so is confidence. It is important to domestic confidence to see residential house prices rise, in both nominal and in real terms, to both release equity and to increase household borrowings. In most of Asia today real property prices are in decline.

It is also important to see investment be given clear signals on where returns can be achieved. An inflexible exchange rate environment does not permit the interest rate mechanism to work smoothly - in fact the opposite is encouraged with real rates moving in wide swings and in the process encouraging investment capital to pursue short term opportunism, rather than more desirable and less disruptive long term allocation.

Or political stability

Similarly is the need for political stability and policy transparency. In today's world of capital mobility it is incumbent upon countries to compete, and a very important element in capital's choice of investment destination is political stability and clarity in the rules governing the movement of capital across asset classes and borders.

External economic focus

Moving onto the external economy, one potential disruption is input supply and costs, particularly in a country such as Thailand where a relatively large share of GDP is trade dependent. The obvious candidates are energy and other hard commodities, over which the importing economy is likely to have little control. Where controls are available, such as long term contractual relationships with suppliers and efficient currency hedging tools, the opportunity to soften disruptions exists. Of course this is a two way street, and a fall in demand for finished product without a mechanism to slow inputs, has an equally devastating effect.

Global interest rate movements have a secondary effect, in that they move consumption in trading partner economies, which in turn moves demand for goods and services, and can dramatically move investment decisions into trading partner countries.

So there are two issues here, these of volatility, and those of continuity, neither of which can realistically be adequately hedged.

On the horizon

We also have the very real environment of terrorism. The uncertainty terrorism generates destabilises investment capital flows and the physical movement of product and people. One has only to look to Bali in Indonesia to see just how long the terrorism tail is, as the island remains well below its tourism potential, and its populace bears the brunt of the disruption.

Along with terrorism there are global warming, health pandemics, the pressures of poverty, and so the list goes on and on.

There are also concentration risks, to export markets, input components and sectors. Any economy which specialises to the extent its future is largely dependent upon one adverse event, is leaving itself prone to disruption.

Dealing with these challenges requires adaptation, creativity and the development of comfort, to retain and grow confidence in an economy.

As a positive, soft commodity prices are likely to rise in future years, providing an incentive for investment into this sector, and geography. This is a real positive for Thailand with its agricultural comparative advantage, and on the assumption government works on continuing to create enabling policies, investment should be drawn away from Bangkok and into the countryside over the longer term. The resultant wealth effect, increased consumption and investment stabilisation, driven by rural growth, should well develop into a virtuous circle of prosperity, further insulating the Thai economy from inevitable external shocks.

Retail participation rate indicator

Without being overly prescriptive, it is appropriate to turn to some possible indicators that may give us a glimpse of what may lie ahead.

One such indicator is retail stock market participation rates. High measures imply confidence in one's domestic opportunity, but that can be a smoke screen. The perception that equities represent an asset class that is attractive to local investors may simply be an asset allocation issue, where other factors have encouraged the shift to listed equities, or it may be restrictions on individuals investing in foreign stock markets. Misreading this indicator may lead to promulgation of policies that disrupt capital markets, ultimately leading to higher costs of capital.

General market direction

Rising regional stock markets appear to be an indicator of underlying health. But here the risk of being fooled is if they are being liquidity-driven they will experience significant fluctuations until underpinned by growth in private and corporate sector credit, evidencing a pickup in domestic investment and confidence.

Loan to deposit ratios

An indicator that domestic confidence is down and the credit cycle is not kicking in is the loan to deposit ratio (which in Thailand in 1997 was 100%, and today is at 66%). Anything above 100% should give rise to caution.

It is interesting to note that the US has been above 100% since 1994, but this deviation is possible of course because the US owns the world's reserve currency!

Similarly measuring private sector credit as a percent of GDP over time, and whether or not credit growth is greater than GDP growth. If we examine this measure today we find it implies much of Asia is experiencing a credit cycle lag, with a commensurate drag on domestic investment expenditure - and similarly with corporate sector borrowing.

Don't forget the exchange rate

Looking at real interest rates across Asia which are at historic lows, and where banks are fully capitalised but borrowing remains low, the implication is an environment of low confidence, or we would otherwise expect borrowing to grow. All indications are that banks are hungry for risk asset growth. In looking for explanations, one is quickly led to the conclusion that the exchange rate mechanism is not working. An efficient exchange rate frees up the central bank to use the interest rate mechanism in its inflationary target management. As soon as one moves away from that freely moving exchange rate, interest rates effectively disappear as an inflation management monetary tool, leading to wide asset price fluctuations, which drives investment capital into short term opportunities, like property.

And the dependency ratio

Another is the dependency ratio - the degree to which those in the workforce support those who are not - which is an excellent demographic signal on the likely attractiveness of new investment, as confidence and credit appetite grow. North America since the 1960s provides an excellent example, where most dependents were young and about to enter the workforce, in contrast to Japan today which is at the opposite end of the spectrum, its population rapidly aging. The Philippines, Vietnam and India are Asia's standouts, where young dependents overwhelm the old.

It is very important to watch this indicator in India - strong across the board today - and China -which is weak today - and Japan -which is very weak - as there is a potentially huge knock on effect to the rest of Asia, Thailand in particular, as this indicator changes.

Why are indicators important

In looking at these indicators, we are not seeking a panacea to protect an economy from all future challenges - that is unrealistic. The indicators are merely tools that collectively provide signals against which policy decisions can be more intelligently taken.

It is very difficult to insulate oneself from external shocks, but it is easier to do so if elements that can be controlled, are. As we learned from the last crisis, prevailing policies exacerbated the intensity and duration of the crisis, and the social pain inflicted.

Working on the assumption that currency flexibility is not in favour with Asia's policy makers today, indicators can provide clues on which other policy tools should be developed and implemented.

Domestic economic strength is a great insulator

Our objective here is to highlight that a well managed domestic economy is far likelier to withstand inevitable external shocks with significantly less pain than one which is not. Governments, where they are elected, are empowered by their constituents to undertake that prudent management responsibility, and as a rule of thumb should do their best to stay out of attempting to manage their economies.

By anticipating that external shocks are likely, it is therefore all the more important to identify what needs to be done at home, and prepare oneself for the inevitable - a head in the sand attitude is not acceptable, as is any measure that makes the economy less flexible.

Exploit comparative advantage

Along with the more obvious issues we have discussed, it is worth again stressing the importance of exploiting one's comparative advantage. All societies have latent talent, which few properly exploit. Thailand is blessed with enormous talent, and appropriate policies will extract and capitalise on that talent. Thailand's economy is relatively export dependent, and external shocks will have powerful effects. These can not be prevented, but can be mitigated with an appropriate domestic policy framework that is focussed on encouraging long term investment into areas of the economy that possess such talent and comparative advantage, particularly the less developed rural countryside.

And that policy framework requires sufficient flexibility that competitive advantage - doing it better, faster and cheaper than one's competitors - can be enabled, turning the comparative advantage into a sustainable state, which in turn will encourage successive rounds of investment. Policies that favour interest groups over the broader economy will only add to the depth of any disruption.

Work on banking deregulation and disintermediation

As one example, one has only to look at what measures can be taken to continue progress on the banking sector disintermediation path as one element in growing investment capital efficiency, or in tourism, where Thailand is one of many available Asian destinations.

Disintermediation goes hand in glove with deregulation - in any exchange rate regime, fully flexible or otherwise, deflation is an inevitable companion, and one has to be absolutely certain one's economy can cope with deflation when it strikes. A banking system that is not robust, nor adequately supervised, will fail to cope and deepen the storm - Hong Kong and Singapore were good examples of robust banking sectors which lessened the depth of the crisis for them.

The ball is squarely in the court of domestic policymakers - it is now up to you to play it.

Finally, I was recently asked by a client whether or not the consensus view on a particular issue was an appropriate measure on which he should base his future plans, which I found quite disturbing, as in all our planning it is extremely important that we plan for and expect the unexpected…

Ladies and gentlemen, I thank you for your patience.