By Dennis Zvinakis, US-AEP Regional Director

In 1996, just five Asian economies -- South Korea, the Philippines, Indonesia, Malaysia and Thailand -- pulled in a net $102.3 billion in overseas investment, or nearly a third of the total of $327.7 billion that flowed into emerging markets world-wide that year. But in 1997 the capital that so generously had flowed into Asia rushed back out, devastating stock prices, souring bank loans and wiping out the savings of millions of people. According to the IMF after economic growth of 7.1% for 1996 and 4% for 1997, Southeast Asia saw output shrink 7% in 1998.

These economic changes were part of a larger paradigm shift that also shook the political and environmental frameworks of Asia. Eight out of the ten countries where US-AEP operates changed government. Some of those took place in the framework of deepening democratic institutions such as in Taiwan, the Philippines and Thailand. Others such as in Hong Kong and Indonesia were more profound and have an outcome that is still uncertain.

The environmental events of the year were no less significant. The major event was, of course, the 1997/98 the global climate phenomenon, El Ni�o Southern Oscillation (ENSO), and the severe regional impacts of drought, fires, and haze it brought to Southeast Asia. The socioeconomic impacts of fire on Southeast Asia, particularly Indonesia, from the smoke and haze generated by extensive land and forest fires were devastating. The smoke and pollution from Indonesian fire started by plantation companies and farmers to clear land cheaply, affected an estimated 5 million hectares of land, about 75 million people and caused $4.5 billion in fire and haze-related damages.

But the effect was also regional. Singapore, a model of environmental stewardship was blanketed with ash from forest fires in Indonesia. Malaysia even more so. At the same time, floods hit Vietnam and Thailand.

Sweeping changes like this encompassing the political, the economic and the environmental arena come only rarely each century. The question that has to be asked now is what has happened since and what does it portend for environmental stewardship in Asia.

Certainly economic conditions have improved. The five Asian economies noted above that were hit hardest by the recent financial crisis will produced an average growth rate of 4% or more in 1999 this year, compared with a 7.8% contraction in 1998.

But this growth is fragile and masks more fundamental problems. Unemployment rates remain painfully high and the credit supply is still vulnerable to sudden shifts in the preferences of domestic/foreign investors. Overall transparency in investment decisions and a rational system of making informed policy choices are a long way from where they should be.

Thailand and Korea did the best job of attracting fresh capital. Foreign direct investment in Korea soared 81% to $5.1 billion last year. Direct investment in Thailand jumped 87% to $7 billion, led by flows to the financial, machinery and automobile sectors. In an period of recovery South Korea is by far the best performer. Korean household expenditures climbed more than 9% and investments in manufacturing rose twice as fast. Growth rates in Malaysia, and the Philippines will be lower this year. In Indonesia a major bank scandal, the consequences of the recent East Timor bloodbath, and a fundamental change in government leadership, make it more difficult to predict a sustained recovery.

Overall, though, by any measure and in nearly every economy recovery remains fragile. This is in part because China is the big unknown, hampered as it is by deflation and slumping investment flows. Overall foreign direct investment into Asia last year fell by 11% to $85 billion, -- largely from decreasing investment in Indonesia, Hong Kong, Singapore and Taiwan -- This was the first cumulative drop since the mid-1980s. But it was far smaller than the large declines in other forms of capital raising, such as bank lending and portfolio investment.

To the extent that one can generalize about Asia, the areas seems to have entered the stabilization phase of what will be a long process of recovery and reform. Asia is past the stage of acute crisis--except perhaps in Indonesia-- but well short of full economic reform. In effect the patient is out of the emergency room but still in the critical ward.

Asia, for example, is years away from having a healthy and reliable financial system. Financial restructuring and the accompanying increased transparency will be on the region's agenda for several years to come, a point make just this week by the outgoing heads of the IMF and the Asia section of the World Bank. Certainly there has been some good progress. Overall in the area banking supervision is stronger, bad loans are better identified and closer to international standard, and there are more prudent limits on foreign-exchange exposure. But all this is still far from saying that there is in place an independent, market-responsive financial architecture.

South Korea is generally considered to be leading reform while Indonesia is at the bottom with reforms tarnished by the Bank Bali scandal. The number of private commercial banks there have been has been nearly halved to 82 from 160. Their share of all liabilities in the system has dropped to 17% from 50% just before the crisis, while that of public banks has risen to 73% from 42%. In Thailand foreign-bank branches doubled their share of bank assets from 6% in 1996 to 12% today.

But while some changes are being made, reform is still slow. Corporate restructuring is lagging even further behind financial-sector changes. This is delaying the recovery of the banks since banks to prosper need strong borrowers. Furthermore even in a recovering economy, gains from new lending will still be offset by losses from the bad loans still on the books. Additionally, there remains great inexperience with managing systemic bankruptcies and massive costs still have to be paid to restructure banks - anywhere from 15% to 45% of their gross domestic product by recent IMF's estimates. By comparison, the U.S. savings-and-loan crisis of the 1980s cost America less than 1% of GDP.

Reform and the trend toward freer financial markets also face the potential for backlash. Malaysia declared controls on its currency, and has since declared them a success. Even Hong Kong in last year's regulation of equity markets has pushed for ways to curb the influence of global capital. This countervailing trend derives from politicians who have a strong incentive to close the doors on global capital and blame their woes on the greed of overseas banks and speculators, rather than look at their own countries shortcomings and address bankruptcies, layoffs, and the potential for social unrest. In sum, recovery is taking place, but fundamental reform lags far behind, making long terms prospects difficult to predict.

What then are the implications for environmental engagement? These can be set forward in a set of premises:

--The larger environmental trends underpinning Asia remain unchanged. The gap between an increasingly complex society and the capacity to manage environmental policy is growing. Years ago the World Bank pointed out that economic growth in Asia brought seven times greater environmental degradation than did a comparable rate of growth in OECD countries. Sadly, there is no evidence that this dismal trend has ended.

--Urbanization continues unabated.--a $1.5 trillion gap between infrastructure in place and infrastructure actually needed is not being narrowed and in fact continues to grow.

--Asia is going to be a dirty place for a long time to come no matter what it does. 12 of the 15 cities with the highest level of airborne particulate matter are still in Asia. 5 of the 7 dirtiest cities are still in Asia (Calcutta, Beijing, Jakarta, New Delhi and Sheyang.) Beijing is one of world's most polluted capital with air 35 times dirtier than London's and 16 times more contaminated than in Tokyo. Despite strong efforts to take corrective action, its been estimated that air pollution will triple in Seoul and Bangkok between 91-2001 and double in Taipei, Jakarta and KL.

--The rate of investment, environmental or otherwise, will depend on greater transparency and faster financial and social reform cited above. It falls to USAID programs such as USAID bilateral efforts and US-AEP to perform something of the role of a catalyst in moving those changes forward. Any program to be effective will demand great cultural sensitivity and tact and diplomatic skills. It is also imperative in my view that the various USAID programs addressing these issues, regional, global and bilateral, partner more closely together. Strong progress has already been made in this area.

--A country's policy apparatus is not monolithic. In the battle of reformers and recidivists, USAID should stand ready to help the reformers. This is good politically, good environmentally and good for our own commercial self-interests.